Lately there is a lot of talk on investment by factors, a process which has established itself amongst institutional investors, and which is also gradually descending to the retail public. Some management companies, such as Investec, have been applying this method for years, since 1999, to build their portfolios. Mark Breedon, Portfolio Manager and Co-Head of 4factor Equities at Investec, explains to Funds Society how the 4factor team works and what the key factors are for this investment method, under which Investec manages $34 billion.
What arethe broad outlines ofthe 4factor process?
The 4factor process observes four factors in all securities that pass through its filter: 1) Quality 2) Value 3) Earning revisions and 4) Momentum. The process is applied to the universe of securities that have a market capitalization of more than 1 billion dollars and which have an average daily trading volume of over $ 10 million (3500). The system sorts the securities according to these four factors and tells you which ones rate best (600); from there, the fundamental analysis of each company by analysts at Investec come into play; they will propose ideas to invest in each of the geographical strategies handled by this method: Global Equity, Dynamic Global Equity, Global Strategic Equity, European Equity, Asia-Pacific Equity, and Asia Equity.
What market environments work best for the 4factor process?
If you're a stock picker, things are easier if the market is cheap, that's where the best opportunities are found. However, erratic markets such as 2009 and part of 2010 and 2011, when the market moved constantly from risk-on to risk-off, are more complicated. In 2012, the selection of good companies carried out in previous months reaped its rewards, and this strategy worked very well. With volatility and correlations at normal levels, disciplined processes such as this tend to function correctly. On the other hand, it is remarkable that such processes of long-term investment perform well in all market environments, because they focus on the company’s fundamentals without placing so much emphasis on political and macroeconomic factors.
What are your 4factor filters saying geographically?
In terms of quality-returns in relation to the cost of capital, there are more US companies listed with high scores, these also show positive earning revisions, as well as good momentum. However, the factor relating to value is poor. We see good signs in emerging markets both in valuation and in momentum and improved corporate earnings; perhaps Asian companies are better positioned than the average emerging markets. Europe does not fare as well. The momentum was excellent in 2012 and 2013, quality and valuation were not bad, but these never came along with positive earning revisions. Now, in addition, the momentum has worsened and it’s bad. Japan represents an opportunity: value is good, earning revisions are improving but, for now, the quality of companies is very bad. The reforms being carried out by Prime Minister Abe may help in making companies gradually improve shareholder returns. Some are applying very positive restructuring measures.
And, by sectors?
In Technology, the result of the filters is positive, but you cannot generalize. Large companies such as Microsoft, IBM, and Hewlett Packard are big cash generators. The cycle of low value-added semiconductor companies is lengthening as there has been no investment in capacity increases, so they also look attractive. Financial institutions, especially insurance companies, are benefitting from the long cycle of low rates. However, it is early days for companies in the commodity and energy sector, the value factor is terrible because the price of commodities is very low.
What are the differential characteristics of the Global Strategic Equity strategy, which you manage?
Investors tend to underestimate change; in a way, we're stuck in the past. We usually set a reference point, and pivot around it. But change is powerful, and in this strategy we seek companies which fare well under the 4factor filter, and which are also undergoing a process of change that can come from a process of restructuring, liberalization of a sector, consolidation moves, spin-off of one of its divisions, etc. An example is Hewlett Packard, a company in which we have invested for a year and half because, besides receiving a good score according to our 4factor filters, it was undergoing a restructuring process that has recently led to the announcement of the spin-off of its business into two and an additional 5,000 job cuts. Another example is Cash America, a pawnshop and payday loan management company which operates mainly in the US, Mexico and the UK, and that is in the process of splitting the two businesses surfacing hidden value.
Finally does your 4factor process shed any ideas for Latin America?
In the emerging markets strategy we are invested in securities listed in Brazil, Chile, and Mexico. An example is Itaú, the bank of Brazilian origin. The valuation factor gives satisfactory results for Brazil, but it’s not positive in Mexico’s case. However, earning revisions in the Mexican market are good.