Pixabay CC0 Public DomainPhoto: xxoktayxx. Turkey’s Crisis: Policy Response Disappointing So Far
Turkey is in the midst of an economic crisis. On August 10th their assets suffered greatly and their currency has fallen to historical lows after President Trump said last week he was doubling the amount of steel and aluminum tariffs on the country. On Wednesday, Tayyip Erdogan doubled import tariffs on some US imports (cars, alcohol, tobacco, cosmetics) and a Turkish court rejected an appeal for the release of a jailed American pastor at the center of the spat between Ankara and Washington.
The Turkish economy remains vulnerable as its current account deficit is the widest among emerging markets (The United States had a trade surplus with Turkey in 2017 of nearly 330 million dollars) and inflation levels are nearly three times the central bank’s target. Aneeka Gupta, analyst at WisdomTree mentions: “The perception from the investment community is that monetary policy in Turkey is not independent as President Erdogan is opposed to higher interest rates, so the central banks would need to defy the president and raise rates to defend the currency and avoid a default scenario.”
According to Delphine Arrighi, fund manager, Old Mutual Emerging Market Debt Fund, Old Mutual Global Investors, the worsening of political tensions between the US and Turkey has been the final blow to an already dire economic situation, with the collapse of the lira now rapidly fuelling concern of a full-blown currency and debt crisis given the amount of USD-denominated debt in the private sector. More over, the meetings between the banking regulator and the central bank over the weekend haven’t yielded the results the market was expecting. “Although the recent measures announced by the Central Bank of the Republic of Turkey (CBRT) will aim to ease onshore liquidity, they will fall short of restoring investors’ confidence. At this stage, the lack of credible policy response is pushing Turkish asset prices into a tailspin” Arrighi mentions adding that “given the reluctance of the CBRT to hike rates at its previous meeting and President Erdogan’s recent comments blaming an international conspiracy rather than acknowledging the real economic crisis resulting from an overheating economy faced with tighter global financial conditions, there is little hope for a return to orthodox policies at this stage”.
Arrighi suggests to include capital controls, “which seem more likely than an appeal to the IMF, but that would certainly not be the least painful and would most likely precipitate a recession while postponing the return of portfolio inflows. Hence a sizable rate hike followed by drastic measures of fiscal consolidation still appear as the most viable option to re-anchor the lira and pull the Turkish economy from the brink. This is very much like what Argentina had to deliver. We doubt the political will is there in Turkey and so more pain might be needed to force policy action. Some resolution of the political spat with the US could lead to some near-term relief in the currency, but this is unlikely to be sustainable if not accompanied by credible economic actions.”
Ranko Berich from Monex Europe mentions that “Normally when a currency falls 10% in a day, political and monetary authorities scramble to promise fiscal discipline and central bank independence. Instead of doing this, Erdogan has reached for the crazy stick and given the lira another whack in a rambling speech that focussed more on combative rhetoric than addressing market concerns… The lira’s issue now isn’t if the central bank is willing to raise rates high enough to combat the coming inflationary shock, but one of credibility. Erdogan’s son in law and economy chief, Berat Albayrak, also gave a speech in which he spoke in favour of central bank independence, so this may represent a sliver of hope for the lira. But the pressure is now on the TCMB to announce a drastic tightening of monetary policy in the order of a 5-10% increase in rates to demonstrate that it has the political mandate to fight inflation and stem the lira’s losses.”
Dave Lafferty, Chief Market strategist at Natixis Investment Managers, adds that: “This risk to EM contagion is sentiment, not fundamental. Turkey has limited trade and economic ties to other EMs. However, market reaction can throw the baby out with the bathwater as we see with other fragile EMs like Argentina and Hungary, who both saw steep currency losses in sympathy with the lira. Argentine CDS also spiked although Hungary CDS held reasonably steady.”
Wikimedia CommonsCourtesy photo. Natixis appoints Jean-Philippe Adam Senior Country Manager, Corporate & Investment Banking, Spain and Portugal
Jean-Philippe Adam has been appointed Senior Country Manager, Corporate & Investment Banking (CIB), Spain and Portugal at Natixis, since July 24, 2018. He retains his current duties as Head of Natixis’ CIB business in Latin America and coordinator for CIB business in Canada. He reports to Luc François, Head of EMEA, CIB and Head of Global Markets, and to Stephane About, Head of Americas, CIB.
Jean-Philippe Adam has over 30 years of banking experience in the Americas and Europe. He began his career at Société Générale in Buenos Aires before moving to Crédit Lyonnais in Buenos Aires and Paris, then to Crédit Agricole Securities in New York where he was Head of Debt Origination for Latin America. He joined Natixis in 2013 in New York as Head of the CIB Latin America platform and in 2017 was made responsible for the coordination of Natixis’ CIB operations in Canada.
Marc Vincent, Global Head of Corporate & Investment Banking, said: “Jean-Philippe has shown great success over the past five years, building our franchise in Latin America and implementing our client-focused and innovative approach in the regions he oversees. He will bring the same dynamism and ambition to our business in Spain and Portugal, ensuring that we provide our clients in the region with the full benefits of Natixis’ Corporate & Investment Banking expertise.”
CC-BY-SA-2.0, FlickrMasja Zandbergen, Head of Sustainability Investment and Integration of ESG criteria at Robeco / Courtesy Photo. According to Robeco, Sustainable Investment Gains Sense Within a Context of Erratic Returns
In 1999, Robeco launched the Robeco Sustainable Equity Fund, one of the first sustainable funds in the market. Since then, and almost 20 years later, the asset management company continues to insist that we are not facing a trend, but rather a new way of understanding investments and the environment. “The time has come to take advantage of the wave of popularity of sustainable investment to make a real change in the way we invest,” says Masja Zandbergen, Head of Sustainability Investment and Integration of ESG criteria at Robeco.
For Zandbergen, sustainable investment is a response to the reality surrounding us, which explains the success it’s having among investors. “There are certain megatrends which justify the weight gain of sustainable investment. Climate change, increasing inequality, and cyber security are three clear trends. To these we must add the great change suffered by consumer behavior, something that is also transferred to finance. Investors not only want profitability, but to be responsible with their current environment and with that of future generations”, she points out.
In this regard, Zandbergen argues that just as there has been a change in the investor, there has also been a change in the way in which this type of investment is approached: “Whereas previously investment was sought in certain activities and when a company did not act in a sustainable manner, investors tended to sell those assets, the current approach is to help companies to meet their challenges in terms of ESG criteria, something that investors also value more because they consider that it has a greater impact and greater capacity for change,” she says.
Evidence of how sustainable investment has changed is the evolution of the common investment strategies. “Exclusion continues to be the most common strategy, but the strategies that grow most among investors are those of integration of ESG criteria in impact analysis and investment, proof of which is the popularity of the thematic funds,” explains Zandbergen. In fact, these grew by 13.3% and 20.5% between 2014 and 2016, according to Robeco’s global data.
The management company argues for a comprehensive vision of sustainable investment because it provides valuable data to the non-financial analysis they carry out. “We looked at the ESG fundamentals and criteria and, in 35% of cases, we found that these had a significant impact on the financial analysis. In an erratic world of profitability, I believe that sustainable investments have earned their place,” she concludes.
Another trend observed by Zandbergen regarding sustainable investment is that there is increasing evidence that ESG criteria are an engine that drives the good behavior and profitability of an asset. In her opinion, “it’s clear that sustainability is a factor that influences the valuation of an asset simply because of the risks it avoids”. One further step would be, according to her criteria, that you could come to consider a factor when investing. “We are still far from something like that, but there is growing evidence of the fact that, in the long term, these criteria add value,” she insists.
The theory behind the value investing style is very straightforward. You buy stocks that are undervalued and then hold them until the market recognizes the inherent value and bids the share higher. Many of the most famous investors of all-time are known for their adherence to the value investing style. This group includes the likes of Benjamin Graham, John Templeton, Bill Miller, and of course, Warren Buffett. An extra twist to this method, as practiced by famed value investor Mario Gabelli, is to buy value stocks that have a catalyst. Gabelli and his team of analysts look for undervalued companies that have an upcoming potential event that will get the market to notice them.
Historically, value has outperformed growth, vindicating the chosen investment style of the aforementioned titans of finance. However, the last 11 years have been quite a different story as growth has far outpaced value.
What are the reasons for value’s long streak of underperformance?
Well, if we look back at the last decade, we can start with the Great Recession and the Federal Reserve’s actions during the recovery. First, the Fed lowered rates to near zero which effectively neutered one of the tenants of value investing: choose companies with a strong balance sheet. With companies able to raise debt at historically low rates, those that chose not to lever their balance sheets were penalized by investors. Companies that did lever up with cheap debt were able to invest in growth opportunities, both through organic expansion and acquisitions. The same thing can be said for investing in companies with a solid cash flow profile. Historically, value investors flocked to companies with a steady stream of cash flows, but again this attribute became diminished in the eyes of the market.
The second problem was the Fed’s quantitative easing (i.e. flooding the market with cash), which caused investors to be much less discerning with their money. During the last decade, a lot of money has been chasing a finite number of investments, causing investors to stop worrying over valuation. If you don’t believe me, take a look at the valuation of a high flyer like Tesla or Netflix.
So maybe the problem is we’ve had a really long interest rate cycle?
Possibly, and both of the aforementioned problems are winding down as the Fed is raising rates and is no longer growing its balance sheet. Let’s not forget to mention that since 1928, value has outperformed growth every time rates have risen.
Related to the extended interest rate cycle is that financials has been the worst performing sector over the last decade, and unfortunately for value investors it is the sector with the largest weighting in value indices. Look at the top holdings of any large cap value fund and you will see some combination of JP Morgan, Wells Fargo, Citibank, and Bank of America. The third largest sector in most value indices is energy, and until recently, it had performed poorly for years. Financials and energy combine for a stunning 43% of the Russell 1000 Value Index. Technology, on the other hand, only accounts for 9% of the value index, but it is a third of the growth index.
Has value investing relinquished its throne or do we perhaps need to re-evaluate how we define it?
In 1992, Nobel Laureate Eugene Fama, who is commonly known as the ‘father of modern finance,’ and fellow professor Kenneth French created the Three-Factor Model which predicts that value stocks outperform growth stocks.
One of the key ratios used by Fama and French to discriminate between value and growth stocks is the Price-to-Book ratio (P/B). In this ratio, ‘price’ is simply the market value of the company, while ‘book’ is the assets minus liabilities. A low P/B ratio has historically been treated as an indicator of an undervalued company, but is that still true? The methodology used to select the constituents of the Russell 1000 Value Index is heavily weighted towards low P/B ratios. This is why the index is stuffed with financial companies and why it also overweighs old economy industrial companies that own many physical assets. Conversely, technology companies mostly get ignored, as they typically do not have many assets. A great example of this problem is Apple. The maker of the iPhone appears to be a value stock based on profitability, cash flow and balance sheet, among other metrics, but because of its relatively high P/B, it falls into the growth index. Warren Buffett would seem to agree that Apple is a value stock since he recently made it the largest holding at Berkshire Hathaway.
Perhaps value hasn’t really underperformed as badly as we had thought. Maybe we need to evolve our understanding of value investing just as Warren Buffett has.
Nick Sheridan, courtesy photo. Nick Sheridan: “Politics has Taken Centre Stage in Europe Over the Past Few Months, With Italy the Most Recent Epicentre"
For Nick Sheridan, manager of the Janus Henderson Horizon Euroland, Europe remains a key and essential market in the global portfolios of investors. In his opinion, periods of uncertainty and volatility of the European market, mainly led by geopolitical issues such as Italy and Brexit, are always to be expected.
What is your forecast for European equities in the remaining months of the year?
While recent sentiment towards Europe has been undermined by political uncertainty, the trading environment for companies in the region remains positive and valuations, when compared to other developed markets, appear attractive. We believe that the European Central Bank (ECB) is limited in its scope to continue with quantitative easing into 2019, which could have a material impact on ‘safe haven’ bond yields and the factors driving equity markets. Nonetheless, world GDP growth remains at levels conducive to a good environment for corporate Europe.
We see that investors are increasingly taking on more risk and many of them have moved from fixed income to variable positions. How are you tackling this from a fund manager and portfolio perspective?
This has little impact on an equity manager, but we tend to agree that bonds offer little value at present.
Are politics still a risk for Europe? What is your assessment of how the European equities market has reacted to events such as Italy, Brexit negotiations and Catalonia?
Politics has taken centre stage in Europe over the past few months, with Italy the most recent epicentre. The unlikely alliance between the populist Five-Star Movement and Lega parties caused a bond market collapse, exacerbated by the potential for fresh elections (where the issue of euro membership would most likely be front and centre). While in the US, the Trump administration has started what could turn into a tit-for-tat tariff escalation on world trade.
Periods of market uncertainty, such as this, are always to be expected, although the specific factors that precipitate short-term falls may differ. Over the longer term, periods of short-term negativity are nothing to be feared for longer-term strategies, often providing an opportunity to invest in quality companies at an attractive entry price.
Regarding Brexit, do British equities represent an opportunity at the moment?
The UK market is busy de-rating relative to other markets and relative to where it has been in the past, because investors are running away from Brexit-related uncertainty. At some stage that will change, but I do not think it is going to change any time soon, because negotiations are ongoing, and the Eurozone seems to be playing its cards extremely well. The UK government’s handling of Brexit seems dysfunctional, which is adding to uncertainty – a particular problem when the clock is steadily ticking.
What are the most attractive markets in Europe? And their valuations?
Geographic exposure is driven primarily by bottom-up stock selection, although we do pay attention to more significant factors, if we believe they can impact on the broader investment rationale behind holding a stock.
In light of the current change in the economic cycle and landscape (rate hikes, return of volatility, increasing inflation), how are you modifying your portfolio to adapt to this new scenario?
Stock selection for my value-biased strategy is driven by analysis of individual companies and market data, rather than short-term market ‘noise’. We look for stocks that have strong franchises but are priced such that growth is undervalued, offering a higher than average return on equity, and normally an attractive dividend policy. Real value investing also requires a longer term horizon and we assess companies first and foremost on their underlying qualities, rather than the potential impact of short-term market trends or news.
What do you think makes your Janus Henderson Horizon Euroland Fund stand out against other funds in the sector?
We look for solid, dependable firms capable of creating value for investors, rather than following the latest market trends or fashions. Entry price is key and my investment strategy is designed to follow the value, wherever it is, judging companies first and foremost on their underlying qualities. What differentiates the fund from many of its competitors is our pragmatic approach to valuing stocks, which includes looking to gauge the value of potential growth within each stock. This is a major feature that differentiates the fund from conventional ‘deep value’ funds.
Photo: WCM Investment Management . Natixis Investment Managers to Acquire Stake in WCM Investment Management
Natixis Investment Managers (Natixis) signed an agreement to acquire a minority stake in WCM Investment Management (WCM) and become their exclusive third-party distributor, subject to limited exclusions. The agreement establishes a long-term partnership that will allow Natixis to distribute WCM’s investment strategies globally, which in turn enhances WCM’s ability to grow and create opportunity for its clients and employees while upholding its focus on its culture and investment process.
Under the terms of the agreement, Natixis Investment Managers will acquire a 24.9% stake in WCM and enter into a long-term exclusive distribution agreement, subject to limited exclusions. WCM will retain its independence and autonomy over the management of its business, its investment philosophy and process, and its culture, while benefitting from a strong global partner. Paul Black and Kurt Winrich will remain as co-CEOs, and there will be no changes to management or investment teams. The impact of the transaction on Natixis’ CET1 ratio is estimated to be approximately -15 basis points (bps).
“We are pleased to become the global third-party distributor for WCM, whose strong track record and proven investment process make them an excellent partner and strong addition to our global offering,” said Jean Raby, CEO of Natixis Investment Managers. “Our investment in WCM exemplifies our commitment to adding high-conviction, highly active investment managers to our multi-affiliate platform in order to provide our clients with a wide range of unique investment opportunities.”
“We’re really excited to enter into this partnership with Natixis,” said Paul Black, Co-CEO of WCM Investment Management. “After a lot of thought and collective input, we concluded the smartest way to enhance our stability, and to guard our investment temperament, was to partner with a world-class global distribution platform. For some time now we’ve known that diversifying the product mix within the firm – by raising the profile of our global strategy, our emerging markets strategy, and various other investment strategies – is the key to making this happen.”
“Our culture starts with kindling an entrepreneurial spirit, driven by empowerment and transparency,” said Kurt Winrich, Co-CEO of WCM Investment Management. “We try hard to pay attention, seize opportunity, be smart, stay humble, and stay hungry. While working hard and caring for your people is essential, we strongly believe it doesn’t explain everything, and that success also involves being given some opportunities. Today, we have another opportunity placed before us. This partnership will allow us to stay focused on what we do best; namely nurturing and growing a vibrant, robust culture, and generating superior performance for our clients.”
With $29 billion of assets under management (as of May 31, 2018), employee-owned WCM is best known for managing low-turnover, alpha-generating equity portfolios with a focused, global growth approach.
Heather Brilliant, CFA. CFA Institute Reaches Milestone As Women Elected to Board Leadership Positions
Heather Brilliant, CFA, has been elected the new chair and Diane C. Nordin, CFA, the vice chair of the Board of Governors of CFA Institute, the global association of investment management professionals. The election marks a significant milestone in the organization’s history with women elected to the top two leadership positions on the Board, the highest governing authority of CFA Institute. In total, five of the 15 Board positions (30%) for fiscal year 2019 will be filled by women – a goal CFA Institute set in 2016 and realized ahead of schedule in 2017. Brilliant will assume the chair on Sept. 1, 2018, succeeding Robert Jenkins, FSIP, who will continue on the Board, which is staffed by volunteers.
“Heather’s depth of experience in the investment management industry and her passion for the mission of CFA Institute are a powerful combination,” said Paul Smith, CFA, president and CEO of CFA Institute. “Building a better world for investors involves challenging industry norms and closing the gender gap, as well as raising standards in our profession. That sounds like a tall order but with Heather at the helm of our board, supported by Diane Nordin as vice chair and the rest of the Board, I am confident that we will continue to make meaningful progress.”
“I am honored to serve as chair of the Board and am proud of the organization’s dedication to building our industry on a foundation of ethics and integrity,” Brilliant said. “Investment management faces many headwinds: business models are changing; client demographics are shifting and products are increasingly commoditized. As chair, my goal is to ensure CFA Institute and our members are ready for the challenges they face and are equipped to take advantage of the opportunities they bring.”
Brilliant is managing director, Americas, of First State Investments where she is responsible for expanding First State’s market presence across the Americas. She was previously CEO of Morningstar Australasia, and was global director of equity and corporate credit research for seven years prior. Before joining Morningstar, Brilliant spent several years as an equity research analyst for boutique investment firms. Brilliant is co-author of “Why Moats Matter: The Morningstar Approach to Stock Investing” (John Wiley & Sons, 2014), a book on sustainable competitive advantage analysis. She has served on the CFA Institute Board of Governors for five years, and is a member of the CEO Search Committee, Compensation Committee, and Executive Committee. Brilliant holds a bachelor’s degree from Northwestern University and a master’s degree from the University of Chicago Booth School of Business.
Diane Nordin brings more than 35 years of experience in the investment industry to her position as vice chair. She is a director of Fannie Mae, where she serves as chair of the Compensation Committee and member of the Audit Committee. Recently, she was named to the Principal Financial Group Board, and is also on the Board of Antares, a spinout of GE Capital. Nordin is a former partner of Wellington Management Company LLP, where she held numerous global leadership positions, including director of fixed income, director of global relationship management, and director of fixed income product management. She has served on the CFA Institute Board for two years and is chair of the Audit and Risk Committee and CEO Search Committee. She holds a bachelor’s degree from Wheaton College.
Board of Governors Roster
The 2019 CFA Institute Board of Governors will comprise a diverse group of 15 members who reside in seven countries, namely: Australia, China, India, Malaysia, United Arab Emirates, United Kingdom, and the United States. The CFA Institute membership elects officers for a one-year term and governors for a three-year term that runs from Sept. 1 to Aug. 31. The full list of Board members for the new term is:
Heather Brilliant, CFA, (United States), First State Investments
Diane Nordin, CFA, (United States), Wellington Management Company (retired)
Quim Abril, Courtesy photo. "The Only Way To Truly Stand-Out Is By Real Active Management, Uncorrelated To Market Indices"
Independent asset management in Spain is currently booming and most of these newly-focused funds are either set up as UCITS or structured as hedge funds. At the recent ForoMed Cap in Madrid, an annual event that brings together European investors and small and medium cap companies that are prime investment candidates for these independent funds, we caught up with Quim Abril, Founder and Hedge fund manager of the Global Quality Edge Fund, a project that just celebrated its 1st year anniversary.
In this interview with Funds Society, Quim Abril, Founder and PM takes a look back at his 1st year experience since launching the fund, the advantages it offers investors and the goals he has outlined for himself in the year ahead; including his on-going search for “extraordinary companies overlooked by the markets” and “growing the fund size to 10 million euros to start to attract institutional investors”.
The fund has recently celebrated its 1st year anniversary: What is your assessment of these months gone by and how has your fund performed?
I think my assessment could not be more positive. In the last 12 months, I successfully managed to set up and launch the fund, I have spoken to and met up with the senior management of our portfolio companies while also continued to raise funds by travelling in and out of Spain; visiting and privately talking to would-be investors in other main European capitals. In terms of total return, the fund has grown by 6.6% since inception or 4.5% year-to-date – even though our strategy is aimed at mid-to-long term growth.
Why should an investor choose Global Quality Edge Fund?
Global Quality Edge fund offers some unique characteristics that are not common in other funds in Spain or in the rest of Europe, outside the UK market: Firstly, Portfolio Concentration (UCITS do not allow for this); secondly, it invests in small companies overlooked by the market but nonetheless qualify as extraordinary investment opportunities; thirdly, it’s less correlated to equity market indices and lastly, we hedge our portfolio of shares when the economy begins to show signs of recession through tail hedging strategies.
Setting yourself apart from competition is one of your top priorities, why would you say this is even more relevant in today’s context?
ETFs have grown exponentially and their lower commissions are putting the banking sector under a lot of pressure; especially when the larger players sell passive-like management products under the impression that they are actively managed. The only way to truly stand-out is by real active management, uncorrelated to market indices. This is what Global Quality Edge Fund has set out to propose.
Would you define yourself as a value investor?
I’m not sure if I am but what I would say is that quality companies with sustainable competitive advantages do not trade at a 7-8x price to earnings, let alone in today’s economic cycle. Global Quality Edge fund therefore differentiates itself by buying true quality companies, below 15x its earnings in today’s environment and perhaps 10x during an economic recession.
In what type of companies do you invest? Why are the mostly small and mid cap?
The fund largely invests in extraordinary companies with solid and long-standing competitive advantages that are leaders in their niche markets with low or null competition threats, low broker analyst coverage, proven sound capital management, high ROIC and a clear interest alignment between the company and its shareholders. In terms of size, we do mostly invest in micro&small and mid&cap stocks. The reasoning behind this can be broken down into 10 points:
Firstly, 80% of the investable equity universe across the world is made up by companies with a market cap below 2.5 billion euros. These businesses are easier to understand, analyze and monitor given the fact that they focus and operate in niche markets. Thirdly, they are more approachable and you have a greater chance of speaking to their top and most senior management (the CEO) than you would do in a larger cap company. They also offer higher earnings growth and longer term returns that don’t always have to be at the expense of higher volatility. Their lower or non-existent broker analyst coverage, their uncorrelated price performance against benchmark indices, their higher percentage of insider trading, their increased likelihood of being M&A targets and the positive effect they experienced from the recent U.S. tax reform are other reasons why we draw our attention to these companies.
You state you do not invest in all sectors, which of these do you leave out and what advantages does this decision bring to the fund?
Even though now some value investors have commodity-driven businesses in their portfolios, I can categorically state that Global Quality Edge Fund will not invest in them. The reason behind it is because these companies are cyclical businesses, where the company has no control or pricing power on their products and services, since the supply and demand of these commodities (oil, copper, gold…) largely influences and dictates the companies’ performance. The fund only invests in anti or low-cyclical companies, achieving a higher forecasting certainty when mapping out the evolution of future earnings and lower expected volatility. The main goal is to be capable of analyzing the results of a company across an entire economic cycle, not only during current periods of bonanza. Airlines and restaurants are other industries in which we do not foresee investing.
You have a concentrated portfolio of companies, would you say this is an advantage or an inconvenience in asset management?
Portfolio concentration is one of 2 reasons why we chose to operate as a hedge fund, ruling out the UCITS structure – a more commonly adopted approach in Spain. To explain our reasoning, I always say that ‘a fund manager may have 5, 10 or 15 good investment ideas but never 50 or 60 good ideas. For that matter, you might as well choose an ETF’. At the same time, a concentrated portfolio allows for a better understanding and knowledge of the companies in a fund, reducing the likelihood of mistakes, as well as volatility. The American gurus in the business all have funds with 5 or 10 shares only but in Europe this level of concentration is hardly seen. Global Quality Edge Fund will invest in up to 25 different shares and the top 10 and 20 holdings will represent more than 50% and 80% of the fund’s capital. There are a number of academic papers that highlight how adding one more stock to a fund with more than 20 different investments [that do not necessarily have any sectorial correlation between them] does not substantially reduce the fund’s volatility.
You also insist on avoiding red accounting flags when investing, what are these red flags?
After reading and analyzing 10-Ks (ie: annual reports), you can clearly identify potential risks and creative accounting practices that could diminish or conceal the true earnings potential or the cash flow position of a company. The difficulty lies in the fact that these filings are long and complex to understand and without a solid knowledge base in accounting, these could be overlooked. They, therefore, require a detailed and manual analysis to uncover them. To quote an example, one of the most common red flags is an impaired goodwill adjustment, when the company is forced by its auditor to recognize the loss on its income statement after the acquired asset or business failed to meet the company’s expectations. In order to see if there is an underlying risk or red flag of this sort, we would have to determine if there is a direct high relation between ‘Goodwill’ and the company’s market cap. If there is one, we would immediately refer ourselves to the company’s 10-K filing to read up on the Goodwill and estimate the value of the adjustment – for example – check to see how cash flow projections were calculated; how the business units are split and reported on; how the macro hypothesis are implicit in the cash flow forecasts; see if there are any changes in methodology and analyze the transaction price composition on their material recent transactions.
Some other accounting Red Flags could be: Delay the earnings report date, change from conservative accounting policies to a more aggressive ones, extend an asset’s depreciation period life or increase residual value, too much off-balance sheet assets and not computing off-balance sheet assets like operating lease as a real debt , aggressive revenue recognition policies, not taking in account restricted cash, capitalize cost to the balance sheet (interest cost, software development and inventory),not threat pension deficit as more debt, etc.
One of your differentiating factors is how you choose to hedge, could you explain how these work and the benefit?
The idea behind hedging through options is to protect the tail-risk of the market, a practice that is also known as Tail-hedging. Throughout history, most drops in equity indices above 20% have been recorded when the economy enters into recession. Our most recent evidence of this is the dot-com bubble in 2000 and the financial crisis in 2008. To avoid or diminish the drop, we buy out-of-the-money put options on market indices to protect our fund from market downturns greater than 20-25% whenever there is a significantly high chance of this occurring throw the reading of US Conference Board indicators (Leading, Coincident and Lagging indicators).
Reaching out to companies is key when deciding to add them to your portfolio, why would you say this is a necessary step and how many companies do you meet throughout the year?
The main reason behind getting in touch with companies is to get a deeper understanding of the business and a broader sense of their market. In order to achieve this, you have to speak to the CEO; especially when a small cap sized company has low analyst coverage and information about their business is limited. Once we make contact, we gather useful insights that are not widely known. We find that they tend to share more information about themselves than a larger and more guarded listed company would. The lower the market cap, the higher the chance we have to speak to the CEO. However, reaching out to them requires preparation beforehand. We would only do this after running our own thorough analysis on the company’s numbers ensuring we make the most out of the call, listing a specific set of questions and doubts we may have come across. In 2017, we spoke to 45 companies’ senior management teams and during the first half of 2018, we are slightly ahead, compared to last year, on a year to date period.
Would you be able to tell us about a company you have invested in your fund?
Victrex plc is a British specialty chemicals company and global leader in engineering thermoplastics. Their signature polymer solution, PEEK, is an essential value-added component and key material used in different manufacturing industries. Their competitive advantage could not be beaten with a 65% market share; well ahead of the second, third and even from the rest of the players (25%) that make us this fragmented market, allowing Victrex to continue growing organically and inorganically. In terms of entry barriers, these come in the form of research and development investment (6% of Victrex’s total revenue) and, above all, high switching costs. Victrex’s clients would find it hard to replace PEEK with a substitute of lesser quality that would not compromise the quality of their own products. Their client retention is therefore very high helped by the fact that they personalize each of their products for their clients. To this day, Victrex continues to produce new products and uncover even more critical use cases where this material can prove essential for other industries. This has led the company to increase their market share even further, particularly in those segments where margins are higher and price increases are not hard to deliver. We bought Victrex at an average price of £18.5 in June last year and we sold it in January 2018 at £27, after reaching our target price and finding other investment opportunities with a higher safety margin.
Where and how to you find new investment ideas?
There are different ways to generate new investment ideas, from the most common approach by building out a screen and narrowing down to a list of companies to more interesting options like participating in investment forums and idea exchanges with other fund managers, especially those in the U.S.
In today’s environment, how do you deal with volatility and how do you react to it?
Our exposure to volatility is low, given the fact that our fund is made up of mostly small companies that are not as liquid and have low analyst coverage. In terms of liquidity, whenever there is a correction in the market (a downturn less than 20%), fund managers tend to sell their most liquid stock because most of the time there are very few securities available in the market. On the broker analyst front, earnings releases have little or no effect on the small companies’ share price, compared to larger listed companies that are exposed to higher volatility when broker estimates fail or exceed broker consensus expectations. If we look at our fund, the last twelve month volatility is 7% and the downside risk is below 5; numbers that are ways below comparable funds in the global market.
There is always a ‘but’ and in this case, an economic recession hits smaller companies the hardest, making their share price drop even further than bigger listed companies. Global Quality Edge Fund therefore uses Tail Hedging strategies to protect and preserve the total return of the fund compared to others that do not and find themselves immersed in significant losses during recession periods of the economy.
What are you objectives for next year?
Firstly, find extraordinary companies overlooked by the markets and the general public and patiently wait until they come across an adverse situation that temporarily drops their share price, making the point of entry of our investment more attractive with a reasonable margin of safety. I will also continue holding private discussions with would-be Global Quality Edge Fund investors, highlighting the reasons why they should invest in our fund; not only under the current macro-environment but under our broader and longer term view full economic cycle. Thirdly, I want to grow the fund size to 10 million euros to start to attract institutional investors by the end of this year.
Pixabay CC0 Public DomainPhoto: Monsterkoi. Convertible Bonds Gain Popularity Given Volatility’s Return
During the first quarter of the year, convertible bonds were one of the most attractive assets, especially after seeing the first signs of the return of volatility to the market. In this second quarter of the year, this type of asset has continued to please investors.
As explained by Arnaud Brillois, Head of Convertibles at Lazard Asset Managementand and manager of its long-term convertibles, the main advantage of this asset is that it allows investing in attractive and volatile stocks, limiting risks.
“The greater the volatility of the underlying stock, the greater the value of the convertible bond. In addition, due to its main virtue, convexity, convertible bonds increase their exposure to equity with a rise in the underlying, and market exposure decreases with the fall of the underlying,” says Brillois.
Undoubtedly, the return of volatility and the investor’s certainty that it has come to stay, drives the popularity of this fixed income asset. According to RWC Partners, “the market has been assessing a level of volatility that is too low for the current level of stock valuations and the point in the economic cycle.”
Finally, Brillois points out as another positive characteristic of this asset that they have a short average life of 2.5 years and, consequently, “the impact of interest rate hikes is limited”.
More Issuances
Convertibles are among the very few asset classes that offer positive exposure at increasing levels of volatility. According to RWC Partners, this has also led to increased issuances within the convertible bond market.
“This increase in issuance is a trend now and is expected to continue as rates increase further. January 2018 saw spectacular increase of 120%, compared to the same period last year,” he says.
