Investing in the US Part 5

Elisa Trovato: Do you favour value or growth at the moment for US equity funds?

Lars Kalbreier: For US equity funds, the analysis that we do for the investment committee just tells us that, right now, there is more value in value than in growth. It is something which is very tactical in nature and can change quickly. It is very much valuation-based.

Claudia Panseri: We use sector allocation rather than style. However, in terms of value and growth, we are right now more into banks and building materials in the US, so I would probably say value relative to growth.

Grant Bughman: One of the things to point to regarding value and growth is the difference in the benchmarks. Financials is a much larger percentage of the value benchmark – it is over 25 per cent; it is 4 per cent of the growth benchmarks. Technology is a much larger percentage of the growth benchmark than it is of the value benchmark. You have to think about questions regarding whether value is cheap or whether growth is cheap in the context of what types of companies you are paying for.

We are growth managers, so we obviously have a growth bias. Our clients have hired us to be a growth manager, but they have done so with the expectation that we can beat the S&P 500, and we have been able to demonstrate that over time because of the flexibility that we have to buy growth companies that some may think are expensive, as well as very cheap companies that we think are still good businesses.

Lars Kalbreier: Perhaps just one way around this kind of dilemma between value and growth – and we do not like these religious boxes – is a management style called Growth at a Reasonable Price. That is a bit of a hybrid.

Elisa Trovato: US equity managers are often criticised for being very oriented towards stock-picking and for not sufficiently integrating macroeconomic factors in their investment philosophy, which leads to problems in generating consistent alpha. Do you agree?

Bill McQuaker: There is some truth in it. I think there is, to an unusual degree, a focus on stock-picking per se among US managers. They talk about building the portfolio from the bottom up more than you would find in the UK or Europe. There are, nevertheless, some managers who do build in some kind of macro influence, even if they are bottom-up in nature. An example would be people who are alert to broad changes in the macro environment and use that to drive the extent to which they are demanding of underlying company characteristics.

In the summer of 2011, the environment was looking decidedly questionable. A valid response to that would be, ‘We are going to look at all the stocks in our portfolio and satisfy ourselves that, even if this deterioration in the macroeconomic climate continues, they will be robust in the face of it’. That is still a stock-picker’s view of the world, but what they have done in terms of managing the portfolio has been informed by the macro climate.

Grant Bughman: Yes, that is absolutely right. Most people look at the valuations and say, ‘This looks cheap.  I am continuing to buy, even in the face of the changing world’.  We have a saying in the office in New York that ‘We are all macroeconomists now’, while none of us are actually macroeconomists.

We are stock-pickers but we do so in a way that is mindful of the risks in the world as a whole.  Last summer, we looked across the pond and said, ‘Banks in Europe cannot fund themselves. If they cannot fund themselves, what is the chance that the earnings of the companies that we own decline significantly?’ and so we stripped out cyclical business models that saw declines in earnings of more than 20 per cent in 2008-09. 

Lars Kalbreier: Grant’s point that all portfolio managers have become macro managers is really interesting. And that is true. I guess as a stock picker, in the past, probably until 2007, the job was quite different than it is now, where you need to take much more macroeconomic decisions into consideration when picking stocks. You probably start considering that skill set as well when picking managers

Mouhammed Choukeir: If you are thinking about the macro considerations, the tool that you really need to have to navigate a crisis is cash. Go into cash when the macro outlook is not so great and the macro factors are quite bleak. A lot of equity managers limit their cash budget, as it were, for two reasons: one is the tracking-error issues that we discussed. Second, the reason why asset allocators allocate to an equity manager is not to make that asset-allocation call. They say, ‘You have to be fully invested most of the time, so you go and pick the best stocks’. Even if the stockmarket is going down, you have to stay invested, so that limits the ability to navigate using macro factors.

Lars Kalbreier: If you have a strategic asset allocation that tells you to have 10 per cent in European equities, you want this 10 per cent to be fully invested. You do not want to have a European equity manager running 20 per cent cash within that allocation.

Bill McQuaker: Personally I am just less hung-up on the notion that only I or only people who I work with should influence the overall allocation of the fund. I will subcontract some of the responsibility in that space, if I believe that the person I am subcontracting it to has skill.

In some ways, it is a win-win: if they have skill and I have skill, and their skill comes in at different times, you get the same return and lower volatility.

Elisa Trovato: When selecting managers and funds, are there any specific criteria that have gained importance, especially for the US market, over the past couple of years? 

Lars Kalbreier: In terms of managers who are multi-asset class, we see a distinction between the typical private banking managers and the institutional ones. That is something that has crystallised over the last three or four years. We see that the managers that are successful in private banking are those who recognise that, if you take the normal distribution of returns, the left hand might be more important for private clients than for institutional clients. They tend to manage more the left hand of the tail. That is quite interesting and perhaps also goes into behavioural finance. From a private client perspective, for one unit of risk taken, the potential unit of return on the left hand side is probably marginally more important than the same unit of return, which he would be getting on the right hand side. For me that is a new trend. In the institutional world there is less of this behavioural finance element in it. 

Also, Grant’s point that all portfolio managers have become macro managers is really interesting. That is true. I guess as a stock picker, in the past, probably until 2007, the job was quite different than it is now, where you need to take much more macroeconomic decisions into consideration when picking stocks. You probably start considering that skill set as well when picking managers. 

Mouhammed Choukeir: One of the things that is different today than it was pre‑2007/8 is 2008 performance.  You cannot sit in front of a manager and not ask how they did in 2008.  It is very difficult to allocate to a manager who had a tough time. It is not impossible because some of them had a tough 2008 but a really good 2009 and actually over the cycle have done quite well. However, I think managers who had a tough time during the credit crisis are essentially going to struggle to raise assets.  The focus on draw‑down and those big losses is much more important today than it has ever been.

Stefano Spurio: For us it is important to ask what managers learned from the crisis, and whether the crisis impacted or even changed their investment process. If I cannot capture 2 per cent to the upside on the US market, clients will not be happy but they do not get too worked up about it. Whereas if we lost 20% when the markets lost 25, the client will not be happy to have relatively outperformed. That is not good enough anymore, you have to react before you lose the 20%. Funnily enough some asset managers did not integrate that over the last four years.  Some still have the same way of explaining their business and explaining their investment process and their relative performance. 

Bill McQuaker: This sensitivity to downside risk again makes perfect sense in the short run, but one wonders if it continues if it will blind people to the opportunity to gain on the upside, and that people will be too risk averse for too long. Look at 2012: the mood music of markets is that it is dreadful.  The reality of markets is that people have made good money by taking risks this year. That is kind of odd.