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A significant feature of Old Mutual Global Equity Fund’s* award-winning quants team in London is that it does not forecast macro and nor does it seek to add value relative to its index from country and sector positions.
Ninety percent of its alpha comes from stock selection within sectors, and 10% from sector selection.
This has worked splendidly for it in the past and continues to do so.
The fund is currently top of the log in the South African global equity sector and has held that position for the past five years.
Leon Kok spoke to award-winning Old Mutual head of global equities, Ian Heslop:
What’s your cutting edge?
The key to success for us is two-fold. First, don’t try to forecast if you don’t have to.
This is for the simple reason that even if you forecast a variable correctly, you still run the risk of not getting the market right.
The second point is don’t build style-concentrated portfolios given how rotational individual styles are.
The past few years have been ones of huge style rotation and, as we always say, the diversified nature of our investment process has been a major benefit to the performance we have achieved.
It has also been very important to have a dynamic way to adjust fund style exposures to ensure the portfolio remains correctly set even as the market changes underneath it.
How close is the S&P 500 Index to fair valuation?
I’m pleased to say I don’t have to make that call as I look to find cheap stocks even within an expensive market.
Portfolio construction doesn’t try to tilt significantly away from regional exposures held in the index, where country valuation would perhaps play more of a part.
However, on many metrics the US equity market is certainly not cheap. It is definitely the case where there are areas of the market that are perhaps beyond fair value due in no small part to ETF flow.
Will the global economic growth momentum be maintained in the foreseeable future?
The current economic climate globally has been supportive for global equities. We see economic growth continuing in the US, leading to robust earnings growth.
Unemployment remains low and there is little sign of inflation pressure.
Europe is also beginning to move in the right direction after a difficult economic period.
The beginning of the end of emergency economic policy will need to be carefully navigated, but the general economic outlook remains benign.
Risks for the current global picture?
Global equities are perhaps at an inflection point as we look forward.
The US Federal Reserve is signalling the likely beginning of the removal of the emergency liquidity that central banks have pumped into markets since the crisis.
We have also seen a fall in share buybacks in the US, another support for the market over the last few years.
The problem is what are we to make of all these data points?
We are in an environment where I would argue it is even more difficult to forecast. Take volatility as an example.
This is normally used by investors to understand levels of market uncertainty; it is not doing that at the moment, just look at how volatile style returns have been to get a real understanding of uncertainty in markets.
So overall we have growth in earnings supporting markets, but with tailwinds being removed in a period where valuations are high in many areas.
With the recent 30th anniversary of the 1987 stock market crash, any chance of that being repeated in the foreseeable future?
There is always a chance that these events could be repeated. Current valuations of equities could be classed as “not cheap” and there is a reasonably rosy view of global economic growth.
As central banks move to normalise economic policy, there is a risk that sentiment changes rapidly and equity prices unwind just as quickly. This is not likely, but we can’t assert it will not happen.
How do you select stocks for your portfolio?
The process used by our global equity team can be thought of as “Diversified Alpha”, with many different styles embedded in the portfolio and the ability to tilt the portfolio away from those types of stocks unlikely to perform due to the current market environment.
Thus our style exposures tend to be temporary and there to capture those stocks likely to perform given the current market environment.
The key to managing through these types of environments is to diversify your alpha sources and avoid double counting.
We work hard to ensure that the components we use to pick stocks are truly different from one another to try and reduce the cyclicality of the returns achieved.
How do you track changing market environments?
As you know we don’t explicitly forecast macro variables. You could say we are far more interested in the impact of those variables, alongside everything else going on in the world, on the investors in equities.
If investors are optimistic, for whatever reason, they will tend to buy certain types of stocks and avoid others.
Similarly, if the market becomes unstable, with volatility high, this will have an impact on the types of stocks bought.
Rising markets have a similar impact, as do changes in dispersion patterns in markets.
The key to using this information is constantly taking the temperature of the market, measuring variables that describe the market and then using those to decide when we have seen the current environment before and what the outcome was for our stock selection tools.
Do you see upside opportunity in any broad cluster of companies that you believe have been excessively punished?
The majority of our outperformance comes from picking the best stocks within an industry or sector, so we don’t tend to think in this way.
Industry and sector positions within the fund are an amalgamation of investor sentiment towards that area of the market.
That being said, only a small amount of our alpha comes from sector positioning.
*Disclaimer: Old Mutual Investment Group (Pty) Ltd is a licensed FSP. The above fund* is a registered collective investment scheme administered by Old Mutual Unit Trust Managers (RF) (Pty) Ltd. The relevant fund’s Minimum Disclosure Document is available on www.omut.co.za.
This article is part of the December 2017 FundFocus survey, which appeared in the 30 November edition of finweek. Buy and download the magazine here.
