Investing with a cool head amid the ‘noise’
THE success of the Old Mutual Managed Alpha Equity Fund is based on a focus on profiting from the varying themes that are driving the market at any given point in time, coupled with anomalies in the market caused by investor emotion and mood.
This is achieved using a proprietary investment process.
Asset managers are typically faced with vast amounts of information and data to absorb before making a decision to invest in a particular listed entity.
For example, Thomson Reuters releases, on average, more than two million business- or economics-related articles a year.
Faced with such a deluge of information, the risk is subconsciously ignoring information that may very well be important and relevant to their decision-making.
Old Mutual Investment Group has therefore developed a methodology which uses a strategy to collate information and then assess and prioritise news flows, economic conditions, currency sensitivities, shortand long-term interest rates, financial statements and other market-related measures.
The methodology utilises the exposure of the underlying companies in its investment universe, quantifies the rewards or penalties of the themes driving the market, and then constructs a portfolio that will produce good returns across all market environments.
Using this methodology allows portfolio managers to assess whether news flows are influencing the performance of the market. If so, they are able to determine whether these news releases offer a positive or negative bias to each company.
“The mood of the market often has a direct impact on prices,” explains Grant Watson, portfolio manager of the Old Mutual Managed Alpha Equity Fund.
“Our process identifies the themes — and the various market moods —– driving the market at any given time. No one theme ever constantly drives the market. Once you have successfully identified the current themes driving the market you have to consider how your portfolio of shares behaves relative to those themes on a share-by-share basis, and then adjust the portfolio holdings accordingly.”
Volatility is one of the themes that at times drives the market, he says. “Our ability to efficiently form deep insights and identify the current dominant themes based on news flow data allows our fund to exploit the inherent behavioural biases of investors.”
Market volatility over the short term is inevitable and is driven by a number of factors including current information about the listed entity as well as market-moving events. Investor reactions to these events tend to reflect collective psychological or behavioural biases.
In the past 18 months there have been a number of key market-moving events which have impacted share prices, including Nenegate, Brexit and the election of Donald Trump as US president.
These market-moving events have all provided opportunities for the Managed Alpha Equity Fund, says Watson.
“During Nenegate, for instance, we observed a significant slump in general market sentiment within the banking sector. Simultaneous to this drop in sentiment, the banking sector suffered a significant setback in the days that followed. Our strategy is dynamic, which enabled us to gain from the change in market sentiment.”
With the surprising result of the Brexit referendum, he adds, sentiment around gold stocks soared as investors looked towards metals as a potential safe haven, and a gold stock rally ensued.
“When we analysed the market sentiment after the unexpected Trump victory, we saw much of the same story: the mood of the market around precious metals, especially gold, was comfortably in the largely positive sentiment category.”
According to Watson, market volatility as an investment style sometimes pays off and is rewarded — but this is not guaranteed.
“We understand that you cannot build a portfolio based on just one theme. Our strategy takes cognisance of all prevailing themes and our positions in the portfolio are adjusted accordingly,” he reveals.
That’s not to say that Watson and his team don’t take advantage of market volatility when it pays off.
“As a fund which is looking to achieve a higher return than the FTSE JSE shareholder weighted index, which is the fund’s benchmark, there are times we want to be able to take advantage of market volatility,” explains Watson.
“It’s a dynamic process and we constantly adjust the portfolio to various themes as they pay off. For example, value versus growth, resources versus financials and large-market-capitalisation shares versus small-marketcapitalisation shares, depending on what is driving the market at that particular time.”
At the same time, however, in order to maximise long-term capital growth, the team are highly cognisant of risk. “A risk focus leads to the preservation of capital,” explains Warren McLeod, co-portfolio manager of the Old Mutual Managed Alpha Equity Fund.
“Our portfolio does not have a significant concentration in a small number of shares. In fact, we’ve aimed for breadth across a number of sectors so that it is not a small pocket of shares that will determine performance.”
McLeod says key to a successful investment strategy is to consider whether volatility is a driver and whether individual shares will be influenced by this volatility.
“If an individual share is likely to be influenced by volatility then it’s critical to be correctly exposed,” he says.
One of the biggest advantages of the fund’s investment strategy, says Watson, is that it is based on a multitude of themes including fundamental factors such as debt to earnings, earnings growth and profitability, among others.
“We consider all the influences before making investment decisions, including macro drivers such as currency and interest rate sensitivities. Only once we are in a position to consider how the share stacks up relative to all themes do we make an investment decision.”
The portfolio is then tilted appropriately to achieve the best return, given that no single share will exhibit all the positives. Watson explains: “It’s an approach to investing which is quantitative in nature. Essentially it’s about looking at the market and determining what is driving it, and then tilting the portfolio in order to derive the greatest returns given that the fund aims to achieve a better growth of capital and a higher return compared to other general equity funds to achieve long-term inflation-beating growth. This approach allows us to identify and separate both winning and losing stocks.”
At its very core, says Watson, what he and his team of fellow portfolio managers, Saliegh Salaam and McLeod, are doing is real portfolio construction.
“Many fund managers only pay lip service to portfolio construction. They tend to consider profitability and whether or not a stock is under- or overvalued. This is all well and good, but this information needs to be taken further and layered with additional information. When you combine this data with market sentiment and machine-readable news, for example, you have much greater insight into how the market will behave.”
This process of using objective measures to explain and predict market movements has served Old Mutual Managed Alpha Equity Fund investors well as the fund has remained in the top quartile in the general equity asset class for the past three, five, seven and 10 years. “The fund has weathered all the recent global crises as well as local political instability and the latest credit downgrades earlier this year, largely as a result of our objective rather than subjective approach,” points out Watson.
“It’s a quantitative approach that is not skewed by short-term behavioural biases and eliminates rash and impulsive decisions. It’s a strategy that is cognisant of the environment we find ourselves in.”
Emotional reactions to market-moving events tend not to pay off, points out Watson, adding that fund man- agers who reacted emotionally to the firing of former finance minister Pravin Gordhan, for instance, have underperformed the market.
“Our approach has taught us to expect a violent reaction to marketmoving events in the short term. However, over the longer term this reaction is more muted as it is primarily a short-term noise based on emotive reaction and behavioural bias,” says Watson.
The fund’s team are steering clear of this short-term behavioural noise and have built a robust, risk-managed portfolio. “The fund’s focus on portfolio construction, of which risk management is a component, gives it an ability to ride out all storms, crises and uncertainty with the result that it really is a fund for all seasons,” concludes Watson.
Our process identifies the themes — and the market moods — driving the market There are times we want to be able to take advantage of market volatility It is not skewed by short-term behavioural biases and eliminates rash decisions