Equity Markets are inefficient and good active managers can add value.

What we mean by inefficient is that information on companies in these markets is misinterpreted and that other investors, against which we compete for our returns, make mistakes which are both predictable and persistent.

Stock prices can move for a number of reasons. Cheap valuation is one of them but so are factors like shifting investor preferences for safe balance sheets and positive earnings announcements. We therefore use a long established and proprietary stock ranking model which quantifies many of these attributes. This is called a ‘PAR’ multi-factor model where P represents risk Premium or market discounted valuation, A for Action which quantifies newsflow around the stock and R or Resilience which quantifies the quality of the earnings and balance sheet and their ability to withstand adverse market developments.

The higher PAR scores are the attractive candidates for the portfolio and we then perform further fundamental analysis or due diligence to verify the opportunity.

This fundamental analysis focuses upon A or accounting treatment of earnings and balance sheets, S or strategic positioning of the assets and G or governance as it pertains to management’s allocation of capital including treatment of shareholders.

A commitment to research, and to incorporate discoveries in the investment process, is vital to maintain any competitive advantage.

It is our contention that an investment process, or team, which doesn’t change and/or adapt is likely to be superseded and lose any competitive advantage it held.

Most clients would like no change to an investment process but we believe that other investors are smart and motivated, and are also looking for the inefficiencies we are trying to spot. Once sufficient numbers of investors have ‘cottoned on’, then the inefficiency will have disappeared. Thus one has to ‘keep researching for an ‘edge’.

Therefore, we continue to look for new sources of market error and expect to add and subtract factor tools to our process once we are happy that they are persistent and have a connection to the real world.

Management of the return volatility is critical  “Winning by not losing”

Risk is the independent variable and return is the dependent. Thus any process that fails to acknowledge the importance of risk analysis and management is very likely to produce highly volatile and inefficient returns. Our approach to portfolio construction is to identify a benchmark or hurdle rate of return that the client and competition is using. Then we aim to outperform that benchmark through the use of the PAR model, fundamental analysis and portfolio construction techniques which calculate the exposure of the portfolio of stocks to common risk factors such as interest rates and oil prices and growth rates. Our portfolio of stocks is composed of stock positions that in aggregate provide an expected excess return with identified and tolerable levels of active risk compared to the benchmark.

We use a macro economic framework to assess systematic risks and opportunities but most of the portfolio risk comes from stock selection. 
We aim to be patient and expect lower levels of stock turnover – this benefits investors by reducing transaction costs.

No single stock position should jeopardise fund performance – a diversified portfolio means prudence.

Communication between team members is crucial in detecting investment opportunities and focusing on the correct management of the portfolio.

Portfolio management is not best done by consensus.

However we do like the portfolio managers’ thesis to be tested since they are unlikely to have a monopoly on good ideas, nor able to keep abreast of every relevant development for the portfolio.

We have found over many years that a team approach is the best way to avoid errors that an individual can make.

Investing in a disciplined and systematic way, with the use of quantitative models, helps us to identify both risks, and opportunities.

All investing is the result of decisions made by humans – it’s all judgement. However the use of quantitative models (designed by humans) can reduce the tendency to extrapolate the recent past and to ignore signals which run counter to our own beliefs.

Combining forward looking ‘fundamental’ research work with the historic based ‘quantitative’ modelling approach mitigates the errors that each discipline alone tends to make.

Our fundamental research ‘ASG’ further refines the list of candidates removing all companies that fail to meet our standards. What do we know that the numbers aren’t telling us? Is the company’s strategy valid? Is company’s governance structure consistent with interests of shareholders?

Accounting

• Appendix of Report & Accounts – accurate or misleading?
• Goodwill treatment?
• ‘Aggressive’ accounting?
• Changes in accounting policies?

Strategic

• Is PAR model being fooled?
• Long term decline and impairment of assets?
• How distressed are competitors?
• New entrants or departures?

Governance

• Separation of executive functions?
• Independent directors?
• Compliance with ESG regulations and reporting requirements?

Our quantitative research ‘PAR’ eliminates thousands of companies, our risk control model suggests the best. Our fundamental research ‘ASG’ further refines the list of candidates, removing all companies that fail to meet our standards.

• Country, Sector, and Stock Weights carefully managed
• Use of 3rd party risk model – Northfield – to verify exposures
• Most appropriate 50-110 companies selected for the portfolio
• Performance Attribution and Stock Reviews to ensure process adds value
• Low turnover
• Regular update of new listings and exiting companies