Three of the four Seven Investment Management (7IM) Equity Value funds marked their third anniversary last month. The funds share the same investment philosophy, but differ in their geographical sectors. Their manager, Alessandro Laurent, joined 7IM in 2013. We asked him how he runs these value-based active equity strategies.
Do you use a smart beta investment style?
I have been doing smart beta investing for 12 years. First it was called quant investing, then it became systematic strategies. Today, it is known as smart beta. These are all expressions to describe a way of getting exposure to the risk factors that explain the performance of equities.
The expression ‘smart beta’ is not well-defined. But it is generally used to describe funds that are a step away from purely passive market-cap-weighted index trackers. So, smart beta is often used to describe investing in straightforward factors such as value, growth, momentum and quality. What we are doing is creating a genuinely active portfolio, but one that is run in a systematic way.
What do you mean by systematic?
We select stocks on the basis of rules. These rules are defined by company fundamentals, meaning the data from balance sheets, income statements and cashflow statements. In that sense, we are no different from active portfolio managers.
Where we differ is we do not rely on meetings with company executives, or on analysts’ forecasts of company earnings. We rely uniquely on the hard, reported data. We try to select companies on the basis of particular characteristics.
What are these characteristics?
We try to select cashflow-generating companies with prospects for good earnings growth. Most importantly, they should trade at a discount to their intrinsic value, defined in terms of traditional metrics such as price-to-earnings, price-to-book and return on invested capital. Value is a key element of our strategy. We do not want to overpay for growth potential.
This sounds like traditional value investing. How do you differ from a normal value fund manager?
Traditional value fund managers, who base their stock selection on the traditional investment metrics, could be exposed indirectly to other risk factors. For example, high price-to-book companies are often small cap and have negative share price momentum. We have seen this with mining and oil companies in the past couple of years.
Using traditional metrics can lead value managers to invest heavily in certain sectors, such as financials or consumer discretionary. But they disregard defensive sectors, like consumer staples. This sector-specific exposure explains the poor performance of traditional value fund managers over the past 10 years.
We want to avoid overexposure to particular unwanted factors and sectors, and construct portfolios to reflect this. It means we sometimes have exposure to companies that look expensive from the perspective of traditional value metrics, but they still benefit the portfolio as a whole.
How does your risk-return profile compare with traditional value managers?
We might miss a short-term, sector-specific value rally. But, if it is long-lasting, our portfolios will benefit alongside those of traditional value managers. The flipside is we will not experience prolonged periods of underperformance when traditional value investing is not working, as has happened since the financial crisis.
This downside protection is not only due to avoiding specific unwanted factors. It is also due to our exposure to profitability and factors such as growth and quality.
How do your costs compare with low-cost passive strategies?
The ongoing charges figures of our funds, at between 35 basis points and 45 basis points, are typically a little more expensive than pure passive strategies. But they are significantly lower than those of traditional active funds.
What is your benchmark?
It depends on the fund. Our US fund is benchmarked against the MSCI USA Index. We use MSCI cap-weighted indices as our benchmarks. We generally hold 20% to 40% of the stocks in the index.
2013-present: Head of systematic strategies, Seven Investment Management
2007-2013: Director, systematic equity strategies, F&C
2007: Quantitative equity analyst, Carousel Capital.