Zverev: Stock selection is the biggest driver of return on equities

For Standard Life Investments (SLI), the asset management unit of the Standard Life Group, stock selection has proven to be the biggest driver of its return on equities. Their investment strategy is anchored on a bottom-up and style-agnostic approach that shies away from sector or macro views.

This model has worked for SLI’s global equity fund that’s available in Hong Kong, delivering solid performances for the three-year, five-year and 10-year period versus its Morningstar peer group.

“As a pure stock selection house, we’re not style-driven, we’re not sector-driven, and we’re not macro-driven. In our view, a high quality source of alpha [from stock selection] complements an asset allocation portfolio which creates a turbocharger of returns over and above what a portfolio allocator might be doing in terms of regional or sector allocations,” says Mikhail Zverev, head of global equities for SLI.

He runs a desk of global equities core strategies with about US$10 billion in assets under management (AUM). Their fund available in Hong Kong has US$320 million AUM.

This bottom-up and style-agnostic approach has also worked well when it comes to risk management, thus resulting in highly diversified portfolios with risks that are totally uncorrelated. This diversification and lack of correlation mean that SLI’s portfolio remains largely unaffected by macro and sectoral risks and performs well throughout the economic cycle.

About 70%-80% of their portfolio risk is stock specific while the rest can be attributed to various factors, according to Zverev.

The diversity of SLI’s current portfolio is shown by the inclusion of stocks of convenience retail companies such as Alimentation Couche-Tard and Seven & I as well as bio-tech research companies like Roche, Amgen and UCB.

On September 3, Canada-based Alimentation Couche-Tard, one of the largest convenience store operators in the world, reported a 5.7% increase in net profit in the first quarter of its financial year, while Japan-based Seven & I has been expanding its retail franchise in Europe.

Roche, Amgen and UCB have gained prominence in improving bio-tech research and drug pipeline value as they benefit from the scientific breakthroughs they achieved in the late 1990s and early 2000s.

“When we think risk management, we’ve built very bottom-up portfolios of stock-specific ideas. If you build the portfolio from the bottom, what we discover is we have fundamentally uncorrelated risks. Of course, we still have sectoral or regional weightings and we end up with risk factors as a residual of those process. We have a number of risk control systems but we try to minimize those,” Zverev explains.

This is not to say that SLI has no macro or sectoral views at all when it comes to managing its global equities portfolio. The firm has a strong macro team responsible for its popular GARS (global absolute return strategies) product and Zverev’s team works closely with them.

“We work very closely with the GARS team to understand their view of the world. But for us, we think that being stock specific is the biggest driver in portfolio management so we are not led into investment by macroeconomic views but we can skirt out of an investment because of macroeconomic risks. So we take these bigger picture views as a way to self-check and risk-control with what we’re doing in the bottom up,” he comments.

Citing a specific example when SLI considered a potentially compelling stock-specific investment but where the macro risks inhibited them from investing, he points out Yes Bank, a private sector bank in India.

“It’s really well run with a growing focus on SME lending. But there was a period in the beginning of last year when there was a lot of focus on the twin deficits in emerging markets and India as well as Indonesia fell into this risk category. In their case, there was real risk, and we picked it up from our macro and emerging market debt colleagues. At that time, there was a real risk that international liquidity available to these markets will dry up,” Zverev recalls.

He explained that for a bank dependent to a degree on wholesale funding, that would be a potentially dangerous situation seen in other markets before. “We decided that although it was a great stock-specific opportunity, we’d rather not take the market risk, so we walked away. In hindsight, that proved to be a mistake because that problem came and went and Yes Bank performed well.”

Another example was a Greek bank where SLI considered investing in 2010 before the economic crisis in that country. “In 2012, before the crisis in Greece, we said that’s a great bank with really good opportunities. So it was a very compelling stock-specific story but the Greek risk will outweigh that. We were not the first to notice the Greek risk. We decided we don’t want to take the Greek macro risks and we took our losses and walked away. We have a very disciplined process of being able to walk away from a stock-specific risk if we feel the macro risk outweighs the stock-specific opportunity,” Zverev notes.

On marketing, he admits that it may not be easy to market their global equity strategies to investors because these do not fall into a specific category as a result of its bottom-up focus and its style-agnostic investment approach. On the other hand, their good performance makes these strategies interesting for investors because it is a good measure of their risk-adjusted returns.

“Investors would want their portfolio manager not just to implement their views but to add value that fund investors may not have available to them. And we find this in pure stock selection. If you look at where we derive that from, we’re not just targeting funds for stock selection, we deliver from stock selection. About 80% plus of our stock returns have been from stock selection and that is a very complementary addition to what else investors may be doing in your portfolio,” Zverev remarks.

The SLI global core strategies portfolio is currently underweight US and Europe while overweight Japan not because SLI is negative or positive on these markets. “It’s because these are the markets where we find company-specific ideas. In the long run, we find that stock selection is the biggest driver of return on equities and has been for us. But we’ve also seen data that shows that has been the case for the market as a whole,” he says.