Urvesh Desai of Old Mutual Investment Group outlines the historically overlooked quantitative investment approach for South African investors, an investment approach that underpins the Old Mutual Global Managed Alpha Fund.
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SIMON BROWN: I’m chatting with Urvesh Desai, head of the Old Mutual Global Managed Alpha Fund. Urvesh, I appreciate the time today. It’s been quite some three years, the last couple of years. On the scale of uncertainty, does what we’ve seen across global markets over these last couple of years compare to the highest market uncertainty levels throughout history? How unprecedented has this market uncertainty actually been?
URVESH DESAI: Hi, Simon. It is interesting. We’ve had a period where Covid introduced us to unprecedented events in markets where you had a sudden global stop to the economy, and then a restart. That caused its own level of volatility in markets.
I think what we’re currently seeing is uncertainty, which is a weird word because in a sense there’s a level of perception that comes into that. So if I think about markets and investors and investor perceptions and their expectations for the future, there is certainly a very high level of uncertainty.
But if we look at markets and what is playing out in the data, if you look at equity markets, the Vix index as an indicator of volatility is actually very low. It’s at extremely low levels, lower than kind of pre-Covid.
But where the uncertainty is coming in is that you’ll know that there’s been a recession called by various parts of the market for the last years – and it’s been the best-expected recession that has never happened. So I think the large uncertainty is about what is going to happen with economic growth for the world, and for the US in particular.
With the rapid amount and size and quantity and speed of interest rate hikes that we’ve had in the US and in other parts of the world, how does that actually play through?
History would suggest that we should already be in a recession, and that certainty is coming from the fact that actually we’re not there yet. So I think that’s coming through with a large amount of uncertainty, and then I think a more recent kind of introduction or driver of uncertainty.
I saw an interesting stat yesterday that, if you look at the last 200 years, 2024 will be a year where the largest proportion of the world’s population will be undergoing a presidential election. So with that theme of elections – and especially for South African citizens the South African elections – and for investors everywhere around the world what’s going to happen with the US elections, these are key things, and the uncertainties related to these outcomes are significant. The potential impacts on investors and markets could be significant.
SIMON BROWN: I think there are around 40 countries that are going to be having elections and, to your point, some of the big ones – notably the US. So in short we can expect this uncertainty to continue into 2024 because the talk around a recession in developed markets, most notably the US, is still on the table.
You mentioned elections around the world. What are those sorts of major risks for investors to consider? Is it going to be the recession or are there other risks perhaps lurking in the background?
URVESH DESAI: I think at the heart of it the biggest risk has to be the US growth outcome, and whether the US goes into a recession as the largest economy in the world, as the largest market in global markets, as the consumer force.
The US consumer has been a dominant force in global markets and has driven the global economy for a significant period. It matters to the rest of the world what happens in the US.
So in terms of impact and size of impact, I would say the biggest risk is the US economy and whether the recession eventually materialises. What is the extent of it, how deep is it, and how prolonged is it? That would be the biggest risk.
There are a few geopolitical risks happening. And of the elections, I would say by far for South African investors the South African and US elections are still the biggest geopolitical risks. There are others. It’s in all the news and it’s hard to miss what’s going on around the world. But from a markets and investment perspective, the impact of those is likely to be much less felt than items like the US elections and what happens there – who is the winner and what policies they will implement. It’s the same case for South Africa. What are the policies that come through from the results of the elections?
SIMON BROWN: Yes. It’s that, the policy that that potentially comes.
Let’s change tack a little bit and sort of focus more on Old Mutual and the fund that you’ve got there – the Global Managed Alpha Fund, quantitative investing emerging as a fairly effective investment approach for investors. How has your quantitative approach provided an edge over the last couple of years with Covid-19, rampant inflation, disrupted global markets … I could carry on forever with a list of, as you say, unprecedented circumstances.
URVESH DESAI: Exactly. As you mentioned, Global Managed Alpha follows a purely systematic and quantitative approach. What that means is that there are a couple of different things that come into that. One is that we focus on data and what is happening in markets, and the characteristics of stocks, and we try and align the characteristics of companies with what is driving returns in the marketplace. That process is done very rigorously and systematically, using computer algorithms, etc, and we rank stocks from our most preferred to least preferred.
Then we will construct a portfolio, again using an algorithm to come up with a portfolio that is ideally suited not only to our ranking of stocks but also to the market circumstances at the moment.
Here’s the interesting aspect. It’s that when one picks a manager to manage our assets, managers have different styles or they’re accessing different aspects of markets to get this outperformance of the market. These styles or flavours of investing also have patterns in which – given the market environment, given the economic scenario – some of these styles do better and some of these styles do worse. If you look at different industry types and sectors, some sectors will do better in particular economic scenarios, and some sectors will do worse.
If we look at growth and prospects for a recession, typically what happens in these environments is that economically sensitive companies do less well because your economy is slowing down. Your more defensive types of companies do better.
Now, in a style sense, you will get quality types of styles and quality managers outperforming, and managers that may be more economically sensitive – like value managers or even your more cyclical growth managers might underperform. That comes also from an aspect of what sectors these managers are focused on, and where they are looking.
Your typical defensive sectors, which actually may not be as defensive as you would think anymore, would be consumer staples, utilities, etc. IT has come to be a relatively defensive sector, but your more cyclical ones, your sectors that are more exposed to economic sensitivity, could be financials, energy and consumer discretionary – what consumers are buying.
So from that aspect, when you choose a manager you’re already making an allocation decision. And even though you don’t know it, you might be making a decision about what you’re thinking regarding markets.
Now, the thing about investing – when humans invest I think we struggle to hold two belief systems in our head at the same time, so we tend to kind of focus on one thing, and that is our truth and we go ahead with that.
The beauty of following an algorithmic approach or a systematic computer-driven approach is that actually it can optimise across multiple dimensions at the same time.
So we look at all these aspects. We look at the quality of our companies that we’re investing in, how much debt they have on their balance sheets, the variability of their earnings. We look at how cheap or expensive they are, their price-to-book, their price-to-earnings ratio. We look at the earnings growth that they’re churning out. Is the market favouring these stocks? Do they have good momentum or bad momentum? Across various styles and metrics we then are looking at how to construct the optimal portfolio.
So we are not picking which one is going to outperform at a particular time. We have exposure across all of them. And then over and above that, the approach we particularly use in Global Managed Alpha is a very dynamic and flexible approach that is led by the market in a sense – what is happening in the market.
Now that particular approach was very useful during the last period, and the strategy performed.
We’ve been running it and it’ll come up for its six-year anniversary next month. Over five years it’s in the top five or six percentile of funds across the world.
How did it do that? It’s because we’ve been through Covid and in this last five-year period we’ve been through an environment where at times growth was working amazingly well and growth companies were doing well.
Then we had a period where value had a bit of a resurgence and then that tailed off and we had growth coming back again.
The beauty of our strategy is that we don’t predetermine the outcome and base it on a belief that says, okay, we believe value is going to be doing well and we will bias the portfolio to value. We let it emerge from a data perspective. That’s how the portfolio is structured and that’s how the portfolio biases move through time.
Through Covid what happened is you had a spike in volatility and everything crashed at once. During that period there was a contraction of risk in the portfolio. And, coming out of that, as we emerged there were different theories about inflation going to be incredibly high and that would mean value would outperform for a very long time.
We’ve seen some of those theories fall apart, but actually as we’ve followed the data-driven approach we’ve managed to navigate these markets relatively well. And that flexible approach, that dynamic responsive approach, has been quite an all-weather portfolio and has driven those results that you’re seeing, which are well ranked across global managers.
SIMON BROWN: You make a good point. You mentioned value. I had forgotten that at the beginning of last year globally it was all about value for a while. And then suddenly it was the Magnificent Seven. This approach makes you nimbler, because you kind of remove those cognitive biases we have as humans.
URVESH DESAI: Completely. Exactly right. And at the heart of why these approaches work is that as humans it’s impossible not to be influenced by our emotions and to make decisions based on how we’re feeling.
As part of a team that runs money both on a fundamental approach and a quantitative approach, I know, as part of fundamental investors trade diaries, what we do is we’ll record, when we do the trade, how we are feeling at that point in time. That’s because we’ve aware that as investors, if we’re humans making decisions, our emotions do impact those decisions.
So the beauty of this approach is it removes those kinds of biases. It is looking purely at the data approach in the sense that we will look at historical data and we’ll crosscheck this with academic research that’s coming out, to say we don’t just establish a belief that if you buy a company on a cheap price to book, it’s going to outperform.
We actually look at what academic research is saying. We test this. We look at what evidence is saying ourselves, and then it will be included in our process to drive our portfolio and our stock selection.
So that approach, that discipline, is actually very important and gets us away from areas where emotions can lead us to bias, where we believe in a story so much that we get captured by the growth momentum of particular companies and get captured by the story just at the time when they’re about to turn, or we get stuck in our beliefs that, no, this is a very cheap company and it will outperform eventually, and we just have to wait and hold on. If it falls more, we are going to have to buy more.
Those kinds of belief systems can be very risky for investors and can cause huge destruction in value. So getting away from those biases is very useful.
SIMON BROWN: I often think the biggest risk to my portfolio is me and my biases. This neatly sort of nips that in the bud.
But a last question. Taking this into account, how are you and your team positioned as we head into 2024?
URVESH DESAI: As I said, we’re in an environment where there is still significant uncertainty. Again, just to highlight that, our portfolio is selected purely on a bottom-up approach. We’re looking at the stock level, what’s attractive, and then we compose the portfolio from a very risk-cognisant perspective. So the biases in the portfolio from a country or sector perspective are emerging from that bottom-up perspective.
But how we’ve structured the portfolio currently is let’s start with the factor and style perspective. Our portfolio currently is biased towards quality, and that’s because we’re in an uncertain environment where economic growth is slowing. You want to be more in the quality, the more stable names, the more stable earnings outcomes.
But at the same time we are in a period where growth-type companies have outperformed for a very long time. And, including the Magnificent Seven, some of them are on very high valuations. So we also in our portfolio are building in a bias to value companies. And that barbell type of approach of being biased to value and to quality is how we are handling this period of uncertainty and the possibility of dual outcomes.
Our portfolio is both overweight, biased, to its companies in the US as well as China. China has underperformed for a significant period, and the problems that the country is going through are well publicised. But what that means is that there are good companies being sold down with bad companies, and there’s good value there.
In the US similarly, you’ve got the Fed coming in and desperately trying to slow the economy and slow inflation, and with that you’re getting the slowing impact. Because of that, we’re biased towards owning quality companies there that will maintain their profitability better through the headwinds that are increasing in the US.
So it’s that kind of barbell approach and a multi-factorial approach that we find will be useful going into markets like this.
SIMON BROWN: We’ll leave it there. Urvesh Desai, head of Old Mutual Global Managed Alpha Fund, part of the Old Mutual Investment Group, I appreciate the insights.
Brought to you by Old Mutual Investment Group.
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