Old Mutual’s multiple strategies for finding mispriced shares pay off
OLD MUTUAL GLOBAL EQUITY FUND
Raging Bull Award for the Best Foreign (South African-domiciled) Equity Fund – the top-performing fund on straight performance in the foreign equity general sub-category over three years to the end of December 2012
A fund that follows investment themes to capture the mispricing of shares around the world earned its investors the best returns among all the foreign equity general funds over the past three years.
The Old Mutual Global Equity Fund was the top-performing fund over three years to the end of December 2012, with a return of 14.78 percent a year in rands, according to ProfileData. The benchmark for the foreign equity general sub-category, the Morgan Stanley Capital World Index (MSCI), returned 9.57 percent a year over the same period.
The fund is managed from London by Ian Heslop, head of quantitative strategies for Old Mutual Asset Managers (Omam) in the United Kingdom.
Rather than adopting a single investment philosophy that will result in periods of out- and under-performance, Omam UK takes a multi-strategy approach that aims to identify shares that are mispriced.
The emphasis on shares that fit Omam’s five investment strategies is rotated, depending on market conditions, and the decision on which strategy to intensify at any point is driven by hard empirical information, Heslop says. In this way, the fund is able to produce more stable returns, he says.
Although making stock selection calls based on mispricing is powerful, it is difficult to make calls on how to allocate to countries, Heslop says. Therefore, the fund closely tracks the country allocation of its benchmark, the MSCI, relying on stock selection to add value.
For example, who would have predicted at the beginning of 2012 that the German stock market would out-perform during that year to the extent that it did, he says.
Share positions are taken relative to the shares included in the MSCI, but the fund will invest only up to half a percentage point overweight or underweight relative to the benchmark. Therefore if the fund identifies a share that is not included in the benchmark, it may invest only half a percent of the fund in that share, Heslop says.
The fund invests in a large number of shares – currently about 270. Heslop says investing in so many shares does not mean that Omam lacks conviction; the manager’s conviction lies in its investment strategies.
The first of the five strategies the fund uses to identify mispriced shares is based on selecting shares that are undervalued but where the company has a strong balance sheet.
However, there are times when cheap shares get even cheaper and, as a result, this valuation-based strategy under-performs, Heslop says. During these times, Omam UK relies on its other strategies: market dynamics, sustainable growth, analyst sentiment and company management.
The market dynamics strategy identifies shares that will benefit from strong medium- or short-term economic trends but whose prices do not reflect the expected benefits. In this strategy, industries supported by economic factors are identified.
The sustainable growth strategy identifies the shares of companies that have strong growth characteristics but are mispriced for various reasons, Heslop says.
The analyst sentiment strategy identifies the shares that analysts have identified as ones that are likely to do well but where that information has not yet reached the market and is therefore not yet reflected in the prices of the shares.
The company management strategy identifies the shares of companies with a good management team making quality decisions that impact positively on these companies’ balance sheets.
Heslop says analysts cannot always see what decisions managers are making, but if they can identify company managers who are making good decisions where these are visible, it is likely that managers are making good decisions in other areas of the business.
By using the five strategies, the fund enjoys diversification not only across different markets, but also in stock selection, Heslop says.
He says at all times at least some of the strategies deliver good returns. For example, last year the valuation strategy did not do so well, but the other four strategies delivered good returns.
Omam UK turns the volume up or down on its different strategies depending on the prevailing market conditions in the different countries in which the fund invests.
In a good month, 55 percent of the fund’s shares will out-perform and 45 will not, Heslop says. In a bad month, only 45 percent of the shares in the fund perform badly.
The fund’s wide diversification means its investors never feel the pain of the fund manager making wrong calls on large numbers of a few select shares, he says.
Two stock picks that have worked particularly well for the fund over the past three years are Priceline.com and Bank of America.
Priceline.com is a web-based company that helps consumers obtain discount rates for travel-related purchases, such as airline tickets and hotel stays.
Heslop says the fund favoured Priceline.com because it was identified as being well managed, having a good balance sheet and trading in a favourable market.
The share delivered a period of sustained price appreciation and the fund sold its holding in the stock in the middle of last year, when its price caught up with its valuation.
Omam’s analysis favours Bank of America stocks based on valuation, although it does not fare well when analysed for the quality of the share.
When investor sentiment, and hence risk appetite, have been strong, the fund has taken positions on this share, but when investors’ appetite for risk has waned, the fund has moved out of it, he says.