Zverev, who manages the firm’s global equities fund, begins with a thematic approach to investing. He looks for change “that has a material impact on a business but is not fully appreciated”.
Some examples of thematic change he cited are the consumer shift to healthier foods, cars turning into electric vehicles and offline retail shops disrupted by ecommerce.
To assess a potential investment, he has access to the firm’s global research team — about 60 people work on equities almost 50 on credit, he said. They examine an individual stock and make company visits to gain an information advantage.
Thus, the fund’s portfolio is not built to a benchmark. “We’re 90% active management.”
Macro events, sector or geography are largely irrelevant to taking a position in a stock, Zverev said. “Investors will always have a headline to worry about.”
He doesn’t keep track of where the fund is over or underweight in terms of sector or geography, “but I can tell you in detail about individual stocks in the portfolio”.
However, macro events could drive him out of a position. “Regions or sectors become risk controls. Themes as well. We look at them as common threads to investment cases and understand why they bring risk. We ask if we are too exposed to, for example, Chinese consumer companies or European airlines.”
Oil price risk is an example. He believes the oil industry is in structural decline, largely due to the proliferation of electronic cars.
“More electric cars are becoming more affordable in the mass market and conversations with battery manufacturers shows a very robust declining cost curve. So in three years, what multiple is going to apply that reflects that maybe oil is a structural declining commodity?”
About 40% of oil consumption is used in passenger transport, he said. Electric cars won’t replace all combustion engine vehicles, “but this logic limits the upside in oil equities”.
Yet his portfolio has a position in an oil company – Portugal’s Galp Energia. Zverev explained that company-specific details — its current and projected output in one of Brazil’s largest oil fields — make it attractive. “We own Galp because of what they’re doing, the output and recovery of the wells, not because of a bet on the price of oil.
“The only risk we want is a highly company-specific risk, which is a statistical term. We want an information advantage on a non-consensus view.”
Active vs passive
Next he turned to the timely and contentious topic of active vs passive funds. Obviously, Zverev remains a hardcore believer in stock picking. To back up his view, he cited two separate studies by Citigroup and Deutsche Bank that analysed the historical performance of hundreds of stocks. The aim was to determine if there was a key driver for past outperformance: timing, sector or regional allocation, investment style or stock selection.
“Both studies had different methodologies but arrived at the same conclusion: Stock selection explains 70-80% returns.”
But ongoing studies by S&P Dow Jones have shown that the majority of actively-managed funds in the US and Europe fail to beat their benchmarks over three-, five- and ten-year periods. In response, capital has been flowing out of mutual funds and into ETFs as investors choose to pay lower fees and get better performance.
In the US last year, for example, investors withdrew $207bn from mutual funds and invested $413.8bn into index-tracking funds, according to Morningstar.
“There is more scrutiny by investors on how well active managers are doing,” he admitted.
Free riders
Active managers, Zverev said, are useful to the market because they acquire information and make projections for businesses, and “serve as a collective pricing engine by setting the price of a security”.
He estimated that 30-40% of global equity market investment is in passive products, which he said were “free riders on someone else doing the work.
“There is an equilibrium between those who determine pricing and those who choose to free ride. Is 40% [of global capital in passive products] the right balance? I don’t know. The pendulum is swinging toward more money being run passively.”
The feedback mechanism that keeps an equilibrium between active and passive can be up to seven years long, he said.
“It is conceivable the next decade will be the golden era of active management in terms of returns because so much money had abandoned it for passive.”
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Standard Life Invesment’s Global Equity Fund vs its benchmark, the MSCI AC World
