SLI’s global equities team hunts for positive changes not yet understood by the broader market.
The operating principle is that the market is slow to recognise when a company is going through internal or external change, creating buying opportunities, explained Zverev, who has a background in physics.
As an example of internal change, he cited US microprocessor developer Cavium. The company’s ARM-based technology uses less energy than Intel’s, but performance is close. Clients include Alibaba, Microsoft and Tencent, which run big server farms.
Cavium also makes microprocessors for networking equipment, which needs to get smarter due to more security challenges requiring more data analytics. “We see the company as a challenger to Intel’s dominance in network and server microprocessors.”
An example of external change is video game publisher Activision Blizzard, which is behind the extremely popular game franchises Call of Duty and World of Warcraft. Zverev sees “real change coming as computer games move from physical goods such as a CD-ROM to digital, allowing the buyer to download the game”.
Additionally, last year the company bought King Digital, maker of the Candy Crush game for mobile phones. “Activision Blizzard intends to bring their existing portfoilo of characters to a smartphone platform.”
Guidelines for change
The global equities team, he explained, is not driven by macro events, but is “macro-aware,” meaning they will walk away from an investment if macroeconomic risk threatens to overwhelm their stock-specific view.
The team uses five questions as guidelines in developing an investment argument. The questions, such as defining the specific change and how it will play out, force the 60 equity analysts “to formalise a description of a roadmap for change into clear quantifiable statements.”
The result is a concise two-page summary. The analysts who cover individual stocks make recommendations and the portfolio managers make the final decisions. But most of the analysts are also portfolio managers, Zverev said. “The dual role makes analysts think as investors. The danger of pure sector analysts is that they become very narrow and relative to the sector.”
Once a stock is selected, the change thesis for a company is reviewed every three months.
“Broadly, it takes the market two-three years to see what we have found. We don’t wait for the change to play out completely. We just need to see investors pricing in that opportunity. That’s typically how we make money.”
Not always right
Despite the process, the team has made “painful mistakes” in the past, Zverev said. A recent one involved Italian banks.
The Italian banking system is undergoing a number of fundamental changes, he explained. The government put measures in place to make bad loan recovery more efficient and to encourage the consolidation of smaller unprofitable banks. His team saw powerful change, he said.
“In the second half of 2016, post-Brexit, investors looked at Europe and thought Brexit was the beginning of Europe’s problems. With further elections coming, people questioned whether the EU was wobbling and Italy was one of the most at-risk countries. So Italian banks sold off badly.
“At the industry level, changes played out as we thought. What exactly is [priced-in] is what we got wrong.”
He added that some lessons were learned after last year’s two huge and unexpected macro events – Brexit and the US presidential election – impacted markets.
Last year, the problem of “unintended biases” in a portfolio was made clear.
“In 2016 we realised the accumulation of residual exposures. This is when you are unintentionally over-exposed to sector, regional or style bets. Last year, any unit or percent of that risk you had cost you a lot more in terms of performance than previously. It was a big headache for us. The market reacted to these events a lot harsher than in the past.
“Therefore, we must run our risk profile much tighter than in the past. We haven’t changed the way we look for stocks but as we construct a portfolio we become aware of accumulating unintended biases.”
Three-year performance of SLI’s global equities fund, co-managed by Zverev, over three years.
Source: FE. Fund NAV and index are shown in USD for comparison purposes.
Zverev vs his peer group. Total return performance to last month end.