The growing popularity of passively-managed funds stems, in part, from research showing that it’s rare for active fund managers to consistently outperform their benchmarks over the long term.
The reason behind it, explains Ian Heslop, head of global equities at OMGI, is that many fund managers run funds with a high concentration on one of the traditional styles: growth or value. They do it either deliberately or by having a style implicitly embedded in their stock selection process.
Investment styles and factors (such as quality or momentum), however, are cyclical. The commitment to one style irrespective of market conditions results in periods of underperformance.
In order to avoid this cyclicality, “we blend different styles together to get a diversified-style fund,” said Heslop.
Avoiding macro
Heslop also avoids making geopolitical and macroeconomic forecasts.
“Macro is a very difficult thing to get right,” he said. Not only one is trying to predict a macro event, but also its effect on the market.
The geopolitical events of 2016 and markets’ unexpected reaction to them is a good example. “You can get your macro forecast correct, but you can get the market wrong,” said Heslop.
Instead, Heslop’s team of three portfolio managers and four analysts tries to understand what is happening in the market and how it affects the behaviour of investors. Based on this understanding, their portfolios tilt toward one style or another, depending on the likelihood of outperformance.
Similarly, the team’s analysts don’t try to predict fortunes of individual companies. “It isn’t whether we get Apple right or wrong,” said Heslop, “it is whether we get the styles we think are going to outperform correct in the portfolio”.
Quant system
In the centre of the process lies a data-heavy quantitative system evaluating daily more than 5000 stocks in OMGI’s equity universe. It combines fundamental data with the view of the markets by making use of company balance sheet data, profitability, views of analysts, and stock pricing.
The process is largely automated, resulting in daily trading. The management team minimises the cost of trading by transacting in big baskets of stocks, with small volumes of individual names, and paying only execution fees on all trades, he said.
The OMGI Global Equity Income Fund holds, on average, 400-450 positions. The regional funds, the North American Equity Fund and the Asia Pacific Fund hold around 200 names each and the OMGI Global Equity Absolute Return Fund, between 600 and 700, according to Heslop.
The stocks are held for 3-6 months on average, but ranging from a few weeks to a year, depending on the investment thesis that triggered their purchase.
With automated decisions, the firm’s portfolios risk being “whipsawed” in reaction to sudden investor sentiment changes. The model mitigates this risk by implementing radical sentiment-driven changes over 4-6 weeks, he said.
The main role of the team’s analysts is to constantly work on refining the quantitative model, to incorporate new academic research and the evolving understanding of how the markets work.
The team also reviews investment decisions made by the model, to incorporate factors that are not taken into account. “With every stock added to the portfolio for the first time, we look to understand why our views are changing,” said Heslop.
Exclusion filters
The management may exclude a company from consideration if its business is too complex or opaque to understand, if other risks, for example regulatory, play a role, or if independent investment decisions result in risk concentration.
In October 2016, before the presidential election in the US, the team reduced its exposure to sectors in which it expected volatility irrespective of the result of the election, such as healthcare, energy and financials. “It was an event that we weren’t prepared to forecast,” said Heslop. Reducing the exposure was a way to reduce risk of the portfolios.
Unlike many fund managers, Heslop sees no value in meeting with company management teams in the universe of mid and large-caps, globally. After Regulation Fair Disclosure implemented by the US Securities and Exchange Commission in 2000 mandated a high level of openness about company financials, his team found that there is no value in meeting managers in person.
“We can better understand management decision-making based on the data,” said Heslop. The company management signal in the portfolio model is based on the extensive financial data and the quality of decisions made by the management in the past, he explained.
