- Hi, I'm Kevin Barr Head of SEI's Investment Management Unit. I've asked Eugene Barbaneagra Portfolio Manager of our factor-based portfolios, to join me today. We're filming from remote locations, to do our part for social distancing. Thank you for joining me today, Eugene. I'd like to start off by asking you how the current marketing conditions are impacting our portfolios.
- [Eugene] Thank you Kevin. As you know, we run our factor portfolios along the time tested alpha source models. Things like value, momentum, stability. So since market peak in February 19th, most of our factor portfolios both in the U.S. and globally have outperformed broad market benchmarks. I'll bid with a number of mutually offset in return drivers. For notably, a stability particularly for its high profitability, high margin components, delivered the strongest outperformance. The drivers were exposures to large cap software names, as well as, some of the low volatility factors. Although the low volatility factors overall, failed to deliver meaningful protection and I will cover that later on in our discussion. On the other side, on the less positive side, value was lagging substantially, as investors’ doubt everything exposed to the traditional brick and mortar economy. And momentum, generally came out in the middle, slightly above the benchmark globally and slightly below the benchmark in the U.S. The reason for that, some of the previously established trends have continued or all the others have shattered. One of the beneficial trends of course was the exposure to the same big tech, large, big tech, particularly in the U.S. And finally and most importantly over this period, it was liquidity. It was an extremely important driver, weighing on returns of all active strategies, be it fundamental or activate.
- [Kevin] So where are we seeing opportunities coming from this crisis?
- [Eugene] Sure. So I think indeed that it is indeed, the case for value has suffered for the last 10 years. Just to remind you and remind everyone, our approach is based on the time tested alpha sources, value, momentum and stability. We invest value, not because value has performed last five or 10 years, well or poorly, but because value rewards investors for the last 20, 30, 50, 100 years in all countries, in all markets. Value is a well understood and well rewarded alpha source. Now, we also like it tactically, so relative our strategic position of an overweight value with even more so doing that today. The reason for that is the forward, first we see foliation dispersion or the difference between the most expensive and the cheapest names is being the highest we've ever observed. So that's currently exceeded financial crisis of 2008, it's exceeded that tech bubble of 2000. In all of those examples, following the returns to value over the following 12 to 36 months have been extremely attractive. So we like value because it is attractive from, the underlying valuation perspective. But also like it from the top down perspective. We observe the market has reacted strongly to the developments of the pandemic and effectively creating myopic forecast and horizon. Investors are busy forecasting the next week, the next quarter, the next year. Valuing equities is about discounting future cash flows over the next 20, 30, 50 years and that has been thrown out completely out of the investor's attention. What we see going forward as normality returns, as investors start thinking about the earnings and not their case, growth around the world, we will see those attractive earnings being priced in. Now finally, one more point to make, is that we've just seen unprecedented fiscal and monetary stimulus around the world, and it's probably not over. We've seen it of course in the U.S. but also would like to remind investors that Germany has announced the fiscal stimulus which exceeds the U.S. stimulus, once you adjust for the size of Germany economy and exceeds by the way, by two or three times. In other words, what I'm trying to say is that, the stimulus is coordinated from all over the world. Now, it is not going to create inflation in the months ahead, that's certain, but over the next several years, that is likely to have additional inflationary pressures. And naturally value stocks are better suited of riding those inflation and precious relative to the darlings of a large cap growth stocks. One more point to make is about the signs. We also had an extreme dislocation, between small cap, large cap stocks. When investors dump everything for cash, they naturally create a much bigger price impact, on small caps. That price impact was 15, 20, 25% bigger or small relative to large. That is temporary. When there are full of rebalance and starts taking place, when investors start looking into the existing holdings and perhaps they can profits from the holding which held up much better and taking the opportunities and those stocks which have been oversold, we see these normalization return. Naturally of course in the recent past, the larger you are, the better you performed. And that's naturally benefited capitalization weighted benchmarks, like S&P 500 like Russell 1000. Again when the, fundamental analysis returns when forward looking opportunity research returns, we expect investors to be more picky and those mispricings will be arbitraged from the current available opportunities set.
- [Kevin] Great. So from the perspective of a U recovery versus a V recovery, one, does it really matter and then two how are our portfolios positioned for the eventual rebound?
- [Eugene] It does matter. It matters to an extent of the speed of the recovery. So we have a view recovery. First of all, we of course will have a much faster repricing of everything. We will see much stronger small cap bounds, small mid cap bounds and perhaps, exceed in 2009 of velocity, but also will have a very strong value rebound, of course. If we have a, U recovery, so in other words, if the economy continues stagnating over the certain period of time with some feedback loops, then their repricing will take time. So we will still see outperformance of the cheapest securities but perhaps not come in as soon as in a view recovery and perhaps not to the same magnitude. Now what's important either V or U ends at the same point.
- [Kevin] Active management has struggled over the last 10 years, we've talked with clients about the reasons. Do you think that we're moving into an environment where stock selection and active management can be successful? And can you give me some examples of, why you think this is the case?
- [Eugene] You know, I don't want to give a cliché answer of, yes, of course. And what kind of active manager will say otherwise, but instead of just, as you mentioned, give you examples rather than, answer yes or no, let me give you three, of what I believe are objective points. So first of all, active management generally leads to underweight to the very top of the market. A portfolio of the largest names, something that passive investments allocate relatively greater weight. It's a well-documented, long-term laggard. If you can, sell the largest name in every benchmark around the world in the long run, it's one of the best performed performance portfolios. But of course, in the last five years, this relationship has dislocated. And particularly over the last couple of months. And this is of course overdue for a snapback. The other point is that active management in general is about value and future earnings. And then paying a lower than the market price for that. In other words, it doesn't have to be value. You don't have to be a low multiple investor but you still are or most active managers are fundamental space. It's about forecasting something which is good about the company, some sort of an earnings metric, cashflow metric and understanding how much you're willing to pay for it. Today as I mentioned, a lot of investors are being, too short term. They are armchair epidemiologists and they discount the next month rather than the next 10, 20 or 30 years, which is of course short term or leads us an opportunity, to a long term investor, to pick some of the attractive investments. Finally, active management is selective. When is it better time to be selective if it's not when the market indiscriminately liquidates holdings into cash. We see it prevalently in mid and small cap part of the market. Many names with a little debt and risk were sold off to the same degree as much more challenged companies. They were sold off just because they we're in the wrong neighborhood. And when no one pays attention to their holdings, paying attention can be a strong advantage. This is what most active managers are doing diligently, today. So yes, it's a great time to be active and it's a great time to be selective.
- [Kevin] Great. Thank you, Eugene.
- [Eugene] Thank you, Kevin.
Glossary of Terms:
- Alpha source: Our strategies are designed to capitalize on long-term drivers of market performance through exposure to persistent sources of returns such as mean reversion, trend-following and stability. We have refined our approach to identifying these alpha sources and the factor groups we employ as proxies to measure and capture their performance.
- Momentum Alpha Source: The investment manager seeks to benefit from investor under-reaction—due to anchoring. Such groups of stocks trend in price as perceptions change directionally and serially with incoming data, leading to herding behavior by investors.
- Stability Alpha Source: The investment manager seeks to benefit from investor tendency to undervalue lower-risk, higher-stability businesses—resulting from a focus on short time horizons and overconfidence in forecasts for momentum-driven stocks. Stability-oriented stocks have the power to exceed market expectations by consistently outperforming (rather than reverting to average market returns) and through the power of stable, long-term compounding.
- Value Alpha Source: The investment manager seeks to benefit from investor overreaction—resulting from aversion to loss. Such groups of stocks revert to the mean, as fear over the perception of the investment’s risk dissipates.
- Basis point: One basis point is equal to 1/100th of 1%.
- Beta: Beta is a measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole.
- Correction: A correction is a decline of 10% or greater in the price of a security, asset, or a financial market.
- Correlation: Correlation is a statistic that measures the degree to which two securities move in relation to each other.
- FAANG Stocks: FAANG stocks are Facebook, Amazon, Apple, Netflix and Alphabet (formerly Google).
- Price-to-Earnings Ratio: The price-to-earnings ratio is the most recent price of a security divided by the company’s annual fiscal year basis earnings per share. Price to book ratio is the most recent price of a security divided by the company’s annual fiscal year basis book value per share.
- U-Shaped recovery: A U-shaped recovery refers to a decline and recovery scenario in which a given metric (such as stock market performance or employment data) declines and then gradually recovers over time.
- V-Shaped recovery: A V-shaped recovery refers to a decline and recovery scenario in which a given metric (such as stock market performance or employment data) declines rapidly and then recovers quickly.
- Standard Deviation: Standard deviation is applied to the annual rate of return of an investment to measure the investment's volatility. Standard deviation is also known as historical volatility and is used by investors as a gauge for the amount of expected volatility.
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