Crude assumptions

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Alec Harper, client portfolio manager at AXA Rosenberg, the systematic equity expertise of AXA IM

There are two common misconceptions we face when speaking with investors about AXA Rosenberg’s investment process. The first misconception is that in calculating the fair value of a company we have a pre-determined ‘value’ that we attach to the individual business lines and components of financial statements.

The second misconception is that because we do not meet the management of companies we lack insight into future earnings, which could limit the model’s ability to adapt to changing market environments.

In this context then, we must surely think the oil sector is very cheap right now given the recent slump in the price of oil? In fact, nothing could be further from the truth.

The first step in our valuation of any stock is to determine in which business lines it operates and, crucially, what the market is currently willing to pay for a unit of assets deployed in each business line. This basic valuation underpins our view of each company’s fair value, (subsequently adjusted for the form the assets take and uniqueness).

However, because we use current prices our view of a company’s value is dynamic and reacts quickly to market events. Exhibit, below, plots the daily appraisal factor (how much on average the market is willing to pay for a unit of assets in each business line) calculated by our valuation model against the price of Brent Crude, from 3 October to 3 December 20124.

Our appraisal of oil assets fell in lock step with the oil price and, in contrast, the valuation of airlines, an industry that uses oil heavily, rose. Having this current understanding of asset value in relation to the market environment is the cornerstone of our stock selection model.

However, fundamental value is just one side of the coin: it’s as important to have a view on future earnings. Whilst we don’t meet company management, we believe we can pretty accurately capture expected changes to earnings by using a modified view of consensus IBES data.

We saw a similar revision in our models which, in conjunction with a revaluation of oil assets, caused portfolios to be repositioned. In the AXA Rosenberg US Equity Alpha Fund, for example, the energy sector was held overweight 1.9% relative to the benchmark at the end of September, falling to 0.6% underweight by the end of November, with reductions in holdings of names such as Murphy Oil and Apache.

We retain some exposure to the sector, with a current preference for those stocks with higher-quality assets, low debt and less cost-intensive extraction techniques, which may be better placed to withstand a persistently lower oil price.

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