Germany Forum delegates hear of benefits of fundamental analysis
Delegates at InvestmentEurope’s recent Frankfurt Fund Selector Forum heard a unified message from fund managers – whether the top-down view is positive or negative, it is the analysis that matters.
Ignis Asset Management head of credit research David Meade said his team’s work on the newly launched Absolute Return Credit fund was intensive and fundamentally-based.
In conducting bottom-up analysis of credit, Meade and his team avoid EM “as we need to be able to ensure we understand the credits we are investing in”.
A key plank of Meade’s activity for Ignis’s Absolute Return Credit fund is pairs trades, using liquid CDS, to engage with 10 to 30 pairs at any one time. His team’s five sector-based analysts put forward a detailed case for pairs candidates, including performance drivers/catalysts, suitable hedge instrument, price targets and time-horizons, the downside case and stop-loss, and expected pay-off from the pair. Each leg of a pair typically inhabits the same broad sector.
Ideas that have been accepted are then sized based on analysis of their historic volatility, and an exit strategy is formed. The overall volatility target is 6% or less.
A hedge ratio for the pair is tailored to eliminate market beta, and calculated from CDS spreads of the pair – including the cost of the hedge. The historic volatility of the pair is calculated based on the ratio. A maximum position is sized to one month’s standard deviation of the historic volatility of the pair. Meade said using pairs can help ‘immunise’ a strategy from broad market moves.
The strategy launched in July also employs two stop-loss levels for trades. At a 25bp loss the position will be reviewed, and at 50bps it will be cut completely, though Meade notes this has not yet happened.
He added: “There is no yield curve or duration exposure in the strategy, so you get away from the beta risk, which you do not want in these kinds of markets.”
Ignis requires at least two quotes for each CDS, and has relationships with up to 10 CDS dealers.
Analysis of a paper portfolio’s performance from August 2011 to July 2012, then of the Absolute Return Credit fund to 28 September, showed returns had nil or negative correlation to MSCI World Index, the Citigroup European Government Bond Index, iBoxx Non Gilt, iBoxx Non Sovereign and the JPM Emerging Market Bond Index.
Marc Bataillon, head of European equities at Lombard Odier Investment Managers, acknowledged headlines around Europe have made for dispiriting reading, but added: “Europe’s sheer size makes it an attractive region for investing in.”
The eurozone population of 332 million exceeds that of the US (331 million), while its $15trn GDP rivals the US.
Investing domestically, Europe offers world-class companies, such as Nestlé, SAP and LVMH, “but if you want emerging market exposure, Europe is a great way to invest in emerging market growth with Western-style management and shareholder friendliness”, he said.
Bataillon added it was equally important to know what does not justify investment. Here he highlighted businesses whose development is unpredictable – such as banks – or whose balance sheets are “difficult to penetrate”, such as insurers.
The long-only LOF Europe High Conviction portfolio of 30 to 40 equally weighted positions is constructed around three distinct categories, “so as to aggregate positions that will not correlate strongly”. The groupings are of high-quality companies such as Nestle; corporate event candidates such as Puma; and high-growth companies such as LVMH.
Bataillon follows a strict discipline of avoiding certain sectors, including making “any investment revolving around the price of an underlying commodity”. This excludes oil, oil services and miners from his universe.
Although the basis of his team’s analysis is fundamental, Bataillon acknowledged the importance of top-down macro analysis, too.
He therefore monitors Europe’s general economic backdrop, government and/or central bank intervention in the economy, and any obstacles to supply and demand at a sector level. At a company level, he avoids companies “in the midst of a transformational turnaround in operations [or] in financial distress and/or massively leveraged equity plays [and] value traps when identifiable and/or very illiquid securities”.
His team also avoids “momentum trades crowded with fast money investors” and where there is the risk, or reality, of “significant government intervention in corporate governance, units sold or pricing”.
Clients in the high conviction fund have made 48.2% from its December 1997 launch to October 2012, about 10% above MSCI Europe.