With nearly eight years of experience managing equity portfolios for Unigestion’s institutional and high-net worth clients, this spring Bruno Taillardat got the opportunity to make an even bigger mark on the way his company manages money – he got to build a fund from scratch.
One of Taillardat’s clients, a U.K. pension manager, asked Unigestion for a new fund that would follow a factor-investing strategy. Based at Unigestion’s headquarters in Geneva, Switzerland, Taillardat is an equities portfolio manager and investment director. He has a background in quantitative research. He and a team of researchers, analysts and asset allocation specialists began combing through academic journals, monitoring company fundamentals and conducting quantitative analyses to come up with their ideal portfolio.
The team chose to base the global equities fund on four factors: quality, value, momentum and size. They’ve run simulations using 20 years of market history, monitoring how the factors perform, how to weight them and whether their returns are sustainable. “We know that some macro regimes are more beneficial for some factors than others,” says Taillardat. “For example, quality does better during a recession. Momentum would be better in a bull period. So, depending on the phase of the equity market, we can emphasize one factor over the others.”
The fund will launch by year-end. Currently, the firm manages about US$18.1 billion in assets for pensions, local governments, sovereign wealth funds, insurance companies and wealthy investors worldwide. Of this, Taillardat manages US$11.6 billion in equities.
Q: How do you measure each factor?
A: Quality means stocks with low leverage, low credit risk and earnings stability. Consumer staples or consumer discretionary, such as Nike, would be high-quality stocks. To see whether a stock is high-quality, we look at different factors depending on its industry.
For example, debt-to-equity is one of the factors, but we need to be industry neutral because some sectors are more leveraged than others. Consider telecom or utilities, which have big infrastructure and capital expenditures. They need to finance this infrastructure, so sometimes they’re more leveraged but it’s for good reason. As for size, we know small-caps tend to outperform large-cap stocks in the long term. We usually look at stocks with capitalizations under US$15 billion. We don’t have fixed limits, but we divide the universe by quintile. We invest in the smallest quintile of stocks, because capitalization tends to vary.
Value stocks mean we buy cheaper stocks compared to the average of the universe. We want to make sure we don’t overpay for our stocks, so we mainly look at price-to-earnings and price-to-book ratios.
Momentum has to do with the momentum of the stock price. We generally have stocks with earnings growth between 5% and 10% per annum. Usually we look at stocks over a period of 12 months. The time frame should be long enough that you’re sure the stock is clearly improving and increasing. If it’s too short, there can be a mean-reverting effect on the stock price. Momentum can be quite speculative: the price can go up while the earnings don’t move, because market participants tend to overestimate the stock’s earnings potential.
Q: Once you’ve identified stocks, how do you assemble the portfolio?
A: Each factor contains a long list of approximately 250 stocks, but with our risk-
management process we invest in a total of only 80 stocks, because we want the lowest-risk stocks within each factor. Then we weight the factors so that we have one portfolio that is a combination of the four factors, so we’re sure to be diversified with low risk.
Q: How do you define low risk?
A: We start with volatility and correlation: we favour stocks with low volatility and low correlation to each other. We want to have stocks with different performance cycles. Then, we look at a broad spectrum of risks. We look at company fundamentals. For example, with a low-cost retailer, is there the threat of a new entrant to the market? That could damage a historical player’s business. Environmental, social and corporate governance is also important to us. When a stock with bad governance is in the newspaper, you can bet the stock price has declined and the portfolio will be affected. Also, the risk is multi-dimensional and it’s important to be forward-looking.
We also need to ensure minimum exposure to macro risks. Right now, it’s better to be underweight China and Russia. Even though you may detect a high-quality stock in these countries, it’s better not to invest because there’s a contagion effect from the country to the stock. Another one is interest rates: you have to make sure none of your stocks will be negatively impacted should interest rates go up in the U.S.
Q: Can you give me an example of a stock in your portfolio and explain why it fits?
A: People don’t often know the name Inditex, but everybody knows Zara, the unisex fashion retailer, which it owns. Inditex is a Spanish company, and it’s a high-quality stock because it has earnings growth of about 10% per annum. It has low leverage, it’s well-managed, and it’s well-diversified because only 20% of its sales are in Spain and the rest are all over the world. We bought it in February 2012 for about €13.65, and gradually the price went up. In April 2015, we reduced our holding because of valuation. We sold it at around €29.92. This is where looking at different risk factors is important: it was still a low-volatility, high-quality name, but it started to be very expensive. When we bought it, the price-to-earnings ratio was slightly below 20, and it’s now at 28. At that level we believe that, going forward, volatility could be higher. There are high expectations for a stock that has a price-to-earnings ratio of 28. That can turn into uncertainty. A stock that we sold completely is U.K. retailer Tesco. We bought Tesco in May 2012 for about 305 pence. At the time, it was good exposure to U.K. supermarkets, which were growing. In March 2014, there was a sharp decline in the stock price, so we analyzed the company and we were worried about the fundamentals.
Discount supermarkets, such as Lidl in Germany, were clearly posing a problem to Tesco because they were affecting Tesco’s margins by selling so many low-cost products. We sold in March 2014 for 321.6 pence, when the stock was down 15% since the beginning of the year. You could think we were late, but the price actually went down by 40% after.
Q: Geneva’s financial sector made the news in January when the Swiss National Bank unpegged the franc from the euro, causing the exchange to go from €1 equaling 1.2 francs to €1 equaling as little as 0.85 francs. What was that day like for you?
A: It was quite a crazy day. The Swiss central bank’s balance sheet had been accumulating euros to maintain the exchange rate, so we thought eventually they would abandon the peg, but nobody expected it then.
We were overweight Swiss equities, so we sold some to come back to the index’s weighting. We sold the stocks that were highly impacted by the new Swiss franc paradigm. For instance, Geberit is a company that manufactures plumbing fixtures. The majority of their costs are in Switzerland, and the majority of their revenues are in Germany, Italy and France. So, suddenly, there was a mismatch between their costs (which are in francs) and their revenues (which are in euros).
Especially for mid-cap companies, such as Geberit and Swatch, the unpegging was quite a problem. Large-cap companies, such as Nestlé: all of their production costs are outside of Switzerland, because they have subsidiaries all over the world, so they were unaffected.
Correction: November 3, 2015
An earlier version of this article misstated how long Bruno Taillardat worked at Unigestion. He’s been there for eight years, not 20 years.
Originally published in Advisor's Edge Report
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