How much time do you spend researching stocks, or different portfolio construction methods? Do you stick to what’s offered in-house, or do you look elsewhere for another view?
For many, the answer to the first question is, “Not as much as I’d like,” and to the second, “I stay in-house.” Changing your answers to both will make you better at what you do. We talked to top advisors who spend a lot of time—and money—on research to find out how you can refine your process.
Marc Dalpé, portfolio manager at DalpéMilette | Richardson GMP in Montreal, spends about $100,000 a year on research.
“It looks like a lot, but it’s peanuts,” he says, when he considers the pivotal role it plays in the advice he gives clients, and in generating $5 million a year in revenue for his group.
He uses a top-down approach focusing on large caps, and this informs the research he buys. About 95% of the analysis that goes into building his portfolios deals with macroeconomics and geopolitics. The other 5% is company-specific. His research budget reflects this split.
“Before getting the right call on a company, you have to have the right call on the industry,” as well as trends around interest rates and currencies, for instance. “You can buy a great company, but if it’s in a poorly performing sector, or if it’s getting hit by a currency devaluation you haven’t predicted, you’re stuck with an investment that does nothing.”
One of his sources for macro insight is London-based Capital Economics. A subscription costs north of $20,000 a year, and he gets between five and seven reports a day. Dalpé also uses Gavekal and MRB Partners.
For geopolitics, Dalpé relies heavily on Texas-based Stratfor. Its research covers everything from military deployments to terrorism to vessel movements, which helps him make calls on the direction of oil prices, for instance. “They’re so smart and thorough, and they cost close to nothing. I get stuff from them seven days a week.”
Dalpé spends four hours a day reading research. He likes providers who let their analysts disagree with each other; Montreal-based BCA Research stands out. “Their China guy is very bullish, but their emerging markets guy, who also covers China, is bearish. I don’t want a house view; I’m issuing the house view.”
Stay focused, he adds, on the purpose of research: the practical task of building client portfolios. “There was one publication we subscribed to for two, three years, which cost about US$10,000 a year. It provided intelligent, well-thought-out research, but I found it was more entertaining than useful.” Since it lacked practical analysis he could act on, he cancelled. “If it was a $100 subscription, I wouldn’t mind. But, when it’s $10,000, my business partner raises his eyebrows.”
Do it yourself
Adam Butler, portfolio manager at Dundee Goodman Private Wealth in Toronto, and his partners, Michael Philbrick and Rodrigo Gordillo, aren’t just advisors with voracious appetites for cutting-edge research. They also publish their own analyses on their blog, GestaltU.com.
The impetus was 2008: “During the crisis, it became terrifyingly clear that traditional methods of planning, portfolio management, risk management and security selection were woefully inadequate,” says Butler.
They dug deep into the literature for alternatives and drew two main conclusions.
1. Expert judgement is unreliable.
Based on research by Philip Tetlock and others, they concluded experts in most areas, including the markets, have a lousy record of making accurate predictions. “There is no evidence that traditional idiosyncratic security selection delivers alpha in excess of what might be expected from random chance,” says Butler. He cites various studies, including S&P Dow Jones Indices Versus Active Funds reports, that show a large majority of active managers underperform benchmarks after fees in any given five-year period.
2. Anomalies deliver.
Researchers have identified dozens of anomalies, but Butler says only three are persistent enough to guide investment decisions:
- Value (long-term mean reversion)
- Low volatility
“Everything else is either noise or a derivative of these phenomena. Investment success is most often a function of […] disciplined exposure to one or more of these three anomalies.”
Butler and his partners’ analysis focuses on refining the way these anomalies factor into the portfolio construction models they’ve developed.
Matt Barasch, head of Canadian Equities in the Portfolio Advisory Group at RBC Wealth Management, runs a team that helps RBC Dominion Securities advisors manage their clients’ portfolios. Advisors aren’t required to follow their stock recommendations, though many do.
Barasch’s process begins with quantitative and technical screens. Stocks that survive go through fundamental analysis. He emphasizes return on invested capital (ROIC), which tells you the revenue each dollar put into the business generates.
Free cash flow’s another key metric. “Unless there’s an out-and-out fraud, it’s pretty reliable,” he says. “But if you see earnings far outpacing cash flow, it’s a warning sign.” The rationale: If there’s all that revenue coming in, but low cash flow, where’s the money?
Barasch also looks for what he calls unvalued optionality. This is potential value in a company the market isn’t pricing in. For example, when Pershing Square got involved in CP Rail, CP had been generating a suboptimal ROIC relative to peers for years. And CN, for instance, was spending 60 cents of every dollar on costs, while CP was spending 75 cents or more, notes Barasch.
“If CP could get it down to say, 65, what would that mean for the stock? It doesn’t mean you would need that to happen for the stock to work, but what would it look like?”
He warns against firms with overly complex financials. Companies that make a lot of acquisitions tend to have this problem. He’s passed on a few opportunities for this reason, and though some ended up performing well, his caution has on balance paid off.
It comes down to knowing what you’re investing in, he says. If hours of analysis leave a team of experts perplexed about how all the accounting and other pieces fit together, it can’t say it understands the name well enough to justify recommending it. “We don’t want to wake up and find out something has gone terribly wrong with a company we weren’t able to analyze properly.”
Butler spends a lot of time reading academic literature. Like all research, it isn’t completely free of bias; but, it typically isn’t skewed by marketing objectives.
“So much of research is actually marketing, so we want to filter that out. The biggest tip-off that someone is shilling unhelpful research is if it’s accompanied by a story. Stories are exciting and motivating; they feed our primal need for explanation and certainty. Unfortunately, markets are highly complex systems that don’t lend themselves to linear narratives.”
“It takes between six and 24 months for a paper to work through the editorial boards at the major journals and into a published issue, so if you want cutting-edge thought leadership, it pays to look online.”
Working papers benefit from reader feedback and typically go through multiple revisions. “But they’re not as reliable as peer-reviewed papers,” Butler says. So, when he sees an idea in a working paper he likes, he reviews its assumptions himself before putting it into practice.
Peer-reviewed journals on Butler’s list include:
- The Journal of Portfolio Management
- Financial Analysts Journal
- The Journal of Finance
- The Journal of Alternative Investments
- Journal of Empirical Finance
- Institutional Investor
They’re aimed at practitioners, so they usually have articles that advisors and asset managers can act upon. Blogs can also be a good source of fresh ideas, Butler says. “They highlight new academic research we might otherwise miss. But it takes experience to sift through all the noise.” His top picks include:
- CXO Advisory
- The Whole Street
- CSS Analytics
- E.P. Chan
- Meb Faber Research
- Alpha Architect
- Millennial Invest
- The Aleph Blog
- Abnormal Returns
- Systematic Investor
- Philosophical Economics
- Cliff’s Perspective
- Timely Portfolio
It’s a lot to take in, and that’s why Butler spends 80% of his day on research. His team’s structure makes this possible: “We built a team with diverse skills, so each member could specialize.”
His best tip: Do as much as you can to strengthen your knowledge of industry concepts, because that depth is a prerequisite for absorbing and applying the best available research.
Penny Walker, director of wealth management at Richardson GMP in Calgary, gets research from three main providers.
The Investment Reporter, around since 1941, covers the TSX and parts of the U.S. market. She likes that it presents research in a way clients can understand.
Every month it publishes a best buys list, which classifies stocks in various categories, including income and growth. “They pick names that haven’t had a huge run, so there’s still some value in them. They’re all big-cap, blue-chip names.”
There’s also a monthly list of 25 market beaters, and 25 laggers. “If you’re looking for contrarian ideas, the laggers list gives you some.” You also get ideas on how to balance a portfolio cost-effectively, as well as sector analysis with suggestions on overweighting and underweighting.
Walker also subscribes to two providers for technical analysis. One is Ron Meisels’s Phases & Cycles, which provides both short- and long-term ideas, mainly on large caps. “I often take his reports and then look at the fundamental research,” which she gets either in-house, or from Morningstar, Credit Suisse or the Canadian banks.
The other is SIACharts.com. “It allows you to follow a broad range of stocks and tells you when they go in and out of favoured zones. I use it more on the downside.”
Walker’s in-house research (from GMP Securities) focuses on the mid-cap and smaller mid-cap space. In the morning, she gets research produced overnight; the team also sends notes throughout the day. “Analysts comment on current happenings and how they affect not only the companies involved, but other companies clients have in their portfolios.”
There’s also a top picks list, typically populated by underpriced names. But advisors don’t have to buy them.
She also asks other advisors who they consider top analysts. “My big thing is when they have the guts to say this quarter is not going to be good, and they move a stock down. I think it’s easier to increase your target […] when the stock’s going up. I want the guy who’s okay to put a stock from a buy to a hold.”
Originally published in Advisor's Edge Report
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