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Existential returns in developed equity: to US or not US?

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What are the growth, value and macro-economic conditions shaping strategies today? Two pros in the asset management world got together at FundForum 2018 in Berlin to share their insights. 

Manulife Asset Management and John Hancock Investments are two partners in global wealth and asset management, who bring best in class asset management in public and private markets that is aligned to client needs.

Boston Partners, whose particular expertise lies in value equity and alternative investments, is one of Manulife and John Hancock Investments long standing partners in their multi manager platform.  

The macroeconomic

Michael Mullaney, Director of Global Markets Research at Boston Partners, gave us a brief overview of the global macroeconomic landscape.

The Global PMI heatmap – the purchasing managers indices – shows that, from a manufacturing perspective, the world is still in an expansionary mode. Almost all of the countries in the index are in expansion, and on the non-manufacturing and service side, the picture looks much the same.

Looking at GDP, the 2018 IMF GDP forecast for 206 countries shows that only eight are in contraction mode.

Despite the positive backdrop, however, markets have had a decidedly lacklustre first five months, and Mullaney explained why:

“We’ve had excellent growth in first quarter on a worldwide basis, upwards of 20%. What has held back returns is the contraction of P/E ratios, caused by rising inflation, rising interest rates and geopolitical risk. All that has been factored into a little bit more of a risk-off mentality on the part of investors.”

Input factors affecting currency valuations

Regarding the dollar, Mullaney said that there was a mix of good and bad. Real yield differentials favoured the dollar, which were upwards of 3% compared with Europe. But structural balances – whether current account deficits and/or fiscal deficits – leaned towards Europe, which is generally in better shape.

Economic growth has favoured the dollar, and what most people don’t realise, he stated, is that the Q1 GDP number was the strongest in five years.

Purchasing power parity figures showed that the Euro was still undervalued relative to the dollar. And in monetary policy, the Fed’s tightening was leading the world’s central banks.

Positioning and sentiment were interesting, he continued. There were a tremendous amount of net shorts on the dollar, but it was most likely that they would have to be covered towards more of a neutral position, benefitting additional dollar buying down the road. While most thought the dollar would go higher, no one had taken dramatic positions to back up their thoughts.

Geopolitical risk was too close to call. While the tariff situation and chaotic nature of the current administration pointed to geopolitical risk out of the US, recent events in Italy meant that just as much risk was coming out of Europe.

“Add them all together,” concluded Mullaney, “and we think that, on a short term basis, the dollar should continue to be stronger in near term. Longer term though, what will win out is structural balances. Over time, if the US continues to have a degradation of their balances –and it’s not known if these tariffs are going to improve the current account deficit – and/or if we continue to get more geopolitical risk out of the US, the dollar will continue suffering. It’s harder to say on a longer term that the dollar will do better.

Growth vs value

There has been over 300bps differential between EAFA growth and EAFA value returns this year, with growth in the lead. The gap has been extraordinarily wide based on historical standards. Why has value lagged growth?

Mullaney said that earnings growth differentials had been a key factor, along with the fact that EAFA growth had only recently become greater than one standard valuation rich relative to EAFA value from a forward PE standpoint. “If you look back, you’ve had superior growth being driven from the growth composition of the index and you weren’t paying outrageous prices for it, so it made sense to continue investing in growth at that time.

“Buyers will probably become more discerning in their choices going forward because now they are starting to pay more exorbitant prices for it.”

A value portfolio

Boston Partners are very much about value, and Mullaney explained how there were three basic tenants to their investment strategy.

1. That low valuation stocks will beat higher valuation stocks over time. “We’re a firm believer that value will win over time.”

2. That companies with strong fundamentals are better than companies with weak fundamentals.

3. That companies that have strong business momentum are better than those with weak business momentum.

“This is a very logical way of looking at investing in stocks over time,” said Mullaney. In terms of investment approach, this was very much quantitative first and qualitative later. “We do quantitative at the front end on our stock selection process, but then we hand the ball over to a team of fundamental analysts who do their work before it gets handed to portfolio managers.

“We win by not losing. We try to mitigate the downside the best we can, because it’s the old adage, if we have a dollar and we lose 50%, we need a 100% gain to get it back.”

The investment process

For more than 30 years, Boston Partners has stuck to a three circles approach in its investment process.

“We look at business fundamentals, companies with a positive free cash flow generation, that have commanding market share, have innovation in their products and are growing their top line sales growth.

“The key is valuation. We’re not going to pay exorbitant prices for these companies.”

Overall, there’s a total of 42 different factors that go in these three circles.

US Large Cap core philosophy and process

Jonathan White, Senior Portfolio Manager at Manulife Asset Management took an altogether different approach to their investment process.

Manulife are style-agnostic investors, he explained, where market cycle and growth/value were not as important as company fundamentals.

“We’re looking for really good businesses where we understand how they generate sustainable economic returns greater than their cost of capital over a full cycle. Not just the business on their own, but we want to pay a discounted price. We’re long term in nature and deep fundamental analysts. We are macro-aware, but our decisions come from company fundamentals,” explained White.

Their investment approach involves a seven step process that tries to identify upfront what is it a company has that is unique. That could be brand, intellectual property, size and scale. “We want to be able to see that the company has demonstrated this fact by looking at its return on capital over a full economic cycle. We want businesses that generate cashflow, we want to make sure cash doesn’t get eaten up by the business to simply stand still.

“How do we do it? We stress test our assumptions and at the end of the day, if we think a stock is worth 100 we only want to pay 70, that’s the absolute minimum we need in order to buy,” said White.

Since 2002, when strategy started, Manulife has had outperformed S&P 500 by 120%. “When the wins were value-led we outperformed, when they were growth-led we outperformed,” he stated. “We’re going to go where the most mispriced stocks are – in recent years that was in growth markets. Today we are starting to shift away to slower growth industries - think large cap biopharma. We move the ship to where the opportunities lie.”

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