This mixture of quantitative screening and qualitative analysis works well in a universe as vast as the MSCI World and the model is able to narrow down the 4,500 potential holdings whose market caps exceed $1bn to a more manageable list of 500 names. The process was born out of the team’s desire to cut through the ever increasing amounts of market data in a useful and repeatable way. It aims to find good quality companies at reasonable val
uations and incorporates the behavioural finance observation that investor over or under-reaction to news flow exacerbates inefficiencies in the market. As a result the quantitative process looks at four distinct factors. It starts with a company’s strategy and its historical ability to grow cash flow, with a focus on cash flow return on investment (CFROI), before moving on to an assessment of valuation with the use of discounted cash flow modelling. The model then looks at earnings revisions and favours companies whose profit forecasts are being upgraded. Finally, it looks at technical indicators to see if the market is already starting to reward the stock. If it is not the previous assumptions will be reassessed to make sure the fund is not walking headlong into a value trap.
Each of the four factors are weighted equally and graded 1-4. Any stock with a combined score of 12 or more is subject to further fundamental assessment by the analyst team, whose responsibilities are organised by super-sector. The team places a heavy emphasis on CFROI, firstly for valuation purposes to assess the returns and growth rates assumed by the market and secondly to monitor likely changes in it over time. Ideal investments are those companies who generate high and growing returns above their cost of capital. These ideas feed into a portfolio which aims to be super-sector neutral and contains a fairly eclectic mix of stocks from across the value, growth and market-cap spectrum. This places the fund in the Morningstar Global Large-Cap Blend Category. An emphasis on rising technical indicators also gives the fund a momentum bias, partly illustrated by the high standard deviation which exceeds the category average by 12%.
The fund strongly outperformed its Global Large-Cap Blend peers in 2006 and 2007, but lagged badly during the ensuing downturn. This weakness during market inflections is common to many quant approaches. However, despite posting a loss 5% above the category average in 2008 the fund still manages to outperform its average peer since the strategy was implemented. It also holds up better than some of the pure quant strategies we track thanks to the work of the equity analysts. Although the losses in 2008 can be hard to bear, we believe investors have good reason to look beyond one bad year here: in our view, the fund's experienced analyst team, robust process and longer-term strength make it a solid core global equity holding.
