Neuberger Berman is an active management house – very active – and has a shared investment philosophy and process. Yet there is one part of its business that is completely inactive: its New York-based quantitative investment group (QIG), which follows a hybrid approach that shuns face-to-face contact with the companies in which it invests.
“We do not do management interviews, we do not travel to factories or stores, nor do we interview their customers,” says QIG equity portfolio manager Ping Zhou, explaining how the strategy works.
Rather than describing this process using buzzwords such as ‘black box’, or in terms of impersonal, computer-driven algorithms, Zhou says the strategy is based on the analysis of a multitude of measures of company fundamentals – without ever walking through a company’s doors.
At the heart of all this is data, academic theories and research findings that fundamentally shape the team’s investment view.
"We start with data. We are guided by theory and market intuition, we form expected returns for all those assets and then we put together a portfolio given our client’s constraints."
Summing up the way in which he and his team run money, he says: “A model is simply a thought process that has been formalised.” And it is this thought process that is responsible for the systematic global equity strategy, among others.
This strategy is benchmarked against the MSCI All Country World Index, so invests in developed and emerging markets. Alongside the 2,500 stocks in this index, Zhou considers a further 3,000 securities, moving his potential universe down the cap scale.
“We start with data. We are guided by theory and market intuition, we form expected returns for all those assets and then we put together a portfolio given our client’s constraints,” he says.
Portfolio building
Admittedly, 5,500 companies is a pretty big universe but there are plenty of other fund groups that have far larger universes from which to design highly concentrated portfolios.
But for these fund groups, visiting the companies they are considering invest in is an integral part of the investment process. Gary Greenberg, head of global emerging market equities at Hermes, whittles down 30,000-plus companies to 60 in this way.
Yet Zhou is adamant that he is not missing out by not making face-to-face contact. “We think about the breadth and the depth of an investment. We have the advantage of breadth as we cover thousands of companies and look at aspects that many managers are not aware of across different timeframes.
“The disadvantage is we do not have the depth of some investors. We do not know if a chief executive officer is going through a divorce, whether the product is a flop or if the customers are dissatisfied. But even though we don’t know those things, some people in the market do and their information will be revealed one way or another,” he says.
His logic is that analysts, venture capitalists and other investors are already following these companies; and their knowledge, both quantitative and qualitative, will be reflected in publicly available information. If a CEO is going through a divorce, for example, those who are already watching the company are likely to have priced it into their valuations.
He adds: “For example, price is a very powerful metric that captures a lot of the information. By paying attention to price momentum and the trend in share price movements, we can infer a lot of information that is not published in financial statements.”
Zhou and I meet at the Growth Forum Hong Kong, hosted by International Adviser’s sister publication Fund Selector Asia. Given the topic under discussion, he is quick to say that he finds no need to separate growth from value, adding that nobody wants to buy anything that has neither value nor the opportunity to grow.
“If you think about modern financial theory, what is really driving abnormal returns is not growth itself but unexpected growth. If a company grows just slightly better than people expect, the return to the company can be very good.
“If growth is slower than people expect the return could be negative. So it is not the absolute level of growth but the unexpected growth that matters to investors, including us.”
Where is he finding growth opportunities? Geographically, he says, Europe is underappreciated, with investors focusing on headline risks while underestimating the economic potential of the region, or the impact of the European Central Bank’s monetary policy.
European stocks, he observes, are outperforming US stocks as investors go cold on the latter. He also likes emerging markets, with a particular focus on Asia, reckoning they will become more attractive from both a valuation and growth perspective.
Given he has a PhD in accounting, it is perhaps no surprise to hear Zhou say: “It is very important to be conservative.” He adds: “A central principle in accounting is conservatism. You want to record potential losses but not potential gains – that is conservatism.
“To quote Warren Buffet: ‘There are two important rules: rule number one, do not lose money; rule number two, do not forget rule number one.’
“History shows long-term success in investing depends on making fewer catastrophic mistakes than more heroic wins. It is more important to be conservative, not taking excessive risk, not being arrogant and overconfident.” He adds that he tries to avoid what he calls “the lottery stocks”.
