Behaviour insights give team the upper hand

8 March 2010 | By Hannah Smith

Ross Hollyman joined Liontrust from GAM in January, along with his team, to develop the group’s global equity product range. Since his appointment the European hedge fund specialist has been working on three new investment processes for Liontrust. He will also run two new long-only and long/short European equity products.

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Q: How would you describe your investment process?

A: We start from the thing that gets us interested–looking at the way people behave when they have to make an investment decision. We apply that in different ways.

There is lots of fascinating psychological research on how people behave when fed contradictory information. Most people, ourselves included, struggle to process that information in a rational way. People tend to be overconfident and think their forecasts are more accurate than they are.

Maybe people have over-extrapolated recent growth patterns and pushed up stocks to high valuations, such as during the dotcom boom. Those stocks were perceived as overvalued. If you looked at, say, pub stocks, post the dotcom bubble they were trading on attractive valuations but investors were bored with them and focused their attention elsewhere. So it is really ’what are investors doing and does that create opportunities?’. (article continues below)

Q: How does the way you run money at Liontrust differ from how you ran money at GAM?

A: There is evolution in terms of what we are doing but the fundamentals are still the same. Going back further, it is similar to what I was doing at Flemings, before I joined GAM. The fundamentals have been in place a long time but inevitably you evolve the detail a bit as you gain experience as an investor and go through different market environments. We have technology improvements we’ve been able to incorporate, and we focus on company research more than we did at GAM.

 

Q: How has your stock screening process changed?

A: We have a little bit more data. We have done more research and brought things more up to date. We have used more academic research. Really it’s reviewing the process in the light of experience and looking at how we can do this better. Rather than one big thing it has been more like 20 or 30 little tweaks and improvements across the board. We have tried to do more research but to structure and organise it much more, so when we look at a company and it comes out of the screening looking attractive, we then focus our further research in three areas–valuation, quality, and earnings revisions and momentum. We are focusing our subjective work in the same way as we are focusing our screening.

 

Q: What are the main differences between the three new processes you have in development (Global Earnings Surprise, Global Multi-Factor and Global Value) and have you finished documenting them yet?

A: We have more to do in terms of documenting them, but in terms of how they fit together we are almost there. They are an evolution of what we did at GAM–we had a value process and a couple of funds in that space, and the value funds we run now work in a similar way. All the processes start with the behavioural finance way of looking at the world.

The value process [Global Value] focuses on the way investors tend to effectively overreact–so when companies and sectors have performed well over time they buy into them in a major way so they become overvalued. On the other side of the coin, investors tend to neglect stocks they think are boring or dull. An invisible hand makes those stocks people think are boring have growth rates that are greater. That’s why value investing works–you are buying stocks that are out of favour.

The growth process [Global Earnings Surprise] relies more on underreaction than overreaction. It is based on the idea that once investors have formed ideas about the growth potential of certain stocks, they tend to become attached to those stocks and are slow to update when new information comes along.

For example, at the start of the credit crisis, analysts cut banks’ earnings forecasts by 5% or 10%. If they had started from a clean sheet of paper they would have come up with much bigger downgrades than that. If you can be nimble, you can work out where the market has got its growth estimates wrong and you can take advantage of that.

The dynamic process [Global Multi-Factor] looks for both value and growth stocks and tries to identify which types of stocks investors are interested in.

Those trends tend to persist for some time. We will rotate between value and growth styles, different market cap segments and other characteristics as well. An example would be leverage. In 2006 people wanted to buy stocks that were highly leveraged, then in 2008 and 2009 it was the last thing people wanted, then it came back into fashion again.

 

Q: What do you think are the most interesting trends in the industry?

A: There is a lot of flux going on in general. A lot of banks have bought into the fund management industry, and if they look to reduce that exposure to non-core areas, we will see fund management companies being sold and merged. We are seeing that in many industries but it is particularly pertinent to fund management at the moment. In the hedge fund sector one trend we would point to is transparency in terms of portfolio and process. It is inevitable after what has happened that people want to know fund managers are doing what they say they are doing. That is one trend that is emerging.

 

Q: What are the prospects for European companies versus British companies over the coming year?

A: A key factor affecting better UK companies and more international companies has been the performance of sterling relative to other currencies. It has meant better UK manufacturing companies have got an incredible competitive advantage from the devaluation of sterling, and have become more competitive relative to companies that have got a harder currency cost base. Some of these companies are incredibly well placed.

To an extent, the converse applies to some European stocks. Then you have to look at growth and recovery rates. Our view is that investors have overdone it in terms of the recovery prospects for some stocks. We would be less optimistic about the immediate return to levels of high growth for some of those names, and that applies across the UK and Europe.

 

Q: Which sectors are performing well in Europe?

A: Some areas have got ahead of themselves. In the European Value fund we revel in being dull, investing in less exciting sectors such as healthcare, pharmaceuticals and telecoms at the expense of some of the cyclicals.

 

Q: What products are in the pipeline?

A: Our main focus is the [forthcoming] European Value long-only fund and the European Growth long/short fund. These are at the forefront of
our attention.