Three keys that unlock investor behaviour

Silvio Tarca co-manages the JPMF US fund. He is also a vice-president of JP Morgan Investment Management and heads the portfolio management team for US equity behavioural finance funds (JP Morgan Intrepid series, JPMF US Dynamic fund). An employee since 2000, Tarca previously worked as a quantitative analyst in JP Morgan’s global emerging markets group based in New York.

Q: How would you describe your investment process?

A: The investment strategy for the US fund is based on behavioural finance principles. Behavioural finance says that human behaviour affects investment and this can lead to irrationality. Our investment strategy seeks to capitalise on market inefficiencies while resisting irrational behaviour.

There are three examples of behaviour related to our investment process. The first is that investors are overly optimistic about past winners and overly pessimistic about past losers. Expectations for “glamour stocks”, are high and they may become overpriced as investors rush to buy them. For past losers, they may become undervalued as they are shunned by investors.

The second behaviour is that analysts underreact to earnings information when they revise their forecasts. They also succumb to the illusion of validity. Some analysts pay attention to evidence that confirms their views and dismiss conflicting evidence. The third behaviour is that investors are predisposed to holding losers in the hopes of breaking even. We try to capitalise on value and momentum anomalies.

Q: How has the fund changed since you took over as manager a year ago?

A: The fund was previously on a manager-driven investment process, which had an emphasis on valuation as opposed to the behavioural finance process we are currently using. What we did was move to the behavioural finance process to use our proprietary stock selection model to identify stocks with good value and strong momentum.

In constructing our portfolio, we ensure the fund has significant exposure to common factors that we expect will generate excess returns, while controlling for other risk exposure. We adhere to our discipline for stock selection and portfolio construction and strive to make rational investment decisions rather than those driven by emotion. Our process is not driven by company prospects or analyst opinion. We do not meet company management.

Q: How does the relationship work with your co-manager Rob Weller?

A: I would characterise our method of investment as one that emphasises process rather than individuals. In terms of the portfolio management and research tasks, the team members are interchangeable in many of those tasks. The skills we have on the team include financial knowledge, portfolio management expertise, computing skills and client interfacing skills.

Q: Which sectors do you favour?

A: At the moment, and this has been the case for the last nine to 12 months, we believe the energy and materials sectors have strong momentum and we are overweight those sectors. Despite weak economic data in America, which has raised fears of a soft patch, we still see strong momentum in these two areas.

Q: Are you avoiding any sectors?

A: Sectors we dislike are information technology and, within healthcare, pharma and biotech are sectors which do not have momentum and we are therefore underweight in these areas.

Q: Is it currently difficult to find value within the American large-cap sector?

A: For us, this is relative. We rank stocks relative to each other in their investment universe. We can always find stocks that are cheaper than average and will always favour those that are cheaper with better momentum.

Q: How important is it for the manager of a US fund that is domiciled in Britain to be based in America?

A: We are focused exclusively on large-caps within US equity markets. Our investment process uses data that is readily available in America. Technology could make this data available to investors in Britain or Europe. But from my perspective, the advantage is that we are a team focused on US equities and we have ready access to reliable data, which really drives our investment process, here in the US. However, processes that rely heavily on contact with company management or sell-side analysts would rely more heavily on being located in New York.

Q: What is your attitude to risk?

A: The portfolio has a tracking error range of 3-5%. We are near the middle of that range at the moment. We control risk through the number of securities we hold, through sectors and industries and by the size bias of the portfolio.

Q: How many stocks does this fund hold?

A: We hold approximately 120 securities at the moment.

Q: What is the annual turnover like?

A: Turnover on this fund is in the vicinity of 75-100% annualised. With this not being a particularly aggressive strategy, we are happy with a turnover that is around the average for American mutual funds.

Q: What has the implementation of JPMF’s behavioural finance process meant for investors in your fund?

A: We like to think that it has meant good performance over the past year. In the IMA North America sector over one year, we rank ninth out of 83. That is perhaps the most important thing for our investors.

Q: What sets your fund apart from other US large-cap offerings?

A: The investment process is what distinguishes our fund from other strategies. We adhere to a disciplined process for stock selection and portfolio construction. Our investment decisions are not biased by spin from management or sell-side analysts, because we do not meet with them. With stock selection, we use a proprietary, multi-factor model, which allows us to buy cheap stocks with good momentum.

Q: How concerned are you about macroeconomic factors, such as rising American interest rates or inflation this year?

A: Because of the momentum exposure of our strategies, they tend to perform best in trending markets. If there is a major shift in market sentiment, our strategies would tend to struggle for a couple of months. We are concerned about macroeconomic shifts and the resulting change in market sentiment, but we will pick that up through the momentum part of our model.

Q: What about the volatility of the dollar?

A: With the US fund, we are fully invested in US equities, so we are not trying to hedge on market correction or on the currency. We stay fully invested in the market.

Q: Do you invest in the fund yourself?

A: Yes I do. We have seven strategies, including five US-domiciled mutual funds and two offshore vehicles. One is the UK-domiciled JPMF US fund and the other is the offshore JPMF US Dynamic fund, a Luxembourg Sicav. I am invested in all five of our US mutual fund offerings, including this fund’s equivalent US mutual fund, open to US-domiciled investors.