Investment processes – important as they are – can be very dull and repetitive. Indeed, if I had a pound for every time I'd heard a fund manager describe themselves as 'bottom-up contrarian' or a 'pure growth stock-picker' I'd have likely retired by now and be sitting on a beach somewhere sipping a cocktail, rather than writing this blog on a grey day in Fulham.
I exaggerate (only slightly). But you get my drift. So it's really rather refreshing when someone who says they 'do something a bit different' actually does. I met one such manager recently: Mike Clements from SYZ Asset Management. He runs their Oyster Continental European Selection fund and is approaching his three-year track record - so on our watchlist.
Mike says there are three ways to beat the market consistently:
The third way is basically his way, and at first it's a familiar story… he looks for companies with high returns on equity across the business cycle that can generate free cash flow in a sustainable way. Businesses with strong brands, strong market share, possibly a technical edge and pricing power. Ideally a company that does one thing and does it well.
Lots of fund managers do that, so what makes Mike different? There is a fine line between being a contrarian investor and being wrong (or early as some prefer to describe it!) so Mike spends a lot of time researching stock ideas to try and limit the mistakes he will inevitably make along the way.
It's how he goes about finding those stock ideas that sets him apart. Here are a couple of examples:
The summer was a quiet one for markets. Trading and volatility was low. Indeed, the VIX (a volatility index) recorded its longest ever run of nine days below 10 (VIX values greater than 30 are generally associated with a large amount of volatility, as a result of investor fear or uncertainty, while values below 20 generally correspond to less stressful, even complacent, times in markets*). The previous record at this significant level was just 4 days, way back in 1993.**
Looking at these multi-decade lows, Mike knew there had to be a way of making some money. What he found was a Dutch company called Flow Traders. They are the European leader in market making for Exchange Traded Funds (ETFs). When volatility is high, the volume of ETFs traded goes through the roof. So even if volatility gets back to 'normal' levels, he should make money.
Italian banks have been in a bad way for a while, their situation exacerbated by the fact that more than half of the sector consists of mutual or co-operative banks, with strong ties to the communities in which they operate, very poor underwriting and so much red tape and inefficiencies in the judicial system that collection of loans is a nightmare. The market was full of distressed sellers of non-performing loans (NPLs) - EUR300 billion in fact - and the team's contrarian instincts were alerted to a possible opportunity.
However, while the recovery potential of the sector was huge, they struggled to put a downside floor on the banks themselves. Instead they found Eurocastle Investment Ltd, another Dutch listed company. Eurocastle is uniquely positioned to price, acquire and manage NPLs – they basically service the loans and have the best data around to make sure they recover enough to make a profit themselves.
Having worked for a state-owned enterprise in Italy myself, I'm only too aware of the numerous inefficiencies to be found in the system. NPLs are not the only payments difficult to collect – basic invoice payments are too. It's stereotypical but it makes a point: the average time for payment of invoices in Italy is 53 days compared with just 14 in Germany!
The pharmaceutical sector is an example of where Mike has found an opportunity to make money from this inefficiency. If a pharmaceutical company is selling drugs to an Italian hospital, it knows that the hospital will be slow to pay the invoice. So the pharmaceutical company 'sells' the invoice to a company like Banca Sistema at a discount.
Banca Sistema has an edge as it knows who to talk to and what forms need filling in to get the money. Most of the parties involved are state owned, so Banca Sistema knows it will get paid - eventually.
The ideas are far from obvious and make for a very different European equity portfolio composition. If you are looking for something new in this asset class, your search may be over.
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. The views expressed are those of the author and fund manager and do not constitute financial advice.
By Sam Slator, head of communications
**Montanaro Asset Management, August 2017