Interactive Investor

Our algorithm has never been so bullish on value shares

23rd March 2023 16:21

by Sam Benstead from interactive investor

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Co-managed by Raheel Altaf, the Artemis SmartGARP Global Equity fund, which appears in interactive investor’s Super 60 list of investment ideas, invests globally but currently has a bias towards emerging markets and value shares. Altaf explains why a human and computer-driven approach to investing is successful and why the portfolio is so concentrated in cheap stocks at the moment. He also reveals why the fund sold tech stocks last year and why Asian firms will make good investments. 

Sam Benstead, deputy collectives editor, interactive investor: Hello and welcome to the latest Insider Interview. Our guest today is Raheel Altaf, manager of the Artemis SmartGARP Global Equity fund. Raheel, thanks for coming into the studio.

Raheel Altaf, manager of the Artemis SmartGARP Global Equity fund: Thanks for having me. It's good to see you.

Sam Benstead: So, can you please explain what the fund does? What does SmartGARP mean and how do you invest?

Raheel Altaf: Sure. SmartGARP is the investment process that we've designed to help us pick winning stocks. As the name suggests, GARP is growth at a reasonable price. So, we think an approach that focuses on a company's growth characteristics, but also pays attention to the price that you're paying for those prospects, is a strong and rewarding combination.

The smart side of it is that we've built a systematic screening tool that helps us scan thousands of companies around the world and highlight those that have the most attractive financial characteristics. And in our view, those are the best opportunities you should be investing in. So, looking at the SmartGARP Global Equity fund, it's a diversified offering that invests in all regions, sectors and across the market cap spectrum, but it is biased towards those best opportunities that come from the investment process.

Sam Benstead: And what are those attractive financial characteristics that you're looking for? What are you screening for?

Raheel Altaf: The systematic process is objective and it's evidence-based. So, we're taking company fundamental data, we're taking economic data, and we're taking market data from lots of different sources, and then we're bringing that all together and trying to exploit the trends and the behavioural insights that we can glean from the data. So, there's lots of inputs that go into it. When you look at the process, it is mostly focused on bottom-up, so company-specific information, whether that's coming from the income statement, the balance sheet of a company, whether it's the earnings forecast or the cash flow forecast of a company. But then we're also looking at the economic environment and trying to understand where you might want to be positioned. We've seen that inflation has been rising in the last few years. Interest rates have been going up, so the environment is changing and that means your portfolio needs to change and adapt for the environment.

Sam Benstead: It's a systematic fund, so computers help you manage it, but there's also a human element involved. How do those two factors compete and how do they influence the portfolio?

Raheel Altaf: That's right, there is a human side to it, which we think is very important. The systematic side is, it's automated, so everything runs overnight on a daily basis. So, for thousands of companies, we know on a daily basis what their relative attractiveness is. But we think that there's a need for the human side, which is us spending our time doing company-specific due diligence, trying to make sure that there is a sound investment case in the company that we're trying to put our capital behind.

And the real world is quite difficult to model. We see political risks, we see corporate activity, we see changes in management, and these things can be difficult to understand and model. And we find that human judgement is much better at understanding these issues, and our job is really to understand those issues. So, you can think of it as having a human sense check as an overlay for a machine that's giving you the output. We think over time that does deliver some value.

Sam Benstead: And can you give an example of where the computers signalled that one part of the stock market looked attractive, but the human team overruled that and said we're going to focus on this area instead, or we're going to limit exposure to that area?

Raheel Altaf: Yes. So, our job isn't really to second-guess what the model is telling us. It's really to kind of control the level of enthusiasm, if you like. So, one example might be if we go back to last year, commodity prices were rising quite rapidly. And so what you're seeing is the main driver for commodity stocks is improving and that's leading to better profits for those companies, but lots of commodity companies suddenly looked very attractive. And so you want to taper that enthusiasm because there is a cyclicality to some of those companies and you don't want to be biased too much towards one specific area. So, our job is really to control the amount of exposure that we're taking and ensure that there is diversification across the portfolio. So that's one example where human judgement would be controlling the amount of exposure and just thinking about what's the right way to allocate across that idea.

Sam Benstead: The fund's been running for about 20 years. What is its track record like?

Raheel Altaf:  It has been running for almost 20 years and performance since we took over this strategy in 2003, has been good. It's outperformed the index by just under 2% per annum after fees. But there have been times where the strategy has done exceptionally well and there have been a few periods where the strategy has not delivered. But over a very long period, I think investors in the fund have been very happy with the returns that they've achieved.

Sam Benstead: Is it a growth or a value fund? And in which typical macroeconomic environments does it perform best?

Raheel Altaf: Well, it's a combination of both. We see the merits of both value and growth investing. If you can identify the companies that outgrow the market, the rewards are going to be significant. But it's very difficult to forecast. You know, those companies and yes, with the benefit of hindsight, we can go back and say Amazon (NASDAQ:AMZN) was a great success or a number of companies in the US market, Apple Inc (NASDAQ:AAPL), for example.

But going back 20 years, it wasn't so easy to forecast that. And so, forecasting future growth is a challenge. Valuation as a discipline has a lot of merits, and maybe that's taken a bit of a back seat in investors' minds of late because it's been a punishing time to be a value investor. But there is an advantage to having a valuation discipline. There's a margin of safety that's reflected in the price that you're paying for a company. And when things go wrong or you have volatile markets, you are somewhat protected. So, what we're doing is, we see the individual merits of growth investing and value investing, but if you combine them, you can do even better. And so our approach is to think about using both of those inputs. And there are times where we will have more in value or more in growth, and today we have a huge preference for value stocks. You know, they've been out of favour for some time and the tide is starting to change, and we think that the years ahead are likely to be quite good for that part of the market.

Sam Benstead: And has this value approach worked for the past couple of years, has there been a bit of a resurgence in value, and is the price-to-earnings ratio of about eight for the portfolio versus 14 for the MSCI World Index, is that typical or is that very value driven, or is that even perhaps growth-ier than you normally are?

Raheel Altaf:  I think when you look at the fund today, it's in the extreme deep value part of the market, and it's rare that we've never had such a significant value tilt, so as you point out, the price-earnings ratio of the fund is less than eight times, whereas the market is close to 15.

So, you're paying half the price of the market for this fund and it's a diversified fund, it's not concentrated in one area. I think it's rare that you can achieve that kind of characteristics for a portfolio, but it's because of the market environment we find ourselves in. Value stocks have been punished, we think unduly. There's evidence that there are more tailwinds for those parts of the market, and there are risks for some of the higher growth parts of the market. And so we think having more of a value bias now is the right thing to be doing. But that is not typical. If you look over the 20 years, there's been a much more balanced approach between value and growth.

Sam Benstead: So even though we've had two years, two good years for value, there's still many more good years to come for this style of investing?

Raheel Altaf:  Yes, our belief is that this is the early stage of a recovery and it has been volatile. We see that there is a comfort zone that investors are going back to continually where they want to go back to the stocks that have worked in the last decade. But let's not forget that we've seen higher inflation than anyone was expecting, interest rates are going up and we're seeing central banks in tightening mode. And that's a big shift from where we've been in the last decade. And our sense is that there's going to be a change in market leadership, and that the change in market leadership is going to be beneficial to a number of companies that have been out of favour for the last decade or so, and they happen to be a number of deep value companies.

Sam Benstead: Can you talk me through some of the top positions in the portfolio? Why are they there, and what fundamental characteristics do they share?

Raheel Altaf: Sure. If you look at the top 10 positions in the fund, we've got a very differentiated offering to many of the global equity funds out there. If you compare our positions today to where we were a year ago, we no longer hold Apple, we no longer hold Microsoft (NASDAQ:MSFT) and we no longer hold Alphabet (NASDAQ:GOOG). Why is that? Well, it's because we see risks to earnings for those companies. Yes, those companies have done exceptionally well for a number of years and they've delivered exceptional growth, but they now trade on quite lofty valuations. And those valuations don't reflect some of the risks that we're starting to see with high inflation in the economy. We're seeing earnings risks and risks to profit margins, and that's not reflected in the prices there.

So, we've come out of those names, and we think there are better opportunities elsewhere, where the growth prospects are improving. One example is looking towards Asia. If you look at our top 10 holdings, China and Japan make up five of the positions in our top 10. Now, why are we optimistic about that part of the market? Well, you've got pretty benign inflation in both those economies. You've had almost a decade of poor returns versus US equities, but the tide is starting to change. The Chinese economy is reopening, that's a strong tailwind for the earnings for a number of companies in that part of the market.

I think the government has enough tools at its disposal to support economic growth in the future, and clearly there are some reasons that you might be optimistic about an economy that is largely quite self-sufficient, and is driven by the consumer. So, when you look at the top 10 positions, we're invested in some of the infrastructure stocks within China. We're invested in some of the Japanese companies that have strong balance sheets and have been delivering very good cash flows to investors.

Sam Benstead: You sold US technology shares at the end of last year and bought Chinese internet stocks. Why did you do that, and has that trade worked out for you?

Raheel Altaf: That's right and I'd say the start of the year has been a little bit more challenging and more like what we've experienced in the early part of the last decade, let's say. But that hasn't changed our conviction. When we look at the bottom-up picture, and we see the evidence that's coming through our process, we're sticking to our guns there.

We have talked about some of the risks in technology stocks for a few years now, whether it's regulation, whether it's competitive threats or whether it's rising inflation and therefore higher interest rates. When we look at China, mega-cap tech companies in China have really been punished. There's been a strict regulatory regime and share prices there have fallen quite dramatically. But when you look at the US stocks, you don't see the same dynamic, and so I think the risks are there in some of the US tech names, but actually at the end of last year, we saw evidence that the Chinese tech stocks had hit a bottom and started to see much better news flow. And in terms of the risk/reward imbalance there, we shifted away from the US into those Chinese tech names where we think there are better opportunities now.

Sam Benstead: Raheel, thanks very much for coming into the studio.

Raheel Altaf: Thank you.

Sam Benstead: And that's all we have time for today. You can check out more Insider Interviews on our YouTube channel where you can like, comment, and subscribe. See you next time.

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