Pzena Investment Management out of New York, a US, global and emerging markets house, can’t see anything much of value in Australia right now. But globally the spread between the cheapest and most expensive stocks is very wide, providing opportunities.
Pzena is a rare breed these days – a ‘deep’ value manager which looks to ‘right size’ its strategy within a client’s portfolio. That is, it doesn’t oversell its promises by trying to be a core manager or larger part of a client fund’s total portfolio. Deep value investors need to be patient.
Most big global value managers have added some momentum to their processes over the years, especially after the caning they took in the tech boom and as their businesses grew and they had more at risk in a market which doesn’t suit their style.
Pzena prefers to contain risk at the portfolio level, looking for downside protection in the companies it adds to its portfolio by trying to skew the risk/reward profile for the future in its favour, such as targeting a return of more than 60 per cent on the upside and a loss of less than 30 per cent on the downside.
Pzena is reasonably well known to large Australian super funds. It has about $2 billion invested on their behalf and a Melbourne representative office run by David Taylor, director of business development and client services.
In October it launched an Australian-domiciled commingled trust for its emerging markets strategy with a $70 million seed investor and next year it will launch a trust for its global developed markets strategy, as it looks to roll out its capability to smaller clients. Both strategies are concentrated, with about 55 stocks in the emerging markets portfolio and closer to 80 in the developed markets portfolio. Both are benchmark unaware.
Caroline Cai, a New York-based portfolio manager and principal, said on a regular visit to Australia last week that the most sustainable and beneficial client relationships are those where the Pzena strategy has been sized appropriately to utilize the manager’s diversification attributes in a standard portfolio.
Pzena, is named after its founder and chief executive, Richard Pzena, who left Bernstein, another New York value shop which merged with a growth manager to form Alliance Bernstein, to form his own firm in 1996. It has about 90 staff, mostly in New York, of whom 25 are investment professionals. They manage US$30 billion currently.
The firm has a two-tiered approach to its research. It takes a “quick look” first, which for the global portfolio will mean screening the largest 2,000 companies over a 10-year history to provide a naïve “normal earnings” forecast and then sort them to isolate the cheapest quintile – leaving about 400 stocks. It will ask why the stock is cheap and call whether this is temporary or permanent, and also whether it can identify a way to “fix” the problem that has made it cheap.
Cai says that the “quick look” can take anything from two days to two weeks. “We look for the critical drivers of each stock and whether we can research them. And is there a way for us to get downside protection.”
The manager then does a “deep dive” on the remaining universe, which can take anywhere from four weeks to four months, Cai says. “We are not traders. We take a long-term view. We go and visit the companies’ management and talk to them about what they see as their competitive advantage and so on.,” she says. “If we still like [the stock] we bring in a sell-side broker who is bearish on it or a manager who is shorting the stock… to make sure we haven’t missed something.”
Pzena’s global portfolio currently has a weighted average price-to-normal-earnings ratio of 8.4 times, compared with the median valuation for its 2000-stock universe of 15 times. The emerging markets portfolio has a P:E in the mid 7.0s against 14.5 for the 750 stocks in its universe.
Cai says that a stock is not inherently a value or a growth stock, it’s about a point in time. What’s cheap changes over time.
Valuation spreads are wider than one standard deviation currently, she says, everywhere in the world. This is the first time this has happened for 40-50 years.
Consensus expectations seem to be that there will be lower GDP growth everywhere “forever” and that there will be quantitative easing “forever” and lower interest rates “forever”.
“Every value cycle starts with a grain of truth to it and then goes to an extreme,” she says. “I discussing commodity companies, which are now starting to screen in Pzena’s cheapest quintile she observed that a cure for a low price is a low price. When the pain is severe enough firms start shutting down their capacity.”
– Greg Bright