Q&A: High Conviction, Low Correlation

Oct 30 2014 | 7:35am ET

Acadian Asset Management's numbers are big: over $70 billion in assets under management, 60 markets in its investment universe, 40,000 stocks in its database, 70 underlying characteristics used to evaluate companies. Specializing in active global and international equity strategies, the Boston-based firm employs an array of quantitative investment techniques and analytical models for active stock selection as well as peer group valuation. FINalternatives' Mary Campbell recently spoke to Acadian's director of long/short strategies, Gartmore Group-vet Alex Voitenok.

Tell me about Acadian's long/short equity strategies.

Our core philosophy is that fundamentals inevitably should drive equity prices: book values, earnings, quality of earnings, growth of earnings. Investors systematically make behavioral mistakes in evaluating those fundamentals and understanding to what extent they should be related to equity prices. And we believe that systematic evaluation of the underlying, underpinning fundamentals is the best way to capture mispricings that arise from those behavioral mistakes.

We evaluate 40,000 companies on any given day—in fact, we evaluate them three times a day—and we consider 70 underlying equity characteristics, like price-to-book value, price-to-earnings, price-to-cash-earnings, asset quality and some of the technical, more behavioral characteristics, like short-term price behavior. But, the key focus is on those underlying equity fundamentals. And we construct return forecasts for every single one of those 40,000 companies, globally. 

We appreciate that a lot of things explain equity returns; sometimes small companies outperform large companies, sometimes the other way around. There is this known volatility premium that has been exploited where low-volatility companies tend to outperform high volatility companies, contrary to the capital market theory. We know that, clearly, industries and countries move in ways that explains a lot of equity returns. All of that we take out of our portfolios, so they would be uncorrelated to broad equity markets. We would not attempt to say, “Hey, we like banks” or, “We like certain countries.” In fact, we would say within banks and even within banks of a certain country, “We like Bank A and we really don't like Bank B.” And when the country goes off a cliff or when the banking sector slows, we should not see an impact from such a market movement on our portfolio. 

What is your usual holding period?

The average holding period for stocks in our strategy is six to 12 months. Most of what we call factors or company characteristics that should eventually define company returns are fundamental. That's why our holding periods are so long. We look like a disciplined fundamental manager.

How many positions do you generally hold?

We tend to hold anywhere between 1,000 and 2,000 positions, split evenly between longs and shorts. One of the questions that comes up inevitably is, “Does that represent a high-conviction portfolio? You have so many positions.” And the answer is yes, absolutely. It's just that the conviction is not as much in each individual position but in the focused number of underlying mispricings that we take exposures to through these positions. 

What percentage does each position represent?

No position can be more than 1% of the portfolio because we want to avoid binary bets. We want to avoid the risk of one position, one short, going against us. On average, these stocks do, and have done through time, exactly what we expected them to do based on their characteristics. Distributing our exposures to multiple stocks with similar characteristics just gives us a more stable stream of returns. 

What is the chief advantage of evaluating such a huge universe of stocks?

We can price 40,000 companies on 70 fundamental and technical characteristics day after day after day. There's no way that a retail investor or individual fund manager who's doing this on a discretionary basis would be able to price this correctly, this huge matrix of companies, relative to each other. And, given that we have an edge in systematically evaluating that information, there will always be opportunities worldwide across this large matrix of global stocks. That gives us an edge over investors that act on their emotions and try to pick stocks out of that huge opportunity set.

Where are you currently seeing opportunity?

The strategy is designed to be market-neutral, so by definition we would not be overweight or underweight one sector or region. What would be more relevant is in what sector stock-picking, if you will, based on fundamental characteristics, is easier or more difficult. And I've got to tell you that technology and healthcare—specifically biotech—are sectors where you're just seeing a lot of overvalued companies, or at least what we see as overvalued companies. In my history, I have not seen the U.S. Federal Reserve coming out and saying, “Hey, market, take a look—biotech and new technology companies are overvalued.” And you have seen a substantial sell-off in these really expensive companies, companies where there was deep price appreciation over 2013 based on growth in just the top line, in company revenues.

Some analysts, and I kind of agree with their point of view, attribute that expanded top line to the fact that credit, effectively, in the United States is cheap if not free due to the Fed’s policies. Such external financing with external cheap or free debt is not necessarily sustainable. So if the rates were to rise, companies with such business models would probably get hurt. And this is exactly what we have seen in February, March, April of this year, where these companies with very expensive valuations in tech and healthcare have been sold off. And these periods were very profitable to our strategy that takes short exposures in overvalued companies with lack of real growth in earnings. 

What I'm pointing out is not as much an attractive investment but an area where I believe long investors should exercise great caution. And it just suffices to say that our short positions in such companies are working exceedingly well this year.


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