Breaking the bonds
Last month’s Strategically Speaking looked at how the dynamics of ageing, pension fund decumulation and tighter capital adequacy had influenced Schroders’ transformation from UK equities investor to global multi-asset manager. One might expect global bond managers with liability-driven investment expertise to be rubbing their hands together waiting for the liquidity from equity portfolio sales to come flooding their way.
There is no such complacency at $1.2trn (€872.5bn) US giant PIMCO. Best known as a fixed income investor, it has really been a multi-asset manager for years - and the launch of its global and European deep-value EqS Pathfinder funds in 2010 added active equities. Head of new investment initiatives Neel Kashkari says that it is just as important for bond managers to adapt to the new order as it is for equity managers.
“Clients need investment solutions today, rather than products,” he says. “When they come to us to outline investment objectives and ask us to help them meet those objectives it is clear that the solutions cannot simply be bonds. It needs to be multi-asset. Pre-crisis, people were focused on narrow products as they tried to put together their own solutions from components bought from disparate providers. For many investors that approach did not work out and more and more are turning to trusted advisers for help on a complete solution. It’s imperative for equity managers to move in that direction.”
Until now PIMCO’s multi-asset strategies have taken equity exposure via index futures. Now they will be able to take some equity alpha risk via the new funds - Pathfinder has already picked up assets from the Global Multi-Asset Fund managed by co-CIO Mohamed El-Erian - but the new teams are also expected to feed ideas into PIMCO’s broader investment process.
“There are no walls between fixed income and equity,” says Kashkari. “We want maximum integration. We debate every company and sector across asset classes, from the top of the capital structure to the bottom. An equity portfolio manager travelling to Asia brings home information not only about the companies but about the economic conditions that those companies are experiencing - all this gets fed into our process.”
Anne Gudefin, the global equity portfolio manager who runs Pathfinder alongside fellow Templeton alumnus Charls Lahr, offers a perfect example from 2010 - BP. Visibility was low as the scale of the Gulf of Mexico accident unfolded and PIMCO’s investment committee concluded that the risk was too great to justify owning BP assets. Gudefin and Lahr, whose strategy is tilted towards asset and cash-flow-based valuation metrics over multiples-based metrics, saw a different angle. BP’s net debt-to-EBITDA ratio was less than 1.0 and its plummeting market cap had begun to price-in the destruction of all of its US assets - as if President Obama, Chavez-like, was about to nationalise the company.
“That was overdoing it,” says Gudefin. “Any self-respecting value investor would have to look at this situation. We had a very interesting discussion with the credit analyst and with the team members who are focused on Washington, and in the end PIMCO decided to buy BP across the organisation.”
The information flows the other way, too. Now, rather than getting their macro input from the sell-side, equity teams will get it from PIMCO’s top-down analysts and economists. They also get expertise in tail-risk protection - useful when you run a portfolio with 20-30% of assets concentrated in its top-10 holdings, as Pathfinder does. PIMCO is looking for bottom-up managers who will get the most out of this. That means global and regional strategists; and avoiding managers who are so focused on balance sheets that they neglect the benefits of a coherent macro view. It is also why it has ruled out acquiring larger firms in favour of smaller teams that are open to adapting their strategy to exploit what PIMCO can offer.
“PIMCO’s expansion has taken an investment process and applied it to new markets,” Kashkari says. “It’s imperative that we find active equity managers who are a good cultural fit for PIMCO.”
Again, Gudefin can provide a good example. Pathfinder does not hold any National Bank of Greece, even though it looked good at the end of 2009 under the fund’s bottom-up criteria of deep value for strong franchises in industries with high barriers to entry. It is the number-one Greek franchise, and a top-three challenger in fast-growing Turkey. In late 2009 you could buy it for the value of the Turkish assets and get Greece for free. Of course, it looked distinctly less attractive when Gudefin’s everyday background noise was dark murmurings from PIMCO analysts about the fiscal clouds gathering over southern Europe.
“The macroeconomic input was crucial there,” says Gudefin. “More broadly, I am monitoring some other European companies that I like, with large revenue exposure to southern Europe. I sense we have not seen the worse from these economies, so I will wait for better entry points.”
These are typical deep-value tactics. But the BP example shows how much overlap Pathfinder’s asset-based value strategy can have with growth. That ‘growthy’ feel might be emphasised when the fund uses its capacity to take opportunistic positions in distressed debt (which it hasn’t) and larger merger arbitrage deals (which it has).
“We are more focused on what a company can become over 3-5 years than on current earnings or dividends,” Gudefin says. “We invest a lot in turnaround situations, or ‘ex-darling’ momentum stocks that have not delivered on their earnings growth promise. We look for deep value but also catalysts to unlock that value, usually new management coming on board with a restructuring programme or plans to sell non-core assets.”
Last year Gudefin bought Gemalto, the Dutch electronic security and smartcard manufacturer, one of a handful of players in a $5bn industry set for huge growth as office security needs and credit card and mobile use goes up in emerging economies. The stock has appreciated by one-third. “That was clearly a growth stock that had not delivered and came into value territory,” she says.
Gemalto reflects how IT has risen to prominence in the portfolio and Gudefin also notes a growing allocation to oil services and shipyards. Growth managers started picking up BP when the story became one of offshore drilling technology, the same reason for Gudefin’s five-year holding in Norway’s Seadrill. When she bought (at NOK90 per share), oil majors were only replacing 80% of their reserves and she knew that offshore would have to be the way to go to return to sustainability. Seadrill was early ordering rigs, which means it has now paid down most of that capex and is set for 20-25 years of double-digit free cash flow from its new kit.
After hitting NOK180 in summer 2008 Gudefin trimmed her position, buying back in when the stock slumped to NOK45 - just as Seadrill’s competitors had to rent their rigs at the highest day rates ever. It now trades in the NOK180-200 range. “I’m not making huge macro assumptions about growth,” Gudefin says. “I’m just trying to buy high-quality franchises at a time when they are undervalued.”
Whether one characterises Pathfinder as deep-value, growth, or deep-value growth, Kashkari says that PIMCO is looking outside the value space for its next active equity funds. He expects the 30-strong new investment initiatives team to double during 2011, and regulatory filings in the US last year have already prepared the way for its second active equity strategy, the EqS Emerging Markets fund, to be run by Goldman Sachs alumnus Maria Gordon.
“We are searching for managers to run global growth and global income strategies,” Kashkari adds. “Value, growth, income and emerging markets are the focus, but we are also open-minded about alternatives. Long/short equity could be another possibility. The true determinant will always be whether we can find equity portfolio managers who can utilise PIMCO’s global macroeconomic expertise.”