The trend towards researching companies globally on a sector basis is well established, coming first from the sell-side, and mirrored by the buy-side, particularly larger asset managers with the resources to hire star analysts. The unstoppable force of globalisation and industry rationalisation has created in most sectors companies whose businesses have broken through national boundaries and whose products are sold on a global stage. Dividing equity allocations into regions against this background becomes an anomaly, and consultants report an increasing trend towards allocating global equity mandates. The ability to research stocks according to global sector has become a precondition for manager selection in this space. Having come to the conclusion that managing stocks according to global sectors generates more alpha, will investors now start to cherry-pick managers according to sector skill, and award mandates accordingly?
To some extent this trend has already started with some pension plans in northern European awarding sector mandates. But many plans believe they are getting the benefit of sector allocation by either adopting a sector focus internally, or by awarding a global equity mandate to a house with sector research teams. Some funds are adopting the sector approach ad hoc, as a specialist within a core:satellite structure.
Gary Dowsett, investment consultant at Watson Wyatt in the UK, comments: “Within the larger global asset managers, the global sector teams are already managing live money as part of a global mandate and there is no reason why this specific competence could not be broken out.” Dutch pensions giant ABP’s CIO of equity investment, Jan Straatman sees no particular reason for ABP to award a sector mandate, because ABP runs all internal money along sector lines. Comments Straatman: “External managers have to add value, either by having a different investment style, or being specialist in a certain area or region, such as emerging markets,” although he adds: “Having an external manager in a sector which requires a deep level of specialism might be of interest because we could compare their views with our own.”
Some industries lend themselves to a sector approach, particularly those where a good understanding of the science behind the business is required. Viren Mehta, CIO of MP Asset Managers in the US, a specialist healthcare manager, comments: “There is a trend for investors to demand a speciality sector service, and pharmaceuticals and biotech benefit from a concentrated effort. An in-depth understanding of the industry should lead to better calls.” Most sector funds were launched to meet retail demand when the sector was in vogue. Following on from technology and healthcare funds in the late 1990s, investor interest is now more towards commodities, mining and utilities funds. Technology companies also awarded mandates to managers in their own sector to fulfil demand from employees for a tech component in DC pension plans. US endowments and family offices in particular seek specialist sector hedge funds. Even now, global technology specialists report demand for existing and new institutional mandates. As Stuart O’Gorman, manager of Henderson technology funds, explains: “Simply investing money with a US technology manager on the basis that the biggest technology companies are in the US makes an erroneous assumption that the US managers are better placed to understand the sector. To be totally on top of a company’s prospects it is important to understand the risk of competition from Europe and Asia.”
Investors who allocate to a global equity house with genuine global sector research can access a significant proportion of the benefits from improved stock selection and alpha generation, in the view of Divyesh Hindocha, partner at Mercer Investment Consulting. A pure sector based approach requires making a decision on sector allocation and it could be argued that, if appropriately structured, this approach may help investors in avoiding getting drawn into sectors which turn out to be “overbought”. Also investors need to recognise that some sectors are less subject to global dynamics (eg, the retail sector). Sector skill is becoming increasingly important in the allocation of global equities mandates, as Hans Danielsson, CIO of AIG Investment Management in the US, comments: “In the selection process it is noticeable that the number of questions relating to sector allocation and capabilities is increasing.” However, Danielsson considers that it may be dangerous for an asset manager to focus too much attention on certain sectors as it is difficult to maintain a sustainable advantage and such a focus might harm its ability to win global generalist mandates.
Another difficulty that is created by the sector approach is in ensuring that there is no duplication or omission of exposure. If the plan retains a market cap benchmark, like MSCI World, it will need to run a balancing portfolio to add in exposures that do not fit within sector confines. Passive mandates are more malleable in this regard. Otherwise, the plan will have to adopt a composite benchmark. Sam Isaly, managing partner of Orbimed, a healthcare specialist manager, suggests that sector specialist funds could be a way for generalist plans to modify sector exposure tactically. In Isaly’s opinion, the complications in terms of structuring are outweighed by the benefits of greater insight and better information achieved by sector investing. Comments Isaly: “The pitfall of global sector analyst teams is that the portfolio manager is a generalist and that the analysts are spread across the world. To really make the sector approach work requires a cohesive team in a single location.”