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‘Frothy markets offer me opportunities’

23-02-2014 | UK | Insight | Chris Hart The current stock market turbulence creates opportunities for stock pickers who look for dislocations between corporate reality and market froth. That’s the conviction of Robeco Boston Partners’ Chris Hart. The portfolio manager, who has been nominated for the Morningstar Awards nine times in Europe, reveals the secrets behind his outperformance.


Speed read:
  • Rocky markets can undervalue companies
  • Investment style looks for ‘dislocation’
  • Philosophy is based on the ‘three-circles’ approach
  • Fund has consistently outperformed over time
Concerns over the health of emerging market economies have caused equities to fall recently. But in his long career as a portfolio manager, Hart has seen all this before.

“There is no comparison to 2008, when markets declined heavily,” says Hart, who manages the Robeco Boston Partners Global Premium Equities Fund. “Markets can get frothy and can have pullbacks. This sentiment offers opportunity to find companies where the markets have been too negative and which share valuations are cheap.”

Some worries are overly discounted
“For example, investors are currently more worried about the emerging markets exposure of some companies. Their worries are overly discounted as they fail to include the fact that the majority of these businesses is still doing well overall.”

“I do not find the equity market as a whole is overly expensive, although there are pockets of expensiveness.” According to the portfolio manager this can be seen in the differences between large cap (valued at above USD 20 billion), mid cap (USD 2-20 billion), and small cap (below USD 2 billion).

The mid cap arena is the ‘sweet spot’ where there are opportunities, says Hart, who has been nominated for Morningstar Awards in Europe and has already won three, in Switzerland, Spain and Finland. “A lot of European large cap companies are priced to perfection. And I find that small cap names globally tend to be expensive,” he says.

Cherry-picking stocks
Hart has shown consistent outperformance with his fund over one, three and five years, and is ranked in the best 10% of his category. Of course, the secret behind his success is the investment philosophy of the fund. But in addition to that he says he learnt a very simple lesson many years ago from watching his grandfather’s fruit business.

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* Performance for periods longer than one year is annualized. The figures shown are net of fees. The value of your investments may fluctuate. Past results are no guarantee of future performance. Source: Robeco, MSCI

“My grandfather influenced my investment style,” he says. “He ran a fruit business in the 50s, 60s and 70s. In that kind of business you need to be quick, you have to understand cash flow and know the market well.”

“It was a very straightforward business. Just being around him and seeing how he ran his business was very influential”, says Hart. And how Robeco Boston Partners invests in equities exemplifies his way of doing business. “It is oriented towards looking for free cash flow; we look for companies that are misunderstood by the market.”

“We are realistic. I always ask myself” what I am buying, why am I buying it and what is the real return?”

Just as his grandfather chose the best apples, pears and grapefruits to sell to customers, Hart uses the bottom-up approach to pick the best stocks. You might well call it cherry picking – and the approach has worked, as the fund has outperformed its benchmark over most time periods over the past five years.

The three circles approach
Robeco Boston Partners uses the ‘three-circles’ approach when deciding what stocks to invest in. “We want to buy stocks that have a low valuation, positive business momentum and good business fundamentals,” he says.

This is because low-valuation stocks have been shown to outperform their higher-valuation peers, while companies with strong fundamentals, such as a high returns on invested capital, outperform those with poor fundamentals. And stocks with positive business momentum due to improving trends or rising earnings generally outperform those with negative momentum.

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The three circles approach. Source: Robeco

Putting the philosophy into practice may sometimes mean not following the herd instincts of the wider market to find stocks which exhibit ‘dislocation’ – when a company’s share price does not reflect the real underlying value of the business, resulting in high levels of active exposures relative to the constraints of an index.

“We want to find companies with an employed asset base that is generating a free cash flow,” says Hart. “The market reacts to news and wants to predict future earnings perfectly. But inevitably it is wrong; sometimes the market overreacts and the multiple compresses.”

“This is a ‘dislocation’ in the market. Valuation may go down even when there is nothing wrong with the employed asset base. This dislocation creates opportunities. We want to find the timeframes where market is not correctly estimating the potential for earnings growth: it can be one to two years out.”

Consistency is key
Hart says consistency is key, as the strategy has been shown to work in good times and bad. “The most important aspect is that the Boston Partners approach is used across every product in the same way,” he says. “The firm has been strong at taking a simple philosophy and process. We stick to it and apply it to different opportunity sets.”

“Some 35-40 years ago we started with large caps. Then we applied it to other strategies – all cap, mid-cap, small cap, long-short, global and non-US. Each successive portfolio has proven to be successful. The system is efficient and repeatable.”

“The different portfolios of Robeco Boston Partners show the same characteristics. We look for companies with a higher than average return on invested capital and earnings momentum that are better than that of the wider market. We maintain a high level of discipline to ensure that all of our attributes are reflected in the portfolio.”

100% bottom-up style
And while macroeconomic factors such as emerging market worries, falling currencies or the impact of tapering by the US Federal Reserve affect all markets, the ‘top-down’ approach cannot identify the best opportunities, he says.

“Our investment style is 100% bottom up. It is one stock at a time. We do not employ any type of macro overlay or foreign exchange overlay,” says Hart.

“We do not make a distinction between, for example, Germany and France. We look at individual companies. We want the most attractive investment, wherever they are from. We want to ensure that the assets of those companies we invest in are still good. We don’t want to buy firms where the deterioration is continuing.”

And while looking for dislocation valuation support is always a key underlying factor and the starting point for all analysis. The additional inputs include looking at business fundamentals – the ‘core’ approach – and the ‘momentum’ that the company may enjoy going forward.

“We are not traditional value investors: the Boston Partners style does not fit nicely into one box,” says Hart. “We fluctuate between the ‘core’ and ‘value’ box depending on the degree of quality and momentum imbedded in the portfolio - we also look at growth and quality, and those two latter attributes tend to be more ‘core’.”

“It is always the balance between the three-circles processes. We try to take advantage of little dislocations in the market. We have a disciplined adherence to the three circles: valuation, business momentum and long-term fundamentals. Every stock and our entire portfolio fit into this context.”
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