Richard Brody's north american fund opts for financials and cyclicals
The schism between growth and value which has overshadowed the market for the past four years is unlikely to be as marked again, according to Richard Brody the manager of the Prudential North American fund for almost 10 years.
Brody, with Prudential since 1992, operates with a value style bias, something visible in his track record. Although the fund's three-year numbers display the impact the technology bubble had on value funds, the last two years have seen consistent top quartile performance with below average beta from Brody and his team.
Over the three years to the 12 April, the fund is down 4.73%, bid to bid, versus a 0.97% sector average gain, but over one year it has risen by 4.03% compared to a sector average fall of 6.53%.
Value has come back into fashion. What do you think is behind this resurgence?
The last four years, I believe, were an aberration not likely to happen again soon. There was a huge disparity between the growth side of the market led by technology, followed by the reverse of that over the last two years. Overall the market did not perform well, but other sectors that had been depressed came back.
The gap between value and growth was too wide, which created a lot of opportunities. Stocks were selling on valuations that were inexpensive not just relative to the market, but on an absolute basis. Moving forward it is going to be a stockpickers market and not to much driven by broad trends.
When do you expect the much-vaunted US economic recovery to kick in?
We are positive on the potential for an economic recovery, the question is what is the timing of that. Many stocks we own have economic sensitivity, but they are also priced at ultra-attractive valuations, so even if the recovery is delayed they are still attractive from an intermediate to long term perspective.
It is very difficult to forecast economic events on a short-term basis. We would rather focus on the long term and if we find stocks that we have in the short term go down, then we will add to those positions.
What sectors are you favouring at the moment?
We are overweight financials and traditional cyclicals as well as some of the consumer discretionary sectors, like retail and autos. We go where we can find value. We do have exposure to technology, primarily on the large cap side, but have a distinct underweight position in the telecom equipment market where there is still excess capacity. Overall we still think technology and healthcare are expensive.
How is your investment team structured?
I started the team in 1992 and structured how I thought we could best combine the roles of research and decision-making. I wanted to put in place a well defined investment approach following a consistent structured research and decision making process to suit our style.
We have three senior people with over 20 years experience each and it is very much a team decision making process as opposed to one person making all the decisions.
How would you describe the mechanics of the portfolio construction process?
We carry out in-depth research focused on making active bets in the value component of the fund. This is a value fund and stock selection is driven by the valuation process.
We do have strong risk controls, which are basically focused on tracking error and our overweighting and underweighting of stocks.
We do have a segment of the portfolio, which holds stock from sectors we tend to be light in, in order to satisfy these risk controls.
Outline your stock selection process
It is very much a bottom-up stock selection process. If you look at our underweight positions, you can see some very large companies and this is in part driven by our large overweights on a sector basis, to limit our exposure to individual areas of the market. The valuation process really drives the performance of the fund though and our top 10 overweights are all decent sized positions.
How would you describe the equity valuation process?
We use a lot of valuation techniques. We do not do screening. We do use quantitative tools to rank securities and that information serves as a tool for us. It could, for example, identify a situation whereby a cyclical company looks expensive, but actually has depressed earnings, so on a normal basis looks attractive.
Often the overall market and individual managers focus on a much shorter term perspective than we do. There is very much a sell side focus in the US. Analysts will factor in near term interest rate expectations into whether they like a financial stock. It may be a company with superior management and a very clean balance sheet, but will be undervalued just because the consensus of investors may expect interest rates to rise over the next few quarters. This is an opportunity to us because we look past that. We are looking to buy companies that have at least average balance sheets and earnings growth, but are on attractive valuations.
What makes you sell a stock and what is the average holding period?
It really depends. If you have a good understanding of your companies you can act on new news and if it is significant it can change your target weighting, but if it is not relevant over the long-term then you can more or less ignore it.
We stay fully invested in our portfolio, so when we come to a decision to make a new purchase we have to make a simultaneous sell decision. To be attractive to us, a company has to be attractive not just relative to the market, but also relative to our portfolio.
Are portfolio construction disciplines becoming more important as markets seemingly grow more volatile?
Discipline is key. You constantly have to recheck what you are doing. It is particularly important to do that with a value style, because at the time of initial purchase, the outside world can give you a number of reasons why you should not own that stock. You need to look at those factors and if the market is misreading them, you can push them aside.
How much emphasis do you place on company visits?
We manage about $5.5bn in our group and when we make an investment in a stock it is generally a fairly large position in terms of dollars. So for the most part we try to organise research visits to the management of any potential investment and have good access to company management in our Chicago office.
We would not visit a company like General Electric on site as there is so much research available it is difficult to add value.
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