Allianz RCM's US Core Equity funds have been returning impressive figures with the portfolio outperforming its benchmark year to date. Tiffany Hancock looks at the company's unique investment approach
In an age when quantitative investing has come to the fore, an investment team that places more weight on its fundamental credentials is unusual. At Allianz RCM, Seung Minn, Kimberlee Millar and Shibin Xie are such a team. Heading up the US Core Equity desk, the team manage assets of $1.1bn (£532m), of which $573m (£277m) is in the Allianz RCM US Equity fund (Ireland) and $284m (£137m) is in the Allianz RCM Systematic fund (Luxembourg). Their results have been impressive: year-to-date against the S&P 500 benchmark, the portfolio has outperformed by 630 basis points.
However, as Christian Pachtner, head of client relations and international business development, explains, in order to understand the investment strategy for the US Core Equity team, it is important to understand the guiding principles behind RCM. Unique to the firm are the extensive Grassroots studies that it conducts.
"Our Grassroots approach is very unusual and is something that we have been doing since 1984. It is a research effort that is proprietary to RCM. Essentially it is about working with independent reporters and field investigators to provide us with certain information about market trends and certain companies," says Pachtner.
The firm conducts 40-50 studies a month and has 11 Grassroots employees on staff, with nine in San Francisco (from where all the US equity mandates are managed), one in Frankfurt and one in Hong Kong. These employees help co-ordinate the studies and devise questions for the reporters to ask. "Setting up a system like this takes a lot of trial and error but we've been going at it for a long time and have now set up more than 50,000 industry contacts. The barrier to entry for building a research platform like this is fairly high," says Pachtner.
Pachtner uses Apple Computer as an example of how the Grassroots study might work: "If you are a tech analyst interested in Apple Computer, then the potential sales figures for the iPhone will be a big variable in your earnings forecasts. In order to get a better grip on what those earnings forecasts might be, you might commission a Grassroots study with five questions. A team of reporters will then question customers leaving the Apple store and the results of that survey will influence the analyst's assessment of the earning potential." The Grassroots results are then examined in conjunction with what the management team have to say. As Pachtner says: "We're in a great position as we can then confront the management with those findings if we believe that their forecasts are way off."
Important though they are, the Grassroots studies are commissioned fairly late in the process for stock selection. The primary selection process is a quantitative one. The focus is on large-cap undervalued names and all companies with a market capitalisation of less than $2bn (£968m) are excluded. The process leaves 1,200-1,500 names to choose from and a composite score then ranks those stocks from most to least attractive and divides them into three groups: buy-rated, neutral-rated and sell-rated. This division is the only real limitation that the investment team faces. They can only pick stocks from the buy-rated category, and stocks that are brand new and don't have a history will never make it into the buy-rated group. From this stage, the analyst will conduct price range analysis (and possibly commission a Grassroots study) and then calculate the upside and downside potential. "We wouldn't buy a stock with a higher downside potential than 20%, which is fairly conservative but is something that has helped us enormously over the last few months," says Pachtner.
The portfolio holds between 50 and 80 names and has a tracking error of 3-7%. It also has a long-term average turnover goal of 50% a year. Within the portfolio, Pachtner estimates that 60-70% of the alpha comes from stock-specific risk while roughly 20% comes from sector-specific risk. "We are not about large versus small or one sector versus another," says Pachtner. "We want the performance to come from stock-specific risk."
Unsurprisingly for an investment team based in San Francisco, it is most overweight technology stocks (almost 9% over the benchmark) and is particularly keen on communications equipment, holding names like Cisco Systems and Corning. The other large overweight is healthcare. The fund is 6% over the benchmark in healthcare stocks, with a well-diversified portfolio that includes some of the big pharmaceutical names such as Johnson & Johnson and Pfizer as well as equipment manufacturers such as Zimmer Holdings, which makes artificial joints, and Varian Medical Systems, which produces radiography and radiotherapy equipment. In contrast, the team is heavily underweight financials and has been since 2002.
In good hands
Of potential concern for investors is the recent departure of Ian Clayton from the management team in early October. Xie is his replacement and is focused on the quantitative side of the process. Pachtner says: "I don't want to downplay Ian's role but Seung has always headed up the portfolio, so he was always the one making the final call. At the end of the day, he's the guy behind the product and he's been with RCM since 1998, so he has a good grip on things."
Management team and performance of the fund aside, another of the key issues for investors is whether or not they would want to invest in a US equity fund at present. Minn argues: "The US is a very flexible economy. I believe it might experience a little bit of weakness, going down to maybe 2% growth rates, but I do believe it is not going into a recessionary environment. I'm cautiously optimistic. I do believe that once again the stockmarket will offer about a 10-12% or 13% return for the whole of 2007, and we hope that next year will be similar."
Pachtner says: "Yes, the dollar is weak, and yes there has been turmoil in the financial sector. However, I would argue that if you are interested in a diversified portfolio then even as a European investor, you need to have exposure to the US market." In the case of the Allianz RCM US Equity fund, Pachtner points out that the fund has good downside protection and that the US large-cap stocks are all global in a sense - firms such as Coca-Cola make more than 50% of their revenue outside the US - and in many cases the weaker dollar plays to their favour. n
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