US equities have remained strong performers in recent months in spite of unexpected macro and geopolitical issues, and for Martin Flood, US portfolio manager at Lazard Asset Management, the outlook remains optimistic.
The manager notes: “On the economy, we’re entering the next phase of growth and we’re still bullish on US equities. One part of the economy [that has struggled] has been the working middle class, and there are signs that confidence has improved. We are still on a deleveraging mode that began in 2008 and that will continue, but I think we can grind along at 2-2.5 per cent [growth] for the foreseeable future.”
Of course, strong performance has led to higher valuations, leading some to ask just how many attractive opportunities remain.
Mr Flood acknowledges: “Valuations are not cheap. But we’re not buying the market, we’re buying stocks. The composition, the structural nature of the S&P’s margin has changed. Technology is a bigger component than 30 to 40 years ago. Structurally, margins have edged upwards and the composition of the index makes you feel a little bit more comfortable on valuations.
“It will be a market you have to stockpick your way around. Buying the market now is probably not a good idea, as if you buy the S&P500 then you’re buying all the overvalued stocks,” he says.
After 17 years in the US equity space, Mr Flood should know what he’s talking about. He originally started in public accounting, but his auditing work led to him being introduced to Lazard and after meeting people on the fund management side, he decided to move across.
Initially joining in a hybrid marketing client communication role – “someone who could talk to clients about their investments” – he moved to a purely investment role around 2000.
“We have five US strategies that have scale and I show up as the portfolio manager in every one. I act as the spokesperson for the US platform, but I am actually the portfolio manager for certain strategies, I’m the final decision maker,” he says.
For UK investors, Mr Flood acts as backup to Chris Blake on the Lazard US Equity Concentrated Ucits fund.
He notes: “There are 24 of us that focus on US equities and we run around $24bn (£18.5bn) under a similar investment philosophy. The only difference between strategies is the structure of the fund and the lead manager.”
For Mr Flood, one of the highlights has been the ability to “build the business in a very difficult environment for active management”, especially with the concentrated portfolio.
He explains: “We are growing in a very difficult environment to grow in. I think we can grow because this is a truly actively managed portfolio. Too many funds in the US are considered to be active but the reality is they are closet indexed portfolios charging an active fund, and if you do the likelihood of the client winning consistently is low. We have been able to create a strategy that has performed well in multiple environments and I think the client understands what they’re getting. It’s the way we describe the investment process and performance expectations both good and bad.”
The team follows a relative value philosophy instilled in a number of strategies across Lazard. Mr Flood points out this is implemented in the portfolio construction stage for the concentrated fund. But the process has undergone some changes, especially in the wake of the credit crisis.
“During times of stress, different sectors behaved very similarly even though you think of them differently. One of the enhancements we’ve made is we’ve limited our financial exposure in the portfolio. Coming out of the credit crisis, we had very little exposure to banks as they are inherently credit creators,” he explains.
“We’ve changed how we think about leverage, we’re more comfortable having leverage within consumer than in financials in this 20-stock portfolio. In a more diversified portfolio we’re more comfortable holding larger weights in financials. In this portfolio we’ve drawn a line in the sand and that’s an enhancement we’ve made to the process.”
However, there have been challenges in operating a concentrated portfolio: “The automatic assumption is if you’re investing in a more concentrated way you’re taking on a lot more risk. That doesn’t necessarily have to be the case,” he argues.
Mr Flood continues: “The risk with a concentrated portfolio is idiosyncratic in nature, stock- specific risk is your number one risk. The key for our concentrated portfolio is [the] way we think about risk. [We invest] large sums of money in companies we know a lot about, and have followed for some time and we’re patient with those investments. Then we complement them with businesses that have more volatility in the investment thesis, but that is reflected in position sizes.”
Another key tenet is not to allow any one theme to drive portfolio construction.
“The concept we’re trying to build is a public holding company structure. We view the portfolio as its own business and each subsidiary to the business is a stock and each stock has to do something different.”
While the concentrated fund has a small pool of between 20-25 holdings, Mr Flood highlights the overall resources of the US team.
“The analysts are the ones that do the heavy lifting around the companies. For every stock we consider in the portfolio, we view the base case, bull case and bear case. There are around 200 [stocks] held across the other strategies. We’re trying to find the best 20-25 that go together.”
As a result, he suggests the portfolio has a turnover of roughly 60-70 per cent a year, which equates to roughly 10-12 new names. “We don’t constantly need new ideas. We always have the ability to find something reasonably valued, so we have these 200 names and monitor the scenarios as information becomes available.” The manager also points out “you don’t want to be overly pessimistic or optimistic. That’s where you get yourself in trouble. If you’re overly pessimistic sometimes you don’t make enough money, and if you’re overly optimistic you’re staying at the party too late.”
Reasons for turnover include a stock reaching its upside position, leading to profit taking; a simple trade for a stock with a better risk reward; and in some cases stocks where the investment thesis becomes invalidated.
“We don’t need to be heroes. If we’re wrong – and you’re wrong a lot in this industry – we’re very quick to acknowledge those mistakes. As we have a fairly high bar to get into the portfolio, we’ll take that loss and move on. We have a very deep and wide pond to throw our fly in because there is a lot of coverage and a seasoned team.”
Looking ahead, Mr Flood suggests the priority is maintaining what the team already has.
“We’ve got a diverse client base that we want to deliver for and keep happy. This [fund] is a huge component of our team and for our success, it’s our most successful concentrated portfolio and the way the market is headed, its products that are different. We know the industry, for more traditional ways of asset management, is probably changing, so you have to be able to provide a solution that is repeatable and provides a level of consistency. Concentrated investing is nothing new, and we will probably see more and more products that are different from the index.”
Therefore future growth plans could include new ways for the team to expand concentrated investing in different equity strategies.
“So small and mid caps, could we do it there? Is there demand for a concentrated portfolio? What about a concentrated large cap portfolio? Maybe it’s something we could [develop] later,” he says.
“I would consider bringing a concentrated small mid-cap portfolio to the Ucits market. We’ve got to do work on it, but I think there’s demand there and we have a good team and process that could take advantage of that.”
CV – Martin Flood
2005 – Present
Portfolio manager/analyst on US and global equities teams
1996-2005
Joined Lazard Asset Management as an associate
1993-1996
Joined Arthur Andersen LLP as senior accountant