Global equities: Systematic approach highlights unloved areas

Our approach to investing is based on our belief that inefficiencies exist in global stock markets because investors do not always act rationally. This creates opportunities.

We think the most efficient way to identify the best of these opportunities is through a rigorous quantitative process. We use a screening tool, SmartGARP, tried and tested at Artemis over more than 20 years. In essence, the process aims to find and invest in undervalued stocks that have improving fundamentals.

From a universe of around 7,500 global companies, SmartGARP helps to identify companies that are growing faster than the market but are trading on lower valuations than the market average. Ideally, these companies should be enjoying strong and consistent upgrades to profit forecasts and be under-owned by the investment community, while at the same time benefiting from helpful macroeconomic trends.

Companies are scored on eight factors (macro, investor sentiment, growth, valuation, estimate revisions, momentum, ESG and accruals) and ranked out of 100. Those that score over 90 can potentially be included in the portfolio but first need a further check. Because we recognise that all quantitative processes have their inherent limitations, human judgement now comes into play. Together with my co-manager, Raheel Altaf, I carry out due diligence on each stock before investing. The process promotes timely – and often against-the-trend – decision-making. This creates a portfolio that often looks very different to other global funds.

Favouring emerging markets…

For example, the fund currently has a pronounced overweight to emerging markets, in particular China. In these Asian markets, inflation is much more contained and economic policy is more supportive than in developed markets. The Chinese market has also seen a particularly wide dispersion in valuations, which has produced some interesting opportunities at the value end of the market.

Our largest Chinese holdings are not the index heavyweights you might expect. They include PICC Property, the leading property/casualty insurer in the country. Motor vehicle and health insurance are growth drivers, with insurance demands from an ageing population increasing. Yet the stock trades on a p/e of 5.3x, with a dividend yield of 7.6%*.

Other large Chinese holdings include China Railway Group (a play on Chinese construction and infrastructure build) and Bank of Communications (a major Chinese bank). This overweight to emerging markets is balanced by an underweight to the US. It is slightly overweight Europe and we have recently added to Japan.

Value bias

The nature of the SmartGARP screening tool means that the style bias of the fund can change over time. Over recent years, for instance, it has had a very pronounced value bias (see the chart below). As at the end of August 2022, the fund traded on a P/E of 6.8x, vs. 14.1x for the MSCI AC World, that is, a 52% discount to the market and one of the cheapest among its peers investing in global equities.

This value tilt is reflected in regional allocation, such as the overweight in China, but also in the fund’s sector allocation. The fund is overweight unfashionable areas such as banks, insurance, construction and energy and underweight technology, retail, healthcare and industrials.

Following the SmartGARP process meant that the fund did not chase the highly rated growth (particularly technology) stocks that drove the market over the last few years. This obviously held back performance at the time. But it also insulated the fund from the big sell-off in these types of stocks this year. Meanwhile, as growth stocks continue to derate, if their fundamentals remain sound they may look increasingly attractive on the SmartGARP screen and start to come back into the portfolio in greater numbers.

Looking ahead…

For the medium term, the backdrop of high inflation, its associated monetary tightening by developed market central banks and persistent geopolitical risk suggest caution. Against this backdrop, our fund’s bias towards cheaply valued, relatively stable businesses continues to be warranted.

Fundamentally, we make money for clients by investing in companies whose earnings grow faster than those of the market average. Valuation changes can act as headwinds or tailwinds in the short to medium term, but in the end superior growth of company fundamentals such as earnings, cash flows, book values etc will win through.

While the outlook for equity indices may be muted, however, we continue to believe that there are some segments in the global stock market where the gap between low valuations and strongly improving fundamentals remains wide and exceptional opportunities exist.

Our investment process, SmartGARP, has been designed to bring to our attention instances when companies’ share prices and their fundamentals diverge. As highlighted above, these opportunities are at present concentrated especially in emerging markets, where, in a number of countries (notably China) inflation is much more contained than in developed markets.

The upshot from this is that even if global equities struggle to make progress the opportunities to generate outperformance remain, in our opinion, unusually plentiful.

Peter Saacke, manager of the Artemis SmartGARP Global Equity Fund

* FactSet as at July 31 2022.

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