Fund managers who claim to only focus on bottom-up stock picking may still take an indirect view on macroeconomic factors – whether they like it or not – according to some experts.
It is quite common for asset managers to say that they don’t consider macroeconomic factors when investing, preferring to focus instead on company-specific fundamentals.
James Penny, chief investment officer at TAM Asset Management, said that about 90% of the fund managers that he meets will say something along the lines of ‘we don't have a macro view; all we do is focus on bottom-up quality stocks’
“While it is important that a fund manager looks through the macro volatility and concentrates on what they believe are good stocks, I also think being cognisant of the wider market around how your stocks are operating within is also really important,” Penny said.
“Understanding there are interest rate rises, understanding if inflation is moving in one direction, what is QE [quantitative easing] looking like, what are treasury yields looking like – importantly how are they going to feed into the performance of your stocks?
“I think sometimes it can be a little bit flippant of managers to say, ‘Oh, well, we don't consider any of those factors at all.’”
Penny suspected that many fund managers do consider macroeconomic factors when investing, but would rather claim they do not, so that they can avoid a lengthy macroeconomic debate with their investors.
“I would be very surprised if managers ignore the macro as much as they say they do,” he said. “I think that they just don't want to get into it when they talk to clients.”
He said that when fund managers talk to investors and express a macroeconomic view, they run the risk that the investor will disagree with that macroeconomic view and will therefore not invest with them.
“Whereas if you just ignore all of that and focus on how good you are at picking stocks and how good you are at evaluating companies, you kind of get to bypass that debate stage,” he said.
“At the end of the day when they talk to clients, they want to leapfrog the general discussion and get straight down to the nuts and bolts of how their fund is constructed.
“I do understand that, but I do think that there's a reason why investors want to talk about the macro, because it does feed into portfolio management and it is extremely important.”
While it is important to build portfolios from the bottom-up, investors cannot do it in a vacuum, especially when there are shifts in the macroeconomic environment.
This is according to David Polak, investment director at Capital Group, who said that the level of inflation and therefore interest rates have a very powerful determinant on the valuation that the market is willing to accord companies.
He said: “If you're buying banks without a thought on interest rates going forward, then you could buy the best bank, it isn't going to matter.
“If you've got a portfolio full of really interesting growth companies and you're really confident with the fundamentals: they can all hit their earnings number in fact probably surpass it – but rates shoot up – it isn't going to matter.”
Polak explained that if the discount rate that investors use to value stocks goes up enough, how far into the future the market is willing to price in earnings comes right in.
“The market says: ‘Oh I was really happy to think about how many cars a company can sell in 2030, or how many eyeballs they could attract in 2030, but now interest rates have gone up and I run the mathematics, actually, that means I really need to look at 2025.’”
He warned that this can lead to a “big air pocket” where nobody wants to buy the stock. This is a concern for those that have got carried away with extrapolating into the future.
“The problem is it's very easy for us to say ‘well, we're long-term investors so we just hold our nerve’. But people are affected when something falls a lot,” he said.
Penny said he values a fund manager who is willing to discuss macroeconomics and how it feeds into their stock picking, but admitted that they a rare minority.
He said: “When macro helps them, they say ‘we got it right’. But then when it doesn't help them, they say: ‘we're not interested in macro, it's not something that we're paid to look at’.
“They want all the accolades of bottom-up stock picking without being engaged on any of the trickier issues, which are often macro ones.”