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October 13, 2014 01:00 AM

GARP managers hold firm on EAFE portfolios despite losses

James Comtois
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    Simon Webber said low interest rates in EAFE countries are causing investors to overlook growth companies in favor of income-producing investments.

    Some global growth-at-a-reasonable price money managers are coping with client losses stemming from underperforming Europe, Australasia and Far East strategies.

    Among the firms are Schroders PLC, Baring Asset Management Ltd. and Newton Investment Management Ltd., all based in London, along with GE Asset Management, Stamford, Conn.

    Still, these managers have decided to stay the course, since they — and consultants with whom Pensions & Investments spoke — see signs that conditions within the EAFE markets are changing in GARP investing's favor.

    “There have been dynamics in the global market going against the GARP approach,” said Simon Webber, lead portfolio manager for global and international equities at Schroders. “One of them has been the search for yield. Low interest rates, particularly in an EAFE context, have led to income-chasing and not necessarily growth companies.”

    GARP combines growth and value investing. Portfolio managers typically look to invest in companies that show consistent earnings growth above market levels but avoid companies with high valuations.

    Data from eVestment LLC, Marietta, Ga., show that Schroders' international alpha strategy, one of its EAFE strategies that uses the GARP approach, underperformed for the year ended June 30, but outperformed for the five- and 10-year periods. The strategy had $1.72 billion in North American institutional assets as of June 30, down 23% from a year earlier.

    Of the 28 EAFE equity strategies that use a GARP approach, 17 underperformed their benchmarks for the year ended June 30, according to eVestment. Of the eight that underperformed for five years, seven also lagged for the year.

    Four strategies underperformed their 10-year benchmarks; one of the four lagged for the year and one underperformed for five years.

    GARP strategy returns vs. benchmark
    Returns are for periods ended June 30; multiyear returns are annualized.
    Manager/strategy1 year5 years10 years
    Schroders/international alpha21.13%12.97%8.84%
    GE Asset Mgmt./international equity18.31%10.04%7.61%
    Newton/international equity 16.38%11.60%8.04%
    Barings/focused international15.35%11.54%9.86%
    Barings/focused international-plus14.15%N/A9.08%
    Benchmark: MSCI EAFE index 23.57%11.77%6.93%
    Source: eVestment LLC

    Two Barings equity strategies and one GE Asset Management strategy, all of which use GARP, have also been struggling.

    Barings' focused international and focused international-plus strategies and GE's international equity strategy underperformed for the year and five years ended June 30, but outperformed for 10 years, eVestment data show.

    Barings' focused international equity strategy had $1.74 billion in North American institutional assets as of June 30, down 8% from a year earlier. Its focused international-plus equity strategy had about $960 million in North American institutional assets, down 48% from June 30, 2013. GE's EAFE strategy had $7.23 billion in North American institutional assets at June 30 — down 7% — from the $7.79 billion the same time the year before.

    “Over the last several quarters, (we've faced) some challenges with respect to performance because market sentiment doesn't always coincide with our views,” said Michael A. Siciliano, Barings' senior vice president and head of sales and business development for North America, Boston. “Peripheral Europe has outperformed core Europe. There's been a low-quality resurgence in certain sectors around the globe, and that doesn't mesh well with our philosophy and process.”

    Still, Mr. Siciliano said Barings is “not looking to change gears” because “there's a lot of conviction in the process and in the team, both in the portfolio managers and our analysts.”

    GE spokesman Chris Linehan declined to comment.

    Newton's international equity strategy underperformed for the year and five years ended June 30 vs. the benchmark, but outperformed for the 10-year period.

    “We have felt that high cash returns would look attractive at a time when interest rates have been anchored artificially low in order to keep debt serviceable,” said Newton portfolio manager Paul Markham, London. “This hurt Newton's performance for the first couple of years of (quantitative easing) policies as investors drove up prices of risky assets on the basis of their cost of capital being low.”

    He noted the recent hunt for yield in the market has benefited the firm. “As markets have rallied and are now on much higher multiples, outright capital return may be harder to come by,” Mr. Markham said. “More of return will come from cash returns, rather than capital returns.”

    North American institutional assets in Newton's strategy were $2.04 billion as of June 30, up 48% from a year earlier.

    Global market conditions, including such geopolitical events this year as Scotland's vote on leaving or staying in the U.K., and Russia's military intervention in Ukraine, have led to macro factors being bigger drivers of stock prices than company fundamentals, sources said.

    Hilary Wiek, vice president and head of global equity research at investment consultant Segal Rogerscasey, Darien, Conn., said the EAFE markets haven't benefited GARP investors in the past couple of years because there's been a “disconnect between fundamentals and stock prices.”

    “The markets have just been whipsawed too much,” Ms. Wiek explained. “GARP managers tend to be quality managers. They're looking for good management with sustainable quality. I think they're finding good management, it's just that the markets aren't supporting those names.”

    Iain Douglas, investment consultant, head of Asia ex-Japan equity manager research and part of the global manager research team at Towers Watson & Co. in New York, said GARP is “not clearly defined (because) what a reasonable price is can vary from manager to manager.” Still, Mr. Douglas agreed the markets haven't been supportive of what could be categorized as GARP investing in international equities over the last three to five years.

    “So depending on how you define GARP,” Mr. Douglas said, “it may have been a detractor to performance.”

    Encouraging sign

    One encouraging sign for GARP EAFE investors that Ms. Wiek noted is the increase in global mergers and acquisitions transactions in 2014.

    “Private equity and strategic acquirers are not looking to overspend, so they're looking for growth at a reasonable price,” she said.

    Mr. Webber pointed out that although Schroders' EAFE strategies have faced some choppy waters while seeking growth unappreciated by the market, he sees no reason to change directions.

    “We've been doing this process for over 10 years and we know that it works,” he said. “What's important is to have a consistent process and philosophy. A portfolio built on these (value) companies will grow over time.”

    Added Ms. Wiek: “Sticking to your guns should pay off in the long run. It's just been a very long run where the stars have not been in alignment in (the GARP managers') favor.”

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