By Dawn Francfort
The buy side’s main focus is performance. PMs and Analysts are evaluated on their performance vs. their appropriate benchmarks and the alpha created. The team’s performance is tracked daily and, therefore, how well the team is doing is very “black & white.” The starting point for the buy-side team is to:
Anticipation is Key to Driving Good Performance
The buy side wants to be ahead of the sell side, with their funds positioned to generate alpha before the Street research hits the tape. Therefore, when the first signs of a potential virus threat hits the news, smart investors were evaluating which holdings would be most at risk in case the virus was worse than originally feared. Avoiding “blow ups” in a fund is just as important as picking “wins.” A couple blow ups vs. the benchmark can destroy a fund’s yearly performance.
Evaluating the Current Portfolio Positions and Assessing Risk
With performance being top of mind, the buy-side team scrubs the portfolio to see which positions have the most risk in light of Covid-19. The team is thinking about total risk, including revenue, financial liquidity, cash flow, covenant, sector, geographic and trading liquidity. Depending on the mandate of the fund, the risks are ranked differently. For example, Equity Income Funds are very focused on dividend payments. These funds want to avoid potential dividend cuts, suspensions or withdrawals, as stocks historically get hit hard in these scenarios. Also, investors are focused on those sectors that will be the most negatively impacted by the event and would position the fund to be underweight those in anticipation of potential bad news. On the upside, the manager wants to overweight those sectors that are better able to weather the storm or that would benefit from the event. By now, most funds have adjusted their weightings.
Making a “Wish List” of Potential New Holdings
Market corrections can create opportunity for Investors. Companies with strong management teams, execution and balance sheets, and those that are good stewards of capital, usually trade at high multiples. Therefore, if those companies have a temporary slowdown in normal business trends, valuation multiples can contract significantly. A market correction can allow investors to build positions in those well-managed companies at a much more reasonable valuation. Therefore, investors create their “wish lists” of potential new holdings, ready to react when they believe the risk/reward is favorable. And during this process, the better funds will place a high importance on access to management teams and their answers to critical questions.
What Can Companies Do? – High Performers Control the Controllables
Management teams should:
Dawn Francfort joined ICR in December 2020 after 20+ years on the buy side including Foresters Investment Management, Chartwell Investment Partners, AIG SunAmerica Asset Management, Sursum Capital Management and Lehman Brothers Proprietary