It’s easy to follow the crowd into some of the world’s largest and most expensive companies. It’s much harder to invest with a contrarian focus on the metrics that really matter. Investing from a global universe of 15,000 stocks across Australian, Global and Emerging markets, Andrew Francis, Chief Executive of $32.2 billion investment firm RQI Investors, shares his learnings about the mistakes that weigh investors down in global markets and the unconventional yet telling data his team focus on.
Passive investment strategies are popular and cheap. However, we believe they don’t necessarily provide adequate diversification and will not shield investors from bubbles and crashes.
Owning market cap indices can overexpose investors to some of the world’s largest and most expensive companies.
And index concentration is now higher than ever before. By index weighting, just 7 technology firms account for more than 30% of the S&P 500.
These concentrated positions amplify risk during market downturns.
The recent slump we saw in Chinese indices after rallying 30% prior to Golden Week is another reminder of the behavioural biases that exist in markets.
Share prices constantly change their mind, mood and expectations. They can be overly optimistic on the upside, incorporating overly imaginative future cash flows into prices and overly pessimistic on the downside, extrapolating the bad news into the future.
Avoiding inflated stocks and market fads can provide a robust defence against the kind of price bubbles and crashes that have plagued markets throughout history.
The real price of passive
Over time, index investors will also find themselves progressively underweight to the cheapest stocks. Whether or not these companies are creating shareholder value with solid fundamentals. As Warren Buffet has said, ‘the stock market is the only place where items go on sale, people run out the door’, and that is what index investors are doing.
We know the metrics that matter include company fundamentals such as healthy sales, book value, cash flow, and dividends.
Weighting by these fundamentals – rather than how popular the underlying stocks prices are – can result in an investment portfolio that is steadier across market cycles, avoiding the noise associated with prices.
The resulting portfolio is more attractive than the index with a higher yield, cheaper than the index, and can provide a robust defense against bubbles.
This approach is inherently contrarian but highly effective over time.
The perils of a bias for unloved stocks
There are risks when taking a contrarian approach. An investor must have the discipline to take profits from their winners and buy into underperformers with potential to recover. The systematic approach that RQI takes allows for effective rebalancing of the portfolio.
However, one of the most significant risks we seek to avoid is falling into value traps – stocks that appear cheap based on surface-level metrics – but are plagued by deeper, often unfixable, issues.
This is where technology – and increasingly sophisticated data sets – come into play, combined with people who have the insights to use data and technology. And this is what sets RQI apart from other value managers.
Avoiding the value traps
RQI identified Credit Suisse as a value trap before the bank’s well-documented struggles became public and the company folded into UBS in 2023.
In addition to scrutinising traditional financial metrics such as profitability, we use AI to assess the tone and sentiment of management earnings calls.
We found that nervous management teams tend to use longer sentences, complex words and lighter use of numeric statements when trying to conceal future negative financial performance.
We continue to explore this area of research to aid selection of stocks with true recovery potential.
Sweeping non-traditional data sets at scale
Our experience has shown non-traditional data sets hold signals that can be dramatically predictive of future stock performance.
Our team consider areas such as management transparency, diversity metrics and carbon efficiency when choosing companies to own and avoid. This holistic view can provide a more accurate picture of a company’s operational health.
A smarter way to invest
Whether you’re looking to diversify your portfolio domestically, globally or tap into emerging market opportunities, RQI provides a disciplined, data-driven approach that has consistently outperformed benchmarks across multiple regions and market segments over the long term.
RQI Investors, formerly Realindex Investments, is part of the First Sentier Group.
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