The Case For Active Equity Investing – A Fund Manager’s Perspective

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TRANSCRIPT

Oscar Pulido: Welcome to The Bid, where we break down what's happening in the markets and explore the forces changing the economy and finance. I'm Oscar Pulido.

Active equity investing isn't just about picking stocks, it's about making informed strategic decisions to beat the market or generate alpha. But what does that really mean for your portfolio, and how can you consider long-term investing strategies when faced with volatile markets?

Joining me live in London at BlackRock's annual UK Wealth Investors Forum is Alister Hibbert, head of BlackRock's Strategic Equity Team. Alister will help me explore the nuances of active investing, how to be selective when considering companies for a portfolio, and how to think long term when faced with short-term headwinds. We'll also discuss how to identify opportunities in various sectors and what it takes to stay ahead in the ever-changing market landscape.

Alister, thank you so much for joining us on The Bid.

Alister Hibbert: Thank you, Oscar.

Oscar Pulido: So, Alister, you're a professional fund manager, a stock picker, an active equity investor. I think all of these terms apply. Tell us a little bit about what does that actually mean day-to-day?

Alister Hibbert: When we start each and every day, we need to remind ourselves that the equity market is the richest, broadest, and deepest opportunity set that there are in financial markets, you know, and therefore and therefore it dwarfs the opportunities that you can find in any other asset class.

And within that equity market construct over a long period of time. And I'm thinking here, five to 10 years. Most companies will not do anything particularly surprising. They will do well, as the overall market does well, but they won't be astonishing, and they won't create one of those huge opportunities that are marked from time to time, which is what we're really looking for.

So, if we think about that, we try to ignore all of those companies, which are probably going to be relatively average over a long period of time. And then we need to find those companies, which are going to be extraordinary. Those are the best businesses that we've found are in the entire of the world's equity markets. They're typically great franchises with huge barriers to entry. And if we can identify those and own them over a long period of time, they do extraordinary things as they compound.

Oscar Pulido: When you try and focus on those, extraordinary franchises, it sounds like you're trying to be very selective as you look at perhaps hundreds and maybe even thousands of companies that are out there in the markets. What do you mean by extraordinary franchises and how do you get selective when you look at the equity markets?

Alister Hibbert: Yeah, I think that's a very important starting point. So, what we'd say is that the world changes massively over any given decade. Nearly all the time analytically, we would not have a view about how a company would look that far into the future. So, a starting perception, if you will, is that this is incredibly rare and out of all of the thousands and thousands of securities that we've analyzed over all of the years, there's clearly no more than 50 companies that we would ever focus on and believe we had strong conviction about them being fabulous franchises for the future over that kind of a timeframe. But where we find them, we think they're demonstrably enormously undervalued because the investment universe and the entire of the market is looking at a much shorter duration outcome.

So, these are special businesses, and they could be things like brands in the luxury good space, for instance. Or they could be incredibly well embedded technology companies with huge barriers to entry and switching costs and all of these kinds of things. So, there are not many, but those companies are truly spectacular. What we're looking for are companies that will grow ahead of global economy over the long term but with those high returns and those high returns being sustainable, or in fact even, likely to go up over that 10-year period. If we can identify those, we think there's an enormous opportunity there.

Oscar Pulido: So, you said the short list of companies that you look at can be about 50 companies. So, you really do start to narrow down the universe quite considerably. How do you deal with the headlines around geopolitics or around central bank policy? These are a lot of the headlines that tend to dominate the day-to-day, which is what is going on at the macro level, so how does that impact what you're doing at the individual company level?

Alister Hibbert: There's a lot of noise in markets and I think we need to be thoughtful about that. Over time, of course, there's been more volatility and more noise because of changes within the structure of the market. There are more data points about now, it means that stocks go up and down really quite violently from time to time in a way, which is pretty unpredictable to be honest over the short term. And so, when we think about these issues, we need to be very steady about it. We need to thoughtfully pick through all of these changing narratives in the market and try to understand which of these actually will have an impact on this business over a longer period of time. And if the answer is that this noise is not going to impact on these companies to any significant extent, then we need to hold steady and we need to be calm. And we need to let that volatility play itself out.

Oscar Pulido: You talk about volatility, we are in an environment where inflation is high one moment, and then it seems to be declining and maybe it's okay, and interest rates are rising and now they're declining, maybe we're in a recession, maybe not. There is a lot of volatility in the headlines, in the macro data. So, does that mean you have to manage equity or stock portfolios differently through these types of regimes that we're in?

Alister Hibbert: Not really, no. We need to still remain steady handed. This year alone, we've seen multiple of these narratives, and we describe them as false narratives. And when they appear almost overnight, they become a strong consensus and they're very easy to fall for, which is why a lot of these narratives ultimately lead investors astray.

We've had that, for instance, in April when we saw the March CPI print, people really worried about core services within that, which started to re-accelerate. Then suddenly there was the cry for sticky inflation. The question is, how do you see through that? Because that wasn't what you were seeing, it just appeared to look like that, and it fit a very overly simplistic narrative. What you really saw was that auto P&C motor insurance was very, very strong. And that's because it's the last part of the repricing chain. If you crash your car, the car now to replace it is much more expensive than it would've been. The insurers didn't see that coming, and so they needed to rebuild their price architecture. That process in the US was slowed down by national state regulators who were worried about these big increases in premiums that were required. And as a result, the real question is not 'is there sticky inflation?' but 'what's happening in auto P&C insurance?' And when you start delving at the company level as an analyst, that there's nothing strange going on, everything is understandable, the industry does not look any different from the way it was historically, and this company and these industries do not have infinite pricing power. So, it's not indicative, in a way that supports a notion of sticky inflation and therefore the answer is we have to do nothing about it. And if we do anything at all, it's just to lean in the other way. But these narratives, if you will, they appear much more frequently now than they used to. We just need to be very cautious, and we need to exercise some proper critical thinking.

Oscar Pulido: And just listening to you, it sounds like you have an incredible amount of patience and ability to maybe ignore some of the noise that is out there, these narratives that exist. And going back to that list of extraordinary franchises that you look at, these companies that have a competitive advantage – is there a psychological or emotional component to being a good active equity investor, a stock picker, that you have to possess in order to be able to ignore that noise?

Alister Hibbert: I think so. The stock market is flawed, right? And it's flawed because it's been built and the people who are active in it are humans and human beings are flawed with behavioral flaws. And that is something that you then see magnified time and time again around market moves over the short period of time and that's something that we need to be on our guard for.

So, at BlackRock, we work with behavioral psychologists to try to understand this, in particular, issues around myopic short-term decision making, which is the kind of thing which plagues active managers. I find it incredibly interesting that there's a huge contrast between fund managers who are running active portfolios in the equity market and those who work in private equity, and that itself is telling you there are behavioral issues.

And so, what do I mean by that? I mean that if we go into a cyclical downturn for a company, if we're a private equity company and we own this business and it's in a cyclical recession, that's fine, we're not going to sell it, we're going to wait until things are better, and then we'll dispose of it at that stage when all things look much better. So, you'll almost never find a private equity specialist who would sell in a downturn.

And conversely, if I go to public active equities, you'll almost never find a fund manager who won't sell in a cyclical downturn. And inherently that is all about this issue of short-term myopic decision making. What that is, of course, is loss avoidance and the market is bullying you out of your position, and you need to be on guard for that at all times. You need to try to consider where will this company be over time and be clear about the one truth, which is often forgotten at moments of stress, which is that if this is a cyclical problem for a company and it is just a cyclical problem, then over time it's all going to be sorted out anyway.

Today, if you think about your perspective over Covid, there were many stressful moments over Covid in the stock market but actually the world is fine and the world should have been long equities at all stages, but people got whipsawed by a lot of these shorter-term considerations. If it is cyclical, it's self-healing, so stop worrying about it.

Oscar Pulido: And part of why you get bullied out of your position in the public markets is that the price is public every day, so you know what your mark to market is on any given day versus the private equity investor who may not know exactly what the value of their investment is on any given day. They might have a rough estimation based on some comparables, but it sounds like the public market bullies you out because of that day-to-day transparency.

Alister Hibbert: Absolutely, and let's be clear, it's a great asset. It means that we can change our mind very quickly and very readily. However, that comes with a lot of these behavioral pitfalls, and we need to be on our guard against making sure that we're not making these short-term decisions. Why would a public active equity manager sell a company in a cyclical downturn? Because they're worried that the incremental set of results is going to be weak, that there will be earnings downgrades, and are worried about the near-term market to market loss. However, on a 2, 3, 4, 5 year, or longer basis, actually these things just won't matter whatsoever, and the risk is that the portfolio manager in that instance would sell the security for cyclical reasons and would never buy it back and therefore rob themselves of an amazing opportunity. And this nature of being whipsawed within stock markets is as furious today as it's ever been. And that is the biggest downfall for active managers.

Oscar Pulido: And so basically what you're saying is, thinking a little bit more long term has benefits and that's part of what you're trying to implement in your approach. Maybe we can come back to the economy for a second. We've been in this period of growth is still strong enough, but some people feel it's weakening, maybe we're entering a recession, it depends on what part of the world that we're talking about. How do you think about the economy overall, its impact on the equity markets, as you think about investment opportunities?

Alister Hibbert: Yeah, that's our day job is to try to understand our way through what's going on in the economy. But we would do that in a very different way from most fund managers. Most fund managers believe that we need to look at top-down variables in order to get a feel for what's happening. They make forward looking judgements frequently.

Those really don't pan out. We're sitting here now in 2024, it wasn't so long ago that we were at the beginning of 2023, and you would scarcely manage to find an economist or a strategist who did not believe that we were in a bear market and who did not believe that we were going into recession. Now, the reality is that there's an overly simplistic way of thinking about the path of the economy, and we can do it by looking at the whole system. So instead of just looking at these limited macro top-down data, we talk to all of the companies which make up all of the industries, which in their entirety are the economy.

And it's in there that you'll find the key and the message that you need in order to understand, are we going into recession or are we not going into recession? And at the beginning of 23, in our Outlook pieces, we are very clear. We said we thought that the market had bottomed in October and that we needed to be long. The market, that soft landing narrative was there and there was a very powerful disinflationary cycle manifesting. And that was informing our overall positioning, and we were very constructive at the time. And so, the question is, what do we see that others don't? Well, I think the first thing I'd say is that our ability to forecast is no better than any economist or strategist, but what we can do is talk to the companies and find out exactly what is going on. And that gives us a very high conviction, evidence-based process, and that will help us navigate through cycles.

So, if I go back to that issue around inflation, at the heart of all inflation concerns has always been the US labor market. Will wage growth decelerate to a level consistent with the Fed's target, or do we need a recession to get to that place? And that's something that we would spend a lot of time talking to companies with because it's companies that make the decision whether or not to up people's pay. And so, they would be looking at their own internal data metrics that they're looking at, the number of unfilled vacancies. They're looking at the job turnover and how many people are leaving the organization in any given quarter. And that will inform their decision making. So, we would track what's happening in the labor market, via the eyes of the companies who are actually having to make the decisions, which then eventually will form into those macro variables that people are so incredibly excited about.

And if I go back to the last 18 months, if there is going to be a recession, we will find it. We will find it in a cyclical area of the economy where things are deteriorating really terrifyingly. And that is not the case today. It was not the case in the second quarter earnings season. We've now seen September, which gives us a lot of information from conferences that companies attend. We're not expecting any major shocks coming through in the third quarter earnings season either. And if we look at big building blocks like construction or auto, it doesn't really look like there is anything particularly significant going on.

And the underlying resilience of the economy has really come from the fact that there are no imbalances in the private sector. And the reason that we have had recessions historically is because there's an imbalance in the economy, the Fed hikes rates, and then the economy has to go through a recessionary process to rebalance itself.

And you will see that either in the corporate sector or in the household sector, and you couldn't see either of those happening over the last couple of years, which is the core reason why we've gone through a strong tightening cycle, but the economy did not suddenly crash. And it's just much more resilient this time around. So, we certainly don't think there's any recession, and nor do we think there's any inflation left out there.

Oscar Pulido: And it's interesting just to hear you talk about how you use companies and the discussions that you have with companies to inform a lot of your view around the economy. So, I'm curious, when you talk to these same companies, what do they say about some of these mega forces that we've been talking about on The Bid, things like aging demographics, things like artificial intelligence? Do these structural drivers of return that the BlackRock Investment Institute has talked about, do they come up in the conversation with companies and are they influencing maybe some of the investment themes that you pursue?

Alister Hibbert: Absolutely, there's no shortage of management teams who want to explain how they're the beneficiary I promise you that has not gone unnoticed in the C-suite of the Western corporate sector. And if I go back to that core tenet of, what is it that we look for as stock pickers when we're thinking about these longer duration holdings.

Sure, we want companies with high returns, and we want them to be able to sustain those returns over a long period of time, which is why they're undervalued. They're discounting, and the share prices are discounting a fade in those returns over the long term. But we also want a good reinvestment opportunity, i.e. we want them to be able to invest and grow, at least in line with the global economy, but hopefully a little bit more. And that really is where you start seeing these themes come through.

So, it could be artificial intelligence, which is in an incredibly strong position right now. There's a lot of uncertainty about where that will be in three- or four-year’s time, but make no mistake, right now all of these companies are all in on the AI investment thematic. And even if they don't have immediate revenues to prove the return on that investment, that is not going to stop them from doing this investment so long as they believe that the large language models are going to continue to scale, this is an arms race and none of them are in a mood to give up on that and hand that opportunity set to somebody else.

You see it in other areas, weight loss drugs, with some of the positions in the companies involved, which are incredibly interesting. That creates an enormous amount of value for people over time. So, these trends are incredibly important. They really link into what we're trying to do because those trends are the reason why we think there's a good reinvestment opportunity, and we always have to remember it's not just high returns, but it's the degree that you can invest at those high returns that really generates the overall growth of the franchise and all of the compounding that we're looking for.

Oscar Pulido: So Alister, you've been an active equity investor for I think over 25 years, so you've been at this for a while and I guess my question for you then is, what keeps you excited about this space and as you look out to the long term, what is it that keeps you energized about continuing to look for these companies?

Alister Hibbert: It remains always the most fascinating occupation of them all, and you know that in that equity market, somewhere in there, there are the keys that can create extraordinary return potential for us and clients, and that is the reason to get up and go searching every day. If I think about these long duration compounding companies that I've been talking about – I've sat there based out of London originally as a European fund manager, now as a developed world global fund manager, but I've been watching Bernard Arnault, who's the principal owner of the LVMH conglomerate, that's home to Louis Vuitton and Dior, and all sorts of other fabulous luxury brands. Now if you go and trace that story to its origin,

That is what equities have, and that is why it's a more powerful asset class than anything else you can find. Obviously, you need to be active if you're going to find those types of opportunities. And it's the search for that, which is obviously the most important thing and the most attractive thing about the job. And my wife always reminds me, you have to think about investing both as your job but also your hobby, and she's completely right.

Oscar Pulido: Equities are a powerful asset class. They provide the potential for good long-term return. But it sounds like you also have to have patience in order to see some of these returns play out, which is something, Alister, that is coming across clear that you have.

Alister, thanks for sharing these insights and thank you for doing it with us here on The Bid.

Alister Hibbert: Great. Thanks so much, Oscar.

Oscar Pulido: Thanks for listening to this episode of The Bid. If you've enjoyed this episode, remember to subscribe to The Bid wherever you get your podcasts.

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