Newly appointed PIMCO managers Anne Gudefin and Charles Lahr discuss the tried and tested formula for their new funds
Last week saw PIMCO launch their first equity offering into the UK retail space, the deep value PIMCO EqS Pathfinder fund and the PIMCO EqS Pathfinder Europe fund. The funds form part of PIMCO’s Ucits III Global Investor Series (GIS) fund range. The vehicles will be managed by Charles Lahr and Anne Gudefin, two recent recruits from Franklin Templeton.
In this interview, Charles Lahr explains the thinking behind the new funds and what the move to PIMCO meant for the management duo.
You are running the funds from both London and New York. What does this bring to the process?
Anne and I have worked together for many years and we have always worked with me in New York and her in London. Working in that manner, we are in constant contact and have local presence. Obviously, both these geographies are large but we have actual access into the markets.
I would go further and say PIMCO has a global reach that brings additional value. This has been part of our strategy before and we are happy to have it persist.
You have a global remit with one fund. Do you see a lot of emerging market opportunities?
Emerging markets are an area where we have invested before, and we have a deep value approach exporting to every corner of the globe. There are no restrictions, except we insist that what we invest in fits the qualifications of being deep value. Right now, in emerging markets there are some areas, some individual stocks that are interesting, but we are finding more compelling value in Europe.
Some stocks are down for good reason, however, many are down for no reason. This is the classic type of panic the market is having with the baby being thrown out with the bathwater.
Historically, as global investors, we have consistently found you get European blue chips with the same quality as any developed market and the same growth, but at a far lower valuation level.
Are particular sectors providing you with good opportunities?
Within the fund we identify value in a bottom-up stock-by-stock basis. But if you look at the aggregate sector where we are positioned, it reflects much of what is going on in Europe right now.
We are finding some outstanding value in consumer staples. We also have a reasonable weighting in certain financials. Not an overweight, but a market weight level. It is a big sector and globally, particularly in the US, we have found some interesting companies. Not only at the smaller bank level, but also in certain insurance businesses too.
What are your key triggers to buy a stock?
In the buy discipline we are looking to purchase equities at approximately a 30% to 40% discount of what we think is intrinsic value. We calculate that on a basis of an asset valuation approach – the value of the assets in the company net of the debt, or on an earnings or free cashflow base method with the appropriate multiple or capitalising cashflow at the right yield. That gives us the intrinsic value. The price is always the key criteria – what is the difference between the price and the value for that discount.
A lot of value in equities can be added by investing with the right management and understanding what management is doing. A number of triggers can be sought with management with a restructuring plan or a plan to return capital to shareholders, or plans to grow the business by acquisition. We have a three- to five-year time horizon and throughout the course of that time, which implies a 20% to 30% turnover level, there are a series of triggers through which we seek to release intrinsic value, and what management does in steering the company is one of those.
What about your sell discipline?
We sell when something has reached fair value or if thesis is broken and we are not comfortable with the upside downside relationship anymore.
How do you weight your convictions in the portfolio?
We would think of having 100 positions as normal, so a normal position would be 100 basis points. The top 10 is usually about 25% and a high conviction or a high risk-adjusted return potential equity would probably be a 3% position. Then you have a tail, from there after that top 10.
We invest in equities, but as part of the process we brought over from our former employers, which had a very specific 60-year old style with successful repetitive performance, we also invest in distressed debt and merger arbitrage to supplement returns.
Leverage is something we do not use, which is a frequent question on the merger arbitrage side.
What do you look for in merger arbitrage opportunities?
We are looking for safe, industrially driven, announced deals. In the current market you can earn an 8% to 12% annualised return on a lot of these and that is a great substitute instead of having cash.
In derivatives, we use different instruments to hedge out market risk, remove beta from the portfolio and focus on the alpha. These are used tactically, unfortunately most successfully in 2007-08, buying puts out of the money we were offered inexpensively. It is something we use tactically when we think risk is being mispriced.
In your quest for value stocks, how do you avoid the value trap?
It is something you have to keep your eye on and I suppose the crisis of 2008 and early 2009 was a good test for value traps. You were dealing with permanent capital loss.
Focusing on binary outcomes and avoiding them is a critical part of avoiding value traps, but a more normal market value trap is sometimes alluded to as being dead money. Part of it is buying the stock inexpensively and focusing on management that is aligned with delivering shareholder value. It is nice if you get paid to wait with a large sustainable dividend and actually working it through to the end. One of the tools we have available to us is to be active with a company.
It is something we use selectively, in a consultative role with a company to help release value. It is something we are experienced in and at some point, to avoid a value trap, certain actions should be taken to release the value.
Is there an element of behavioural finance to what you do, in the sense you are looking beyond what the market is pricing in on stocks?
We do like to take advantage of fear in the market in the form of buying and taking advantage of greed in the form of selling. That is all part of a process which is very focused on intrinsic value.
What do you see as the key growth drivers over the next two years?
In terms of the names we are investing in, growth can be something that leads to value. On the other hand, if we see something that has no growth and is still trading at a substantial discount to its intrinsic value it might still be interesting.
We are living in a world we at PIMCO call the new normal. Challenged volatile growth, more government involvement, higher taxes, stretched government balance sheets.
In this kind of backdrop we focus on companies with a solid bottom-up stock-specific ability to deliver growth or cut cost. We find a lot more potential for this in Europe because a lot of the US companies are already pretty lean. They also have the willingness to do this in the European companies and will have natural sustainable growth because of their dominant positions.
There is a lot of fear in the market at the moment. It started in Dubai last year, spread to Greece and now we are talking about Hungary. It is an interesting time to be a value investor.
Part of the benefit of being with PIMCO is to get access to some of the best minds in the world on central bank policy, macro economics and fixed income. All of these things are pretty critical to equity valuation. We have been able to avoid a lot of the names that are down for the right reason in Europe and get our sights drawn on names that are down for the wrong reason.
How do you cope with currency volatility?
We are definitely in the camp of hedging currency. We have flexible mandate when it comes to currency and right now we are fully hedged.
Once upon at time, Anne and I would struggle with the currency issue because it was not our area of expertise – at PIMCO it is.
