What differentiates VFM Global Macro Fund from the rest?

March 2020

We put the following questions to Tony Bell, fund manager of the VFM Global Macro Fund to understand what differentiates this fund from the rest:

 Can you outline your investment philosophy for the fund?

Global macro has two points of focus. The first is to identify companies within the global universe who are or have the ability to increase the rate of change in earnings growth. The second point of focus is to aggressively manage drawdown risk. The philosophy behind the first point of focus is that alpha is generated not by forecasting earnings one, two or three years ahead, but correctly estimating the rate of change of a company’s earning a priori. It is common cause that “the market” already knows about consensus estimates and any change to these, so using these estimates as a basis for generating alpha in the global universe is not productive. In their seminal paper Gleason, Johnson & Li  entitled “The Earnings Forecast Accuracy, Valuation Model Use, and Price Target Performance of Sell-Side Equity Analysts” in which they studied 136 000 forecasts, found that unless an analyst was in the top decile of the top decile of forecasts the ability to produce alpha consistently was limited. But what if there was a way to isolate those companies that could deliver the alpha every manager is after?

 And the excellent performance of this fund in particular?

Global Macro has delivered on its philosophy by successfully integrating alpha generation and risk management. Howard Marks, in his much publicised newsletters to clients, speaks of the difference between simple and complex analysis. Simple projections, based on a variation of consensus earnings, is unlikely to produce “alpha”. In most cases alpha is a product of portfolio weighting schemes rather than uncovering some hidden “value” in a stock. In the global macro world we seek out those companies that have a combination of several distinct profit drivers, namely;  Industry, X Factor, Brand, Product, Position, Price and Margin combine with Distribution and Economic Leverage to deliver Free Cash Flow. The latter forms the basis of VFM’s  analysis into the potential for an improved Return on Equity. When one or more of these factors change, VFM reviews the investment case and often begins to proportionally reduce his position in the stock.

 Could you be a bit more specific by providing an example?

At its inception in 2013 VFM identified Amazon as a stock with a great deal of earnings potential. But the investment case seemed “baked” into the numbers as the price:earnings multiple at the time was around 250x. Most analysts (and clients) questioned whether this stock should be in the portfolio let alone the top holding. The “key” to unlocking the investment case for Amazon lay in working through the cash flow statement linked to the income statement. It was patently obvious that earnings were being understated, but how? The answer lay in the cash flow being used to fund an, as yet, unknown business – Amazon Web services. The rest is history as the saying goes. VFM started to lighten its position in late 2018 and held no Amazon until recently. Not surprisingly when Amazon revealed the “existence” of AWS almost all analysts increased their estimate of earnings and changed their recommendation to a “buy”.

 What hasn’t worked out quite as well?

After a protracted period of success, Bristol Myers Squibb failed to get one of its new development drugs approved. The price declined by 40% almost overnight and has not quite recovered. In this case position sizing is everything and reminded us that pharmaceutical businesses are extremely risky and need to be well diversified within the portfolio

 According to your February 2020 fact sheet, you had the fund relatively defensively positioned, with 30% in offshore cash (US dollars). Was the virus a factor, or had you taken a defensive stance before the onset of Covid19?

The virus was a factor. But more importantly VFM had identified the “freeze” in the interbank market in the US during Q4 2019. Based on experience, VFM closely monitors the transmission mechanisms in liquidity between the primary and secondary markets. Loosely defined, the primary market exists between a Reserve Bank and the Commercial Banks whereas the secondary market exists between the Banks and Companies/Individuals. The sub-prime crisis of 2018 occurred in the secondary market where banks had become overzealous in granting credit to home buyers. In late 2019 the primary market started to freeze as banks themselves had extended their leverage in certain transactions and were running their reserve ratio’s so tight that any increase in interest rates would push them into a delicate liquidity position. It should, therefore have come as no surprise when the US Federal Reserve started to raise interest rates in 2017 that a point would be reached where US Banks would run into trouble. VFMnheld the view in January 2020 that the primary risk to equity markets was a liquidity crunch as the volatility of overnight rates in the interbank market remained persistently high. The spread of CoVid 19 exacerbated the downturn by annihilating the earnings growth prospects of a number of sectors.

 Any other comments, perhaps around finding buying opportunities post the big market movements in March?

Buying opportunities should be seen against the background of a very rapidly changing macro-economic picture. VFM’s primary concern at this point is contagion risk sweeping across the US and the lockdown period that may be required in the UK and other parts of Europe. We may well be in the first phase of moving from a liquidity crisis to a solvency crisis. But it is simply too soon to tell. VFM has increased equity exposure from 55% mid-March to 68% as risks appear to have ameliorated somewhat with the instruction of the Fed’s unprecedented stimulus package. But risks to this picture remain. The US is far from the levels of quarantine needed with many opinions varied as to whether this is even necessary. Vigilance remains the watchword.