In this video [8min], Boston-based Lee Rosenbaum, who is responsible for managing over US$8 billion of dollars in global equities, discusses how the Loomis Sayles Global Equity Fund manages risk effectively to produce favourable investor outcomes.

This video and the content contained within is provided and maintained by Investors Mutual Limited (AFSL 229988). Investors Mutual Limited is the issuer and responsible entity for the Loomis Sayles Global Equity Fund. Loomis Sayles & Company, LP. is the investment manager. The information in this video is provided for general information purposes.

Peter McPhee: The Loomis Sayles Global Equity Fund is an active, concentrated global equities portfolio, unconstrained by style, sector, and geographical limits. These characteristics have been shown over time to generate value for investors. While valuable, a concentrated, unconstrained approach also makes effective risk management essential. In the following in-depth video interview, Co-Portfolio Manager Lee Rosenbaum discusses how the team manage risk effectively to produce favourable investor outcomes.

Peter McPhee: How do you think about risk, and why is it important to consider and manage it?

Lee Rosenbaum: We mitigate risk by aligning it with our core competency of conducting deep fundamental research. We want stock-specific risk, or idiosyncratic risk, to be the largest factor in our portfolio, because this is where we believe that we have the ability to add potential value for clients.

Our investment approach is unconstrained – we invest across geographies, sectors and even style to find the best ideas, typically 35 – 65 businesses. Having a concentrated portfolio, allows us to understand and quantify the opportunities and risks associated with each security. We believe that is essential to managing risk in a concentrated portfolio.

We do not invest in a company if we do not believe we have been able to effectively quantify the risks facing each business.

Peter McPhee: Can you give us a bit more detail on your fundamental research process?

Lee Rosenbaum: To fully understand and quantify potential opportunities and risks we utilise our three alpha drivers of quality, intrinsic value growth, and valuation to assess each company. These alpha drivers allow us to capture two market efficiencies – a mispricing and a duration effect. The duration effect is the value generated from compounding cash flows over time.

If we have conviction that a business meets our quality and intrinsic value growth drivers, then we conduct a discounted cash flow analysis as we believe it is an effective way to value high quality companies which can grow intrinsic value over time.

We establish a ‘base case’ scenario, which is what we consider to be the probable trajectory of the business; a ‘downside case’ which is the possible risks to our base case scenario; and a ‘best case’ outcome which is where potential events can exceed our ‘base case’ assumptions. We believe this scenario analysis a key component of our risk management.

Peter McPhee: How do you manage risk at the overall portfolio level?

Lee Rosenbaum: We utilise a proprietary relative risk profile tool, which plots a stock’s attractiveness on the basis of our scenario analysis and its contribution to downside risk. We use this tool to help determine what we believe is the optimal position size for a business in our portfolio. We strive for a portfolio that is diversified among our three alpha drivers. Sector and geographical diversification are secondary considerations to potential alpha opportunities. Where we are finding our best risk-adjusted alpha opportunities drives portfolio positioning.

Peter McPhee: How do you ensure that you invest in the best risk-adjusted opportunity set available?

Lee Rosenbaum: In our view, in a ‘best ideas’ strategy, capital needs to be ‘fungible’ across sectors and countries. We have a dedicated team, which works together collaboratively, to ensure we are investing in the best possible opportunities. It is also important to note, our team is compensated based on strategy level performance, rather than individual performance – and this compensation approach reinforces teamwork and aligns our interests with those of our clients.

A minimum of three people are involved in the research process for each business – both co-portfolio managers and at least one analyst – and our dual portfolio management structure requires unanimous agreement for all investment decisions.

It’s also important to note, we have strong idea generation processes. And we do this through the building of a ‘tracking list’, which is our list of high potential investment opportunities; and this list it allows us to react quickly when markets move to a risk-off mode.

Peter McPhee: What other tools do you use to manage risk in the portfolio?

Lee Rosenbaum: When appropriate, we can leverage our in-house research capabilities in both macro and credit research, which can provide valuable insights into an existing or potential investment opportunities. For example, we collaborated with our credit research team to further understand the debt and risk profile of one business called IQVIA during the onset of the COVID-19 pandemic.

We also have a firm level Investment Risk Management team; they work with us to understand our investment process and confirm that our portfolio positioning aligns with our strategy.

Peter McPhee: Are there sectors, industries, or types of companies you consider to be inherently more risky than others, and how do you manage this?

Lee Rosenbaum: We typically find opportunities across most sectors.

However, there are some areas of the market where we feel don’t offer as many opportunities, such as oil and gas exploration, and metals and mining. These companies are typically price-takers rather than price-makers, and don’t meet our quality attributes. They tend to have a high and unpredictable level of capital intensity, which reduces our confidence in their ability to grow free cash flow. We also don’t find many businesses in the utilities sector.

Peter McPhee: Some investors may be concerned with currency movements when investing in global equities. What is your view on currency risk and hedging?

Lee Rosenbaum: We do not believe we have any particular advantage in predicting currency movements. Therefore, our portfolio is unhedged. Our analysis has shown that currency movements, while they can affect the value of the portfolio over shorter time periods, over longer-term periods, this ‘washes out’. We believe our success is determined by our fundamental research.

Peter McPhee: Can you summarise how you manage risk in your portfolio? 

Lee Rosenbaum: To sum up we manage our active, concentrated, unconstrained global equity portfolio by focusing on our strengths, drawing from our deep fundamental research, ensuring we have robust idea generation, and using our risk analysis methodology to quantify risk both on the upside and the downside. Over time, this process has managed risk effectively and historically delivered favourable investor outcomes.