Phillip N. Davidson, CFA, Chief Investment Officer U.S. Value Equity
Benefits can accrue from the ongoing use of an investment process that works. Adopting such a regimen requires upfront consideration of investment goals extending beyond an investment policy statement. Adhering to a systematic approach demands diligent attention and perseverance so as to not capitulate. The result can be very desirable – a durable portfolio, able to deliver attractive relative performance over the full course of business cycles.
Investment Processes Worth Repeating
It can be said that the goal of an investment process is to generate desirable risk-adjusted returns. If this goal is met, the logical extension is to make this process repeatable so as to replicate the results. In order to create and maintain a repeatable investment process that works, it needs to be both understandable and capable of generating desirable performance contours over longer time periods.
First, a viable investment process needs to be well understood by its managers and should be congruous with the investment’s stated strategy. Comprehending the capabilities and allowable flexibilities of the process are crucial to current and long-term performance. As market conditions change, it makes good investment sense to not leave circumstances to chance but to instead consistently apply the strategy’s process. A random act that works out well in one period has no rational basis for success in a new period. Additionally, managers need to be able to articulate the process to investors. This can foster appreciation for the care that is shown toward investors and their capital.
Second, a feasible investment process needs to result in acceptable risk-adjusted returns over the full course of business cycles. These results are even more highly desired when they are delivered with relatively low volatility. Granted, investments have up and down phases. Therefore it’s important that managers explain to clients how the pertinent portfolio is expected to behave. A good process will possess features that help make it apparent to managers why the performance exceeded, met, or fell short of expectations. When an investment process has proven to be capable, is well understood, and is carefully adhered to, it faces the best opportunity of generating attractive long-term performance contours.
Value Investing
Before proceeding we note that value investing holds no exclusive claim to the use of repeatable investment processes. Repeatable processes have useful purposes for all investment disciplines. Here, we briefly highlight why repeatable processes are particularly well-suited to value investing.
A key objective of value-based equity investing is to uncover the intrinsic value of the stock under consideration. This is achieved through fundamental bottom-up company analysis. The emphasis is placed on examining the company’s balance sheet in order to evaluate the company’s strength and degree of financial leverage employed. This focus, combined with the use of other non-balance sheet fundamentals allows managers to determine the company’s level of earnings, cash flow, and allocation of capital relative to the stock’s valuation.
We believe that repeatable investment processes, consistently applied over time, help value-based managers determine which undervalued stocks are likely to recover (of a transitory, cyclical nature) and those likely to continue waning (of a secular nature). Because these types of determinations are associated with this style of investing, we can say that repeatable processes lend themselves very well to the value discipline. Minimizing exposure to broken companies (value traps) is part of our “winning by not losing” mantra.
The opinions expressed are those of Phillip N. Davidson, CFA, and are no guarantee of the future performance of any American Century Investments portfolio.
For educational use only. This information is not intended to serve as investment advice.
