For something that’s supposed to help people connect, social media can be pretty divisive.
It turns out that hot takes coupled with a tight word count is not a good recipe for nuanced thought and debate. While this is particularly true of politics at the moment, the standard for discourse is not always much better in the world of investments, where tribalism can often trump a reasoned discussion about a given investment style or a manager’s track record.
It’s certainly not an approach that appeals to James St. Aubin and the team at Los Angeles-based HighMark Capital Management.
‘The industry can be very dogmatic at times and tends to overgeneralize,’ St. Aubin says. ‘One of the key elements of our process is that we try to stay open-minded about certain topics – not just portfolios managers, but the active/passive debate too. There tends to be this industry trend to go to one extreme or the other and to find no middle ground. We like to be more pragmatic about how we build portfolios and develop our approved list.’
Working alongside Razmig Der-Tavitian and Andrew Jarrous, St. Aubin puts together a list of around 203 approved vehicles. These picks are used by portfolio managers at HighMark and parent company Union Bank to build portfolios for around 3,800 clients, with combined assets of $15.3 billion.
The list breaks down as 70 active mutual funds, 82 ETFs, 34 hedge funds, nine SMAs and eight passive index funds, and the firm’s portfolio managers cannot deviate from these options.
‘They are our best ideas and our only ideas,’ jokes St. Aubin, who leads the team in his role as chief multi-asset strategist. It’s a position which means he also sets the asset allocation and portfolio construction guidelines for the firm’s portfolio managers and models.
The trio works from curated menus from SEI Investments for SMAs, and from iCapital and Conway Investment Research for hedge funds. Everything else is open architecture.
Better than luck
Pragmatism may be at the heart of the trio’s process, but that doesn’t mean there isn’t a clear philosophy at work too.
‘Philosophically, what we are trying to do is separate luck from skill and identify managers with an edge,’ St. Aubin says. ‘Anybody can pick the hot dot and look at performance to see whether a manager has been successful, but some of that inevitably comes from being in the right place at the right time, while another portion of that is determined by skill. We definitely want to understand the fundamental drivers of skill.’
To do this, the team starts by studying a given asset class or category in which it is looking for a manager. The next step is considering how the strategy might fit with what HighMark already offers in the space.
‘With three people, we don’t really have the resources to meet every single manager and then select the one we like,’ Der-Tavitian says. ‘Quite frankly, I don’t think the best way to pick outperformers is to meet with every single fund and pick out the one you like the best. I think the best way to pick outperformers, first and foremost, is to understand the market you are going to end up in, understand the efficiencies and the inefficiencies and then find the types of strategies that can extrapolate those.
‘We are not dogmatic about what kind of managers we approach, because we believe each kind of market is different. As a result, each one requires a different kind of approach.’
For example, when we speak, the team is in the middle of replacing an international large-cap manager – a category that requires a different approach to, say, US small caps.
‘We believe that that market [international large caps] is quite efficient and difficult to beat, so we place more emphasis on fees. We are more willing to go with a strategy that tries to capture outperformance through factors, either risk-based factors such as value or behavioural factors such as momentum,’ Der-Tavitian explains.
While staying open-minded is the name of the game, the team won’t consider funds below certain minimums. These include a three-year track record under the same manager, around $300 million in assets and, ideally, fees lower than the category median.
Simply the best
The trio has little time for also-rans. Only strategies that stand out are good enough.
‘If the manager is not unique in any way, that doesn’t tend to get high on our radar,’ St. Aubin explains. ‘We try to look for continuous improvement and how they are planning to stay ahead of the competition.’
‘If you look over the past 50 years, the game has become a lot more competitive. To outperform, you have to do better or be different,’ Der-Tavitian adds.
‘It has become exponentially harder to be better than everybody else. Every manager you talk to has a 40-person research team, puts together a model and talks to management. They all do very similar things, so we think it is very hard to outperform unless you do something different that you can take advantage of.’
One shop that ticks this box for the HighMark team is Fuller & Thaler Asset Management, the San Mateo, California-based firm co-founded by behavioral economist Richard Thaler, who won the Nobel Prize in economics in 2017.
The trio added the Undiscovered Managers Behavioral Value fund, distributed by JP Morgan and subadvised by Fuller & Thaler, in November 2015 – long before the firm hit everyone else’s radar following Thaler’s Nobel win.
‘A consultant firm that we have a relationship with said the fund was not an interesting idea as it does not have a lot of the basic qualities it looks for in a manager. It has a single PM, no real analyst team and the fees are a bit high, so the firm failed on a lot of the check-the-box stuff that people look for,’ Der-Tavitian says.
‘But we really liked it because we thought it had found a unique way to extract outperformance from the market, using a lot of information that the market can provide. It’s a behavioral strategy, which is quite simple, but the elegance is in how the firm executes it.’
The fund focuses on stocks that have recently underperformed and looks for triggers to buy in based on human behavior, specifically insider behavior. If an executive at a company is buying more stock despite recent underperformance, this could be a sign that it’s time to invest – especially if that executive is the CFO.
‘If it’s the CFO buying, it is a much stronger signal than if the CEO is buying,’ Der-Tavitian says. ‘CEOs tend to be more charismatic and optimistic, whereas CFOs tend to be more focused on the numbers.’ The fund’s managers, Russell Fuller and David Potter, also study how much stock an insider is buying relative to their compensation and how much they already own.
‘The fund has done phenomenally since we added it, and now the firm has attracted a lot more attention since Richard Thaler won the Nobel Prize,’ Der-Tavitian adds.
Different doesn’t always pay
Still, not every firm that is unique necessarily outperforms all the time. For example, the HighMark team likes Cliff Asness’s quant shop AQR and holds its Style Premia Alternative fund, which combines factors such as value, momentum, carry and defensive across a range of asset classes in an effort to avoid traditional market risk.
However, as with many of AQR’s strategies this year, the fund’s performance has dipped significantly. Over three years, it sits 15th out of 55 funds in the Citywire Multi-Strategy category, but over one year it ranks 56th out of 65.
In a recent interview with Bloomberg, Asness attributed this underperformance to systematic value investing’s poor run of form and the fact that other factors had failed to make up for this.
The HighMark team is not overly troubled by the dip and knows that it stands to lose more by selling at the bottom. ‘We have a lot of respect for AQR,’ Der-Tavitian says. ‘It ticks all the boxes in terms of being humble, intellectually honest and trying to find a unique advantage in the market.
‘If you look at mutual fund performance, it’s a lot more than most people’s dollar returns. That’s because people are very reactionary – they buy what has worked and they sell what hasn’t.’
A pleasant surprise
St. Aubin, Der-Tavitian and Jarrous’s pragmatic approach sometimes means that they end up picking managers that surprise even them.
The HighMark sustainable offering is made up of three ESG funds, in US equities, international equities and core bonds respectively. For the latter category, the managers opted for the Pimco Total Return ESG fund, despite some initial misgivings.
Jarrous, HighMark’s vice president of manager research, explains: ‘The big problem we have with most ESG is that the amount of capital quoted as being in ESG is just marketing. Firms tend to focus on the G of governance – which any investor would of course focus on – and then automatically call all of their assets ESG. We really try to focus on the E, the S and the G.
‘I cringe a bit when I say it,’ Jarrous adds, ‘but with Pimco, we thought it was just a large marketing machine. Then we had a call and we were really impressed by the capability on the ESG side, how it was engaging with companies and what it has been able to achieve.’
St. Aubin says: ‘We have all been in the business long enough to know how labels can be slapped on anything just to make it marketable, so managers might not be fully engaged in the practice. That wasn’t the case here. We had some preconceived notions about Pimco which were invalidated when we got into the weeds.’ It’s certainly a fitting result for this pragmatic trio.