In accordance with our policy of maximum transparency in company-client relations, we share the technologies behind our investment process. In our company the investment process may be divided into the following stages:
Stage one – search for opportunities and influence factors
This stage describes opportunities that may be taken in the framework of our Asset Management strategies and factors that may influence the value of financial instruments. For this purpose we have worked out three databases including macroeconomics, stocks, and bonds.
Two main maxims are used as foundations for the information bases:
1) availability of impartial proven facts
2) no estimates or guesses
The main aim of this stage is to structure data for efficient search and analysis. Each manager follows most of the information collected at this stage. This is why Alexandr Pavlov, the managing director, and Vladimir Astrahantsev, the leading manager, prior to working in the commercial management department of Energocapital were analysts at the company’s investment panel.
Stage two – risk management
On the second stage we combine two traditional approaches, top-down and bottom-up ones. (top-down & bottom-up).
Forecasting that concerns global and Russian economies, capital flow forecasting, and commodities price forecasting is carried out through top-down analysis. Our aim is to research opinions of other experts and to find weak and strong points in them. We believe that it is highly important to know the general opinion of the market on the current situation and the nearest future. With this knowledge we can forecast how disappointing could a wrong estimation of the current situation be.
We form our own opinion regarding general trends and risks in the economy. The opinion is further discussed by the investment panel at a monthly meeting. Risk factors and growth drivers, defined in the process of analysis of global and Russian market and economy, are taken into account when working out portfolios and strategies.
Forecasts concerning issuers and their securities are made through bottom-up analysis. The following section gives more detailed information on stocks and bond analysis process:
Bottom-up analysis for stocks:
In our analysis we use all available data collected in our database on stocks, interest rate guidelines, prices on raw materials, and growth rate of the economy against macroeconomic analysis. These are decided by the investment panel and must be used in the analysis of all shares. In our work we use critical approach to the research of side analysts and find weak and strong points in their analysis.
The main point in such analysis is to detect opportunities and risks for certain stock that the market has not yet assessed. Dividing all information into minor and major data is highly important on this stage.
Opportunities assessment:
1. possible changes in the structure of owners
2. a difference between our views and the popular ones (rate forecasts, commodity prices, etc.)
3. underestimated assets (volume and quality) of a company and the structure of its debt
4. market growth in terms of quality and quantity
5. changes in management
6. competitive advantages
7. coefficients (relevant to a certain sphere)
Risk assessment:
1. structure, shareholders, risks of restructuring
2. macroeconomic and global risks that have not been factored into by the market
3. political risks
4. unaccounted outlet volume deficiency
5. debt structure
6. liquidity risks
7. competition growth risks
8. inefficient management risks
We realize that working out DCF models without taking into account the opinions of marker participants is inefficient from the management prospective. A 10 dollar fluctuation in oil price means a 60-100% change in the evaluation of an oil industry company and a 30-80% change in that of a company engaged in other industry sector. Accordingly, a similar change in the evaluation may happen due to a minor mistake in the interest rate dynamics.
It is far more efficient to detect existing risk factors and opportunities that are not yet fully taken into account or that are underestimated by the marker participants, and to add them to the DCF model, used by most of the market participants, and thus to make conclusions concerning potential increase or decrease of stock prices. Furthermore, we find it necessary to analyze susceptibility of equities to this or that factor. If the factor comes into effect, our managers will be able to promptly take it into account, outdoing other market participants in terms of the speed of decision-making for over a month. For efficient Asset Management it is crucial to conduct independent assessment of how a factor may influence fair market price of specific shares.
Bottom-up analysis for bonds:
For both stocks and bonds bottom-up analysis we use all the data collected at the first stage. Furthermore, investment panel sets guidelines for interest rates, prices on raw materials, and economy growth rates, to be used by all managers of our company.
The focus of our attention is credit quality of an issuer, which makes bond analysis different from stocks analysis. But the methods used remain the same and include finding new opportunities and especially risks.
We do not fully rely on ratings. In bond analysis the relevant factors are ownership structure of the issuer and who the majority owners are. These risks are not evident from financial reports of the company and are not easily detected and assessed. The 2008 crisis showed the importance of paying much attention to the public image of the main shareholders.
Furthermore, we look for stability in the full sense of the word. Conclusions on stability of an issuer are made after conducting a comprehensive analysis of financial reports. We also take into account if the issuer has new announced projects, or is seeking new credit sources and refinancing.
We pay special attention to stock liquidity risks and check if the bond is included in trading lists.
On this stage we attach certain weight to specific quality indicators and turn it into quantity figures describing risks (traditionally concerning interest rate). As opposed to stock analysis, in bonds analysis there is room for less dependence on the market participants’ opinion and for an independent assessment, which comes as the result of higher efficiency of the market and shorter term on bonds.
Stage three – investment policy statement limitations
Investment policy statement is the main guideline for an asset manager. This document outlines limitations on investment objects, structure of assets, as well as stop-alert and stop-loss levels.
If we speak about investment policy statements regarding collective investment funds, they specify investment objects and the structure of assets. Russian laws on collective investment funds are rather strict. A company must notify Federal Financial Markets Service (FFMS) on the reasons behind a violation. Furthermore, composition and structure of assets are daily checked against the specialized depositaries that also file reports to FFMS. Violating the mentioned procedures may result in a fine and a short-term license suspension.
Trust agreements do not require daily check of asset structure and composition. However, FFMS monitors activities and the company is liable to report violations.
Investment policy statement limitations significantly reduce the possible number of tailored portfolios. But at the same time such limitations are a tool for risk management. Investment policy statement is a powerful and efficient instrument for the government to ensure the rights of investors and to monitor the activities of management companies.
In addition to investment policy statement limitation, Energocapital investment panel binds managers to follow internal limitation policies in regard to various kinds of investment agreements. A vivid example of such internal limitations is the limitation the investment panel worked out for activities of Energocapital-Sberegatelny fund that involve shares. The investment panel has barred including shares in portfolios, although there is no such law or investment policy statement provision that would prohibit such investment strategies.
Apart from strategy limitations by the investment panel, there are liquidity and tactical limitations.
Liquidity limitations:
All available securities fall into several groups depending on the quarter turnover volume. The calculations include only stock turnover in Moscow Interbank Currency Exchange and RTS GSK. Off-exchange trading is not included in the turnover; although volumes of such transactions may exceed stock exchange ones tenfold. Additional limitations are set for each strategy depending on risk level and overall volume. The additional limitation policies for each investment policy statement are reviewed once a quarter.
Tactical limitations:
Our experts discuss global market situation and identify threats and opportunities that may have a bearing on the Russian market. Our investment panel divides threats into four categories (green, yellow, orange, and red), each of them having a set maximum figure of shares in portfolio composition.
Such set figures are added to the information in the trading software used by managers, and risk manager can control violations even if they have been introduced by the manager during the day.
Stage four – search for effective decisions in the multitude of available portfolios.
The set of available portfolios is worked out with regard to investment policy statement limitation and additional limitations by the investment panel. According to the efficient set theorem, optimal portfolios chosen from the multitude of available portfolios:
1. provide maximum yield for specific risk level
2. are of minimal risk for certain yield estimates
Our justified opinion is that backtesting is futile, which means that making efficient decisions requires a different method. Based on the efficient set theorem, we resort to comparative analysis to identify the most efficient decisions. This is a highly relevant difference in investment philosophy that introduces significant changes to the decision-making process as compared to most of the other companies. This is what may be the secret of our success.
How does it work?
The corner stone of our investment process is continuous management of the portfolio, which includes on-going analysis of issuers and the portfolio, rather than just daily concluding deals. Such analysis allows making efficiency-driven decisions on changes in the portfolio structure.
Within comparative analysis we use five main directions: stocks, bonds, economy sectors, duration, and currency in the portfolio. We rely on information in our databases collected at stage one. We compare issuers influenced by similar factors.
Comparative analysis involves comparing all factors. The scope of efficient portfolios is determined with the help of a principle similar to Pareto optimality that means a system where each specific indicator describing the system cannot be improved without worsening other elements of the system. This principle is used for analysis of stocks regarded as a set of opportunities and risks.
Thus, we analyze similar opportunities from the point of view of a number of factors, and if one opportunity is better than the other one in terms of at least on criterion and not worse in terms of all the other criteria, we single it out as a more efficient one.
On-going analysis is crucial. It is thanks to such continuity of influence factors comparative analysis we improve investment process efficiency. The system thus is regarded as a dynamic one. Our analysis is more efficient and comprehensive, which is a competitive advantage leading to more successful Asset Management .
We review portfolios both with the emergence of an influence factor and with its disappearance. Moreover, daily fluctuations of security prices are also reflected in reviews. Such system allows to add (increase the share) and to sell (decrease the share) of certain securities (sectors, etc.) in the portfolio. This way we conduct both buy-side and sell-side analysis.
Experience and talent of an asset manager is a decisive factor in portfolio management. This becomes most evident at stage five. Despite the essential work done on the previous stage, a manager still has a wide range of decisions aimed at forming the best portfolio. Ambiguity, that is characteristic of the market, and a large number of influence factors provide for such a wide range of choices.
Managers use their own experience to select from a Pareto-optimal set the structure for a perfect portfolio. Managers must reduce a set of quality and quantity indicators to a common denominator. The calculations applied to each factor are highly-precise. Manager’s knowledge and experience help take into account several factors and to tailor a portfolio closest to the efficient set.
Apart from limitations by the investment panel, the manager can change risk avoidance within limitations set in the portfolio strategy. In the framework of traditional portfolio analysis, this means that the manager can change the slope of the indifference curve.
The task of managing director and head of Asset Management department is to bring out a manager’s talent and help develop it. It is necessary to guide a manager so as to work with an investment area they are most gifted in. In this case the manager performs with maximum yield which shows that the investments process is operating efficiently.