Artificial intelligence and trading algorithms are now a more formidable opponent for fund managers than their human peers, according to Miton’s Carlos Moreno, who says the only way of gaining an edge in the market is through using an investment technique that computers cannot replicate.
Moreno, who runs the LF Miton European Opportunities fund alongside Thomas Brown, aims to invest in quality businesses, which he defines as those with a high return on invested capital and a strong balance sheet.
Once he has identified a company that meets these criteria, he attempts to forecast the earnings power of the business over the next five years.
“We tend to look into the far future because you can have a differentiated view then,” he said.
“If a good-quality business has an opportunity, and if X, Y and Z happen, the product is a success, the new market entry works out – we try to work out what its earnings power will be.
“If I had to guess what you’re going to do next week, the chances are all I need to do is work out what you are doing this week, and it’ll be the same. Whereas in five years’ time there are much wider possibilities.”
And the manager said this longer-term outlook is becoming ever more important with the pace of technological advances.
“We think our competitors nowadays are computers and their algorithms – soon they will be AI rather than human,” he explained.
“Any process that sounds computable, you’re trying to take a computer head on. And it’s a mistake.
“I think the short-term is brutally efficient, companies have ERP [enterprise resource planning] systems as well as so much guidance. Any obvious valuation anomaly will be jumped on.”
Moreno added that this could help to explain why value investing has fallen so far out of favour – with traditional value approaches “all about the short term”, he said “computers are all over it”.
Returning to his process, he said that once he has calculated the earnings power of a company over the next five years, it is relatively simple to predict a future P/E (price-to-earnings) ratio. He then calculates an IRR (internal rate of return) between the two points, looking for companies that can compound their value at 15 to 20 per cent per annum.
Brown added that in a universe of 1,100 to 1,200 names, there are other techniques they can use to gain an edge over their peers – and computer programs.
“The main thing is just having that breadth to be able to go and find some really interesting names that other people don’t have the opportunity to invest in,” he said.
“To cover that broad investment universe, we do a lot of the standard things, but we do a couple of things that make us stand out a little bit.
“We speak to local brokers in the regions where these companies are listed rather than the big bulge-bracket firms based in London who, due to their large cost base, can only make money trading the top 400 or 500 stocks in Europe.
“That’s less than half of our investment universe.”
Brown said the second thing the managers do is make the effort to visit current and potential holdings. He pointed out that while being based in London means they are well served by representatives from European companies, many of those towards the lower end of the market cap scale appear to be more comfortable speaking to their domestic fund manager community.
“If you go and see them in their office, they’re a lot more relaxed, they’re a lot more expansive,” he added.
“This goes back to what Carlos was saying about having a long investment horizon and thinking about not just the next quarter’s numbers, but the really difficult imponderable that we spend most of our time thinking about – the durability of the barriers to entry that are going to maintain this high return on capital.
“[Visiting them] gives us an opportunity to really get a handle on that most important factor that we’re focusing on.
“Being willing to jump on an easyJet flight out of Gatwick is not high glamour, but super easy and super cheap.”
Moreno pointed to Gaztransport & Technigaz (GTT) as an example of a stock he and Brown are particularly excited about at the moment.
The managers were initially attracted to the French company, which makes the linings for liquefied natural gas (LNG) tanks, by the high return on capital. Further investigation showed other reasons for optimism.
“The actual cost of LNG tank lining is quite low relative to the cost of the ship. But if you’re in a storm, and to get insurance on a ship, this is [vital],” said Moreno.
“They actually have a 99 per cent market share, so you’d really have to have a very novel new design to unseat them. It’s just a lovely business, really, because the financial metrics are extremely good.”
The manager said that GTT is also operating in a growing market. Although governments are under pressure to stop burning fossil fuels, the priority is to stop burning coal, meaning a greater requirement for thermal power stations which run on gas.
He said this is evident from demand from Asia. And, because gas is difficult to pipe, the most economical way of moving it around is by shipping it as LNG.
“And basically GTT have a monopoly on that, but a very high return on capital monopoly on that,” he continued.
“That’s an example of a classic barrier to entry. Very high market shares mean that unless they make an absolute fist at it, which can happen, it’s very difficult to compete against a company like that, because you really would have to be revolutionary with what you’re proposing.”
Data from FE Analytics shows that LF Miton European Opportunities has made 101.28 per cent since launch in December 2015, compared with gains of 45.17 per cent from its IA Europe ex UK sector and 48.44 per cent from the MSCI Europe index.
Performance of fund vs sector and index since launch
Source: FE Analytics
It has ongoing charges of 0.94 per cent and is £700m in in size. The managers said they plan to soft-close the fund when it reaches £2bn.