A quantitative approach to stock selection
November 18, 2013
Dan Newhall: Hello, I'm Dan Newhall of Vanguard's Portfolio Review Group. I'm here with Tom Stevens of Los Angeles Capital Management, who manages a third of the Vanguard Growth and Income Fund. Tom, thanks for joining us.
Tom Stevens: Glad to be here.
Dan Newhall: Tom, why don't we start by having you tell us a little bit about your firm, Los Angeles Capital Management, and its history?
Tom Stevens: Okay, well basically, we've had an 11½-year period over which we've been in operation. Previously, the four founders, we were all together at another financial services firm, and in 2002, we decided to split off and start our own business. The four founders are still the senior members of the team today, and we have grown the business and grown the team to comprise nearly 50 people today, who really are all oriented toward building a global investment management business.
What we do clearly is different from what other firms do. We do like to emphasize that we have our fundamental roots. Many of us got our start on the fundamental side. I worked in an organization that was a very fundamental-oriented operation. I then went on to work in a quantitative environment building quantitative applications and structured applications.
We like to think of what we are doing today as really the best observations that we've made from all those experiences.
Dan Newhall: Maybe you can take a minute to talk about your investment philosophy. And really day-to-day, how do you go about building the portfolios?
Tom Stevens: In our process, we basically like to focus on the fact that investor preferences are constantly changing. Investor attitudes about various risk metrics, fundamental characteristics, whatever, change as we go from period to period in the economic environment.
Stocks have exposure to various characteristics, and as characteristics change our attitudes about owning and selling various companies are going to change with that. It's really oriented much more around trying to understand what it is that the preferences are today, and then using that information to let it build portfolios.
Dan Newhall: Maybe you could talk about some of those characteristics, some of those factors that you're focusing on. I gather some of them are more traditional; others are a little bit more exotic, if you will, for a regular investor.
Tom Stevens: What you will find are typical, traditional, fundamental metrics that you would expect to see in any approach. Classic factors like PE, price to book, profit margin, those types of things. We have a few other items that we would call more proprietary, but still they get at the essence of what we feel are important. Things like pension risk, we think those are issues that investors think about and should be incorporated into the process.
The factors then basically are constantly analyzed. And basically, we do that by looking at how they are behaving in the market and do a lot of statistical techniques basically to come up with cleaner more clearer pictures of how a particular factor is behaving.
Dan Newhall: So as we sit here today and markets are as challenging as ever, really, and there's a lot of uncertainty about the economy, what are your quantitative models telling you?
Tom Stevens: Prior to the last couple of months, we were trumpeting that we were actually seeing investors embracing some of the elements of risk that are embodied in our approach.
But having said that, in the last couple of months we have seen a retracement from that. And essentially in most recent periods, we're seeing investors pulling in their horns a little bit and basically reacting to obviously the issues of the day, which are a lot of uncertainty regarding where we're headed with some of our policies and what not coming out of Washington. Clearly I would say right now we're detecting elements of apprehension in the part of investors.
Dan Newhall: So heightened uncertainty once again.
Tom Stevens: Yes, once again.
Dan Newhall: So as you look at it though, are there any sectors or stock characteristics that do seem to have some more appeal to you?
Tom Stevens: You know, it's interesting. We've seen a persistent bias toward quality, so we tend to see quality kind of reigning true throughout all of this. Even during the periods when there seemed to be elements of risk creeping into the picture, there still was that preference for higher-quality companies. So I think quality has been the most consistent kind of metric that we have picked up on.
Dan Newhall: Your portfolio has been underweight technology for much of the past year, but I gather you're starting to see some opportunity there, and are starting to do some buying. Is that correct?
Tom Stevens: That's correct. Basically that's been the area where we've seen the most amount of increase and focus and we've seen the most amount of movement back into technology. We're still underweighted, but really it was driven by essentially a lack of IT spending and lack of opportunity from that perspective. What we're seeing now, actually the earnings yield component being one of the drivers there of that shift. So yes, we are moving back into that sector.
Dan Newhall: So while this is a very systematic quantitative process, that's really not very different from what a traditional analyst or stock-picker would do. They would love to find a company where on multiple metrics, it's working. That's probably where they put the most weight.
Tom Stevens: I frequently refer to my early days as a fundamental analyst. We worked in a very narrow perspective looking at one particular way of identifying value in companies. Obviously our frustration was when our particular style was out of favor, we really didn't have any other views or any other measures that we could bring to bear on helping us make those stock-selection decisions. So I often comment it would've been nice to have had this multifactor approach available back then, because it certainly would've helped us identify where we could find value in those types of periods.
Dan Newhall: Finally, do you have thoughts for our investors?
Tom Stevens: One thought would be essentially, I guess, sharing an observation we made back in the financial crisis. And that was that during that period, essentially, what we saw dominating investors' minds were concerns about balance sheet. And essentially earnings metrics as well as value metrics were effectively ignored. Had we not had a process that had the ability to focus on things like leverage and distress, yield and those types of characteristics, quite honestly it would have been very difficult to figure out how to basically make our stock selections back then.
So our comment would be: As you go forward, it's best to make sure you have a sufficient enough set of metrics to consider as you're making stock-selection decisions, because invariably we'll be going through periods again where they get very narrow again in terms of focus, and the number of factors that actually are helpful you want to make sure you have those available to you. You don't want to be left out in the cold.
Dan Newhall: Tom, thanks for your time today.
Tom Stevens: Okay, thank you.
For more information about Vanguard funds, visit Funds, Stocks & ETFs or call 877-662-7447 to obtain a prospectus. Investment objectives, risks, charges, expenses, and other important information about a fund are contained in the prospectus; read and consider it carefully before investing.
All investments, including a portfolio's current and future holdings are subject to risks, which may result in the possible loss of the money you invest.
Past performance is not a guarantee of future results.
© 2013 The Vanguard Group, Inc.All rights reserved. Vanguard Marketing Corporation, Distributor.
A conversation with Tom Stevens of Los Angeles Capital Management
In a recent video interview, Tom Stevens of Los Angeles Capital Management, who manages a portion of Vanguard Growth and Income Fund, discusses his views on stock selection and how he manages his portfolio in the current market environment.
- All investments, including a portfolio's current and future holdings, are subject to risks, which may result in the possible loss of the money you invest.
- Past performance is not a guarantee of future results.
© 2013 The Vanguard Group, Inc. All rights reserved. Vanguard Marketing Corporation, Distributor.