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Aberdeen US equity chief: 'these are the times active managers earn their stripes'

Aberdeen US equity chief: 'these are the times active managers earn their stripes'

Every summer, thousands of CrossFit devotees compete to earn the title of ‘Fittest on Earth.’ The CrossFit Games are unique because competitors only learn the details of the challenges a few hours in advance, meaning they must rely on their multi-disciplinary training to prepare them for any eventuality.

With its focus on measurable, observable and repeatable results that can be tested in a remorseless and unpredictable competition, it’s no surprise that Citywire + rated Ralph Bassett was drawn to CrossFit.

‘I love doing CrossFit. I do it every morning before I come into the office, which I think really is the best way to get yourself ready for the day because you can clear your mind,’ he says.

Having conditioned himself for whatever challenges CrossFit can throw at him, Bassett then heads into Aberdeen’s Philadelphia headquarters and conditions his investment regime for the unpredictable market.

Going the distance

Bassett has been running the group’s US-domiciled Aberdeen US Small Cap Equity fund since 2008 and its Ucits version, the $410 million Aberdeen Global North American Smaller Companies, since 2014. Faced with the gruelling challenge of generating returns in a hotly contested field, Bassett has proved himself a long-term outperformer.

Over three years to the end of February 2017, his US small cap strategy has seen Bassett produce returns of 42.8% against the Russell 2000 TR benchmark’s 22.3%. Over five years he has returned 109.3% against the benchmark’s 83.4%. Bassett’s cumulative performance across all the funds he runs is also comfortably ahead of the average manager in his sector over both periods.

Bassett, who has been head of the group’s US equity team for two years despite being only 33 years of age, says this stellar long-term performance is down to his 14-strong team’s rigorous bottom-up approach, which entails constantly visiting companies to uncover the best and most attractively priced businesses.

His approach also emphasizes conviction in strong positions even in the face of short-term challenges – something that has been tested recently as the fund has struggled to maintain its enviable track record. Over the past 12 months, the fund has returned 27.2%, falling short of the benchmark’s 36.1%.

Beyond ‘a few stock specific issues,’ Bassett says the unforgiving market environment was largely to blame for the weaker performance, with the gap between the fundamental quality of stocks and their performance widening.

‘The market in the third quarter was what we deemed to be a very low-quality rally. We saw companies with low returns on equity, high operating leverage and – quite frankly – high financial leverage outperform,’ he says.

This year there has been a bit more risk-taking and this has been specific to the US. The fact the economy is re-inflating, that GDP growth is going to accelerate, naturally moves people to take more risk and therefore buy lower-quality companies.

However, this short-term performance blip hasn’t shaken his confidence in his approach to identifying winning plays for the long haul.

‘What we find over time, though, is that things will even out, and stock selection will shine through. Importantly, our process has predicted that those quality businesses, for the most part, will be good preservers of capital in more difficult markets, and we still haven’t seen that recently.

‘Maintaining conviction from an investment perspective is most challenging in times where markets are disagreeing with you in the short term.

‘This has been a challenge through the whole 11-year career I have had here at Aberdeen. These are interesting times and interesting markets. It makes the job challenging but it also makes the job very interesting.'

As active managers, these are the times when you earn your stripes.

Aberdeen itself is going through a bit of a shakeup, as it recently announced its merger with Standard Life. Bassett could not comment on the changes, but take a look at Nisha’s Verdict below to see how he will likely be seen as an asset.

Active instinct

The active versus passive debate has been highlighted by record inflows into ETFs in recent months, with $11 billion of inflows into the US small-caps sector alone since the US election. Nonetheless, Bassett says he doesn’t see trackers as a threat.

‘In small caps specifically, I would say ETFs bring a lot of core quality companies with them. There is a very small tail of the index where you see illiquid stocks and lower-quality companies.'

Small caps are a prime example of an inefficient market that still exists in the mass, in the sense that you can still find quite a lot of companies and the gradations between good quality and bad quality companies.

Bassett says this wide dispersion of quality in the sector means it’s not enough to focus on returns – you need to understand how returns are generated.

‘On the risk side of the equation, we think about de-risking, good stock selection and investments in high-quality companies. It’s a risky area of the market, so clients are very prone to focus only on return. When you are looking at asset classes that carry more risk, it’s worth bearing in mind how that return is generated by managers, and as active managers we can do that much more sensibly for clients.’

Identifying overpriced companies, even those that have good business models, is one way the team looks to control risk in the portfolio.

‘We need to ensure what we are buying has downside protection. We are looking for businesses that we think are of inherent value and can be sustained through time. They need to have a competitive moat, fairly good, substantial returns and open management teams that are able to adapt to changing times.’

Champion plays

Bassett has a clear preference for the industrials sector at present, with 21.8% of the portfolio allocated to the space as at January 31 2017.

Virginia-based Beacon Roofing Supply makes it into the top 10 holdings, with 3.4% allocated to the company, alongside a 2.6% allocation to printing company Multi-Color Corporation.

However, it’s a manufacturer of residential and commercial building products, Gibraltar Industries, that Bassett champions as one of his top stocks over the past year and a perfect example of the virtues he looks for in his selections.

‘We have around 2% allocated to the company, but we have been bringing the weight down as outperformance has occurred. But that’s one where they have gone through the process of really improving margins.

‘They have a great management team that came in from Illinois Tool Works focused on doing simple blocking and taxing, making sure that lines of business make sense, making sure that they are as efficient as possible.’

This may all be ‘very simple stuff,’ in Bassett’s words, but when you are dealing with small-cap companies the improvement to returns in margins can be very meaningful.

Swimming against the tide

On the opposite side of the table, Bassett says one of the areas where the team has reduced exposure in the fund is consumer staples, which currently accounts for 5.2% of the fund. ‘That’s really been because we thought valuations were higher than other areas of the market.

‘We are trying to be as contrarian as possible in a market that doesn’t have that many companies and that is witnessing fundamental weakness. But there are areas of the retail landscape, within healthcare for instance, that we are taking a look at. These areas are under structural pressures, and we need to be aware of that, I think we are being careful to pick our spots.’

Another area of the market piquing Bassett’s interest is the real estate sector.

We are probably getting more intrigued by real estate companies because they will be very sensitive to interest rates as we move through what is going to be a higher interest rate environment.

'They will have a natural pressure on their businesses just as a factor of the refinancing risk that they have. But the market moves fine in anticipation of these events, and we should see, perhaps, those companies become more attractive. We would perhaps build up our weights or find an initiation in a company.’

The road ahead

Turning to the outlook for the US economy, Bassett paints a mixed picture.

‘There is a view that new government policy is going to be very pro-business, whether it’s tax cuts or deregulation. In the short term, that will lead to an expansion of tax profits and cash flows. But what we have reservations over is the timing and degree of tax cuts and how they are funding these. These are all things that have yet to be answered.’

When asked whether or not he thinks Trump’s presidency will boost the small-cap sector, Bassett says this is already taking place today. The small-cap sector typically generates most of its earnings revenues from the domestic market, which could prove crucial.

‘Things from here are going to be, perhaps not more difficult, but certainly more tempered. If we were to see small caps outperform just because they have seen an acceleration, or multiple expansion, which is really predicated on an acceleration of earnings growth and cash flow growth, the multiple has really moved in anticipation of that.

‘I certainly think small caps are generally more tied to the domestic economy as they have less exposure to a stronger dollar. All these things combined, at least from what we have witnessed, should benefit market performance, especially relative to larger caps.’

Nisha's Verdict

Nisha Long
Head of cross border investment research, Citywire

With the merger of Aberdeen and Standard Life Investments, Ralph Bassett is set to bring his expertise of the US small- and mid-cap market to the fore. Standard Life does not have an offering in this space, and with Bassett’s eight years of managing money in the sector, this partnership should prove positive.

He currently manages three funds in the Equity – US Small & Medium Companies sector: the US domiciled Aberdeen US Mid Cap Equity fund and Aberdeen US Small Cap Equity fund and the Luxembourg-domiciled Aberdeen Global - North America Smaller Companies fund. He has posted outstanding risk-adjusted returns in the sector, ranking him within the first decile against his peers in the sector over three, five and seven years.

What Bassett can bring to the mix is his consistent outperformance against his peers in what has been a challenging environment. Over all his funds in the sector, he has posted average returns of 42.1% over the past three years. In comparison, the average manager in the sector has returned 20.9% and the Russell 2000 index has returned 22.2% in US dollar terms to the end of February.

The US small- and mid-cap space is still an area where active managers can add value by exploiting the less efficient markets compared with the efficient large-cap market, where valuations have rocketed. Bassett has the capability and expertise in the sector to take advantage of these inefficiencies.

Bassett’s appeal to investors is that he is not a ‘reactive’ investor, but will watch a company for years before adding it to his portfolio – a trait that is welcome in today’s market.

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Ralph Bassett
Ralph Bassett
8/63 in Equity - US Small & Medium Companies (Performance over 3 years) Average Total Return: 36.74%
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