Value: Uncontrolled Designation of Origin

Like everything in life, we have “substance” and we have “form”. The “substance” is what’s really and effectively done every day, the daily process, the attitude.  Then there’s the “form”, which is what we need to show.

It’s quite common for investors faced with a very broad array of the same or ostensibly similar products to be influenced by the packaging and not to read the small print. Or else they may decide to buy what other people recommend. The funds sector is not very different from any other, and it’s essential to understand how the offer of products is structured in this market.

But how does the offer reach the investors? This tends to occur through consultants and fund brokers, who create menus of available funds for their clients based on a prior selection or a due diligence process that helps to filter and select.

The criteria vary according to the type of fund, but funds without a record of about three years, small funds, funds with assets of under 100 million and funds that don’t offer any incentive for the broker are discarded out of hand.

The first quantitative filter eliminates hundreds of managers and funds at a stroke. The “professional” selectors who analyse funds for the general public are often looking for a mass-market product –a best-seller, and one that’s currently fashionable.

After the quantitative filter, some professional selectors carry out a qualitative analysis of the management company. The management company uses a series of assessment criteria which also include the expectation of an input of money in the fund –a promise of economic survival for the fund management industry. All this is totally legitimate and may represent both a source of Alpha and a lost opportunity for the fund buyer, trapped in a rigid process.

Finally, due diligence processes have a very broad format which is designed to obtain information on the management company’s internal policies, explicit documentation on the investment process and risk control, the best execution policy for purchasing securities and even the insurance policy the company has in place to respond to any possible contingencies!

In parallel, face-to-face meetings are held with managers and supervisors in the management company to verify the record of written answers, through a dialogue such as: Who presses the button for purchasing and selling securities? Or to understand the management process more precisely, what is the source of the generation of ideas? Is there a detection or first screening filter for the universe? What assessment method is used? Why is equity sold? This is a legitimate task when done with a focus on “substance” rather than “form” and when the task of management is understood as being halfway between art and science.

Hunters of value opportunities don’t read the menu, they track down the ingredients to design a unique recipe, the promise of a good yield.

Value management has become the latest craze in Spain. A management company only needs to go through a basic assessment process to call itself “a value manager”.

It’s sometimes difficult for the investor auditing these new structures for the first time to separate the wheat from the chaff. What’s the difference between one value manager and another who also calls himself a value manager? How will they stand the test of time?

The terms “value” or “evaluation by fundamentals”, or even “stock picking” are used liberally without any controlled Designation of Origin. So we need to distinguish the two aspects, the famous “substance” which justifies the name of value management, and the actions that only differentiate it in terms of “form” –opportunistic marketing to exploit the latest trend.

Finding the idea is sometimes easy and sometimes hard. True value managers work full time to come up with original ideas. They look for the gold nugget, the one that for many reasons is hard to spot and identify, and is not merely the result of a quantitative filter. This requires a painstaking work of identification, and an understanding of both the valuation and of the quality of the company’s activity in its context.

Value managers are not merely stock pickers –they are undervalued stock hunters. They go hunting where others never venture, using their curiosity, their reasoning, their experience, their independence, their patience and their freedom of action. They don’t read the menu, they track down the ingredients and design a unique recipe, the promise of a good yield.

Value opportunity hunters don’t always reach the supermarket where the form is better than the substance. In the same way there are also fund hunters, and the two always end up meeting.

These hunters are faithful to the principles of the most radical value management.