2019 Best Global Equity Fund Winner Q&A - AB Low Volatility Equity Portfolio Class AD USD

M: Morningstar A: AllianceBernstein

M: Can you highlight any major changes you made to the portfolio over the course of 2018? Were there any particular holding(s) that drove the fund’s performance for the year?

A: We build our AB Low Volatility Equity Portfolio with companies that fulfill three key requirements – quality, stability and price. One, they must be very high quality and profitable businesses, and have been for some time thanks to the competitive advantages of their business model. Second, they must be consistently less volatile than the market. Third, these businesses must be available for an attractive valuation, which we measure specifically by the free cash yield generated by the business relative to its price. We must also share the conviction of our fundamental analysts that companies we own will remain high quality and stable in the future.

Because quality, stability and price (QSP as we call it) are styles of investing that work in different stages of the market cycle, we feel by combining them, we can deliver a more consistent pattern of performance over time. For example, whereas some of our very high quality technology names outperformed in the first half of 2018, our least volatile holdings in sectors like consumer staples and utilities did the best in the difficult fourth quarter of last year. Our discipline on QSP means we are not bound to own any particular companies in any particular sector, but can go on an unconstrained basis to wherever the best opportunities may be.

We’d also point out that high quality, stable companies can be found all around the world, and sometimes like last year firms outside the US can be available at an even more attractive price. Although the US was the best performing equity market last year on a relative basis, and a little over half of our portfolio is listed in the US, our three biggest contributors to performance last year were an acquaculture farming company in Norway, an Israeli tech services company and a telecom company in Hong Kong. To us, it demonstrates it pays to be unconstrained in searching for the best high quality and stable companies across developed markets.

M: What is your outlook for 2019 specific to the markets you cover, and how are you positioned to take advantage of opportunities and/or mitigate potential risks?

A: Our research at AB shows that in the history of economic cycles for developed markets like the US, certain styles of equity market investing work better in particular periods of the cycle, than others. Recovery is defined as when the ISM PMI rises above 50 into expansionary territory, expansion is defined by periods when the ISM PMI rises above 55, moderation is when it is above 50 but falling, and contraction is when the ISM PMI falls below 50.

What was interesting about last year was how quickly investors extrapolated from deteriorating data that we were going from ‘expansion’ straight into a contraction. The recovery we’ve seen so far this year is because investors realized that while global data and earnings weren’t great, we weren’t going into recession either. We think the appropriate base case scenario is that 2019 will be a year of moderation, which tends to see quality as well as growth strategies perform the best.

What we would like to highlight is that while AB Low Volatility Equity Portfolio is a fundamental bottom up strategy, whether you think this year is more about moderation or contraction, all three of the styles embedded into our investment process are either positive or neutral. Another way to look at it is that the stable, highly profitable businesses with competitive advantages that we’ve bought at attractive cash flow valuations tend to be more resilient to fluctuations in the business cycle, and to later cycle volatility.

M: How have financial market risks, such as the ongoing trade war between the United States and China and tightening monetary policies in major economies, impacted your recent investment decisions? What are some underreported risks that could surface in 2019 or beyond?

A: We see all such market events like a US-China trade war as a risk to be managed, rather than as an opportunity for a binary bet. But this is also where our preference for stable and consistently profitable cash generating companies works to our advantage. The type of company that we prefer are generally less makers of ‘goods’ that are subject to tariffs, and more the dominant providers of services in their industries. Such companies tend to be less exposed to negative outcomes in the event of an escalation of the current trade tensions between the US and China, and so naturally should prove more resilient in the event of a trade conflict than a carmaker, for instance.

We believe that markets are finely poised at the moment. There is a current market consensus that we will experience slow but not negative growth, and that the Federal Reserve will be on hold for all of 2019. While this scenario is plausible, we could see how an easing of trade tensions could lead to a re-acceleration of corporate investment, and coupled with improving US consumption and inflation-causing wage growth could lead to rate hikes again for 2019. Rate hikes indicate an economy is solid, but could provide headwinds for fixed income that investors are currently underestimating.

As mentioned, we look at owning companies that are likely to be able to prosper through a range of different economic and geopolitical scenarios. This focus of ours has been what has made us successful in mitigating the downside risks of our investors in every temporary ‘crisis’ in the markets, allowing them to start from a higher base when equities inevitably resume their upward march.

M: How is your investment team organized? Have there been any changes to the investment team or structure over the past year? Do you anticipate adding to the team in the near future?

A: Our two portfolio managers, Kent Hargis and Sammy Suzuki, sit in New York. They have access to sector specialist research analysts around the world, all of whom provide deep dive research reviews of existing and prospective positions. We have a QSP quantitative model that parses through the daily noise of the markets to narrow the global investment universe to a few hundred companies – and we share our shortlist regularly with our analysts. We then build the AB Low Volatility Equity Portfolio using their convictions about which companies will remain high quality and stable, and provide the most value with their cash flows, in the future.

We elevated both Kent and Sammy from Portfolio Managers to co-CIOs of the AB Low Volatility Equity Portfolio last year. This move was AB’s way of recognizing the tremendous performance and client outcomes they have delivered since the platform was founded in 2011. Since those humble beginnings, the platform, across US, global, international, emerging markets and Asia, all run using the same process - have now gathered over USD $8 billion of client assets, in stark contrast to other trends in active equity asset management. We do not anticipate adding to our portfolio management team.

M: Where do you feel that the investment team or the investment process can be improved upon in the future?

A: At AB, we have a culture of continuous improvement in our processes and in our people. After every year, all of our portfolio managers do a post-mortem on the previous year, looking at where we have succeeded and where we could have done better. AB Low Volatility Equity Portfolio performed well in 2018 as compared to the MSCI World Index, but have still identified investment issues that we might have latched onto earlier. We also do a lot of additional research on correlations and on complementary quantitative processes that may improve our stock-picking, for instance on the source and nature of volatility; we have incorporated some of our additional insights on volatility into our process so as to be able to better mitigate the downside risks of our clients and further improve returns.

View all Morningstar Singapore Fund Awards 2019 articles here.