Bryant VanCronkhite, managing director and senior portfolio manager for the Allspring Special Global Equity team, speaks with Christine Collins, investment strategies consultant, on how his team approaches portfolio construction as it relates to the Russian-Ukraine War, inflation, and other global factors.
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Christine Collins: I’m Christine Collins, an investment strategies consultant for Allspring Global Investments, and you’re listening to On the Trading Desk®.
There’s no denying that 2022 has gotten off to a volatile start across many areas of our lives, including geopolitical, market, and economic, just to name a few. During times of market volatility, it can be important to take a step back and refocus on some of the core components of investing.
Joining us today to help us refocus and explore these core components is Bryant VanCronkhite, managing director and senior portfolio manager for the Special Global Equity team. Thanks for being here, Bryant.
Bryant VanCronkhite: Hi, Christine. It’s good to talk with you today.
Christine: Thanks. One of the elements of an investment process that we don’t frequently discuss but is of critical importance is portfolio construction. I know this is a key component of your process, so can you talk about the Allspring Special Global Equity team’s approach to portfolio construction?
Bryant: Christine, I think you’re right. Portfolio construction is critical to a successful investment process, but oftentimes overlooked.
I want to start with bit with a visualization. I think most clients give an investment manager a bucket, and every year they want them to fill that bucket with alpha. And, typically, for a fundamental manager, that alpha is supposed be filled through stock selection.
So every day, every week, every quarter, investment teams are filling their bucket with alpha through stock selection. And if they’re not careful, holes in that bucket can open up for things that they didn’t intend, things like style factor exposures or country exposures. Obviously, the Russia-Ukraine geopolitical events right now are exposing holes in buckets all over the place, and we’ll talk about that, I’m sure, in a little bit.
But the idea being that as an investment manager who focuses on stock selection, the last thing you want to do is have your hard-earned alpha leaked out of the bucket for things you never desired to bet on in the first place.
So the way the Special Global Equity team approaches portfolio construction is by having a very clear awareness that our strength lies in our unique approach to selecting stocks, and that beyond that we really want to have as little impact as possible from other non-stock selection factors.
So the best way to approach this is in a very intentional and clear understanding of how every stock in your portfolio builds a profile for the entire portfolio or, said otherwise, how it can create a certain tracking error versus a benchmark.
And not only do we as investment managers focus on the amount of tracking error in a portfolio, we also need to think about what kind of tracking error is in that portfolio. The way we approach this is by using a Barra risk model that decomposes the tracking error for the portfolio into five buckets.
One bucket is stock selection. The second is sector allocation. The third is style factors. The fourth is country risk. And the fifth is currency risk.
And as our team goes through our daily process and builds portfolios by picking stocks, we recognize that four of those five—sectors, style, currency, and country—really don’t play to our strengths. And so as we’re building the portfolio, we are designing the portfolio to mitigate, to the degree possible, exposure to all the things that aren’t stock selection related.
And as a result, when we look back at the end of a quarter or a year, it’s much more probable that we’re going to have an outcome that is based on the successes of our stock selection, as opposed to stock selection minus style factors, minus country risk, minus currency risk.
That approach, for us, helps give us confidence in the repeatability of our outcome stream for clients quarter after quarter after quarter.
Christine: You mentioned the Russia-Ukraine military conflict, and I’m sure that is top of mind for many of our listeners today. Can you apply the same portfolio construction methodology to issues like what we’re seeing in Russia and Eastern Europe right now?
Bryant: Yes, the portfolio construction process I just went through is incredibly helpful in understanding your exposure to geopolitical risks, like Russia and Ukraine, and also where you can find additional places to allocate capital for alpha generation in the future.
So when we think about Russia and Ukraine, we need to begin with the company-level exposure, so you think about where are the assets of the organization within which countries, where are the revenue sources for the company. And a lot of that is still stock selection based but still focused on Russia.
As you get into the portfolio construction elements of it, we start to think of things like inflation. I’m sure we’ll discuss inflation, as well, but how are the Russia-Ukraine events going to impact inflation across the globe and what does that mean for a portfolio in terms of style factor exposures? A very obvious and direct tracking error risk in this situation is your country or region exposure. Obviously, Eastern Europe is directly exposed and a higher-risk place to be, but even as you move throughout Europe and you think about energy impacts throughout businesses in Europe, having exposure to other parts of the EU (European Union), relative to your benchmark, opens up risk profiles. And how can you maybe hedge that by being underweight other areas or overweight Japan, who might be a beneficiary from this. So looking at the country risks and tracking error from a country is important, as well.
And finally, when you think about demand, a lot of concern right now is being priced into the marketplace around GDP (gross domestic product) expectations falling as a result of the geopolitical conflict. Whether that’s true or not, we’ll have to wait and see, but the way that plays out is usually through style factors. The market will sell off beta, for example, or value factor as GDP expectations come down. And to the extent you’re able to mitigate the exposure or neutralize the exposure to beta or value factor going into an event, that will help your portfolio see yourself through and then again, everything else that remains is stock selection.
So the Russia-Ukraine events are important to us, but if your portfolio is built correctly to begin with, a lot of that risk is mitigated because you’ve already naturally hedged out the country risk, the value factor risk, and the growth factor risk that come from inflation.
Christine: Those are some great insights, Bryant. Thank you. You did mention inflation and I did want to get to that topic. It’s been an issue for several quarters now. How do you see the Russia-Ukraine conflict exasperating inflation, or do you not think it will have an impact?
Bryant: Let me start with how we’re thinking about inflation across all of our portfolios. And at the very first level, we need to look at it as a microeconomic issue.
Inflation does not happen in a vacuum, and the inflationary bucket that every company experiences is different from company to company and, now importantly, from country to country.
And so our team’s approach to this is first and foremost understanding every company’s cost basket and how it’s being uniquely impacted by inflationary pressures, whether it’s energy inflation or labor inflation or down the line. And so we start with that to understand the exposure there and the ability for our companies to offset that with price over time.
When we think about the Russia conflict and what’s happening in Eastern Europe, the biggest component of inflationary pressure now is going to be obviously the energy bucket. Whether it’s natural gas or oil, it is going to have a meaningful impact on inflationary pressures, especially throughout Europe.
As we look at our international portfolios, one of the things we are considering is how is that impacting the competitive dynamic for those companies. Do they compete in a global landscape, or do they compete in a regionalized landscape? The more global your company is and your industry is, the more likely you are to have competitors now who are going to have a different energy framework with which they’re operating and, thus, a different cost structure in which they’re operating, which could be challenging for companies in that situation.
And so we do think that, in the short run, the Russia-Ukraine conflict will put upward pressure on inflation. But that really isn’t a huge concern at a macro level. It’s more of a micro level and how each company is exposed.
Over the long run or over the intermediate term, if inflation pressures do put pressure on GDP, it will have a natural neutralizing effect, which will lower inflation across the board and ultimately bring us back to a more harmonistic environment.
Christine: Great. With the time we have left and we think about the volatility, whether it’s geopolitical or market-driven, are there any last thoughts you would want to leave with our listeners?
Bryant: I think it’s easy to be fearful in moments of volatility. But if you’re an active manager, it’s the volatility that provides opportunity. Whether it’s Brexit, whether it’s elections, whether it’s central bank–based volatility, or whether it’s geopolitical conflicts, it really is the opportunity for active managers that allows them to create that alpha and fill that bucket longer term.
I think Buffett and, originally before Buffett, Graham said that markets in the short term are voting machines but, in the long term, weighing machines. And it’s very clear right now, the market is voting. It’s voting very quickly that GDP is going to fall or that the conflict is going to expand or that inflation is going to take off.
But in the longer, grand scheme of things, as the market weighs the results and the outcomes of these events and every event, stock selection that understands and appreciates the risks and the rewards ultimately is rewarded over longer time periods, and that’s the opportunity for us as active managers. And so I would say it’s OK to be fearful of what’s happening now, but ultimately embrace the volatility as a chance to create alpha over the next three-plus years.
Christine: Thank you so much for being with us today and sharing your insights.
Bryant: It’s my pleasure.
Christine: That wraps up this episode of On the Trading Desk. If you’d like to read more market insights and investment perspectives from Allspring Global Investments, you can find them at our firm’s website, allspringglobal.com.
To stay connected with On the Trading Desk and listen to past and future episodes of the program, you can subscribe to the podcast on Apple Podcasts, Spotify, Google Podcasts, or whatever podcast subscription service you use. Until next time, I’m Christine Collins and stay invested.
Disclosure: All investing involves risk, including the possible loss of principal. There can be no assurance that any investment strategy will be successful. Investments fluctuate with changes in market and economic conditions and in different environments due to numerous factors, some of which may be unpredictable. Each asset class has its own risk and return characteristics. Alpha measures the excess return of an investment vehicle, such as a mutual fund, relative to the return of its benchmark, given its level risk as measured by beta. Alpha is based on historical performance and does not represent future results.
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