Contrarian Approach Paying Off For Zadig
Trends in investor flows away from more expensive, actively managed equity products towards cheaper, passively managed equity products means that active equity managers need to significantly outperform equity markets to justify fees to their investors. That’s not easy when central bank monetary policies produce equity market bubbles, but Luxembourg and London-based active equity manager Zadig is doing just that. The firm’s flagship Memnon European Equity Fund – a discretionary, bottom-up, long only UCITS fund - is up over 26% in 2019 to date.
Zadig takes its name from the protagonist of the novel Zadig ou la Destinée by Enlightenment writer Voltaire; the novel underlines Voltaire’s belief that if someone is endowed with good sense, patience, ingenuity and courage, their wisdom will eventually triumph over any predetermined destiny. Zadig’s approach to investing takes inspiration from this belief.
“Our approach, which is rational, cautious and patient, is critical to our success”, says Pierre Philippon, Zadig Co-Founder and CEO. “Our research enables us to overcome irrationalities in the market”.
Zadig is a valuation-based investor but a contrarian one – it screens for companies which are ‘unloved’ by the market and conducts bottom-up research to gauge whether it thinks that the market is being irrational.
“We investigate companies that have issues, such as a change in management that’s perceived as negative by the market, or M&A activity that the market doesn’t like, or companies that have one division doing well but another doing badly. We invest in imperfect businesses and a lot of what we do is about understanding why the market doesn’t like a stock, but might like it in the future,” says Philippon.
Philippon co-founded Zadig with fellow Partner Laurent Saglio in 2005. Saglio’s partner at Voltaire Asset Management decided to stop managing third party money in June of that year but both Saglio and Philippon, who was the risk manager at Voltaire, wanted to continue, so they decided to close the Voltaire Fund and launch Zadig.
Memnon European Equity regularly uses company news flow as a research tool in security selection. In particular, Philippon says it screens negative news for valuation opportunities that might arise when Zadig’s signals show that markets are overreacting.
“We see what’s happening in the market and often, bad news is priced into the stock. The worst case is that there isn’t much downside to the stock price if we get it wrong, but when we enter into a position, obviously we think that the market is overestimating the damage to the stock and any sign of improvement would trigger disproportionate gains.”
Zadig is a signatory to the UN Principles for Responsible Investment, and Philippon says that using ESG screens is an important part of the firm’s research.
“Integrating ESG factors into our process helps us to not select the wrong stocks. It’s critical to our approach. We like buying into controversies and integrating ESG in our risk assessment helps us buy the right ones.”
The research team meets the management of all companies considered for investment, which is an opportunity to engage on ESG matters
The fund also ensures a balanced portfolio across industries and no two stocks held by the fund have a high correlation to each other. “We end up with a tracking error that’s lower”, says Philippon. “We’re careful about risk.”
In recent years, Zadig has been expanding its UCITS product range. It launched an equity market neutral product - Zadig Memnon Market Neutral - in 2016 which replaced the Zadig Fund, the non-UCITS long/short equity hedge fund that Saglio and Philippon originally launched the firm in the mid-noughties. The market neutral product has approximately 15/20 short positions to go with the 25 longs and can short an index as well. Investor demand drove the launch.
“There was client demand - driven by fear of a downturn and a need to replace bond allocations - for a liquid absolute return market neutral product” says Philippon. “Launching this strategy in a UCITS-compliant structure was a natural move.”
Zadig’s product range also includes an alternative risk premia product, which was launched back in 2013. Zadig brought in Sebastien Maillard to run the Global Macro strategy; Maillard had done something similar at Société Générale subsidiary Lyxor Asset Management. The ARP product takes a risk parity approach to its portfolio construction, is fully systematic, rebalances weekly and can trade any of government bonds, equities, commodities and credit via liquid index futures and ETFs.
At the time we launched Global Macro, our only alternative product was the Zadig Fund so we thought offering a different product in a UCITS would be a nice addition to the fund range. The track record and process are strong and when the market becomes more favourable to macro systematic strategies, especially in case of a prolonged Equity or Bond market turmoil, I think it’ll really do well”, says Philippon.
The bulk of the EUR1.5bn Zadig manages is in Memnon European Equity and institutional mandates. Philippon acknowledges the challenges that active equity managers face in both raising assets and delivering alpha in the current market climate, but believes that Zadig’s differentiated strategy produces a distinctive return stream for investors.
“As our fund is exposed to Cyclical, Defensive and Growth names at all times, there is hardly any style embedded and as a result, we do something that can’t be replaced by an ETF. We’re not buying a theme – we’re buying companies,” he says. “Also, because we often avoid consensual momentum stocks and favour unloved companies, our excess returns tend to be decorrelated from those of our peers, bringing diversification to our investors’ portfolios.”
Philippon adds: “Yes, we take risk, but it’s measured risk. We’re right no more than 50%-60% of the time, but rather than being always right, we prefer having large positive contributors and small negative contributors. There will be good years and bad years, but after a bad patch the market becomes rational again. Our message is that consistent alpha can be generated by being contrarian and patient.”
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