Equity portfolio managers must adapt stock-picking process

The report highlights that half of the top quartile of European equity fund managers between 2005 and 2008 are below the median in the past three years.

Aymeric Poizot, Managing Director in Fitch's Fund and Asset Manager Rating Group, said:

"Most of the equity managers with solid performances between 2001 and 2008 had favoured value-oriented stock-picking. Since 2007, value stocks are structurally underperforming growth stocks."

In post-2007 market conditions, Fitch identifies five critical factors that have a direct implication for stock-picking: low growth prospects, the sovereign crisis, globalisation, disruptive innovation and mass trading.

In this context, many investment processes - Growth at Reasonable Price (GARP) or value - need to be reinvented. Indeed, GARP buys cheap growth, but growth is becoming scarce, while value managers are threatened by "value traps" (stocks stuck at a discounted price).

Fitch believes that equity portfolio managers will have to manage the top down, update their stock selection criteria or think beyond blue chips indices.

The report also notes the associated cultural challenges and the need to change investors' habits, preferences and subsequently investment mandates.

First, in a macro driven world, stock-pickers cannot escape developing thematic, sector and country views, in order to identify growth opportunities or conversely avoid value traps.

Furthermore, to limit downside in stressed periods where increased correlation neutralises the benefit of stock-picking, macro overlays or hedging are gaining momentum.

Second, stock selection criteria are also changing.

Manuel Arrive, Senior Director in Fitch's Fund and Asset Manager Rating Group, adds:

"During most of the 2000s, valuation was the predominant criterion to select stocks. However, companies' strategic analysis is now becoming the number one criteria, ahead of valuation,"

Valuation criteria come second, to identify entry and exit points and adjust positions accordingly.

Finally, Fitch notes that managing against market indexes can be sub-optimal. Indeed, leading companies may be represented by mid-cap or overseas stocks, absent from domestic blue chip indices.

Stock-pickers will have to increasingly manage global or all cap mandates, with more concentrated portfolios, more radical sector choices or out of benchmark bets.