10 July 2023

Categorizing Companies by Lifecycle: A Better Mousetrap for Alpha in Global Equities

Author:

Rob Hinchliffe, CFA

Portfolio Manager, Head of Global Sector Cluster Research

Categorizing Companies by Lifecycle: A Better Mousetrap for Alpha in Global Equities

Capital at Risk

All investments involve risk. The value of your investment and the income from it will fluctuate and a loss of capital may occur.

Active management exists because some investors want to generate better returns than the overall market: alpha, in other words, rather than just beta. In exchange for this opportunity, investors frequently submit to greater risk, inconsistent returns, and portfolio characteristics that differ from the reference benchmark.

PineBridge Investments focuses on alpha, but at a similar level of risk to the benchmark. Our alpha tools are designed to consistently seek excess returns from stock selection without adding tracking error or other market risk and have been tested across widely varying market conditions1. And our global platform is structured to facilitate collaboration among analysts working in different regions and capitalization ranges to identify potential investment opportunities wherever they may exist.

One of the most important tools is our Lifecycle Categorization Research (LCR) framework, which we use to evaluate a company based on its maturity and cyclicality. We view this longstanding framework (it has existed at our firm for over two decades) as a “better mousetrap” than the standard approach of thinking about companies based on GICS-assigned sectors. What makes us think our system is better, at least for our purposes? As portfolio managers wholly focused on deriving active risk from stock-specific sources, we simply think it gives us a more fine-tuned instrument for picking up on and isolating the mispricing opportunities that arise as companies evolve through time. To illustrate how this worked over the last three years (as of 31 May 2023) for the PineBridge Global Focus Equity Fund, for example, the Fund featured an annual excess return of 4.9% (net of fees) that placed it in the top first percentile of Morningstar’s universe of 1,501 global large cap core equity managers2. Stock selection drove nearly all the alpha and each LCR category was a positive contributor.

A Clearer Signal – Stock Selection Effect for Global Focus Equity

Source: PineBridge and FactSet, as of 31 March 2023. Represents performance attribution information for the PineBridge Global Focus Equity Fund (the “Fund”), which is a sub-fund of PineBridge Global Funds, an Irish domiciled UCITS umbrella fund, authorised and regulated by the Central Bank of Ireland. The Fund’s inception date is 7 January 1999 with the current portfolio manager commencing on 1 January 2016. There can be no assurance that any of the above allocations will remain in the portfolio at the time this information is presented. Diversification does not ensure against loss in any market. Benchmarks are used for illustrative purposes only - it is not possible to invest directly in an index. Past performance is not indicative of future results.

Apples to apples

To determine whether a stock is a good investment, every investor needs a sound basis for comparison. Because the global stock universe encompasses some 58,000 names, many investors start by categorizing them into sectors and industry or sub-industry groupings. In this way, they aim to create smaller subsets of companies with similar characteristics and risk profiles that can help highlight whether a company’s current and future earnings potential is being priced attractively by the market, or not.

And the approach makes a lot of sense… some of the time. For illustrative purposes and not an indication of whether we own or will own these stocks, take Ford, Toyota, and GM3. They all fit together naturally enough in the automobile industry group of the Consumer Discretionary sector. Each operates under roughly similar capital structures, growth drivers, and sets of expectations that play into how the market values their earnings and earnings potential. But then what to make of a company like Tesla, another automobile industry constituent valued using almost a diametrically different set of expectations? Or take the adjacent Consumer Discretionary retail industry group. Are Target and The Home Depot really the best comparators for a company like Lululemon, or Amazon for that matter?

Unfortunately, such awkward and misaligned comparisons are an all-too-common result of sector- and industry-based analysis. That’s why we created a system for grouping companies into more homogenous categories based on a company’s position in its lifecycle and its overall sensitivity to the economic cycle. We have six categories in our taxonomy, each with its own criteria, valuation method, and return requirement. In classifying a cyclical company, for example, we’ll first normalize its revenue and earnings to smooth out the “lumps” across the economic cycle. We then assess its underlying growth trend to determine whether it is presently a High Cyclical Growth or Mature Cyclical company: the faster it is growing through the cycle, the likelier we are to categorize it as the former and value it using a higher multiple to reflect those higher future-state earnings estimates. In contrast, a company with a stable revenue and margin outlook is more likely to be a Mature Stable company. A company in this category will be valued against the market, peers, and its own history – and given its better visibility, require less return potential than a High Stable Growth company to be an attractive investment.

For illustrative purposes only. Any views represent the opinion of the investment manager and are subject to change.

Once the categories are set, we can then start comparing like companies to like companies. This is where mispricing opportunities start to emerge that (to our benefit) are often missed by investors using the standard GICS groupings. A US industrial automation company, for instance, that appears expensive relative to other Industrials may look quite a bit more reasonably priced when viewed instead across the sectors against other Mature Stable companies with similarly healthy levels of profitability and steady (if unspectacular) growth.

Moving left

As the name implies, Lifecycle is about movement, and the opportunity to anticipate and capture changes in a business as it evolves over time. We don’t need a company to change lifecycle categories to be a good investment. But if it is going to move, we want it to move left in the diagram below, transitioning from a more mature business back toward a more robust stage of growth. In such instances, we expect its valuation to re-rate higher as the market gains visibility into the new lifecycle stage.

Lifecycle Categories

For illustrative purposes only. Any views represent the opinion of the investment manager and are subject to change.

For illustrative purposes, Microsoft4 is an interesting case to examine here. Through the course of its history, the company has run the entire LCR gamut from Exceptional Growth (A) to Mature Stable (D3) and back to High Stable Growth (B). In its early years in the early to mid-1980s, we likely would have categorized Microsoft as an A stock. We would have assessed its likelihood of success, evaluated its funding sources, required a high return potential to justify the risks, and used a standard discounted cash flow model for valuation. A decade later, the company became a B stock as revenue grew and its outlook became more stable. Continued steady (and accelerating) growth along with expanding margins are textbook B-stock traits that would have attracted the PineBridge equity team and allowed us to lower our return requirements and look beyond the earnings multiple at which the stock was trading given its steadier footing and improved revenue and earnings visibility. However, by the aughts, the company had begun shifting back to the right and became a D3 company as the revenue and earnings compounded annual growth rate (CAGR) downshifted below 10%. The forward-looking nature of LCR ideally would have anticipated this change well before it occurred. Ditto the emergence of its cloud business 15 years later that foretold yet another shift – this one back to the leftward part of the LCR curve.

The companies we keep (and the risks we don’t)

Stock selection is our only alpha source. To keep it that way, in addition to our portfolio of high-quality, high-conviction investments, we seek to mitigate all other risks, including the psychological risks of exiting holdings early as a natural reaction to portfolio excess return volatility or exiting too late due to overconfidence.

We control these risks by limiting the active exposure of the portfolio to LCR categories, since investment styles that roughly correlate with a company’s growth rate (i.e., “growth” vs. “value”) are some of the biggest sources of market risk in equity portfolios. (See “Global Equities: Thinking Outside the (Style) Box for More Sustained Alpha.”) A recent case in point was the dramatic shift in style leadership in 2022, which saw growth stocks, after years of outperformance, plummet by three times as much as those categorized as value shares. Of course, controlling for LCR categories means the LCR characteristics of the benchmark must also be known. So, our global equity team maps the benchmark’s alignment to our LCR categories twice per year.

This risk management discipline contributes to a surprisingly low tracking error given our portfolios’ generally high active share. For example, the PineBridge Global Focus Equity Fund has a tracking error since inception (7 January 1999) of just 4.4%, as of 31 March 2023 (some active managers range as high as 7% or more). It also maintains a portfolio beta of roughly 1 and yet boasts an active share of 93% from inception to 31 March 2023. This unique juxtaposition of high conviction and low tracking error and market risk is a direct product of the organic and differentiated way that LCR allows the portfolio team to home in on the business operations risks specific to each holding while controlling for the style, interest rate, currency, and other market risks around which the team has far less conviction. Focusing and diversifying risks this way also helps to limit relative volatility, which improves our ability to own investments over the medium to long term, consistent with the time frame over which we anticipate alpha from each investment will develop.

Finally, the precision of LCR for risk management alleviates the need to own positions whose primary role is risk management. This frees the portfolio management team to invest in a wider range of companies and results in an even more differentiated portfolio. Of interest to note, as of the first quarter of 2023, six of the PineBridge Global Focus Equity Fund's top 10 holdings weren't even among the top 300 positions of its benchmark.

Footnotes

1 Past performance is not indicative of future results.

2 Source: Morningstar, as of 31 May 2023. Reference class: Y. The peer group is the Morningstar Global Large Cap Core Equity Universe, which in the 3-year period had 1,501 members. Performance is calculated net of fees on NAV to NAV in USD with dividends reinvested. The benchmark for the Fund is the MSCI All-Country World (ACWI) Daily Total Return (Net) Index. Past performance is not indicative of future results.

3 For illustrative purposes only. Information provided should not be construed as a recommendation to buy or sell a security. There is no indication given that the securities shown were purchased, sold or recommended in any portfolio. Any views are the opinion of the Investment Manager and are subject to change.

4 For illustrative purposes only. The selected case study has been chosen by PineBridge to illustrate the investment process. It is not necessarily representative or indicative of all investments made in the existing strategy or fund. Information provided about a portfolio company is intended to be illustrative, and should not be used as an indication of current or future performance of any security, investment, or portfolio company. Prospective investors should be aware that these summaries are selective by nature, do not include all of the transactions made by the Manager's investment team on behalf of the composite and are not necessarily representative or indicative of all of the investments in the portfolio for any period. Past performance is not indicative of future results.

PineBridge Global Focus Equity Fund Endnotes

PineBridge Investments (‘PineBridge’) is a group of international companies acquired by Pacific Century Group from American international Group, Inc. in March 2010. PineBridge companies provide investment advice and market asset management products and services to clients around the world.

PineBridge Investments is a registered trademark proprietary to PineBridge Investments IP Holding Company Limited. Services and products are provided by one or more affiliates of PineBridge however certain incidental middle and back office services may be outsourced to 3rd parties.

PineBridge Global Focus Equity Fund (the “Fund”) is a sub-fund of PineBridge Global Funds, an Irish domiciled UCITS umbrella fund, authorised and regulated by the Central Bank of Ireland. The Fund was formed as a successor fund to AIG Global Equity Fund plc (the "Company") following a scheme of amalgamation with the Company and was launched on 29 July 2005. PineBridge Investments LLC, an Investment Adviser registered with the United States Securities & Exchange Commission and PineBridge Investments Europe Ltd., authorised and regulated by the Financial Conduct Authority, are the Investment Managers to the Fund and also acted in this capacity for the Company.

The inception date of Class ‘Y’ of the Fund was 07 January 1999.

Where performance is presented herein it is representative of Class ‘Y’ in U.S. dollars.

The benchmark for the Fund is the MSCI All Country World Index (ACWI) Daily Total Return Net (the “Index”). The Index is a free float-adjusted market capitalisation weighted index that is designed to measure the equity market performance of developed and Emerging Markets. From inception to 10 February 2014, the benchmark was MSCI World DTR Net Index. From 27 October 2016, the benchmark was changed to the MSCI All Country World Index (ACWI) Daily Total Return Net.

Any performance presented is historical, assumes reinvestment of all interest, dividends and capital gains, and is not indicative of future results. Investment return and principal value of an account will fluctuate, and there can be no assurances that losses will not be incurred.

Rates of return and asset valuations, if shown, are in U.S. dollars, unless otherwise stated and are computed using a time-weighted rate of return. Any performance results for periods of less than one year are not annualized. Income is included net of irrecoverable withholding tax deducted at source in accordance with the domicile of the underlying portfolios. Portfolios are valued on a trade date basis.

Where gross performance returns are quoted, they are presented net of transaction costs and before the deduction of management fees and all operating costs (which include custodian and administration fees).

Where net performance returns are quoted, they are presented net of transaction costs and net of the deduction of management fees and all operating costs (which include custodian and administration fees).

Fund fees and expenses are described in PineBridge Global Fund’s offering documentation, which is available upon request. These fees will reduce a client’s initial investment and expected returns.

Past performance may not be a reliable guide to future performance. The value of units and the income from them may fluctuate.

Before making any investment decision, you must read the Prospectus of the Fund and Sub-Fund, available in English, as well as the Key Investor Information document (KIID), available in one of the official languages of the country.

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Investors and potential investors can obtain a summary of investor rights and information on access to collective redress mechanisms at www.pinebridge.com/investorrights. The information presented relates to an account that is subject to laws and regulations that may be different from those applicable to an account for an investor in a different jurisdiction. Therefore, results may differ materially due to different investment limitations, regulatory environments and portfolio compositions.

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The units of the Fund may not be offered, sold or delivered in the United States or to or for the account of U.S. Persons.

Last updated as of 01 July 2022.

For Singapore Investors

For Institutional/Professional Investor Use Only and Not for Retail Use or Distribution.

We are not soliciting or recommending any action based on this material. This document should be read in conjunction with the Singapore Prospectus (including defined terms) and the product highlights sheet and is subject at all times to the terms and conditions as set out therein. PineBridge Global Focus Equity Fund (the “Fund”) is a sub-fund of PineBridge Global Funds, an Irish domiciled UCITS umbrella fund, authorized and regulated by the Central Bank of Ireland and registered as a recognised scheme under the Securities and Futures Act (Cap 289) in Singapore. The manager of the Fund, PineBridge Investments Ireland Limited (the “Manager”), has appointed PineBridge Investments Singapore Limited (“PBIS”) as its representative in Singapore. Investors should seek professional advice, and read the prospectus and the product highlights sheet, available from PBIS or any of its appointed distributors, for further details including the risk factors, before investing. Past performance may not be a reliable guide to future performance. Investment involves risks including the possible loss of principal amount invested. The value of the units in the Fund and the income accruing to the units, if any, may fall or rise. The Fund may use or invest in financial derivatives for efficient portfolio management and hedging purposes. This material has not been reviewed or endorsed by the MAS. PineBridge Investments is a group of international companies that provide investment advice and market asset management products and services to clients around the world. PineBridge Investments is a registered trademark proprietary to PineBridge Investments IP Holding Company Limited, PineBridge Investments Singapore Limited (Co. Reg. No. 199602054E), 1 George Street, One George Street, #21-06, Singapore 049145.

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