Unlocking Alpha: Schroders’ Philosophy of Deep Dive Stock Selection in a Volatile Market
In the dynamic world of investing, simply knowing when to buy a stock is only part of the equation. The true competitive edge, according to the team at Schroders, lies in understanding why the market might be getting it wrong. Since the inception of their Global Equity Alpha Fund in 2018, Schroders’ investment managers have navigated a period characterised by unprecedented shifts, from the seismic disruptions of a global pandemic to persistent inflation shocks and the explosive rise of artificial intelligence. Throughout these turbulent times, their investment strategy has remained steadfastly anchored to a fundamental principle: stock selection, not broad macroeconomic forecasting, is the most reliable engine for generating investment returns.
This approach eschews the common practice of rapidly rotating between investment styles or making sweeping thematic calls. Instead, portfolio managers dedicate their efforts to meticulously identifying companies whose future earnings are, in their assessment, being mispriced by the market. This philosophy is not built on the fickle sands of prediction, but on the bedrock of repeatability, informing every facet of their investment process, from the initial construction of portfolios to the rigorous management of risk. Investors seeking to tap into this proven strategy have two avenues: direct investment in the Global Equity Alpha Fund or through its Australian Securities Exchange (ASX)-listed Exchange Traded Fund (ETF), the Schroder Global Equity Alpha Fund – Active ETF (ASX: ALPH).
To gain a deeper understanding of how this strategy translates into tangible investment decisions, we spoke with Ben Arnold, Investment Director in Global Equities at Schroders.
“We firmly believe that identifying stocks where the underlying fundamentals are not being recognised by the market is a far more repeatable and sustainable skill than making binary bets on a particular style, theme, or a significant macroeconomic call,” Arnold explained.
This core conviction directly fuels what he terms the “growth gap” – the divergence between prevailing market expectations for a company’s future earnings and the reality of its actual performance. In this exclusive Q&A, Arnold elaborates on how the Schroders team targets this gap, the art of balancing core and opportunistic investment ideas, and where they are currently uncovering promising opportunities.
Prioritising Stock Selection Over Macroeconomic Predictions
The investment approach adopted by Schroders has been in place since 2018, a period marked by a relentless barrage of macroeconomic shocks. However, Arnold stresses that the team has deliberately steered clear of attempting to predict these events.
“We navigate these diverse market environments by ensuring that our stock selection process is the primary driver of investment performance,” he stated. This unwavering focus on repeatability is a conscious decision. Rather than engaging in the challenging task of timing market cycles or chasing ephemeral themes, the team remains committed to the disciplined pursuit of mispriced earnings, allowing their investment theses to unfold organically.
Defining the Elusive “Growth Gap”
At the heart of Schroders’ investment methodology lies the concept of the “growth gap.” This refers to situations where the broader market is underestimating a company’s future earnings growth trajectory.
“The common thread uniting our most compelling investment ideas is that the market is not fully appreciating each company’s potential for future earnings growth,” Arnold observed.
He further explains that this mispricing can manifest across various time horizons. In the shorter term, investment opportunities frequently arise from situations such as corporate turnarounds, the impact of new management teams, or the successful introduction of new product cycles, typically playing out over 12 to 18 months. Over longer periods, spanning three to five years, the opportunity lies with companies where the market has applied an overly conservative growth rate, failing to acknowledge their sustained expansion potential. The most attractive investments, Arnold notes, are those where both short-term and long-term growth potential are being underestimated, thereby creating multiple avenues for significant capital appreciation.
Constructing a High-Conviction Portfolio
The Global Equity Alpha Fund typically maintains a concentrated portfolio of between 40 and 60 stocks. These holdings represent the team’s highest conviction ideas, meticulously selected for both the fund and its ETF counterpart.
“The equilibrium between our ‘core’ and ‘opportunistic’ holdings is invariably dictated by the bottom-up opportunity set we uncover,” Arnold commented. Core holdings are generally characterised by their high quality, their ability to compound shareholder value over time, strong market positions, enduring competitive advantages, and a consistent commitment to investing in innovation. Opportunistic positions, on the other hand, tend to be more tactical in nature, often driven by clear inflection points such as significant operational turnarounds or shifts in industry dynamics. Crucially, this allocation is not influenced by top-down macroeconomic calls or stylistic rotations; it simply reflects where the team identifies the most compelling investment prospects.
Risk Management: A Synergy of Data and Debate
Given the concentrated nature of the portfolio, rigorous risk management is paramount. Arnold describes a dual-pronged approach that combines sophisticated data analysis with robust intellectual challenge.
On the data front, the team collaborates closely with an independent equity risk group. “We engage an independent equity risk team that functions as risk consultants, dissecting the portfolio from numerous angles to assist the portfolio manager in viewing risk through different lenses. This includes analysing factor risk, conducting scenario analysis, and performing sensitivity analysis,” Arnold stated.
However, the human element is considered equally, if not more, important. On a weekly basis, portfolio managers convene to rigorously pressure-test individual positions and the overall portfolio construction.
“Every Thursday, we engage in a comprehensive debate regarding portfolio construction as a collective of portfolio managers. It’s essential to acknowledge that individuals, including fund managers, have inherent blind spots,” Arnold admitted. These discussions are deliberately designed to uncover potential risks that might not be immediately apparent from the data alone.
“By bringing together a group of experienced portfolio managers within the team, all managing similar strategies, and fostering open discussion, we can significantly reduce the likelihood of overlooking unforeseen risks,” he added. Ultimately, the objective is not to eliminate risk entirely, but rather to ensure that any risk taken is done so deliberately and with a full understanding of the potential implications – “with eyes wide open.”
Identifying Emerging Opportunities
The current positioning of the portfolio is a direct consequence of the team’s bottom-up stock selection process, rather than any top-down strategic allocation. This has resulted in notable deviations from the benchmark index across various regions and sectors.
Currently, the team has increased its exposure to companies integral to AI-related infrastructure, including semiconductor manufacturers and networking providers. “These companies are responsible for producing the chips and networking equipment that power data centres – critical components that stand to benefit immensely from the substantial AI-related investments recently announced by major hyperscale cloud providers, such as Meta (NASDAQ: META), Google (NASDAQ: GOOG), and Microsoft (NASDAQ: MSFT),” Arnold explained.
Beyond these widely recognised technology giants, Arnold highlights AIA Group (HKG: 1299) as a particularly compelling opportunity. The investment case for AIA hinges on the persistent structural underinsurance prevalent across Asia and the market’s apparent underestimation of the company’s long-term earnings potential. “We firmly believe that the market continues to underestimate AIA’s profitability potential, which is underpinned by the structurally long-term growth trajectory of the insurance sector in Asia,” he commented.
Concurrently, the team has demonstrated discipline in realising profits when appropriate. Recent divestments include Netflix (NASDAQ: NFLX) and Eli Lilly (NYSE: LLY). In Arnold’s view, the strong share price performance of these companies has now fully captured their respective growth outlooks. “In both instances, we were content to crystallise these gains and redeploy the capital into other companies that we believe the market is currently under-appreciating,” he stated.
Accessible Investment Through Fund or ETF
Investors have the flexibility to access Schroders’ Global Equity Alpha strategy through either a traditional managed fund structure or its ASX-listed ETF, offering a convenient entry point for a wide range of investors.
“Active ETFs, such as ALPH, are readily accessible through the ASX and trade in a manner identical to ordinary shares,” Arnold noted. The ETF structure provides investors with the ability to buy and sell units throughout the trading day, with no minimum investment requirement beyond the purchase of a single unit. This accessibility allows investors to participate in the same high-conviction global equity strategy managed by Schroders. Ultimately, the core tenet of the strategy remains unchanged: to take calculated risks with a clear understanding of the potential upsides and downsides, always with a vigilant awareness of inherent blind spots.
