• Vanguard Global Emerging Markets Fund co-portfolio manager Caroline Cai reflects on the art and science of building a portfolio of good businesses.
• Pzena employs a proprietary quantitative screening model that looks to identify businesses which have been undervalued by the market. 
• Pzena believes that a focus on valuations at the outset can lead to strong performance over the long term.

The Vanguard Global Emerging Markets Fund is an active equity fund managed by three investment firms with complementary investment styles: Pzena in New York, Oaktree in Los Angeles and Baillie Gifford in Edinburgh. Pzena employs a value investment strategy, which focuses on investing in companies that are undervalued relative to their peers or in historic terms. 

Caroline Cai, part of the team which manages the Pzena portion of the fund, reflects on Pzena’s investment philosophy and process which identifies businesses that have a profitable history but might be experiencing a short-term issue or earnings slump. This Q&A and accompanying video is the second in a three-part series.

What is Pzena’s investment philosophy?

The investment philosophy of Pzena is actually quite straightforward. Every portfolio manager wants to buy exposure to a good business and pay a good price for it. We think one investment opportunity is when something has gone wrong in the company that's obvious to everyone, but the resolution is not clear. It's just psychology - we don't like uncertainties. So, when things aren't going well, it's more likely than not that the market starts discounting a lack of improvement from here or further deterioration in the business. 

On the other hand, businesses are run by people. They react to the environment, they take on restructuring, they do all sorts of self-help; and for us, the opportunity resides in if the market is already anticipating the downside case, maybe there is the prospect of only a further 20 to 30% fall in the share price from here. 

How would you describe Pzena’s investment process? 

Our process is really geared around implementing our philosophy in a systematic, disciplined and repeatable way. It starts with our proprietary quantitative screening model that essentially tries to find businesses that have a good profitable history but are not making as much money as they used to. 

If you believe those issues can be fixed, and they are in the cheapest 20% of the potential universe from a valuation standpoint, we believe there is an opportunity. And once our quantitative screening model identifies the stock as a potential investment, we will spend up to two to three months typically, sometimes up to four to five months, analysing what made this business great and profitable to start with, what's going wrong today and do we think management has a reasonable plan for addressing the issues. 

At the end of the process, we look at the likely outcome that could materialise for this company, and we aim to build a portfolio of between 30 and 50 businesses, all of which are in pain for uncorrelated reasons. The idea is that the fixes will be different as well. We think that it's a very repeatable process to implement and that the value philosophy should work out over the long run. 

Could you elaborate on your investment team?  

Our team structure really reflects our investment philosophy and process. For our investment outcomes, we think of it as 80% coming from the company-specific research and around 20% from the portfolio construction process. On this basis, every member in our team views themselves as research analysts, students of businesses with some of us having additional portfolio manager responsibilities. 

We're all global industry analysts. We do not have regional or product specialists because studying how competitors or business models evolve in different parts of the world is the best way to understand longer term how this specific business model can evolve. And all of our portfolio management teams have two to four co-portfolio managers. If you want to be the rock star, this is not the place for you. We make decisions collectively. Everyone has equal voting power on buy and sell decisions. And we think that the diversity of viewpoint that the co-portfolio manager structure brings in is a critical part of being a successful value manager over the long run.  

What do you look for in a global industry analyst?

The ideal analyst is someone that reflects how the team is structured, someone who's curious about how business works, somebody who likes, appreciates and really buys into the team concept, the value of collaboration, and, obviously, someone who has a natural inclination for value and being sensitive to the price you pay for something. We don't actually look for a typical Wall Street or financial background. We really want people who look at potential investment opportunities as businesses run by people, not just lines in a spreadsheet.