Quant Strategies For A Volatile Market (Video Transcript)
- We speak with Ruerd Heeg about his quantitative approach and what opportunities he is finding.
- While he is pessimistic about market valuations as a whole, he sees a number of cheap stocks he thinks could work.
- He also sheds light on how he applies his quantitative strategy.
Editors' Note: This is the transcript of the video we posted last Thursday. Please note that due to time and audio constraints, transcription may not be perfect. We encourage you to listen to the video as well as a podcast embedded below if you need any clarification. We hope you enjoy.
Daniel Shvartsman: I’m Daniel Shvartsman, Director of the Seeking Alpha Marketplace. We’re continuing our Roundtable series with marketplace authors about the coronavirus market. Today, I’m speaking with Ruerd Heeg, author of Global Deep Value Stocks, which offers high returns on value stocks from seven quantitative strategies back for the research.
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Ruerd, good morning. How are you?
RH: Good morning. Fine. How are you?
DS: I’m good. It’s good to talk with you today. So just before we’re going to go into a lot of quantitative stuff, a lot of strategies that you run. But what’s your general – what’s the context of how you approach the market today? Obviously, we’ve had a big sell off in February and March. We’ve rebounded to almost a year starting year levels loosely. So what’s your outlook for the market as a whole before we get into the details of your strategies?
RH: Right. I’m very pessimistic because of the lockdowns and because of massive off of federations still. I expect restrictions to be lifted soon. I think politicians have recognized this mistake. But in the meantime, much damage has already been done. And lots of people and companies will go bankrupt because of this, and eventually, that will have a big effect on the stock market. I’m surprised, we haven’t seen this already. But I think, the coronavirus will have a much smaller impact on the very cheapest stocks globally, more on the high flyers. yes.
DS: Okay. So that takes us to, given that outlook in – I mentioned in the elevator pitch for your service that you have seven different strategies we were talking by e-mail before this. What’s the strategy you’re focused on currently given that outlook, or what are you looking at right now?
RH: Right. Well, normally I focus on niche and companies with market caps below US$25 million. And I think that is still a good focus today. But in – I use reserves, right, from others to – for my new service. And in times of high volatility, I also pay extra attention to so-called falling knives. And falling knives are stocks that have gone down with at least 60% during the last 12 month. And I think when these investments, they did some research about this strategy. And their publication, I think, mentions such stocks have even better returns when they originate from times with high market volatility.
So the stocks that went down much that became falling knives in March, and still are, they should do much better even than normal falling knives.
DS: Okay. That’s – speaking quickly the – with these market caps under $25 million, do you – one of the things we’ve seen is larger companies have bigger balance sheets. They have big. The market seems to be – we’ve seen a little bit of a change this week, but the market has generally been favoring larger companies. And small business seems to be an area that would be most affected by what’s going on. Do you worry about that at all with the nature of the lockdowns and everything else? Or you feel that because they’re net-nets, they still have the balance sheet and they should be fine to make it through?
RH: Right. That’s one thing. If the discount is large enough, then it should be okay, provided if the cash is there and the management doesn’t steal too much, whatever, right? And I avoid companies with too much debt. I think that it’s important to avoid these companies in this time. You’ve already seen it with Hertz (HTZ) and certain airlines.
And I think, in this time, it’s more difficult to refinance debt. And also in normal time, companies can outgrow their financial problems by generating profit – profits now, that’s more – it’s going to be more more difficult, right? So one of my focus is also companies with strong balance sheets. And by the way, another focus is the beaten down sectors.
DS: So what are the examples? Any examples of either the strong balance sheet or the falling knife, or the beaten down sectors that you’re looking at closely?
RH: Yes, yes. Well, the – all those great companies, they are not one is the same. They are all very different. And I can give you a prepared six examples of falling knives net-nets and nano caps that I recently looked at and I find them interesting and if you – if you’re okay with that.
RH: Well, an interesting falling knife is German – the German company, HAEMATO. I think, you pronounce it as HAEMATO. They are traded on the Xetra and their ticker is HAE. And they import and produce generic drugs. So this is a company that you might expect, these discloses might be good for them, right, but apparently not. At the moment, they sell, for instance, drugs for heart disease. And they – in Germany, they keep the hospitals empty also for this group of patients with heart disease.
They’re not extremely cheap, but small margin improvement can make the company very profitable. And until recently, this company paid Fed dividends and now they have suspended it those high-yield investors they sold. So, yes, it’s good stock for deep value investors, but you don’t know, right? It’s with these small companies, especially the companies with market caps of US$10 million, US$15 million, it’s often the outliers. And by buying many small positions in these stocks, you prevent – you make your chances on an outlier higher.
Another interesting falling knife, this HAEMATO was a falling knife. But another one is Lion Rock Group. And this ticker, 1127 in Hong Kong. And this is basically a printing company with good earnings quality and also shareholder-friendly.
There’s a famous investor in the stock and that’s David Webb. He owns a large stake, I think, 13%. And David Webb is a well-known value investor from Hong Kong. And he specializes in companies with good governance and cheap companies with good governance and good earnings quality. So that’s remarkable that the – such a stock is in the top of my list.
Another great net-net is Italian company, Isagro. The ticker is ISG, and it trades in Milan. And this company produces biological molecules for use in agriculture. And there are some debts, but the company has also sold an important asset. And I – I’m pretty sure this transaction completes. It sells it to a big American large-cap company. And when it completes, I think, beginning of October, end of September, the stock trades below liquidation value.
So, this is a great example of net-net that can go up much. I like net-nets that have spent a lot on research and development during the last five years. This is one of them or other net-nets like that are biotechs – field biotechs. So biotech, those are trial. It feels stock crisis. And well then, if it’s cheap enough, if the discount to liquidation value is good enough, then yes, it’s often a good stock.
Another net-net in a beaten down sector and also a nano cap is BowLeven (OTCPK:BWLVF). Ticker is BLVN in London. And they invest in an oil project somewhere in Africa. I think, it was offshore in Cameroon, and they have plenty of cash. And normally, they would receive a big milestone payment at the end of this year. But that depends on this project. And with this oil situation, I suppose it will be delayed, but we’ll see.
Another similar oil net-net is Enteq Upstream (OTC:ENQQF), and the ticker is NTQ in London. And it’s not really similar. It supplies drilling equipment for fracking in the U.S.
RH: So that doesn’t sound very promising. But this equipment can also be used for drilling conventional oil projects. It is trying to sell its equipment to countries like Russia, Saudi Arabia, and so on. And I like it. Also it seems to have some intellectual property. I don’t know how much. I’ve – before this interview, I looked at how much they spent during the last five-year, but I couldn’t find it in my screener. But I think that they mentioned it in their annual report, I think.
And last one, a good nano cap, it might be Shinto Co. And it’s – this is totally different. There’s no growth story, nothing. The ticker symbol is 5380 in Japan, and this company, guess what, it manufactures roof tiles from clay. So good old fashioned roof tiles, I suppose. And it’s extremely cheap based on price book, however, is not so profitable. But until a couple of years, it was very profitable. So who knows? Will the good times come back ever with a price book of 0.2 or so? Yes.
DS: You don’t need a lot.
RH: You don’t need a lot. You just need to double or so, right, off the profit. But right now, it’s kind of break-even. So these are six examples. I have a couple of more, but for this – these strategies I focus on.
DS: So what I want to ask is, what’s interesting to me is, you just presented six stocks and I’ve looked at your service before, I know you and you shared something before. You have Excel sheets with hundreds, if not thousands of stocks on quantitative rankings. What I’m curious is, in seven different strategies as we mentioned, how do you – what does that mean for how you run your portfolio?
Are you – you sort of said statistically that if you give yourself enough chances, you’ll – these will work out. So I guess, the question is, how wide a portfolio do you normally run? And in these cases, you shared us six different names, you shared us some information. But are you normally – how much research do you have to do before a stock enters your portfolio? Is it just a sanity check, so that they’re not criminals, like you said, or how does that work for you?
RH: Yes. Well, I research first of all, I have so many stocks in these spreadsheets. I cannot research them all. But I research many, and it adds up. I’m doing this already five years. So 20 stocks per month, even a bit more, sometimes.
So if I can always find something or not always, but very often, I can find something I have written before on the stocking with a good ranking in the list. How much time it cost? It depends. It depends on what has happened with this company sometimes this Japanese stock in play roof tiles that was an easy one. But then this Italian stock was more difficult. I had to keep track of the transactions and so on.
But in general, I do whatever it takes to – for – to make a good business description, I look at related party transactions who owns the stock. I look at the balance sheet, whether the stock is distressed. I look at discounts to liquidation value, that kind of stuff. And if I’m lucky, it takes three hours for one, right, for the Japanese stock, maybe 2.5 or 2 hours. So, but sometimes, yes, if there’s sometimes annual report, it’s difficult to find, cannot be translated in Google Translate and so on, then it takes long, much longer, it can take more than a day.
DS: Taking the Italian stock Isagro was the ISG?
DS: That was interesting to me, because you said that it will be below liquidation value after its transaction completes. So how does that pop up in the first place? Is it already a net-net, or it’s already sort of close to that level? And so it’s on your list, and then you do the work and you see, oh, and there’s also a transaction that’s going to actually pull it even more, or because that seems more than just the quantitative, right?
RH: Yes. Yes, this is a great question. And it showed us a net-net. But many net-nets with a great ranking in my list, they are not really net-net. Often there is a subsequent event like a dividend, large dividend payment and so on. So I see this.
I think for that reason, I think, you cannot really take my list and invest in these stocks just alternatively. You always need to exclude stocks that are not really net-nets. And with the other strategies that is much less so, but this stock showed up as a net-net, then I looked and then my conclusion was, it was not a net-net. And then I think what happens – happened recently and so on, and then I found this transaction.
And then I thought, so what have they sold? Well, it took some more digging. And my conclusion was that sold mostly intangible assets. And also they make a very nice profit on this. I think, they sell these assets for $50 million and they book a profit of $20 million or so. So that adds up to the balance sheet. So then I make kind of balance sheet, including this transaction and then I do the rest of the work.
RH: This was quite a complicated thing to research. So – well, one of the more difficult ones.
DS: Right. Very interesting, though. I mean, yes, I guess it’s – I mean, it’s still a classic screener approach, right? You have screen. You have standards and then you look further and – but with –yes, it’s just interesting how that played out.
Another strategy we talked about when we’re e-mailing that I thought was interesting and I want to just ask real quickly was the idea you said you like expected high volatility stocks, because the expected high volatility, as I understood, it ultimately means that the market is building in a bigger discount, but not actual high volatility stocks. So I guess, I was wondering if you could elaborate a little more in any example of something like this?
RH: Yes. Yes, I – indeed, I don’t like full of those [ph] stocks. I think they might perform as good as other stocks, but they are more risky. So for every stock, I compute the – for every stock I look into, I computed three years volatility based on stock prices in U.S. dollars. So I get many stock prices in many currencies. I convert them to U.S. dollars, all the stock prices and I compute for utilities, and then I think the highest number should be avoided.
But then in December – I keep reading research. And in December 2019, I finished a free book, free PDF from very good researchers about the concept of popularity in investing. And in one of the chapters, it said that stocks investors expect, they will go down more than the market. Those stocks are often in the price. They have higher returns than other stocks.
So this was a great insight for me. And yes, so that’s what I’m also using. It doesn’t need to be true always, but it’s just one way. And in this market, yes, we have the beaten down sectors, of course. And, for instance, this BowLeven net-net and also large-cap Lukoil (OTC:LUKOY) (OTC:LUKOF). This is a Russian oil and exploration company with assets in Russia and also other countries. I think they are also in the project with BowLeven and their large asset is in Iraq.
Surprisingly, I haven’t found many cheap tourism stocks. That’s also a beaten down sector. I think, I thought about it, why not? Well, I’m looking for cheap stocks, either based on earnings or based on price book without financial distress. And the problem with tourism stocks, maybe they are usually financially distressed. They have too much debt.
When I think about the situation here in Amsterdam, for a long time, tourism was seen as a steady growth business, that basically could not feel. In Amsterdam, number of tourists increase every year until now, of course. So I wouldn’t be surprised if many hotel businesses, for instance, and airlines have leveraged too much, because they thought that it was – they couldn’t feel.
And – but I have found two interesting stocks, that one is Dolphin Capital (OTCPK:DOLHF), ticker DCI in London. And this company owns tourist resorts, but wants to update, is in runoff mode. And there are some governance issues, I think, or at least things – payments to management of size – of a size that I don’t like. And the consolidated balance sheet looks strong, but there may be some financial distress in one of the subsidiaries.
And more risky is Aseana Properties, I think, that is ticker ASPL in London. And by the way, this stock is low volatile stock, but I consider it still as more risky. And this company invests in property in Malaysia and Vietnam. They own a mall, shopping mall to hotels, apartments and hospital.
So there is some direct exposure to tourism and a lot of indirect exposure. And that this company is in divestment mode, miss I like. And unfortunately, it has a lot of depth on its balance sheet. And I didn’t recommend it to my subscribers. And after discussing it in my newsletter, it went down with another 20% to 25%. And the company also announced a related party transaction that may be either troublesome or just fantastic.
So, yes, and there’s another example of this principle and I feel there. For years, I have been looking at many extremely cheap Japanese construction stocks, and I don’t think I have ever invested in one of them. But I should have, I think, if I had known this principle, and yes, that’s a pity.
The idea is also with the stocks that there was a lot of demand for construction because of the Olympic Games. And what you see after Olympic Games in many countries that the economy you get in recession. Yes, so that was my fear with this, of course, stupid.
DS: When you say this principle, what do you mean by that? If you had known this principle, you’re talking about the Olympic effect or something, I’m sorry, I may have missed what you’re referring to?
RH: This principle of the people avoid stocks that go down more than the market.
DS: Okay, got it. Okay. When you said the related party transaction that was either troublesome or fantastic, what did you – what do you mean by – what’s going on there?
RH: Yes. This Aseana Properties, I didn’t look at in – I didn’t look into it in much detail. But they want to sell some of the assets to the majority shareholder. And the majority shareholder, it pays in shares. So it basically exits, I think, can be great, can be troublesome. We don’t know.
DS: Right. I see. Yes, that is interesting. Okay. So I think the tourism sector is an interesting one, because I suspect, I invest in a lot of travel-related stocks. I suspected split between high asset, but highly levered stocks, which you mentioned hotels, airlines, cruise lines, on the one hand, or asset-light service-oriented stocks that probably don’t trade cheaply to book value, because they don’t have a high tangible book value. So that may be part of the issue?
RH: Well, if they are the latter category, if those stocks have high earnings, backward looking, then they could be great.
DS: Right. Yes – but, of course, the market, I made this point on Twitter. It seems like the market is pricing in a lot of positive outcomes in a lot of different seemingly contradictory areas travel highlights?
RH: I think so, too, yes, at a moment still, but maybe not in a couple of month.
DS: So that’s the last question for you that is you look at stocks around the world. I – even though I live in Europe, I focus on the U.S. market and so I have more mindshare about, okay, the U.S. market to me seems like it’s priced in a lot. But where are you – are you seeing any markets that specifically stand out as offering a lot of value? Or is it – how do you see the differentiation across different countries, different markets in the world?
RH: Yes. I think that the stocks in Hong Kong net-nets in low enterprise value divided by earnings before interest in tax. Those stocks, they might be the cheap – the cheapest stocks globally. It’s – from China, there is continuously continuous flow of bad news. And investors in these stocks, they have suffered from governance issues for many years. And in 2017, David Webb, he published a great blog article on the so-called Enigma Network. He called them 50 companies not to own.
And since then, I think, governance has improved somewhat. It’s not great at all still, but we see that the regulator even started handling out fines again and is criticizing certain direct – certain companies, certain Boards. I think, one needs to be careful, still very careful, but future returns are worth the effort of investigating the stocks.
And examples of quality stocks. Over there, I think, they are Tsaker Chemical Group, ticker 1986; and again, Lion Rock Group (OTC:PTRGF), I’ve already mentioned it; and there is also Huabao International Holdings, ticker 336. So 336. And yes, they have good – they seem to have good capital allocation and good earnings quality in this Huabao stock. They have a past with hit pieces and so on with lot of discussions. And yes, there are some governance issues, I think, still over there.
And another interesting market is Poland. Poland has one of these governance – governments that I think in the long run this kind of govern – governments are not good for the economy. But at the moment, there are many cheap Polish stocks. And in general, governance is very good in Poland. But again, we’ll need to be careful.
I translate the filings in Google Translate and they supply a lot of information, also small companies, which is good. I think still, it’s best to avoid those polish stocks with even minor issues. But a lot of companies are absolutely clean, maybe not great businesses, but cheap, and I looked into three recently, and Patentus, ticker symbol PAT. What did they do? Or maybe – yes, they supply this – they produce mining equipment and they’ve only two customers, but they are cheap.
DS: Keep some more risk.
RH: Coal mines, right, so not so good business. And there is APS Energia. Ticker APE. They supply power units, power conversion, power supply units. I think for maybe half of – maybe half of their revenue is from Russia. And there is Monnari Trade, ticker MON, and that’s women apparel company.
DS: It’s quite a variety for the Poland market.
RH: Yes, as anywhere.
DS: Yes, of course. That’s – yes, obviously – and obviously, Hong Kong right now, if you think of all those be greedy when others are fearful, I would think Hong Kong this week, especially with all the news is probably opening up a lot of fear in that market.
RH: Yes. Surprisingly, I sold the Hong Kong dollar trading at its strongest point of it’s been with U.S. dollar. It’s – there’s a peg, and the peg is between HK70.75 and HK70.85 for U.S. dollar. And right now, it’s more like HK70.75.
DS: Interesting. And that’s what – to go back to the expected high volatility, it’s – what’s fascinating about the market is that, it’s not just fundamentals. It’s also that what do people think will happen, and so that can be that George Soros reflexivity, and that can end up causing a lot of effects that shouldn’t happen, but that do and then end up marrying out.
RH: Right. Yes, yes.
DS: So – okay, great. This has been a lot of fun. I’ve been talking to Ruerd Heeg, who writes Global Deep Value Stocks on Seeking Alpha. You can find his work there or on the Seeking Alpha Marketplace. Ruerd, before we wrap up, any positions in any of the stocks you mentioned?
RH: Yes. My portfolio is now very small, because I anticipate further down to turn off the market, so I have no positions.
DS: Okay, fair enough. Okay, but does – it’s quite an interesting shopping list, hopefully people can find something to invest in.
DS: So, okay, great. Ruerd, thank you so much. All the best to you with you’re investing and hopefully, you stay safe out there and thank you for taking your time this morning.
RH: Yes. Thank you. Bye-bye.
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Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Neither Ruerd Heeg nor I have any positions in any stocks mentioned. Nothing on this video should be taken as investment advice.
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