Enzio Von Pfeil founded Commercial Economics Asia in early 2000 after a career as an economist within large banks and brokerages including stints at JPMorgan, Schroders, SG Warburg, ABN Amro and Smith New Court. The firm pioneers the use of a rigourous economic framework called the Economic Clock. Within that framework the firm then translates economics into sector and stock investment strategies. Crucially, investors pay to receive this research, ensuring that it is free from any of the baggage that comes with normal investment research.
What was the thinking behind setting up Commercial Economics Asia?
Von Pfeil: A number of customers liked my very hands on commercial approach to economics rather than the rather turgid academic approach reporting on numbers. In a traditional brokerage, economists cannot talk about strategy or indeed stocks because the brokerages have hired strategists and analysts to do that. So what my customers wanted me to do was to develop a macro input to the stock picking equation that cuts across these strictly defined job functions. This is simply because stocks operate in a macro environment and when investors say that they are only bottom up I am a little bit surprised. It seems to me that if you don't know that certain stocks are very sensitive to particular economic variables, then your bottom up approach can be very misleading. So the differences between traditional researchers and us is that we are 'and, and', whereas they are 'either, or'. We say it is the company and the macro environment, they say it is either the company or the economics.
So when you started your company was there a gap in the market and no other analysts were looking at research like you?
Von Pfeil: They cannot look at it like us. Within normal brokerages this would be disallowed because you would always have fights and turf wars.
Vizzone: It's a product of the very strict demarcations of labour that exist in banks and brokerages. So, in effect, we take advantage of a structural arbitrage in that we can work outside of these confines and produce something new and fresh û something out of the box.
Having worked at a number of global banks and brokerages, were there many pressures there that you were beholden to? As a result is your research now better because it is not beholden to these pressures?
Von Pfeil: It is more independent now. If you have a chief economist and a house view, it is hell for any economist to operate within that because each economist is going to have his or her own views.
How have investors taken to your approach and style? How is business?
Von Pfeil: Business is very good and has been picking up very steadily on the back of greater brand recognition. It has not been easy because we are not offering plain vanilla economics. Most fund managers have been weaned into this triangular way of thinking where they will talk to company analysts, strategists and economists. I just don't buy it, that a stock is divorced from the economics.
What is your access to the companies you cover? Many observers comment that independent researchers do not have the investment bank leverage to be able to get into the companies and talk to the CFOs.
Von Pfeil: We don't want to talk to them. We give investors what they are not going to get from the very good say property or shipping analyst. What these analysts cannot deliver is what we deliver, which is how macro impacts individual stocks and sectors. For instance we can tell investors our thoughts on US retail sales and which stocks are likely to be most effected by that particular variable. The investor can then go and talk to their favourite consumer analysts to widen the scope.
Vizzone: What we do is different from what most analysts do and therefore has somewhat limited applicability. Our approach is most applicable to large cap stocks with lots of liquidity, as they tend to move with economic fundamentals. We don't need to go and see management or look at their books. We are concerned with how economic fundamentals impacts share price.
Do you make recommendations?
Vizzone: We have a number of different products and in one of them, "MacroTrades", we do make stock recommendations. We take a very top down view saying this is what the fundamentals are doing, and this is what the stock should do on the back of the change in the macro landscape. Hence, if the macro drivers are solid we recommend the stock and vice-versa. We also do quantitative research, again with a macro slant. Here we look for statistical arbitrage or suggest pair trades, long/short plays and the like. Occasionally we will do valuations analysis û global comparables for instance û this just adds to the flavour.
Von Pfeil: We will also certainly make relative country recommendations, for instance sell Korea, buy Taiwan. We will also make stock or sector recommendations to the extent that we think for instance retail sales are about to start taking off in Taiwan and so these are the retail sale sensitive stocks.
What do you think of the state of equity research in Asia?
Von Pfeil: I take some issue with the current attack on all of these analysts because surely fund managers know that these houses are working for corporate finance departments. For it to take them this long to work it out is a bit ridiculous. Analysts have jobs to do. If they continue having sell recommendation on stocks for years and years then the sales department quite understandably asks why they should pay for it. What we are reading about now is something that has been known for ages.
Do you think there might be more regulatory oversight of the research business as a result?
Von Pfeil: I have seen what Andrew Sheng of the SFC in Hong Kong has been saying. It is not bad to regulate but it's a bit like trying to catch a fish with your hands.
Vizzone: There's already sufficient oversight. In Hong Kong we have the SFC. There's a strong ethics component within the CFA [Chartered Financial Analyst exams]. Indeed, portions of the local brokerage exams you now have to take also have a strong regulatory framework section. So the structure and education are in place to deal with these issues. However, when set against the internal machinations of investment banks, something's becoming unstuck. However, what is in place at the moment should really do the job.
Do you think that given the pressures on banks and research departments that more analysts might just set up shop on their own and offer independent research such as you are doing?
Von Pfeil: I don't think so. To become an independent you need a hell of a lot of staying power. It's fun having a big name behind you but it is a very different world when you are on your own. If it is something that if you really want to do, you need the psychological staying power and the resources to go with it.
Vizzone: From a business standpoint it goes far beyond just producing quality research. There is a whole raft of other aspects you need to look at. Running a business is not easy. Also franchises are easier to create with the huge support network you get within a bulge bracket name. When you're out on your own this is a luxury that's sorely missed.
Von Pfeil: Also the kind of work that we do is not vanilla economics, its really out of the box stuff and most people do not want to think out of the box. It is much more comfortable to go with the herd. One thing I find surprising about some fund managers is that despite what they say, their actions suggest that they want to read what everyone else is reading, which flies in the face of competitive edge.
I can sort of understand where these guys are coming from as they largely just follow indices. But I am afraid that at some stage the normal retail fund investor will ask why they are paying 1.5% when they can just buy a tracker fund, pay 3bp and never underperform the market. That is also why hedge funds are blossoming. That is where the big awakening will come from, much more than people realizing that analysts are not as independent as they should be.
Also, having worked with many fund managers over the years, the reason they like the company analysts, is because of their access to management. Fund managers are not stupid. They know when a bank is doing a deal for a company they are producing research on.
Is it easier being an independent economist than an independent stock analyst?
Von Pfeil: I think it depends on your clout in the market. I know of some very good company analysts who have set up very good systems on their own. Frankly for economists it is difficult because fund managers get too much economics anyway. And most economists can only tell you the time by look at someone else's watch.
Vizzone: It's the right environment to be independent. There is a dearth of quality, bottom up independent research set against a great demand for this type of product. I think that if you run a good, bottom up research house, then it is easier than what we are doing. In our space, we are dealing within a very specialized niche û only 3% of the market might actually be interested in what we do. But that number goes up dramatically when you are talking about quality, bottom up research. It's because of the way the buy-side are wired: very simply they are more bottom up than top down.
Quite a few of the independent houses actually have to link their research to another business to subsidize it û a hedge fund or consultancy of some kind.
Vizzone: There is a very good reason for that û money. If this type of business is to be successful the payment mechanism must be painless. Soft dollars are great but often not the panacea they're made out to be. In a traditional house, votes translate into commission which equals money. That is the way the research is paid for û in part at least.
If independent operations such as ours don't have that seamless payment mechanism or aren't attached to a hedge fund or whatever, then it can become difficult to operate as an ongoing concern.
Von Pfeil: One of the problems is the patent refusal by the larger fund management houses to pay for research. Now if I've ever heard one naive statement from the industry it is "we don't pay for research", as if Morgan Stanley is a charity! What is really being said is "we want to read what everyone else is reading." So what I want to know is where is the investor going to get his edge from?
So is now the time for fund managers to start thinking out of the box and stop slavishly following the index?
Von Pfeil: Yes. Firstly, because there is definitely a role for country allocation. The cement cycle is not global. The banking cycle is not global. The retail sales cycle is not global. There are very few global sectors û shipping and perhaps tech. But even the steel cycle is not global. Our overall call on Asia has been correct and we have outperformed the MSCI by 17% since last December. Our individual country calls have also been correct.
Vizzone: I agree. A rising tide lifts all boats û county allocation is key. For example our Economic Clock recently called correctly that Korea would come off and Taiwan would start to outperform. That one switch is likely to be the most important asset reallocation this year.
Many people are suggesting that analysts should be paid by the accuracy of their calls. Isn't it dangerous making this whole industry dependent on prophecy?
Von Pfeil: This industry is driven by heads of research. If the head of research is a 30 year old, they really do not know what they are talking about because they lack experience. The older fund managers know that only paying analysts for the correctness of their calls is complete rubbish. The smarter ones on the buy-side say "provoke me, tell me something I don't know."
Do you invest your own money in your calls?
Von Pfeil: We have our own money invested and we are just refining the systems to launch a hedge fund based on our research to be launched in the first or second quarter of next year. We have already had some large names saying that they will fund it.
