Investor interview with Marco Pabst
Interview #6: Marco Pabst shares his investment strategy, how he thinks about risk management, and his top ideas.
Welcome to investor interview #6. I’m putting together this series to bring you diverse experiences and perspectives from other investors.
This week’s guest is Marco Pabst, Group Chief Investment Officer at Arbion. Marco has more than 30 years of experience in investing and his team currently manages several billion dollars across equities, fixed income, hedge funds, and private investments. You can follow his thoughts or connect with him on Twitter or Linkedin.
Hi Marco, thank you for taking the time to do this interview. Excited to have you here! Can you please tell our readers a little more about your background and also about your investment firm Arbion?
I started as an equity research analyst on the sell-side, working for a large German private bank covering small and midcaps, and then focused on European software companies, working for UBS in the late 1990s. After the dot-com bubble, I moved to the “buy-side” and joined a multi-family office in London in 2004.
We subsequently grew this business to just under $5bn and then sold it to Swiss private bank UBP - Union Bancaire Privee - in 2018. UBP currently manages around CHF 140bn ($156bn) globally for wealthy clients.
However, over time I felt that our clients preferred working under a multi-family office setup and, therefore, I left the bank last year, having been their CIO in London and Chairman of the global equity committee of the bank.
At Arbion with a team of 30, we manage several billion dollars across equities, fixed income, hedge funds, and private investments for around 200 families worldwide. On the liquid side, our core business is discretionary multi-asset portfolios but we also run tailored fixed-income and equity allocations for clients. In terms of structures, we typically run managed accounts but we also have a range of funds.
Incredible. Congratulations on your success. Something we are always curious about while interviewing fund managers is how much of their own portfolio is with their fund.
As I run or oversee most of Arbion’s strategies, logically all my liquid funds are in investments that we also own for clients. If I identify what I believe could be an interesting idea for clients, why would I not also invest my own money into it? So, yes, all my skin is in the game.
That’s nice. What made you get into investing and what’s your investment strategy?
As a student, I started trading stocks and warrants of Japanese companies at the tail end of the Japanese equity bubble in the early 1990s as they tended to be mispriced, trading in Europe versus their home market. I then focused on European deep-value names before moving into what we call growth stocks today. Alongside that, in macro terms, I was in the market during the 1994 bond crash, LTCM, the Russian, the Asian crisis, and everything that followed.
So whilst my primary interest is in equities and credit, I also spend a fair amount of time looking at the bigger picture. This blend of macro and micro is what I find the most interesting, where everything comes together, not always but most of the time. As most people just focus on one particular area, they often ignore signals from others. Ignorance is every investor’s worst enemy.
Leaving the macro part aside, and whilst I don’t mind the occasional trade, I would consider myself a medium to long-term investor. If I can find the right business to invest in, ideally I would like to own it for as long as possible.
Given the number of market crashes and hype bubbles that you have experienced, what has been your best learning? Can you tell us a bit about how your mindset toward money and investing changed over the years?
There are many things that I have learned over time, and almost all of them are associated with mistakes I made. This led to an investment process that has elements of risk management at every single step even if it is not explicitly called risk management.
As a result of this negative selection process, there are many areas and strategies that I don’t spend much time on anymore, as the odds of success in them, at least from my perspective, are stacked against me.
I tend to ignore most things that are exotic, illiquid, looking too cheap, or overly complex. Similarly, I would not spend much time on industries that are highly commoditized, very complex to evaluate, extremely capital-intensive, have no particular edge, or have not shown any attractive sector economics historically. Typically, this includes mining, airlines, football clubs, biotech, most oil companies, banks, and some others.
This has narrowed my focus towards companies with defendable strong business models, that are not too cyclical, generate high returns on capital, are run by strong and incentivized management, and are not overly leveraged. Therefore, stable non-cyclical compounders are the ideal bedrock for a great long-term portfolio. Whatever the macro worry might be, the best names also tend to bounce back the fastest.
This led to another important learning which is that time in the market is much more important than trying to time the market, which is what many people appear to be attempting primarily. However, I would be lying if I said we don’t also look at timing aspects. There are pros and cons to it but I admit, that less is more sometimes.
I strongly believe that there is no growth without value and no value without growth. When I look at many companies today, including large tech businesses, I would find it hard to categorize them - hence I tend to skip this whole debate.
I believe most people who own stocks today are not very familiar with them. I am convinced that the average investor spends more time choosing a $3,000 TV set than a $50,000 stock investment. Hence, I am convinced that someone who reads the company presentation from the investor relations section is already ahead of 75% of his co-investors in that company. Annual and quarterly reports contain a lot of interesting details that help build a good mental picture of the business in question and this accumulated knowledge then leads to a much steadier hand, holding this investment hopefully for the long term. From that base of knowledge, it is then easy to expand into the broader sector and other competitors. As a result, the time I spend reading it is increasing every month.
Yes. We have also observed this time and again where investors go all in without doing adequate due diligence. Historian Cyril Parkinson coined a thing called Parkinson’s Law of Triviality that fits here perfectly. It states: “The amount of attention a problem gets is the inverse of its importance.”
So, what’s your research process like? What are some of the common red flags and positive signs when researching a company?
The size and scope of our investment universe have not massively changed over the years. There are just not that many good companies out there that are worth considering for investment. Hence, the process is more gradual now as we keep processing new information to inform an existing view.
The fundamental selection process is fairly straightforward and not too unique: we look for not-too-cyclical businesses with high and sustainable returns on investment and a strong position in their core markets. In addition, management and balance sheet quality are also important. I am not a fan of too much leverage, i.e. anything higher than 3x EBITDA typically. So far so good.
What I then like to do is to look at the whole capital structure and see if there is any other interesting angle. For instance, in some cases, I start investing via selling out-of-the-money put options because implied volatility was temporarily very high for the stock for some reason. In several cases, this is how an investment started – with a short put that typically yielded more than 20-25% annualized.
Sometimes, we also approach an investment from the bond side only. Spreads could be attractive for some reason or occasionally we also find the odd busted convertible that pays an interesting yield and has the call option upside. As always, there are many ways to skin a cat.
Looking at the whole capital structure is obviously generally quite informative as it reveals what other markets are thinking about a company. Very often, one can find cases where the stock price is under pressure but credit is trading fine – a clear divergence. Conversely, a weak picture on the credit side but unfazed equity would be a major red flag in my books.
Aggressive accounting or accounting changes in that direction are also always a precursor for exiting a position. Frequent management changes are another.
On the other hand, insider purchases are certainly a positive as are conservative accounting methods and incentivized management. A strong R&D profile in businesses where this is important, strong cash conversion, and sector leadership are also key elements we are looking at.
Once we have identified our target investments, I like adding a somewhat contrarian angle to it and maybe this is where an element of market timing is entering the equation too. I like entering such positions when they are somewhat out of favor (after a profit warning or another otherwise short-term issue). Equally, I am rather a seller when something is in unusually high demand. This general approach is not limited to stocks.
A good example was Brexit Day – the day after the 23rd June 2016 Brexit referendum. The result of the vote was unexpected and domestic equities crashed alongside the currency. We were heavy buyers of these names on that day and the day after when many of them lost 30% and more during the panic selling. Buying when others were indiscriminately selling for little fundamental reason turned out to be an exceptionally profitable opportunity for us.
Two other more recent examples maybe to highlight this approach outside direct equities: In the third quarter of 2019, equity markets were riding high whilst the yield curve was inverting, signaling some potential trouble ahead. Because of the bullish equity environment, implied volatility was low, so I hedged the majority of our equity holdings at little running cost. The insurance premium simply was so low that it almost didn’t matter, creating a very asymmetric potential return outcome. Then, as the COVID pandemic broke out, we were almost fully hedged and performance benefitted accordingly.
Another important allocation decision and similarly contrarian was when I drastically reduced fixed-income holdings in the course of 2021. Yields at the time were still very low but started rising and the risk of increasing inflation and more hawkish central banks was on the horizon. This simply created an environment for investment-grade bonds where there was little upside and a lot of downside. The rest is history. After the bond crash of last year, we have built back a lot of exposure in the space as the risk/reward has completely changed: bonds are now a very viable alternative for investors vis-a-vis equities and they also have a hedging value again - providing protection when risk markets decline.
There is a lot of research on how index funds are beating active fund managers – Where do you think the need for active management arises? How do you think the fee compression affects the asset management landscape long-term?
I believe active management still plays a very important role in asset allocation, i.e. deciding what areas in the market a client should be focusing on and developing appropriate strategies for it. Risk management is also critical in that context, i.e. managing net exposures in equities, managing duration, and credit risk within fixed income as well as currency overlays.
Passive strategies and index funds play an important role in our portfolios, especially in equities, when we are just looking for ways to get liquid exposure to broader sectors or geographies without trying to pick the best companies.
Within fixed income though there is still tremendous value in active strategies and “bond-picking” as indices are almost always tilted to the fundamentally worst, i.e. most-indebted, issuers. Here, one can add substantial value for clients. Also, in contrast to funds/ETFs where one is typically exposed to more or less constant duration, I can easily design fixed maturity portfolios that match a certain event in the future and run down into cash over time.
Fee compression has been an issue across the board, from ETFs to hedge funds with discretionary strategies sitting somewhere in the middle. I believe this trend is unlikely to stop anytime soon although we are approaching some kind of floor, certainly for the more active strategies.
There simply is a certain cost associated with a very tailored strategy that requires constant attention by professionals and this needs to be reflected in a fair price. At current levels, I don’t think that the price is very high. For commoditized strategies which can effectively be run by a machine, costs will continue to be kept under pressure by competition.
More generally speaking, the broader answer is of course, that a larger scale is required. The threshold to operate a financially sustainable business in terms of minimum AUM today is several times higher than what it was 20 years ago.
Interesting. So, what are some of your favorite ideas on your radar now? (Long/short companies and industries)
More thematically, the areas I spend a lot of time on now are: