There appears to be pockets of the market that have become incredibly expensive. How do you think this frothiness we’re seeing in the market sets up a relative value approach like yours?
In short, it's good. Spreads between the most expensive and the cheapest stocks, whether you look across the market or within sectors, are at the extremes of wide. It should end at some point and typically does in favor of the inexpensive cohort. At the end of the day, cash flows drive stock prices, not stories, and the rubber band has to snap back eventually. We do manage a core strategy, but from a relative value standpoint, we are finding the best opportunities on the value side of the style spectrum. Many of these stocks look very attractive on an absolute basis as well. When the big swing to these more attractively priced stocks will occur is impossible to know, but there are several factors at play currently that would lead us to believe it will be sooner rather than later.
We’ve seen a continued trend of the yield curve steepening. How has this affected your view of the financials sector?
We're underweight financials by 2%, but we're higher than we have been in the past. We're expecting the curve to continue to steepen, which helps banks make money. With the enormous stimulus being proposed by the Biden administration, combined with the reopening of the global economy, we could see high single-digit to low double-digit nominal gross domestic product (GDP) growth. We would expect for this to taper off towards the back half of the year and into 2022, but interest rates are still low. We’re seeing a historic spread between nominal GDP and quality bond yields.
Generally, how would you say positioning of the portfolio has changed over the last couple of months?
Relative value is what drives portfolio decisions we make with the strategy. We’ve been thinking about our portfolio in the context of three different types of exposures: Lockdown stocks, reopening stocks and hybrid stocks.
An example of a lockdown stock would be Getinge AB, which is a company that we recently re-entered that makes ventilators that treat people and has been a beneficiary of the COVID-19 environment. We exited early during COVID-19 because we thought there wasn't much higher to go there. We recently reevaluated and we're comfortable with that name again. We believe their business improved, they have a solid management team that we’re familiar with, and they’ve been able to expand on margins. However, the market hasn't rewarded the stock yet.
Canada Goose Holdings, Inc. is an example of a hybrid stock. This is a high-end winter clothing retailer that has a long runway for penetration in the wholesale, online and in-store markets that we added last year because we viewed it as undervalued.
HeidelbergCement AG is a German multinational materials company that is a perfect example of a reopening stock and is a recent add to the portfolio. We believe the stock has a 12% free cash flow yield. We see the Green New Deal and similar developments in Europe, as well as the extremely low rates driving housing, to be very positive for cement, but we feel the stock remains relatively inexpensive.
How would you quantify the mix of the three exposures you just mentioned?
That's hard to quantify because there's no risk model that can go through and do this. The pandemic is new in a lot of ways and there haven't been models accurately built around that kind of situation. Where we see segments of the market where investors aren't recognizing those areas, that's what we're getting into. We believe we’re balanced across these three exposures, but we’re skewed towards a re-opening economy in the near-term future.
What are people getting wrong on the re-opening of the economy?
The macro backdrop is different than what we've had for the past 11 years. However, the most rewarded stocks are the same they have been in the last 11 years. It will be hard to keep inflation rates down. The entire market seems to be on the "low rates forever" side of the boat. Interest rates are a key driver for a lot of these growth stocks because they are what are used to discount future earnings. Over 30% of the Fund is invested in stocks that we expect to have double-digit free cash flow yields and some as high as almost 30% in a market that’s around 3-4%. Those short duration stocks should be better performers than they have been over the last six years where there hasn’t been as much stimulus or growth. We think it’s right to hedge yourself in areas where the market’s not betting.
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Top 10 equity holdings as a percent of net assets as of 12/31/2020: Merck KGaA 2.7%, Roche Holdings AG, Genusscheine 2.7%, Samsung Electronic Co. Ltd. 2.2%, DNB ASA 2.1%, Airbus SE 2.0%, Legal & General Group plc 2.0%, AIA Group Ltd. 1.8%, Carrefour S.A. 1.8%, WPP Group plc 1.8% and ENGIE 1.6%.
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