An updated 2020 outlook
As each year ends, we spend time thinking about what
events will most likely shape the months and quarters
ahead. Coming into 2020, we thought another minicycle
was likely to begin, potentially creating a favorable
backdrop for value investors. Quality growth companies
had performed well throughout most of 2018 and the
first three quarters of 2019, then the narrative changed.
The Federal Reserve began lowering the Federal Funds
target rate as downside risks in the U.S. economy grew,
and more accommodative monetary policy improved
investor confidence as stronger economic growth seemed
likely. Against that backdrop, the market started to
reward cheaper, lower-quality businesses — those that
would typically lead in the early stages of an economic
recovery as they are most dependent on strong
The COVID-19 pandemic has made us re-evaluate
our views, and two possible outcomes seem most likely
- This is a short-term supply disruption and a temporary
pause in demand. Markets recover as the impact from
COVID-19 wanes and economic growth returns in the
second half of 2020. Supportive monetary and fiscal
policy around the globe suggests yet another mini-cycle
of economic growth.
- Public and private reaction to the pandemic creates a
meaningful and sustained drop in consumer demand,
thus pressuring businesses to lay off workers and cut
wages. Gross domestic product (GDP) growth remains
low or negative for multiple quarters as unemployment
rises and remains high for an extended period of time.
The broad scenarios we’ve outlined could have
substantially different implications for investors, both in
absolute and relative terms. In the first, we would expect
value-oriented businesses to lead and higher-quality
companies to lag, at least in the early stages. The second
scenario would likely favor higher quality businesses
with less potential for downside revisions. In our view,
it’s still too early to know exactly how the situation will
unfold. We should start gaining a better understanding
of how this pandemic will impact the health of the U.S.
economy, our citizens and investors in the weeks and
Managing risk amidst uncertainty
We often speak about the risks inherent in large-cap
growth investing, namely the possibility of business
model failure risk and significant downside risk.
Many large-cap growth companies have attractive
characteristics — high margins, growing end markets,
and attractive returns on their assets and capital, to
name a few. These characteristics invite competition
and disruption, as others want a piece of the pie. At the
same time, investors historically pay a premium for these
businesses in the form of higher price multiples. These
lofty growth expectations are often unmet, leading to
multiple compression and meaningful losses in investor
capital. In other words, significant downside risk is
always a concern. These risks represent an opportunity
for the Fund’s fundamental, long-term approach.
Our goal is to own enduring, competitively advantaged
business models that we believe are capable of withstanding
disruption. We think owning these businesses helps give the
Fund the best opportunity to outperform over the long term.
This philosophy also allows us to remain invested during
short-term market disruptions. Owning high-quality
businesses is an outcome of our fundamental research,
and these companies should typically outperform in
challenging environments. It’s important to note that
this should not come at the expense of participating in
the eventual recovery, whenever that occurs. We need
to be exposed to risk in order to deliver performance, all
the while being measured in our approach and believing
that we’re appropriately compensated for accepting those
risks over a long investment horizon.
We approach risk in a few ways, and environments like this
where volatility and uncertainty seem higher than normal
present an opportunity to revisit these principles:
- Competition for capital: Regardless of the macro
environment, we continually evaluate each of the
companies within the portfolio and those we’re
considering for new investment. We want to be adequately
compensated for the risks we take, and this exercise helps
us tilt the portfolio toward companies with better expected
upside potential and lower expected downside potential
as the environment changes, sometimes rapidly.
- Sources of risk: We intend to let stock selection drive
risk, not industry or factor exposure. We entered this
environment, even before the COVID-19 outbreak, with a
more balanced approach to risk, not wanting individual
factors like momentum, beta, value, etc. to drive portfolio
positioning and overwhelm our fundamental research.
We continue to monitor these exposures regularly, being
intentional with where those exposures lie.
- Focus on business models: Our expertise lies in deep,
ongoing fundamental research on individual businesses.
We don’t have an edge on market timing, so we remain
invested and don’t typically adjust sector weights in order
to express a macro view.
Late summer of 2019 is a recent example of the first two
principles listed above — competition for capital and active
risk management. Our portfolio performed well from the
beginning of 2018 through August 2019, returning nearly
30% compared to 21.4% for the Russell 1000 Growth Index,
the Fund’s benchmark. Valuations for some of our holdings
were becoming stretched and, in our view, no longer offered
adequate long-term return potential, and the portfolio was
becoming tilted toward momentum. Stocks with positive
momentum are those that have performed well relative to
their peers in the recent past, and higher-quality businesses
had certainly been in favor. We took that opportunity to
rebalance away from some of the more expensive businesses
and recent outperformers in favor of companies with better
potential future returns.
An example of the first and third principles is Estee Lauder.
We invested in Estee Lauder during a period when it
was underperforming in the fourth quarter of 2018. The
company performed extremely well through the first half of
2019. At that point, we determined upside, both near and
long term, appeared limited. So, we dramatically reduced the position size despite still believing the company’s
business model was very attractive. The fundamentals
remained strong, but expectations had risen to a point
where valuations were stretched. Potential for meaningful
downside grew, and the upside seemed minimal, but we
didn’t know what the trigger would be. Going through
this exercise helps us minimize potentially negative
consequences and we’re comfortable waiting for a more
attractive time to make incremental investments.
ESTEE LAUDER COMPANIES INC. CLASS A — Total Return Relative to Russell 1000 Growth Index (%)
Source: Factset -- Data 06/29/2018 to 03/31/2020. Past performance is no guarantee of future results.
Looking beyond the noise
When the market is focused on the very short term, we try
to take the opposite approach by looking for opportunities
to re-position the portfolio into companies where we have
high conviction in the long-term ability of these holdings
to execute and withstand market disruptions.
We continue to focus on underlying business models, not
emotions or the news of the day. Some of the highest quality
businesses in the Fund’s portfolio are being priced in a way
that would have a person believe the next six months are all
that matters, when that’s clearly not the case. While we think
there will be disruption in the short term, our focus will be
on executing the Fund’s investment process of emphasizing
fundamental research and multi-year time horizons to help
us remain focused on the most important issues for our
We believe COVID-19 will impact the global consumer
over the next quarter. However, will this event really change
the amount of discretionary dollars flowing into the retail
footwear and athletic wear industry over the next three to
four years? Is this pause in activity going to significantly
impair long-term contact lens consumption and growth? Is
the near-term disruption going to derail multi-year upgrades
and replacements to public safety communication and
surveillance networks? We hold a view that with this nearterm
pause, in terms of consumption and economic growth
around the coronavirus, is not going to change the long-term
value of companies like Nike, Inc., Cooper Companies or
Motorola Solutions. If the market starts discounting these
types of companies over the long term, we are more than
willing to increase our positions in order to realize those
expected potential compounded annual returns.
Travel and tourism will be impacted, without question.
Some airlines and cruise lines have seen their stock prices
fall between 50–80% since the beginning of the year. While
these companies typically lack the traits we look for in more
durable businesses, there may be opportunities in related
areas. Booking Holdings is likely to be materially impacted
by the stall in travel demand. However, we believe this shortterm
disruption is going to solidify the value the company
can bring both to consumers, through convenient trip
planning, and to the travel industry, by allowing hotels and
rental cars fleets to gain access to high conversion consumer
demand in one location. As investors react to significant
near-term negative revisions, we will watch patiently and
work diligently to make sure Booking Holdings is managing
its business in a manner that drives an even stronger
competitive moat looking out past the rubble.
In a market drawdown, we look for opportunities to
reallocate to stocks where we have higher conviction. We
also look at stocks within the Fund’s portfolio that have
held up well in the downturn and reallocate to holdings that
appear to offer better upside potential. We tend to be more
thoughtful and patient in drawdowns and try to avoid being
reactive. We choose to stay focused on business models
with strong three- to four-year prospects, rather than worry
about short-term estimate revisions. If we’re seeing that the
market is discounting a business model to a point where
we’re getting very attractive long-term compounded annual
returns, then we’ll consider stepping into that short-term
risk. It may not be the right answer for the next quarter
ahead, but we believe it will be the right thing to do for our
shareholders over the long term.
Past performance is no guarantee of future results. The opinions expressed are those of the Fund’s manager and are not meant as investment advice or to predict or project the future performance of any
investment product. The opinions are current through April 2020, are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed. This commentary is being
provided as a general source of information and is not intended as a recommendation to purchase, sell, or hold any specific security or to engage in any investment strategy. Investment decisions should always be
made based on an investor’s specific objectives, financial needs, risk tolerance and time horizon.
Risk factors: The value of the Fund’s shares will change, and you could lose money on your investment. Investing in companies involved primarily in a single asset class (large cap) may be more risky and volatile than
an investment with greater diversification. The Fund typically holds a limited number of stocks (generally 40 to 60), and the Fund’s portfolio manager also tends to invest a significant portion of the Fund’s total assets
in a limited number of stocks. As a result, the appreciation or depreciation of any one security held by the Fund may have a greater impact on the Fund’s NAV than it would if the Fund invested in a larger number of
securities or if the Fund’s portfolio manager invested a greater portion of the Fund’s total assets in a larger number of stocks. An investment in the Fund is not a bank deposit and is not insured or guaranteed by the
Federal Deposit Insurance Corporation or any other government agency. Not all funds or fund classes may be offered at all broker/dealers. These and other risks are more fully described in the Fund’s prospectus.
The impact of COVID-19, and other infectious illness outbreaks that may arise in the future, could adversely affect the economies of many nations or the entire global economy, individual issuers and capital markets
in ways that cannot necessarily be foreseen. In addition, the impact of infectious illnesses in emerging market countries may be greater due to generally less established healthcare systems. Public health crises
caused by the COVID-19 outbreak may exacerbate other pre-existing political, social and economic risks in certain countries or globally. The duration of the COVID-19 outbreak and its effects cannot be determined
The Russell 1000 Growth Index measures the performance of the large-cap growth segment of the U.S. equity universe. It is not possible to invest directly in an index.
Class I shares are only available to certain types of investors.