4 compelling stocks for a post-pandemic world
In many ways, living through the COVID era has been like living in a bad science-fiction comedy drama. Reviewers have probably had enough of the plot line, but no one has ever seen better production values.
The silver lining for funds managers is that any sort of shakeup creates opportunity.
Veterans who have been able to take a long-term perspective and ride the ups and downs of 2020 and 2021 have something to teach lesser mortals. The US funds manager Loomis Sayles is more mature than most, having opened its doors in 1926.
For its take on living with COVID, I spoke to Loomis Sayles Vice-President and global equities Portfolio Manager Eileen Riley.
In this wire, she explains the three 'alpha drivers' that Loomis Sayles looks for, and discusses several companies that they've been building positions in recently. Her discussion of the company's proven approach to investing makes for illuminating reading.
Benefiting from change
The world's big adjustments of the recent past have included the lightning-fast development of effective coronavirus vaccinations, the election of Joe Biden as US President, and the post-COVID reopening of numerous economies.
"I think the key learning for investors, and what was reinforced for us over this time, was that change is constant, and that the volatility that typically follows can be viewed as an opportunity," Riley says.
"Over the past year and a half we were able to initiate in names that had been on our tracking list for some time — that is, companies we had previously researched and met our quality and intrinsic value growth criteria but we viewed as too expensive.
"By focusing our investment theses on long-term value drivers, we’re able to navigate quickly changing markets.
"We capitalised on the market dislocation during the beginning of the pandemic, and spreads did widen while other risk assets sold off.
"With global monetary and fiscal support initiatives, the global economic backdrop held up, and both equity and fixed income markets rebounded."
Loomis Sayles is optimistic about the prospects for economies the world over as post-pandemic reopening takes place.
"Our current base-case scenario is for the global economy to continue on an expansion trajectory," Riley says. "We anticipate further synchronised global growth, as Europe and emerging markets rebound as the impact of the virus diminishes."
However, they don't expect sustained inflation or excessive price rises heading into 2022.
"We also expect the major central banks to remain accommodative and do not foresee the US Federal Reserve raising rates until 2023, although we are expecting a reduction in quantitative easing as early as the beginning of 2022," Riley says.
"The pace of employment growth in the next several months will also be critical.
"Risks do remain, including the persistence of higher than expected inflationary pressures, another COVID-19 surge that hampers job recovery, and geopolitical risks."
Life after COVID
The early days of the pandemic might have directed Loomis Sayles' attention away from sectors such as hospitality and airlines, but the company's investment philosophy remains the same.
"We are long-term investors and as such, our playbook has not materially changed," Riley says. "We continue to seek companies with the alpha drivers of quality, intrinsic value growth and valuation.
"We currently hold a diverse group of technology names spanning digital payments, cloud storage and collaboration, and semiconductor manufacturing and equipment."
"We have selective exposure to consumer-related names, focusing on leading e-commerce platform retailers and physical retailers with compelling value propositions. We also have exposure to the growing on-line fitness industry.
"We have focused our healthcare exposure toward higher growth areas in the industry, and away from areas exposed to reimbursement risk.
"We continue to have no direct exposure to energy or utilities sectors, as we typically do not find many opportunities that meet our three alpha drivers."
Three alpha drivers
Riley and the team believe there are three alpha drivers that are crucial to generating long-term outperformance: quality, intrinsic value growth and valuation.
They believe quality companies that can grow intrinsic value over time, and which trade at an attractive valuation, are key to long-term alpha generation.
Getting back into hospitality
Riley gives two examples of investments that have spent time in the doghouse during the pandemic but are crying out to be forgiven.
"We have invested in a couple of names that fall in the hospitality industry, namely Airbnb, an online marketplace for short-term stays and vacation rentals, and Vail Resorts," Riley says.
"Over the last decade, Airbnb has disrupted the lodging industry by creating a medium where homeowners can offer their properties for rent, introducing significantly more choice for consumers.
"Our investment thesis on Airbnb is driven by its leadership position within this large addressable market and its associated network effect — the more property owners who list their properties, the more renters it attracts, and vice versa."
Vail Resorts has a deep moat protecting its competitive advantage. "This company owns luxury resorts in world-class ski locations across the globe," Riley says. "Its branded network of properties would be challenging to replicate.
"Vail has successfully launched Epic, a pass program that enabled the company to convert approximately half of its revenue from lift fees into recurring revenue, similar to a subscription program.
"We believe Vail Resorts will continue to grow sales through increased skier visits and higher pricing while leveraging cost synergies and operating expenses to help grow operating profit."
Investing in technology
Loomis Sayles has been building up holdings in two interesting information technology companies that are not exactly household names, but are famous in offices and creative studios around the world: Nvidia and Salesforce.com.
Nvidia originated in computer hardware and gaming, and created the world’s first discrete graphics processing unit (GPU) in 1999.
"The company has since evolved into a larger ecosystem of products with the GPU at its core," Riley says.
"Its accelerators are used in the gaming, professional visualisation, data centre and automotive markets.
"The company has grown by creating new uses for its hardware and software. Specifically, the recent artificial intelligence renaissance — increasingly leveraging GPUs rather than CPUs (central processing units) — has led to new and larger opportunities in the data centre and automotive markets.
"The company is starting to explore its options to monetise its software, which is presently bundled "free" with its hardware, via licensing and subscription models."
Salesforce.com supplies enterprise management systems to businesses.
"Salesforce.com is a leading customer relationship management (CRM) software company, integrating marketing, sales, service, and information technology," Riley says.
"Since its founding in 1999, Salesforce has fine-tuned its original CRM product and added additional services. It now operates four clouds: Sales Cloud, Service Cloud, Marketing and Commerce Cloud, and Salesforce Platform.
"We believe it is a leader in a growing addressable market, as businesses continue to move to digital technologies."
A fundamental approach
The long history of Loomis Sayles gives the company a unique perspective of world-changing events such as the pandemic.
"Loomis Sayles was founded on the belief that doing deep, fundamental research can help uncover opportunities in the market," Riley says. "Nearly a century later, that belief remains unchanged.
"We view our team’s core competency as our ability to conduct deep, fundamental research.
"It’s through this process we uncover companies that possess a duration effect, which is our term for the value created from the compounding of cash flows over time."
Filtering out noise
Riley uses the example of the share buyback, a controversial instrument in the US, to demonstrate the benefit of taking a fundamental approach.
Investment managers are able to filter out the noise of the market, in this case controversy surrounding share buybacks, to uncover more important factors.
"Our focus is on identifying companies that have strong capital allocation policies rather than specifically focusing on companies that buy back their own shares," Riley says.
"If companies can earn above their cost of capital, we want to see them reinvest cash back into the business.
"However, if they can’t, then we do like to see cash returned to shareholders, and buybacks are one mechanism to do that."
Loomis Sayles pays close attention to the risks of investing and is particularly conscious of the growing role of environmental, social and governance factors.
"For us, assessing risk happens first at the security level," Riley says. "We focus on idiosyncratic risk, as we believe this aligns with our core competency of conducting deep, fundamental research.
"We quantify risks in our scenario analysis framework, where we forecast a base, best, and downside case for every new idea and holding in the portfolio. If we can’t adequately quantify the downside, we will not invest in the business.
"From a broader risk perspective, we feel that it’s important for investors to consider how ESG factors affect the long-term value of a company.
"For us, ESG elements are considered as part of our overall quality assessment of a business. It is also important to note that there can be ESG opportunities as well."
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Patrick was one of Livewire’s first employees, joining in 2015 after nearly a decade working in insurance, superannuation, and retail banking. He is passionate about investing, with a particular interest in Australian small-caps.
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