How GMO is investing as headwinds rage (and one stock to keep your portfolio afloat)

I've said it before and I'll say it again - it's an incredibly tough time to be an investor right now. Anecdotally, several fund managers have recently told me their personal portfolios are heavy on cash (some up to 80%), while many funds themselves are as cashed up as their mandates will allow. 

The secret to outperforming in this environment, according to Kim Mayer of GMO, is positioning your portfolio towards companies with sound fundamentals - those that can weather the various scenarios that markets could throw at them over the foreseeable future, those that can continue to post profits no matter what the Fed does or doesn't do. 

This could even be growth stocks - the most heavily hit segment of the market this year - as long as you don't pay too much for them. 

In this Expert Insights video, Mayer shares the types of companies that can continue to outperform in this environment, why he believes quality stocks can outperform no matter where we are in the cycle, as well as one undervalued stock that he believes can bolster portfolios over the months ahead. 

Note: This interview was recorded on 16th August 2022. You can watch the video or read an edited transcript below. 

Edited transcript 

Ally Selby: Hello and welcome to Livewire Markets, I'm Ally Selby. And if you are like me, your portfolio has probably seen a little bit of red in 2022. But as they say, "New financial year, new you." So today we are sitting down with GMO's Kim Mayer, he joins us all the way from Boston. The Quality Fund has really been able to withstand some of the volatility that we've seen this year. So he is going to provide investors with some helpful tips today. Thanks so much for joining me today, Kim.

Kim Mayer: Thanks Ally. It's great to be here today.

Ally Selby: As mentioned in that intro just there, a lot of investors have had a really tough time in 2022. The Quality Fund has been able to outperform the benchmark. What do you think that you are doing that's different from the rest of the pack?

Kim Mayer: So it has been a challenging investing environment so far in 2022. If we think about what's worked and what hasn't, almost across the board, what really hasn't worked in 2022 has been anything associated with growth. We manage a quality strategy, so we're going to have exposure to growth. Quality companies tend to grow their earnings faster than the rest of the market. 

The way that we protected ourselves from experiencing that downturn that growth has had so far in 2022 is, and this is going to sound a little bit counterintuitive, to pay attention to value as you're investing in quality growth companies. 

And so the way we've protected ourselves, at least on a relative basis so far in 2022, is by focusing on not paying too much for growth.

Ally Selby: I am hoping for a little bit of a hot tip from you today. For investors' portfolios that are really deeply in the red, should they try and stick through this period of volatility or are we entering a new market regime where the winners before aren't going to lead the pack again?

Kim Mayer: So I'm going to give you a little, probably not as hot a tip as you're looking for, but instead a little bit of a yes and no answer around that Ally. So to the extent that your portfolio was overly exposed to what worked so well over the last five years, which is really the sharpest, steepest growth trajectory names, the Nvidias (NASDAQ: NVDA) of the world, the Teslas (NASDAQ: TSLA) of the world, companies that haven't even experienced any profitability yet included in that group as well. 

There's probably a need to shift that a little bit more towards companies that have more sound fundamentals, and that are able therefore to weather the various scenarios that the market could be staring at in the not too distant future, whether we're talking about inflation, recession, growth shocks, or geopolitical events. 

It's companies that have the highest multiples that tend to contract the most when the market is experiencing shocks such as that. And so to the extent you still have a lot of exposure there, I would recommend moving some of that weight towards companies with sounder fundamentals, probably not quite as hyper-growthy is a good move. But to the extent you already have a decently balanced portfolio, there's no need to trade excessively.

Ally Selby: You listed off quite a few headwinds just then, but there are some economists who are predicting rate cuts as early as next year. Could we see growth stocks rebound in that time?

Kim Mayer: I think that we should see growth stocks rebound as we begin to move towards more balanced central bank activity, to the extent that we enter some kind of slower growth environment overall. The market is always looking ahead. So right now you're already seeing the most forward-looking traders anticipating what the Fed is going to be doing in the next cycle, which to your point could, as early as next year, begin a rate-cutting environment. 

So I would not recommend investing around a huge view on whether the Fed's going to continue tightening or start easing in 2023. Instead, I would try to find those business models for whom what the Fed does or doesn't do really doesn't matter. 

Companies which are more in charge of their own destiny. In other words, less dependent on capital markets funding. Less dependent, perhaps, on rising input costs. So companies that are asset-light. Companies that are less dependent on wage inflation. Those types of companies are resilient throughout a number of different market environments and having exposure to those is always going to serve you well, particularly if you're paying attention to the price that you're paying for them.

Ally Selby: Okay. So if growth stocks aren't going to outperform, why do you think quality will?

Kim Mayer: So let's look at a couple of different scenarios. To the extent the market continues to focus on inflation, how do quality companies do in an inflationary environment? They're not going to be the single best portfolio that you could imagine. 

If you knew that we were going to continue to have raging inflation over the course of the next couple of years, probably what you would want to do is load up on a portfolio filled with resource stocks. That's probably the best single inflation hedge that you can imagine. 

Having said that, quality companies do perform better than the broader market. As I mentioned a moment ago, they're less exposed to wage inflation, they're less exposed to rising input costs, and they also tend to be leaders within their particular industries, so they're able to pass those rising costs on to their customers in the form of rising prices and so inflation doesn't cut into them as much.

When we look back over history and examine how quality companies have done in various inflationary periods over the course of the last 100 years or so, they do decently better than the rest of the market. 

Now, if instead of that scenario, we see recession come to the forefront even more quickly than the market is currently anticipating, companies that have these very sound fundamentals, companies that are more defensive - those business models are able to continue to do quite well in a recessionary environment. 

So companies like consumer staples, big pharmaceutical companies, and to a certain extent, certain types of financial companies, can do very, very well in that type of environment as well.

Ally Selby: Okay, Kim. Last one for today. As we've discussed in this interview, the market environment is really uncertain right now, as is the future. Is there one quality stock that you think can help bolster investors' portfolios during the months ahead?

Kim Mayer: So I would say don't put all your eggs in one basket. Certainly own a well-diversified portfolio of quality companies and I think that's going to serve you very well, but I do want to try to answer that question. One of the companies that we really like looking forward from here is Taiwan Semiconductor (NYSE: TSM). The reason that we like it is it's the foundry to the world. They build the majority of the chips for various chip designers all around the world. It's a very interconnected supply chain within semiconductors and it's come down a lot in price. But these guys do something that nobody else does. And the price has come down well more than the long-term fundamentals of this company warrant. So we like that company a lot, but it's not the only company that we like.

Ally Selby: Kim, are there any risks there to the outlook for Taiwan Semiconductor? Obviously, we've seen heightened geopolitical tensions over the past few weeks. Are there any risks to that outlook?

Kim Mayer: There are geopolitical risks that we're all aware of. And yet even if the worst-case scenario was to develop, Taiwan Semiconductor is likely to maintain its position. The entire semiconductor industry, not just in the United States, not just in Europe, not just in China, is highly dependent on Taiwan Semiconductor. And so there are risks, and I would expect to see continued volatility around supply chain issues, around geopolitical issues, but the long-term prospects remain very, very high.

Ally Selby: Well, thank you so much for your time today. Kim, I really enjoyed that chat. If you enjoyed it too, remember to give that video a like and subscribe to our YouTube channel. We're adding new content every week.

Access a portfolio of high-quality companies

Kim and the team believe that companies with established track records of historical profitability and strong fundamentals are able to outgrow the average company over time and are therefore worth a premium price. To learn more about GMO's Quality Trust, please visit their website.