How to invest throughout the market cycle (and three stocks to do so)

It's all about finding businesses that can withstand the volatility of the market, says Eileen Riley of Loomis Sayles.
Chris Conway

Livewire Markets

There is a 50% chance of the world entering into a recession within the next 12 months, with the next downturn likely to be on the milder side. 

That's according to Eileen Riley, the portfolio manager for the Loomis Sayles global equity opportunities and global allocation strategies. 

With those kinds of odds, you would think that money managers would have plenty of dry powder on the side. But these portfolios are actually fully invested. 

"Our role is to be fully invested. We build a concentrated portfolio and some of those other allocation decisions are often made by the individual allocators," Riley told me. 

Furthermore, Riley is not one for buying companies on the basis of tick-by-tick economic data or specific interest rate decisions. 

She believes far more in owning quality companies throughout the cycle - and capitalising on mispriced opportunities when these occur.

In this edition of Expert Insights, Riley uncovers her investment process and shares why she always wants to be "ready" when volatility spikes. We'll also hear about three stocks that possess the stability and quality traits that Riley looks for when investing on behalf of clients.

Note: This interview was recorded on Tuesday, March 28, 2023. You can watch the video or read an edited transcript below. 


LW: What has influenced the way you think about markets?

Riley: One of the biggest influences in my evolution as an investor, besides some of the people who have had big influences on me, has come from starting in this industry as an analyst and a deep fundamental analyst. That's had a big impact on how I think about my role as a portfolio manager, and specifically how I think about constructing a concentrated portfolio of focused ideas. 

What comes out of that background as an analyst is the drive and the desire to truly understand businesses. Digging in on the financials, understand not only the macro (not from the economic macro) but the macro from the trends where things are going over the long term. Then pairing that with an understanding of the bottom up, the fundamentals, and how any given business is executing at a point in time.

LW: How does that impact your investment process today?

Riley: I don't think it's any different in any environment. Of course, an environment shapes what's going on at individual businesses. But the way that we execute and I execute as an investor and against our investment process isn't going to change in any one environment. 

What comes from that background of being an analyst is it is an iterative process that we've built for our team. Specifically, it's not about reaching an investment conclusion and isolation, it's about iterating, discussing, debating, and reaching an investment conclusion out of that entire process.

LW: The fund is almost fully invested. What is the thinking behind that?

Riley: Our view is that our role is to be fully invested in global equities. We build a concentrated portfolio, and some of those other allocation decisions are often made by individual allocators. But from our perspective, we think our role is to be fully invested across global equities.

LW: Which sectors are you overweight today?

Riley: Technology and consumer discretionary are significant sectors in our portfolio, but I think it's more instructive to look at actually the underlying securities than it is to say here's the sector allocation and draw a conclusion. 

If you take a step back and look at the underlying securities, it's actually a fairly diversified and eclectic mix of businesses as opposed to expressing one single underlying business area or business model. 

Within technology, we have IT services across several geographies, and global businesses headquartered in a series of different end markets. At the same time, we have hardware and global hardware businesses. And then in the middle, we have a variety of software businesses. Some of them are quite small and niche and focused, others are very broad and large global players. And I would also add there, we also have some technology that I would really call financial services.

Within consumer discretionary, I would say also it's a real variety of businesses. We've found some opportunities within retail, we've found some opportunities within some strong consumer brands, and we've also found some opportunities within more of the technology internet space within consumer discretionary. 

LW: What is the number one investment theme over the next three to five years?

Riley: We don't think about thematic investing. We do construct the portfolio from the bottom up. That said, when you take a step back, you often can see things across the portfolio. One of the things that I think is going to be a constant is complexities. I think that crosses a variety of industries, sectors, and markets. One of the ways that we think we can invest and take advantage of that complexities, and specifically the need to address those complexities, is through the IT consulting firm, Accenture (NYSE: ACN).

Accenture is a global platform for technology solutions and IT consulting. And when we think about solving complexities and the need to do that, I think one thing in this post-COVID period has been what's become apparent across a variety of end markets is something that I've heard Accenture refer to as their technological debt, and that is the need to invest specifically in technology. 

Businesses need to innovate. And if your technology is 20 and 30 years old, it's very hard to innovate at the pace the market is requiring given the complexities in the market. 

And so, that would be one business that I think addresses that huge challenge that we're going to see for, I think, the next many years around complexities.

LW: What is your view on the recession outlook?

Riley: At Loomis, our firm view is that the probability of recession is 50%, and our view is that that's likely to be a mild recession. 

From the perspective of our portfolio, we think if you're going to own businesses that are quality businesses and grow their intrinsic value and you have that long-term time horizon, we think that there are many businesses that you can own through a variety of economic cycles. The idea that cash flow may be pressured by a bigger picture recession in the short term, we think, in many cases, these are still businesses that we can own through that period of time.

LW: How do you decide which stocks make it into the portfolio?

Riley: Our process is focused on exploiting two market inefficiencies. The first is the duration effect, and the second is mispricing. 

When we see duration effect from our perspective, that's not duration in the fixed income sense. It's actually thinking about the compounding of businesses in the future and the ability to do that over time. And the second, mispricing, is exactly what it sounds like. It's the starting point of any investment that matters. 

The way that we do that is it starts with our assessment of quality. In our view, quality businesses are businesses that have a durable competitive advantage. And then, it moves into the second alpha driver of intrinsic value growth. From our perspective, that is the positive slope of the free cash flow trajectory of any firm. It's not about a given level of growth, it's about that positive slope.

The last one is valuation, and that's an important one. From our perspective, it's driven by a discounted cash flow approach to valuation, and using a framework of scenarios to dimension risk/reward, and drive not only new ideas entering a portfolio, but also thinking about how do we recycle capital within our existing holdings given the opportunity from a valuation perspective.

LW: How have rising inflation and interest rates impacted your portfolio positioning?

Riley: I can't point to any one investment decision recently that was specifically driven by higher inflation or by rising interest rates. But what I can say is sometimes the most powerful thing we can do as portfolio managers is actually to do nothing. It does not mean not doing the homework and doing the research. It's by holding the positions that you're confident in. One that I can talk to is Linde (NYSE: LIN), the industrial gas company.

If we think about an inflationary environment, the importance of that is what is the ability of any given business to be able to take price relative to their cost base. Linde is a great example of a business that we think has been having success in terms of their ability to execute on taking price. The resulting cash flows generation or specifically free cash flow generation for them, and their deployment of that free cash flow has been incredibly strong, not only back into their business, but in terms of the excess free cash flow in terms of shrinking the share count, which accrues to all of us as shareholders.

LW: Markets are incredibly volatile today. How are you taking advantage that?

Riley: Over the next 12 months. I think that point about volatility is a really interesting one, and that's actually something that brings some excitement for us from this portfolio's perspective, and specifically, that point that volatility creates opportunity is something that we believe very strongly in. 

It's very difficult to forecast the exact moment when you're going to see that volatility within markets, but you know that it comes. I think our job is to be ready so that we can take action and take advantage of the opportunities that markets present us within the short term relative to long-term conviction that we have in either existing holdings and shifting weight within them or with new names that we've been tracking and following.

LW: Is there one data point that you are tracking at the moment?

Riley: The most important aspect of our decision-making isn't about any one data point. I think that's a misconception that there can be just one that sort of solves a puzzle, so to speak, on an investment decision. 

I think the most important factor overall is our process and the consistency of our process. I think consistency of process is what allows you to deliver results over time. And then within that, I would say one of the most important aspects besides some of the key tenets of our alpha drivers is the fact that our process is iterative.

An iterative process I think allows us to do two things. One, it allows us to debate questions and issues along the way so that when we reach significant conclusions, we're ready to make those decisions. The other thing an iterative process does for us is we're long term in our view and long term in our investment horizon. 

You need to have that iterative process to constantly be revisiting your investment thesis, the incremental data points, and reach a conclusion of whether or not you still have the conviction in the initial conclusions or if something has changed. Things can change for the better, and they can change for the worse. Change isn't necessarily a bad thing, but I think that the iterative aspect of the process is very important for us.

LW: What portfolio position are you excited about right now?

Riley: It's always hard to pick just one, but since you've asked for one, I would start with Danaher (NYSE: DHR). They're a US-based healthcare company. They're within biopharma testing diagnostics, and they also have a third segment, environmental and applied solutions. 

One of the most interesting things about the Danaher business model is that about 70% of their revenue is recurring. That gives them a lot of visibility as they look into the future and think about where it is that they need to take their business and where the spending patterns and investment areas of the business need to be.

The other thing I think is interesting about Danaher right now is the leverage. Their leverage ratio is coming down pretty close to the bottom end of the range where the company typically likes to run, and they have an incredibly long track record of execution around M&A. We think that that's another opportunity when we look into the future. The timing's uncertain, but given their historical track record, that's another thing that we find interesting about Danaher at this point in time.

Think Broadly. Act Decisively 

The Loomis Sayles Global Equity Fund seeks to provide a concentrated portfolio of best ideas in global equities. The research-driven approach is unconstrained by style, sector, or geography, with the flexibility to invest across market capitalisations. To learn more, visit the fund profile below. 

Managed Fund
Loomis Sayles Global Equity
Global Shares
This information in this video is provided for general information purposes only and does not take into account the investment objectives, financial situation or needs of any person. Investors Mutual Limited (AFSL 229988) is the issuer and responsible entity of the Loomis Sayles Global Equity Fund (‘Fund’). Loomis, Sayles & Company L.P. is the investment manager. This information should not be relied upon in determining whether to invest in the Fund and is not a recommendation to buy, sell or hold any financial product, security or other instrument. In deciding whether to acquire or continue to hold an investment in the Fund, an investor should consider the Fund’s Product Disclosure Statement and Target Market Determination, available on the website or by contacting us on 1300 157 862. Past performance is not a reliable indicator of future performance. Investment in the Fund are not a deposit with, or other liability of, Investors Mutual Limited and are subject to investment risk, including possible delays in repayment and loss of income and principle invested. Investing involves risk including possible loss of principal and there is no guarantee that the Fund will generate positive or excess return. Any opinions or forecasts contained herein reflect the subjective judgments and assumptions of the presenter only, and do not necessarily reflect the views of Loomis, Sayles & Company, L.P. Investment recommendations may be inconsistent with these opinions. There is no assurance that developments will transpire as forecasted and actual results will be different. This information is subject to change at any time without notice.

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Chris Conway
Managing Editor
Livewire Markets

My passion is equity research, portfolio construction, and investment education. There are some powerful processes that can help all investors identify great opportunities and outperform the market, and I want to bring them to life and share them...

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