What Lazard's Landy learned during the longest bull market in history

Hans Lee

Livewire Markets

When it comes to viewing one's own work with a dispassionate eye, Lazard Asset Management portfolio manager Matthew Landy gets straight to the point.

The global equities market's longest bull run in modern history has come to a screeching halt, the S&P 500 down 20% from its most recent high in January to enter a technical bear market. But Landy has an easy lesson for all of us, in case you've been licking your wounds at the sight of your portfolio's declines.

The lesson we've learned - and it's becoming very apparent right now - stick to your guns.

Through the last couple of years, in particular, the huge increase in tech share prices and wider earnings multiples across all areas of the stock market has been a sight to behold. They have also been, what Landy calls, "the great temptation."

In this latest edition of Expert Insights, Landy will share with us his "sticking to your guns" thesis. We'll talk about the stocks he held through the pandemic despite initial shocks, general volatility, and through to now - the end of the "low rates forever" era. He will also share with us why having a concentrated portfolio is actually a benefit during times like these.

Get access now by watching the video or reading the edited transcript.


LW: What lessons did the Lazard team take away from the 12-year bull market?

Matthew Landy: I think the lesson that we've learned, and it's really becoming very apparent right now, is that if you are a value investor, stick to your guns

The great temptation over the past three or four years has been, I think, for many investors to say, "Oh, look, these great, big, mega-cap tech companies are taking over the world. They're growing like crazy, there're huge markets, and they just go up every year. We may as well just own those stocks." And you've also had continuous, multiple expansion across almost the entire stock market. 

So, it's not just growth companies - you've had bond proxies - things that have stable cash flows and look a little bit like bonds from a risk profile standpoint in the stock market, things like regulated utilities in the US, have been re-rated enormously. You've had consumer staples in the US that have been re-rated to double their historical multiples in some cases and you've had very high-quality companies with high returns on equity, relatively low leverage, trading at record high multiples.

If you look at those groups of companies, all that's really changed is that interest rates fell. And what's happening now is that interest rates are rising. 

We think there is a real risk and we think that investors are going to be quite shocked at some of the multiple contractions you're going to see in some of those businesses. And what we've done over that time is effectively concentrated our portfolio. So rather than just saying, "Well, we will just own Google and Microsoft or the FAANGs," we've gone, "No, we're only going to own the stocks that we think are actually cheap." 

So, we've gone from about 38 stocks in 2013 down to about 26 stocks today. And the reason for that is that simply more and more stocks have become expensive. We've had to concentrate the portfolio into only those stocks that can offer us a return above our target, which is 10% over five years.

It was brutal being a value investor in the pandemic, but we felt like we owned the stocks that were actually cheap, incorporating a negative economic scenario, and we stuck to our guns. 

Pre-pandemic, we had a portfolio that we felt was very well built for a recession. We owned businesses like AB InBev, which is the largest brewer in the world. People tend to drink beer in recessions as much as they do in good times. We owned Medtronic, which is the largest medical devices manufacturer. Well, people get sick in recessions as well. We owned IGT, which is the largest lottery concession owner in the world, and people like a flutter on the lottery in hard times too. However, when you have a pandemic and you shut bars, clubs, and restaurants, people can't drink as much beer!

When hospitals are overrun with COVID patients, elective surgeries can't be performed and so, medical device sales fall. And when you lockdown Italy for six months and you own the Italian lottery, people can't buy as many lottery tickets.

So, what we did were three things:

  • The first thing we did was recast all of our macroeconomic forecasts to assume a long, deep recession and a prolonged recovery. 
  • We then applied that on a case-by-case basis to each company in our portfolio, taking a scoop out of revenues over that time. 
  • And then, the last thing we did was really stress-test our businesses, so to say, "What if we're wrong? What if it's even worse than that? How far does revenue have to fall before these companies can't meet their fixed operating costs and their fixed costs of debt?"

And the conclusion was we thought they could even in a worst-case scenario. And so, what happened in the pandemic was effective that what was cheap got cheaper and what was expensive got even more expensive. So things that had been working in the stock market, like the FAANGs and so on, continued to perform really well. Things that were cheap got really cheap. 

That meant that our portfolio didn't change very much because the stocks that we owned, despite having incorporated a pre-negative scenario in their cash flows, were still very attractive and still very cheap. And we still own many of those stocks today. 

So again, on the stick to your guns theme, that was very much a case in point where our analysis suggested that we own the right stocks.

LW: Why is stock concentration a good thing for portfolios?

Matthew Landy: We basically construct a portfolio of 25 to 50 stocks, and the reason for that is that we think most of the diversification benefits beyond 50 are diminutive. There's no point owning more than 50 stocks in our minds anyway. And 25, as a minimum, is an adequate level of diversification. 

Of course, we're only focused on economic franchises, which in themselves, we think, reduces the risk a lot. We're not punting on the oil price in 10 years' time or what the bank credit cycle might be, etc. These are businesses that have big competitive advantages and stable cash flows. So, that reduces your risk and we think enables you to concentrate. 

But the number of stocks that we own is really driven by the opportunity set available to us.

If this market falls another 30%, you might find us with a 50-stock portfolio because there are lots of cheap stocks we can buy and we can diversify and reduce our stock-specific risk. 

If it continues to be expensive, we will maintain a concentrated portfolio because we'd rather own a concentrated portfolio of cheap economic franchises than an index where you're owning a lot of expensive stocks that could fall in value and also where today, you're arguably not getting the same level of diversification that you have because you've got this unusual concentration of mega-cap IT which is really dominating the indices. 

We look at the indices and we are concerned because there's this concentration risk and there's still this valuation issue, which is getting worked out right now, but we would argue still has further to go.

Access companies with an 'economic franchise'

The Lazard Global Equity Franchise Fund seeks long-term, defensive returns by investing in listed companies which possess a combination of high degree of earnings forecastability and large competitive advantages. Find out more here.

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Hans Lee
Content Editor
Livewire Markets

Hans is a content editor at Livewire Markets and Market Index. He is the creator and moderator of Livewire's economics series "Signal or Noise". Each month, Hans sits down with Australia's best macro minds to explain how the big picture affects...

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