Nobody wants to invest in questionable, weak, unethical or incompetent companies. And investing in the right company for financial success is the holy grail we’re all searching for. This clearly isn’t easy, and nobody is perfect. If they were, they would be the only investment option in town. Thornburg IM has asked four of its equity portfolio managers (Brian McMahon, Miguel Oleaga, Lei Wang and Josh Rubin) what their criteria are for identifying strong companies from the relevant universe for their respective strategies, what impact the COVID- 19 pandemic has had and how ESG considerations are relevant to determining whether a company is strong.
Can you describe your research process?
Miguel Oleaga: Our process involves narrowing the universe of stocks by looking for what we believe are strong companies, which drive idea generation. We perform deep fundamental research on those names, ultimately generating a short list of investable ideas and then investigating those ideas thoroughly. The Global Opportunities portfolios utilize an intrinsic value framework that seeks to understand if a business is likely to create value over the long-term, with less of an emphasis on near-term valuation metrics. Often market commentators and investors attempt to assess valuations and opportunities simply on near-term statistical metrics, such as a P/E or a P/B multiple. In our view, these can be useful datapoints but do not paint the complete picture of whether a business is fairly valued. To be able to thoroughly analyze and determine intrinsic value, we need to know what we own and therefore limit our holdings to about 30–40 stocks.
Josh Rubin: A key consideration for our emerging markets investment strategies is really honing in on the strong businesses, not just high profit margins, but a really strong management team, strong corporate governance, strong operational policies, strong market positions and the other types of components that lead companies to win market share or outgrow their industry competitors.
Lei (“Rocky”) Wang: We think in the next phase of the recovery the outperformance of higher beta value names may give way to companies which can demonstrate earnings growth and may therefore favor bottom-up stock selection and a more balanced core approach to portfolio construction, both of which we have practiced successfully for more than two decades.
What adaptations to the process have you made as result of the COVID-19 pandemic and the resulting changes in the environment?
Miguel Oleaga: We haven’t made any changes to our process. We believe a well-thought-out and executed philosophy and process should withstand the tests of time. I do think COVID has changed the investment landscape. For example, the recent increase in retail participation in equity markets means more investors competing in the market, which, ultimately, should make the markets more efficient with periods of excessive price moves. However, increased market efficiency also means simple strategies that utilize valuation multiples or other metrics that can be easily accessed via online trading platforms or financial websites will create little to no excess returns on average. In fact, greater retail participation will mean that achieving excess returns consistently makes having a well-thought-out investment philosophy and rigorous process even more critical to add value over time.
Rocky Wang: We haven’t changed our process, but where we focus has shifted. For example, the inflation narrative and sentiment are getting hot these days, which trigger sometimes erratic rate movements. But we focus on fundamentals rather than headlines, so we are always trying to see the reality vs. perception.
Commodity prices are definitely in the news these days as they have been shooting up. Is that due to the shortage of the commodity production itself, or just a paucity of qualified drivers who can deliver the commodity from point A to B? Is it transitory or structural in nature? We care about the depth of the details like that and how to construct a portfolio which will sail through this noisy patch.
Brian McMahon: Our process of finding investments that offer both resilience and growth over time has remained consistent. If you look at our top holdings, you’ll see that we have both. We’re not loaded up with companies that have plus and minus 20 percent revenues, based on the cycle, but we do have companies that have tended to grow their revenue, cash flow and dividends over time. And that’s what the Income Builder portfolios are all about.
It’s a yield-starved world out there. So, we think that dividend payers are especially important and especially timely right now when some of the safest bonds and longer duration bonds look a little iffy.
How do ESG considerations help determine whether a company is “strong” or not?
Miguel Oleaga: ESG considerations provide investors with a toolkit for assessing whether a business is creating value for all its stakeholders, from employees to its community to shareholders. ESG also provides insight into analyzing a business’s go-forward prospects—a lens on whether that company is competing in expanding or contracting markets due to evolving environmental or regulatory considerations, for example.
Governance is another important set of issues where poor practice can lead to substantial corporate risk such as expensive legal actions and negative publicity. In our opinion, these insights about where risks lie are crucial in determining what the business is worth and providing effective stewardship of the investment.
Josh Rubin: Particularly in emerging markets where transparency might be lower or the regulatory oversight regime might not be as strong or as advanced as we see in developed markets, we do think that consideration of ESG characteristics are very important for every investment.
We are not using a negative overlay investment strategy—not avoiding, for example, carbon-producing or alcohol beverage companies, but we look at each of the relevant industry risk factors of ESG to be sure we are mitigating risk in our portfolios, particularly in an emerging markets context, which can mean higher volatility, abrupt shifts from value to growth and vice versa, a heavy retail component and less sophisticated investors.
Rocky Wang: We use ESG analysis to find what we believe are financially sustainable businesses. At the end of the day, active managers identify mispricings in the market to create a diversified portfolio that will outperform. ESG analysis is a powerful tool to help accomplish that goal.
Understanding the stage in a company’s lifecycle is important for both traditional fundamental and material ESG analysis. Emerging franchises often race to grow employee headcount, assets and processes to support early life hyper growth. As a company begins to mature it can leverage these resources to more fully capture profits from the competitive advantages it has established. But it can also take a deeper examination of its impact on society and work to align its business with benefits for the communities in which it operates.
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