Portfolio Manager Susan Bao and Laura Huang explain their equity investment strategy to deliver returns with lower volatility over the long term.
Would you give us an overview of your strategy as large cap portfolio managers?
We invest in large cap leaders, companies we believe are quality earnings compounders that can be purchased at a reasonable price. We invest in 40 to 60 large cap stocks in which we have high conviction, across all sectors and styles (growth, value, defensive, cyclical, etc.).
Our research shows that quality earnings compounders, purchased at reasonable prices, can deliver superior returns with lower volatility over time. When it comes to our investments, we are owners, not renters, so we take a long-term approach – our turnover rate is around 20%. For example, we’ve owned two of our highest conviction holdings, UnitedHealth Group (UNH) and Google (GOOG), for over a decade. Holding equities for that length of time also leads to tax efficiency.
Can you say some more about your stock selection process?
We partner with a team of more than 20 dedicated senior research analysts who use a time-tested fundamental process more than 35 years old to identify the best investment ideas. Then we filter those ideas through a “quality” framework to select stocks with three key attributes:
- Attractive business models: The company should have pricing power, durable competitive advantages and secular tailwinds.
- Best-in-class management teams: That means corporate managers with foresight, good stewardship of capital and proven ability to execute.
- Sustainable earnings: The companies we’ll select have healthy cash flows and a defensible balance sheet.
We pair this quality framework with a disciplined valuation process. We look to identify underappreciated earnings compounders and to avoid riskier investments, such as value traps whose prices continue declining, or companies with growth but that are unprofitable.
We believe the large cap leaders we’ve identified can navigate today's choppy environment better than their competitors.
How are these quality large caps weathering today’s environment?
What's interesting and unusual about the current market is that quality stocks are trading at a discount, during (and in anticipation of) an economic slowdown when investors would typically be willing to pay a premium for stability and visibility into earnings.
Yet instead, we saw an indiscriminate rotation from growth to value last year , which gave us an opportunity to add while these stocks were on sale. With the ongoing economic uncertainty, and valuations that are still supportive of our quality compounders, we continue to see opportunity.
It’s becoming apparent that what matters are the strategic and capital allocation decisions that company managers’ made years ago. Our valuation process focuses on long-term normalized earnings (earnings agnostic of where the economy is in the cycle). The process lets us capture those management decisions that compound and cascade.
We believe the large cap leaders we’ve identified can navigate today's choppy environment better than their competitors, capturing market share and preserving earnings, so they’re more likely to come out of the cycle stronger.
Where do you see investment opportunities?
The signs of an economic slowdown are more apparent today than they were a year ago. Uncertainty and higher volatility give active managers promising investment opportunities – but we need to be nimbler and more selective than usual.
We’re maintaining a balanced approach in our portfolio positioning, with a defensive and “GARP” (growth at a reasonable price) tilt. Our largest sector overweight is still health care because it's trading at an attractive valuation and it’s less economically sensitive than many other sectors.
Our largest underweight is in REITs. We’re neutral on the financial sector, but our positioning within the sector is nuanced: We don't have any exposure to regional banks and we’re underweight traditional money center banks.
ConocoPhillips, S&P Global and UnitedHealth are among the companies we believe are well positioned to deliver superior returns over the long term.
Would you tell us about a few examples of stocks in your portfolio?
Sure. Here are three where we see a disconnect between short-term cyclical concerns and long-term secular value:
ConocoPhillips (COP): We think COP's disciplined use of capital and diversified, high-quality asset base make it a likely outperformer among oil and gas exploration and production companies. The market underappreciates COP’s role in the energy transition, including its strategic exposures to liquid natural gas, Brent oil and European gas. We also see tailwinds from a commodity price perspective, around oil demand, as China reopens.
S&P Global (SPGI): SPGI is a diversified financial services company with defensible and sustainable competitive advantages. With the interest rate hiking cycle closer to the end than the beginning, and issuance in debt capital markets well below trend but likely to resume soon, we believe SPGI’s largest segment, bond ratings, will benefit as bond sales resume. Data and analytics are another source of recurring revenue, and SPGI has pricing power there. Its recent merger with IHS Markit Ltd. (INFO), an analytics provider, should also provide synergy and opportunities for cost efficiency.
UnitedHealth Group (UNH): UNH operates a health insurer, a pharmacy benefit manager and a physician network. We think the sum is greater than the parts due to its scale and data advantage. Management foresight has helped create a leading innovator in health care services. After a strong 2022, UNH has underperformed the market this year-to-date, driven by investors rotating away from defensive stocks, and a negative reaction to government-mandated decrease in Medicare Advantage reimbursement rates. We think the market underappreciates, in our view, UNH’s very strong chances of achieving durable, low- to mid-teens EPS growth over the foreseeable future, under most economic conditions.
ConocoPhillips, S&P Global and UnitedHealth are among the companies we believe are well positioned to deliver superior returns for investors over the long term.