Sharpen Your FAANGs Exposure?

Key Takeaways

• During Q1 2020, the Fund outperformed the index by 7%¹
• Key shifting driver ahead is “digitalization” – 35%² Fund exposure
• Novo Nordisk holding is a frontrunner for new diabetic treatments

As restrictions increase globally, analysts are expecting another rollercoaster ride for markets and the VIX index. Has that led to any significant changes in the portfolio?

MH: While there have been some minor changes (including selling companies, like Tiffany, that were on the way out of the portfolio already), overall, it hasn’t. We don’t rotate the portfolio in anticipation of certain market conditions, or try to guess which way the markets are moving. Instead, we go through life with a portfolio that’s designed to cope with difficult market conditions should they occur, and at the same time, keep pace with markets when they're rising. Think of it as being permanently defensive.

In fact, during the first quarter of this year, the strategy outperformed the index by approximately 7%¹. That's because it's comprised of high-quality companies with sustainable growth trends and sensible valuations. We don’t whipsaw around, but rather invest in companies for a 5-10-year period and stick with them.

Sectors such as IT and healthcare have experienced sky-high valuations. What impact, if any, has that had on portfolio rebalancing?

MH: IT, in particular, is an interesting one because that’s been doing very well in the second and third quarters. Stocks that were already expensive became even more so, and to some extent, it’s been the same situation with healthcare. Money has been flooding into markets this year, driven by government stimulus and all-time low interest rates, which means that quality bond market returns are weak at the moment. All this has boosted valuations for companies like Amazon and Netflix – the big FAANGS – for which trading conditions are near perfect in the “lockdown” environment.

That said, we’ve been outperforming without FAANGs in the portfolio (with exception to Alphabet, which we think is not excessively valued). Interestingly enough, when news of the COVID vaccine first came out, markets rallied but big tech stocks gave ground because investors were betting there would be a broader-based recovery in U.S. equities. So, if you subscribe to the idea of a generally more positive environment next year, big tech may not be the best way to play it.

We think that the FAANGS are in “casino” territory right now – that doesn’t mean they won’t continue to outperform, but they could also equally underperform. Either way, when the valuation of a company parts with its earnings power, we’re just not interested.

Your team often takes “Days Out Researching Anything” (DORA) to dig deeper on long-term trends. What value does that bring to your equity analysis? Also, have those drivers shifted in 2020 – and beyond?

MH: For us, if you want to understand the future of a company, you have to understand the future itself. The world's changing very fast, and we must ensure we’re not investing in corporations that could be disrupted by the emergence of a new trend. So, we keep one step ahead, with the aim we’ll never be in the situation that befell Nokia shareholders in 2007, for example, when the arrival of the iPhone rendered its technology obsolete.

The key shifting driver right now is digitalization, brought on by the experience of everyone working, shopping and socializing from home. People have realized the power of the computer to make their lives more convenient – from working digitally to shopping online – and we expect some permanent shifts in behaviour going forward. As a result, approximately 35%² of BMO Concentrated Global Equity Fund is exposed to digitalization in one form or another, and even beyond that if you include companies like Nike, which have put connecting with their customers digitally at the core of their growth strategy.

Given that Quality screens can vary across managers and issuers, how do you define a strong company? Give us an example of your ideal long-term holding.

MH: Our whole process starts with the idea that markets are very efficient, with exception to their ability to look far enough into the future. Everything in markets is about the short-term, which means that companies capable of sustainable growth beyond the market’s time horizon have a high chance of being fundamentally undervalued. However, we think, forecast and invest long term, and that’s how we take advantage of the market.

In addition, we have a set of criteria around quality – which includes the maturity of the business – so we don’t invest in sexy start-ups, or heavily indebted corporations, but rather look for well-established, cash-generative, unleveraged companies locked into a long-term growth trend. Importantly, our portfolio companies have capital-light business models, with no requirement for large amounts of heavy machinery or property to function, and they’re diversified across product lines and consumer markets. It’s all about allowing your clients to sleep well at night by offering downside protection if stocks tumble.

A great example of this in our portfolio is global pharmaceutical company Novo Nordisk, whose diabetes care products will still generate demand even if the economy is weak. As a result, it has held up well in the current environment, and it has tremendous competitive advantages because it’s in a leadership position for providing new diabetic treatments. Add to this a strong balance sheet, top ESG standards, and the benefits of an ever-growing market – no surprise, it’s one of our ideal investments.

To sum up, what do you believe BMO Concentrated Global Equity Fund can offer investors in the current environment?

MH: Apart from the COVID crisis and all of its ramifications, these are incredibly unstable times. We appear to have just avoided a potentially disastrous political situation in the U.S. Brexit threatens the stability of the Eurozone. Relations – trade and otherwise - between the west and the east are at all-time lows. To what extent will economies be able to recover from the double dip that we will have to endure thanks to the current wave of lockdowns? How quickly can economies recover post-vaccination? What happens when government and central bank stimulus is removed and how will the abundance of new debt incurred by governments and loss-making corporations be repaid?

Ultimately, our portfolio is an effective way to navigate through this volatility because of its proven ability to hold up when markets turn for the worse, and to keep up when conditions improve. We believe that if we continue to follow our high-conviction strategy over time, returns will outperform because every single company within the Fund represents quality, with a rock-solid business model that doesn’t depend excessively on continued strong economic growth to provide earnings growth. Our strategy brings some certainty in a very uncertain world. So, while the Fund is concentrated, it has historically generated less volatility than the benchmark; we also have an active share of 95%, which means only 5% overlaps the index.³

Michael, one last question. We like to end our PM interviews by asking for a book recommendation for our Advisor audience. What are you reading these days?

MH: I’ve just picked up Tomorrow will be a Good Day, an autobiography by Captain Tom Moore. It’s an incredibly heartwarming story about the life of a national hero, and the past 100 years in Britain. Starting by walking laps around his garden, he raised more than 32 million pounds for our National Healthcare System in the run-up to his 100^th birthday in April. He was also knighted at Windsor Castle in the summer. I’m excited to start reading the book. Hopefully, tomorrow will be a good day.