Steven Romick from First Pacific Advisors, co-Portfolio Manager of the Nedgroup Investments Global Flexible Fund, shares how the Fund fared in what he terms an exceptionally unexceptional year, the challenges facing value managers and how this will impact the Fund’s positioning and ability to deliver on its objectives through a full market cycle.
Portfolio composition and performance
The Fund’s objective is to provide an equity-like return over the long term with less risk than the market while avoiding permanent impairment of capital. A key characteristic includes full flexibility to invest across the capital structure. At the end of Q4, we had 72% in equities, 2% in credit bonds and 26% in cash and cash equivalents. We are concerned about the global wanton printing of money that at some point will render fiat currencies less volatile. This has caused greater volatility in the portfolio than previously but we can’t forget about our need to make money over longer time frames. In Q1 and Q2, we took advantage of the market’s swoon and committed a lot of capital within the portfolio. 43% of the equity exposure is in North America. More than half of the revenues of the companies in our portfolio are domiciled or sourced outside of the US. We are value investors and invest with a margin of safety, which has shifted from the value of the balance sheet to the value of the business and this creates greater volatility.
While the portfolio lags the MSCI World Index over the 5-year period (8% vs 12.2%), two significant variables are driving this performance benchmark. The index is much more growth tilted and includes the global bond index, which has benefitted from a decline in rates. We’ve comfortably outperformed the market on the MSCI World Value Index, especially over the last year (10% vs
-1.2%). Over Q4, the portfolio had a significant rebound, returning 17.2% vs the MSCI World of 14% and MSCI World Value of 15.7%, largely as a result of the capital we put to work in Q1 and Q2. We reduced some of the cash in the portfolio and bought many of the businesses that people had given up on. We believed that over time we would travel again, stay in hotels, dine out, etc. yet the stock market valued many of these businesses as if that would never happen again. So, we were able to take advantage of those opportunities and saw a big rebound in Q4 2020 and into Q1 2021.
While there weren’t many detractors in Q4, we tend to look long term. Over the last year, technology has been one of the biggest drivers in the market and been a great driver of returns for the portfolio through Alphabet, Broadcom, Facebook and Baidu. We bought many of these companies in 2011 and have held them ever since. Some of the companies that have not performed as well were more traditional value investments, e.g. Howmet Aerospace. We are very sensitive to price and price does matter.
In 2020, growth was the driver with the returns for the MSCI ACWI Growth Index at 33.6% and the S&P Growth Index at 33.47% well ahead of all other indexes, including the S&P500 Value Index and the MSCI ACWI Value Index at 1.36% and -0.33% respectively. Long-term equity returns have been achieved with significant variability around the mean and is why this past year was called an exceptionally unexceptional year, but with great variability within that year. The MSCI ACWI Index has returned 6% over the past 22 years, but in only two instances were the returns even within 2% of the average.
In 68% of the cases, the returns were more than 10% points higher or lower than the average with a 69% spread between the best and worst years. 26.7% was the best performing year with a loss of 42% in 2008. The variability we saw in 2020 created some opportunity for us with more stocks trading cheaply. In March, valuation spreads (how cheap the cheapest quintile of stocks are compared to the average stock) for global and U.S. equities reached their widest levels since 2009. As of December 31 2020, valuation spreads were 1.4 standard deviations above the mean. In the past, similar conditions have meant strong absolute and relative performance for our strategy. Many of the stocks that have been “working” in the market have been at the expense of those that have not. The cheaper, high beta stocks have performed better and showed that price doesn’t matter.
We own businesses that are growing businesses, even though they may not be growing at the same rate as some of the technology companies, but their values for the growth we are receiving are much more attractive. At some point, the headwinds in the market over the last decade for our style of investing, which is more value hewn where price does matter, may turn around. We could see low volatility stocks being high volatility. US, which has outperformed international may become less attractive. We hope that high yield is up for a window of opportunity in the portfolio. We made some investments in the cruise industry through high yields earlier this year. Interest rates may not be as low as they have been, although they greatly benefit growth stocks. We expect some combination of the above to turn around in the future.
Until then, we’ll continue to deliver a sensitivity to buying good businesses and protecting capital along the way.