Four Thornburg equity PMs discuss how they identify strong but undervalued companies while also seeking to mitigate material ESG issue risks.
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. However, we believe our approach to finding unrealized value relies on bottom-up research which can help identify “strong companies.”
We asked four of our equity portfolio managers what their criteria are for identifying strong companies from the relevant universe and what impact the COVID-19 pandemic has had.
Q: Let’s begin with some context. What are equity investors looking for these days?
Brian McMahon: Equity investors expect mid, high single-digit GDP growth around the world, and that would translate into more than 20 percent global earnings growth. And bond investors expect a rise, but a limited rise, in long maturity interest rates, and they expect strong credit performance this year.
Central banks are flooding economies with liquidity, commercial bank deposits are growing rapidly in the U.S. and elsewhere. In addition to that, the U.S. Congress has so far passed more than $5 trillion of fiscal mitigation measures over the last year, and other countries have done broadly similar things.
There’s an expectation that this might lead to inflation. Indeed, commodity prices, and producer prices are elevated, and shortages have been reported in many key materials. We do expect both positive and negative news in the months to come. We continue to emphasize resilience in the investments that we own and, as always, ability and willingness to pay good dividends.
Q: 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. We 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 data points 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.
Q: What adaptations to the process have you made as a 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.
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.
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