Funds: This Fund Doesn't Own Nvidia. It's Still Beating the Market. -- Barron's

By Debbie Carlson

Don't call Daniel Hanson an ESG investor.

Hanson, senior portfolio manager of the $1.5 billion Neuberger Berman Sustainable Equity fund, is an acolyte of Warren Buffett and Benjamin Graham's investing style, which favors high-quality companies at undervalued or fair prices and holding them for the long term to benefit from compounding growth. As such, the fund seeks out companies that display high-quality hallmarks, such as high profit margins, low debt, consistent earnings growth, and strong management teams.

Hanson likes to use what he calls a "stakeholder lens" for his fund's holdings, which considers how a company treats its employees, customers, and its communities. He says it helps him identify intangible factors and long-term drivers of quality outcomes.

"Being customer-centric employers of choice, businesses that are viewed as positive to their communities -- those all contribute to the flywheel of good business outcomes," the New York City--based manager says.

Hanson, 53, who celebrated his second anniversary at the fund this month, has already made an impressive mark. Sustainable Equity is up 9.1% so far this year, and is up 29.4% on a one-year annualized basis, handily beating both its peers' one-year return of 21.5% and the 24% gain of its benchmark, the S&P 500 index, according to Morningstar. That puts the fund in the top 7% of large-blend funds. Its three-year annualized return, which includes his predecessors' record, is up 7.4%, versus peers' gain of 6.8% and the S&P 500's 8.2% return. The A shares carry a 5.75% front load, which is waived at some brokers. Morningstar considers its 1.06% annual fee average.

Hanson, previously chief investment officer at Waddell & Reed and Ivy Investments, took over the Neuberger fund after his two predecessors retired. He prefers the term "sustainability" over environmental, social, and governance, or ESG, investing, as the acronym has become maligned and misunderstood and has an unclear definition.

Sustainability is broader than a simplistic score card, and it fits in with how Hanson's philosophy emulates Buffett, by owning high-quality companies with durable competitive advantages. Sustainability considers how managers run the business, attract and retain the best employees, create value for their customers, and use resources efficiently with a long-term focus. He says high-quality business practices deepen the competitive advantage, what Buffett calls "moat."

Hanson also prefers strong management teams with an ownership mind-set that bring the intensity of a founder but also have cultures of candor and accountability. "This is age-old, classic, fundamental bottom-up investing," he says. "We want to know businesses inside out."

Hanson says his "North Star" is to own businesses that grow enduring value that shows up in financials like unit revenue growth; businesses with pricing power that shows up in margins. Moat matters. A company could be ethically run by strong managers, but if it operates in a highly competitive, commodity-type space, the competitive advantage won't last. "They're just different actors arguing over slices of a fixed pie," he says.

Since taking the helm, Hanson has shuffled the portfolio to add more high-quality growth names that reflect durable competitive advantage and high-quality business practices. Stock selection is important, but so is portfolio construction, and the two have equally contributed to performance, he says. Of the 38 names in the portfolio, he has increased the holding sizes of his highest-conviction names, with about 50% of the portfolio in the top 10 holdings. The fund's top 10 holdings previously had a 37% weighting.

Among the changes: increasing Sustainable Equity's position in now-No. 1 holding Microsoft from underweight to 9% and adding No. 2 Amazon.com and No. 3 Berkshire Hathaway in 2022. In 2023, it bought No. 7 semiconductor equipment maker Applied Materials and No. 8 brokerage firm Interactive Brokers Group. Another new name, although not in the top 10, was retailer Costco Wholesale.

Hanson took advantage of 2022's growth selloff to ramp up the fund's position in Microsoft and add Amazon. At the time, he says, Amazon's reduced valuation was driven more by fears over how its marketplace division would survive a possible recession than concerns over Amazon Web Services, which drives most of its business. He picked up Applied Materials in late 2023 at a discount to intrinsic value and sees it as a way to play semiconductors' secular growth.

Sustainable Equity's portfolio construction reflects a barbell approach, with higher-growth, higher-valuation names such as Microsoft and Costco but also ones such as equipment-rental firm United Rentals and drug wholesaler Cencora -- tangible-value-driven business models that trade at a discount to intrinsic value. Those names can better weather an economic cycle in which growth isn't in favor.

What the fund doesn't own is just as important as what it does. In 2023, Sustainable Equity matched the S&P 500's return, and it did it without owning Tesla, Nvidia, or Meta Platforms, three of the biggest-gaining Magnificent Seven stocks. Hanson admits they're impressive companies, but they don't fit with his philosophy. He thinks the valuation ascribed to future growth and strong market share for Nvidia and Tesla are too high. And despite Meta's strong financials and founder-led attitude, Hanson says the company doesn't align with their ethos. "The DNA of the company is to, frankly, exploit the user. That is their business model," he says.

He isn't worried about whether interest rates remain elevated, noting that the fund's high-quality holdings weathered the rate hikes without difficulty. He's excited about artificial intelligence, given his positions in Microsoft, Amazon, and Alphabet. Yes, there's plenty of hype around the technology, but he's more comfortable owning large-cap names rather than up-and-coming companies with unproven tech. He disagrees that the AI hype is like the dot-com bubble of 2000, seeing differences in valuations, initial public offerings, merger and acquisition activity, and management sentiment.

"You don't have anywhere near the markers of the excesses as back then," Hanson says.

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April 19, 2024 21:30 ET (01:30 GMT)

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