By Debbie Carlson
Picking winning stocks is the game that fund managers play, but it's just as important to know when to sell.
Guy Pope, co-manager of the $9.7 billion Columbia Balanced fund's equity sleeve, uses a contrarian approach to discover undervalued names, selectively buying stocks that are trading in the bottom third of their 52-week lows. Buying unloved equities also means keeping a close eye on their performance and setting strict rules on selling.
Among the Balanced fund's strategies: cutting a stock's portfolio position by a third if the name has fallen by 15% relative to its cost. Pope and his team of three other equity managers and 24 analysts will revisit the name and treat it as if it's a new holding.
"It's very easy when you have a troubled stock to hope you're wrong and that it will get back on track," he says of his disciplined approach. "Hope is a bad strategy when dealing with capital and investing."
If the team members believe that their thesis is sound but that they could be early to an investment, they'll keep the stock, but they will sell if their thesis is wrong. "It's a good rule to check your ego," says Pope, 58.
The Portland, Ore.--based Pope and his team spend each day either looking for new names to add or revisiting the Balanced fund's roughly 75 to 80 names and making sure they want to continue holding them. Fixed-income co-manager Ron Stahl, 56, says his team of two other managers and 63 analysts strive to achieve roughly 0.80% of excess return annually over the Bloomberg Aggregate Index, with a similar risk level.
As its name suggests, the Balanced fund has a roughly 60/40 stock/bond tilt. The fund managers' goal with this moderate allocation fund is to make it easy for investors to know what they own, says Stahl, rather than managing the fund in opaque and myriad ways to produce returns. "Having a strategy where it's easy to explain and easy to remember what they own, I think, is very good for clients," he says.
A cautiously contrarian approach gives the Balanced fund a leg up on its moderate allocation peers, according to Morningstar. The four-star fund boasts a 8.3% return over the past 10 years, versus 6.6% for peers, putting it in the top 13% of moderate allocation funds. It costs 0.93% annually to own, a fee that Morningstar considers below average, and its front load of 5.75% is waived at most brokerages.
Pope says his team screens for beaten-up stocks mired by transitional issues that are fixable over an 18-to-24-month time frame. From there, the team conducts bottom-up research and employs a quantitative model to narrow down names. Stocks that enter the portfolio have a clear investment thesis, and all of its holdings have upside price targets and are ranked by highest appreciation expectations.
He will own a stock until price targets are met or exceeded, the team has found better ideas, or the investment thesis proves wrong. He will also trim holdings to maintain appropriate size. The fund caps sector weights at 9%.
One of Pope's recent portfolio additions is ON Semiconductor. Broadly diversified semiconductor makers are lagging behind names specializing in artificial intelligence, like Nvidia, as they experience a cyclical slowdown in their end markets and their inventories are elevated. Clearing those inventories should be a tailwind, he says. ON's stock price should rise before earnings reflect a change in the cycle, which he suggests could happen in the next 12 months. The stock trades at 16 times next year's earnings estimates, and he sees an upside of more than 25% from current levels.
Pope expects that managed-care company Elevance Health, another holding, can get through its current underperformance versus peers in the next two years. Medicaid cost trends were above the company's expectations, forcing Elevance to lower earnings estimates. As it begins to reprice its Medicaid business, he thinks earnings will return to their usual low-double digits. He forecasts that it could have more than 20% upside from here.
The market is too pessimistic about Honeywell International, Pope argues. because it lags behind its peers in organic growth. A sluggish industrial economy weighs on the company's industrial and building automation side, but its aerospace unit is strong. Once the industrial business cycle turns, he suggests the stock could rise more than 20% in the next 18 months.
He stresses that the portfolio's composition reflects a mix of new contrarian ideas and stocks that look less contrarian, such as names such as Nvidia, Apple, and Microsoft. The less-contrarian include ones where Pope's team think there is still upside.
Generally speaking, earnings have been "good to good enough," he says. Markets are exiting the seasonally weak time of year, and it appears the Federal Reserve has engineered a soft landing, says Pope, reflecting on the stock market's robustness and greater breadth. He cautions investors to keep a level head, pointing out that the multiple for the S&P 500 index's estimated earnings is high no matter the time frame.
"It is showing signs of exuberance, so it would not surprise me at some point for the market to hit a period of digestion or consolidation," Pope says. "That doesn't mean a bear market, but it just has to let the earnings grow into the multiple that it has right now."
The fixed-income side of the Balanced fund features a 46% weighting in securitized offerings and is overweight agency mortgages. Going into the fall, Stahl became cautious, boosting the portfolio's AAA-rated holdings to 56% and moving to the shorter end of the yield curve, as yields have risen there despite the Fed's recent interest-rate cuts.
Agency- and nonagency-backed mortgages offer better spreads over U.S. Treasuries, he says, at about 135 to 150 basis points above the risk-free rate, versus investment-grade corporates or high-yield bonds, where spreads are historically tight. In particular, Stahl has lately favored shorter-dated AAA nonagency-backed mortgages, where demand has been strong.
Stahl has moved to the front end of the yield curve to take advantage of more attractive yields versus longer-dated bonds. "The back end is vulnerable to...[concerns about] deficits. If that continues to get worse, the back end is going to underperform," he says.
Email: editors@barrons.com
This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.
(END) Dow Jones Newswires
November 20, 2024 02:00 ET (07:00 GMT)
Copyright (c) 2024 Dow Jones & Company, Inc.
Comments