By Reshma Kapadia
Hilda Applbaum's blueberry bushes are her pride and joy. Applbaum, who lives in Oakland, Calif., takes particular satisfaction in planting tiny seedlings, watching them grow and flower, and plucking the fresh fruit to top off her morning yogurt.
As co-manager of the $144 billion-in-assets American Funds Income Fund of America, Applbaum takes a similar approach to investing. The actively managed fund often buys cheap shares of challenged companies yielding at least 2.5%, and waits for a turnaround to sprout -- sometimes several years -- before harvesting the gains. She puts her approach in literary terms, however. "We invested in the prologue," she says of fund winners.
Applbaum, the longest-tenured member on the Income Fund of America's team , invests in a mix of U.S. and international stocks. Her successful approach has enabled the fund to beat 98% of its peers over 15 years, returning an average of 8.6% annually, according to Morningstar.
Applbaum studied economics at Barnard College of Columbia University, then worked as a Federal Reserve watcher at Telerate and an economist at the Federal Farm Credit System before moving to the West Coast and into the world of convertible securities. She first joined the California Public Employees' Retirement System, or Calpers, and then moved to Capital Group, home of American Funds, in the mid-1990s, working as an analyst of convertible securities before becoming a portfolio manager.
Known at Capital for her steady temperament, Applbaum seeks income-related investments stable enough to allow investors to stay in the market, even during tough times. Barron's spoke with her on March 5 about the opportunities she sees in stocks such as Starbucks, Amgen, and CVS Health, and why she likes Brazilian miner Vale.
An edited version of the conversation follows.
Barron's : The war in Iran is raising concerns about higher oil prices and the impact on energy-intensive industries. including semiconductor firms like those your fund owns. How do you think about the ripple effects?
Hilda Applbaum: History would suggest that conflict, on average, doesn't tend to have long legs [in terms of market impact], and this fund is long-term oriented. A year will be a long time for geopolitics to have influence on things such as energy prices unless you go back to the 1970s, and that was more about embargoes, and when the U.S. didn't have energy self-sufficiency.
We purchased Taiwan Semiconductor Manufacturing and Broadcom when they had high dividends and much lower price/earnings ratios than today. These are great examples of how we look at stocks when they are less in favor but we see strong long-term prospects. We tend to invest in them early and then allow the story to unfold over the next five to 10 years, while we get paid with a high dividend yield. It isn't that we saw the artificial-intelligence boom, but we saw a tech- and chip-heavy world, whether in autonomous devices or data centers or cloud.
Broadcom, for example, was acquisitive. It tended to buy what were viewed as less-attractive, old-world technologies such as Computer Associates and VMware. At the time, the market didn't recognize the ability to run Computer Associates much more efficiently and take necessary but maybe unsexy products and sell them across a much broader customer base. It isn't that people didn't understand what Broadcom was doing at that moment, but rather, they didn't understand the quality of the management and how Broadcom viewed these acquisitions.
What is a similar opportunity today?
Starbucks is like a seed. The company has struggled for some time, but we didn't feel the brand had been harmed. Instead, the management of the brand, stores, real estate, and product mix was undermanaged. The company changed management, hiring Brian Niccol, whom we knew when he ran Chipotle Mexican Grill, where he undertook a turnaround, changing the menu, making the stores more efficient, and rationalizing the real estate. We have confidence that Starbucks has at least a playbook to succeed, and a brand that hasn't been impaired to a great extent.
What type of management behavior raises flags for you?
A personal pet peeve is when I meet with a company's management and the executives comment on our shareholdings -- whether that they keep meeting with us and we still don't own the stock, or that we sold down the stock, or even that we have been adding to it. They need to manage their business, and I need to manage my portfolio. That is a waving red flag because they are managing to the wrong thing.
What else catches your attention?
As an income investor, one of my red flags tends to be overuse of leverage, or levering the balance sheet not because the business suggests it's the right thing to do. When companies use leverage to make earnings look better, it is worrisome.
I also want management to be opportunistic in the use of capital. So, many management teams buy back stock at the top of the market and are paralyzed at the bottom. When management is a thermometer, reflecting market sentiment, instead of a barometer, reflecting what they see in the business, I get worried. I would rather see steady buybacks and potential tweaks as stock prices fall if companies think the best investment is their own stock. When I see a stock hitting all-time highs and management announcing buybacks, that is worrying.
About a quarter of the fund is invested in shares of companies based outside the U.S. What is the draw?
International markets underperformed the U.S. for more than a decade, and valuations and yield fell to attractive levels. We have also seen some [positive] decision-making, whether it is the Value Up programs in Korea or Japan [to improve corporate governance and make capital-allocation decisions that bolster valuations], or more economic stimulus. That gave us more confidence to move more of our equity investing outside the U.S. For example, we own KB Financial Group in Korea and Mizuho Financial Group in Japan.
Some of that stimulus is focused on increased military spending. What is the opportunity there?
BAE Systems is a stock we bought when it was trading at a single multiple and had a high dividend yield. At the time, a lot of people were focused on when the company would secure a large Middle Eastern contract and worried it wasn't coming through. We saw much more: BAE Systems has a U.S. division that does tremendous work in areas such as cybersecurity, and there were other businesses that gave us confidence the company could generate good earnings growth with or without the contract.
Roll forward 10 years and BAE has the perfect portfolio, in the perfect geography, with Europe announcing it will spend closer to 2% of gross domestic product as part of its North Atlantic Treaty Organization agreement. Spending is coming through [on defense], and with conflicts, particularly the war in Iran, a lot of product is being used. It will take years to retool [military equipment] , and the move to onshore a lot of production and development means the United Kingdom, France, Korea, and the U.S. will benefit.
We invested in the prologue and are in the meat of the story right now. There will be an epilogue. BAE trades for 25.4 times forward earnings, higher than its five-year average of 17.5 times. Valuation will be important, so we will have to reassess as the stock rises.
What do increased spending on the military and the war in Iran mean for inflation?
We don't have a house view. The Hilda view: I don't see worrisome inflation but think the European Union and U.S. will struggle to get back to central banks' inflation target of 2%, short of an economic downturn. The economy can function reasonably well somewhere between 2% and 3% inflation, even with more spending and greater nationalism, because if we get some inflation, such as higher energy prices even for a period, consumers may spend a bit less. I don't think inflation gets above 3%, partly because central banks don't want it to.
What opportunities do you see in gold and commodities?
We own a gold miner, Agnico Eagle Mines. As the dollar fell in value and trading in cryptocurrencies grew more volatile than initially advertised, gold began to serve its historical role as a store of value. The advance in gold might be in the later innings, although the conflict and inflation suggest gold could still have an important place in portfolios.
We also own Vale and Rio Tinto. As we build -- whether it's physical infrastructure, data centers, or housing -- these companies produce necessary metals that are in short supply and have become very valuable. We bought Vale when it was trading at single-digit multiples and double-digit yields after a terrible accident [related to the collapse of a dam that killed 290 people in Brazil]. It had become untouchable.
What made you think otherwise?
Visiting with management, meeting government officials, seeing the facilities, and understanding that it was in everyone's interest to get a settlement and the community back on its feet. Seeing the company's willingness to make those settlements and move on with new management gave us confidence to take that large position. We are in the later stages of that settlement, payment, and litigation process.
Healthcare is another area that some have avoided but you have leaned into. What interests you?
My portfolio has been weighted toward healthcare, whether drug companies, HMO insurers, or companies such as CVS Health, a top holding for the fund, which I bought because I saw there was a turnaround to be had. We are now seeing that turnaround begin to play out, and it remains a high-conviction stock.
A newer holding is Amgen. Everyone knows that there are some drugs rolling off patent. But we see an opportunity for some of the company's earlier-stage drugs to have huge potential. There is more uncertainty because they are in Phase 2 or Phase 3 trials, but there are enough of them that we don't have to be right on every single one.
Which ones are especially exciting?
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