Given all the bad news roiling markets, investors are becoming
increasingly fearful about investing in equities. But Shawn Price,
manager of
Touchstone Large Cap Growth
(TEQAX, 800-543-0407)
, says it's still possible to make money in this perilous
market by focusing on the fundamentals. Price's system of stock
selection blends quantitative measures of volatility and risk with
a keen eye for strong fundamentals. This approach has catapulted
the fund to the top of Morningstar's Large-Growth
category-Touchstone Large Cap Growth ranks in the top decile for
the trailing 10-year period.
Is this volatile market environment here to
stay?
Right now, I don't see any turns for the foreseeable future.
People are fearful not so much because the data is scary, but
because of the unknowns. Unemployment seemed like it was improving,
but the US economy is not creating jobs, and the August report of
zero job growth will probably be revised to negative growth. In
addition, another election cycle is underway in the wake of the
debate in Washington over our nation's debt. Our politicians seem
more interested in taking partisan jabs at each other than actually
trying to fix things. Europe is just as dysfunctional, with
governments implementing massive austerity measures that are
causing riots across the region. It will be at least another six
months before we'll have any clarity on these developments. As
such, I'm shifting my portfolio toward greater diversification
among lower volatility stocks.
Nevertheless, there are opportunities for investors. For
example, our portfolio has the strongest fundamentals on an
absolute basis that it's ever had, as well as on a relative basis
compared to the Russell 1000. Of course, companies are entering a
period in which the comparison of their fundamentals will be
against relatively strong numbers, as opposed to the dismal numbers
posted during the recession. On the other hand, companies have
reduced overhead by closing down unproductive facilities and
instituting lay-offs. In many cases, firms cut back their expenses
and then drew down their inventories. While it's good to get lean
and mean, you can only cut so much. Now corporations need to
demonstrate top-line growth by increasing sales while operating in
an environment of low consumer confidence and high
unemployment.
I'm not optimistic that these problems will be resolved in the
near term, but that doesn't mean investors should idle in cash. If
you hold substantial cash, you're almost guaranteed to have your
wealth eaten away. We're printing money at an unprecedented rate,
and once inflation rears its head it's going to destroy any cash
holdings. Unfortunately, bonds are also not offering much as an
asset class. In most cases, bond yields are below the rate of
inflation, so they're an almost guaranteed loser. And commodities
are just too frothy, particularly gold. At nearly $1,900 an ounce,
gold is closer to the end of its bull run than the beginning. For
the average investor, there's really only one attractive asset
class at the moment-equities. Though the turmoil in the market may
be terrifying, equities are the one asset class currently offering
decent prospects without a guaranteed loss. But this difficult
environment demands diversifying among stocks with the strongest
fundamentals.
How has your portfolio coped with the recent
volatility?
According to our Morningstar and Lipper ratings, we're in the
top 4 percent of large-cap growth funds year to date. One of the
reasons our system has held up so well is that we demand a
fundamentally superior portfolio relative to the constituents of
our benchmark index. For example, our average operating margins are
slightly over 15 percent versus negative 7 percent for the Russell
1000. We have a reinvestment rate of 25 percent versus 19 percent,
and year-over-year earnings growth of 109 percent versus 103
percent. These strong fundamentals have insulated our portfolio
from the recent volatility.
Also, our system keeps us well diversified. We limit our bets by
not allocating more than 5 percent to any one stock. Fortunately,
we've found a number of compelling stocks. We have exposure to
producers and manufacturers, materials, technology, energy, health
care technology, and a range of other industries. This broad
exposure keeps our portfolio from experiencing booms and busts
based on individual sectors. During the past year, our focus on
diversification and strong fundamentals has kept volatility down
and produced gains relative to our benchmark.
Your fund has a heavy allocation to consumer cyclical
stocks. How does this exposure dampen volatility?
In many cases, consumer cyclicals are naturally lower-beta
investments. And when volatility creeps into the market, our system
is designed to seek out lower-volatility stocks and sectors. Our
portfolio currently has about 44 stocks, versus 37 one year ago. As
the market became more treacherous, we diversified to spread the
risk among more stocks.
Our system is statistically driven, so it's unable to be biased
toward a particular stock or sector. The system doesn't know
whether you're feeding it an
Apple
(
APPL
) or a
Chipotle Mexican Grill
(
CMG
). But statistically, the system will adjust beta upward or
downward by highlighting particular sectors depending upon overall
market conditions.
What are some low beta names you're system has recently
led you to?
We hold natural gas pipeline and exploration company
El Paso Corp
(
EP
), specialty coffee and coffeemaker producer
Green Mountain Coffee Roasters
(
GMCR
),
MasterCard
(
MA
),
Ralph Lauren
(RL),
Starbucks
(SBUX), and
Tiffany & Company
(NYSE: TIFF). Overall, those are pretty tame names.
MasterCard may sound like a counterintuitive play with all of
the deleveraging underway, but the company's numbers have been
strong. The firm's margins are running at 34 percent, it has a
tremendous reinvestment rate, a 23 percent return on equity, and a
fairly moderate price-to-earnings multiple of 19. Analysts have
been aggressively revising earnings estimates higher to 29 percent
annual earnings growth. We all know about the consumer-deleveraging
story, but we don't let that narrative get in the way of a sound
investment opportunity.
The system has also directed our attention to cloud computing
solutions provider
Citrix Systems
(CTXS) and network optimization software maker
F5 Networks
(FFIV). The common theme is that our system's been trading up for
the lower beta names with strong recent earnings, qualities that it
considers paramount.
The flow of money on Wall Street is being driven by fear, and
consequently, risk aversion. Investors are pulling out of more
volatile names and putting that money into government securities,
lower beta stocks, such as the ones we're holding, or even sitting
in cash. Investing is a very manic depressive sort of pursuit, so
the money flow is obviously going to reflect that. When the market
was still clearly on its bull run 18 months ago, our portfolio was
chock full of high-beta and high-alpha stocks because the money
flow was guiding us in that direction. As fear returned to the
market over the past five months, investors started to abandon more
volatile securities in favor of steadier fare. That behavior
ultimately affects the alphas and standard deviations that drive
changes in our portfolio allocations.
What's your best advice for investors?
Pay attention to overall fundamentals. There are companies on
the market that are thriving and snatching market share from
competitors that have fallen by the wayside. There will be
companies that come out of this downturn stronger and healthier.
The US economy won't just fold; the country will weather this
difficult period. There are always opportunities to make money,
even if you're avoiding the sexier stocks.
However, investors need to stay diversified. This isn't the time
to make any wild bets in the market. Just spread your investments
across a number of healthy companies.