Harin de Silva, CFA, Ph.D., Portfolio Manager
Analytic Investors, Sub-Advisor to:
361 Global Long/Short Equity Fund (AGAZX/AGAQX)
361 Domestic Long/Short Equity Fund (ADMZX/ADMQX)
Harin de Silva, CFA, Ph.D. was recently featured in a Wells Fargo Asset Management On The Trading Desk® podcast discussing how the Analytic Investors team has navigated the ups and downs of 2020 and how they plan on approaching the continued uncertainty for the rest of the year.
Q: For many, 2020 has been a year of losing balance, on a personal, social, and for many, a financial level. And hopefully, the rest of the year can be about finding balance. Are there any imbalances that you’re still seeing in your area of focus?
A: The biggest imbalance we’re seeing is the discrepancy in the performance of the U.S. stock market versus the rest of the world.
As we all know the U.S. market is near all-time highs. The P/E’s around 24, so it’s high from a historical standpoint, but it’s high also in comparison to some of the other markets in the world, especially the developed markets, which have actually done a better job in terms of navigating the crisis. And what I mean by better job is more of the economy in some of these markets, like Germany, for example, or the Netherlands, is open. There’s more companies that are returned to work as normal, more businesses that have brought all their employees back, so it’s very hard to reconcile why we’re seeing so much optimism in the U.S. market versus some of these other markets.
Now there’s two things that you’ve got to keep in mind here. One is the U.S. is obviously one of the wealthier economies, so the level of stimulus we’ve been able to provide is really, really high and so maybe that’s what’s reflected in the high valuation. And also the valuation reflects the average stock and what we’ve seen is really that certain parts of the market have done really well—tech, in particular—and other parts of the market have really suffered.
So I think you can explain the high level of valuation by that to some degree, but I think as investors, you need to be aware that there’s lots of opportunity available on a worldwide basis and you don’t need to pay the high multiple that you’re going to pay if you invest just in the U.S. market.
Q: We’ve all had to adapt to new ways of living during this tumultuous year. Are there any areas of your portfolios that have adapted, or changed significantly, since the beginning of the year? Maybe in terms of cash holdings, sector or factor exposures? Harin, what are your views on this? Any major changes in the portfolios, almost like the pre-COVID and during-COVID period?
A: This is probably the single biggest revision we’ve seen in our portfolios in the 30 years I’ve been at Analytic, so dramatic changes in the market. Dramatic changes in the risk profile of companies.
I tried to put the changes we’ve seen in historical context by going back to the early 1900’s and you’ve never seen this kind of rotation in terms of a company that’s been high-risk becoming low-risk and a company that’s being low-risk becoming high-risk. Because what’s happened is the ability of companies to respond to the stay-at-home factor was not priced into the way stocks are behaving.
So if you took a company like Disney, it was regarded as safe and you took a company like Netflix, it was regarded as very sensitive to the market. And what happened through this crisis was you realized that one of the companies, Netflix, had the ability to survive this and therefore, its beta—the systematic risk of the stock—fell dramatically.
And you’ve seen that happen to a great degree, even with certain parts of the tech sectors. If you look at semiconductors, as long as I can remember, the beta of the semiconductor industry has been greater than one, and now it’s close to one because everyone’s realized that these are companies that are going to survive this type of shock.
So huge turnover in the portfolios as we’ve migrated away from stocks that have more systematic risks to stocks that have less systematic risks. And huge turnover in also fundamentals, in the types of fundamentals that have been rewarded in the marketplace. So there’s been a lot of emphasis on return of assets as a factor as opposed to return on equity [ROE]. And the distinction between those two is subtle, except that ROE reflects leverage in a company and everyone’s been moving away from highly-leveraged companies.
So lots of opportunity in the market but also really, really high levels of turnover to exploit this really rapid change we’re seeing.
Q: Let’s talk about uncertainty. It’s an inherent part of investing since we don’t know with certainty what the future holds, and maybe it’s a little bit of recency bias on my part, but it seems like there’s radical uncertainty today.
And so starting with you, Harin, how does your process help you address uncertainty when you don’t know over the near-term or possibly even over the long-term which factors will win, which companies will thrive, or which issuers of debt will make good on their promises?
A: Brian, you can actually measure the level of uncertainty using, for example, the dispersion in stock returns, or the level of implied volatility in stock returns, or the level of correlation in stock returns. So we use all these different measures and what it universally points to is really two things.
One is you need a portfolio that’s more diversified than average. So if you look at our portfolios, you’ll see portfolios that have many more stocks in them than they have historically. So if we had 100 stocks in the portfolio, we now have around 150 stocks in the portfolio.
And you also see the portfolio being diversified from a sector and a factor perspective. So we realized both recently and through historical analysis that in times like this, it’s hard to pick convincingly what winners are going to be, so you do need to have tilts in the portfolio, but also we need to recognize that things have changed very rapidly and make sure that those tilts themselves are small. So we have a lot of different tilts to different industries and different factors, but they’re smaller than they are historically and there’s more of them.
Q: Let’s speak directly to investors. Some investors might find it difficult to act or make changes in this type of environment. Could you all provide words of wisdom about how to take action despite the cloud of uncertainty that persists?
A: Yes, in some ways, you’ve got to recognize that the COVID crisis has probably just accelerated some of the changes that were happening in the economy to begin with, right?
We’ve seen the beta of the energy sector go up, and that’s partly due to COVID, but it’s also partly due to the fact that people are moving away from carbon and towards more greener technologies.
We’ve see the beta of the tech sector come down and that’s partly because we realize that technology is an essential ingredient in our life. If you have a kid, you know your kid’s been telling you for years that an iPhone is a consumer staple, and this probably reflects a little bit of that.
So I think we are seeing an unprecedented opportunity in markets to position our portfolios and exploit some of these changes. And I think it’s important to see the opportunity and realize that this is probably something you’re going to see only once in a decade.