Our process has remained the same for the past 15 years. Over the past year, we have been very focused on our downside risk analysis, stress-testing our company models to help determine how companies may perform in a less favorable environment for profits.
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Overweights
Our biggest overweight versus the benchmark is in the consumer staples sector. (The fund had a 19.48% weighting in the sector versus 8.60% for the Russell 1000 Value Index as of Dec. 31, 2017.5) We have high conviction in the resilience of cash flows and earnings generated by our consumer staples holdings, particularly given efforts in recent years to improve margins by reducing costs and complexity, implementing supply chain efficiencies and optimizing brand portfolios.
Another sector in which we’re overweight is utilities. (The fund had a 15.37% weighting in the sector versus 5.91% for the Russell 1000 Value Index as of Dec. 31, 2017.5) Our utilities exposure has ranged from 3% to 15% historically, and we are now at the high end of that range. We have identified several investment opportunities in utilities in recent years based on our triangulated valuation approach as sentiment, particularly around rising interest rates, created dislocation in stock prices.
Underweights
Our biggest underweight is in financials. (The fund had a 13.90% weighting in the sector versus 26.68% for the Russell 1000 Value Index as of Dec. 31, 2017.5) We believe financials are modestly attractive today on a P/TB (price to tangible book value) basis. However, we have a more conservative view of banks’ full cycle ROA (return on assets) versus the Street. While investors were focused on the myriad of macro and regulatory headwinds from 2009 to 2011, our bottom-up research identified numerous regional banks that were attractively valued with strong deposit franchises and sound capital ratios. Though some are still reasonably attractive today, our extensive analysis indicates that the opportunity for growth in book value is currently less apparent.
We are also underweight in information technology (IT). (The fund had a 0.94% weighting in the sector versus 8.45% for the Russell 1000 Value Index as of Dec. 31, 2017.5) Most of the best performing names in 2017 were momentum-oriented, which is not a part of our investment process. Within the value universe, some companies are subject to secular risks given rapid technological change that could negatively impair their business model. Today we see IT companies with high valuations and/or business models threatened by these secular changes.
Key takeaway for equities
The goal of our strategy has always been to provide capital appreciation with better downside preservation. This full-cycle mindset has been embedded in our investment process since the strategy’s inception. More recently, we have placed particular emphasis on managing downside risk through sensitivity analysis of our modeled assumptions, given our belief that the profit cycle appears to be waning, valuations are extended, and the narrowness of market conditions warrants focus.
This article has been republished with permission from Invesco Powershares.