US Equity Update

Market Update

• While the equity market sell-off in the first quarter of this year was extreme, in our view the market’s response to the fear and unknowns of the global coronavirus pandemic was actually quite logical. Equities have subsequently rallied due to a combination of monetary and fiscal support, news of COVID-19 curves flattening and loosening of lockdowns in Europe and some cities in the US, and rising hope that Gilead Science’s antiviral drug Remdesivir can help patients recover.

Portfolio Positioning

• In the first quarter of 2020, our US Equity portfolio generated negative absolute returns, but modestly outperformed the S&P 500 Index during the tumultuous period. Our holdings Alphabet (Google), Amazon and Microsoft – three of the five large cap companies that now represent roughly 20% of the S&P 500 Index – performed relatively well.
• At the other end of the spectrum, our consumer staples holdings, which have historically helped returns during periods of uncertainty or economic downturns, have lagged. But, given today’s unique circumstances with consumers confined to their homes, spending patterns are changing. Our staples holdings that are exposed to greater on-trade consumption (restaurants and bars) are suffering, but a portion of those lost revenues should be picked up by an increase in off-trade (at home) demand. We think investors are underestimating the potential switch to off-trade consumption.
• As market volatility accelerated, our investment team conducted extreme stress-testing on all of our holdings to ensure they possess the financial strength to endure a shutdown in the economy for two or three quarters. After speaking to company managements, we tested for heavy pressure on revenues, profits, and cash flow. Our balance sheet analysis extends far beyond the usual metrics associated with EBITDA and leverage. We assess debt rollovers, covenants, lines of liquidity, and the capacity/terms to draw on those lines. We also evaluate changes to fixed and variable costs.
• We have been actively aiming to upgrade and de-risk the portfolio. We sold a limited number of companies where we were concerned about their ability to survive and used price dislocations to buy stocks in companies in the industrials, health care and consumer discretionary sectors. We believe that we have increased the ROE and the growth prospects of the portfolio while purchasing at attractive valuations.
• Information technology remains our largest sector allocation, at 21%, followed by health care, at 19%, consumer staples, also at 19%, and consumer discretionary, at 16%. We continue to maintain a zero weight to energy and commodity-based businesses due to their lack of earnings consistency.
• In IT, we continue to hold payments companies Visa, MasterCard, and PayPal despite the temporary impact of lower consumer spending and diminution in cross-border transactions. For years prior to the crisis, these companies were reporting double-digit earnings growth. And, with a significant percent of transactions in the world still in cash, there is plenty of runway for growth. We continue to believe that the franchise value of MasterCard, Visa, and PayPal is robust.

Outlook

• Many companies have suspended earning guidance at least in the near term. Thus far in the reporting season, we have noted companies providing pre-COVID and post-COVID comments because the pandemic hit at the end of March. We therefore think second quarter results and third quarter outlooks will be far more telling.
• De-globalization presents a risk to corporate profit margins, which have increased in the last five years because of labor moving to China, unions losing bargaining power, lower taxes and lower interest rates. The shift to de-globalization should negatively affect corporate profitability, but will not be felt uniformly across all companies.
• Despite the preoccupation with COVID-19 and ensuing market volatility, we remain committed to our ESG standards. ESG has been an integral part of our investment process for years and we continue to monitor our portfolio holdings for ESG-related risks and engage companies with ESG-related questions.
• In our view, the difference between growth and value is an artificial dichotomy. Investors want to buy stocks for less than they are fundamentally worth and want to see earnings growth. During an economic recovery lower quality stocks tend to experience a short-term bounce off their lows, supported by accommodative monetary policy. But over the long run, good high quality growth stocks can outperform as equity prices will ultimately reflect underlying company fundamentals. We invest with a three to five year horizon. Our goal is the same as always, to preserve and grow our clients’ capital with quality growth companies through the full market cycle.

Past performance is not indicative of future results. The information described in this Insight should not be construed as a recommendation to purchase or sell securities.