2 Top Managers on Secular Change and the Market

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A recurring theme at the conference was: Will value investing ever rebound? Is a reversion to the mean forthcoming or has the market fundamentally changed during the past decade?

Morningstar’s director of equity strategies Katie Reichart posed those questions–and many others–to two fund managers who’ve proved adept at valuing companies relative to their growth prospects: Giroux, who manages Gold-rated 

“It has definitely changed over the past decade,” Giroux replied. Specifically, the market has experienced a secular change. Giroux argued that secular risk is now a bigger defining factor in the market, touching more industries and companies than ever before. To wit: T. Rowe Price estimated a few years ago that 27% of the S&P 500 was facing secular risk; that figure stands 31% today. So while it’s true that value investing had a mean-reverting element to it over past 80 years–companies would struggle, recover, and then revert to the mean–that’s less likely today.

Giroux pointed to retail as an example: Fewer people are going to the mall, there’s less brand loyalty, and the Internet has fundamentally changed how we shop. As a result, most retailers can’t revert to the mean. So while the traditional light and heavy cyclicals have continued to show mean reversion, other industries aren’t–hurting traditional value approaches. To make matters worse, said Giroux, management teams of companies facing secular risk are making poor capital-allocation decisions to reinvent their companies–

Hynes noted that healthcare has become more consolidated and less fragmented in the past decade, with the bigger players gaining even more scale and market share. Hynes also noted that drugmakers, in particular, have been experiencing a “supercycle” of innovation and an intense period of regulatory scrutiny, which has injected more uncertainty and misvaluation of revenue streams. When asked what uncertainty

Reichart asked Giroux and Hynes for specific examples of such secularly challenged companies. Giroux named one that his fund in fact owns–

According to Hynes, drugmakers that have benefited greatly from biologics/specialty drugs on the market for more than 20 years are facing biosimilar competition that will create a gap in earnings for those that don’t have the pipeline to offset it. She’s seeing a lot of this already in Europe, where the presence of biosimilars has been more rapid than expected.

Reichart then asked the managers to explore how the presence of disruptors has forced them to change their approaches to valuation.

Hynes brought up

Giroux noted that, yes, the traditional yardsticks for valuing companies may be less useful today. For instance, looking out into the future, Amazon looks cheaper than

“The middle is where the most attractive part of the market is,” he argued, meaning those growth-at-a-reasonable-price stocks. Specifically, Giroux likes companies with improving margins, 4% to 5% organic growth, and less cyclicality–that’s where today’s inefficiencies lie. Giroux likes buying companies that neither value nor growth investors want–and he’s willing to occasionally pay a slight premium for them.

Both managers agreed that the market has become shorter-term-focused; those investors looking at the long term are differentiated from the rest. Giroux said there’s no easier way to make money in the market today than to buy a company that you feel good about in the long term that’s suffering from undue market stress in the short term.

What companies qualify?

Hynes cited portfolio holding

Giroux, meanwhile, used

Overall, Giroux isn’t finding a lot of value in the equity market today; instead, he’s finding “idiosyncratic opportunities.” For instance, he picked up loans on First Data (FDC) with a 5% yield that will be going away in six months after its acquisition by

The duo closed with more examples of change.

Healthcare is changing at a more accelerated rate at any other time in her career, Hynes said. She noted that with the costs of sequencing the human genome coming down and a better understanding of disease pathways, there will be more research and development dedicated to diseases that we’ve never treated before. That could bring dramatic change to 60% of the healthcare market, she estimated. She also expects a very robust healthcare market in China, and noted that demographics in the next decade will challenge governments with aging populations.

Giroux noted one sector that’s changing dramatically but has gone unnoticed is utilities. The cost of wind and solar energy and renewables has led to a shift in the business models of utilities. He expects to see accelerating earnings growth as more power is coming from renewable sources, and sees renewables as a very powerful 20-year tailwind for utilities. “It seems like a great long-term place to be,” he concluded.



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