Portfolio Changes
In keeping with the Fund’s long-term and somewhat contrarian approach, the trades this quarter involve incrementally going against the market. While all trades are bottom-up driven, in several cases the team upgraded the growth of the portfolio without significantly changing the valuation profile. In other words, they trimmed a slower growth name while adding to a higher growth one at a similar valuation (though not necessarily in the same industry). For example, the team sold out of staples name Colgate and trimmed health insurer Cigna, broadband provider Charter and Chinese ecommerce giant Alibaba. Other significant trims during the quarter included Dollarama, American Tower Corp and Starbucks. On the add side, the team shifted into higher growth names including software firm Adobe, auto supplier Aptiv, health care sterilization leader Steris, asset manager Schwab and spices and Swiss specialty chemical company Sika.
The team started a new position Gartner, the technology research and consulting firm that had been on the watch list for some time. While not cheap on near term estimates, they believe the valuation is within the range they consider appropriate for our GARP-y style. From a growth perspective, the long-term fundamental thesis is driven by Gartner's competitive positioning and research insights as the "gold standard" for chief technology officers in making critical and expensive tech-related decisions for their companies in a fast-changing landscape. In addition, their seat-based licensing model offers a strong value proposition and return on investment for their customers relative to a full-service consultant experience. Competitively, Gartner is 10 times the size of the number two player and is widening its lead through investing more in sales and research. The team believes Gartner will sustain revenue growth compounding potential, fueled by IT industry spending growth, increasing tech complexity requiring more advice, a significantly underpenetrated addressable market, and an ability to capture share faster than the competition. The Fund also initiated a position in Thomson Reuters Corp during the quarter.
Fund Positioning
The team remains purely bottom-up investors, constructing the portfolio stock by stock to try to identify individual businesses that meet the quality and growth hurdles and appear attractively valued on a relative basis with a long-term view. Despite the bottom-up focus, the team continues to have a lot of internal conversations about bigger picture macro and equity market trends amid the recent downside volatility. Regarding multiple compression in the market sell-off, the team still believes that the fastest growth tier of growth stocks generally still appears too expensive for the Fund’s conservative growth style as valuations have gone from very expensive to just expensive. To put that in context, with regard to U.S. stocks in the Fund’s investable universe, the most expensive quintile of stocks in the Russell 1000 Growth index currently trade at more than a 500% premium to the overall S&P 500, which is well above the team’s typical limit. While equities have sold off considerably this year and multiples have contracted, earnings estimates have remained surprisingly resilient across the market. Consensus estimates for corporate earnings growth over the next twelve months are still well above long-term averages, which in our opinion is overly optimistic. On the possibility of continuing high inflation, the team believes that the Fund’s bias towards high-quality franchises naturally tilts the portfolio towards companies with pricing power and high margins, and leaves the Fund relatively well positioned versus the index. Said differently, companies with wide competitive moats and high margin profiles tend to have lower expenses as a percentage of sales so are better able to manage inflating costs than lower-quality companies with the opposite margin profile.
During the quarter, the team trimmed slower growth names while adding to a higher growth ones at a similar valuation. The overweight sectors in Q3 relative to the benchmark remained similar to the previous quarter. However, the Fund made incremental changes to shift exposure from the Consumer Discretionary and Consumer Staple sectors to the Information Technology and Health Care sectors. The Fund’s exposure to Information Technology increased from 25.8% in Q2 to 27.5% in Q3. Health Care also rose marginally from 13.7% to 14.1%. Consumer Staples and Consumer Discretionary lowered from 11.2% to 10.2% and 14.1% to 12.7% respectively. From the underweight sectors, the Fund lowered Real Estate and increased Financials by trimming American Tower Corp and adding to Charles Schwab Corp. The Fund’s exposure to Real Estate declined from 2.1% in Q2 to 1.3% in Q3. While Financials remainded the most underweight sector, it became less underweight relative to the benchmark where exposure increased from 7.2% in Q2 to 8.9% in Q3.
Keep in mind that the team rarely makes drastic changes to the Fund’s overall composition within a short period of time. All changes are made gradually and strategically over the long term. They believe in making incremental changes that will likely have a positive impact to the Fund when opportunities present themselves. The team’s commitment to their investment process and philosophy remains unchanged always. They maintain their long-term investment horizon and focus on owning durable growth compounders where there’s high confidence in the sustainability of profits over the long term. The Fund remains fully invested in the equity markets as the team believes it is challenging to predict equity market returns over the short term.
