Large Cap Value – 1Q20 Review

Transcript:

Good day. This is Brian Barish, president of Cambiar Investors and portfolio manager for the Cambiar Large Cap US strategy. I’m here today to talk about first quarter 2020 results and as well provide some thoughts on what we’re doing and why we’re doing it in the context of the global virus crisis and global lockdown recession that we are facing.

So for the quarter we had a good quarter, if you can call it that. In the context of a furious bear market, we were down 20.7%, that is 600 basis points better than the Russell 1000 Value Index, which was down 26.7% for the quarter. It’s rather interesting, at the beginning of the year we were somewhat wary of what performance might be in 2020 largely because performance in 2019 was well above market norms. The S&P 500 was up over 30%, the Russell 1000 Value was up in the mid 20% range. So much above normal returns and we were nervous and keeping with that we sold a couple of positions down and liquidated some other positions, mostly in the financial sector and in the technology sector. Thinking that it just didn’t seem reasonable to believe you weren’t going to have some wiggles in the market. Little did we know what was about to happen.

The market ended the year 2019 in a very good mood and more defensive type of sectors had tended to lag. So ironically early in the quarter, we picked up positions in Colgate-Palmolive as well as Pfizer. Well before the virus crisis had started just thinking that they looked inexpensive relative to their business prospects. At Cambiar Investors, we have a strong focus in all of our portfolio management products, on the underwriting of stocks, in our capital, in stewardship and discipline. As we hold positions and in the way that the companies we own are managed.

Great underwriting means a few things. It means that we want to have a very deep analytical dive into the company in question and what we think the commercial outlook is for their product or services, what we think the market structure is in which they operate, the industry structure in which they operate and obviously what kind of value proposition they represent from a financial perspective. We also have a big focus on capital stewardship and discipline. Now, that is a mouthful and it can mean a lot of things, but it generally means that companies are thoughtful and conservative with respect to their balance sheets. They don’t take on a lot of debt, they don’t engage in a lot of speculative accounting or M&A, and they tend to be rather scrupulous with respect to their financial dealings in general.

In good times and in bad times. What has tended to occur is that companies, whether growth or value that engage in quality, capital, stewardship, and discipline tend to outperform those that don’t. And when I look back at the quarter and how it unfolded, that combination of attributes is focused on capital stewardship and discipline. The care that has gone into stock selection in terms of the industry structure and the analytical outlook themselves for companies, that’s been very instrumental in our results, as the full impact of the global virus crisis and great lockdown and the unbelievable recession that we are dealing with became evident, and that occurred right at the very tail end of February.

We recognized that we were going to need to marry our normal approach to investing with some thoughtfulness in terms of what the impacts of the deep recession that we are in was going to be on companies and on their balance sheets and on their investability. We explained some of this in more depth in an earlier podcast, but just to make a quick summary, we have divided stocks up into five buckets. Companies with small, medium, large, “large with balance sheet destruction”, and “need recessing” categories. And it is our view that as the recession associated with suppressing the COVID virus unfolds, it is appropriate and it is prudent to consider investments in the first three buckets and to be very reserved if not outright eschew investments in the final two buckets. We think the prospects for capital destruction and for a loss of principal are just much greater in those categories.

So if you look at what performed well and what didn’t perform well, it’s all very much in keeping with which bucket stocks belong in. We put energy in the fifth bucket, an area that needs reassessing. We had one energy stock, which was Chevron. We concluded in early March the energy market had become completely uninvestable and we exited that position. Banks and industrial companies, they fall in the medium to medium large category in terms of business disruption and consequently those were down more than more defensive businesses such as healthcare, food, and digital marketplaces. We added to some of those positions actually over the course of the quarter thinking that the decline in stock values was more than adequate to discount the earnings loss and maybe protracted recovery that some of those companies will face. But we think their balance sheet should be adequate to weather what we are contending with.

We’ve tried to pace our buying over the course of this. Understanding that in a bear market, these tend to be more of an endurance race than a sprint and more a question of maintaining your calm in the face of violent markets that will very much test your ability to stay calm. I’m going to go through a list of stocks that we bought and some that we sold and I will tell you that this is one of the most active quarters I can ever recall. We certainly didn’t plan it this way, but we bought in the January and February time periods. This is before things got really ugly. Colgate and Pfizer, which I mentioned 3M, TE Connectivity, which is a stock that we had been eyeballing for some time. We swapped that for a position in Hewlett Packard.

Amazon, which might not jump out as the most value of stocks, but if you look at the history of the stock market, the very, very largest market cap stocks have tended to be those that dominated business technology. That’s mostly IBM and Microsoft. If you’re looking back over the last 50 or so years. Amazon with their AWS business looks like it has a very good chance to join those ranks and we thought that represented an intriguing value proposition.

Once the market got messy, we tried to be opportunistic and looked at a lot of different things. One is Sempra Energy, which is a utility that got sold off pretty harshly. PPG, which is a chemicals company that specializes in paint and paint-related products, Union Pacific Railroad, Visa, JP Morgan, which was a swap for Wells Fargo, which had been hit fairly hard, but we just felt we wanted to accompany with a generally better track record of stewardship and capital discipline given what we’re facing in the financial sector. We have several stocks that we’ve owned for some time that we like, they got clubbed but we decided that they were worth buying. These include Skyworks, American Express, Raytheon, andb\ Citigroup.

So very active, I suspect we will not be anywhere near as active as this in the coming quarters, but we are trying to be opportunistic as we intimated in our earlier podcast. This is an event-driven bear market. The event is the virus and the economic response to it and we don’t think the bear market is truly going to be over with until we have a complete medical response to what we’re dealing with and as of this moment, which is in late April. We don’t have that so we are going to be wary. We are going to be vigilant, but it’s also our job to identify attractive stocks as we go through this.

One last point; many, many years ago in the late 1990s there was a distinction made in the market between old economy companies and new economy companies with investors eschewing interest in the old economy and focusing on the new economy that at the time meant basically semiconductors and computers and telephone equipment. In today’s market, perhaps a slightly more nuanced version of that is appropriate, which is to look at the digital economy versus the physical economy and at the moment, because we are all in lockdown, engaging with and using and interacting with the physical economy is proving to be practically impossible.

The digital economy, on the other hand, is doing just fine. We have made investments in the digital economy. We intend to continue to do so. It will be very interesting to see what the blend is between the digital and the physical economies as we exit this. At the moment, there is a lot of destruction and some of it appears to be fairly permanent in the physical economy. We think a lot of commodity sectors, commercial, real estate, and overly leveraged companies, they will need recessing. Whereas the digital economy, hopefully we’re using it a little bit less a year from now because this thing is over with.

Anyway, we thank you for your confidence in Cambiar. Please feel free to reach out to us if you have any questions.

Cambiar President Brian Barish details the active first quarter for the Large Cap Value portfolio and what led to outperformance.