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Global search for short-term losers and long-term winners

Interview with Ted Maloney, Chief Investment Officer, Global Director of Research and Equity Portfolio Manager at MFS Investment Management. He has been with MFS since 2005.

 

GH: We’ve seen COVID accelerate global trends, with some companies compressing 10 years of growth into one year. What challenges and opportunities does this throw up for you as an active manager?

TM: The first thing most fund managers had to do is make sure they have their teams in place remotely and are able to do their jobs. It was fairly seamless for us given we are a global firm and we're used to spending time on video conferences working with our colleagues around the world.

On the investing side, there are industries that are advantaged or disadvantaged, and what is most interesting is where there is a mispricing. We have developed a 2x2 matrix with long-term COVID winners and losers on one axis and short-term COVID winners and losers on the other, and the best opportunities are in short-term losers and long-term winners. That’s where we can uncover value. We know some are overvalued but others really will be worth what they're trading at today. It’s our job to sift through knowing there are factors at work that are distorting asset prices.

GH: But there must be disagreement about which box different companies belong in.

TM: Well, our views will show up in our investments but, yes, we couldn't publish a document on the matrix because there's inherent disagreement in the team. A critical part of our process is making sure that we have a culture that allows for genuine disagreement. As we collaborate and debate to get to the right answer, one person's long-term winner might be another’s long-term loser.

GH: We’ve seen some extraordinary rises in stock prices, particularly in tech and in growth versus value. We seem to publish a new chart each week which shows how elevated the market looks and then a month later, it’s even higher. Where does MFS stand on whether the market’s got ahead of itself, or is it justifiable that the Microsofts and Teslas of the world are gaining from the way the world is changing?

TM: I’d say both. There are pockets of excessive exuberance and perhaps bubbles, but you tend to not be able to declare something is a bubble until after it's burst. While you can identify where you think a bubble might be expanding, there are also real businesses doing well.

The overarching reality is that monetary policy, particularly in the last year, is causing market distortions. Free money will find a home in assets, especially where the DCF (Discounted Cash Flow) will tell you that most of the value is in the outer years. So companies that have a story that they're going to grow until the end of time have done well. We know some are overvalued but others really will be worth what they're trading at today. It’s our job to sift through knowing there are factors at work that are distorting asset prices. As long-term investors, it is a positive for our ability to deliver for our clients.

GH: You take a global perspective in your investing. Are you seeing pockets of success and a wide variance between different countries around the world?

TM: The home country of the big trends we were talking about is the US but there are certainly examples in every market around the world. In Australia, there are companies that have behaved exactly like some of the US companies. When we're talking about overall indices, it’s the US that has been most impacted by the easy monetary policy and the resulting high valuations, but we do look for relative value comparing businesses in the same industry to others around the world.

GH: How much has the different impact of the pandemic around the world influenced your investing?

TM: Given that we are long-term investors, we’re not sitting around watching the daily infection rates for each country for investing purposes. We do watch it closely for managing our own business and looking out for our colleagues in different countries. But we are watching the implications for specific companies, such as where they are paying extra to their employees and spending more on safety measures that will hurt near-term but will deliver for customers and for employees over the long term.

That's where sustainability investing is crucial in any market and COVID is a great test. Companies always like to say that they care about their employees and they care about their customers and they care about everyone. But when they're put into stress, you can see what they really care about.

GH: We know many sectors, such as online shopping, have done well in the last 12 months but do you think there are some sectors that are doing better than the market recognises and they look fundamentally cheap at the moment?

TM: The market tends to be good at pricing in what's happening right now. But one example is live entertainment, which is non-existent now but we think it will come back bigger than ever. While it’s important in investing not to over-emphasise one's own perspective, I know that my price elasticity for the next concert where I feel safe will be extremely inelastic.

Another example that we debate is business travel versus personal travel. Most of us agree that personal travel experiences will come back stronger than ever, but business travel probably will not come back to its full strength.

What’s overlooked in this discussion is the strength of a company’s balance sheet. A company might be well-positioned for a COVID recovery in five years, but that’s not much good if they're insolvent between now and then. We have the advantage of equity, fixed income and quant teams that are completely integrated and in moments of stress, for example, the credit analyst can give the equity analyst a different perspective.

GH: Do you have examples of themes where prices might have gone ahead of value?

TM: Well, obviously anything that you can consume from the comfort of your home has benefited greatly from COVID and many of those companies have executed well. Our job is to decide how much of 10 years of growth has been pulled forward as part of a permanent paradigm shift and how much will evaporate in a return to normal.

GH: We've seen an extraordinary week or two on the Reddit platform, with ‘Robinhood’ traders and a stock like GameStop. How strong are you seeing the influence of this new retail movement on the market, such as the ability of the combined impact of thousands of smaller investors taking on the might of Wall Street and the hedge funds in particular?

TM: If there was any doubt about their influence in the last year, it's undeniable over the last week. I think the root cause goes back to monetary policy and free money trying to find a home. At the same time, lots of people are sitting in their homes and figuring out what to do with their free money, and it's a dangerous cocktail. But we worry about what happens when the tide goes out and individual investors will be harmed.

We do not worry about imprudent risk managers, professional risk managers who are in a lot of trouble by being short excessively some stocks. They have exposed themselves to a coordinated attack by individual investors and there's some poetry to that, to be honest. We don't necessarily root for it but our job is to identify market inefficiencies and understand what short-term market actors are doing, and that gives us opportunity to invest for the long term.

What's a bit more subtle is that due to the short squeezes, full hedge fund books have been liquidated, including long positions, without regard for prices or their views on the stock. Our investment managers and traders are paid to understand the technicals of the market and when a company we like is now 5% cheaper due to a forced seller driven by short-term incentives, we can go in and buy that that stock because 5% has just been handed to us. We realise it could be down 5% tomorrow and another 5% the next day but if we understand the real value of the company, in the long term we will deliver for our clients.

GH: A platform like Robinhood publishes its turnover each day. Would a professional house like MFS watch that as an input to your own process?

TM: We examine all data that may be of use and available. If we're trying to understand why a company is, say, trading off sharply and we can't explain it for fundamental reasons, then we look for other market factors. In the last couple of weeks, we've paid more attention to the retail turnover data but I wouldn't expect that in six months’ time various Twitter feeds will be included in our models. But we do need to adapt our process on the margin. Our job is to come up with creative approaches to discover value in the marketplace.

GH: It's hard to ignore the five big tech companies, the FAANGs, as they make up a quarter of the S&P500 and affect almost everyone. Do you have a view whether the tech titans are overvalued or are they just such great businesses that current values are justified?

TM: It's a company by company judgement. They are certainly highly valued and they are all excellent companies, so that's where the job gets hard. We ask how much growth do we need out of a given company to justify the valuation? In many cases, the answer is more than could possibly be justified by the current valuation.

We try to bring original insights to the analysis and regulation is something that we worry a lot about in this space. Regulators don’t care much that a few hedge fund managers have been harmed but when it reverses, regulators do care deeply about the harm to individuals. There are platforms putting individual investors at harm and that will probably draw some regulatory scrutiny. The same is true across the tech and social media landscape as regulators increasingly become concerned about the potential harm in one form or another.

GH: With 300 MFS investment professionals around the world, what are some key principles to manage the culture and coordinate so many people?

TM: In this environment, everyone in our firm understands that if you're taking care of your colleagues not only from an investment perspective but also from an operational and personal perspective, then you can make sure you're also taking care of your clients. The main job of the leadership team is to set the tone and culture.

A big part of our process is making sure that we have an environment where people can strongly disagree with each other and bring different viewpoints in order to get to better insights. There's lots of different ways to create and debate different viewpoints, but a good foundation is having people with diverse backgrounds. Diversity is key to success and we work hard to get better at it and then importantly, we think that the companies that we invest in should do the same. They'll benefit their own clients and our clients as shareholders. And it's all part of being a sustainable investor to drive true long-term value.

 

Graham Hand is Managing Editor of Firstlinks. This article is general information and does not consider the circumstances of any investor. MFS International Australia is a sponsor of Firstlinks.

For more articles and papers from MFS, please click here.

 

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