Joshua C. White, CFA, and David T. Cohen, CFA, portfolio managers, Boston Partners, join podcast host John P. Bryson to talk about the short-term and long-term case for value stocks for today’s investors. They also talk about Boston Partners’ value strategy and approach and how they stuck to it during times of volatility. Josh and David, who are also portfolio managers of John Hancock Disciplined Value Fund, which celebrated its 25th anniversary this year, throw light on where they’re finding the most opportunities in the current environment. Finally, they offer their insight and advice to help investors navigate these volatile times.
John Bryson:
Hello, and welcome to the Portfolio Intelligence podcast. I'm your host, John Bryson, head of investment consulting at John Hancock Investment Management. Today is March 17, 2022. Happy St. Patrick's Day to all the Irish out there. I am joined today by David Cohen and Josh White of Boston Partners, who are both managers on John Hancock Disciplined Value Fund. Earlier this year, the fund hit its 25th anniversary, and we're very excited about the success it's had and the opportunities going forward. Just to give you a little bit of info, since fund launched in 1997, it's outperformed its benchmark by 30 basis points, and the large value peers by 150 basis points each year, so we're very happy with the performance. So I have David and Josh on. Guys, welcome to the podcast.
David Cohen:
Hey, John.
Josh White:
Hey, John. Thanks for having us on today.
John Bryson:
All right. Excellent. I want to talk about the opportunity in value, and maybe David, I'll start with you. What's the short-term and the long-term case for value right now?
David Cohen:
Sure. I think to really understand the short- and the long-term cases, you need to understand the context of growth versus value in the markets. Everyone knows we've gone through this unprecedented period of outperformance of growth stocks over the past decade, particularly from 2017 through 2021, but why? Really, if you rewind the clock, we were in a disinflationary environment. You had interest rates that were very low around the world; negative in Europe. You had low levels of inflation, scarce growth that was focused almost exclusively in the tech sector. That forced investors further and further out the risk curve, and they started to capitalize earnings far into the distant future, which led to this massive expansion in multiples for growth stocks.
David Cohen:
If you look at where we are today, the investment landscape completely changed during COVID. You had massive stimulus during COVID, which included the Fed's balance sheet doubling. You had stimulus checks being handed out to consumers and support provided to businesses. Then, if you fast-forward to really the fall of 2020, we got the vaccines, and demand recovered very, very quickly. Today, where are we? We have record job openings with just 4% unemployment, CPI of 8%, a housing market that's on fire, spiking oil and gas prices, with very high food and materials prices. And then you have persistent supply chain issues that are likely to continue for at least the next 12 to 24 months. That backdrop is very supportive for value investments.
David Cohen:
So over the short term, growth is in price discovery mode. I have a former colleague and a good friend that runs a high-profile growth fund at a competitor shop, and he used to tell me that the old rule of thumb was you buy growth stocks at five times sales, and then you sell them when they get to 10 times. Well here we are; last cycle we got to 30 to 80 times sales multiples for hyper-growth stocks. That's unsustainable, and it's unwinding, and we think over the short term, that'll continue to unwind as the Fed tightens. Then on the flip side of that, value is attractive. If you look at the P/E multiples for large-cap value, it's in line with its historical mean, as opposed to these growth stocks, which are trading well above long-term multiples.
David Cohen:
Then if you just look over the longer term, we think that the setup for value has some very attractive sectors. You have a mix of secular and cyclical drivers in the healthcare, tech, energy, and industrial space, which we think are going to play out over time.
John Bryson:
Excellent. I think we can dig into some of those going forward. But Josh, I want to pull you into the conversation. Let's talk about the Boston Partners value approach. How did it start, and maybe how has it evolved over time?
Josh White:
Sure. Boston Partners was founded over 25 years ago, and we really had one investment philosophy and process across all of our strategies. That remains as true today as it was back then. We invest exactly how we tell our clients that we invest. We don't drift from our process or philosophy, no matter what the market throws at us. And really, our specialty is value investing, with an equal emphasis not only on value, but also business fundamentals and business momentum.
Josh White:
I think a few key points to sort of take away from this discussion, for each stock that's in our portfolio, we have a clear alpha thesis that's developed by analyzing the business fundamentals, the business momentum, and the valuation. We have very low employee turnover and a lot of investing experience within our organization, so personally, I've been with Boston Partners for almost 16 years now, beginning as an analyst and then working my way up through the system internally. We joke that we like to find people early in their career and sort of brainwash them into our style of investing, and it's a joke, but there's some truth to that joke as well.
Josh White:
But I think that when you look across all of our products, there's very consistent trends in performance, and I think that that just shows that our results are driven more by the consistent application of our philosophy and our process by the entire investment team rather than the contributions of a key person. Then finally, we invest a lot of our own money into our funds, so our interests are very much aligned with those of our clients.
Josh White:
When you think about the style of value investing that Boston Partners employees, it's really rooted in a concept that we call the three circles. You should expect our funds to have more attractive valuation, quality, and momentum characteristics than the market and the benchmark. We think this is important, because stocks that generally trade at a discount to their intrinsic value outperform expensive stocks over longer time periods. Second, companies that have very strong business fundamentals outperform lower-quality businesses. Then third, stocks with positive momentum and tangible catalysts will outperform stocks with negative momentum. If you can be better on all three of those factors, you've tilted the probabilities in your favor before you even layer in the bottom-up alpha thesis on each individual holding.
Josh White:
Very early in the value cycle, you tend to see deep value outperform dramatically for a short period of time. Then as you move into the middle innings, you want to own good businesses with positive business momentum that trade at valuations below their intrinsic value. That's where we think we are right now, and it's really the sweet spot for our strategy, but we'll talk about, in a little bit more detail, about different markets and how our strategy performs in those markets historically. But we think our style generally has a more consistent return characteristic and is less prone to sort of those feast and famine periods in a way that a deep value investor might be.
John Bryson:
David, you were on my podcast at the beginning of the COVID pandemic. That was a period of stress, and I want to ask, in these periods of stress, there's going to be this pressure to keep up with what's going on in the market. How do you and the team manage that pressure and stick with your approach versus trying to chase opportunities and returns?
David Cohen:
I think it comes down to the discipline of the organization. I mean at Boston Partners we really have one specific process and philosophy that we've employed since the beginning of the organization, since it was founded in the '90s, and we just go back to that. We're looking for very specific things in stocks and investments. We're looking for attractive valuation, we're looking for quality businesses, and we're looking for businesses that are improving. We easily keep ourselves on track by just focusing on those things, and if we can do that, and everybody in the organization is focused on working the process, we think that we can continue to deliver for shareholders.
John Bryson:
All right. That makes sense. Josh, I want to talk to you and maybe start around current opportunities. We've seen a lot of volatility. Are opportunities popping up? What do you like? Josh, talk to us about healthcare.
Josh White:
Sure. So when we look at some of the more traditional defensive sectors in the marketplace, healthcare really stands out to us as one that has the most attractive valuation characteristics. A lot of the others, consumer staples and utilities and rates, they've been bond proxies for the past decade plus. So as interest rates have been falling toward zero, the valuations at these businesses have expanded and are not as attractive as they have been historically. On the flip side of that, healthcare really today represents in new attractive value opportunity, but also has those defensive characteristics that we're looking for. So within healthcare, I think you can really break down the universe of stocks into two momentum buckets. The first would be the COVID beneficiaries. You could include companies that produce COVID vaccines, companies that produce COVID tests, companies that process COVID tests, and then you have those that have had COVID-related headwinds.
Josh White:
And for those companies that have headwinds, the last two years have seen some issues either in the form of higher costs for healthcare services or slower growth at pharmaceutical and med device companies. And this is just because doctors’ visits were slower than usual, healthcare facility staffing has been an issue, and there's really a long laundry list here of issues that these companies have been facing.
Josh White:
So what we're seeing right now is that earnings momentum is starting to recover while many of these businesses are trading at very inexpensive valuations. And then in addition, as I mentioned, they have those defensive attributes that are going to serve us well, if the economy slows going forward. So we've been adding to our exposure in this sector.
John Bryson:
David, again, back to the podcast we had, you had me thinking about buying oil around 30. I wish I had listened. Let's talk about energy right now. It's a really interesting sector. What's going on there? Where are you finding opportunities? Where are you being careful?
David Cohen:
Yeah. John, I remember doing the podcast with you. It was late spring or early summer of 2020, the day that oil prices went negative in the United States.
John Bryson:
Yeah, yeah.
David Cohen:
As a long-term energy analyst, I never thought I'd see that, but we did. And we had believed as an organization for a few years now that we were entering a period of sustainably higher oil and gas prices, and that's certainly materialized particularly over the past few months. Underinvestment in energy infrastructure over the past decade has finally caught up with the world. We have a full-blown energy crisis in Europe, with skyrocketing gas prices, high oil prices, fears of just shortage. Russia is a major oil and gas supplier to Europe and the rest of the world, and there's a threat to that source of supply, and we just haven't invested enough to come up with alternative sources of oil and gas supply.
David Cohen:
Replacing that production if Russia happens to go off will be virtually impossible. We're drawing down inventories rapidly. We're scrambling to bring back production from Iran and Venezuela. The Saudis are reluctant to grow production, and the U.S. investors have become very disciplined. So as long as demand stays strong and capital investment in the sector stays disciplined, we're likely to see high prices with the potential for spikes.
David Cohen:
You know, if you look at it from an investment perspective, energy stocks, particularly the exploration and production companies, represent extraordinary value. A lot of these stocks trade at 15% to 20% free cash flow yields, some of them as high as 30%, and the balance sheets are phenomenally strong, and they have great cash return profiles. Many of the companies moved to defined cash distribution frameworks. They invest to hold oils flat, or for modest growth for oil volumes, but the vast majority of free cash flow goes back to shareholders, through dividends and stock buybacks. That's a profile we like a lot at Boston Partners, and we've invested fairly heavily in the E&P sector.
David Cohen:
If you think about it from a risk perspective, the main risk is that demand falls due to a recession, but there needs to be a structural fix for this problem. We have to invest, or we have to find substitution, and either of those things is going to require significant CapEx over the next several years, and it's not going to be coming from the U.S., so we think that the energy tightness and the potential for spikes is going to go on for several years.
John Bryson:
Now, David, Josh had actually mentioned tech as one of the best opportunities, so energy's a classic one, healthcare we talked about, but tech you don't hear a lot, and I think a month ago, maybe two months ago, he would never have said tech is an interesting value opportunity. Dig into that for our clients. What's going on right now that really identifies some options for you?
David Cohen:
Yeah. We like the setup for technology a lot. On a secular basis, we think that these companies are set up to grow faster than the market, and to deliver very high margins and be very cash generative over time. And really, it starts with what's going on in the broader economy in terms of digitization and just this move to a data economy. Every sector of the economy is becoming digitized and electrified. If you look at consumer devices, it's obvious with cellphones, but even in the industrial space. I had a call with a large industrial company yesterday, and they were talking about how they need to hire 15,000 people over the next five years, and there just aren't that many people around, so they're looking heavily at automation and robotics to help offset some of the labor demands.
David Cohen:
Well, what needs to happen for that technology to be deployed? You need to invest in semiconductors, because semiconductors are the enabling technology for everything that's going on in terms of this digitization trend. We have a very heavy weight to semiconductors in the portfolio, semiconductor capital equipment companies. These are very high-quality businesses, high margins, gross and EBITDA margins, very cash generative, great cash conversion, and they give a lot of the cash back to shareholders. We think the secular trends in technology are strong, and the valuations are quite attractive. We see low- to mid-teen P/E multiples with sort of 6%, 7%, 8% free cash flow yields in some cases, for businesses, again, that have high returns, high margins, that are likely to outgrow the economy for the better part of the next decade.
John Bryson:
Love it. At the beginning of the podcast, I mentioned it's the 25th year anniversary of the strategy, and we actually had a podcast scheduled for earlier in the year, but with all the volatility going on, as we talked, we said, "You know what? We got work to do." You guys had work to do, finding opportunities. "Let's push the podcast a little bit." But what I'd ask both of you, and David, maybe I'll start with you, is as we face these volatile times, and volatility's not going away, you've been doing this for decades. What's your advice for investors to navigate these volatile times?
David Cohen:
I think the main thing that comes to mind; it's really two things. One is stick with what you do best, and as I mentioned earlier, Boston Partners has a very defined process, and I think particularly now, that momentum circle is what keeps us out of trouble. You might have a stock that's extremely high quality or that is extremely attractively valued, but the momentum is just negative, and sometimes you have to take shots on stocks that have negative mo. if they're unusual opportunities, but I think being disciplined around all three circles for us is really the thing that keeps us on track.
John Bryson:
Excellent, excellent. Josh, what would you share with our listeners about what you've learned; how to navigate these volatile times?
Josh White:
Yeah, so I would just, again, reiterate what David said, is you need to have a disciplined process and you need to stick to it. When you spend years and decades developing and refining a process, you just have to recognize all the time, and effort, and brainpower that went into developing that process, and when something in the market catches you by surprise or you start to doubt it, you just have to stick to it and realize that you've been through periods like this before. You've stuck to this process, and it's worked in your favor, so I think avoiding emotional decision-making and really trying to understand the way that markets work, the way that investor psychology works, and just trying to keep your head above that and not get caught up in the noise is super important in times like this.
John Bryson:
It's great advice. Guys, I want to congratulate you and the team on a great 25-year stretch. Looking forward to another 25. Thanks for joining me today as always. Nice to connect with both of you. Folks, if you want to hear more, please subscribe to the Portfolio Intelligence podcast on iTunes or our website at jhinvestments.com. You can catch up with all the stuff that we're talking about. There's a lot of things going on in the marketplace. We want to keep you up to speed. Thanks for listening to the show. We'll talk to you next time.
Disclosure:
This podcast is being brought to you by John Hancock Investment Management Distributors, LLC, member FINRA, SIPC. The views and opinions expressed in this podcast are those of the speaker, are subject to change as market and other conditions warrant and do not constitute investment advice or a recommendation regarding any specific product or security. There is no guarantee that any investment strategy discussed will be successful or achieve any particular level of results. Any economic or market performance information is historical and is not indicative of future results, and no forecasts are guaranteed. Investing involves risks, including the potential loss of principal.
Price to earnings (P/E) is a valuation measure comparing the ratio of a stock’s price with its earnings per share.
The Russell 1000 Value Index tracks the performance of publicly traded large-cap companies in the United States with lower price-to-book ratios and lower forecasted growth values. It is not possible to invest directly in an index.
Value stocks may decline in price. Foreign investing, especially in emerging markets, has additional risks, such as currency and market volatility and political and social instability. Large company stocks could fall out of favor, and illiquid securities may be difficult to sell at a price approximating their value. Please see the fund’s prospectus for additional risks.
Clients should carefully consider a fund’s investment objectives, risks, charges, and expenses before investing. To request a prospectus or summary prospectus with this and other important information, please call us at 800-225-6020, or visit us at jhinvestments.com.
All data is as of 3/31/22.
John Hancock Disciplined Value Class I performance without sales charge. One year return 13.73%, three year 14.27%, five year 11.10%, 10 year 11.66% since inception 9.11%. Russell 1000 Value Index, one year return, 11.67%, three year 13.02%, five year 10.29%, 10 year 11.70% since inception 8.77%. The large value category performance one year 12.97%, three year 13.21%, five year 10.56%, 10 year 10.87%. Expense ratio Class I gross 0.77% net 0.77%.
The past performance shown here reflects reinvested distributions and the beneficial effect of any expense reductions, and does not guarantee future results. The sales charge for Class A shares, reflects the maximum sales charge of 5.0%. For Class I shares, there is no sales charge. Returns for periods shorter than one year are cumulative, and results for other share classes will vary. Shares will fluctuate in value and, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than the performance cited. For the most recent month-end performance, visit jhinvestments.com.
Returns prior to the commencement dates of Class A and Class I shares are those of Robeco Boston Partners Large Cap Value Fund (the predecessor fund) and have not been adjusted for expenses; otherwise, returns would vary.
The Russell 1000 Value Index tracks the performance of publicly traded large-cap companies in the United States with lower price-to-book ratios and lower forecasted growth values.
It is not possible to invest directly in an index.
Performance data shown excludes fees and expenses. The performance data would be lower if such fees and expenses were included. Past performance does not guarantee future results.