Transcript
This podcast is for professional investors only.
Chris Hart (CH): What we’re really looking for is we’re trying to buy skepticism in the market. What we see today is that, you know, markets today, markets in the short term can be very inefficient. They can overpay for certain securities; they pay too high multiple. And on the other side of that, they pay multiples or just say they use discount rates that are overly draconian relative to the underlying cash flow and growth characteristics. And that’s where, again, that’s the sandbox that we’re playing in.
Welcome to a new episode of the Robeco Podcast. Erika van der Merwe (EM): In a world in which the momentum factor is still a key driver of investor flows, and where investment sentiment is heavily skewed towards US mega caps, maintaining a cool head and an independent mind is a valuable skill, and especially so at a time when the US is poised for new policies that could be disruptive to global trade and manufacturing. Chris Hart is portfolio manager of the Boston Partners Global Equity strategy. And as a dyed-in-the-wool value investor, he is an ideal guest with whom to discuss these phenomenal market trends we witnessing and to get his opinion on whether the investment strategies that worked in 2024 will still be relevant in 2025. Welcome on the podcast, Chris.
CH: Thank you. Erika.
EM: Now, Chris, I had a look at your fund objective. So you’re a global investor with an all-cap mandate, and it gives you plenty of stocks to choose from. Where does one even begin? What’s your philosophy in your stock selection process?
CH: Yeah, I think we like to set up a framework about how we think about investing. And when you think about frameworks, you know, there’s really three major ones. You have cap-em, dividend discount model, DCF. These are the physics of investing. And it’s a good framework for the basis of, I would say, for all investors. But what we’re – what’s interesting that comes out of all of these three major types of investing frameworks are three characteristics: free cash flow return on invested capital, free cash flow EPS momentum. And then most importantly for us, the discount rate are multiple that one pays for the cash flow that we’re looking to invest in. For us, that discount rate or that multiple is extremely important. And so what we think about, from an investing perspective in our philosophy, is we utilize these three major tenets, or we call them three circles. And that this is a very disciplined approach to investment investing. It drives security selection, importantly, that security selection by default also drives the portfolio characteristics themselves. So what we’re really consistently looking to achieve is we’re trying to generate or populate a portfolio with mispriced higher quality businesses, mispriced moments, or companies that have better than average revision and earnings momentum characteristics as well. But that underlying valuation support or multiple that we pay is extremely important. I can’t emphasize more how much we really focus on not overpaying for cash flows. Because what we’re really looking for is we’re trying to buy skepticism in the market. What we’re really looking for is we’re trying to buy skepticism in the market. What we see today is that, you know, markets today, markets in the short term can be very inefficient. They can overpay for certain securities; they pay too high multiple. And on the other side of that, they pay multiples or just say they use discount rates that are overly draconian relative to the underlying cash flow and growth characteristics. And that’s where, again, that’s the sandbox that we’re playing in. And there’s an aspect of contrarianism within that as well. There’s a reason why the market might be skeptical. And like I said, I think today what we’re really seeing is and just really over the last six years, what we’ve really seen is, I would say, a lot more macro overlay, bigger picture types of strategies driven by ETFs, narrow ETFs, algorithmic trading, single data points. And often these types of strategies, really disregard the valuation multiple because if you’re just buying a basket of stocks, you’re not looking at the valuation. You’re looking at, you’re trying to find some sort of loose correlation. And this is populated the market in the market today. It also offers great opportunities for our style, especially being an unconstrained all-cap manager, which also as we get further into our conversation, you know, we’ll discuss about the exposures. It’s one of the reasons why we are heavily underweight the US. And in reality, over the last 17 years, we’ve been underweight the US the overwhelming majority of the time of running this fund.
EM: So, Chris, you’ve very helpfully set the scene there and I’ve just picking up on the word skepticism, if you use your valuation tool set. So in light of that thinking and that philosophy, what are your views then on the Magnificent Seven phenomenon? So as you said, we’ll discuss more fully your stance on sectors and regions in a bit. But the Magnificent Seven have been a major conundrum for investors who feel that valuations are stretched but who don’t want to underperform.
CH: As a point of reference, I mean, The Magnificent Seven for us, interestingly, if we actually we take a step back and go back about ten years, we owned a number of them. If people don’t, I would say investors don’t realize 2011, ‘12, ‘13, ‘14 you can own Apple as a value investor, you can own Microsoft. And there was a period of time when Google was actually very interesting from a free cash flow generation perspective. Again, the multiple that one pays. But I think as we enter that 2016/17 period, that’s when we started to see significant multiple expansion. That was obviously the original FAANG period, especially in ‘18 and ‘19. And then we fast forward to ‘23, where it was interesting. Out of the woodwork comes AI. And it happened rather violently. And all of a sudden, this is the new thematienvironment that took over, where, you know, obviously a name like Nvidia, I think investors can draw a pretty clear conclusion that they are generating revenues from selling chips. The other side of that is who’s buying those chips? You have businesses that historically are not very capital intensive, now having to spend hundreds of billions of dollars on chips, with actually no real business models associated with them. They’re generally good businesses, obviously a good returns on capital, great free cash flow generation. But the market, I think, is pricing for perfection without actually clearly understanding the revenue model associated with the massive amount of capital expenditures, the massive increase in fixed capital expenditures that these businesses are having to spend and on an ex-ante basis with no idea of where this where the revenues are coming from. arguably a bit of data coming off of an existing cloud that call it one dollar. If the new Nvidia chip costs 10 to 15 times more, logically, that new bit of data is going to have to be charged by the cloud provider or the AI provider 10 to 15 times more. It’s not necessarily clear that type of, I would say, revenue models going to work, as pervasively as the cloud business has. Cloud was pretty simple. So I think there’s to me, there’s a lot of skepticism around this. Of course, there’s going to be various industries where AI is going to be, you know, a game changer. There’s others, not so much. And I think what you’ve seen today in the market is that you see a kind of waning of the AI Mag Seven idea. Or I should say, driving – we all know that those stocks significantly drove the market over the last year and a half. But really over the last 12 weeks, that has changed dramatically, where the market has shifted its focus much more towards mega large cap quality. Now, of course, those stocks fit into that cohort. But what we’re seeing today is that the market is, again, heavily driven by large mega cap quality, mostly in the US, a little bit outside the US. But it is an environment today, again, when you think about valuation, it’s a difficult environment for value investors because especially disciplined value investors because we’re not going to chase that performance, right. Many of those are good businesses.
EM: If I look at your list of your top, your bottom ten. So the stocks that you are not owning or where you’re underweight, it’s a list of the Magnificent Seven, plus a few other big names. So you have clearly steered clear of that. But now this exuberance that you spoke about the last year and a half related to Magnificent Seven that was extended by the outcome of the US elections. Market markets took a very firm view on what a Trump administration with a strong mandate would mean for the US economy, but also what it would mean for Europe, for China and other export-focused markets. So on this topic, broadly speaking, how do you expect Trump policies to shape investment opportunities in the coming months?
CH: Trump is very much of I would say he’s very Machiavellian. He sees – he has somewhat of a disregard for traditional types of diplomacy. He sees things at face value. Very pragmatic. He will use tariffs to achieve what he wants. We live on both sides of the Atlantic, and we could say, I want this or you want that, but when it comes down to it, I think cooler heads will prevail. I think that’s one of the aspects, I think, I think that investors have to be very careful about the, I would say, the excessive commentary surrounding Trump. His bark tends to be a lot worse than his bite but he uses this – again I think he uses it from a leverage perspective. Still within the US, your biggest thing, I think you see in the US tax policy continues the same as it has for the last five years, or actually, really the last eight years. Maybe some relief from the corporate tax perspective, which will be beneficiary. But also comes down to regulation, an incremental reduction in US regulation that emanates out of the executive branch. It can be very favorable for many industries, and not the least really about small business. It’s really the small business or medium-sized businesses that over the last four years have had to, I would say, absorb a significant amount of bureaucracy and red tape that removes you – generally removes friction in the economy. Then of course, there will be benefits to banks and other larger sectors. But to me, I think it’s really about – from the bottom up, kind of a grassroots improvement in economic growth. One area where I think that there actually might be increased regulation is in healthcare. The question is, is US managed care over earning? We have reduced some of our exposures in the portfolio because of that. It also comes down to the questions of vaccines. We’ve reduced Santa Fe in the portfolio with concerns or surrounding that as well. And that will be in front of Congress and obviously the RFK scrutiny is going to happen. We’ve seen this before. It’s somewhat probably very similar to when Obamacare was first debated in the US Congress. There will be there will be pressure and uncertainty. So healthcare is one area in the US where, yes, there is value. But the sentiment is going to be, I would say, rather difficult over the next 1 to 2 years.
EM: So what you’ve described is very much a US domestic story, and I’m sure you have opinions too on what a Trump administration would mean for the rest of the world. How are you positioning for that then?
CH: Yeah, I would say that the majority of our non-US exposures, which we are over overweight, we could really separate the two into businesses that have – where a significant amount of their earnings growth and cash flow growth is predominantly located in the US.
EM: So because that’s in your portfolio, you heavily overweight Europe and UK. And yet there seems to be this view that Europe has become irrelevant and able to innovate at a competitive pace and incapable of decent growth to excite investors. You are excited.
CH: Actually, this reminds me of 2011 and 2012 where everyone thought Europe was dead. You’re talking – combine the EU is, you know, second, third largest economy in the world. There’s pockets of growth, there’s pockets of opportunity. There’s also pockets of regulatory burden and to navigate around those regulatory burdens which will end up compressing returns. That’s what you avoid. That’s what stock picking is.
EM: Yes. Understood. So, Chris, you’ve given us quite a few clues along the way, now also on your sector perspective. And I understand that this is the outcome of your bottom-up stock selection. but I mean, for instance, I note that you are overweight on industrials, heavily overweight on consumer staples. What are some of the stories behind this?
CH: Let’s start with consumer staples. If we go back to 2014, ‘15, ‘16, consumer staples became a smaller and smaller piece of the portfolio. Down to somewhere around 1 to 2%. A lot of that was really driven from valuation. Consumer staples names became the darling of the yield curve trade. What we saw was that good businesses, stable growth, were priced for perfection. Names that should be trading at – that historically traded at market multiples – all of a sudden trading eight to nine to ten times turns higher. And that was purely driven by this concept of stability, low volatility. Now the irony of that is that when you looked at the actual fundamentals of the business, i.e. the volatility around cash flows, many of them were actually not low volatility. What was low volatility was the stock price, not necessarily the fundamentals. I think that there were a lot of promises made by many management teams about high level of growth going forward. Many of those companies, those promises never came to fruition. Yet the valuations in ’17, ’18, ‘19 reflected something very different. They were reflecting an increase or a higher step function of growth that never came through. We got into Covid, obviously stayed at home. You had a bolus of growth, which was then accelerated by inflationary effects because they passed on – many consumer products companies were generating 10 to 12% top line growth. But the fact was they were exhibiting negative volumes. eventually the market sniffed that out. Companies that were trading 20, 22, 24 times, collapsed to low teens. We looked at them at that time and said, “I can model out what I think volume is going to do. I can model out what reasonable pricing can be, input costs.” And we made a decision then to significantly increase our consumer staples exposure, but built on a single stock at a time. Some of the pressure also was facing consumer staples companies, obviously over the last two years was the GLP-1, which theoretically would reduce the demand for food– I don’t necessarily know if that’s going to be true or not – but was another factor that resulted in significant multiple compression, especially in a number of the US consumer food companies. Now, with respect to my commentary earlier about healthcare, now we can dial in another issue about food ingredients in the US. I always love to use the example of why is US peanut butter any different than peanut butter sold in the UK that is manufactured by the same company?
EM: You sound like RFK.
CH: Yeah, exactly. And the question is, is there really any differentiation in margins because of the formulation of that peanut butter, specifically when it comes down to sugar and preservatives? And I suspect that peanut butter in the UK has a similar shelf life to peanut butter in the US. So that’s just kind of a cynical view of – when you think about it, these companies are manufacturing companies. And if they make similar widgets in different regions, the question comes down to that formulation. So I think maybe it’s not a risk. Maybe that actually is a positive. And I think that is something that will be heavily looked at underneath the new administration as well.
EM: And then, Chris, just very briefly, you just if you could highlight some aspects of industrials why you’re overweight there on a global perspective.
CH: What we saw in ‘23 into mid-‘24, I think a fair amount of the deterioration that was occurring globally was pretty evident. It was transparent. It was coming out of China. So we saw in ‘23 some weakening in moment, didn’t change our view of the medium to long term outlook on returns and cash flow generation. And what we saw was a real bifurcation. We saw that the European businesses that had a higher level of Asian exposure had significant multiple compression. Now, what’s interesting is that these are businesses that also have sizable or marketable exposures to the US as well. The US growth that they were experiencing more than offset the deterioration in Asia. So what we saw was on a risk-reward – the market was really focusing on that China deterioration. They were forgetting about the US. And so we thought what we saw was that businesses that exhibited, I would say deteriorating Chinese or Asian revenue streams or profitability more than made up by the US, now trade at multiples that represented a significant disconnect between the growth rates over the next one to two to three years relative to the US exposures, or I’d say US opportunity set. Now, I’ll give you an example. I can buy European finance. I can buy European industrials that have the same profitability characteristics that have very similar earnings and revision characteristics at multiples 50% cheaper.
EM: Wow.
CH: We’re not arguing about – I mean the concept of value, you can usually drive a truck through valuation whether companies worth 16 or 18 times, that’s debatable. But when you can buy an industrial in Europe that’s trading at 12 to 13 times when the comparable US company is trading at 22 to 23 times. That is an extremely compelling risk-reward which results in our overweight on European and UK industrials relative to US industrials. Risk-reward driven by that valuation circle. And again that valuation circle matters a lot. But we don’t also want to buy bad businesses. We have to have that momentum piece within our framework that keeps us away from deep value. That’s one area that we shy away from consistently because deep value tends to be a way to ruin one’s return quite quickly.
EM: And Chris, how are you positioned in financials in general and by region?
CH: The financial side is quite interesting because my view, we did not own a European financial from 2008 to really about 2019. There’s significant change. There was significant regulatory changes, many business models, for example, Commerz Bank and ING, they were big. It took them ten years to really change their – it took them ten years to move from a quasi-investment bank to what I would call a traditional credit spread lender, a traditional bank. You had a significant amount of credit forbearance that was occurring. But you fast forward to today and you see something vastly different. You have businesses that are much better. They generate much better levels of profitability. Not as strong as many US banks, but good. And again, it comes down to the multiple that you’re paying for it, but they generate significant amount of excess capital. From the majority of the banks that we own in the portfolio – overweight European UK banks, Japanese banks – is the capital return combined share buyback combined with dividends. You’re talking anywhere between a 10 to 15% total return just from that. That’s extremely compelling. You could buy European banks today that trade at 6, 7, 8 times earnings relative to the US brethren. They’re trading at 13, 14, 15 times, which is full value. And this goes back again to that concept of we’re not splitting hairs of “oh, it’s 10 versus 12.” We’re talking 6, 7, versus 14, 15. There’s a wide gap in valuation here that really is not explained by fundamentals or earnings growth at all. It comes down to this narrative that’s entered the market, the starting point today, the US market is trading at 24, 25 times earnings. The starting point in 2016 when Trump got elected, it was 16 times earnings. So again you’re talking about wide golf between forward price to earnings estimates and valuation. Whatever benefit I think’s going to happen to US is probably already priced in. And it really started to get priced in starting in September. So it was really a long runway.
And that’s why I think you started to see some breakdown in the Magnificent Seven that expanded into US large mega-cap, high quality businesses, because that’s the trade. A lot of trades become playbooks. This is what you’re supposed to do, many times without the actual underlying fundamental support that would really rationalize the multiple expansion that came to fruition. There’s many US industrials today that are I mean, when I say price – there are multiple US industrials today that trade at a higher multiple than Microsoft. EM: Wow. CH:And Microsoft’s really not a cyclical business. Those businesses are cyclical. It’s crazy but it’s absolutely priced for perfection in the US. It’s the widest that we’ve ever seen since the history of managing this fund.
EM: But Chris – and I know you ask this all the time –if you take these contrarian views by region, by sector, what is it that will unlock that value, that will generate bring those returns within your portfolio?
CH: Yeah, I think markets are inefficient in the short term. I think if markets become much more efficient over the medium to long term, over the last six years, I would say that level of inefficiency, the duration of that inefficiency, has been somewhat longer than one would expect. I think it gets to the point where the rubber band gets stretched so far that the market can’t disregard it anymore. Where we start to see –we saw it in ‘21, in ‘22, where all of a sudden the rubber band snapped. And value-oriented strategies picked up a significant amount of the underperformance that emanated over the prior several years. You saw it after 1999, 2000, you saw after the Nifty 50 as well. So there’s it becomes an issue where it just becomes so stretched that it defies logic. And when you start to look at the characteristics today between valuations in the US relative to valuations in developed non-US, there becomes a very strong compelling argument that Europe, UK, pockets of Asia are significantly undervalued relative to their cash flow streams. And that last part of that statement is very important because you do need that cash flow stream to – that’s that piece of momentum where the market has to start to figure this out. If it doesn’t, who knows what happens? But that would make absolutely no economic sense at all. It would defy the physics of economics.
EM: And how long could that continue the defiance which you feel could not persist forever?
CH: I would have told you in 2018 it wouldn’t last long, but it did. I really have no answer. I mean, a lot of this comes down to some technical issues that comes down to money flows. It comes down to investment strategies. As I spoke about before, these exposure, narrow ETFs, they have a disproportionate effect upon what I would consider the prudent man rule. And I think a prudent man would look at many businesses today – if we removed the index and if you removed, I would say investor or particular investment strategies having to outperform an index, and you made it just based upon the characteristics of that portfolio, I think you would see a very vastly different market structure today, because the game today by many investors is to just beat an index. And many times, in order to beat that index, you have to basically remove one of the three facets of investing that I spoke about value, quality and momentum or heavily focus on one more than the other. So I think the construction of indices have created this. It’s money flow, it’s esoteric strategies. It’s excessive amount of leverage in the system as well. You kind of saw this when you had the yen carry trade unwind how quickly large mega-cap US technology, social media, expensive stocks in the US just collapsed precipitously. And those were not fundamental investors. That was just purely a game that was being played.
EM: Chris, thank you so much. I know this is one of those podcasts where I wish I had two hours in which to ask you everything I wanted and to get more of that depth out of you. It’s been delightful speaking to you. Thanks for your time.
CH: No, thank you very much Erika.
EM: And to listeners, thanks for being here with us. We publish a new episode every month covering a range of investment related topics. This podcast and Robeco’s markets podcast, In Tune with the Markets, are available on all major podcast platforms and on the Robeco website, so if you subscribe, you’ll receive a notification as soon as the new episode is published. In the meantime, please rate the show and share the show link with a friend. Until next time.
Thanks for joining this Robeco podcast. Please tune in next time as well. Important information. This publication is intended for professional investors. The podcast was brought to you by Robeco and in the US by Robeco Institutional Asset Management US Inc, a Delaware corporation as well as an investment advisor registered with the US Securities and Exchange Commission. Robeco Institutional Asset Management US is a wholly owned subsidiary of ORIX Corporation Europe N.V., a Dutch investment management firm located in Rotterdam, the Netherlands. Robeco Institutional Asset Management B.V. has a license as manager of UCITS and AIFS for the Netherlands Authority for the Financial Markets in Amsterdam.
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