Active managers have had a long-documented struggle beating their benchmarks — and value managers have had an especially hard time, with growth stocks having beaten value stocks for a decade.
Against that backdrop, the AllianzGI NFJ Mid-Cap Value fund (PQNAX) has stood out, turning in market-beating returns last year and trouncing its peers.
The dividend-oriented fund, which is run out of Dallas by the firm's U.S. value equity team, returned almost 27% last year, topping its Morningstar mid-cap value category and nearly doubling the 14% gain of the Russell 1000 Value Index (.RUI). It has returned an average annualized 15% over the past five years, beating 86% of its peers, as it lost less during downturns. The fund also slightly outpaced the Russell 1000 Value's 14.6% return. It charges a 5.5% front-end load and annual expenses of 0.99%.
At the core of the fund's strategy is an approach the team has used since 1989. John Mowrey, 34, is chief investment officer of the team and a lead co-manager of the fund. The team tries to minimize risk as it hunts for dividend stocks, paying close attention to valuation, price momentum, earnings revision, and short interest to steer clear of value traps. The result is a fund that yields 1.97%, higher than 80% of its mid-cap value peers, but one that has held up better during downturns.
We caught up with Mowrey to see where he is finding moderately priced stocks in a pricey market.
Q: You beat the market without owning any FANG stocks. How?
A: We tend to be very diversified across sectors and stocks. We equal-weight the 100 stocks in the portfolio, with about 1% of assets in each holding, and we don't take sector bets. There were not one or two sectors or stocks that drove performance. Our top performer was chip firm Lam Research (LRCX). But other strong performers included builder D.R. Horton (DHI), motor-home company Thor Industries (THO), and Owens Corning (OC), which makes roof shingles and benefited from unexpected natural disasters. All have continued to grow earnings, and valuations still appear favorable.
Q: What type of dividend payers do you favor?
A: Dividend payers have boasted higher absolute returns versus the overall market — with lower levels of volatility. But it's not just about yield. We don't have a dividend-yield threshold, and we don't want to overpay for yield. In fact, we are underweight some of the heaviest-yielding areas of the market, like utilities and real estate investment trusts.
Q: Why have you steered clear of these sectors?
A: A lot of REITs, especially in retail, are still under pressure because of the Amazon effect. It may be boring because you hear that a lot, but that's the truth, so we don't have a lot of exposure to retail REITs. Instead, we own REITs not tied to retail, like American Tower (AMT), an infrastructure play, and Weyerhaeuser (WY), which would do better in a rising-rate environment since it has commodities exposure through timber. We also think it is hard to justify dipping into utilities, which are sitting at 25-year high valuations, so we are still underweight both REITs and utilities and don't see that changing in the near term.
Q: What red flags do you look for to avoid value traps?
A: Take energy. It was a very hard place to earn money last year. We avoided the drillers and servicers. We didn't like their valuations. They didn't have earnings, dividend yields were cut to low levels, and debt levels were excessive. Given those risks and poor momentum in the stocks, we found value instead in master limited partnerships and refiners.
Q: Oil prices have had a bounce. Does that change your view?
A: With oil prices breaking out over $63, we have started to re-evaluate exploration-and-production companies. We are beginning to see a turn, and we could begin to dip back into these areas as we see better cash flow.
Q: What does that mean for your view on MLPs?
A: Utilities and REITs are going to have a harder time competing with higher rates because they don't have the ability to raise dividends as quickly, whereas MLPs increase dividends quickly and aggressively if rates are higher. As a result, we think MLPs will fare better than other bond proxies. For example, we own Magellan Midstream Partners (MMP), which yields 5% and has a midteens multiple, which is cheap compared to its historical average.
Q: Where else are you finding cheap stocks?
A: We had a mini-growth story for regional banks, which traded at 15 times, and earnings are now catching up, so multiples are contracting and still moderate. SunTrust Banks (STI), which we added to in June, is now trading at about 14 times forward earnings. The stock has powered higher on the back of earnings growth, not multiple expansion. We are seeing earnings pick up for regional banks, and that is causing multiples to contract. And we are seeing similar earnings revisions and multiple contractions in consumer-discretionary and industrial stocks.
Q: Can you give us some examples of attractive industrials?
A: Industrials, like machinery or rail stocks, are benefiting from a cyclical uptick in earnings. We still see value there. For example, we own Kansas City Southern (KSU), [which gets about a quarter of its revenue from U.S.-Mexico sales]. It's controversial going into discussions for Nafta [the North American Free Trade Agreement], but that is an exogenous event. KSU has attractive rail lines and benefits from the widening of the Panama Canal, and it is buying back shares.
We bought it at a steep discount to its historical valuation of 20 times earnings, and it offers an attractive dividend yield -- 50% higher than what it has historically yielded -- so we think some of the risk is priced in. Nafta talks have come back into the forefront, so we still like the valuation. KSU has consistently grown earnings over the last several years and blended forward estimates are now at the highest level over the last decade. Rails should also benefit from lower taxes, and rail carloads were up in the fourth quarter above estimates -- all of which should translate into healthy operating margins and free cash flow. KSU should also benefit from the pickup in GDP. Investors have to embrace some of the volatility though. [Nafta talks] are something we will monitor to see if we are getting into a more-protectionist environment.
Q: Value managers have lost out to growth for years. Is this the year value makes a comeback?
A: The Russell Mid-Cap Value index (.RMCCV) is at its cheapest relative to the S&P 500 (.SPX) in a decade. If you look at the Russell Mid-Cap Value index versus the Russell Mid-Cap Growth index (.RMCCG), it is also the cheapest in 10 years. We are stretching this rubber band further and further. On top of that, our fund is several multiples cheaper than the benchmark Russell Mid-Cap Value index. Lower valuations should produce more favorable returns.
|For more news you can use to help guide your financial life, visit our Insights page.|