As the stock market weighs the prospects for earnings and recovery, Putnam Large Cap Growth Fund Portfolio Managers Richard E. Bodzy and Gregory D. McCullough, CFA discuss their strategies and outlook.
- We are seeing new opportunities across a range of industries, especially in the technology, health-care, and consumer segments of the market.
- When we consider new holdings for the portfolio, we manage risk by looking at the stock’s prior downside capture.
- We are analyzing demand drivers that are likely to persist through the remainder of the downturn and into the recovery and normalization phases.
What’s next? Headwinds and opportunities
Richard: Our portfolio is not immune to the impacts of COVID-19, but we want to emphasize that our strategy does not require economic acceleration to succeed. However, we anticipate challenging times ahead as unemployment will rise, default rates will increase, and we’re likely to enter a recessionary environment for some period of time. Conversely, we’re impressed with the speed of fiscal and monetary stimulus, which has helped to stabilize the markets. We don’t see $2 trillion — the size of emergency economic relief — as a magic number, and we think stimulus measures will increase.
Greg: The macro uncertainty is challenging, but we believe the downturn presents opportunities. We are absolutely using weakness in the overall market to add to existing holdings or to initiate new positions. There are many stocks that have been on our radar for months, if not years, but did not make it into our portfolio for various reasons, often due to their high valuations. Today, valuations have become much more attractive for a number of businesses that meet our investment criteria. They are in many sectors, but principally in the technology, health-care, and consumer segments of the market.
We are absolutely using weakness in the overall market to add to existing holdings or to initiate new positions.
Managing risk amid uncertainty
Greg: Although the portfolio was not completely immune from a massive economic shock like this, we believe we came into it with better positioning. We spend a significant amount of time on portfolio construction. We aim to allocate our risk budget to specific stocks, rather than trying to make calls on sectors or industries. We typically keep our sector weights in a 3% band relative to the benchmark. We want individual stock selection to drive performance of the fund as opposed to an over-allocation to a sector or industry.
For risk management, we look at prior downside capture when evaluating a new name for the portfolio. We consider how a business has performed fundamentally in other difficult economic environments. We spend as much time thinking about the vulnerabilities of a business as we do about the opportunities.
We spend as much time thinking about the vulnerabilities of a business as we do about the opportunities.
We seek more than just absolute growth
Richard: For our process, it’s much more than simply finding the highest grower in a particular sector. We are fixated on the duration and durability of growth as much as the absolute level of growth. We don’t want a company that will grow 40% in one quarter, only to decline 10% in the following quarter. We’re looking for a very narrow range of financial outcomes. We are attracted to business models in which there is visibility around cash flows as well as a lack of economic sensitivity. We believe this criteria differentiates us from many of our growth peers.
Many businesses are poised to benefit from the challenge
Greg: If you think about how our lives have changed in the past several weeks, the benefits of cloud computing become apparent. This is the infrastructure that enables distance learning, business communication and productivity tools, social media, and gaming. As the COVID-19 crisis escalated, we witnessed a significant rise in the adoption of public cloud systems as demand soared from businesses, schools, and consumers. We believe these demand drivers are likely to persist through the remainder of the downturn and into the recovery and normalization phases. Not only have these businesses been resilient and strong during the crisis, they are likely to become stronger in the aftermath.
Emerging from the crisis: What to expect
Richard: In our ongoing discussions, we think about potential changes in behavior, and what might look different as we come out on the other side of the pandemic. After 9/11, for example, we saw significant changes in TSA procedures and airline passenger screening. Now, we could see people getting their temperature taken upon entering a football stadium or boarding a plane. We may see individual states stockpiling medical supplies as a matter of course. Some changes will be temporary, others more lasting.
Greg: In our research and analysis, we do not try to call a market bottom. We are focused on identifying companies that can weather the storm and emerge even stronger. We’re not looking for the industry or company that’s been the most damaged, hoping for a V-shaped snap-back in demand in a certain end market. We are discussing what the new normal will look like, and which companies will benefit in a more radical and durable way. The online grocery business, for example, may enjoy longer-lasting benefits, as many consumers have opened multiple online grocery accounts in the midst of this crisis. Even as brick-and-mortar stores re-open, demand could stay strong as more consumers now recognize the advantages of online grocery shopping.
We are discussing what the new normal will look like, and which companies will benefit in a more radical and durable way.
In other areas of retail, there are businesses that were in a strong position coming into this, with solid strategies in place to drive e-commerce penetration. Over the past several weeks, we’ve seen these businesses accelerate their e-commerce investments, and they have gained new customers among demographic groups they would never have imagined a month ago.
Strategy for success going forward: Active management
Richard: Six weeks ago, none of us could have anticipated a very rapid 30% decline in the Russell 1000 Growth Index, much less the unprecedented financial “plumbing” efforts we have seen to stabilize the markets and economy. The overall effects of this pandemic are still uncertain, but we do know that the business landscape will look different as the economy turns a corner to recover from this crisis.
Greg: As investors are faced with many uncertainties, we are focused on the advantages of our active management approach — one that does not require economic acceleration to succeed. We are able to target companies that fit our stringent criteria and that may not be held in our benchmark or in the portfolios of our growth fund peers. These are businesses we believe can not only grow though this challenging economic environment, but also have the potential to improve their market share and competitive positioning as we emerge from this into a new business cycle.
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Consider these risks before investing: Growth stocks may be more susceptible to earnings disappointments, and the market may not favor growth-style investing. The value of investments in the fund’s portfolio may fall or fail to rise over extended periods of time for a variety of reasons, including general economic, political, or financial market conditions; investor sentiment and market perceptions; government actions; geopolitical events or changes; and factors related to a specific issuer, geography, industry, or sector. These and other factors may lead to increased volatility and reduced liquidity in the fund’s portfolio holdings. From time to time, the fund may invest a significant portion of its assets in companies in one or more related industries or sectors, which would make the fund more vulnerable to adverse developments affecting those industries or sectors. You can lose money by investing in the fund.
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