Wed, 21 Sep 2011
The Columbia Acorn manager makes the case for the fund's 'downstream from technology' and 'American brands' themes, and comments on the upcoming earnings season.
We recently attended the Columbia Acorn Funds shareholder meeting and caught up with Chuck McQuaid, manager on the Columbia Acorn Fund, to learn about the fund's recent investment themes, how he's been managing through the recent volatility, and his expectations for earnings season.
Jason Stipp: Chuck, the Morningstar Analyst who covers your fund mentions that you employ some top-down views on mostly a bottom-up process. I wanted to start with your top-down views and how they've been informing your portfolio-building process. There has been a lot of uncertainty about the economic situation; this has led to some volatility. How are you thinking about that uncertainty as you look at your portfolio and your holdings?
Chuck McQuaid: The top-down views typically are not regular macroeconomic views such as will GDP grow 2% versus 3.5% next year or will the interest rates go up some. The top-down views are more big picture, and they are not just economic, but they are also valuation-type views.
So the biggest top-down issues in the last 10 years have been first, the tech/media/telecom bubble, where stocks were clearly overpriced and where we retreated from those groups. And then, of course, the housing bubble, and knowing there was a housing bubble we owned very few homebuilder stocks, for example.
But other than that, we try to invest thematically from the top-down, and we've had several themes over lifetime of the fund that have paid off big time, and we have others that we've started relatively recently.
Over lifetime of the fund, we've had "downstream from technology" as a theme. When you think about technology, you could think about the technology producers, the people that make the devices, and it's a very tough competitive business. Whereas, some of the users or the companies in the middle, they can benefit a lot.
So for example, the cell phone industry: How many years ago, who was on top? Motorola and Nokia and then RIM BlackBerry and now Apple. Well that's a tough business, but we've made lots of money in the past on the cell phone franchises. Early on they were duopolies and later on there were only a handful of franchises and now most of them have sold out and many of those companies selling out, we owned. And more recently we've invested in the tower companies, and as more people use more data, we benefit because you need more antennas and more towers.
So those are how we invest top-down, thematically. Two other themes are the orphan-drug theme, which we've adopted more recently, and the American brands theme, the affordable luxury brands that are selling worldwide.
Stipp: You mentioned that there was a theme on things to avoid in the early 2000s with the tech bubble. Are there any themes right now that have caused you to shy away from certain areas where the valuations just don't look right, or the fundamentals are questionable, and so you may be tend to de-emphasize that portion of the market?
McQuaid: Well more so from an industry standpoint than a thematic standpoint, we've been underweight REITs for a while. The REIT companies are typically not growing that fast, and they are not at the low end of their valuations. We are not allergic to REITs, but we are a fund investing in growth at a reasonable price. So way back during tech/media/telecom bubble, when tech/media/telecom was very expensive and REITs were very cheap, we owned a lot of REITs, but they are typically not fast-growing companies. So, the only reason you really want to own them as if they are selling below average prices, and we don’t think they are today, so we are underweighting REITs.
And likewise we are underweight utilities; we think a lot of investors have reached out for yields and have driven utility stocks to unattractive levels. We think we can find a lot of other companies that are growing faster and are priced more reasonably.
Stipp: I want to talk to you about the market environment. We’ve seen some volatility, quite a bit of volatility in August and over the last few weeks. I wanted to ask you, if you believe the market on a day-to-day basis, these values of these companies could be moving up [or down] 1% and 2% as these new bits of information come in. But the way that you are looking at your companies, has anything that you’ve seen over the summer or over these periods of volatility caused you to rethink those fundamental valuations, or is it just a matter of a lot of noise and a very jittery market right now that’s creating ups and downs that perhaps aren't meaningful to the longer term?
McQuaid: Well, in general we think that there is a lot of noise out there. Now, clearly there are lot of risk factors in the headlines, but everybody knows about them already. We are looking at long-term fundamentals. We are trying to ignore a lot of the talking heads on television that are causing a lot of alarm, so it's company-by-company and theme-by-theme that we are investing in, and sometimes if some stock prices move enough in one direction or another to point where we call it an anomaly, we would be going against the crowd and buying something that people are all worried about, and we think unnecessarily worried, and would be selling things that we think a lot of people are too bullish on.
Stipp: You generally maintain a pretty low-turnover portfolio, but would you say recently that you have been finding some of those opportunities to put money to work or to do some trimming. Have you been more active over this period of volatility?
McQuaid: We are just actually starting to find some companies where we think that prices are way off-base. Recently, we’ve added a little bit to a couple of semiconductor companies; we are not big fans of semiconductors, but with some of the stocks off 30% or more, we’ve added to a few.
Stipp: I wanted to ask, as we're on the cusp of earnings season, about your take on earnings. It seems like before every earnings season folks say this could be a disappointing one, but corporations have generally been able to turn in pretty decent earnings over the recovery. A lot of that has had to do with cost-cutting and becoming lean and mean during the really rough years in 2008 early 2009.
When you look at your company specifically, what expectations do you have for this earnings season. Do you think that we are still going to be able to eke out pretty good earnings growth, and do you think that it's going to be due more to the revenue side or are companies still trimming the fat?
McQuaid: I think in general the small- and mid-cap companies did not do a lot of cost-cutting. Small- and mid-cap companies don’t have that kind of bureaucracy and cost blow that a lot of big companies do. Now I think the magic with the small companies is that in lot of cases they've had their sales increase far faster than their expenses--they’ve kept costs under continued control as sales have grown. You know some of our favorite companies, the industrials, they are still showing organic growth in the upper single digits or in some cases well into the teens. And with costs relatively well controlled, the margins are still rising.
Given the date on the calendar, Sept. 21, we'd be in the middle of pre-announcement season. If a lot of companies had fears that their Street estimates were too high or their guidance was too higher, they'd be announcing that they're going to take guidance down, and we've seen almost zero pre-announcements so far.
Now, naturally, year-over-year earnings comparisons are getting tougher. In general, we think companies will make their numbers. Companies in general made their numbers last quarter, I think there were several cases in technology were they took guidance down a little bit, but other than that, guidance was flat to up for most of our stocks.
Stipp: Last question for you, Chuck: You mentioned industrials as an area where you'd been investing. I know that your portfolio also has an overweighed in consumer cyclicals. I am interested in the thinking that led to that overweight, and the opportunities that you are finding there. Are there any specific themes that you are building on in consumer cyclicals specifically? Consumer is an area, obviously, of big concern for a lot of folks. So I find it an interesting area for you folks to be interested in.
McQuaid: Well, we are overweighed in consumer and the primary reason is a theme in consumer, which is affordable luxury by American brands. If you think about the European brands, you can buy very nice $3,000 handbag with a designer name on it from Europe, or you can buy a $400 handbag with a name from the USA. Likewise, some of the teen fashion brands are affordable luxuries, and a lot of these companies are opening stores or otherwise marketing overseas.
And given that you see growth, particularly in emerging countries, where middle class may well be $10,000 in income, they cannot afford a $3,000 handbag. But in lot of cases, they can afford something at a fraction of that price that has an American brand name on it. Or the teen brands or other American brands, they can afford that. And it’s a status symbol in an emerging country, and a lot of those companies have been very successful.
Stipp: Chuck McQuaid of Columbia Acorn Fund, thanks so much for sitting down with me today, and for your insights on the market and your stock holdings.
McQuaid: Thank you.