Greg Carlson: My name is Greg Carlson, and I'm a fund analyst with Morningstar. I'm here today with David Giroux, the manager of T. Rowe Price Capital Appreciation Fund, who won our Fund Manager of the Year Award for allocation funds last year.
David, thanks for joining us today.
David Giroux: My pleasure.
Carlson: We were talking previously about how the fund has changed. We should mention here that it covers a lot of ground. You own equities, traditional bonds, convertible bonds to a small degree, some preferred stocks, leveraged loans. Cash can be a significant factor. Any other elements you would mention? The covered call strategy?
Giroux: The covered call strategy, and I think you said leveraged loans. We own some mortgage paper as well. But those are the largest asset classes.
Carlson: You've got a lot of irons in the fire here. So there is a lot to talk about.
Maybe we can start with the equity portfolio. We talked about how the overall equity weighting hasn't changed much lately. But within that portfolio, there have been some changes. The portfolio has become a little more concentrated as you're finding fewer attractive stocks.
Giroux: That's right. I think as the markets rallied, the number of … attractive ideas we see in the marketplace has shrunk, so our equity has become a little more concentrated in more of a handful of ideas, if you will.
I'd also say, within equities, we are seeing a little more value today than what we've seen in the last two or three years in things that have a little bit higher dividend yield. In the last couple of years, people have been chasing high dividend yield at almost any price, and as rates have risen here, you're starting to see more attractive ideas within consumer staples, within utilities, where we're seeing a little more attractive value.
Carlson: To that point, one of the names you added in the first half of the year was Nestle.
Giroux: Yes. Nestle is a great example of the kind of name we're looking for. It's a company that has a great, long-term outlook; it's company that deploys capital very well, pays a nice dividend yield. It's really de-rated relative to its U.S. peers, relative to its European peers, as [Nestle's] organic growth has slowed a little bit here in the short term against some very difficult comps. But I think if you take a longer-term view of the attractiveness of their emerging-market business, the attractiveness of the opportunity for them to improve margins, improve cash flow and grow earnings at a mid- to high-single-digit rate on a long-term basis, given where the valuation is today, we think it's pretty compelling.
Carlson: So the growth previously was perhaps unsustainable, and so they suffered with tough comparisons.
Giroux: Yes, tough comparisons. I think sometimes it's hard for stocks to work in the short term when they have decelerating growth. We tend to like this kind of situation, because comps eventually get easier and growth usually reaccelerates. So we want to be buying those names prior to that reacceleration, because the market tends to be a little forward-looking. So we think that if you look at the next two to three years, Nestle's organic growth should probably accelerate a little bit. Even if it doesn't, the valuation is still compelling, and I think it'll still be a good stock. But if you actually have that reacceleration in the growth rate, which we think you're going to see as comps become easier, we think Nestle should be a very good stock.
Carlson: You've extended your investing time horizon to some degree, right?
Giroux: You are seeing our involuntary turnover come down a little bit. We are searching for more ideas, where we say, these are names we can hold for a long period of time. We call it the "2020 process," trying to identify companies that are doing all the right things, where the valuation is reasonable. There is no secular challenge, … earnings volatility is usually low, and capital allocation is really compelling. We're trying to find more of those ideas that we can hold for a longer period of time.
Carlson: Through the year 2020?
Giroux: Through 2020, theoretically--no guarantee--but ideas that we think potentially could be a name we could hold for a long period of time.
Carlson: Marsh & McLennan was another recent purchase that fit that.
Giroux: Marsh is a great story, in that it is sort of de-rated a little bit as their organic growth, similar to Nestle, decelerated a little bit in the second half of last year. A new management team has come in; it should be a little more shareholder-friendly in terms of capital allocation. In a marketplace where margins are very, very high for the market in general, their margins still have significant room for improvement. So it's a situation where you have a company that is less volatile, less risky than the market, trading at a market multiple, but they should grow earnings at a faster pace, have an above-average dividend yield relative to the market, above-average capital allocation, above-average management team. We feel really good about that on a longer-term basis--on a short-term basis, and also on a longer-term basis.
Carlson: How much of a view on the insurance business as a whole do you have to have to model out there?
Giroux: It's more of an insurance brokerage business. So there is not as much volatility in their underlying results as you would find in a traditional P&C company. They usually get paid on premiums or even relationships they have in placing insurance with different carriers, if you will. So their business is much less volatile than what you'd see with a traditional P&C company. Again, it's more of a fee-based business as opposed to a capital-intensive business.
Carlson: On the flipside, something that was sold out of the portfolio in the first half of the year that perhaps didn't fit your long-term perspective was Apple.
Giroux: Yes. Apple was a small position for us. It was a name that, I think, we become more concerned over time about the commoditization of smartphones and as smartphone growth slows down. And so much of Apple's profit comes from the iPhone and smartphones in general that we feel that the idea that Apple will continue to be able to sell an iPhone for $500-$600 in an environment of commoditization, and they'll be able to make those same kind of gross profits that they do [now] is not sustainable most likely. So there is probably a near-term trade--it could probably go up--in Apple in the short term. I think longer term, we feel … less good about that name.