The Active Investor: Mapping Opportunities in Global Equities

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The Active Investor

The Active Investor: Mapping Opportunities in Global Equities

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Brian Foerster: This is Brian Foerster, and welcome to The Active Investor podcast, our monthly look at asset classes and investment styles that have the potential for delivering alpha. And we also get a chance to hear how some of our investment leaders at Lord Abbett are looking at opportunities today.

And for this episode we are back to talking about equities, and more specifically, thinking from a global perspective about where some of the great themes are today, as well as some of the best companies in the world. And we have exactly the right guest for that discussion today in Ryan Howard, the lead portfolio manager on Lord Abbett's top-ranked global equity strategy, and also a portfolio manager for our U.S. equity income portfolio, and our international value portfolio. So, welcome, Ryan.

Ryan Howard: Thank you, Brian. It's great to be here.

Foerster: So, Ryan's background and his CV can be covered pretty quickly, as he has spent his entire 21-year career here at Lord Abbett, starting as a research analyst in the international equity area, and then progressively moving into portfolio management on the equities team.

He's a CFA [Chartered Financial Analyst] charter holder, and also has an MBA [Master of Business Administration degree] from NYU [New York University]. And I think I'd most notably say that he has a passion for understanding great businesses and what makes them tick. And I guess that brings me to my first question for you, Ryan. How did you get started in investing? What drew you to wanting to be in this area of finance? Any interesting anecdotes from your personal history to connect the dots?

Howard: Yeah, of course. So, while there are many people in our industry, many very good people in our industry that have taken sort of long and circuitous routes to their place in the industry, I'm not one of those people. I've been attracted to finance most of my life.

One of my first memories of being intrigued by finance was as an elementary schooler, when a friend of mine received a bond from his grandparents for Christmas. And he was describing to me what this thing was, and I was absolutely enamored by the compounding element of it.

The idea that you could buy something that will pay you more money, in my nine-year-old brain it was like using your wish to wish for more wishes. I was amazed that you could do this. So following that, I spent the next six months begging my dad to open up a savings account for me so I could replicate this strategy.

I had a piggy bank full of dollar bills that were just sitting there. So I was convinced, in my mind, that I was missing out. He finally took me to the bank and we opened up an account. And my second lesson in finance was savings deposits and CDs are a very painful way to grow your wealth.

So fast forward to high school, economics was offered as an elective, which I took. I absolutely loved it. I declared as an economics major even before I got to university campus. In that period, I was attracted quite a bit to macro[economics], so some of my favorite coursework was things like international macro, and money and banking. I graduated and was fortunate enough to find a job here at Lord Abbett, just as the International Equity Group was commencing. It was a really fun time to be in international [equities].

Emerging markets were booming. Jim O'Neill from Goldman [Sachs] had just coined the term BRICS: Brazil, Russia, Indian, China, and South Africa. And this all fit very nicely into my macro leanings. These were large, domestic markets, they were driven by rising consumption and a growing middle class.

And it wasn't until later in my career, with a pivot back to developed markets, when I really began to see microeconomics and the analysis of a company's market position and industry structure as the pure faith and the more efficacious analysis.

Reading and listening to people like Michael Mauboussin, Pat Dorsey, and Creating Shareholder Value by Alfred Rappaport really helped me solidify that as a key focus of mine in investments going forward.

Maybe more than you wanted to know, but that's a little bit on my journey through finance and economics.

Foerster: Interesting. So, from sort of the excitement of trading savings bonds, up to BRICS, up to today. Good stuff. So when you think about your 21 years at Lord Abbett and kind of all that's changed in the financial world in that time, and you think about the rise of indexing, the massive boom in tech stocks and technology in our lives, which has now become really known by the massive kind of megacap names, we've seen some really big changes in how investors look at the stock market.

At the same time, non-U.S. stocks and value stocks were really left behind between 2009 all the way until 2022. And now we seem to be in a new environment for stocks, with higher interest rates, still some meaningful inflation, and concern over the massive influence of those megacap stocks. So, I guess my question for you is: How do you see the world, as an equity investor, with that backdrop?

Howard: So, first of all, we're constructive on the outlook for equities at large. We see a resilient global economy with data, which, on the margin, seems to be getting, if anything, better; a Fed [U.S. Federal Reserve] which looks to be on, hold at worst, and cutting [interest rates] at best.

And you put all that together, and the outlook for corporate earnings is strong. So the last point is I think is the key one, and you mentioned the ups and downs of certain parts of the equity market over the years, and a lot certainly has changed.

But there's one constant, and that's the expectations for earnings and cash flow drive stocks. And I think it might be worth getting a little bit more into the weeds here as to how we think about that, and that will lead us to how we're thinking about positioning in the current market.

So as you think about the earnings and cash flow profile of a business, I would look at it along three dimensions. And the first and most intuitive is the rate of growth of your earnings and cash flow, and that's a pretty intuitive concept for most people. The faster you can grow your earnings and cash flow the more valuable a business should be. And of course, that's true.

But there are two other ones that are equally as important. The second is the predictability of that stream of earnings and cash flow. So, an entrenched software business, which is growing at 10%, will be valued quite differently than an airline growing at 10% because of the predictability and believability and durability of that stream of cash flows.

And then lastly, how much capital needs to be invested to generate that growth in earnings and cash flow. So, is the business capital efficient? And can they grow by investing a limited amount of capital, or do they have to invest a lot to generate that similar stream of earnings and cash flow? And I think as we think about the backdrop for investing today in a higher-interest rate world, that last one is a big part of it.

So we've been through this period of ultra-loose monetary policy, and capital was very cheap and very plentiful, and there was a proliferation of business models, which were quite dependent on a constant need for external financing. And that was okay in that environment because it was readily available.

In a higher-rate world, where capital is a little tighter, we think you need to be looking for businesses which can, first and foremost, generate cash internally to fund their growth ambitions. And second, businesses which can reinvest that internally generated cash flow at a high rate of return. And that, over the long run, is going to drive better growth at those businesses, and they'll be more richly rewarded.

Foerster: Yeah. Interesting. So, another question I think that comes up when you hear about a global equity strategy, it's something along the lines of, "So, Ryan, what are your favorite regions or markets right now?" Or, "How are you tilted to areas like India or EM [emerging markets]?"

Or, "Aren't you concerned about slower growth in other regions?" Or, "Is it time to lighten up on the U.S.?" Those types of questions. Now, I know you think a lot about all of those topics, and probably a lot more. But is that the main driver of how you think about investing around the world?

Howard: We do, of course, follow the global economic data, and we understand how various markets are performing, and what's driving that market performance. But it's not really the primary way we make decisions. In the global equity strategy, we're primarily investing in developed market multi-national businesses.

So a bottom-up style, which is looking for businesses with strong market positions, sustainable competitive advantages is really a better fit for the strategy versus a top-down allocation strategy. And I'll give you some examples and some numbers, which I hope will shed some light on this concept.

The average company in our portfolio derives about 42% of its revenue outside of its country of listing. And if you exclude the U.S. companies and only look at the non-U.S. businesses we own, that number jumps to 58% of revenue coming from outside the country's listing.

So these businesses are not always tied to the economic fortunes of their home market. They're very much global businesses, for the most part. And Novo Nordisk is a great example of this. It's a Danish pharmaceutical company and the maker of Ozempic, which most people--

Foerster: Never heard of it.

Howard: --which most people will be familiar with. We invested in the company because we see an evolving duopoly in the fast-growing market for obesity therapeutics. The business has a mountain of corporate intellectual property that will allow them to retain a cutting edge in that market, and meaningful production capacity and distribution to commercialize that opportunity. We didn't allocate to Novo because of the European economy or the European market.

Another great example is Nintendo. So we believe Nintendo is the best gaming business on the planet. They have a well-invested, fully owned content library that continues to get better as they enhance it through movies and theme parks, things like the Mario Brothers movie, which drove software title sales for the business.

They have an engaged audience of 130 million Nintendo Switch users, and they'll be transitioning that audience to the Switch 2, so a nice upcoming product cycle within the next 12 months. It wasn't because of the Japanese economy or the Japanese market that attracted us to Nintendo. It was the company's market position and the prospects for its business.

Foerster: I guess it's really just about finding the best businesses anywhere, right? So, following on with that thought, let's talk specifics, then, on what you look for across really some very different types of businesses.

You just mentioned a few companies that are great in their own right, but in very different industries; they do very different things. Some could be classified as maybe high-innovation growth, others as value stocks, some in the U.S., some in Europe, Asia, et cetera.

One way, I guess, maybe to think it about it is there's just a lot you don't own in your portfolios as well, right? So again, given all the differences there, can you give a quick overview on kind of what you think are the key commonalities across the 80 or stocks that you do buy?

Howard: Yes, of course. The first thing we look for in any business, irrespective of what part of the market it's coming from, whether it's domestic, international, growth, or value, is one of three forms of sustainable competitive advantage. And that's either a consumer advantage, a producer advantage, or a network advantage.

And maybe before we get into the details of what each of those are, maybe just a word on why it's important. So, as we're all taught in our Finance 101 classes, high returns on capital reinvested drives your growth over a longer period of time. We're also taught in those same classes that high returns on capital in excess of your cost of capital can't be sustained, because competition will come in and bid those returns down to lower levels.

And it's the last part that I would sort of beg to differ with. In practice, we can and do find businesses which are able to sustain high rates of return for a number of cycles, if not more. And they're usually able to retain it because they have one of these three forms of competitive advantage.

So a consumer advantage, there's something special about the product. This is something that the consumer struggles to find elsewhere in a competing product, or that new entrants really struggle to replicate it. It could be a trusted brand, a unique patented feature, something the consumer is willing to pay up for. So, a good example here is [luxury-goods company] LVMH. Brian, you and I could start a handbag company tomorrow, it wouldn't be [LVMH subsidiary Louis] Vuitton.

Foerster: Nope.

Howard: There's unique brand equity, there's a unique heritage there that is very challenging for all but a handful of companies to replicate. And that advantage manifests itself in pricing power, and you have a business that can price in excess of most competitors.

So that's what drives its sustained high return is a high-margin structure through time that can't be competed away. The second advantage is a producer advantage. And here it's not the product that's special, it's the way it's produced that's hard to replicate.

So these are generally economies of scale or economies of scope businesses. And you can think of an example like Costco. There's nothing really special about the product. The customer doesn't really care where they get their strawberries from, but they're looking for a cheap price.

And the scale and the business model that Costco has allow them to price cheaper [with] very favorable economics, despite those low prices that they charge. So if you look at these businesses, they tend to not get to a high-return structure through margins but through asset turnover, so a high volume of sales on an asset base. And again, consistent with what you see with economies of scale and economies of scope businesses.

The last one is a network advantage. So, a network advantage occurs when all parties on the network derive value from growing scale of the network. So you can think about this like Visa or Mastercard, where if I'm the only one with a credit card from a credit card company, and there's only one merchant in the world that has a terminal, that's not worth very much to me, and it's not worth very much to the merchant.

However, as that network scales, and you have millions and millions of merchants on the network, and also millions and millions of people with a Visa or Mastercard credit card that works on that network, that becomes a very difficult thing to challenge for a new entrant.

And that happens because existing members of the network have very little incentive to go seek out an alternative network, really at any cost. So what you find with network advantage businesses is, if you see a first mover, and they get there, and they get there first, and everyone on the network is happy, it becomes very difficult to displace them, because there's just very little incentive for members to leave the network.

Foerster: Gotcha. Great, thank you. That was a lot of interesting detail, a lot of interesting examples there. A couple more questions here. And your last answer kind of prompted me to think of this one, that idea of competitive advantage. And then also the idea of kind of trying to find the best ideas at any given time.

And really that is kind of time dependent, I think. You think about the bizarre environment of 2020 with the COVID-19 lockdowns, and how a big part of the stock market just got hammered if you were a business that was dependent on social gathering. So, you think about traditional retail, travel, restaurants. We all remember. And then on the flip side, you had monster stocks that benefited from the need for virtual empowerment, like Zoom and Roku, Chewy, Amazon. And you guys kind of leaned into that trend and it paid off well. Not saying it was those exact stocks necessarily, just the broader trend.

And then you had the re-opening trade of 2021, where value and cyclicals kind of ripped off the bottom, and tech sold off pretty harshly. Then you had 2022, and just a brutal year for risk assets overall. And then last year, a market dominated by a handful of tech stocks. So after all that, my question then is, after that kind of journey down memory lane: How do you balance finding the best of the best companies, but then also adapting to changing market environments?

Howard: Yeah, thanks, Brian. You mentioned the concept of time dependence, and there's some time dependence to competitive advantage. And Warren Buffett is famous for going around the office asking his people, "Are a company's moats [competitive advantages] wider or narrower today?"

So it does change over time. I wouldn't say that's what drives most of the change in the portfolio. So in addition to one of three forms of competitive advantage, we're looking for three sources of total return to put together a reasonable total return prospect for our investors.

So we operate on a 24-month time horizon, and the three sources of total return are your earnings growth, the multiple re-rating or de-rating, so the multiple change that you put on that stream of earnings, and your dividend income. And those are the three ways to get to a total return as we look at a stock.

And that is certainly very time dependent, and it depends on how a business is valued, it depends on how we're seeing the growth profile of the business in the coming years, and it depends on elements to the investment thesis, which can serve to raise or lower the P/E multiple on a business. So, three sources of competitive advantage. The next step is three sources of total return, and what do they stack up to? And that's really what drives the change in the portfolio, for the most part, over time.

Foerster: Right, okay. So one last question for you, and this is really just to get your pulse on “why buy equities now”? Now, I know an equity PM [portfolio manager] is often going to say it's a great time to buy equities, but it is still I think very surprising, to me at least, how averse investors still are to equities right now after the big drawdown in 2022.

You talked about a big re-rating of risk over a couple-year period because of inflation. But you think about just the amount of cash on the sidelines, $23 trillion. And the big outflows in equity [mutual] funds, for many years now, is kind of surprising, and I guess maybe even a little concerning, given the need that many people have, and institutions have, for equity returns to reach their long-term goals. Yeah, I guess I just ask you: How do you, as a global investor, think about the world of equities now from kind of a risk-reward standpoint?

Howard: As I said in the onset of the conversation, we're constructive on equities, and I think what belies that confidence is the outlook for corporate earnings. So in the near term we have a lotta people who are debating, "Does the Fed hold [interest rates where they are]? Do they cut once? Do they cut three times?"

I think the thing to keep your eye on is just the underlying strength of the economy. And unless that Fed policy upsets the apple cart, in terms of the outlook for corporate earnings, equities should continue to do well. Valuations have gotten high in parts of the market, but there are certain parts of the market where you have a meaningful rebound in earnings still ahead of you, and that's areas like small caps. The data seems to be getting decidedly better in Europe. So there's a lot to be constructive on out there. And I would just take a step back and think about the outlook for corporate earnings, which looks very constructive from here.

Foerster: All right, good stuff. So with that I think we can wrap things up. And I'll just say thank you, Ryan, for joining the podcast. Some really interesting insights on global equity investing and what's likely to drive investment returns in the coming years. Definitely look forward to having you back later this year to check in.

Howard: Thank you, Brian. That would be great. I would love that.

Foerster: Awesome. Thanks again, Ryan. And for listeners wanting to learn more about Lord Abbett's views on the markets, please visit the Insights section of lordabbett.com. We actually have a newly published article on global equity investing that touches on a lot of what Ryan and I discussed here today.

And lastly, we'd also like to hear from our listeners. So, if you have any comments about today's podcast or ideas for future podcasts, we welcome your thoughts, and email podcasts@lordabbett.com. And so, we'll leave it there. I'm Brian Foerster. This has been The Active Investor podcast. Thank you for listening.

Related Investment

Global Equity

The strategy seeks long-term growth of capital by investing in stocks of both U.S. and non-U.S. companies.

Learn More

About the Contributors

Brian Foerster, CFA

Investment Strategist

Ryan C. Howard, CFA

Portfolio Manager

Important Information

Reference to level of cash held by U.S. investors is based on data from the Investment Company Institute, U.S. Federal Reserve, and Bloomberg, and is as of March 31, 2024.

Data for portfolio company revenue by geographic region is derived from Lord Abbett analysis of company financial statements.

Data for Nintendo Switch user base is from Nintendo as of December 31, 2023.

Bottom-up investing is an investment approach that focuses on analyzing individual stocks and de-emphasizes the significance of macroeconomic and market cycles. Top-down investing takes the opposite approach, focusing on the macro factors of the economy and how they may influence the investment case for a particular security.

CDs refers to certificates of deposit.

Cash flow is the amount of cash or cash-equivalent which the company receives or gives out by the way of payment(s) to creditors.

Cyclical stocks represent companies that make or sell discretionary items and services that are in demand when the economy is doing well.

A drawdown is an investment term that refers to the decline in value of a single investment or an investment portfolio from a relative peak value to a relative low point.

Duopoly refers to a situation in which two companies together control all, or nearly all, of the market for a given product or service.

An entrenched business is characterized by well-established product or service offerings and market positioning.

Growth/value investing: Growth stocks are companies that investors expect will grow much faster than others. These companies are relatively new, or in rapidly growing industries (such as technology). Investors seek growth stocks for their future earnings prospects as compared to their industry and the overall market. Value investors are interested in stocks that appear to be undervalued. Value stocks may have some of the following characteristics, as compared to a market index: lower price/earnings (P/E) ratio; lower price-to-cash-flow ratio; lower price-to-book (P/B) ratio; and a higher dividend yield.

Indexing is a form of passive fund management in which the fund manager builds a portfolio that aims to mirror the securities of a particular index.

Macroeconomics is a branch of economics that studies the behavior of an overall economy, which encompasses markets, businesses, consumers, and governments. Microeconomics is the study of individuals' and businesses' decisions, and their effect on an economy’s performance.

Market capitalization: The U.S. Financial Industry Regulatory Authority, or FINRA, defines the following categories of stocks based on their market value: mega-cap stocks, $200 billion or more; large-cap stocks, between $10 billion and $200 billion; mid-cap stocks, between $2 billion and $10 billion; small cap stocks, between $250 million and $2 billion; and micro-cap stocks, less than $250 million.

Monetary policy is a set of actions, generally taken by central banks, to control a nation's overall money supply and achieve economic growth.

Price-to-Earnings Ratio: Stock analysts calculate a price-to-earnings ratio, or P/E multiple, by dividing a stock's current price by its earnings per share on a trailing 12-month basis. A forward price-to-earnings ratio is calculated by dividing a stock's current price by estimated future earnings per share. “Multiple re-rating” refers to changes in how investors and analysts value stocks based on variations in P/E ratios over time.

Return on invested capital (ROIC) is calculated by dividing a company’s net operating profit after tax by invested capital. ROIC gives a sense of how well a company is using its capital to generate profits.

The U.S. Federal Reserve (Fed) is the central bank of the United States. The federal funds (fed funds) rate is the target interest rate set by the Fed at which commercial banks borrow and lend their excess reserves to each other overnight.

The credit quality of fixed-income securities in a portfolio is assigned by a nationally recognized statistical rating organization (NRSRO), such as Standard & Poor’s, Moody’s, or Fitch, as an indication of an issuer’s creditworthiness. Ratings range from ‘AAA’ (highest) to ‘D’ (lowest). Bonds rated ‘BBB’ or above are considered investment grade. Credit ratings ‘BB’ and below are lower-rated securities (junk bonds).

Mentions of specific companies are for reference purposes only and are not meant to describe the investment merits of, or potential or actual portfolio changes related to, securities of those companies.

Unless otherwise noted, all discussions are based on U.S. markets and U.S. monetary and fiscal policies.

Market forecasts and projections are based on current market conditions and are subject to change without notice. Projections should not be considered a guarantee.

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