Manager Insight

Eileen Riley targets high-quality businesses for her "best ideas" portfolio.
By Jade Hemeon | 15/11/18

Eileen Riley, vice president and portfolio manager at Boston-based Loomis, Sayles & Co. LP and a member the four-person investment team managing IA Clarington Global Allocation, prefers to make a long-term commitment to stocks she holds in the global balanced fund's portfolio. That's why she seeks companies with "multiple drivers" to spur performance.

About the Author
Jade Hemeon is a Toronto-based freelance financial journalist with more than 20 years experience. She has previously been a staff reporter for the Financial Post and Toronto Star, and has also held positions in the mutual funds and financial planning industries.

"We are not constrained by geography, sector or style," says Riley. "We believe that businesses with multiple alpha drivers are in the best position to outperform."

She targets high-quality businesses with the ability to grow intrinsic value, especially free cash flow, over the long term, and limits the fund to 35 to 65 "best idea" stocks.

"We think about how a business would do in multiple scenarios, and use that framework to establish upside and downside guideposts," she says. "Scenarios may change over time with significant new fundamental information, but typically price volatility alone does not change our view."

If anything, Riley welcomes market downturns such as the broad-based stock correction in October as an opportunity to add to attractive holdings. Conversely, when stocks become expensive it can be an invitation to trim.

There are several attributes that she analyzes to determine the quality of a potential investment, including expertise of the management team, the business model, intangible assets, return on investment capital, track record in allocating capital as well as future allocation plans, and the company's approach to ESG (environmental, social and governance) criteria. Valuation is also key.

"We look for attractive valuations, and this means not just a one-time catch-up opportunity for the stock price, but the potential for future compounding as the company experiences growth," Riley says.

Such careful scrutiny at the outset means turnover in IA Clarington Global Allocation tends to be low. Riley says average annual turnover in stock holdings has been about 40% during the past five years, and much of that has been buying or selling around the edges of existing holdings to take advantage of short-term movements in the market price. The average holding period for a company tends to be about four or five years, she says, and some equity holdings go back as far as a decade.

Riley says the goal for the global balanced fund is to achieve equity-like returns with lower-than-average volatility, and one of the keys is superior returns for the fixed income portfolio.

Fixed income currently accounts for about 30% of the asset mix, which is less than its benchmark allocation of 40%. The mix of fixed income securities is wide-ranging and may include global and emerging market bonds, corporate and government securities, high yield bonds, convertibles and mortgage-backed securities.

The team expects interest rates to continue their rising trend, with one more hike by the U.S. central bank in 2018, and another four hikes in 2019. A short-term focus is being maintained on the fixed income side, with an unusually high 28% of assets held in cash equivalents such as Treasury bills.

The average duration of the portfolio was 2.87 as of Sept. 30, significantly less than the 7.75 duration shown by the fund's fixed income benchmark, the Citigroup Word Government Bond Index (WGBI) index. The average maturity of the fund's fixed income portfolio was 3.75, far less than the benchmark's 9.48.

"The high cash position is not typical," Riley says. "We are waiting for an opportunity to deploy the cash at better valuations on the fixed income side."

Despite the short-term bias on the fixed income side, the average yield at Sept. 30 was a healthy 3.5%, significantly higher than the 1.7% yield offered by the Citigroup WGBI index.

"Our approach to allocating capital -- whether in fixed income or equities -- is bottom-up, based on relative value and expected return," Riley says. "We look at fixed income not just to provide balance or asset class diversification, but to deliver alpha on its own."

On the corporate bond side, the fund's managers seek exposure in companies with strong fundamentals. Performance has been given a boost this year from holdings in communications and energy issues.

The fund has a "go anywhere" mandate and is broadly diversified geographically. Riley finds it useful to view the fund's regional allocations based on the source of revenue of corporate holdings, rather than where they are domiciled. On the equity side, 47% of corporate revenue currently comes from North America, 20% from Asia and 21% from Europe. Within equities, the largest sectors are currently information technology and financials.

Among the top long-term holdings is  Roper Technologies (ROP), a manufacturer of industrial equipment and software with a focus on products that create an attractive recurring revenue stream, Riley says, such as toll-readers for highway toll systems. The company has four main business lines including industrial technology, radio frequency technology, scientific and industrial imaging and energy systems and controls. It has a strong track record in making accretive acquisitions.

Other long-term holdings in the fund are AIA Group, which provides life and health insurance as well as financial services throughout Asia and is benefitting as the region's growing middle class has more need for insurance; and  Sherwin-Williams (SHW), a manufacturer of paint and other coatings for building exteriors and interiors, as well as for other products such as bridges, cars and tractors.

A recent purchase is  Parker Hannifin (PH), a manufacturer of motion control products for use in such areas as aerospace, climate control, electromechanical, filtration and pneumatics. The company is putting more effort into customization and client support, which Riley believes will strengthen client relationships.

On the sell side, the team decided in the third quarter to discard  Colgate-Palmolive (CL), a maker of consumer products such as soap, detergent and toothpaste.

"Globally there is a shift toward online shopping, and this, along with local competition in emerging markets, is creating new competition for the older brands that have dominated traditional retailing," Riley says.

Don’t miss out on communications from Morningstar Canada! Sign up for our specialised newsletters, get early notice of our events, and get access to exclusive promotional content. Manage your subscriptions here.
Video Reports
More...
Click here to view all