Investing Insights From Our Research Team

Jim Lowell:

Hello, this is Jim Lowell and I’m the chief investment officer at Adviser Investments. I’m here with another The Adviser You Can Talk To Podcast. And today I’m joined by several members of our outstanding investment research team and its team leader, as well as one of our expert dividend income portfolio managers, to drill down into their areas of expertise and discuss specific risks and opportunities they see as we head into 2021.

Speaking of heading into 2021, Dan Wiener, chairman of Adviser Investments and I offered our bird’s eye view of investing in and through 2021 in a recent podcast. But here I’m going to orchestrate many moving research analysts and parts, the spokes to our overall 2021 investment outlooks wheel. Jeff, to begin with, you lead our analysts in the research team. Can you share how the team’s research is both divvied up among our analysts and how we’ll unite their spokes to our overall investment approach?

Jeff DeMaso:

I’d be happy to. Thanks for having me on this new format podcast, Jim. As the investment team, those 10 professionals who are dedicated to investment research at the firm and as you alluded to, we’re kind of divided up into a few sub-teams or maybe areas of expertise is a better way to think of it. You mentioned Charlie, he leads our dividend income team. Jen Zebniak works really closely with Chris Keith on our Managed Bond Program. Josh Jurbala leads our tactical efforts. And then we have our core strategies, our strategic long-term diversified portfolios, which you and I and Dan and really the whole team work on to bring our best ideas from all those different spokes. We do have a senior investment committee, which provides some oversight for those teams, but the idea is to let each team really manage their strategy to the best of their abilities day to day without too much hassle or red tape to try and cut through to make their best investment decisions.

Jeff DeMaso:

When it comes to the analysts on those core portfolios, and I count myself among those ranks alongside Liz Laprade and Jen Zebniak, who you’ll also hear from in a moment. But we’re generalists. We try and cover the broad investment universe and we made this shift from just being specialized in say, large-cap U.S. stocks, to being generalists because it leads to better conversations. It means that we’ve got more than one set of eyes on an investment idea.

Jeff DeMaso:

And then to round it out, how do we bring all those different points of view together, whether it’s from an analyst or from Charlie and his team or from Chris on the bond world? Well, we meet every Monday at our weekly research meeting, we get all 10 professionals together and we discuss markets, portfolios, opportunities, risks, trends, really digging in on individual investment ideas as well as trying to keep the big picture in mind. And then of course there’s plenty of emails going back and forth. I would say water cooler talk, but maybe it’s now Zoom talk happens as well. Kind of those ad hoc conversations. Sometimes the best ideas come from just those spur of the moment conversations.

Jim Lowell:

Thanks, Jeff. I want to move quickly to Liz, equity research analyst. Liz, one of your more brilliant pieces of research persuaded all of us that investing in international mid-small-cap stocks not only didn’t import more risk into the portfolios and investing in traditional international large-caps, but it often delivered better total returns in terms of your research. And this sounds kind of counterintuitive. Can you explain it to us? And can you start perhaps with explaining why investing overseas makes sense at all?

Liz Laprade:

Sure. Jeff and I actually dug into this pretty well on a separate podcast a few weeks ago so I’m going to keep it high level here, but for my full ended response, definitely give that a listen, but yes, let me start with “why international?” first. We do get that question a lot and I would say rightfully so. The U.S. stock market has outperformed most international markets for the last 10 years or so, but I’ll go ahead and highlight two reasons to invest globally.

The first is diversification. If the U.S. stock market starts to decline, you really just don’t want all your eggs in one basket. It’s as simple as that. Secondly, I think if you’re looking today, there are some tailwinds for international. You have cheaper valuations, certain economies recovering at different times and a weakening dollar, which benefits international companies and we saw that happening last year and I think there are reasons that we’re going to see that continue this year as well.

Liz Laprade:

When it comes to kind of that counterintuitive risk relationship. I think we’re a little biased being in the U.S. because here, small-cap stocks tend to be riskier investments than large-cap stocks. Abroad however, small and large cap companies pose essentially the same levels of investment risk. I think the difference in risk relations really just comes down to the type of companies. In the U.S., the largest allocation in the Russell 2000 are biotech companies. Typically these companies are not profitable for a long time and their stock prices rely on binary outcomes, which can lead to big stock-price swings and we saw a ton of that last year with the vaccine race. Internationally however, small-caps are more concentrated in sectors like real estate, banks and broader industrial companies, which are more likely to be profitable and potentially more stable when they go public.

Jim Lowell:

Very interesting distinction, that boots on the ground, selling your goods and services to your neighbors, as opposed to trying to bankroll great ideas and see if they pan out. It’s clearly helped us add some value to the portfolio on both relative return, but also risk-adjusted perspective. Thank you for that perspective, Liz.

And while I have you, why don’t we dig into yet another one of your research gems, which was all about bitcoin and I know we don’t have hours to discuss this, but in more than a few nanoseconds, can you describe to us what bitcoin is? What the current state of play, maybe current state of mania on bitcoin is and whether or not it even qualifies as an investment. Or is it purely a speculative gambit?

Liz Laprade:

That’s a great question. It’s definitely been something that’s been in the news a lot lately. I sometimes do think you need hours to explain it, but I will try and kind of get to your questions briefly. To start with what is bitcoin, at its simplest definition, it is a cryptocurrency. This means that there are no physical coins. If you own a bitcoin, you basically just own the right to transact with that bitcoin through a crypto exchange. And really the idea behind bitcoin is that it is an entirely digital and decentralized currency. Unlike the U.S. dollar, which is backed by the government, there is no single entity behind bitcoin. Transactions at the simplest of explanations are verified by other computers known as miners. We’ve seen the price of Bitcoin run up like crazy recently, but it’s been around since it’s invention by an anonymous coder since 2009.

Liz Laprade:

It gained traction in 2017 when the value of a Bitcoin went from $1,000 peaking at $19,000 at the end of that year. Unfortunately for bitcoin investors or owners, it crashed some 80% the following year. Fast forward to 2020. We have a global pandemic, a recession, low interest rates, increased money supply and thus potential inflation spike expectations. With all of those factors, I think investors realize that maybe putting money into the crypto space could be a better way to earn some cash than maybe low-interest-bearing instruments or gold. I think it then snowballed as large financial institutions and investment managers began to endorse and offer it and then maybe some fear of missing out set in as the price rose and then more and more people piled in.

Liz Laprade:

That kind of brings me to the question of, is it an investment or is it just speculative? I think it’s both. I think it’s a speculative investment. You can buy it and trade it for varying values in a market, but given its volatility, it’s a risky one for sure. Don’t forget when the market corrected last March, the S&P 500 was down 34%, and bitcoin without the big run-up we’ve seen lately, was down 54%.

Jim Lowell:

Ouch.

Liz Laprade:

Yeah. Yeah, exactly. I would not think of it as a preservation of value or a gold substitute. I will say though, unlike 2017’s boom and bust, I do think crypto has gained some actual institutional traction over the past year, which could potentially bring in a higher support line on the value if it were to bust again. Would I personally allocate a large portion of my portfolio here? Probably not, especially not after it has run up more than 300% over the last year with 200% of that just within the last three months. But I can understand the investment thesis and if you want some exposure, I think as long as you have the right risk appetite and tolerance for it, then sure, buy some. My advice to you then is maybe don’t buy more than you’d be willing to lose right now.

Jim Lowell:

Excellent advice, Liz. And it’s not to say that we are not thinking as hard and as fast as we can about cryptocurrency and the inevitable evolution towards some sort of stable store of value, but you’re absolutely right, bitcoin is not there yet, not in any way, shape or form. Liz, you just touched on one area to consider in 2021, international small-caps, mid-caps, one sort of speculative potential investment gambit to learn more about but maybe certainly not bet the ranch upon. Let’s bring some belt and suspenders investing back into the room. And in order to do that, let me bring in Jennifer Zebniak, income research analyst. Jen, bond investors typically hate surprises so naturally, I’m going to ask you, what surprised you the most about 2020’s bond market?

Jennifer Zebniak:

Yeah, so from an asset class that you’d expect to be pretty stable, I would say what surprised me the most was the speed of the recovery after the sell-off that we had seen in the spring. Bonds ended up having a really good year overall. After spreads widened pretty dramatically in March, we saw those yields on almost everything come back down and reach near or all-time lows, which really just showed how the Fed stepping in quickly had really helped.

Jim Lowell:

Looking at your 2021 crystal ball, we know that last year we saw continued really increased interest in taxable muni bonds. What are they? Are they riskier than the non-taxable muni bonds? And what kinds of risks do you associate with both non-taxable and taxable muni bonds? And is there enough of a yield reward for investors to consider them?

Jennifer Zebniak:

Sure. Typically when an investor thinks of a muni bond, they do think about those tax-exempt securities, but taxable muni bonds are exactly what they say they are, they’re taxable. I would say there are no riskier than your regular tax-exempt muni bond, but it’s still important to do your due diligence on each particular issue or issuer. Taxable munis do offer slightly more yield than a tax exempt muni because you do need to pay taxes on those. But there are times like last year, for example, where an investor is able to get more yield in a taxable muni versus a corporate bond, which is also taxable. And like you said, taxable munis have been seeing a lot of demands. They saw a record issuance last year and they’ve had their best year of performance since 2011.

Jim Lowell:

I’m going to put you on the spot and ask you, maybe it’s almost a quasi-political question. As an investment research team, we think we’ll continue to see some forms, manners, modes of stimulus coming from the Fed, fiscal stimulus, certainly looking to global counterparts to do the same, to really try and safeguard the domestic global economy against the toll of the current pandemic where we’re managing through. If we see a massive infrastructure stimulus spend in 2021, does that bode well for muni bonds?

Jennifer Zebniak:

I think so. Investors, even with yields so low, I would argue that muni bonds are even more of a reward because for someone who’s looking for a tax-exempt form of income, with muni bonds, you keep all of your income. With yields already so low, I think there is still a strong demand for munis in the infrastructure bill and then the supply that will come with that will be well received.

Jim Lowell:

Especially perhaps if we see some changes to tax laws that might make muni bonds even more attractive. We’ll have to wait and see on that one. One of the things we can’t wait and see on is yield and the question of what’s an income investor to do in 2021 in what remains a very low yield environment. What are your thoughts on that?

Jennifer Zebniak:

My thoughts are, please don’t give up on bonds. They are still always there when you need them. Yes, yields are low, but they are not negative here in the United States. And an investor is still earning some yield, even though it is a low yield. They’ll still be there and play that defensive role in your portfolio.

Jim Lowell:

Excellent, Jen. Thank you very much. I’m now going to transition to Charlie Toole, dividend income portfolio manager. And of course, Charlie, we just heard from Jennifer, one of our bond experts that the yield is hard to find, income hard to find. Your expertise may enable stock investors and bond investors to have their cake and eat it, too. Can you briefly define why dividend stock investing can and likely should play a role in virtually every investor’s portfolio?

Charlie Toole:

Thanks Jim. Yeah, I think that dividend stocks do play a role in just about every portfolio. When you’re investing in a dividend-paying stock, you get the benefits of the income, but you also get the benefit of capital appreciation that comes with owning stocks. And so you can depending on your risk tolerance, combine dividend-paying stocks with municipal bonds and have a nice well-rounded portfolio that’s delivering you income. What we do here is we focus on a specific part of the dividend market and those are companies that are called dividend growth stocks.

Charlie Toole:

Those are companies that raise their dividends year in and year out and to be able to do that consistently year over year, these types of companies are typically financially strong with battleship balance sheets, lots of cash on the balance sheet and a strong and solid business model that generates a lot of cash that they can return to shareholders. One of the things that’s happened over the last year is this segment of the market underperformed but we think a lot of the companies that we own and that are in this space have set themselves up well for 2021. These are like I said, strong businesses. They’ve increased market share or they have strong balance sheets where they can go out and maybe acquire companies that can help strengthen their businesses going forward.

Jim Lowell:

Charlie, many investors still think that dividend stock is a synonym for value stocks. Can you discuss how this has changed and how it’s reflected in your portfolio? And maybe touch on valuations on both the growth and value side of the dividend-stock ledger?

Charlie Toole:

Sure. I think it’s very easy for investors, old people like me that remember what dividends stocks used to be. And then those used to be telephone companies or other utility companies, big oil companies and big banks. And that is what dividend stocks used to be. But now there are stocks in every sector that are paying a dividend, including growth sectors like technology and biotechnology. You can find, or you can build a portfolio of dividend-paying stocks that covers all the broad sectors. I think that looking at valuations, there’s certainly a discrepancy between higher growth stocks or companies and traditional value companies and while I won’t get into the growth versus value argument, I will give an example just based on different sectors.

Charlie Toole:

A traditional value sector would be the energy sector. And if you’re an energy company, you have to spend a lot of money to discover oil. And then once you discover where the oil is, you have to spend a lot of money to put in the infrastructure to get it out of the ground. And you have to keep doing that to replenish those reserves. That’s a lot of cash that an energy company has to spend. On the flip side. If you’re a technology company, say a software company, you need to hire people to build the software and you need to hire or buy computer and servers to run that software. But that’s a small amount of cash that you have to deploy relative to the energy company.

Charlie Toole:

When you look at a lot of growth stocks are what we would call asset light. They don’t have to spend a lot of money to build a big infrastructure around how they run their business. And so that would lead to a higher valuation. Meaning because when the tech companies or when the software company is generating revenue, a lot more of that revenue is kept for the investors, whether it’s dividends, stock buybacks or reinvesting in the business. For a lot of value stocks, they have to put a lot of their revenue into maintaining their business so they don’t generate as much cash. And so that’s where you get the discrepancy in valuation, but over time, and over the last few years, we’ve seen a lot of money gravitate towards that growth. Growth sectors, those growth stocks and that’s driving the valuations higher relative to the value sector or sectors.

Jim Lowell:

Excellent. Jeff, team, we believe in discipline, diversification and thanks to Liz, Jen and Charlie for providing diversified views on the stock and the bond market. Let me bring it back to Jeff to weave together all we have just heard. And Jeff ask you to deliver, as you do every week for the investment committee and our whole firm, a summary view. What you think are the biggest investment in income challenges and opportunities in 2021.

Jeff DeMaso:

That’s a tall order, Jim. I’ll see what I can do, but my first thought is actually, while it feels like we’re living through a year for the history books, the challenges we face as investors are really the same that we always do. We know that over time investing in the stock market has been the best way to grow and compound wealth but the price of doing so, of growing your wealth is that the stock market’s volatile. There are declines, there are bear markets, there are curve balls and risks out of left field as we’ve got a great example of this past year. And on average, stocks drop 14% from a high point on average every year. We know how we’re going to face difficulties and challenges and there’s going to be periods where it feels like the market’s going to keep on going down and that the end of the world is near, but we’ve also seen examples that the economy and the markets are enduring and adaptable.

Jeff DeMaso:

If I think specifically to 2021, I think the biggest challenges and opportunities are really two sides of the same coin. And that’s the return to normal, if we can call it that or if we ever do end up going back to normal. But nonetheless, there is a lot of pent-up demand and activity out there. We all want to get back to being social and being mobile and traveling and going out to eat as we used to do. And there is a lot of opportunity in that. At the same time, I think that’s also where the biggest challenge is, is that if the economy is growing, what does that mean for interest rates and bond prices? I agree with Jen when she says, “Don’t give up on bonds, they have a valuable role to play in your portfolio.” But yields are low and that suggests that the returns coming from that side of our portfolio are also going to be low in the years ahead. And so that’s a challenge that we have to think through and plan for as we move on down the road.

Jeff DeMaso:

And if I could end on just one kind of big-picture idea, I’m always a long-term optimist. And I don’t necessarily know what will come out of this past year, but I do know that when we’re faced with challenges, problems to solve, that’s when the seeds of progress are planted. When everything’s going well and smoothly, there’s less need to innovate or find new ideas. But again, when we have a problem to solve, that’s when we make new discoveries and advances. I just saw today that 1.5 million new businesses were started in the U.S. in the third quarter alone. In pre-COVID times, the high was 800,000 to 900,000 new businesses in a quarter. A lot of new businesses were started. That’s a huge increase. And of course, many of them are going to fail, but the seeds of growth and progress have been planted there.

Jim Lowell:

Excellent point to end on Jeff. Where danger exists, there the saving ground arises. And what remain uncertain times, one thing is certain, we haven’t changed our investment discipline based on what others fear. Instead, for more than 25 years, we’ve invested based on the facts we know and no matter how volatile the next 25 days or 25 years will be, we look forward to helping you secure your financial future. And look to our podcast as one way in which we’re always not just on your side, but by your side every step of the investment way. And on that note, this has been Jim Lowell and key members of our Adviser Investments research and manager teams. Many thanks to each of today’s participants and to all who listened into another The Adviser You Can Talk To Podcast. If you enjoyed this conversation, please subscribe and review our show. You can check us out at adviserinvestments.com/podcast. And of course your feedback is always welcome. And if you have any questions or topics you’d like us to explore, email us at info@adviserinvestments.com, and thank you for listening.