Jeremy Grantham Favors High Quality US Stocks: Market Commentary

Today we're doing a bit of 'market-strategy-Monday' here on Market Folly and will kick things off with the often-read missive of GMO's Jeremy Grantham. He is now a deflationista as he thinks it has trumped inflation as the biggest concern in the near-term. While Grantham doesn't seem too anxious to be a buyer of many asset classes, there are three areas he has deemed compelling. GMO's asset allocation portfolios are built on a seven-year forecast and here are his thoughts:

Firstly, Grantham sees value in high quality large cap US companies. The main argument? Valuation. Just last week, we highlighted hedge fund T2 Partners' bullish presentation on 3 large cap stocks. The 'buy high quality large cap' theme has been long underway in hedge fund land as a plethora of managers have now sung the praises of this opportunity. Pershing Square's Bill Ackman went long Kraft (KFT) on this notion (among other reasons) and East Coast Asset Management likes quality names as well. Grantham's GMO colleague Edward Chancellor echoes these thoughts. He says,

"When we look through the various classes of equities, we find in the U.S. that companies that are so-called quality have high expected returns relative to the market; in other words, companies that tend not to go bust, and tend to maintain their positions—the sorts of businesses that Warren Buffett made his fortune investing in and are trading at a P/E of about 14. Johnson & Johnson (JNJ) and Pfizer (PFE) are key companies—the sort that your grandmother had in her portfolio or are typically owned by trust companies. Normally they trade at premiums to market, but right now they’re not."

Chancellor also sees opportunities in the European high quality equivalent. In particular, he mentions Nestle (NSRGY), Novartis (NVS), and Unilever (UN). Last week we also pointed out how hedge fund Viking Global has a large stake in Unilever as well.

Secondly, Grantham believes that emerging market equities are the next best play. This is mainly attributable to the fact that the fundamentals in these countries are so much better than our own markets. While EAGE equities are slightly expensive, they are a much better option than say, fixed income.

Lastly, Grantham remains staunch on his view of forestry (i.e. timber). He has long advocated a place in portfolios for timber as it serves as a good diversification tool during the good times. And, during periods of uncertainty, it is a "brilliant store of value should inflation unexpectedly run away, and a historically excellent defensive investment should the economy unravel."

Embedded below is Jeremy Grantham's latest market commentary from GMO:



You can download a .pdf copy here.

For more excellent commentary be sure to head to the latest hedge fund letters where prominent managers share their thoughts on the markets.

Hedge Fund Viking Global Likes American Tower (AMT), Invesco (IVZ): Q2 Letter

Andreas Halvorsen's hedge fund firm Viking Global is out with its second quarter 2010 investor letter and courtesy of Dealbreaker we wanted to highlight some of their latest portfolio maneuvers. Here are Viking's latest top 10 positions:

1. Invesco (IVZ)
2. Unilever (UN)
3. American Tower (AMT)
4. Oracle (ORCL)
5. Comcast (CMCSA)
6. News Corp (NWSA)
7. Tyco International (TYC)
8. Sherwin-Williams (SHW)
9. Goodrich (GR)
10. Adobe Systems (ADBE)

Right off the bat there are several changes to highlight between Q1 and Q2. Back in the first quarter, Visa (V) was Viking's largest position. This time around, Visa is nowhere to be found in their top 10 positions. One might assume they reduced or exited this position, but there was no commentary on this stake to verify. If you read into their letter, you'll see that they are more focused on building concentrated positions and as a result ramped up stakes in various companies. Visa, apparently, was not one of them.

It's quite possible that the credit card processor is still a holding at Viking and other portfolio positions merely leapfrogged their V stake. The same could be said for their position in Express Scripts (ESRX) as it was their fourth largest holding in the first quarter and is nowhere to be found on their top 10 holdings for Q2. These positions will certainly be something to look for in their Q2 13F filing that we'll cover when it's released in a few weeks.

For the second quarter, Halvorsen's hedge fund maintains its long-held position in Invesco as it moves back up to their top holding. Halvorsen writes,

"Our largest loss in the quarter was Invesco which cost us 1.3% in VGE and 1.4% in VLF. Invesco has been in our top ten list since we initiated the position in the fourth quarter of 2007 and was our second most profitable investment in 2009. During the second quarter, Invesco sold off along with other asset managers despite reporting better than consensus first quarter earnings and higher synergy estimates from the Van Kampen acquisition. Encouraged by the fundamental strength of the company and financial and strategic benefits from the Van Kampen acquisition, our core thesis has not changed and we continue to believe that Invesco will outperform its competitors. Viking is currently net long 2.4% in the Asset Management and Custody Banks sub-industry group, which includes the Invesco long position and short positions in asset managers that we believe will experience deteriorating fundamentals and are more levered towards a declining market."

In terms of other Viking positions, Unilever also remains a high conviction pick for them. Moving down the top 10 positions list, News Corp and Tyco also retain their status as a top holding from Q1 to Q2. In terms of new additions, Viking has moved up the following positions: Adobe, American Tower, Comcast, Goodrich, Oracle, and Sherwin-Williams.

Of those stakes, Viking has increased conviction in their new American Tower (AMT) position. Viking likes the company due to its solid business model with high barriers of entry, pricing power, and strong secular growth. Additionally, the company has compelling operations overseas in numerous growth markets. Of this stake, Halvorsen writes,

"We have owned American Tower in the past and we re-initiated a position this quarter because we believe the market has taken many of these characteristics for granted and is underestimating future growth opportunities both domestically and internationally. Additionally, we believe that American Tower’s shareholder remuneration will accelerate over the next several quarters and that, in light of certain tax incentives, the company may convert to a REIT. We find American Tower to have a superior business model relative to most traditional REITs, yet it trades at a discount to the REIT-average. We believe the combination of predictable growth, accelerating shareholder returns, and pending REIT status will generate greater shareholder interest over the next several quarters causing the stock to trade closer to our price target over time. As of June 30, American Tower was our third largest long position at 4.3% of VGE capital and 4.9% of VLF capital."

We've touched on this industry as a compelling investment numerous times as hedge funds favor wireless tower stocks. Numerous high profile managers have moved in and around AMT. Additionally, we've highlighted how hedge funds are bullish on rival company Crown Castle International (CCI) as well. SBA Communications (SBAC) is the other player in the sector and some funds have moved in and out of stakes there as well.

In addition to these portfolio changes, it's obviously worth noting that Viking has struggled performance-wise this year as their Viking Global Equities portfolio was down 5% in the second quarter. As such, Halvorsen penned quite an explanation as to how Viking will strive to atone for these errors and the solution apparently circles around the idea of increased concentration in their highest conviction picks. As such, Viking has added to numerous positions, many of which we've detailed recently. It will be interesting to see if Viking's increased concentration (and possibly increased volatility) is a recipe for correcting their recent struggles.

We highly recommend reading Viking Global's entire letter on Dealbreaker here.

Andreas Halvorsen & Viking Global Betting On Visa (V): Portfolio Update

Dealbreaker recently posted up the latest letter from Andreas Halvorsen's hedge fund Viking Global. In it, we learn that Chief Investment Officer David Ott will be stepping down to spend more time with family. We also get a glimpse as to what Viking's portfolio looked like at the end of the first quarter and what their next 13F filing will likely look like. Here are their top 10 positions:


1. Visa (V)
2. Invesco (IVZ)
3. Unilever (UN)
4. Express Scripts (ESRX)
5. Tyco International (TYC)
6. Bank of America (BAC)
7. Metlife (MET)
8. News Corp (NWSA)
9. JPMorgan Chase (JPM)
10. Barclays (BCS)


Right away you'll notice that these positions are slightly different from Viking's prior portfolio that we examined. Four of their top ten longs are either new or re-entered positions, including: Tyco, Metlife, News Corp, and Barclays.

Their largest position, Visa, represents 7.0% of capital in their Viking Global Equities fund. We finally get some color as to the investment thesis for each payment processor in particular via Halvorsen's letter. Viking previously owned Mastercard (MA) as well, but they did not own it at the end of the first quarter. Halvorsen writes,

"Our largest loss in the quarter was in Mastercard (MA.N) which cost us 0.7% in VGE and 0.9% in VLF. We have owned Mastercard at various points since its IPO and continue to believe in the long-term strength of its business model. Mastercard was our largest profit contributor in 2007, second-largest in 2008 and third-largest in 2009. Although we continue to believe in strong secular revenue growth for transaction processors, Mastercard relies heavily on credit card spending (which offers slower secular growth than debit cards) and has suffered a few key customer losses that will weigh on results in the short-to-medium term. Visa, which was our largest position as of March 31, was the beneficiary of this share shift."

This is intriguing to note because some hedge funds have owned both payment processors while some managers have favored one over the other. While Viking is monitoring Mastercard for potential re-entry points, it's clear that for now they'll stick with Visa as they expect its strong debit card exposure to bolster performance. You can see which hedge funds own Mastercard here and which hedge funds own Visa here.

The letter also provides some color on their Express Scripts (ESRX) stake as they expect this big pharmacy benefit manager (PBM) to benefit from the impending brand-t0-generic drug conversion. Viking sees significant upside and thinks ESRX commands a multiple of 20x earnings versus the current 16.5x 2011 numbers. Lastly, we just want to highlight Viking's large position in News Corp (NWSA). That stock of course is one of Seth Klarman's big holdings at Baupost Group.

Results wise, Viking has struggled recently. In the first quarter, they were down 0.1% as noted in our recent hedge fund performance numbers post. Halvorsen mentioned that their poor performance this time around was attributed to a few large long positions. This is a shift from the losses they suffered on the short side of the portfolio in 2009 as covered in a previous Viking investor letter. Viking Global Equities' ten largest single name short positions accounted for 15.9% of capital as of March 31st, 2010.

In terms of a pure long/short trade, Viking, like many other hedge funds, had on a long moneycenter banks, short regional banks trade. Halvorsen writes, "Bank longs contributed 0.2% while Bank shorts cost us 1.3%. The longs represented large, well-capitalized banks that, in our opinion, have adequately provided for losses in their loan portfolios. We were short a collection of smaller, regional banks with significant commercial real-estate related loan exposures that we believe have not yet been fully marked-to-market leading to a need for additional capital over time."

Below is an excerpt Viking's first quarter commentary where Halvorsen addresses the notion of hedge fund herding:

"We are often asked by investors how we think about owning stocks that are widely held by other hedge funds. There is no categorical answer to this question, but I would like to discuss some of the factors we consider when establishing and maintaining positions in companies known to be popular with our peers. First and foremost, the critical issue is whether we are ultimately proven right in our analysis. Every single position we take has been independently researched by a Viking analyst and each investment decision has been thoughtfully deliberated by one or more of our portfolio managers. We do not borrow conviction from another firm or individual, although we frequently find it informative to talk to other investors to understand the attributes they value. These conversations can help us better assess what has already been reflected in the prevailing stock price. Incidentally, we often find the greatest success in investments where we have a differentiated view from the Street, but we do not shy away from high conviction ideas just because other hedge funds are involved. Although we thrive on standing alone, we do not take positions opposite other firms just to be contrarian. We recognize that all the shares of a given company must be owned by someone and it can be comforting to know that the other shareholders represent firms that we respect rather than not. There is obviously some risk associated with being in an investment alongside likeminded investors who may have been trained in the stock-picking trade in similar ways in that we may decide to sell at the same time. To limit the consequences of crowded exits, we pay attention to the liquidity of the stocks we trade and take large positions only in the most liquid stocks in the world. The problem of crowding is most acute in our shorts due to the risk of unlimited loss and the potential for cancelled borrow arrangements. Here we do tread carefully. As you are aware, we are guarded in disclosing our shorts to anyone and we do on occasion limit the size of our positions, or eliminate them altogether, when we perceive a position to be tight in the borrow market or crowded by equity long-short investors. Ultimately, we live and die by our analysis, portfolio management skills and efforts to contain risk – managing crowded trades is merely another challenge we face in delivering attractive returns at reasonable risk."

One last thing we found interesting in Halvorsen's commentary is that he essentially confirmed that all the Tiger Cubs talk and bounce investment ideas off each other. Let's face it, we already knew this. But it's still intriguing to see his response to investor concern over holding stocks that many other hedge funds also own.

Keep in mind that you can replicate Viking's long US equity holdings via the Tiger Cub Portfolio created with Alphaclone, the hedge fund backtesting and replication software we use. Alphaclone gave our readers a special free 30 day trial for those interested, so take advantage of it. While Viking Global was originally founded by three Tiger Management veterans (Brian Olson, David Ott, & Andreas Halvorsen), only one of those founders now remains (Halvorsen).