Large Cap Value: Today, Tomorrow, and Going Forward

Today’s podcast features a conversation around why large cap value is really appealing in this environment and how our Special Global Equity Team is approaching investing in the space. To discuss these implications is Bryant VanCronkhite, Co-Team Leader and Senior Portfolio Manager with the Special Global Equity Team.

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Brandon Brouillard: I’m Brandon Brouillard, and you’re listening to On the Trading Desk®.

I’m really excited for today’s conversation around why large cap value is really appealing in this environment and how our Special Global Equity Team is approaching investing in the space.

With this in mind, we’ll be talking about three things that are deserving of investor’s attention right now: The first, sourcing alpha in large cap value, despite current levels for the S&P 500; the second, how the U.S. infrastructure bill could impact large cap companies; and the third, why expertise across all cap ranges creates opportunity for our team.

With me to discuss these implications is Bryant VanCronkhite, Co-Team Leader and Senior Portfolio Manager with the Special Global Equity Team. Welcome to On the Trading Desk®, Bryant.

Bryant VanCronkhite: Thanks for having me, Brandon.

Brandon: Absolutely. So let’s jump in right away to set the stage for our listeners around what’s driving equity markets today. With the SPX (S&P 500) near all-time highs, what are you thinking about for opportunities in large cap?

Bryant: The large cap universe is rich with amazing businesses. It’s sometimes easy for us to think about it as just the S&P 500 or, even more narrowly, as the FAANG stocks, FAANG being Facebook, Apple, Amazon, Netflix, Google, and you can even throw in Tesla. But the Russell 1000 Index includes companies from $2 billion in market cap all the way up to $1.5 trillion. The unique nature of how the S&P 500 constituents are determined and weighted can skew investor perceptions of what it means to invest in the category of large cap stocks and oftentimes how we measure the success of our investments within large caps.

What I really find intriguing about large caps is the hunt. As a team of almost 20 people, the Special Global Equity Team has scoured for opportunities to invest in companies that control their own destinies.

The reality is that many of the large cap companies have already proven themselves to be tremendous businesses in many different aspects, right? They demonstrate the presence of competitive advantage. They have a diverse set of products or services sold across multiple geographies. Their cash flow generation is bountiful and sustainable. The list of glowing remarks goes on and on with these businesses. That’s why they become large cap companies in the first place.

However, none of those things necessarily make them good investments. When everyone knows those things about a business already exist, it’s oftentimes valued as such. We don’t buy great businesses when they’re fairly valued. We’re looking for businesses that are exceptional in every way, but the market’s treated them unfairly for some reason today.

So what excites me about the large cap universe is the perception that companies struggle to differentiate and that the market is super-efficient and that active management can’t add value. I’ll be the first to say that those comments are accurate for a good-sized portion of the large cap universe. But I expect our differentiated approach, designed to identify companies that have the ability to drive value creation through the use of their balance sheet, will lead us to some very unique and exciting opportunities.

Brandon: That’s interesting and really great insight there and great to know that there’s still a lot of favorable elements in place to fuel large cap opportunities going forward.

Among these I’m sure includes some opportunities that are arising from the infrastructure bill that was announced earlier this year. Can you talk about how you foresee this bill impacting large cap names and what the team’s doing to position for this opportunity?

Bryant: Well, as you know, Brandon, the infrastructure bill is taking daily twists and turns as it moves through the political process. The range of outcomes is still reasonably wide. But as investors, we need to be forward-thinking and appreciate not only the potential rewards of fiscal policy but also the risks.

We on the Special Global Equity Team always focus on risk first, so let’s start the conversation there.

So number one, infrastructure spending has to be paid for in some way. The most sizeable bucket to pay for spending is likely to come from increased taxes that might uniquely impact large cap companies. That’s not to say that small cap and mid-sized companies can’t even be more negatively exposed, but there are some provisions being tossed around that could hit large cap businesses across several sectors.

Our team is looking at potential ramifications from a minimum 50% book tax to an outright increase in corporate tax rates. And navigating that financial impact on a company-by-company basis is challenging, but an endeavor that we are pursuing and chasing every single day.

Second, we shouldn’t discount the possibility that a bill doesn’t get done at all, and what does that mean for valuations in the overall market if that were to happen?

And third, we have to appreciate the challenges of procuring the resources needed to fulfill the spending embedded in the bill’s efforts, so things like materials and cement and steel and even labor. Finding those resources is challenging.

But that leads us to the reward side, and what’s exciting about this bill, and especially for large cap companies, is that large cap businesses that are best positioned to procure those needed materials. They’re best positioned to raise their pricing, get labor, and benefit meaningfully from a bill, if it were to pass.

Second, having an infrastructure bill that’s being proposed which is paired with accommodative monetary policy is likely to bring meaningful economic stimulants to the U.S economy. The effects of that should accrue actually to small and mid-cap stocks to a greater degree than large cap stocks, but more importantly, if the accommodation triggers broad economic expansion and inflation, that likely could trigger higher interest over time. And if rates move higher, it could have a unique impact on the large cap indices, such as the S&P 500 versus the Russell 1000 Value.

And so it’s important to appreciate how interest rates and interest rate sensitivity impacts growth versus value and how certain benchmarks are tilted in that regard.

So with that said, large cap stocks touch every aspect of the economic universe and a fiscal package as large as the one proposed by the administration will provide fertile hunting ground for us to explore.

Brandon: Thanks for that insight. And it’s likely that this bill doesn’t just impact large cap names, but it’ll have implications for small and mid-cap names, as well.

So the Special Global Equity Team now manages portfolios in the small, mid, and large cap space. Why is it important to you and your team to have exposure across all caps, particularly as you look to capitalize on opportunities like this infrastructure bill and inform your investing around large caps?

Bryant: Yeah, it’s sort of silly to state the obvious that we live in a global and connected world. I spent the last 15 years of my career analyzing small and mid-sized companies and it’s with rare exception where we can find a company where the financial profile’s only impacted by the country of domicile of that business or not impacted by a host of companies that are up and down the food chain from them.

So whether that company is a B2B company, which is business-to-business, or business-to-consumer company, they’re impacted by a customer, a competitor, a supply chain provider up and down the market cap spectrum.

And let’s just look at a few industries as an example. So look at GM and Ford and the impact those companies have on the auto part companies in the small and mid-cap universe. Or how about the challenges that Boeing in the large cap space over the last two years impacted dozens of smaller players down their supply chain? But the same is true in the opposite direction. The auto OEMs (original equipment manufacturers) of Ford and GM rely on smaller companies where they buy their semiconductors. And the inability to do that has brought their plants to a halt, negatively impacting their revenue, their earnings, their reputation, and definitely the stock prices of these larger companies.

So the fact that our team is monitoring not just an isolated area of the market, but rather we’re in the weeds of companies all way down to sub-$1 billion in market cap and all the way up to over $1.5 trillion gives our team a unique perspective, and on top of that, the fact that we’re global investors and not just focused on the U.S., amplifies the value of that diversity. So we’re excited to be able to look up and down market cap and use that across all our portfolios.

Brandon: That’s definitely exciting and great insight there. Thanks for sharing that. And so expanding on the team and your process, how does it fit and work in large caps? And have you had to make or what kind of accommodations or adjustments have you had to make to align with large cap investing?

Bryant: We haven’t had to make any adjustments to our process. As a quick refresher, our process is focused on identifying companies that control their destiny by deploying their balance sheet. So we spend our time analyzing companies’ balance sheets and trying to figure out how much capital they’re able to spend over a 3- to 5-year investment horizon. And then we assess how they’re going to spend it. Are they going to make acquisitions? Are they going to invest in organic growth through R&D budgets, research and development? Maybe they’re going to invest in vertical integration. Maybe they’ll do buybacks and dividends. That’s a host of choices any company can make.

Our approach is to figure out how much money a company can spend, how they’re going to spend it, and the returns they’ll get for those choices. And we look for where the market’s mispricing this ability to control your own destiny by deploying your balance sheet.

That is applicable from the smallest companies we look at to the very largest companies we look at. But the reality is as you move up cap, the ability for these large cap companies to spend billions and billions of dollars over 3- to 5-years becomes more challenging. It’s hard to make $50, $60 billion acquisitions. It’s hard to invest all that capital or organic investments to move your top line one or two percentage points.

So you’ll see our portfolio have fewer names in it. We’ll own 40 or less stocks in large cap compared to 70 in mid-cap and 100+ in small cap. The only distinction between our portfolios up and down market cap is based on how many names we own to isolate for the opportunity set that exists in each universe.

Brandon: Fantastic. So shifting the conversation to flows in the large cap space for a moment, a lot of money has moved into passive investments in large cap over the last 5+ years. What advice would you offer the passive versus active decision for investors in the large cap arena?

Bryant: The key to active management in every market cap is differentiation.

We have to recognize that most investment teams have the same general goals of generating alpha for a determined level of risk. If every active manager approaches the same goal in the same way, the ability for anyone to achieve that goal on a perpetual basis is extremely low.

That’s the reality for large caps, for mid-caps, for small caps. It just so happens that there are more brains and talking heads following large cap companies than they are in small and mid-cap and, therefore, the large cap universe is more efficient.

However, that doesn’t mean that the opportunity to generate alpha at a determined risk profile isn’t as great in large cap as it is in down cap. It’s just that we need to focus our portfolios more so than we do in small and mid, going back to the previous question.

So trying to outguess everybody regarding quarterly earnings against several hundred brilliant investment teams and dozens of dedicated sell-side analysts is begging for long-term mediocrity, in our opinion.

However, attacking the quest for alpha through a unique balance sheet-based approach is rarely done, and it leaves room for inefficiency that we can exploit the large cap space. We’ve dedicated our careers to that unique point of differentiation, and we just plan to keep our heads down, focus on our process, and we believe we can demonstrate that active management in the large cap universe still has a place in most investors’ portfolios.

Brandon: Thanks, Bryant. That’s an exciting proposition, for sure, as we look forward to a large cap value investing. Well, we have about a minute or so left and I wondered if you could share parting thought for our listeners.

Bryant: Thanks, Brandon, and to everyone else for the time today.

My final thoughts would be to recommend taking a wide-angle lens to the large cap market. In our rapidly-approaching post-COVID world, we’ll all be going back to parties and family gatherings, and we’ll end up getting asked about the markets and stocks. And so often, that conversation leads to a narrow discussion about the S&P 500 or one of the FAANG stocks or Tesla.

The large cap market is so much more than that. And even though just a handful stocks are the focus of the media and actually have driven the results of the S&P 500 recently, if we take a step back and appreciate the breadth of the large cap universe and appreciate the risk and the narrowness of some of the more common benchmarks, it really does change the perspective and possibly the investment decision.

The large cap universe is really exciting to invest, especially right now, given the unique characteristics of the market that we face today. And so we’re really excited to be in it for all of our clients.

Brandon: That’s fantastic and it got me excited and pumped up now after this call. Well, thanks again, Bryant. I really appreciate the opportunity to speak with you today. This has been enjoyable and definitely a very informative discussion. So thank you so much.

Bryant: It’s truly my pleasure, Brandon. Thank you.

Brandon: Well, that wraps up this episode of the On the Trading Desk podcast. If you’d like to read more market insights and investment perspectives from our investment teams, you can find them at our AdvantageVoice® blog.

To stay connected to On the Trading Desk and listen to past and future episodes of the program, you can subscribe to the podcast on iTunes, Stitcher, Google Podcasts, or Overcast. Thanks for listening. I’m Brandon Brouillard. We’ll catch you next time.

Originally Posted on June 9, 2021 – Large Cap Value: Today, Tomorrow, and Going Forward

Disclosure: The S&P 500 Index consists of 500 stocks chosen for market size, liquidity, and industry group representation. It is a market-value-weighted index with each stock’s weight in the index proportionate to its market value. You cannot invest directly in an index. The Russell 1000 Index measures the performance of the large cap segment of the U.S. equity universe. It is a subset of the Russell 3000. The Russell 1000 represents approximately 92% of the U.S. market. You cannot invest directly in an index. The Russell 1000 Value Index measures the performance of those Russell 1000 companies with lower price book ratios and lower forecasted growth values. You cannot invest directly in an index. Alpha measures the excess return of an investment vehicle, such as a mutual fund, relative to the return of its benchmark, given its level of risk, as measured by beta. Alpha is based on historical performance and does not represent future results.

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