Michael Hatcher, head of global equities and director of research at Trimark Investments, says that given that the equity market is no longer cheap, one strategy is to look for companies that have been erroneously priced because of investor concern about disruption from new technology.
"It is necessary to assess the specific business of each company to evaluate its vulnerability," says Hatcher, a value manager. "The equity market is taking a broad-brush approach regarding the potential challenges posed by the major tech companies to a variety of sectors, he says. "Yet there are high barriers to entry in the case of some individual businesses that are caught up in this general concern." These businesses "have proprietary products/services and an established clientele." The equity market, in taking these stocks down, has overlooked this, he notes.
There is no doubt, says Hatcher, that the bull market in equities is "getting longer in the tooth and valuations are up there." Following the 2008 global financial crisis, the equity market rebounded in early 2009 and has gone up since then, he says. "This has been fuelled by both the gradual global economic recovery and historically low interest rates."
The benign interest-rate environment has changed, says Hatcher. "We are now experiencing a period of structurally rising interest rates, after living through decades of declining rates." This altered interest-rate environment, combined with the high valuation in the equity market, "increases the risk to the system." The equity market has certainly become more volatile since the beginning of 2018, after many years of relative calm, he says.
In the first three months to the end of March, the MSCI ACWI Investable Market Index, an all-country world index, had a slightly negative total return in U.S.-dollar terms of minus 0.78%. But for the 12 months ended in March, the index returned a solid 15.61%. This 12-month return is comfortably above the average three-year total return on this index of 8.84% in U.S.-dollar terms. "The strength in the global equity market can continue for some time, even though the risks are increasing," says Hatcher.
At Trimark Investments, a division of Toronto-based Invesco Canada Ltd., Hatcher's wide-ranging responsibilities include that of lead manager of the flagship Trimark Fund and other key mandates such as Trimark Global Fundamental Equity and Trimark Global Dividend Class.
Essentially a bottom-up stock picker, Hatcher's investment horizon is longer-term. His targets are companies that are leaders in their field, have high defendable barriers to entry, are strong generators of free cash flow and produce high returns on invested capital. On valuation, the stocks of these targets must trade at a discount to Hatcher's estimated intrinsic value of the company.
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| Michael Hatcher | |
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At the end of March, Trimark Fund, with 34 names, had 52% of its holdings in U.S.-based companies and 11% in companies based in the United Kingdom. These are its two largest country weights. Emerging markets represented 7% of the portfolio at the end of March, or roughly half of their weight in the fund a year ago. "Developing-markets stocks have had a strong run and it was time to take some money off the table," Hatcher says.
The biggest sector weights in the fund at the end of March were industrials (23%), information technology (22%) and consumer staples (17%). An industrial stock that is currently suffering from investor concern about potential disruption is UK-based Nielsen Holdings PLC. The stock trades in New York under the ticker NLSN. Hatcher reports that he has taken advantage of the weakness in this stock to add to its weighting in the fund.
Founded in Chicago in 1923, Nielsen provides consumer market-research data and tracks media market shares. There is concern that the readily available data over the Internet reduces the value of Nielsen's proprietary offerings, says Hatcher. "But Nielsen's information is consistent, reliable and rigorous, unlike that on the Internet." Over the past two years, Nielsen has, he says, developed a more robust platform and added new products. "The barriers to entry into its two principal businesses are much higher than investors are giving the company credit for."
The shares of the industrial-supply company 
W.W. Grainger Inc. (GWW) had also come under pressure on concerns about disruption, says Hatcher. Investors were worried that the online shopping giant Amazon.com Inc. (AMZN) would put Grainger out of business. "But Amazon is geared to the consumer and Grainger is geared to industry." The latter is a major distributor of a comprehensive range of cleaning supplies and other maintenance items for industry. "This business is highly specialized and the barriers to entry are high." The market recognizes this now, says Hatcher, and the stock has had a good run. "I reduced the fund's holding in Grainger, based on valuation."
| Nielsen Holdings PLC | W.W. Grainger, Inc. | |
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| May 14 close | $30.52 | $295.71 |
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| 52-week high/low | $43.61-$29.65 | $309.80-$155.00 |
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| Market cap | $10.9 billion | $16.7 billion |
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| Total % return 1Y* | -21.1 | 63.0 |
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| Total % return 3Y* | -8.7 | 7.9 |
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| Total % return 5Y* | 0.8 | 4.0 |
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| *As of May 14, 2018. All figures in U.S. dollars Source: Morningstar |
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A new tech name in Trimark Fund is Analog Devices Inc. (ADI). This is a U.S.-based multinational company that makes a broad range of high-performance analog, mixed-signal and digital signal-processing integrated circuits "used in many applications." This includes computer systems for vehicles, automated factories and medical systems.
Analog Devices is one of two dominant players in this business, says Hatcher. The other is Texas Instruments Inc. (TXN). There is growing secular demand for these specialized semiconductors, he says, "as their use increases and applications broaden." Analog Devices generates strong cash flow and a high return on capital, he says. The stock trades at 15.5 times 2019 earnings-per-share estimates.
Microsoft Corp. (MSFT) remains a core holding in Trimark Fund. "It is broadening its offering through acquisitions and is building its business in Cloud computing, which is a high-growth business," says Hatcher. The stock trades at 24 times next year's estimated earnings per share. "The strong long-term trends in Microsoft's businesses do justify this valuation, but the stock is not cheap."
As a dominant search-engine company and advertising medium, Alphabet Inc./Google is a disruptor, says Hatcher. "Like Microsoft, the company has a strong secular demand for its services." Trimark Fund owns both the Class A shares (GOOGL) and Class C shares (GOOG). "As a data collector from its users, Google has to be conscious of privacy issues and not cross the line." The stock trades at 24 times 2019 earnings-per-share estimates, "which also indicates a richly priced market."
In the consumer-staples sector, the global tobacco and cigarette manufacturer British American Tobacco PLC (BAT) is a major holding in Trimark Fund. The UK-based company has an American Depository Receipt and trades in New York under the ticker BTI.
BAT and its rival U.S.-based Philip Morris International Inc. (PM) have introduced a "heat-not-burn" tobacco device that aims at reducing the adverse health effects of smoking, says Hatcher. "The idea is that because it does not burn the tobacco, the device will release less harmful chemicals than those found in tobacco smoke from conventional cigarettes."
So far, says Hatcher, the product has been successfully tested in Japan, "where it has gained significant market share." The next step is to obtain regulatory approval from the U.S. Food and Drug Administration so that the product can enter the U.S. market, he says. The stock trades at 12 times earnings-per-share estimates for 2019. "Investors still view the tobacco industry as a declining one."
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