In today’s podcast, we will speak with Harindra de Silva, Ph.D., CFA®, Portfolio Manager for the Wells Fargo Asset Management (WFAM) Analytic Investors team, about how a new factor, the stay-at-home order, has changed historical risk profiles and what it may mean for a portfolio’s risk profile.
Laurie King: Factor investing has some important lessons for us about how risk has changed in the marketplace. Today we’ll get an update about the stay-at-home factor and the effect it’s having. I’m Laurie King, and you are listening to On the Trading Desk®.
Today I’ll be talking with Harin de Silva, Portfolio Manager for the Wells Fargo Asset Management Analytic Investors team about factor investing. Their models, which adapt to the current conditions and deliver up-to-date snapshots of the risk environment, provide important and timely information to consider when making investment decisions.
Welcome to the program, Harin.
Harin de Silva: Happy to be here, Laurie.
Laurie: So the last time we spoke about this topic back in May, you said that investors should review their portfolios, because the type of risk they thought they had exposure to may now be completely different. And that factor you were talking about was the stay-at-home factor. Can you tell us more?
Harin: Yeah, what we mean by the stay-at-home factor is really how susceptible a business is to the general populace being asked to stay at home or operate their businesses from home.
So if you think about what happened in February, March, April of this year, a large portion of the population chose to stay home or was told to stay home. And that had a dramatic impact on the revenue model and the business model of a number of businesses, and what we mean by the stay-at-home factor is basically how sensitive is a business to that behavior.
Laurie: So let’s focus on equities. If there have been massive changes in equity market betas, what is beta and why does it matter? Or how would an investor use that information?
Harin: So, well, a beta measures how sensitive of a stock or a security is to systematic risk. So when this new factor arrived, the definition of systematic risk changed, right?
So if you think about as of the end of last year, when you were looking at a company, you never thought of a company and said, hey, how sensitive are the profits of this company if everyone decides to stay at home?
Whereas now, it’s something you think about, and what beta measures now is how susceptible the company is to that type of risk.
Laurie: So how is the stay-at-home factor affecting the stock market and, specifically, sectors within the stock market?
Harin: So within the market, you’ve really seen some really surprising developments, because there have been companies within the semiconductor sector, for example, which have seen a dramatic decline in their risk because these are companies where their business model is not sensitive to people staying at home.
Same with some companies in the biotech industries, so these are, again, companies which are not affected by this new tendency.
Whereas you’ve seen companies in the real estate sector, you’ve seen companies in the travel sector, you’ve seen companies in the retail sector, or in the restaurant industry, all have their risk go up, because they are very susceptible whether the people are staying at home or not. So you really see the big differential impact across sectors in terms of the way the profits of these sectors and, therefore, the price volatility of these companies, has gotten affected.
Laurie: And within an industry, can you share an example of what the new risk factor may mean at the actual stock level?
Harin: Yeah, within an industry, I think it’s really fascinating to see the changes. So if you take two companies—like, for example, Netflix and Disney—Disney has a business model that’s very diversified, but it’s very susceptible to people staying at home. So if you can’t go to a theme park, if you can’t go to a hotel, you’re still going to watch Disney movies, but that’s only a small portion of their revenue.
Contrast that with something like Netflix, which has really no big physical assets and all of the revenues are from streaming and they’re able to produce new content and people are consuming even more of the content. So Netflix has very low exposure to this factor. In fact, it benefits from people staying at home, where Disney actually gets affected by that.
Even within the retail sector, you’ve seen this type of differentiation. So if you think Macy’s versus Walmart, similar customer base. One of them, unfortunately, Macy’s has a lot of exposure to retail traffic in malls, and they’ve been very badly affected by the pandemic and the stay-at-home factor, whereas Walmart has had record profits, and their revenues haven’t been affected at all by this factor. So very different impact, even though these companies are in the same industry.
Laurie: That’s interesting. Is the stay-at-home factor affecting investment-grade credit bonds differently than it is those sectors within equities? Or what were your most important findings regarding investment-grade credit issuers?
Harin: Very similar impact in investment-grade credit on a sector basis. The only big difference, I think, is that investment-grade credit is not that common with newer companies and not that common in the technology sector. So we haven’t been able to actually observe that, because, obviously, a lot of technology companies don’t have debt. So we haven’t seen them, in a sense, benefit from this factor showing up.
Laurie: Now that you have recognized and measured the effect of new behavior—this staying-at-home behavior—on equity and credit assets, what is the next step for investors? What should an investor do with that information, for example?
Harin: Well, what we’ve been able to do is basically quantify this, right?
So the first step in anything is measure it, and what you’ve been able to do is basically say, is a company benefiting from the stay-at-home factor? So I’m just going to pick on Netflix and say Netflix benefits from the stay-at-home factor versus a company like Macy’s, which gets hurt by the stay-at-home factor.
So you’re going to decide whether a security gets benefited or hurt as a result of the factor or whether the company is basically immune to the factor. So Walmart is immune to the factor because as we go forward, as the economy reopens, the return to this factor is actually going to be negative, right? So what you need to do is make sure that if you’re holding a company that benefited from this factor, you’re not going to get hurt when we go back to normal.
So as we enter into this kind of reopening era over the next six months, you’re almost going to see the reverse of what we saw over the last six months. So in my kind of stock example, I would say Walmart is kind of, from a risk factor perspective, the place to be because it neither benefited nor got hurt. It was basically immune to the stay-at-home factor.
Laurie: As we wrap up this episode of On the Trading Desk, do you have a takeaway message that you’d like to leave our listeners with?
Harin: I do. I think when we think about this, it’s really got an important lesson for us, because obviously, we can’t put the pandemic genie back in the bottle, but when we think about the last six months, what the last six months basically tells you is it really highlights the importance of having systematic asset allocation.
Because if you ignored the decline we saw in February, you actually had pretty good returns this year, right? Because the market reacted, we had a lot of creativity in terms of the way industries responded, we had the arrival of very rapid development of new vaccines, and if you’d kind of shut your eyes and say, I realize equities are risky and this is the risk of associating equities, but history is going to repeat in terms of a recovery in the market, you’re going to be okay. So it really highlights the important of having a systematic asset allocation strategy when you are looking at individual asset classes.
Within an asset class, you have to realize that new risks do arrive. So in the 70’s, you had the oil crisis, in the late 90’s and early 2000’s, you had the Internet factor arrive. So when these factors arrive, they’re around for a long time, so as I said earlier, you can’t put this pandemic genie back in the bottle, but this risk factor is going to be with us for a long time, and I think companies that have shown that they can manage through this crisis in terms of having a business model that’s not susceptible to these types of shocks will actually do better going forward.
So again, very important to measure this type of risk and adjust your portfolio accordingly.
Laurie: Well, thank you for that and thanks so much for joining us today, Harin.
Harin: Thank you, Laurie.
Laurie: For our listeners, if you’d like to read more market insights from Analytic Investors, you can find them at our AdvantageVoice® blog. Our full range of Investment Perspectives can be found by visiting wellsfargoassetmanagement.com.
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