Harin de Silva, Portfolio Manager with our Analytic Investors team, discusses stay-at-home vs. return-to-work as quantitative factors, how they’ve affected equity markets, and their potential impacts going forward.
Marilyn Johnson: I’m Marilyn Johnson and you’re listening to On the Trading Desk®.
In this podcast, we’re discussing the emergence of stay-at-home, or SAH, and return-to-office, or RTO, as quantitative factors during the pandemic and the impacts they’ve had—and they likely will continue to have—going forward.
Our guest today is Harin de Silva, Portfolio Manager for the Analytic Investors team. Harin, welcome to the program.
Harin de Silva: Hi, Marilyn. Thanks for having me. Pleasure to be here, as always.
Marilyn: Sure, looking forward to our conversation. So let’s get right into this discussion around what you’ve observed and learned regarding the pandemic’s impacts on equity markets since March of 2020.
Analytic Investors has been researching SAH companies versus RTO companies and how each type has been affected by the pandemic. Can you walk through the general characteristics of companies that could fall into each category, and then also, the implications of each group in a portfolio management setting?
Harin: Yeah, the emergence of this factor has really been fascinating because it’s a factor, or a group of factors in this case—stay-at-home and return-to-office, as we call them—that are not really related to any sector or any industry, because what it’s really capturing is the ability of a company to thrive in an environment where individuals or the economy generally is characterized by individuals sitting at home or individuals going back to the work in the way they did in 2019.
And what you see is companies that, if you look at, for example, the entertainment sector, you’ll see a distinction between a company like Disney and a company like Netflix. And if you look at the retail sector, you’ll see a distinction between a company like Walmart and a company like Macy’s, which is very retail, right? They’re both in similar industries, but they behave very differently depending on whether we’re a stay-at-home environment or a return-to-office environment.
Marilyn: Okay, so how could the emergence of SAH and RTO, how can they influence the way or ways that investors approach active and passive equity solutions? For example, indexes are likely composed of companies exhibiting both characteristics. So is there a disadvantage to owning both?
Harin: I think the first thing you need to do is kind of be aware of how much of each you have. So even if it’s a passive index or an active index, I think knowing how much you have is the first thing you need to be able to measure.
The second thing is realizing that I don’t think there’s a disadvantage to owning both, because the goal should be to have a diversified portfolio. And it’s exceedingly difficult right now to say whether the normal world we’ll enjoy going forward is going to be characterized by more of a stay-at-home environment or a return-to-office environment, so a 2019-type of environment.
So I think from that standpoint, it’s really important to have exposure to both these factors in your portfolio because the pandemic or the environment that we have isn’t going to go away, from our view, in the next six months or next year. So both these types of companies have the potential to actually do well. So we really recommend that you maintain a diversified approach by having exposure to both factors in your portfolio.
Marilyn: That makes a lot of sense. So given that we’ve been living in a post-pandemic world for more than a year and half now, how has Analytic Investors evaluated the importance of these factors to markets? And how have you turned them into actionable data points for your portfolios?
Harin: So what we do on a monthly basis is actually reevaluate how sensitive each company in our universe is to each of these factors. And what’s really fascinating is to see some of the changes.
So for example, when the pandemic first started, it was very clear that there were certain types of companies that were more stay-at-home, right? So if you were in the physical fitness industry, if you were dining, if you’re retail, if you’re cruise ships, those are all things that do poorly in a stay-at-home environment.
But as we’ve transitioned in the last year and a half into this economy where we realize that the pandemic is going to be with us for a while, you’ve seen certain companies evolve their business models and be able to thrive in this environment.
So actually being able to measure the change is really, really important. So every month, what we do is we look at the recent stock price returns of companies and then measure statistically how correlated they are with the behavior of a stay-at-home factor vs. a return-to-office factor, and that allows us to characterize our portfolios and then manage the risk of these portfolios.
Marilyn: Well, as more data continue to emerge around variants of the COVID-19 virus, what types of societal shifts are you modeling for and what potential risks should investors take note of?
Harin: Something we’ve been actively managing is really the difference in geographic differences because historically, if you looked at European countries, for example, there hasn’t been a meaningful difference between, say, as an example, France and Germany.
But the way these countries have responded in terms of their vaccination programs, in terms of the level of the stimulus differs widely, even in an economically integrated area like Europe. So we really had to manage country risk in a way that’s very different now than we did in 2019 where the world was really a lot more integrated.
The same thing goes for emerging markets (EM) because EM markets are way behind from a vaccination standpoint. So managing risk on really a country-by-country basis has become a lot more important recently than it was three years ago.
So I’d say investors really need to be aware of country exposures they have in their portfolio and the dependence of the countries on travel and the country’s role in the global supply chain.
Marilyn: Interesting. Thanks for that insight. Specific to companies, Bloomberg manages a list of globally-affected companies and this list keeps changing over time. How do you use this information as an input into your approach and what’s the composition of the investable pool?
Harin: Well, we obviously look at a number of different sources. Bloomberg is one of them. I wouldn’t say we treat it as any different than any of the others. But for us, really tracking how analysts are ranking these different stocks, how they’re changing their estimate revisions of the stocks, that’s actually more important than keeping track of a list. And we do exclude companies where there’s a lot of uncertainty around the earnings outlook from our investment pool.
Marilyn: Shifting a bit to groups of stocks, I’d like to talk for a moment about FAANG stocks—Facebook, Amazon, Apple, Netflix, and Alphabet, or Google—as well as meme stocks. It seems that both of these styles of equity securities have enjoyed significant runs in the late-pandemic world. What are valuations of these companies indicating today and how can investors potentially best position themselves in light of these valuations?
Harin: Valuation is a tough question for these companies. Right now, I think, obviously, valuations are really high for these companies as a group. And the most difficult thing is to compare them to others because there’s a group of companies that have really suffered in the last year.
So if you’re looking at valuations, I tell people that they should be literally looking at things from a forecast earnings standpoint. So look at price to forecasts earnings. Don’t look at trailing earnings, because trailing earnings is really affected by what’s happened in the last year.
But if you look at FAANG stocks, I would really draw a strong distinction between FAANG stocks and meme stocks, because to me, FAANG stocks represent a fundamental shift in the economy. It reflects a change in the way we do business. It reflects a change in the amount of time we spend looking at screens, for example, or the role of advertising. So it’s a fundamental change, and I think FAANG stocks and the performance of FAANG stocks reflects that.
I think meme stocks are something that’s very different. The performance of meme stocks reflects herding behavior, and the performance of those stocks are incredibly correlated. So I really think if you’re going to invest in meme stocks, you really need to be aware of the fact that they have a very high correlation with each other and reduce the diversification in your portfolio by a pretty big impact. And so we really try to take that into account when look at the behavior of meme stocks and incorporate even some of them in our portfolio.
Marilyn: Okay, and now thinking about factors, what types of characteristics do you see FAANG and meme stocks exhibiting? Are these associated with high or low quality, and what are momentum indicators suggesting in terms of shifts across groups?
Harin: Yeah, there’s actually a huge difference between FAANG stocks and meme stocks.
So for FAANG stocks, what you see is really high quality, so you see a lot of profitability. You see companies that are very efficient in their business models. You see very high profit margins.
Whereas generally with meme stocks, as a rule, you see stocks that have been beaten up, have very poor business models, and have, generally, a very speculative risk profile. So I think they’re two very different things.
And if you’re investing in meme stocks, what’s really important is that you’re aware of the risk profile that’s associated with them. And a lot of these companies are under $10 or under $5 and they look cheap from a historical perspective, but they have a very dubious outlook, and I think you need to be aware of that when you’re investing in these companies.
From a momentum standpoint, I think we’re seeing a lot of rotation in the marketplace. You’re seeing a slowdown in the performance of FAANG stocks. And that’s not surprising, given that we’re coming out of a period of slow economic growth and there’s a lot of potential optimism about the growth part of the economy going forward. So the rotation you’re seeing in the market, I think, is not surprising. But we haven’t seen a clear trend yet, so it’s really hard to identify which one of these is going to be successful.
I think from a portfolio positioning standpoint, most of our portfolios have a really strong quality tilt right now, and I think that’s probably, to me, the most important thing in constructing a portfolio right now. It’s to make sure that the portfolios have strong quality characteristics and the ability to actually withstand any potential shocks that we might see in the next year or so.
Marilyn: So we have a minute or so left and I’m wondering if you might have a parting thought for our listeners?
Harin: I’d say we’ve spent a lot of time here talking about stay-at-home and return-to-office, and I really encourage people to think of their portfolios from not a stay-at-home perspective, not a return-to-office perspective, but a “return to the new normal” perspective.
Because we’re in an environment now where you have a change in the way global supply chains work. We have a change in the way people work. If you talk to a lot of the younger generation, they want to work from home.
So I think this is the new normal and I think the real challenge for us is to think about what types of companies, what types of businesses are going to thrive in this new environment as opposed to trying to envision an environment where we go back to the world that existed in 2019.
Marilyn: Well, thank you, Harin. I appreciate you taking the time to speak with me today.
Harin: Marilyn, thanks for having me on the show. Pleasure, as always.
Marilyn: And that wraps up this episode of the On the Trading Desk podcast.
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Diversification does not ensure or guarantee better performance and cannot eliminate the risk of investment losses.