Globally Diversified in Industry Leaders
PGIM Jennison Global Opportunities Fund
Author: Ticker Magazine
Last Update: Jul 25, 12:19 PM EDT
|As economies around the world become more interconnected, local companies can accelerate on the path of regional or global leadership with the right kind of products and management preparedness. Thomas Davis, co-portfolio manager of the PGIM Jennison Global Opportunities Fund, explains how the teamís high-conviction, concentrated strategy seeks the best ideas globally.
ďOur goal is to put together a collection of select, unique, differentiated securities that are market leaders in their respective industry. Typically, these companies have sustainable competitive advantages that continue for years.Ē
Q: What is your strategy if your assumptions prove wrong?
If we find that we are wrong, we are very quick to exit. We think that we have a good process to identify opportunities and to bring them into the portfolio. If we are wrong and the revenue growth doesnít materialize or if it starts to decelerate, our expected earnings growth will not materialize, and we would have a problem. So we would exit that position quickly.
Importantly, when we are correct, and the stock price starts to dramatically move upwards, we will periodically harvest some of the profits and effectively lock down some of the success. The position is unlikely to go to zero exposure purely based on valuation, because there might be another leg to the story. Thatís especially important in this day and age of technology development and scalability of the products.
For example, when we initially owned Apple Inc in 2004 and 2005, it was on the back of the personal computer business, the iPod and the concept of iTunes. There were no iPhones or iPads, but Apple was a highly creative and innovative company. The thesis evolved as the opportunity set expanded with the iPhone and was pushed into global markets. A few years later the iPad came along and resulted in another expansion.
Q: How do you factor in your valuation that the fast growing companies disrupting industries often have to work under lower margins than the legacy businesses?
We have to assume that the potential for lower margins can exist in a wide range of disruptive situations. We canít assume that Amazon, for example, will achieve the same margin as traditional retail stores, but it still can be successful with lower margins and higher volume. Higher margins of legacy businesses, including traditional retail, do not guarantee the success and visibility of those business models. Amazon should be profitable over time and will be one of the dominant retailers. Our goal is to ensure that we own the winners of today and tomorrow, not the losers, because there are losers in any destructive industrial transformation.
Today Amazon is earning about 40 to 45 cents of every e-commerce dollar in the U.S., up from the high 30s about 18 months ago. It is taking huge market share and signing up more subscribers and Prime members. Other aspects of its business are very profitable; the AWS business has a margin of more than 25% as Amazon is leveraging elements of its core expertise into other areas.
When we model the opportunities, we use conservative and relatively reasonable expectations. We have no delusions about a lower margin profile. A few years ago, Amazon had 1,000 robots in its distribution centers and today it has 100,000. With robots that can effectively work almost 24/7, costs should go down. So, there are less traditional ways to arrive at the desired profitability.
These aspects are incorporated in our analysis and thought process, but the critical element is that Amazon is offering a service that people are using more because itís making life easier. They have vast scale and breadth of product; this is the first place that most people would go to search for a product online. We could make the same case for Alibaba in China and online platforms in Europe, the UK and elsewhere. These are businesses with rapid growth and will be more profitable over time, but the margin profile will look different.
Q: Would you describe your portfolio construction process?
Concentration is a key element of our design. Every position ideally represents a different kind of exposure, opportunity set, profit pool, and perhaps a different end market. We think of it as diversification by business model, not diversification by sector or geographic spread.
Our portfolio today runs between 35 and 45 positions. The average position size is typically in the range of 2.5% to 4.5%, occasionally larger, and rarely goes below 1%. A position of more than 4.5% would reflect a powerful company whose business model is substantially rewarded in the market.
The construction process is based on the analystís fundamental assessment on the magnitude of the opportunity and the differentiation of the business. We take the analystís recommendations and simultaneously compare that opportunity against everything that we own. If the idea is better than what we already own, then we will figure out how to include it in the portfolio. If itís not, then we will discard the idea.
For instance, if we own Mastercard, it is highly unlikely we will buy Visa as well, or vice versa. They represent the same opportunity and are not going to trade that differently. We are careful to ensure that we donít duplicate exposure and we avoid factors that bring highly correlated performance.
We benchmark ourselves against the MSCI All Country World Index, but we can also be measured against the MSCI ACWI Growth Index.
Q: What is the rationale behind owning only one of similar companies?
With 35 to 45 stocks, we are not necessarily diversifying by sector or region, so we make sure to keep the correlation across our holdings low. We monitor the direction and the pairwise correlations on rolling 60-day periods across the entire portfolio and by sector. The idea is to avoid highly correlated names, because they behave in a similar fashion across different market environments. If we are careful with construction, there is enough diversity within the sectors and low correlation in the portfolio.
We donít want to split the allocation between two similar companies. At any given time, we own one or the other, and we will go with the one in which our analysts have the highest conviction. While we have owned Mastercard and Visa over time, weíve never owned them simultaneously, because owning both companies would mean duplicate exposure to the same opportunity.
The decision depends on the better opportunity at the time. When we make a choice, we assess the fundamental strength of the companies, because the businesses may be influenced by similar considerations, but their underlying strategies may have differences that result in different growth rates.
On the other hand, that doesnít mean that we canít invest in Facebook and Tencent at the same time, for example, because the two companies have different end markets and customers. The same refers to Alibaba and Amazon, because Amazon does very little business in China, while Alibaba is largely a Chinese market player. Thereís a differentiated capability in two vast markets and largely uncorrelated developments.
Q: How do you define and manage risk?
We focus largely on absolute risk. The risk management process begins with the analysis of the fundamental opportunity. We assess the potential market size, the risk of competition, and the potential for governmental influence. Is the product or service differentiated enough to provide a multi-year competitive advantage or is it fairly generic? Are we going to face a potential competitor in the next 12 months? There are many absolute risks that we consider at the fundamental research level.
At the portfolio level, we analyze how differentiated the portfolio is. We make sure to understand how our holdings interact with each other and how they might perform in different scenarios.
The next level is the ongoing monitoring. We monitor factor exposures and the components of attribution to our performance. Given the nature of our work, we want the bulk of our excess return to be driven by the fundamentals of the underlying businesses, and stock-specific factors. Historically, about 70% to 80% of the excess return over a multi-year horizon is derived from stock-specific characteristics.
The ultimate measure of our success comes down to performance and delivering what we set out to deliver, namely, meaningful excess return for our institutional and retail clients on a regular basis. Since we are hired to be growth managers, we have to deliver a product and performance in a consistent fashion. We donít stray from what we do, and we are constantly focused on the same process and characteristics.
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