Anatomy of a Recession: Post-Election Outlook
November 23, 2020
Jenna Dagenhart: Hello, and welcome to Asset TV. Joining us now is Aram Green, Managing Director and Portfolio Manager at ClearBridge Investments. Aram, give us an overview of your overall approach to investing.
Aram Green: Thanks, Jenna. So, I started my career in the tech entrepreneurial world and I had started a business, grew it, and eventually ended up selling it. And through that, I decided to take 180-degree pivot, and was more interested in investing in the entrepreneur and alongside their business rather than being the serial entrepreneur. I joined a team that managed a long/short strategy that used hedging to balance out risk. And investors came to us and said that they really liked what we were doing on the long side, yet it was dampening volatility and returns, and so they really wanted to see a strategy that highlighted our ability to invest for the long-term and on the long side within equities.
Aram Green: And that's where we created the select strategy. A select version of that long/short strategy that heavily emphasized long-term investing. It takes an unconstrained approach with a lot of latitude to cut across sectors and industries, as well as participate up and down the cap spectrum. So, we have the ability to use shorting, fixed income, derivatives and other instruments alongside the tool set that we bring to bear in investing in equities.
Jenna Dagenhart: Well, that's a pretty broad mandate. So, help us narrow it down a little bit. What kind of companies are you targeting in your select strategy?
Aram Green: There's four main areas where we find opportunity, historically. The biggest area is within rapid disrupting businesses, and this is historically represented around half of the portfolio. These are companies that are very innovative. They're investing very heavily in their business to create new products, expand into new geographies. And so, as a consequence while they're growing quite rapidly, usually margins and free cash flow are at lower levels. And that's okay because we believe that there's a very large addressable market with in the long-term, very high rates of return. And therefore, we want to see these companies go after the dreams that they are developing.
Aram Green: Example is investments we've made early in the software as a service space or in telemedicine companies. Again, really innovative businesses, a lot of new product development and a lot of growth to come. The other area that we have found a lot of opportunity is in what we call the compounding businesses. And these are businesses that have represented around a third of the portfolio. These companies might have been wild disrupters years ago and they've sort of solidified their place in the market, or they're just in slower to adopt industries. And so, as a consequence, the growth rate in these businesses usually averages in the mid-single digits, well into the double digits.
Aram Green: But again, they have abundant free cash flow. There's just less avenues to aggress as heavily in their business because the growth is at lower levels. And that area of the portfolio has provided really good downside capture and protection in more choppy environments. Around 20% of the portfolio is in evolving opportunities. And these are companies that for one reason or another, have got themselves into hot water in the past, maybe they miss executed, maybe they've over promised and under delivered on a new product or solution.
Aram Green: Maybe they've made an acquisition and put some leverage on the balance sheet at the same time. Whatever it is, we now see ourselves investing in a company that has had some troubles in the past. But looking to the future, there's a number of positive catalysts that will improve the fundamentals of the business, and therefore the valuation that investors are willing to pay will be substantially higher. So, we look at these as coiled springs with a lot of upside and minimal downside.
Aram Green: And then the last area that we have found opportunity in the marketplace is in what we call the Alts area. And that really is investing in everything that's not investing long equities. So, we can short, we can make private investments, we can use derivatives, we can use fixed income securities. It always comes back to investing in a business, but sometimes there's a better risk adjusted way to gain exposure to that business, that's not just buying common equity in the company.
Jenna Dagenhart: Would you say that all area offers some additional diversification benefits as well?
Aram Green: Yes, it does. It adds some diversification element. It adds better risk reward. And the other reason that we spend time in that space is it makes us smarter on the other 90% of the portfolio. So, looking at companies as if you were going to short them and looking for cracks in the foundation of their thesis, or looking at the options to understand why the implied volatility going into this earning season is so much higher than prior earnings. Is there something that we're missing in the fundamental story or set up going into earnings that we should be paying attention to? Or maybe it's credit spreads have blown out for this company and why are credit spreads so much higher, the company's ability to go out and access capital may be so much more challenged than it has been in the past versus pure companies. So, it really adds another element of due risking to the overall portfolio.
Jenna Dagenhart: In taking a closer, look at innovation here. What are some of the benefits of being early to innovation?
Aram Green: There are numerous benefits to being early on these innovative businesses. First and foremost, comes back to risk. So always paying attention to what are the upstart companies that could be challenging in the future to the companies that we own in the portfolio. So that competitive analysis, making sure that we're always seeing who's coming up the ranks that could disrupt our companies that we think are in a very good position today and want to make sure that they stay in that, in that place. The other ways that it benefits us to look at these later stage private companies is it gives us a broader context of what's going on within the ecosystem and within the marketplace. So, we get a lot of information, not just from the public companies, but also from the private companies of how business is evolving. Another way that it benefits us in the strategy is we have the ability to invest in some of these late stage companies.
Aram Green: So we're always looking for new investments within the late stage VC arena. And the last reason why we spend time talking to private companies is, if these companies continue to be successful, there's a good chance that they end up going public. And so, to get to know these businesses early, to be ready to make that investment when they go public, gives us an information edge that you don't really see as much in the public markets.
Aram Green: So that's the reason we spend time on these early innovators, and we believe that you should be spending time broadly speaking in this space, because innovation is really the growth engine of our economy. And there's just a tremendous amount of innovation that's taking place due to development of new technologies. And a lot of it comes down to cloud computing and services delivered through the internet.
Jenna Dagenhart: And finally Aram, are you still finding opportunities in the momentum led market to deploy client capital?
Aram Green: We certainly are finding new opportunities in growth and innovation and faster growing businesses. While the strategy continues to heavily emphasize that area because there's a tremendous amount of visible growth. And we're seeing a real acceleration of adoption of these services in this new environment, I think that there were many skeptics that thought that they could hold on to certain services or certain products specifically speaking in the enterprise for a longer period of time. And they're realizing that work from home and this distributed environment really favors these new generation technologies. And so, we're just seeing a rapid adoption and an acceleration of trends that were already underway and that's just happening at a faster clip than we expected before.
Aram Green: So we're seeing an improvement in value in those companies above and beyond where our expectations were and that's continuing to this day. So, we continue to favor those companies. With that said, we are starting to add incrementally to some of those areas that have been out of favor. We are looking at valuations that look incredibly attractive, where valuations are similar to where they were in the great financial collapse. Yet, we believe that the current health crisis is going to be a finite period of time. And as we look into 2021, it's going to be an improving environment. And so, we're going to see a number of companies that have had challenges in their business solely due to depressed levels of revenue and sales due to the health crisis, those are going to start to lift.
Aram Green: And meanwhile, we have identified some companies that are doing some really great things. They're seizing this opportunity to invest in product and innovation, to take market share. And so, as a consequence, we believe that they're going to ride out of this storm in a much better place than they were going into this environment. And so, we're investing behind some of these companies that again, we think are rightly positioned to take a lot of market share and be much stronger six to nine months from now, that are trading at incredibly attractive valuations.
Jenna Dagenhart: Well, Aram, thank you so much for your time and your insights. Really great to have you.
Aram Green: Thank you, Jenna. Nice talking to you today.
Jenna Dagenhart: And thank you for watching. That was Aram Green, Managing Director and Portfolio Manager at ClearBridge investments. I'm Jenna Dagenhart with Asset TV.