Bryant VanCronkhite and Christine Collins discuss the impact of the macro events shaping our world and how his team is able to filter through the noise and maintain discipline in the face of uncertainty.
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Christine Collins: Hi, I’m Christine Collins, an investment strategies consultant for Allspring Global Investments, and you’re listening to On the Trading Desk®. Joining me today is Bryant VanCronkhite, managing director and senior portfolio manager for the Allspring Special Global Equity team. We will be discussing the impact of the many macro events currently shaping our world and how Bryant and his team are able to filter through the noise and maintain discipline in the face of such uncertainty. Thanks for being here, Bryant.
Bryant VanCronkhite: Hi, Christine. Pleasure to be with you.
Christine: There’s so much macro data to consider right now from the Fed (Federal Reserve) rate hikes, inflation, Russia-Ukraine conflict, China-U.S. trade wars. Why are these themes important to your team right now?
Bryant: That’s a great question. The macro has an incredible ability to move markets in the short term. And it can be very impactful to individual companies and to overall portfolio positioning; risk; and, ultimately, success. So, we have to understand the macro. We have to pay attention to the macro. But I think the unique difference we have is how we digest the macro and build it into our process.
Christine: So how are you digesting and responding to all these macro considerations?
Bryant: As we see it, there’s two important ways to digest and use the macro in our analysis.
Number one goes back to a previous podcast when we talked about leaky-bucket syndrome, which is the ability to build a portfolio that, broadly speaking, neutralizes the impact of macro considerations, like inflation or changes in GDP (gross domestic product), by using portfolio construction tools to minimize tracking error to macro issues.
The second way we think about it, and one we’ll talk about more today, is understanding how it impacts individual company financial statements. So, if you start with inflation, which is a hot topic today, the inflationary bucket for every company is different. The cost of goods sold basket, for example, for an industrial company is very different from that of a food company.
And, so, when you simply look at the broad CPI (consumer price index) numbers, you can be wildly misled in your understanding of how individual companies will be impacted by inflationary pressures. Importantly, we want to look at how is this company able to respond to that? What’s their ability for pricing power and elasticity of demand around that? What’s the company’s ability to invest in tools that will improve their supply chain and logistics, for example?
And, so, we build into our modeling, real time, our view and interpretation of the inflationary pressures for every company. When we think about GDP, the way, again, a food company demand for their products changes with a change in GDP is very different from that of a semiconductor company, for example. We want to understand these issues at the micro level for each company so that we can model our businesses correctly.
I think the greatest opportunities as stock pickers and active managers is an appreciation that markets love to obsess about these macro concerns and issues on a day-to-day basis. Modeling the financial impact is important. However, we believe that the true value creation comes from identifying companies that are not just able to weather the macro storms of inflation and GDP. And it’s not about our ability to predict the direction of future changes in these metrics, but our key to our success at identifying companies that can actually take advantage of them through the things that they control.
Christine: So, can you expand on what you mean by that? How you’re taking advantage of these times in your companies that you’re investing in?
Bryant: Sure. Every company is going to deal with macro headwinds and tailwinds. As I mentioned, they’re a bit different in importance and magnitude for every company, but every company is going to face them at the same general time and in the same general direction. However, what is truly unique for each company is the ability to take advantage of the opportunities that these macro changes present.
So, to be abundantly clear on how we think about macro is that we are owners of businesses and not traders of stocks. And when you own a business, you are focused on long-term value creation and driving value through what is controllable by the people who run the businesses we own.
Universally, CEOs and CFOs do not control inflation or GDP or geopolitical conflicts. What they control through a cycle is how they deploy their capital. And it’s through smart and timely capital allocation that companies take control of their own destiny and it is to the presence of financial freedom that allows them the ability to do that.
Our team’s focus and our edge is in our ability to quantify a company’s financial freedom through our analysis of a company’s balance sheet. It is there we can identify the companies that are best able to weather the macro storms and, most importantly, take advantage of them with a long-term mindset around capital allocation. Now we have this saying that one of the most powerful positions to be in, both as an individual and as a company, is the ability to play offense while the rest of the world plays defense. That’s a unique capability that resides only with those people and those companies that have properly built their balance sheets over time, which allows them a tremendous amount of financial flexibility.
So, our investment process uniquely identifies this rare group of companies and quantifies the amount of freedom they possess. And through our qualitative work and our frequent engagement with company management teams, we are able to understand how a company might spend this financial freedom to generate future returns. Frequently, the market’s obsession with the near-term macro oscillations and income statement impacts leaves a large inefficiency in the pricing of this balance sheet potential. That is our edge as stock pickers and as portfolio managers.
Christine: Bryant, can you give an example of how these companies in your portfolios have used their balance sheets during the pandemic or the more recent macro events year to date?
Bryant: Yeah, I’d love to say that all CEOs and CFOs eat at the same restaurant. And what I mean by that is the menu of options for how a company can spend their money is the same. They have acquisitions to expand their adjustable markets. They can use organic investments of research and development or capex (capital expenditure) to grow the organic top-line growth rates. They can invest in vertical integration, which is really important right now to improve the supply chain and improve their margins. They can even use buybacks and dividends.
The menu is the same for every company. But what a CEO or CFO or company should choose off that menu varies by company based on many things, such as where they are in their lifecycle, the competitive dynamics in the industry, the strength of the players around them. All these issues impact what a company should do with their own capital.
As an example, we own a commercial building products company that recently made an acquisition of a private company that was a leader in a series of products that our company didn’t currently manufacture. However, those products were purchased and installed by the same group of customers for both companies. By buying this company in the heart of the pandemic, they were able to get a great price and expand their revenue potential with additional complementary products. They benefit from cost synergies by making themselves bigger buyers of the same raw materials. They opened their doors to a new set of customers they didn’t already work with. All these things helped grow their revenue potential and improve their margins and the market didn’t appreciate the potential of this deal. And then even after it was announced, it was still underappreciated regarding the financial impact it would have. As the company reported their quarterly results after closing this transaction, the stock meaningfully outperformed as a result.
Another example is a consumer-facing technology company that we recently sold that spent the year before the pandemic and the years through the pandemic spending a tremendous amount of money to optimize the technology platform that they had that was working behind the scenes for their multi-brand portfolio. These investments were costly and could not have been made without an offensive mindset in a time of tremendous stress. The company wasn’t worried about hunkering down during a temporary moment of macro weakness, but rather focused on playing offense while the rest of the world played defense. However, the benefits of this potential disinvestment were wildly ignored, in our minds, as all the focus was on macro impact on near-term earnings. We’re confident that the long-term owner mindset would reap the benefits of the macro picture normalizing but also capture the alpha as the company’s investments allow them to make higher margins on a similar level of revenue as pre-pandemic. This indeed played out and created a very nice return for us.
In each of these cases, in two different companies, they each dealt with the same macro concerns. Each is exposed a little differently, but the key to our success as owner of these stocks was never about predicting the macro impact, but rather by having a clear view on the ability of the company to control their own destiny by wisely deploying capital to create future value.
Christine: So, Bryant, you seem like you have great insights into your companies. How do you get access to this information from the management of the companies you invest in?
Bryant: You don’t want to overstate the importance of meeting with company CEOs and CFOs, although it’s important, and it’s impactful to our ability to analyze a company’s future decision-making. But beyond that, we have to confirm, if you will, that the company actually is able to do what they say they want to do. And, so, we look back at financial statements in the past, we engage with their competitors and their supply chains and their customers to truly understand a holistic view of how companies are able to and likely to spend their capital to drive future value. But being large shareholders and being part of a large organization like Allspring, it gives us preferential access, in many cases, to companies’ CEOs and CFOs that, again, gives us a bit of an edge in making this sort of analysis.
Christine: So, with the time we have left, is there anything else creative you’ve seen companies do? And what do you want our listeners to take away from today’s discussion?
Bryant: Another common conversation we’re having with company management teams today is how to use your balance sheet flexibility to reduce risk exposure to concerns that fall into the environmental and social buckets. Allocation of capital to these initiatives is allowing companies to reduce downside risk and improve their overall cost of capital in very unique ways. Sometimes playing defense with your capital allows a company to reduce volatility of future cash flow streams, which allows the market to place a higher multiple on the overall cash flow. Not to mention less volatile cash flow streams and lower cost of capital are two key ingredients to increasing your balance sheet flexibility. It’s a virtuous circle that positions a company to control their own destiny while so many other companies are at the whim of the macro headwinds and tailwinds. As a final thought, as an investor, it’s a very uncomfortable position to be in when you feel like your success or failure is based on guessing macro outcomes. Remaining unemotional in times of macro uncertainty is critical to long-term success. By identifying and owning these special companies that are uniquely able to control their own destiny, by using their abundance of financial flexibility, provides us great comfort through the entire business cycle.
Christine: Thank you, Bryant, for being with us today and sharing your insights.
Bryant: My pleasure, Christine.
Christine: That wraps up this episode of On the Trading Desk. If you’d like to read more market insights and investment perspectives from Allspring Global Investments, you can find them at our firm’s website, allspringglobal.com. And to stay connected to On the Trading Desk and listen to past and future episodes of the program, you can subscribe to the podcast on Apple Podcasts, Spotify, or wherever you get your podcasts. Until next time, I’m Christine Collins and thanks for listening.
Disclosure: Alpha measures the excess return of an investment vehicle, such as a mutual fund, relative to the return of its benchmark, given its level of risk as measured by data. Alpha is based on historical performance and does not represent future results. The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services. You cannot invest directly in an index.