Why this ETF is avoiding the Magnificent 7 at market highs

Transcript:

Caroline Woods: The market is hitting record highs, but in some sectors valuations are stretched. So how do you find high quality growth without overpaying. Joining me now is Alex Hoy from GQG partners. He joins me at the desk. Great to have you.

Alex Hoy: Oh thanks for having me.

Caroline Woods: So we hear this word quality thrown around a lot. But tell us, what does it mean to you? What's the one really key metric that matters most to you?

Alex Hoy: Yeah, it's an interesting question because there really isn't just one metric. And when we are looking for quality companies at Ukg, we're really assessing companies on a forward looking basis, looking for forward looking quality characteristics that they may be exhibiting. And what this means is what are the skills, the attributes, fundamentals of course, that they are exhibiting right now that may be supportive of compounding their earnings on a go forward basis. And so getting back to your, you know, the heart of your question, finding these high quality companies without overpaying today. That's really been the challenge because a lot of the companies that are doing well from a share price perspective are certainly ones where we feel their valuations are stretched, and so we are avoiding many of them. Many of the major seven companies that that we all know well, and instead the companies that we're looking for, and this is across all periods, not just right now, we're looking for companies that can achieve a high single digit to a low double digit total return. And we still feel there are plenty of high quality companies out there able to do that at much more reasonable valuations.

Caroline Woods: So that's where your ETF comes in. ETF spotlight GQ, US equity ETF, GQ, GQ your top holding is Philip Morris followed by Progressive Cigna. So why is a tobacco giant a higher quality name than the Mag seven a? I didn't even see any of the Mag seven in your ETF.

Alex Hoy: Yeah. And that's right. And so thinking about Philip Morris for an example, you know, we've own Philip Morris for quite some time. And we've owned it in the past. We own other tobacco companies and our Gpgpu strategy, which is our US equity portfolio in the past. But what Philip Morris is exhibiting right now, it's it's a real growth trajectory away from traditional cigarets or traditional combustible products. They're now selling excuse me, newer products. Call it the heat, not burn. Call it the pouches. They have specific product lines here that are real drivers of growth for this company. Going forward. So much so that from a revenue perspective, a little over 40% of their revenues lately are now derived from these newer products as opposed to traditional cigarets. So on a forward looking basis, this is a totally different company than what it was in the past, giving us a lot of conviction to, to put it at a higher weight in our portfolio today.

Caroline Woods: I also mentioned Progressive and Cigna. What are some other names in there that might surprise us when it comes to high quality growth?

Alex Hoy: Yeah, progressive and Cigna. So other insurance companies or MCO companies we have a few of them in the portfolio. We also have some utility companies in the portfolio too. Quite a few names and roughly let's call it 20% of the portfolio. These are boring companies for all intents and purposes. But what do they offer? They offer earnings stability. They offer earnings visibility. Due to the regulated nature of many of these companies, the regulated utilities are where we are focusing more so than some other areas. That gives us more certainty that they're going to achieve this earnings growth on a go forward basis out over the next 3 to 5 years. And and that's the time period that we assess every business in which to own. And just given the way that they operate with their regulatory oversight, their rate base that they can charge, the certainty is much higher for us today than some of the other names that you alluded to.

Caroline Woods: We've leaned on big Tech for, for so long to really drive this market higher. Is there still quality in those names though?

Alex Hoy: There are. There absolutely are. And by not owning any of the major seven or other tech companies, we're not saying that their fundamentals are broken or the companies themselves are broken by any means. We just don't see the earnings visibility out over the next few years with the degree of certainty that we need or that we see in other areas. And we also feel that valuations are pretty stretched in many of those places today. And and we know underlying a lot of this tech trade is I and we are believers in AI internally, but we don't see AI being monetized yet in ways that would be supportive of some of the, the hopes, and the expectations that have been built up for these seven companies. And that's what we need to see. We're not going to invest, you know, based on hopes and prayers. We're going to invest based on the fundamentals as we see them.

Caroline Woods: So a diversified approach with your ETF. But it feels defensive to me. So does that mean that you're expecting the market to not sit at highs for or make new highs this year?

Alex Hoy: So we haven't been shy about saying that we believe we're in an AI driven bubble right now. So we do feel that there's a very big risk of multiple compression on the horizon when that happens, whether it's, you know, tomorrow, three months from now or six months from now, we don't have an answer for that. But we're preparing for that outcome. And that's part of our investment philosophy. We aim to protect when times get tough. We also aim to keep up in those up market periods, make no mistake. But we've really protected well for our clients over the long term and generated a substantial amount of our returns by doing that, by doing so. And so our positioning right now is a reflection of the opportunity set, as we see it, that we believe in a difficult environment that we do believe is on the horizon, will be a portfolio that will protect well and lead to success over the long term.

Caroline Woods: If AI is a bubble, what happens when it bursts? What does that look like?

Alex Hoy: Anyone's guess. And for what it's worth, I think we'd be foolish to say even our portfolio wouldn't sell off even a little at the beginning. But given the earnings stability and visibility of the businesses we own versus ones that we feel might pop, and we feel that the earnings certainty will shine through, and there should be a, higher floor for our businesses as a result.

Caroline Woods: What's the bigger risk missing out on the next leg up or overpaying for what's already happened?

Alex Hoy: Yeah, well, we've missed out on some of the legs up lately, which has been disappointing. We feel very strongly about the reasons why. The fundamental reasons why why we haven't been there. So at this point, certainly valuations feel like more of a concern because if you are buying in today, say you didn't have an allocation either to, you know, a typical growth portfolio or even the S&P, you're buying at peak valuations in many ways. If you're looking at price to earnings, price to sales, price to book on a historical basis, right now the market is in the top decile of historical or expensive. Yes. So putting your money to work right now is a real risk, in our opinion, of that multiple compression coming back and hitting you in the face, so differently to buy now, you really have to believe that there is further room to run in for these businesses to grow into these valuations in ways that we really haven't seen historically.

Caroline Woods: Putting money to work is a risk at these valuations in any part of the market. Are you just talking about in the in the high flying AI names?

Alex Hoy: Yeah, certainly in the high flying AI names. But even if you look at the S&P itself right now, roughly 50% of it is in TMT related tech, companies. So mainly tech and tech related businesses. That's a level that's never been seen before. So I'm kind of seen both at the same time because it's AI that we feel is very, very expensive or rich. But that's also what's driving the S&P itself.

Caroline Woods: So how much of your portfolio should be focused on high quality growth?

Alex Hoy: All of our portfolio is we're just willing to find growth in different areas. So we're not bound to the traditional style box labels of growth or value. On the other side, we're looking for forward looking quality companies. And these are companies that are growing their earnings no matter the economic environment we're in, if we're in a good environment or a bad environment. And so our definition of growth is is a bit different than some others. But our portfolio holdings are very much growing right now.

Caroline Woods: So what's just to wrap things up. What's your best advice to investors as they see the market sitting at a potentially even higher highs? And as they maybe have a little bit of FOMO about not chasing the momentum?

Alex Hoy: Yeah. Yeah, well, I am I'm not in the business of offering financial advice. I don't want to run afoul of anyone there. But if I was looking at my own portfolio after seeing a very large write up in the S&P last year, I would be wondering if it's time to shift out of the high flying growth names and put some money to work either more defensively or simply just take money off the table from areas that feel like there is that valuation risk and also fundamental concerns in our opinion. So revisiting your allocations, revisiting your portfolio, I think would be the best step at this stage.

Caroline Woods: Okay. We'll leave it there. Alex, really appreciate your insights. Thanks so much. Thank you. That's Alex Hoy from GQG partners.