Alger Spectra Fund 4Q12 Update with Patrick Kelly

Transcription

1 Alger Spectra Fund 4Q12 Update with Patrick Kelly print Alger Spectra Fund Portfolio Manager Patrick Kelly gives his quarterly update on the Fund and his broader outlook for the markets. Click here for more information on the Alger Spectra Fund. Ray Pinelli: Hello. This is Ray Pinelli of Alger. I d like to welcome all of you to our fourth quarter 2012 Spectra strategy update with portfolio manager, Patrick Kelly. As always, we at Alger, would like to thank you for your business and your continued support, and we appreciate any feedback you would have on the content or the format of this update. Patrick? Patrick Kelly: Thanks Ray. The market fell modestly in the quarter ended December 31, The S&P 500 fell 38 basis points while the Russell 1000 Growth fell 1.32% and the Russell 3000 Growth Index fell 1.19%. For the year, the S&P 500 rose 16%, while the Russell 1000 Growth was up 15.26% and the Russell 3000 Growth was up 15.21%. Despite a lot of negative commentary from the press on the recession in Europe and the policy conflicts in Washington we are constructive on the macro environment. For one, the Fed seems committed to keeping rates low over the next several years. The FOMC announced in mid-december it would replace Operation Twist with the same amount ($45 billion) of QE, constituted entirely of long dated Treasury securities. Together with the continuing $40 billion in MBS purchases, open-ended QE will now be $85 billion per month. Two, the U.S. housing data continues to be positive. The Case Schiller National home price index increased 4% year-over-year in October, the largest year-over-year increase in 2.5 years. Homebuilder confidence rose in December for the 7th straight month to the highest level in more than 6.5 years. We also expect housing starts to be up over 25% year-over-year in Three, Europe is still fragile, but the Eurozone sovereign yields have come in with the ECB providing a more credible backstop. Four, China is improving. Evidence is widespread, from PMIs to freight data, container data and the consumer spending levels. And five, on valuation, we think equities look attractive on both an absolute and relative basis yet investors continue to pile into bonds and out of equities. In the most recent quarter October, November, December the outflows from equities continued.

2 Morningstar reported that over $40 billion came out of U.S. equity funds and close to $95 billion flowed into fixed income funds. However, net inflows into equity funds these are worldwide numbers monitored by data provider EPFR hit $22.2 billion in the week of January 9th the highest since September 2007 and the second highest since comparable data began in There is clearly a lot of cash on the sidelines and any modest improvement in sentiment could be very positive for the market. We think the 10-year bond yield of less than 2% is reflective of a moderate GDP growth environment going forward. However, we also believe that the moderate GDP growth environment has been priced into equities. Over 50% of the companies in the S&P 500 still have dividend yields north of the 10-year bond. Many of these companies have fairly large buyback programs so the dividend yield does not capture the total cash yield being returned to shareholders. Companies continue to generate strong free cash flow despite the modest GDP environment and are demonstrating more of a willingness to return that cash to shareholders. In terms of the themes that we re focused on, many of them remain the same. One, investing in companies that are well positioned to leverage increased internet usage. We think the trends here are only accelerating. Ecommerce growth accelerated in 2011, growing 13%, and accelerated again in 2012, growing 16%. In the U.S., ecommerce is now 10% of total retail, and has been gaining roughly a point of share per year. We believe this shift is accelerating, and believe ecommerce can represent over 15% of total retail by We think companies such as Amazon and ebay are wellpositioned to benefit from this trend. Two, favoring market dominant companies with strong brands that are well positioned to benefit from growth in emerging markets; companies such as McDonald s, IBM, Phillip Van Heusen, and Apple. Three, positioned in companies that are benefitting from the recovering domestic housing activity which I alluded to, earlier. These companies include Lowe s, Wells Fargo, and Citigroup. Four, emphasizing companies with strong free cash yields, which includes companies like CVS, Time Warner Cable, and Lowe s. We continue to favor companies with strong free cash flow yields who are then positioned to return that capital back to shareholders. We have seen companies with attractive cash yields perform very well in the market and think that can continue. This makes a lot of sense considering bonds are not offering attractive yields and the 10- year bond is yielding less than 2%. There are many good solid dominant companies with cash yields north of 5% which we believe is attractive on an absolute basis and especially relative to bonds. And we also continue to focus on the change in the cash yields for our companies; companies that are significantly increasing the amount of cash they are returning to shareholders. A good example is CVS.

3 We added to our position in CVS this quarter. We think the company is executing well in both its retail business and its pharmacy benefit management business line. CVS has close to an 8% free cash flow yield. CVS continues to focus on returning cash to shareholders. The company recently increased their dividend by 36% and now has a dividend yield of 1.7%. In addition CVS plans to buy back $4 billion worth of stock in 2013 which equates to a buyback yield of over 6%. As a result of this the total cash yield the dividend yield plus the buyback yield is currently yielding 7.7%. And we believe that this type of cash return can also continue over the next three to five years. We think this is very attractive with the 10-year yielding less than 2%. And lastly, companies benefiting from the infrastructure build-out of the oil and gas shales in the US. Examples include: United Rentals, Chicago Bridge and Iron, and Quanta Services. Quanta is the largest long-haul pipeline construction company in the U.S., and is benefiting from rising investment in electric power infrastructure. Chicago Bridge and Iron represents almost a pure-play on global energy infrastructure. And we also think that Quanta and Chicago Bridge could also benefit from the build-out of the Keystone Pipeline which we expect to be approved sometime this year. I thought I d briefly go through the sector weightings. Technology is currently around 29% of the portfolio. Apple is still our largest position in technology. It seems to have gone from a loved stock to a hated stock. We believe that growth will slow going forward and we also think that near term numbers will have to come down. However, we think this is widely expected and we think the valuation reflects that at 9x Enterprise value to free cash flow. At that valuation, apple is priced as if it will never grow again and profits will decline sometime in the future. Although we expect much slower growth, we believe there is still growth for Apple in the future. We still think they will continue to gain market share in handsets and PC s and also believe that emerging markets still represent a big opportunity for Apple. The CEO was recently quoted as saying they still believe China will ultimately be their largest market. We would like to see Apple introduce a low end iphone to address lower price points and would also like to see them return more of their cash to shareholders considering they have well over $100 billion in net cash on the balance sheet, and this balance continues to rapidly grow. ebay is another large weighting within Technology. They just reported a strong quarter. Their marketplace business has turned the corner and is now growing faster than overall ecommerce. One of the main reasons behind this is that the retailers are using ebay more and more as a distribution channel. In 2012, ebay enabled $175B of global commerce volume this is both marketplace and Paypal which represents approximately 19% of the global ecommerce market, but only 2% of global retail sales. We also added to our position in Facebook in Q4, taking advantage of the lock-up expirations. We think Facebook will be a key beneficiary from the shift to online advertising. Consumer discretionary is 19% of the portfolio. Amazon remains our largest position in consumer discretionary. We believe Amazon is extremely well-positioned to benefit from the shift to ecommerce sales. Amazon s U.S. gross merchandise sales represented 23% of total U.S. ecommerce in That is up from less than 15% in We expect Amazon to grow to over 30% of U.S. ecommerce by 2016, which would still only represent 5% of total retail.

4 Industrials is 13% of the portfolio. Honeywell remains our largest position within Industrials. We really like the management team there, and they continue to execute well. We also added a position in Chicago Bridge & Iron in Q4, which I referred to earlier. Energy is close to 5% of the portfolio; Materials is roughly 4.5% of the portfolio. We are still below normalized gas prices in the U.S. and think there is a trade to a normalized gas price of over $4.00. However, our expectations on gas prices have been tempered by the mild winter thus far in the U.S. Anadarko Petroleum remains our largest position in Energy. We believe Anadarko can grow production between 7-9% annually with midteens annual oil production growth. It continues to have the best portfolio of exploration projects of any company within its peer group. And Anadarko continues to trade at a big discount to its Net Asset Value and we believe actions will be taken to close that gap. In Materials, we added to a position in Monsanto in Q4. We think Monsanto can benefit from continued adoption of genetically modified seeds in Latin America, penetration in emerging markets, improved pricing, and new licensing agreements. Healthcare is 11% of the portfolio. Express Scripts, the pharmacy benefit manager, is our largest weighting within in Healthcare. We think Express Scripts is a company that will help reduce healthcare costs, and they should benefit from continued generic penetration and the synergies derived from the Medco merger. We also favor the pharma names as we think the cash yields in this group are very attractive. Pfizer remains our largest position within the pharmaceutical space. The company continues to go through a tremendous amount of change. They are in the midst of a transformation through spinning off or selling non-core divisions, specifically its nutritional business which they sold to Nestle; and soon will be spinning off the animal health division. We believe these spin-offs and divestitures are value creating, as the multiples for these spun off divisions are at a substantial premium relative to the base business, making the company which already trades at the low end of the pharma group appear even cheaper. In addition, the new Pfizer re-set revenue base will be much more weighted towards longer-life assets with Lipitor s expiration in the past and with the revenue potential for new drug launches. Financials is 8% of the portfolio. We think many of the financial companies will benefit from the continued improvement in U.S. housing prices. These names include Citigroup, Wells Fargo, Zions. Our largest position in Financials is now Morgan Stanley which we added in the most recent quarter. We think Morgan Stanley has a number of catalysts for value creation. One, is the potential to return $10 billion in capital, which is over 20% of the market cap, in 2014 and 2015 from downsizing of the fixed income business. Two, margin expansion in the wealth management business from the low-teens in 2012 to over 20% in We think the wealth management business will be well over 50% of earnings in 2015 which should lead to multiple expansion for the stock. This also does not account for the contribution from the asset management business. And three, we think the valuation is very attractive at 0.8x book/value. We find the valuation very compelling given Morgan Stanley will be in a position to buy back significant amounts of the stock and the wealth management business will become a much greater percentage of the earnings which carries a higher multiple.

5 Consumer Staples is 7.5% of the portfolio. CVS is our largest weighting in staples, which we spoke about earlier. We also favor companies with strong brands that will benefit from emerging markets growth. We continue to like Philip Morris for its strong brand, exposure to emerging markets and attractive cash yield. In sum, we expect stimulus from the central banks around the world to continue to be positive for the equity markets. We believe that equities continue to look attractive on an absolute basis but especially relative to bonds and especially when you consider the cash returns you are getting from many of these companies. There continues to be a lot of fear and skepticism and risk aversion in the markets. We think that a modest sentiment coupled with a modestly improving global macro environment should be positive for equities in RP: Patrick, as you know, Spectra has the ability to short. If you don t mind, could you please give us an idea that you re currently short in the strategy? PK: One short I ll discuss is Infosys. Infosys is an Indian offshore services company. Despite likely single digit growth, top line growth, and flat-to-modest EPS growth over the next several years, Infosys still trades at 16x next-twelve-months EPS. Infosys peer Cognizant is growing revenue and EPS in the high teens and trades at 20x. Infosys has operating margins of 26% - which were down 200 basis points year-over-year despite the 200 basis point favorable currency benefit. And this compares to Cognizant s margins at 19%. We believe margins at Infosys will have to come down over time making it difficult to have much EPS growth over the next several years. The stock did gap higher recently on slightly better core results as expectations were very low. However, we took this as an opportunity to add to our short position as our thesis has not changed on the company. I will end it there, but want to thank you for your continued support. RP: Thanks Patrick, and good luck in the upcoming quarter and in The views expressed are the views of Fred Alger Management, Inc. as of 01/30/2013. These views are subject to change at any time and they do not guarantee the future performance of the markets, any security or any funds managed by Fred Alger Management, Inc. These views should not be considered a recommendation to purchase or sell securities. Individual securities or industries/sectors mentioned, if any, should be considered in the context of an overall portfolio and therefore reference to them should not be construed as a recommendation or offer to purchase or sell securities. References to or implications regarding the performance of an individual security or group of securities are not intended as an indication of the characteristics or performance of any specific sector, industry, security, group of securities or a portfolio and are for illustrative purposes only. Investing in companies of all capitalizations involves the risk that smaller, newer issuers in which Alger invests may have limited product lines or financial resources or lack of management depth. As of 12/31/2012, the following represents the Fund's assets under management: Amazon Com, Inc. 1.83%; Anadarko Petroleum Corp. 1.63%; Apple, Inc. 7.34%; Chicago Bridge & Iron, Co. 0.75%; Citigroup, Inc. 0.74%; Cognizant Tech Solutions Corp. 0.67%; CVS Caremark Corp. 2.48%; ebay, Inc. 2.09%; Express Scripts Holding Co. 2.06%; Facebook, Inc. 1.04%; Honeywell International, Inc. 1.90%; Infosys Technologies Limited -0.50%; IBM Corp. 2.69%; Lowes Companies, Inc. 0.68%; McDonalds Corp. 0.74%; Monsanto Co. 0.53%; Morgan Stanley 0.97%; Pfizer, Inc. 1.49%; Philip Morris International 1.63%; Pvh Corp. 0.94%; Quanta Services, Inc. 1.03%; Time Warner Cable, Inc. 1.25%; United Rentals, Inc. 0.58%; Wells Fargo & Co. 0.36%; Zions Bancorp. 0.77%. Investing in the stock market involves gains and losses and may not be suitable for all investors. Growth stocks tend to be more volatile than other stocks as the prices of growth stocks tend to be higher in relation to their companies' earnings and may be more sensitive to market, political and economic

6 developments. Investing in companies of all capitalizations involves the risk that smaller, newer issuers in which the Fund invests may have limited product lines or financial resources or lack of management depth. The use of derivatives involves risks different from, and possibly greater than, the risks of investing directly in the underlying assets. A small investment in derivatives could have a large impact on the performance of the Fund. Derivative instruments involve counterparty risks, liquidity risks, and risks that the derivative does not correlate with the underlying instruments. The cost of borrowing money to leverage could exceed the returns for securities purchased or the securities purchased may actually go down in value; thus, the Fund s net asset value could decrease more quickly than if it had not borrowed. The Alger Spectra portfolio may engage in selling stocks short. In order to engage in a short sale, Spectra arranges with a broker to borrow the security being sold short. In order to close out its short position, Spectra will replace the security by purchasing the security at the price prevailing at the time of replacement. Spectra will incur a loss if the price of the security sold short has increased since the time of the short sale and may experience a gain if the price has decreased since the short sale. Investors should consider a Fund's investment objectives, risks, and charges and expenses carefully before investing. For a prospectus containing this and other information about an Alger fund, click on Read the prospectus carefully before investing. Distributor: Fred Alger & Company, Incorporated. Member: NYSE Euronext/SIPC. Alger 2013 All Rights Reserved Terms of Use Privacy Policy