The Value of Quality

By almost any measure, the markets have cooperated with investors in 2017. Riskier investments have generated higher returns, and more conservative investments have plodded along, just as one might expect. In that sense, the markets have brought many investors comfort. There haven’t been many bumps along the way, and for the most part, the threat of a struggling economy and other investor preoccupations have faded from the collective view.

In keeping with the more risk, more return theme, investors in our Growth Portfolio fared best during the second quarter with a return in the quarter of 5.12%. This brings the year-to-date return to 12.05%. To provide context, the S&P 500 Index returned 3.09% and 9.34% over the same periods, respectively.* Likewise, investors in our Stable Growth Portfolio had a return of 4.25% and 11.10% for the quarter and year-to-date periods, and investors in our Dividend Growth Portfolio had a return of 3.95% and 10.39% for the same periods, respectively.**

These results show clearly the relationship of risk to return. In a rising market, we often expect to riskier investments to out-pace the broad market, and more conservative investments to deliver less. Of course, when the markets are languishing, we expect the opposite relationship, where more aggressive investments under-perform, and more conservative investments hold up well under pressure.

We cannot emphasize enough the importance of owning high-quality companies, and purchasing them when they are good values. This is the backbone of our process, and over time, it has led to solid results. Mutual funds and exchange traded funds, for all their benefits, haven’t been able to capture this approach because at its core, it is an active process. We actively seek quality companies, and we actively add and remove them from the portfolio when valuation warrants such changes.

These truths are no less applicable today than they were last year, or in years before. We are still in a rising interest rate environment, and though the pressure it is putting on the economy seems to be muted, it is pressure nonetheless. We are also sitting at a point of historically high valuations for stock investments, creating another potential headwind for investors, as it’s difficult for valuations to continue to rise when prices are already rich. By focusing on quality companies, and constantly striving to move away from expensive stocks toward ones which are a better value, we create a buffer for ourselves—our portfolio isn’t as richly-valued as the market, or as the average investor’s portfolio—and it gives us the best chance to see solid growth over long periods, when the markets are facing potential headwinds.

On balance, we like the direction things are going this year. The economy seems stable and as a nation, we have asserted our strength as a global leader, economically and politically. These conditions bode well for investors, but as encouraged as we are, we still want to be prudent about what, and when, we buy.

* The goal of the Growth Portfolio is to own a select group of high quality companies with good growth prospects, purchased at good values. Likewise, the goal of the Stable Growth Portfolio is to own a select group of high quality and stable companies, purchased at good values, and the goal of the Dividend Growth Portfolio is to own a select group of high quality companies which pay stable and growing dividends, also purchased at good values. Out-performing the S&P 500 Index is not the goal of any of our strategies, but showing performance relative to this benchmark provides useful context for understanding returns.
** Performance is shown net of fees. Past performance is not indicative of future results.

Market Commentary – First Quarter 2017

Two-thousand, sixteen was a year characterized by profound and unexpected changes around the world. From Brexit to the presidential election, the results of these changes are that 2017 presents very different opportunities, and challenges, for investors, then previous years did.

As the fourth quarter began, and even in the prior months which led to the election, it was hard to know how the markets would react to either a Trump or Clinton victory. With either, it was hard to make a case as to why the markets would react favorably, as it was generally accepted that a vote for one would lead to higher taxes and more regulation, and a vote for the other would lead to international trade difficulties.

Despite the tone going in, investors clearly cheered the results of the election, perhaps as much because the uncertainly was over as much as for the result itself, and the markets were propelled higher in what will be known forevermore as the “Trump bump”. For markets, which were richly valued to begin with, the rally has given investors a simultaneous sense of relief, and sense of uncertainty.

The challenges we faced to economic growth are the same today as they have been for years. Every economic expansion of the past fifty years has had the benefit of falling interests to fuel growth. We don’t have this benefit today, as interest rates are already below reasonable levels, and are trending higher. Naturally this creates a headwind for growth, and one which is still likely to retard the stimulus of expansionary policies like lower taxes and deregulation. In addition, the specter of isolationist policies which could reduce international trade, may also affect economic growth in a negative way.

Headwinds notwithstanding, the overall tone is positive for economic growth and expansion, and some areas of the market should benefit as a result. Energy and defense are two areas which can clearly lead in an environment such as this. Healthcare, on the other hand, could go either way as the debate continues around affordable care. On balance, stock investors are likely to benefit the most, but it will still pay to be cautious, ever mindful of valuations, and always seeking investments in the highest-quality business. This has been the approach which has led to the best results for our clients in the past few years, and it’s how we will continue to add value in the year ahead.

Travis Raish, CFA