Brown Advisory Ethical Selection Q4 2022 commentary
SaxoSelect Commentaries
| Instruments traded | Stocks |
| Asset classes | US Stocks |
| Investment style | Fundamental analysis focused on ethical, social and governance (ESG) |
| Quarterly return | 5.44% (net of fees) |
| Annualised volatility (since inception) | 18% |
Market overview
Q4 2022
During the last quarter of the year, the largest detractors were financial services and healthcare. In both cases there were business-specific reasons for weakness within a few holdings where there is an expectation to be transitory in nature. Notably, the lack of energy holdings was the third largest detractor. Offsetting this was strength in the consumer discretionary sector, which was driven by strong selection.
The market remained volatile in the fourth quarter of 2022. While the Russell 3000 index initially rebounded, the end of the year was met with more pressure on asset prices.
Admittedly, there is quite a lot to be excited about right now: the pandemic is largely in the rear-view, associated logistical bottlenecks have eased considerably, business activity remains quite robust, consumer balance sheets are strong and the job market is healthy. Yet sentiment continues to move lower for as many, albeit different reasons: the Fed continues its hawkish stance, affordability measures are down across the board, business spend in certain areas of the economy are starting to moderate and capital markets have dried up. The public commentary has all but guaranteed a recession as we move further into 2023, with the only real debate now as to how deep this recession actually is. The market seems stuck between these two narratives, with many speculating that asset prices will stabilise and move directionally only once we have more clarity around many of these driving factors, notably interest rates and inflation.
For a bottom-up strategy like this one, times like these are both exciting and unique, especially relative to the most recent chapter of the market’s history (post the great financial crisis). Asset price correlations are dropping, resilient business models are becoming again distinguishable, and investors are increasingly focused on valuation frameworks that underpin true economic value. This provides the opportunity to take advantage and select business models that will outperform in a variety of economic environments, particularly one as uncertain as 2023 is shaping up to be.
Portfolio performance (net of fees)
| October | 9.11% |
| November | 6.55% |
| December | -3.81% |
| Since inception (March 2019) | 26% |
Best-performing positions Q4 2022 (note performance shown for the quarter reflects the performance of the security during the part of the quarter it was owned by Brown Advisory, not necessarily the performance of the security itself for the full quarter)
- During the quarter, United Rentals reported strong demand and sales, and increased its revenue guidance. The company made progress on the sustainability front, investing some of its capital expenditures in new fleet that lowers carbon emissions on job sites (such as zero-emissions hydrogen power generators) and other tools to help customers track emissions generated through United Rentals equipment. Despite the softening economy, the construction industry is stable, driven by non-residential demand and supported by higher federal bills. The company can liquidate used equipment during downturns.
- Visa, a global payments leader, traded higher in October on the strength of its third-quarter earnings that exceeded consensus revenue and expectations. Visa’s across-the-board growth in year-over-year transaction volume signalled continued strength in consumer payments, resilience in e-commerce, and an ongoing recovery in cross-border travel despite persistent inflation and rising interest rates.
- Nike beat quarterly expectations on revenue and gross margins. The revenue outperformance was broad based across multiple geographies and channels. Despite a challenged macro environment, Nike’s China business inflected positively. Nike’s valuation premium is warranted given its combination of global brand dominance and a superior operating model at scale, which is likely to become even more profitable as it further migrates to a digitally enabled direct consumer model.
- During the quarter, Cisco beat estimates across the board as supply eased and the company was better able to ship to backlog. The company also announced a new 2025 goal to incorporate 50 percent recycled plastic content in all products, and pointed to the large opportunity set as Cisco’s technologies such as IoT, Silicon One and Power over Ethernet drive a significant reduction in power consumption for customers.
- WEX outperformed during the year given strong execution and leverage to high fuel prices; the strength in the fourth quarter was also due to a snap-back from a sell-off that occurred late in the third quarter.
Calendar Year Top Five Contributors to Return – 2022
- UnitedHealth, the largest health insurer in the United States, reported consistent financial outperformance throughout the year. During the first quarter, the company announced the acquisition of home–based provider LHC Group for roughly USD6 billion including debt. This deal is in line with Optum’s strategy to become a comprehensive provider of healthcare services through a value-based model.
- Unilever was a new addition to the portfolio early in the fourth quarter. The company raised guidance and reported strong, broad-based growth above peers Procter & Gamble and Nestle. The company benefited from its recent efforts around pricing and product innovation.
- During the year, United Rental’s demand and fleet productivity remained strong despite investors' concerns regarding construction activities. The company raised guidance for 2022 based on continued favourable industry trends such as strong equipment rental demand from a broad array of end markets (including electric grid and power infrastructure, rail services, broadband, public transit, and water) and higher prices for used equipment sales.
- WEX outperformed during the year given strong execution and leverage to high fuel prices; the strength in the fourth quarter was also due to a snap-back from a sell-off that occurred late in the third quarter.
- H.B. Fuller has continued to execute very well as the company has been able to get price and gain share over competitors. During the third quarter, the company started to show signs of margin improvement as raw material inflation began to decelerate.
Worst-performing positions Q4 2022 (note performance shown for the quarter reflects the performance of the security during the part of the quarter it was owned by Brown Advisory, not necessarily the performance of the security itself for the full quarter)
- During the quarter, Eastern Bankshares gave back its year-to-date outperformance from the first three quarters of the year, as the company guided to a notably higher expense run rate than the market was expecting. This brought down estimates and suggests that expected operating leverage going forward will likely be limited in the near term.
- Assurant reported weak quarterly results during the quarter due to several macroeconomic headwinds affecting both its Global Lifestyle and Global Housing segments. Global Housing is seeing higher attritional losses due to inflation and higher reinsurance costs. However, the company is taking several steps to reposition Global Housing and improve expense efficiencies. In addition, the mobile trade-in business should continue to benefit from the 5G upgrade cycle, investment income is accelerating from rising interest rates and capital return should remain high.
- Alphabet traded down after posting disappointing quarterly results led by deceleration in advertising revenue and a strong currency headwind. While Search was relatively strong, YouTube was weak. Positively, Cloud revenue beat expectations and margins improved. Management plans to slow hiring going forward reflect a weaker environment.
- Marvell Technology entered the year at close to an all-time high, and sold off more than most. Demand has softened in key end markets like data centre storage, and estimates have come down commensurately, but it will take a couple of quarters for inventory to correct and Marvell to get back to trendline growth. The company’s multiple has corrected to levels last seen in early 2019, and is below its 10-year average.
- Amazon traded down in the fourth quarter on the heels of a disappointing third quarter earnings report and lowered fourth quarter guidance issued at the end of October.
Calendar Year Bottom Five Contributors to Return – 2022
- Zoetis stock was challenged in 2022, along with many other high quality, high multiple large-cap stocks. On top of this, the company reported a rare miss in its third quarter results, mainly due to supply chain issues that impacted the company’s largest growth driver which resulted in the growth of its key Companion segment coming in below expectations. Zoetis is reasonably confident that these issues can be addressed and it does not expect an impact on FY23 performance.
- KKR was weighed down given an increasingly bearish sentiment around its capital markets franchise, the ability to generate performance-related earnings (realisations) in this environment, and a more cautious backdrop for private equity fundraising. Despite the negative sentiment, the company is positioned favourably for many different environments.
- Amazon underperformed in 2022 due to the challenges of overcoming difficult COVID-19 driven sales comparisons. As it turned out, the company over-hired and overbuilt capacity to keep up with demand, which ultimately hurt margins especially as sales decelerated faster than expected. The company’s cloud division, AWS, also decelerated in the second half of the year.
- Alphabet’s advertising business was not immune to the industry’s slowdown in 2022. While Search held up relatively well, YouTube suffered disproportionately. This has been offset by the company’s strong performance in Google Cloud.
- Marvell Technology entered the year at close to an all-time high, and sold off more than most. Demand has softened in key end markets like data centre storage, and estimates have come down commensurately, but it will take a couple of quarters for inventory to correct and the company to get back to trendline growth. Marvell’s multiple has corrected to levels last seen in early 2019, and is below its 10-year average.
Changes to the portfolio throughout the quarter
QTD additions:
- The global branded consumer products company Unilever was added during the quarter. It is expected that Unilever has the ability to turn around its business following a recent operational reorganisation, a commitment to reinvest in its core, and innovate new products. Historically, Unilever’s sustainable brands and products grew faster than the rest of the business, accounting for over half of the company’s growth in recent history. It has been successful in embedding sustainability into its supply chain practices and company culture, improving efficiency, responsibly managing water use and reducing supply chain risks.
QTD deletions:
- The small position in Disney was sold during the quarter. The company has taken several missteps that will likely take some time to sort out before achieving profitable growth. In particular, the exit of Bob Chapek and the subsequent return of former CEO Bob Iger indicates that there was a lack of effective leadership during a particularly challenging time period for Disney. There seems to be a lot of franchise value within the company, but this is offset by emerging cyclical and secular challenges.