Can you give a brief overview of your strategy in terms of what you are trying to achieve for investors, your investment process and the make-up of the investment team?
Harris' U.S. Equity strategy seeks to outperform the S&P 500 over time through the consistent application of our value investment philosophy. Our intensive, fundamental research process is akin to a private equity due diligence analysis. We identify management teams that think and act as owners and companies that will grow shareholder value over time. We patiently wait to invest in these business at a discount of at least 30% to our estimate of intrinsic value. Investing in high-quality businesses at a margin of safety has helped us avoid value traps and build long-term capital appreciation for our shareholders since our firm's founding in 1976. The U.S. Equity strategy ranks in the top decile versus its U.S. large-cap value peers on a 1-, 3-, 5- 10- and 15-year basis, return. The strategy has returned 8.6% a year since inception in 1998 and has outperformed its peers by 2.7% a year over the last 10 years.
The Harris U.S. research team consists of generalist analysts who search for undervalued stocks across all sectors. The generalist approach to finding and evaluating potential investments leads to more robust debate, which allows the team to better assess potential risks and estimate business values. Every new idea is vetted by the entire investment team. At the culmination of the review, the voting members of the Stock Selection Group decide if the stocks meet the Harris criteria. Only approved stocks enter the U.S. equity portfolio, which generally consists of roughly 40 equities with over $5 billion in market capitalization. Stock selection skill is magnified through portfolio construction. Portfolio managers weigh each company by conviction as measured by upside to intrinsic value rather than its weight in a benchmark.
How have you been trying to weather the storm caused by the Covid-19 pandemic and what could be the longer-term implications for your strategy?
Every few years, stormy market conditions appear that eventually end up leading to investment opportunities. We believe the Covid-19 pandemic is yet another bump in the road, such as the tech bubble in the late 90s and the global financial crisis of the 2000s. Every one of those bumps provided the fuel to outperform the market when fears subside. We believe Harris Associates is successful at "harvesting fear" because we stubbornly make decisions based on company fundamentals rather than macroeconomic worries and market volatility. We capitalize on human nature, which leads to disconnects between share prices and fundamental value. We believe that investment success comes from correctly assessing business value rather than correctly predicting macro trends.
Our investment process provided a yardstick to measure value to confidently act on our convictions during the pandemic. We added 13 new ideas to the portfolio in 2020 amidst the volatility, which is twice the typical level. The U.S. Equity portfolio was repositioned to benefit from the re-opening of the economy. Today it boasts an above average growth rate (18.7% ROE) at a discount to the market.
Can you identify a couple of key investment opportunities for your fund you are playing at the moment in the portfolio? This could be at a stock, sector or thematic level.
Some of the pandemic changes have led to real improvements—think of the transition to "touchless" everything, from doors to faucets to toilets to elevators. Why would we want to turn back from these changes? One example of the "new normal" that we think will persist is the growth of all things digital. During the lockdown months, video streaming gained share over linear television. As a result, several of our holdings benefitted, including obvious players like Netflix and Alphabet (YouTube), but also less obvious names, like internet service providers Charter Communications, Comcast and T-Mobile. We expect our overweights to communication services and consumer discretionary to benefit.
The growth of digital also accelerated in the financials sector, our largest sector overweight. Banks are viewed as macro proxies by the market but what is missing in this analysis is how much improvement there has been since the last downturn—the global financial crisis. Wise intangible investments into the digital experience have kept our financials in the lead. Processing online transactions is much less expensive than in-branch banking, a trend that helped several of our holdings, including Bank of America, Citigroup and Wells Fargo, reduce costs and remain profitable despite low interest rates.
