Diloc Kraisatapon
[A key challenge of investing in large-cap value stocks is that all investors have extensive access to large-capitalization company information and the thinking and strategies of their corporate management teams. There are plentiful analyst research reports, easy-to-retrieve company fundamental metrics, leadership interviews, stock tracking tools, and so on. When you literally have the full range of institutional and retail investors across the world investing on similar footing alongside you, how do you get an edge on your stock selection and portfolio construction for this large-cap value asset class?
To learn how some large-cap value managers work to differentiate and position themselves for investment advantage, we were introduced to Paul Roukis and Jeff Agne, Portfolio Managers of the Large Cap Value Strategy at Great Lakes Advisors, LLC – a Chicago-based asset manager founded in 1981 with a strong affinity of serving those who serve others including clients that run health and welfare funds, Taft-Hartley plans, police and fire retirement funds, public funds, religious organizations, endowments and foundations, financial advisor intermediaries, and private wealth clients. The firm offers a wide range of client-focused, actively managed equity, fixed-income, and multi-asset strategy solutions. We focused our questions specifically on their Large Cap Value strategy which seeks to outperform the Russell 1000 Value Index through a differentiated philosophy, process, and team structure. They have demonstrated a level of consistency in that pursuit by outperforming their value index in 19 of the past 23 calendar years since inception as of December 31, 2023, and gross of investment management fees.]
Holtz: What is your view on the large-cap value asset class?
Lukes: The world of large-cap value stocks has changed dramatically over the past few decades. Technological innovation has further accelerated these changes. Historically, large-cap value stocks were perceived as stable, mature, dividend-paying stocks with low but steady growth. Today, innovation is driving change in these legacy sectors, whether it be healthcare, financial services, industrials, or in general, and the realm of large-cap value stocks is quite different. Successful companies today have the financial capacity to reinvest in their operations to gain market share and expand their competitive advantage. As an investment manager, these companies are evolving rapidly, and you need to be willing to adapt to that change.
Agne: “Furthermore, the large-cap value space currently offers opportunities to capitalize on many of the key long-term investment themes driving the market, such as global electrification and decarbonization trends, domestic manufacturing and supply chain security, and artificial intelligence (AI), but these require more stringent valuation criteria than growth stocks. We often look for investment ideas that are second- and third-order derivatives of these long-term themes that are a little bit off some people’s radar screens, allowing us to invest in more attractive ways. We also believe that many other sectors, such as healthcare and manufacturing, are well-positioned to benefit from idiosyncratic opportunities.”
Holtz: What specific benefits and opportunities does your large-cap value investing approach provide investors?
Lukes: The goal of our investment approach is not occasional spectacular performance, but consistent superiority. If you ask our clients what they appreciate most about our Large Cap Value strategy, it’s the consistency of its return profile. The strategy has outperformed the Russell 1000 Value benchmark in 19 of the past 23 calendar years and is on track to outperform by approximately 1.7% on an annualized basis since inception as of December 31, 2023 (both metrics net of fees). Importantly, in calendar years in which the Russell 1000 Value delivered negative returns, it has protected capital better than the benchmark. The result is a strategy that has delivered strong risk-adjusted returns as measured by the information ratio, a metric many fund complexes use to evaluate investment managers.
Agne: This consistency of performance comes from intentionally not making large bets, a very holistic way of looking at stocks, and a relative valuation mindset. We manage diversified portfolios and do not make top-down decisions on the direction of interest rates or commodity prices. We recognize the rapidly changing business environment that all industries currently face, and therefore minimize factor and sector bets. It is a bottom-up stock selection approach that seeks to manage enterprise risk and deliver consistently outperform benchmarks. Our clients appreciate the consistent and predictable return pattern we have delivered in both up and down markets.
We also care very much about style purity: by investing in our large-cap value product, you get a large-cap value portfolio that is very similar to the Russell 1000 Value benchmark, but tilted towards stocks with attractive valuations relative to their peers that have dynamic catalysts that can address the valuation divergences we see in the market.
Lukis: When it comes to the stock selection process, I like to use the phrase Newton’s Law. Objects in motion tend to stay in motionThe same goes for companies. We’re not trying to catch a falling knife. We’re not looking for the most highly valued stocks with a mean-reversion mentality. Our goal is to focus on companies that are growing market share and generating enough cash flow to reinvest in the business and reward shareholders. At the same time, we don’t want to overpay for those stocks. We believe our particular investment approach is a healthy balance in the market and takes a more modern stock selection approach.
Hotz: How does your investment perspective and investment process help differentiate large-cap value from other large-cap value products?
Agne: A lot of value managers, especially deep value managers, have relied solely on valuation. We have a second lever in our process, and that is valuation. Combined with Improvements in business fundamentals, cash flows, or catalysts that can help a portfolio company develop a competitive advantage over the long term. These catalysts can unlock the value we see in the company and can come in many forms, including product innovation, margin enhancement opportunities, policy changes, pricing power, capital allocations, new management, etc. Without clearly identified catalysts, we often find ourselves falling into a value trap.
As you might expect, there’s usually a good reason why stocks are cheap. Valuations aren’t the only way value managers can outperform. Companies with improving business trends or signs of future improvement often coincide with companies that outperform market expectations and ultimately see higher stock prices.
Lukis: We believe we take a pragmatic and modern approach to investing and portfolio construction. We believe inefficiencies exist at the equity level and therefore our investment process is focused on minimizing factor and sector bets. Therefore, we believe another source of differentiation is how we construct our portfolios. A key element of our portfolio construction process is to closely monitor the characteristics of the portfolio, especially in relation to the benchmark. Examples of key factors we consider include sector and industry exposure, size and market beta. We seek balance within our portfolios, allowing stock selection to be the primary driver of returns. We believe stock selection is the most repeatable form of alpha. We believe in the value of diversification and fully respect the consequences of mispricing risk in our portfolios.
Finally, our team structure is also a differentiator: there are many ways to succeed in this business, but we intentionally work as a small, agile team of five experienced people. We believe this allows information to flow freely and quickly, allowing us to take advantage of market inefficiencies that typically don’t last long.
Hotz: Why is the large-cap value asset class and your strategy attractive right now?
AgneFrom an asset class perspective, large value stocks offer broad exposure to cyclical, defensive, dividend income and secular growth sectors of the market that are sensitive to fundamentals and valuations. Cash flow is a key factor within the value universe, providing capital allocation options for different economic conditions.
Lukes: Corporate earnings and cash flow trends are stronger than expected, favoring stocks in traditional “value” sectors such as energy, materials, consumer staples, healthcare, utilities, and select areas of financial services. As mentioned above, traditional value-oriented sectors are experiencing rapid change driven by technological innovation. The fund invests in large players within the large value universe that are participating in these important secular trends. We believe investors should participate in that growth.
We believe that a relative value investing approach offers the opportunity to perform well through most parts of a market cycle. Within this framework, we believe it is important to center a portfolio on profitable, growth-oriented companies with attractive valuations, and balance it with more cyclical and undervalued stocks. And finally, we believe the valuation gap between growth and value stocks has widened through 2023 and 2024, with the Russell 1000 Value Index near a 30-year low versus the Russell 1000 Growth Index, providing an attractive entry point for value stocks.
