After starting his career as a technology stock analyst, Matthew Andrews in September 2009 joined Private Capital Advisors, a New York–based registered investment adviser founded by his family. Andrews, the CIO, oversees all the firm’s allocations, including its long-only equity portfolio and a multistrategy hedge fund. Andrews and his $418 million firm have ridden the recent bull market using an overweight in large-cap U.S. equities. With fourth-quarter 2014 earnings season having come to a close, equity investors are left pondering their allocations for the rest of 2015 amid high valuations in U.S. stocks and the anticipation surrounding the Federal Reserve’s monetary policy tightening. Institutional Investor recently spoke with Andrews about how he is positioning his portfolios in this investment environment.
Institutional Investor: What are your expectations for U.S. equities for the rest of 2015?
Andrews: Investor uncertainty is driving market volatility. This is a function of geopolitics, oil prices, concerns over Chinese growth and the pace of Federal Reserve tightening.
Until recently, these were all reliable macro indicators. Now many investors accustomed to crisis points and the subsequent soothing actions of central banks feel they don’t have a good grasp on what’s occurring in front of them. This is a function of the deliberate efforts of policymakers, which obfuscate the true metrics. But this also is a function of the fact that we live in a very global economy, and there are so many variables in play. To synthesize the economy down to one thing is impossible. We remain focused on U.S. equities and are believers in U.S. dollar strength, as, in our view, the relationship between monetary policy and the underlying economy is real in this country. In Europe and Japan, on the other hand, it is inflating the value of financial assets with real-world impact. We are zeroed in on a few key sectors where we see more value in innovation, such as media, health care, technology and industrials. Having said that, we are also believers that the majority of the outsize returns are behind us for this cycle. Our anticipated range for the year is roughly zero to 8 percent.
What are the big macro factors driving stock markets?
On the macro policy front, the European Central Bank’s aggressive action bears the closest resemblance to U.S. quantitative easing we have seen yet. Regarding Japan so far, monetary policy has not been effective enough to declare victory, which casts a shadow over the rest of the world’s ability to duplicate the Fed’s success.
Ultimately, the shift in sentiment in November, December and January was so rapid that it left many to wonder what had just happened. Empty catchphrases such as “buy the dip,” “don’t buck the Fed” and “falling knife” rang hollow and forced a lot of people to focus on what it was they actually owned in their portfolios — and on what companies actually do to generate profits and how they do it. It resembled the first time in roughly three years where bottom-up analysis started to matter. From the bottom [in 2009] right through to the end of 2014, we lived in an environment where all stocks rose and fell together. They were all coming off of cyclical lows and all experienced multiple expansion in step with one another. Today the primary indexes are fairly valued — perhaps richly valued. Each individual sector, industry group and stock will trade subject to its underlying fundamental value to a greater degree.
How are high equity valuations impacting your asset allocation decisions?
If you are a short-term investor, the increase in volatility is enough of a reason to shift your allocation to short-term bonds. If you are a long-term allocator, however, you obviously are aware of where the market trades today, yet you can find solace in the fact that a reasonable return can still be earned over a five-, ten- or 15-year picture, if positioned correctly. If you are taking a longer view, equities are still best. For the foreseeable future, though, investors need to accept greater volatility and focus on durable business models, strong free cash flow generation, good management, relevant products and U.S. geographic-centric footprints.
What is your current weighting approach?
Durability of cash flow is what really gets you resilience during cycles of stress. We see good opportunities in health care and some segments of technology and energy. This may surprise some, but we like a few select industrials that bridge with defense and science. I feel that right now you want to be invested in buying into U.S. brands, into companies investing to change the future and into tools that drive productivity. Otherwise, it’s just a trade. We are focused on trying to identify companies that keep innovating and are not a cyclical story. Sometimes this takes the form of a disruptive innovator, but often it is simply a durable business model that will always exist.
Can you cite some specific examples of positions you hold?
Google is an obvious one. It is a flagship technology company that is constantly investing in the future, whether that turns out to be virtual reality, driverless cars or the connected home. Another is McKesson Corp., the drug distributor. It’s a simple business: It negotiates large contracts with producers and redistributes product to smaller buyers. McKesson’s entire franchise revolves around economies of scale and logistics. It’s a business model with durability and cash flows that are less cyclical than either the broad market or the underlying economy. Health care spending is likely to grow in the coming years because of demographics. McKesson has achieved a scale that will be hard for any competitor to achieve.
How do you approach risk management?
What I have come to learn is that sizing is your near-term risk management tool, and timing is your long-term risk management tool. A lot of people like to discuss investment strategy and risk management as distinct, separate things, but in my view they are one and the same.
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