‘We liked the volatility’: Why inflation means opportunities

This article was featured in Wealth Professional.

Inflation is often painted in broad negative strokes, a brooding menace infecting all areas of the economy. For policy makers and consumers, there is no doubt it is a source of deep anxiety. However, for a process-driven, bottom-up senior portfolio managers, like Manulife Investment Management’s Patrick Blais, it also represents clear investment opportunities.

The head of the Fundamental Equity Team, which manages the Manulife Fundamental Balanced Class and the Manulife Canadian Equity Class, believes there are companies in which inflation risk has not been reflected in its valuation. Conversely, names that have pricing power, where valuation is still reasonable, have looked more positive in the current economic light.

“The fear of inflation and the impact it has had on some names has led to clear opportunities,” Blais said. “We liked the volatility; we liked the dispersion in the market. In many instances, the market became frightened and oversold names, and that gave us the opportunity to buy some companies that, to be honest, had always been expensive.”

The Manulife Fundamental Balanced Class and the Manulife Canadian Equity Class are leaders in their respective field. The Manulife Fundamental Balanced Class Private Segregated Pool has been added to the MPIP Private segregated pools, giving segregated fund investors greater access to the team's historically strong performance, which was rewarded with a Lipper Award in 2022^*.

As bottom-up investors, Blais and his team do not make big calls related to the economy, but he believes trends now point to persistent long-term inflationary pressures. Rising costs have led to fresh analysis and repositioning of his portfolio, including a reassessment of sectors like technology which were hit badly by negative sentiment.

Blais cited Oracle as an example of a stock that was pricing in a lot of pessimism – “literally a terminal decline of record data business, which made no sense,” Blais remarks – and it became one of the Manulife Fundamental Balanced Classes biggest positions, as the stock rebounded massively.

It was a similar story with Microsoft, which Blais believes had overshot to the downside. But he tempers these two standouts by saying that many technology stocks’ valuations are speculative and hard to justify based on the cash they generate.

He said: “Inflation has impacted our structure, but only in a way that's relevant to our approach and our process. Inflation has been a critical factor that's led to some repositioning we think in our favour as we're identifying the best risk-return names.”

Drug distributors represent another strong position in the portfolio, a sector that was not appreciated by the market and was trading cheaply. A value play, it came back into favour as rising interest rates lead to the de-rating of more expensive growth plays. Not only did this sector generate a lot of cash but, operationally, things were improving.

Blais explained: “This is a sector that was penalized because it was seen as a commodity service. They were also dealing with a lot of litigation issues surrounding the distribution of opioids. But the truth is, the opioid litigation issue was resolved, there was a large settlement that put a lot of those issues behind. And we think that the market was missing the fact that the business had moved away or was moving away or adding a highly value-added service.”

Sifting through the markets’ sands to identify the discounted and the overlooked that will become the future stars of the portfolio is an exacting process. The Fundamental Equity Team at Manulife have a list of over 300 names that they’ve meticulously researched and modelled, which they go through at the weekly portfolio construction meeting where they challenge each other to build a portfolio of 40 names. These must have the best risk return profiles, enable portfolio diversification, and be able to capture upside in a rising market while shielding it from the downside. A big part of that complex task is ensuring that valuations are on their side.

It is a process that has been producing results over the past 10 years. The team manages a number of funds rated 5-star by Morningstar including Manulife Fundamental Balanced Class, Manulife Canadian Equity Class, Manulife Fundamental Equity Fund^** and have impressive risk-return profiles. Blais said: “We tend to deliver solid downside protection and keep up when times are good.”

And times are unquestionably good now. Blais is in no doubt that the current environment has been a beneficial one, with lots of opportunities to pick up pure Alpha ideas that are music to investors’ ears.

“The market is proving to be fickle where there are large swings in individual names but that leads us to be able to take advantage of those opportunities and buy names on the cheap that are quality, sustainable businesses with a great risk-return profile,” Blais said, adding: “Last year has been a good one for stock pickers.”

*Manulife Fundamental Balanced Class - series FT6 was awarded the 2022 Lipper Fund Award in the Canadian Equity Balanced category for the 5 year period out of a total of 45 funds ending July 31, 2022. Performance for the fund for the period ended January 31, 2023 is 0.80% (1 year), 7.96% (3 years), 8.54% (5 years), 8.57% (10 years), and 8.85% (since inception on August 9, 2012). Performance for Global Neutral Balanced category for the same period is -1.82% (1 year), 5.48% (3 years), and 5.16% (5 years), 6.20% (10 years). The corresponding Lipper Leader ratings of the fund for the same period are as follows: N/A (1 year), 5 (3 years) [326 funds], 5 (5 years) [296 funds], 5 (10 years) [196 funds].

**Series F – Fundamental Equity Team Page
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The Morningstar Rating, commonly referred to as the Star Rating, relates how a fund has performed on a risk-adjusted basis against its Morningstar category peers and is subject to change every month. Calculations are based on the funds in each Morningstar category to better measure fund manager skill. The Star Ratings as of January 31, 2023 for the Funds shown and the number of funds within their categories for each period are: Manulife Fundamental Balanced Class within the Canada Fund Canadian Equity Balanced category: 1 year period, n/a stars & 367 funds, 3 year period, 5 stars & 325 funds, 5 year period, 5 stars & 297 funds, 10 year period, 5 stars & 198 funds.

The Star Ratings as of January 31, 2023 for the Funds shown and the number of funds within their categories for each period are: Manulife Canadian Equity Class within the Canada Fund Canadian Equity category: 1 year period, n/a stars & 611 funds, 3 year period, 5 stars & 521 funds, 5 year period, n/a stars & 451 funds, 10 year period, n/a stars & 261 funds.

The Star Ratings as of January 31, 2023 for the Funds shown and the number of funds within their categories for each period are: Manulife Fundamental Equity Fund within the Canada Fund Canadian Focused Equity category: 1 year period, n/a stars & 553 funds, 3 year period, 5 stars & 539 funds, 5 year period, 5 stars & 494 funds, 10 year period, 4 stars & 323 funds.

Funds are ranked by their Morningstar Risk-Adjusted Return scores with the top 10% of funds in a category receiving 5 stars, the top 22.5% receiving 4 stars; a fund in the middle 35% receiving 3 stars; a fund in the next 22.5% receiving 2 stars and a fund in the bottom 10% receiving 1 star. The Overall Star Rating for a fund is a weighted combination of its 3, 5 and 10 year ratings. Overall ratings are adjusted where a fund has less than 5 or 10 years of history. Please refer to www.morningstar.ca for greater detail on the calculation of the Star Ratings.