Three value stocks that can offer safety as interest rates rise

Equities have had a rocky road this year as investors tried to anticipate every possible move by the Federal Reserve to fight inflation.

Value strategies have held up better than growth strategies. But instead of focusing on indices, investors could be well served with diversification in conservatively run companies selected by value managers with a global perspective.

An example is First Eagle Global Fund SGIIX, -0.28%, which takes a value approach across multiple asset classes. The fund has a five-star rating (the highest rating) in the Morningstar World Allocation category.

Headquartered in New York, First Eagle Investments has approximately $110 billion in assets under management. Kimball Brooker, co-manager of the First Eagle Global Fund, discussed the firm’s philosophy of selecting conservatively managed companies by value. He made the case for three companies.

It’s time to diversify to complement your index funds

The US benchmark S&P 500 Index SPX, -0.34% is weighted by market capitalization, which means if you own shares of the SPDR S&P 500 ETF Trust SPY, -0.37%, 23% of your money will be invested in five companies: Apple Inc .AAPL, +1.15%, Microsoft Corp. MSFT, -1.12%, Amazon.com Inc. AMZN, -0.22%, Tesla Inc. TSLA, +1.13% and Alphabet Inc. GOOG, -1.10%, GOOGL, -0.86% .

These are great companies and SPY has very low costs. But the high concentration on tech-focused stocks sets the stage for something many investors just aren’t used to: tepid returns during a cycle of high inflation, rising interest rates, and possibly a recession, as the combination results in slower consumer spending.

US inflation hit a new 40-year high in March, with the CPI up 8.5% year-on-year, according to the Bureau of Labor Statistics.

A long period of deflation had accustomed investors to excellent returns in the stock market. More recently, massive economic stimulus from the federal government’s direct payments to consumers, coupled with the Federal Reserve’s efforts to keep interest rates very low, made stocks even more attractive.

But times have changed, as the stock market shows us this year. Investors may have to adjust to a different environment in the stock market, where index funds may no longer seem as safe.

Over the five years through 2021, the average annual return for the S&P 500 (dividends reinvested) was 16.6%. For the previous 10-year period (end of 2001 to end of 2011) it was only 2.9%. Yes, these are arbitrarily chosen periods of time. Going longer, the S&P 500’s compound annual return over the 20 years to 2021 was 9.5%.

Now consider the 20-year return for the institutional share class of the First Eagle Global Fund compared to that of the S&P 500 through 2021:

fact set

If we go back to five-year numbers through 2021, the First Eagle Global Fund returned 54%, while the S&P 500 returned 133%. But the 20-year chart shows the benefit of diversification with clear outperformance for First Eagle’s active international value strategy.

Three international value stocks

The First Eagle Global Fund has nearly $50 billion in assets under management. The portfolio was 42% concentrated in US equities as of December 31, with 36% in non-US equities, 14% in gold-related investments, 7% in cash and 1% in bonds.

In an interview, Brooker said the environment of rising interest rates has been particularly tough for tech companies that are trading at high valuations because they tend to “have future cash flows that you are pricing in today.”

And the rebates will be higher as interest rates rise, he said.

“Our preference in our portfolios is to hold companies that are producing cash today,” Brooker added.

He gave three examples of companies held by the First Eagle Global Fund that he believes represent excellent values ​​at this time:

Bank of New York Mellon – Unlocking Higher Interest Rates

Bank of New York Mellon Corp. BK, -0.87% Not focused on traditional lending. It has a huge securities custody business and also a $2.4 trillion wealth management business by the end of 2021.

Within the wealth management entity are money market funds, which are mutual funds that have a fixed unit price of one dollar. Traditionally, money market funds have higher returns than bank accounts while being fully liquid. Money funds do this by investing in commercial and government securities with a typical average maturity of 90 days. But since the 2008 credit crunch, there have been long periods of very low yields for 3-month US Treasury TMUBMUSD03M, 0.751%. Was the three-month return as of 31.12. only at 0.06%, it has now risen to 0.76%.

For years, with interest rates near zero, the Bank of New York Mellon and peers were forced to subsidize money market funds. Otherwise, they risked “breaking the buck,” which would mean a drop in the stock price and potentially a fund closure and massive losses.

Ending the subsidy during this period of rising interest rates could eventually increase the Bank of New York’s annual revenue by as much as $1 billion, according to Brooker. That’s a staggering figure compared to the company’s 2021 net income of $3.77 billion.

“For three years, the company has averaged $4 billion in net income while paying about $1 billion a year in dividends and doing $3 billion a year in buybacks,” Brooker said. BK’s current dividend yield is 2.83%.

With low credit exposure, the Bank of New York Mellon would have a much easier time managing a decline in credit quality during a recession than lending-focused banks.

Brooker called the bank’s price-to-earnings rating “unassuming.” Bank of New York Mellon shares are trading at 9.9 times consensus earnings estimates for the next 12 months among analysts polled by FactSet. This compares to an expected price-to-earnings ratio of 11.3 for the S&P 500 group of banks and 19 for the S&P 500 as a whole.

Jardine Matheson – a conservative play about reopening Asia

Jardine Matheson Holdings Ltd. J36, -0.32% is located in Hong Kong. The company’s shares held by First Eagle are listed on the Singapore Stock Exchange. There is also an American depositary receipt: JMHLY, +0.21%.

Jardines was founded in 1832 and moved its headquarters to Hong Kong in 1844. The company is a conglomerate that trades at a forward P/E of just 9.4, according to FactSet. “As a sum of the parts, we believe it is trading at a significant discount as many components are public,” Brooker said.

Brooker emphasized that Jardines has a strong management team and low debt. He also said US investors adjusting to a post-pandemic economy may not realize that much of Asia is still in partial lockdown, with Shanghai as a recent example.

Brooker said that while US investors are right to be concerned about the validity of some Chinese companies’ accounting, Jardine Matheson’s accounting is “in our view impeccable.” He added that the majority of the company’s business engagements are in Indonesia.

Publicly traded entities controlled by Jardine Matheson include:

• Dairy Farm International Holdings Ltd. D01, -2.13% DFIHY, +0.54%, operates convenience stores and supermarkets.

• Hong Kong Land Holdings Ltd. H78, -0.81% HNGKY, -0.61%.

• Jardine Cycle & Carriage Ltd. C07, -1.10% JCYGY, -2.96%, which invests in auto and other industries in Southeast Asia.

• Mandarin Oriental International Ltd. M04, -0.97%, a hotel operator.

Jardines stock has a dividend yield of about 3.50%, paid twice a year.

Brooker emphasized the corporate culture of “doing with honor.”

Exxon Mobil – the advantage of diverse assets

Exxon Mobil Corp. XOM, +2.09%, was the second largest stock position for the First Eagle Global Fund as of February 28, accounting for 2.7% of the portfolio.

Even after climbing 37% this year and up 48% in 2021, Exxon’s stock is trading at a forward price-to-earnings ratio of just 9.6. The stock has a dividend yield of 4.20%, and the company hasn’t been forced to cut its payout during the 2020 oil price doldrums.

When asked about the influence of activist investors, led by Engine No. 1, who gained presence on Exxon’s board, Brooker said it was seen as a “great win for ESG efforts.” But he went on to say that what really happened was “more complicated” and that the board was focused on the efficient allocation of capital.

Looking ahead, Brooker expects Exxon and other big integrated oil companies to be “part of the climate risk solution.”

In the near term, at a time when the world’s energy markets are so disrupted, he sees Exxon as a compelling company because of the diversity of its business and energy assets, particularly in the US and Canada.

He pointed to higher risks for companies that have their oil production facilities in certain regions. In contrast, “Exxon can move capital to where it is best and most utilized,” he said.

top stocks

The First Eagle Global Fund’s largest position as of February 28 was gold bullion, which represented 11.1% of the portfolio. Here are the next nine positions to round out the top 10 holdings:

Click on the tickers to learn more about each company.

Click here for Tomi Kilgore’s in-depth guide to the wealth of information available for free on MarketWatch’s price page.

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