It seems like everything we talk about in recent times has been about resilience. Is the customer resilient enough to handle the inflation we are seeing? Are households resilient enough to handle higher interest rates on their loans and mortgages? Are corporate balance sheets resilient enough to manage through a recession? Certainly, in recent times we can see why these questions are asked – depending on whether the economic forecasts we are seeing are correct, the probability of a recession seems quite high.
Most asset managers will say something to the extent that they are positioned “defensively” today with “resilient” companies. We would concur that we also believe that our strategies are positioned defensively as well. But what exactly does that mean? What does it mean to have a defensive or resilient business?
The most common answer to what resiliency entails is investing in a company that won’t see its revenues fall very much if a recession comes. Certainly, that is one aspect of resiliency. But in our opinion, resiliency can take on several other forms. Another form of resilience is investing in an economically sensitive business, but one that doesn’t carry much debt – allowing them to weather downturns. Another measure of resilience may simply be a strong management team. Even if you own a very stable business, a poor management team is unlikely to produce resilient outcomes. Lastly, resilience means that we, as asset managers, are disciplined enough to ensure we are paying the right price for an investment.
We often talk about companies we own and how we feel that they have flexibility or resiliency. Here are a few examples of when we exited or trimmed a business because the resilience we expected out of our investments was hurt in some way.
We exited Open Text when it announced its acquisition of Micro Focus. Open Text’s business was very slow growing, but Micro Focus’ business was in a state of decline which we felt hurt the combined business’ economic resilience. Open Text’s balance sheet also went from reasonably strong to very vulnerable, as it will be assuming Micro Focus’ considerable debt load.
We exited Rogers Communications when the CFO was openly dismissed via press release. Rogers and Shaw are large players in a mature industry that is relatively resilient to recession risks. In other words, earnings risk wasn’t a significant source of concern. What got us worried was the apparent evidence suggesting significant turmoil at the senior management level. A stable business run by unstable management is still a non-resilient investment.
The demand for stable businesses hit very high levels in mid 2022 which we believe was the reason behind the valuations of Fortis and Telus hitting all time highs (see chart below). We think highly of both businesses and their respective management teams. However, valuation risk is still a risk that impacts the resiliency of an investment. When we saw the high valuations, we made the decision to trim Fortis and exit Telus. Money lost because an investment was hurt by economic sensitivity and money lost due to valuation de-rating result in the same outcome financially.
Source: S&P Capital IQ
We continue to believe that we are well-positioned for economic headwinds with a defensive strategy. We believe that we hold a suite of resilient investments that will weather economic hardship well.
