Portfolio Drivers: Industrials, Energy, and Consumer Discretionary

Cornerstone Mid Cap 30 Fund Portfolio Managers Ryan Kelley and Josh Wein review the Fund’s investment strategy, discuss the most recent rebalance, and highlight a few fundamental drivers of the portfolio.

November 2023
  • Neil J. Hennessy
    Neil J. Hennessy
    Chief Market Strategist and Portfolio Manager
  • Ryan C. Kelley
    Ryan C. Kelley, CFA
    Chief Investment Officer and Portfolio Manager
  • L. Joshua Wein, CAIA
    L. Joshua Wein, CAIA
    Portfolio Manager

What is the Fund’s investment strategy?

The Cornerstone Mid Cap 30 Fund utilizes a formula to select 30 domestic, mid-cap stocks with market capitalizations between $1 and $10 billion that exhibit both value and momentum characteristics. The formula selects stocks with higher year-over-year earnings, positive stock price appreciation, and lower price-to-sales ratios. The universe of mid-cap stocks is screened using these criteria, and the portfolio is rebalanced annually, generally in the fall. Each stock is equally weighted at approximately 3.3% of the portfolio at the onset of the rebalance, although stock price movements can cause relative weights to change over time.

Would you please discuss the composition of the Fund?

Following the most recent annual rebalance in October 2023, the Fund’s holdings include stocks representing eight of the 11 GICS (Global Industry Classification System) sectors with no holdings in Health Care, Real Estate or Utilities. The largest sector exposure is Industrials with eleven holdings, and the second largest is Energy with eight holdings. This year, we retained three out of 30 holdings from last year’s portfolio: stocks which we refer to as “keepers.” Finally, while the Fund overall remains highly concentrated in merely 30 stocks, we note that this year’s portfolio is diversified across 22 different GICS sub-industries. 

Compared to the Russell Midcap® Index, Energy is the most significantly overweight sector. With persistently high energy prices, significantly strong cash flows, and continued global geopolitical disruptions, we believe many of the Fund’s investments in the Energy sector could continue to perform well. The Fund’s exposure to Industrials is the second most overweight as compared to the benchmark. We believe Industrials could continue to benefit from an improving economy, continued domestic investment in manufacturing, construction, energy infrastructure, and housing, and strong demand and need for distribution and transportation. Lastly, the Fund has a substantial overweight position in consumer-related stocks, both Consumer Discretionary and, to a lesser extent, Consumer Staples. While inflation and high rates remain a focus, we believe a robust job market, a healthy consumer, and strong wages could continue to drive spending, which in turn may drive higher growth in earnings and positive stock price performance for many of the Fund’s consumer-related holdings.

Is there a common investment theme in the current portfolio?

With over half of the portfolio concentrated in the Industrials and Energy sectors, we believe that primary drivers of relative performance this year will include the overall growth of the economy as well as demand for energy. With holdings related to manufacturing, construction, housing, auto, industrial machinery, and trading and distribution companies, any uptick in economic output, construction spending, and energy and infrastructure improvements could benefit certain of the companies in the portfolio. In addition, the Fund has holdings up and down the energy supply chain, primarily upstream and midstream companies, with exposure to oil, natural gas, ethanol, renewables, coal, and other sources of energy. While the initial surge in energy prices in 2022 has abated somewhat, higher prices and strong demand have been beneficial for energy companies, a trend which we believe should continue into 2024 as growth in domestic production could continue to lag increasing demand and as worldwide supply constraints persist.  

What is the median market capitalization of the Fund’s holdings following the most recent rebalance?

The Fund selects its holdings from a universe of stocks with market capitalizations ranging from $1 billion to $10 billion. As of October 31, 2023, the median market cap of the Fund was $3.5 billion, down from last year’s $3.9 billion at the end of the rebalance in 2022 and less than half the median market cap of the Russell® Midcap Index. We believe small- to mid-cap stocks offer untapped potential and that investors may be surprised to learn that mid-cap stocks have outperformed both small- and large-cap stocks over the past twenty-year period with less risk than small-cap stocks.

Would you please discuss the relative valuation of the Fund’s holdings compared with the benchmark?

Attractive valuation is an important criterion in the Fund’s stock selection process. The Fund uses price-to-sales as its primary valuation metric because it is a simple metric, can be universally applied, and is difficult for companies to manipulate. The Fund selects stocks with price-to-sales ratios below 1.5x. The weighted average price-to-sales ratio of the portfolio was just 0.8x as of October 31, 2023, compared to 1.5x for its benchmark index, the Russell® Midcap Index.

The Fund’s holdings are also trading at a discount in terms of price-to-earnings. The Fund’s weighted average estimated forward price-to-earnings ratio was 14.0x as of October 31, 2023, versus 16.2x for its benchmark index.