Strong Consumption and Capital Spending

Portfolio Manager Ryan Kelley reviews the Fund’s investment strategy and discusses the Fund’s most recent rebalance and changes in the portfolio composition. He also highlights the fundamental drivers of the sectors with the highest weightings in the portfolio.

 

November 2018

  • Neil J. Hennessy
    Neil J. Hennessy
    Chief Investment Officer and Portfolio Manager
  • Ryan C. Kelley
    Ryan C. Kelley, CFA
    Portfolio Manager

What is the Fund’s investment strategy?

The Cornerstone Mid Cap 30 Fund utilizes a quantitative formula to select 30 domestic, mid-cap stocks that exhibit both value and momentum characteristics, choosing stocks with higher year-over-year earnings, positive stock price appreciation, and low 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.

In addition to the regular annual rebalance, we may reconstitute the Fund’s portfolio more frequently, generally on a quarterly basis. We may sell the three lowest-performing stocks from the portfolio and select the top three best-performing stocks, as replacements, from the universe of mid-cap stocks that pass the Fund’s investment criteria.

Would you please discuss sector weightings and the themes supporting those sectors?

Following the most recent annual rebalance, the Fund’s portfolio is well diversified, with investments in 9 of the 11 GICS sectors. The Fund has meaningful weightings in Information Technology and Health Care—two sectors not represented in 2017’s portfolio.

Compared to the Russell Midcap Index, the Fund continues to have a substantial overweight position in consumer stocks, with just over one third of the Fund invested in the Consumer Discretionary and Consumer Staples sectors. Many of the Fund’s current holdings are in traditional retail, such as American Eagle Outfitters and RH (previously known as Restoration Hardware), as well as industry groups such as consumer products and restaurants.

Consumer spending has been growing rapidly over the last year, reaching 5% growth in the second quarter of 2018, driven by robust job growth and higher wages. This growth in consumption has been driving growth in earnings and positive stock price performance for many retail and consumer stocks over the last year. These are two important investment criteria considered in the stock selection process for the Fund.

The Fund is also overweight the Industrials sector and slightly overweight Materials and Energy compared to the Russell Midcap Index. Industrials, Materials, and Energy companies have also been reporting solid growth in earnings and have seen their stock prices perform well due to strong economic growth in the U.S. and an upturn in capital spending. Annual gross domestic product (GDP) growth has averaged 3% over the last two quarters and investment spending grew more than 10% over the previous year in the first half of 2018.

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 midcap stocks with market capitalizations ranging from $1 billion to $10 billion. Following the rebalance, the Fund’s holdings have a median market cap of $4.7 billion.

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

Attractive valuation is an important factor 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 a price-to-sales ratio below 1.5x, and the median price-to-sales ratio of the portfolio was just 1.1x at the end of September 2018 compared to 1.6x for its benchmark index, the Russell Midcap Index.

Interestingly, the Fund’s holdings are also trading at a discount in terms of price-to-cash-flow. The Fund’s price-to-cash-flow ratio was 9.5x at the end of September versus 11.7x for its benchmark index.

Diversification does not assure a profit nor protect against loss in a declining market.