Worth the Weight

by | Sep 30, 2020

Our fundamental, bottom-up approach of investing in quality companies at attractive valuations results in high active share, evidenced by a portfolio that looks very different from the index. To provide deeper insight into our investment process, we highlight both Materials and Health Care sectors where the Fund has been overweight and underweight, respectively, for a decade.

The Materials sector encompasses one of the most diverse collections of companies, ranging from pure play commodities firms to companies that develop specialized, value-added products that are used in highly sophisticated applications. For example: Victrex, the pioneer and leading global player of ultra-high performance PEEK plastics; Fuchs Petrolub, a global leader producing tailored, sophisticated lubricants; Johnson Matthey, a worldwide leader in vehicle catalyst systems; and BASF, one of the world’s largest and most innovative, diversified chemical companies.

As seen in Table I, our Materials holdings represent higher quality in relative terms, with Projected ROE of 14.5% versus 11% for the index. Importantly, this higher quality has lower risk as Financial Leverage of our holdings is 1.9x, lower than the index at 2.8x. Valuation of our Materials holdings is at a discount, with Normalized P/E (“NPE”) of 13.3x compared to 14.3x for the overall index.

Table I. Materials Holdings


[Note: The data points, tables and graphs included in this report pertain to Sprucegrove’s International Representative Portfolio and is intended to provide an illustrative example of Sprucegrove’s process, consistently applied across all mandates. Actual weightings of each holding, therefore, may vary between those presented here and the actual weightings in other portfolios.]

Striving to invest in quality names is our primary focus. We will not buy quality at any price. Our team has no shortage of examples where we have identified quality companies but have waited years, or decades in certain instances, before valuations came down to attractive enough levels before we initiated a position.

In reviewing the Representative Portfolio’s Health Care holdings, 10 years ago the portfolio was invested in five different companies and, over the course of the subsequent decade, we added a number of new names. However, given our disciplined approach of trimming positions as valuations become lofty and redeploying that capital into more attractively priced opportunities, we have ultimately eliminated all but Novartis, a global leader focused on cancer, immunology, neurology and cardiovascular diseases; and Nihon Kohden, a highly innovative manufacturer of high quality medical equipment. As shown in Table II, our Health Care holdings represent high quality, with Projected ROE higher than that of the index with lower financial leverage.

Table II. Health Care Holdings


In reviewing the past decade, our bottom-up process has resulted in finding high quality Materials names at attractive valuations, resulting in an upward trend of the Portfolio’s weighting relative to the index, as shown in Graph I. As stated above, with Health Care companies commanding relatively rich valuations for much of the past ten years, the Portfolio’s resultant underweighting continues to widen (Graph II) as we find quality names at more favorable valuations elsewhere.

Graph I. Materials Sector Weightings (%)

  Graph II. Health Care Sector Weightings (%)

The Sprucegrove investment team diligently analyzes investment opportunities across all sectors and regions. We continue to monitor and revisit more than 380 Working List names (our inventory of investable candidates), virtually meeting with management and conducting ongoing analysis to ensure the quality of each company remains intact. Furthermore, research is regularly underway on new companies across every sector, in both developed and emerging markets, to add new names to our Working List whenever they meet our quality standards.

The Working List is valued on an ongoing basis and should a particular company’s stock price have an attractive NPE and continues to meet our quality requirements, the portfolio managers will evaluate whether it should be purchased for our clients. The decisions regarding what stocks we will own, how much we will invest, and when we will purchase or sell is the outcome following the review of relative quality and valuation.

Ultimately, we believe that our fundamental approach creates diversification and attractive characteristics for investors with a long-term perspective.

This information is intended to provide insight into our disciplined investment process, consistently applied across all portfolios. Holdings examples may not apply across all accounts. Data is “as of” the date indicated and should not be relied upon as a complete or current listing of holdings (or top holdings) of the Representative Account. Holdings are subject to change without notice, and may not represent current or future portfolio composition.

The opinions, estimates and views expressed are on behalf of Sprucegrove, constitute Sprucegrove’s best judgement as of the date of this document and are subject to change at any time based on market or other conditions. Sprucegrove does not guarantee the accuracy, adequacy or completeness of any third party data. Any predictions, opinions, and other information contained in this report are subject to change and without notice of any kind and may no longer be true and accurate after the date this report was first completed and disseminated. Any forecasts contained herein are for illustrative purposes only and are not to be relied upon as advice or interpreted as a recommendation. In addition, any forecasts are based upon subjective estimates and assumptions about circumstances and events that may not yet have taken place or may never do so. While the information set out in this document has been prepared in good faith, no representation or warranty is given, and no responsibility is accepted, by Sprucegrove in relation to its accuracy or completeness.

The information provided herein should not be considered a recommendation to purchase or sell any particular security. The securities discussed herein are examples of Sprucegrove’s investment approach but do not represent an entire portfolio or the performance of a fund or strategy and in the aggregate may represent only a small percentage of portfolio holdings. It should not be assumed that any of the securities discussed herein were or will prove to be profitable, or that the investment recommendations or decisions made by Sprucegrove in the future will be profitable.

Any index information provided is for illustrative purposes only and is not intended to imply past or future performance. Please note an investor cannot invest directly in an index. Unless otherwise noted, index returns reflect the reinvestment of income and dividends, if any, but do not reflect fees, brokerage commissions or other expenses of investing.

The MSCI data is comprised of a custom index calculated by MSCI for, and as requested by, Sprucegrove. The MSCI data is for internal use only and may not be redistributed or used in connection with creating or offering and securities, financial products or indices. Neither MSCI nor any other third party involved in or related to compiling, computing or creating the MSCI data (the “MSCI Parties”) makes any express or implied warranties or representations with respect to such data (or the results to be obtained by the use thereof), and the MSCI Parties hereby expressly disclaim all warranties of originality, accuracy, completeness, merchantability or fitness for a particular purpose with respect to such data. Without limiting any of the foregoing, in no event shall any of the MSCI Parties have any liability for any direct, indirect, special, punitive, consequential or any other damages (including lost profits) even if notified of the possibility of such damages. [www.msci.com)

This material is for informational purposes only to provide general information and is not meant to be legal or tax advice for any particular investor, which can only be provided by qualified tax and legal counsel. Please read the constating documents carefully prior to investing. Parties should independently investigate any investment strategy or manager, and should consult with qualified investment, legal, and tax professionals before making any investments.

All data is in U.S. dollars, unless otherwise noted. Past performance is no guarantee of future results.

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