Rupal Bhansali is the chief investment officer for international and global equities at John Rogers (Trades, Portfolio)’ Ariel Investments, a Chicago-based firm with $12.7 billion in assets under management.
Heading up the Ariel Global Fund and Ariel International Fund, Bhansali began her buy-side career at Soros Fund Management over 20 years ago. She joined Ariel in 2001 and now manages approximately $7 billion in portfolios for both institutional and retail clients.
The newest member of the prestigious Barron’s Investment Roundtable, she recently published a book through Columbia Business School Publishing on non-consensus investing. Titled “Non-Consensus Investing: Being Right When Everyone Else Is Wrong,” Bhansali said she wrote her book to “pay it forward,” as the last chapter contains encouragement and advice for young women in finance looking to break through the glass ceiling.
Bhansali answered questions about investing that GuruFocus readers asked recently. Read her responses in the interview below.
We are fortunate to have Bhansali as one of our speakers at the 2020 GuruFocus Value Conference in Omaha, Nebraska next year. For more information on the event and to purchase tickets, please go here.
You can also check out Ariel Investments’ current portfolio here.
GuruFocus question: How do you stay focused on your strategy of non-consensus investing when you may face criticism and pressure from the media, other investors or even your clients?
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Bhansali: I have been a portfolio manager for more than two decades and while my long-term performance track record has been excellent overall, every portfolio manager goes through shorter-term phases when performance lags. While we appreciate the interest of the media and others, we are most focused on our clients. One of the best ways to reduce criticism and pressure from clients is to spend time with them upfront and manage their expectations, not just their money. In our interactions, I not only discuss my investment philosophy and process, but also the environments when our investment approach may face headwinds or tailwinds. Since patience is critical to a contrarian investment strategy, we educate our clients that for them to secure the full power and payoff from us, it is their discipline that matters too, not just ours.
I believe we have done a good job on this front as many of our clients and prospects give us more money to manage when we are underperforming as they have confidence our performance will turn, allowing them to generate even more alpha from our approach than we can on our own. Differently put, just as we go against the grain and average down on our positions as others are selling, our clients do the same by putting more money with us when we are lagging.
Question: You have said FAANG stocks are extremely risky. What factors lead you to reach that conclusion?
Bhansali: Whenever a set of companies have achieved spectacular success as the FAANGS have done, there is a tendency for investors to extrapolate that success into the future and pay up for it. This is a risky set up as good news is priced in, but bad news is not. Investors are not getting paid for risks because they are mistakenly assuming no risks exist. But risks do exist and are growing. Facebook (NASDAQ:FB) and Google (NASDAQ:GOOG) face significant regulatory risk. Amazon (NASDAQ:AMZN) faces large reinvestment needs in both its logistics and data center businesses, which will depress returns on capital employed, while Netflix (NASDAQ:NFLX) and Apple (NASDAQ:AAPL) face increasing competitive risks, which are not priced in. There are significant liabilities which the market is turning a blind eye to – whether it is growing financial leverage risk at Netflix or increasing dilution risk from restricted stock unit issuance to employees where large portions of free cash flows are used to buy back shares merely to offset such dilution as opposed to reduce shares outstanding. In addition, there is significant valuation risk as these stocks trade on significant premiums. Finally, they are a crowded trade with most investors overweight these darling stocks.
This is likely a bad risk-reward setup, which is why we would avoid owning FAANG and prefer to own MANG (Michelin (XPAR:ML), Amdocs (NASDAQ:DOX), Nintendo (TSE:7974) and GlaxoSmithKline (NYSE:GSK)).
Question: Do you believe your MANG stocks will become more popular among investors based on your analysis? Why or why not?
Bhansali: We are not trying to win a popularity contest. We highlighted MANG stocks as a lonely trade versus the crowded trade of FAANG stocks to draw attention to overlooked segments of the market where value is hiding in plain sight.
Question: One major issue in the global markets right now is U.S.–China trade negotiations. How do you expect the trade deal, or lack thereof, between the U.S. and China will affect your investing strategy in the upcoming months?
Bhansali: Trade and tax policy are important and a tariff is nothing but a tax on trade. Trade and taxes can impact global economic growth. Given the slowing economic backdrop, there is a risk that adverse outcomes on trade policy could further increase the risk of a recession. We are overweight in sectors like telecommunications and health care, which are less impacted by global trade policy or cyclical economic developments and more influenced by domestic and demographic demand drivers with secular growth prospects.
Question: What regions outside of the U.S. are you seeing the most value opportunities in, if any?
Bhansali It is more company and industry-specific, rather that regional. The only regional observation I would make is that the U.S. market is the global epicenter of risky valuations for growth and momentum stocks. U.S. companies are also currently generating operating margins near multi-decade historical peaks. In contrast, many companies outside the U.S., especially in Europe, are generating operating well below historical peaks. As a result, the cyclical and stock market risk for many U.S. companies is likely considerably higher than for many non-U.S. companies. However, we do not invest based on a regional view. We are bottom-up investors.
Question: From your viewpoint, how and in what ways will the recent U.S. interest rate cuts affect growth stock overvaluation and the potential for an economic recession?
Bhansali: As it relates to equity markets, interest rate cuts have been largely discounted and evident in the outperformance of growth vs. value stocks during the first half of 2019, in stark contrast to their correction in fourth-quarter 2018, when the market was pricing in rate increases.
As it relates to the economy and recession, the economic cycle looks long in the tooth to us, but we will leave macro forecasting to economists and stick to our job of stock picking. We are not macro-driven investors, but we are macro aware in that we incorporate industry and macro scenarios into bottom-up, company-specific intrinsic valuation work. Our process is not about predicting the future but about stress testing the business under different scenarios, from best case to worst case. More generally, as long-term investors, our theses are driven by much longer-term, through-the-cycle secular and normalized outlooks rather than point-in-time forecasts.
Question: Do you think index funds and exchange-traded funds are good options for average private investors? Why?
Bhansali: Passive or ETFs are an investment vehicle, not an investment strategy. One must always pay attention to whether an investment is undervalued or overvalued. It is generally a bad idea to own overvalued investments and a good idea to buy undervalued ones and playing blind (not knowing if your investments are overvalued or undervalued) is never a good idea. With passive, there is no attempt made to figure this out. Active at least makes an attempt and the good ones succeed.
I would spend the time and effort to identify good active managers who can deliver superior risk-adjusted returns. Studies have shown that good active managers are those with relatively concentrated portfolios, a high active share, low portfolio turnover and where the portfolio manager has skin in the game, with their own money invested in the strategy. In my opinion, it is far easier for an individual to figure out good active managers as the criteria is fairly straightforward, than whether the package deal of stocks embedded in the passive vehicle or ETF are overvalued or undervalued. In my view, the challenge is not in finding a good active manager but sticking with them when they underperform.
Question: How do you avoid value traps? How do you identify if you’ve invested in one, and how do you get out of it?
Bhansali: I avoid them by approaching investing from the lens of a business analyst as opposed to a security analyst. Investors who invest based on low multiples are more likely to end up with value traps as they pay overwhelming attention to the statistical valuation multiples (what you pay) instead of business fundamentals (what you get). As intrinsic value investors, we first figure out what we are getting (the risk and return profile of the business as evidenced by competitive position, profitability, business opportunity, balance sheet, among many other factors) rather than what we are being asked to pay (the stock price). Focusing upfront on the business quality, as opposed to valuation multiples, greatly reduces the risk of buying cheap for cheap sake, also known as a value trap.
Also, as long as the long-run business fundamentals are tracking your thesis, even if the stock is not, you can hold on and even average down. However, if your thesis is invalidated or undermined, you need to reconsider your investment and exiting may be the more appropriate course of action. Once again, pay attention to what is going on in the business, not the share price.
Question: What’s a go-to resource for you for investment ideas and inspiration, beyond typical business publications and websites?
Bhansali: There is no single resource or silver bullet when it comes to generating investment ideas. The goal of good fundamental bottom-up research is to figure out what is misunderstood and, therefore, mispriced. So developing deep domain expertise on the industry or company you are researching is critical. This can happen in a multitude of ways, none of which need be mutually exclusive. You could have studied the subject in school or worked in that industry and learnt it as a practitioner or talked to key opinion leaders who have subject matter expertise. Ultimately, it is about cultivating a habit to read or listen to a broad and eclectic set of materials and people to develop cognitive diversity. Everything from CEO autobiographies to Harvard Business Review case studies to attending conferences hosted by industry trade associations can be useful. Even reading up on the history of markets and companies can prove influential, not just tracking the current state of affairs because it can provide perspective, not just knowledge.