In this interview, Doug Rao, co-Portfolio Manager of the Janus Henderson Forty Fund, discusses what he and the portfolio management team view as key themes investors should be aware of in a changing market environment.

Key takeaways:

• Over the next three to five years, inflation and interest rates will matter more for equity growth valuations, particularly for high growth companies.
• Select tech and healthcare companies have the ability to produce wide profit margins and operate with a lower level of labour intensity than other market segments, which could make the impact of inflation less pronounced.
• As markets shift, we continue to focus on companies poised for multi-year, secular growth in areas requiring a significant amount of investment.

What is your process for identifying companies that you believe have sustainable competitive advantages?

We focus on companies that are dominant in their field and are driving innovation and change through disruptive technologies, products or business models. One of the key attributes we look for is a wide moat, which means a company has distinct attributes that are difficult for competitors to copy. In our view, these wide moats are key to a company’s ability to sustain its competitive advantages and grow market share globally over time.

What are the implications of higher inflation and rising rates for these types of growth-oriented companies?

Over the next three to five years, we believe inflation and, similarly, interest rates, will matter for equity growth valuations. Since the Global Financial Crisis, we have enjoyed an extended period of both very low interest rates and inflation, during which historically low rates incentivized investors to bid up growth valuations. This dynamic can change quickly as interest rates rise, particularly for high-growth companies with expected cash flows far out in the future.

Stock prices are a function of earnings, earnings growth and the multiples investors are willing to pay for earnings and earnings growth. As rates have risen, earnings multiples have contracted. In our opinion, this has made it increasingly important to invest in companies that can outrun multiple contraction through sustained earnings growth.

A large portion of the growth investing landscape is made up of information technology and health care stocks. Select companies in these sectors have the ability to produce wide profit margins and operate with a lower level of labor intensity than other market segments. So, while inflation will certainly matter for tech and health care companies, these characteristics could make its impact less pronounced.

What key market and macroeconomic themes are you seeing and how are they impacting positioning within the Fund?

The market environment in 2022 has evolved into one of opposing forces and an uncertain outlook. While the pandemic health situation has improved in the U.S., persistent inflation, shifting monetary and fiscal policies and geopolitical uncertainty from Russia’s invasion of Ukraine have presented new challenges.

The ultimate impact of the war in Ukraine remains unknown, but surges in commodities prices – particularly crude oil – could trigger a recession. However, while inflation and the threat of an economic slowdown exist, we maintain a generally positive outlook for equities, especially relative to other asset classes. Relative advantages of equities include their free cash flow yields above that of other asset classes as well as their free cash flow growth. Equities’ potential for growth may also provide a hedge during inflationary periods.

As markets shift, we continue to focus on companies poised for multi-year, secular growth in areas requiring a significant amount of investment. High-quality businesses that can capture a disproportionate share of those economics may be less exposed to external factors as more of their growth stems from capturing market share.

Where are you seeing opportunities in the current environment?

One of the lessons we learned through the pandemic is that direct digital relationships with customers are significant. Companies that have successfully forged these relationships have gained the ability not only to constantly communicate with their customers, but also learn from them – to better manage inventory, working capital and other business functions. From an investment standpoint, these digital relationships have added flexibility and resiliency, strengthening businesses across the economy.

We also believe there is still a long runway of growth for the large cloud platform providers. Semiconductors are providing building blocks for rising cloud server demand as well as key components in the shift to electric – and, ultimately, autonomous – vehicles. As manufacturers ramp up electric vehicle (EV) production, essential chips and components that weren’t present in internal combustion vehicles will be in high demand.

In a similar vein is the growth of biopharmaceuticals such as protein-based therapeutics, gene therapy and mRNA vaccines. Along with the progress of these technologies, costs in pharmaceutical production will likely increase dramatically, and companies selling the various components used in their production will possibly have powerful demand over the next 10 to 15 years.

What role do you see the Forty Fund playing in an investor’s overall portfolio?

The U.S. is home to many of the most innovative large franchises in the world, and the Forty Fund has the benefit of selecting stocks from this cohort. This is especially important in the current market environment, where external factors such as monetary policy and geopolitics are strongly influencing equity markets. We aim to build a portfolio of 30 to 40 high-conviction ideas, focusing on businesses with growth opportunities stemming from sustainable competitive advantages. We believe these companies are likely to be less impacted by uncontrollable external factors. Given its concentrated nature, the Fund may exhibit moderately higher volatility than its benchmark, with the goal of using risk wisely to deliver long-term growth of capital and drive potential outperformance of the index over time.

Learn more about Janus Henderson Forty Fund

Fiscal policy: government policy relating to setting tax rates and spending levels. 

Monetary policy: policies of a central bank, aimed at influencing the level of inflation and growth in an economy including controlling interest rates and the supply of money. 

Yield: the level of income on a security, typically expressed as a percentage rate. For equities, a common measure is the dividend yield, which divides recent dividend payments for each share by the share price. For a bond, this is calculated as the coupon payment divided by the current bond price.

Volatility: measures risk using the dispersion of returns for a given investment.