Stocks Not to Invest In with Will Rhind (Episode 5)

Well, I think the, fortunately, you know, the majority of clients that, that we have would be longer term investors kind of by nature. So I don't think that they are too worried about what's happened certainly over the last few days. I mean, naturally they do get calls from clients who are much more concerned, uh, about the markets, but I think they themselves are more long term. I think if, if I had to say probably what the biggest concern is at the moment, I'd, I'd say 100% it's inflation. And that's something that we hear from, from all of our clients that they're, they're really focused on inflation and obviously how that manifests itself and how that affects all of the asset classes that they own. And, you know, whether that means that they need to put more ballast on the portfolio in terms of hedge, you know, for a potential downturn or whether that means that actually they should continue to, you know, invest in the market, continue to take risks because inflation will be more under control. But I think that's really the, the key, the key question of today,

Well, I think that, um, those that had hedges from the beginning of the year are probably feeling pretty good about themselves. So whether that was, you know, uh, holding in gold or short term treasuries, or, you know, options, you know, something along those lines that would, you know, help shield a portfolio in the event of a, of a correction or, or dislocation, I think, um, you know, clearly that's something that has worked. I think the other thing is probably people being opportunistic on the assumption that you are a longer term investor and, and a bit more optimistic about the prospects for things more generally, I think it's a chance to potentially buy some of these assets and some of these opportunities, um, that have been beaten up very badly. Obviously most of those kind of fallen under the broad technology umbrella, but I think that's sort of where we see people looking at at the beginning of the year.

Yeah. And I think it's sort of brings up a, again, another very interesting question, which is really this whole argument or push and pull between value and growth and, and what is the right way to value something. And, you know, obviously the markets and a lot of investors are fixated on price to earning ratios and looking at the price to earnings ratio of the S and P and then looking at some of these technology companies, which have a higher price earnings ratio. And, and I just wonder, you know, whether that's really the right measure, uh, and whether that really can, uh, something so simple as price to earnings ratio, something can capture the value of, uh, some of these companies. And certainly I think, you know, to sort of flip it on its head, you know, when you look at companies that have a low price winnings ratio versus the market, I don't think it's necessarily the case that those are, are sort of bargains if you will. And I think there's a, there's sometimes a very good reason as to why those companies are trading at a big discount, uh, to the market.

We? Yeah, no, absolutely. And I think if you look at a company like Microsoft, you know, it was so crazy to me that they announced their earnings and then the stock went down and, you know, for all intensivess purposes, when you're looking at their earnings, you look at the, the front page. I mean, it's, it's, it's incredibly strong, you know, what a fantastic story. And yet the stock was down. I think part of that obviously is the environment that we're in people are, people are slightly scared, but at the same time, you know, the official reason for it was that the, the growth and the cloud, you know, part of the business, perhaps wasn't growing as fast or wouldn't be growing as fast in future. But, you know, I think if the market's looking to price perfection, then you know, clearly there's gonna be a lot of opportunity for people to buy. Don't like Microsoft. And obviously today, you know, the, the stock's up quite considerably off the back of it. But I, I think there was a good example where there are some funny things going on at the moment, which, you know, for the right investor there's opportunities, mm-hmm

Exactly. I think some sometimes, um, sometimes I think you could definitely say that.

Yeah, no. Um, XL is an interesting, interesting strategy, really. I think let's, let's start by saying, you know, there are really two schools of investing, you know, in the market. There's the school of active management, which is all about picking winners. So in other words, trying to identify the winning stocks going forward, and we know that's very, very difficult to do over a long period of time, you know, the, the speed report as it's called in the industry, but that's produced by standard and pause. And it's a, a measurement, if you will, of all of the, the active funds in the market mutual funds versus the, the benchmark S and P 500 and last year in the large cap space, 60% of managers underperformed the S and P 500. And that's the same thing that's been happening now for 11 years in a row. So you've got picking winners on one side, and then for those that really sort of disagree, or, or don't think that's possible, you have passive management and pure passive management.

I E just holding an index means that you're guaranteed to underperform by virtue of the fact that you pay management fees. And therefore you accept that outperformance is impossible. And there you, you just accept the average. And what XL tries to do is really put itself somewhere in the middle. And the rationale is that, well, if it's so difficult to pick winners, is it easier to identify losers? In other words, is it easier to identify stocks that are likely to underperform than it is to find a winner, or I guess put more simply the strategy is about avoiding the next Enron, as opposed to finding the next Google. That's really what XL is all about. And it's a large cap us equity strategy that aims to avoid stocks that we think are at risk of underperforming or in secular decline.

Yeah, no, absolutely. I mean, it, it, like I said, it's the core, it's a us large cap equity strategy. It's a buy and hold core position. But despite the fact that stocks, you know, and we obviously believe that stocks over the long run will go up in value. The key in investing is really avoiding the big mistakes. And, you know, when, when you're thinking about long term returns, a lot of people forget that, you know, if you have a drawdown of 50%, for example, you know, that requires a return of a hundred percent to get back to break even. So if, if you can minimize the drawdowns or you can avoid the big mistakes, you'll have a much better, longer term outcome. Now,

Yeah, a absolutely. And, and the reason being that, you know, if you take, um, the S and P 500 just in its, you know, standardized market capitalization form, you know, what a lot of firms have done over the years is try to reshape that in different ways. So you can get, you know, S and P 500, that's equally weighted. You can get a reverse weighted, you can get tilts to devalue and growth. And so people have tried to reshape that index a number of different ways. And so at its core, all we are opposing is that, you know, X out and the philosophy of avoiding losing companies should really be at the core of a portfolio, as opposed to, you know, the obvious floor and passive investing, which is you buy every company in the market, regardless of whether it's a good or a bad company. So

Yeah. So we, the way we do it is we start with the universe of 500 largest stocks by market cap in the us. And we have a, a model which scores every one of those companies. And we have seven fundamental criteria that we use to Decore those stocks. So we're gonna look at revenue growth, employee growth, R and D investment, buybacks, profitability, earnings, forecasts, and management scores. There's seven criteria, they're all fundamental criteria. And then that creates a score when those are blended together, ranks a company zero to five. And so we evaluate all the companies, the 500 companies, and we exclude the 250. So we exclude half that have the lowest scores, and then the 250, but the best scores end up being our portfolio. So we're really taking 500 largest companies and we're removing half of them and that's on every quarter and it rebalances every quarter.

Yeah. So this is kind of one of the most followed things in this strategy, because instead of, you know, most, uh, fund managers or most strategies, you know, to post the top 10 holdings, I know we of course have that, but the thing that people are more interested in with us is our top 10 X outs. Oh, so what are the, what are the 10 largest companies that we exclude? Because a lot of people obviously own these companies, you know, in various strategies that they have. So the largest company that we exclude at the moment by market cap is visa. And we have some banks in there. We have JP Morgan, we have bank of America. We have some of the energy companies, Exxon Chevron, uh, and then we have names like Disney and telecommunications companies are Verizons and at and T so no a number of different companies from different sectors.

Exed out? It's interesting because at a very high level, if you look at a five year chart of visa against the S and P five, it has outperformed. However, the devil is in the detail. And if you look at the last one year, the last two years, the last three years, it's underperformed. So it's clearly losing momentum versus the market. Why is that? So in terms of what our model identified was weak revenue growth, poor management execution. Those are kind of really the two key things. It's revenue performances below the median in both the current and trailer revenue basis. And, and frankly, investors have better options when it comes to payments companies and the payments technology sector more broadly. And so visa is a company that, you know, really is kind of been eaten alive by all of these startup. And, and obviously some of them now are, are massive companies, but these FinTech, upstarts payments companies that are coming into the market and just slowly eating away at their market share, we're looking

exactly in different, different parts of the market. But, you know, I mean, so some of these companies obviously are extremely significant market caps and come from zero, but it's that kind of idea that this is once across monopoly company, um, that has just gradually been eaten by these smaller upstarts payments companies,

100%. Um, so this is, this is a, a strategy that again, you have to believe in the story, um, and you know, the, the performance numbers are just the output of that story, but the story is long term technological disruption is one of the biggest forward facing risks facing every investor. And how do you mitigate against that? And so every company in the market is at risk from technological disruption and what the X out model tries to do is sort of model a factor called tech disruption to identify companies at risk and exclude them

No, absolutely. I mean, Disney's one that that can be quite controversial. So that's an X out that we have as one of our largest X outs. And, and I think that's a company that for whatever reason, a lot of advisors own it, a lot of investors own it and are quite passionate about the company. And I think, you know, in terms of the model, Disney's underperform the market by 80% S and P over the last five years. So that that's just the top line. That's just the bare facts, but the shares are down more recently. And I think it's, it's really goes to this idea of, you know, chasing emotion instead of quantitative analysis. So in the model it's consistently scored quite poorly. And so not only does revenue growth and revenue acceleration remain negative, but gross profitability is also in the lowest quintile that we measure and investment meaning R and D investment is the second lowest quintile.

And I think that, you know, when you look at the, the CEO, Bob IGA, who was a, who was kinda a legendary figure, I guess, in the market, and certainly as a CEO, you know, he's gone new management coming in. And I think one of the bright spots for Disney was it's, you know, entrance into the streaming war, the streaming wars and the streaming market and competing against the likes of Netflix and, you know, gaining market share against some incumbents. But as we saw from the Netflix results, um, just a few days ago that, you know, subscriber growth is closed, is slowing down. And that's really as a result of more competition in the space and, you know, less people, I guess, sitting at home and just watching TV as they were during the height of the pandemic. And so that affects companies like Netflix badly, but it also affects companies like Disney and the stock's been down accordingly.

Yeah, no, absolutely. So the, um, the strategies is called hips. That's the ticket code I P S and that stands for high income pass through securities. So what, what hips does is it invests in it's a segment of the market that, you know, some people will be familiar with, but I don't think it would be an obvious or well known to, to the majority of investors. And it's a type of security called a pass through security. And what a pass through security is, is it's a publicly listed or publicly traded entity that doesn't pay or is not subject to corporation tax. So its unique tax circumstance means that it has to distribute, you know, substantially all of its income to the investor or to the shareholder. And so that means that automatically from the get go, you're starting at a higher level of income and examples of pass securities.

Some of the main sectors would be things like REIT real estate, investment trusts, MLP master limited partnerships, BDCs business development companies and close end funds. And so what hips tries to do is to take a portfolio of the highest yielding securities in those particular sectors with the lowest volatility and then pays a fixed distribution of 10.75 cents per share per month. And then what that equates to at the moment is a yield of around 8.7% per annum. So it's not strictly a bond fund, it's more akin to an equity fund, but it invests in this sort of segment of the market that, uh, is called pass through securities. And that, I think that's really, again, you know, the, the reason we came up with this particular strategy is again, the traditional ways of looking at yield or the traditional mechanisms to generate yield, arguably fundamentally flawed in this environment where there's very difficult to get yield from any fixed income, be a high yield bond or any other bond, especially factored inflation. And then on the equity side, you know, traditional dividend paying stocks offer suffered a lot during the, the COVID pandemic and many, many stocks cut dividends or abandoned dividends altogether. So this is a new, different area of the market that I think warrants a closer look, uh, for anybody that's looking for income and, and a particularly a decent above inflation level of income,

Uh, it can be. And the reason why I say that obviously is difficult to say, you know, versus, you know, how everybody uses it. I think if, if I was to say, or try and try and categorize the, the list of clients and that I know of that use this fund, I would say that I think the majority of people use it because they take money or have taken money away from their bond allocation in the portfolio and have put money into this because what it's gonna do is automatically increase the yield of whatever income strategy they have. But because the, the distribution is fixed, it's uncorrelated to the bond market. So yes, I'd say probably the majority of people that I'm aware of are using this as a replacement for some of the bonds that they, that they used to own.

Well, it, it's certainly a long term, a longer term play. It's a buy and hold strategy. And again, the, the main idea is it pays a fixed distribution every month. So it's paid the same amount, every month's since inception. And it's done that through different market cycles, through ups and downs and the, the way that we've constructed the portfolio. And the reason why that these four sectors that are in there is because it's, it's designed to be an all weather income portfolio. So it's designed to pay that 10.75 cents or roughly that sort of eight to 10% per annum, regardless of market conditions. So whether we're in a low growth environment or a high growth environment, a low inflation environment, or a high inflation environment, there'll be some part of the portfolio that is performing well, even if another part is not performing well. And therefore you can create that, that all weather income generation,

People can go to the website, which is just granite shares.com or www.graniteshares.com. Contact us directly, obviously, to get more information about any of the funds we've talked about today or any of our other strategies. So visit the website. And if you want to, to find out, well, please feel free to reach out directly.

Kay. Thank you so much for having me. It was been an absolute pleasure. Thank you.