Citywire AA-rated Peter Bye, who runs the UBS (Lux) EF Mid Caps USA fund, recently won a Citywire US Offshore Award for his three-year risk-adjusted performance in the US Small & Mid Cap equity category.
Bye is head of US Growth at UBS Asset Management and reveals how he has been positioning his portfolio to deal with the past year’s market volatility. He is long-time believer that digital transformation is driving material changes in technology and the broader economy – a trend that’s been accelerating since the onset of the pandemic.
You can see the full of Citywire US Offshore Awards PM winners here.
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What were the biggest drivers of your fund’s performance over the past three years?
The mid-cap growth space provides an opportunity to find early growth names that are often either creating or disintermediating large existing total addressable markets (TAM’s). We believe that the market often misprices the duration and/or magnitude of the potential growth implied by this capitalist creative destruction process. While positive returns have been most notably in the technology sector, we’d note that almost all sectors have had positive contributions to performance. We have long been believers that digital transformation is driving material changes both in technology and the broader economy (so this is a cross-sector theme not simply concentrated in the information technology GIC), and we’ve seen that trend only accelerate during the recent pandemic.
What key changes did you make to your portfolio in 2020?
Early on, we exited positions with significant in-person consumer exposure, and pivoted to less exposed names or technology platforms that we thought could benefit from an acceleration in digital transformation. As the year progressed, we pivoted back in some cases to names where we thought the business would not be permanently impaired post-Covid and where valuations implied a significant discount. We also used dislocations throughout the year to add to positions where we thought the market was overly punishing business models that we thought would be more resilient than expected and or demand was merely deferred or delayed due to the virus not permanently impaired or disrupted.
What themes/sectors are you favoring in 2021?
Although we have a bottom-up stock specific process, thematic trends do emerge from the bubble up process of idea generation. We are finding ideas across the duration of the growth curve not just long duration ‘open ended’ growth stories. On the shorter duration end we have found ideas in cyclicals (i.e. automotive, semiconductors, and infrastructure sectors amongst others) and Covid recovery stories in leisure, travel, customer experiences and healthcare (exposure to elective/schedulable procedures, therapeutics, non-Covid screening/diagnostics and hospital visits, etc.).
On the secular growth side, we are still finding under-appreciated duration of growth and/or TAM names in some digital transformation stocks that include ‘pure play’ software and social media themes but also enabling technologies for 5G and healthcare (drug discovery tools, diagnostics, care delivery, etc.). We also are finding favorable ideas with exposure to ‘new energy’ names and have increased our positioning in EVs and alternative energy. We expect non-carbon/low carbon penetration to continue to grow in both the automotive and broader energy markets.
What is your contrarian call for this year?
To a certain extent everything we own in the portfolio has some contrarian components to it given that we believe they are relatively mispriced securities. Thus, our portfolio isn’t constructed with any large top down contrarian themes, but rather more by a series of lowly correlated small, individual, stock-specific contrarian calls. For example, we expect to do equally well in 2021 relative to the benchmark in an inflationary and non-inflationary environment; the same was true for our positioning headed into the US election this past November as we eschew taking large top down bets based on potential macro binary outcomes.
What is the biggest challenge facing your investment sector this year?
We think the biggest challenge is likely to be volatility around the exit from pandemic lockdowns and return to normalcy as vaccines are rolled out and governments inject additional stimulus into the economy. However, given our long-term approach to investing, we would view any temporary dislocations as opportunities to acquire strong growth businesses at favorable prices.
How are you embracing ESG factors in your investment approach?
ESG is integrated into our process as every potential investment or update of our existing names includes an examination of a company’s ESG metrics. We also engage with management on these issues throughout the year. Given the early-stage nature of many mid-cap names, we often give a hard look at the management teams that are guiding these companies, especially founder-led ones, where an investment in the stock is typically an approval of their vision.
What lessons have you learned over the past year?
Well, aside from humility, which seems to be a lesson the market teaches us every year, I’d say in a market that had several head-turns and factor rotations it was to stay true to our process. For us that means continually noodling; 1) What is a good business with good returns?, 2) Who has defensible moats?, 3) What is transitory and what is secular change?, 4) What is market pricing for future duration and magnitude of growth?
We also want to be able to quantify the ‘known knowns’ and the ‘known unknowns’ while giving ourselves some valuation support for all the ‘unkown unkowns.’ We tend to be data driven: what can we quantify from current data points and focus on rate of change (RoC)?
We have found the market is efficient in pricing consensus expectations, but these forward-looking estimates tend to have a linear modeling bias, which often mis-models the downturn and eventual recovery and sigmoidal curves that result in both revenue and incremental/decremental margins.
We look to reverse engineer what the market is telling us about the gating of that future incremental or decremental growth. While it is important to be nimble and react to changing economic factors and the macro environment, we don’t want to overreact to transitory events and under-react to secular trends and themes.
The pandemic provided a strong test case that exposed which companies had shifted their businesses to address where the market is going, and we could see clear examples of winners and losers across the consumer, media, healthcare and technology sectors as a result.
