Seeking growth in all market environments
February 16, 2012
Click on each topic below to read Jeff Van Harte's comments on:
The information technology sector
The information technology (IT) sector is particularly interesting to us because, in recent years, certain companies within this sector have exhibited an ability either to establish and control technological standards and intellectual property or to carve out unique competitive positions, or both — and we are interested in these types of technology companies only. When companies, for example, create unique intellectual property, or a single company stands out for creating the most effective search engine or inventing a wireless technology standard, growth can become viral very quickly and can last for a long time. These types of achievements often lead to very scalable economics and a market share position that can be difficult to compete with. This is very different from 20 years ago, when technology was notorious for running large obsolescence risk. Obsolescence risk still exists today, but the information explosion has created an environment in which technology standards — whether official or de facto standards — combined with an enhanced competitive position, can make IT companies powerful businesses to own.
It’s important to note, however, that while we currently find a number of tech companies attractive, sector weightings within the strategies we manage are byproducts of our bottom-up investment process. We do not make any explicit “sector bets,” as our portfolios are constructed on a stock-by-stock, bottom-up basis. Within any particular sector, we look for different types of business models that have a high degree of idiosyncratic, company-specific risk, rather than aggregate sector or market risk.
Furthermore, sector classifications, in our opinion, can sometimes be misleading. For example, Standard & Poor’s uses the Global Industry Classification Standard (GICS®) classification. The GICS classification shows the information technology weighting within one of our portfolios as almost 45% of the portfolio. By comparison, the Russell classification shows our IT weighting for that same portfolio at roughly 32%, and the Wilshire classification likely has our information technology weighting as yet another number. The point is that index providers will classify companies using various criteria, and we don’t pay much attention to the classification rationale.
Finding growth companies in today’s environment
We believe investors can always find companies that take advantage of secular growth opportunities or that have competitive positions that enable them to earn sustainable excess return on investment. In our view, this is true even in difficult environments in which many companies struggle.
Secular growth can be found in various parts of the economy (beyond the IT sector) even when the overall macroeconomic environment is challenging. The leading manufacturer of private-label over-the-counter drug and consumer products sold through retail outlets (for example, Walgreen-brand cough syrup) is but one example.
We believe private-label penetration of overall consumer sales in this channel is a secular growth mode, and we believe we own the best company in this area. Our wireless holdings are additional examples of companies that can participate in the inexorable trend toward mobile communications, despite the level of overall economic activity.
Another holding, which not only dominates the “name your own price” travel niche and fits in well with the current consumer spending environment, but also has leading market share in the fragmented European hotel booking market, which is showing significant secular growth, is another example of a company that we believe can thrive through difficult conditions. When the economic background becomes more favorable, we believe the company should certainly benefit from a tailwind, but in the mean time, it can still benefit from its unique competitive position in Europe and from the overall secular growth rate in its niche within the travel market through today’s more challenging economic environment. We believe these characteristics give it an “all-weather” aspect, and indeed we seek this characteristic in all of our holdings.
Another way to find growth opportunities, even in difficult economic environments, is when temporary controversies or transitory events uncover opportunities to invest in solid growth franchises, often because investors are unwilling to weather short-term uncertainty. Because we define growth as the “growth of intrinsic business value” (and not some arbitrary hurdle rate of revenue or reported earnings growth), opportunity often comes about when market volatility or even stock-specific uncertainty creates attractive valuation dislocations. In these instances, we attempt to take advantage of “time arbitrage” opportunities, whereas other, shorter-term investors may take a more myopic view. A company in the for-profit education industry is a good example of this phenomenon.
The for-profit education industry is currently experiencing a painful transition as federal government scrutiny and regulation has forced many companies within this industry to change their business focus. In many cases, these changes have caused severe dislocations in revenues and earnings. In our opinion, even though the industry may actually be in a negative- to no-growth environment in the intermediate term, it should emerge as a leaner, more transparent, and possibly better industry longer term. Many of our growth investor peers fled this sector in 2010, when the group sold off. In contrast, we bought stock of a leading company in this industry at that time, amid the industry controversy. We believe that the company’s business model transition — from an overemphasis on revenue generation to more of a focus on profitability — should ultimately lead to growth in its intrinsic business value. Our long-term view on this transition and value creation was in contrast with the market’s short-term view. We believe that this leads to a classic example of time arbitrage. Incidentally, this position has already added value to our portfolios.
The team’s current focus
Our key focus, now and always, is to continue to construct portfolios with quality business franchises that control their own destinies. This is particularly important during a time such as today, when we believe many companies have lost control of their own destinies amid massive economic and market volatility. We seek the truth about companies and attempt to invest accordingly.
We remain consistent with our long-term approach and believe that the portfolio metrics (performance, risk-reward metrics, turnover) support it. We believe our approach helps our portfolios perform particularly well during periods of volatility (both economic and investment). We believe we offer a unique combination that seeks to protect investors’ downside with quality holdings, while owning companies that can take advantage of secular and opportunistic growth opportunities.
The Delaware Investments Focus Growth Equity team manages the following growth equity funds:
*Delaware Select Growth Fund and Delaware Smid Cap Growth Fund were closed to new investors following the close of business on June 8, 2012 and Feb. 24, 2012, respectively. Existing shareholders of the Funds as of the applicable closing date; certain retirement plans and IRA transfers and rollovers from these plans; and certain advisory or fee-based programs sponsored by and/or controlled by financial intermediaries where the financial intermediary has entered into an arrangement with the Funds’ Distributor or transfer agent (mutual fund wrap accounts) may continue to purchase shares. Please read the Delaware Select Growth Fund’s prospectus and supplement dated May 25, 2012 and the Delaware Smid Cap Growth Fund’s prospectus and supplement dated Feb. 9, 2012, and their summary prospectuses for more information concerning these events.
The views expressed represent the Manager’s assessment of the market environment as of February 2012, and should not be considered a recommendation to buy, hold, or sell any security, and should not be relied on as research or investment advice. Views are subject to change without notice and may not reflect the manager's current views.
Carefully consider the Funds' investment objectives, risk factors, charges, and expenses before investing. This and other information can be found in the Funds' prospectuses and their summary prospectuses, which may be obtained by visiting the fund literature page or calling 800 523-1918. Investors should read the prospectus and the summary prospectus carefully before investing.
IMPORTANT RISK CONSIDERATIONS
Investing involves risk, including the possible loss of principal.
Investments in small and/or medium-sized companies typically exhibit greater risk and higher volatility than larger, more established companies.
International investments entail risks not ordinarily associated with U.S. investments including fluctuation in currency values, differences in accounting principles, or economic or political instability in other nations.
Investing in emerging markets can be riskier than investing in established foreign markets due to increased volatility and lower trading volume.
Narrowly focused investments may exhibit higher volatility than investments in multiple industry sectors. Technology companies may be subject to severe competition and product obsolescence.