- Fund manager Chip Reed had an extremely strong year without including any of the market-favorite FAANG stocks in his Eaton Vance Capital Select Equity fund.
- Reed says that by betting on companies with strong long-term earnings and good financial standing, he’s created a portfolio that is defensive but still brought in powerful returns.
- While some investors succeeded by playing defense this year, Reed succeeded in limiting downside without buying traditionally safe stocks like utilities.
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At the end of a dramatic but very strong year for the market, it’s fairly clear what worked best: playing extreme offense with high-growth stocks, and playing extreme defense with high-yield stocks.
But Chip Reed — lead manager of the Eaton Vance Atlanta Capital Select Equity Fund — has pulled off the feat of beating the market this year without making some of its most popular bets.
The fund is up 37.4% in 2019, putting it in the 97th percentile versus peers, and well ahead of the S&P 500. And it’s done that without including the so-called FAANG cohort consisting of Facebook, Amazon, Apple, Netflix, and Google.
That might seem like a big obstacle considering how well some of those companies have done. Google’s parent company Alphabet is up 30% this year, Facebook has climbed more than 50%, and Apple has surged almost 80%. But Reed has no second thoughts about the strategy.
“Our portfolio does not look like any of the other large-cap growth managers out there,” Reed told Business Insider in an exclusive interview. “I think over over a cycle we’re going to be able to outperform things like the S&P or the Russell 1000.”
The FAANG stocks and a few other companies like Apple and Microsoft are so dominant in the US stock market that they inevitably make up big chunks of a lot of mutual funds. That’s been good news for investors in those companies, but Reed says it’s created a herd effect where a lot of funds look the same and basically mirror the S&P 500 itself.
And because the FAANG stocks have won for so long and become famous high-flyers, they were hammered when the market suffered its big downturns in late 2018.
“We’re willing to look different than the benchmark,” he said. “I think if there’s something contrarian that we do, it’s that. If I like Apple, I’m going to own Apple. If I don’t like Apple, I’m not going to own it.”
What Reed did instead
For Reed and his co-managers, the most important attribute for any company is quality earnings. They want to find companies with strong cash flows that aren’t taking on debt. Reed says a company like that is likely to thrive no matter how the economy is doing, which means his portfolio will do the same.
“For us is, it’s consistency in earnings reported earnings over 40 quarters, 10 years of history is, I think, a pretty good proxy for that,” he said.
That means Reed’s investments are much less cyclical than a those of many growth stock fund managers. And in a world with an uncertain economic trajectory, unprecedented negative interest rates, and high trade and political tensions, he’s built a low-risk portfolio.
His fund has as strong defensive tilt, with substantial bets on payments companies, insurance conglomerate White Mountains, discount retailers, healthcare companies, and glass jar maker Ball Corp. — the best performer on the S&P 500 over the first three quarters of 2019.
To underscore the “odd” makeup of the portfolio, Reed adds that he adopted a defensive stance without investing in any utilities or REITs, as utilities don’t deliver enough returns and real estate companies don’t have enough free cash.
While low risk can mean low reward, he’s been rewarded for his steady approach. And even in a more difficult market, that odd way of playing offense and defense paid off: The Select Equity fund substantially beat the market in 2018 as well.
“We’re very conscious of downside protection,” Reed said