Chevy Chase Trust
Our Vision
WATCH VIDEO

The $26 Billion Woman Posted in: Featured, People - Read the Washington Business Journal profile on Amy Raskin, Chief Investment Officer, at Chevy Chase Trust.

Amy was also recently featured on CNBC. View below:
Don’t just take our word for it. Posted in: Featured - At Chevy Chase Trust, we specialize in global research and thematic investing informed by careful planning, and it's working. Forbes and RIA Channel recently ranked us among the highest in their Top 100 list, for 2 years running. Important Disclosures
Chevy Chase Trust - Investment Update, Third Quarter 2018 Investment Update, Third Quarter 2018 Posted in: Investment Update, Noteworthy - The S&P 500 Index generated a total return of 7.71% for the third quarter, bringing the nine month return to 10.56%.
Other News
  • Pros, Cons to Buying Nvidia Stock - Chevy Chase Trust Pros, Cons to Buying Nvidia Stock Posted in: Insights, Noteworthy - As Nvidia makes deep inroads into AI, its share price is skyrocketing. Bobby Eubank, Equity Research Analyst weighs in.

    From U.S. News and World Report: Nvidia Corporation (Nasdaq: NVDA) has quite a story to tell and investors seem to be all ears these days — with good reason.

    Nvidia bills itself as a pioneer that has “supercharged” a form of computing loved by the most demanding and eclectic computer users in the world — scientists, designers, artists, and gamers. For them, NVDA has “built the equivalent of a time machine,” the company states on its website.

    “Nvidia has over $5 billion of net cash and investments on its balance sheet, despite having spent a cumulative $15 billion in R&D, funding numerous startups via its venture program, and is just completing a massive new state-of-the-art headquarters,” says Bobby Eubank, equity research analyst at Chevy Chase Trust. “Nvidia has done this by generating close to $3 billion in free cash flow last year via high revenue growth with nice margin expansion.”

    Of the $3 billion in free cash flow, $1.25 billion was used for dividends and stock repurchases, Eubank adds.

    To read the full article, click here.

    Important Disclosures

  • Chevy Chase Trust - Investment Update, Third Quarter 2018 Investment Update, Third Quarter 2018 Posted in: Investment Update, Noteworthy - The S&P 500 Index generated a total return of 7.71% for the third quarter, bringing the nine month return to 10.56%.

    Macroeconomic Outlook — The S&P 500 Index generated a total return of 7.71% for the third quarter, bringing the nine month return to 10.56%. It reached an all-time high of 2,931 on September 20th, before retreating slightly to end the quarter at 2,914. Global desynchronization continued with international markets underperforming the U.S. by a wide margin. The MSCI All Country World Index ex-U.S. generated a meager total return of 0.8% for the third quarter while the global composite index, of which U.S. stocks represent 52%, returned 4.40%.

    Two factors contributed to the relative strength of the U.S. market. Two years of fiscal stimulus in the form of tax cuts and government spending have helped corporate earnings. Second, there is a structural difference in the composition of the U.S. Index. Growth and non-cyclical stocks in the technology, consumer discretionary and healthcare sectors represent more than half of the S&P 500 Index. In contrast, most non-U.S. markets have heavier representation in cyclical and value oriented stocks in sectors such as materials and financials. 

    We have been in a relatively slow growth world which makes companies with strong top line momentum more valuable for their scarcity. More of these successful growth companies are domiciled in the U.S. than elsewhere. Valuation spreads between growth and value stocks began 2018 at near record levels and have only grown wider. Indeed, even beyond the U.S., the most expensive and least cyclical markets at the start of the year have performed best. The NASDAQ, the most expensive global market, is also the best performing. Japan, which we discuss below, is another expensive and positive performing market.

     

    The widening gap between growth and value has some parallels to the late 1990s/early 2000s period. That was the last time earnings expectations were this high and technology this large a percentage of the S&P 500.  However, while similar on the surface, there are differences. The betas of the most expensive stocks in the market are much lower today than two decades ago. If a stock has a beta of less than 1, the security is theoretically less volatile than the market as a whole. If a stock has a beta of more than 1, it is more volatile. Interestingly, in the late 1990s/early 2000s, expensive or high P/E stocks, which included technology stocks, had an average beta of 1.2, or 20% more volatile than the market. Today, this same group has a beta of 0.96, slightly less volatile than the overall market. Conversely, the beta of the lowest P/E stocks averaged 0.98 in the early 2000s and today are actually more volatile with a beta of 1.23.

    Technology has been the work horse of this bull market. Unlike the late 1990s and 2000s, technology companies are not being measured exclusively by clicks and eyeballs. Today, the technology sector is fundamentally sound in terms of exceptionally strong profit and cash flow generation. The chart below shows the impact of improving technology profit margins on the overall equity market for the better part of a decade. Without technology, the operating margin for the S&P would be significantly lower. Naturally, increasing profits must underpin the parabolic rise in margins. Since 2006, technology’s earnings per share has almost quadrupled, pulling overall S&P profits higher. 

     

     

     

     

    In our view, the profit outlook for the technology sector remains bright, driven to a large extent by capital expenditures. Technology continues to make inroads in the overall capex pie, and now has doubled its share since the 2008/2009 financial crisis to roughly 12%. Technology new orders-to-inventories are also picking up and suggest that market analysts are underestimating relative earnings per share growth. Finally, consumer outlays on tech goods are increasing faster than overall consumer spending. Nevertheless, we have moderated our technology sector overweight due to extremely strong relative performance of our core tech holdings, but they remain some of our highest conviction thematic holdings.

     

    What’s Depressing Growth? 

    While demographics are weighing on global growth, in our opinion high levels of debt are also a major contributor to slower growth. The real rate of GDP growth when debt levels are high has historically been half the rate of that when debt levels are low.

    Debt represents consumption today at the expense of consumption in the future. Excessive debt is a burden on growth unless it is used for productive investment. Unfortunately, it appears much of the recent incremental debt has been used for consumption.

    Within the U.S., from an aggregate perspective, total nonfinancial debt-to-GDP has remained largely stable since the 2008/2009 financial crisis. But there has been a distinct change in attitudes toward debt – households have deleveraged with the ratio of consumer debt to income down from 130% to 100%. However, public sector debt has more than offset the slowdown in consumer borrowing. 

     

     

    There is a catch-22 aspect in this. If more robust economic growth leads to a normalization of interest rates, debt service could soar which would then likely put the economy back in a very slow growth environment. Since the Fed started raising the federal funds rate at the end of 2015, net interest paid by the U.S. Government rose from $225.5 billion during the 12 months of 2015 to a record high of $320.3 billion for the 12 months ended August 2018. Over this same period, publicly-held U.S. Treasury bonds jumped $2.1 trillion to a record $15.8 trillion. If the Fed succeeds in gradually normalizing monetary policy and the federal funds rate rises to 3.00% by the end of 2019, the current amount of debt outstanding would push the government’s interest expense to over $500 billion annually by 2020. 

    It is difficult to predict when debt and deficit levels will weigh on markets. However, if interest rates start to rise above a neutral rate as a result of excessive debt levels, equity and fixed income markets will likely suffer.

     

    Japan

    In a year marked by ex-U.S. global equity weakness, Japan is one market that continues to stand out with the Nikkei breaking out to seven-month highs in September. 

    The Bank of Japan recently reaffirmed its intention to keep interest rates low indefinitely. Shinzo Abe was re-elected in late September and will become the country’s longest-serving prime minister with a term running to 2021. Corporate profitability is at a record high, yet foreign investors have pulled more than $40 billion out of Japanese equities, masking some of the market’s strength. 

    The Japanese economy is showing the strongest signs yet of breaking out of its deflationary funk. Unfavorable demographics is often blamed for all that ails Asia’s second largest economy. But recent tightness in the labor market has led to a rise in the participation rate. Even with a larger labor force, demand for workers remains unmet and wage gains are now becoming more broad-based. If sustained, this rise in workers’ pay should lead to stronger consumer spending.

    Japanese companies appear able to absorb the increased cost of labor. Across a swathe of sectors, profit margins have risen to record highs as an undervalued yen boosts competitiveness. As long as labor productivity improvements keep pace with the rise in wages, profit margins are unlikely to come under undue pressure. And while changes in productivity are notoriously hard to measure, the renewed willingness of Japanese companies to invest in the domestic economy suggests productivity growth will likely continue.

    After the U.S., Japan is our largest portfolio weighting. As the gap between economic momentum in the U.S. and the rest of the world narrows, we may increase our weighting in Japanese companies, as many are also leading participants in our themes.

     

    Genomics

    Genomics and the advent of molecular medicine is one of our high conviction investment themes. This year the one millionth whole genome sequence was completed. The cost of sequencing the genome dropped below $1,000. Applications were filed with the FDA to begin trials of treatments using a gene editing technique called CRISPR. Scientists have identified more than five million genetic mutations with links to cancer. All of these developments give us confidence in the investment thesis.

    From an investment perspective, not only is the market for genomic sequencers growing at an accelerating rate, but the machines in service are also being more fully utilized. We estimate that the market for genome sequencing equipment is growing about 10% per year.  The market for consumables, which are the materials used with each run of a sequencer, is growing about three times faster. This is important because the genomic equipment sector follows the “razor/razor blade” model. Once a lab or a hospital buys a machine, they have to purchase consumables to run the machine. Similar to the shaving paradigm, over a lifetime of use, the recurring revenue from the consumables is likely to exceed the cost of the initial equipment. According to Illumina’s most recent reports, during 2018 customers will purchase an average of approximately $900,000 of consumables for each of its new NovaSeq sequencers. This exceeds initial company estimates of $730,000. Current forecasts are for the amount to rise to $1.5 million by 2021.

    As more diagnostics, and ultimately treatments, rely on understanding specific genetic sequences, we expect the market for sequencing equipment, and more important, the recurring revenue from higher margin consumable sales to grow rapidly. Beyond the equipment and supply manufacturers, we are researching and investing in companies that are developing never-before possible therapies for previously hard to treat or untreatable diseases.

     

    Fixed Income

    The 10-year U.S. bond yield continued to fluctuate in a relatively narrow range during the third quarter. It reached a low of 2.81% on August 24 and a high of 3.10% on September 25. Yields ended the quarter at 3.06%. 

    As expected, the Federal Reserve again raised the fed funds rate during the quarter by 25 basis points (0.25%).  Since the long end of the yield curve did not rise by a commensurate amount, the slope of the curve flattened. In fact, on August 27, the difference between the yields on 10-year Treasury bonds and 2-year Treasury bonds hit an intraday cycle low of 18 basis points. Unlike an inverted yield curve, a flat curve is not necessarily a sign of impending recession, but it is a signal that the Federal Reserve may not be able to raise rates much more before tightening slows economic growth. 

    Long-term bond yields are still far short of the 3.50% to 3.75% levels many were forecasting at the beginning of the year. We think yields will advance slowly in the near to intermediate term before falling back below 3.00% when the cycle inevitably turns.

  • What will it take to attract the next generation of advisers to the private wealth business - Chevy Chase Trust - Noteworthy What will it take to attract the next generation of advisers to the private wealth business? Posted in: Noteworthy, People - From Real Assets Adviser: The private wealth business is facing a persistent and decades-old personnel crisis. Marc Wishkoff, Managing Director, weighs in on what will it take to attract the next generation of advisers.

    From Real Assets Adviser: The private wealth business is facing a persistent and decades-old personnel crisis. The number of financial advisers continues to dwindle as RIAs struggle to attract young talent to the business. U.S. financial advisers number roughly 285,000, down from about 500,000 in the mid-1990s. The average age of a financial adviser is 51, and 38 percent of advisers are expecting to retire in the next 10 years, according to a report from Cerulli Associates. Only 10 percent of financial advisers are less than 35 years of age.

    What do RIAs need to do to reverse the trend? We asked a dozen leaders in the private wealth profession to offer their observations.

    Marc Wishkoff, Managing Director, “We believe the next generation of advisers will seek organizations where they can take pride in the collective achievement of the firm and a differentiated service model. Successful firms will emphasize attracting people who want to be a part of something, in contrast to those who simply aggregate assets, outsource investments, build a personal book of business and guard its portability. Providing talented advisers with an environment to focus on their chosen area of expertise — whether it be investment, planning or fiduciary work — will instill a culture that attracts ever more talent and shared success.”

    To read the full article, click here.

  • Should You Move to a Retirement Community Before Retiring - Chevy Chase Trust - Noteworthy Should You Move to a Retirement Community Before Retiring? Posted in: Noteworthy, People - From U.S. News & World Report: While many people relocate to retirement communities after they leave the workforce, some Americans are moving to one before stepping away from the office. Laly Kassa, Managing Director weighs in.

    If you’re thinking of settling in a retirement community while still in your working years, there are numerous financial advantages, as well as a few disadvantages, to be aware of. Follow these steps before moving to a senior living community prior to retiring.

    Check your current bills. If you live in an older, large home that requires an ample amount of upkeep, you might find it more expensive to stay in it while working. Upcoming repairs, such as replacing the roof or fixing the main floor, could translate to high future investments. “If home maintenance costs are high and keeping up with the house bills is getting you down, it may be time to sell your primary residence and move sooner rather than later,” says Laly Kassa, managing director of Chevy Chase Trust in Bethesda, Maryland.

    Read the full article here.
    Download the article here.
  • Amy Raskin featured on CNBC’s Fast Money Halftime Report Posted in: Noteworthy, Video - Amy Raskin, Chief Investment Officer, appeared on CNBC's Fast Money Halftime Report on August 28, 2018 to discuss current market conditions and what they mean for investors.

    Is today’s positive vibe on the economy based on sentiment or fact? Amy Raskin, Chief Investment Officer at Chevy Chase Trust, recently discussed market conditions and what they mean for investors on CNBC’s Fast Money Halftime Report. She also shared three stocks that have her attention.
  • Q & A with Ed Dobranetski Posted in: Noteworthy, People - We recently sat down with Ed Dobranetski, a Managing Director at Chevy Chase Trust, to learn more about his background and how he became interested in investment management.

    We recently sat down with Ed Dobranetski, a Managing Director at Chevy Chase Trust, to learn more about his background and how he became interested in investment management.

     

    What was your first job out of college?

    My career started near the trough of a business cycle, so securing anythingto do with financial markets was important to me.  I started as a broker, purely in sales, so I could take the Series 7 exam and have something to differentiate myself. I did various other odd jobs that young people do while they seek opportunities.  I washed windows at the Watergate once, for example.

     

    How did you become interested in investment management?

    Beginning college as a Political Science major, I changed to Business after a friend convinced me to compete in a national investment challenge game for college students.  Other students from my school won by a large margin, so I sought them out to learn what they did.  Consequently, I learned everything I could about Options trading that summer and earned all my spending money for the rest of my college days from a few hundred dollars.  The next semester I took a class in Futures and Commodities Trading, and passed the appropriate registration exam over winter break.  The following semester I started a “Hedge Fund” in the dorm.  It was a rollercoaster ride, but fun.  In the end, we only had enough for a very small cocktail party.

     

    What do you enjoy most about your career?

    What I enjoy most is working in the financial markets, and with clients. It is one of the world’s great laboratories for studying strategy.  Every day the landscape changes in some way.

     

    What is the most important lesson you learned from a mentor?

    I learned to manage with sincerity.  Most of our clients are experts in a field other than investment management.  In most cases, all of their savings are in our hands, and they trust us with the latitude appropriate for an expert. Trust and loyalty are a two way street; we both have obligations in the relationship.

    And also: “If something said in ten words can be said in five; use five words.”  I am still working on that one.

     

    What would you do if not this? Otherwise, I probably would have had a military career, who knows?  I have never considered anything else.

     

    What is your favorite place to visit/vacation?

    Fifteen years ago, I heard one of my favorite economist/strategists speak about investing in China when it was still very, very early in evolving.  He said: “you can’t sit here in your fancy country club and buy ETFs – you have to go there.”  I have probably been to Asia fifteen times since, and plan to retire there. We would go to Japan every year, but the dynamic stillness is too intense.

     

    What advice would you give to someone considering a path similar to yours?

    We are asked that question a lot. Getting paid to pick stocks is a desirable career, but it’s more than that. I am still learning.  It has been almost thirty years in the same industry; if I make it to fifty, I may have it figured out.  My advice: Empty your cup and find a good teacher to work for; that is the most important thing.

     

    Continue to Ed Dobranetski’s biography

  • Chevy Chase Trust - Investment Update, Third Quarter 2018 Investment Update, Second Quarter 2018 Posted in: Investment Update, Noteworthy - The S&P 500 Index began 2018 with an initial surge from 2,674 to a high of 2,873 on January 26th.

    Equity Market Performance  — The S&P 500 Index began 2018 with an initial surge from 2,674 to a high of 2,873 on January 26th. It then quickly and sharply pulled back to a low of 2,533 on February 9th. Since then the Index has largely moved sideways, ending the second quarter at 2,718, 5.4% below its high and 7.3% above its low.

    Year to date the global equity market represented by the MSCI All Country World Index (ACWI) has been relatively flat. For the first half of 2018, the ACWI generated a slightly negative return of -0.13%. The S&P 500, as the largest component of the ACWI, generated a positive return of slightly less than 3%. Most other regions, including Emerging Markets, Japan and Europe were down.

     

    MACROECONOMIC BACKDROP

    Last year, the global economy experienced a synchronized expansion. Global real GDP growth accelerated to 3.8% in 2017 from 3.2% in 2016. Euro countries, Japan and many emerging markets moved from laggards to leaders in global growth.

    The opposite pattern is occurring in 2018. Global growth has slowed and the U.S. is the only major economy where leading economic indicators are still rising. The latest tracking data suggest that U.S. real GDP growth could reach 4% in the second quarter, more than double most estimates of trend growth. 

    This lofty pace cannot be sustained. For the first time in over a decade, the U.S. economy has reached full employment. The unemployment rate stands at a 48 year low of 3.75%. The number of people outside the labor force who want a job, as a percentage of the total working-age population, is back to pre-recession lows. For the first time in the history of the Bureau of Labor Statistics’ Job Openings and Labor Turnover Survey (JOLTS), there are more job vacancies than unemployed workers. 

    In addition, the central bank is raising rates, equity valuations are relatively high and forward earnings estimates are at their highest level in nearly 20 years (see chart below).  All of these factors indicate that the U.S. is in the late stages of an expansion.

     

     

    As the chart shows, even with high expectations, the market can overshoot to the upside and equities may rally to fresh highs before this cycle is over. Given our bias for capital preservation and view that it is the late stage of this business cycle, we think it is prudent to be moderately defensive. However, we do not believe we are on the cusp of a recession. Traditional recession signals that we watch do not suggest a recession is imminent. For example, the spread between yields of 2 year bonds and 10 year bonds is falling, but still positive. This metric tends to turn negative approximately 12 to 14 months before recessions commence. Leading indicators (LEIs) also usually fall below zero when a recession is imminent. The May LEI rose by 6% year over year. Initial claims for unemployment insurance for the week ending June 16th were 24,000 below their reading six months earlier. Typically, a six month increase in unemployment claims of between 75,000 and 100,000 would presage a recession. Absent a recession, equity market corrections tend to be shallow and short-lived.

     

    TRADE WARS, THE ELEPHANT IN THE ROOM

    Our rule of thumb in investing is to ignore politics and focus on fundamentals. This has served us well. However, we view trade differently. We believe many investors and politicians may be underestimating the potential consequences of tariffs.

    In our opinion, a trade war is one of the greatest risks to the U.S. equity market. The current cycle has not been about top-line growth. In fact, in terms of revenue growth, this has been one of the slowest recoveries on record. This cycle has been defined by the exceptional margin progression of “manufacturers,” defined broadly as companies who make something somewhere.

    The S&P’s steady rise in profit margins over the last two decades has been driven by manufacturers. There are currently 182 manufacturers in the S&P 500. Their net margins have risen from 8% in 2000 to 14%, an astounding 75% increase. Roughly half of the manufacturing stocks are drawn from the technology, industrial capital goods and auto sectors, and represent about a quarter of the earnings of the entire S&P 500.

     

     

    While there have been four primary drivers behind margin expansion: moving production to lower cost regions, lower interest expense, benefits of robotics and automation, and a decline in effective tax rates, globalization has been the gift that just kept on giving. The world operates far differently than it did 20 years ago. Sales from foreign affiliates of U.S. multinationals are roughly $6 trillion, nearly four times the $1.6 trillion of exported U.S. goods. The U.S. trade position with China looks decidedly more balanced when revenues from foreign affiliates of U.S. companies are taken into account.

     

     

    Trade is no longer a matter of producing goods in one country and selling them to another. Trade is now dominated by intermediate goods. The exchange of goods and services takes place within the context of a massive global supply chain. Automobiles, technology and apparel are produced from components sourced all over the world. Some components cross borders multiple times. As a result, trade in intermediary goods (components) now exceeds both trade in primary goods (raw materials) and finished goods. This arrangement has many advantages, but it also harbors numerous fragilities. A small fire at a factory in Japan that manufactured 60% of the epoxy resin used in chip casings led to a major spike in RAM prices in 1993. Flooding in Thailand in 2011 wreaked havoc on the global auto industry. The global supply chain is highly vulnerable to even small shocks. We believe the impacts of a global trade war would be seismic by comparison. Given current lofty earnings expectations, a trade war would likely inflict disproportionately more harm on the U.S. equity market than it would on the U.S. economy.

    Importantly, many industry reports are minimizing trade war impacts, particularly on equity markets. The analysis laid out in these reports is as follows: a 25% duty on $34 billion worth of products, which represents the amount of the first section 301 tariffs set to be imposed on July 6th, is roughly $8.5 billion, a fraction of the $800 billion in fiscal stimulus expected this year. Even if this amount is raised to include the $16 billion of Chinese imports that are under further review by the USTR and another $200 billion of Chinese goods under consideration for a 10% tariff, it will not approach the amount of stimulus. There is little discussion of the negative impact on companies and financial markets. Nor is there analysis of the implications to supply chains.  This underestimation will likely be revealed and its impact felt in financial markets later in the year when quarterly results begin to reflect companies’ increasing inventories on hand in anticipation of new and changing tariff and trade rules. Bottom line, although we have no way of handicapping the odds of a full blown trade war, the risks are clearly up. Like a nuclear standoff, the only thing preventing a trade war is mutually assured destruction.

     

    GROWTH VERSUS VALUE AND THE TECHNOLOGY SECTOR

    Things have gone from bad to worse for value investors, with value stocks underperforming in all regions around the world so far in 2018. While the performance gap is reaching an unprecedented level, we still do not see the catalyst to overweight value. Weaker global leading economic indicators and a stronger dollar clearly favor longer-duration growth companies.

     

     

    Among growth stocks, technology was again one of the market’s best-returning sectors in the first half of 2018, up almost 11% and outperforming the S&P 500 by over 800 basis points (8%), driven entirely by an increase in tech’s relative earnings multiple. Actual earnings growth was relatively muted. Moreover, year-to-date multiple expansion was broad-based across the tech sector, in contrast to last year when it was concentrated in a few stocks. The technology sector now trades at 1.13 times the market’s multiple on a capitalization weighted basis, higher than it has in nearly a decade, but still less than half of the peak reached in 2000. 

    The risk profiles of technology stocks have become significantly more favorable over the course of this cycle. Free cash flow margins have been rising for 20 years, due in part to a sustained decline in capital intensity. In the last four quarters, tech’s top-line growth rate has been double that of the market. These are fundamental strengths. As important, we don’t see signs of self-undermining excesses. None of the time-tested indicators of systematic risk – price volatility, share turnover, equity issuance, retail flows, or the performance of initial public offerings, are even flashing yellow. Tech’s free cash flow production has become large enough to be crucial to the outlook for the entire market. In 2005, the sector accounted for 20% of aggregate output and now that share tops 30%. In this cycle, the tech sector has been responsible for most of the cash flow generation of the market.

     

    Soon, almost every company will be a tech company in some respect. The leaders in this equity market: Facebook, Apple, Amazon, Netflix and Google, (FAANG), have not only reshaped the investment landscape, they have also reshaped the consumer by capturing their time and their wallets. As a group, they have added over $300 billion in sales over four years. The five FAANG companies now have as much brand equity as the top 50 consumer brands put together. Profits of these five companies now account for a greater share of the U.S. profit pool than all the large capitalization consumer staples companies combined. 

    We have recently trimmed some of our largest technology winners and will be closely watching for signs of relative weakness. However, leading companies today are nowhere near as “risky” as the leaders were 20 years ago. If the fundamentals remain solid, we will continue to own technology stocks that are some of our highest conviction thematic holdings.

     

    FIXED INCOME

    When 2018 began, still-strong global growth and extremely robust earnings led most fixed income analysts to predict that yields would rise across the curve and the U.S. 10 year bond yield would lift towards 3.5%. While the 10 year yield finally did exceed 3% for about ten days during the second quarter, the high point was only 3.11% and it closed the quarter at 2.86%, only 12 basis points (0.12%) higher than at the end of the first quarter. 

    The Fed has now hiked short rates seven times (175 basis points or 1.75%) and plans on two more this year followed by three next. The Fed’s balance sheet is now down $200 billion from its peak and is set to continue falling at a quickening pace into the fall. The spread between 2 year bond yields and 10 year bond yields fell to 33 basis points at the end of quarter. This is roughly the lowest spread since August 27, 2007. We are closer to an inverted yield curve today than at any point in this cycle.

    The Fed’s Summary of Economic Projections suggests a yield curve inversion next year (assuming long rates remain near current levels) and a 100 basis point rise in the unemployment rate, something that has never occurred outside a recession.

    Periods when the curve is flat are consistent with much lower excess returns than when the slope is greater than 50 basis points. Given the low potential reward, we believe sticking with a strategy of buying relatively short duration, high quality bonds makes prudent sense.

    We expect the 10 year yield will remain in a range between 2.50% and 3.00% until the threat of a trade war either lifts, in which case yields will likely rise across the entire curve, or a trade war causes a rush to safety and long term yields fall below 2.5%.

  • Finding Opportunity in Disruptive Change: Retailing and its Supply Chain Posted in: Noteworthy, Video - Today in the retail industry we're seeing that traditional brick-and-mortar stores are struggling despite a relatively healthy economy.

    Finding Opportunity in Disruptive Change: Retailing and Its Supply Chain

    We’re in the early stages of a revolution in retailing that is creating compelling new investment opportunities.

    As thematic investors, we look for phenomena that are transforming cash flows and profitability across multiple industries. Then we seek to identify companies that will benefit, are investable through public equities with ample liquidity, and likely to pay off within three to five years.

    Here we discuss one of these phenomena—how the next generation of automation is impacting the retail industry.

    See our latest research and what it means for investors.

    Download the whitepaper here.

  • Financial Planning and College Savings Posted in: Noteworthy, Video - Every client at Chevy Chase Trust receives comprehensive financial planning.

    Smart college planning is the gift that keeps on giving. From UTMA accounts to 529s, Chevy Chase Trust shows clients how to build a legacy of learning through personalized tuition savings strategies that take into account a family’s complete financial picture. Chevy Chase Trust’s Laly Kassa and Leslie Smith share their insights on the best savings strategies for maximizing returns.

  • Thematic Investing at Chevy Chase Trust Posted in: Insights, Noteworthy, Whitepapers - In some ways, thematic investing is a throwback to investing in a simpler time.

    In some ways, thematic investing is a throwback to investing in a simpler time. Before there were 15,000 mutual funds in 115 different fund categories. Before there were over 8,000 hedge funds and 2,000 ETFs traded daily. Before 17,000 new CFAs were credentialed every year, and before sell-side firms had analysts dedicated to specific sub-industries within each sector. Thematic investing doesn’t fit into any of Morningstar’s 115 fund categories or fit neatly into one of its style boxes.

    The modern version of thematic investing emerged 15 to 20 years ago in response to the extreme segmentation of the investment industry. It gained greater visibility in recent years, as institutional investors and consultants, having turned to passive investing for larger and larger portions of assets, sought supplementary equity strategies that could generate alpha in a variety of different market regimes with some degree of reliability.

    The term “thematic” is used to describe several different investment approaches, from single theme ETFs to portfolios where specific industries or sectors are deemed thematic. Here ‘s our definition:

    Thematic investing seeks investable ideas that stem from economic or technological changes powerful enough to influence corporate performance across multiple industries.  

    It is instructive to contextualize three of the essential terms in this definition.

     

    “multiple industries”

    Today, most Wall Street research, on both the sell-side and buy-side, is organized by industry, with each analyst tasked with being an expert in his or her niche. The result? Few researchers look at the big picture—or even know how to. This creates an inefficiency. 

    One of the first people who decided to exploit this inefficiency was Lewis Sanders, when he headed AllianceBernstein. In 2003, Sanders tapped Amy Raskin to run a new research group at AllianceBernstein dedicated to studying strategic changes that spanned multiple industries (essentially, thematic research). Broadband internet service was the first theme the Research on Strategic Change group tackled.  The team thought about how this new technology would affect media, entertainment, advertising, video games, retail, and telecom services. It asked who would benefit, who would lose, and which industries would be disrupted. The group went on to study many other themes over the next 10 years, each time learning from its mistakes and refining the process. 

    Chevy Chase Trust adopted a similar investment philosophy when it acquired an investment boutique in 2001. The boutique’s global, multicap, unconstrained equity strategy invested in secular themes influencing economies and markets around the world. In 2014, when Amy Raskin joined Chevy Chase Trust as its Chief Investment Officer, the firm integrated the best aspects of the two processes.  One important and fundamental decision was to organize research analysts by theme, not industry. Each analyst was tasked with thinking about his or her themes holistically and uncovering relevant investment opportunities regardless of industry or geography.

     

    “corporate performance”

    Our approach to investing focuses on changes that are most likely to have a profound influence on corporate performance, seeking to buy companies that will be beneficiaries of thematic tailwinds and avoid companies that will be casualties of creative disruption. We think some thematic investors fail to distinguish between a trend and a potentially profitable investment theme. There are many significant changes occurring across the globe. But, in our vernacular, most of these changes are simply trends and not investment themes because they are not likely to create economic advantages that will result in sustainable profits. 

    Wireless broadband, known as wi-fi, is one example of a disruptive technological change that would not have been a great investment theme. The top left map below is a Manhattan neighborhood south of Central Park in 2001. There were no wi-fi hotspots. The top right map is the same neighborhood in 2011, where the purple dots indicate how wi-fi hotspots had proliferated. The bottom map shows that in early 2018, wi-fi hotspots are almost everywhere.

     

     

     

    It’s amazing how this technology took off. Most people have wi-fi at home and would not think of staying in a hotel without wi-fi access. Coffee shops, restaurants, airports and subways provide it for free. A recent consumer survey ranked wi-fi second only to food in its importance in daily living. 

    While unit sales of wi-fi router equipment boomed, the profitability of the equipment makers was never impressive. Wi-fi is based on a set of a well-defined standards, so barriers to entry were low, and the number of competitors was high. During the decade of explosive growth, average operating margins for wi-fi equipment makers were in the mid-single digits. 

    Investors focusing on disruptive change must be cognizant of a basic tenet: more often than not, technological change ends up benefitting consumers far more than the companies enabling it, particularly when barriers to entry are low and competition is intense. Consumers have benefited from virtually ubiquitous access to wi-fi, but the companies that manufactured wi-fi routers didn’t profit enough to be great long-term investments. 

    Other examples of disruptive technological changes that we see as trends, not investment themes, include high-definition and smart television, activity trackers, streaming music, virtual worlds, home meal kits and ride-sharing services. While some of these may be surprising, the last is probably the most controversial. Here’s why we think ride-sharing would be an unsuccessful investment theme.  

    Introduced by Uber, the concept of a simple, frictionless car-hire platform that matches riders with drivers fills a compelling consumer need. As the concept was embraced globally, business for Uber and Lyft rose from fulfilling rides worth less than $1 billion in 2013 to almost $40 billion in the 12 months ended September 2017. 

    But a great service is not necessarily a great business. Most of the ride-sharing revenue, roughly 80%, goes to drivers. Some goes to attracting customers. As a result, Uber and Lyft have been losing money at an accelerating rate, and revenue growth has slowed.  Their combined losses were roughly $2 billion in 2015, $3 billion in 2016, and $5 billion in 2017.  This is not the hallmark of a sustainable business model.

    It might be a good business model if, after attracting drivers and riders, the platforms could retain them with fewer incentives. Unfortunately, Uber, Lyft and similar platforms don’t appear to have a strong hold over either group. Drivers around the world are taking advantage of competitive services that give them a larger share of fares, and customers keep switching to new services with lower prices. Google’s mapping app now offers riders direct price and convenience comparisons between ride-sharing platforms, which may dissolve any customer loyalty that the platforms have created. 

    Gett, Grab, Via, Ola, Didi, Sidecar, Zimride, BlaBlaCar, Carma, Ridejoy, Easy Taxi, Taxify, YandexTaxi and Careem, are all similar services. Over the past three years, Uber has lost its monopoly position in New York City, where its market share has fallen below 75%, with no sign of stabilization. 

     

    “investable”

    We seek themes that are “investable,” which includes two traits. First, there must be enough public companies that are beneficiaries of the theme with sufficient liquidity for us to invest at least 5% of our portfolios in the theme. Water as a scarce resource, nanotechnology and space travel may be fascinating trends that could have major impacts on the world, but they are not among our investment themes because we haven’t found sufficient or appropriate investment candidates. 

    Second, we must believe that other investors will begin to discount the change or disruption into their valuation models within a reasonable time frame, which for us is three to five years. We don’t have to expect the change or disruption to mature within that time frame, just that other investors will begin to expect it. The market is a discounting mechanism, so company share prices reflect investor expectations, not necessarily current reality. For example, the share price of NVIDIA, which manufactures a key component of self-driving cars, is now discounting widespread future adoption of autonomous vehicles, although only about 700 driverless cars are on roads today.

    Having noted two trends, wi-fi and ride-sharing,  that we think were not or are not investment themes, two trends that meet our criteria for investment  themes are advances in molecular medicine and wealth migration in the U.S.

     

    Molecular Medicine

    Molecular medicine is the revolution in medical treatment created by the ability to detect tiny variations in the human genome that can cause disease. Molecular medicine is already providing both diagnostic tools and highly targeted treatments for certain cancers and other genetic diseases. Because almost all disease has some genetic component, the ability to pinpoint specific genetic mutations that can lead to disease and potentially alter or prevent the mutation’s impact, will revolutionize healthcare. Millions of people with devastating diseases will be cured as a direct result of the breakthroughs made possible by the sequencing of the human genome. Yet all of this is relatively new. The first sequencing of a human genome was completed in 2003. It took 13 years and cost about $3 billion. Today, complete human genomes are sequenced in little more than an hour for less than $1,000. The chart below shows the extraordinary decline in sequencing cost. If the decline merely followed Moore’s Law, which posited a 50% decline every two years for semiconductor technology, the cost of sequencing a genome would be 360 times higher than it is today. 

     

    The modest profitability of wi-fi equipment makers, despite soaring demand for routers, might lead one to conclude that investments in sequencing technology would also be a poor investment. Not so. Genetic sequencing is extremely complicated. Few companies can make this technology, and the number of competitors has actually declined as the market has grown. We estimate that Illumina, the market leader, now produces nine out of 10 new sequencers sold—and its gross margins have been flat to up over the past five years, averaging near 70%. Demand accelerated, the dominant player gained market share, margins improved and the leader wasn’t buying market share with discount pricing. To us, this is what a great long-term investment opportunity looks like. 

    We expect stronger demand growth for genomic sequencing and related technologies than many other observers. Our view is that the industry is at the beginning of a steep upward climb in demand driven by new applications for sequencing. Most analysts are focused on the number of research labs, existing machines and remaining capacity, to predict growth. We believe they are missing the bigger picture, which will include applications for agriculture, veterinary care, and other uses still on the horizon.How do we invest in this theme? The opportunity set is broader than sequencing equipment. “Big data” investments are particularly interesting. Each human genome contains three billion base pairs and requires 200 billion bytes of digital storage. Genomics was one of the first fields requiring big data storage and processing solutions. 

    Taking a holistic, thematic research approach can lead to investments that may not be apparent to sector specific analysts. Few analysts covering healthcare or even life science tools were thinking about the investment opportunities in big data, and few semiconductor analysts were focused on the massive amount of data produced by genomics. 

    Our molecular medicine theme has also broadened to include investments related to CRISPR, a genomic-editing process, and CAR-T, a form of cellular immunotherapy, both of which may disrupt traditional pharmaceutical companies.

     

    U.S. Wealth Migration

    Investment themes aren’t always the result of technological breakthroughs. Another current theme in our portfolios is the massive U.S. wealth migration toward urban areas, which reflects new lifestyle preferences, influenced by social changes, secular changes in the economy, and improved urban planning. 

    Why does this matter to us as investors? Each year U.S. consumers spend $13 trillion dollars, so understanding shifts in spending is crucial. People in cities spend money differently than people in suburban or rural areas. Urban dwellers spend less on transportation, and more on cosmetics, restaurants and travel. Also, denser neighborhoods attract companies and services, such as GrubHub/Seamless, Instacart, Task Rabbit and Via, that wouldn’t be profitable in less dense neighborhoods. The combination of convenience and choice that such companies provide reinforces the allure and advantages of urban living. There’s a virtuous loop of sorts at work. For more on this theme, see our white paper, “Investing in Disruptive Change: The Great U.S. Wealth Migration.” 

     

    Portfolio Construction

    It’s always possible to miss a crucial flaw in what seems like an exciting theme or get the timing wrong. This leads to considerations of risk management and portfolio construction, which is underscored by some recent research. In early 2017, an economist named Henrik Bessembinder published research showing that since 1926, four out of seven common stocks in a database of listed U.S. stocks had lifetime buy-and-hold returns lower than the return of one-month Treasuries. He also found that when market returns are stated in terms of lifetime dollar wealth creation, the best-performing 4% of listed companies account for the net gain of the entire U.S. stock market since 1926. All the other stocks collectively matched Treasury returns. Bessembinder concluded that these results “help to explain why poorly-diversified active strategies most often underperform market averages.”

    Some people have seized on Bessembinder’s research as another reason to give up on active management in favor of passive. That doesn’t make sense to us. Passive investing requires owning all stocks in the market index all the time. If the future is like the past, passive investors would dedicate virtually all their equity capital to obtain a T-bill like return, to get the upside from the tiny sliver of stocks that do well.

    Instead, we conclude that active equity managers need to have a strong basis for selecting stocks with exceptional return potential and to diversify sufficiently to mitigate the impact of being wrong about a theme or an individual stock. We believe that thematic investing informs good stock selection and provides diversification. 

    The strong basis for stock selection comes from whittling down the thousands of public securities around the world to a manageable group of companies identified through our thematic research. This initial screening process is perhaps the most important part of investing. 

    Many firms use a quantitative screen, such as low price-to-earnings, or strong return on investment. Most, such as emerging markets growth managers, focus on geography and style. Our investments are largely defined by our themes. We invest almost exclusively in stocks that we think are likely to benefit from disruptive changes, because that’s where we think the risk/reward tradeoff is in our favor. 

    We don’t need to get everything right to be successful. If the places where we spend the majority our time and energy are even slightly more likely to provide fruitful investments than other areas, our odds of delivering strong performance go up meaningfully. Screening out companies whose business appear likely to be disrupted by new developments also improves our odds of success. 

    Some thematic ETFs and mutual funds invest in just one theme. But there are often only a handful of companies that have enough exposure to any theme to impact performance significantly. As a result, most single-theme portfolios either have a very small number of holdings, so they lack diversification, or they include every company tangentially related to a theme and, as a result, bear other unintended risks. 

    Our portfolios, by contrast, typically have about 40 stocks and five to seven themes. Some stocks represent more than one theme; these tend to be our largest positions. We rarely invest more than 25% of the portfolio in any one theme, and we carefully size our positions in each theme, taking into account industry, geographic and factor exposures. Some of our themes, such as molecular medicine, are composed mostly of stocks in classic growth sectors, such as technology and healthcare. Others, like supply chain automation, are more heavily weighted towards value stocks in the industrials and real estate sectors. Our U.S. wealth migration theme is tilted toward consumer discretionary stocks. 

    Large-caps, small-caps, growth, value and multiple countries are represented both in our opportunity set and in our portfolios. Typically, the largest systematic risk in our portfolios is a skew to the U.S., because, a disproportionate share of innovation and disruptive technology takes place in the U.S. When we put it together, we get a relatively concentrated yet intentionally diversified global portfolio with high active share that generates alpha primarily from stock selection. We’re proud of the results.

     

    Download the white paper here.

See what we’re reading   View all articles