In the corporate sphere, the value of U.S. corporate bonds outstanding has more than doubled from $3.8 trillion in 2008 to the current $8.8 trillion. This 8.8% annual rate of increase is more than two times GDP growth in that same period. While this debt has funded shareholder-friendly activities such as mergers and acquisitions, leveraged buyouts and share repurchases, Romick is concerned that at this point the demand for corporate debt could slacken. Eventually, some companies could have trouble meeting their existing debt obligations if a recession hits, if their cash flow weakens or if investors begin demanding higher coupon rates to justify the perceived risks.
Another area of concern is the consumer staples sector, where the disruption created by internet sales and overseas competition has put enormous pressure on product prices. Romick points to Procter & Gamble as a company in the sector that is overvalued. Despite its earnings growth of less than 2% over the last seven years, its stock trades at roughly 21 times 2019 consensus earnings. “I used to brush my teeth with Crest,” he says. “Now I use one of the brands my kids showed me on Instagram.” He also dislikes real estate investment trusts (REITs) and master limited partnerships because they are so highly leveraged.
Last year was one of the fund’s more active periods on record as the managers took advantage of the volatility to eliminate and reduce certain positions while initiating and increasing others. The fund bought 18 new names and sold or reduced 23 others, some by more than half their stakes. The managers increased exposure to certain financial companies, bought some light industrial and more cyclical businesses and added to some positions in internet platform businesses. When selling off, the managers focused on high-quality businesses that had reached their price targets.
Despite the new buys, the fund still had about one-quarter of its assets in cash by the end of 2018. “To put more capital to work, we require a larger margin of safety than what the market currently offers,” Romick told shareholders.