Q4 2022 Balanced Fund Update Recording

Q4 2022 Balanced Fund Update Recording

January 19, 2023

As we start a new year, we invite you to listen to Kevin Earley and Bob Thompson, portfolio managers of the Mairs & Power Balanced Fund, as they talk with Scott Howard, Vice President of Investor Relations, about current economic and market conditions and the impact on the Balanced Fund.

But first, we have a firm update. We are sad to report that Allen Steinkopf, our friend, partner, and colleague, passed away on December 21, 2022. He played a large role in the success of Mairs & Power during his nine years with the firm. Allen spent time leading the Mairs & Power Small Cap Fund (MSCFX), managing advisory accounts, and providing insightful opinions on companies and investments.

Allen cared deeply about research, managing investments, and learning about the companies in which we invest. He also made sure his clients knew they were valued and appreciated. He brought so much more than his keen intellect and thoughtful analysis. Allen was passionate about coaching and mentoring younger staff to enable them to believe in themselves. He touched people’s hearts and changed their lives. He will be greatly missed by all of us who had the privilege of knowing him.

 

Executive Summary

It was a difficult year for the market in 2022, which reacted to higher interest rates, and the likelihood of recession and lower earnings. The year holds the distinction as the first time in 150 years when stocks and bonds both fell more than 10%.

For the year, the Mairs & Power Balanced Fund returned -14.91% versus -16.00% for the Composite Index and -13.84 for the Morningstar peer group. Looking at the 5-and-10-year horizons, the Fund returns slightly lagged the benchmarks but significantly outperforms both over the longer term.

The challenging absolute returns for the Fund are largely attributable to several macro factors, most notably the tight labor market and a sharp increase in the rate of inflation. This caused the Federal Reserve to raise rates aggressively throughout the year, which adversely impacted performance in both the stock and bond markets.

While absolute returns were disappointing, our relative returns were better than the benchmark for both equities and fixed income.

The stock side of our portfolio outperformed its primary benchmark, the S&P 500, and the fixed income side of the portfolio outperformed its primary benchmark, the Bloomberg U.S. Government Credit Bond Index.

However, the relative outperformance in both stocks and bonds was modestly offset by a minor headwind from asset allocation due to an overweight in equities during a year in which they underperformed bonds.

Equities Performance

The equity portion of our portfolio outperformed its primary benchmark in 2022, aided by our outperformance in the Technology and Consumer Discretionary sectors.

The Fund’s underweight to Technology provided a pronounced positive impact on relative equity returns, and selection within the sector added to performance.

The Fund was helped again by an underweight allocation in the Consumer Discretionary sector and favorable stock selection. Our two traditional retailers, Home Depot and Target, held up better than others in the sector.

Our overweight in Industrials also proved favorable for relative performance and the Communications Services sector was a net contributor mostly due to the stocks we avoided, namely social media and streaming. However, this was partly offset by weak performance from the Fund’s largest holding, Alphabet (GOOG), which lagged the market due to concerns around advertising trends in the face of a potential recession.

Eli Lilly (LLY) was the strongest performer on the equity side of the portfolio. Principal Financial Group (PFG), Visa (V), Fiserv (FSV), and The Toro Company (TTC), one of the Fund’s largest holdings, also performed well in 2022.

On the downside, the Energy sector was the largest drag on relative performance. We maintain a zero-weight stance and Energy was the market’s best performing sector in 2022. However, we still believe this commodity business will struggle long term and will steer clear of investing in the sector.

Other detractors were the Materials and Financials sectors.

Fixed Income Performance

The Balanced Fund experienced another year of relative returns that beat the Bloomberg U.S. Government Credit Bond Index. However, this was small consolation in what was the most challenging year in fixed income market in the last 150 years.

Historically, bond returns have helped smooth the volatile nature of stock returns. Yet, with the Federal Reserve induced return to normalcy in interest rates, we are experiencing painful withdrawals after years of cheap credits.

In addition, credit spreads widened roughly 50 basis points, leading to a challenging year for fixed income returns as both yields and spreads increased, which means prices came down.

For the year, U.S. Treasury bonds were down 12.46% and U.S. Corporate bonds were down 15.76%, which resulted in the Bloomberg U.S. Government Bond Index being down 13.58%.

Our fixed income portfolio was able to outperform the bond index because it maintained a duration short of the index, which more than offset the portfolios overweight to corporate credit.

Market Outlook

The economic evidence in front of us suggests a recession will occur in 2023.

However, the tight labor market, the strength of the banking sector, and resilient consumer spending provide hope that it could be a mild recession. Inflation, especially wage inflation, could prove to be a challenge for the Fed, even with the rate hikes implemented in 2022.

We could see further weakness in the economy and lower corporate earnings this year, but we expect this to surface opportunities for long-term investments in equities at reasonable valuations.

On the fixed income side, our focus has been, and will continue to be, to selectively underwrite companies to achieve long-term outperformance. We believe that the Funds’ long-term overweight to corporate credit and focus on sound fundamental analysis will both aid relative performance and provide relative protection against interest rate and inflation volatility. We feel the portfolio is well positioned to perform well on a relative basis as we move into 2023.

Firm Updates

Due to capital gains being elevated for the last few years, we’ve entered a relationship with ReFlow Fund, LLC. There are ancillary benefits to working with ReFlow, like access to cash flow, lower cash position, and lower trading activity, but the main goal is to decrease the annual capital gains distribution that shareholders receive over the long term.

Finally, as we begin 2023, Mairs & Power has moved from the First National Bank Building to the Wells Fargo Place, also in downtown St. Paul. We’re happy to all be working on one floor, providing more space for collaboration, and staying true to our St. Paul roots since 1931. Our new address is 30 East 7th Street, Suite 2500, St. Paul, MN 55101.

 

Top 10 Fund Holdings (subject to change)

Mairs & Power Balanced Fund   

 

Click Here for standardized performance. 

Expense ratio: 0.69%

The Composite Index reflects an unmanaged portfolio of 60% of the S&P 500 TR Index and 40% of the Bloomberg Barclays U.S. Government/Credit Bond Index. It is not possible to invest directly in an index.

Morningstar US Fund Allocation-50% to 70% Equity Category is designed to benchmark target-date and target-risk investment products. Index isbased on well-established asset allocation methodology from Ibbotson Associates, a Morningstar company. Index has 60% global equity exposure and 40% global bond exposure. It is not possible to invest directly in an index.

The S&P 500 TR (Total Return) Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. It is not possible to invest directly in an index.

The Bloomberg U.S. Government/Credit Bond Index is a broad-based flagship benchmark that measures the non-securitized component of the U.S. Aggregate Index. It includes investment-grade, U.S. dollar-denominated, fixed-rate treasuries, government related and corporate securities. One cannot invest in an index.

Basis point is a unit of measure for interest rates and other percentages in finance. One basis point is equal to 1/100th of 1%, or 0.01%, or 0.0001.

Duration is a measure of the sensitivity of the price of a bond or other debt instrument to a change in interest rates.  

All investments have risks and loss of principal is possible. The Balanced Fund is designedfor long-term investors.

Equity investments are subject to market fluctuations and the Fund’s share price can fall because of weakness in the broad market, a particular industry, or specific holdings.

Investments in small and midcap companies generally are more volatile. International investing risks include among others political, social or economic instability, difficulty in predicting international trade patterns, taxation and foreign trading practices, and greater fluctuations in price than U.S. corporations.

The Balanced Fund is subject to yield and share price variances with changes in interest rates and market conditions. Investors should note that if interest rates rise significantly from current levels, bond total returns will decline and may even turn negative in the short-term. There is also a chance that some of the Balanced Fund’s holdings may have their credit rating downgraded or may default.

The Funds’ investment objectives, risks, charges and expenses must be considered carefully before investing. The prospectus and summary prospectuses contain this and other important information about the Funds, andmay be obtained by calling Shareholder Services at (800) 304-7404, or by visiting www.mairsandpower.com. Read the prospectus and summary prospectuses carefully before investing.

Foreside Fund Services, LLC. is the Distributor for the Mairs & Power Funds

The statements and opinions expressed are those of the speakers and are as of the date of this call. All information is historical and not indicative of future results and subject to change. 

Scott Howard is a registered representative of Foreside Fund Services, LLC. 

Performance data quoted represents past performance and does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance of the Fund may be lower or higher than the performance quoted. Performance as of the most recent month end is available by calling 800-304-7404.