Q4 2022 Growth Fund Update Recording

Q4 2022 Growth Fund Update Recording

January 19, 2023

As we start a new year, we invite you to listen in as Andy Adams and Pete Johnson provide an update on the state of the market, the status of the Mairs & Power Growth Fund, and an investment outlook for 2023.

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 Mairs & Power Growth Fund. While the Growth Fund still edges out the S&P 500 TR Index and the Morningstar peer group when it comes to long-term performance, the Fund underperformed both in 2022.

Absolute performance of the Fund was down 21.07% for the year while the S&P 500 TR Index was down 18.11%. The Fund also underperformed its peer group, as measured by the Morningstar Large Blend Category Index, which was down 16.94% for the year.

Our decision to not hold stocks in the Energy sector was a significant headwind to relative performance. It cost the Fund approximately 2.2% in relative return as Energy was the best performing sector in the S&P 500, up 66% for the year.

Higher energy prices also negatively impacted our stocks in the overweighted Materials sector that relies so heavily upon it. Still, over the long term, we expect the Energy sector will return to its history of below market returns, especially as demand growth slows significantly in the future. We will continue to avoid stocks in companies whose primary business is centered on fossil fuels.

Another major factor in 2022 performance was our stock selection skewed the portfolio toward “growthier” stocks. Because we’re searching for companies with secure competitive positions that are taking market share, these tend to be seen as “growthier” businesses. This slight shift hurt relative performance in 2022 as growth stocks significantly underperformed “value” stocks by approximately 24%. This was a result of the Federal Reserve’s aggressive interest rate hikes from near zero at the beginning of the year to over 4% at year end. Over the long term, the performance of growth and value investments tend to even out. So, we expect this headwind will become a tailwind for the Fund.

Individual Stock Performance

Three stocks that particularly lagged in the Fund exemplify that growth headwind.

Alphabet (GOOG), Bio-Techne (TECHNE), and Ecolab (ECL) hurt the portfolio in 2022. All three have been great investments through the years and rarely struggle like they did last year. In fact, Alphabet and Bio-Techne posted such high returns in 2021 that we felt their valuations had become stretched and we trimmed our positions. Both companies’ valuations have since returned to more normal levels, thanks in part to higher interest rates.

However, Google has also been impacted by advertisers pulling back on spending as the economy cools. Bio-Techne, on the other hand, has been hamstrung by continued lockdowns in China and the current geopolitical tensions in Europe. For Ecolab, oil is a major input for its products and higher prices hurt margins, with the company also impacted by the economic slowdown in Europe. Ecolab is a core holding for the Fund and we believe in the company’s ability to pass through price increases to offset inflation, and margins are expected to expand in 2023.

On the positive side, two Minnesota companies, The Toro Company (TTC) and UnitedHealth Group (UHG), were top performers in 2022.

Toro has been a successful long-term holding for the Fund and 2022 was another impressive year for the company. Toro finished the year with nearly 2.3 billion in backlog orders, more than 10 times greater than normal. This backlog, most of which should ship this year, provides protection in the event of an economic slowdown.

UnitedHealth Group saw revenue increase 13% and earnings grow 19% this year and it continues to see high enrollment. UnitedHealth’s Optum business, which provides primary, specialty, and surgical care, posted even higher revenue growth of 17%. The company has heavily invested to provide efficient health care and the results have been impressive.

Looking Ahead                      

At some point, inflation will likely come back under control and the upward pressure on interest rates should recede. Then, the end of rate hikes can lay the foundation for renewed economic growth. Despite this, our market outlook calls for a mild recession at some point in 2023. The Fed is working hard to cool the economy and while it appears that aggressive strategy is finding success lowering inflation, wages remain persistent.

As a result, we are adding to companies we feel can alleviate some of the labor market bottleneck, whether through automation, software, or something else.

Also, because 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 Growth Fund 

Expense ratio: 0.61%

S&P 500 TR Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market.

Morningstar large-blend portfolio are fairly representative of the overall U.S. stock marketing in size, growth rates, and price. Stocks in the to 70% of the capitalization of the U.S equity market are defined as large-cap. The blend style is assigned to portfolios where neither growth nor value characteristics predominate. These portfolios tend to invest across the spectrum of U.S. industries, and owing to their broad exposure, the portfolios’ returns are often similar to those of the S&P 500 Index.

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. Characteristics and other statistical measures refer to underlying stocks in the portfolio and do not represent or predict the performance of any fund.

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

All investments have risks. The Growth Fund is designed for 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.

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. Click Here for standardized performance.