Listen to Kevin Earley and Bob Thompson, portfolio managers of the Balanced Fund, as they talk with Scott Howard, VP, Investor Relations Manager, on October 21, 2020 to provide an update on current economic and market conditions and their impact on the Mairs & Power Balanced Fund.
The Mairs & Power Balanced Fund finished the quarter 5.53%, while its benchmark composite index (60% S&P 500 Total Return Index and 40% Bloomberg Barclays U.S. Government/Credit Bond Index) gained 5.71%. Nine months year-to-date, the Fund is up slightly at .30% and the benchmark is up 7.16%. The Fund’s other benchmark, the Morningstar U.S. Fund Allocation, gained 4.93% in the third quarter and was up 1.16% in the first three quarters of 2020.
The Fund’s underperformance compared to its blended benchmark was the result of underperformance on the equity side, which represented 64.5% of the portfolio’s assets at the quarter’s end. This was substantially offset by outperformance on a fixed income side.
The underperformance of the Fund’s equity component during the quarter was due primarily to its underweight in Technology (the market’s strongest performing sector this year), the adverse performance in its Financial holdings (particularly banks), and its overweight in Industrial and Healthcare, which underperformed.
In the third quarter, the Fund added weight to its Technology holdings with Texas Instruments, a global leader in analog semiconductor manufacturing. The company has a durable competitive advantage due to its scale-driven manufacturing cost advantage and its collection of proprietary chip designs. It serves a wide variety of markets and should benefit from several long-term secular growth drivers, including factory automation, smart grids, Internet of Things applications, automotive electrification and 5G infrastructure.
During the quarter, the Fund eliminated its position in Travelers. We expect that the continued competition in Travelers’ commercial and personal lines of business will lead to long-term erosion of its profit margin.
Fixed Income Performance
Our long-term overweight in corporate bonds took a heavy toll on relative performance in the first quarter, as it always has during recessions. However, corporate bonds have always rallied back strongly. Over the full economic cycle, we have generally earned the excess spreads that corporate bonds pay over Treasuries.
The Fund’s average rating has remained steady at BBB, while the average rating of the government credit index has dropped two notches over the past two years. Considering that nearly 60% of the index is AAA-rated government securities, you can see the negative ratings effects from the 40% of the index that is credit oriented.
Aside from a small allocation to airline equipment trusts, the Fund has minimal to no exposure to the sectors that have been most negatively impacted by the virus's economic fallout. We have been trading up in quality over the past two years, believing that the long economic expansion would end at some point.
Our ratings demonstrate the positive impacts of those trades. The Fund has regained about two-thirds of that underperformance over the past two quarters. Corporate bond spreads have tightened significantly, and have a long way to go to reach where they were at the beginning of 2020. But we believe the Fund’s fixed income holdings are well positioned to make up more ground in the coming quarters.
Our general outlook is cautious, primarily because of the pandemic.
We expect there soon will be results from COVID-19 vaccines that are current in trials. Our understanding is that vaccine developers are trying to hit a 50% efficacy rate. We’re concerned by how low that target rate is, plus the likelihood that a large percentage of the population won't get vaccinated. That suggests that we could end up living with COVID-19 for a long time.
We're baking that possibility into our investment process as we go through our companies stock by stock. We think the evaluations look reasonable, and that the Fund holds companies well-positioned for the market’s twists and turns. But there are concerns about much longer the pandemic might last.
Top 10 Fund Holdings (subject to change)
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 ALPS Distributors, Inc.