Impact Blog
Low-quality headwinds may create long-term opportunities

The views expressed in these posts are those of the authors and are current only through the date stated. These views are subject to change at any time based upon market or other conditions, and Calvert disclaims any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions for Calvert are based on many factors, may not be relied upon as an indication of trading intent on behalf of any Calvert fund. References to individual companies for Engagement or Research purposes are provided for illustrative purposes only and may not be representative of the results of all of Calvert’s engagement efforts. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. Past performance is no guarantee of future results.

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      By Joe Hudepohl, CFAPortfolio Manager and Managing Director, Atlanta Capital

      Atlanta - Thus far in 2020, equity market returns have been narrowly focused, led by a handful of obvious growth stocks — including technology and others that have benefited from what has transpired during COVID-19. Low quality has also dominated its high-quality counterpart.1 According to our analysis, over the year-to-date period ending August 31, 2020, low-quality stocks within the Russell 1000 Growth Index outperformed high-quality stocks by 24.5%.

      Index distortions and risks

      Within the growth universe, we view concentration and valuation risks to be especially high. As of August 31, approximately 40% of the Russell 1000 Growth Index was concentrated in its top five stocks — Microsoft, Apple, Amazon, Facebook and Alphabet. The information technology sector alone accounted for 45% of the index — as distorted as it has been since the 2000 tech-bubble era. If we take into consideration some of the internet stocks that were shifted out of technology and re-categorized into communication services in 2018, this large-cap growth index looks to us like a technology sector fund — and not adequately diversified.


      From the perspective of managers who focus on higher-quality companies, such low-quality leadership has been a headwind for relative performance in the near term, but also provides longer-term opportunities to build portfolio positions. We have been especially active so far this year, initiating positions in businesses that we believe are attractively valued.

      A long-term lens

      Despite all this uncertainty, we do believe it is in times like this that our long-term investment horizon is of real value. While we don't know what is going to happen in the near term, we have much higher confidence that over the next several years the economy is going to normalize as a vaccine, treatment, and herd immunity diminish the risk of COVID-19. We believe that our high-quality companies are going to perform well in the meantime and reward investors over time. Our historical analysis suggests that high-quality equities tend to outperform over full market cycles and generally do well in periods of market volatility.

      Bottom line: The high concentration in the Russell 1000 Growth Index — along with the outperformance of low-quality stocks — has created some notable distortions in the market. We are taking advantage of the long-term, risk-adjusted opportunities we are seeing until the economy improves and conditions shift.

      1 Higher-quality companies typically have consistent earnings, strong balance sheets, significant free-cash-flow generation, growing revenues and meaningful competitive advantages, whereas the opposite is true for their lower-quality counterparts. Historically, high-quality equities have outperformed over full market cycles.