Not Your Father’s Oldsmobile
Happy New Year! This letter will be longer than our usual Quarterly Letters because we have a lot to share with you. Over the years, Granite Investment Advisors has transformed from a single product offering to a multi-disciplined manager. We are “Not your Father’s Oldsmobile.” The sole purpose of our evolution is to offer you more choices to better meet your unique investment objectives.
To this end, we are pleased to announce the asset acquisition of Hutchens Investment Management, owned by William D. Hutchens, Jr., CFA. This transaction adds significant service capabilities and provides a broader range of investment and institutional offerings for our growing client base. Specifically, the acquisition expands our focus from primarily ‘value’ investing to now include ‘growth’ investment options.
The combined firm, with $685 million under management, provides increased investment research depth and administrative compliance support. In addition to expanding our client offerings, this acquisition is a ‘homecoming’ for Bill Hutchens. Bill essentially started his investment management career with us nearly 25 years ago. He joins us as Managing Director of the Core Growth equity strategy and Head of Institutional Investments, and we are pleased to see him return to his roots. We still firmly believe that over the long term, Value investing will outperform the overall market. However, Core Growth has its own discreet cycles which can benefit overall performance.
We now have four unique disciplines-Large Cap Value, Dividend Growth, Core Growth and Global. All can be used as stand-alone solutions or blended to create further diversification for you. Additionally, we can closely replicate these disciplines through Granite Exchange Traded Funds (ETF) for accounts that do not meet our stated minimums. All of these equity solutions can be combined with our fixed income strategy to create balanced asset allocations, as well.
Unique Investment Disciplines
Large Cap Value
Granite Investment Advisors Large Cap Value discipline employs proprietary quantitative and qualitative criteria to identify attractive potential investments. We look for financially strong, profitable companies that earn a high return on capital, and sell at a discount to their historical averages, industry or peer group. We believe that by buying these stocks when they are relatively inexpensive and selling them as they become fairly valued, we take less risk, have the potential to earn above market returns, and reduce the level of volatility in our portfolios.
Granite Investment Advisors Dividend Growth Portfolios are comprised of stocks with an emphasis on companies that offer unique and distinctive products and services that give them a strong market franchise. This investment strategy focuses on value-oriented securities, and places an extra emphasis on income generation. Stock selection for the Granite Dividend Growth Product centers on companies with strong free cash flow, and dividend yields above the market average.
Granite Investment Advisors Core Growth portfolios invest in stocks of large capitalization, blue chip companies benefiting from an economic shift and earnings or sales surprise, while demonstrating reasonable valuations. This investment strategy combines the best of a quantitative, fundamentally-driven framework with seasoned analysis and foresight. We employ a bottom up approach to security selection and macro theme generation.
Granite Investment Advisors ETF Portfolios are designed with one goal in mind: portfolio customization to fit your unique investment needs. Using tax-efficient and low-cost Exchange Traded Funds (ETFs), we can create an investment solution that is specifically tailored for your income, return and risk requirements. Our investment approach avoids fads or bubbles, and your portfolio is personalized to accommodate your specific risk tolerance. The investment strategy originates with a proper allocation among equity sectors and fixed income. We believe that the best returns are achieved with constant monitoring and rebalancing of the portfolio.
Global Asset Allocation
Granite Investment Advisors’ Global Asset Allocation is designed to combine our best strategies in one portfolio by investing in our individually managed equity strategies in concert with low-cost exchange traded funds (ETF’s). This strategy combines active management with the tactical management of index products. This diversified portfolio includes an allocation to fixed income securities, value and growth oriented domestic stocks, small and mid- capitalization ETF’s, and developed international and emerging market ETF’s.
Introducing Financial Planning Capabilities
We now also have comprehensive financial planning capabilities to help you better assess your current financial condition and how to meet your long term goals. We utilize tools that quantifiably determine your risk tolerance by evaluating your current asset allocation in order to determine if your portfolio matches your needs. This differentiates us from how others approach financial planning. In many cases, we have found clients’ true risk tolerances are not properly reflected in their asset allocation due to the subjectivity in simply defining oneself as “aggressive” or “conservative.” Using quantitative tools eliminates the majority of that subjectivity. Once your risk profile has been properly identified, we can apply financial planning techniques such as budgeting, needs analysis and investment planning. Please speak with your portfolio manager if you would like further details.
Improving Our Research and Investment Process
In addition to our new disciplines, we have enhanced our research process. We are always asking ourselves, “How can we improve?” As you well know, active investing has been out of favor since 2007, and our performance has lagged the indices most of this time. This has been a very frustrating time for clients and for us as well. Our goal is to produce better returns than the market net of fees.
In 2018, we will be implementing some new research methods and rules to our investing framework to drive better performance. We have upgraded our quantitative efforts to include a greater focus on price action and revenue and cash flow changes. Also, we will have the added insight from the new members of our team. We believe these changes will have a positive effect on the long-term performance of our strategies. While we cannot make any promises on future results, we believe we have the people and structure to achieve our performance goals in the years to come.
We were constructive heading into 2017 for a number of reasons – valuations appeared reasonable, inflation was under control, and global economic growth seemed to be accelerating in a synchronized manner. While some investors felt that the U.S. economic expansion was coming to an end and a recession was on the horizon, our view was that while the U.S. economy has been expanding since 2010, income levels for the vast majority of the population had been stagnant for most of the expansion. Middle and low skilled workers did not experience wage growth until late 2014 (See Quarterly Letter October 2016- Climbing Walls of Worry). This demographic typically spends what they earn, and had pent up demand from years of hunkering down after the death spiral of the Financial Crisis. It was this new found disposable income that drove the economy in 2017, and which should contribute to the strength of the economy in 2018 and beyond.
Global economic growth is robust and improving. Inflation remains benign, and the benefits from U.S. corporate tax reductions have yet to filter through to corporate profits. While our crystal ball is as cloudy as others, our belief is that global economic growth will surprise to the upside, boosting corporate profits. Exhibit 1 depicts levels of free cash flow for both corporations and individuals. Note that prior to the Financial Crisis, individuals actually had negative free cash flow, likely due to mounting debt tied to real estate. After experiencing the devastation of the Financial Crisis, both groups became more conservative by decreasing spending and building up savings. This suggests that, pent up demand from years of austerity will reduce the likelihood of a major retreat in spending or investment in 2018.
Contrary to many of the nay-sayers, 2017 was a very good year for investors globally. While valuations are not as attractive as they once were, we do not see them out of line with historic averages. With the exception of a handful of companies, including the FANG stocks and some of the new crypto currencies, we are not seeing the broad based speculation that is often indicative of market tops and or bubbles. We are monitoring inflation as one potential concern. In the past, tight labor markets, accelerating global economic growth, increasing bond yields and commodity prices lead to higher inflation. Although inflation remains muted, capital markets are showing concern as investors bid up the yield of the 10-year Treasury in anticipation of future inflationary pressures. For the time being we remain constructive overall.
As always we thank you for the trust and confidence you place in us.
Scott B. Schermerhorn
Managing Partner and Chief Investment Officer
There can be no assurance that any of the securities referred to herein were produced for or remain in portfolios managed by Granite Investment Advisors. A complete list of all Granite Investment Advisors' recommendations within the preceding year is available upon request. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities described herein.