- Billy Hwan became the lead manager of Parnassus’ Enveador Fund this year and started a major update.
- He’s diversifying dramatically and says he wanted to reduce the risks in the portfolio.
- Hwan explained how he’s changed his allocations and discussed three top picks.
Don’t mess with success. But don’t get stuck in your ways and lose touch with the times either.
That’s essentially the dilemma Billy Hwan faced when he became the lead manager of Parnassus’ Endeavor Fund at the start of 2021. Under the management of Parnassus founder Jerry Dodson, the 16-year-old fund had a sterling track record during a tough period for value stock pickers.
During Dodson’s tenure, Endeavor returned 564% to investors, according to Morningstar. That’s far better than the S&P 500 total return index, which would have delivered 349%. Put another way, Morningstar says the fund has returned 15.2% a year over the 15 years that ended on November 5, beating 99% of value funds.
Hwan didn’t want to change things for their own sake, but he told Insider he saw some things that needed to be addressed. For one thing, the fund had become extremely concentrated, with 60% of its money in 10 stocks — a few of which took up 10% of its assets.
“That led to kind of high, both on the upside when we were doing very well, and then on the downside when those stocks were out of favor,” Hwan said in an exclusive interview. “I think that made it very difficult for institutional investors to stomach our risk profile.”
He’s still outperforming most of the value universe with a 27.9% return this year, according to Morningstar data.
Hwan now has 40-plus stocks in the fund, up from about 28, and with that change he’s limited his largest positions to about 4%. He says he wanted to put more emphasis on risk management.
“When you pay very, very high prices for assets, your future returns, expected returns are likely to be lower. That’s just math,”he said. “When you have very low expectations, low valuations built into the stock, that’s a level of risk management that may be the most important.”
While stock market valuations are higher than ever by some metrics, meaning investor expectations are getting unrealistically high. So he’s focusing on stocks that have been “de-risked” because investors assume the worst, and on sectors that have gotten left out of the recent rally.
“We’re still looking for quality companies that have increasingly relevant products and services that have fantastic competitive advantages that are sustained over time,” he said. “But I am also threading the needle and looking for companies that are inexpensive relative to their own history, or the sector they operate in, or the market.”
He expects market turbulence to increase, and says that buying less expensive stocks will keep his performance safer. Since taking over, Hwan sold some of the fund’s financial stocks and started building positions in consumer staples and real estate, which hadn’t been represented at all. He also created a significant overweight in healthcare stocks.
He says that big biopharma companies make big R&D investments like tech companies do, but in some cases, their “valuations are still single digits, low double digits, and have tremendous returns, wide moats, good prospects for the future.”
For those reasons, he’s very bullish on Merck, which he first bought in April. The stock traded around the low $70s at that time.
“The market had pretty much given up on Merck because it’s highly dependent on one blockbuster, albeit a giant blockbuster drug, Keytruda,” Hwan said. “We purchased it earlier this year, when the valuation was quite depressed and subsequently Merck has continued to surprise.”
Hwan says new approvals for Keytruda will keep its sales going, and revenue from HPV vaccine Gardasil will pick up as people start going to the doctor more often.
Merck stock soared in October after it said its COVID-19 treatment molnupiravir cut hospitalizations in half. British regulators quickly gave the drug emergency approval. That took the stock to $90, but it dropped about 10% Friday after Pfizer said its COVID pill cut the risk of hospitalization and death by 90%.
Still, the COVID pill isn’t central to his thesis on the company.
Meanwhile Hwan says Pepsi became appealing because consumer staples companies have lagged during the recent rally, making their valuations more attractive.
“We bought it cheap when nobody loved it,” he said, praising Pepsi’s management for focusing on efficiency. “That should translate to about eight to 9% earnings growth because of the increased margins as they shift from less healthy to healthier snacks. And then they also have a fantastic dividend.”
Meanwhile Simon Property Group has gone from neglected to very popular since Hwan started buying it in May. The mall operator has rallied 33% in six months. While e-commerce has decimated malls, Hwan says Simon has a strong portfolio, and the mall won’t go extinct. For now, they’re working as a re-opening play.
“We’re owning companies that own land in suburban areas that are becoming more valuable as kind of millennials decide to leave the cities and put roots down in communities where having the mall is actually extremely valuable,” he said.
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