Spotify, Solar Power and Beer Cans: How 3 Investors Beat the Market

Spotify, Solar Power and Beer Cans: How 3 Investors Beat the Market

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In the third quarter, as the stock market defied the pandemic with its rise, managers of three top-performing mutual funds profited from bets as varied as music streaming, solar power and beer cans.

One fund in the trio — the Morgan Stanley Discovery Portfolio — has managed to achieve an excellent long-term record, too, beating both the S&P 500 and its peers.

The fund returned an annual average of 18.91 percent for the decade that ended Sept. 30, compared with a 13.74 average annual total return for the S&P 500 over the same period. That result put it ahead of 98 percent of the midcap growth funds tracked by Morningstar.

Dennis Lynch lead manager of Morgan Stanley Discovery, said he and his team aim to “collect unique companies that we think can be much larger in the future.”

They’re seeking financially sturdy outfits with the potential to dominate their markets, he said.

A recent top holding was Spotify, which streams music and other forms of audio. Several companies are competing in audio streaming, including heavyweights like Alphabet, Amazon and Apple.

Spotify, however, is “rapidly gaining scale with the sheer number of paying and free users,” Mr. Lynch said. At midyear, the company reported having 299 million users worldwide.

“Our thesis is they’ve created a hub for audio streaming and a scale advantage, and they’ll find new ways to monetize that,” he said. Spotify, for example, has lately enhanced its offerings with a spate of acquisitions of podcast producers, including The Ringer, a sports outfit led by the journalist Bill Simmons.

Mr. Lynch’s team, known as Morgan Stanley’s Counterpoint Global group, includes four researchers tasked with identifying disruptive technologies. They try to spot developments like streaming long before they become dominant, he said.

A decade ago, the fund’s analysts tagged software-as-a-service as such an opportunity. With software-as-a-service, a customer receives software online via subscription, instead of paying a licensing fee and downloading the software to a desktop computer. Today, it’s represented in the Discovery fund by such holdings as Veeva Systems, which operates in the life-sciences industry, and Okta, which enables secure online identification.

Discovery is one of four Morgan Stanley funds managed by Mr. Lynch’s team that landed among the third quarter’s top performers. The others are the Insight Fund, Growth Portfolio and Inception Portfolio. Mr. Lynch said Insight holds his team’s “best ideas,” regardless of market capitalization, while Growth typically owns large-cap stocks and Inception small-cap ones.

Discovery, whose A shares have an expense ratio of 1 percent, returned 24.98 percent in the quarter, compared with a total return of 8.93 percent for the S&P 500 stock index.

If Mr. Lynch wants companies that can grow into dominance, then Shawn Reynolds, lead manager of the VanEck Global Hard Assets Fund, seeks ones that provide the necessities — energy, materials and agricultural products — that feed that kind of growth.

Mr. Reynolds’s fund doesn’t buy commodities, like oil, copper or corn. Instead, it invests in companies that produce them or assist in their production.

“More and more economies in the world are becoming service oriented,” Mr. Reynolds said. “But none of that happens without energy, materials and agriculture.”

Offerings like the VanEck fund are often called natural resources funds, and they usually hold lots of oil-and-gas companies.

Mr. Reynolds has a portion of those, but lately his biggest bet is on renewable energy, especially solar power. That accounts for his three top holdings — Sunrun, SolarEdge Technologies and Hannon Armstrong Sustainable Infrastructure Capital — and nearly one-fifth of his fund’s assets.

Mr. Reynolds said he saw a presentation by Sunrun’s founders several years ago and was struck by their practicality. “They talked about how they’d make money, rather than saving the world.”

Sunrun installs and finances solar systems. Back then, it was another company fighting for a piece of a crowded market. Today, it’s “by far the largest,” with more than 300,000 home-solar installations, Mr. Reynolds said.

Its managers have developed a reputation for prudence, he added, keeping costs low in a competitive business. “What you want out of any company is somebody running it who’s paying attention to every penny,” Mr. Reynolds said.

Another recent bet by Mr. Reynolds is miners, especially gold miners. “A year and a half ago or so, we went from about 10 percent gold to about 20 percent,” he said, referring to the fund’s overall asset allocation.

The price of gold has risen this year, as it often does during times of economic stress — it was up about 25 percent for the year through September. That has propelled gold-mining stocks like Kinross Gold, a Canadian producer.

Mining in general is a much-improved business today, compared with five years ago, Mr. Reynolds said. Many miners have restructured and paid off debt. As a result, many pay solid dividends.

Mr. Reynolds said he especially likes Rio Tinto, an Anglo-Australian company that unearths minerals like copper and iron ore. “They’re drowning in cash.”

The VanEck fund, whose A shares have a net expense ratio of 1.38 percent, returned 20.43 percent in the third quarter. Longer term, the fund has struggled, losing an annualized average of 3.54 percent over the decade that ended Sept. 30.

The managers of Hennessy Cornerstone Midcap 30 Fund don’t pick stocks.

They instead rely on a simple formula to do that for them, and Neil J. Hennessy, chief investment officer of Hennessy Funds, said they don’t deviate from it. “The formula eliminates the emotion,” he said.

It entails four factors. A company must have a price-to-sales ratio below 1.5 and revenue from $1 billion to $10 billion. Its earnings must exceed the previous year’s, and its stock must have appreciated over the last three and six months. (That is, it must have shown what investment professionals call momentum.)

Every fall, the fund buys the 30 stocks, in equal amounts, that rank best based on the formula and holds them until the following fall, when it rebalances.

“The reason the formula works is that we’re not buying in the first inning,” Mr. Hennessy said. “We’re not trying to catch a stock at the bottom. We might get it in the third inning.” The use of the price-to-sales ratio ensures that the fund buys shares that represent good values, he said, and the revenue restriction limits it to midcap stocks.

Mr. Hennessy said the fund’s aim is to not lose money in any calendar year. In the last decade, it has achieved that every year but 2018, when it lost 22.44 percent.

“I’ve always loved the midcaps,” Mr. Hennessy said. “They’re large enough to withstand an economic tsunami and to acquire smaller companies, but they’re small enough to be acquired themselves.”

The formula has lately yielded a stock, Crown Holdings, that has benefited from the pandemic.

Crown makes packaging, including beverage cans. The company even has a product line catering to craft brewers.

“All of a sudden, because of the virus, the restaurants and bars are closed,” Mr. Hennessy said. “People aren’t ordering kegs, but they’re going to the store and buying beer in cans.”

The Hennessy fund, whose investor-class shares have an expense ratio of 1.36 percent, returned 22.23 percent in the third quarter.


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