REPORTANNUAL 2120
REPORTANNUAL 2120 ROLAND GEORGE INVESTMENTS STETSONPROGRAMUNIVERSITY
CONTENTSOFTABLE INTRODUCTION 3 OUR TEAM 5 DIRECTOR�S NOTE 7 PROFESSOR S NOTE 9 CIO�S NOTE 11 PORTFOLIO PERFORMANCE 13 EQUITY SECTOR REPORTS 21
INTRODUCTION
Carter Randall, a noted lecturer, writer and panelist on PBS’s “Wall Street Week,” was selected as the first Distinguished Visiting Professor. Randall proved to be instrumental to the program, as his efforts as lecturer, advisor and fund consultant established the ambitious standards RGIP holds itself to today. From 1982 to 1987, Gerald T. Kennedy assumed this position and introduced the use of computers to scan stocks meeting criteria derived from student research. Students advanced their research methods through the introduction of services such as Value Line and Dow Jones News Retrieval, in conjunction MAKING ROLAND GEORGE’S DREAM A REALITY THAT HAS THRIVED FOR 40 YEARS.
During his lifetime, Roland endeavored to spread these ideas but was unable to find a sponsor in the academic community for such a program. Offers on his part to assist in creating and financing a “practical” investments course went unaccepted. However, on Aug. 20, 1980, Sarah George transferred assets valuing just under $500,000 to Stetson, accompanied by contributions from President Pope Duncan, Dean David Nylen, H. Douglas Lee and Professor Kenneth Jackson. Then came a memorandum stating the terms of the new Roland George Investments Program (RGIP), which the school was committed to bring to life for the approaching spring semester.
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After the passing of Roland J. George, Sarah George approached Stetson University determined to bring her late husband’s dream to life. Roland, who had suffered vast investment failures of his own in the market crash of 1929, insisted the truest way to learn the principles of investing was to learn by doing. He embraced failures and mistakes as a critical part of the learning process. Theory and principle are important in an investor’s learning path, but nothing can replace practical learning experiences. The Georges envisioned a program in which students would not only have the traditional classroom experience, but also be given the opportunity to manage a real portfolio – purchasing and selling securities, constantly monitoring the portfolio, and enduring the pressures of generating sufficient income to pay for the program’s expenses.
The RGIP further progressed through its division into a twosemester course. During the first semester, emphasis lies on the Growth Fund and equity management techniques. The following semester, focus shifts to managing the Income Fund, which includes bonds and other income-generating securities.
with data sources such as Zack’s Icarus Services and the O’Neil Reports. Sarah George passed away in 1988, and in her will she left a gift of $3.6 million to establish the Roland and Sarah George Investments Institute, where the Roland George Investments Program (RGIP) was born. The Institute provides support for investment education at Stetson to bring investment professionals and academic theorists together, and helps provide access to research in investments for the School of Business Administration faculty. The Stetson community greatly appreciates Sarah George’s generosity and vision for investment education. The George endowment has also allowed RGIP to have a full-time resident professor with applied experience.
The RGIP is unique in its concept and design, giving Stetson business students the opportunity to simultaneously learn the theory behind portfolio management and put that learning into practice with a lot more than test grades at stake. While many universities offer courses using computer-simulated programs with “play” money, RGIP students are trusted to invest more than $5 million. Roland George believed the best way to prepare for a career in investments was through participation in actual investment decisions under the supervision of experienced investment managers. His dream is now a reality, as the program has thrived for the past 40 years and has fundamentally changed the way Stetson University teaches investments. 4
Although students monitor both portfolios year-round, this structure allows for students to concentrate their efforts in specific areas of investments throughout the year. Max Zavanelli was selected as the first Roland George Distinguished Visiting Professor of Applied Investments. Since then, Ned Schmidt, Frank Castle and K.C. Ma have served as visiting professors, with David Mascio currently holding this position. These individuals were selected because they applied investment experience and the enthusiasm to effectively convey this knowledge to the students in the program. Their efforts have helped materialize Mr. and Mrs. George’s dream of developing the RGIP into a first-rate organization for applied investment research and investment education.
OUR TEAM BenedictKyle ANALYST MarkhamSarah INVESTOR RELATIONS OFFICER BerryElayna ANALYST MauraBenjamin ALTERNATE TRUSTEE BerdanisNicolas ANALYST MastersonAdam VALUE MANAGERPORTFOLIO CookeMichael ANALYST McCulloughMax ANALYST GennesTim PORTFOLIO MANAGERDIGITAL ASSET PORTFOLIO KentChristopher LEAD SECTOR ANALYST LakaJoshua PORTFOLIO MANAGERDIGITAL ASSET PORTFOLIO LevyGuy ANALYST MillerMichelle ANALYST MontalvoTristen RISK & OFFICERCOMPLIANCE 5
O’BrienZachary FIXED INCOME PORTFOLIO MANAGER SoeZel ANALYST TranMinh ANALYST RaffertySam LEAD SECTOR ANALYST OlivaEnzo LEAD SECTOR ANALYST SundbergNoah GROWTH MANAGERPORTFOLIO WahlMadison LEAD SECTOR ANALYST ALTERNATEWojciechowskiMichaelTRUSTEEOFFICERCHIEFReidFermonINVESTMENT ServiGabe LEAD SECTOR ANALYST SharmaVishal LEAD SECTOR ANALYST 6
On a program level, RGIP continues to shine brightly, and we are making substantial improvements to both the physical infrastructure of the program and the learning experiences.
During calendar year 2021 we secured funding approvals for the new RGIP learning lab and have transferred our brokerage accounts from the custody of a retail broker to that of a prime broker. The new lab will provide a state-of-the-art learning environment, while the new trading platform will provide access to more markets, trading algorithms, and greater exposure to professional portfolio management and financial reporting. Our intention with both decisions was to make RGIP as close to the “real world” as possible in an academic environment. Additionally, we received approval from both the School of Business and the University Curriculum Committees to proceed with the next phase of RGIP in the Advanced Portfolio Management course. This course expands the RGIP experience from two semesters to three and will add financial reporting, derivatives and advanced portfolio construction techniques to the learning experience.
DIRECTOR 7
In a year like we just had, it might be convenient to adjust our benchmarks to hide our failures, but what has always made RGIP great is that we do not measure ourselves using absolute or even relevant performance; we measure our success on the quality of our student learning, and in that regard, 2021 was one of our best years on record. In this letter I will address the year’s highs and lows and provide an update on what we are doing to continue building the program’s reputation as the premier learning experience among a rapidly growing number of student-managed investment programs.
During calendar year 2021 Stetson continued to operate under COVID protocols that severely limited the events we could pursue. We were extremely disappointed to not be able to take the students to NYC, travel to competitions, host public trustee events or welcome alumni back to our annual homecoming tailgate. Throughout this time, the students showed a tremendous amount of resiliency and maturity. The leadership cohorts in both the graduating class of 2021 and the incoming trustees and portfolio managers are among the most capable and driven students I have encountered in my time at Stetson University. At the time of drafting this report, 23 of last year’s 26 graduating seniors are either gainfully employed or seeking advanced degrees. They truly are a remarkable group, and I am impressed by each and every one of them.
In calendar year 2021 the Roland George Investments Program delivered on its mission to engage students in superior educational learning opportunities but failed to deliver superior returns. In a word, our performance was “mixed.” In later sections of this report, you will see we underperformed the S&P 500 and the Wilshire 5000 in both our Growth and Value portfolios while outperforming in our Fixed Income Portfolio.
The Growth and Value Portfolios fell short of the corresponding benchmarks with 16.8% and 18.6% annual returns respectively, while the Fixed Income Portfolio exceeded the Bloomberg Aggregate Bond Index by over 6%. In 2021 the market witnessed a dramatic rise in Large Cap Equity, specifically the mega-cap glamour stocks, which represent the largest weighting in major indexes. As a point of comparison, the S&P 500 saw a 28.7% annual return while the Russell 2000’s annual return was only 14.8% - the difference driven by only Hurst
DIRECTOR’S NOTE Matthew
The highlights from 2021 demonstrate the Roland George Investment Program is among the elite studentmanaged funds, both in performance and as a learning experience. At the annual Quinnipiac G.A.M.E. portfolio management competition, the RGIP was awarded 2nd place in the Value category and Champion in the Fixed Income Category, continuing a long and growing legacy. a handful of stocks. The RGIP typically does not hold ETFs and traditionally eschews holding glamour stocks. However, this was one year where passive or naïve diversification outperformed our active management strategies. The primary reason for our underperformance can be attributed to the asset allocation decision. Diving deeper into our asset class holdings, we barely missed the performance of large cap stocks while maintaining a significantly lower beta, and our small-cap stock holdings drastically outperformed, which indicates superior security selection. One area where we made a catastrophic miscalculation was in the holding of Chinese equities. In this area alone, we underperformed the MSCI benchmark by a staggering 27%. Although the performance of the Growth and Value funds underperformed, our overall performance of 16.45% was in line with Schwab’s Moderately Aggressive Benchmark of 16.82%. The aforementioned benchmark consists of a 35% weighting in the S&P 500, 35% in the Bloomberg U.S. Aggregate Bond, 15% in MSCI EAFE (TRN), 10% in Russell 2000, and 5% in the FTSE 3-Month Treasury Bill. The underperformance of actively managed funds was pervasive in the industry last year. As a reference, the S&P Indices versus Active (SPIVA) scorecard, which tracks the performance of actively managed funds against their respective category benchmarks, showed 79% of fund managers underperformed the S&P 500 during calendar year 2021. Overall, the student managers delivered total fund returns consistent with professional money managers and significantly outperformed the real return needed to fund the operating expenses for the program. The highlights from 2021 demonstrate the Roland George Investments Program is among the elite student-managed funds, both in performance and as a learning experience. At the annual Quinnipiac G.A.M.E. portfolio management competition, the RGIP was awarded 2nd place in the Value category and Champion in the Fixed Income Category, continuing a long and growing legacy. The particular programmatic accomplishment from 2021 that brings me the most joy and pride is the achievement of both teams competing in the CFA Institute Research Challenge. The competition is global in scope, with more than 1,100 teams participating each year. At the local (state) level, the competition requires an intensive research paper recommending either a buy or sell decision for a local company. Teams advancing to the local finals and beyond are required to present their findings to a panel of CFA judges and are judged on content, persuasiveness, professionalism and their responses to a battery of questions. Last year both teams from Stetson made it to the state finals with one team taking the title and advancing all the way to the America’s final, putting them among the top 10 teams globally. Last year marked the first time Stetson won the state competition since 2011 and the first time in our history we advanced to the hemisphere finals. Throughout the entire process, the team worked tirelessly on perfecting their research, comported themselves with the utmost professionalism, and recognized in real-time they had achieved something momentous: the learning experience of a lifetime. In a competition where the cream rises to the top, Stetson showed we are the cream of the crop. 8
The economyU.S. has recovered from the COVID-19 lockdowns in 2020 inincreasedthepolicy.monetarybecauseprimarilyof“loose”andfiscalInflationatconsumerlevelby5.6%2021.
The Taylor Rule, which is the annual inflation rate divided by the benchmark interest rate (1.5/5.6 = 0.267) suggests the central bank and the U.S. Treasury are behind the curve in controlling future inflation. Ideally, this ratio should be at 1.5, not 0.267. The benchmark interest rate should not be below the current inflation.
PROFESSOR’S NOTE
Davis Mascio PROFESSOR
The U.S. economy has recovered from the COVID-19 lockdowns in 2020 primarily because of “loose” monetary and fiscal policy. Inflation at the consumer level increased by 5.6% in 2021, which is a two-decade high. Most economists (including this one) believe the rapid rise in energy costs, increasing home prices and supply constraints will drive core inflation to levels we have not seen since the 1970s and early The1980s.more important question is how monetary and fiscal will work together to combat higher levels of inflation. At the end of 2021, the overnight lending rate remained between 0.00% and 0.25%, while the benchmark 10-year U.S. Treasury Note yield stood near 1.5%. The Federal Reserve Bank has been highly accommodative, which will ultimately result in considerable inflationary risk going into 2022. Both Janet Yellen (U.S. Treasury Secretary) and Jerome Powell (Federal Reserve Chairman) have stated that the current level of inflation is merely a result of the reopening of the overall economy. In addition, they believe inflation will abate by mid-year 2022.
The economic environment within the United States in 2021 can be characterized by unprecedented monetary and fiscal policy expansion. The U.S. unemployment rate held steady between 3.5% - 4.0%, the S&P 500 Stock Index finished the year at an all-time high near 4,800, and the U.S. economy grew by 7.0%. This current expansion is long in the tooth and will likely move in the opposite direction because of the significant increase in inflation.
So, why has the central bank been slow to raise interest rates? In short, it believes this current inflation spike is temporary due to the fact manufacturing output has not kept up with consumers re-opening demand from the lockdowns in 2020. Therefore, this problem will fix itself with time. More dovish economists believe the high current levels of inflation are
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“transitory” and will subside later in 2022. Either way, the central bank needs to allow interest rates to increase at every maturity along the yield curve to ensure that inflation does not become a major problem in 2022 and into 2023. To conclude, 2021 will go down as one of the most significant economic expansionary periods in modern times, fueled by unprecedented amounts of government spending and extraordinarily low interest rates. Unfortunately, the entire global economy will have to deal with high levels of inflation in the years to come because central bankers and the Treasury Department have been slow to react to the current inflationary environment. 10
CIO’S NOTE FERMON REID CHIEF INFORMATION OFFICER 2021 was a year characterized by economic recovery. U.S. GDP grew by 5.7%, the largest gain since 1984. Following a year of uncertainty and anticipation, the economic recovery was supported by historic corporate earnings and vigorous economic activity. Economic trends in the United States accelerated as coronavirus vaccination rates increased, restrictions eased and more of the world returned to a new form of normalcy. However, this recovery faced plenty of challenges, including new COVID variants, supply chain bottlenecks and rising inflation. In 2021, we saw inflation reach highs we have not seen in 40 years and a disrupted global supply chain that could not keep up with the increased demand for goods. The first half of the year was marked by vaccine rollouts, enhanced economic growth due to stimulus and the first signs of runaway inflation. However, these were not the only market phenomena of the year. In early 2021, we saw individual retail investors team up on Reddit and shock Wall Street by raising the price of videogame retailer GameStop and other “meme-stocks” to newfound heights. Shares of GameStop rose 400% in the last week of January, closing at an all-time high of $347.51. The labor market was slowly improving, with vaccines becoming more readily available and more people heading back to work. The unemployment rate fell to 5.9% by the end of June. Consumer spending capacity was significantly increased because of the massive $1.9 trillion stimulus package increasing economic activity. During Q2 of 2021, inflation drastically increased as the disrupted supply chain could not keep up with the demand for goods and services. Despite the increasing CPI and PPI numbers, the Federal Reserve and Jerome Powell insisted these price increases were only Duringtransitory.the summer, the Delta variant of COVID-19 began to spread across the globe rapidly. Originating in India, the Delta variant was more contagious than any other strains of the virus. The Delta variant caused countries to reinstate their previous lockdown measures and halted many companies’ return-to-the-office plans. Global supply chain shortages were amplified as a result. Throughout Europe and Asia, factories were forced to slow down or stop production, crippling an already-battered supply chain. Consumer and producer prices continued to soar largely in part due to the continued supply 2021 anotherwassolid year for the RGIP. At the end of the year, our growth portfolio was up 17.91%. 11
Throughout my time in the RGIP, I have watched myself and others grow tremendously. From the countless hours spent in the lab writing reports to the daily economic discussions, the program does a fantastic job replicating a real-world investment fund. My involvement with the program has been one of the highlights of my career at Stetson University. It has taught me invaluable lessons that will undoubtedly assist me and my classmates throughout our entire careers. Furthermore, this program has gifted us connections, friendships and relationships that will last a lifetime.
chain disruptions. Despite the obstacles from the Delta variant, the unemployment rate fell to 4.9% in September, and jobless claims fell to post-pandemic lows. In Q4 2021, inflation showed us it is not transitory. CPI rose 6.8% annually in November, the largest annual increase since 1982. CPI continued to rise in December, increasing by 7% from a year ago. Gasoline prices were up 49.6% YoY, meats, poultry, fish and eggs were up 12.5% YoY, and the price of used vehicles was up 37.3% due to continued chip shortages.
Unfortunately, inflation is here to stay and will continue to rise until the Federal Reserve starts to raise rates. The emergence of the Omicron variant led to the most daily coronavirus cases since the beginning of the pandemic. Despite the challenges presented by the Omicron variant, the stock market proved it could look beyond case numbers. Arguably the greatest bull market of all time will more than likely come to an end in 2022. The Federal Reserve is being forced to raise interest rates several times in hopes of combatting inflation. Oil and gas prices will be near all-time highs, and consumers worldwide will be paying for it at the pump. Geopolitical tensions between Russia and Ukraine will send commodity prices soaring and will continue to add uncertainty to our economy.
The mission of this program is to provide an invaluable learning experience by allowing students to manage money and learn from industry veterans. Under the tutelage and guidance of Dr. Hurst and Dr. Mascio, students excelled inside and outside the classroom. Our students placed 1st and 3rd at the CFA Institute Research Challenge’s Florida state tournament this past March. They beat out 13 other schools, including the University of Central Florida, University of Florida, Florida State University, University of South Florida, Rollins College and Jacksonville University. After winning the state tournament, our B team advanced to the regional tournament and finished as one of five final teams. Following graduation, students have accepted jobs at BNY Mellon, Siemens, Financial Technology Partners and Costa Development. One of our students plans to sit for the CFP (Certified Financial Planner) exam in July. Two students will be pursuing their master’s degree at Florida State University and North Carolina State University. Other students are currently working or have accepted internships at firms such as Atlantico Capital, BNY Mellon, United States Rentals, Calamos Investments, David Vaughan Investments and Regions Bank.
2021 was another solid year for the RGIP. At the end of the year, our growth portfolio was up 17.91%. Information Technology was the top-performing sector within the growth fund. Stocks such as Microsoft and HubSpot excelled, posting returns of 52.48% and 98.33%, respectively. The value portfolio had a positive return of 15.85%. Energy and Financials were the topperforming sectors in the value portfolio. Valero and Chevron had outstanding returns of 46.32% and 43.23%. PNC Financial Services and Royal Bank of Canada lead the pack in financials, boasting annual returns of 38.22% and 34.09%.
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FIXEDVALUEGROWTHINCOME PERFORMANCEPORTFOLIO 14
ENVIRONMENT AND GROWTH PORTFOLIO POSITIONING
MARKET ENVIRONMENT & 2021
• Single security purchases may not exceed 5% of the portfolio. • Single security investments exceeding 10% of the portfolio’s assets must be trimmed to 5%
GROWTH 3025201510-505Dec-20 Jan-21Feb-21 Mar-21 Apr-21May-21 Jun-21 Jul-21 Aug-21Sep-21 Oct-21 Nov-21 Dec-21
• Provide an invaluable learning opportunity for student analysts Maximize alpha while maintaining an average beta of 1 ± 0.2
MAJOR CONSTRAINTS
• Avoid Funds and ETFs except when using as temporary placeholders to maintain weighting.
• No more than 5% of the portfolio may be in cash.
OBJECTIVE
RGIP Growth vs. Wilshire 5000 Growth Portfolio Wilshire 5000
2021
GROWTH PORTFOLIO PERFORMANCE
PORTFOLIO SundbergNoah PORTFOLIO MANAGER
•
FIGURE 1 15
The next trading year will continue to be filled with highly volatile trading and questions regarding how the Fed will address inflation. In the first quarter of 2022, the NASDAQ is down 16.5% and the S&P 500 is down 9%. The markets are having to value progressing geopolitical tensions between Russia and Ukraine, potential interest rate hikes by the Federal Reserve, supply constraints and high inflation. As the program develops to a more mature investment fund, sector allocations and re-evaluations of current holdings will become more frequent. The current trustees have voted unanimously to adjust the Growth Fund’s current sector allocations. The trustees are positioning the Growth Fund to take advantage of higher interest rates and better supply constraints in the coming 12 months through a stronger allocation of assets in Financial and Information Technology sectors. The lowest allocation is in Real Estate, as a rising interest rate environment hurts this sector.
GROWTH INVESTMENT POLICY STATEMENT
• Sector allocation cannot exceed 150% of the benchmark.
• Prohibited from investing in securities that have filed for IPO within the last six months.
• Investments in markets that have experienced inflation of 20% or higher in the previous 12 months are forbidden.
As 2020 came to an end, we reflected back on a stock market that defied expectations. Back in 2019, analysts expected to finish the 2020 year up 5%. Instead, the markets beat historical averages, returning 15%. However, Figure 1 does not include the litnany of gas into consumble fuels such as gasoline, diesel fuel, jet fuel, waxes, lubricants and other petrochemicals.
The overall market performed extremely well in 2021 with continued quantitative easing, consumer spending, riskseeking investments and lower interest rates. Lower interest rates forced investors into more risky asset classes such as equities and higher growth companies. Forward P/E surged to highs not seen since before the 2008 financial crisis and has since come back to more reasonable levels. The Willshire 5000 index returned 27%, whereas RGIP Growth portfolio returned 18%. This underperformance started around April 2021 from Chinese equities (see Figure 1). Financials and Communication Services were the two worst performing sectors compared to the benchmark, underperforming by nearly 3.6% each (see Figure 2 on page 16). The worst performing equities were sold and replaced during our initial re-evaluation in midSeptember.
FIGURE 2 16
• Entire portfolio may not exceed 65% of the portfolio in conjunction with the fixed-income portfolio.
• Sector allocation cannot exceed 150% of the benchmark.
VALUE PORTFOLIO
• Invest in high-quality and yielding equities to boost the return profile of the value-orientated strategy
• Avoid funds and ETFs except when using as temporary placeholders to maintain weighting.
FUTURE OUTLOOK OF MARKET ENVIRONMENT & VALUE PORTFOLIO POSITIONING
• Prohibited from investing in securities that have filed for IPO within the last six months.
In 2021, the market faced very little resistance as the rebound continued from the bottom of the Covid-19 pandemic and led to one of the best years of the 2000s, with the S&P 500 returning nearly 29%. Many key pieces contributed to the market’s success over the past 12 months, but perhaps the main factor was the record government spending that occurred; U.S. citizens and businesses received billions in funding from the government through stimulus packages. The assistance received assisted in boosting the economy by allowing millions of people to invest this stimulus money into the country, which helped businesses experience record increases in profits and huge market growth. In terms of portfolio performance relating to the RGIP fund, our Value portfolio benchmark, the S&P Composite 1500 Pure Value index, saw a strong yearly return of 32.5%, while the Roland George Investment Program’s Value portfolio returned 16.5%. The RGIP Value portfolio underperformed its benchmark by around 15% (see Figure 1 on page 18). This underperformance occurred after 2020 when the RGIP Value portfolio outperformed by nearly 4%, but overall, the underperformance relative to our index was not what we had hoped. The Value portfolio had a few equities that did not perform as expected in the first few quarters of the year, and these specific securities played a large role in impacting the performance of our overall portfolio return. The most negatively impactful sectors for the Value portfolio included Materials, Communication Services and Health Care. The equities in our Materials sector underperformed the benchmark by 50%, with our securities returning -22% and the benchmark returning 28%, our Communication Service equities underperformed by 18%, and our Healthcare sector underperformed by 30% (see Figure 2 on page 18). Much of these large losses occurred in the first half of the year, and the equities that weren’t performing well were sold and replaced during the initial Hold/Sell reports that occurred during the mid-fall semester.
MAJOR CONSTRAINTS
2021 MARKET ENVIRONMENT & 2021 VALUE PORTFOLIO PERFORMANCE
This upcoming year is one likely going to be filled with uncertainty. The general markets have started 2022 in a pullback, with the S&P, the DOW and the NASDAQ down strong to start the year. Equity markets are coming into 2022 faced with the prospect of a major reduction in fiscal stimulus, record inflation, FOMC policy decisions, global political tensions, war and midterm elections. This uncertainty is going to cause volatility to continue throughout the year, but this may provide value investing with an opportunity to see better returns than in years past, as many investors will likely look to place their cash in more mature, less risky equities. The RGIP is aiming to make changes this year that will allow for better management of the portfolios. We implemented another Hold/Sell date at the beginning of spring semester so we can ensure updated sector allocation and monitor the performance of the equities to determine whether any changes need to be
OBJECTIVE
MastersonAdam VALUE MANAGERPORTFOLIO 17
• Provide an invaluable learning opportunity for student analysts
GROWTH INVESTMENT POLICY STATEMENT
• Up to 2% of the portfolio may be used for hedging purposes.
• Maintain portfolio beta of 1 +/- .02.
• Single security purchases may not exceed 5% of the portfolio.
STATISTICS RGIP S&P 1500 VALUE TOTAL RETURN 16.55 34.14 MEAN RETURN (ANNUALIZED) 25.00 49.80 STANDARD DEVIATION (ANNUALIZED) 11.63 14.39 DOWNSIDE RISK (ANNUALIZED) 8.33 10.44 SHARPE RATIO 1.52 2.32 BETA 0.74 CORRELATION 0.94 FIGURE 1 FIGURE 2 FIGURE 3 18
made. In addition, next fall’s portfolio managers and CIO will be determined before the end of the spring semester so year-round portfolio monitoring can occur, which eliminates the previous gap in management that occurred during the Lookingsummer.
at the macroeconomic factors likely to effect equity markets in the first half of 2022, the Value portfolio was rebalanced strategically to be in the best position possible to outperform the benchmark. The investment committee voted to remain strongly weighted in Energy, Consumer Staples and Financials. The committee believes these sectors will remain strong as rate hikes occur, energy demand continues to be too much for supply, and volatility urges investors to enter the defensive Consumer Staples sector. The Value portfolios’ lowest allocation is in Real Estate and Consumer Discretionary. This is due to the belief that many average Americans will see their discretionary income become extremely limited as inflation rages on and that the housing market will face a slowdown as mortgage rates continue their slow creep up from historical lows, reducing the purchasing power of consumers. In addition, the investment committee voted to add Gold to the Value portfolio as a small hedge against market downturns and volatility due to its historically positive performance during uncertain times. Overall, the RGIP feels positively about the position of the Value portfolio, and as the portfolio manager, I am confident the work the investment committee and the analysts have done will produce great results throughout 2022.
• Two-level credit changes will incur review of the position. • Investment in markets that have incurred a 20% rise in inflation are prohibited.
Within the same window inflation rose the highest in four decades, yields failed to effectively follow. Compared to the CPI’s 7% YoY rise, the 10-year Treasury yield climbed only 59 basis points as through November, the Fed supplemented demand for Treasury securities by means of $80B worth of monthly treasury purchases. However, tapering began in November and is set to end by March 2022, which should allow rates to rise and help combat inflation. Foreign investment was another factor keeping a lid on U.S. interest rates, as comparatively, our low rates were attractive to other countries even lower (and in some cases negative) rates. Overall, the events and decisions of 2021 resulted in a substantial disequilibrium between interest rates and inflation that will need to be solved down the road.
O’BrienZachary FIXED PORTFOLIOINCOMEMANAGER 19
• Provide an invaluable learning opportunity for student analysts Utilize investment-grade and high-yield debt instruments with an enhanced indexing approach
FIXED INCOME PORTFOLIO
MAJOR CONSTRAINTS
In the bond market, high-yield debt grossly outperformed investment grade debt over the past year as investors were forced into riskier alternatives. This was another reason why equity securities dominated their fixed income counterparts: investors were pushed into equities, which traditionally have greater returns coupled with greater risk, as the nominal rates on bonds remained at all-time lows. In the fixed income universe, bond managers were pushed into high-yield and junk bonds rather than investment-grade. Comparatively, the Morningstar U.S. High Yield Bond Index rose 5.2%, while the Morningstar U.S. Corporate Bond Index, which tracks investment-grade issues, stated a loss of 1.1%, exemplifying investors’ willingness to accept greater risk in return for higher yields. Bond managers who chased low-yield investmentgrade securities had to take on additional leverage to achieve an acceptable return.
2021 MARKET ENVIRONMENT & FIXED INCOME PORTFOLIO PERFORMANCE
• Maximum of 10% should be invested in broad-based ETF’s.
• 80% of the portfolio will be constituted by investment grade and 20% by high-yield.
The RGIP Fixed Income Portfolio outperformed our benchmark (LBUFTRUU) during 2021 due to our high allocation in high-yield bonds comparatively to investment grade. With an overall portfolio credit rating of BBB/BBB-, the fixed income portfolio was able to outperform by 4.61%, returning 3.04% on the year, compared to the benchmark loss of –1.58%.
The 2021 bond market was summarized by investors desperately hunting for yields in a low-interest rate environment. Complicating matters was the looming threat of inflation, while the Fed walked along the balance beam of tightening monetary policy that would result in backlash from the equity markets.
•
OBJECTIVESTATEMENT
The Fed entered 2021 with two major problems: an economy recovering from the global pandemic and rapidly increasing inflation levels. Continuing to keep rates low aids the former, while raising them benefits the latter. They chose to focus on assisting the recovery of the U.S. economy, and the Fed took the stance that inflation was transitory throughout most of the year. This outlook eliminated the pressure to raise rates, which would be essential to combat persistent inflation. However, this assumption was abandoned in November as CPI numbers continued to rise and eventually ended the year at an astonishing 7% YoY change, levels that have not been witnessed since the early 1980s.
• Benchmark Index: Bloomberg U.S. Aggregate Float Adjusted Total Return Index Value Unhedged (LBUFTRUU)
FIXED INCOME INVESTMENT POLICY
RGIP RUSSELL 3000 2021 RETURN 3.04% -1.58% STD DEV 2.76% 3.67% CORRELATION 0.6761 1 CREDIT RATING BBB/BBBYIELD TO MAT. 2.53% MEAN POS. WEIGHT 6.25% FIGURE 1 FIGURE 2 RGIP Fixed Income VS. Benchmark 20
ENVIRONMENT &
FUTURE OUTLOOK OF MARKET FIXED INCOME PORTFOLIO POSITIONING
The committee asserts that an increase in interest rates is eminent. The U.S. Treasury Yield Curve steepened dramatically throughout 2021 as rates between the one- and seven-year rose disproportionately to short- as well as long-term rates. At the FOMC meeting in December, three rate hikes were implied for 2022, which is reflected in the market with the one-year forward rate sitting at just over 1% compared to the current spot rate of 0.02%. Taking the current environment into consideration, the RGIP considers the coming few years to be a waiting period for the Fixed Income Portfolio. Current inflation is almost guaranteed to push interest rates higher, causing present-day investment in fixed income securities to be less attractive than investment in the future. Furthermore, raising rates will spur a rotation back into higher credit quality debt as yields will be sufficient for fixed-income investors. Looking forward, the RGIP will seek to shorten its duration for short-term protection as well as raise our credit quality to both capitalize off the coming rotation as well as provide liquidity once attractive opportunities become presen.
EQUITY REPORTSSECTOR
CONSUMER DISCRETIONARY CONSUMER STAPLES UTILITIESREALHEALTHCAREFINANCIALENERGYESTATE 22
BIDEN’S STIMULUS BILL AND UNEMPLOYMENT BENEFITS
WAGE INFLATION AND MINIMUM WAGE INCREASE
The Consumer Discretionary sector contains goods and services that are non-essential to consumers’ everyday lives. These include, but are not limited to, automobiles, hotels, restaurants, textiles and luxury goods. The purchase of goods within the Consumer Discretionary is often discussed in comparison to Consumer Staples. Both sectors are heavily influenced by economic cycles. When the economy is strong or strengthening, the Consumer Discretionary sector prevails as consumers are able to spend more money on non-essential items. This sector has continued its rapid expansion in 2021 since the recovery of the COVID-19 pandemic. Riding the coattails of a favorable macroeconomic backdrop, many companies saw tremendous top-line growth. Stimulus checks and wage increases fueled consumer spending during a redhot economy with all-time low-interest rates, which in turn, led to a 28.24% increase in the Consumer Discretionary Select Sector SPDR Fund (U.S.).
CONSUMER DISCRETIONARY REPORT
ABSTRACT/INTRODUCTION
Many companies, particularly in the Construction, Manufacturing and Restaurant sectors, were desperately looking for workers this year. The unemployment benefits, although providing the stimulus they were intended for, indirectly incentivized Americans to not work. Many were getting paid close to the same amount, if not more, by the weekly checks than they would have if they were working a minimum wage job. Pressure was put on companies to raise their wages and increase employee benefits to attract and retain their workers. It is feared that rising wages will eat into consumer discretionary profit margins. However, historically, the opposite has been
BIGGEST COMPANIES IN THE S&P 500 FALL UNDER CONSUMER DISCRETIONARY
MastersonAdam VALUE MANAGERPORTFOLIO TranMinh ANALYST 23
In March 2021, President Biden signed the $1.9 Trillion American Rescue Act into law. This Act delivered checks worth $1,400 to qualified Americans. The IRS had issued more than 175 million stimulus checks worth $400 billion under the third round of federal stimulus. Furthermore, unemployment benefits were distributed weekly to through September 6th. During the month of May, there were more than 16 million Americans (this number came down to around 7.5 million in August) receiving an average of $618 per week. Other initiatives were put into place regarding health insurance, student loans, and even food stamps to help stimulate the economy. As disposable income is increased through those stimulus checks and other benefits, consumers were able to spend more on the luxury and non-essential products that make up the Consumer Discretionary sector.
Massive companies such as Apple, Amazon, Tesla and many more are all functioning under the umbrella of Consumer Discretionary. The Consumer Discretionary sector makes up 9.8% of the S&P 500, being led by these companies, which are continuing to grow into the strong, well-known companies of this century. Therefore, Consumer Discretionary is one of the fastest-growing sectors to this date. Another key factor for growth in this sector is that many up-and-coming technology companies operate under the Consumer Discretionary sector, which allows for continued growth in the future.
INFLATIONARY OUTLOOK
COVID-19 OUTLOOK
Looking forward, CPI numbers have steadily rose and are well above interest rates, showing that inflationary pressures should not slow down any time soon. As immense amounts of cash have been pumped into our economy, supply chain disruptions continue, shortages of truck drivers and chips exist, and less workers are willing to work for normal wages, we certainly will see more inflation. Higher prices will then be passed on to the consumer, who will then require even higher wages, and the endless cycle will continue. As this dilemma significantly escalates, demand will have to come down and draw back in consumer spending will take place. The timeline for this, however, is uncertain. After a staggering year of revenue and earnings growth, such returns should not be continuously expected. The economic and market landscape has become highly uncertain as a result of an unprecedented and volatile series of events. It is prudent to maintain sector allocations in line with the overall market until more clarity on how the sharp rise in commodity prices, tightening financial conditions, and likely Federal Reserve interest rate hikes will impact the economy and underlying fundamentals that drive relative sector performance become available.
As inflation remains elevated and supply chain bottlenecks continue, rising input costs have hurt margins, as not all cost can be passed on to the consumer. Oil prices per barrel rising from $47 to over $76 (production has been reduced in the United States.) and a national truck driver shortage of more than 80,000 significantly impacted freight costs. Aluminum, Resin and other basic commodities have also seen steep increases in prices. Inflation, which was thought to be transitory earlier in the year, has proven to not only be here to stay but to be much worse than expected.
SUPPLY CHAIN ISSUES AND RISING INPUT COSTS
Many of the most battered stocks in the sector, such as those in the apparel and hotel industries, have recovered much, if not all, of their crisis-related losses now that much of the economy has reopened. Because the COVID-19 Delta variant remains a headwind, the cruise industry and some hotels have been exceptions. These industries, however, are frequently overshadowed by larger companies in the sector, such as Amazon and Tesla, which account for more than 40% of the sector’s market capitalization. The longer-term trend toward e-commerce and electric vehicles is likely to support these growth industries’ fundamentals, but investor enthusiasm may have pushed valuations too high. Furthermore, despite investor interest in electric vehicles supporting the automotive industry indices, a severe semiconductor shortage is an ongoing risk to vehicle production.
true: During periods of rising wages, the sector’s margins have increased 60% of the time (according to Fidelity Investments, as of 11/30/21), likely because consumers have more money to spend. Outside of recessions, this trend has held even for the highest wage-growth quartile. In 2021, 21 states decided to raise their minimum wage rates on January 1, 2022. Of these 21 states, 17 of them increased their wages by 50 cents or more. In New York and seven other states, the increases are part of scheduled raises in efforts to reach $15 minimum wages in the years to come. Biden also raised the federal contractors’ minimum wage up to $15 (see Figure 1 below). Although the CPI continued to soar, the increase in disposable income has been a major boon for the economy, proving to be a significant tailwind for the Consumer Discretionary sector.
FIGURE 1 24
WAGE PRICE INFLATION STATE NEW WAGE PREV. WAGE INCREASE Arizona $12.80 $12.15 $0.65 California $15.00 $14.00 $1.00 Colorado $12.56 $12.32 $0.24 Delaware $10.50 $9.25 $1.25 Illinois $12.00 $11.00 $1.00 Maine $12.75 $12.15 $0.60 Maryland $12.50 $11.75 $0.75 Massachusetts $14.25 $13.50 $0.75 Michigan $9.87 $9.65 $0.22 Minnesota $10.33 $10.08 $0.25 Missouri $11.15 $10.30 $0.85 Montana $9.20 $8.75 $0.45 New Jersey $13.00 $12.00 $1.00 New Mexico $11.50 $10.50 $1.00 New York $13.20 $12.50 $0.70 Ohio $9.30 $8.80 $0.50 Rhode Island $12.25 $11.50 $0.75 South Dakota $9.95 $9.45 $0.50 Vermont $12.55 $11.75 $0.80 Virginia $11.00 $9.50 $1.50 Washington $14.49 $13.69 $0.80 25
RGIP CONSUMER STAPLES PORTFOLIO
SECTOR OVERVIEW
OVERVIEW
CONSUMER STAPLES REPORT
2021 REVIEW Market conditions for 2021 were on the rise for most of the year. During 2021, we saw a rise in consumer prices throughout the whole consumer staples sector. For instance, the CPI (Consumer Price Index) for food increased from 1.6% in 12/31/2020 to 5.2% in 12/31/2021. We also saw transportation and labor costs increase due to the increased overall CPI and input prices (gasoline). As the prices for the overall market increased, so did the cost for firms to fabricate or provide staples products. Due to stimulus throughout the pandemic, there was more money than ever before in the market chasing fewer goods, which caused shortages within the broader market. Disposable income within the United States experienced a massive increase from January 2021 to March 2021, then took a steep dive from March 2021 to April 2021. As disposable income increased from February to March, so did the sales in Retail and Food Services. Labor costs increased due to the overall market price change, and gasoline prices skyrocketed due to the United States switching from energy independence to energy dependence.
MastersonAdam
The GICS (Global Industry Classification Standard) includes most of the supply chain for staple products such as food. The industries included within this sector are Food & Staples Retailing, Food, Beverage & Tobacco, and Household & Personal Products. Most of the goods provided within the Consumer Staples sector is inelastic in demand. Due to this inelastic demand, this sector is more on the defensive side of things, usually underperforming the market when broader market prices are on the rise.
FOOD & STAPLES RETAILING: Using the S&P 500 Food and Staples Retailing index, the industry saw a return of 23.19% increase for the year 2021. If we account for dividends reinvested, we see that return increase to 24.79% using a dividend reinvestment rate of .4047%.
For the following industries within the Consumer Staples sector, their returns were analyzed (see Figure 1 on page 27):
FOOD, BEVERAGE & TOBACCO: Using the S&P 500 Food Beverage & Tobacco index, the industry saw a return of 12.37% in 2021. If we account for dividends reinvested, we see that returns increase to 15.86% when using a dividend reinvestment rate of .4047%. VALUE MANAGERPORTFOLIO OlivaEnzo LEAD ANALYSTSECTOR
The top performer for the Consumer Staples section within the Value portfolio was Costco Wholesale Corp. with a total year return of 51.81%. The worst performer in the Consumer Staples sector within the Value portfolio was Walmart Inc. with a total year return of just 1.97%. In conclusion, the overall performance between both portfolios was great, but there were a couple of outliers that did not perform as well.
26
2021 INDUSTRY RETURNS
The overall performance for the Consumer Staples sector was lucrative. For the Growth portfolio, the total return for 2021 reached 27.03%. The top performer within Consumer Staples in the Growth portfolio was Celsius Holdings Inc. with a 48.22% total year return. The wort performer within Consumer Staples in the Growth portfolio was Beyond Meat Inc, with a total year return of -16.01%. For the Value portfolio, the total return for the Consumer Staples sector was at 21.96%.
CONCLUSION
Considering demand for consumer goods is inelastic, we will see a slight decrease in overall sector returns in 2022. During 2021, we saw an exacerbated increase in the overall sector return due to that inelastic demand and the increased change in price. In 2022, we expect those prices to decrease in the last two quarters of 2022.
2022 OUTLOOK In 2021, we saw an increase in consumer prices due to inflation and commodity price increases (inputs). In 2022, we expect to see a slight downward shift in those prices. We also expect to see inflation in products to decrease due to a potential increase in supply, which would alleviate demand in the long run. We expect to see slight increases in inflation in the first two quarters, then see a decrease in inflation due to alleviated supply constraints like oil or natural gas. Around 90% of the overall price increase was due to increased distribution costs (cost of oil and labor). Although cost of labor will most likely stay the same, we can expect the cost of oil to decrease over the last two quarters of 2022. So, what will happen to return?
HOUSEHOLD & PERSONAL PRODUCTS: Using the S&P 500 Household & Personal Products industry index, we saw a return of 15.26% in 2021. If we account for dividends reinvested, we see that the return increases to 17.51% using a dividend reinvestment rate of .4047%.
RELATIVE VALUATION In 2020, we saw the S&P 500 price-to-earnings (P/E) ratio jump drastically relative to that of the S&P 500 Consumer Staples sector (see Figure 2). Prior to this widening, the sector’s P/E was in line with and a little greater than the P/E of the S&P 500 index. In 2021, the S&P 500 P/E ratio dropped from the previous 30.69 to 24.58. The index saw a drop in P/E, while the S&P 500 Consumer Staples sector saw an increase from its former 22.58 in 2020 to 23.11 (see Figure 2). With the drop in P/E ratio for the index and increase for the sector, the gap between the two has been reduced closer to what could be considered “normal” based on historical trends. Given the P/E ratios of the index and sector and the spread between the two, we believe the Consumer Staples sector provides investors with attractive relative valuations.
All the industries within the Consumer Staples sector performed positively in 2021.
27
The overall Consumer Staples sector performance was robust. We experienced positive returns throughout all industries and have also seen within the RGIP portfolio the amazing returns the sector experienced in 2021. Although, in consideration to the inflated market, we could see our returns decrease in 2022, but they are still expected to be positive. Returns 2021 P/E Ratios
FIGURE 1 FIGURE 2 Industry
The main overarching driver for the Energy sector is economic activity (see Figure 4 on page 29). Other critical drivers affecting the demand for energy include the gross domestic product (GDP), population growth, employment, disposable income and the industrial production index. In 2021, people
WTI CRUDE OIL (dollars per barrel) $39.17 $68.14 73.96%
SECTOR INDUSTRY PERFORMANCE (% CHANGE AS OF 3/8/2021) YTD 1-YEAR 3-YEAR ENERGY EQUIPMENTENERGY & SERVICES 45.96% 43.92% 43.92% OIL, GAS CONSUMABLE&FUELS 36.14% 46.12% 22.01%
Note: While the Energy sector often contains renewable energy to stick with the GICS system, renewables will be covered in the Utility sector.
Electricity was the only resource with a relatively modest YoY increase because electricity is less prone to cyclical swings in the economy. This sector’s performance is largely tied to oil prices, and if those prices continue to increase, Energy will have another strong year in 2022.
NATURAL GAS (dollars per thousand cf) $10.68 $12.24 14.61% hour)(centsELECTRICITYperkilowatt- $0.132 $0.137 3.94%
*Source: Fidelity Research INTRODUCTION
In 2020, the Energy sector was crushed by the COVID-19 pandemic. With the world shut down, energy demand and consumption were at all-time lows. Following the sector’s abysmal performance in 2020, Energy has rebounded tremendously. For the first time since 2016, Energy was the top-performing sector in the S&P 500. In 2021, energy consumption in the United States returned to pre-pandemic levels as the government eased coronavirus restrictions (see Figure 2 below). The increased energy consumption combined with higher demand caused oil and gas prices to go through the roof. The annual average price of WTI Crude Oil and Brent Crude Oil were up 73% and 68% from 2020 to 2021.
RESOURCE 2020 2021 YoY % Change
FIGURE 2 FIGURE 1 28
ENERGY REPORT
SECTOR DRIVERS
The price of nearly all energy resources was up by at least 10%.
The GICS splits the Energy sector into two primary industries: Energy Equipment & Services, and Oil Gas & Consumable Fuels. Energy Equipment & Services are made up of two sub-industries: Oil & Gas Drilling and Oil & Gas Equipment & Services. Oil Gas & Consumable Fuels are made up of multiple sub-industries including: Integrated Oil & Gas, Coal & Consumable Fuels, Exploration & Production, Refining & Marketing, and Storage & Transportation. Companies in the Energy sector are classified into three main components of the supply chain: upstream, midstream and downstream. Upstream companies are directly involved in the exploration of crude oil and natural gas. These companies obtain energy resources through drilling and operating wells. Midstream companies offer storage, transportation and wholesale marketing for energy products and resources. Downstream companies are responsible for all postproduction activities, such as refining and distributing consumable fuels such as gasoline, diesel fuel, jet fuel, waxes, lubricants and other petrochemicals.
PRICE SUMMARY
BRENT CRUDE OIL (dollars per barrel) $41.69 $70.68 68.45% (dollarsGASOLINEpergallon) $2.18 $3.01 38.07% (dollarsDIESELper gallon) $2.55 $3.21 25.88%
HEATING OIL (dollars per gallon) $2.45 $3.11 26.94%
ReidFermon CHIEF OFFICERINVESTMENT
2021 PERFORMANCE (as of 3/8/2022)
Manufacturing Production
Q1
FIGURE
OPPORTUNITIES & THREATS
Energy Consumption Natural
As 2021 comes to a close, we are seeing optimism and expectations for growth across the Energy sector following the downturn in 2020. As the Energy sector is slowly in transition to a lower-carbon future, companies within the sector have the opportunity to capitalize on this and reinvent themselves. Entering 2022, many oil and gas companies are already looking to do so by practicing capital discipline, focusing on financial health, committing to climate change and transforming business models. These companies have the opportunity to streamline and optimize their resource portfolios, embrace and develop smart goals for the energy transition, attract and retain employees in a tight labor market, and come to closer terms with additional environmental, social and governance (ESG) requirements. Management can focus on building strategies that target low-carbon business models, developing ESG metrics that are transparent to the public, investing in promising zero-emission concepts that adhere to the contributions of the Paris Climate Agreement, and supporting coal-to-gas transitions by financing the necessary infrastructure. From an investor’s standpoint, they should look to companies that initiate these efforts because these companies are most likely to survive the transition.
Q1 '20 Q2 '20 Q3 '20 Q4 '20 Q1 '21 Q2 '21 Q3 '21 Q4 '21 Energy Drivers U.S. Total Consumption (quadrillion btu) Real Domestic Product (% Change YoY) Index (% Change YoY) 2119.51816.5151801501209060 '20 Q2 '20 Q3 '20 Q4 '20 Q1 '21 Q2 '21 Q3 '21 Q4 '21 U.S. Gas (billion cubic feet/day) Coal (million short tons) Fuels (million barrels/day) 3 4 29
FIGURE
GENERAL OUTLOOK/FORECAST
On the other hand, this optimistic outlook is also marked by caution as threats of labor shortages, supply chain disruptions, and high costs continue to challenge companies across the Energy sector. Even as people continue to return to work, there are challenges regarding workforce shortages as open positions go unfilled. In the oil and gas industry, more than 100,000 jobs were lost in 2020, and 50% of those positions remain open following the end of 2021. In addition, pervasive supply chain challenges are another pressure point across these industries. These pain points may become less significant in the coming months, but it is safe to say they need to be watched closely.
started returning to work, and real GDP grew by 5.5%. This increase in economic activity helped fuel the sector’s incredible performance. The Energy sector is a highly cyclical industry. During periods of expansion and increased business activity, the demand and price of oil increases. During a recession with decreased business activity, the demand and price of oil decreases. Seasonal changes and the weather also impact the consumption of energy. Gas prices are usually higher in the summer than the winter because (1) gas demand is usually higher in the summer, and (2) summer-grade fuels cost more to produce than their winter counterparts.
Liquid
Energy
U.S.
Looking ahead, we expect 2022 to be another positive year for the Energy sector, but its ultimate performance will likely be dictated by oil prices. If global economic growth and mobility continue to improve while global crude oil supplies remain constrained, high oil prices may be here to stay this year. Higher crude oil prices likely mean increased profits and potentially higher stock prices for energy stock investors. While demand for crude oil has managed to recover faster than expected as economies have rebounded from the COVID-driven slowdown, the oil supply has been slow to rebound due to a number of factors. Oil companies have been placing a greater focus on using their spending to develop cleaner fuel sources, while some oil projects have been delayed due to COVIDrelated challenges. Other oil companies have simply been 20%10%0%-10%-20%2826242220
Gross
PRICE SUMMARY RESOURCE 2021
spending less in general due to their high debt levels incurred earlier in the pandemic and increased focus from investors on corporate capital discipline. This has resulted in supplies from non-OPEC nations being slow to respond to the rise in oil prices. Natural gas markets have experienced a similar but even more extreme price recovery; they face similar supply issues with low spending on projects in the early stages of development. In addition, several unexpected weather trends, including cold winters in Europe and Asia, low wind speeds in Europe and a severe drought in South America, have boosted demand for natural gas and have depleted inventories to lower Robustlevels. economic growth and continued recovery in air transportation in 2022 could drive global oil demand above even pre-pandemic levels. In terms of who might benefit from sustained high prices, investors may want to look toward Exploration & Production (E&P) companies. Some U.S.-based E&Ps, in particular, may be able to return significant amounts of capital to investors via dividends and/or share buybacks. Though the weather will continue to play a factor in the oil and gas markets, underlying demand for oil and gas should continue to grow as economic growth continues while supplies are likely to remain relatively restrained. As a result, we predict the oil and gas producers of the sector are likely to continue to enjoy strong profitability and stock performance in 2022 (see Figure 5 below). 2022 YoY % Change OIL (dollars per barrel) 34.22% CRUDE (dollars per 32.95% (dollarsGASOLINEpergallon) (dollarsDIESELper gallon) 19.31% per gallon) 21.54% per thousand cf) hour)(centsELECTRICITYperkilowatt-
BRENT
OIL
barrel) $70.68 $92.97
$3.21 $3.83
HEATING OIL (dollars
$3.01 $3.46 14.95%
NATURAL GAS (dollars
WTI CRUDE
$3.11 $3.78
$68.14 $91.46
$12.24 $13.13 7.27%
$0.137 $0.143 3.94% FIGURE 5 30
DRIVERS
PRELIMINARY INSIGHT
The Financials sector has a massive role, as it drives the economy. It provides liquidity and free cash flow of capital into the market by efficiently allocating funds through its lending processes. Additionally, the sector allows the safe transfer of payments and transfer risk to limit the exposures of individuals. When the economy thrives, the Financials sector is aligned and tends to perform excellently as it is critical in the functioning process (see Figure 3).
The success of the Financials sector is attributed to favorable economic conditions. Some key components that affect the maximum profitability for Financials include interest rates, inflation and economic growth. These elements are optimal when the economy is recovering from a recession because corporate profits are growing, monetary policy is loose and consumer spending is elevating. As such, inflation coincides with elevated spending, indicating a strong correlation with the performance of the Financials sector. Indicated between
Within the Global Industry Classification Standard (GICS), Financials is the 5th-largest sector, constituting 11% compared to the other 10 sectors (see Figure 1). Coincidentally, the Financials sector weighting in the S&P 500 is also approximately equal to 11% where notable companies include JPMorgan Chase and Berkshire Hathaway. Each sector is expanded outward and classified into its respective industries. The Financials sector is comprised of three industries: Banks, Diversified Financials and Insurance. Diversified Financials compose the majority of the Financials sector with 54%, followed by Banks with 33%, and Insurance with the remaining 13% (see Figure 2). The reason why Diversified Financials is the largest component of the Financials sector is because they provide a wide range of services to people and corporations, such as asset management, brokerage services and investment banking. Within each industry, they can be further expanded into sub-industries that specify more accurately the classification of each company. For example, Diversified Financials are categorized into four sub-industries: Diversified Financial Services, Consumer Finance, Capital Markets and Mortgage Real Estate Investment Trusts (REITs).
ServiGabe LEAD FinancialSectorANALYSTSECTORRotationSector FIGURE 1 FIGURE 2 FIGURE 3 31
FINANCE REPORT
The sector tailwinds that have propelled Financials thus far are expected to continue into the near future with merger and acquisitions values for many of the major banks already surpassing their 2021 cumulative value. For example, in 2021 Goldman Sachs posted $265.87 billion in cash flow for M&A, and the 2022 year-to-date value of M&A transactions for Goldman already amounts to 307.08 billion, per Dealogic. 6 CPI VS. PCE S&P 500 vs. Financials: Percentage Return 10 Year Treasury Yield v. Purchase & Refinance of Mortgages 32
2021 PERFORMANCE
two dashed vertical lines, the period of 2021 is represented in Figure 4 displaying CPI and personal consumption expenditures (PCE). The positive relationship is illustrated, and one noticeable feature is that PCE rises more rapidly than CPI. The demand for consumption drives inflation and triumph for the Financials sector. Additionally, when the economy is facing a recession, interest rates are engineered to be lower due to monetary policy by the Federal Reserve, and this sequentially increases investments such as mortgages, either through purchasing or refinancing. As Figure 6 illustrates, an inverse relationship exists between the purchase and refinance of mortgages and interest rates represented by the 10 Year Treasury Yield. For example, when interest rates were lowered due to the recessionary effects of COVID-19, this spiked more mortgages being purchased and refinanced, which has persisted throughout 2021.
The Financials sector as a whole saw widespread growth during 2021 due to a combination of factors, such as a rise in investment banking deals like mergers, acquisitions and underwritings. Additionally, increased trading volume and liquidity in capital markets boosted many bottom lines across the sector. In 2021, the Financials sector outperformed the S&P 500 index by 6.06% and had a total percentage return of 36.9%. The S&P 500, by comparison, had only a 30.84% return in 2021. Overall, in 2021, Financials had a strong recovery from its lows in 2020 due to Covid-19, when the industry was one of the hardest hit during the 2020 Covid crash, ultimately drawing down more than 40%. The Financials sector was the third best performing sector of the GICS sectors, only tailing Energy, which saw over a 53% return in 2021, and Real Estate, which closely followed at 46.1% on the year.
SECTOR OUTLOOK
FIGURE 4 FIGURE 5 FIGURE
However, it is also important to note that while mergers and acquisitions continue to smash expectations, other segments such as equity and debt issuances are lagging in comparison to 2021. Equity issuances, in particular, appear to be struggling as the wave of nonstop IPOs that once dominated headlines have stalled in the wake of a weakening market currently amid a correction. With all being said, investment banking (IB) revenues are still on track to surpass that of 2021 (see Figure 7).
33
FIGURE
Inflation and interest rates are of particular interest going forward, not only for the broader market, but especially for Financials. The Federal Reserve has stated it is going to raise rates in 2022, but the question still remains: By how much? With the CPI clocking in at a whopping 7.9% for February, the pressure is on the Fed to do something to tame inflation; however, raising interest rates too much could spook the market. Therefore, if and how much the Federal Reserve decides to raise interest rates will determine the course of the market for the rest of the year. Either way, the Financials sector is in a good position to take advantage of rising interest rates, as rate hikes would mean widening spreads for banks, translating to larger profits. 7 Investment Banking (IB) Revenue
(Source: remainder-2021)09-21-financial-effects-covid-19-hospital-outlook-https://www.aha.org/guidesreports/2021-
As of March 2022, reported COVID-19 deaths had surpassed 6 million, with more than 459 million cases worldwide. The United States accounts for more than 81 million cases and 994,115 deaths. The race to create a vaccine led to the rapid expansion of biotechnology and pharmaceuticals segments, supported by government and academic spending in research and development. Heightened investment outlook is largely driven by the COVID-19 impact on pharma and biotech funding, supply chain security and infectious disease research. In response to the pandemic, there has been a huge emphasis on biotechnology and pharmaceutical development. Despite vaccinations developed in the past 12 months, the ongoing concern and effects of the pandemic are still creating operating losses for hospitals. In 2021, the American Hospital Association (AHA) reported financial losses due to the Delta variant of COVID-19. Cases and hospitalizations remained high as a result of unvaccinated persons who were infected with the variant. Sicker patients, higher expenses and fewer outpatient visits led to the AHA’s projections that hospitals nationwide will lose an estimated $54 billion, and more than one third of hospitals nationwide will maintain negative operating margins through year’s end. Despite the effects of the Delta variant, the Health Care sector has seen growth since 2020, when the AHA estimated operating losses of up to $323.1 billion for the year.
THE LIGHT AT THE END OF THE TUNNEL
The pace of change has accelerated, and industry trends have been forced to reevaluate their core strategies. The pandemic
The Health Care sector is comprised of industries and businesses that produce and distribute medical supplies, equipment, medicines, vaccines and other therapies. It also includes treatment facilities such as hospitals and doctor’s offices that render treatment to patients. U.S. health care spending reached nearly $4.1 trillion in 2020, attributing to roughly 19.7% of the nation’s GDP, as opposed to 17.6% in 2019. The growth in this sector is largely a result of the 2019 novel coronavirus (COVID-19) pandemic, and the positive trends in government spending on health care, vaccine therapies and influx of research in this sector that resulted from the pandemic (see Figure 1).
COVID-19’S IMPACT ON THE HEALTH SYSTEM
-20%-40%0%20%40%60%80%Sep-19 Feb-20 Jul-20 Dec-20 SPX VHT -20%-40%-60%-80%0%20%40% 2020Q4 2021Q1 2021Q2 2021Q3 2021Q4* Net Income Revenue Kyaw Zel Soe ANALYST SPX vs VHT Returns Annual YoY Health Industry Growth Rates FIGURE 1 FIGURE 2 34
HEALTH CARE REPORT
INTRODUCTION
TELEHEALTH, TREND AND OPPORTUNITY
has boosted health care spending by governments and private citizens over the past year. The vaccine has been the center of attention, and efforts by governments and companies to output funds in the development of a cure have been astronomical. Through Operation WARP, the U.S. government alone has spent over $9 billion spread among several companies for drug research and production. Post-development, these vaccines have been rapidly approved by regulatory agencies in the United States, the EU and UK as well as many other essential health care products in an effort to stop the pandemic. For example, the FDA issued more than 300 emergency use authorizations through 2020 (see Figure 3). Despite initial hesitation to receive the cure due to an unprecedented speed of approval, demand has far outpaced the current supply. As of early February 2021, Israel and UAE are leading the distribution, reporting more than 67% and 45% of their populations having received the first dose while the United States reports over 13%. Looking into the future should COVID-19 become endemic like flu and cold viruses, demand for medical equipment, COVID-19 testing kits and vaccines will continue into the foreseeable future as people around the world continue to get infected by the viruses. New virus variants require companies such as Pfizer and Moderna to regularly update their shots.
Similarly,patients.
The pandemic accelerated the adoption of online meetings and collaboration tools across the economy, and the Health Care sector is no exception. Two ongoing problems are accessibility and reimbursement, as clear procedures have not been set yet, and the technology still needs to be adapted. Telehealth is in a very fast development phase and is here to stay. A McKinsey study suggested the increase in the number of patients from 11% to 46% in 2020 could account for 20%, or $250 billion, of U.S. health care spending in the near future. In Figure 3 we can see the growth statistics for telemedicine, according to Google Trends, for the same periods pre- and post-pandemic. Companies such as Teledoc (TDOC), whose stock has risen 158.6% in the last year, reflects a long-term trend towards online doctors’ visits, which could allow doctors to see more
0% 50% 100% 150% 200% 250% 300% Search Web Tra c AppActiveDownloadsUsers Now Pre-pandemic 289 22 26 5 In vitro diagnostics products Personal Protection Equipment Ventilators and other medical devices Drug and biological products Emergency Use Authorizations by the FDA in 2020 Telemedicine Growth Comparison on Google Trends FIGURE 3 FIGURE 4 35
more clinical trials are going virtual. Forced to minimize in-person contact, companies are more prone to conduct remote trials, which has boosted participation. Other trend throughout this year include the increasing demand for preventive and well-being medicine products. Deloitte predicts health spending will be roughly $8.3 trillion by 2040. This could reduce demand for medications and care for non-communicable diseases such as diabetes and heart disease in the long run but could make room for growth in
Besides vaccine development and telehealth, other factors have also driven the sector and present great opportunities. A major digital transformation is occurring, as the automation of administrative tasks and digitalized records, the implementation of digital tools for physicians, and real- time data analysis are among the new health systems introduced in 2021. As the pandemic progressed, the supply chains were also affected, with organizations scrambling to secure resources. These disruptions have spiked costs and uncovered an inefficient supply chain. The target of the sector is to rebuild the supply chain to function with more flexibility and Cybersecuritytransparency. was a major concern in 2020, with a record increase in hacking incidents and attackers gaining access to patient data. Remote workers and third-party vendors transferring data insecurely, along with phishing, ransomware and storage vulnerabilities are the main reasons for these breaches. Budgets for IT have been reduced, leaving the industry more vulnerable than ever to these attacks. With increasing public concerns about data and privacy, as well as the implementation of data-driven technologies, potential exposure has increased.
To mitigate the effects of the pandemic on patients and businesses, funds were infused into the sector, as well as regulation aimed at providing financial stability and flexibility. In November 2020 many organizations showed growth in revenues instead of the expected losses.
Despite the recent volatility that has spread throughout the United States and reached the Health Care sector due to geopolitical events, we project a healthy outlook in Health Care for 2022. In 2020, the start of the global pandemic uncovered the lack of preparedness to face a worldwide crisis. Large health care corporations such as Thermo Fisher Scientific have adjusted to the situation by increasing supply chain security and strategically aligning themselves to serve attractive biotechnology and pharmaceutical markets. They have also focused on delivering to emerging markets, specifically in China. The influx of government spending and academic research centered on development of advancements in pharmaceuticals and biotechnology has strategically positioned the sector to mitigate the risk of the ever-present global pandemic. 36
President Joe Biden’s administration has released a $1.9 billion plan to fight the pandemic, which includes vaccination and testing programs, domestic production of equipment and expanded health care coverage. Nevertheless, the sector will be watching for the Affordable Care Act and the administration’s actions. The Act includes more patient-focused programs and an extension of the Medicaid and Medicare system among other measures. This expansion in health care program funding and new regulations may decrease the collected revenues of Health Care sector companies.
HEALTH CARE 2022 OUTLOOK
other health-related industries such as fitness and health monitoring technology.
REGULATION AND THE NEW ADMINISTRATION
DIGITAL TRANSFORMATION, SUPPLY CHAIN AND CYBERSECURITY
The North American Real Estate Investment Trust (NAREIT) sector is formed by six different types of Real Estate Investment Trusts (REITs), which include residential, office, retail, health care, industrial and self-storage REITs. Other forms of REIT’s include resorts, timber, mortgage and infrastructure. There are also sub-REIT’s such as hotels, warehouses, data centers and cell towers that fall into the six main REIT sectors. By definition, a REIT, or real estate investment trusts, are companies that own income-producing real estate in hopes of real return. REIT’s trade on major exchanges, but mostly on the New York Stock Exchange (NYSE). Much like mutual funds, REIT’s pool capital from numerous investors allows individual investors to earn dividends without having to manage or buy property. Their mutual fund-like structure makes REIT’s very liquid, unlike real property, which adds to their attractiveness.
INTRODUCTION
As depicted in Figure 2, real estate performed very well in 2021, as it returned nearly 22%. 2021 ranked as one of the best years for the sector in more than 10 years. Real property and REIT’s saw large price increases that have not been seen in the past 10-15 years. However, the S&P 500 index outperformed the Real Estate sector, which was led by large increases in Technology, Financials and Energy sectors. One big reason for the positive performance in REIT’s in 2021 is its natural ability to hedge against inflation. Americans saw the largest increase in inflation in more than 40 years (7%), which created fear amongst investors. This phenomenon brought many investors to real estate, since property values and rent tend to increase when inflation incurs, which proved to be very valuable to the Real Estate sector in 2021. Increased prices also increased net operating income (NOI), which is an important element in valuation of REITs. Also depicted in Figure 3 are the returns of the six main segments of REITs. The top performing segment, Self-Storage, has performed especially well during the Covid-19 pandemic (57.6% increase). As self-storage growth slowed in 2021, it allowed companies to increase rental rates and lower marketing costs, which both boost FFO. Residential and retail also had a very large rebound year, 45.8% and 41.9% respectively, since rent was no longer allowed to be deferred. Additionally, increased rental rates also boosted FFO for
REAL ESTATE REPORT BenedictKyle ANALYST BerdanisNick ANALYST REAL ESTATE INDUSTRY OVERVIEW AVG DIV. YIELD 2.90% P/E (2021 GAAP) 37.00 2021 TOTAL RETURN 21.96% REV. 1YR GROWTH 25.85% FIGURE 1 21.96% 26.90%30.00%25.00%20.00%15.00%10.00%5.00%0.00% Real Estate S&P 500 Index 2021 Total Return REIT Segments 2020 Total Stock Return FIGURE 2 37
REIT’s are exempt from federal, state and corporate income taxation at the entity level. However, many requirements must be met to qualify as a REIT. Some requirements include that at least 90% of taxable income be in the form of dividends each year, invest at least 75% of total assets in real estate, cash, or U.S. Treasuries, and must be managed by a board of directors. While most of the REIT revenue is fairly divided, retail REIT’s bring in the most revenue per year versus the six main sectors.
2021 PERFORMANCE
RETAIL REITS Retail struggled in 2021, and the outlook for 2022 is not much different. Even before the pandemic, the shift to online shopping was well underway. Brick-and-mortar stores closed by the thousands, and it is predicted that 9% of stores, or 80,000 more, will close by the end of 2026, additional hurting retail REITs. Malls are currently the most heavily shorted REIT property type, and other retail is the second heaviest, showing there is not much confidence in the market heading further into 2022.
As shown by the green line in the graph, industrial REITs, selfstorage, and residential were the top-performing segments of 2021. Industrials had the highest FFO multiple and returned 45.40% in 2021. As industrial companies re-opened and revamped production in 2021, cash flows grew, and people began to back the industrial REIT as an inflation hedge. As inflation skyrocketed in 2021, residential REIT’s became the 2nd-best REIT in which to invest. Household prices exponentially increased by 16.9% in 2021, the highest increase since 1999. This, along with an inflation increase of 7%, helped residential REITs return 45.80% in 2021. The biggest overperformer for 2021 was self-storage, which returned 57.6% and had the 3rd-highest FFO multiple. As stated earlier, the slowing of self-storage growth allowed for higher rental rates, lower marketing costs and less expenses to be paid for new projects. These combined factors, along with inflating rental and property costs, allowed the Self Storage segment to see tremendous returns and a high FFO multiple.
OVER/UNDERPERFORMERS & KEY UNDERPERFORMERSDRIVERS
OVERPERFORMERS
4035302520151050ResidentialHealthCareIndustrial Office RetailSelfStorage Multiples REIT Segments’ Ending 2021 FFO Multiple 0.00% 20.00% 40.00% 60.00% 80.00% SelfHealthIndustrialStorageCareOfficeResidentialRetail Series 1 REIT Segments’ Ending 2021 FFO Multiple FIGUREFIGURE34 38
Figure 4 shows the relative performance of each REIT segment in terms of the ending 2021 FFO multiple. FFO stands for Funds from Operations, and the FFO multiple helps us evaluate a company’s share price by using FFO as a performance measure as it makes adjustments for depreciation, preferred dividends and distributions. Every major REIT increased its FFO multiple from the previous year. However, the two worst performing REITs, as shown in the graph, were office and retail REITs. Retail REITs specifically weighed down the industry index the most in 2021. The pandemic forced mall closures, which fueled retailers’ neglecting rent payments, ultimately hurting cash flows for landlords and shopping giants. Although retail had a great year in total stock return (41.9%), it had the 2nd-lowest FFO multiple of the major segments. Office REITs had the 3rd-lowest stock return (13.4%) and the lowest FFO multiple of 2021. As American workers refuse to return back to the office, office REITs have lagged behind.
OPPORTUNITIES & THREATS
both the Residential and Retail sectors. Residential and Retail sectors saw -10.7% and -25.2% decreases in 2020 mainly in part because of the Covid-19 pandemic. 2021 proved to be a big rebound year for the main six REIT segments.
INDUSTRY
OUTLOOK & FORECAST
SELF STORAGE REITS
As previously mentioned, self storage outperformed all other REITs with an astounding return of 57.6%. Revenue for all national self storage REITs grew by 15.8%, net operating income grew by 22.9% and costs decreased by 2.3%. However, going into 2022, there are some concerns investors should be aware of. After the boom of developments that peaked in 2019, some markets for self storage have become oversaturated, but due to Covid-19, families were moving and downsizing at record rate. This continued to assist growth in 2021, but in 2022, now that our situation is starting to normalize, the oversaturation may come to light, causing a decrease in demand for self storage. Self storage is a proven and resilient industry, but these factors should not be overlooked for investors in 2022.
HEALTH CARE REITS With society slowly returning to normal again, demand for health care REITs will continue to climb. Those who opted out of assisted living due to pandemic restrictions are now able to enter assisted living facilities. The elderly population is also expecting to grow in 2022, with a 3% increase in 80 year olds and over, meaning an uptrend in the number of customers who may eventually need assisted living.
INDUSTRIAL REITS Industrial REITs have a positive outlook for 2022. The main factors that caused industrials to become an overperformer are still in play in our economy today and are expected to continue to benefit the industry. The e-commerce boom caused by the pandemic continues to drive demand up, and it does not show signs of slowing down anytime soon. E-commerce revenue increased by 48% between 2019 and 2021 and is expected to double over the next four years, which raises demand and value of warehouses, whereas supply is unchanged. As interest rate hikes continue to become a growing concern for investors, a common place to hedge investments is in industrials. This segment is not hit nearly as hard as others, as the real estate is purchased by old businesses with very stable and strong finances. Prologis is the largest and most stable REIT and is positioned to hedge against interest rate increases in the future.
The REIT sector rebounded well in 2021, and it is expected to continue to stay strong through 2022. Most notably, the industrial and residential segments leading the industry will likely remain strong. There are no signs of a reduced demand of housing, only clear signs housing prices will continue to increase. Self storage is alongside being a top producing REIT. However, there are some risks associated with them, and it would not be surprising to see more vacancies. Offices and retail REITs will likely continue to have staggered, if not backwards, growth due to decrease demand caused by online shopping and remote working. REITs have always been a place investors turn when trying to hedge against an increase in interest rates. With the recent news of possible interest rate hikes throughout the year, this makes REITs an even more attractive investment for most.
RESIDENTIAL REITS 2021 was an exceptional year for residential REITs. The major increase in residential real estate pricing is forcing more people to rent. Combine this with the increase in population and possible increase in rates, and demand will continue to thrive for residential REITs. Housing prices show no signs of decreasing anytime soon, as materials are getting more expensive and inflation steadily increasing, thus adding to the demand for residential REITs. Unlike retail or office REITs, residential REITs tend to be recession proof. The demand for a place to live will always be there no matter the economic situation, adding to the value in 2022.
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OFFICE REITS Along with retail, office REITs had a down trending year for 2021, and the outlook for 2022 is not improving. ULI (Urban Land Institute) reports indicate that office spaces will have a negative growth nationwide in 2022. With employees and employers having learned to navigate working from home, this trend seems as though it will continue to remain prominent for many companies. The ULI report also believes office space utilization will decrease between 5% and 15% through 2024.
The Utilities sector displayed a 17% growth in 2021-2022. This growth was primarily led by a recovery and appreciation in input and commodity prices in the post-Covid world, resulting in additional revenues for utility-based companies. Water and electric utilities drove overall utility growth, as they present non-cyclical services people cannot substitute. Therefore, in a world of diminishing consumer spending due to pandemic
The EIA (Energy Information Administration) forecasts that electricity demand in the United States will increase by 29% from 2012 to 2040. Implying that more energy will need to be generated helps boost this whole space. Energy companies, no matter the economic situation, will always be in demand due to their dependence on everyday life. On the other hand, it holds to be controversial to say the same about renewable and clean energy. Although the current government administration leans towards showing an immense amount of support towards clean energy and infrastructural growth, renewable and clean energy continue to have diminished demands. The sub-industry is favored by many people simply because of the environmental benefits it has, however, it still seems extremely early for clean energy providers to come up with positive earnings through their business models.
repercussions, the Utilities sector profited off supplying necessities and grew rapidly through a decreased cost of expense. With a 2.42% weightage allocated towards value and 0.95% towards growth, the Utilities sector makes up 3.37% of the RGIP fund. Value companies in the Utilities sector saw increased profits because of apparent foreshadowing of dominant developments in their future cash flows and strong corporate growth strategies. Atmos Energy Corp, a value stock that holds a majority of the utility weighting, remains a rapidly growing company and provided exceptional year-to-date returns of 9.30%. This return on investment stands superior to the year-to-date return of value stocks within the S&P 500 while also outperforming the index by 15.11%. Atmos Energy Corp, according to our analysts, has the potential to see further growth. On the other hand, Nextera Energy makes up the entirety of growth-driven utility stocks in the portfolio. A longterm investment, Nextera Energy has severely appreciated since its addition to the fund. In the 2021-2022 annual year, Nextera Energy appreciated by 25.79%. Electric utility providers such as Nextera enjoyed additional revenues during the pandemic as a severe decline in interest rates decreased its cost of debt and furthermore incentivized it to take on leverage, allowing the company to rapidly expand its corporate growth strategy.
2021 INDUSTRY PERFORMANCE GICS LEVEL 4 SUB – INDUSTRY PERFORMANCE GAS UTILITIES 11.42% MULTI-UTILITIES 12.36% ELECTRIC UTILITIES 17.90% INDEPENDENT POWER AND RENEWABLE ELECTRICITY PRODUCERS 4.50% WATER UTILITIES 25.70% UTILITIES SECTOR 17.00% SharmaVishal LEAD ANALYSTSECTOR LevyGuy ANALYST FIGURE 1 40
UTILITIES REPORT
OVERVIEW In the electric utilities space, there are many players, ranging from NextEra to NRG Energy. These companies are the backbone of the United States because, while they may not get much shine, they are vital to the everyday life of Americans.
For example, NextEra Energy develops, constructs and operates power projects to provide electricity to households and businesses. Without its everyday operations, millions of households across the country would be without power.
PERFORMANCE
As with nearly every sector, Covid-19 had an impact on Utilities. The demand severely depressed electricity demand across the globe, which caused consequences to revenues as well as the financial health of utilities, especially the smaller providers and off-grid companies. Another issue that arose was the fact that some customers were simply unable to pay for their services due to crippling conditions in the workspace. Government support helped alleviate some of the pains felt in this sector, and many companies have installed programs to ensure affordability, avoidance of long-term market disruptions and system reforms from occuring in the future.
COVID-19 SETBACKS & SUPPLY CHAIN ISSUES
In 2022 and beyond, the Utilities sector will continue to make a path to a cleaner, more reliable and resilient grid. While today’s challenges will likely persist, our annual industry outlook explores how digital technologies, market developments and government investment in next-generation energy technologies can help pave the way. In 2022, the tough challenges remain—boosting clean energy, ensuring reliability and resiliency and maintaining security while also keeping costs down. To achieve this, the Utilities sector will likely continue to advance in its “3D” transformation: decarbonization, digitalization and decentralization. We will be watching for technology deployments to advance and markets to evolve. Industry spending will likely remain high, and renewable penetration could accelerate further. The Utilities sector as a whole is poised to make further advancements in both markets and real-world settings. Renewable and clean energy has seen an increased amount of interest from consumers in the past couple of months due to the prevalent geopolitical conditions taking place in the world. Due to a shortage of oil supply, domestic prices have seen a parabolic movement, creating uncertainty within consumers regarding the price reliability of oil and natural gas. This uncertainty presents the potential to turn an increased number of consumers to clean and renewable energy to minimize their cost spent on energy every year. In the renewable and clean energy sub-industry, a positive return on investment is contingent on a company’s ability to grow its future cash flows, report positive earnings and minimize its expenses.
SECTOR OUTLOOK & OPPORTUNITIES
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Another downfall to inflation on the impact of this sector is that rising interest rates can make bonds more attractive to investors seeking that yield. Also, these companies’ shares typically offer high yields, which then compete with fixed income instruments for investor interest, causing a trickle effect. While inflation is typically bad for the economy, electric utility companies tend to perform better than other sectors due to our dependence on energy. Our everyday activities cannot take place without electricity powering our houses and our offices, thus making this sector critical.
Renewable energy companies, on the other hand, tend to under-perform in either runaway inflationary or stagflationary environments due to the additional cost of inputs. Providers are forced to pay to be able to produce their goods or expand their corporate growth. As consumer sentiment during an inflationary environment remains minimal, people turn away from purchasing sustainable energy products, thus stunting corporate expansion in the short run.
INFLATION Inflation has a significant influence on electric utility stocks’ performance. Since these companies use a lot of debt, the higher interest rates make it more expensive to raise money and even refinance debt. Also, since high yielding dividends are common among these companies, higher interest rates and inflation make it difficult for their dividends to consistently raise over time, thus either keeping them plateaued or lower.
While this caused many setbacks, the sector as a whole was able to bounce back 44% from the bottom that set in during the pandemic. Covid-19 created many bottlenecks in the supply chain for these companies, but by having many suppliers in various regions, they were able to avoid major disruptions to their everyday operations.
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ROLAND GEORGE STETSONPROGRAMINVESTMENTSUNIVERSITY ANNUAL REPORT 2021
