FidelityConnects: Driving alpha through dividends

[00:02:51] Pamela Ritchie: Hello, and welcome to Fidelity Connects. I'm Pamela Richie. It's no secret that volatility is back but some of the signals aren't exactly where you would expect. In a market with muted dispersion and no obvious valuation playbook positioning matters perhaps more than the bold top-down calls. As our next guest says here today  exogenous shocks are reshaping how investors think, tilting the focus towards quality, pricing power, and diversified baskets. Where is the real signal right now? Is it in the US, is it further abroad? Growth or value, defence or cyclical? How do pair trades, for instance, and even turnaround stories fit into the overall investment picture? Joining us here today to tell us about where she's finding high quality investment and to provide a bit of an update on the Fidelity US Dividend Fund is Portfolio Manager, Ramona Persaud. Warm welcome to you. You're here in Toronto. Thank you for being here.

[00:03:51] Ramona Persaud: Nice to be here.

[00:03:51] Pamela Ritchie: It's great to have you here. I'll just remind everyone joining us that this discussion is available with live French audio interpretation so join us in either official language. Let's begin with, gosh, the markets have, well, they're just all tidied up and  right back up to all-time highs. Here we are. But the whipsaw feeling, I think, is with everyone at every moment. What do we do with it?

[00:04:12] Ramona Persaud: I's nice when markets recover, of course, after a period of high uncertainty, and it's a nice when that can be a bit predictable, when the drivers of that you can get your arms around a little bit more.

[00:04:27] Pamela Ritchie: Can we?

[00:04:28] Ramona Persaud: Well, I think what I've been saying for a while, certainly all of last year and then through this year, is the drivers of volatility, to me, are more exogenous than usual, which just means less predictable than usual. As a result when the market whipsaws into drawdowns or back into euphoria to me that's not especially reliable, especially if there wasn't necessarily a big fundamental backdrop for that, such as valuation. Valuations didn't really get super dislocated across the board, maybe in spots, so you didn't really have a fundamental underpinning for that. A lot of it is sentiment. When the market's being driven by exogenous, so external, unpredictable outside factors with a lot of sentiment, I call that unreliable.

[00:05:16] Pamela Ritchie Unreliable, and in moments such as this, I mean, in a way your style, the portfolios that you manage, are meant to get you exactly through these very difficult to read moments. Maybe just take us through that a little bit because this is sort of this is it, we're in it.

[00:05:38] Ramona Persaud: I do like building portfolios that are, what I consider, reliable, to use that word again, that are resilient. I'm not looking for big chunky alpha at any given point in time. I'm looking for much more steady excess return over time that when you compound it that ends up being very big excess return, especially on a risk-adjusted basis, so if you risk adjust it it's pretty smooth. The way that I think about that is waiting for periods like this, actually, periods where the volatility is very hard to predict because then many companies through their stocks get fairly dislocated. You get deeper apathy, maybe deeper controversy, especially in boring parts of the market, or really cheap parts of market, when you can't really predict what's going to drive the market next.

[00:06:31] There were periods last year where large-cap healthcare got very dislocated. You got some pretty reasonable companies at single digit multiples of earnings. There are periods when even the glamour stuff, some of them get characterized, so say in tech some of them get characterized as winners or losers so the losers derate to say somewhere between 15 and 20 times earnings, which is maybe half of what the winners are trading at, or more than half. You essentially then go back to the research, do a lot of analysis, figure out are they really going to lose as much as this valuation implies? That's your opportunity. I think we're in that kind of environment.

[00:07:08] Pamela Ritchie So you do. It's really interesting on the valuation side of things how you go about it right now, because it does seem like there was a drawdown, there have been drawdowns. It was compared to the tariff tantrum last year but it really has righted itself quite quickly. I guess just take us through what it's meant to you the last sort of month, month and a half, in terms of finding things.

[00:07:28] Ramona Persaud: There is a speed now and sometimes it can seem like it's an accelerating speed, accelerated drawdowns into accelerated recoveries. Frankly, it has like a manic quality to it which when I see that ... part of it is technical and machines, there's a lot of non-human elements to the way securities are priced so you do have to be ready for those drawdown's and know your companies really well and have your valuation targets ready. Yes, it has snapped back very quickly. I am generally, you asked me about valuation, I am generally looking for valuation disparities, that's fundamental to my process.

[00:08:10] An example is, let's take the entire US market and let's take the most expensive versus the cheapest part of the US market, and let's measure that difference in valuation today versus what that difference has been over time. If today's difference is bigger than the typical difference over time then that means that the cheapest stocks are cheaper than usual so that's a signal for value in the market. You can do that in any way. I tend to add in large versus small, growth versus value, cyclical versus defence, US versus ex-US. I look for valuation ... it's essentially looking to figure out where is there fertile hunting grounds for valuation anomalies. I slice and dice the global market all sorts of different ways. Frankly, there just hasn't been a lot of dispersion. The market is fairly inefficient and the market itself is pretty diversified.

[00:09:01] There's a lot of different offsetting factors that leaves top-down valuation looking flat. Then you have to go and peel layers back and go many levels down to find where there's more target-rich sources of price inefficiency. For instance, in the last year US versus non-US has been a big one, and it's worked really well. It got to this really big valuation. It had been building for a decade and the US had outperformed, and then it got to some very big difference and we had perfect conditions in place for, say, European banks to really lead European markets. That disparity is still there, just not as much, so that's typically what I'm looking for.

[00:09:48] Pamela Ritchie That's really interesting to ask you because there's some discussion that that has snapped back. It had its time and then there's sort of a [indecipherable] valuation. How is it still an opportunity right now?

[00:10:00] Ramona Persaud: It's not as disparate, to use that word again, as it was at the end of 2024. In statistical terms it got to 2 1/2 standard deviations, which is really big. Two standard deviators I think captures  95% of observation so 2 1/2 you're at something higher than 95. If we're generally a self-correcting mechanism, which the market tends to be, then when you're beyond 95% you're going to correct back into that part of the distribution. That's why that metric tends to be effective. I gave you that number to contextualize today. Today we're at 1 which is not particularly compelling. In fact, in the past when we've been at this valuation difference between EAFE, which is developed ex-US markets, and the US that has not moved the needle, but when you compare that relative to sort of the rest of everything, everything is flat to zero in terms of ... everything is sort of at average to somewhat less attractive than average valuation differences.

[00:11:02] I think this is still interesting. Part of why there is this persistence in a valuation opportunity is currently it has to do with energy independence. Europe, on average, as we've seen since the Ukraine situation is fairly energy vulnerable. Now that we've got vulnerability in global energy supply there's now valuation opportunity again in Europe. You have to believe that that vulnerability sort of corrects in some way in order to to take advantage of this valuation opportunity today.

[00:11:39] Pamela Ritchie That they will plug the hole. There will be a solution but in the meantime there's some interesting opportunities.

[00:11:45] Ramona Persaud: In fact, seeing that, essentially, your alpha signal got really strong around double the dispersion from where we are today you could make the argument that there is more room to go in derating in this universe.

[00:12:03] Pamela Ritchie That's interesting. Have we bottomed, there might be some areas where no.

[00:12:07] Ramona Persaud: But here's the thing, if you try to time bottoms I think that is not an effective strategy. As long as there's enough sort of diversification or resilience in a portfolio you can add to positions, or build positions, into a derating, as long it's not what we call, what's it called, a falling knife, I think it's called.

[00:12:30] Pamela Ritchie Catch a falling knife.

[00:12:31 Ramona Persaud: Catch a falling knife. There may be potential for some more derating but if there are other parts of the portfolio that can absorb shock, I try to build portfolios with a lot of shock absorption, then I can maybe get some interesting valuation opportunities in these next several months of energy malaise, chaos, whatever you want to call it.

[00:12:54] Pamela Ritchie A more comfortable ride, shock absorbers. Tell us a little bit how you are seeing the role of dividends. We wanted to ask you about this. Sometimes in times of real uncertainty you'll hear a lot of, well, we're in the car analogy right now, just strap in, you're getting paid to wait. Wait out the volatility on some level. I actually don't hear that a lot right now. I don't know why but that's exactly what dividends can provide in moments like this.

[00:13:21] Ramona Persaud: Yes, so you can get your income ... first of all, income becomes very attractive. There's a craving of income when broad interest rates generally are quite depressed. We saw that coming out of the global financial crisis where all of the central banks around the world solved the global financial crisis by--

[00:13:41] Pamela Ritchie: Throwing money at it.

[00:13:43] Ramona Persaud: --excess monetary policy. So you had no rates, now you have some rates. In the no rate land income from stocks became very attractive so those stocks got very, very expensive. Now you've got some level of rates so fixed income is a decent alternative to getting your income from stock. Part of why you're not hearing about dividend stocks I think to the same extent as we did in the last one to two decades is there is now competition with bonds. Then there's a sort of risk tolerance conversation to have about the role of bonds in the portfolio, what you're trying to do in terms of risk, the role of stocks in the portfolio, and then what's the benefit of dividends from stocks, part of that is protection against inflation, so real growth in earnings and therefore real growth in dividends so you get some amount of protection, whereas you don't get that on fixed income. There is just a more nuanced conversation today than there was 15 years ago.

[00:14:48] Pamela Ritchie Does that ultimately provide, from a valuation perspective, for some of those, sometimes we call them bond proxies, but dividend providers and so on, does it actually look more attractive because there are alternatives right now.

[00:15:00] Ramona Persaud: That's right. Exactly. In contrast 15 or so years ago, I mean, I remember one,  Campbell's Soup. It doesn't grow but it had a 3 1/2% dividend and rates were zero to negative. That company had a richer evaluation than Google at the time. It wasn't being rewarded for growth, the market was rewarding income and capital return. Today, when you look at the dividend paying universe of stocks and you do this valuation analysis, what you'll see is that the valuation of dividend yield as a factor is actually reasonably attractive. There is some amount of spread in there. Then when you go looking for where it exists it's in places that have dislocated, so consumer staples, the impact of GLP-1s, packaged food and spirits and other consumption type categories are fairly derated.

[00:15:58] Pamela Ritchie Because the narrative is that there's less snacking and alcohol.

[00:16:01] Ramona Persaud: There is less consumption, there is less fun.

[00:16:10] Pamela Ritchie That's overdone, you probably think, or there's a possibility it's overdone.

[00:16:13] Ramona Persaud: I think there is one style of investing where you can do really well capturing the spread between a gradual fade in cash flow and a market expectation of cash flow that's falling off a cliff. You've got the cliff that looks like this, the gradual that looks like, so the wider that spread ... and sometimes a lot of these are value traps but when you combine that with really good research you can actually capture that delta. Maybe...

[00:16:43] Pamela Ritchie Not unlike the AI disruptor stocks where a lot of the software companies--

[00:16:52] Ramona Persaud: Disruptive, yes.

[00:16:52] Pamela Ritchie: --still have revenues and profits that they're doing fine for now until longer term.

[00:16:55] Ramona Persaud: In the market that's typically called controversy. There's some forms of controversy that you can get your arms around and some forms that are harder. I think software is hard. I think some forms ... much more what we call slow moving categories may be easier to get your arms around. If I can buy a cash flow fade at something that optically looks like seven to eight times earnings, and we can do enough research to say that maybe it's not that bad--

[00:17:27] Pamela Ritchie It's got X years in it.

[00:17:29] Ramona Persaud: --and there's not a lot of good news priced in it doesn't take much for those stocks to work. There are many people who are really good at the glamour stuff and there are many people who are not, I'm not. I'm...

[00:17:39] Pamela Ritchie: You're just glamorous but choose another part of the market.

[00:17:43] Ramona Persaud: Not in my investing, not in my investing. I like these what are called melting ice cubes. That's also not core to my portfolio, that's just one basket in what I do.

[00:17:55] Pamela Ritchie Let's go to the other baskets.

[00:17:56] Ramona Persaud: Some other baskets are just really high quality, almost like monopolistic businesses. I like monopoly businesses that are boring, that people don't tend to get excited about, because there are times, those are more like apathy, there are times when those trade at sort of a mid-teens multiple when the market doesn't care about them. To be able to buy a monopolistic, or oligopolistic, business for a mid-teens multiple is exciting. To me, building a portfolio with just very different types of baskets in a market environment that has higher than average exogenous volatility is the resilience equation in my type of strategy.

[00:18:40] Pamela Ritchie That's fascinating. Take us to the resilience of so-called defence which seems to just be changing, as sometimes sectors and styles do change over time. I mean, you go to either the utilities, you can look at some of the other ones that are always there for that, their business models, in some cases, are changing, and then also staples seem to be your phone, right? It's like things have changed a bit on that front.

[00:19:06] Ramona Persaud: We see this in the way that beta moves around across sectors, as an example, but when, just to be more concrete, when I looked at the valuation, the valuation difference the way I just explained it, between, say, cyclicals and defence, and looked at that over time we had some opportunity last year where, and healthcare was a big ... pharma was a big part of this, these parts of staples I mentioned was a big part of, the utilities that have no AI part of their business was a big part of this, where defence versus non-defence, if you will, just got dislocated. In moments like that when you can get a valuation difference that's better than average, better than a long term average, then you go start looking in those sectors.

[00:19:53] For instance, pharma was a place where I ended up. I was looking at some of these like a Roche or an AstraZeneca. Right now those are Bristol and Santa Fe that over... when you look at their businesses there was a lot of ... it was because of policy, they derated a lot because of all of the policy headlines that were coming out along with fear over their life of exclusivity, how long they could have their products on patent. Sometimes it's just overdone. These things repeat. I remember seeing this in 2009 or '10 or so and it just kind of took me back. So sometimes when you've been doing this long enough you catch multiple cycles and you remember, but you have to be careful not to get too caught in the past too because things can be different.

[00:20:50] Pamela Ritchie For sure. Tell us about the importance of pair trades. I don't know if that is something useful now, and that's often within a sector, it's something that you will deploy, is it something that is useful now?

[00:21:06] Ramona Persaud: My portfolios benefitted a lot in the last several years from just pairing off various names versus others, like Taiwan Semi versus Intel, Lilly versus Pfizer, Walmart versus Target.

[00:21:21] Pamela Ritchie They're competitors [crosstalk].

[00:21:21] Ramona Persaud: The competitors within their businesses where you just had differentiation between two competitors and if they're both in your universe and you own one and completely don't own the other one. I found there was enough of a winner versus loser type dynamic. Say Walmart versus Target, not now, Walmart has massively rerated, but in the last 10 years they both started out when they were both losing to e-commerce, they both got to a 13 times multiple so...

[00:21:53] Pamela Ritchie: Now they're tech firms.

[00:21:55] Ramona Persaud: Well, one is. It was a really interesting case of value investing, because in value investing there's this belief in mean reversion, the way that I describe things usually sort of like come back into the fat part of the distribution. The quality of your research really matters, where our research said 10 years ago that Walmart was building, essentially, this engine to be able to compete with Amazon, and it was derated at some really low multiple because when you're investing a ton in something that big, whose returns you can't predict, nobody's going to buy that and pay for that. So you had to sort of do the work to figure out if it could have any legs and frankly, at 13 times you didn't really have to ... it didn't really have to get it that right and, in fact, they got it very right. So staying very close to it and seeing it rerate from 13 to 20, if you were taking a traditional value approach where you believe in complete reversion you would never expect it to have gotten to 20, 25, 30.

[00:22:56] There's this way that you also have to recognize business model change, or just quality of business change, so that you can think about something rerating in a sustainable fashion. Then you had to ask yourself back then, can Target do that as well, or is Target going to stay in this purgatory of 13 to 16 times, which it did. Then you get to this place ... this is the journey of explaining the pair trade of Walmart versus Target ... then the journey was, well, look, now all of a sudden Walmart's at 40 times so great for the funds to hold onto it maybe until 30, 35--

[00:23:30] Pamela Ritchie: That's what I was going to ask you, how do you handle that?

[00:23:33] Ramona Persaud: --so then the math became, all right, they were going after Amazon, they did a good enough job. The market really rewarded that. Let's look at the valuation versus Amazon and let's look at that traditional valuation difference over time. When Walmart flipped into being more expensive than Amazon, that was a moment. I'm not really sure I'm there, one, two, and then let's look at the valuation difference with Target. When Walmart's valuation difference with Target, even though it became a sustainably better business, more resilient business, more resilient to the world of e-commerce, should it be 3 to 4 standard deviations more expensive than a Target? So at that point to me--

[00:24:10] Pamela Ritchie It was over its skis, potentially.

[00:24:13] Ramona Persaud: --Target makes more sense. A lot of this is analytical and a lot of it is sort of instinctive.

[00:24:24] Pamela Ritchie It just seems like a really interesting moment to ask exactly about traditional companies being disrupted but those that will probably benefit from better technology within AI technology within ... but they are sort of the so-called old economy getting reinvigorated. There's something to that in the analogy.

[00:24:42] Ramona Persaud: Yes, and to reinvent themselves.

[00:24:43] Pamela Ritchie To what extent does that play into how you are looking at companies that have a good strategy for AI even if it's not deployed within yet, it's not bottom line.

[00:24:53] Ramona Persaud: I'll actually go back to the Walmart Target because it's accessible, it's more concrete.

[00:25:00] Pamela Ritchie Yeah, you saw it happen.

[00:25:02] Ramona Persaud: Well, we saw it happen but there are also businesses that are easy to understand because we interact with them in our daily lives. Walmart and Target coming out of COVID had major inventory issues, and they each had a really rough quarter, and they each came in to meet with us to explain the quarter and what they were going to do about it. This is where I think research really makes a difference. Lots of the companies...

[00:25:23] Pamela Ritchie And the fact that you can invite them to your corporate boardroom and have a chat.

[00:25:27] Ramona Persaud: Well, of course. A lot of companies are being disrupted today and this was a different kind of ... not nearly as profound a disruption. What really mattered to me, it wasn't just the valuation argument I just laid out, it was listening to each company talk about how it was going to address its next 5 to 10 years. Walmart was having a completely different conversation from the one that Target was having at the time, and the valuation difference between the two was still insignificant, it was not big enough. So all of a sudden you've got a company that's positioning, that sees itself in a completely different ecosystem in the world than its primary competitor without much valuation difference. That's what I'm looking for today. While a collection of companies might be disrupted I think it's more important than ever to listen to how they think about reinventing themselves and concretely what they're doing in their reinvention strategy.

[00:26:28] Pamela Ritchie I'm sure the answer is it depends but at what point do you then get in because you trust what they're doing is going to at least mostly follow higher profits?

[00:26:41] Ramona Persaud: Valuation. What I said about Walmart Target, they were both disrupted at the time. The market wasn't there yet on trusting that Walmart's strategy would work. If you can get there sooner with really robust research, and you don't have to own a hundred of these, you just need to find a handful.

[00:27:05] Pamela Ritchie A couple. Do you have the idea of cash on hand? Are you ready to deploy? Just tell us a little bit about getting through this market but also, I mean, some people will say that we haven't felt the energy shock fully yet and there's more to come. Talk to us about that.

[00:27:20] Ramona Persaud: I try to go back to valuation as well because I've learned about myself, I tend to not be too predictive. I try to prepare for a very wide range of outcomes, most of which I can't predict. That's just my personality. In fact, the chairwoman of our company runs our business that way as well so it's nice to have a model of a woman who thinks of risk in the same way, that there's going to be all kinds of exogenous risk and if I build a battleship, which is what she's built Fidelity into with lots of different resilient type businesses, they will sort of hedge each other for a net win. That's the way I do my portfolio as well. Today when I look at valuation there just isn't at the surface level. You have to go really deep to find where the anomalies are.

[00:28:09] When I see that I'm not really being paid for very active, highly concentrated risk, especially when I have a sensitivity to how much volatility is in my returns. If I have the luxury of being able to whipsaw my returns that's one thing I can concentrate, even in a market without a lot of valuation dispersion. The sorts of investors that I have that are more conservative, that want to take a certain amount of cash flow off of the return stream, if I were to whipsaw, allow the returns to whipsaw, I would lose their trust and I would lose them in the strategies at the wrong time in the market cycle. So I'm very careful--

[00:28:47] Pamela Ritchie This strategy helps you keep your investors in.

[00:28:50] Ramona Persaud: --I'm very careful about how much volatility is in the return stream. As a result, when I see not a lot of obvious valuation opportunity I do have some firepower, if you will, waiting for it, and you do get it, you get massive valuation dispersion spikes and that's when you deploy your firepower.

[00:29:16] Pamela Ritchie What do you think about sort of going forward the importance of income? It's always going to be important to lots of different people but there are different times when a version of income and growth have different moments. What is this moment, would you say? Do people want some money in their pocket?

[00:29:33] Ramona Persaud: There are a lot of different drivers. Right now you've got a Western world and an Eastern world, you've got a world that's ageing, so you're moving into a phase of life, on average, where you need more income. That's very structural. Then you've got much less predictable inflationary conditions, sort of more maybe cyclically, I don't know, that might be some structural too. In that case what really benefits a portfolio is high quality companies because they tend to have command of their operating environment, there tends to be less competition which means that they have real pricing power. Real pricing power is your defence against inflationary conditions. Income generating companies that pay those out in dividends, typically those dividends are growing alongside earnings, which if those earnings are benefiting from real pricing power your earnings are growing in a real way, which means your dividends are growing in a real way, so dividends from stocks tend to be protective against inflation as well. There are many different reasons for having some income from stocks in a portfolio.

[00:30:42] Pamela Ritchie It's amazing how calm you are about all of this, and your brilliance. I'm very grateful to have a chance to see you in person.

[00:30:49] Ramona Persaud: You too.

[00:30:49] Pamela Ritchie: And to hear about what you're doing in these wild markets, which is keeping everyone calm. Ramona Persaud, thank you for joining us.

[00:30:55] Ramona Persaud: Important to stay calm.

[00:30:55] Pamela Ritchie: Important to stay calm.

[00:30:57] Ramona Persaud: And carry on.

[00:30:58] Pamela Ritchie: Great to see you. Thank you for being here.

[00:30:59] Ramona Persaud: Thank you. Nice to see you.

[00:31:01] Pamela Ritchie: That's Ramona Persaud joining us here in the studio which is a treat she's usually in the Boston area. Coming up tomorrow, Andrea Rigobon. She'll be sitting down with Nancy Mehrad. She is founder, CEO, and securities lawyer at Registrant Law. Nancy's going to unpack the key guidance and findings from regulatory audits of the KYC, KYP, and suitability provisions of the client-focused reforms, including where advisors and dealers got it right and where compliance fell short of regulatory expectations. This webcast is going to be available in English with live French, Cantonese and Mandarin audio interpretation so do join us in any of those languages tomorrow.

[00:31:38] On Friday Fidelity Europe Fund portfolio manager, Marcel Stötzel. He's going to be making his Fidelity Connects debut sharing his latest perspectives on European equity, the landscape there. We'll ask a number of those questions of what makes up his thesis at this moment, what's driving the markets and ultimately how he's positioning the portfolio amid rather shifting economic and geopolitical currents, to put it mildly.

[00:32:03] We will kick off the trading week next week with Jurrien Timmer. He is head of Global Macro and he becomes armed with very beautiful and amazing charts to help guide and set up your week of trade ahead. Thanks for joining us. We'll see you soon. I'm Pamela Ritchie.