October 26, 2022
Vanguard subadvisor and Wellington portfolio manager Keith White discusses the cyclical nature of the markets, his perspective on the global economy, and his active-investment edge.
Meet the expert
Keith E. White
White manages the $1.4 billion Vanguard Global Capital Cycles Fund, where he looks for opportunities arising from changing investor sentiment resulting from cycles of under- and over investment in capital-intensive industries. The fund requires a 25% or more investment in the mining industry (inclusive of precious metals). Before 2018, the fund was managed as Vanguard Precious Metals and Mining Fund. Returns before then do not reflect the current mandate.
Note: This interview was edited for length and clarity.
White: I grew up on a farm in the Shenandoah Valley of Virginia, right on the West Virginia border. Farming is very cyclical and, when I was growing up, there were times when it didn’t pay the bills. When that happened, my father would drive a truck. I would ride along with him, missing school for weeks at a time. While on the road, I’d read books about the stock market and about business in general. At the age of 13, I landed a job driving a forklift at a local warehouse. I used those paychecks to start investing in the market.
I was in college when the tech bubble swelled. I invested a lot but then lost it all in 2000 when the bubble burst. That loss was a nice lesson about the cyclical nature of the markets.
I eventually landed a job at Cambridge Associates, covering hedge funds. My favorite managers were Ernst von Metzsch and Karl Bandtel, former portfolio managers of Vanguard Energy Fund. I loved their humility, willingness to be different, and strength to go against the tide. Once I landed at Wellington, I had the opportunity to learn from mentors in the metals and mining field. From there, I revised and improved upon my own philosophy and process.
It was the culmination of these life experiences that gave me the vantage point from which to view and assess changing cycles within the market.
White: Because of the way we view and value companies, we are comfortable sitting with a portfolio that’s really different. Our edge is a willingness and ability to look at almost any investment opportunity, see the potential range of outcomes, and then run that opportunity set through our intrinsic return framework. This process uncovers a unique perspective on the value of the businesses we consider. That’s true for a wide range of businesses, from the highly stable utility to the highly cyclical miner.
In a nutshell, we’re consistently trying to allocate capital to where it’s most scarce, most needed, and most likely to earn high returns. Over longer periods, those attributes are what lead to outsized outperformance.
White: In this environment, our portfolio reflects two key themes: energy transition/decarbonization and structural inflation. Right now, the economy is going through what we view as a 40-year structural shift away from disinflation and more toward structural inflation. That shift is being driven by big political, geopolitical, and demographic forces. Those include a shrinking and aging labor force, a Chinese population on the verge of decline, and massive deglobalization. The implication of these conditions is that the market winners and losers will be different than they were during the past decade.
As for structural inflation, we don’t expect interest rates to rise in a straight line, but they will be much higher and more volatile than we’ve seen in the past five years. One of the best indicators for forward price/earnings ratios is inflation volatility. So the combination of higher inflation and higher inflation volatility will lead to lower P/E ratios, which will act as a sizable headwind for the U.S. equity market. That, in turn, will create substantial opportunities in areas that already have really low P/E ratios, like the emerging markets. I expect that shift will set the big cycle of the next five years in motion as investors reallocate out of the U.S. and into international markets.
As global economies move toward energy transition and decarbonization, we’ll see a focus on building out the electricity grid. This may seem counterintuitive, but that focus will require short- to medium-term investment in metals and mining, which will be necessary to build the needed infrastructure.
White: While the Chinese government may not report official recession-indicating numbers, it’s possible that the world’s second-largest economy is already experiencing a substantial recession.1 The question, then, is how much will China’s slowdown affect the rest of the world?
In the event of a further downturn, utilities would probably hold up well, as they typically benefit from their stability during turbulence. On a similar vein, though, is the recognition of how essential energy investment is to the world. The U.S. isn’t seeing the effects of the energy crisis so much, but in Europe, the effects are sad. Families are seeing electricity bills that are 10 times their norm. That’s just not sustainable for the average family.
I also expect that gold and gold mining companies would perform well in a recessionary environment. Gold has been used as money for longer than any other currency in the world and is one of the only assets that offer real positive returns in a stagflationary environment. Gold also offers a strong negative correlation to equities. In today’s environment, you can buy gold at a double-digit cash flow yield and at an almost 4% dividend yield.
White: Earlier I mentioned our intrinsic return framework. That number is essentially the cash-flow yield that an asset throws off each year, plus reinvestment, plus dividend payments. Every investment we make has a double-digit intrinsic return.
Let’s look at the Standard & Poor’s 500 Index as an example. The index has an intrinsic return of about 4%. When we created this fund, we had the idea that if you can compound the portfolio at low double digits over long periods of time, you’ll beat most any market index. So with every investment we make, there is that underlying goal: low double-digit returns. The fund’s dividend yield alone sits right at 4%. That’s higher than for a lot of income funds. With that in mind, as we move into an environment marked by energy transition, decarbonization, and a shift to structural inflation, I do think the fund will act as a hedge against inflation.
White: In general, we prefer a more concentrated portfolio. I’ve been working to get our number of holdings below 40, but we’re not quite there yet. Right now, we hold 47 stocks. Our differentiated focus means we’re willing to make opportunistic stock purchases and veer from our benchmark, which holds close to 15,000 securities.
That said, our largest positions are in companies we have a lot of confidence in, and we reflect that in our positions. Our top 10 holdings make up about 41% of the portfolio. We feel comfortable with this positioning because of our fundamental framework—we actively screen for companies with enduring scarcity, whose true intrinsic value isn’t likely to change.
1 Subadvisor opinions don’t necessarily reflect those of Vanguard.
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