WINN - WINN: A Plethora Of Long-Term Winners Inside Yet Also A Lot To Dislike

2023-05-31 13:48:03 ET

Summary

• WINN is an actively managed fund targeting U.S. and foreign stocks demonstrating remarkable long-term growth prospects.
• Although its performance in 2022 was lackluster, it has delivered strong gains in 2023.
• The article discusses WINN’s valuation, quality, and growth characteristics.
• For a fund with an earnings yield in the low-single-digits and an exceedingly large share of holdings with a D+ Quant Valuation grade or worse, the risks are not to be ignored.
• In this regard, WINN earns a conservative Hold rating.

Harbor Long-Term Growers ETF ( WINN ) is an actively managed fund targeting U.S. and foreign stocks demonstrating remarkable long-term growth prospects. In the summary prospectus , it is said that the ETF "seeks long-term growth of capital." It is important to note that both preferred and common stocks can qualify for its portfolio.

Launched in February 2022, a period that was hardly opportune for growth style maximalists, even for those that do not compromise on quality and do not buy recklessly into momentum stories, WINN demonstrated completely lackluster performance last year, losing about 26% during the March-December period.

With that being said, the ETF has turned around in 2023 and achieved a total return more than two times the one of the iShares Core S&P 500 ETF ( IVV ), rising by over 20% during the first four months of the year, fueled by the bets on interest rate cuts on the horizon and almost unhindered by the waves of the banking crisis.

Nevertheless, despite the rampant recovery, the ETF is yet to return to its February 2022 level, and the path for it remains rather uncertain as a recession can easily remove valuation excesses from growth stories, typically amassed as investors rush in. That is to say, for a fund with an earnings yield in the low-single-digits and an exceedingly large share of holdings with a D+ Quant Valuation grade or worse, the risks are not to be ignored. This is aggravated by its weighting schema which I personally find out of proportion. In theory, its excellent quality exposure might counter-balance valuation risks, but this is not what I would bet on. Hence, assuming my view of the present market conditions, a rating above Hold would be unjustified.

The strategy and equity mix it produced

With the portfolio being managed actively, as clarified in the summary prospectus, managers favor names that have "above-average prospects for long-term growth." For that purpose, as the document describes, "a proprietary combination of bottom-up, fundamental research and systematic portfolio construction" is used "to build a portfolio of high-conviction stocks reflecting the views of the Subadvisor." It is also said that such names typically demonstrate a mix of characteristics like "market-leading position in core business areas," robust "cash flow generation and reinvestment," balance sheet resilience, etc. This is a mix I would call nicely aligned with my personal investment philosophy. However, there are a few nuances that will be discussed in greater depth below. Importantly, WINN takes into account ESG considerations as well.

The fund's strategy is rather flexible when it comes to foreign stocks, even though the current portfolio is U.S. centered. In the summary prospectus, it is mentioned that up to 20% of the total assets can be deployed to foreign stocks including those from emerging markets. Investors might note here that this could be a tailwind for the portfolio's appreciation as the interest rate cuts in the U.S. are most likely on the horizon already, and this could result in the dollar drifting lower, but I do not view the end of the hiking cycle as a sufficient reason for its inevitable devaluation over the short term.

In the current version, a few non-U.S. bellwether names can be spotted, like LVMH Moet Hennessy - Louis Vuitton ( OTCPK:LVMUY ), a Paris-based luxury behemoth that has seen tremendous gains in the previous months, with the LVMUY ADR boasting an over 39% one-year price return. LVMUY had a 2.4% weight in the fund as of May 25. Though I have not covered LVMH since April 2019 , it should be noted that I still remain constructive on the stock as its leading position in the global luxury market undergirded by the exceptional brand portfolio bodes well for long-term capital appreciation despite traditionally rich valuation . WINN's exposure to high-end products and, hence, affluent customers who have specific and at times recession-resistant demand is not limited to Louis Vuitton. Another top player in this market is Compagnie Financière Richemont ( OTCPK:CFRUY ), an owner of Cartier and Montblanc, among others; the fund allocated 58 bps to it.

Upon closer inspection, WINN's portfolio of 75 equities is too heavy in Apple ( AAPL ) and Microsoft ( MSFT ), with a total weight of about 23.3%. Valued at almost $1 trillion, NVIDIA ( NVDA ), a semiconductor name that has recently seen meteoric gains amid the AI hype, is the third-largest holding with a ~7.1% weight. As a consequence, my calculations show a weighted-average market cap of ~$960.5 billion as of May 30, and an earnings yield of just 2.3%. The S&P 500 index currently has an EY of about 4.5%. For more context, such a compressed yield is not a consequence of a large share of holdings not turning a profit; in fact, just ~6% are currently loss-making, so their impact on the EY is minimal. At the same time, the Price/Sales ratio is clearly at a speculative level of almost 10x.

Most importantly, only one stock has an A- Valuation grade, namely Centene Corporation ( CNC ), which operates in the managed healthcare industry; its weight is about 70 bps. Meanwhile, the share of those with D+ grades and worse is close to 97%. In fairness, this is the most overvalued stock mix (from a Quant perspective) that I have covered to date. This makes me conclude that WINN is priced for perfection and, in my opinion, should be avoided by investors who do not compromise on relative valuation and are not ready to take excessive risks in the case of a U.S. recession.

Is WINN's valuation supported by quality and growth? There is no denying that it is. As my analysis revealed, longer-duration equities that the fund holds have an exceedingly robust quality en masse. There are a few key points to discuss here.

• First, as usual, I should emphasize that almost 97% of the holdings have a B- Quant Profitability grade or higher, a level worth appreciating.
• Second, companies incapable of delivering positive net CFFO are simply absent, which chimes well with the fund's focus on "strong cash flow generation and reinvestment" mentioned in the prospectus.
• Third, the weighted-average Return on Equity of 40.4% coupled with Return on Assets of 12.5% indicates strong capital efficiency, another indicator I believe is of principal importance.

There is also no denying that the growth characteristics of this mix are excellent as illustrated by the table below.

Computed by the author using data from Seeking Alpha and the fund

With 2023 being a bright spot, WINN's p erformance is bleak for now

WINN has had a racy start to 2023, with a total return ahead of IVV's. It has also beaten the iShares Russell 1000 Growth ETF ( IWF ), which tracks its benchmark. Nevertheless, the Invesco QQQ ETF ( QQQ ) still has seen stronger gains.

During the March 2022-April 2023 period, the fund underperformed all the mentioned ETFs; the standard deviation was on par with QQQ.

Created by the author using data from Portfolio Visualizer

In sum, looking at the performance numbers, I struggle to find a reason strong enough for a Buy thesis, especially considering WINN comes with an expense ratio of 57 bps , which should be one of the main detractors from the long-term total returns.

The Verdict

The WINN bull thesis should revolve around the fund's extremely robust quality, something most growth funds cannot demonstrate owing to the fact growth is frequently synonymous with mounting losses and cash flows being negative for prolonged periods. However, as most of its holdings are priced at a sizeable premium to their respective sectors, with the ETF's earnings yield at just 2.3% and debt-adjusted yield (EBITDA/EV) at 2.9%, I believe WINN is only a Hold.

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