Morningstar Magazine - August/September 2018 - 21

might not be too surprising given the global
economy is now in its ninth consecutive year of
expansion. Consumer defensive ranks among
the more undervalued sectors, trading at a price/
fair value of 0.94 on a cap-weighted basis.
One of our top picks here is General Mills GIS,
shares of which have suffered amid volume
softness across the packaged food space as well
as skepticism related to the acquisition of
natural pet food company Blue Buffalo. We're
more optimistic about the firm's ability to
reinvigorate growth through reinvestment in its
brands and integrate and grow Blue Buffalo
by following the same playbook it did with Annie's,
which it acquired in 2014.
Healthcare, another sector that tends to hold up
well when the economy heads south, trades
at a 0.98 price/fair value. One of the names we like
here is Allergan AGN. In contrast to most of
its peers in specialty pharma, the firm boasts an
attractive product portfolio and innovative
pipeline thanks to a successful mix of internal
research and M&A.
At the other end of the spectrum, the basic
materials, energy, and industrials sectors
all trade above our estimates of intrinsic value
on a cap-weighted basis. In energy, we
believe the market continues to underestimate
the shale industry's capacity to throw oil
markets back into oversupply. Crude prices

have largely held above $65 per barrel for West
Texas Intermediate, or WTI, in 2018, which
provides attractive economics for many
U.S. producers. But the reckoning may not happen
as quickly as we previously thought amid
supply disruptions. Eventually, we expect pain
for oil prices as growing U.S. production serves as
the primary weight to tip oil markets back
into oversupply. Our midcycle forecast for WTI
is still $55/bbl.
Canadian midstream company Enbridge ENB
is one of our top picks in this generally
overbought space. We see nearly 50% upside
in the stock, as we believe the market doesn't
realize the full potential of the company's
growth portfolio.
Daniel Rohr, CFA, is director of North American equity
research for Morningstar Research Services.

Cash Not Always King
Cash is always helpful to meet redemptions, but
it should not be the first-and certainly
not the only-variable investors look at when
evaluating the liquidity of a fund. Indeed, the
diversification of a portfolio and its overall
investment process will usually prove more useful
in assessing liquidity risks. For example,
the high-yield segment of the credit market is
often considered illiquid. Instinctively, one

might think avoiding the largest funds in that
Morningstar Category and opting for one with
plenty of cash in the portfolio should help
mitigate liquidity risk. Unfortunately, history has
proved those instincts insufficient.
The rise and fall of Third Avenue Focused Credit
TFCIX is the perfect illustration of why
keeping high cash levels is a short-term patch
that can't make up for a concentrated
portfolio, even for a comparatively small fund.
When investors yank money out of a fund
and its cash is used to fund those outflows, its
portfolio concentration increases at every
level, whether defined by credit quality, issue,
or issuer, for example. To make things worse,
the Third Avenue fund was lacking diversification
at each of these levels even before it suffered
major redemptions.
The fund's team made a practice of searching out
deals in sectors and companies that were
under pressure, positioning the fund as
a competitor to distressed-debt hedge funds. The
fund did tend to hold relatively high cash
stakes-in theory for liquidity purposes. Over time,
cash ranged from 5% during 2011's second
half to 32% as of April 2012. By November 2012,
cash stood at a more typical 14%. However,
the portfolio comprised only 60 names at that time,
and the fund's top 10 holdings accounted
for close to 40% of its assets. That translated to a
heavy concentration in lower-quality tiers of

Global Greenhouse Gas Oscillates. Until...
CO₂ (Parts Per Million)
400
PPM
335

Highest Historical CO₂ Level

270
205
1950

400
350
300
Thousands of Years Before Today

250

200

150

100

140

For 400,000 years, carbon dioxide levels fluctuated
between 180 and 280 parts per million.
Ice ages occurred when levels declined to 180.
Interglacial periods happened at 280. But in
the 70 years since the typical interglacial peak in
1950, we have added another 120 parts per
million of CO₂ , about the same amount as what
separates an ice age and an interglacial
period. "It is a dramatic, reckless experiment,"
Grantham said.

50

Source: Reconstruction from ice cores, National Oceanic and Atmospheric Administration.

21



Table of Contents for the Digital Edition of Morningstar Magazine - August/September 2018

Contents
Morningstar Magazine - August/September 2018 - Cover1
Morningstar Magazine - August/September 2018 - Cover2
Morningstar Magazine - August/September 2018 - 1
Morningstar Magazine - August/September 2018 - 2
Morningstar Magazine - August/September 2018 - Contents
Morningstar Magazine - August/September 2018 - 4
Morningstar Magazine - August/September 2018 - 5
Morningstar Magazine - August/September 2018 - 6
Morningstar Magazine - August/September 2018 - 7
Morningstar Magazine - August/September 2018 - 8
Morningstar Magazine - August/September 2018 - 9
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Morningstar Magazine - August/September 2018 - 11
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Morningstar Magazine - August/September 2018 - Cover3
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