A $490 billion investing firm is worried that record corporate profitability is unsustainable. Here's its how it's preparing for an 'inevitable' collapse.
- Corporate profit margins have been on an unsustainable growth trajectory and are now poised to unwind, according to Rob Almeida, the global investment strategist at MFS Investment Management.
- In a recent interview with Business Insider, he laid out why his colleagues have expressed this concern, and how he is investing for this eventuality in the portfolio he manages.
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For example, companies have been able to simultaneously maximize margins and keep shareholders happy by keeping their costs in check."We generated above-average margins not by selling more and better dishwashers, but through cost optimization," Almeida said. The heyday of such tactics is coming to an end, in his view.
That is because costs are rising, particularly the cost of labor as companies come under pressure to invest more in their employees.
But that's not an easy proposition due to technology. It has lowered the barrier of entry for many business models and made mass production easier. It has also improved price discovery, such that customers can always purchase at the lowest price and sellers can easily undercut their competitors.
Companies could also make up for higher costs by selling more products. However, this move equally depends on the demand pull from consumers - and there's no guarantee of a resurgence on that end.
Preparing for a profit slowdownWhile Almeida has clearly mapped out the road to lower profit margins, he is less certain about whether the reckoning will be an outright earnings recession. It could look more like a slog of slow earnings growth that jolts investors out of companies with the weakest value propositions and into those with the strongest.
In addition to being the global investment strategist, he is lead portfolio manager of the MFS Diversified Income Fund. The fund has returned 10% and bested 96% of its peers over the past year, according to Bloomberg data.What's worked includes shedding dividend-paying stocks and high-yield bonds, where he has an "almost maximum underweight," and allocating capital instead to Real Estate Investment Trusts.
REITS, Almeida said, have not pulled the same kind of financial levers that companies in other sectors have to maximize their profit margins. He also likes the sector because housing is an income-producing asset that is not as easy to duplicate as other consumer products.His fund's top REIT holdings include AvalonBay Communities, Alexandria Real Estate Equities, and Simon Property Group.
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