Portfolio Manager Q&A - Haruki Toyama

With interest rates continuing to rise, and the recent trouble in the banking sector, Head of Mid and Large Cap Equity, Haruki Toyama, sheds light on how these factors have impacted the markets, and where opportunities may present themselves moving forward.


Chris Aleman 00:04

Hello and welcome back to Madison's video series of conversations with a PM. My name is Christopher Aleman, regional investment director for Madison investments, and I support advisors in the Northeast. This series is designed to bring our portfolio managers in, to discuss relevant topics that you and your clients are seeing. Primarily recent headlines, stories that create uncertainty, opportunities that we are finding value in, and potential challenges to be on the lookout for. Today, I'm joined by Haruki Toriyama, head of large and mid cap equities in Madison, as well as Portfolio Manager on the strategies. Hi, Haruki, thank you for joining me to that.

Haruki Toyama 00:44

Hi, I'm happy to be here, Chris.

Chris Aleman 00:47

So let's dive right in and start with some questions that people are asking. One of the topics that continues to be on the front of everyone's mind is interest rates. The Fed continues to raise interest rates in an effort to curb inflation. However, the rapid rise in rates is causing multiple ripples throughout the economy. First in the banking sector, as we've seen, but I'm sure is soon to be more broadly. Given the movement and rates, what have you been seeing in the equity markets as a reaction to this news over the last few months?

Haruki Toyama 01:19

Yeah, so a few things are going on. One, if you just look at the overall stock market, obviously, they’re reacting to sort of the interest rate rises that have happened over the past year, a year and a half. I think, I think the initial reaction was pretty harsh, as you remember, from a year plus ago, but uh, things have settled down, I think the dust is cleared a little bit. And people are starting to think about which companies industries may be impacted more than others. So I think you're seeing some of that being sorted out. You know, from our standpoint, we didn't just wake up a year or a year and a half ago, thinking about, “hey, how do we position our portfolio for rising rates,” or, “that's a risk we should think about?” This is something that we've thought about for 2030 plus years since the very beginning. Right? And obviously, we've operated in a declining rate environment for many decades. But we knew that one day that would end. And so whenever we look at a company or an industry, we think about, okay, how would that company do in a rising rate environment. And so you've noticed that if you look at our portfolios, we haven't necessarily rapidly turned over the companies that we own in the past year or two, because we feel like we already own companies that should do well, in a potentially rising rate environment. Right, we think we try to think about buying what we call all weather companies, right? Companies that should thrive in both declining and rising rate, environment. So one thing we look at, for example, if you look on the liability side of the balance sheets of these companies, you want to make sure they don't have a lot of variable debt. Or that if they do, that sort of rising rates on their liability side can be offset by rising income on the asset side. Right. So that's the kind of stuff we've always thought about. And so, we think from an overall standpoint, the impact on our portfolio should be relatively negligible. I think, economically and for the market, obviously, I think they're really sorting out. Two or three things. One, of course, is companies where a lot of the valuation is dependent on profits, 10-20 years down the road, as opposed to today. Right, because when rates go up, your discounting mechanism, tends to be a bigger factor. So you're seeing some revaluation of not necessarily high growth so much as companies are not necessarily showing a lot of profits today. So that's mattered more, I think you're also seeing some impact in some of the financial areas as well, which we know we can talk about later as well. But that's an issue.

Chris Aleman 03:54

I think that's an important point to make. And I actually liked the comments about all weather companies. So following up on this, though, we've seen a string of regional bank sell off in the month of March. A lot of this is we know has to do with the uncertainty in the banking sector. However, do you feel that larger institutions are at risk of a similar fate? Or for that matter? Do you believe other financials are in jeopardy? I think what a lot of people are trying to understand what this question is, are all financials equal? Can you shed a little bit of light on this one?

Haruki Toyama 04:26

Yeah, that's a great point. So there's a few points that I can address. One is, to us again, the risk is somewhat heightened today with regional banks and other financial companies, but we think the risk was always there. Right? So something we thought about incorporated in our portfolio and I think you put a good way which is are all financials impacted? And the answer, of course, is no right. Banks are especially vulnerable to bank runs by definition, right. That's how their model operates. They lend long but borrow short, right? Deposits are actually just a way of borrowing very short. And I think what we're finding out now is that if your deposit franchise isn't really strong, in other words, you can lose a lot of your deposits very quickly, because of the type of customers you have, then you're much more susceptible to a bank run. And so we own a couple banks in our portfolios. And we've been very careful to own the ones where we think they have phenomenal deposit franchises. And so in the two banks we own, for example, across our portfolios, from what we can gather that they've actually been net beneficiaries and achieve net inflows and deposits because of the strength of their customer base. And then when you look at financials, of course, there's so many different kinds, we happen to own a bunch of insurance companies, for example, they're actually going to be net beneficiaries coming out of this for a bunch of reasons. One is, if these, if this means there's more disruption in capital markets, A, it tends to be good for risk awareness. Right. So it just, it's much more conducive to an environment where people would be looking to buy insurance, or insurance like products, number one. Number two, and to tie it back to rising interest rates, insurers should benefit from a rising interest rate environment, because they tend to take the premiums that they get from their customers, and invest it in various securities. And so the better yield you can get on those investments, the better your profits can be. Right. So again, within financials, I think different kinds of industries and companies can have totally different factors that work into future profits. So I think, I think we're very well aware of that.

Chris Aleman 06:37

I think that makes sense. I think we do need to be made aware of the differences even within the sectors themselves. So I think that's been one of the questions that’s been on a lot of advisors minds that I'm speaking with. But switching gears a little bit, I wanted to bring up active management, and why it's especially important today. Reason being with all the news headlines, market moves, etc, that we've been talking about, it seems very difficult to know, not only what's going on, but keeping a level head when the market does swing like this. How do you continue to look for opportunities with all of this outside noise going on?

Haruki Toyama 07:14

Yeah, that's a good point. And I think it helps that our underlying philosophy is really to be truly bottoms up, right? We're trying to buy what we think of as stakes in actual company. So, we don't really think sort of top down, you know, in terms of what the markets going to do, what our interest rates going to do. What kind of sectors may benefit in certain environments. Again, like I said, before, we try to buy all weather companies. So we're comfortable buying stakes in those 25 to 30 companies that we think can thrive over the next 5-10 plus years in any environment. And so we're hoping and actually, we're finding that this kind of environment, which can be a little volatile, actually uncovers a lot of opportunities for us. You know, we always, there's two ways to find out from us. One is that we always have a library of companies we stay on top of and they're very interested in buying. And we're just waiting for the right time. Very often because of valuation, right. So hopefully, we can find something here. Another one is we have different sectors and industries that, you know, when we look and think that there's something temporary going on, that we can take advantage of. We put a lot of resources behind that. So that's kind of what we're doing.

Chris Aleman 08:24

I think that makes sense. And I think that that touches on my last point that I wanted to go with, which is I wanted to go back to inflation for a little bit. Now. You are the head of the large and mid cap portfolios. But at the end of the day, you're still an analyst. So putting your analyst hat on for a minute, what are the heads of companies that you're speaking with saying about the overall state of the economy? And how are they offsetting the rising costs due to inflation?

Haruki Toyama 08:52

Yeah, that's a great point, because I think what we found out in the last year and a half or so. So far, is that there was quite a bit of pricing power available to a lot of different companies. So you can see margins got squeezed a little bit in the general economy as a whole. But they held up quite well, which tells you that sort of the five to ten percent inflation that we saw, was mostly being passed through. Now, some industries, some companies have passed it on faster than others. So that's happened. And what that really tells you number one is probably that the overall economy is in good health. Right? both consumers and business customers have been able to absorb those price increases, and sort of unit demand has not come down, has not been as as elastic as one would think. But I think what we're seeing now is that that sort of run of ability to pass through all the cost, inflation may be slowing down. And so again, you're starting to see I think, a lot more variability in which companies have the ability to continue to pass through prices based on the strength of their franchise. Right, how loyal their customers are, how good they might be at sort of making sure their services and products are uninterrupted in this environment. And so we're really hoping and we think that the kind of companies we own are the ones that have really strong franchises, they can continue to pass on any higher cost.

Chris Aleman 10:16

That makes sense, I think, touching on that last point, the companies that we own, I think that's a great place to wrap up today. So Haruki, I really appreciate you taking the time with me and shed some light on what's been going on in the markets.

Haruki Toyama 10:31

Sure, thank you, my pleasure.

Chris Aleman 10:33

Haruki Toyama head of large and mid cap equities and portfolio manager at Madison investments. To see more conversations with a PM or to learn more about Madison suite of strategies, please visit Madison investments.com or reach out to the regional director in your area. Thank you and take care.

Haruki PM interview Haruki Toyama is Head of Mid & Large Cap Equity and Portfolio Manager on the strategies.
“Madison” and/or “Madison Investments” is the unifying tradename of Madison Investment Holdings, Inc., Madison Asset Management, LLC (“MAM”), and Madison Investment Advisors, LLC (“MIA”). MAM and MIA are registered as investment advisers with the U.S. Securities and Exchange Commission. Madison Funds are distributed by MFD Distributor, LLC. MFD Distributor, LLC is registered with the U.S. Securities and Exchange Commission as a broker-dealer and is a member firm of the Financial Industry Regulatory Authority. The home office for each firm listed above is 550 Science Drive, Madison, WI 53711. Madison’s toll-free number is 800-767-0300.

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