It's not every year that seven stocks mint money and leave the rest of the pack behind on Wall Street. The market of 2023 presented such a unique challenge for the best mutual funds.
But the stock market isn't just about the Magnificent Seven megacap tech stocks. That's why Daniel Mahr and his team at Federated Hermes MDT All Cap Core (QIACX) take a "whole market" approach to picking stocks for their best mutual fund.
Unlike most fund managers who can't stray from a certain style of stock, such as large-cap growth or small-cap value, Mahr can search anywhere he wants to find stocks. His goal: find different kinds of stocks that have the right stuff to outperform the market.
Best Mutual Funds Looking At The Whole Market
Mahr can pick any stock in the Russell 3000, a broad market index. He can shop there for megacap stocks. He can browse the aisle with shelves filled with growth stocks, too. Or sort through the "on sale" bins for value stocks. Or purchase midsize stocks or small caps on his shopping list.
"We're trying to find the best opportunities in the market," said Mahr. "We cover all 3,000 stocks every single day."
What the fund buys isn't about fitting into a Morningstar style box. It's about piecing together a diversified portfolio that works in all types of markets. And finding potential winners wherever they might be in the market.
"If we're seeing more opportunities in the midcap space, the portfolio will shift toward overweighting midcaps," said Mahr. "If we see more opportunities in growth versus value, we'll shift in that direction. Having that all-cap core mentality gives us a ton of flexibility to follow opportunities. And always have the portfolio positioned for where we think the market is most likely to outperform."
Best Mutual Funds Find Opportunities
That go-anywhere philosophy has served investors well. The fund, an IBD Best Mutual Fund winner in 2022, has bested or matched the S&P 500 in the past three-, five- and 10-year periods, according to fund-tracker Morningstar. And in 2023, despite a healthy helping of midcap holdings (roughly 40% of the fund assets are invested in midsize companies), Federated Hermes MDT All Cap Core returned 23.5% vs. 26.3% for the S&P 500.
There's a bottoms-up systematic method to Mahr's stock-picking shopping trips. The team's model analyzes 16 distinct factors when sizing up the potential of all 3,000 stocks to outpace the market benchmark. And stocks that get a closer look are segmented by three main themes, or buckets: value, market sentiment and quality, says Mahr.
In a nutshell, he's looking for pricing inefficiencies or what he views as incorrect market views on stocks he owns or is considering buying or selling. Before any stock is purchased, the fund team gathers to review the trade to make sure the model isn't missing anything beyond the data, such as an upcoming acquisition or a looming legal issue or management change. Think of it as the human touch.
"We want to make sure there's nothing going on at the company that will make us want to avoid a particular situation," said Mahr.
Bringing A Human Touch
On the value side, Mahr analyzes how cheap something is on a company's balance sheet or income statement relative to its current trading price.
When it comes to sentiment, he looks at whether Wall Street analysts and other investors are overly excited about a company's prospects. He might also see if they're getting too pessimistic and how that's reflected in stock prices or future earnings projections.
Quality is all about companies generating gobs of cash flow and then putting that cash to good use to grow the company or pay back investors in the form of dividends and stock buybacks.
Like many traders who use sentiment as a trading barometer, Mahr says he may take a contrarian approach to the investing herd or follow along with the momentum.
Don't Rule Out Momentum
But it depends on the type of stock he's analyzing. For growth stocks, he says the team wants to see momentum. "We want to see analysts raising earning forecasts," said Mahr. "We want to see price charts going up to the right."
In contrast, he also sees opportunity when quality companies are beaten down so much that the next likely move is up. "When something temporarily has gone wrong and the stock price has dropped precipitously, we do find that can be a positive signal for a potential rebound," he said.
The fund doesn't deviate much from its benchmark sector weightings. That's why the fund owns all the Magnificent Seven. And while Mahr doesn't think these stocks will outperform as a group in 2024, he says the fund still must own them, mainly to manage the portfolio's risk.
"Microsoft is 6% of the Russell 3000," said Mahr. "You have to have exposure to it. Because if you don't own Microsoft, that's an incredibly large bet that you've taken versus the benchmark. And if Microsoft does really well as it has done this year, no having any exposure even if you have a modestly negative view on the stock just exposes you to too much potential volatility."
Best Mutual Funds Looking To 2024
After a big year for megacap stocks in 2023, they're richly valued, according to Mahr.
As a result, Mahr sees the "most opportunity" in midcaps in 2024. The market is likely to broaden out and new winners are likely to emerge.
"We see targeted opportunities in the midcap space, and that's how we're positioned," said Mahr. "We think investing in companies that haven't done quite as well in the last couple of years will pay off in 2024."
One stock that Mahr likes for 2024 is Spotify Technology. After selling off in 2022 when interest rates shot up and tech names sold off, the audio streaming giant soared more than 140% in 2023.
But Mahr, who bought it as a rebound play, now sees it as a quality company with positive momentum on its side. "As Spotify rebounded, it's sentiment and growth characteristics started looking very attractive," said Mahr. "So, we continue to own it."
To boost profitability, Spotify, best known for its podcasts, has been cutting workers and has also raised the prices of its U.S. subscriptions.
Another name Mahr is bullish on is Dell Technologies. Once known mainly for its personal computers, Dell is now known for selling and supporting information technology infrastructure. Mahr says the company is generating "really strong cash flows."
Another plus: "The stock remains cheap," he says. The stock is trading at a below market multiple. "It ticks a lot of boxes for us."
Digging Into Energy
Gazing into the oil patch, Mahr likes Marathon Petroleum. The oil company has been generous in returning cash to shareholders. In the third quarter of 2023, it generated $5 billion in net cash and raised its quarterly dividend by 10%. The company's earnings power will move up in lockstep with oil prices as the economy picks up. "On a forward-looking basis, we continue to see a bunch of value in the stock," said Mahr.
While Mahr says the fund doesn't make economic or market predictions, he hopes the stock market in 2024 won't be tilted in favor of just a handful of stocks.
"I certainly hope we're talking about a market driven by the other 493 stocks" in the S&P 500, said Mahr.
Staying Diversified
But Mahr and his fund are sticking to their diversified roots.
"We're expecting good opportunities on both sides of the growth and value divide," said Mahr. He also sees opportunities up and down the market-cap range.
The portfolio is designed to fare well no matter what the Federal Reserve does with interest rates, what happens to oil prices, or if GDP numbers come in light or strong, Mahr says.
"We want to be exposed to all sectors and not be exposed to macro forces," said Mahr.
