Defense Wins Championships, Protects Investments

For many of us in the Detroit metro area, disappointment does not even begin to describe the heart-wrenching loss that our beloved Lions took on Saturday. While fans and players should both feel proud of everything the team accomplished this season, and they are primed to contend for a title again in the future, there will be one clear point of emphasis in the offseason - defense.

The Lions had arguably the NFL’s best offense this year, averaging a league-leading 33.2 points per game, and were second in yards per game (409.5).¹ Ultimately though, what cost them their season might have been their injury-riddled defense, which ranked in the bottom half for yards allowed per game, which was the second-lowest mark of all playoff teams. This is all to say, a good football team plays offense and defense and there is some truth in the mantra “Defense wins championships,” which we believe applies not only sports, but also investing.

While past performance is no guarantee of future results, the Investment Team’s bottom-up, value-based investment approach has excelled at protecting capital during drawdowns. However, that capital preservation comes at a cost; our strategies may struggle to keep pace in a runaway bull market. Over the past two years, the S&P 500 experienced the strongest two-year run in history, fueled by American exceptionalism, Artificial Intelligence (AI) optimism, and valuation expansion, as shown in the graph below.

Despite this, we pride ourselves on our downside protection, which, like the NFL’s best defenses, tends to deliver in a clutch moment when it matters most.

Health Care: A Cornerback

There are many ways to play defense when considering investments. One that we believe offers long-term opportunities at historically attractive valuations, coupled with attractive dividend yields, is the health care sector. From a historical perspective, the health care sector as measured by the Health Care Select Sector SPDR Fund (XLV) is trading at a discount to the S&P 500. Specifically, on a forward earnings basis, the sector is trading at its largest discount in nearly five years.  And on a price-to-sales  basis, the sector trades at its largest discount over a 16-year period. This is despite earnings growth expectations in 2025 that are second only to the Technology sector.

So, why the disconnect? The sector faces uncertainty under the new administration. But importantly, we note it has proven itself to be able to navigate through policy changes over time. Further challenging the sector as a whole is a large patent expiration cycle through the year 2030. We believe the disconnects to the sector have created opportunities in specific names that have minimal exposure to the headwinds facing the industry as a whole, and our specific investments have limited exposure to the anticipated patent cliff. More importantly, we believe that Wall Street has yet to reward the sector for their technological investments.

In fact, the heart of our health care investment thesis is centered around the adoption of technology, across both pharmaceuticals and medical device technology. The Health Care sector has been an early adopter of innovative technologies, particularly AI, as a means to improve research efficiency as well as lower costs and improve margins. One of the holdings in our Global portfolios is Novartis (NVS). An early adopter of AI, NVS pledged their focus to AI in 2018. Since that time, the company has significantly improved their research efficiency, while at the same time improving company-level margins. As an example of their research efforts, management recently highlighted a reduction in their clinical stage pipeline by 40%, 155 projects down to just 94 projects, allowing the company to increase the resources around any one project, increasing the likelihood of success. This has translated into a 50% increase over the last year on resources per project, and development spend per project up 5%. Trading at just over 12 times forward earnings (compared to over 22 for the S&P 500), we believe the shares are attractively valued.

You may recall a year ago we discussed our belief that the adoption of AI will move from the technology leaders to the technology adopters. We believe the AI theme in the broader markets will widen as investors embrace companies that successfully integrate AI into their businesses in order to improve efficiencies, drive down costs, and/or increase revenues. We also expressed that it was a prudent way of participating in the AI movement without paying exceedingly high valuations, thereby offering a more favorable risk-adjusted return opportunity. We believe select names withing the health care sector are one of those beneficiaries.

We encourage you to contact your MAP representative with any questions or concerns.

Managed Asset Portfolios Investment Team

Michael Dzialo, Karen Culver, Peter Swan, Zachary Fellows, John Dalton, and Nicolas Vilotti

¹https://www.espn.com/nfl/stats/team/_/view/defense/season/2024/seasontype/2

January 27, 2025

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Certain statements may be forward-looking statements and projections which describe our strategies, goals, outlook, expectations, or projections. These statements are only predictions and involve known and unknown risks, uncertainties, and other factors that may cause actual results to differ materially from those expressed or implied by such forward-looking statements. The information contained herein represents our views as of the aforementioned date and does not represent a recommendation by us to buy or sell this security or any other financial instrument associated with it. Managed Asset Portfolios, our clients and our employees may buy, sell, or hold any or all of the securities mentioned. We are not obligated to provide an update if any of the figures or views presented change. Past performance is no guarantee of future results.