MW A pickleball play and two other companies that tap into a growing sweet spot of the stock market

By Barbara Kollmeyer

American Century Mid-Cap Value Fund's manager discusses risk-averse stocks for right now

Like other fund managers, Nathan Rawlins has been fielding calls from clients concerned about economic uncertainty amid tariff headlines, "wondering when the market environment will turn, if it'll turn and what that looks like."

Rawlins co-manages the $7.7 billion American Century Mid-Cap Value Fund ACMVX, an asset class that could increasingly draw more investor attention as perceived riskier portions of the market - and strong drivers such as big technology shift - fall out of favor in early 2025.

"We've seen a pretty big rotation back toward quality, low volatility, especially over the last couple of weeks. And so we're positioned for things that can happen very quickly," the manager told MarketWatch in a recent interview.

It's been a tough couple of years for value-themed funds, though over time, the Morningstar four-star rated fund has held its own against its benchmark, the Russell Mid-Cap Value Index XX:RMCCV. What it offers investors is protection.

"We generally are very risk-focused in trying to avoid ... the value traps and really trying to outperform by not losing when the market goes down," Rawlins said. His fund looks for attractively priced, high-quality midsize companies with high returns on capital and strong balance sheets.

Modeling downside risk is a major part of the fund's process that whittles 5,000 potentially investible companies to 575. A company is then selected for a high-quality watchlist before it makes it into its batch of 90 to 130 stocks.

In Rawlins' view, midcap value stocks are the "sweet spot within the market," offering more mature businesses and potentially a higher-quality company," than small-cap rivals. Both mid and small-caps are also expected to see earnings improvement over the next two years, following two years of negative earnings growth, he said. That could help the market broaden to favor those companies, though the economy remains something of a wild card for now.

And while midcaps traditionally traded at a premium to large-caps, the latter has traded at a 40% premium to them since 2021, barring a 25% premium in 2022, he said. "The only time we've seen valuations that are similar to that level were kind of around the tech boom," he said.

The fund's biggest holding is Zimmer Biomet Holdings Inc. $(ZBH)$, an orthopedics-products manufacturer they've held since 2008. It is the No. 1 player among four in a tight and highly regulated industry, with clearly a high barrier to new entrants. "Once an orthopedic surgeon is trained on an implant, they usually will use that for a large portion of their career," said Rawlins.

While COVID-19-related backlogs have been worked through and the environment is more normalized, Zimmer still has "strong secular drivers. "Aging would be the primary one. They are the leading advertiser for pickleball," he said of the popular sport blamed for a rising number of fractures for its often older players.

He said they were under-earning going into COVID, and that hasn't changed, with upside potential for margins and good product cycles, such as a robotics arm. "Even through recessions they generally do pretty well, so they're much less cyclical than the broader economy," he said.

The fund's second-biggest holding is Henry Schein $(HSIC)$, a "stable, durable" business that distributes goods and services equipment for dental offices. "They're largely just thought of as a dental distributor, but if you look, half their EBIT (earnings before interest and taxes) comes from their own specialty products and their own manufactured products."

He said the company has taken a bit longer to fully recapture share loss from a cyberattack just over a year ago, "through all of this, it's still a very, very stable business."

He added: "The volatility of their returns are at the low end of any company that we could invest in and their earnings growth over time has generally been high single digits, low double digits, very, very stable."

The company purchased shares of Henry Schein, in 2017, sold them in 2018 and then repurchased them in 2019. The company was also the target of an activist who pushed for changes that Rawlins said they also welcomed, and investment firm KKR now owns a 10% stake.

Graphic Packaging Holding Co. (GPK), which makes paper-based cartons for food and beverage products, is in the fund's top 15 holdings. Good returns on capital, and end markets "much more stable than a lot of the rest of materials businesses," are positive attributes, he said.

Rawlins said GPK has been investing in plants, which has leaned on cash flow, but that is rolling off. It operates in a fairly consolidated end markets and secular trends, such as a shift away from plastic to paper are working in its favor.

"I think that's still a trend that consumers will move toward, and that helps their growth by 100 or 200 basis points a year. So it's not like it's all of a sudden going to massively accelerate growth, but it does provide a nice tailwind," he said.

If the economy does enter some turbulence, as markets have worried about this year, Rawlins said companies like the above offer durable businesses that aren't too cyclical. "They all have high returns, at least relative to their peers or other investment options. We think they are attractively valued," he said.

-Barbara Kollmeyer

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March 07, 2025 09:10 ET (14:10 GMT)

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