Q: What is the history of the company and fund?
The Marsico Flexible Capital Fund was launched in December 2006, and as its name suggests, it uses a uniquely flexible style and a multi-cap strategy to generate long-term, risk-adjusted returns.
Adjustments to the portfolio can be made over time, allowing us to make investments that reflect our outlook on the global fundamentals. Depending on where we see opportunities, this flexibility may lead us to become more aggressive in equities or high yield, or to change the mix between cash and stocks and bonds. At the end of the day, it allows us to invest where we see the best risk-reward balance.
In the past, the fund has been as high as 20% in cash when we sat out risky market events, protecting capital for short periods of time. It is currently invested for a low global growth and lower than historical stock market returns outlook.
Marsico Capital Management was founded in 1997 by Tom Marsico, who ran the Janus Twenty Fund for nine years before starting the company. We have co-managed this fund since July 2012. Currently, assets under management are approximately $420 million.
Q: What is your investment philosophy?
We run a concentrated, bottom-up investment portfolio focused on long-term, risk-adjusted returns for the fund.
Generally, we are looking for stocks that exhibit several attributes like dominance in their markets, a wide moat around their businesses, strong management teams, and franchise durability. Additionally, we look for a history of generating consistent free cash flow, and returning this cash flow to shareholders through buybacks and/or dividends.
Q: How does your investment process work?
We look for quality growth stocks continuously, particularly those with a lifecycle event that will help them outperform the market, then marry that with our top-down macroeconomic view. We also concentrate on performing incremental research in areas where there are changing themes or disruptions taking place that provide unique opportunities, like autonomous car development or the changing media landscape.
Once opportunities are identified, we spend a significant amount of time on due diligence. We talk to competitive management teams, contacts within the industry, and suppliers. One discussion we always have is whether we are better off owning the equity, or a company’s debt instruments Also, great ideas might not make it into the portfolio immediately because of the fund’s concentrated mandate, and as a result, we have a buy list of stocks that are being watched.
If our thesis about a company changes – say there is an acquisition, a change in management or corporate governance, or a change in capital – we may use that as an opportunity to sell one stock and displace it with another on the buy list. We call this process forced displacement.
Our process is always bottom-up. Even though a certain company, asset class, or country may appear favorable, it will not be forced into the Fund if it does not meet our process and current risk/reward outlook.
For example, in our opinion Mexico has interesting positive dynamics. However, we currently have no investments in it because we have not been able to find any bottom-up stock ideas that fit our criteria.
To find ideas, we constantly evaluate the changing landscape of the economy and look at emerging trends. Currently, we are interested in the area of convergence and mobility; consumers are rapidly shifting to doing more with their mobile devices, and data usage is through the roof. When we see an accelerating trend like this, we try to identify stocks that will benefit from it over a long period
One such stock might be Crown Castle International Corp, a company that owns, operates, and leases towers and other wireless infrastructure. Over time, we feel the carriers will have to invest in more capacity on the towers given the greater demand for mobile phones and data usage that will benefit CCI.
Another trend we have examined is population demographics. Which companies will benefit from the world’s aging population, or from the increase in leisure travel as baby boomers retire? How will these trends be tangible in the economy? To take advantage of a stock-specific selection that expresses our views, we might look at Johnson & Johnson, which makes replacement joints and drugs needed by older consumers, or cruise lines.
Q: How do you look for opportunities as part of your research process?
Research has always been a hallmark of Marsico Capital. Not only do we learn about a company’s fundamentals and management team, but before investing in it, we also talk to suppliers and other industry people to get their perspectives about how its business may be improving or evolving.
Constellation Brands, Inc. is a good example that illustrates our research process. The company is in the international alcoholic beverage business, including spirits, beer, and wine.
We have followed Constellation for some time and did not own the stock. We have followed and researched the beverage and beer space for 15 years, so we had an understanding of the company as well as deep industry expertise
The company had what we call a lifecycle change moment. It had owned half of a joint venture for the U.S. rights to the Corona and Modelo beer brands, and three years ago, was able to purchase the other half, gaining full ownership.
This allowed Constellation to completely remake the business model and improve on the already good fundamentals of the Corona and Modelo brands.
So, we dug in deep – we talked to suppliers and beer distributors, met with management, built models of the company, went through different scenarios on how beer volume growth could play out, and what the company could do over time with its cash flow.
The fund bought a starter position as we were waiting for the Department of Justice to approve the merger. We thought there was a small possibility the deal would be blocked, and we wanted to protect some of the downside if that happened.
When the deal was approved, it became one of our top positions in the Fund and we have owned it ever since. Constellation’s earnings have grown from around $2 per share a couple years ago to potentially $8 in 2018 or 2019.
Q: Could you give an example from another industry?
One thing we focus on is disruptive innovators.
We liked Tesla Motors Inc early on, a name many of our peers passed on because they deemed the risk too high. Given our mandate is flexible capital, when we find a mispricing opportunity, we take advantage of it. To take a position in a company like Tesla, which was in the beginning stage of generating revenue and earnings, we needed to see significant upside with relatively low downside.
The electric car is not anything new. Though the concept has been around for a long time, a lot of things were happening in the industry that we thought would benefit Tesla.
Because the cost of solar had become incredibly competitive – at parity with coal in certain states – it was possible to charge electric cars for little money. On the other hand, gasoline prices and oil prices had gone up significantly, making electric cars even more competitive.
Battery costs had dropped as well, to the point where Tesla could make an electric car on par with a combustion engine. Add in things like carbon fiber, alternative materials, software technology that allows a car to be updated in real time – all these things came together at the right point in time.
We first took our position in 2013. The company’s CEO Elon Musk was about to launch the Tesla Model S, and was looking to raise capital to fund this expansion. When Tesla issued a secondary convertible bond, its stock price went down as a result of dilution.
But did Tesla’s lower price give it enough value to add to the portfolio? Additional research was needed for us to determine the risk/reward tradeoff.
We went to the Tesla facilities in California where we met with Elon and were among the first to drive the new model on a test track. We were absolutely blown away.
After returning to our office, we made assumptions about the number of units Elon thought the company could produce. And when General Motors and Toyota liquidated during the forced bankruptcy of the Big Three automakers, Tesla had the luxury of buying their automotive plant for pennies on the dollar. So we knew the company had low costs and a lot of capacity.
Two years ago, I met with the head of BMW’s electric car business in Germany, and determined it was far behind Tesla in terms of reducing the costs of the electric engine. Its production targets also compared unfavorably. This gave us more confidence that Tesla had a clear lead, and there was no viable second player.
When we put the numbers together, we realized the stock was trading incredibly cheap relative to the intrinsic value of the business. Our first position was taken at $25 to $30, and we exited the last of our position around $250.
Q: What is your portfolio construction process?
When constructing the portfolio, we consider the macroeconomic environment and our risk tolerance within it. Depending on the multiples of the marketplace, the growth of global gross domestic products (GDPs), and the health of the markets, the mix will be adjusted to be more or less aggressive accordingly.
Today, facing a fairly low growth, low GDP world, that continues to have geopolitical risks, medium valuations, and declining yields, we feel the overall market return will be lower than it has been historically. As a result, the fund is positioned to be more income-producing in terms of yields, and to have stocks that are more conservative.
Using our top-down outlook for the global economy, we have tried to construct a fund that is well-positioned. About a third of the portfolio is in stocks with a yield/income component, and 20% is in bonds or preferred stocks to continue to add to the fund’s income component, giving the Fund an approximate 3.5% total yield.
This is the core base of the portfolio. We also include stocks that we call “core compounders,” stocks like Visa Inc and Home Depot Inc, which are all-weather stocks that grow in almost any environment and provide consistent compounding returns to the Fund and shareholders.
The last piece, or approximately 25% of the fund, is made up of research-driven growth stocks like Constellation Brands. These more aggressive picks provide the alpha to the Fund.
We do have the ability to invest in emerging markets though currently the Fund has no position in any. Outside of the U.S., our investments are primarily in the U.K., but we also have domestic stocks that are listed as foreign stocks in other countries, and have previously owned stocks in Hong Kong, Japan and Canada. The international mix is usually below 25%.
Currently, the fund is benchmarked against the S&P 500 Index. Although this index is not always a perfect fit because the fund has the ability to become more dividend-oriented in times of slower growth, we feel it is reasonable nonetheless, and aim to provide risk-adjusted returns close to the S&P 500.
In the past three years, the portfolio has had 100% turnover, but recently it has been lower
We are a long-only mutual fund. In terms of position size, the portfolio is diversified across stocks and sectors to help mitigate risk, but overall, it remains concentrated. When we have high conviction in a stock, equity positions may be as high as 5% to 7%.
The fixed income component is limited to 40%, and the highest it has been is 20%. If we are uncomfortable with the market, significant cash positions can be taken.
Q: How do you define and mitigate risk in the portfolio?
Knowing our companies well is important to our risk management. Beyond that, we consider other factors that impact risk, such as liquidity of the stock, the cross correlations in the portfolio with foreign exchange markets, commodity prices, and the intertwined global marketplace.
For a portion of our Fund, the dividend yield on certain stocks provides a floor to the valuation and helps protect us from downside risk. Even though this is a concentrated Fund, investing across categories does diversify it significantly, without diluting our research efforts.
Investors tend to connote concentrated portfolios with greater risk. We think this is absolutely false for a number of reasons.
First, there is actually lower risk with having fewer names, because it is easier to be on top of the fundamentals. Mistakes can happen when there are more names that are less closely followed.
Second, other portfolios might contain, for example, two to four Consumer Staples names while ours has only one. Our approach may seem riskier, but it is not; considering those two to four stocks might have a correlation close to 1.0, they effectively create one heavily-correlated position.
We believe you can manage a concentrated portfolio and have relativity low risk as long as you focus on low correlation.
