Q: What is the history of the fund?
The fund was incepted on March 14, 2012, but the strategy dates back to 2004. At the time, we wanted to create a global strategy, because we were starting to see a lot of opportunities that were more global in nature. Different elements of the economy were effectively globalizing. U.S. companies were taking their business, products and services abroad, and many non-U.S. companies were bringing their products and services into the U.S. market.
We manage a concentrated portfolio with the goal to invest in our best global ideas and to express these convictions in meaningful ways. Another important aspect is that we have intentionally designed our fund to be as unconstrained as possible. The only constraint is that no single position can grow larger than 10% of the assets. It is a high-conviction, concentrated strategy, which allows us to seek the best ideas globally and to combine them into a portfolio of unique and differentiated securities.
Q: What is your investable universe in terms of geography and market capitalization?
The portfolio literally goes anywhere, so our geographic footprint is the world. We are a bottom-up fund and we have no top-down influences or biases. We find our opportunities and holdings one stock at a time, so our exposures are the result of our bottom-up process. It all depends on where and when the opportunities arise and where the profit pools are.
In terms of capitalization, we consider investment opportunities with a market cap of more than $1 billion, but we typically invest in companies with a minimum between $7 billion and $10 billion for liquidity reasons. We seek upcoming opportunities or companies that offer a unique product or service that can grow in size steadily and quickly. Currently, we are skewed to the large and mega-cap areas, while in the past we’ve had greater representation in mid-cap names.
Q: Would you describe the core beliefs that drive your investment philosophy?
First and foremost, we are growth investors, and we stick to who we are and what we are good at. Although the names change over time, the characteristics of the portfolio remain similar and consistent. The growth rate and price-to-earnings always show a growth portfolio, even as the names change.
Our goal is to put together a collection of select, unique, differentiated securities that are market leaders in their respective industries. Typically, these companies have sustainable competitive advantages that continue for years. They may have patent protections such as might be found among pharmaceutical companies, or a proprietary technology like the iOS of Apple, or a scale effect like Netflix, which has a rapidly growing subscriber base that provides a monthly revenue stream, that can fund incremental content to draw in more subscribers. These are long-term sustainable advantages that we love.
Q: Are there certain areas or sectors that you find attractive?
We source ideas largely from the technology and the consumer areas because that’s where the innovation and creativity are. Tech and consumer products and services are being designed, built and offered to the marketplace on a global basis.
We tend not to find ideas in the energy and materials sectors or in coal and oil companies, where the underlying product is the same, regardless of who is extracting it out of the ground. Also, we don’t find opportunities in utilities and even in the telecom sector. Financials have become increasingly difficult because of the political and capital pressure in many parts of the world. There’s just not a lot of creativity, innovation and profit generation in these areas.
As a result, our exposure today comes largely from the consumer and technology sectors. Fortunately, both of these sectors are highly diverse, with many embedded sub-industries. Despite the concentration of the strategy on the surface, it is still a diversified portfolio of business models and consumers served by a wide range of companies.
Q: How do you transform that philosophy into an investment process?
The process starts with our research team, which is responsible for almost all idea generation. We have an experienced team of 15 analysts, who are experts in their fields, with average experience of 20 years. They are specifically focused on growth portfolios.
Our analysts travel the world on a regular basis to meet with companies, suppliers, customers and competitors, both upstream and downstream. Based on this groundwork, we identify the opportunities that have the best likelihood to generate outsized revenue and earnings growth within their respective global industries.
When they identify an opportunity, they’ll do a full analysis to identify the quality and unique aspects of the opportunity, what makes this product or service special, and what the total addressable market could be over time.
The next step of the analysis is valuation. The valuation metrics vary depending on the sector and the industry, but the goal is to develop a reasonable estimate of fair value or a range of fair values depending upon assumptions. By the time the analysts come to us, we all have a good sense of the overall opportunity, the assumptions, and the potential upside in earnings and return.
Q: How do you evaluate two similar investment opportunities?
It depends mostly on the type of business and the addressable market and the potential growth rate of the opportunity. For instance, if a company in Mexico has a product or a service that is sellable across South America, while a Thai company has a product that is specific to Thailand, we might choose the Mexican company because of the larger growth opportunity. On the other hand, if you have a company selling products globally under consideration, we might choose that one because it has the larger addressable market.
If two companies are very similar, we will choose the most promising opportunity, but not both. Since we have limited spots in our concentrated portfolio, we make sure that our names are as differentiated as possible.
Q: What financial metrics do you focus on?
We look for top-line growth because it signals a product or a service that’s clearly in demand. However, we need to understand the roadmap from revenue down to profit and loss, and how long it would take for that revenue growth to work its way down into earnings. We need to understand the P&L lifecycle. If an opportunity cannot translate into earnings, returns and free cash, then it is not good for us.
That said, we can’t be entirely focused on earnings, returns and free cash flow up front. If we were, we might be missing out on innovative companies investing in the earlier stages of expansion and growth of a terrific product or service. Ultimately, all the metrics are important. They may not all show up at the same time. Sometimes the best earnings, returns, and free cash may not show up until the medium term, but that doesn’t mean we wouldn’t want to own the company today.
For example, Netflix and Amazon are not incredibly profitable today, but they generate tremendous top-line growth and are expanding their active user base. Over time, we believe that will eventually translate into earnings growth and cash flow generation.
Q: What is your strategy if your assumptions prove wrong?
If we find that we are wrong, we are very quick to exit. We think that we have a good process to identify opportunities and to bring them into the portfolio. If we are wrong and the revenue growth doesn’t materialize or if it starts to decelerate, our expected earnings growth will not materialize, and we would have a problem. So we would exit that position quickly.
Importantly, when we are correct, and the stock price starts to dramatically move upwards, we will periodically harvest some of the profits and effectively lock down some of the success. The position is unlikely to go to zero exposure purely based on valuation, because there might be another leg to the story. That’s especially important in this day and age of technology development and scalability of the products.
For example, when we initially owned Apple Inc in 2004 and 2005, it was on the back of the personal computer business, the iPod and the concept of iTunes. There were no iPhones or iPads, but Apple was a highly creative and innovative company. The thesis evolved as the opportunity set expanded with the iPhone and was pushed into global markets. A few years later the iPad came along and resulted in another expansion.
Q: How do you factor in your valuation that the fast growing companies disrupting industries often have to work under lower margins than the legacy businesses?
We have to assume that the potential for lower margins can exist in a wide range of disruptive situations. We can’t assume that Amazon, for example, will achieve the same margin as traditional retail stores, but it still can be successful with lower margins and higher volume. Higher margins of legacy businesses, including traditional retail, do not guarantee the success and visibility of those business models. Amazon should be profitable over time and will be one of the dominant retailers. Our goal is to ensure that we own the winners of today and tomorrow, not the losers, because there are losers in any destructive industrial transformation.
Today Amazon is earning about 40 to 45 cents of every e-commerce dollar in the U.S., up from the high 30s about 18 months ago. It is taking huge market share and signing up more subscribers and Prime members. Other aspects of its business are very profitable; the AWS business has a margin of more than 25% as Amazon is leveraging elements of its core expertise into other areas.
When we model the opportunities, we use conservative and relatively reasonable expectations. We have no delusions about a lower margin profile. A few years ago, Amazon had 1,000 robots in its distribution centers and today it has 100,000. With robots that can effectively work almost 24/7, costs should go down. So, there are less traditional ways to arrive at the desired profitability.
These aspects are incorporated in our analysis and thought process, but the critical element is that Amazon is offering a service that people are using more because it’s making life easier. They have vast scale and breadth of product; this is the first place that most people would go to search for a product online. We could make the same case for Alibaba in China and online platforms in Europe, the UK and elsewhere. These are businesses with rapid growth and will be more profitable over time, but the margin profile will look different.
Q: Would you describe your portfolio construction process?
Concentration is a key element of our design. Every position ideally represents a different kind of exposure, opportunity set, profit pool, and perhaps a different end market. We think of it as diversification by business model, not diversification by sector or geographic spread.
Our portfolio today runs between 35 and 45 positions. The average position size is typically in the range of 2.5% to 4.5%, occasionally larger, and rarely goes below 1%. A position of more than 4.5% would reflect a powerful company whose business model is substantially rewarded in the market.
The construction process is based on the analyst’s fundamental assessment on the magnitude of the opportunity and the differentiation of the business. We take the analyst’s recommendations and simultaneously compare that opportunity against everything that we own. If the idea is better than what we already own, then we will figure out how to include it in the portfolio. If it’s not, then we will discard the idea.
For instance, if we own Mastercard, it is highly unlikely we will buy Visa as well, or vice versa. They represent the same opportunity and are not going to trade that differently. We are careful to ensure that we don’t duplicate exposure and we avoid factors that bring highly correlated performance.
We benchmark ourselves against the MSCI All Country World Index, but we can also be measured against the MSCI ACWI Growth Index.
Q: What is the rationale behind owning only one of similar companies?
With 35 to 45 stocks, we are not necessarily diversifying by sector or region, so we make sure to keep the correlation across our holdings low. We monitor the direction and the pairwise correlations on rolling 60-day periods across the entire portfolio and by sector. The idea is to avoid highly correlated names, because they behave in a similar fashion across different market environments. If we are careful with construction, there is enough diversity within the sectors and low correlation in the portfolio.
We don’t want to split the allocation between two similar companies. At any given time, we own one or the other, and we will go with the one in which our analysts have the highest conviction. While we have owned Mastercard and Visa over time, we’ve never owned them simultaneously, because owning both companies would mean duplicate exposure to the same opportunity.
The decision depends on the better opportunity at the time. When we make a choice, we assess the fundamental strength of the companies, because the businesses may be influenced by similar considerations, but their underlying strategies may have differences that result in different growth rates.
On the other hand, that doesn’t mean that we can’t invest in Facebook and Tencent at the same time, for example, because the two companies have different end markets and customers. The same refers to Alibaba and Amazon, because Amazon does very little business in China, while Alibaba is largely a Chinese market player. There’s a differentiated capability in two vast markets and largely uncorrelated developments.
Q: How do you define and manage risk?
We focus largely on absolute risk. The risk management process begins with the analysis of the fundamental opportunity. We assess the potential market size, the risk of competition, and the potential for governmental influence. Is the product or service differentiated enough to provide a multi-year competitive advantage or is it fairly generic? Are we going to face a potential competitor in the next 12 months? There are many absolute risks that we consider at the fundamental research level.
At the portfolio level, we analyze how differentiated the portfolio is. We make sure to understand how our holdings interact with each other and how they might perform in different scenarios.
The next level is the ongoing monitoring. We monitor factor exposures and the components of attribution to our performance. Given the nature of our work, we want the bulk of our excess return to be driven by the fundamentals of the underlying businesses, and stock-specific factors. Historically, about 70% to 80% of the excess return over a multi-year horizon is derived from stock-specific characteristics.
The ultimate measure of our success comes down to performance and delivering what we set out to deliver, namely, meaningful excess return for our institutional and retail clients on a regular basis. Since we are hired to be growth managers, we have to deliver a product and performance in a consistent fashion. We don’t stray from what we do, and we are constantly focused on the same process and characteristics.
