Q: What is the history of the fund?

RBC Global Opportunities Fund was launched in December 2014, but the underlying strategy has been team managed with the same process and philosophy for 12 years. The investment subadvisor is RBC Global Asset Management (UK) Limited.

Q: What core beliefs drive your investment philosophy?

Our philosophy is to invest in great businesses at attractive valuations. We define great businesses as ones that generate value over many years not only for their owners and shareholders, but also for the employees and the customers. 

We have two core beliefs when identifying those great businesses. First, regardless of how great a business is, if we overpay for it, we are likely to lose money, so valuation is key. Second, we believe that it is not enough to simply identify the best ideas. The way we assemble these ideas into a portfolio has a significant impact on the returns for investors. That’s why portfolio construction is critical.

Another important aspect of our philosophy is the alpha source. We examine corporate culture, the business model, employee engagement, diversity and ESG factors. It is important how management thinks and feels—do they act like owners and are they are prepared to invest for long-term value creation?

These great businesses are scattered across the world. Our task is to identify the best investments; to make sure that we have diversity in terms of sectors and a portfolio that’s sustainable through different types of volatilities.

Q: How does your philosophy translate into an investment strategy?

We have developed a framework called “Contingent Assets and Contingent Liabilities” or “Extra Financial Assets and Extra Financial Liabilities.” For example, when a management team cuts its training or R&D budget, profits go up in the short term but they will be running a higher-risk business. These contingent liabilities will become financial liabilities. This is a very important aspect of what we do.

There are businesses that invest in their future; in their people, suppliers, customers and communities. This costs money. The market, however, values a dollar of earnings generated from this investment in the same way as it values a dollar of earnings created by borrowing through curtailing this investment. That’s the inefficiency of the market that we seek to exploit. We believe that businesses that create contingent assets have more sustainable future value creation. If we can identify these factors, then we know that the financial returns will come in the future.

Future sales and profits grow in great businesses with great business models, people, R&D, engaged employees and loyal customers. On the other hand, there are businesses with high profits in the short term, which have disengaged employees, customers and suppliers. For us, these are not sustainable businesses, because future profits will decline. 

Q: What is the process of identifying these businesses?

We use qualitative techniques to identify great value-creating businesses and quantitative techniques to capture the returns from those businesses for our investors. We’ve developed a rigorous framework and we spend a lot of time traveling, talking to junior employees and ex-employees, to customers, suppliers and regulators. 

For example, our healthcare specialist goes to medical conferences and talks to doctors, surgeons and academics to figure out who is spending on R&D in the right place, who’s attracting the best brains and who’s doing the most interesting programs. Our industrials industry expert attended an Industrial Automation Show in Shanghai recently to see who is undertaking interesting work in robotics. 

Our starting point is who has the most engaged employees, who is doing the best R&D and who has the best customer satisfaction. We don’t believe that the highest margins will necessarily result in the highest value creation. That’s our alpha source and we spend a lot of time on these qualitative factors.  The end result is rating the quality of the business. We are not interested in anything average or below average; we are only interested in the top ranked companies.

The second part of the process is valuation where we use discounted cash flow models. These are long-term forecasts, which involve a considerable degree of judgment. We forecast the investments and the returns; we project when sales growth will come or when new products will come through. We develop optimistic and pessimistic scenarios and we stress test the results. The outcome of our valuation work is a rating in order of attractiveness. 

The next step is creating a ranking of our best ideas, combining the strongest fundamentals and most attractive valuation. The ranking is critical, because we know that our best ideas give us the highest returns. We concentrate into our best ideas, but we need to check the correlation between them, because the beta may overwhelm everything that we have done.

Similarly, we check for any significant bias towards unintended exposures such as country, region, style, commodity price, interest rate direction, exchange rates, company size or volatility, because these are biases can feed into a concentrated portfolio if constructed without an awareness of intended versus unintended risks..

Q: What are the main factors of your due diligence process?

We always look for new ideas because we know that businesses, management teams and business models change. We have eight people on the team dedicated to specific industries such as industrials, financials and healthcare. We regularly conduct strategic analysis of industries to see where the industry will be in three or five years and like to know what’s changing.

In healthcare, for example, every time there is a major technological breakthrough, we assess its impact. If immunotherapy succeeds in cancer treatment, traditional treatments like surgery, chemotherapy and radiotherapy should become redundant. We have to be constantly looking forward know who will be tomorrow’s winners.

We also examine the corporate culture and engagement of human capital. One of the differentiating factors is how we work, collaborate and grow together, as well as the constant drive to learn and improve.

We are aware of our role and aim to act accordingly. Individuals are saving for their retirement, for the education of their children or for healthcare. Institutions are saving for future investments, research, endowments or foundations. The better outcomes we can produce, the more our investors will have for their retirement, healthcare or children’s education. It is very important to remember that our job is to invest in a way that meets the objectives of our clients and in a way that we can be proud of.

Q: How do you narrow down your investable universe?

We start by looking for businesses with a winning business model and a sustainable edge over their competitors. Then we look for a rising market share. Thirdly, we like growing end markets because the opportunity to create value is magnified. The fourth aspect is the management. We look for management teams that think and act like owners and will create extra financial assets as opposed to extra financial liabilities. We need to see all these four factors before we even start to think about investing in a business.

A significant part of our analysis is traveling globally for meetings; listening to companies, their customers, suppliers, regulators, related academics and other. Only through this hard work can we come up with interesting ideas.

Once a month I sit down with each of our industry experts to develop a program of five or six interesting ideas that we want to evaluate over the next month. The ideas are based on our four-step checklist of business model, market share, end-market growth and management. Only when we find a business that passes the entire checklist, do we go on to value the business. Then we present the idea to the team for a debate. The rating is entered into our database and that database then creates the ranking of our best ideas.

We have a weekly meeting during which we review our rankings. Any team member can challenge anything. Anyone on the team can contribute with new information, for example about the management team or regulatory changes. In such cases, the stock in question needs to be reviewed by the relevant industry expert. We are constantly challenging the assumptions we have in our database.

Q: Why is it important to have an elaborate database?

Because we have been recording all our judgments in our database since the inception of the strategy 12 years ago., we have a record of every single decision that we have made, including businesses that we rejected because of the management or the valuation. We review our past decisions at least twice a year. Although we spend some time on what has worked on our successes, we spend the majority of the time on our mistakes.

When we analyze them, we can learn from them and see if our forecasting was overly optimistic or pessimistic. Then we devise a control or a warning sign that we can build into the process. We need to have it embedded in the collective memory of the team so that we don’t make the same mistake again.

We meet weekly to review all of our exception reports. We’ve developed different warning signs that flash up based on previous mistakes and observations. This is critical. We are in a competitive industry so we need to have a culture of intellectual humility. We are honest with ourselves about the reasons for past mistakes, so we all learn from them. I believe this is a significant source of improvement.

Q: How do you handle the different economic metrics globally?

Over the years there has been significant progress with IFRS. There have been major improvements in the harmonization of accounting standards, especially now with ADRs and GDRs. We have several CFAs and qualified accountants in the team, but it’s important to say that the issue of accounting standards is less important today than it was 25 years ago.

We spend a lot of time considering exchange rates. For example, Toyota actually makes most of its profits in the U.S. The exchange rate benefit and cost may not be obvious and we have to look at correlations. This is where our risk models are very valuable.

For instance, 25 years ago the capital of the semi-conductor industry was the Silicon Valley. Today it is Taiwan or Korea and we have to go to different places to find the world’s best semi-conductor businesses. That’s also the case with healthcare, where businesses all over the world generate new pharmaceutical drugs. In the technology industry, businesses are growing in India, China, Israel and Asia, as well as in the US, the UK and Germany. So we have to look at these industries in a global context. 

Q: Are there certain industries or countries that you typically avoid?

When running a concentrated portfolio of 32 or 33 stocks, we have to be conscious of what we don’t own. For example for many years we didn’t have enough Japanese ideas - there are 500 investable Japanese companies. We have had to spend more time in Japan to understand the culture and to get beneath the surface of businesses to identify the ideas that meet our criteria. 

Q: How do you construct your portfolio?

Portfolio construction is a balance between investing in our very best ideas and making sure that there are no large unintended market or factor risks that enter the portfolio. In this way the return stream delivered to our investors comes from the risk that we want, which is from the risk of investing in great businesses at attractive valuations. We make sure that the majority of the portfolio risk is in line with our philosophy.

We look at a tight set of risk controls to avoid large unintended bets. The first step is to adjust the position sizes of our best ideas to reduce any unintended risks. Occasionally, we need to add an idea that is good, but not the best, to improve the risk-return profile of the portfolio.

We have between 30 and 70 securities and the maximum position size is 7.5%. We have country and sector limits but we examine correlations as well. We may have consumer businesses that actually behave like technology businesses or large-cap businesses that behave like small-cap businesses. A Taiwanese business may behave like a US business or some US businesses may have the characteristics of emerging markets businesses. We need to be very conscious of those dimensions and to look at the portfolio through the lens of risk.

Our benchmark for the global portfolios is the MSCI ACWI Net Total Return USD Index. In principle, there’s no limit for market capitalization, but given the size of our portfolios and the need to maintain liquidity, we consider only companies with market capitalization of $2 billion or higher.

Q: What are the key aspects of risk management?

There are two main aspects. For us, return is inextricably linked to a risk source. The risk source that we are happy to embrace is the risk of investing in great businesses at attractive valuations. These are the businesses that meet our four criteria for their business model, market share, end market growth and management. If these businesses have attractive valuations, we would be happy to invest, because we believe that we are paid for this risk over the long term. I believe there’s a very positive return associated with that risk.

We do not take the risks of timing the market or calling interest rates, commodity prices, exchange rates and value versus growth. We aim to minimize these risks and to make sure that 70% to 80% of the portfolio risk comes from the idiosyncratic, company-specific risk that we want to take.

We have our own proprietary framework and three team members dedicated to risk management. We use seven different risk models from four different providers, but we have also built our own proprietary framework to analyze portfolios and make sure that we control and minimize factor, style, and asset allocation risks.

The outcome is that we can run highly concentrated portfolios of 32 or 33 stocks with relatively low tracking errors of 3.5% to 4% and active shares of around 95%. This leads to a robust and well-controlled return stream from a concentrated portfolio, because we take only the risks that we want to take.