Q: What is the history and the core mission of the fund?

A: The history of the fund actually starts before it was established. The team came together at the end of 2003. Using the same strategy we employ today, we primarily managed institutional international and global equity portfolios. In 2008, we established the fund in order to bring the strategy to retail investors.

Q: How does the fund differ from its peers?

A: We have a differentiated style of management and we own companies that often are not  present in other growth portfolios. In addition to the large-cap companies, we  include mid-cap names in the portfolio, and we tend to invest less in mega caps than many of our peers. As a result, the weighted average market cap for our portfolios is lower.

We tend to be “growthier” than many of our peers, which in part results from our preference for more focused businesses. We tend to invest in companies with one, two or three lines of business, where we find better visibility and transparency, and tend not to invest in large conglomerates.

Other differentiators include our approach to risk management and, relative to some other strategies, our high-conviction, concentrated approach.

The depth of our research is a central aspect of what we do. Our analysts only cover the companies that we own. Of course, they are aware of the competitive environment, the customers and the suppliers, but we don’t cover them in depth if we don’t own or won’t own them. Each analyst covers eight to 12 companies and has the time to research the company and the industry well and to look at the broad universe for new investment ideas.

Q: What is your investment universe? How do you define ‘international’?

A: We consider companies that are domiciled or registered outside of the United States. While our main focus is developed markets, we can invest in emerging markets if the companies meet our growth, quality and valuation criteria. Our exposure to emerging markets is limited to 20% of the fund. Over time, this allocation has been 10% of the fund or less.

Q: What type of growth do you invest in?

A: We look for sustainable growth, or to put it another way, growth coming from a sustainable business model. We look for free cash flow generation or companies that are close to generating free cash flow, and a competitive advantage that should be durable over time. Our investment horizon is at least three to five years. Typically, we find our companies benefiting from secular growth drivers, such as secular changes in the business or economy.

Overall, we look for long-term holdings with sustainable drivers and growth. The free cash flow is important, because it means that a company can support its growth, at least partially, through generating cash internally, so it isn’t completely reliant on the capital markets.

Q: What are the guiding principles of your investment philosophy?

A: We believe that the ownership of a select group of high-quality growth companies with attractive and enduring secular drivers, combined in a risk-managed portfolio, can lead to long-term capital appreciation and attractive relative returns.

The long-term nature of the holdings is driven by deep research and analysis of the growth, the quality, and the valuation. This deep fundamental research is essential, including the analysis of the management and its ability to execute the business plans and its focus on shareholder return, which is another aspect of the growth analysis. We need to see if the business can grow in a way that offers attractive returns for investors.

From a growth standpoint, our ultimate focus is the cash flow. Income statement analysis is an important aspect of our work, and in many ways drives the cash flow, but it is the cash generated by a business that enables a company to reinvest and further its growth, to maintain a leadership position, and to generate cash to reward the shareholders. The balance sheet is clearly important as well, and we consider it an essential aspect of our quality analysis. The structure of the balance sheet, the reliance on raising capital, and the capital structure, have a profound impact on the sustainability of the growth story over time.

Q: What are the critical steps of your investment process?

A: We have a purely bottom-up strategy, where the stock selection isn’t driven by top-down macro calls. We believe in selecting the stocks and putting them together in a risk-managed portfolio. Our fund is meaningfully driven by the analysts, who typically specialize in specific sectors, although we have a couple of generalists as well.

The process starts with the analysts examining their sectors and looking for attractive growth opportunities. They do research and talk to companies and experts to identify an industry or a company that’s attractive from a growth standpoint. Identifying a company would lead to examining the industry in terms of drivers, value creation and growth opportunities. The analysts also look at the competitors, customers and suppliers to find the most attractive place for investing in terms of long-term secular growth, free cash flow generation and margins.

We have an interactive approach, where the portfolio managers and the sector teams meet on a weekly basis. The analysts discuss their ideas and what they consider attractive about the particular industry. As they drill down on the companies, they receive feedback and input from the other analysts and from the portfolio managers. In their work, they talk not only to the company’s management, customers and suppliers, but also to other experts. That approach helps us to reach an independent conclusion on the risks and the opportunities.

They build a model and refine it as they get additional input. Then they do scenario analysis within the model. For every company, we build bear, base and bull case scenarios, which are refined and discussed over time. It takes months to bring a name into the portfolio. Ultimately, by the time the analyst recommends the new company, we are comfortable that it fits our growth, quality and valuation criteria, as well as the overall portfolio from a risk management standpoint.

Q: How is your research team organized?

A: Our team consists of 11 people. John Remmert and I are portfolio managers and the rest of the people are analysts, in some cases beginning to take on portfolio management roles in addition to their analytical work. We put our resources behind research and aim to leverage that research in the portfolios. So the majority of the team, nine out of 11 people, are focused on research, most with deep sector expertise. Most of our analysts have been with the team for more than 10 years.

The team is located in New York, with the exception of one analyst, who is in Australia and is helpful for understanding both the Australian and greater Asian marketplaces.

Q: Do you approach sector analysis from a global or from a regional point of view?

A: We generally organize our research along global sector lines. We value the sector and industry expertise that can be brought to bear by our analysts. The majority of companies we own have fairly global footprints. Even when looking at businesses focused on a particular region, we find that industry expertise carries over. A retailer in Europe and a retailer in Asia may operate in  different markets, but they’re both retailers – dealing with common aspects like distribution, e-commerce and store expansion. Additionally, our analysts have plenty of resources available to help them understand a specific regional market.

Q: Could you illustrate the process with some stock-specific examples?

A: An example would be DSV Panalpina A/S, the transportation logistics company resulting from DSV’s acquisition of Panalpina last year. DSV navigates the increasingly complicated global supply chain and provides logistics that would help a manufacturer get his product from the plant to the end customer. DSV is an asset-light services business, and its software is key component of its success.

The logistics industry is highly fragmented, with many regional players. We see an opportunity for stronger players to make acquisitions and gain market share, particularly companies with free cash flow and the business acumen to ride through cycles.

As we analyzed the industry initially, DSV exhibited strong management with focus on free cash flow generation, which it uses to fund acquisitions, payment of related debt, investments in the business, dividends and stock buybacks. The management was focused on shareholder value creation; the free cash flow and the secular growth drivers were attractive. We concluded that the business would be an attractive long-term holding.

Q: What kind of growth did you see in DSV?

A: The basic building block is the strong growth of global trade, and an increasingly complex supply chain. In addition, DSV is able to gain market share through the quality of its service and through expansion. The top line growth drives a business model that offers operating leverage. With its recent acquisitions, DSV demonstrated the ability to buy companies with weaker margins and to quickly bring them up to corporate levels.

Q: Could you cite another example in a different industry?

A: Another example is the Chinese company TAL Education Group. We had investments in education before and the analyst kept looking at the space. She found an interesting situation in China, where the educational system is highly competitive. After-school tutoring is growing, but has a lower penetration than some of China’s neighbors. TAL Education and New Oriental Education are the two major companies that provide after-school tutoring and both are listed in the U.S.

The analyst was specifically attracted to TAL, as opposed to New Oriental, because of its business model.  TAL centralizes the development of its curriculum, which is then followed by all of their centers. That’s a leverageable model, and ensures consistent quality of its programs. TAL is available for young children, so if the program is successful, they continue to use it through their entire education.

TAL is one of the leaders in the field with large market share in the major cities. Over the last few years, it has invested in online and offline programs. The online program enables them to expand their reach into smaller cities without major capital investments. Earlier this year, due to Covid, the company managed to convert many offline programs and students to its online program. TAL is profitable and generates free cash flow, although it goes through periods when it invests more in building the tutoring programs or to meet some regulations.

Q: What is your portfolio construction process?

A: For us, portfolio construction is all about risk management. The two pillars of the strategy are first, idea generation through deep research, and second, the combination of those holdings in the portfolio. When we build the portfolio, we look for companies with relatively low overlap of underlying economic drivers.

In other words, we wouldn’t own companies that do the same thing, with the same customer base and the same underlying drivers. We wouldn’t own New Oriental and TAL in the same portfolio, for example, because that would double the regulatory risk.

Limiting the overlapping drivers results in a portfolio invested across  a number of sectors and world regions. We could get Chinese consumer exposure from TAL Education or a bank in China or an industrial company, based elsewhere but manufacturing for the Chinese market. As the analysts work on their ideas, we discuss the underlying economic drivers in the portfolio. If we are comfortable with the exposure and any overlap, we may consider the new idea.

For us, this approach is more meaningful than constructing a portfolio based on sector or geographic lines. Sectors represent broad classifications of companies that often tell little about the underlying business. And in the large and mid-cap space, many of the companies we own are true global businesses. The place where they are domiciled or listed means nothing about the economic exposure of the portfolio.

Q: What is the rationale behind not owning two competing companies?

A: We don’t want to own two companies solely exposed to identical underlying drivers and doubling the risk. We make sure that negative developments of some factors, such as regulations, consumer weakness in a particular region, or commodity prices, would not have a cascading domino effect on the portfolio. And in a concentrated portfolio, duplicating positions take up valuable real estate that could be used for another, more differentiated, holding.

Q: What is your approach towards valuation? Do you use price targets?

A: In the valuation analysis, we look at the same characteristics as from a growth standpoint, the free cash flow generated for shareholders. For most companies, we use the discounted cash flow model. For some companies, like banks, where the free cash flow concept is not particularly relevant, we use a dividend discounted model. But in both cases we focus on the free cash flow generated and available to investors.

We fix a number of the inputs into those models to provide commonality, so that we can compare the after-school tutoring company in China with a manufacturer in Denmark, for example. In the valuation analysis, we again develop a bear, base and bull case for each company. That gives us an idea of the relative valuation attractiveness of the companies we own or consider.

We don’t set specific price targets. In practice we don’t find them particularly useful, in part because they often assume a fairly stable market environment, which is not necessarily realistic. We are always invested, so it is the relative valuation that matters. The key question is whether an investment opportunity is more expensive than our holdings and whether the price is acceptable given our growth expectations.

The scenario analysis makes sense, because a single point forecast for growth from, say, a new product cycle or a fast-growing new concept, would require a level of visibility that often doesn’t exist. The key aspect is making sure that the growth and quality characteristics of the business model are right and, secondarily, that the valuation is acceptable given these characteristics.

Q: What drives your sell discipline?

A: There are four reasons we’d eliminate a position. The first reason is to fund purchase of a more compelling opportunity.  This could be a more compelling opportunity with the same underlying drivers as an existing position, because we wouldn’t own two such similar companies. For example, if our analyst recommended New Oriental Education as extremely attractive, then we would need to compare the opportunity to TAL Education, because we wouldn’t own both of them.

The second reason is a deterioration of the fundamentals, a change in the growth drivers or the execution of the company. We would investigate if that investment still fits our parameters. In some cases, companies just grow past the strong part of their growth cycle and become less attractive for us.

The third reason is valuation, although it isn’t the main driver behind most of our outright sales. If valuation becomes less attractive, we would decrease the position size and take some of the risk out of the portfolio. To entirely sell a stock due solely to valuation, we must see no additional upside after giving credit for all of the “optionality” we envision for the company – the benefit of all R&D, and product or market expansion that aren’t necessarily in our base case valuation. When all of that is reflected in the stock price, then we can’t justify owning the stock any longer.

The fourth reason is our “twenty-percent rule,” where if a stock underperforms its peers by 20% or more over 30 to 60 days, we would look to either add to the position or sell it. That keeps us true to the idea of a high-conviction portfolio. We don’t have a neutral rating; each company has to be rated ‘outperform’ to be in a portfolio, or is a ‘sell’ and is on its way out. If the share price has been deteriorating relative to the peers, we either have the conviction to add to the position or we would sell it.

Typically, we don’t wait for that rule to be activated to take action. Clearly, if fundamentals are deteriorating, we’re analyzing and discussing the changes, and taking appropriate action. And reaching a decision may take some time to do thorough research on the changed circumstances – we won’t make a knee-jerk decision. For example, years ago a healthcare company we owned faced a recall for its newest generation product. To make an educated decision, we did research and a survey of doctors who used that product. We needed to determine what would happen to the market and the brand name before making a decision.

Q: How do you define and manage risk?

A: We think of risk in two ways. Within our portfolio, there is position-level risk, including permanent loss of capital and the risk of underperformance. Investors in our strategy look to outperform the benchmark over time, so we consider both the absolute and the relative risk. We control risk through deep fundamental research and scenario analysis. We make sure to consider all the aspects of a company and all the risks it faces. The fundamental research is key for the position-related risk.

At the portfolio level, risk tends to be more related to downside volatility, and again, over the longer term, underperformance relative to our benchmark. We manage this risk in two ways.  First is clearly through portfolio construction – limiting overlap of underlying economic drivers, so the portfolio is diversified despite its concentration. The second is through capping our position sizes. We don’t have any positions over 5% of the portfolio; few are over 4% of the portfolio. Since the companies we buy are focused in a particular area, which could be a niche of the global economy, they tend to carry stock-specific risk.

For example, within healthcare we own a company like Cochlear, which makes hearing implants, as opposed to, say, a major pharmaceutical company. The major pharmaceutical company might be considered to be more of a healthcare sector benchmark proxy. On the other hand, Cochlear, by its nature, as with many of the other focused businesses we own, would be expected to have more idiosyncratic risk. Therefore, we wouldn’t amplify that risk by owning larger positions.