“The frequency of correctness doesn’t really matter, what matters is how much money you make when you are right, versus how much money you lose when you are wrong.”
Those are the views of Wall Street investment strategist, author and professor Michael J Mauboussin in his book ‘Thirty Years: Reflections on the Ten Attributes of Great Investors’. He believes investors miss a trick simply because they are risk averse - basically we like to be right a lot more than we are wrong.
It is a view shared by the managers of this week’s Best in Class, who feel the importance of capital allocation is being overlooked within the investment process when compared to picking winners over losers.
Investors miss a trick simply because they are risk averse - basically we like to be right a lot more than we are wrongBrown Advisory Global Leaders fund managers Mick Dillon and Bertie Thompson say that when they find winners, they will seek to gain a reasonable allocation - typically 2 per cent to 2.5 per cent of NAV, within two months of initiating a new position.
A good example of this was their investment in Aspen Technology, which uses AI in industrial manufacturing. Dillon says Aspen Technology approached the two-month time limit in the second quarter of 2020, which saw the managers scale up the position to just over 2 per cent, at just a 5 per cent premium to the price they began investing in the company.
He says: “Aspen’s move to a new subscription model resulted in the company announcing guidance for fiscal 2021 that was materially above consensus expectations during their full year 2020 results. Accordingly, Aspen’s share price shot up 25 per cent.”
The managers are fundamental, bottom-up stock-pickers who invest in companies and management teams, as opposed to countries, economies or macro factors. The result is a 30-strong portfolio from the 2,250 in the MSCI ACWI index.
They begin by screening companies for high returns on capital, free cash-flow, valuation and sales growth. This reduces their investable universe to around 300 companies.
All ideas then go through a four-stage check-list process. Firstly, companies need to offer an exceptional customer outcome. Typically, these businesses will have a dominant market position and multiple competitive advantages.
Secondly, companies must have a 20 per cent return on invested capital or a pathway to it within five years. Thirdly, company management must demonstrate it has allocated capital skilfully and ethically in the past.
Finally, the valuation must be appealing. An investment must pass all four stages of the process for possible inclusion.
Once they have passed, the team will undertake full due diligence on the stock including detailed models and company visits. The managers will also interview the company's customers to really understand if the product or service it is selling is indispensable.
They also conduct an Environmental, Social and Governance analysis to ensure the business is sustainable.
Thompson says the team are not looking for companies which simply provide good outcomes, resulting in a relative competitive strength – but also those companies that provide goods or services that satisfy the customer in a unique way, in turn giving the company a dominant and sustainable position among its peers.
The managers also believe in backing their businesses for the long-term, with almost half of the stocks held in the portfolio since launch.
Performance has been very strong, returning 124.3 per cent in the past five years, compared with 86.57 per cent for the average fund in the IA Global Sector. The ongoing charges figure stands at 0.87 per cent.
There are plenty of high conviction global mandates available to investors today, but we feel this fund’s relentless focus on businesses which deliver 'superior customer outcomes' offers something both different and complimentary to its peers.
We also like the emphasis on high quality fundamental stock research and the managers' willingness to analyse their own performance and mistakes, and their constant desire to improve.
Darius McDermott is managing director of FundCalibre
