During this webinar Jon Tringale, Client Portfolio Manager talks to Marty Switzer, CEO of Contango Asset Management about investing in some of the best global small cap growth opportunities.
The session covers how the WCM International Small Cap Growth Fund provides Australian investors with exposure to an asset class that has been historically hard to access, the most important factors to consider when selecting global growth companies and examples of small cap stocks WCM has identified with positive moat trajectories and aligned corporate cultures.
Marty Switzer (MS): Hello, ladies and gentlemen, and welcome to our webinar on investing in small cap companies. I’m Marty Switzer, CEO of Contango Asset Management, and with me today is Jon Tringale, Client Portfolio Manager at WCM Investment Management. Now, many of today’s attendees would be familiar with WCM’s large cap strategy, WCM Quality Global Growth, but WCM also have a top-performing small cap strategy called the WCM International Small Cap Growth Fund. Since launching in the US six years ago, the strategy has delivered an annualized return of over 25%, beating its benchmark by almost 15%.
Now, before we start talking to Jon, the strategy is available in Australia as a wholesale, unlisted managed fund, the minimum investment is $50,000, and due strong global demand and outstanding investment performance, this Fund is going to close at the end of this quarter or by June 30. Now, if you want to learn more about the Fund, please leave a comment in the Q&A section or call us on our number on this screen. And now, without further ado, let’s hear from Client Portfolio Manager Jon Tringale. Jon, welcome.
Jon Tringale (JT): Good day, Marty.
MS: Great to see you. Jon for those that aren’t familiar with WCM’s investment process, and there would be a lot on the line that are, but for those that aren’t, can you give us a bit of background about, one, the firm and who you guys are, and two, the unique features of your investment process?
JT: Absolutely, so WCM as a firm, we still think of ourselves as a boutique asset manager, we’re independent, employee-owned, based out of Laguna Beach, California, and there’s about 71 of us in the firm. 34 of us are shareholders or partners of the firm, so we think that broad-based employee ownership really matters. And in terms of our portfolios and how we invest, there are a few philosophical underpinnings that you’ll see common through all our strategies, which include having a very long-term orientation. So, even though we’re investing in publicly traded stocks, we really think like business owners, so we’re asking ourselves the question, is this a business that we want to own for the next five years or more? If it’s not, we’re not going to buy the stock. Of course, you don’t always own a business for five years, but that’s the intention. We really believe partnering with great businesses and letting them work for us, letting them compound returns for us, gives us the best chance of maximizing our returns.
The second idea is all of our strategies are relatively concentrated, best ideas portfolios in the asset class. There’s no magic to the exact number of holdings we’re going to have in each strategy, but we want to have meaningful position sizes. If we’re correct about these businesses outperforming expectations in the future, we want those to be big enough weights that they really move the needle and help drive our returns, and of course, we don’t want to dilute the portfolio with less than our best ideas. And then, the third idea, we really believe the most important thing you need to achieve if you want to win the investment game, or said differently, if you want to build a great long-term track record, and that’s what motivates all of us at WCM to skip to work every day, we want to win the investment game, and we think the single most important thing to do again to achieve that is you have to be able to protect capital well in the inevitable market drawdowns.
You never know when they’re coming, but we all know how the math works, right? 2008 comes along. If you lose 50% in your portfolio, you now need 100% return to get back to even money. You don’t get a lot of 100% years in public equity, so the better we can stay in the game and protect capital, lose less in those periods of volatility to the downside, like the first quarter of 2020, then the more capital we have to compound, of course, when the market returns its march upwards again, and that math is just so powerful over time. So, really, the hallmark of all of our strategies has been excellent downside protection.
So, those are kind of the big ideas, but getting into the more specifics of what’s truly unique and differentiated about our approach, what inefficiencies are we exploiting in the marketplace, that’s where you get to really two main pillars for us. The first one is the differentiated way that we look at competitive advantages. Warren Buffett has popularized the metaphor of an economic moat. Many investors, I think most of us, when you’re getting your analyst training, you’re going to business school, you’re learning how to build financial models, I think we’re all taught a lot of the same ideas, which is the way to invest is you want to buy high quality businesses. There aren’t a lot of people to teach you or that advertise that they buy low quality.
You can of course buy a business with a large competitive advantage or a wide economic moat, going back to that metaphor, and you don’t want to overpay, you want to buy these stocks at a discount to their intrinsic value. And that’s really been a mantra that’s been so prevalent on Wall Street for many years. Maybe 40 years ago, with that approach, you could have generated a lot of alpha. In today’s world, there are just so many smart people, who work hard all over the world, looking for those same characteristics, and if that’s all you’re doing, our contention is there’s probably not a lot of inefficiencies for you to exploit.
We bring a different twist to that. We do spend much of our effort on the investment team, studying, analyzing, assessing competitive advantages, but we do so from the lens that they’re very dynamic in nature, that they’re always changing. Any business we look at around the world is either getting stronger or weaker vis-a-vis its competition, vis-a-vis others in its industry, and our whole goal is really to try and fill our portfolios with businesses where we can make a compelling case based on our fundamental, bottom up, and really heavily qualitative research on not only the company, but their whole industry, their whole value chain. We can make the case, that the company is growing its advantages. If there were high barriers to compete with this company in the past, those barriers are actually rising. If they had sticky customer relationships, those relationships are becoming even more sticky and harder to break for customers, they’re becoming more essential.
So, that really leads you ultimately to companies that we think, by definition, can defy the fade or beat expectations around the durability of the growth that they can generate into the future. So, that moat trajectory concept, that’s the term we use internally, is really the biggest driver of our stock selection process. We want to own companies with a positive moat trajectory, and when we’re no longer convinced that those moats are still growing, they could still have a wide moat, but if it’s not improving, that’s a business we’re going to sell from the portfolio, and certainly, we want to avoid any businesses where those moats are contracting – that’s where you tend to get value traps and destroy a lot of capital.
So, that’s point number one, and point number two, which is very much aligned and supportive of that moat trajectory, is this notion of corporate culture. If you’re going to be a long-term investor in these businesses, like we are at WCM, people really matter. Who is leading the organization matters. How people are incentivized and energized, how they are aligned with the strategy of the business to grow its moat really matters over time. If you’re trading in and out of stocks every six months there is no need to pay attention to culture, but if you want to find those relatively rare companies that can defy the expected fade and sustain growth at higher rates and for much longer than people expect, the culture and those qualitative elements are a huge driver of that. I think it’s apparent in sports teams. It’s certainly apparent in businesses, but we have a pretty exhaustive process and framework for assessing culture in that context. So, those would really be the two biggest distinctions about our approach.
MS: Jon, thank you, and we mentioned in the intro that a number of the listeners today or the attendees on the webinar would be familiar with the successful large cap strategy that we’ve been distributing in Australia now for some time, that there is a fantastically performing small cap strategy, so we wanted to focus on that today. Can you sort of give us your outlook for global small cap stocks and a way of seeing opportunities at the moment in that space?
JT: Our outlook is quite optimistic. There is so much change happening in the world, I mean, the rate of change because of things like technology, because of rising wealth around the world and so on, is creating a lot of opportunity for a lot of companies, and oftentimes, a lot of the most disruptive companies or the big name companies of 10 years from now are small caps today, and so we’re seeing an abundance of opportunity. I would say, most poignantly, I would highlight technology, healthcare, and some niche industrial businesses.
In the case of healthcare, we’re just seeing an explosion of healthcare spending in large population, emerging market countries. We’re seeing aging populations around the globe demanding more healthcare, and there’s a bunch of really exciting companies in small cap playing in that space. Technology, of course, is another area that we just see a plethora of opportunities on a global basis. I think, going back in time a lot of new technology on the innovation side happened in the US. It’s a much more global phenomenon now, and in the small cap portfolio, we can find companies that maybe dominate a certain segment of software, enterprise software, or digitalization, but maybe in a smaller geography, or maybe in a more niche application, but they’re every bit as dominant as a large cap company.
I think I’d be remiss to not acknowledge some of the companies that maybe have been depressed during COVID the last 15, 16, 17, however many months, but really are poised for recovery and that could include some travel stocks. There’s a business, Wizz Air, which is the leading low-cost air provider in Eastern Europe, a fantastic business. Their advantages, because of their cost structure, low cost structure, have only grown. On others it’s been a tough year for the whole industry, but they’ve been able to take some offensive moves, given their strong balance sheet and given their superior cost structure and model, to come out of this pandemic, we think, with a lot more market share, for example. So, it’s really widespread, Marty, but those are just a few ideas.
MS: One of the views of the firm is that quite often in the small cap space, the best opportunities are actually outside of the US. Can you just sort of talk to that a bit?
JT: Absolutely, and it goes at a little bit of what I hinted at, which is a lot of our holdings are really dominant businesses getting stronger, but maybe they’re selling to a smaller market. In the case of Wizz Air in Eastern Europe, a much smaller market for travel than the US. The same can be said about enterprise software, medical testing, supplies, tools, things like that. In the US, I mean, it’s such a big market on its own, you’re not going to dominate any sizable market in the US as a company and be a small cap, but that’s not the case in many European countries, Latin America, Asia.
MS: What are some of the key differences between the large cap portfolio and the small cap portfolio?
JT: A couple of main differences: financials tend to be a larger part of the large cap global universe because by definition most banks tend to be a scaled business, so you need a certain scale to be a relevant player. So, you have more of those and bigger constituents in the large cap universe, so we tend not to do a ton in banks. There are some exceptions we make, so I think we’re maybe less underweight in financials in small cap because it’s just a smaller part of the benchmark naturally. The same could be true for energy which is another kind of scaled business we tend to be light in. We’re not as distinct there. But the key one I’ll mention, though, is we do run with a few more holdings in our international small cap. It’s still relatively concentrated, but a bit less, so just because of the abundance of ideas. And so, we’d rather diversify a little bit more because the difference between our 25th and 26th or 30th favourite idea in small cap isn’t that great, whereas in the global space we tend to run closer to that 35 number of names, and beyond that, it gets a little bit harder to find the same level of conviction. That’s not the case in small cap, so we do, again, run just a few more holdings there.
MS: Jon, you touched on it at the start of our conversation, but just sort of getting back to this, the concept of downside capture and it’s been a hallmark of the firm’s success. Talk us through how this works and how you actually achieved this.
JT: That’s the key question, right? I don’t think there’s an investor out there who wouldn’t want to have good downside protection, but the tricky part is, of course, doing it with any consistency. So, I’d say, probably the least relevant, but I’ll still mention it, factor in that is we do invest in a very kind of high-quality universe based on balance sheets and financial statements. That’s not unique, but it does help when many of our holdings have net cash on the balance sheet, they have no debt. That tends to be a favourable trait in periods like the first quarter of 2020, right, when there’s concern about solvency and liquidity for a lot of businesses in the marketplace. If you’re net cash you just kind of, by definition, have a pretty big advantage, and investors are more comfortable and maybe a bit less panicked in some of those names and periods of distress. So, that does help some. That’s probably the least significant factor of the ones I’m going to mention.
More significant, I think, is that work around moat trajectory. We talk a lot about, in this industry, finding great investment ideas. How do you find that next great investment? It’s all about kind of the buy, when do you buy, how do you find them? I think the thing that’s much less talked about, but every bit as important, and frankly, is a lot harder to get right, is when do you sell a stock? That can be a really challenging thing because you don’t want to flinch at shadows and get spooked out of a great growth story too early based on maybe one tough quarter of earnings or a bad headline. You don’t want to get spooked out if there’s a lot of runway left. At the same time, you don’t want to fall in love with your businesses and keep owning them if they’re no longer getting better, and I think that’s the lament of the growth investors. You find a stock you like, you buy it, it goes up, you fall in love with it, and maybe you ride it back down later on.
So, knowing when to exit these companies is of paramount importance, and our sell discipline is quite simple. It all goes back to that framework around competitive advantage change. Once we can no longer make the case that a competitive advantage is still expanding, still getting better, we’re going to sell the stock from the portfolio. I think that’s quite a bit different than the conventional wisdom, which teaches us you maybe sell once the moat gets breached. In our experience, by the time it’s obvious a company has a competitive issue, the stocks are already way down. So, I think maintaining that sell discipline around the moat has to be strengthening or we sell has helped us be earlier and better sellers of stocks than many.
And then, the last point is portfolio construction. Yes, we’re a growth manager, yes, we’re fairly concentrated, but we’re intentional to have a balance of revenue exposure to different parts of the world, different currencies, different industries, exposure to different tailwinds. We have a mix of some defensive growth companies, some secular or rapid growth companies, and some cyclical growth companies. So, we really try and build the portfolio to be fairly all-weather in nature, which prevents us from being all tech all the time, which is great when tech is working, but that cuts both ways. So, having some real balance in those different types of growth profiles has been important, and the last thing I’ll mention is a big portion of our turnover comes from adding and trimming to existing holdings based on valuation. So, we have stocks that appreciate a lot in a short period of time. If our thesis is still intact, we probably won’t sell it, but we’ll trim the position way back, and then we’ll take those proceeds and put them into other parts of the portfolio that perhaps haven’t been doing as well, but where we still have a lot of conviction long term. So, being prudent with trimming back the winners and reallocating that, I think, has been another contributor to the downside protection over time.
MS: And the important point just to really highlight is that these results have been achieved without going up or down the cash. You’re fully invested throughout the process, aren’t you?
JT: That’s correct. We stay fully invested, which means 5% or less cash all the time.
MS: Jon, could you talk us through some of the stocks in the portfolio, how you found them and why you liked them, a couple of examples?
JT: Let’s bring it to life a little bit. The first one I’ll talk about is a Danish company called Royal Unibrew, and this is one that we purchased in March of 2020. They’re one of the largest brewers, beer producers in that region. Fantastic products, but as you can imagine, with COVID happening and all the pubs being shut down, the market was panicked that their sales were going away and the stock came under a lot of pressure, and I think what the market didn’t realize is they still have a very large percentage of sales that go through store channels, so they were able to still generate plenty of revenue, and they’ve been able to position themselves really well for when things do reopen. And it’s a company that’s got great brands, high quality, there’s premiumization going on, and it’s been able to really maybe go on offense in the last 15, 18 months, when some of their competitors, who aren’t as well connected, don’t have the same resources, are going away a bit. So, this is a great example of a company that has a large market and is positioned really well as we start to see a bit of a recovery.
MS: And another company that’s of interest?
JT: I’ll go from beer to IT services, and specifically IT outsourcing, with a company called Globant, which is based out of Argentina, and this is a key enabler of digitalization, whether it’s social, mobile, analytics, cloud. As corporations continue to go through a digital transformation, which is really a global phenomenon, it was happening before COVID, it’s been kicked into overdrive, this is a company that has great relationships with many of the leading companies around the world, and they’re able to leverage a very highly skilled, but lower wage, employee base that live in Argentina and other countries and serve many of the largest companies in the United States, in Europe, and on a global basis. They’re able to scout engineers at the top schools in these regions, and it’s a company that, again, it tends to be a very sticky relationship because once they get entrenched with these corporations, they’re helping them migrate to the cloud, they’re helping them with their security, they really own those relationships and are a key enabler of more technology advancement. So, as long as you believe technology is going to continue to proliferate more and more business, this is a key enabler of that, maybe without having to pick who’s going to have the software solution this year.
MS: Jon, that’s all we’ve got time for today. As always, thanks for your time and look forward to talking again very soon.
JT: Me too, thanks, Marty.
MS: Thank you for joining us for today’s webinar. As a reminder, due to strong global demand, the Fund is expected to close to new applications by June 30 or the end of this quarter. The Fund is available to wholesale investors only. If you’d like to invest or learn more, you can call us on 1300-001-750, you can email us at [email protected], or you can go to our website, contango.com.au. Thanks for joining us today.
DISCLAIMER: Past performance is not a predictor of future returns. This update has been prepared for information purposes only. Any figures provided in this document are unaudited and approximate. This post does not contain investment recommendations nor provide investment advice.
You are strongly encouraged to obtain detailed professional advice and to read any relevant offer document in full before making any investment decision. This is not an offer to invest in any security or financial product.
© 2022 Contango Asset Management Limited.
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