WCM Investment Management (WCM) believes that corporate culture is the biggest influence on a company’s ability to grow its competitive advantage or ‘moat’. This idea is the ethos of WCM and its investment process. While this is a simple concept to grasp, knowing how to identify a healthy culture is much less straightforward.
During this live webinar, Contango Asset Management’s Head of Distribution, Andrew Aitken spoke to WCM’s Business Culture Analyst, William ‘J.B.’ Horner, and Client Portfolio Manager, Brian Huerta and discussed how corporate culture can impact the direction of a company’s competitive advantage, how to identify companies with cultures aligned to their economic moat, and provided an update on the WCM Quality Global Growth Equity Strategy.
Andrew Aitken: Thank you for attending today’s webinar. My name’s Andrew Aitken from Contango Asset Management. Today, we’re going to be hearing from two portfolio managers from WCM Investment Manager. They’re both based in Laguna Beach today, which looks a lot better than where we are here at the moment, and they’ve probably got their freedom as well. I’ll introduce you to Brian, who is a Client Portfolio Manager. Hello, Brian.
Brian Huerta: Hi there, Andrew.
Andrew Aitken: Also, with him today is JB Horner. JB is the star of the show today. He’s the Culture Analyst that’s worked with WCM Investment Management since 2014. It’s quite a unique part of the investment process that not many other managers around the world would talk about culture and habits. So, embedded in their process as WCM do, and that framework was really helped developed by JB. So, we’ll be talking to him in a lot of depth later in this webinar. So, welcome JB.
JB Horner: Hi Andrew, thanks.
Andrew Aitken: Just a reminder to everyone this is an interactive webinar. If you’ve got questions, send them through and we’re happy to ask the guys at any stage during the webinar. I’ll just briefly introduce the investment manager of the WCM Quality Global Growth Strategy. This can be accessed in Australia via an LIC also by an ETMF (exchange traded managed fund). We also have two PTs unitized trust – one is unhedged to currency and the other one is hedged. So, they’re the access points for the strategy that we’re talking about today in Australia.
I’m just going to start with Brian if you don’t mind. Brian, just to give us a bit of an introduction to WCM, its history and how you go about investing.
Brian Huerta: Sure, I’d be happy to and thanks everybody for tuning in today. As mentioned, I’m Brian Huerta, one of the client portfolio managers. Just to give you a little bit of a background on WCM, WCM is based in Laguna beach, California, probably one of the places you’d least expect to find a money manager. We’re just a stone throw away from the beach here, and that’s partly by design. If we get a chance maybe towards the end, we’ll talk a little bit about our choice of the location.
We’re known for being quality global growth investors. We have quite a long history of identifying stocks and investing in them for the long haul. We’re a stable team as well. We’ve been around for some time, and the portfolio management team that is overseeing this strategy has been working together as a cohesive unit for more than a decade now. One thing they do say is we do our own cooking here. Most of our portfolio managers and the employees here invest their liquid net worth in the funds is as well. So that’s a little bit about WCM and our background. I’m happy to talk a little about the global growth strategy as well. Andrew, would you like me to kind of launch into that?
Andrew Aitken: Please, please.
Brian Huerta: Well, it’s, the portfolio that we’re really excited to talk about. It’s our least constrained strategy. There are just literally thousands of stocks that we can choose from. We’re looking for those special companies that have a proven ability to expand their competitive advantages and are supported by healthy and strong cultures. They also need to meet our strict criteria of quality. So again, it’s one of our least constrained strategies. It’s one that a lot of the portfolio managers, the analysts, and the employees of WCM all invest in as well. It’s a high conviction strategy. So, we’ll talk a little bit more about the philosophy in our process and how we go about the markets, but it gives you a little bit of sense as to what we’re looking for and what’s available to us in managing the strategy.
Andrew Aitken: One of the unique things for me has been your discussion around many managers talk about just an absolute moat and looking to promote and a company, of course, that’s well understood. Can you talk us through how you look at that differently?
Brian Huerta: I guess maybe just to start, just to define what a moat is. It said that a body of water that protects a business or its fortress, is cash flows and it helps compete. Keep the competitors at arm’s length. It’s a concept that Warren buffet started maybe in the 1990s. We certainly followed that idea around economic moats, but as we started to grow and evolve, we started to realise that also has some limitations and quite frankly, some weaknesses in just looking for companies with wide economic moats.
So, we’ve taken it up a notch we’ve even added another filter to it and are looking for companies that we think can expand their economic moats that are growing their competitive advantage over time, over five years or more. The focus is not what the company is doing now or what they’ve done in the past, but what they’re going to do in the future. We spend quite a bit of time understanding business models, business types, and how companies reinvest in their business to get stronger over the next five years. So, the bar is quite high. We’re looking for a low single digit percentage of companies out of those thousands of stocks that we choose from that can meet the strict criteria. That’s a real important part of our understanding, competitive advantages and whether a company is exceeded and able to expand them.
It makes intuitive sense, right? Our view is that the competitive environment is always changing. It’s quite dynamic, and companies are either getting stronger or they’re getting weaker. Companies that lose their competitive edge often suffer. I think everyone probably on this webinar could relate to buying a growth stock and seeing that company lose their competitive edge and being on the wrong side of what we call that moat trajectory, that competitive advantage that’s starting to slowly decay. It could be quite a painful ride. So, we’re explicitly trying to avoid those companies that might be vulnerable with respect to their economic moats and only look for those companies that we can have confidence that are going to continue to expand their competitive edge.
Andrew Aitken: We’ll get to the other unique parts of the process in a second. But that idea of moat, obviously that’s come from somewhere in a bit of the history in regard to what the business did previously and has it always. I suppose, I’m leading towards, hasn’t it always looked at just expanding markets and why that came to be? Maybe if you’ve got some examples of stocks.
Brian Huerta: Sure. We quite truthfully, Andrew, we’ve learned the hard way over the last couple of decades by investing in companies that simply had wide economic moats. I could give you some examples because they’re very easy to relate to. In the early to mid-part of 2000, we were buying certain technology stocks. Companies like E-Bay over Amazon or Dell over Apple, Yahoo versus Google. The companies that we invested in had wide economic moats but underneath the surface, they were losing their competitive edge and losing out to the three companies that I’ve mentioned. We were gaining competitive edge, but it wasn’t so clear if you take a step back and you look at which companies are growing, their competitive advantage, it was Apple, it was Google, it was Amazon. So, making those three bad decisions almost buried this firm. The results could be very painful if you stick to just looking at wide economic moat businesses, that’s been our experience. We’re really looking for companies that we have confidence that can expand those competitive advantages.
Andrew Aitken: I think that’s worth noting that this business over the history of 30 years has made all the mistakes, but happy to recognise it. We’ll talk about that later in regards to the culture and the culture inside the firm. Can you talk about the other unique side of the process?
Brian Huerta: Well, I won’t steal the thunder for JB, but a big part of our process in addition to looking at widening economic moats is this idea around culture. This is just some recognition that the people matter and the people who run the business, who make the decisions matter a lot and culture is the set of values that help drive behaviours. It’s the way things get done, and it’s not just simply about the numbers, but it’s about the people. When JB comes on, we’ll talk a little bit about our process, what steps are involved in looking at culture and the framework that we apply and the reasons why some of it is intuitive, right?
We know that companies that have strong cultures or if there is a strong culture, people tend to behave differently. They think about all stakeholders, they tend to approach their jobs differently, with more energy, they’re not just thinking about what my job is and what is the next job that I might be able to get from this. There’s just a different mindset at a culture. When you’re investing for the long term, like this fund does, we’re again, looking for companies that have very low turnover that we think it’s going to grow over five years. Culture makes a huge difference. If you’re a year-to-year investor, maybe you don’t need to consider culture, but if you’re a long-term investor, you’re really looking for phenomenally great companies as opposed to the merely good companies, and culture makes a huge difference.
Andrew Aitken: Well, on that note, we’ll hand over to JB. I think that’s this idea of culture, how you measure it and how it fits into a process is really interesting because it is unique. I’ve never seen it before. I know that you guys are looking at Laguna Beach, WCM talk a lot about, valuation and return on invested capital – those sorts of things that are just ‘tickets to the dance’. This culture and expanding moat idea are how you can measure a company that goes from being a good company to a great company.
So JB, on that note, I’d like you to just introduce us to how it was introduced to the firm, this side of culture. When you joined back in 2014, I believe it hadn’t been developed at that stage. Do you mind just taking us through that journey?
JB Horner: Sure, absolutely. Brian alluded to it briefly, but I think it’s important to kind of discuss what culture is. One of my favourite interactions we’ve had with the manager is with Evan Greenberg from Chubb Limited and beforehand, we knew that he was a very culture-focused CEO. We had read plenty on his views on culture. We were very eager to talk to him about culture. So long story short, we jumped on the phone with him and as we started to ask about culture, he kind of pauses and said, so let’s back up for a second. He says, everybody talks about culture, but what the F does that really mean? I think that that’s kind of an important thing to talk about.
So, the kind of the definitions we’ve settled on is really culture has a common set of norms and values that kind of guide behaviour within an organisation and behaviours is really the operative term. To get back to the idea of moat trajectory, we’re always framing culture within the context of the investment thesis and ultimately within the context of moat trajectory. When we think of culture, we think of what behaviours are being driven and to what degree are those supportive of expanding moat trajectory and how we kind of got there. I mean, the interest in culture at WCM definitely predates me. I think the earliest incarnation of it was really just in the insight that culture was really instrumental to the health and performance of WCM itself. There was the natural insight that, ‘hey, if it matters here, it probably matters in portfolio companies as well’. That initial insight is spot on there. In the earliest days there wasn’t a lot of probably sophistication, in terms of how culture was thought about. I think over time, the PM, Mike Trigg, Pete, Sanjay and others started to develop a bit of an intuitive sense around what to look for in management teams, what to look for in culture, what are some patterns between companies that tend to do well over the long-term versus those that don’t from a cultural perspective. I would kind of call that maybe stage 1.0, of the culture journey as it relates to investment process.
Stage two started more in the 2015-16 timeframe. At that time, it was clear that there was a lot of interest in doing more on culture, but as a small team, there was limited bandwidth to really push the kind of framework for it in the way that we really want it to. Just a testament to WCM’s own internal culture, when I proposed some ideas around ways that we might be able to improve our thinking on culture, I didn’t know how it’d be received, but a PM or someone else might kind of run with the idea. They just turned around and said, ‘okay, go do it, go chase it, go chase these ideas’. It was really a free license to explore what was out there.
The most obvious insight from that whole process was that there’s been a lot of good research done within business schools all over the world. Also, with thought leaders and such that had been thinking about culture in a more disciplined way than us for a lot longer. There was a natural opportunity to bring those insights into the organisation. The most pivotal of those relationships was a relationship with James Heskett. He’s a retired HBS (Harvard Business School) Professor down in Florida. He’s still very active and actually he’s 88 now. He has a 200-300 page book coming out in I think, a month or two. Quite a spray character, an incredibly sharp thinker when it comes to culture. What really intrigued us about Heskett’s work was some of the first that we had seen that explicitly tried to tie corporate culture back to financial performance, getting back to this idea that culture’s perceived as a very soft and fuzzy kind of ephemeral concept. I think he did a very good job of realising that if it was going to be taken seriously by business leaders, there needed to be a clear route to the bottom line. Through that process and working with Heskett, we both created a more robust rigorous framework around how to assess culture across different companies so that there was some consistency and with as much objectivity as you can hope to have, as well as experimenting with creative ways of both sourcing cultural data. You can’t look it up in most companies’ filings, there’s a glass door and such, but there’s all the issues with those sorts of sources. What we also realised early on was really the key to doing good culture research is understanding the right questions to ask and most importantly how to ask them. That’s been an ongoing journey and more recently, I think we’ve been able to benefit from having just a lot of repetitions of doing cultural analysis of companies and improving a pattern recognition standpoint and arriving at some of our own markers. What makes for an effective culture versus a dysfunctional culture that may go beyond what’s available in the current academic literature, for example.
Andrew Aitken: I’m the CEO of a company, you guys come to visit me. When you ask me, what’s the culture like, I’m going to tell you it’s really good. It’s fantastic. So, how do you get around that? And how do you frame the questions?
JB Horner: This was like that early work I spoke about with Heskett. This is one of the challenges – how do you knock CEO’s off their canned talking points? Most people who become CEO of a good-sized public company are going to be very articulate, able to think on their feet and are honestly pretty good at dodging questions just to be frank. One thing that we realised was that you have to structure your questions around elements of culture that really do trace back to performance, otherwise what are you doing? In terms of how you ask them that is the secret sauce of kind of getting beneath the surface level, beyond vision values that you can look up on a website, for example, and really understanding how people are making decisions and behaving within an organisation. They have to be approachable if you come out and with these overlay academic theoretical questions, you really don’t get anywhere.
So, if you were a CEO and we’re going to talk about culture, something I may ask you is, let’s say a friend’s son or daughter who is starting tomorrow at your company, you’re grabbing coffee with them in the morning, what would the advice be that you would give them to help them be successful in your organisation? Advice that goes beyond the typical, work hard, those sorts of pieces of advice that are common across any company. If you were to give them the inside scoop on how to be successful within your company in particular, what would you say? We have a whole laundry list of those sorts of the questions. Another thing we love to knock people off their canned talking points is, what’s the biggest mistake you’ve made in the last couple of years? Then we can get into a lot of follow-ups on that, like what learnings came out of it, things like that. I think those were very straightforward, slightly kind of out of the box questions. They’re pretty helpful.
Andrew Aitken: That’s good. I’d probably say at the moment you have to be really efficient at home-schooling to work.
So, I’m in China or I’m in India. Am I judged by the same set of cultural standards when you’re investing in a firm there and a company as the United States or Australia, for example? How do you work out what’s appropriate, and maybe that’s just company to company, but if you can explain the that cross-jurisdictional?
JB Horner: It’s a great question. You know, running a global portfolio, it’s something we run into all the time. I think a good way to think about culture is it’s easy to become optically focused on a particular company’s culture, but you really have to understand it within the umbrella of the national culture and potentially even the regional culture or the culture of that company’s industry.
I don’t have any precise figures around this, but I wouldn’t be surprised if 50 to 60% or more of a company’s culture is actually more a result of the national culture or industry culture. Even though I think people within the organisation, it may be difficult for them to see that I think it’s oftentimes the case. There’s a lot of complexity there, obviously. One way, that’s one of the advantages of having a lot of repetitions doing a lot of different cultural workups on companies, as we are able to spot patterns over time and develop a benchmark understanding for what does a typical French culture look like? What does a typical Indian culture look like? A typical Chinese culture look like? What are some of the common issues inherent in companies that are operating within those countries from a cultural perspective? That’s part of it, but there’s a lot of complexity there.
I think one way to bypass that is to get back to the root of it, is the culture effective? Even though we don’t have a great basis with an Indian culture, for example, when we’re out talking to former employees, who’ve worked at these companies, we can essentially lean on their understanding of the culture and the effectiveness of it. That’s kind of a way to bypass, I guess, some of the murkiness you might encounter if you’re trying to assess a company in a foreign country that you may not have a lot of familiarity with. Leaning on people on the ground who do know the national culture well. It’s not a perfect science though. That’s for sure.
Andrew Aitken: I’m going to get a couple of questions because we’ve got some interesting ones from the floor. This is from Peter Griffin; how would you describe the culture in WCM?
If we go back before, I think there was a quote, ‘we eat what we cook’ in regards to PM’s and employees investing in the fund. Do you ‘eat what you cook’ when it comes to culture?
JB Horner: It’s a fun question. If you did dive into academic research on culture, there’s a principle that essentially you can’t understand a culture that you’re a part of, but to the classic thing where there’s some parable of two fish swimming along, somebody mentioned something about water and they both go, ‘what’s water?’. That being said, the culture at WCM, at the core of it, our core values are kind of fun and gratitude at a surface level that may seems a little bit fluffy, especially if you know that we wear flip flops and are in Laguna Beach. If you penetrate below that, Mike Trigg in our team wrote a piece about this, it’s essentially the other stuff. There’s a lot of things about the WCM culture that I think are difficult to understand either by reading the core values or the casual conversation. At the core of it, I would say would be, we talked about it a bit, not to get kind of too lofty, but it’s really a platform that I think has done a very good job of getting the most out of each person. It’s a bit hard to articulate, but I think there’s a real energy here around people understanding the uniqueness of the opportunity that they have to learn and grow within the organisation and take on more than honestly, they’re probably qualified to do.
When I started in this role, I had a lot of background interest in culture, but no real formal qualifications. That’s pretty common if you look across the whole organisation, people have fairly eclectic backgrounds. I think we pride ourselves on being a little scrappy and unconventional, and I think driven a little bit of an edge. This predates me, but there’s probably a chip on our shoulder from way back when we were taking this seriously by certain institutional investors and such.
I would sum it up as a scrappy irreverence, a little bit gritty, but at the end of the day, it’s incredibly relationship based. I think there’s warmer relationships here than I’ve seen at any other company and I’ve adapted to those kinds of relationships. It’s very common to for people to have their core group of friends also be at WCM. It helps that we’re in a fairly isolated area in a way. I would say relationship-based, scrappy, irreverent, and a strong sense of gratitude for the opportunity that we have.
Andrew Aitken: Just get just finalising on the culture, do you mind give us a couple of examples perhaps of a stock that has gone from good to great or is great compared to its peers because it has a culture that really stands out, perhaps?
JB Horner: It’s funny, the challenge has been deciding which one to speak to, given how much of a cultural focus there is in the portfolio, it’s almost like a who’s who list of great cultures in the world. I’m biased, but I think so. I would say a good one to think about is one people in Australia maybe familiar with. I don’t know how familiar people are with Shopify. We referenced this one quite a bit, but it’s hard not to just given how exceptional of a culture it really has.
Shopify started as a snowboard store. The founder was told that his e-commerce plugin that he built for his snowboard shop online was far more valuable than selling snowboards, but that’s another story. I think that really the interesting thing about Shopify, that has given us confidence to underwrite it in a very meaningful way at very significant or very kind of lofty evaluations, really comes back to our faith and the adaptability of the organisation.
When I mentioned earlier that we worked with Heskett to development framework around culture, something that was quickly apparent in the empirical studies that have been in culture are the words of adoptability. In a simple sense, it’s to what degree is a company attuned to changes when they occur in an external environment? Things like changing customer preferences, or maybe changing regulations, maybe a changing competitive landscape. Then two, do they have the internal flexibility and agility to mount an effective response to that change? It’s reflected both in terms innovation and process improvement and strategic pivots, if you will.
At every chapter in Shopify story, we’ve watched as it went from a snowboard shop to an e-commerce plugin to today – they have payments, they’re going into logistics. When we look at each stage in that process, the organisation has basically been reshuffled to optimize it around, whatever the most urgent priority is for the company at the time. Something the co-founder and CEO Toby likes to talk about is this concept of being anti-fragile, with the sense that the only way that a company is going to last over the long-term is by being flexible, by being adaptable and really optimizing around not just the opportunities it has directly in front of it, but really as he puts it, finding the absolute maximum of the opportunities. So, they very easily could have stayed a snowboard shop, they realized that the greater opportunity was in e-commerce – they could have stayed there and done that. They also realize that there are adjacencies in terms of payments, and they executed incredibly well going after those opportunities. It’s the cultural insights coupled with the proof in the pudding of actually saying execution follow suit that allow us to essentially maintain confidence in the ability of that company to continue to perform.
Andrew Aitken: I’ll just ask you one or two more questions before we go back to Brian, where we’ll get a bit of a summary on the current outlook and the portfolio, and maybe a couple of stock examples that we can talk to. But in regards to who you speak to, to CEO’s, to ex-employees, what sort of different channels do you go down?
JB Horner: I wouldn’t say it’s super proprietary, a little bit of it is, but I think we found a lot of value in speaking to former employees. There’s a little bit of nuance to who the best people are to talk to about culture, but in an ideal scenario, we do a lot of background digging on our culture with former employees and through other means. We then take that background understanding into our CEO meetings that are focused on culture. So oftentimes we’ll do it an hour focusing solely on culture with the CEO.
To your question earlier, how do you knock these CEOs off their canned talking points, If you come in armed, I mean, we’re not adversarial in any way at all, but if you come in armed with a very deep understanding of the culture, the history, why things are the way they are, as well as the real issues that the company is facing on a go-forward basis, that forces a level of candour that I don’t think you’d get otherwise. In the CEO’s mind, you can almost see the switch flip over, they go ‘okay, these people clearly know what’s going on inside the business. It probably wouldn’t be a great idea to B.S them’ for lack of a better term.
Andrew Aitken: Just because we’ve got a couple of CEOs, managers, and leaders on this call, I suppose many just look after their small business.
What are the books? I think you mentioned James Heskett previously was someone that you’ve listened to and has helped you on the journey. Are there any books out there that some people should refer to?
JB Horner: Yeah, I’ll say more authors. I liked Charles O’Reilly a lot as well. He’s at Stanford, he’s done a lot of stuff around innovation, adaptability, and culture more broadly. Heskett’s book ‘Win From Within’ comes out in a few months. He also has one called the ‘Culture Cycle’ that I think came out in 2012 or so. That was a great kind of overview of it. I’d probably start there. I’m sure others will come to me.
Brian Huerta: Maybe I could add something there too. One thing that we’ve learned over the years of just studying some of the investment greats, like the Warren Buffet’s, the Phil Fisher’s, the Charlie Munger’s of the world is when you think about some of their success and what they say, they often refer to the qualitative aspect of their approach. We’ve learned so much from them, not just the academics, but the actual investors that we’ve learned, it’s so much more than just doing a DCF, but getting into the weeds and understanding the people who run the business.
One book I think that was published in the Fifties or Sixties, from Phil Fisher, ‘Common Stocks and Uncommon Profits’ that really lays out this checklist of 15 or 20 or so items – more than more than 10 of them highlight qualitative aspects to a business as part of that checklist, which says a lot to us. If they’ve been so incredibly successful and some of these lessons are absolutely timeless, there’s just a lot to learn from listening to them because they certainly will share their thoughts around that. I think Charlie Munger and Warren Buffet are prolific and reminding investors that sometimes the fallacy of just making it all about the numbers and less about the people.
Andrew Aitken: While I’ve got you Brian, we’re going to come back to you, getting a few questions around what I would describe as sort of macro views that the company might have, and I think that’s probably a good time for you to discuss your views on just macro analysis, the top-down work and how your experience has been. There’s always a question about interest rates or things of that nature, but how that is taken in consideration in your process.
Brian Huerta: It’s a great question. We try to stay macro aware here at WCM, but in our own experience and when we may have our portfolio manager meetings, if macro comes in and starts dominating the discussion, that’s usually when we just kind of call the time out. What we really want to focus our attention on are the companies that are doing the bottom-up fundamental analysis. In our history when macro has driven our decisions, we’ve made bad decisions. It’s taken us down the wrong road.
Our approach really is to identify those companies that can continue to grow, expand, and maintain their competitive edge through any cycle, whether it be geopolitical, or macro cycle, rate cycle, we’re specifically looking for companies that we think can withstand some of those forces. We like to stay macro aware, but we don’t want it to drive our process. We’re looking for companies again, that can fight those pressures of macro.
Frankly, we’ve used macro as a good timing tool in the sense that when people are very concerned about macro, when it’s led to an across-the-board derating of a country or group of stocks when it’s led to indiscriminate selling. We’ve used those type of events to upgrade our portfolio. We have some examples of doing such things in the last decade or so when Brazil, for example, was under a lot of pressure. We went to Brazil and met with a bunch of companies to find those individual enterprises that are focused on driving value over the next 5 to 10 years. That’s part of how we found MercadoLibre, one of our most successful investments as a firm. That’s just one example of us using macro, perhaps to our advantage as a timing tool, as a place to enter stocks.
Andrew Aitken: On that note, I’m going to ask you a little bit of about MercadoLibre. If you could give us a bit of insight into that company and why it’s in the portfolio. I suppose that leads into another question that’s been asked here in regards to COVID, and the fact that the team has found it pretty tough to travel. I know you haven’t been out to Australia in the last 12 months, which sounds like it’s disappointing everybody over there, but how has COVID affected your ability to get down and talk about the culture, understand the expanding moats, understand companies?
Brian Huerta: I’ll address that first. You know, the borders are off. We aren’t able to do international travel like we have, but there’s been some benefits from that as well. The companies themselves aren’t traveling so our access to management teams is better than it’s ever been before. Having us all together, mostly virtually, but also on occasion here in the office, collaborating together, it’s made it quite easy because people are spending less time on planes and things like that, attending conferences. I think we’ve also been able to dig deeper into different resources that we didn’t have the time to dig into before. So, broaden our number of contacts or scope of contacts. We think we’ve gotten better too, with the types of questions that we’ve been able to ask over virtual Zoom presentations or over the phone. I think we’ve taken advantage of the situation as best as we possibly can, but we are looking forward to getting back out on the road. There’s nothing that does replace face-to-face interactions and we’re all dying to go to Australia.
Andrew Aitken: We’re looking forward to having you down here, got quite a cast on today and prefer to see when inside an auditorium somewhere.
Just a general outlook and portfolio position in relation to sectors and countries, et cetera, if you want touch on that?
Brian Huerta: A really well-balanced portfolio. We invest across the entire growth spectrum, if you will. We have companies that are growing mid-to-high single digits all the way up to 50% or more – that’s by design. It’s diverse from a geographic perspective. We have great companies in Europe and Asia – just the entire Asia region and Latin America and of course, here in the U.S. about 50% of our portfolio is in U.S. companies currently, which is still well below or a few hundred basis points below the benchmark.
We’re excited about what we own, and we have a really full pipeline with some really exciting stocks. We’ve made a couple of additions to the portfolio. We’ve trimmed a few of our winners recently. We like where it’s positioned. Our focus is always the primary criteria is around quality. The quality of the portfolio that we have now, a couple of stocks that I can mention that we added to the portfolio in the first half of the year, a company like Integris, which is a niche supplier to the semiconductor industry, essentially has two main businesses, applying different gases and liquids on top of semiconductors that it gets etched away. It’s really important as the industry moves to leading edge. So, seven nanometre and below, when you get to the leading edge, just the complexity increases and their content per wafer increases. So Integris we think is really well positioned to help solve this chip shortage, but also help these companies achieve the yields that they need to get from the manufacturing at the leading edge.
A company like Evolution, we added to the portfolio, really excited about this stock. They make live casino content for operators. They’re supplying the studio, generated gaming entertainment with live dealers that so players can interact directly with the dealer and with other players. They really are the only one that is able to do it with any scale, with highly well-done studio content that scales very rapidly. They’re growing in Europe, America and also in Asia. It’s a beautiful business model with nearly 70% EBITDA margin.
We’re excited about what some of the new additions that we made to the portfolio, but the focus is always around making sure that we have the highest quality ideas. Of course, just managing risks, which we do through portfolio construction, but also some mechanical limitations too, around the sector and industry exposure, as well as position size and country.
Andrew Aitken: Well, I’ll take it one more question from the floor here, which is around trimming winners. Is the reason you trim is to maintain a balanced portfolio? Do you tend to turn over the portfolio a lot that new names pop in and out of the portfolio? What can we expect from that?
Brian Huerta: This is a lower turnover portfolio. We generally have anywhere between 25 and 30% on average turnover of about a third or up to a half is just adds and trims. The actual turnover is actually quite less. It might be closer to 15 to 20%. We really have a long-term perspective when we make investments, investing over five years or more. So that’s how we approach turnover.
How we think about adding and trimming, we have an upper limit of 10% but we never get there. Typically, if a position gets to about 5 to 6%, we’re paring it back so long as the competitive advantages are continuing to expand, the company is continuing to get better, we’re likely to trim back or pair back that position but keep the stock in the portfolio. Some of our best decisions have been to own a stock but manage the position size. We don’t want a position size to get too big, because that could be a real distraction to the portfolio managers, and it could add more risk and volatility to our fundholders. There are other reasons too why we like to keep an upper limit of about 5.5 to 6% because we don’t want that to happen. That could just take an outside portion of our PM’s attention and incurs additional risk for the portfolio as well.
Andrew Aitken: Once again, another questions just come from the floor, and this may be either you or J.B, can you provide an example of a holding that experienced an adverse change in culture and caused you to sell the position?
JB Horner: Oftentimes there’s other factors that contributed to it as well. When we were involved with Under Armour, culture definitely factored into that decision. Essentially what was going on, and it’s a common challenge that we see fast-growing companies encounter common growing pains, was the style of leadership. To put it more bluntly, there was a lot of micromanagement going on. What we saw was a failure for the leadership team to outgrow that style. It worked okay when they were principally going after U.S. consumers of sports apparel. So, wicking base layers for football players, for example. The management team knew that audience really well because a lot of the management team were actually former college athletes, college football players themselves.
Where they starting to run into trouble, as part of our investment thesis really hinged on their ability to go into footwear, go into lifestyle or leisure and to international markets in more meaningful ways to provide a platform for future growth and to help diversify the business. The problem with this is, what we didn’t see happen was actually hiring some good external people with experience in these areas. I think most notably story I came across was they actually plucked away a few really talented footwear designers from Nike. People in the industry thought it was like a coup, that was unheard of.
So that was a positive marker, if you will, in terms of their cultural journey and trajectory. We were looking for them leveling up and scaling the culture and the talent to essentially enable them to go after these other opportunities. What started to filter out after that though, were stories of executives coming in and basically changing these really important details or colorways on shoes, for example, that these designers had spent the last six months or the last nine months perfecting. From the outside, we started to see churn, so they went through a few good CEOs, a few good marketing executives, the designers that we mentioned I think left, don’t quote me on this, but roughly a year after joining. Across the board, we saw this pattern where management was basically failing to make the best use of the type of talent and the type of people that they would need to unlock the next leg of growth. We had far less confidence and the forward-looking prospects of their ability to execute on these other opportunities. There are other things that play as well, but that’s a pretty good example of an instance of when we were very positive on a culture, then as we continue to watch it, we actually turned negative on it.
Andrew Aitken: Well, it’s 10:46 local times down here, and we’ve kept people on for a while. I’d just like to thank you, both Brian and JB for your contribution day. It’s been great. Thank you, guys.
If you have questions, please go to the Contango website, www.contango.com.au where you can access this product, As I said earlier, in four different forms – there is an LIC, an ETF, and two-unit trusts, one hedged and one unhedged. So those are the access points for that.
Okay, everybody, thank you very much for your time. We really appreciate the amount of people that turned up today. It’s been terrific. Thanks everyone.
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