Recently shareholders of Contango Income Generator approved the appointment of a new global long short investment strategy managed by WCM Investment Management a world-class fund manager with an outstanding track record.
The proposed WCM Quality Global Growth Long Short Strategy has, since inception on 30 June 2014, generated a return of 23.5% per annum, outperforming its benchmark, the MSCI All Country World Index by an annualised 11.9% per annum.
During this webinar with Ryan Quinn, Client Portfolio Manager, WCM Investment Management discusses long short strategy, WCM’s investment process and how its team is investing in the current environment.
This webinar was recorded live on 02 September 2020. The numbers referenced in the recording and in the transcript below are correct as at the time of the live webinar.
Marty Switzer (MS): Good morning, ladies and gentlemen. Welcome to today’s webinar. I’m Marty Switzer, CEO of Contango Asset Management. I’m also a Director of Contango Income Generator.
WCM Investment Management, for those who don’t know, but we realise there are a lot of shareholders that are aware of WCM, WCM are a top quarter global equities manager from Laguna Beach, California. The team manages $85 billion, they have an outstanding investment track record across multiple strategies. The Large Cap strategy has averaged around 15% per annum since 2008. The Small Cap strategy has averaged about 23.4% since 2014, and this proposed strategy, the WCM Quality Global Growth long-short strategy has averaged 23.5 % for the past six years. So their track record is outstanding. In terms of today’s presentation, we’re very lucky to have Ryan Quinn from WCM on the line.
Ryan is going to be interviewed by our Head of Distribution, Al Dunne who’s today is based down in Melbourne and in lockdown there. So that’s fantastic to have him on the line today. Ryan’s in Laguna beach, California. Alistair is going to talk to Ryan about the strategy, how WCM invest and the process that they use at WCM.
Thank you very much for all your time, all your support, thank you for the correspondence that we’ve been receiving and all the positive communication that’s been coming back. We look forward to talking more throughout the day, but without further ado, I’ll now throw to Alistair who we’ll be interviewing Ryan. Good day, guys, over to you.
Alistair Dunne (AD): Thanks, Marty. And, I’d just like to take the opportunity to also extend my thanks to everyone on the call. It’s greatly appreciated that you’re taking the time out of your day to join us, and in particular, Ryan, thank you for taking the time as well. Ryan, if I may, so WCM are known for having quite a differentiated investment process. Are you able to take us through how that works in a portfolio stock selection process?
Ryan Quinn (RQ): Absolutely. And it’s important to note that throughout all of our portfolios, we do utilize very similar processes, we just apply them to different marketplaces. So anyone on the call who knows WCM, from our Quality Global Growth vehicle, can transport quite a few of those fundamental pieces of knowledge into what the long-short vehicle is. So, to take a step back, for those who may not be as fundamentally aware of WCM, we do start pre-civil process of investing much of which is similar to other managers. We invest in global growth businesses, typically large and mega-cap names, that have clean financials, lower or no debt, strong, free cash flow generation, consistent earnings and revenue growth over time and then we put them into a concentrated portfolio with a long-term time horizon. So that’s nothing that’s very unique as compared to our peer set. Where we differentiate ourselves and where we’ve really been able to put ourselves ahead of the class, is really through our work and our view on economic moats, and secondly, our analysis of the cultures inside the businesses that we buy.
AD: Now that you touched on two things there that I wouldn’t mind unpacking just a little bit. The moat, it’s kind of a well held investment sort of thesis, I guess. Are you able to just explain what it is that you do differently at WCM around the moat and the work that you do on them?
RQ: certainly. I think Warren Buffett was the first one to make the concept of an economic moat popular. It’s very tangible to a lot of investors, so it’s not surprising that it really stuck and resonated with folks. You think about large businesses that have developed competitive advantage over time through an extremely strong brand and success in the marketplace, that’s a business with a great moat. However, what we’ve looked at over time, and WCM does quite a bit of learnings over history, when we look into the market and we see that there have been quite a few businesses with very wide moats that have ended up with extremely poor performance.
I mean, just think back historically over the last 15 or 20 years, if you owned Yahoo instead of Google, if you owned Dell instead of Apple or Nokia or Blackberry versus Apple, you would have done very poorly. And those three simple decisions could have made you a superstar, huge amount of money, or you could have looked like a pretty poor investor. All those businesses at one point had an extremely wide economic moat, but what we realized is that it doesn’t matter necessarily how wide or skinny or narrow the economic moat is, we spent all of our time trying to decide and really illuminate the moat trajectory of a business.
As long as the moat trajectory is positive, meaning the business is taking share, it means the business is growing, it means the business is getting better rather than worse in any given period, and that’s a business that we want to own. We like trying to understand the moat objective of business because it’s not a line element in the financials. It’s something that we, over time, have honed our skill at being able to really identify, we’ve done it through learnings in time and learnings in history. But you can also look at things like high and rising return on invested capital, or things like organic sales growth as really indicators of a positive moat trajectory. And we utilise that moat trajectory to help us make all of our decisions, whether it’s buying a name, adding to a name during different periods, trimming from an existing holding or selling it outright.
So the economic moat trajectory is really the deciding factor that’s going to drive our portfolio management around a holding. And in this case it also points to us putting a short position on. Moving to the culture side of things, WCM realized very early in our own success story that the culture internally here has been a significant factor in our success. So we sort of came to the epiphany that why not turn that lens onto our businesses? Why not take the culture of each enterprise that we’re looking at and view it as the DNAs of that business? Really the defining factor that will push employee behaviours and those behaviours either enable success or foster failure over good times and bad times. So that corporate culture is really going to be kind of a challenging factor to point to, but it’s really the defining factor that’s going to be a sink or swim moment for businesses when they either have tailwinds at their back, or they have a headwind in front of them. So then an accurate assessment of a corporate culture is challenging to do, it’s something that sets us apart from our peers, because it takes quite a bit of time and repetition, and we’ve invested that time and repetition and personnel to focus on that factor for our investment holdings.
AD: Thanks, Ryan. Culture is clearly something particularly done here and probably across the globe that’s resonating more and more. There’s not a day that goes by in the financial press that we’re not seeing culture being tatted on the cover, other than positive or negative, but the impact that can have on shareholder returns at a corporate level and an investor level is quite pronounced. So thanks for taking the time to talk us through that. Your success as a manager on the long-side of the portfolio is well documented and a number of people on the call and in the market would have experienced that. Are you able to give us an understanding of the performance on the short-side and how that plays into the strategy?
RQ: WCM as a manager, by employing this moat trajectory piece and the culture piece, we unearth significant data points in the business that we feel like others don’t. And so over time, we’ve done a great job harvesting gains and really winning on the long-side by focusing on these factors. But we’ve sort of left some performance off the table or left some profits off the table by really not making decisions around businesses we knew for sure were declining or deteriorating or going to be facing a more losing environment than a winning environment. So what we did, is we took those two key structures, the corporate culture and the economic moat, and decided to see what would happen if we made bets against companies where we felt like we could very much point to a declining moat trajectory and a deteriorating corporate culture.
We don’t manage our long-short fund in a traditional hedge fund way. We run a directionally long portfolio, so it still feels like to us the same way we run our long portfolio. And then we make diversified shorts on the other side that are specifically tied to declining moat trajectories, and corporate cultures and that ability to make money on the short side allows us to gain more conviction and have more capital to lay out on the long side. So the goal of the short book is not to beat the market, the goal of the short book is to really enable the performance of the high conviction long ideas. They’re not hedges, it’s not going to be that we buy Wizz Air and we short Ryanair. It’s not a pair trade, it’s not a market neutral strategy, these are alpha generated investments that are risk-managed to a point that allow us to have more and higher conviction on the long book. I think since inception, the short book is down about 8%. Over that time, the MSCI ACWI index was up 50%. So you can imagine if by only losing 8% in a market that is up 50%, our shorts have done a nice job of protecting capital as that market tide has risen. One of the reasons we don’t need to have outside short bets, like many other hedge funds do are the characteristics of our long book. Historically, WCM longs lose less money in negative markets and capture more of the upside in positive markets. That’s a defining factor. It makes our long only portfolio much less risky than it would sound, and so we don’t have to take a significant amount of risk on the short side to generate that performance. In fact, our performance over the long-term has been significantly higher than the index and it’s really attributed by the longs losing less money in negative markets, the shorts not losing as much money as the market in the general upswing and our upside capture of our long portfolio over that period as well.
AD: Thanks, Ryan. If we’re talking about a directionally long portfolio, are you able to just talk us through what that looks like from the characteristics point of view? Number of longs, number of shorts, potentially the net and gross exposure on average for the portfolio?
RQ: Absolutely. So the long book will have, in general, around 110 to 125% of total gross exposure. That’ll be in 30 to 50 holdings, think of a 2% to 5% position size. It’s typical, portfolio management style for our long portfolio for our Quality Global Growth vehicle. On the short side, we’re targeting around 30 to 40% total gross short. Okay, that’ll be, again, in 30 to 50 holdings. The same number of holdings, but significantly less exposure means that our typical position size is going to be around a half of a percent to maybe up to 3%, but that would be a very large short for us. So, really a much tighter range as to where the short positions will be. And that gets us to a portfolio of a total gross exposure range, around 140 to 160% on a gross basis and then on a net basis, as we mentioned, directionally long, we’re going to be about 80% to 90% net long at any given time.
AD: Excellent. And how does that get expressed at a sector level or an industry level within the portfolio, looking at the long side and in the first instance?
RQ: So, we’re going be investing, whether it’s long or short, in areas that have long- term global tailwinds, right? So there are winners and losers when tailwinds happen. And so we want to be with the winners on the long book around global tailwinds and then we want to be short, some of the names that are getting disintermediated or that are just not keeping up with that type of progress. When it comes to sector-wise, what we won’t be having is we’re not going to be long growth in short value, right? So we’re not trying to be long factors and short factors. We really wanted to hang our hat on and hitch our wagon to alpha driven investments, whether they’re long or short.
We are growth investors, so you can expect us to be in the sectors that we typically plan because we’re not going to start doing work on energy companies when we don’t own any of them, just to find some shorts. That’s not a holistically balanced portfolio. We tend to avoid those classic value sectors and so we won’t have those value sectors in the short book. We’re really truly going to be finding businesses in healthcare, technology, materials, some of the industrial names that are going to be the real generators of ideas for us. And so there isn’t a great overweight underweight discussion when it comes to a long-short strategy versus an index but I can say that our largest exposures in the portfolio will continue to be very consistent with the rest of our portfolios in terms of being in technology, healthcare, industrials, et cetera and we will then always be significantly underweight if not exposed at all to areas like real estate utilities and energy.
AD: That’s great thank you. And perhaps now we might just have a look at some of the stocks in the portfolio, maybe an aim on the long side, just to give a bit of an understanding of how that comes to life from a process point of view.
RQ: Sure. So, around WCM we like to talk about picks and shovels businesses. It’s a reference to the gold rush that happened in America and where the miners made very much less money than the businesses that sold those miners their picks and shovels. And so, from a technology perspective, one of our favourite holdings that we own in the long book, which we own in multiple different portfolios, whether it’s our global vehicle, the emerging markets portfolio, et cetera, is Taiwan Semiconductor. It’s also a major holding in the long-short strategy. It’s a picks and shovels business within the chip making industry. So their moat grows and remains positive as long as the complexity of advanced chip making persists within the industry. Taiwan Semiconductors is the only independent foundry that is creating these microchips that are going into everything from your coffee maker to your watch, to the technology in your car or frankly, into any high-speed computing that is necessary across governments, military, et cetera. And so Taiwan Semi has a really full pipeline of demand for its processes.
Now, what we love about being involved in that space is that there is a race to create the next best chip, the next highest performing processor. We don’t have to pick the winning horse, we’re with the foundry that’s going to be creating all the chips. So they’re sitting dead in the middle of the value proposition in a long-term tail, one that we think we can count on over time. In fact, we’ve owned this name for over 15 years in our Focus Growth International portfolio. The complexity of microchips these days, we we’re seeing get down to a significantly small, infinitesimally small level that only a company like Taiwan Semiconductor can do. And what we’d like to say, they’ve climbed the value chain. They’re an outsourced research and development partner to Apple, AMD, Intel, any business that wants to create these chips because they can’t backfill all the R&D, the 20 years of investment that Taiwan Semiconductor has already put in the ground to create these chips. So their value proposition is massive because the businesses that want to create the chips can’t create the foundry to do it. So that’s a business that has a significantly positive moat trajectory, a long runway of opportunity in front of it, and a very classic picks and shovels business that we’d like to own.
AD: Great. Well, as Marty said, I’m in Victoria on lockdown with three children home-schooling. The amount of technology flooding around this house with Taiwan Semiconductor chips in it, I’m probably expecting a Christmas card from them. Are you able to provide then an understanding of potentially a company name or an example on the short side of the portfolio, just to bring that to life a little bit?
RQ: Sure. I appreciate you being sensitive to that, and obviously, it’s not a great reputation to be a short seller of businesses and we are long-term partners to the companies we invest with. And so, what I will be able to share is the business that we’ve been short on and off, over time, called Ambev. It actually was a long holding in our emerging markets portfolio, as well as our focus growth international portfolio for some time. And the long thesis was that it’s a very large Brazilian beer company that had 80% market share in places like Argentina and Brazil, which was the significant portion of their volumes, and they were the dominant provider of beer to the Latin American region.
The goal of the business, as seen by Anheuser Busch taking over control in 2016, was to provide premiumization of beer consumption within Latin America. And so they felt like they would be able to, with their scale, rollout premium beers that would be purchased by the consumer in Latin America. What we saw and what actually led us to selling the business out of our long book was that they were struggling to affect that premiumization playbook. Their volumes began to fall. And then we also noticed that there is significant correlation to the economic environment within Latin America. At the time Brazil was going through a crushing foreign exchange decline, their government was in a disarray and they’re facing crippling inflation. And that led to a significant decline in beer sales. And that’s a little unique because on the other hand in areas like the US and Europe that tends to lead to greater beer sales, and for some reason in Latin America, they turned away from the beers at that time.
So in seeing that, we exited the name and now when we turned and continued our work on the business, because we never completely turn our back on a business, we noticed that there were a couple of different competitors that were bringing premium beers to the market and actually taking market share. And we watched Ambev’s market share fall from the mid 80s down to 60% and the share winners, those that were having a positive moat trajectory were Heineken and Petrópolis Group. And so we continued to see them winning in this premiumization trade, and Ambev, where their prior, their scale and their reach and their size really afforded advantages of distribution and economies of scale, that failed to come true anymore. And the competitors are slowly eating away at their competitive advantage. So we’ve been kind of in and out of the name based on the health of the Brazilian economy and based on what’s been going on the investor base over time and really the declining moat trajectory, is the reason that we won’t own the name again and likely while we will continue to be a tourist on the short side for the business.
AD: That’s a really interesting way of thinking about it, that moat being a live entity, I guess, and as it expands it’s a long position potentially, as it contracts it can quite quickly become a short idea. It’s an interesting way of thinking about the portfolio.
MS: Fantastic. Well, we might leave it there. There are no more questions. Ryan, thank you very much for your time, thank you very much for your support. Thank you very much and have a fantastic day.
 AS at 30 June 2020
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.
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