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Speaker 1: Welcome to the Fear and Greed Business Interview. I'm sure, alma.

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Speaker 1: What does a global investment giant look for when building

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Speaker 1: a portfolio of companies to deliver returns well? According to

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Speaker 1: the International Equity team at Morgan Stanley Investment Management, the

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Speaker 1: key is well managed companies with sustainably higher returns over

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Speaker 1: the long term. It also helps to be patient. Along

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Speaker 1: with its affiliates, Morgan Stanley Investment Management has more than

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Speaker 1: one point five trillion dollars in assets under management of supervision.

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Speaker 1: Remember the following conversation is general information only. You should

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Speaker 1: aways see professional advice before making investment decisions. Today I

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Speaker 1: am joined by Bruno Paulson, Managing director of Morgan Stanley

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Speaker 1: Investment Management's International Equity team, who's visiting Australia for a

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Speaker 1: few days. Bruno, Welcome to Fear and Greed.

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Speaker 2: Thank you great to be here.

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Speaker 1: I want to talk about the idea of compounding returns

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Speaker 1: on equities. We all talk about compounding interest being you know,

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Speaker 1: one of the great investment tricks of all time, but

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Speaker 1: you talk more about compounding returns on equities. Just explain

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Speaker 1: what you're talking about.

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Speaker 2: So it's about investing companies which steadily deliver year after year.

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Speaker 2: So if you have a company, if you have a

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Speaker 2: portfolio companies that can grow at mid single digit, five

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Speaker 2: to six percent, maybe squeeze a bit of extra margin

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Speaker 2: and then have the cash coming back, which in terms

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Speaker 2: of dividends or buybacks the six plus four. Or if

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Speaker 2: you can find companies a compound at ten percent across cycles,

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Speaker 2: then over seven years you double ruler seventy two, fourteen years,

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Speaker 2: you quadruple. And so it's finding the companies. It's not

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Speaker 2: looking things which double in a year or do anything spectacular.

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Speaker 2: It's looking for companies where the underlying company is steadily

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Speaker 2: compound over time. Evaluations move up and down, but if

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Speaker 2: you're compounding over time, that will dominate over the long run.

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Speaker 2: And that's what our global portfolio have been doing since

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Speaker 2: nineteen ninety six.

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Speaker 1: Okay, So typically, what sort of companies are they? Can

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Speaker 1: you be? Are they from different sectors, they have certain

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Speaker 1: traits that similar across the board. Just explain how you

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Speaker 1: think about these companies and how you discover them.

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Speaker 2: Really, so we're looking for companies which are very profitable

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Speaker 2: and grow steadily with strong intangible assets that can be

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Speaker 2: brands or it can be networks and those will give

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Speaker 2: you pricing power, which defends you. And we also love

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Speaker 2: recurring revenue that might be from a twenty five year

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Speaker 2: contract on an elevator, or a long term cloud contract,

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Speaker 2: or just going and always buying the same shampoo. So

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Speaker 2: it's high returns on capital, pricing power, recurring revenue, not

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Speaker 2: too much leverage, but on a simple screen to find

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Speaker 2: profitable companies, then think very hard about which ones are

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Speaker 2: a going to stay profitable and be the management are

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Speaker 2: going to mess it up and see don't pay too much.

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Speaker 1: Okay. So intangibles is an interesting one because we seldom

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Speaker 1: mean whenever we're talking about it, people downplay in tangibles.

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Speaker 1: But what you're saying, it's very important. So a company

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Speaker 1: like or Nike in I'm not suggesting that you do

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Speaker 1: or don't invest in any of these, but it's kind

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Speaker 1: of those brand names that actually do meta a bit.

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Speaker 2: Yeah, and we're not invested in either of those at present.

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Speaker 2: But the I mean, these brands have often been built

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Speaker 2: up over decades or in some cases centuries, of loads

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Speaker 2: of investment year after year. Off D's not on the

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Speaker 2: balance sheet because it just goes through the p and

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Speaker 2: l and that gives a significant barrier to entry, just

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Speaker 2: as a network everyone using Excel, because everyone using x

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Speaker 2: sell as a barrier to entry. If your assets are tangible,

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Speaker 2: you have a factory, you have a mine, then that's

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Speaker 2: quite easy for other people to imitate, Whereas these intangible

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Speaker 2: assets are much more difficult to imitate and give potential

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Speaker 2: barriers to entry.

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Speaker 1: So startups are less likely to be part of your portfolio.

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Speaker 1: For example.

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Speaker 2: Absolutely, we want long term proven winners. Sometimes the company

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Speaker 2: is maybe relatively young, like hallim spun out of Gskofhizer,

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Speaker 2: but you have the long term data for those companies

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Speaker 2: over long we want proven as we believe are going

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Speaker 2: to keep winning.

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Speaker 1: How do you think about the tech stocks then, generally,

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Speaker 1: because that's the sector which rises in falls or has

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Speaker 1: risen and fallen. Sometimes it's sort of an extreme extent,

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Speaker 1: how do you think about those companies?

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Speaker 2: So about the quarter of the portfolio is in tech,

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Speaker 2: but tech covers a lot of different things. So there's hardware,

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Speaker 2: and there's hardware and semiconductors and the software and services.

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Speaker 2: We're skewed towards the software and services. We like companies

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Speaker 2: which particularly set a business to business companies, and that

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Speaker 2: their steadier and less per pacula. Your Microsoft SAPs your accentius.

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Speaker 2: They are amongst some of the largest holding the portfolio,

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Speaker 2: and that they're not at the most exciting edge of tech.

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Speaker 2: They are already profitable. There's a lot of unprofitable companies

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Speaker 2: in techst the younger companies, particularly once you charge them

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Speaker 2: for share based compensation. So we avoid those companies. What

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Speaker 2: the established profitable companies which aren't as volatile as some

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Speaker 2: of the ones you're described, but I mean Microsoft.

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Speaker 1: So in Vidia as an example in the game. And

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Speaker 1: we're not saying you are or you are not investing

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Speaker 1: in Nvidia, but how would you think about talking about that?

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Speaker 1: That goes so hard because then you have all sorts

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Speaker 1: of valuation risks. But what you're saying that actually because

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Speaker 1: you're talking about compounding return. So if it's continuing to

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Speaker 1: make money, that's okay.

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Speaker 2: So in Nvidia is a genuinely profitable and amazing company.

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Speaker 2: The issue for us as are out the uncertainty about

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Speaker 2: the future profitability. You know, will how fast will AI go?

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Speaker 2: I mean, I think we agree that Jennai was going

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Speaker 2: to be a significant force, but how fast will those

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Speaker 2: revenues come through, which actually feeds with revenues and will

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Speaker 2: there remain dominant. Those are two significant uncertainties.

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Speaker 1: Stay with me, Bruno will be back in a minute.

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Speaker 1: I'm speaking to Bruno Paulsen from Morgan Stanley Investment Management. Okay,

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Speaker 1: so let's move away from technology. What about miners. It's

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Speaker 1: such a big part of the Australian Index and the miners.

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Speaker 1: How do you view miners because gain commodity prices can

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Speaker 1: be very volatile.

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Speaker 2: This is something we do not go near thinking about

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Speaker 2: approaching investing in our portfolios, right because we want companies

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Speaker 2: which are high return on capital, not cyclical, and the

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Speaker 2: price makers have some pricing part. Commodity companies are very

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Speaker 2: low return on capital, they're very cyclical and they are

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Speaker 2: price takers. And so you know, asking what the HPU,

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Speaker 2: whoever it is, what their profit's going to be in

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Speaker 2: five years? You want to know what the aren or

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Speaker 2: prices you want to you just don't know, right, They

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Speaker 2: don't have don't have that control over their destiny and volatile.

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Speaker 2: We want the companies to have some control over the

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Speaker 2: destiny and you have a far higher level of confidence

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Speaker 2: of what the economics are going to look like in

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Speaker 2: five years. So if you are going to describe the

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Speaker 2: opposite of what we invested, it will be a minu

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Speaker 2: or a back.

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Speaker 1: Oh no, you've really strowning. It's because we are Australian

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Speaker 1: here and you've you've thrown the banks in which, of course,

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Speaker 1: as you would know, our market is dominated by the

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Speaker 1: banks at top ten, So why why not? I don't

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Speaker 1: quit mean some of those have great brand names, they

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Speaker 1: probably don't have a high return on capital.

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Speaker 2: They've got great brand names, they do not have a

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Speaker 2: high return on a lever capital. Yeah, I mean we're

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Speaker 2: looking our portfolios. The unleavered unleavered important word here, unlevered

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Speaker 2: return on operating capital. This that's goodwill and things for

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Speaker 2: our portfolios is the order of fifty to sixty percent

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Speaker 2: banks will be a well run bank and a decent

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Speaker 2: year might be at one. Yeah, so they're only fifty

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Speaker 2: times short because to get to a fifteen to twenty

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Speaker 2: percent row, they're levered up fifteen times, which means when

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Speaker 2: things go wrong, they go fifteen times more wrong. And

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Speaker 2: so it's the exact empathesis. We want companies who are very,

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Speaker 2: very profitable and high returns and capital without using leverage.

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Speaker 2: Banks by their nature use enormous amounts of leverage, which

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Speaker 2: is fine on the way up, it's less fine on

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Speaker 2: the way down. And it does make what we do

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Speaker 2: quite diversifying for people with Australian portfolios because we don't

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Speaker 2: do mining or banking.

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Speaker 1: Yeah, so I mean tektoks are a quarter of your portfolio.

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Speaker 1: What else is in that portfolio?

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Speaker 2: So the tech stocks skewed towards the services and software

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Speaker 2: I mentioned. Then you've got healthcare, not the pharmaceuticals, because

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Speaker 2: you're profitable because the patents and the patents expire and

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Speaker 2: so the reason you're profitable goes away. Remember I said,

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Speaker 2: we pick profitable things and then think hard about where

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Speaker 2: they're going to stay profitable. The reason then you're just

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Speaker 2: hoping they'll find another painment. So it's the life sciences

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Speaker 2: and equipment and a few providers, so that that's the healthcare.

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Speaker 2: You then have financials. You're saying, what do you mean financials?

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Speaker 2: You just said you hate banks, that there are financials

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Speaker 2: which aren't really financial. You have payments like Visa, you

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Speaker 2: have exchanges, ICE and CME. You have the insurance brokers

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Speaker 2: like Aaron and aj Gallagher. So you have these companies

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Speaker 2: which don't have balance sheets. So we like the financials

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Speaker 2: which don't have these niches within financials much don't have

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Speaker 2: balance sheets. You don't have industrials, but again it's not

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Speaker 2: the dirty, heavy, grimy industrials. Yes, we like elevator companies

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Speaker 2: because as I mentioned, they've got the twenty five year contracts,

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Speaker 2: so you don't need much money making the left and

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Speaker 2: installing it. But then you get twenty five year contract aside.

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Speaker 2: But then it's information companies like you know rouks or

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Speaker 2: credit Scoring, credit rating and ADP the payroll provider in

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Speaker 2: the US. So it's capital light and also carbon light.

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Speaker 2: Does it havepen companies?

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Speaker 1: One final question, Bruno, how do you get your head

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Speaker 1: across all the companies that you have the potential to

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Speaker 1: invest in, because I often think it's interesting in the

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Speaker 1: Australian market, which is relatively small in terms of the

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Speaker 1: number of stocks that are investable at least, I'm amazed

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Speaker 1: at how our analysts get across all of them. How

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Speaker 1: do you know, Bruno, because you're.

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Speaker 2: Cheat cheat sheet is because we're only looking for the

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Speaker 2: well cheese perfoman, we're only looking for the proven winners,

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Speaker 2: and so you start off with a couple of thousand,

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Speaker 2: you know, reasonably advice. We run our quantitive screen looking

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Speaker 2: for high returns capital and not too much capital intensity,

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Speaker 2: nice fat gross margins, not too much leverage, and even

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Speaker 2: before you start thinking about valuation, you're down to a

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Speaker 2: few hundred. And then it's within those you're looking at.

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Speaker 2: Those we have a spirit. We have an investment team

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Speaker 2: of fifteen people experience for investment team fifteen people and

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Speaker 2: with our universe is shrunk, so we're able to focus

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Speaker 2: on those companies which make it through the screen, some

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Speaker 2: of which we will reject quite quickly, and so we're

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Speaker 2: on the areas and sectors which are interesting and potentially interesting.

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Speaker 2: We're able to focus in quite closely while not worrying

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Speaker 2: about the iron ore price. That's not our problem.

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Speaker 1: Brune I, thank you very much for talking to Fear

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Speaker 1: and Grade.

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Speaker 2: It's been a pleasure. Thank you for your time.

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Speaker 1: That was Bruno Paulsen, Managing director of Morgan's Stanley Investment

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Speaker 1: Management's International Equity team. This is the Fear and Grade

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Speaker 1: Business Interview. Remember this is general information only and you

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Speaker 1: should always seek professional advice before making investment decisions. Join

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Speaker 1: us every morning for the full episode of Fear and

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Speaker 1: Greed Business news for people who make their own decisions.

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Speaker 1: I'm Sean Elmer. I'nhow you Today,