WEBVTT - T. Rowe Price’s McQueen on Free Cash Flow 0:00:15.520 --> 0:00:18.799 Welcome to Inside Active, a podcast about active managers that 0:00:18.840 --> 0:00:22.119 goes beyond sound bites and headlines and looks deeper into 0:00:22.160 --> 0:00:27.480 their processes, challenges and philosophies and security selection. I'm David Cohne, 0:00:27.520 --> 0:00:30.520 I lead mutual fund and active research at Bloomberg Intelligence. 0:00:30.960 --> 0:00:35.360 Today my co host is Laurent Dulier, senior equity strategist 0:00:35.400 --> 0:00:38.440 at Bloomberg Intelligence. Laurent, thank you for joining me today. 0:00:39.360 --> 0:00:42.440 Thanks for inviting me, so I wanted. 0:00:42.240 --> 0:00:45.360 To ask you about your note today. In Europe, the 0:00:45.360 --> 0:00:48.120 healthcare sector has underperformed the rest of the market since 0:00:48.159 --> 0:00:51.560 the summer and its valuation has come back below its 0:00:51.600 --> 0:00:54.520 long term average. What do you think the market is 0:00:54.600 --> 0:00:57.080 concerned about and what could reverse that trend? 0:00:58.400 --> 0:01:00.840 Yeah, I think there are two main reason for this. 0:01:01.520 --> 0:01:06.280 The first one is definitely the uncertainty surrounding the health 0:01:06.319 --> 0:01:11.600 policies of the Trump administration. The President elect during his 0:01:11.760 --> 0:01:17.520 campaign not commented that drugmakers have engaged in deception, misinformation 0:01:17.720 --> 0:01:21.520 and disinformation. So I think it suggests that potentially is 0:01:21.560 --> 0:01:26.400 going to take a tough stance against some pharmaceutical companies, 0:01:26.440 --> 0:01:29.000 and the ones that I wrow is the most are 0:01:29.040 --> 0:01:34.080 definitely the European ones, because many European companies or pharmer 0:01:34.200 --> 0:01:38.520 companies have a very large export to the US market. 0:01:39.319 --> 0:01:42.959 And the second reason I think for the underperformance of 0:01:43.040 --> 0:01:46.399 the sector is that we had a mixed newsflow on 0:01:46.600 --> 0:01:50.560 farmer companies over the past few months. First, we're seeing 0:01:50.680 --> 0:01:55.040 increasing competition in the anti obesity drug market and we 0:01:55.120 --> 0:01:59.320 have in Europe a champion with novel Artisk, but the 0:01:59.400 --> 0:02:02.440 company had some supply issues and it lost market share 0:02:02.520 --> 0:02:05.680 to Helivily LII in the US, and I think it 0:02:05.720 --> 0:02:09.520 has a negative impact on its valuation. But also during 0:02:09.639 --> 0:02:14.240 the quarterly reporting season in October, we had mixed newsflow 0:02:14.400 --> 0:02:18.799 from nov Artists and Glaxo Smiths clin regarding their twenty 0:02:18.880 --> 0:02:22.160 twenty five outlooks. So I think it added a bit 0:02:22.240 --> 0:02:27.040 more clouds on the prospect of this sector in Europe. 0:02:27.680 --> 0:02:30.680 To your question about what could reverse the trend, I 0:02:30.720 --> 0:02:35.639 think at this stage regarding the health policy in the US, 0:02:35.680 --> 0:02:38.520 there is a lot of speculation about what Donald Trump 0:02:38.639 --> 0:02:41.079 will do or not, so I think here we need 0:02:41.120 --> 0:02:43.080 to wait and see what are going to be his 0:02:43.280 --> 0:02:46.920 initial measures and see how drastic he is going to 0:02:46.960 --> 0:02:52.440 be regarding the competition in the anti obosited drug market. 0:02:52.560 --> 0:02:57.240 Our industry analysts in Europe do believe that the injectable 0:02:57.360 --> 0:03:02.760 drugs of Helilyli and Novo Nordisk will remain the dominant 0:03:02.840 --> 0:03:06.360 solution over the coming years up towards the end of 0:03:06.440 --> 0:03:10.320 vis decades. So potentially the competitive threat may not be 0:03:10.400 --> 0:03:14.320 as big as expected. So I think when the market 0:03:14.480 --> 0:03:19.160 realize that those two companies potentially are going to remain 0:03:19.280 --> 0:03:24.960 the dominant players, market may be less negative on those two. 0:03:26.240 --> 0:03:28.680 Great. Well, let's bring in our guests who may have 0:03:28.760 --> 0:03:31.040 thought on his own about this. I'd like to welcome 0:03:31.120 --> 0:03:35.120 Colin McQueen, who is vice president TI Price Group Interior 0:03:35.200 --> 0:03:39.240 Price International Limited and a portfolio manager in the equity division, 0:03:39.280 --> 0:03:44.240 including the International Value Equity fund ticker TRIGX. Colin, thanks 0:03:44.240 --> 0:03:45.560 for joining us, Hi. 0:03:45.480 --> 0:03:46.680 Thanks very much, good to be here. 0:03:47.160 --> 0:03:50.600 Maybe I will start the conversation by a question on 0:03:51.240 --> 0:03:56.680 value companies, because in Europe often value companies are seeing 0:03:56.840 --> 0:04:02.040 as being cheap for fundamental reasons, and I would like 0:04:02.120 --> 0:04:05.400 to know as a value investors, what is your secret 0:04:05.480 --> 0:04:10.520 source in a sense to avoid investing in those value 0:04:10.560 --> 0:04:14.360 trap because there are usually the one which it's severally 0:04:15.160 --> 0:04:16.200 as a performance of. 0:04:16.279 --> 0:04:18.880 A fund thank you, Ron. I think there's a couple 0:04:18.880 --> 0:04:21.640 of aspects to that that are worth touching on in 0:04:21.720 --> 0:04:23.840 terms of sort of I guess the stocks being perceived 0:04:23.880 --> 0:04:27.840 as value traps. Values really just coming off probably one 0:04:27.839 --> 0:04:31.279 of its worst periods in history, the decade after the GFC. 0:04:32.320 --> 0:04:34.120 You have to go back to the nineteen thirties to 0:04:34.120 --> 0:04:37.320 find a worse period for value, So, you know, in 0:04:37.320 --> 0:04:40.720 that sense, I think the market has become very skeptical 0:04:40.760 --> 0:04:45.960 about valuation as a driver of out performance. I do 0:04:46.080 --> 0:04:48.599 think though, that some of the headwinds that are faced 0:04:49.480 --> 0:04:53.560 value companies in that period are abating, if not even 0:04:53.560 --> 0:04:57.400 potentially reversing. And we've seen, perhaps kind of the other 0:04:57.520 --> 0:05:02.000 side of the pandemic and the Ukraine War, some changes 0:05:02.040 --> 0:05:06.200 in terms of outlook that I think kind of level 0:05:06.240 --> 0:05:09.800 the playing field a little bit. More specifically, those for 0:05:09.839 --> 0:05:13.520 me would be the change in interest rates. You know, 0:05:13.560 --> 0:05:17.679 we've had a decade of very negative interest rates continuously falling, 0:05:17.800 --> 0:05:20.840 ending with I guess a third of the world's bond 0:05:20.880 --> 0:05:25.440 markets negative yielding at one stage negative interest rates, particularly 0:05:25.520 --> 0:05:31.000 in Europe. That's negative for value companies, both technically in 0:05:31.080 --> 0:05:34.360 terms of the discount rate movement, but also it's been 0:05:34.400 --> 0:05:37.320 a massive headwind for financial companies, which tend to be 0:05:37.360 --> 0:05:41.520 overrepresented in the value universe, and really I guess banks 0:05:41.560 --> 0:05:45.000 particularly just don't work at negative interest rates. So the 0:05:45.080 --> 0:05:49.440 reset we've seen in interest rates has been a material positive, 0:05:49.839 --> 0:05:53.320 particularly I would say for European banks. I mean, on 0:05:53.360 --> 0:05:55.800 our estimates, we've sort of moved the average ROWE from 0:05:55.800 --> 0:06:00.200 about eight to twelve, which is a very material change. 0:06:00.320 --> 0:06:03.640 The second thing I think is we're getting a broadening 0:06:03.720 --> 0:06:07.520 of some of the sources of growth in the economy. 0:06:07.880 --> 0:06:10.160 We spent a lot of period after the GFC with 0:06:11.279 --> 0:06:14.760 really a lot of growth being driven by the build 0:06:14.800 --> 0:06:19.039 out of Internet platforms, driven by companies with intangible assets. 0:06:19.080 --> 0:06:22.120 We've seen a very sort of concentrated pattern of demand growth. 0:06:24.040 --> 0:06:26.120 Looking the other side of the pandemic, I think we're 0:06:26.120 --> 0:06:29.760 seeing a broadening to that, and particularly in the industrial area. 0:06:30.400 --> 0:06:33.719 So we're seeing a big wave of expenditure from on 0:06:33.920 --> 0:06:37.320 energy transition and obviously the build out of aidentity data 0:06:37.360 --> 0:06:42.600 centers is turbo charging that materially. We're also seeing quite 0:06:42.640 --> 0:06:47.640 a change in terms of where supply chains are built. Both, 0:06:47.680 --> 0:06:50.640 I guess, from a geopolitical perspective, sort of near suring 0:06:51.080 --> 0:06:54.440 or friendshuring. But also I think as we saw in 0:06:54.480 --> 0:06:59.560 the pandemic problems at places with extended supply chains, we've 0:06:59.560 --> 0:07:02.919 seen places where infrastructure just didn't work as well as 0:07:02.960 --> 0:07:05.680 we might have hoped when it was stress tested. So 0:07:05.960 --> 0:07:10.560 we're seeing quite a broadening of the areas of expenditure, 0:07:11.160 --> 0:07:13.640 not to mention also at least the reversal of the 0:07:13.720 --> 0:07:18.200 Defense Peace divid end. So I think the outlook for 0:07:18.320 --> 0:07:21.200 growth and demand for a lot of companies making kind 0:07:21.240 --> 0:07:25.320 of tangible goods capital equipment has improved, and that obviously 0:07:25.400 --> 0:07:28.640 drags through a lot of materials demand with that. So 0:07:29.560 --> 0:07:31.400 we've seen an aggregate if we look at sort of 0:07:31.480 --> 0:07:36.520 international value companies as a cohort, earning's growth in the 0:07:36.600 --> 0:07:40.120 decade after the GFC was a pretty miserable zero point 0:07:40.200 --> 0:07:43.920 five percent per annum, which compared to about eight percent 0:07:44.200 --> 0:07:46.280 of the S and P five hundred on our numbers, 0:07:46.320 --> 0:07:50.080 so a massive gap. It's not surprising potentially that these 0:07:50.120 --> 0:07:54.280 companies didn't really perform very well. If we take that 0:07:54.320 --> 0:07:56.960 from the start of the pandemic, we've seen growth accelerate 0:07:57.040 --> 0:07:59.760 up to about four just over four percent per annum 0:08:00.600 --> 0:08:03.400 with the US again remaining at eight. So we're not 0:08:03.480 --> 0:08:06.240 delivering the growth in international value stocks of the S 0:08:06.280 --> 0:08:09.320 and P five hundred yet, but the gap has materially closed, 0:08:09.880 --> 0:08:13.800 whilst at the same time the valuation dispersion has widened 0:08:13.880 --> 0:08:17.400 yet further. It's now, you know, versus the US, the 0:08:17.400 --> 0:08:20.880 widest it's been on history. So I think there's a 0:08:21.080 --> 0:08:24.920 there's an opportunity in terms of value stocks Internationally, we're 0:08:24.920 --> 0:08:29.560 seeing improving prospects, a better outlook, and yet the valuations 0:08:29.600 --> 0:08:34.160 remain very much in the doldrums. You'd asked also specifically 0:08:34.160 --> 0:08:37.720 on how how I think about sort of avoiding value 0:08:37.760 --> 0:08:41.480 traps in the portfolio reading that out, and really there's 0:08:41.559 --> 0:08:43.880 kind of two aspects to that for me. One is 0:08:45.000 --> 0:08:46.560 maybe as well, we'll sort of get into a little 0:08:46.559 --> 0:08:49.520 bit later. For me, a lot of what we're trying 0:08:49.559 --> 0:08:54.000 to achieve in the portfolio is to buy undervalued free 0:08:54.040 --> 0:08:56.800 cash flow generation from companies. So we want to buy 0:08:58.040 --> 0:09:01.560 good companies when they're out of favor, trading cheaply and 0:09:01.600 --> 0:09:04.800 when we can. Basically, we think of the underlying value 0:09:04.800 --> 0:09:07.000 of the business as driven by its free cash generation. 0:09:07.280 --> 0:09:11.319 So if we're having free cash generative companies, if we're 0:09:11.360 --> 0:09:15.320 early in buying them. Assuming we're right on the free 0:09:15.320 --> 0:09:18.040 cash generation, the opportunity will tend to get bigger rather 0:09:18.080 --> 0:09:21.240 than smaller over time. So that's probably I guess the 0:09:21.280 --> 0:09:24.720 primary sort of defense point. The second one is whenever 0:09:24.760 --> 0:09:28.520 we buy initiate positions in companies, we kind of do 0:09:28.559 --> 0:09:32.160 a downside valuation exercise to ask ourselves what is this 0:09:32.240 --> 0:09:37.040 business worth if we're wrong? And ideally we're looking for 0:09:37.080 --> 0:09:41.640 situations where we don't have a lot of absolute downside. 0:09:41.960 --> 0:09:45.680 You can't always always get that happy combo. But again, 0:09:45.920 --> 0:09:49.000 I'm sort of equally pleased where our research has done 0:09:49.000 --> 0:09:52.360 its job on the value protection side. So we may 0:09:52.400 --> 0:09:55.040 miss a bit of opportunity costs, but we don't lose 0:09:55.040 --> 0:09:55.840 money on a stock. 0:09:57.520 --> 0:10:00.280 That's great. Why don't we take a step back back, 0:10:00.400 --> 0:10:02.880 and you know, I'd love to hear about how you 0:10:02.920 --> 0:10:04.120 got your start and investing. 0:10:06.920 --> 0:10:10.520 Yep, sure, I guess I was relatively lucky. I joined 0:10:10.559 --> 0:10:14.520 the industry in nineteen eighty nine fresh from an economics 0:10:14.520 --> 0:10:18.840 master's degree, which I guess persuaded me to move to 0:10:19.040 --> 0:10:21.480 a career in investment management rather than being an economist 0:10:21.960 --> 0:10:25.560 at that stage, partly as I think driven by I 0:10:25.600 --> 0:10:28.760 started to develop an increasing interest in industries and how 0:10:28.760 --> 0:10:32.280 companies worked, and investment management sort of lets you get 0:10:32.400 --> 0:10:36.160 up close and personal with that. So I was fortunate 0:10:36.559 --> 0:10:39.560 to land a job straight in the industry from university. 0:10:40.360 --> 0:10:44.360 I think also fortunate in that respect that I joined 0:10:45.160 --> 0:10:49.240 a UK based deep value shop at that time, which 0:10:50.120 --> 0:10:53.959 me gave a very good grounding in terms of how 0:10:54.000 --> 0:10:56.120 to look at out of favor companies, what to look 0:10:56.160 --> 0:11:00.640 for in Stockton market didn't like, but also taught the 0:11:00.679 --> 0:11:05.199 emotional discipline around that. I think everyone's a contrarian investor 0:11:05.240 --> 0:11:08.000 on paper, but it's a lot harder to do when 0:11:08.400 --> 0:11:11.600 you're buying aerospace stocks in the middle of COVID. So 0:11:12.120 --> 0:11:16.600 I think, although obviously you adapt processes and methodologies over time, 0:11:17.160 --> 0:11:21.080 I think that sort of core DNA of being comfortable 0:11:21.160 --> 0:11:25.800 with going against the market being uncomfortable has kind of 0:11:25.840 --> 0:11:29.560 stayed with me throughout that piece. I think also I 0:11:29.559 --> 0:11:33.040 was fortunate at that time for somebody who spent an 0:11:33.200 --> 0:11:36.320 entire career in value investing in I started my career, 0:11:37.080 --> 0:11:38.560 or at least the first half of it, in the 0:11:38.559 --> 0:11:41.840 period where value investing worked as it had done traditionally 0:11:41.840 --> 0:11:46.280 in the textbooks. So in fact, almost to the extent 0:11:46.320 --> 0:11:48.920 that you wondered why anybody did anything else, and then 0:11:48.960 --> 0:11:51.679 probably spent the last fifteen years after the GFC getting 0:11:51.679 --> 0:11:54.360 the answer to that question. So I think a lot 0:11:54.400 --> 0:11:57.160 of investors have sort of spent their career really in 0:11:58.200 --> 0:12:02.280 this very unusual market condition we've seen since the GFC. 0:12:02.720 --> 0:12:06.240 So I regard myself as fortunate in having seen both 0:12:06.280 --> 0:12:07.240 sides of the coin there. 0:12:09.000 --> 0:12:12.920 So if we focus into the international Value Equity fund, 0:12:13.280 --> 0:12:16.400 you mentioned what you're looking for in terms of valuations, 0:12:16.440 --> 0:12:18.480 can you expand a little bit of you know, how 0:12:18.520 --> 0:12:22.160 the process works of you know where you start when 0:12:22.160 --> 0:12:25.120 you're selecting positions for the portfolio. 0:12:27.240 --> 0:12:30.559 Yes, absolutely, so Again for me, the aim is, as 0:12:30.559 --> 0:12:33.880 I mentioned, to companies when they're out of favor and 0:12:33.920 --> 0:12:38.960 trading material discounts to their underlying value. That can be sparked. 0:12:39.240 --> 0:12:42.040 It's usually sparked by concerns in some form or another. 0:12:42.480 --> 0:12:45.840 That can be concerns are aut an industry, as I mentioned, 0:12:45.960 --> 0:12:49.640 anything to do with travel in COVID was trading flat 0:12:49.640 --> 0:12:52.440 on its back for a while. It can be to 0:12:52.480 --> 0:12:55.640 do with geographic news and certainly some of the political 0:12:55.679 --> 0:12:59.080 headlines we've been seeing over recent weeks can offer you 0:12:59.080 --> 0:13:02.360 opportunities that at some pretty contrarian investments, or it can 0:13:02.440 --> 0:13:05.360 simply be an individual company having a bump in the 0:13:05.440 --> 0:13:08.559 road in terms of product roadmap or something going wrong. 0:13:09.200 --> 0:13:12.760 So try to focus in on areas of the market 0:13:12.800 --> 0:13:16.480 that are out of favor, that have underperformed, where we're 0:13:16.480 --> 0:13:21.079 seeing sort of negative sentiment emerging, and going to sort 0:13:21.120 --> 0:13:23.800 of kick the tires and understand what drives the future 0:13:23.840 --> 0:13:27.080 free cash flow. So to think about what will drive 0:13:27.160 --> 0:13:30.760 free cash generation over a cycle, to understand the sort 0:13:30.800 --> 0:13:35.679 of product competitiveness, the cost competitiveness, how well that profitability 0:13:35.720 --> 0:13:39.440 then trade fleets into cash flow and looking to be 0:13:39.480 --> 0:13:42.400 disciplined to pay kind of a maximum of eighty five 0:13:42.480 --> 0:13:46.520 cents in the dollar. There's periods where things are much 0:13:46.600 --> 0:13:49.840 much cheaper than that, but you know, again we have 0:13:49.880 --> 0:13:52.199 a sort of strict discipline that we won't pay above 0:13:52.240 --> 0:13:55.240 that level. So that kind of is the bread and 0:13:55.320 --> 0:13:58.400 butter of what we're looking for as a firm. We 0:13:58.520 --> 0:14:02.360 also pay a lot of attention to restructuring potential. Again, 0:14:02.440 --> 0:14:06.400 one of the things you often find without a favor companies, 0:14:07.120 --> 0:14:09.280 often they haven't been performing as well as they might 0:14:09.320 --> 0:14:11.840 have done, so we spend a lot of time thinking 0:14:11.880 --> 0:14:15.520 about how a company can get better, what can be 0:14:15.600 --> 0:14:19.360 changed operationally, whether in some cases we're finding from a 0:14:19.400 --> 0:14:22.560 portfolio perspective there's a good business hiding behind a bad one. 0:14:24.080 --> 0:14:27.280 And I guess, really where we get the home runs 0:14:27.280 --> 0:14:29.560 in the portfolios where both sides of that kick in, 0:14:29.640 --> 0:14:32.720 where we get the undervalued free cashflow stream and also 0:14:32.760 --> 0:14:39.440 we get the improvement process of the restructuring, adding materially 0:14:39.480 --> 0:14:43.040 to the underlying value of the company. The process of 0:14:43.120 --> 0:14:48.440 doing that really is helped materially by the strength of 0:14:48.440 --> 0:14:50.520 the research platform that I have to draw on. I 0:14:50.560 --> 0:14:55.360 could say, in having been an investment management for thirty 0:14:55.360 --> 0:14:58.320 odd years, I could say, hand on heart, probably the 0:14:59.080 --> 0:15:01.920 tiro price we should this platform is the best resource 0:15:02.880 --> 0:15:05.520 I've had to work with. So we have one hundred 0:15:05.520 --> 0:15:10.720 and seventy research analysts around the world with deep knowledge 0:15:10.720 --> 0:15:14.600 of their companies and industries. So I spend the majority 0:15:14.600 --> 0:15:17.920 of my time working with those guys discussing through what 0:15:18.720 --> 0:15:20.880 a company could look like in the medium term, what 0:15:20.920 --> 0:15:23.920 are the downside risks, and really trying to get to 0:15:23.960 --> 0:15:27.480 the answers where we're getting that combination of an attractive 0:15:27.480 --> 0:15:32.520 reward with relatively minimal downside. I think just two things 0:15:32.520 --> 0:15:35.160 maybe to add on that. In terms of the portfolio side, 0:15:36.880 --> 0:15:39.840 we try to deliberately take quite a wide net to 0:15:39.880 --> 0:15:43.280 the sort of companies we're looking for. I think over 0:15:44.760 --> 0:15:46.360 the course of my career, I've worked at a number 0:15:46.360 --> 0:15:49.920 of different value firms, and we find the value tent 0:15:50.080 --> 0:15:53.320 is actually much broader than it's often labeled to be. 0:15:53.640 --> 0:15:55.520 So you know, at one end, you can have the 0:15:56.480 --> 0:15:59.640 kind of deep value approaches, you know, buying steel companies 0:15:59.680 --> 0:16:02.680 at the on the cycle, the other end of the spectrum, 0:16:02.720 --> 0:16:04.960 we're looking at sort of war On Buffett buying Coca Cola, 0:16:05.440 --> 0:16:09.040 much more sort of high quality compounding companies. We find 0:16:09.080 --> 0:16:11.880 a lot of firms tend to gravitate to one or 0:16:11.920 --> 0:16:17.160 other side of that spectrum. We've kind of developed the 0:16:17.240 --> 0:16:20.080 processes and the tools to operate really across the piece, 0:16:20.200 --> 0:16:22.320 so that gives us a lot of shots on goal. 0:16:22.920 --> 0:16:28.200 It also gives us, from a portfolio perspective, a lot 0:16:28.240 --> 0:16:31.880 of opportunities to improve the risk reward and again that's 0:16:31.880 --> 0:16:33.960 something we've paid quite a lot of attention to. On 0:16:34.000 --> 0:16:37.800 the portfolio side. Again, I've found over the course of 0:16:37.840 --> 0:16:43.320 my career that value investing often and contrarian investing doesn't 0:16:43.320 --> 0:16:48.119 work linearly. You tend to get returns in spurts and cycles. 0:16:48.760 --> 0:16:52.160 So partly from bottom up, but also developed a sort 0:16:52.160 --> 0:16:56.520 of risk dashboard to try and figure out when when 0:16:56.560 --> 0:16:58.600 we want to be taking maximum risk and when we 0:16:58.640 --> 0:17:00.520 want to be keeping a bit more powdered r. I 0:17:00.600 --> 0:17:03.480 kind of think that almost as the similar to the 0:17:03.520 --> 0:17:06.120 process of counting cards at a blackjack table. We want 0:17:06.119 --> 0:17:10.080 to know when the when the playing field is set 0:17:10.160 --> 0:17:13.720 up really for us to make big returns, or when 0:17:13.760 --> 0:17:15.720 we want to be a bit more cautious and wait 0:17:15.720 --> 0:17:16.920 for the better opportunities. 0:17:18.400 --> 0:17:23.520 So you mentioned, you know, finding opportunities during COVID, and 0:17:23.560 --> 0:17:26.879 then also you mentioned a risk model, and so would 0:17:26.880 --> 0:17:28.960 you say the portfolio was kind of a mix of 0:17:29.000 --> 0:17:31.000 both top down and bottom up research. 0:17:33.359 --> 0:17:38.360 It's principally driven by bottom up research. So the starting 0:17:38.400 --> 0:17:42.679 point is kind of really company by company, what are 0:17:42.680 --> 0:17:45.760 the opportunity sets? How undervalued is this business in terms 0:17:45.760 --> 0:17:49.719 of what we think free cash generation can do. We 0:17:49.800 --> 0:17:52.879 incorporate elements I guess of top down primarily as a 0:17:52.880 --> 0:17:56.880 sense check, so you know, we want to understand if 0:17:56.880 --> 0:18:01.600 we're buying a company that has a cyclical strain. Ideally 0:18:01.600 --> 0:18:03.199 we're not buying it at the top of the cycle, 0:18:03.680 --> 0:18:07.080 would rather be buying it at the bottom. So kind 0:18:07.080 --> 0:18:09.280 of some understanding around where we are in terms of 0:18:09.280 --> 0:18:14.639 economic cycles business cycles is helpful, but it's nothing I 0:18:14.640 --> 0:18:17.200 would I wouldn't claim the crystal ball that we add 0:18:17.200 --> 0:18:19.800 a lot of value that way. It's more defensive to 0:18:19.840 --> 0:18:22.200 make sure we're not not kind of making a mistake. 0:18:22.800 --> 0:18:25.639 And similarly, in portfolio terms, we spend a lot of 0:18:25.680 --> 0:18:30.719 time on scenario analysis around the portfolio. So what happens 0:18:30.720 --> 0:18:34.520 if economies start to weaken more than we expected, what 0:18:34.600 --> 0:18:38.000 happens if there's bursts of growth, what happens if the 0:18:38.080 --> 0:18:42.080 dollar actually finally eventually starts to weaken at some stage. Again, 0:18:42.119 --> 0:18:46.200 we want to make sure that we're getting a diversification 0:18:46.280 --> 0:18:49.200 of drivers within the portfolio. So what's really doing the 0:18:49.240 --> 0:18:53.800 heavy lifting is kind of the research insights and basically 0:18:53.800 --> 0:18:55.600 buying that free cash flow at eighty five cents in 0:18:55.680 --> 0:18:56.080 the dollar. 0:18:57.760 --> 0:19:00.040 So you know, in addition to cash flow in and 0:19:01.160 --> 0:19:02.600 some of the other things you mentioned, there are other 0:19:02.680 --> 0:19:07.520 financial characteristics you look at when you're evaluating balance sheets 0:19:07.520 --> 0:19:08.360 and income statements. 0:19:10.119 --> 0:19:12.240 I mean in terms of balance sheets, obviously we're looking 0:19:12.280 --> 0:19:17.320 for also looking at excess assets that are potentially could 0:19:17.359 --> 0:19:22.720 be better deployed. So that kind of is on the 0:19:23.440 --> 0:19:26.840 offense side, what additional value could be unlocked from a 0:19:26.880 --> 0:19:29.919 company's balance sheet. It's fair to say, though, for me, 0:19:30.000 --> 0:19:33.720 when we think talk about balance sheets, the starting point 0:19:33.760 --> 0:19:36.560 is pretty much almost the cash flow statement. I think 0:19:36.600 --> 0:19:39.560 that tells you the most about how a company behaves 0:19:39.560 --> 0:19:46.480 over time. So tracking its cash generation performance is kind 0:19:46.480 --> 0:19:49.160 of a big driver. And clearly if we have companies 0:19:49.160 --> 0:19:52.520 that are self funding and generating free cash flow over time, 0:19:53.760 --> 0:19:57.199 that tends to sort of overshadow the balance sheet condition 0:19:57.240 --> 0:20:01.360 for a lot of periods. It's important though Obviously we're 0:20:01.359 --> 0:20:05.479 going to have companies that we know will draw in 0:20:05.560 --> 0:20:08.240 debt at times, and you want to make sure the 0:20:08.240 --> 0:20:10.520 balance sheet is kind of strong enough to withstand that. 0:20:11.280 --> 0:20:15.080 So we look at probably relatively conventional metrics around net 0:20:15.080 --> 0:20:21.000 debt to ebit are clusters of debro financing, etc. I 0:20:21.000 --> 0:20:24.040 think the other thing we've found probably over recent years, 0:20:24.880 --> 0:20:28.400 it's important in sort of understanding finances also to think 0:20:28.440 --> 0:20:32.400 about preemption rights, and we found that's actually added quite 0:20:32.400 --> 0:20:35.679 a lot of value particularly during COVID in companies like 0:20:35.760 --> 0:20:39.359 Rolls Royce or Outstorm, where you know, the long short 0:20:39.359 --> 0:20:43.320 community often likes to cluster around companies that they think 0:20:43.320 --> 0:20:46.080 are going to need a refinancing. If you're running a 0:20:46.160 --> 0:20:50.400 lawn short portfolio, that's a win you You can tend 0:20:50.400 --> 0:20:53.840 to close the short relatively well. It has led to 0:20:53.880 --> 0:20:57.040 some cases, however, where the kind of total enterprise value 0:20:57.040 --> 0:21:00.280 of the company gets really mispriced and we're we can 0:21:00.320 --> 0:21:04.879 have confidence that we can participate as shareholders in that refinancing. 0:21:06.080 --> 0:21:09.359 We've been willing to be proactive and buy ahead of 0:21:09.560 --> 0:21:13.440 unexpected rights issues from companies, and again those have turned 0:21:13.480 --> 0:21:16.920 out to be home runs for the portfolio in many cases. 0:21:18.920 --> 0:21:23.160 Looking at value opportunities on a geographic basis, I would 0:21:23.280 --> 0:21:26.760 like to have your view on Japan because many investors 0:21:26.800 --> 0:21:31.440 things that the country is undergoing structural shift with a 0:21:31.600 --> 0:21:36.440 move from deflation to reflation. Corporate governance is being much 0:21:36.480 --> 0:21:39.560 more shareholder friendly than it used to be in the past. 0:21:40.080 --> 0:21:42.600 So market has done quite well over the past two 0:21:42.600 --> 0:21:44.960 to three years. Where do you think we are in 0:21:45.000 --> 0:21:45.600 this cycle. 0:21:47.720 --> 0:21:49.840 Yes, certainly the market has done well, and I think 0:21:49.840 --> 0:21:52.879 also within Japan, the sort of value cohort of stocks 0:21:52.880 --> 0:21:56.400 have done well as we've seen some of those changes unlocking. 0:21:59.359 --> 0:22:01.480 I think all of those things are happening. So we 0:22:01.560 --> 0:22:06.439 are seeing restructuring in Japan. We're seeing an accelerating release 0:22:06.480 --> 0:22:11.560 of cross shareholdings. We're seeing companies being a bit more 0:22:12.080 --> 0:22:16.359 deliberate about capital allocation, a bit more shareholder return driven 0:22:16.800 --> 0:22:20.040 in some of those policies. Having said that, I think, 0:22:20.920 --> 0:22:24.080 as you said, the market has become more consensual about 0:22:24.119 --> 0:22:26.000 these things. There was a lot of debate around that 0:22:26.040 --> 0:22:28.960 a couple of years ago. It now seems to be 0:22:29.080 --> 0:22:32.320 very much received wisdom. So we're finding you have to 0:22:32.359 --> 0:22:34.680 pick your spots a bit more carefully in Japan now. 0:22:35.920 --> 0:22:41.440 So we're looking for opportunities, I guess actively for restructuring. 0:22:41.560 --> 0:22:43.680 It's one of the sort of tenets of the portfolio, 0:22:44.480 --> 0:22:47.200 but we're perhaps finding we're rotating a little bit away 0:22:47.240 --> 0:22:50.520 from some of the industrial and export sectors. And again 0:22:50.560 --> 0:22:53.480 some of those companies, things like Katachu held in the 0:22:53.480 --> 0:22:56.320 portfolio for ten years, it's been a great restructuring story. 0:22:56.880 --> 0:23:03.000 But we're seeing, I guess, a a consensus around restructuring 0:23:03.040 --> 0:23:06.080 for some of these companies. But also there's been quite 0:23:06.080 --> 0:23:09.280 a benefit from the weekend for a lot of exporters, 0:23:09.320 --> 0:23:13.479 which again we don't want to sort of bake in 0:23:13.520 --> 0:23:16.800 as permanent. And we're also seeing perhaps quite a change 0:23:16.800 --> 0:23:21.080 in terms of the competitive levels for some Japanese companies 0:23:21.160 --> 0:23:25.719 versus Chinese competitors, and certainly where where China has been 0:23:25.720 --> 0:23:28.840 a big end market, we're seeing quite an increase in 0:23:28.880 --> 0:23:33.520 sort of domestic competition, so rotating a little bit away 0:23:33.560 --> 0:23:36.119 from some of the export industries, and we've been finding 0:23:36.119 --> 0:23:39.760 more opportunities on the domestic side. Companies like seven to 0:23:39.760 --> 0:23:43.160 eleven have been a big additions to the portfolio this year. 0:23:43.760 --> 0:23:47.600 This is like Cow where we're seeing prices rise for 0:23:47.640 --> 0:23:50.280 the first time in twenty odd years. And we're also 0:23:50.359 --> 0:23:53.520 finding we're moving a little bit down the capitalization spectrum, 0:23:53.640 --> 0:23:56.840 so more opportunity in the mid cap and Japan, but 0:23:57.600 --> 0:24:02.200 netnet for fund has now moved underweight Japan. In contrast, 0:24:02.600 --> 0:24:05.040 we've probably been adding over the last eighteen months or 0:24:05.119 --> 0:24:09.560 so to positions in Korea quite heavily. I think it 0:24:09.640 --> 0:24:13.880 feels to me like Korea is at an earlier stage 0:24:14.280 --> 0:24:18.280 to Japan in terms of its value up program. But 0:24:18.320 --> 0:24:22.520 there's a certainly we're finding from companies a drive to 0:24:22.640 --> 0:24:27.040 sort of better define capital allocation. We probably need some 0:24:27.080 --> 0:24:30.840 tax changes more to see asset release. But again there's 0:24:30.880 --> 0:24:34.520 a sort of relatively lowly valued set of companies that 0:24:34.600 --> 0:24:37.239 start to be starting to change. So Korea is an 0:24:37.280 --> 0:24:41.520 area of spending increasing time. Obviously, the political events of 0:24:41.560 --> 0:24:44.560 the last few days don't help the case in the 0:24:44.560 --> 0:24:45.000 short run. 0:24:45.040 --> 0:24:49.440 There coming back very quickly. On Japan. Do you think 0:24:49.480 --> 0:24:53.639 that if the boj increase rates over the next twelve 0:24:53.680 --> 0:24:57.040