WEBVTT - GMO’s Hancock on the Importance of Profitability 0:00:13.200 --> 0:00:16.360 Welcome to Inside Active, a podcast about active managers that 0:00:16.400 --> 0:00:19.639 goes beyond sound bites and headlines and looks deeper into 0:00:19.680 --> 0:00:25.000 the processes, challenges, and philosophies and security selection. I'm David Cohne, 0:00:25.040 --> 0:00:28.120 I lead mutual fund and active Research at Bloomberg Intelligence. 0:00:28.440 --> 0:00:32.400 Today I'm joined by Christopher Kaine, us quantitative strategist at 0:00:32.400 --> 0:00:35.200 Bloomberg Intelligence. Chris, thanks for joining me today. 0:00:35.479 --> 0:00:36.240 Thank you for David. 0:00:37.200 --> 0:00:39.320 So you wrote a note last week on the BI 0:00:39.479 --> 0:00:43.000 factor scorecard. Can you tell our listeners what the scorecard 0:00:43.120 --> 0:00:45.480 is and where the quality factor currently rings? 0:00:46.280 --> 0:00:49.480 Sure? So the design of the scorecard is to inform 0:00:49.920 --> 0:00:54.080 let's call it tactical decision making around factors or timing factors, 0:00:54.080 --> 0:00:57.200 if you will. Now that's a bit of a controversial subject, 0:00:57.240 --> 0:00:59.640 no doubt about it. But some, you know, many clients 0:00:59.680 --> 0:01:02.560 do want, you know, to be a little tactical around 0:01:02.600 --> 0:01:07.160 the factors. So the factor scorecard really takes two broad 0:01:08.200 --> 0:01:11.440 you know, variables into account. It's the the the trends 0:01:11.480 --> 0:01:14.320 of the long short factors themselves, which has been shown 0:01:14.360 --> 0:01:17.280 to at least somewhat predict future factor returns, as well 0:01:17.319 --> 0:01:21.000 as the relative valuations of the long and the short 0:01:21.080 --> 0:01:24.680 legs and how that compares the history. So of our 0:01:24.720 --> 0:01:29.160 five main factors, which is low ball, quality, momentum, value, 0:01:29.360 --> 0:01:32.600 and small size, we have a quality as the second 0:01:32.680 --> 0:01:35.640 best or the second highest on the on the scorecard, 0:01:35.880 --> 0:01:40.000 low volatility is number one. Now, both low volatility, as 0:01:40.000 --> 0:01:42.440 far as long short factors, and quality have done very 0:01:42.440 --> 0:01:45.759 well this year. You know, even though the market is 0:01:45.840 --> 0:01:48.160 you know, coming to all time highs or making all 0:01:48.160 --> 0:01:50.560 time highs, there is a bit of a defensive tone 0:01:50.600 --> 0:01:53.800 of the market, meaning like low vall stocks are beating 0:01:53.880 --> 0:01:57.880 high vall, high qualities beating low quality. So both of 0:01:57.920 --> 0:01:59.920 those trends are positive. That's why they're number one and 0:02:00.080 --> 0:02:03.520 number two. Now. Lowvall is number one because its valuations 0:02:03.600 --> 0:02:08.519 historically are not extreme, whereas quality is a little expensive 0:02:08.840 --> 0:02:11.960 historically when you look at the high quality verse low 0:02:12.120 --> 0:02:14.840 or high quality versity index, so that does drop it 0:02:14.880 --> 0:02:17.920 down just a notch. So quality number two. Momentum is 0:02:17.919 --> 0:02:19.800 the middle of the pack, and in value in small 0:02:19.840 --> 0:02:22.760 size around out the scorecard great well. 0:02:22.800 --> 0:02:26.360 Speaking of quality, I'd like to welcome Tom Hancock, head 0:02:26.360 --> 0:02:30.160 of Focused Equity and a portfolio manager at GMO. Tom 0:02:30.200 --> 0:02:34.760 manages the GMO US Quality ETF ticker qlt Y, and 0:02:34.880 --> 0:02:37.720 a number of other funds at the firm. Tom, thank 0:02:37.760 --> 0:02:39.680 you for taking the time to speak with us today. 0:02:40.240 --> 0:02:41.600 Hey David, thanks for having me. 0:02:42.400 --> 0:02:44.320 So I'd like to begin by asking you about your 0:02:44.360 --> 0:02:47.359 investment background. Can you tell us how you got your 0:02:47.360 --> 0:02:48.280 start in investing. 0:02:49.360 --> 0:02:52.639 Yeah, so I've been at GMO, granted maya an autoloo 0:02:52.840 --> 0:02:57.400 for approaching thirty years now. I joined in nineteen ninety five, 0:02:57.800 --> 0:03:01.040 and maybe not coincidentally, this is the only investment industry 0:03:01.160 --> 0:03:04.560 job I've had. My background before GMO was actually in 0:03:04.600 --> 0:03:08.160 computer science. I worked as a software engineer for a period, 0:03:08.160 --> 0:03:11.680 then I went to grad school did academic research actually 0:03:11.720 --> 0:03:14.400 in the artificial intelligence area, which is the time a 0:03:14.400 --> 0:03:17.440 little bit of a sleepy backwater. And for many years 0:03:17.440 --> 0:03:19.280 I said, I mean there were great right to rear 0:03:19.400 --> 0:03:21.520 choice to come into investments. Now I'm not so sure, 0:03:21.600 --> 0:03:24.000 but nonetheless I've enjoyed it for thirty years, so I 0:03:24.040 --> 0:03:26.320 think it was still the right choice. And so with 0:03:26.440 --> 0:03:29.639 that kind of quantitative background when I joined GMO, one 0:03:29.639 --> 0:03:32.359 of the things GMO is known for is quantitative investing, 0:03:32.360 --> 0:03:36.040 fundamental quantitative investing, things like quality factors, and that's kind 0:03:36.080 --> 0:03:40.560 of how I got my start, initially in portfolio optimization construction, 0:03:40.840 --> 0:03:45.960 then into the investment models, then into portfolio management. Originally 0:03:46.640 --> 0:03:49.680 just on the quantitative side, but I've transitioned over the 0:03:49.760 --> 0:03:54.360 last couple decades into more of a traditional fundamental role. 0:03:54.480 --> 0:03:58.360 But I have that dual quantum fundamental background, that is 0:03:58.400 --> 0:04:01.000 the background in which a lot of our stredges are managed, 0:04:01.040 --> 0:04:04.920 including the quality ETF. It's sort of a quant fundamental hybrid. 0:04:05.000 --> 0:04:06.520 You could say, that's. 0:04:06.400 --> 0:04:09.480 An interesting approach. Actually, so can you give us an 0:04:09.480 --> 0:04:12.160 overview of the GMO approach to investig in I guess 0:04:12.240 --> 0:04:15.920 talk more specifically about the investment process of QLTY. 0:04:16.360 --> 0:04:21.520 Yeah, speaking specifically to our quality strategy and the QLTY investment. 0:04:21.600 --> 0:04:27.320 Our approach is bottom up, and we start with systematic 0:04:27.440 --> 0:04:31.520 screening on a quality factor. Of course, everybody's quality factor 0:04:31.560 --> 0:04:35.720 is a little bit different, but ours includes elements of profitability, 0:04:35.920 --> 0:04:40.599 historical profitability, stability and that profitability, strong balance sheets, and 0:04:40.640 --> 0:04:43.280 I should say, maybe to beat our own drum a 0:04:43.320 --> 0:04:46.920 little bit, the having quality factors an integrade management investment 0:04:46.960 --> 0:04:49.080 process goes all the way back to the nineteen eighty 0:04:49.080 --> 0:04:52.080 stort GMO. So well, I'm not sure I could hold out. 0:04:52.120 --> 0:04:55.720 Our factor is being extremely differentiated. Now we're a very 0:04:56.360 --> 0:05:01.479 early mover in that space. That quality factor, though, is 0:05:01.640 --> 0:05:04.279 just a bit of a starting point for us in 0:05:04.320 --> 0:05:09.120 two ways. One is integrating the fundamental work. So companies 0:05:09.120 --> 0:05:11.599 that have a great history, as measured by this approach 0:05:11.640 --> 0:05:14.200 are probably high quality, but not all of them are 0:05:14.360 --> 0:05:16.560 in a forward looking sense, at least in our views. 0:05:16.640 --> 0:05:19.320 So we want to screen out a few companies that 0:05:19.360 --> 0:05:23.440 we don't think meet that the bill looking forward. We 0:05:23.480 --> 0:05:25.279 also want to be a little bit open minded for 0:05:25.360 --> 0:05:27.719 companies that maybe are newer and don't have the history, 0:05:27.720 --> 0:05:30.120 have all the attributes to being a quality business, but 0:05:30.200 --> 0:05:34.039 don't fit the backward looking quant screen. That's one thing, 0:05:34.080 --> 0:05:36.919 and then the second thing is that we integrate valuation 0:05:37.200 --> 0:05:38.920 into our approach as well. So we don't want to 0:05:38.920 --> 0:05:41.200 buy quality companies at any price. We want to buy 0:05:41.240 --> 0:05:44.960 quality companies at a reasonable price. If you go back 0:05:45.040 --> 0:05:47.839 through GMO's history, we actually originally were very much a 0:05:47.880 --> 0:05:50.760 deep value manager when the firm was founded. The integration 0:05:50.839 --> 0:05:53.400 of quality came kind of later in the game, as 0:05:53.480 --> 0:05:57.679 the founders, Jeremy Granthams, appreciated the benefits of quality companies, 0:05:57.760 --> 0:06:00.640 but we actually started from value. Now we do it 0:06:00.640 --> 0:06:02.640 in the other order. We start with quality for our 0:06:02.680 --> 0:06:05.840 strategy and then add value to it. But that is 0:06:06.240 --> 0:06:09.760 I think an important differentiator from a lot of quality managers, 0:06:09.760 --> 0:06:14.240 whether they be active or passive. Is that valuation tilt 0:06:14.240 --> 0:06:14.640 as well. 0:06:15.279 --> 0:06:17.480 That's really interesting, Tom, I mean, you know, you're kind 0:06:17.520 --> 0:06:19.400 of still in my thunder. I had some of these 0:06:19.480 --> 0:06:22.400 questions already, but you know, one of my questions to you, 0:06:22.440 --> 0:06:25.960 which you already answered, was is your process completely systematic 0:06:26.040 --> 0:06:28.880 or is there some discretionary elements? Obviously there is some 0:06:28.920 --> 0:06:30.560 discretionary elements. 0:06:30.200 --> 0:06:30.359 You know. 0:06:30.480 --> 0:06:32.600 I do speak to a lot of our customers that 0:06:33.200 --> 0:06:35.160 do want to do something like that, right, I mean 0:06:35.200 --> 0:06:38.960 they want to They're not pure quants, but they want 0:06:38.960 --> 0:06:41.560 to use quant screens to maybe whittle down a universe 0:06:41.680 --> 0:06:45.039 and then use their fundamental analysis and kind of discretionary 0:06:45.080 --> 0:06:48.000 decision making. So can you expand on that a little bit? 0:06:48.040 --> 0:06:49.800 Like you don't have to give specifics, but I mean, 0:06:50.240 --> 0:06:53.159 is it more like you're screening for quality stocks and 0:06:53.200 --> 0:06:55.640 you're just kind of like kicking out the bad apples 0:06:55.880 --> 0:06:58.039 or is it more like you're you're just picking the 0:06:58.080 --> 0:07:01.600 best ones? How does the fundamental research. And again you 0:07:01.680 --> 0:07:03.960 have to go in specifics, but how does the fundamental 0:07:03.960 --> 0:07:06.159 research happen with those stocks? Do you do you have 0:07:06.360 --> 0:07:09.479 different analysts look into the companies. A little more insight 0:07:09.520 --> 0:07:10.720 there would be really helpful. 0:07:10.960 --> 0:07:13.960 Yeah. I mean, I think there's a lot to that, 0:07:14.160 --> 0:07:17.240 and it's been forever answering that question. But I think 0:07:17.920 --> 0:07:23.040 it is mainly about bad apples or maybe not great apples. 0:07:23.240 --> 0:07:26.640 Let's say they're not all rotten companies. I mean some 0:07:26.720 --> 0:07:29.240 might be a company like well, not today. A couple 0:07:29.280 --> 0:07:31.560 of years ago, Intel would have, for example, screened is 0:07:31.600 --> 0:07:35.320 a very high quality, and that would be an example, 0:07:35.600 --> 0:07:39.080 a real life example where while we didn't maybe foresee 0:07:39.160 --> 0:07:42.600 all their problems, we would have said and did say, hey, 0:07:42.720 --> 0:07:46.080 you know this model they had where you integrate building 0:07:46.120 --> 0:07:49.360 the chip with designing the chip was kind of yesterday's model. 0:07:49.400 --> 0:07:53.760 And now the actual manufacturing is so expensive and complicated. 0:07:53.800 --> 0:07:57.680 It's consolidated at TSMC and the fabulous companies at the lead. 0:07:57.840 --> 0:07:59.880 So the future isn't going to be like the past. 0:08:00.080 --> 0:08:02.280 Would be sort of an example. One of the things 0:08:03.160 --> 0:08:07.160 we've also found just with our quantitative scoring is sometimes 0:08:07.480 --> 0:08:10.080 they can get fooled by a cycle. So a more 0:08:10.280 --> 0:08:12.800 simple example kind of is just you go back to 0:08:12.880 --> 0:08:15.400 the financial crisis, Like home builders look really great for 0:08:15.440 --> 0:08:17.200 a number of years. Has just been such a long 0:08:17.320 --> 0:08:20.320 bull cycle for them that they were scoring very well, 0:08:20.480 --> 0:08:23.280 but we felt they at their heart weren't quality businesses. 0:08:23.280 --> 0:08:26.680 So that's very important part of what we do. Our 0:08:26.680 --> 0:08:32.040 portfolio is reasonably concentrated. It has about forty stocks in it, 0:08:32.800 --> 0:08:35.880 so it's not like every stock we don't own we 0:08:36.040 --> 0:08:39.479 think is definitely a bad company. There's also a portfolio 0:08:39.760 --> 0:08:43.440 management element of sort of curating it into a basket. 0:08:43.520 --> 0:08:46.560 That is, we have high conviction we can follow each 0:08:46.559 --> 0:08:49.199 of these companies, we have the human capacity for that, 0:08:49.559 --> 0:08:52.439 and yet at the same time give us diversification between 0:08:52.679 --> 0:08:55.920 different kinds of quality stocks. And I heard earlier talking 0:08:55.920 --> 0:08:58.440 about sort of low vall, which is different from quality 0:08:58.480 --> 0:09:01.720 but sort of related. One kind of quality stock is 0:09:01.760 --> 0:09:04.319 or of those more defensive companies. But equally, we think 0:09:04.360 --> 0:09:06.360 the growth companies that of course have been the winner 0:09:06.440 --> 0:09:09.360 or the last decade. There's Microsofts and so forth. Those 0:09:09.440 --> 0:09:12.320 high quality growth companies are also high quality. And we 0:09:12.400 --> 0:09:14.720 think even within sort of what you might think of 0:09:14.760 --> 0:09:17.520 as a narrowly targeted group like quality, you can actually 0:09:17.520 --> 0:09:21.240 got a fairly diversified basket of Going back to your 0:09:21.240 --> 0:09:24.040 original question about what do we do, sort of fundamentally 0:09:24.040 --> 0:09:29.520 beyond the screening, our valuation is also an important fundamental aspect, 0:09:29.720 --> 0:09:33.439 and we're not necessarily trying to find these totally discounted 0:09:33.480 --> 0:09:36.000 fifty cent on the dollar kind of companies that tends 0:09:36.000 --> 0:09:38.959 not to exist in a high quality universe. We want 0:09:39.040 --> 0:09:42.439 to at least find reasonably priced companies and avoid companies 0:09:42.480 --> 0:09:45.720 where maybe the business is great, but the stock price 0:09:45.720 --> 0:09:47.080 has just gotten way ahead of it. 0:09:47.360 --> 0:09:50.520 Thank you. Quality is one of those factors. I would 0:09:50.559 --> 0:09:54.120 say it's the factor with the most let's call it 0:09:54.160 --> 0:09:57.920 dispersion in definitions, you know, I mean I think you know, 0:09:58.160 --> 0:10:01.000 we know what momentum is, we know about value is. 0:10:01.040 --> 0:10:02.599 You could have your own spin on a value or 0:10:02.640 --> 0:10:05.480 momentum factor, but it's not gonna be that different. I mean, 0:10:05.520 --> 0:10:10.640 you touched on, you know, profitability in my experience, and 0:10:11.040 --> 0:10:13.040 you're the experts, so please feel free to push back. 0:10:13.080 --> 0:10:17.959 But profitability seems to be like the constant in almost 0:10:18.000 --> 0:10:21.120 every quality factor I've seen. And then you usually see 0:10:21.160 --> 0:10:24.840 things like low leverage, like you said, financial stability, things 0:10:24.880 --> 0:10:28.800 like volatility of earnings or sales. I've always seen things 0:10:28.840 --> 0:10:31.640 like a CRULS, so you don't have to give away 0:10:31.640 --> 0:10:34.120 the secret sauce, but like, how do you like do 0:10:34.200 --> 0:10:38.560 you equally wait those different types of descriptors, how do 0:10:38.600 --> 0:10:42.400 you think about combining those things with your quality factor? 0:10:42.480 --> 0:10:44.480 And maybe to start a little bit with the history 0:10:44.480 --> 0:10:46.000 and I'll give you kind of a long ash answer 0:10:46.080 --> 0:10:49.640 that question because it's important. One is and when GMO 0:10:49.840 --> 0:10:53.000 started as a value investor and we're buying things like 0:10:53.120 --> 0:10:56.120 low price to book, low pe stocks in nineteen eighty, 0:10:56.559 --> 0:11:00.560 what we're realized we were missing was these companies got 0:11:00.559 --> 0:11:04.000 a high return on their investment capital when they reinvested, 0:11:04.080 --> 0:11:06.600 they had growth opportunities they could invest in, they got 0:11:06.679 --> 0:11:09.240 high return on that. Therefore they should should create a 0:11:09.320 --> 0:11:13.000 premium valuation, and we weren't buying them. So we started 0:11:13.040 --> 0:11:16.400 from a place of how should we adjust the valuation 0:11:17.200 --> 0:11:20.319 target of companies to take into account these better businesses. 0:11:20.320 --> 0:11:23.839 And the key idea for us was companies that will 0:11:23.880 --> 0:11:28.160 deliver a high return on capital on incremental investments. And 0:11:28.360 --> 0:11:30.640 that's great, of course in theory, but that's the future. 0:11:30.679 --> 0:11:32.440 You can't see the future, can do I see the past, 0:11:32.480 --> 0:11:35.320 so we're looking at things that were predictive about of that. 0:11:35.679 --> 0:11:41.200 And the focus on profitability is largely because profitability past 0:11:41.240 --> 0:11:43.880 profitability is actually pretty predictive future profitable, but it's a 0:11:43.920 --> 0:11:47.680 relatively stable characteristic, unlike if you look at growth factors, 0:11:47.720 --> 0:11:50.560 they tend not to persist very long. So you know, 0:11:50.640 --> 0:11:52.559 you buy growth portfolio, you don't have one in three 0:11:52.640 --> 0:11:55.440 years is kind of the risk. So I'll tell you 0:11:55.480 --> 0:11:57.840 that the secret sauce in nineteen eighty five, kind of 0:11:57.840 --> 0:12:00.560 the very original version of a quality factor was simply 0:12:01.640 --> 0:12:05.200 eight year history of high return on equity, eight year 0:12:05.320 --> 0:12:08.960 stability in that return on equity, and low debt to 0:12:09.040 --> 0:12:13.200 equity ratio. So it was profitability, stability, and balance sheet 0:12:13.440 --> 0:12:15.920 and we ranked the universe on those companies and we 0:12:16.240 --> 0:12:19.080 average the ranks. I think the worst one got halfway. Actually, 0:12:19.080 --> 0:12:22.640 that was it for version one point zero. The version 0:12:22.679 --> 0:12:26.560 we use now has a similar flavor in that there's 0:12:26.600 --> 0:12:31.040 a profitability component, a stability of profitability component, and a 0:12:31.080 --> 0:12:35.319 balanced street sheet strength component, and they have many more 0:12:35.320 --> 0:12:38.360 components beneath them, and the combinations a little bit more complicated, 0:12:38.360 --> 0:12:42.360 but in the spirit of that original idea, one thing 0:12:42.400 --> 0:12:44.560 that's different about us, and I think goes back to 0:12:44.559 --> 0:12:46.760 the fact that we actually think valuation is a big 0:12:46.800 --> 0:12:48.960 part of the return driver too. Is when we think 0:12:49.000 --> 0:12:52.679 about an improvement to our or change to our quality factor, 0:12:52.720 --> 0:12:54.680 does this make it better or worse than what we're 0:12:54.760 --> 0:12:58.080 using last year? The question we're tend to be asking 0:12:58.160 --> 0:13:02.000 is does this predict future profitability better? So, if we 0:13:02.040 --> 0:13:05.120 do back testing, it's not does this generate high return 0:13:05.200 --> 0:13:07.920 in the market just as a quality factor. It's more 0:13:08.240 --> 0:13:12.960 do the companies identified on this metric have better profitability 0:13:13.000 --> 0:13:15.400 ten years from now than the ones that don't. So 0:13:15.640 --> 0:13:17.840 we're focused on the fundamentals, and that does, I think 0:13:17.960 --> 0:13:20.840 lead us to some differences in factors we highlight. So 0:13:20.880 --> 0:13:24.000 things like acrules, which are sort of maybe a short 0:13:24.080 --> 0:13:27.240 term alpha factor, they aren't really what we think of 0:13:27.280 --> 0:13:29.800 as a quality factor, so they're not part of our metric. 0:13:30.480 --> 0:13:33.599 They tend not to have meaning over as long horizon. 0:13:34.480 --> 0:13:39.880 Things like stability or like stock price volatility. It's very 0:13:39.920 --> 0:13:42.720 predictive of defensiveness, and so if you're looking for just 0:13:42.760 --> 0:13:45.920 a defensive factor, it's great, but we're not looking just 0:13:45.960 --> 0:13:49.000 for defensiveness. We tend to get defensiveness because if you 0:13:49.040 --> 0:13:52.920 buy businesses where the profitability is reliable, when times are tough, 0:13:53.000 --> 0:13:55.960 the profitability will be relatively reliable. It's more of an 0:13:55.960 --> 0:13:59.480 outcome than explicit objective in our process. And then one 0:13:59.520 --> 0:14:02.720 thing that you mention, and you're right, quality means lots 0:14:02.720 --> 0:14:04.560 of things to lots of people. And I've never heard 0:14:04.559 --> 0:14:07.160 of manager who says their process isn't high quality. But 0:14:07.440 --> 0:14:11.080 one thing we don't use is dividend type metrics, so 0:14:11.160 --> 0:14:14.280 stability and dividend, dividend growth, things like that. Not that 0:14:14.320 --> 0:14:17.480 we have anything against dividends. We like receiving them, but 0:14:17.520 --> 0:14:19.840 what we like even better is companies that reinvest in 0:14:19.840 --> 0:14:21.960 a high rate of return. So they think there are 0:14:21.960 --> 0:14:23.880 a lot of great, high quality companies that don't pay 0:14:23.880 --> 0:14:26.520 a dividend because they're growing the business. Of course, we 0:14:26.600 --> 0:14:29.480 want companies that when their growth opportunities dry up, they 0:14:29.480 --> 0:14:32.360 return capital. But it's not the only way you could 0:14:32.360 --> 0:14:33.560 be a high quality company. 0:14:34.040 --> 0:14:36.360 Yeah, that's some really great insight. I mean, you know, 0:14:36.600 --> 0:14:37.920 that was one of my other questions you kind of 0:14:38.000 --> 0:14:40.960 hit on. It was, you know, I've seen some quants, 0:14:41.560 --> 0:14:44.520 you know, kind of lump in low risk, low vall 0:14:44.680 --> 0:14:48.840 low beta, even things like low idiosyncratic volatility to their 0:14:48.920 --> 0:14:52.080 quality factor, because the thought is like they're similar ideas. 0:14:53.000 --> 0:14:55.480 But I always view the low risk factor as a 0:14:55.480 --> 0:14:59.240 as a separate factor from quality. I would it sounds 0:14:59.240 --> 0:15:00.040 like you agree with that. 0:15:00.240 --> 0:15:00.960 Yeah, yeah, we do. 0:15:01.040 --> 0:15:04.160 Yeah, you mentioned growth, so I kind of want to 0:15:04.160 --> 0:15:06.880 touch upon that a little bit. I'm guessing it's part 0:15:06.920 --> 0:15:11.200 of the fundamental approach, you know, after you've screened you know, 0:15:11.240 --> 0:15:13.400 so I'm just interested in the evaluation of growth. How 0:15:13.400 --> 0:15:16.280 do you assess growth opportunities in these companies as part 0:15:16.280 --> 0:15:16.920 of the process. 0:15:17.080 --> 0:15:19.840 Yeah, and what it is, You're right, it's part of 0:15:19.840 --> 0:15:24.720 the fundamental approach. And now it's not because we it's 0:15:24.800 --> 0:15:26.880 kind of because it's harder. I guess for us, the 0:15:26.960 --> 0:15:30.120 earlier point is we haven't cracked the nut on how 0:15:30.160 --> 0:15:35.200 to find good quantitative metrics for predicting growth over longer periods. 0:15:35.240 --> 0:15:37.680 And I guess the one is that the obvious one 0:15:37.720 --> 0:15:40.240 is high valuation. That's a very good predictor, but that's 0:15:40.520 --> 0:15:43.320 you know, history would suggest you don't want to include 0:15:43.360 --> 0:15:47.640 high valuation in your quantitative model. Is a positive selection criteria, 0:15:47.760 --> 0:15:50.760 So that's not so helpful for us. So when we 0:15:50.800 --> 0:15:56.280 think about growth. What we're really mindful of is who 0:15:56.320 --> 0:15:59.280 has growth that is really going to be sustainable. So 0:15:59.320 --> 0:16:03.160 the kind of growth we like is when there's a 0:16:03.200 --> 0:16:06.760 secular trend that we feel a company can latch onto, 0:16:06.880 --> 0:16:10.720 So for example, demographic trends and what that might imply 0:16:10.960 --> 0:16:16.280 about healthcare, we are willing to the broader the trend 0:16:16.400 --> 0:16:19.160 is the better. So we feel very comfortable with say, 0:16:20.240 --> 0:16:25.360 semiconductor tech content growing broadly, and if your growth as 0:16:25.400 --> 0:16:27.800 a company is sort of levered to that broad thing, 0:16:28.360 --> 0:16:32.680 that's great. If it's a specific technology, that's where we 0:16:32.800 --> 0:16:36.360 are going to be, let's say more conservatives. So honestly, 0:16:36.360 --> 0:16:38.440 something like artificial intelligence, we're probably going to be on 0:16:38.480 --> 0:16:41.000 the more conservative side. As that gets into a more 0:16:41.280 --> 0:16:44.360 specific thing our just experiences, it's harder for us to 0:16:44.400 --> 0:16:48.000 get that right. And then beyond the secular growth that 0:16:48.080 --> 0:16:51.040 they might be associated with an industry, the other thing 0:16:51.080 --> 0:16:55.800 we're asking ourselves around an individual company is they're probably 0:16:55.840 --> 0:16:58.080 going to benefit from if they're in that industry. They'll 0:16:58.080 --> 0:17:01.040 benefit initially because that rising tide raise all boats. The 0:17:01.120 --> 0:17:04.840 question is do they have a competitive advantage that will 0:17:04.880 --> 0:17:08.600 allow them to maintain and grow their share to get 0:17:08.720 --> 0:17:11.240 more than their fair share of the pie. Hopefully, so 0:17:12.080 --> 0:17:14.480 the kind of company where, because of its growth, will 0:17:14.520 --> 0:17:17.480 pay a higher multiple four will be one that's sort 0:17:17.480 --> 0:17:19.960 of in the participating in the early stages of a 0:17:20.000 --> 0:17:24.480 secularly growing industry and as a super strong competitive position 0:17:25.000 --> 0:17:28.800 that we think won't be dislodged. So a intuitive surgical 0:17:28.840 --> 0:17:33.120 for example, in surgical robotics, there's not just broad healthcare trends. 0:17:33.119 --> 0:17:35.520 There's robotic assisted surgery, which you think has a lot 0:17:35.520 --> 0:17:39.040 of legs and their strong competitive position within that. The way, 0:17:39.040 --> 0:17:40.960 we kind of think of that as not so much 0:17:41.880 --> 0:17:44.880 about higher growth within the next one or two years. 0:17:45.119 --> 0:17:49.639 We're more focused on durability above average growth because finding 0:17:49.680 --> 0:17:52.400 those companies that can really outgrow the market for five 0:17:52.680 --> 0:17:55.760 ten years that's actually pretty hard and those are pretty 0:17:55.880 --> 0:18:01.359 rare companies, so it's not like anyone can do that. 0:18:00.240 --> 0:18:02.760 That makes sense. I also want to ask you about 0:18:02.760 --> 0:18:05.119 the portfolio. You know, so if you look at the 0:18:05.160 --> 0:18:07.560 portfolio on the website as of I don't know, I'm 0:18:07.560 --> 0:18:09.960 guessing that's as of August. I noticed a lot of 0:18:10.000 --> 0:18:13.639 large caps. Are you finding more quality in large caps 0:18:13.680 --> 0:18:15.920 as opposed to more of the you know, other mid 0:18:16.000 --> 0:18:17.120 or smaller cap companies. 0:18:17.400 --> 0:18:20.679 Yeah, we are, and that's not a new trend. The 0:18:20.760 --> 0:18:24.440 large cap universe, particularly in the US market, is a 0:18:25.160 --> 0:18:28.560 much higher quality one. Not by definition, i should say, 0:18:28.560 --> 0:18:30.520 but also if you're a great company and a big 0:18:30.560 --> 0:18:34.040 business you are, do you tend to get large. There's 0:18:34.080 --> 0:18:36.640 also a value hit, not so much today, but over 0:18:36.640 --> 0:18:39.360 the past decade or so, there's a been a valuation 0:18:39.560 --> 0:18:42.640 reason in our minds too, where we found smaller cap 0:18:42.680 --> 0:18:45.679 quality companies that tend to be at a premium. That is, 0:18:45.960 --> 0:18:47.760 that has changed a little bit in the last couple 0:18:47.800 --> 0:18:50.840 of years. We actually did launch. It's not not in 0:18:50.840 --> 0:18:53.639 the ETF format. The ETF is large cap, but the 0:18:53.920 --> 0:18:56.399 we do have a small cap quality strategy that's a 0:18:56.400 --> 0:18:59.000 couple of years old. That's looking for kind of those 0:18:59.080 --> 0:19:02.280 niche businesses that maybe they don't grow with much because 0:19:02.440 --> 0:19:04.280 they're smaller cap. They do a specific thing, but they 0:19:04.320 --> 0:19:06.600 do it really well. It's an important thing. So there 0:19:06.680 --> 0:19:11.440 is quality there, but it's not it's not as prevalent. 0:19:11.520 --> 0:19:13.560 Let's say, in the small cap universe. 0:19:13.840 --> 0:19:16.640 Tom, what about waiting your stocks? I mean, just looking 0:19:16.680 --> 0:19:18.960 at the portfolio, it does seem to be market cap 0:19:19.000 --> 0:19:22.640 weighted or at least partially market cap weighted, and please 0:19:22.680 --> 0:19:25.439 correct me if I'm wrong. How do you think about that? 0:19:25.600 --> 0:19:29.040 Is that kind of a function of liquidity and slippage concerns, 0:19:29.400 --> 0:19:32.119 or how do you think about the waiting of the 0:19:32.160 --> 0:19:33.200 stocks in the portfolio? 0:19:33.800 --> 0:19:36.119 Yeah, and you're right there. We're market cap weight in 0:19:36.160 --> 0:19:39.040 the sense that we are close to S and P 0:19:39.200 --> 0:19:42.399 five hundred type market cap, which is unusual for an 0:19:42.440 --> 0:19:46.119 active manager. But we're not actually explicitly market cap waiting 0:19:46.240 --> 0:19:50.000 our positions or managing directly to the benchmark for that matter. 0:19:50.440 --> 0:19:54.120 The general framework for how we think about position sizing 0:19:54.640 --> 0:19:57.199 is the quality of the business that's kind of a 0:19:57.359 --> 0:20:02.040 maximum weight will hold in a stock, and then valuation 0:20:02.280 --> 0:20:04.320 is a little bit of a you know, how far 0:20:04.400 --> 0:20:07.920 through the dial should you be? So even the best 0:20:07.920 --> 0:20:11.000 company in the world, we wouldn't hold it an expensive valuation, 0:20:11.119 --> 0:20:14.400 et cetera, or probably won't hold unless your high quality. 0:20:14.480 --> 0:20:17.520 So the biggest positions in the portfolio will be companies 0:20:17.640 --> 0:20:20.840 that are we're convinced about black quality, and we're also 0:20:20.960 --> 0:20:24.800 find the valuation very compelling, at least when we initially 0:20:24.800 --> 0:20:27.440 bought the company. We do let winners run a bit 0:20:27.560 --> 0:20:30.159 so that doesn't necessarily mean the the cheapest stock in 0:20:30.200 --> 0:20:33.919 the world today, but they were very attractive when we 0:20:33.960 --> 0:20:38.479 originally bought them. And then yes, liquidity matters, and there 0:20:38.520 --> 0:20:40.920 are there will be a few smaller companies. Girrell hold 0:20:40.960 --> 0:20:43.560 small or midcaps companies grow hold smaller positions, but if 0:20:43.600 --> 0:20:45.879 you look at the top ten holdings in that kind 0:20:45.920 --> 0:20:49.000 of name, these are obviously megacap type stocks. For liquid 0:20:49.119 --> 0:20:50.240 is in the constraint for us. 0:20:50.960 --> 0:20:53.200 Yeah, because I talked to a lot of customers that 0:20:53.280 --> 0:20:57.000 that ask me about this, like, are you, you know, 0:20:57.000 --> 0:20:59.280 should you wait your stocks buy let's just call it 0:20:59.280 --> 0:21:03.080 your expect did alpha of the of the of the company, 0:21:03.080 --> 0:21:05.200 which does sound like in a way is what you're 0:21:05.240 --> 0:21:08.159 doing or is it like a explicit you know, I 0:21:08.160 --> 0:21:09.639 talked to other people that are it is you know, 0:21:09.680 --> 0:21:12.560 the waiting decision is an explicit risk management thing, like, 0:21:12.960 --> 0:21:15.200 you know, give me the highest expect to return for 0:21:15.720 --> 0:21:18.320 you know, no ball over ten percent or something like that. 0:21:18.920 --> 0:21:22.080 So I'm always interested in those the thought process behind 0:21:22.080 --> 0:21:22.960 the stock weightings. 0:21:23.000 --> 0:21:26.320