Speaker 1: Welcome to Inside Active, a podcast about active managers that
Speaker 1: goes beyond sound bites and headlines, that looks steeper into
Speaker 1: their processes, challenges and philosophies and security selection. I'm David Cohne,
Speaker 1: i lead mutual fund and active Research at Bloomberg Intelligence.
Speaker 1: Today my cost is Gina Martin Adams, chief Equity strategist
Speaker 1: at Bloomberg Intelligence. Gina, thank you for joining me today
Speaker 1: as my co host.
Speaker 2: Thank you for.
Speaker 3: Having me and David.
Speaker 2: So.
Speaker 1: In your recent note US Equity Monthly Markets Signals, you
Speaker 1: talk about the rotation out of tech stocks and those
Speaker 1: stocks being among the worst performing as the rate cut
Speaker 1: trade persists. Can you tell our listeners what the rate
Speaker 1: cut trade is and what the sector rotation model is
Speaker 1: currently face.
Speaker 3: Yeah, A great question. You know, I think that a
Speaker 3: lot of what we've seen in the equity market volatility
Speaker 3: can be attributed to a change in monetary policy prospects.
Speaker 3: Over the course of the last couple of months, it's
Speaker 3: become clear that the FED is likely to decrease interest rates,
Speaker 3: and that sparked some interest in some sectors that were
Speaker 3: otherwise dormants, some stocks that were otherwise dormant in the
Speaker 3: s and P five hundred. So in addition to maybe
Speaker 3: some fundamental rotation, fundamentally driven rotation, you've got this kind
Speaker 3: of economic policy related factor that's driven interest in financials
Speaker 3: and utilities. Even real estate stocks are breaking out, with
Speaker 3: home builders really starting to rally here. So we're starting
Speaker 3: to see some rotation into other segments of the index.
Speaker 3: I call that the rate cut trade. I think there
Speaker 3: are a few other things behind it, and I look
Speaker 3: forward to discussing that, among other things with our guests today.
Speaker 1: Well, speaking of guests, I'd like to welcome Drew Shilling
Speaker 1: and Clark Shields from Wellington Management here. They do manage
Speaker 1: a part of the Vanguard US Growth Fund ticker BWUSX.
Speaker 1: Drew Clark, thank you for being here today.
Speaker 2: Thanks very much for having us. It's great to be here.
Speaker 4: Great to be here. David, thank you.
Speaker 1: So i'd like to start off with asking, actually both
Speaker 1: of you, how you got your starts in the investment industry. So, actually, Drew,
Speaker 1: we'll start with you.
Speaker 4: I actually was exposed to the markets from a very
Speaker 4: young age. My father was actually the first chief economist
Speaker 4: at Merrill Lynch back in the nineteen sixties. At the
Speaker 4: time the bond houses all had economists, but the stockhouses
Speaker 4: did not, and that changed and he was the first
Speaker 4: chief economist there. So I heard about markets and investing
Speaker 4: around the dinner table from a very young age. And
Speaker 4: I started investing in individual stocks as a teenager, not
Speaker 4: in a huge way, but with my lawnmowing and house
Speaker 4: painting money, and and that definitely got me more and
Speaker 4: more interested about all of the research involved and the
Speaker 4: intrigue about figuring out an investment case for security. And
Speaker 4: following that through out of college, I was in the
Speaker 4: investment banking world as a m and a analyst, and
Speaker 4: that continued my exposure to the markets. And after I
Speaker 4: graduated from business school, I came to Wellington Management and
Speaker 4: I'm in my thirtieth year here, So it started early
Speaker 4: and just developed over time.
Speaker 1: Nice Clark, how about yourself?
Speaker 2: Yeah, So I would.
Speaker 5: Say in college I kind of found my way to
Speaker 5: the business school and started studying finance and really enjoyed it.
Speaker 5: And like most college kids who liked finance, I got
Speaker 5: convinced that I had to go work in investment banking
Speaker 5: and that was the end all of you all. So
Speaker 5: I did that for a couple of years, and I
Speaker 5: really enjoyed the people I work with, but I want
Speaker 5: to be allocating capital. And so in May of two thousand,
Speaker 5: I moved to Boston and I joined an early stage
Speaker 5: venture capital firm, and it was literally within ten days
Speaker 5: of the NASDAC peak, you know, the Internet bubble peak.
Speaker 5: So my timing could have been a little bit better,
Speaker 5: but it was an amazing experience, you know that. You know,
Speaker 5: I saw the I saw the funding environment at that
Speaker 5: time where you had highly speculative businesses getting, you know,
Speaker 5: raising tons of money at very high valuations, and then
Speaker 5: all of a sudden, it just collapsed really quickly. And
Speaker 5: I have memories of going to office buildings with entrepreneurs
Speaker 5: we had invested in with and you know, literally shutting
Speaker 5: the buildings down and turning the lights off.
Speaker 2: And so I kind of saw that speculative activity and collapse.
Speaker 5: But at the same time, we had also invested in
Speaker 5: a small company in a suburb of Boston called Curing,
Speaker 5: the Coffee Company, and they only had.
Speaker 2: Thirty million dollars in revenues.
Speaker 5: They only sold coffee machines into the office space, and
Speaker 5: when I was affiliated with that company, they transitioned in
Speaker 5: the consumer space and started selling coffee machines in the
Speaker 5: consumer and that company absolutely took off and was ultimately
Speaker 5: sold for like fourteen billion dollars. And you know, Karig
Speaker 5: had a great management team. They were attacking a really
Speaker 5: big addressable market. They had competitive advantage because they had
Speaker 5: a lot of patents around the technology that they own.
Speaker 5: And so I think back then that actually started to
Speaker 5: initially shape how I thought about growth investing, being able
Speaker 5: to look at the specultive stuff that never got anywhere
Speaker 5: and blew up versus a qureig that ended up being
Speaker 5: worth fourteen billion dollars.
Speaker 2: So I did that for about four years.
Speaker 5: I went to graduate school, and then I joined t
Speaker 5: ROW for about a decade in Central Research down in Baltimore,
Speaker 5: and now I've been at Wellington for about ten.
Speaker 2: Years working with Drew here on a growth team.
Speaker 1: Well, it's funny you mentioned two thousand. That's actually I
Speaker 1: started my career in late two thousand, right when everything
Speaker 1: started going kind of crazy towards the end. So's you
Speaker 1: mentioned that, But I do want to mention for our listeners.
Speaker 1: Vanguard's active equity mutual funds are managed through external subadvisors,
Speaker 1: usually with multiple managers and I mean that's the case
Speaker 1: with the Vanguard US Growth Fund. So can you tell
Speaker 1: us what your investment process is for your slice of
Speaker 1: the fund.
Speaker 2: Sure, So I'll start, and then you know Drew can
Speaker 2: obviously jump in.
Speaker 5: I'd say the first thing we're looking for is secular growth, right,
Speaker 5: so we're looking for high levels of compounding. We want
Speaker 5: companies that are benefiting from tailwinds. Conversely, we think it's
Speaker 5: really hard to generate alpha in companies where they're structural headwinds.
Speaker 5: So that could be a physical retailer losing share to Amazon,
Speaker 5: or it could be traditional TV losing share to streaming.
Speaker 5: The second thing we look for, and perhaps this is
Speaker 5: the most important, is structural competitive advantages. So we want
Speaker 5: to invest in companies where they're doing something that's really
Speaker 5: hard for others to replicate. So if you think about
Speaker 5: putting those first two things together, the secular growth and
Speaker 5: competitive advantage, that's what enables high levels of earnings and
Speaker 5: free cash flow compounding over intermediate timeframes.
Speaker 2: Third, you know, we.
Speaker 5: Have this idea in our team that we refer to
Speaker 5: as timeframe arbitrage. And this idea speaks to market inefficiency,
Speaker 5: and I also think it speaks to our team having
Speaker 5: a longer time horizon than most market participants. So with
Speaker 5: timeframe arbitrage, we're looking for some sort of short term
Speaker 5: noise for security or in the market, and that could
Speaker 5: be a soft quarter, it could be an industry being
Speaker 5: out of favor. Maybe there's some sort of cyclical soft patch,
Speaker 5: and we want to go in and buy these really
Speaker 5: exceptional companies when you have that dislocation.
Speaker 2: A couple of examples off the top of my head.
Speaker 5: So in the spring of two thousand, at the start
Speaker 5: of COVID, everybody was moving into safe havens, and we
Speaker 5: owned American Tower, right, and American Tower was going up
Speaker 5: every day.
Speaker 2: Is more and more money crowded in there.
Speaker 5: But the other end of the spectrum, you had AMX,
Speaker 5: and nobody want to own AMX right. It's travel oriented,
Speaker 5: it's credit. Who knows what's going to happen to the consumer,
Speaker 5: and so we were trimming America Tower at that point
Speaker 5: in time and buying as Another example would be the
Speaker 5: fourth quarter twenty twenty two. It's hard to believe, but
Speaker 5: nobody wanted to touch semiconductors in the fourth quarter of
Speaker 5: twenty twenty two, numbers had come down, the stocks had underperformed,
Speaker 5: and so we were looking at that space, We're like,
Speaker 5: all right, this is a good time to go overweight Semis.
Speaker 5: We went overweight in Vidia, then we went overweight ASML
Speaker 5: at that point in time. And then the final thing
Speaker 5: I'll mention before turning over Drew is we really believe
Speaker 5: in portfolio balance. So I think a lot of the
Speaker 5: growth portfolios are structured in a way that they have
Speaker 5: very pronounced bets in certain areas and really a lack
Speaker 5: of risk controls and diversifications.
Speaker 2: So, for example, you.
Speaker 5: Could have a thirty or the security portfolio where it's
Speaker 5: almost all high beta internet and high beta software, and
Speaker 5: that can be great in twenty twenty, and that can
Speaker 5: be great in nineteen ninety nine, but then when things
Speaker 5: turn the other way.
Speaker 2: You can have really severe underperformance. And so we pay
Speaker 2: a lot.
Speaker 5: Of attention to risk controls and diversification and balance, and
Speaker 5: we don't want to have that extreme up and down
Speaker 5: ride that you can find with a lot of other
Speaker 5: growth portfolios, Drew, what else would you like to.
Speaker 4: Yeah, just adding to Clark's last point, one of the
Speaker 4: evergreen realities in the investment world is that it is
Speaker 4: still very much human nature is still very much at
Speaker 4: play in terms of how the market moves, certainly in
Speaker 4: the medium shortened medium term, and we do have these
Speaker 4: cycles that go cycle from greed to despair and back
Speaker 4: to greed again, and that happens on individual stocks, and
Speaker 4: it happens on the market itself, especially when you have
Speaker 4: oft economics coming up and you have strong economies ahead
Speaker 4: of you. And so we really think about how that
Speaker 4: impacts investors. And you get the same with individual performance
Speaker 4: of individual mutual funds. And when an investor sees a
Speaker 4: mutual fund that knocks the ball out out of the park,
Speaker 4: they're very happy. But if that's a highly volatile approach
Speaker 4: and it's just as likely to have a mirror image
Speaker 4: period of underperformance. Human nature is such that they could
Speaker 4: do the wrong thing at the wrong time, which is
Speaker 4: to sell your mutual fund and move on to someone
Speaker 4: else's when in fact that might be the exact time
Speaker 4: when you should be buying it. And this human nature
Speaker 4: destroys value over time, and it means that most investors
Speaker 4: don't actually enjoy the long term return stream of the
Speaker 4: equity markets. And so we think very carefully about that
Speaker 4: when we think about balance in what we are delivering
Speaker 4: to our clients and particularly to Vanguard. We don't want
Speaker 4: to get too far away from from from you know,
Speaker 4: that pure growth investing, thinking about what the characteristics of
Speaker 4: the benchmark are, and then we're going to find, you know,
Speaker 4: great companies that that we hope, over time outperform that benchmark.
Speaker 4: But we don't want our clients to experience extreme volatility.
Speaker 3: Great, thank you. Can we dig in a little bit
Speaker 3: more on a couple of a couple of those points
Speaker 3: in terms of your process, I'm just curious how you
Speaker 3: define and identify secular growth. So what are you doing
Speaker 3: specifically to identify those companies that do have those long
Speaker 3: term secular growth prospects? And then also following on the
Speaker 3: other point that you make about seeking companies with competitive advantage?
Speaker 3: What are some metrics or identifiers of companies with competitive advantage?
Speaker 3: How are you finding those companies? How do you identify
Speaker 3: competitive advantage specifically?
Speaker 2: Yeah, so.
Speaker 5: I'll take a crack at that, and then Drew can
Speaker 5: obviously jump in, and so we do. We're bottoms up, okay,
Speaker 5: and so we're looking for great businesses feeding off of
Speaker 5: secular growth, and we find them in lots of different places.
Speaker 5: And we recently did an exercise where we looked at
Speaker 5: the entire portfolio and we said, how many different primary
Speaker 5: secular growth drivers do we have across the portfolio And
Speaker 5: the number was actually like twenty seven, So there's a
Speaker 5: lot in there. So for example, we own a company
Speaker 5: called Copart. It's an auto auction business. It's an amazing business,
Speaker 5: very high market share, they're very dominant. They feed off
Speaker 5: of more technology being added into cars. Right, every year
Speaker 5: a car is more and more like a computer with
Speaker 5: more and more semiconductor content, and so that's what they
Speaker 5: feed off of. That said, when we look at the
Speaker 5: portfolio from a high level and we say, like, what
Speaker 5: are big recurring themes? Right, so that you know semi
Speaker 5: content and autos isn't a big recurring theme, what are
Speaker 5: some big recurring themes? You know, you would have things
Speaker 5: like obviously e commerce, you would have online advertising, increased
Speaker 5: usage of data, adoption of software, shifting software workloads to
Speaker 5: the cloud, innovation and semiconductors, healthcare innovation and you know
Speaker 5: those last two we could talk about gen ai and
Speaker 5: GLP ones in terms for the second point for competitive advantage,
Speaker 5: there's actually eight different things we're looking for. So if
Speaker 5: you're to study, for example, at Harvard Business School with Porter,
Speaker 5: you would say, well, there's these two things that you
Speaker 5: want to look for. You want to look for some
Speaker 5: sort of differentiation or you want to be a low
Speaker 5: cost provider. And we actually have kind of a more
Speaker 5: detailed list of things that we're looking for based on
Speaker 5: our experience. And so one is really unique intellectual property
Speaker 5: that other people do not own. That would be one.
Speaker 5: Another big one that shows up as network effects, right,
Speaker 5: or it can be high switching costs, barriers to scale.
Speaker 5: We probably don't like brand quite as much, especially in
Speaker 5: this area era when people can create brands more easily
Speaker 5: with the Internet and social media, and low cost advantage
Speaker 5: may actually be our least favorite because in a lot
Speaker 5: of ways, I think that's saying that if there's a
Speaker 5: nuclear winter in your industry, you survive, which is really
Speaker 5: doesn't really matter how we want to invest, and you will.
Speaker 2: I think you will.
Speaker 5: Find over time that companies that have, you know, that
Speaker 5: sort of competitive advantage to your question about metrics, A
Speaker 5: lot of times those are very profitable businesses with high
Speaker 5: returns on capital that sustain themselves over time. And so
Speaker 5: if you can identify those financial characteristics.
Speaker 2: You then can kind of do like a deeper.
Speaker 5: Business model, almost qualitative assessment on the competitive advantage pieces.
Speaker 4: True, all this work is really informed by our very
Speaker 4: broad and deep research engine at Wellington. So we have
Speaker 4: almost sixty dedicated global industry analysts in our central research
Speaker 4: pool and they are responsible for covering sectors in tremendous depth.
Speaker 4: These are career positions. These are folks that do this
Speaker 4: in depth research on a narrow group of companies their
Speaker 4: whole careers, and so having that fundamental engine behind is
Speaker 4: what helps us identify not only identify the areas of
Speaker 4: secular growth, but also helping us as we go through
Speaker 4: our wide mote analysis. We have over four hundred investors
Speaker 4: at Wellington, so not just our gias, our central research,
Speaker 4: but our growth team and our dedicated growth analysts and
Speaker 4: all the other portfolio teams around Wellington, so we develop
Speaker 4: a very wide mosaic of information where we have a
Speaker 4: very collaborative culture. It's a it's a very important part
Speaker 4: of our approach to things and and the reason we
Speaker 4: value that so highly is that when you have all
Speaker 4: these people out turning over rocks literally around the world,
Speaker 4: you need a way for that information to be shared
Speaker 4: and integrated, and by having a highly collaborative culture, that
Speaker 4: is the best way to do that. And so we
Speaker 4: bring all of this work together to help us with
Speaker 4: these insights.
Speaker 3: And determinations that your bottom up. You have a lot
Speaker 3: of analysts sort of powering some of the ideas, collaborating
Speaker 3: with the analyst community. How do you collaborate with the
Speaker 3: macro researchers. How do you integrate any kind of macro
Speaker 3: consideration in a predominantly bottom up process.
Speaker 5: Yeah, so I would say, you know, there's there's a
Speaker 5: huge amount of resources Wellington. So there's market strategists, there's
Speaker 5: macro people, there's risk people, there's different teams. Some teams
Speaker 5: are investing just in emerging markets, fixed income alternatives. And
Speaker 5: so I think that kind of speaks to a broader
Speaker 5: question of how do you interact with everybody? Right, because
Speaker 5: you know there are a lot of people here and
Speaker 5: you don't want people siloed. And I think we have
Speaker 5: a lot of channels to encourage communication. And then we
Speaker 5: have a culture that places an extreme value on collaboration.
Speaker 5: So we have had since the firm's founding, a morning meeting,
Speaker 5: a morning investment meeting every single day on a global
Speaker 5: basis where people come in and share ideas, and that's
Speaker 5: all investors, and that starts conversations and may not give
Speaker 5: you an answer, but it starts conversations. And yesterday a
Speaker 5: material piece of that conversation was on US employment trends
Speaker 5: and the macro economy. So we have all sorts of
Speaker 5: people participating in those meetings. We also have obviously broad
Speaker 5: email distribution lists for investment emails. Some of those are
Speaker 5: specific to a sector, healthcare or tech, others are more general.
Speaker 5: And then we have other meetings that can be specific
Speaker 5: to some sort of theme or idea. It could be, hey,
Speaker 5: come to a lunch because we have a macro meeting today,
Speaker 5: or it could be the financial services team is sharing
Speaker 5: best ideas, and so we have to have all these
Speaker 5: different channels. So I feel like we have access to
Speaker 5: that information and Drew can obviously out of this. But
Speaker 5: I also say in terms of macro, I would describe
Speaker 5: us as macro aware, like we need to know what's
Speaker 5: going on. If we're becoming more negative on the consumer,
Speaker 5: it might make sense to take down travel names for example. Right,
Speaker 5: But going back to this idea of balance. We don't
Speaker 5: want an extreme bet in the portfolio. It's extremely unlikely
Speaker 5: that we would ever say there's going to be a recession.
Speaker 5: Let's take our beta way down, let's park all the
Speaker 5: capital and staples and reads and utilities.
Speaker 2: Because if we get that wrong, we're going to get creamed. Right.
Speaker 5: And so we're macro aware and we'll shift a little
Speaker 5: bit based on that information. But again, really from a
Speaker 5: portfolio construction standpoint, the thing we really value is this
Speaker 5: idea of balance.
Speaker 4: Yeah, I think macro informs the background under which the
Speaker 4: individual companies we're looking at operate. So to Clark's point,
Speaker 4: if the consumer is healthy and the macro factors appeared
Speaker 4: that the consumer will continue to be healthy, then that
Speaker 4: informs how we're investing in the consumer sector. But what
Speaker 4: we don't do is make big, a lot of big
Speaker 4: decisions in the portfolio and the position and the portfolio
Speaker 4: based on big macro factors. So people have tried their
Speaker 4: whole careers forecasting big macro factors like interest rates and
Speaker 4: the direction of the price of oil and natural gas,
Speaker 4: and and it's very very difficult to do with any consistency,
Speaker 4: and so that is not uh, that is not a
Speaker 4: big part of what we do. And and the reality
Speaker 4: is if you look at most years, most years that
Speaker 4: any one of the companies, the publicly traded company we're
Speaker 4: going to invest in most years is a moderately positive
Speaker 4: growth economy, right, you have, you have, you have recessions,
Speaker 4: you know, every so often, but it's a minority of
Speaker 4: the environment you're operating in. So that's kind of your
Speaker 4: starting point is moderate economic growth and can we find
Speaker 4: companies that can really thrive in moderate economic growth? And
Speaker 4: then obviously, when there are ways to lean in to
Speaker 4: areas of the macro forecast that we can feel comfortable with,
Speaker 4: we can lean but we're not going to try to
Speaker 4: make the portfolio act in a certain way based on
Speaker 4: a large macro forecast.
Speaker 3: Very fair, And if we were to sort of tie
Speaker 3: this back into the conversation that we started with, where
Speaker 3: it feels to me like we're at this pretty big
Speaker 3: change moment with respect to monetary policy where we're going
Speaker 3: to have suddenly interest rates are falling. Would you ever
Speaker 3: have a macro consideration like that where interest rates are
Speaker 3: potentially now going to reverse direction? Does that ever spark
Speaker 3: idea generation for new ideas to potentially add to the
Speaker 3: portfolio new industries that might benefit from a macro shift
Speaker 3: like that. Do you ever think that way or is
Speaker 3: it a much more methodical process than I'm kind of
Speaker 3: assuming or alluding to.
Speaker 5: Well, I would say, we go ahead. Well, I was
Speaker 5: going to say, we'll certainly think that way. So, for example,
Speaker 5: we have this pool of exceptional companies that we've identified
Speaker 5: that makes sense for our portfolio, and different people on
Speaker 5: the team are responsible for their different pieces of the pool,
Speaker 5: if you will. And so if it's obvious that interest
Speaker 5: rates are going to go down, you know, one thing
Speaker 5: we could do is we could say, you know, we
Speaker 5: own a couple super high quality reads, should we buy
Speaker 5: another one?
Speaker 2: Right?
Speaker 5: So, for for sure, we're willing to do things like
Speaker 5: that and to tilt. And so I think you know,
Speaker 5: the way we kind of just describe it is will
Speaker 5: kind of shift in this direction a little bit, or
Speaker 5: shift in that direction a little bit, which is separate
Speaker 5: obviously than making some very big bet across the portfolio
Speaker 5: where if you get it wrong you're in a lot
Speaker 5: of trouble.
Speaker 4: Yeah, I mean, you know the the right now the
Speaker 4: course of interest rates, you know, really is depends on
Speaker 4: mostly inflation and the growth of the economy, and the
Speaker 4: two were very closely like. So again, trying to forecast
Speaker 4: inflation tough to do with any with any accuracy and consistency.
Speaker 4: But you do have a very long track record of
Speaker 4: the Fed, you know, generally winning out in terms of
Speaker 4: doing what they're trying to do, and they have made
Speaker 4: it very clear they're trying to squash inflation, and and
Speaker 4: so it does you know, the the likely path here
Speaker 4: is that inflation, as we've seen, has gotten under control
Speaker 4: more so than it was a year or two ago,
Speaker 4: and it's possible it could go lower. I think at
Speaker 4: this point it's it's not entirely clear, so you know,
Speaker 4: what is going to be the ongoing level of interest
Speaker 4: of inflation and thus interest rates hard to know exactly.
Speaker 4: But when the when the Fed got on this interest
Speaker 4: rate cutting path that they got on, it was pretty
Speaker 4: clear they were going to be on that path for
Speaker 4: some period of time. Now it's a little less clear,
Speaker 4: so you know, I think obviously easing on the short side,
Speaker 4: but what does that mean for the longside. The longsidees
Speaker 4: come down so much relative to where it was now,
Speaker 4: not relative to the last five years, but relative the
Speaker 4: last thirty years, So those are you know, I think
Speaker 4: we're in a period now where, yeah, short term rates
Speaker 4: I think people think are definitely going to come down.
Speaker 4: That's probably priced in the market.
Speaker 1: H Clark. You had mentioned earlier about buying semiconductor stocks
Speaker 1: when they were out of favor, and so I'm curious
Speaker 1: how you think about valuations. You know, do you kind
Speaker 1: of look at you know, it's a growth portfolio, so
Speaker 1: I'm assuming you're not looking at deep discounted companies, but
Speaker 1: is it more of kind of like reasonable valuations or
Speaker 1: you know, what would you consider?
Speaker 5: Yeah, so I would say, given how we're investing, we
Speaker 5: definitely think for most of the companies, we have to
Speaker 5: be thinking out longer term, and we have to be
Speaker 5: thinking in terms of a range of outcomes, Okay, And
Speaker 5: so what we're generally doing is we're taking the companies
Speaker 5: that we're investing in and we're building a ten year
Speaker 5: DCF model and going out, you know, saying, well, here's
Speaker 5: how many subscribers Netflix is going to have in twenty
Speaker 5: thirty three, and here's the average fee per user, and
Speaker 5: here's how much they're gonna spend on content, and this
Speaker 5: is what margins will look like that. And then we'll
Speaker 5: take that base case scenario, bring it back to a
Speaker 5: president and they'll say, well, could be even better than that,
Speaker 5: or it could be worse than that, right, And so
Speaker 5: then we have this kind of view evaluation based on
Speaker 5: those different scenarios, and then we can see, you know,
Speaker 5: relative to where securities are trading, what looks underpriced or overpriced,
Speaker 5: And you do get into periods of time the past
Speaker 5: few years, you've certainly gotten into periods of time where
Speaker 5: I feel like there were almost you know, fat pitches
Speaker 5: based on the style of company you want to invest in.
Speaker 5: So if you go to the summer of twenty twenty one,
Speaker 5: like nobody wanted anything even remotely boring. It's like, hey,
Speaker 5: these these soft these mid cap software companies at forty
Speaker 5: times revenue, Maybe they'll go to fifty time revenue, right,
Speaker 5: fifty times revenue, And so then you could look in
Speaker 5: that environment, you can say, well, these compounding stocks, which
Speaker 5: could maybe be more like an O'Reilly or Connections or
Speaker 5: a Progressive some other names that we own, their lower
Speaker 5: beta look great. Then twenty twenty two, when we started
Speaker 5: taking up the semis, it was the exact opposite off
Speaker 5: twenty twenty two, the market was in a massive risk
Speaker 5: off mode. We want to own defense, we want to
Speaker 5: own staples, we want to own energy, and we don't
Speaker 5: want any of the growthy stuff. And so then we
Speaker 5: were sitting there in twenty twenty two. We could look
Speaker 5: at this the pool of securities again, and the higher
Speaker 5: growth names, including SEMIS, think about that ten year view,
Speaker 5: use timeframe arbitrage, you know, as the way to describe
Speaker 5: it and initiate those positions when they were out of
Speaker 5: favor and when we thought we had a really fat pitch.
Speaker 2: So I'd say that's generally how we do it.
Speaker 5: You know, sometimes with some slower growth companies we'll look
Speaker 5: at pe multiples, like probably doesn't make a lot of
Speaker 5: sense to build a ten year in DCF for TJX
Speaker 5: for examples, Maybe a little bit of overkill.
Speaker 2: But for the higher growth names, that's generally what we're doing.
Speaker 3: And are you ever using multiples or valuations or your
Speaker 3: time for arbitrage in the reverse direction so multiples get
Speaker 3: too high, we see valuations as too extreme. Are you
Speaker 3: shaving positions on the same methodology or do you employ
Speaker 3: a different sort of perspective for when to get out
Speaker 3: or when to shave some of your positions.
Speaker 5: Yeah, I mean, I would say time frame arbitrage does
Speaker 5: need to go both ways. You know, the example of
Speaker 5: trimming American Tower when COVID first started, right and then
Speaker 5: the end of twenty twenty two, anything that was a
Speaker 5: safe haven was probably extremely expensive.
Speaker 2: And so yeah, I would say, you know, if we
Speaker 2: have a.
Speaker 5: Security, we like, a company we like, we've known it
Speaker 5: and owned it for a long time, and it looks
Speaker 5: very expensive, that is certainly an instance where we are
Speaker 5: likely to trim it but not eliminate it.
Speaker 4: Yeah, we really are. We're really trimming stocks based or
Speaker 4: eliminating stocks based on two things. Either the fundamental case
Speaker 4: that we had laid out when we purchased it is
Speaker 4: not working out. You know, we made a mistake, the
Speaker 4: fundamentals have developed in a different way. That would be
Speaker 4: one of the reasons. And the other reason is that
Speaker 4: the valuation is no longer compelling, and we have other
Speaker 4: opportunities that we we think have more upside. And so
Speaker 4: those are really the two things at play when we're
Speaker 4: you know, when we're adding and trimming.
Speaker 1: So I want to kind of move over to more
Speaker 1: of a qualitative question, you know, you're talking about, you know,
Speaker 1: the different numbers you look at for companies, but what
Speaker 1: do you look for in management teams of companies?
Speaker 5: Yeah, yeah, I'll take I'll take a stab and then
Speaker 5: Drew can add on there. You know, I remember early
Speaker 5: in my career there was someone I worked with and
Speaker 5: he had just said this really long list, like there're
Speaker 5: a literal checklist on like, here's.
Speaker 2: All the things that I'm looking for, Like, that's a
Speaker 2: long list.
Speaker 5: It was like, what can that be consolidated down to
Speaker 5: a couple of key ideas? And so for me, there's
Speaker 5: two key ideas and what is you know, how talented
Speaker 5: do you think the management team is?
Speaker 2: Sony?
Speaker 5: Any assets going to have some sort of inherent trajectory, right,
Speaker 5: And so then the question is will this management team
Speaker 5: inflect that trajectory trajectory higher or could they actually take
Speaker 5: it a lot lower through really bad decisions? So I
Speaker 5: think that's one really important question. And then you can say,
Speaker 5: all right, well how do you think about that? And
Speaker 5: quite frankly, some of it is just spending time with
Speaker 5: a management team and getting a sense in your gut,
Speaker 5: you know, how do they talk about strategy, how do
Speaker 5: they talk about the business, what's kind of their vision,
Speaker 5: what's their track record of execution, is their depth on
Speaker 5: the team, things of that nature.
Speaker 2: Do they outcate capital well?
Speaker 5: And then to me, the second question is, you know,
Speaker 5: do we trust them with massive information in asymmetries? So
Speaker 5: going back earlier to when I worked in BC, there
Speaker 5: were no information these symmetries, right, the company gave you
Speaker 5: whatever you wanted. When you're dealing with public companies, there
Speaker 5: very selectively deciding what to give you and what not
Speaker 5: to give you, right, And there's gonna be information that
Speaker 5: they're not going to share with you, and so then
Speaker 5: there's this element of trust. And again that comes back
Speaker 5: to kind of gut instincts. But the other thing I'd
Speaker 5: say is, I think that's why it can be very
Speaker 5: encouraging to see management teams that own a lot of stock,
Speaker 5: because then you have aligned interests and it's easier to
Speaker 5: trust them. And then also i'd say another thing that
Speaker 5: we look at there is corporate governance behaviors and are
Speaker 5: they reflective of really kind of ethical, thoughtful behavior that's
Speaker 5: shareholder appropriate. So those are kind of like two big categories.
Speaker 5: I mean, drew other stuff that you want to add on.
Speaker 2: Yeah. I mean, I'd just.
Speaker 4: Add to that, you know, do they have a value
Speaker 4: creating mentality? And I'll contrast that to a mentality of
Speaker 4: a CEO or a management team that's enthralled with the
Speaker 4: trappings of the job and all the perquisites that go
Speaker 4: with it. But if they have a value creating mentality,
Speaker 4: then you have that shareholder alignment, you know, an empire
Speaker 4: builder versus somebody who runs the business relative to creating
Speaker 4: good and growing returns. So that's very important. What what
Speaker 4: is management focused on? And what are they incentivized to
Speaker 4: do by the board's incentive structure. So we spend a
Speaker 4: lot of time looking at those the incentive structure. What
Speaker 4: is it that we're paying management to do? Because most
Speaker 4: people do what they're paid paid to do, and and
Speaker 4: so you know, one of the things that we do
Speaker 4: we have a we have a very substantial ESG effort
Speaker 4: here and an entire uh separate group of research analysts
Speaker 4: who focus on the ESG factors for for you know,
Speaker 4: the companies that we invest in, and we dig through
Speaker 4: those filings and make sure we fully understand exactly how
Speaker 4: these managements are our incentivized and we in many cases
Speaker 4: work with the companies and we reflect information, we reflect
Speaker 4: opinions back to the boards, and you know, we're on
Speaker 4: the phone with with lead independent directors, chairman's of the
Speaker 4: board if they're not the CEO, and expressing our views
Speaker 4: if we see room for improvement, and that can be
Speaker 4: a really important part of driving the behavior and thus
Speaker 4: or returns on and when you're talking about an individual company.
Speaker 4: The other one other thing that I really love is
Speaker 4: management that really knows the numbers cold. They know every number,
Speaker 4: they know every detail, and it's amazing the range that
Speaker 4: you get when you talk to managements your whole life.
Speaker 4: Like Clark and I do. You know, some managers are
Speaker 4: a little more up in the clouds and they delegate
Speaker 4: a lot to their people. But remember when you're making
Speaker 4: big strategic decisions, you know, every day, every week, every month,
Speaker 4: really understanding the nuts and the bolts of the business,
Speaker 4: I think likely leads to better decisions. So I love
Speaker 4: to see that.
Speaker 1: I do want to ask also about risk and how
Speaker 1: you manage risk for the portfolio, especially during times when
Speaker 1: growth is out of favor.
Speaker 5: Yeah, so risk is a huge part of what we do.
Speaker 5: It's part of our daily workflow. So you know, if
Speaker 5: we think about our team compared to other growth teams
Speaker 5: that I know in the industry, you know, I think
Speaker 5: our focus on competitive advantage is very differentiated. I think
Speaker 5: a lot of growth investors are looking for just some
Speaker 5: great story where there's high projections on the cell side.
Speaker 5: But if you don't have a moat around that business,
Speaker 5: that's going to collapse, right like a peloton at the
Speaker 5: end of the day, Peloton makes stationary bikes, right, And
Speaker 5: so that's one thing differentiate differentiates us. But also folio
Speaker 5: balance is another thing that I think really differentiates us.
Speaker 2: And kind of the key tool.
Speaker 5: There are risk tools, and so we have tools on
Speaker 5: our desktop where every day we can be looking at
Speaker 5: high level metrics. So it could be what's the tracking risk,
Speaker 5: how does it compare it to the past, how do
Speaker 5: you break down that tracking error between different pieces, what's
Speaker 5: your predicted beta? But then we can also use this
Speaker 5: desktop tool to go deeper. We can say how much
Speaker 5: risk is coming from a sector or industry, how much
Speaker 5: risk is coming from a security how much risk is
Speaker 5: coming from the mag seven as a bucket, because they're
Speaker 5: very big in our benchmark.
Speaker 2: So we have those tools there every single day.
Speaker 5: We also have a quarterly formal risk review with our
Speaker 5: risk team, and our entire team participates in that, and
Speaker 5: so we'll look at all sorts of metrics. But another
Speaker 5: thing we do is we run forty to forty five
Speaker 5: stress tests across the portfolio. So a stress test could
Speaker 5: be interest rates go way up or way down, a
Speaker 5: massive smid cap rally, value rally. You can replicate something
Speaker 5: like what happened after nine to eleven, things of that nature.
Speaker 5: And we look across those stress tests and try to
Speaker 5: find instances where we would have a more extreme reaction
Speaker 5: to that environment than what we want.
Speaker 2: So we're using these tools all the time.
Speaker 5: And I will come back to the MAG seven a
Speaker 5: little bit, because you know that's probably where we.
Speaker 2: Use the risk tools the most.
Speaker 5: If you are naked or if you have a halfway
Speaker 5: in a MAG seven stock, that can actually start to
Speaker 5: end up being twenty thirty percent of the risk in
Speaker 5: the portfolio right because of how our benchmark is constructed.
Speaker 5: So we watch those very closely. The one we probably
Speaker 5: watch the most closely is Tesla. So our risk team
Speaker 5: says they have never seen a company with that market
Speaker 5: cap behave like a smidcap biotech. It literally has the
Speaker 5: behavior patterns of a MidCap biotech. So we watched that
Speaker 5: really closely. The second part of your question, I you know,
Speaker 5: I'll let Drew jump in here. I apologize for the
Speaker 5: long way to the answer, but you know, in terms
Speaker 5: of like when growth out of favor, we would certainly
Speaker 5: use risk tools then, but I think we're at that
Speaker 5: point we're almost more looking at our opportunity set, kind
Speaker 5: of like the end of twenty twenty two, where it's
Speaker 5: more like, hey, ASML is amazing, and video is amazing,
Speaker 5: Netflix is amazing. I'm just throwing somebody out there and
Speaker 5: they look really really cheap now because they're out of favor,
Speaker 5: let's take those up, and it's probably a little bit
Speaker 5: less of a risk tool exercise.
Speaker 4: Drew, Yeah, I mean, I think it's important to remember
Speaker 4: that we're, you know, we're growth investors, and so growth
Speaker 4: is out of favor. We try not to have a
Speaker 4: huge tilt in the portfolio, either growth or value relative
Speaker 4: to the growth index. So the exercise is really just
Speaker 4: identifying the best wide mode growth companies that we can
Speaker 4: find given the market environment we're operating in. So if
Speaker 4: growth is out of favor, it depends how growth is
Speaker 4: out of favor, but it can often mean that some
Speaker 4: of the moderately high growth, really high quality companies looked
Speaker 4: particularly attractive, and we would use that opportunity to add
Speaker 4: to those in the portfolio, and the sources of funds
Speaker 4: would likely be the stocks that have lower growth, more
Speaker 4: value oriented characteristics. So this goes back to the This
Speaker 4: goes back to the twenty twenty with COVID. You know,
Speaker 4: anything that was that that that smelled of safety to
Speaker 4: the market got bit up to very high valuations. While
Speaker 4: everything that had economic sensitivity, you know, particularly anything related
Speaker 4: to travel or you know, anything where you know, staying
Speaker 4: at home and not spending outside the home was going
Speaker 4: to restaurants, you know, that was that got hurt. And
Speaker 4: we weeded through all that and just you know, that
Speaker 4: was a safety market. Probably more value are in market.
Speaker 4: That unearthed tremendous opportunities for us to kind of reload
Speaker 4: the portfolio for the end of twenty and into twenty one,
Speaker 4: which was a very successful period for us.
Speaker 1: Okay, well, I just have one more question actually for
Speaker 1: both of you, what do you consider the most overrated
Speaker 1: investment metric just in investing in general.
Speaker 4: I'll jump in on that. I think PE is very overrated.
Speaker 4: And the first reason that PE is very overrated is
Speaker 4: the earnings are are accounting earnings in the PE ratio,
Speaker 4: they are not cash flow generation. And we believe that
Speaker 4: value you creation is how much cash do you produce now.
Speaker 4: You may not produce it this year, it may be
Speaker 4: next year. But that's why we use this DCF mentality
Speaker 4: to capture a growing business that may be investing now,
Speaker 4: but later on they're harvesting the cash. But we can
Speaker 4: model that out. Is it a cash generative business or
Speaker 4: is it not. I'll give you an example. Airlines over
Speaker 4: time have appeared to have very low pees. But when
Speaker 4: you look at the free cash flow generation, the free
Speaker 4: cash flow generation is very low, and so the earnings quality.
Speaker 4: You hear people talking about earnings quality, the earnings quality
Speaker 4: is low the way we look at it because those
Speaker 4: business models require so much investment upfront, and you have
Speaker 4: to ask yourself do they actually get a good return
Speaker 4: on that investment. And I would suggest to you the
Speaker 4: reason that airlines typically have very low PES is one
Speaker 4: they are closer to commodities than a lot of businesses,
Speaker 4: so very competitive and to the returns on a cash
Speaker 4: flow basis over time have been have been not high.
Speaker 4: And so I think when we are investing companies, we
Speaker 4: are looking at the free cash flow generation of the business,
Speaker 4: not the accounting earnings. Accounting earnings can be very much manipulated.
Speaker 4: It has to do with all kinds of assumptions. What
Speaker 4: are your depreciation assumptions, what are your accrual assumptions. And
Speaker 4: if you go back to WorldCom and Enron, both of
Speaker 4: those situations were predictable if you focused on the cash
Speaker 4: flow and not on the accounting earnings that they were generating.
Speaker 5: Clark, Yeah, I'll share like a more slightly different answer
Speaker 5: where it's maybe a little bit more nuanced, And it's
Speaker 5: just this idea that I think you need to be
Speaker 5: using tools that make sense relative to the task at hand.
Speaker 2: And I had a.
Speaker 5: Graduate school professor and he's like, there's this class on
Speaker 5: using a DCF, and he's like, you gotta be really
Speaker 5: careful because once you give a baby a hammer, everywhere
Speaker 5: he looks, he sees a nail, right, And it's like
Speaker 5: a DCF can work great in certain instances. A PE
Speaker 5: multiple is fine in other instances. EV even does, and
Speaker 5: but you don't want to just have this one thing
Speaker 5: where you just slap it on everything. And I think
Speaker 5: you really kind of want to view yourself more as
Speaker 5: a carpenter, right, And you've got a tool, a bunch
Speaker 5: of tools on your toolkit, and sometimes you want a
Speaker 5: sledgehammer to knock a wall down.
Speaker 2: Maybe that's ev to sales, and.
Speaker 5: Other times maybe you need to do some really nice
Speaker 5: detail work and be a bit more precise, which could
Speaker 5: be like a really thought out DCF model. And so
Speaker 5: I don't I'm not sure there's like tools or metrics
Speaker 5: where I'm like, well, this is just universally bad. But
Speaker 5: I do think investors need to have kind of like
Speaker 5: situational awareness and make sure the tool they're pulling out
Speaker 5: of the toolkit is appropriate relative to the task.
Speaker 1: Well, makes sense, Clark, Drew, thank you so much for
Speaker 1: joining us today.
Speaker 2: Thank you for having us, thanks for having us.
Speaker 1: Enjoyed it, Gina, thank you for being my co host
Speaker 1: once again.
Speaker 3: Thank you, David, and it was really great to meet
Speaker 3: both of you. Thanks for joining us.
Speaker 1: Until next week. This is David Cone with Inside Act