Dear friends,
Rather more than 50 folks dialed in and participated on our call with Matthew and Ian today. I'm suffering from some combination of a major head cold, the side effects of the OTC meds I'm taking for it and the gallon or so of green tea with honey and lemon that I've chugged this morning, so I'm only guessing when I nominate these as highlights of the call.
The guys run two strategies for US investors. The older one, Global Innovators, is a growth strategy that Guinness has been pursuing for 15 years. The newer one, Dividend Builder, is a value strategy that the managers propounded on their own in response to a challenge from founder Tim Guinness. These strategies are manifested in "mirror funds" open to European investors. Curiously, American investors seem taken by the growth strategy ($180M in the US, $30M in the Euro version) while European investors are prone to value ($6M in the US, $120M in the Euro). Both managers have an ownership stake in Guinness Atkinson and hope to work there for 30 years, neither is legally permitted to invest in the US version of the strategy, both intend - following some paperwork - to invest their pensions in the Dublin-based version. The paperwork hang up seems to affect, primarily, the newer Dividend Builder (in Europe, "Global Equity Income") strategy and I failed to ask directly about personal investment in the older strategy.
The growth strategy, Global Innovators IWIRX, starts by looking for firms "doing something smarter than the average company in their industry. Being smarter translates, over time, to higher return on capital, which is the key to all we do." They then buy those companies when they're underpriced. The fund hold 30 equally-weighted positions.
Innovators come in two flavors: disruptors - early stage growth companies, perhaps with recent IPOs, that have everyone excited and continuous improvers - firms with a long history of using innovation to maintain consistently high ROC. In general, the guys prefer the latter because the former tend to be wildly overpriced and haven't proven their ability to translate excitement into growth.
The example they pointed to was the IPO market. Last year they looked at 180 IPOs. Only 60 of those were profitable firms and only 6 or 7 of the stocks were reasonably priced (p/e under 20). Of those six, exactly one had a good ROC profile but its debt/equity ration was greater than 300%. So none of them ended up in the portfolio. Matthew observes that their portfolio is "not pure disruptors. Though those can make you look extremely clever when they go right, they also make you look extremely stupid when they go wrong. We would prefer to avoid that outcome."
This also means that they are
not looking for a portfolio of "the most innovative companies in the world." A commitment to innovation provides a prism or lens through which to identify excellent growth companies. That's illustrated in the separate paths into the portfolio taken by disruptors and continuous improvers. With early stage disruptors, the managers begin by looking for evidence that a firm is truly innovative (for example, by looking at industry coverage in
Fast Company or MIT's
Technology Review) and then look at the prospect that innovation will produce consistent, affordable growth. For the established firms, the team starts with their quantitative screen that finds firms with top 25% return on capital scores in every one of the past ten years, then they pursue a "very subjective qualitative assessment of whether they're innovative, how they might be and how those innovations drive growth."
In both cases, they have a "watch list" of about 200-250 companies but their discipline tends to keep many of the disruptors out because of concerns about sustainability and price. Currently there might be one early stage firm in the portfolio and lots of Boeing, Intel, and Cisco.
They sell when price appreciates (they sold Shire pharmaceuticals after eight months because of an 80% share-price rise), fundamentals deteriorate (fairly rare - of the firms that pass the 10 year ROC screen, 80% will continue passing the screen for each of the subsequent five years) or the firm seems to have lost its way (shifting, for example, from organic growth to growth-through-acquisition).
The value strategy, Dividend Builder GAINX is a permutation of the growth strategy's approach to well-established firms. The value strategy looks only at dividend-paying companies that have provided an inflation-adjusted cash flow return on investment of at least 10% in each of the last 10 years. The secondary screens require at least a moderate dividend yield, a history of rising dividends, low levels of debt and a low payout ratio. In general, they found a high dividend strategy to be a loser and a dividend growth one to be a winner.
In general, the guys are "keen to avoid getting sucked into exciting stories or areas of great media interest. We’re physicists, and we quite like numbers rather than stories." They believe that's a competitive advantage, in part because listening to the numbers rather than the stories and maintaining a compact, equal-weight portfolio both tends to distance them from the herd. The growth strategy's active share, for instance, is 94. That's extraordinarily high for a strategy with a
de facto large cap emphasis.
For those interested but unable to join us,
here's a link to the mp3.
I'd be delighted to hear others' reactions to the call.
David
Comments
And sorry about the delayed response. I had to dash off to teach just after the conference call ended.
International exposure: the managers seem to suggest that they have a high level of exposure to the US because that's where they're finding firms that match their screens. By prospectus, they need to invest at least 40% in firms that have "significant business activities outside the US." Since currently 70-74% of the portfolio (depending on who you ask) is coded as being in the U.S., the prospectus restriction clearly allows for the presence of US domiciled firms whose earnings flow from foreign markets.
While that exposure is high (only 14 global funds in Morningstar's database are at or above 70% US), it doesn't entirely explain the fund's outperformance since many of the US-centered global funds have quite weak records.
Currency exposure: I can find no reference to hedging in the prospectus and the "principal risks" of investing in the fund include "The value of foreign currencies in the countries in which the Fund invests decline relative to the U.S. dollar."
For what that's worth,
David
Two keys: (1) GAINX was the guys' initiative in response to their CIO's challenge to design a winning strategy, so they're personally committed to it and (2) there's $120 million in the European version of the strategy, so it's financially viable. Both the US and European versions are run by the same adviser, so the US assets in the growth strategy keep the smaller European growth fund going and vice versa.
Hope that helps,
David