People Make the Difference
Interviews our 4 investment partners
Speaker1: Hi, it's Mike and Craig here. We're excited to share with you our conversations with some of our key investment partners.
Speaker2: Each year we spend many hours meeting with and researching potential solutions for our clients portfolios.
Speaker1: Most of the time we say no.
Speaker2: You see, only a few select firms have that right mix of people, culture and process to be a part of our portfolios. Here are highlights of interviews with four of our key partners. Have a look.
Speaker1: When did you first know that you wanted to be in the investment management business?
Speaker3: My first job, and it was actually in the financial district in Toronto at Jimmy the Greek. This was sort of my first exposure to professional Bay Street types. I ultimately ended up doing my undergrad at the Ivey School of Business at Western. There I took the now famous value investing course. This exposure really made me believe that earning a living from investing was possible, and all that was required was some hard work, some aptitude and and some capital. But I was fortunate through through my job to actually get exposure to some good firms and edge point being one of those, you.
Speaker4: Know, it wasn't really on my radar. So I went on to university with a focus on economics, business and languages. And then I stumbled into the CFA program during graduate school and it looked modestly interesting, and then it ended up opening the door to my first job in the industry, which was in investment manager. Research manager research was was definitely a strong influence. I spent lots of time analyzing different investment approaches, what makes firms and teams successful and where things might fall apart. And the focus turned pretty quickly to the foundation, which I'd say includes organizational stability and alignment, breadth and depth of research and a balance between continuity and disruption within the investment team. I'd say all of those are important features that allow a company and an investment process to adapt through time.
Speaker5: I guess probably second year of college, I initially enrolled for a Bachelor of Science and then after about a year of working in a lab, I decided that wasn't for me. And so transitioned over to business, went to the U of A, did a finance degree, and then was very fortunate really to get my start on the sell side as a research associate with BMO Capital Markets back in the day and moved over to Bissett back in 2006. And here I am. I first started taking a passion for finance and personal finance from a really young age. Actually, as a teenager I was buying Canada savings bonds.
Speaker2: With allowance.
Speaker5: Money. I got work money I got. So I started investing really young. And then even to the point where my mom would always say I'd be looking at my bank books, looking at all my transactions. So I really took a passion to personal finance early on, just really from there through university. Did a Bachelor of International Business, did finance. After that, I started really working directly into the asset and wealth management industry over 15 years ago. Through that time, I pursued my MBA in finance, did my CFA, CFP. I just really built off that.
Speaker1: Who've been some of your strongest mentors or influences in the investment management business?
Speaker3: You know all the names that you'd be familiar with, the Warren Buffett, the Dan Loeb's, the David Einhorn's. But truthfully, most of my learning has come from Edge Point. The founders, Ty and Jeff, as I've just had first hand exposure and feedback from them on a daily basis for nearly the past seven years. But if there's one investor that I have to give credit to outside of Edge Point, it would definitely have to be.
Speaker4: Joel Greenblatt I had a couple of other influences over the years as well. I spent some time in fixed income and in private assets as well as in multi-asset portfolio management. Those were all really helpful in more appreciating liquidity and thinking across asset classes. And I spent some time in development and strategy where in essence it's about what clients are looking to solve for and really focusing on that. As the North Star.
Speaker5: I worked with Leslie Lundquist for a number of years and and she too kind of imparted on me just that investment management is dollars that we manage, really. They belong to people. Yeah, I think that one's an easy one for me. Actually, one of them is Vanguard's founder, Jack Bogle. So Jack is really one of the great innovators in the investing world. And really he's the pioneer when it came to popularizing, indexing or passive investing and really just having that whole discipline to have a long term investment approach and maintaining discipline. So he's he's definitely one of my my mentors and just definitely one of my influencers, I would say.
Speaker1: So tell me, what makes your firm distinctive in managing portfolios?
Speaker3: There's a couple things. I mean, the most structural piece is the fact that we're employee owned, investment led, and we're not compensated on short term investment results or on we're compensated on three and five year performance. But what really makes our approach unique is we're not stuck to an individual style box. Sometimes we look like growth investors, sometimes we look like value investors. But really that just means we go where the opportunity is and buying a business that can grow and not paying for that growth always looks different and can't be defined by some sort of current price to earnings, multiple or other shorthand quantitative metric.
Speaker4: There are four key features that capital group that stand out to me. The first one is alignment with our clients. In particular, we compensate our investment professionals not based on the level of assets that they manage, but based on the investment results that they generate for our clients. The second one I'd highlight is a deep research platform. We have over 200 equity investment professionals located in 11 offices around the globe, doing over 20,000 company meetings per year. And they collaborate closely and extensively and they share their research. And what that does do to us is provides us flexibility in terms of how and where we can find investment opportunities as market leadership evolves through time. The third one I'd mention is the assignment of multiple portfolio managers to each fund, and that brings different perspectives. More shots on goal. It also helps with succession planning over time. And then lastly, I would argue is our private ownership that allows us the patience to hire and retain people through the cycle. It brings long tenure into our investment group. Our portfolio managers on average have been with Capital Group for over 20 years, analyst For over ten years.
Speaker5: We're definitely fundamental bottom up investors with a real focus on valuing companies. Now you'll hear that from a lot of other firms as well. But I think what is a strength of ours is the ability to stay true to our style. We don't deviate even when it can be temporarily uncomfortable. And I think being able to do that really relies on the fact that the core group of us have been around for a long time. We've worked together for a better part of 15 years. And so there's an element of trust there that I think you really need when you're working in a in a group of professionals. I think Vanguard's very unique as an investment company. We're the only world's mutual investment company. So what that means is we're not owned by outside shareholders, we're not owned by a large family. We're actually owned by our clients. So if you're a client, you invest in a Vanguard Mutual Fund or ETF, you're actually an underlying owner in the company. And that's that's the ownership structure in the US. In Canada, it's a similar it's not exactly the same, but we really still hold the same philosophy of doing what's right for the investors. So why is that all important? That means many companies say they they do what's right for clients. They say they're client centric, put clients first. But we are, I believe, really a true, truly client first company. And this ownership structure allows us to get economies of scale for our clients. So when we grow our products, our funds, we look to do two things with we're not looking to make a profit per se. We're looking to either take the excess excess return and either reinvest it back into the business or give it back to our clients in terms of lower management fees. And we all know that lower fees usually equates to higher returns. At the end of the day.
Speaker1: 2022 has been quite a year. Inflation, war, pandemic. What are some of the events that influenced your investment decisions and how did they influence.
Speaker3: 2022 is just another reminder that the world is highly uncertain and therefore you should never really pay for certainty. Ultimately, at the core of the current market condition is that excess liquidity is finally being reined in by central banks due to ongoing inflation. This is just a reminder that the financial conditions over the last ten years, which were really accentuated during the Covid period, should not be thought of as the norm and rather the exception. And if your investment thesis relies on low interest rates to be successful, it's just unlikely to be a good investment.
Speaker4: Yeah, absolutely. So at the start of the year. I would say that there was certainly upside pressure on inflation and interest rates. Some important developments included ongoing uncertainty in China that included recurring Covid lockdowns, pressure on the property market, as well as political uncertainty. And with that, we see companies globally looking to make their supply chains more resilient and then probably most prominently, the the crisis in Ukraine, first and foremost with the the human tragedy around it. But then from an investment perspective, really a step change with heightened focus on energy security and reliable access to critical resources and much more upside pressure on inflation in a much more persistent way, there was no change to the investment process. We continue to be bottom up fundamental investors with on the ground research across the globe and with the ongoing goal to find companies that can grow capital over the long term. What has changed, though, is where we're seeing investment opportunities. You know, we have a long term investment time horizon average portfolio turnover is is around 30 to 35% per year.
Speaker1: Well, I guess.
Speaker5: You know, probably the penultimate event has been the. Russian invasion of Ukraine and the follow on effect that that's had for energy prices. I think it's been a cautionary tale for countries around the world, particularly those who have outsourced their domestic energy needs to other suppliers. And and certainly the risk of being overly reliant on certain suppliers, whether that supplier ends up being a foe or be becomes on a sanctions list. It can have real world implications for countries and for their economies. In Canada, we happen to be blessed with just the natural abundance of of resources, including energy, both renewable and nonrenewable. One thing that I really become pleased with is how both the the investor sentiment has shifted, I think, in favor of energy. But just as importantly, the companies have shifted in into being what I think is better stewards of capital, focusing more on returns over growth and allowing investors to participate in those returns with various capital return initiatives, whether it be share buybacks, dividends, special dividends, that sort of thing. Yeah, I mean, definitely a very unique year, a couple of years really since 2020. Since the start of the pandemic. I would say it's been a bit of a roller coaster. Obviously, 2022 unique throughout those years, right? Higher inflation, geopolitical risk, now risk of recession in different economies. And that's obviously a concern for for different investors. But I think we really actually look at this type of environment and we actually internally call it vanguard weather. And what I mean by that is sticking to our our discipline, sticking to a prudent, balanced, diversified and low cost approach to investing.
Speaker2: Actually works really well.
Speaker5: In these types of volatile markets. There are a lot of media speak about the death of the 60 over 40 portfolio, 60% equities, 40% bonds. What people don't mention is that the portfolio that's a 60 over 40 balanced portfolio has been around for over 100 years, dating back to the 1920s. And it's seen environments of high inflation, low inflation, bull markets, bear markets and everything in between. And it served investors really well over the long term. We think this will, for example, the 60 over 40 will still continue to serve clients well going forward. We've seen, though, many people this year shy away from bonds, move to cash, perhaps riskier asset classes like cryptocurrency, liquid alts, real estate to try to mitigate some volatility or maybe think that there's a new way going forward. And I think the one thing on on bonds that we've seen is we think there's a lot of opportunity in bonds going forward. And we do believe bonds will act as a diversifier to equities and act as a ballast in the portfolio.
Speaker2: Can you take a moment to highlight some companies in your portfolio that illustrate your investment process?
Speaker3: Take our largest holding today. Dollar Tree. Dollar Tree for the past 50 years has only sold products for $1. Today, though, the company is realizing it has some pricing power and is actually in the midst of increasing prices as they feel that they can offer customers better value than just constraining themselves to some arbitrary $1 price point. If Dollar Tree is successful in raising prices towards, let's just say, the $1.50 cent price point, so $0.50 higher or 50% higher, we can see the company earning over $18 per share shares today, trade for $150. And that means we see this business trading for less than ten times earnings. If we're right on our thesis that Dollar Tree is able to break the buck and charge their customers an average price above $1 per skew.
Speaker4: One company that fits into this is Novo Nordisk. It's a global pharmaceutical company based in Denmark and has a strong balance sheet, strong margins, sound capital allocation. It has no major patent expirations over the medium term, so there's good earnings visibility and a strong growth potential driven by solutions to address diabetes and weight loss. A second example I would highlight is Caterpillar. It's a global leader in earthmoving equipment, among other things. First, Caterpillar has a dominant share in its markets. It has strong collaboration with with its customers and a growing services business. Together, those are making revenues more sticky. It also has structural growth opportunities in new markets, for example, in underground mining equipment. And with all of that, there's significant free cash flow and return to investors.
Speaker5: I'd probably start off with the railroads, CN or CP. Both of those stories work really well for us. Those are companies which have and lend themselves very well to our kind of valuation methodology. If we're looking out and we can see years of future cash flows, we know that what the railroads are going to be doing within ten, 15 years from now, we see pricing power, we see the benefits of having fuel surcharges built right into contracts. Another stock I might throw out there is Nutrien. So this is in the materials. Space materials can be a little bumpier as far as volatility, but we like the merger. When Agrium and Potash came together to form Nutrien, you had that synthesis of the retail business and the primary production of potash and other agricultural inputs, lending itself a much more robust cash flow situation, much less volatility. And that company too has been a really good steward of invested capital.
Speaker2: How do you incorporate stewardship of environmental, social and corporate governance factors in your investment process? And can you give us an example?
Speaker3: So first, we actually have a dedicated individual that makes sure that we're following certain ESG frameworks that have been put out by various organizations. But then as it relates to specific investments, typically the investments that we make are businesses that are what we like to say in the midst of ESG transition. Think the greatest example that underscores this is a business we owned in our Canadian portfolios called Transalta. Transalta is a power producer out of Alberta. Historically, the majority of the power they produced came from coal and they were in the midst of actually taking down this coal generation and retiring their entire coal fleet and transitioning it largely to hydroelectricity and natural gas. While this transition was occurring, the investor base looked at this business unfavorably. Largely for these reasons. However, with someone like ourselves who has a long term approach, we saw that these this ESG negative was actually about to become an ESG positive. And by identifying not only that, the company would be very profitable in the future, given its low cost power production advantage, but it would actually be in the midst of an ESG transition and it would open itself up to a broader investor base, all while satisfying ESG criteria. So I think that's a great example that really underscores our approach to to ESG.
Speaker4: Some of the ways that we've incorporated that more is through scenario analysis, stress testing, playing devil's advocate, raising hypothetical questions around what would you sell if what what would you buy if. So really challenging thinking and anchoring from historic reference points. Second, bringing in on the ground perspectives from across across the globe in a very structured way, including from our Shanghai office. So really understanding what's happening on the ground across various regions as well as onsite visits with companies and as long term investors. It's, you know, it's been critical for us to understand the long term prospects of the companies we invest in, and that includes how they treat their people, how they treat their suppliers, how they engage with local community communities, how exposed they are to scarce resources, changing customer preferences, regulation and so forth. So with this in mind, you know, how do we focus on the issues that are financially material for each company? The first one is investment frameworks. Think of those as tools that highlight issues that are material in a specific industry. So what's important in managed care is different from what's important in metals and mining, which is different from what's important in tobacco, which is different from what's important in energy.
Speaker4: There are over 30 of these frameworks that have been built by our fixed income and equity analysts as well as ESG specialists. These frameworks don't live in a desk drawer somewhere to pull out, you know, once every month or so. They live live in a proprietary proprietary system that populated with live data pulled from over 50 different sources. The second component is the monitoring process, where we screen all holdings against external indicators to make sure that we're not missing anything. And then third, engagement with the companies that we're investing in and voting our proxies. And that is really in support of long term value creation for our shareholders. They can also help us find the best companies. And to give you one example, which really goes back to your question, human capital is a potentially material consideration in most of the industries that we're investing in, issues such as attract ING and retaining the right people, training to develop new skills, maintaining positive labor relations. All of those can help companies create and sustain a competitive advantage.
Speaker5: I guess we've become more formalized with our evaluation of of ESG. I know that can be a hot topic for some people. And what we wanted to do was have a way of translating, which are often qualitative judgments and assessments of companies into some more quantitative objective approach, and then not to just leave that on the shelf somewhere, but to actually incorporate that into our evaluation process. And so by that I mean we have our own proprietary rating where we we figure out what we think are important for companies in particular sector. We weight those factors. We look at measures that explain those factors. And then after we score these companies, those ratings inform our cost of capital assumptions for the different businesses. A good example would be if we took two companies in, say, the oil and gas producer, space companies would have similar financial characteristics, similar leverage, similar production, cash flow per share. But one is a let's call it a much better actor than the other. On the ESG side, what we would see is that we've incorporated a higher cost of capital for the laggard, and that would mean that, all else being equal, the valuation of that company would be lower. That's not where we'd end, though, I would say.
Speaker5: Just because a company might be a good ESG actor doesn't necessarily mean it's a good investment opportunity at that point in time. Know, a lot of people say indexers are not concerned about sustainability in the investment process, but actually it's quite the opposite. Companies like Vanguard and Indexers in general are actually the ultimate long term permanent capital holders, and we actually want to make sure our clients maximize we maximize the value of the companies in our portfolio for our clients. So we actually have the most interest to make sure that those long term holdings, their value has been maximized. So just for an example, we have a whole team called Investment Stewardship that engages with companies on a regular basis. Advocates for for good. Stewardship practices and both proxies on behalf of all our clients. And in 2021, actually, we engaged over 1000 different companies globally across 29 countries that represented almost $3.5 trillion in assets in our equity index funds. And that's that's done by a team of 60 investment stewardship professionals that do all this on behalf of our clients. So and really what they do is they look at investment stewardship that's grounded really in four principles.
Speaker5: One is board composition and effectiveness. One is overseeing the company board strategy and managing risk. Another is executive compensation and just. And the fourth is shareholder rights. An example that maybe could resonate with some of your clients would be with Exxon. But Vanguard's stewardship team has had had over a dozen engagements with members of Exxon's board and leadership team during 2021, and that followed really almost a decade of different engagements with the with the board as well. And this was really discussions on board composition, independence of the board and really just responsiveness to shareholder feedback over the years. And really the outcome of all those engagements was Vanguard voting in favor for the descendant proxy. There is a group of descendant shareholders who wanted change and we supported to descendant director nominees for Exxon's board in our voting because we did have concerns with board dynamics company performance. And just I think industry analysts had also raised concerns about Exxon's overall strategy, its approach to capital allocation and just increasing debt in the company. And really, I think just the long term value creation was not there. So we did vote in favor. And that's an example of. Taking action to maximize long term value for our shareholders.
Speaker1: We do our best to make sure these solutions contribute to you achieving your goals. Goals such as retirement with no worry. Seeing children's education funded. Providing a legacy to those you love and charities you cherish.
Speaker2: Choosing the right investment partners for your portfolios is a continuous task. We carefully monitor our investments to ensure they deliver to their purpose. We are grateful for the quality of Bissett, Vanguard Capital Group and Edge Point.
Speaker1: Its people that truly make the difference. Thanks for watching.