Markets are in freefall amid uncertainty caused by the outbreak of the Coronavirus. So how does WCM Investment Management (WCM) position its portfolios during such an unprecedented time?

During this live webinar, Marty Switzer talked to Jon Tringale, Portfolio Manager, WCM and discussed how WCM invests during a time of crisis and the role corporate culture and expanding economic moats play in a company’s ability to weather a serious economic shock.

If investors have any questions please don’t hesitate to contact the team on 1300 001 750 or invest@contango.com.au.

Marty Switzer (MS): Hi, I’m Marty Switzer. Thank you for joining me on this live webinar today. I’m the CEO of Associate Global Partners. With me today, Jon Tringale from WCM Investment Management.

Firstly, I’d just like to thank everybody very much from the bottom of my heart for your time and support that you provide to us through this challenging environment.

As I mentioned before, Jon’s from WCM, our partner and he’s here today to talk to the audience about how he’s investing at the moment but most importantly, he’s here to answer the questions that you want answered. This is a live interactive webinar and it’s an opportunity for you to ask questions and get the most out of the session. If you click on the question box on your computer, you can enter your question in and we’ll moderate that throughout the day. Jon, welcome. Thanks for your time.

Jon Tringale (JT): G’day Marty, thanks for having me.

MS: Jon, we spoke with your colleague, Paul recently and you know what, I’ll sort of reiterate what we said to him, but Contango, you know what gives us confidence and what should give our clients confidence as well, is the experience that the team has in managing money through, market sell offs such as this.
Before we get into some of the key questions for today’s session. Can you tell us, what is the mood on the street at the moment and can you also cover off your view on the current investment landscape?

JT: Well those are a couple of pretty loaded questions. I think in terms of the mood, here at a WCM is quite calm. We’ve never dealt with COVID-19 or a pandemic like we’re seeing now but we certainly have dealt with periods of market volatility like this and frankly, these are really the environments I think where we have the most opportunity to add value for our investors because emotion plays a large, larger role in some of these daily swings.

When you see a 10, 12% move up one day and down that much the next day it’s, as we all know, very, very unusual and so I think having a steady hand, really knowing what matters in terms of what characteristics are important for long-term business success and ultimately for us in terms of returns that’ll show up really nicely.

You’ve got to have that, that cool hand. I think among investors in general the mood is quite mixed, the rally we’ve seen in the last four or five trading days has really suggested that there is a lot of optimism still out there. I can’t think of many two-week periods where, in one week you literally have investors so scared and selling, just fleeing equities and in the next week they’re talking about fear of missing out in such a tight period. So, it’s really interesting in the last four or five days, is that bear market rally and are we going to create some new lows or is the worst behind us you know? We don’t know, but it’ll be interesting to see what happens here.

MS: And Jon at a community level, we’re I in a partial lockdown here but you’re in a full lockdown but you are able to go to work at the moment because of a government exemption. Is that right?

JT: Yes. Most people are working from home but there are some so-called critical industries that they’re allowing you to, to go into work and we do fit that exemption. Som all of our people are free to work from home and most of them are doing that, but we also have the freedom to come in if we choose.

MS: Jon we’ve been overwhelmed with the number of the attendees we’ve got on this, this webinar which we’re very grateful for. A lot of clients, also a lot of potential clients on the line as well. Could you take us through the key features of the WCM investment process for those that haven’t heard about it before and let us know why it’s particularly effective during falling markets?

JT: Yeah, wonderful question. So really foundational at WCM and this shouldn’t come as a surprise and I shouldn’t have to say it but really we exist because we want to outperform. What’s fun to us is generating significant alpha, significant excess return for our clients and for ourselves who all invest in the strategies as well and we really believe to do that over time, really to win the investment game. The most critical thing that you need to do is to protect capital well in these down markets.

And so for us, every decision we make at the stock selection level as well as at the portfolio construction risk control level is done first and foremost to protect capital. So, what are some of the particular things we do? Some foundational ideas we really subscribe to and implement are just very basically looking for companies with really strong financial health. I mean, that’s a starting point and that’s something I can tell you that, talking to investors around the world the last five, six years doesn’t come up a lot. I don’t get a lot of questions around how much leverage is in your portfolio. The answer is very low. We have a lot of companies that are actually net cash on the balance sheet, but the point is people haven’t really focused on that because they haven’t needed to. The market’s been going one way and people forget about, about debt but a period like this, that is coming back into very acute focus. So certainly owning those stronger financial companies is paying off now.

Secondarily, I mean, we’re looking for businesses that are in really structurally attractive industries or parts of the market where there is very visible, long-term growth. Things like growing healthcare spending as the world gets older. Things like technology proliferating more and more industry, more and more parts of our lives. These are real tailwinds that are here to stay and yes, there’ll be some volatility in stocks in the short run but, but these things you can really hit your wagon to, so to speak in terms of compounding growth over time. So we require that.

And then very importantly, we look for really two elements in these businesses specifically. The first is having a growing competitive advantage, so a company that is clearly demonstrating they’re actually improving their edge on their competition, they’re widening their moat and secondarily that they possess a culture that is really strong, it’s healthy and it’s well aligned with their business model. And I think what a lot of investors overlook, particularly on Wall Street, is that if you’re a long-term investor like we are, organizational health, how people, who’s leading a company, how people are energised and incentivised in an organization, how they behave. The way of doing things is a massive driver of long-term value creation but it’s overlooked by most investors because it’s touchy-feely. You can’t quantify it. It’s fuzzy and yet it’s crucial so I think those elements are, collect and then portfolio construction. I can spend a whole other episode talking about some of the things we do there but all those things in tandem have historically really helped us protect capital well and hopefully will help us do well on the other side of this.

MS: Jon the questions are coming in pretty quickly. There’s a lot of demand, which is fantastic. I’ve got two though before we go to that. The portfolio performed exceptionally well during the GFC. Are you seeing similar opportunities now as you were back then?

JT: We are and this sell off has felt different than the GFC. I think that the playbook back in 2008, early 2009 is, there was a lot of money to be made by buying some of the higher growth, higher beta stocks, if you will. Often times, not just in the GFC but in most sell offs, it’s usually those higher-flying growth companies that are hit the hardest and often these pullbacks are an opportunity to, maybe add some exposure there and really benefit when things rebound.

This sell off has felt different in than that a lot of these high growth, high beta names have been remarkably resilient in this environment. Maybe that has to do with a lot of them being in technology and maybe not having brick and mortar stores or not having maybe as much disruption potentially in their supply chains but for whatever reason, those names have been more resilient and you’ve seen, more of the cyclicals hit harder and so that’s been a bit of a nuance. So we’re seeing opportunity maybe in different pockets of the market.

Healthcare is an area we’re really excited at the moment. The opportunity to add to and buy some really leading franchises, best in the world, in orthopaedics or in wound care or in pharmaceutical packaging companies that are here to stay but have really gotten punished in the short-term with fears that hospitals are going to be overloaded with Coronavirus patients and there’s going to be all these delays and some of the selective procedures, that is very much, is likely to happen over the next six months but guess what? At some point people are going to be back and there’s going to be this catch up dynamic or this pent-up supply or pent-up demand rather, that’s going to help them really accelerate their growth coming out of this. So healthcare in particular, is one part of the market we’ve seen a lot of opportunity in the last month or so.

MS: Jon how is the portfolio performing now through the ‘current crash’ as we call it?

JT: It’s a relatively short period but today here in the US we just finished the first quarter. So the portfolio, we’re pleased hung in pretty well as advertised. We’re about 800 basis points ahead of the all Country World Index year to date. So, again protecting capital well as we would hope. So that’s where we are so far.

MS: That’s a, it’s a great result. So first question to lead in is Marco Mulatto, how do you achieve such low downside capture in the portfolio during market declines? How do you do this? I guess creating such strong downside capture, good opportunity to talk through that. Thanks Marco.

JT: It’s a combination of factors. Some of the things I outlined, I mean, certainly starting with strong financial health is helpful but we’re not the only folks who do that. It’s a great starting point but it’s really this idea of these companies that truly are improving their competitive position because it’s really periods in the world like this where everyone’s facing challenges.

All these businesses are under pressure. So which companies maybe are not only better suited to survive but can actually go on offense, can make some aggressive moves, whether it’s acquiring some companies at a discount, whether it’s actually increasing some of their R & D spend when maybe their competitors are hobbled, those are the type of companies that tend to attract more interest among investors. We also place a huge premium on durability of growth. So our portfolio, you will notice we do have a couple high-growth companies but we have a lot more companies that are just very consistent, steady growers with a lot of consistency and a lot of relative certainty around the growth persisting for many years. Again, I think that consistency of cash flows is really valued by investors in tumultuous times like this and that’s been advantageous for the portfolio.

MS: I’ve got a question from Rick D from Laverton in Victoria. Talking about trading, has it increased over this period and what sectors do you think are attractive at the moment?

JT: Yes our trading has increased. So for those of you who don’t know us as well, we’re very much long-term investors. Our average holding period for a business in the portfolio is over five years. So we really are trying to find and partner with these great businesses, let them compound capital for us.

The one time we tend to get a bit more active is in periods where you have heavy volatility like we’ve seen this year. That’s where we try and look for asymmetric dislocations or said differently, where have certain stocks sold off a lot more than maybe their future prospects have been diminished and where is there some more opportunity there. So, certainly there’s been heightened activity.

We’ve had actually five new companies added to the portfolio this year. We’ve added some existing names. We’ve sold some of our lower conviction names to fund those trades. So we’re certainly still not flipping the whole portfolio or making any what I would call, wholesale changes but we do want to have the ability to be nimble and be a bit more opportunistic. So in terms of where are we seeing that opportunity at the sector level, it’s, again, I would point to healthcare as one area.

The other sector, in any sector really is very broad. Even within healthcare, we’re seeing very different things in Big Pharma versus supplies, versus medical tools and so on. In tech, again, very different story between software, some of the hardware, some of the different components and you can kind of go down the line. So I don’t think there’s kind of one sector in particular that we would just, buy the sector as they would say, but pockets of healthcare certainly elective procedures. That’s probably the one area I would highlight the most.

MS: Jon, next question from Darren G, I love your focus on companies with a growing moat and good corporate culture. You talked of the sectors but have we made any change to the portfolio through the crisis?

TJ: We have. Yeah and I just took my hand to that a little bit but to give you some specifics. So we did sell some of the ideas that are lower conviction, Compass Group, Symrise, SLR, Luxottica, these are companies we’ve done well in over time but we just wanted to free up some cash. So, we were quite excited, earlier in February. Excuse me, earlier in March to add a Lululemon to the portfolio amidst really some heavy downward pressure on that stock. This is, for those of you who don’t know really, the premier brand in Athleisure or Athletic Apparel in North America. They’ve got about 90% of their sales here but they have expanded overseas. I know they do have a decent footprint in Australia but this is really a marquee brand with tons of momentum in their eCommerce business. Tons of momentum in general. It was down 20% in a day, so that was one we jumped all over.

Another thing we like to look at generally and those of you who’ve met with myself or my partners in the past know that we’re not big macro forecasters, not at all really but the one situation that we like to use the macro is if there’s a certain part of the world, whether it’s a country or an industry that is just absolutely hated by investors, sentiment is terrible, no one wants to touch it. That tends to pique our interest. Can we find a really compelling business that fits our criteria but that may be selling off with this broader theme and when you think about, where there are negative headlines today? I mean, they’re pretty much all over the world but looking back in the last few weeks, it’s hard to point to a worse news flow than coming out of Italy and so in this case, we’ve actually used that as an opportunity to rebuy a former position and that is Ferrari. Really at the peak of some of the negative news. They actually had to close down their factories. Again, there’s not much positive insights coming out of Italy and so we’ve used that to buy what we think is one of the really preeminent global luxury franchises. This is a company that over time has been masterful at creating that supply demand imbalance. They had a hefty wait list to buy their cars at 2008, 2009. This time we think will be no different. Lot of upside there. So, bought that through some significant weakness.

We’ve also added, actually CSL out of Australia, which we’ve liked for a long time. We’ve added, HEICO, this is a company based in Florida in the US and they make a lot of aftermarket parts for the aviation and space industry and as you might imagine, that’s a sector, another example of a part of the market that’s gotten clobbered. This is a company with one of the best cultures we’ve encountered in the world and it’s a company, I just spoke with their CEO last week and they’re going on offence. They’ve got cash to deploy that they’re getting an opportunity to make some acquisitions that they actually lost out on in recent months to private equity firms. Well, guess what? Now those firms don’t have the capital to follow through on the deal. HEICO’s getting them at a discount. So those are a couple of the new positions.

We’ve also added to Stryker. This is the global leader in orthopaedics. I talked about this idea of, as we think about where to add in the portfolio, we don’t want to only add to the companies that have sold off the most, although that’s a decent place to start but we also want to think about, who really has an opportunity for some outsize growth when things improve and you think about Stryker they have knee replacement, hip replacements. If you’re struggling to walk in the US and you’re thinking about getting a knee replacement, yes you might be pushing that out now six months or a year because of what’s happening in the hospitals but guess what? You’re still going to get that done at some point.

Also, Alcon out of Switzerland in the portfolio. They make the intraocular lenses for cataract surgery patients. Again, if you’re having trouble with your vision, a lot of people as they get older do need cataract surgeries. Yes you can put it off a little bit but if you wait too long, you will literally go blind. So again, you’re going to get that procedure done maybe just later. So we’ve tried to see where is there opportunity for that increased demand on the other side of that and surprisingly, those stocks have gotten hammered and so we’ve said, we think the market’s misunderstanding this. Let’s step in and add.

MS: A question from Travis. Wanting to know the cash position in the portfolio but also a question around small cap, which we distribute a large cap strategy as well as a small cap strategy. The question is, what’s the cash position? I’m assuming he means in large cap and maybe you can talk about cash in large cap and small cap and then any quick comments on Afterpay, Jon, which is a stock well known in Australia used to be quite a large position in the small cap portfolio but it has reduced in recent times. Thank you Travis.

JT: So in terms of cash, the philosophy in cash position is going to be very similar across our portfolios and we really view our role as to be fully invested and give clients exposure to global equities. So we’re really, if a client wants to raise cash, we leave that up to the allocators. So we stay fully invested, which means 5% or less cash. So we’ve fluctuated between, call it two and a half and 5% this quarter. We’ve been a little bit higher when we’ve been raising cash to deploy and then as we’ve been deploying it, we’ve kind of dipped down. So we’re finishing the quarter right around four and a half percent or so. So we do have some dry powder. We actually do have a trade program underway as we speak. So we are putting some of that money to work and small cap would be very similar. It’s about 4% cash in the small cap portfolio.

In terms of Afterpay, that’s a business that my colleague, Greg Ise who’s the lead PM on that small cap portfolio, it’s been one of his favourite ideas. They certainly made a lot of headway here in the US, it’s a really disruptive model in a lot of ways and unfortunately, with just the shutdown we’re seeing and that hit that consumer confidence has taken. It’s posing some near-term challenges. So Greg could give you more detail on our latest thinking but we certainly have a lot of affinity for the management team, for the culture but it’s a pretty tough shock they’re dealing with at the minute.

MS: Jon, question from Peter on currency. Do you ever hedge the portfolio and maybe you just sort of talk more broadly about the house view when it comes to the currency.

JT: Really the house view on currency is that, neither, we nor anyone else, can predict, consistently predict which way currencies are going to move. So we try as much as we can to eliminate currency as really a meaningful factor in terms of our portfolios’ returns and so there’s a few ways we do that.
Number one, we diversify. We require over a dozen different currencies in the portfolio at all times. Most of our holdings are large multinational businesses that are already hedging currency in the different markets they have their revenues. So you have a layer of hedging built in there and then again we tend to be so long-term with these holdings that it really does wash out over time. So even on, in shorter periods, you can maybe see a minimal impact in the portfolio but we do look from a portfolio construction and we have some risk software we use to kind of make sure we don’t have some hidden currency bet where we’re overexposed to the move of the US dollar or the Euro or anything else.

MS: Thanks Jon, we do have lots of questions coming in ladies and gentlemen and we thank you very much for that. We are trying to work through them all and we will get back to you at some point in time. I’ve got about 10 to 15 minutes to go, so we’ll keep pushing ahead but we will be in contact with everybody directly to answer your question. We just might not get through them all today.

Jon, this is a question from Mr. Noel. Are you seeing any new business models emerge that you are finding attractive and are likely to have a growth trajectory post this challenging market?

JT: That’s a great question. It’s hard to say if there’s anything and I guess it depends how you define new. I would suggest that certain newer models that just, things as basic as food delivery or eCommerce that have, maybe been quite popular with some of the younger and more middle-aged demographic. There was some of these forced ‘stay at home’ ordinances around the world. I think a lot of people who are older or maybe later to adopt some of these services are doing so out of necessity and likely will like the convenience and probably continue using them in a greater capacity when we return to a more normal environment. So that’s one behavioural shift that I think you could see and one benefit, one kind of model that maybe will benefit from this certainly anything with, video conferencing and so on. That’s not a new idea but there might be some behavioural changes there.

I do think, if I may, the scenario and the crisis that we’re seeing in the world today is also quite negative for some other business models. A lot of, more so in the small cap and mid cap space but we’ve seen a lot of businesses really borrow from the Amazon playbook in their early days where they’re investing really aggressively in growth. They’re delaying profitability a long time. They’re relying on debt and the capital markets to fund their growth. Those models are under severe pressure at the moment. A lot of them will break in our view. You will see bankruptcies. I think that whole kind of new age, ‘you don’t need to be profitable for a long time’ model is going to be challenged.

MS: Jon, we’ve had a question from, Joseph and the question is, what’s the research team doing with regards to company meetings at the moment and how are they sort of navigating through the challenging environment? I’m sure you’ll talk about the benefits of technology, but also, what are some of the companies in the portfolio telling you about the current landscape?

JT: Great question. Well on the first point and a big part of our process is traveling all around the world meeting with, not just management teams of companies we invest in or might invest in but also meeting with their competitors, meeting with their customers, meeting with their suppliers. Trying to really get a 360 degree view on the whole industry, the whole value chain and so on. So of course we’re limited in our ability to travel but we’ve actually been very intentional on the team to actually try and increase our phone calls and video calls with these management teams when we know they’re not traveling either.

Just in the last, five, six days, we’ve had a handful of pretty high profile CEO calls. We had, last week I spoke with Calvin McDonald, who’s the CEO of Lululemon, which I mentioned was a new position. Just this morning we’ve talked with, Mark Schneider, who’s the CEO of Nestle. Yesterday we talked with the CEO of Unilever. So these are just a couple examples. HEICO, I mentioned, we spoke with Larry Mendelson last week so, we are I think, we’re getting some pretty good access and trying to continue the calls but just virtually. And what was the second part of the question, Marty?

MS: Just with regards to how businesses are actually finding the environment and how the research team are obviously operating which you covered off in the first part.

JT: It’s been interesting talking to all these executives and these are obviously very seasoned folks running very large companies and the mood has been very calm and I think every single one of them has been, I think shared our view that they have no idea how long this is going to persist or what may be some of the later ramifications will be, it’s unknowable but they’re all, being very tactful with, what can we do now, what’s the right move to make now, how do we, really try and improve our position for when things do turn so that we can recapture that future growth? So it’s, the mood is, it’s not somber surprisingly.

MS: Good. Now a follow up question from Peter just back on hedging, we’ll just cover that off quickly. You still get that whether you buy puts not currency hedging and I guess the answer to that is no?

JT: No, we’re pretty simple, long only by the equity. That’s it.

MS: Another question from Rick from La Perouse, wanting to know your views on Japanese equities at the moment.

JT: Japanese equities is an area we’ve been light consistently over time really not for lack of trying. We go back there a couple of times a year and meet with a lot of companies. We do own more Japanese companies in our small cap strategy. I think our challenge in the large cap space is you have a lot of these, culturally a lot of these Japanese companies historically and continue to be very unfriendly to outside shareholders that their transparency is not good.

Their return of cash to shareholders is pretty pathetic. I see companies even today that’ll have say 40% of their market cap in cash and don’t pay any dividend and domestic consumption stories in Japan, typically there’s not a lot of growth, right? We all know the challenges they have demographically. So we have found select opportunities over the years. We love Keyence, which is a factory automation company and that they’ve got really a global sales. They’re in an awesome spot and in small cap, we do find more opportunities. We find some of these newer businesses have a bit different mindset. They’re more entrepreneurial, they are a bit friendlier to outside shareholders. So I think some positive change is happening but we still don’t have a lot of exposure in large cap.

MS: I want to take one more question and then we’ll just get you to provide some closing remarks. It’s a bit of a macro question but it’s sort of for any, probably covered it off to a degree but I think there’s some benefit in asking and it’s from Greg. What are your thoughts on the fiscal stimulus packages around the world and specifically the impact they might have on stocks in the portfolio?

JT: Based on what I’ve seen globally and certainly what we’ve seen here in the US with a couple of trillion dollars, I use the analogy of life support. If you think of a patient in the hospital is in a coma, the idea and what I’m seeing so far out in the world is they want these people just to be able to survive, hang on so that when we’re past this Coronavirus, we can plug back into the good old days and the economy can resume as though it was uninterrupted. I personally I’m a little sceptical that it’ll be that quick because I think you’re having really a massive loss in confidence by a lot of people. I think the kind of so-called wealth effect. When people see in general, the asset levels in their portfolios are down, that has to impact consumer confidence.
So I think a lot of the stimulus is good. It’s hopefully preventing things from getting a lot worse and hopefully it can keep people afloat and we can resume to some normalcy here soon. I think the governments are certainly acting in the best interest. There’s, the opportunity will be very helpful. Certainly much more helpful than if we did nothing. The longer-term implications are unknowns but so far at least some action’s being taken.

MS: Jon any closing remarks? Obviously extraordinary times that we live in but there’s going to be, there’s going to be a fantastic opportunity at some point for the long-term.

JT: absolutely. I mean, look, we have no idea if, where the bottom is or what these markets are going to do next quarter or the rest of the year but I can say with a lot of confidence looking out over the next five, seven, 10 year pull, I think we’re going to look back at this general time as being fraught with a lot of opportunity and so I think it’s quite exciting from that standpoint. It’s not fun to see what’s happening around the world but at the same time, we are getting some pretty rare chances in some of these businesses and we may continue to get some rare opportunities depending on volatility here ahead. I think that’s a positive for a long-term investor.

MS: Jon, thanks for your time. Greatly appreciated. That’s all we have time for ladies and gentlemen. We didn’t get through all the questions, but we will be calling you and responding to all your questions. Thank you very much for attending.

If you need anything at all, you can contact us. Invest@contango.com.au You can also call us on 1300 001 750. Thank you again for your time and please stay healthy and safe. Have a good afternoon.