WCM Global Portfolio Update – March 2020

As the situation with COVID-19 changes frequently, Paul Black, CEO & Portfolio Manager of WCM Investment Management, provides an update to investors. Paul discusses 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, CEO of Associate Global Partners. With me today is our business partner Paul Black, the CEO and Portfolio Manager at WCM Investment Management.

Paul, thank you very much for being with us today in these very challenging times or extraordinary times.

Paul Black (PB): Thank you, Marty. Great to be with you and good morning to everyone.

MS: Paul, what really gives us confidence at the moment, in times of severe volatility and what’s been a very savage market pullback, is that the experience that yourself, Kurt and the WCM investment team have had through these sorts of market pullbacks.

Before we start talking about the portfolio and how it’s holding up at the moment, could you set the scene? What is it like in the US at the moment? Are you in shutdown and what’s the general vibe and mood right now?

PB: We actually are in shut down in Southern California, actually most of California is in shut down. We did close the office and we fortunately had extensively tested remote abilities to work. We have done that every year for the last five or 10 years. People are panicked and I think the panic is really the greatest concern – more so than the realities of what the potential of the virus is going to do.

So there’s a lot of uncertainty here. I don’t know how long the people will listen to staying in their own homes and not going out. But the only thing that people are doing right now is, as I’m sure they’re doing in Australia, running to the grocery store and hoarding the the toilet paper, and the rice, and the chicken and the reality is there’s plenty of food. There’s just not a lot to be concerned about as far as getting what you need on a daily basis.

MS: There definitely is a lot of bunkering down the hatches here in Australia.

So Paul, let’s get into the portfolio, how you see things at the moment? What are the key features of the WCM investment process? And why is it particularly effective in falling markets like we’re experiencing at the moment?

PB: Well you know, it’s gratifying in this complete chaos and rapid sell off in only three or four weeks, that the portfolio is actually acting how we designed it to act. Which is in very difficult periods of time, when there’s dislocations in the market, our expectation is that we’re gonna do far better than the market when the market’s down. So, while the markets across the globe are down anywhere from what 30 to 45%, depending on what particular index you look at, our portfolio right now is down about 20%, maybe 21%.

So the names in the portfolio have held up really, really well. That’s by design. It is the philosophical underpinnings of what we do as a manager, which is to own those businesses that you’ve heard us talk a lot about, where we can make a strong case that the economic moat or the competitive advantage is actually getting stronger. We have found through history and market tests back in 2008, 2011, 2014, that we’ve done extraordinarily well in those periods of time. So that notion and philosophical underpinning of owning those businesses that we think have a high likelihood of getting better in market dislocation, vis-à-vis everyone else in their industry, is holding up really well.

This is also coupled with the idea that what ultimately drives the competitive advantage to grow in a business, has everything to do with the corporate culture or the set of values kind of inside the business to animate that business. So the companies we own with expanding competitive advantages, usually do extremely well in difficult markets. And the beauty is, because their weaker cousins in their industry tend to suffer during periods of dislocation, they actually get stronger and stronger and stronger.

So when the turn inevitably comes, the companies that we own with great culture supporting a growing competitive advantage tend to lead out from here. Nobody likes to go through this, but the math is overwhelming that if you lose less in difficult markets, obviously you don’t have to do as well in rising markets. We think that we’re well positioned going forward for the next five and 10 year pull.

That’s the important thing, that people that are investing in equities think in terms of decades, not in terms of weeks or months or quarters or even years. But if you can invest with an eye towards the next 10 years, then this is going to be extraordinary time that you’ll look back on and really wish that you would have allocated more capital to the equity markets.

MS: Paul the portfolio performed particularly well in the GFC. Are you seeing similar opportunities now to what you saw back then?

PB: We are, it’s the same kind of carnage where really great companies are getting dragged down with the poor quality companies. As a portfolio manager, when you think in terms of decades, it’s a great time to kind of upgrade the quality of the portfolio to own businesses that you think will be the leaders for the next 10 years. So what we’ve done from a portfolio management side during this crisis, is we’ve started to move away from some of the names that we would consider offensive in nature.

I don’t want to name names but examples of a defensive company that held up well might be a McDonald’s, or you could look at a Costco. Costco is going to have a phenomenal quarter two or three because of the hoarding that’s going on. Those are names that have done extremely well.

Our idea is take a little bit of money from those more defensive growth companies, and then begin to reallocate towards companies where they’ve been pulled down 40 or 50%. The long-term economics of those businesses are not going to be impaired by what’s going on collectively around the globe. As the market turns – and as everyone says, nobody rings a bell at the bottom of the market – but you want to position yourself for that period of time, when it will turn, and therefore the outcome over the next five and 10 year returns, we expect to be every bit as good as what we’ve delivered in the past five and 10 years.

MS: Paul, it’s obviously all happened very quickly the current scenario that we sort of find out ourselves in. What are some of the companies that you’re invested in, telling you right now about the current environment?

PB: What we did a couple years ago, is we moved away from some of the more aggressive technology names. A lot of managers have been loop riding technology companies and had great returns from them, but we began to feel a year and a half or two years ago that those companies were great.

I’m talking about the Amazons of the world, I’m talking about the Facebooks the Googles. The big ubiquitous technology companies. While they were still really good companies, we didn’t feel that they were companies where we could make the case that the moat was actually expanding. So we did sell those names in the portfolio and began to move into names that we thought might make the next leg up.

You’ve heard us talk about Shopify as an example in the portfolio, which is to us is similar to an early stage Amazon. It is a little bit different, but very similar in terms of working with the disintermediation of traditional retailers around the globe.

One of our favorite companies which we would own in the global portfolio is right in your backyard CSL, which is a tremendously successful plasma company. We have put that in the global portfolio but when we talk about Australia, this is an ex-Australia portfolio.

The area that surprises us the most are some of the healthcare companies. There are some really good quality healthcare companies in the device area. Knees, hips, other types of medical device companies that have been, again crushed because there’s this notion that people will put off non-essential surgeries in order to make room for the critical people that are gonna be in the hospitals, theoretically, over the next six months or so. We find that not to be a reasonable assessment of the future. So we actually think some of the healthcare names that are down 40 or 50%, will kick out tremendous amounts of cash flow and are gonna be a really good place to be.

And certainly in six or nine months, if people did postpone a knee or hip replacement, that’s not going to be postponed forever. And so we really believe in the healthcare area and why we’ve always been kind of heavy or at least in the last couple of years. There’s some very good opportunities to buy high-quality businesses there.

Now remember, we don’t buy biotech companies or even big pharma companies where you tend to have binary outcomes. You do tremendously well if a particular drug happens to be approved and take off. But you can also do very poorly if there’s no approval. So we tend to play more of the ‘picks and shovel’ ideas. In healthcare, we found that a much more conservative way to invest in healthcare. But we do believe going forward from here, that’s going to be a very nice, soft way to participate in growth.

MS: Paul, one of the questions we’ve had from some clients is “how is the research team dealing with the restricted access they would have to companies at the moment in the current COVID world?”

PB: This certainly could go on for a year or two, and there might be some issues but just as we’re doing the video conference we just need to get access through the web. We are doing this with the companies that we have in the portfolio, so it’s very easy.

Certainly with our size now, we get a decent amount of access across the globe. And instead of doing face-to-face meetings, we’re doing more video conferences, a lot more telephone calls, the access has not changed at all. This is really an interesting test case for the worldwide web and our ability through technology to stay connected with people and we believe we can continue to do that for quite some time.

MS: The companies that you have in the portfolio at the moment are still open to business in terms of communicating with you and open to taking meetings?

PB: Absolutely, absolutely not a problem at all. We had a trip scheduled for 10 days to Japan about a month ago that was cancelled. But we were able through technology to access the CEOs and the CFOs in the businesses that we really wanted to talk to.

MS: So Paul, who would you say are the winners and losers of the Coronavirus? And more importantly, are you seeing any long-term opportunities at the moment?

PB: That’s what we’re wrestling with right now. I’ve got this notion, which I think is not unique, that after this settles down it seems pretty obvious to me that there’s going to be a rapid move away from China as the ‘lead’ supplier throughout the world. I believe there’s going to be a massive shakeout in China in terms of manufacturing. You’ll probably see it move to other countries in Southeast Asia, whether it’s Thailand or Vietnam or Cambodia. I feel in the North America, we’ll see a lot more manufacturing capabilities come back to Mexico.

Because there’s not really a huge price advantage anymore to go to China, and kind of with the number of dislocations that China’s causing in the markets, it is going to make people think twice about doing business there. So that’s an interesting one; do you still invest in China and expect the same rate of growth over the next 10 years? Probably not. But there’s other opportunities in other countries where we’re beginning to sift through to see if we can find some good ideas that will benefit from that movement.

What is interesting is the discussion around value managers, and how value managers always have a margin of safety. We’ve been coming down to Australia for about eight years now, and the questionswe receive every time when we visit is “wow, growth has done so much better than value for so many years – do you think that can continue on? And of course the answer to that is “yes”. I think it can continue on, just because it’s outperformed for a lot of years doesn’t mean it can’t continue to outperform.

I actually believe there are structural disadvantages, to be a pure value manager than there are to be a pure growth manager. In this current market down graph, you’re seeing value guys down 40, 45, 50%. And that’s because the nature of a value manager means that they’re going to own those banks, and a lot of European banks that are gonna suffer. A value manager is going to own a lot of commodity businesses and a lot of basic industry and industrial companies that are absolutely going to get hammered and clobbered.

So, that whole notion that value is positioned to do better than growth is hard to see. You’d expect me to say that. But I think the kinds of businesses that are still tied into the ability of people to make more money and get wealthier, that’s where they’re gonna spend their capital – on, consumer names, healthcare names and tech names. Healthcare names over the next three to five year pull ought to be a beautiful place to be. Tech will be a great place to be, and of course, really high-quality consumer names, they’re still going to lead going forward. I’d much rather make that investment bet on those names, versus buying European banks or a lot of mining companies or industrial companies going forward.

MS: Paul, we’ve talked about this a lot over the journey so far; the turnover in the portfolio has always been low, does that change at all through this current period of volatility?

PB: I think you’ll see a little uptake here. I actually had a call with the other portfolio managers from the strategy this morning, and was encouraging us to not just fiddle around the edges with the portfolio, meaning, let’s not just do 2 or 3% turnover and move from defensive names to more secular growth names that have long-term tail winds. Let’s be a little bit more aggressive than that and move maybe 7, 8 or 9 or 10% of the portfolio into those names that will really lead out. I would argue that directly, we’re probably looking at  around 22 or 23% turnover.

You might see a uptick because we want to take advantage of the opportunities that are presenting themselves in the market right now. I commiserate with anyone that’s on a fixed income and they’ve seen a drawdown in their portfolios across the board, but to anyone that has cash, it’s an incredible time to allocate. Remember we all know what Buffett says, “when people are fearful, be greedy”. And people are unbelievably fearful, unbelievably panicked. It’s a great time to allocate capital. It doesn’t feel good, but I would argue that it never feels good when it’s right. It feels good to buy the market when the markets top and out. That feels good, but that’s a disaster. It never feels good to make allocations of capital in markets like this. But fast forward 10 years, and you’re going to be handsomely rewarded.

MS: Paul, before we go,do you have any closing remarks you’d like to leave to our clients?

PB: I wish that I could have seen your clients, as we were scheduled to do, as I love going to Australia and I love being there. We will be down there soon and we will get to see everyone. But the main piece is, ‘panic crushes returns’.

If you had to guess right now, what Warren Buffett is doing with $130 billion of cash in his arsenal, what do you think he’s doing? Do you think he’s running for the hills and selling his stocks? No, I guarantee you, what we’re going to find in six months is that he probably put 60 to $70 billion of that cash to work. And it’s pretty simple when you’re not emotional about your money.

When you can step back and say, “look what’s rational, and what’s reasonable right now”, and what’s rational and reasonable is that you can buy companies for a 50% discount from what you could have bought them for a month ago. Inevitably, unless you think the world is ending, that’s a pretty good risk reward ratio.

MS: Paul, thanks for your time.

PB: Thank you, Marty. Wonderful to see you.

MS: Thank you. And thank you to all our trusted clients for making the time to listen to this webinar today during these challenging times.

We’re very grateful for all your support. Our team is accessible and we’ve got remote working arrangements taking place at the moment. But if you need anything at all, feel free to email your respective contacts or invest@contango.com.au or call us at on 1300 001 750.

We appreciate you support. Stay safe, and we’ll be communicating on a regular basis. Thank you very much. Have a great day.

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