During this live webinar, our Business Development Manager, Damian Casey spoke to WCM Investment Management’s Portfolio Manager, Jon Tringale to provide an update on the WCM Quality Global Growth Equity Strategy, the recent changes in the portfolio, and how this portfolio is designed to deliver long-term returns.

For more information on the WCM Quality Global Growth Equity Strategy, click here to learn more.

Transcript

Damian Casey (DC): Good morning and thank you for listening in to our update this morning with WCM. My name is Damian Casey. I’m the Southern Distribution manager for Contango Asset Management, and also your host for today. Before we begin, there’s a few housekeeping messages as well as a message from our compliance team.

Firstly, this is a live and interactive session, and we’d love to hear from you. If you have a question and you’d like us to address it, please submit this via the questions box in the control panel on your screen. We’ll endeavour to get to these questions at the end of our session. Please also be aware that this session is being recorded.

Secondly, this webinar is for educational purposes and of a general nature only. It does not constitute personal advice. It must not be acted on or relied on. This webinar is not an offer, recommendation, or solicitation.

Today I have the pleasure of speaking to Jon Tringale, Portfolio manager at WCM. Good morning, Jon, thank you for your time.

Jon Tringale (JT): Great to be here.

DC: Jon, we might kick off with a few questions today. The macroeconomic environment, of course, has been a significant headwind for the strategy here today. We know that macro analysis isn’t a focus for your team, but can you share with us what you’re hearing from your companies that you are currently invested in around the global economy, inflation, et cetera?

JT: There’s a lot of different directions we can go with that. I would say for the most part within our portfolio companies, they’ve been able to navigate this environment quite well, even though the stock performance has been really challenged, given the growth value rotation, given inflation, and the Fed, and what that’s meant for, different factors that have worked and not worked this year. It’s been really challenging, but talking to companies and also seeing the results, we’ve had now three quarters of earnings releases and guidance, and through those first three quarters of the year, we’ve had, about 90% of the portfolio that has continued to meet or beat earnings expectations. More importantly, maintain or even raise forward guidance. So, again, that’s about 90% of the portfolio, so it’s hard to paint in two broad of brushes what different companies are seeing.

You know, certainly some of the businesses that are more exposed to housing, say, like a floor and decor. Talking to them, it’s a little more challenging with where mortgage rates are going, so their expectations are a little bit more muted in the short term. Some of our semiconductor exposure, talking to those companies, they continue to be extremely bullish on long-term growth, but there’s been a lot of noise around overstocking and the channels and the typical fits and starts, and little mini cycles you have with inventory builds and semis, but the bigger picture narrative is one of expansion and more semi content involved in more of our life and more of business. So, I think overall we’ve been pretty pleased with what we’re hearing from companies in their end markets. Again, with the exception of a couple of pockets of weakness like the housing sector that’s been hit particularly hard, given what rates are doing here.

DC: Looking at your recent performance. Can you take us through what your attribution analysis is saying in terms of the sectors and individual stocks?

JT: Yeah, I don’t think that this will surprise anyone who’s followed the markets this year, but there’s really been, almost nowhere to hide. Whether you’re talking equities or bonds, and when you look at our portfolio and our growth bias that has led us to consistently have overweights in sectors like technology and healthcare where you tend to have more innovation, more long-term structural growth, and that’s been very much out of favour this year, and really the one place to hide, the one place that has worked this year is energy, which has been up more than 25% year to date, and you have pretty much every other sector down to varying degrees. So, the attribution analysis reveals that our overweights to tech and healthcare has hurt us pretty substantially, and then also even more significantly, not owning any energy companies has been a massive headwind to performance, given that has led the market in a massively outsized way, and then when you look at individual stock contributors and detractors, per my previous comments, there’s been a fair amount of detraction within our semiconductor exposure.

Names like Integris and Lam Research, businesses that we think are positioned very well, are very dominant in growing niches of semiconductor manufacturing have been caught up in some of the shorter-term cycles that has had us. And then the one other area where thankfully we didn’t have much exposure because we sold most of it last year, but eCommerce, that has been an area of detraction where you’ve had, really I think the market certainly going back over a year ago was expecting the inflection and higher growth in eCommerce we saw during Covid to continue. And the narrative was that COVID has really forced the adoption of eCommerce amongst a broader audience of consumers. These habits are here to stay. eCommerce growth is just going to continue to accelerate. And what has actually, we’ve seen is eCommerce has gone x growth. You’ve had a pretty weak consumer contributing to that as well as more money being spent on travel and experiences and less money being spent online. So, the one holding that has really hurt worked against us there, which we no longer own is a Canadian company, Shopify. I would say eCommerce and semis have been at the individual stock level, the most challenging part of the market. On the plus side, there’s nothing really that’s been positive in absolute terms. Couple of our names we’ve added more recently like an LPL have actually done quite well, but there’s not a whole lot to call out in terms of star performers here to meet.

DC: What lessons, I suppose, if any, do you think the team has learned during this, this quite challenging longer period of time?

JT: That’s something we think about often. I’m sure we’ll look back and do a post-mortem on this period in a couple years and have maybe some more definitive conclusions. One thing we’ve been thinking a lot about the last really year and you’ve seen reflected in some of the recent trading activity is we’ve started to see unusually high correlations within our entire watch list and particularly within parts of our defensive growth exposure. As a quick reminder, some of those of you who may not be as familiar with us or may not remember, we really manage the portfolio to have a balance of exposure to different types of growth companies. So, we seek to have roughly 40% to 50% of the portfolio in more defensive growth businesses. These are companies with fortress balance sheets. They’re not growing extremely fast, they’re growing nice and steady, they have very little elasticity of demand in their end markets or said differently. They sell their products or services they sell what people are always going to need, think about basic healthcare testing, about basic consumer supplies, things like that. For those reasons, they tend to be safe havens and downturns.

We’ve seen in recent years with interest rates near zero, a lot of defensive growth names have traded in higher correlation and have gotten fairly expensive for that reason, we actually had lowered our exposure the last several years to defensive growth given that the price you were paying relative to the growth was not as attractive as we were seeing in other parts of the market. But what we’ve seen this year is very high correlations in the first quarter selloff and we’ve tried to use that selloff to diversify a bit, not compromise on growing competitive advantages or really well-aligned, strong, adaptable corporate cultures. Those are permission to play, but within that framework, we found defensive growth businesses with a variety of exposure to more diverse end markets. So, things like insurance brokerage, things like drug distribution here in the US even some really focused pharmaceutical companies. Within that defensive growth, we’ve tried to diversify because we’ve seen a pretty high correlation in the market and in the portfolio with a lot of those names trading in tandem. That’s been one of the big objectives in this market downturn is to pick off really high-quality businesses in terms of mode trajectory and corporate culture, but with a bit more diversification in terms of different business drivers and longer-term tailwinds that they’re going to drive business.

DC: You’re talking a lot about short-term performance, share a little bit of things that kind tabulate, you’re kind of looking at the twelve-month numbers, three-month numbers and so often. The long-term performance of this strategy, you can’t be matched, years plus, and you’ve had these times in the past. You’ve come through difficult times – can you tell us a bit and focus on the corporate culture part of the portfolio that’s a big part in your investment process and I suppose how it has helped you through difficult times in the past and also these difficult times this year?

JT: That’s a great question, Damian. We’ve been fortunate to do well for clients, over the long term for a long time now. But there have been some periods that have been really challenging. I think most recently, if you go back to the end of 2016, starting in August through the end of the year, you had a very similar market environment in terms of stylistically what was working and not working. You had that was leading up to and following Donald Trump’s election. He had a whole narrative around deregulating energy in the US, deregulating the financial sector trying to stimulate all the growth. And so again, different drivers than we’ve seen this year. But the end result, was you had energy up double digs, you had basic materials and commodities up strongly, you had financials up strongly. Every other sector was negative, value beat growth, high quality, lagged low quality by over a thousand basis points. In all those respects, very similar to this environment. When we underperform by roughly a thousand basis points in less than a year. We have been through these periods before, it’s inevitable that the market is going to have different styles that come in vogue from time to time.

Our playbook today is the same as our playbook was then, which is really number one, let’s use… Make upgrades to the portfolio, follow this portfolio you’ve observed, we’ve been much more active this year. That’s because we’re trying to upgrade the quality of the portfolio and take advantage of some of these price dislocations. Number two, focus on minimizing mistakes. This is where culture really comes in, and I know is the question Damian, we’re always going to make some mistakes, but how do we mitigate the number of and the severity of damages those mistakes caused to the portfolio? And again, as challenging as performance has been this year, we really haven’t had a lot of companies that have really missed the mark massively. Like I said, we’ve had over 90% of the portfolio that continues to meet or exceed expectations. So I think, but that’s really key when we’re out of favour from a style perspective from… And this is where, and I’ll come back to the culture element of that which is clinical and then the third piece of the playbook is let’s not underestimate the impact of one or two great new investment ideas in a concentrated portfolio like ours.

So, if you go back to ’16, that was a really tough period, fortunately, it was short-lived and we had a great run from 2017 really, through last year. We don’t know what the future holds this time, but we’re sticking to our knitting and really following the same game plan. Now as it relates to culture more specifically, we’re of the view as what will always matters for long-term business performance. People matter, how people are incentivized and energized around the strategic objectives of the business is critical to long-term performance but tends to get ignored because it’s hard to quantify. It’s always important. We would argue that it’s more important right now than ever before because companies are facing a very dynamic environment. You have not only a lot of people working from home companies trying to navigate how to handle coming back from COVID. You have very changing dynamics in terms of how companies engage with customers, with more digitalization, different distribution tactics and so on.

The other curve ball that’s very important right now, especially within technology is you have a lot of companies, especially to us that have really tried to attract and retain top software engineers a talent pool that there’s a massive shortage of. They’ve attracted folks by offering stock options or equity grants. Now with the massive full market, a lot of those options are underwater and worthless, which leads you to the question of how are companies going to retain talent? And a lot of businesses we’ve seen that have grown up in this era of easy money, free money hasn’t really had to bother too much with how they’re actually going to turn a profit. It’s just been the mantra of try and get market share at any cost. We’re starting to see a lot of those companies struggle to retain talent.

So, bringing it full circle, one of the things on our playbook on this year is what are some companies that are in the position to go on offense and poach some top talent from companies, for some of the reasons I mentioned aren’t in a position to do so. One holding we have for example Snowflake, which is really in the data cloud space. Frank Slootman and his lieutenant, have a lot of connections at various start-ups and companies. They’ve been out there, just pound your statement, trying to recruit and bring in top people and doing it quite successfully from a position of strength as a company that’s very profitable, that’s growing very rapidly, has the cash flow and market presence and liquidity to be able to be more attractive for a lot of engineers than even previously. We’re really trying to understand, and that’s specific to software, but we’re really for each industry trying to understand how are things changing in this industry. Which companies are operating from a position of strength from their culture, who has really good engagement, and who’s making the right moves? I think this period is going to be a tremendous litmus test for really how strong and adaptable a lot of these organizations are. There have been some businesses candidly that we’ve lost some conviction in that culture and some of those are ones we’ve sold this year. And on the flip side there is some of businesses where we have a lot of conviction that they’re doing all the right things to set for the next three or five years.

DC: Yeah, and look it’s been a pretty busy year for kind of movements in the portfolio, especially the last quarter. The portfolios have a lot of changes again, can you maybe mention a few of the stocks you have added the portfolio and I suppose how they fit the other part of your investment process being expanding more, typology with that?

JT: I’m going to break this down into two categories as I hint to that building out that defensive growth exposure, selective, very selective. I’ll talk about some of those. And then we’ve also added some faster-growing more disruptive businesses. Within defensive growth, a few different examples there. One we bought more recently is a Canadian company called Waste Connections. Now, this is a business that’s in the pretty mundane sounding business of collecting garbage and disposing it at landfills, which of course is a service that all residential and commercial areas need. They have a pretty unique strategy. They’re the third-largest player in North America. They only focus on second-tier and below markets where they either can have a monopoly position or at maximum compete with one other company. They also only operate in territories where they’re fully vertically integrated, which means they not only have the contracts to collect the garbage, but they actually own the landfills. They have total control over price and the whole experience. Now again, it’s a pretty boring-sounding business, but it’s a business with incredible resiliency. We all need our trash to be taken care of. With that tremendous pricing power and given some of those competitive dynamics, they’ve been able to raise prices more than 5% a year. The last decade, it’s probably more likely to be 8%, 9%, looking out the next three years with no drop in demand. They have basically inflation clauses built into their contracts and that’s a business where we’re getting an attractive multiple that we can very comfortably underwrite the growth and cashflow for a long period of time in a very defensive fashion. That’s one we’ve bought in the recent selloff.

Within healthcare added a couple of names I think are worth mentioning. One of them would be a firm called McKesson, which is one of the three primary drug distributors in the United States. There’s only three players that control together about 95% of the market. They all have the buying scale, the relationships with pharmacies to really implement the really service the growing need for drug volumes as the population gets older. The core business, the model is very strong. With us, we need to make the case that mode is actually getting stronger. And in the case of McKesson, they’ve been moving into beyond just selling drugs, selling more surgical equipment and medical devices. And those business lines are literally 6, 7, 8 times more profitable. The contribution to cash flow and earnings as they’re growing their presence within surgical equipment and medical devices is extremely powerful and we don’t think at all reflected in the current stock price. And they’re gaining a lot of share in that more attractive segment of the market. So again, very different exposure than Waste Connections.

Another defensive growth name is Arthur J. Gallagher, which has a lot of business in Australia. You may be familiar with them. They’re one of the leading players in commercial insurance brokerage. They’re not underwriting any policies, but they’re connecting or get companies with insurance providers and it’s a very sticky essential business. Everyone needs insurance. In the case of Arthur J. Gallagher, over the last 50 years, there’s only been one year that they haven’t grown revenues and that year was I think a 2% or 3% decline. We’re seeing a hardening of the insurance and markets inflation is causing protection for those assets to also go up. You have a very oligopolistic market structure. You’ve got AON and Marsh Mclennan controlling the top and then you have Arthur J. Gallagher kind of in this middle market position that they dominate where they have a bit more pricing power because the customers don’t have the same scale. The other angle to growing their competitive advantage has been through acquisitions. They’ve done about 500 acquisitions in the last 10 years and they continue to roll up and consolidate the middle market brokers. They have a culture and a playbook for integration in terms of what makes them the most desirable suitor in the industry by far. And again, they’ve got a very successful track record of integrating and growing these tuck-in businesses. So, the future is very bright for them. Again, a business we’re able to add at a teen’s multiple that we think can have double-digit earnings growth in a very defensive fashion for a long period of time.

The last one I’ll mention, in that defensive growth bucket is Novo Nordisk, which is a business we have owned in the past. We sold it a few years ago when the reimbursement landscape in the US got more difficult. Some things have changed there. and this is a company that is laser-focused on diabetes and metabolic diseases who competes against primarily very large pharma companies that maybe have diabetes as a division, but they don’t wake up every morning trying to own that market, trying to come up with new innovations to improve the lives of diabetics like Novo does. All their R&D is internal, they’ve got an innovation machine and team of researchers that’s simply unrivalled in what they do. Unfortunately, or fortunately for them, the global incidence of diabetes continues to grow, 10% a year or so. They have by far the best product portfolio to really monetise that and capitalise on that for a long period of time.

So, those are some examples of some defensive growth businesses we’ve added that we think are set up for any environment. But we would expect to do especially, well frankly, if we see the global economy, we can even further, these are businesses that should be extremely resilient in that type of an environment. Now on the other side, we also want to own businesses that are going to really participate when we see growth come back and when you see more optimism. And so, our secular growth portion of the portfolio we’ve also added to steadily throughout the year as it’s been under pressure. But a couple of names worth highlighting there.

One of them you note down under a company Atlassian, which we’ve had our eye on for quite some time and we’ve seen some very significant weakness in the shares over the last 12 months, so we just recently added to that one. They’re of course best known for Jira, which is really unique in terms of the collaboration tool for software developers and others. But there’s a ton of latent pricing power that they probably charge on average maybe 4 or 6 dollars a year per user and add tremendous value. They’ve got a very innovative collaborative culture and that’s one, as they’ve gone through their cloud computing migration have set up better for cross sales of some of the other products they’ve bought and developed internally. So, a lot of room for them to grow their footprint we think. And one that’s should do really, really well, when growth comes back. And then the last one I’ll mention from secular growth because I know we’re running out of time here is Amazon, which we own for about 10 years, sold it in favour of Shopify a number of years ago and have come back to it with the recent selloff. We feel like they’re positioning in cloud computing and also digital advertising dollars with on the search now as well as some latent pricing power in Prime are set up very, very well.

DC: Thanks, Jon. We’ve actually run out of time, but I just want to say thank you again, Jon, for the update. It’s been really informative for us. Please, if you have any other further questions, please reach out to your local distribution representative. You can find us on our Contango Asset Management website or calling 1300 001 750. Thank you all and have a lovely rest of your day.

JT: Thanks.