Hello and welcome. My name is Simon Gregory and joining me in the studio today Habib Subjally, Head of Global Equities at RBC and Senior Portfolio Manager on Habib's Team, Jeremy Richardson. Gents, I'm going to get all philosophical on you in this session, or in fact, more importantly, you're going to get all philosophical on me, because, a critical part of Portfolio Management is having a clear philosophy. Understanding what that is, understanding what it tells you, what it doesn't tell you, and then ultimately, putting that into practice by your Portfolios. So, Habib, Team Head, Architect of the Team, Architect of the Philosophy as well. Could you maybe, just, tell us what the Philosophy of the Team is, and how you arrive to that? Why do you think this is the right philosophy for our clients?
Well, our philosophy's very simple, to invest in great businesses at attractive valuations. And by great businesses I don't mean the kind of stocks that do well for, you know, a quarter or two. I'm talking about businesses that generate wealth, that do something different, that create a huge amount of value for their customers and for their owners, as shareholders, and as a consequence, also for their employees, and their suppliers and their communities. Great businesses, if you look at these things overtime over history, had been immense wealth creators for, you know, not just for their owners, but for all these other stakeholders as well.
At the risk of sounding controversial or obvious, wouldn't everybody want to invest in a great business at attractive valuation?
Yes, but identifying what those great businesses are is one thing, but, the other thing is, some of the... they are... the market is a large and complex place and there's so many different investment strategies out there. You know, there are high-frequency traders who, by all accounts seem to make a very good living by owning stocks for seconds or even fractions of a second. And, you know, all the way from that to our kind of buy and hold great wealth great businesses and there's a whole range in-between. So, clearly different investors have different philosophies, and seek to add value in different ways.
What really led you to this? What was this kind of thinking behind this?
Oh, I guess this goes back to probably my days as an accountant. So, I'm a charge accountant in the early days, when I left university, when I was training as an accountant I would go off on audit on every 2-3 weeks. I would be in a different business, in a different industry often. And you kind of start getting a feel for it, within the first few hours you'd get a sense of yeah, for the first few minutes you walk in and you'd say, you know: "Wow! This is a really nice office. Or My God! This office is a bit of a dump." And, you know, you had a whole range in-between. And you have here, the great chef prepared lunches and, and a factory canteen.
But, within a few hours you'd figured out whether this was a really great business, whether the people worked as a team, whether they cared, whether they took ownership of what is going on, they knew what is going on while they care about their customers and about their roles within the organization. And others will run like bureaucracies and you know, and so and so was, you know, the accounts payable person was away, no one else knew and no one else wanted to know, so well, you had to wait till he gets back. And that sort of attitude, you realize very quickly that some businesses were just better on than others.
So, I was also an accountant and the things I've seen when I was going out on audit week after week, is that one of the measures you can use as an auditor to determine whether or not the business considers and looks after its employees is the quality of the coffee. (Laugh). Cause if you turn up at the coffee machine and it's terrible terrible coffee, you know that actually the labor force there is regarded very much as a factor of production, rather than as an asset. There was one frozen food manufacturer I had to go and see, and this was up in Glasgow. And I got a bit lost on lunchtime and ended up in the dining hall, and I had a very indifferent meal, there I am sitting in my shirt and tie and suits in there... this is in a sort of frozen food factory.
The next day, I got tapped on the shoulder by one of the directors and I'm told that I'd made a mistake, I had myself in the wrong place. I'd just gone to the dining hall like everybody else. The director that told me that, told me that there was a director's dining room, which I was invited to go to, and so I went along to the director's dining room and there I was served at the table, by one of the members of the staff, a chef-prepared meal in a separate dining, completely separately from the rest of the workforce. And even that was criticized by the guy at the end of the table, who happened to be in quality control. (Laugh). So, very different attitudes, very different attitudes.
It seemed like you both enjoy being out on the audits trail, I can see why you entered the world of fund management.
But you know, it sound like, the thing that I sort of took away from that is that there may be a number of businesses in the same industry, their offices may look the same, their factories might look the same, they might employ similar people, but, the difference that the culture makes, the attitudes of the employees, the willingness to go that extra mile, the willingness to cover for each other, that, I noticed was the difference between really good businesses and poorly performing businesses. Even the profits might be similar.
As an accountant there you're not there to audit those sorts of things, are you?
Sure. Oh, absolutely not, but you can't help but notice these things. So, when I became an analyst here, a junior analyst in the investment industry. Again, our job was to build earnings models, and your inputs the earnings models are, you know, just all financial inputs and we're talking about numbers and I couldn't help thinking what really drives the value creation of a business is the quality of their people, the motivation of their people, the choice of their business model, and how effectively they look after their customers, their employees, their suppliers, their communities, their regulators. This is what determines long-term financial performance.
Even though it might cost money in the short-term to support all of these different stakeholders. So, I started to sort of building that into my earnings models and that's kind of where the philosophy came from. The issue is when you build those things that your earnings models, those sort of factors, it takes a long time to play out in the financial numbers. So, you have to be patient. And, you know, you can see how the philosophy has evolved overtime.
So, great businesses, at attracted valuations, how do you make sure, in a previous session we spoke the team and the qualities that the team brings, how do you make sure that the team, one, understands what the philosophy is, and then sticks to that and then bodies it in everything they do?
Well, the philosophy was not just developed by me in isolation, the entire team worked together to articulate the philosophy. Everyone challenged it and we've refined it. So, the philosophy is completely, you know, everyone on the team buys into this, it's our philosophy, it's not my philosophy. Everyone owns the philosophy. And that philosophy then, translates into a process. How we go about looking for these great businesses. Now, the process is a common process, but the way it's applied to each industry and each company is obviously unique. And that is the toolkit that we give to our investors on the team to go and apply it in each individual situation. Maybe Jeremy can talk a bit more about this.
Yes, Habib I think is absolutely right. There is a collective ownership of the investment philosophy. And we've all had the opportunity over the years, in the 12 years that we've been working together, to contribute to how the philosophy's expressed itself. Let's not forget things like great businesses and industry in general, it's a dynamic assessment, right? Nothing stays the same. So, there's always going to be change and what makes a great business is going to evolve as industries evolve. So you just have to look at what's going on in the world around us, with things like music streaming for example or electronic payments and renewable energy, electric cars, gene therapy, these are all things that are being sort of, you know, probably were not part of the public debate, you know, when we started 12 years ago, they're industries which have come up and actually what makes a winning business model within these new industries is going to change, as these industries evolve.
So, what we are trying to do is identify what these great businesses are, we are humble in the face of new information, we are humble in the face of data but we're trying to identify these businesses we should have got something special about them. Something that is unique, that is different and enables them to prevail against their competitors. And as Habib was just saying, it could be down to employees, yeah, it could be, you know, you got better coffee and were able to retain and keep better people for longer. It could be to understand R&D and Innovation. What it will be will be something that enables that business to win.
nd ultimately, clearly, you're be judged on your investment results, but how do you test the efficacy of the philosophy and how do you make sure that it is still relevant?
Well, data, I guess, data, I mean, so...
You could have just got lucky for the last 12 years.
So, I think we have to separate. So, this is why we talk about great companies and attracted valuations, I think we need to separate great company and the, you know, the valuation, the value of the stock if you like. Because, what makes a great company is a fundamental assessment and we know in the long run, it is the performance of companies which drives the majority by far and away the majority of the wealth creation that you see as an onus, not the market necessarily, it is the cashflows that a company is generating and that determines, it defines the amounts of shareholder value that gets created over the very long term.
What the market's prepared to pay for that at any particular point in time can change. And, so, when we think about ourselves, about the efficacy of the investment philosophy, we need to separate it into two parts. Have we been, is our understanding what makes a winning business by industry correct? Have we made mistakes? Is our understanding of what the industry is like today out of date? Has it evolved? Has it changed? Do we need to go back and address that? And that's almost if you like a quantitative assessment, it's a question of reality. What the market is prepared to pay for that investment opportunity is off the subject of fashion. You have greed, you have fear in markets. And the price of money can change. So, there is an open flow of what the market is, is a view opinion of a particular company is going to be at any particular point in time.
And that can create opportunities. So, as investors, if you find a wonderful company, a terrific business that is undervalued because there is too much fear, then, yeah, we'd like nothing more, because we know that's going to change. Our challenge is being disciplined, in that if you, even a wonderful business can be overvalued. And experience has thought us that if you fond something like that, then, actually it's very dangerous, because all you're doing is you're putting your investors and capital at risk.
And, do you think it's... it's enough to have a clear philosophy now, do you think perhaps you might need some broader sense of purpose, as a team of investors?
I think a sense of purpose is very important, you know, you have to know why you're doing what you're doing and that sort of drives, that drives everything, I think that sense of purpose even transcends your philosophy. What is your motivation? Why are you doing this? Why do you go that extra mile? I think that's critical to motivate people, because what we do is, investing is not a 9 to 5 job, it's something that you're sort of thinking about all the time, every time you go to the supermarket, every time you walk through you know, a shop, you go, walk through an airport, you know, you're sort of constantly sort of observing and taking these things and evaluating things, and this does require that sort of, it's a slightly obsessive profession. Why are we obsessive? Because there is a sense of purpose: we believe in what we're doing and why we're doing it.
I think that's kind of on the point, I think that there's a consistency isn't there, between that understanding about what it is that we're trying to do, essentially trying to make a positive difference for our clients, typically by reducing the opportunity cost of saving to make some sort of future financial liability. And by doing that we're trying to give our clients an improvement somehow, you know, it could be quality of life, it could be, sort of, a real financial gain.
And that is something that transpires overtime, typically over a long time. And I said before that, it is the company results that drive SharePoint performance overtime. We have a marriage there between the purpose of what we're trying to do on behalf of our clients, and how we're trying to achieve that in terms of the types businesses that we're investing in. It would not make sense for us to be high-frequency traders with that type of long-term purpose. Similarly, you know, Habib, to your point about, you know, about customers and staff and workforces, if you were trying to, you know, to come back to your point of when you were talking about when you were an accountant, if you were, you identified a company that was not paying attention to the satisfaction of this workforce, employment engagement is very very low.
You wouldn't think that was a very sustainable business in the long run.
You'd lose your best employees and then, you know, your business would be much worse. But, you know, Simon, coming back to a sense of purpose, I think this is key, we have, must always remember, what we're doing is, all our investors have entrusted us with their capital, and our task is to grow that capital as, within a controlled risk framework, you know, this is risk adjusted returns that we're trying to generate, so that when it comes, when our investors need to deploy that capital into consumption, that there's more for them so they consume more, whether that is to pay for someone's retirement or that's to pay for some research to cure cancer or whatever that purpose might be.
That, remembering that is a big motivator and it does keep what we do very real. Otherwise, you know, I know so many people just sit in their office and look at their screen and it's like a computer game.
So you feel a very acute sense of responsibility in that respect.
Absolutely, and I think we have to, that informs the way we invest.
So, looking at philosophy perhaps more, in the most of purer sense, philosophy is frequently talked about in, one, one you can't prove or disprove it. Two, it defines your, your preferred risk sources, and three, frequently, philosophy is described as the market inefficiency that you are looking to exploit. And it can mean different things to different people. How do you like to see philosophy? What does it mean for you?
You know, I think all of those things, so, philosophy defines what we're trying to do. And let's face it, in markets, in business, there's no return without taking risk. So it does determine which risk we take. And see if we want to take the risk of investing in great businesses at attractive valuations, because if we do that, you know, we will make mistakes, not all great businesses will generate a lot of wealth and so on, but, more than half, more than average will produce a lot of wealth. That is a successful strategy. So, that is the risk that we want to take. Now, there are huge implementation issues around that. We don't want to take the risk of betting on oil prices. I have no idea whether oil prices are going up from here or down.
I don't want to take the risk of betting on the Japanese Yen, again, I have no idea which direction that's moving in. You know, or certainly, I may be able to have a reasonably educated view, but I don't think I have particular insights, more than many other market participants. There are other people who know more about this than me. So, I don't want to take that risk, because they will have me on that. I only want to take the risk that I think we are, we have spent all of our time and effort and energy on, which is to identify those great businesses at attractive valuations. So, that is great in theory, but how do we achieve that in practice?
Because every business that you invest in, you know, when you put, take your best ideas and collect them into a portfolio, you end up with lumps and bumps and you have concentrations by country, by size, you may have concentrations that a lot of businesses benefit from a rising U.S Dollar or stickning yield curve. These are things that we don't know about. This is why we do need a different set of expertise on the team. This risk management expertise to help us identify these unintended risks. Cause when you go from taking a group of stock and turn them into a portfolio, there are lots of other things that need to be considered.
So, we won't be seeing a macro Hedge Funds anytime soon...
Stick to what we know.
Yeah, yeah. Yeah, And it's one thing intending to stick to what you know, but it's another thing actually, looking at all those things that, that you're not focused on.
How do you release that, for want of a better phrase, I mean how do you make sure that day in day out, everybody's sticking to it?
So, this is a matter of having a balanced team. It is a matter of, we have three people on that team who are risk and portfolio construction experts that have, I mean these are, I would say rocket scientists in their own right, and they've developed a framework, over the years, you know, a propriety framework to analyze our portfolios on a sort of daily basis, real-time basis to see what risks make up the portfolio. And, so we know the risks that we want to take investing these great businesses at attractive valuations. That's a risk we actually want to take more of. But they are policing and measuring and monitoring all these other risks that can build up in a portfolio, bring that to our attention and providing us with solutions, to manage and mitigate those risks.
So that we, I guess that we end up staying closer to the philosophy, right?
Absolutely. So, that, when you look at the risk of the portfolio, the vast majority of the risk of the portfolio is focused on what we intend to do, that's invest in those great businesses at attractive valuations, and that all those other kind of peripheral risks, that do creep in are relatively small and well-controlled.
It's certainly a very tricky subject and sometimes quite hard to articulate, so I certainly appreciate your comments and your thoughts on the philosophy of your team, so... thank you very much.