As champions for active investment, we felt that it was useful to talk to some of the things critical to good active investing. Of course the definition is wide, and active managers can generate alpha across a number of dimensions, we feel that the following three foundations are an absolute necessity.
1. Every investment strategy needs a core philosophy
Our central belief is that the economics of a business drive the long term shareholder returns. Naturally then, we are growth investors as we are looking for companies that are expanding their economic footprint, organically, through time. We are not looking for mature businesses, businesses who are growing by acquisition, or businesses that are growing earnings by taking costs out of their business. We are looking for capital efficient businesses, not those who grow their economic footprint through optimizing their capital structure. By investing in high quality, growth businesses, that have the ability to generate predictable, above average economic returns we expect to generate superior investment performance in the long term.
2. Repeat-ability of performance requires a well defined investment process
As a high conviction manager, Asset Selection is where we spend the majority of our time. The reason that this part of the process is so important is that it is here, and here only, that we are able to minimize the risk of permanent capital loss.
When we research a company, we are looking for the best businesses we can find. We define this as those businesses which are growing organically, have predictable earnings, and a sustainable competitive advantage(s) that allows them to grow their economic footprint effectively through time. It is for these reasons that you rarely will see us invest in project based businesses such as mining exploration, or biotechnology. It is pretty difficult for us to say, with confidence, that these businesses will be in the portfolio in five years time, or be solvent in ten. We are looking for small businesses that can grow into big businesses, with a high degree of certainty.
Portfolio construction is the process of packaging up theses businesses in a way that maximizes our internal rate of return on a portfolio level, subject to a number of constraints. The reason we do this is because not all investments are created equal. There a mix of different companies in the portfolio, some are earlier in their growth phase, some have recurring income, others rely more heavily on outside financing to generate economic returns. Each of these characteristics adds an embedded risk to our forecasts, and the job of portfolio construction is to take those risks into account, so that we allocate capital across the economic reality of those investments, normalizing for the differences across the portfolio. In doing this, we maximize our exposure to our intended ideas, and minimize our exposure to unintended ones.
3. Managers should be able to articulate where they look for return, and how successful they were are actually finding it
While important to generate excess returns, we believe it is critical t to show how those returns have been delivered through time. Our strategy boils down to investing in really good companies, at the right price, for a long time. We should therefore be able to show that stock selection is where we take the majority of our risk, as well as being able to prove that we get paid for taking those risk through time. It’s no good saying that we are stock pickers, and currency, sector or volatility is driving our returns.
We are believers in active management. Now more than ever, we feel it is appropriate to allocate capital to ideas with conviction. If you agree with this, and want to talk to us further about it, please reach out, we’d love to have a conversation.
The article has been prepared by ECP Asset Management Pty Ltd (ECP). ECP is a funds management firm based in Sydney, Australia. For further information, visit www.ecpam.com. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for financial advice. ECP and the analyst own shares in IDP Education. ABN 26 158 827 582, AFSL 421704, CAR 44198.
