Global Equity Observer

Quality is worth the wait

INVESTMENT INSIGHT | INTERNATIONAL EQUITY TEAM | March 2024

Milestones and anniversaries offer the chance

AUTHOR

for reflection. My deeply held belief, shaped

by some of the world’s great investors, is that WILLIAM LOCK
Managing Director
managing active equities with a focus on high
quality remains critical to compounding capital
over the long term for clients.

10 lessons learned from 30 years of investing “I believe the

1. PICK GREAT BUSINESSES AND GET OUT OF THE WAY OF THE LONG-TERM COMPOUNDING
I believe our understanding of what constitutes a high quality company and secret to
our determination to maintain a high quality bar for our portfolios is what sets
us apart, combined with our long-term perspective. We seek well-managed
longevity in this
companies which can grow at long-term sustainably high returns on operating business is to
capital with low volatility of operating profits, pricing power and limited
leverage. Identifying companies with these characteristics is very important, remain curious,
to keep learning
but just as important is giving these natural long-term compounders time to
compound. We don’t rent businesses, we own them for the long term.

2. YOU WIN TWICE WITH HIGH QUALITY EQUITIES and to continue

Avoiding the permanent destruction of capital is arguably just as important
for investors as the chance to make money. I like to say you win twice by
to ask the right
investing in our high quality equity approach: you win by sticking with winning questions.”
businesses that compound in a superior way over the long term and you win
again by losing less in sustained market downturns. Winning twice drives good
long-term absolute returns.

3. THINK ABSOLUTE, NOT RELATIVE

A focus on risk is important, but I would argue that the industry is too focused
on relative risk. We focus on absolute risk—the chance of losing money on an
investment—not risks relative to a benchmark. We concentrate on seeking to
understand any financially material franchise, regulatory, management, ESG
(environmental, social and governance), and valuation risks associated with
our businesses. We believe that thinking in absolute terms to capture 80% of the upside and only lose 50% on the
means we are more likely to pick long-term winners and, just way down than to achieve 100% on the way up and lose
as importantly, avoid the losers. everything (and possibly more!) on the way down. Whilst
steady compounding may be less exciting than the latest
4. WHAT YOU DON’T OWN IS JUST AS IMPORTANT AS WHAT
YOU DO OWN trend, I believe this steadiness through thick and thin makes
Certain sectors or industries don’t make the grade for our high for an attractive core allocation for investors’ portfolios.
quality portfolios, for example, banks, utilities, real estate and You also get to sleep better compared to some of the wilder
energy. For nearly three decades, our skew to higher quality alternative rides in the market.
stocks in higher quality industries has provided clients with 8. REMAIN CURIOUS
attractive long-term returns and resilience through the cycle. Markets have provided an ever more interesting
5. VALUATION MATTERS environment in which to seek to compound our clients’
We’re not just fussy on quality, we’re also fussy on price— capital. I believe the secret to longevity in this business is
call this being double fussy—which has driven our long-term to remain curious, to keep learning and to continue to ask
returns and the shape of those returns. As the late Charlie the right questions. I’ve learned to encourage my team to
Munger pointed out, there is no great company that cannot question everything and everyone, including me(!), and
become a lousy investment if you pay too much for it. We foster a culture that rewards curiosity. We are lucky enough
seek to buy and own companies at or below a conservative to work in one of the most interesting industries out there.
estimate of their long-term intrinsic value. Valuation If markets bore you, then it’s probably your problem rather
discipline matters, and we focus on free cash flows rather than that of the market! Seek always to kindle this curiosity
than earnings, because cash is real. Even if something is too by surrounding yourself with clever, interesting people who
expensive now, experience has taught me that most things also love what they do.
you want to own come your way eventually. Be patient. 9. STAY RELEVANT

6. ENGAGE AND TRUST YOUR INSTINCTS WITH MANAGEMENT It was Gertrude Stein who said, “Money is always there
We engage with management to understand if they share but the pockets change; it is not in the same pockets after
our same long-term perspective in how they run the a change.” What we look for has never changed over 30
company, and if they allocate cash accordingly. We want years—we buy businesses which can grow at sustainably high
to know if they grow or milk long-term intangibles such as long-term returns on unlevered operating capital and at low
research and development and branding/digital marketing. volatility of unlevered operating profit. However, just as the
Are they able to innovate and grow sustainably? How well world constantly changes, so where we find such businesses
do they allocate capital? Many pay plans incentivise short- has changed over the years. Sometimes rivers cease to flow
term outcomes which get management paid but could have under historic toll bridges, instead diverting to other bridges.
damaging outcomes for long-term compounding. We aim Be aware of this and recognise the need to stay relevant
to be aware of what behaviour is incentivised and whether without giving up your basic principles and discipline.
management will act on these incentives, and we try to 10. QUALITY IS WORTH THE WAIT
encourage change in pay plans we don’t like. I agree with Charlie Munger that “the big money is not in the
7. HIGH QUALITY ASYMMETRIC PORTFOLIOS SERVE INVESTORS buying or the selling, but in the waiting.” Our investment
WELL AS A CORE ALLOCATION approach focuses on identifying high quality companies that
Investment strategies which can compound over time can compound. The art, as we have learned, is being patient
with a high quality asymmetric profile can reap stronger enough to allow them the time to do so. Be the tenacious
and steadier rewards over time; for example, it is better tortoise in a drove of hype-driven hares.1

1
Aesop’s Fable: a race between a tortoise and a hare. The hare is so confident of winning it stops during the race and falls asleep. The tortoise continues to
move slowly and ends up winning the race.

2 QUALIT Y IS WORTH THE WAIT | MARCH 2024

Risk Considerations
There is no assurance that a portfolio will achieve its investment objective. Portfolios are subject to market risk, which is the possibility
that the market value of securities owned by the portfolio will decline. Market values can change daily due to economic and other events
(e.g. natural disasters, health crises, terrorism, conflicts and social unrest) that affect markets, countries, companies or governments. It is
difficult to predict the timing, duration, and potential adverse effects (e.g. portfolio liquidity) of events. Accordingly, you can lose money
investing in this strategy. Please be aware that this strategy may be subject to certain additional risks. Changes in the worldwide economy,
consumer spending, competition, demographics and consumer preferences, government regulation and economic conditions may adversely
affect global franchise companies and may negatively impact the strategy to a greater extent than if the strategy’s assets were invested in
a wider variety of companies. In general, equity securities’ values also fluctuate in response to activities specific to a company. Investments
in foreign markets entail special risks such as currency, political, economic, and market risks. Stocks of small- and mid-capitalisation
companies carry special risks, such as limited product lines, markets and financial resources, and greater market volatility than securities of
larger, more established companies. The risks of investing in emerging market countries are greater than risks associated with investments
in foreign developed markets. Derivative instruments may disproportionately increase losses and have a significant impact on performance.
They also may be subject to counterparty, liquidity, valuation, correlation and market risks. Illiquid securities may be more difficult to sell
and value than publicly traded securities (liquidity risk). Non-diversified portfolios often invest in a more limited number of issuers. As such,
changes in the financial condition or market value of a single issuer may cause greater volatility. ESG strategies that incorporate impact
investing and/or Environmental, Social and Governance (ESG) factors could result in relative investment performance deviating from other
strategies or broad market benchmarks, depending on whether such sectors or investments are in or out of favor in the market. As a result,
there is no assurance ESG strategies could result in more favorable investment performance.

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MARCH 2024 | QUALIT Y IS WORTH THE WAIT 3

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