First Trust ROI Podcast
On the ROI podcast, we discuss some of the most important questions facing investment professionals today, ranging from macroeconomic views, to perspectives on the equity and fixed income markets, to insights on practice management. We aim to cut through the noise, examine the data, and provide fresh insights to investment professionals as they help their clients find better ways to invest…seeking to generate attractive returns on their investments.
First Trust ROI Podcast
Ep 36 | Paul Black and Mike Trigg | Why Culture Matters When Seeking to “Defy the Fade” for International Equities | ROI Podcast
Paul Black and Mike Trigg are portfolio managers and co-CEOs at WCM Investment Management. They join the podcast to discuss WCM’s unique path to becoming a leading global equity manager, highlighting WCM’s unconventional approach for identifying investment opportunities, including why a company’s culture matters and the important of economic moat trajectory.
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Hi, welcome to this episode of the First Trust ROI podcast. I'm Ryan Isakainen, etf strategist at First Trust. For today's episode, I'm joined by Paul Black, co-ceo of WCM Investment Management, as well as Mike Trigg, the other co-CEO at WCM. I'm looking forward to this conversation very much. Wcm actually sub-advises a couple of ETFs and a mutual fund for First Trust. First Trust distributes some of their mutual funds as well, but we're going to dig into what makes WCM unique. We're going to talk all about culture and how you can utilize that in screening companies and finding those diamonds in the rough in the international equity markets. Thanks for joining us on this episode of the First Trust ROI Podcast. Paul Black, mike Trigg I'm glad you guys were able to join us and I'm especially glad we were able to make this work because I live in New York. It's cold and it's beautiful here in Laguna Beach. I don't know how you picked such a beautiful place, but anytime I get a chance to come out here, it's amazing, so thanks for having us.
Paul:Nice to have you here, Ryan, and it's very intentional. I'm sure we'll get into it later in the discussion very intentional.
Ryan:I'm sure we'll get into it later in the discussion. So I'm intrigued by WCM, partly because you guys have had really outstanding growth, and that kind of growth is pretty amazing in itself. But what's really really surprising is that you're an active manager, and that's during a time when active managers just were hemorrhaging money, assets dropping for net outflows for most managers, and you're known for investing internationally and, as you know, international benchmark ETFs, as well as many international investments, have really lagged over that time period. So I guess my first question for you is what are you doing that's different, that has allowed you to get to the point where you are today?
Paul:Wow, there's a lot in that question. There's a lot in that question.
Ryan:We can break it down further as we go here.
Paul:Yeah from. You know, hey, internationals underperformed the US for something like 15 years. Active managers are, you know, going away. If you believe the passive guys, it's not true. And you know why have active managers underperformed? And it's all kind of tied up in this question of most active managers kind of do the same thing, expecting to get different results and I often joke about it.
Paul:You know every manager that will sit across from you when they tell you, kind of philosophically, what they're about, they will say, hey, we buy high quality businesses with strong competitive advantages selling at a discount to intrinsic value. I mean, you know, like 100 out of 100 managers will say that to you. And the truth of the matter is, if that's all you're doing, then you're not going to exceed the returns of the benchmark, because everybody else is doing that and there's a lot of smart people on Wall Street and a lot of smart people around the world competing using that same methodology. So all the inefficiencies are out of that methodology and you will never underperform if you're doing exactly what every other manager in the world is doing. So you know, through our journey, you said we're at $100 billion and we were at a billion dollars back in 2011. There's so much more to unpack in there because I often use this terminology that we right now look like that perfect family photo for the fireplace, where everyone's beautiful, the dog's beautiful, the kids are clean and nobody's fighting, and it looks perfect Moment in time.
Paul:Wcm $100 billion probably the best global growth strategies on the planet 100 people, 66 which own shares in the company and the reality is we look beautiful now, but we haven't always been beautiful and we've had a journey of learning what not to do by mistakes that we've made over the years.
Paul:So we have iterated very aggressively over the last 20 years to find inefficiencies in the market that we can exploit. That really, I know other managers are not exploiting and we'll dig into that more later but you have to do something different. We'll dig into that more later, but you have to do something different. The reason we've had meteoric growth is because we truly are doing something different from everybody else and, in terms of the benchmarks outside the US, underperforming the US, it's true, but there are pockets of gold outside the US. There are companies that you simply must own. In fact, those companies have performed outside the US far better than the broader benchmarks inside the US. So you've got to be very selective, You've got to be specific, You've got to do something very different from everybody else, and all those attributes from learning from failure to doing something different has really led to our success.
Ryan:So WCM, can you tell me a little bit what that stands for?
Mike:It stands for why Culture Matters.
Ryan:Okay, I want you to unpack that a little bit more, because I've had the opportunity to hear you folks at WCM speak on a couple different occasions and culture is one of the things that always comes out. That's something that you talk about a lot. First off, what does that actually mean? What is culture and why is it important as you evaluate investment opportunities?
Mike:Yeah, I mean culture to us is really a set of values or behaviors. It's how people act and behave. It's like, simply said, it's how people act when the boss isn't looking. And you know we learned that many, many years ago through our own trials and tribulations of writing an investor management firm, that the single most important thing we can do as leaders is focus on the culture of our company. As leaders is focused on the culture of our company. And from that there's a long story that actually predates me that Paul can go into.
Mike:But this firm has been through, as Paul said, a pretty long journey and there was a period of time when I don't think it had the best culture in the world or a culture that one can be really proud of.
Mike:And through a lot of hard work and iteration I think we've gotten the culture part right and as we started to see some success, there was a bit of a light bulb moment where we thought, hey, culture's going to matter for WCM and it's going to be the most important thing that's going to drive our success. It needs to be something that we also focus on in the investment process. Paul Bellenhout success it needs to be something that we also focus on in the investment process Joe Brown, md, mph. So when Paul was alluding to, I think what we do that's different. I think one of the pillars is the emphasis that we put on culture and finding companies with effective culture, because it's very difficult to quantify, it's an inefficiency that I think most investors don't exploit and it's something we've kind of lived and breathed ourselves and then, for the past 20 years I think, built a pretty robust investment process around.
Ryan:So how would you describe the culture of WCM?
Mike:Well, we've got three core values that I would sort of think about it as this is how we measure success. When we talk to new people, when we go through our annual reviews with people, obviously we think about performance and accountability, but really, at the end of the day, it's are they behaving in accordance with these three values? And they're pretty simple. They're gratitude, service and fun.
Paul:I would reframe that to fun gratitude and serve others yeah.
Mike:I have just a slightly different perspective. To me, it starts with gratitude. I think everybody that walks into this place every single day feels incredibly lucky to be. I mean, I kind of fondly sort of describe WCM as a lily pad within the investment management industry, and I think everybody that comes here knows how lucky they are. And if that's the mindset that you kind of operate with on a day in and day out basis, you naturally think a little bit less about yourself and more about others. And so I think a grateful heart, a grateful mind just naturally translate into behavior where you really focus on the other people around you, like on the investment team.
Mike:I talk about it all the time and I say you know and just think about investment management. About it all the time. And I say you know and just think about investment management. I mean it's a, it tends to be a an industry that that brings a lot of self-interest and a lot of ambition and and people wanting to climb the ladder, none of which is probably conducive to having really effective teams. And so, if you can, if you could come to the, come to the office every day with with this notion of gratitude, you're just naturally going to think about your team and and and everyone else around you.
Mike:And I say like if everybody can just come in with that mindset and not worry about themselves, but worry about how they make every single person around them better as a company, as a team, we're going to go so much, so much farther faster together. And when you can experience that environment, it is just ridiculously fun when you work on great teams with people that really care about each other and care about each other's success. There is literally no one thing you can do more fun and work than living in an environment like that. So that's why he starts with fun. I start with gratitude, but I'm sure he's got a different way to sort of make that all sound sensible.
Paul:That's debatable, but it's interesting when you think about those three core values gratitude, serve others and fun. They're nowhere else in the industry, right, every other industry. If you say what are your core values, it's going to be integrity, discipline, process. I mean, give me a break. Those are all permission to play. If you don't have those, you shouldn't even be in the game. So what we did a number of 12 years ago is we said what are the what? What really are the values that we live and that we care about that animate us and let's enshrine them in in.
Paul:And to me, as Mike said, if you're grateful, I would put a little different spin on it. If you have a sense of gratitude, then you acknowledge that we're very fortunate to do what we're doing. We're allocating capital in a time and place where you're handsomely rewarded for it. It's an incredibly stimulating intellectual discovery to try to understand the investment equation, but there's a lot of really good people doing it that work really hard. So gratitude should lead to we're fortunate to be where we are. But we should have humility, because we've been given a lot and I think humility leads us to just be scrappy. Just be scrappy. We need to get better. We need to do something different. We need to be better than everybody else out there. So we are relentlessly trying to get better all the time because we've been given so much and the fun is the fun. If you love what you do, as Buffett said, you skip to work every day. You love it. I mean, tell me you're not going to give everything you got.
Paul:But my favorite is the idea of serving others. We had an analyst come in. He was about 26 years old when we hired him. I mean literally. This guy had PTSD for about a year after experiencing a highly toxic, brutal culture that was all about politics and positioning. And when he came here he asked me hey, how can I do really well at WCM? And I said that is the simplest question. Anyone's asked me If you can make everybody around you better, serve your team, serve the people you work with, elevate the team by making them better. Don't politic, don't position yourself for more money, don't position yourself for a title. If you serve everybody on your team and you elevate the whole organization around you, trust me, we will see you and you will be recognized. You know.
Paul:So, when you think about my position and Mike's position as co-CEOs, our job really is to serve everybody in the organization. You know we get to do these podcasts and interviews and we get to be in front of people, but our main priority is making sure that our people have everything they need to be successful. I don't just mean all the tools and all the you know all the different screens and technology they can use, but I mean, more importantly, are they in the position where they can prosper? You know that's what we spend our time doing. Do we have people in the right place?
Paul:And, frankly, are we aware of both the personal and the professional? And you know I think in business, a lot of times you hear these really hardcore, hard-ass people say hey, professional is professional, personal is a personal. I've never bought it. If I have a brutal fight with my wife in the morning and I come to work, are you going to tell me that's not going to impact me professionally and vice versa. You know so we work really really hard on knowing the whole person and what they might be struggling with at home or what they're struggling with here. But the more Mike and I can serve everybody and the more people in the organization serve everybody around them, I'll tell you that that is an incredibly powerful force that is almost impossible to compete with.
Ryan:You know, you said something interesting when you're talking about gratitude and you get to allocate capital, and it strikes me that the process of allocating capital is something that's virtuous, that's actually a good thing. You can help foster the growth of other businesses that are good businesses, and I think that's missing from the investment management industry the idea that it's, you know, not just going to gain for your investors, which is good, but there's actually some virtue in the process of allocating capital as well.
Paul:There's massive virtue. We talk about it all the time, one of the things that's really important to me and I've been doing this 40 years and people say, why do you keep doing it? And I do it because one I love it, I love the people around me and I know that we're changing lives to your point. So if we you know one of our I guess I can talk about a client but one of our clients is St Jude Hospital. They hired us about 10 years ago. If we do a great job and give them significant excess return over the benchmark, what does that do? That helps them spend more money to help children that have cancer, firefighters, policemen, nurses, teachers. You know we talk all the time about hey, this isn't just a mathematical equation about it and it's not just about us making money. It's about changing the lives of the participants that invest their money with us, and we constantly talk about that. We constantly reiterate how much, by doing well and doing things differently, we can change the lives of people.
Mike:And I'd add, I think relationships matter a lot to us.
Mike:One of the things I think we're most proud of is a lot of the relationships we've been able to build over the years with clients and in many cases, if they hired us in the early days, when we were a lot smaller than we are today, they took a chance and it's been obviously incredibly rewarding to reward them with that.
Mike:And it's also incredibly devastating when you go through periods when you don't, because in many cases these people have bought in not just to our investment philosophy and our process and what we say that we do is different, but they've kind of bought into who we are as people and what the firm represents. And so you know you can't help, but you know kind of carry that with you to a degree personally, and so you know he said it a million times I mean this is a great business. It's incredible when it goes well, but when it doesn't, there's nothing more devastating than you know having to deliver. You know bad news to clients, and so you know we think about that and we remember those. We don't forget about those periods where you know we haven't necessarily performed great. That's part of the business, that's part of market cycles and markets, but you know we carry that with us for sure.
Ryan:Okay, so using culture as a way to evaluate companies, to pick stocks. Ultimately, is there some sort of algorithm that you have that says this is the? You know? How do you rank stocks based on their culture? How do you quantify culture?
Mike:Paul alluded to this a second ago, but there's a real. I think one of the reasons that we've been able to sustain the level of success that we have for, you know, the last 20 years call it has been that you know there is an iterative nature to our investment process, and so we have incredibly high standards for what good looks like and we're constantly trying to push boundaries, to get better at what we do, and I think our evolution around analyzing culture, I think, is a perfect example of that. When we first had that light bulb moment that I referred to, you know, I think it was okay. We recognize culture matters, we have a sense for what that looks like in an organization that's call it people-driven, like investment management. Let's go try to find a lot of companies that you know, frankly, like might be places that Paul and I want to go work at, you know, and so if you're looking at you know the retail landscape and I thought, okay, if I wasn't lucky enough to land on the lily pad at WCM and I found myself working in retail, um, you know, like, costco seems like a pretty cool company. You know, people there seem pretty happy as a yeah, like as a customer, like I love going there. You know like and um and you know the obviously they have, uh, financial and stock price results that, um, you know stand out relative to their peer set. So, ok, maybe we should go buy Costco. And so, you know, even early on there was almost a. It was easier in some respects because culture was not quite the buzzword that it's become today. And so if you could even just find companies and management teams that explicitly talked about culture, you kind of thought, okay, maybe we might be on to something here.
Mike:But you know, through that journey we started to realize that there's a little bit of a self-selection bias that can come into, you know, come into that process, right, because you know, hey, what companies Paul and I might want to go work for doesn't necessarily there's probably a lot of other great companies with great cultures that you know maybe he and I wouldn't last very long at. And so you know, if you think about, you know, certain industrial businesses where you know certain industrial businesses where you know scale and like a low cost structure really matter to, you know relative competitive advantage versus peers, where you know those organizations have a lot of focus on numbers and accountability and they can be, you know, stressful, difficult places to work. Maybe that's not where, you know, paul and I would have gravitated to, but like hey, there's a lot of companies out in the world like that that are incredibly successful. So we had to sort of step back and say you know really what is the? We had this moment where we kind of just concluded you know, there is no such thing as a good culture. It's really what is the strategy of the company? How are it's really what is the strategy of the company? How are they going to differentiate and grow their competitive advantage versus their peers? And then do they have a culture which, again, as I said a second ago, is kind of a set of values and behaviors that actually makes sense for what that company is trying to do. And so we start with this notion of there's these, I call it sort of three pillars of our culture process, and the first one is this notion of culture, strategy, alignment, right. So understanding what is the strategy that company to generate great returns, differentiating themselves from their peers, and then do they have the right culture. So that's the first piece. And then the second one is we care a lot about the cultural strength, right? So how successful is the organization at galvanizing all of their people around those, that belief system or those values? So, like in the case of WCM, I mean I would be completely floored if you took anyone aside in this organization and said talk to me about the three core values of WCM and and why they, why they, why they matter and how they help you do your job. So we would hope, and that's what we do.
Mike:When we talk to companies, we don't just talk to the CEO or the president. We're talking to former employees, partners, customers, all the employees that we can get in front of and trying to understand hey, is the stuff the management team's telling us about their culture does that line up with you know, what you? You know with what we're hearing from other folks? I mean, amazon is a great example, I think, in this regard. It's incredibly, you know, you can you know just Google articles about Amazon's culture and see all sorts of you know kind of stories that don't make it sound like it's necessarily the best place to work.
Mike:It's very data driven, it's very it's. It values data, maybe over some of the softer, some of the softer sides of people. But if you ask any employee like what drives decisions there. It's low prices, convenience and selection, you know, and so I'm sorry, and convenience is a big one, and so you know that's, that's a, that's a high degree of cultural strength. And then the last one is we want cultures to be adaptable and to change, and so we want them to have a high degree of external awareness, to study best practices, steal good ideas from other companies, and so when we diligence companies, we're really trying to assess them across those three pillars, and then, if they check all the boxes, then we'll conclude that, okay, this has a culture that we think is up to our standards of considering it as a potential investment. You need other things to get into the portfolios here, but those three things are how we kind of broadly think about the culture of a company.
Paul:And if I had to frame it a little bit, so it's cultural strategy alignment. So alignment between values and what they're trying to achieve. Strength throughout the organization, as Mike said. Adaptability those are kind of the three pillars, but the interesting part is let's talk about first trust. So first trust kind of has grown up with a lot of competitors around it, why have you done so much better than every one of your competitors in terms of raising assets?
Paul:We firmly believe in a pretty commoditized area, right, pretty commoditized area. You know what? The answer is Culture. You guys have deeply embedded cultural values that animate what you do every day. So when you find that in an organization, that organization has a far greater ability of growing its competitive advantage because of how they treat their people and how they behave as an organization than a company that doesn't have a strong values in internally to it.
Paul:So you know, the interesting part is we've, we are so deep into culture and believe so much that it actually allow you know, it allows a company to grow its competitive advantage because of its people that we have four full-time culture analysts. All they do is work on culture. You know they have different backgrounds from different experiences. They may not even know what a competitive advantage is. They've probably never done a DCF model, it doesn't matter. All they do, four of them is work relentlessly on trying to understand the DNA of the companies we want to invest in. And here's the, you know, to your earlier question can you quantify it 100%? No, and that's the beauty because, see, wall Street doesn't believe anything exists unless they can quantify it. So they'll talk culture, they'll throw out kind of the buzzwords, but if Wall Street can't measure it and quantify it and score it, it doesn't exist to them. And that's beautiful, because as long as they continue to believe that, we will continue to have a huge competitive advantage.
Paul:What you're doing with culture is building a mosaic and you build that mosaic over time. We do work on a company. We have a pretty good idea of that alignment, strength and adaptability. But I will tell you, like anything else, you learn as you go too. We get better and better as we own that company and see how it behaves in different periods of time.
Paul:It was Walter Schloss who made a very honest. He's a long, you know, 80 years ago was a great value manager and he said phrases that you can't money managers won't say. You really don't know a company well until you own it. Right, you're supposed to know everything about a company, but the truth is when you own it and you see how it behaves. I'd say the same thing with allocators Allocators that allocate to us or other firms. You don't really know the company well until you see their behaviors in difficult markets. Then you begin to understand and it's either good or it's bad and you can make judgments on that. So culture, work, we have a huge lead. There's not anyone that's going to catch us in that because, again, people believe if you can't quantify it, it doesn't exist, and that's good for us.
Ryan:So how often is your analyzing companies? You find a company that the fundamentals look great, the growth trajectory looks great, and then you get to the cultural assessment and their culture doesn't meet what you're looking for, so you eliminate that. Does that happen frequently? And I guess the other side of that is do you find companies that have great culture but it doesn't show up in their fundamentals and you would maybe not choose to invest?
Mike:Yeah, I mean it's one part of the process right. So yeah, it happens with great frequency actually that we find a company that you know we have a view on what it could do to improve its business right. So we haven't talked about it yet. But the other really, I guess sort of core part of what we do, and I think what's different about what we do at the bottom-up kind of company analysis level is our emphasis on what we call mode trajectory. So, as Paul kind of said at the very, very beginning, you know most managers talk about trying to buy businesses with a sustainable competitive advantage or a wide economic mode. You know, we learned a long time ago that it's not really the size of a company's mode that matters, it's actually the direction and is that competitive advantage.
Mike:Actually expanding and getting better Strategy is a huge part of what enables a company to be able to do that. And so there's all sorts of examples that I can think of where we were just looking at a German healthcare company. It has three businesses. It has a pharma business, a life sciences business and then then kind of a smaller kind of non-core operation, and we really want them to expand and invest in their life sciences businesses, and they're just unwilling to kind of just de-emphasize pharma. That's kind of what the company is known for, and so you know the strategy to us is quite clear of what the company should do to create value.
Mike:But when you go in and you do all the culture work, you realize that there's just no chance that the organization's going to get there. And so you know that would be an example of one where you know, hey, we liked the idea of how this company could improve its moat, but they just didn't have the culture to back it up. And then, but just didn't have the culture to back it up. And then I mean, on the flip side, I think if we just went and bought 35 companies with great cultures and didn't pay attention to competitive positioning, mo, trajectory valuation, I mean I don't think that the portfolio would be set up for success. And so it's part of the puzzle, but it's not the only piece.
Ryan:So another phrase that I've heard, as I've listened to WCM and read some of your materials, is this notion of defy the fade. Talk to me about defy the fade. What is that and why is it important?
Mike:Well, we talk about I mean, I think about it frankly with our own business as well as how we invest. But it does speak to moat trajectory and culture, and so, if you just think about basic finance or economic theory, you know every business you know should be mean reverting over time, right, you know companies can have a period of success. Performance, be it financial or stock price, you know becomes pretty average. These two attributes that we were talking about positive moat trajectories and cultures that are very well aligned around the strategy to grow that moat, those are the companies that are going to defy the fade, and so it requires a slightly longer time horizon. I think Wall Street's decent in most cases at getting the next, you know 12 months, right, I think a lot of the, the inefficiency or the arbitrage that we're exploiting is thinking about these things in a slightly longer term timeframe. Culture is not going to matter. You know data, you know month to month in terms of you know how, how a stock price performs, but over a longer time period three years, five years, 10 years or longer it is the ultimate, you know difference maker, and so we use that defy the fade term to kind of express ultimately what these two things are helping businesses do and you see that also in just the forecasting errors that take place oftentimes on Wall Street, because typically they're not incentivized to think about what's going to happen over the long term. They're trying to get their earnings estimates right over the next 12 months. They've got armies of analysts that are just working spreadsheets and trying to get that EPS number right every single quarter.
Mike:There's a lot of hedge funds and pods and people that are trading around all that information and so if you look at you know some most of the great investments that we've had, you know Wall Street's like okay, let's say just say a business is going to grow, you know 20% next year. Oh, okay, wall Street's pretty good about getting that right. And then, well, then they say well, it's like you can't do that two years in a row, so probably like 18. And then it's going to go down to, you know, within a few years it's down to say 10 percent growth and and that they're kind of modeling that fade, so to speak. And it's the businesses that have these moats that are growing and these cultures around them that you know just time and time again can exceed expectations and sort of did not defy that inevitable fate. And it's that delta between the mean and what the company is able to perform that generates all the alpha in the portfolio.
Paul:You know, finance people. To Mike's point, most finance people, wherever they are in the world, worship at the altar of the DCF right, the discounted cash flow model. They worship it and especially if you're young the younger you are when you come in the business. Everyone teaches you to do a DCF. They think there's something magical in there, but it takes them a while to realize there are probably a hundred thousand people building a similar model to what they're doing and they tweak a couple of numbers here, they tweak a couple of numbers there and, as Mike said, what they typically do is say, hey, this company can't grow that rapidly for that many years. So after a few years they kind of fade their guesstimates to GDP growth out 10 years.
Paul:And again I like to say this a lot, show me a DCF model. Somebody did five years ago and I'll show you how wrong it is. Inevitably Because with these great compounders, with these companies, where we are mostly right about the economic moat or the sustainable competitive advantage growing with a culture supporting it to grow, they will defy that fate. They will defy that overly conservative model. So again, as long as Wall Street thinks it's about the numbers, we're going to win.
Ryan:How much do you pay attention to some of the macroeconomics, some of the external sort of criteria that others might look at when they're allocating, Also like geopolitical issues? A lot of what you do is in international stocks. Do you pay much attention to macro or geopolitics?
Paul:Michael will have probably a different take on this, but I will tell you that every time we've become concerned with macro issues whether it's geopolitical interest rates and environment, gdp growth we've mostly been wrong growth. We've mostly been wrong. We've mostly been wrong. You know, concerned about Taiwan or China invading Taiwan, you know, and therefore what you shouldn't own Taiwan semiconductor because of that geopolitical concern. There's a lot to go into there. You know, concerned about the Mexican peso. You know, wherever we've acted kind of with a macro bent, we've pretty much always been wrong. So we try not to do that.
Mike:It's funny. I, just for an institutional consultant, just got asked a question about process improvement and we have a journaling app that we developed internally where we document all of our not just it's really about any view we have on a company, but it's obviously it starts with all the transactions that we've made in the portfolio and we talk about. You know why we bought them. You know when we sell them, we document the reason that we sold and that there's different tags in there. So if it's, there's a description.
Mike:But we also might say well, the macro was one of the reasons that we sold. And so if you go back over 10 years ago, there was, I think, maybe four or five decisions that we made that had macro as one of the influencing factors for the sale. In the last 10 years we've had just a couple and they've actually proven to be not the worst decisions, and so we use a lot of you know, paul paul talks about macro, but we've actually we use this journaling app to actually embed these lessons in our minds so that we don't fall into the trap again and and and actually um, you know repeat the same mistake twice now, having said that, the macro does matter.
Paul:In emerging economies it really, really does matter. You know what's going on. That's something we learned, but less so in the developed countries.
Mike:And I think the I think about it. On the, I think you know, when macro is bad, I think we look to lean into it because it tends to overshoot to the downside in terms of how stock prices perform. So in that sense, I do think about it. We don't make macro predictions. We don't let macro predictions good or bad influence decisions we make with companies. And the same would be true for, I mean, the geopolitical, geopolitical stuff is just incredibly unknowable.
Mike:And but I could say, like I have just a house view that like there's going to be more instability around the world in the next 10 years than there has been historically. I think that's pretty irrefutable at this point, especially with two wars going on. And so, if you think about the behavior changes that are taking place in Europe and Asia around defense, are defense companies thematically a pretty good place to be right now, knowing that you know NATO is starting to step up. You've got more countries joining NATO. You've got countries in Asia like Japan that are increasing their defense budgets for the first time in decades. Yeah, so like we don't. So do I have a geopolitical view on what's going to happen in China and Taiwan? I just witnessed the most a circular conversation about that a couple of days ago. Nobody has any clue, but I know that people are worried about it and that means that there's going to be probably more spending on defense and that's probably a place we want to invest.
Ryan:So one of the things that you, paul, said towards the beginning of our conversation had to do with the reason why people should even consider stocks outside the US, because if you talk to a lot of the financial professionals that we talk to, they've gotten a little bit discouraged by a decade of underperformance, especially for those passive international benchmarks. So, as you guys are talking to your clients, what are some of the reasons that you maybe refer to as you're thinking about why you should look outside US markets?
Paul:Well, the first thing I'd say and I'll try to say this kindly, but it's complete foolishness to index international markets and it's complete foolishness to index EM in particular, Because most of the index in EM is made up of really junky financial companies, a lot of natural resource companies. Yeah, if that's what advisors are doing, they're saying oh, I don't really know EM, so I'm going to index it. You've just created a massive headwind for yourself.
Mike:Yeah, I mean, that's how I was going to answer the original question about how we've kind of done what we've done. I think you know these international benchmarks are pretty inefficient. There's a lot of bad companies in them, but I think that there are also some amazing companies and if you can find them and you can own them in a meaningful way, like in our case, like all of our portfolios are fairly concentrated right between, say, 30 and 40 positions, they look really, really different than the benchmarks. And I think we've just proven that, despite all the passive versus active stuff, that if you want to take a differentiated view on, a how you look at companies, but B also how you construct your portfolio, active management is alive and well and not going away, and anybody that tells you different is just telling you lies.
Ryan:So, mike, one of the reasons why people have often maybe pitched increasing allocations to international or even just rebalancing to your portfolio in internationals because of the valuation differential, the fact that a lot of the indexes have really low PE ratios or price-to-book ratios, especially in comparison to US stocks. In your opinion, is that one of the best reasons to invest internationally, or how does it fall in your list of reasons that you would consider international investments?
Mike:You know you're going to laugh like coming from an international, focused, you know portfolio manager, but I think that that's actually a total nonsense. It's interesting because it's like we're kind of approaching the end of the year and all sorts of people are like publishing their you know kind of their investment outlooks for next year and there's there are a few like slides I've seen a couple times that show this kind of once-in-a-decade dispersion between US market valuations and non-US. And that's just not how we think about it and that's not why I think it makes sense to invest internationally Some of those, just to frame it, I mean most of those charts or that data that people see is looking at the broad-based benchmarks, right, and I think if you're not familiar with international benchmarks, you probably don't realize that they're incredibly inefficient. They're pretty easy to beat and part of it is because there's just a lot of bad companies in them. There's a lot of European banks, there's a lot of you know kind of commodity driven, mining driven, you know emerging market companies in there and and they're not businesses that we would, we would, ever consider investing in, because they don't, they don't look like they're going to be a ripe source of excess return, and so I think the reason you invest internationally is to actually get access to those few select winners that are out there, and I think we've proven over time that we can find them through our motor trajectory and culture framework and then own them in a way, in a way um, um that allows us to to to outperform those bron those, those benchmarks, over time. So there's a diversification benefit from what you're going to find in the us, but also just like some really, really incredible companies.
Mike:I mean, if you think about, you know, taiwan semiconductor, just to use you know an example, I don't know why anyone wouldn't want to have exposure to that company. You think about everything that's going on in the world right now with artificial intelligence, and you know, right now there's this new debate about. Obviously, nvidia has done incredibly well, it's been a huge contributor to US benchmark returns, but now there's these, you know, alternative chips that you know Amazon may be developing, or Google's TPU, and it's a very difficult call to make on what's going to happen over the next five years. Well, guess what? Guess, what's the easiest way to play? That? The one company that makes all of those chips, no matter who. It is right. And so you know, tsmc, you know, to our mind, is actually probably one of the most important companies in the world, if not the most important company in the world and as an investor, as someone that's trying to allocate money for clients, you want exposure to companies like that.
Paul:So I've done this a long time, as I said earlier. And what is it? For the last 15 years, people have been playing this oh, international and EM. How many times have you heard oh EM? Many times have you heard oh EM? It's far cheaper than the Western world and it's growing much more rapidly. And you know what? There's this whole emerging middle class coming up that's going to spend more money 15 years. And what happens? Well, kind of like, in general, if you buy the benchmark once every 15 years, you get a huge spike in returns and the rest of the time you get nothing.
Paul:Now the truth of the matter, as Mike said and I'll just be a little more blunt the EM indexes are trash. The international indexes are trash, as Mike said, do you want to own a European bank? Okay, the reason the PEs are low is because it's like what? 30% banks that are selling at single-digit PE ratios and a bunch of industrials, and then you know that's why it's cheap. So forget the index argument and realize that there are about 100 brilliant companies that are outside the US. That's kind of you know, 100, 150. That's the field we play in and those companies are, you know, a lot of them are must-haves. Like Mike just said about Taiwan Semiconductor, if you're just US, you've missed one of the greatest runs in one of the greatest companies in the last 20 years. So it's not really an international US argument. It's just buy great companies, no matter where they are, and that's what we do.
Ryan:So if I were to paraphrase what I'm hearing you say anyway, is that you shouldn't necessarily allocate to international benchmarks, because what you end up with is stocks that are cheap, that are probably going to stay cheap because the business model is antiquated or has some regulations in the European banks that might hold them back. But you should allocate internationally because of the opportunities that you look to invest in.
Paul:It's kind of lazy to allocate to the indexes internationally. It's kind of lazy and you're really doing a disservice to your client.
Mike:And even I mean it's not just the indexes, it's these closet index funds that claim to be active and it's ETFs that have some country dynamic to that. Or you think you're getting international exposure through some 125-stock strategy, whether it's active or an ETF. If you want to produce differentiated results, you've got to have a portfolio that looks different than the benchmark, and you can do that by finding great companies and doing it in a concentrated manner, and I think that's especially true now. You know I mean I'm not going to make a market prediction by any means, but obviously you know the US markets have had an incredible run and it's, in part, been driven by, been driven by a small cohort of companies. I think there's going to be probably a different set of winners in the next 10 years, not to say that some of those companies still won't do extremely well. A lot of them will be in the US, but they'll definitely be continuous examples of companies outside the US that will show up. The next MercadoLibre is the next C-Limited.
Paul:One of the greatest companies in the world is Ferrari.
Mike:It's not in the US of a non-US company with obviously an incredible brand and one that has the one that's proven to defy the fade over time. Right, there's a waiting list. They continue to create aspiration around the brand with new models. In many cases, if you want the highly aspirational model to get up the right part of the list, you have to buy pretty much everything else on the list. And you know they've got SUV coming, they've got an electric and hybrid vehicles coming as well, and you know their Formula One team's, you know, not doing too bad either, which I think helps the brand as well.
Ryan:Sure, all right. So this is a question that I've started asking people that I've gotten some really interesting answers, so I'm going to ask you guys as well. Paul, I'll start with you. You mentioned that you've been doing. You've been in this industry for about 40 years. Okay, so imagine you didn't go into this industry. What do you think you'd be doing right now?
Paul:I love that question. I ask that all the time. I love to ask people if you didn't have to make money, what would you do? When we hire them, right? And of course, what I want to hear them say is, oh, I'd do what I'm doing now, I love investing, right. But a lot of them will say, well, I'd open, you just go do that. So, without question, I would be in real estate development. You know it's, you know the two. To me, the two most interesting businesses in the world are the first one's what we do. But if I wasn't doing this, I'd want to keep allocating capital. I'd want to keep allocating capital and I love the idea of developing real estate because you can unlock and create an immense amount of value for clients on that.
Ryan:That would definitely be what I'd be doing. Mike, what about you? What would you do if you weren't in the asset management industry?
Mike:I would either want to be an offensive coordinator for an NFL team With the Kansas City Chiefs, maybe, well, well, yeah, that'd be nice to have my homes, uh, and I've with a good on a team with a good quarterback I am, yeah, I'm from Kansas City, um, or, or, or I would want to be, you know like, the general manager of a baseball team. Um, I like, I like competition. Um, I like finding inefficiencies and how it's sort of like. To me, it's another way to express the things I like about investing in a different way. So I like exploiting inefficient ways of people thinking about what a player may be worth or how the market may be interpreting him.
Mike:I like trying to find the idea of finding a weakness in a defense and then devising a scheme, you know, to go score a touchdown or, you know, to have a set of plays that'll take advantage of that. To me, that would be, you know, imagining me, you know, up in the booth at an NFL game. You know, calling plays for any NFL team would be, would be super fun and it. But I like it because it's the. The things I would like about that are the things I really like about, you know, investing and honing an investment process and trying to make it better and trying new things. And you know you try a play and you would like you know the quarterback would get sacked. Oh, that was a stupid play. We better, we better.
Paul:Iterate on that you know that that type of thing sounds like a lot of fun to me I was a highly successful flag football coach for about eight years I did go to yeah I can attest to that.
Mike:I've been to a couple of those games, yeah, but but you know what?
Paul:but to to illustrate what you know I'm a really good coach, but you, you know what Talent? It's all about talent. Same thing in this company. You know, it is all about talent. I've had discussions like, okay, let's talk about the Patriot way. Oh, it's all about the Patriot way, it's all about Belichick and the Patriot way. And you know, do your job, do your job. No, you know, we've all found out. It wasn't about the Patriot, it wasn't about Bill Belichick or the Patriot way. It was about Tom Brady, it was about raw talent. That elevates everybody else To me. That ends the argument.
Ryan:Okay, so my last question for each of you, so, viewers of the podcast what should they be reading? What have you read recently or what would you recommend?
Paul:Well, I'll tell you what I would definitely recommend you don't do. Don't read the news, don't read any short-term, don't listen to the news, don't watch the news. Shut off CNBC, just turn it off. That is probably. Those items are absolutely the most detrimental to trying to create wealth long-term, because all they're about doing and I don't if it's Fox or CNBC or MSNBC or CNN or anyone they're just trying to create chaos. Right, so and and and so the more you get, and even reading the, you know, reading the paper every day, it's just chaos. So the best thing you can do in my mind, is what we did 25 years ago when we bought the firm is read the classics, read the classics again, read them again and again, and again. So, of course, you know, intelligent investor, you read margin. You know. Just read the two chapters on margin of safety and Mr Market, that's a for sure I mean. And then you get. You got to buy.
Paul:You know Buffett's favorite book after intelligentigent Investors, common Stocks and Uncommon Profits, read that by Phil Fisher. Read that book cover to cover. Do it a couple of times. You got to read all. You should read all the letters of Warren Buffett. There's just gold in there. You know who. I've dug up some really archaic pieces of chapters from John Maynard Keynes. He's mostly known as an economist, but the guy was a brilliant investor. He's got a couple of chapters on how to invest properly, which is in a focused fashion fewer rather than more names. And then I would recommend a book by Lawrence Cunningham that he wrote called Quality Investing. It's very similar. It's written about a firm over in London, but it's very similar to what we do every day and I think if you just read and reread those books and they all have common themes in place and you take them in, you're going to learn to be a very good investor.
Ryan:Anything outside of the investment industry that you would recommend reading Love biographies.
Paul:I can't remember the last one. I read Franklin Roosevelt I just read recently. I read one on Reagan. I've read a lot on Winston Churchill. I love to see how leaders led in difficult times.
Ryan:Mike, what are you reading these days? What would you recommend?
Mike:Well, there's a book Paul just reminded me of that I recommend. Sometimes it might even be free believe it or not, which I don't know if that's a good thing or a bad thing, but it's actually called the Emotionally Intelligent Investor, and I'm a big believer in the importance of self-awareness in all things in life, but I think it's particularly valuable in investing, and emotional intelligence is kind of another way to sort of express that, and so this book talks about that in some detail and different ways that you can be more, understand your biases better, and then tools that you can, and also understanding how the market's actually interpreting companies and situations, and then it gives you actual tools and ideas, like journaling as an example, to get better and become more aware of your strengths and weaknesses. So I like that book quite a bit and it's pretty short, so that's an easy one. It was written by an old Soros hedge fund guy who now has a small hedge fund. That's a good book. I'm reading a book right now that I'm not done with, but it's called 10 Cup Dreams and it's about this. It's about the golfer, esteban Toledo, who I recently played golf with, and he's a guy that's from Mexicali, mexico, and and was able to basically earn his way onto the PGA Tour despite having literally nothing. So that's that's. That's a pretty cool book.
Mike:And then, you know, we're actually in our library right now so it would be easy for me to just kind of scan some of the books on the shelves. We like the book Creativity Inc by Ed Capel that talks a lot about it's a story of Pixar basically and I think particularly in investing, I think the power of creativity whether that's just taking a more optimistic view on a situation or trying to sort of understand how the market may misinterpret situations I think is pretty powerful. So how teams can function well and be creative, I think and think about things different than other people. I think that that's a pretty fun book to read. And then I think, history-wise, I'm kind of intrigued by studying World War I right now, because I think there's some interesting parallels to maybe what's going on in the world right now, to kind of conditions on the ground, kind of pre-World War I. So I just started a book actually this week about that. So those are a few things that come to mind.
Ryan:All right, final, final question Looking forward the next decade or so, are you optimistic or more cautious? I won't use the word pessimistic.
Paul:Well, it's a bad question for me because I think optimists rule the world and I think if you live your life from a position of being optimistic, you're going to have a much more successful, rewarding life. So, again, I'm extremely optimistic. I'm very, you know, kind of like, from a broad market side, very optimistic about the US, from company-specific sides. There are so many great companies that are developing around the world that we're going to be a part of and again, it's really, it's almost you know, it's almost impossible, if you unleash people's creativity and their ability to take risk, what they can do. And so, overall, next decade or so, yeah, it's hard to see that you're not going to get good returns.
Mike:There's not a whole lot I can add.
Mike:It's funny.
Mike:We just went through kind of a website, kind of rebranding process and we're trying to kind of connect some of our values to different things that we hold true, and I made the observation at one point that you know, I think gratitude does lend itself to a degree of optimism.
Mike:I don't know many people that are really grateful, people that you know think the world's coming to an end. I mean most people I know that are really grateful, are happy. People that you know think the world's coming to an end. I mean most people I know that are really grateful are happy. People that you know look at the situations with positive intent and glass half full perspective, and so it would be insane for me to actually sit here and talk about how grateful we are and then answer that question by saying that I'm, at the same time, pretty pessimistic about what the world is going to look like in the next 10 years. I believe in the power of people and, whether that's in the US or people that are living and creating companies anywhere in the world, we all kind of want the same basic human things and I think that's going to lend itself to a lot of incredible companies that are going to be born in the future and there's going to be great opportunities to invest in them.
Ryan:All right, that's a great place to leave the conversation. Mike and Paul, thank you for joining us on the podcast, not only because it gave me an opportunity to come to Laguna Beach in December, but because it's been a really interesting conversation. But thank you very much. Thank you, ryan.
Paul:Great to be here.
Ryan:And thanks to all of you for joining us on this episode of First Trust ROI Podcast. We'll see you next time.
