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By Paul Bosman*
How can asset managers confidently ask clients to invest with them for the very long-term in this rapidly changing and politically uncertain world?
Consider the following words of wisdom by Jeff Bezos, the founder and chairman of Amazon.
“I very frequently get the question: ‘What’s going to change in the next 10 years?’ And that is a very interesting question; it’s a very common one. I almost never get the question: ‘What’s not going to change in the next 10 years?’ And I submit to you that that second question is actually the more important of the two — because you can build a business strategy around the things that are stable in time.
In our retail business, we know that customers want low prices, and I know that’s going to be true 10 years from now. They want fast delivery; they want vast selection. It’s impossible to imagine a future 10 years from now where a customer comes up and says, ‘Jeff I love Amazon; I just wish the prices were a little higher,’ ‘I love Amazon; I just wish you’d deliver a little more slowly.’ Impossible.
So, what will not change at PSG Asset Management, and why does this give us confidence that we will be able to identify good investment opportunities over the next 10 years?
The answer is simple – we will still be applying our 3M approach to picking companies. This entails looking for businesses with a wide moat, operated by exceptional management teams and currently  trading at an acceptable margin of safety. So if we know that we will be applying our 3M approach, the question already becomes simpler: will our approach still be a relevant and successful investment strategy? Let’s consider them each in turn.
Moat
To determine whether a company we’re considering investing in has an enduring economic moat (a sustainable competitive advantage), a very good first step is to think through the supply and demand framework within which the company operates.
- If a company is able to control supply and/or create demand for its product or service, it has pricing power and a profitable franchise. This won’t change.
- If a company is a low cost supplier of a product or service and is able to continue supplying when capacity is going out of the market, this results in outsized profits. This also won’t change.
- Investing in companies whose products or services can easily be swamped by identical or similar products for a sustained period of time is a bad idea. This is unlikely to change.
So as long as the forces of supply and demand hold true, the economic moat phenomenon will exist.
Management
Through the ages there have been exceptional individuals who have been able to
- identify attractive gaps in the free market and/or,
- motivate teams and/or,
- allocate capital wisely
When all three of these attributes are packaged together, the result can be exponential returns for shareholders. When you only have two, or even just one of these attributes in an executive, the odds of success are still very favourable. The correlation between these management attributes and success are as old as commerce itself and won’t be going anywhere.
We have developed metrics to evaluate company executives and identify these exceptional management teams. The questions we ask include:
- Are long-term interests between management and shareholders aligned? Truly smart individuals back themselves and will focus their efforts where they have equity.
- Has the management created a culture of both purpose and excellence?
- Has the management permeated cost consciousness throughout the organisation?
- Is management able to act independently of the herd?
- Does management invest within their moat?
- Is there an inclination to build an empire (at any cost) rather than focus on per-share-return?
Management teams who score highly on these questions are very likely to be successful – irrespective of what the world throws at them. These odds get even better if the management team has a very significant portion of their net worth tied up in company stock. We will be searching for these management teams and, when the price makes sense, be investing our clients’ capital in their companies. This won’t change.
Margin of safety
In the short-term prices of shares, bonds and property are determined by human psyche. The drivers of prices include greed, fear and the tendency to extrapolate recent movements into the future. These drivers tend to result in prices either overshooting intrinsic values as greedy money chases the market or undershooting as fear results in desperate selling. This drama has repeated itself many times and will continue to cause drastic mis-pricing for as long as humans are emotional. We will continue take money off the table when prices are at euphoric levels and employ cash when assets are dumped in the market at irrationally low prices.
We will be investing in what we do know
We do not bet on macro events or the direction of markets, we invest in principles which have proven themselves many times over. We are convinced that this will result in our clients’ capital compounding at attractive real rates – regardless of what the next 10 years have in store for us.
- Paul Bosman is a fund manager at PSG Asset Management
