All we want in life is an unfair advantage – 2nd quarter, 2016
Investing is about the future, and the future is inherently uncertain. Faced with uncertainty, the best we can do is create the circumstances for success and let the outcomes play out.
Geoff and I believe that one of EdgePoint’s biggest advantages is the other four members of your investment team. They’ve added a lot of value for you in the past and will likely continue to do so in the future. This commentary is about our other four colleagues. Over the last eight years, we’ve written 26 commentaries about our approach. We thought you’d be interested in learning more about the team members that put that approach into practice for you on a daily basis.
Attempting to list how each member adds value for you would take too long so this commentary will highlight one unique advantage they each bring to work daily. Prior to that though, it’d be wrong not to mention that these four also share many traits. Here are a few:
Deep understanding of our investment approach
Ability to always live in a narrow emotional band
Strong quantitative skills
Being a team player
Finally, it’s worthwhile noting that Geoff and I didn’t start out with the intention of building an investment team. When the opportunity to partner with someone who could make us stronger came along, we jumped at it (four different times).
In the order that they joined EdgePoint:
Frank joined EdgePoint in 2009 from HSBC where he worked on the derivatives desk. Frank spends his time trying to find fixed-income and equity opportunities for all of our portfolios.
Frank’s unfair advantages are some hard-to-come-by personality traits. Specifically, he has an overabundance of common sense, is a proactive learner and is conscientious. These traits have helped him build wealth for you.
I’m not a psychologist, and therefore I don’t know exactly how Frank honed these unfair advantages but if I had to guess, I would say they came from growing up in an entrepreneurial family and working in the family businesses from a very young age. I don’t believe you can teach common sense or conscientiousness. They have to be learned. Frank spent a good part of his youth learning how to squeeze operational efficiencies out of processes dealing with customers and the importance of cash flow. Additionally, growing up as an entrepreneur in an entrepreneurial family seems to have taught Frank how to operate and succeed in an unstructured environment − something that serves him well today in our unstructured team environment (more on that later).
Frank joined EdgePoint in the middle of the financial crisis. He arrived with a keen sense for business and a passion for investing. He quickly took on anything we were willing to throw his way. Since his first day, he’s been the busiest person on the team – a title he still hasn’t relinquished. At first we gave him specific companies to look at, but in short order we directed Frank towards finding value in entire sectors. Eventually, he also learned his way into adding value in fixed income and today follows his nose to uncover new equity opportunities.
What this means is when oil prices collapsed, we turned to Frank to help identify new ideas. When spreads widened in the fixed-income market, we looked to him for help on adding value. When the discussion turns to hedging foreign currency exposure in our Global portfolios, Frank is in the room. These opportunities weren’t given to Frank; he earned them through his willingness to learn.
The following lists businesses that Frank has helped us with over the years. It excludes fixed-income investments, simply because it would then be too long.
Ted joined EdgePoint in 2011. Geoff and I had worked with him for many years before EdgePoint was founded. Other than Geoff and I, Ted is the only person with the ability to buy businesses for the portfolios.
Everyone on our team is a generalist. A generalist means you have the ability to study a variety of businesses across diverse industries. If you want to effectively practice our investment approach you have to be a generalist. We’re constantly scouring the world for ideas not widely shared by others – what we call proprietary insights. Finding those proprietary insights requires a portfolio manager who can easily switch between studying and understanding a variety of different businesses.
The opposite of a generalist is a specialist. A specialist only looks at businesses in one industry but knows every little tidbit of information about that industry no matter how potentially inconsequential. The advantage of being a specialist is having unparalleled knowledge of an industry, which can be advantageous at times.
The disadvantage is that a specialist can’t compare the relative merit of two ideas from different industries. If you have to build a portfolio of ideas, you must be able to weigh the relative attractiveness of ideas from disparate industries. As such, generalists tend to do better practicing our approach than specialists.
You’re probably saying to yourself that you’d like your EdgePoint portfolio manager to be both. Of course, everyone on your team strives to achieve that balance. The truth is, I’ve yet to meet anyone who achieves the perfect balance better than Ted.
As a generalist, Ted has contributed ideas to the portfolios from a wide variety of industries ranging from pipelines, to software, to death care, to chemicals and almost everything in between. As a specialist, we’ve heard Ted tell CEOs information about their own companies that they didn’t even know. Management teams have admittedly never seen anything like him.
Where does Ted’s unique ability come from? We’re not really sure; however, he does have two particular skills that certainly don’t hurt: a powerful memory that I’ve yet to see a match for and a unique ability to understand even the most difficult business models like those in the health care and technology industries (i.e., his circle of competence is very large).
What does Ted’s strong balance of generalist and specialist skills mean for you? Very simply, since his arrival over five years ago, he’s built material wealth for those who’ve entrusted EdgePoint with their savings. The following is a list of names that Ted has contributed to the portfolios. The list is divided into ideas that have made money for investors, ideas that have lost money for investors and, finally, ideas that are currently in the portfolios (the jury is still out).
|Made Money||Lost Money||STILL IN PORTFOLIO/CYMBRIA|
The second column isn’t an error. Of the names that Ted has purchased and sold, 100% of them have made money. If that weren’t enough, Ted has helped with names that Geoff and I put into the portfolios such as Alere, which have also made money for stakeholders. I know what you’re thinking – you would’ve been better served had Geoff and I stepped aside over the last five years and asked Ted to pick all the ideas. Given the table above, it’s tough to argue with your logic.
Andrew joined us in 2013 from a competing firm. At EdgePoint, Andrew spends the majority of his time on our Canadian portfolios but has also found opportunities to add value on the Global side.
Andrew’s fast mind is one of his unfair advantages.
Generating new ideas requires countless hours of research on a particular company, its industry and its competitors. Thousands of pages of financial statements, research, transcripts and annual reports have to be gathered, consumed and reasoned through. Interviews must be conducted with management teams. Conversations need to be had with industry experts. Andrew has a particularly strong ability to consume information and isolate the most important drivers of value inside a business faster than almost anyone we know. He’s a very clear thinker.
The downside of being a fast/clear thinker is that you arrive at conclusions sooner than most. Getting to an idea first can be frustrating because you’re often forced to bring your colleagues up to speed. That is, unless you enjoy teaching others what you’ve learned. Fortunately, Andrew has a passion for teaching and is also good at it. He frames opportunities well and covers all his bases when laying out his thinking.
Andrew’s speed and clear thinking are advantages to you as they allow us to work through more ideas in an effort to find the gems.
Some of the names Andrew has worked on include the following:
George is in his rookie year at EdgePoint. He joined us from the debt financing group at CIBC. He spends all of his time on the Canadian portfolios and reports to Andrew.
It’s too early to tell what George’s unfair advantage is. He’s at the beginning of his investment career. We have high hopes for him based on his work ethic, business sense and passion for investing. Geoff and I regularly count our blessings that we didn’t have to compete with George when we broke into the industry many years ago. If we had to, George would be writing this commentary today instead of me.
Despite being with us for only a few months, George has already produced three 100-page-research reports on companies that we asked him to analyze. They are Jean Coutu, Potash Corp. and Aimia. We recently started to build a position in one of these names so George has already started adding value. He’s a shoo-in for the 2016 Investment Team Rookie of the Year award.
Team structure: the fifth “unfair advantage”
Now that we’ve gone through the individuals, let’s talk about how the team works together. To start, this is roughly how we’ve broken up our time in the last year:
Don’t hold us to this breakdown as it could change tomorrow. There are no rules in place that dictate how much time each person spends on a particular investment mandate with the exception of Andrew and George who currently spend the majority of their time on Canadian ideas.
Beyond the time breakdown, here are some other key points about how your team does and doesn’t operate:
There are no investment committees.
Geoff and I are ultimately responsible for about 80% of the names in the portfolios and 100% responsible for ensuring the portfolios are properly diversified by idea. When Frank, Andrew and George find ideas, they share them with us and we debate the merits of each idea with them. If we believe it’s worthy of a deeper dive, Geoff and I do the work alongside the team member that came up with the idea so that each one of us “mentally owns” it. Maybe we’re hanging on too long? Both Frank and Andrew are capable of making contributions to the portfolios without our final approval. However, we enjoy the process of exploring their names with them, and we’re trying to maintain a balance between their autonomy and our requirement to have a collection of ideas in the portfolios that makes sense. You should expect their autonomy to grow over time but the requirement for the portfolios to make sense won’t change.
Ted is responsible for about 20% of the names in the portfolios. He enjoys the process of formulating his thoughts about a particular idea to the point where he can walk Geoff or me through it, so we continue to follow that process. It’s not one-sided – we like discussing his ideas with him as well.
There are no regularly scheduled investment meetings. When we have something to say to one another, we say it. Otherwise we prefer to read in our offices or travel to visit companies.
The team has been structured in a generational fashion. Ted, Geoff and I form the oldest generation. Frank and Andrew form the next and George is the beginning of the third. This is our early attempt at long-term succession planning. Future team members may be added in any generation. I hope the oldest generation keeps adding value for decades to come.
Only George is directed to look at certain companies. The other team members follow their noses.
A team member can go for long periods without knowing what the rest are working on. We like, trust and admire each other, so this doesn’t bother us.
As you can tell, our team process is fluid. The nature of the structure and the singular effort grounded in one shared investment approach allows new team members to join and be additive to the team without being disruptive to the others.
So, we can add people without being disruptive to the team, but what happens if we lose someone in the future? The truth is they and their “unfair advantages” will be missed, though we believe the team has moved beyond being reliant on any one person. With our investment approach at the core and the unstructured nature of how our partners add value, we believe the team will march on.
If that last phrase made you think we’re about to lose someone, we have no reason to believe that to be the case. We do everything we can to ensure that our team members have no interest in leaving and we believe your team is happy. What may be interesting to you is that making them happy has less to do with money and more to do with intangible stuff than you might think. Ted, Frank, Andrew and George could work anywhere and likely make similar (or better) wages to what they do here. If I had to guess, what keeps them here are some of the EdgePoint intangibles such as:
Freedom. In our judgment, the best and brightest want freedom to pursue their passion. We try to create an environment where Ted, Frank and Andrew have the freedom to follow their noses, and explore new ideas when and how they like.
Ownership. In our judgment, the best and brightest don’t want to work for “the man.” They prefer to work in their own businesses with like-minded individuals. Ted, Frank and Andrew are material owners of EdgePoint and George has the potential to become one.
Culture. Culture is hard to define, but everyone knows that it has to do with the people in the company. Being able to pick your own partners is one of the world’s most underrated luxuries. There are 52 partners at EdgePoint and Ted, Frank and Andrew have had a hand in helping to bring in a number of them. Although George has been here for only six months, he has become one of EdgePoint’s top recruiters.
The Crusade. We all believe in what we’re trying to achieve at EdgePoint and enjoy the camaraderie of the crusade.
Freedom, ownership, culture and the crusade have all played a role in keeping your “unfair advantages” at EdgePoint. We hope this will remain true down the road.
We regularly interview companies that we own, or companies we’re thinking about buying for your portfolios. Geoff and I are disappointed if we’re the smartest guys on our side of the table in those meetings. With Ted, Frank, Andrew and George in the room, we don’t have to worry about that.
Historically, their unfair advantages have created a lot of value for you and we believe this will remain true in the future.
We continue to approach investing in these markets with measured confidence, value your trust in us and look forward to working to build your wealth in an effort to be worthy of that trust.
We’re looking to grow our small investment team by one person. Specifically, Frank is looking for a credit analyst. We understand that extraordinary human ability is a scarce resource in high demand. If you think you’ve got some or know someone who does and are interested in our company, please take a look at the following posting.
With or without EU
By Frank Mullen, portfolio manager
The quarter ended in a dramatic fashion as the world watched events unfold in Britain. It’s rare for financial markets to be surprised as much as they were when the “leave” vote won. For weeks, experts were paraded on CNBC talking about how Brexit would never occur. Financial markets seemed to agree as they rallied leading up to the vote. James Grant, a popular investment commentator said it best as the markets tumbled following the vote: “It’s a great day for humility” and “Markets proverbially were able to see through things that individuals were not and markets were absolutely wrong on this.”i
We’re fundamental investors who practice an approach that’s centred on the ownership of individual businesses. We don’t think we have an edge in predicting what will happen in the macro environment. Even if we thought we could predict what may happen, I’m not convinced we’d know how to take advantage of it.
Rather than trying to predict what will happen, we try to analyze our portfolio exposures and how they may be affected should a particular set of circumstances arise. Weeks before the Brexit vote, we were discussing how the outcome could affect the fundamental drivers of the individual businesses whose equity and debt we own. We understood that a “leave” vote could impact these businesses in the short term; however, we were comfortable that the fundamentals would remain solid regardless of the outcome.
That doesn’t mean we believed their bond or stock prices wouldn’t decline. Our portfolios are always susceptible to market risk. Though, when we believe the fundamentals of the actual businesses aren’t at risk, we view any material change in price as an opportunity to take advantage of the market’s short-term emotions.
While many so-called experts spent a great deal of time analyzing whether or not Brexit would occur, we spent our time practicing our investment approach. Instead of asking if Britain would stay or leave, we looked at each business and asked ourselves the following:
When will the Alere Inc. and Abbott Laboratories merger close and what’s the risk if it doesn’t?
Will energy companies eventually be incented to drill for oil and gas subsequently stimulating demand for energy service companies?
Will Calfrac Well Services’ management team decide to buy back its bonds at a discount in the open market?
Will Gran Tierra Energy Inc. use the capital that it just raised by issuing a convertible bond to buy another company or participate in drilling contracts with state-owned energy companies?
Will the global art market continue to decline and how will Sotheby’s react to the slowing demand?
Will the CEO of Seacor Holdings Inc. find a great acquisition opportunity created by the downturn in shipping and oil & gas?
Will Granite REIT use its under-levered balance sheet to diversify its exposure to Magna International?
Will weak auto sales in Alberta spill over into other provinces?
Will children’s television content continue to drive customer retention at Netflix and Amazon Prime?
Will deflation in Europe set in allowing Fairfax to profit from its swap contracts?
Each one of these questions is core to a particular investment thesis for bonds we own. I believe that our investment partners are best served when the team is focusing on questions like the ones above and not wasting our time trying to guess how macro and political events will unfold.
We’ll always stress test the portfolios to analyze how the businesses we own may be affected by the potential macro and political risks and continue to diversify by business idea with the goal of ensuring that we’re not overexposed to events that are out of our control.
We welcome the uncertainty caused by events like Brexit and strongly believe that any increase in volatility is bound to provide an opportunity to find mispriced investment ideas.