Quality and Growth: The narrative and the numbers

You're watching the first nighttime webinar of Investment Markets Investor webinar, focusing on the Australian perspectives.

Our next speaker is Andrew Dale, Partner and Portfolio Manager from ECP Asset Management.

The ECP Growth Companies Fund invests in a concentrated portfolio of high-quality ASX-listed businesses in the growth phase of their lifecycle.

As an all-cap strategy, the fund can invest across the market capitalization spectrum to take advantage of mid and small cap opportunities in addition to larger companies.

Andrew is going to talk about quality and growth, the narrative and the numbers.

Welcome, Andrew.

Thank you very much for having me.

And it's great to be here with you all to talk about the markets, particularly in these

But as pointed out, we're going to focus on the quality and growth segment of the market.

I'll just draw your attention to the disclaimer here.

Please have a quick look at that.

If we look at the ECP asset management, I'll just give you a little bit of a high level understanding of who we are.

Firstly, we were founded over 10 years ago by Manny Pol and Jared Pol.

I joined the team shortly after and we're very much a fund dedicated to high quality investing, very high conviction investing also.

We've built the team over time to nine investment professionals and two distribution, and we've created a good track record over the period that we've been in operation.

Here you can see the team, a good sort of range of people and diversity.

We've also got a really good range of industry experience, people from engineering, people from banking, people from software, people from different parts of the market that help to contribute to a diverse thought process.

One of the key questions I think when looking at fund managers is, you know, how does a firm or how does ECP differentiate itself from others?

Now, this is a difficult question to answer in an industry which is essentially quite modularised.

Most fund managers are looking to invest money into stocks and gain alpha, and it's quite hard to differentiate.

But when you look at ECP, I think there's a combination of factors that help to set us apart.

Firstly, we've got a very decentralised model.

We have no key man risk.

You'll know that in the past there have been funds where there have been a key one or two individuals that have really driven the performance of a fund.

And if there's any issues with those people, there can be issues with the fund and the flow of funds going forward.

We don't have that here.

The firm is 100% owned by staff.

There's a rigorous research process, which we don't just talk about.

That is a three to four month period of time required to get a stock in the portfolio.

So there is a genuinely deep,

period of understanding of the company before it's added to the portfolio.

We've also got a holding period, which is in excess of five years, low turnover, 30% indicated there.

And it's very much a high conviction concentrated fund with intense scrutiny from the analysts themselves.

So what is growth investing to ECP?

Well, growth investing really is focusing on the economics of the business that drives long term returns.

If you look at this chart here on the right,

you'll see that we're looking for companies in that growth period of the cycle.

That typically also means we're looking for companies that are in industries that are growing.

Industries that are mature tend to offer less opportunities for companies.

So we're really focusing on things where there is a growth in the industry and a company that is doing well within that.

These companies tend to be capital efficient and they also have strong balance sheets.

So part of our process metrics require that a company has at least five times interest coverage

because we find then that they have capital to deploy into future growth opportunities going forward.

Now, some of these companies will move into the maturity phase of the lifecycle, and that is when we continue to own them.

However, we do put more pressure on an investment case when they're in the mature stage of the lifecycle, and more often than not, we divest out of those companies.

So often we're looking for inefficiencies or areas where the market is not properly assessing

and growth of a company going forward.

One section I'll look on a little bit later, but in the healthcare segment of the market is a great example of how the market tends to focus on short-term valuation metrics and then being quite negative on the opportunities.

And they don't take into account the sustainable opportunities long-term for those companies.

We're really about looking through those short-term valuation metrics and focusing on five, 10-year cash flows to try and ascertain a high-quality business.

So how do we define quality at ECP?

Really, what we're looking for when we do our detailed research analysis is we're trying to assess and work out whether the company has a sustainable competitive advantage within the industry they operate in.

Part of doing that is trying to assess whether they are a quality franchise.

And you'll see here on the right, the six pillars of a quality franchise as we denote them.

And going through those, we're looking for industries that are growing as already discussed, we're looking for high quality businesses within those industries, competitive environments where the company that we're investing in is well placed to continue to grow, strong financial strength, and also sustainability.

More recently, we've focused heavily on management, in particular, the culture that a company has.

We believe that high quality cultures within an organisation really help to

help to drive long-term fundamentals, and we spend a lot of time assessing culture to ensure that a business is on the right track, because with a good culture, we believe most businesses can achieve anything.

I want to focus on a couple of examples now.

If you look at realestate.com, I always think it's an interesting stock to look at.

Most Australian people particularly have a view on the real estate sector.

This is a company that's been in operation now for a very long time.

In actual fact, since listing,

It's delivered over two and a half thousand percent return.

Now, a lot of that was gained in the first five years of its listing.

In recent years, you'll see the growth of the share price has been over 200% since we've had it in the portfolio.

The metrics in the table on the top right show that while it has had very strong earnings history, that we are expecting double digit growth going forward.

Importantly, the return on equity is around that 30% level, which is something that we're really focused on.

It is moving more into the maturity phase of its life cycle, but we still believe it has a number of levers that it can pull to continue to drive its overall earnings.

The stock currently has an IRR according to our system of 8.8%, which means that it's slightly lower than our overall portfolio of about 14 to 15%, hence the weight is a bit lower.

If you look at the competitive advantage of a company like REA, really it's centered around its physical competitive advantage, which means it's market share

denoting around a 60 to 70 percent market share in its category.

It continues to innovate and bring new product and new ways of driving returns.

And financially, it's superior to its competitors.

The next bucket of stocks I want to look at is the healthcare category.

Now, when we look at healthcare at ECP, we tend to focus on device manufacturers.

The reason we look at device manufacturers is predominantly because they have very high market shares in the Australian market.

They're also capital efficient and they continue to drive innovation.

If you look at the companies like Cochlear, ResMed and Fisher and Paykel, which are very device driven, all of those companies have market shares in their primary products of around 70%, which really helps to drive earnings growth in the long term and also helps to deliver us that ROE of in excess of 20%.

If you look at the bottom right chart, what we're displaying here is at the time of acquiring these stocks into the portfolio,

They were all on a negative rating by most sell-side brokerage firms because they were looking only at one or two year earnings forecast.

Fortunately at ECP, given our longer dated earnings focus on a five or 10 year basis, we're able to look through those short term metrics and we're able to invest in companies like these.

And you'll see on the chart on the left, all those companies are up between two to three to 400% over the period that we've held them.

So I want to leave you with some thoughts, and that is that at ECP, we truly believe that high quality businesses are the place to invest.

We focus a lot of our research time and intensity on the companies within the portfolio.

And I think this is an important thing to remember.

The companies you own are the ones you must understand well, and you must do lots of research on.

We're always looking for new ideas to put in the portfolio, but we must get the existing ones right first.

If you look at the next slide, this is some details about the ECP Growth Companies Fund.

You'll see all the details there about how to invest.

We are working with a number of partners in both distribution and consulting to help promote that product.

And we also work with our partners who have had a long time relationship with Copia.

And you can see the details of the people there to contact in order to get exposure to the ECP Fund.

Thank you for your time today.

I appreciate it and good luck out there investing.

Thank you, Andrew.

Now, you talk about those very special companies with quality and growth characteristics.

So how does ECP's ability to find these companies change through the economic cycle, particularly given that we're in a rising interest rate and inflation environment?

Yeah, look, clearly over the past 12 to 18 months, interest rates have been a key focus for investors in the market.

I think wrongly the market quickly discounts growth opportunities given rising interest rates.

But you do have a scenario where now investors do have a range of opportunities to invest their money in multiple places.

I mean, it was only a short time ago that you couldn't put money in the bank and generate a return.

Now you can get anywhere around 5%.

But what a rising interest rate market does is it really polarises high quality businesses and it discounts the ones that don't have high quality franchises.

A really good example of this is a stock that's in the portfolio and that's Xero, the accounting software company.

That company's been around for quite a while.

It's got a very good business model, very good customer base, very good penetration into its markets and has done really well over the past five to six years.

But not until recently did the strength of that business model become apparent.

with a new CEO and leadership team in place.

They've been able to tweak their business model or the payment mechanism for their product and that the company has gone on to perform incredibly well in an environment where interest rates continue to rise.

In fact, that stocks up 60% year to date relative to the ASX, which is near on flat as we speak.

So I think that really a rising interest rate environment and also some macro cyclical

factors that put downward pressure on overall growth really makes high quality growth companies even more important because they will be the companies that outperform over the long term, while those untested franchises will suffer as capital becomes less freely available.

Well, thank you, Andrew.

It's great to see you.

Take care.

Thank you very much.