What are you looking for in a manager? Getting clear on your investment philosophy

Next speaker is William Mufford from OSCAT Asset Management.

Will is an investment analyst at OSCAP Asset Management.

OSCAP was founded in 2012 with the goal to create a longstanding successful firm that is a preeminent value equities manager in the market.

It focuses on delivering long-term outperformance for clients by building an unconstrained concentrated portfolio of best of breed businesses with a focus on quality and value.

Importantly, risk management is embedded into each level of the investment process.

Will's topic today is what are you looking for in a manager?

Getting clear on your investment philosophy.

Over to you, Will.

Okay, thanks everyone.

It's great to be here.

Please note the disclaimer that's up on the screen.

We're living in a very uncertain time.

Inflation has hit its highest levels since the 1980s.

The cash rate is at its highest level in over a decade.

China is reopening after years of lockdown.

The Ukraine conflict has unfortunately now entered its second year, and the implications of the Silicon Valley bank collapse continue to be felt.

Now, these are all important issues, and how we respond to them is likely to have a tangible impact on the fund's performance in the coming months.

So it's right that they're issues that our investment team researches, analyzes, and discusses almost every single day.

While there are many variables here that are inherently unpredictable, our framework tends to be data-driven and probabilistic.

But if we were to wind forward to 2028 and wanted to know whether our portfolios have outperformed or underperformed, is this slide going to be the full story?

While the market's primary focus is always on the topical headlines, it can be hard to notice the businesses that are just gradually chipping away in the background.

But it's our view that over time, the compounding effect of earnings growth

capital allocation and business quality take over to be by far the most important driver of stock returns.

These longer-term factors also have a few big advantages.

They tend to be more predictable than shorter-term price movements, they tend to be more repeatable and they get less of the market's attention.

We call it time horizon arbitrage.

So with this in mind, there are four questions that we look to answer to give our fund the best chance of outperformance over the medium to longer term.

Firstly, can our holdings grow earnings per share faster than GDP and the market on a through the cycle basis?

Over time, we expect earnings growth to become the most important driver of stock performance.

But there is a caveat here.

Are we paying a sensible price for this anticipated growth

Between 2001 and 2013, Microsoft's earnings grew over 300% and the stock was flat for this whole period because its starting multiple was too high.

On the other hand, we don't want to focus on a valuation multiple regardless of quality.

We try to adopt Buffett's maxim that it's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.

Thirdly,

Are our holdings high-quality businesses that are maintaining or preferably increasing their competitive advantage?

We're long-term investors and we want our holdings to be investing for the long term in a sustainable way.

Finally, is there balance in the portfolio?

While all of our holdings have to meet a very high standard, there's no point in us having 40 stocks in our portfolio if they all end up being one big bet on interest rates, a commodity price or a factor.

This recognizes that the future is unknowable and unpredictable.

So to answer these questions, we want to make sure that our bottom-up process, and we are first and foremost bottom-up stock pickers, leads us to owning a selection of the best businesses on the ASX, provided their valuation is reasonable.

So this is what we look for.

We want stocks that earn, not burn cash, with high margins and high return on capital.

They should have a long history of listed success.

We generally avoid IPOs and be conservatively geared.

We prefer simple businesses in stable industries with rational competition and pricing power.

Businesses that are the leading player in their sector, either in terms of having the highest market share or having a differentiating characteristic that should see them grow their market share for many years to come.

We avoid companies with binary risk

such as exposure to a regulatory regime or those with structural concerns.

Our process also places a huge emphasis on insider alignment.

We love businesses that are founder-led or where management and the board have large share hornings.

On top of our formal ESG policy, we don't like products with issues of significant societal concern.

We think being a good corporate citizen makes the best long-term business sense.

This leaves us with a target list of about 80 businesses, with our portfolio forming a subset of this list.

Now, I did want to reiterate the importance of insider alignment to Ozcap.

71% of our portfolio are led by a major shareholder, either a CEO or on the board.

This is important because based on our estimates, the ASX is the reverse of this, at less than 25%.

We think the agency problem is one of the biggest issues that faces shareholders in listed businesses.

While modern corporate governance practices and independent boards have had a positive impact on agency risks, ultimately, we think the best way to make sure an executive team is acting in the best long-term interests of the company is for a significant chunk of their net worth to rely on it.

This is no different to outside investors wanting fund managers to have significant co-investments in the funds they manage.

Once we've got our list of businesses that made our hurdles, we want to make sure there's balance.

So we group our holdings into a few buckets made famous by Peter Lynch.

We want growth compounded businesses to represent the largest weighting within our portfolio.

In fact, as of today, this bucket is more than half of our funds.

These businesses have a long runway of revenue and earnings growth with a strong financial profile, a powerful combination.

But within this bucket,

we make sure that there's diversity by business model, sector, and valuation.

Our holdings range from investment platforms, digital marketplaces, category killers, alternative asset managers, offshore growers, to insurance brokers.

When we've identified these businesses, we tend to hold them for a long period of time, in some cases like JB HiFi, until they transition into the next bucket, stalwart.

Our long hold periods mean we tend to build strong relationships with management teams who know we're in their corner and there for the long term.

For those that are interested, we discussed our investment thesis for one of our holdings in this bucket, car sales, in our January newsletter, which is available on our website.

Storeworts are our second largest bucket.

These are businesses that dominate their market and have a long track record of financial success.

They sell items that are non-discretionary, such as consumer staples or healthcare.

This bucket provides an important counter cyclical role in times of market volatility.

The balance of our portfolio is made up of yield, cyclical and turnaround asset play businesses.

When it comes to yield, which is another defensive portfolio bucket, we're looking for a largely passive income stream that is underpinning a structurally growing yield.

We think the current interest rate environment is another timely reminder to focus on income streams that are structurally growing and with conservative gearing for yield-based investments.

We're not afraid of businesses that have exposure to cyclicality.

In fact, cyclical downturns have proved hugely transformational for some of our holdings, as these periods can lead to big market share gains and permanent changes to cost bases.

But we do want to own the leaders in cyclical businesses, and we still expect these businesses to grow strongly over the cycle.

However, we tend to manage position sizes of these exposures relatively actively.

The last grouping is turnaround asset play businesses.

While the financial metrics within this bucket tend to have a slightly lower starting point than the rest of the portfolio, we would expect to see tangible evidence that these metrics are improving, and we won't compromise on strong balance sheets for these holdings.

Telstra is a good example.

It's been through multiple years of intense competition, headwinds and cost out.

But now the sector is consolidated, we've seen a return to price rises, and Telstra's revenue trajectory appears to have returned to growth.

In addition, Telstra owns infrastructure assets that have the potential to create significant shareholder value if sold, which is an option that management are exploring.

Here are our top holdings and weightings relative to the index.

You'll notice that our exposure to major banks and materials is more balanced relative to the index.

We do have more exposure to consumer discretionary than the market, which is an area we believe there are more founder-led growth compounder businesses.

These span a variety of industries.

We're planning on covering our view on the consumer in more detail in our upcoming April newsletter.

You can sign up to our mailing list on our website.

Collectively, we believe the portfolio has attractive metrics based on consensus numbers, which of course carry the usual risks.

The historic statutory return on equity is significantly higher than the broader market, an indication of the quality of the businesses held in the fund.

The fund holdings are anticipated to grow earnings considerably faster than the broader market, and we hold businesses that generate significant levels of cash, resulting in a dividend yield that is higher than the market.

Now, you'll notice that while we're a value manager, the weighted PE of our portfolio is slightly higher than the market.

There are two factors at play here.

Firstly, we're underweight the banks, materials and energy sectors which have lower PEs.

Secondly, we hold high quality businesses that are generally regarded as such.

So we're being compensated for this through better management alignment, return on equity, earnings growth and balance sheets relative to the market.

So, my key messages today are that shorter term topical issues are important, and we do take a probabilistic and data-driven approach to them.

But you definitely can't afford to miss the longer term drivers.

Can our holdings grow earnings faster than the market?

Are the prices on offer attractive?

Are our holdings high quality and at least maintaining their competitive advantage?

Does our portfolio have balance?

The odds cap fund has delivered 15.2% per annum since inception, net of all fees.

This compares to the all odds return of 9.3% per annum over this period.

Of course, this is subject to the usual caveat that past performance is not a reliable indicator of future performance.

Finally, the key facts about the fund, which has now been around for over a decade and is recommended by Zenith and Loncek.

We think our portfolio is genuinely active, and it doesn't look like the index, with our active share being 80%.

And as we've discussed today, we're very big on value, but that doesn't mean we're willing to compromise on quality.

So thanks very much for your time.

I hope this helps you get some insight into how we think about our portfolio.

If you have any questions, you can check out our website.

All the details for our header distribution are on the screen.

Thanks again.

Thank you, Will.