Boutique management within global equities

By Jayson Forrest

Three Australian-based global equities boutique managers - Hugh MacNally (Private Portfolio Managers), Monik Kotecha (Insync Funds Management), and Stephen Arnold (Aoris Investment Management) - discuss the advantages of a boutique and their approach to portfolio construction when using a managed accounts structure.

Being in a boutique relieves you of the corporate pressures. You’re not part of a big conglomerate, where decisions are driven from head office,” says Hugh MacNally - Director and Founder of Private Portfolio Managers (PPM). “Instead, boutique managers either live or die by their own efforts. It’s this degree of autonomy that boutiques thrive with, and which I believe provides boutique managers with a definitely competitive advantage.”

Speaking at an IMAP Specialist Webinar Series on ‘The advantages of being a boutique manager’, Hugh says the availability of information today has essentially removed many of the advantages previously enjoyed by global equity managers based in financial hubs, like New York, London, and Hong Kong. He says this has delivered an advantage to Australian-based global equity boutique managers.

“The amount of information that is available today is unprecedented, and it can be acquired inexpensively. This makes it a lot easier for investment management to become decentralised, which has seen a rise in boutique managers.”

It’s a view supported by Stephen Arnold - Managing Director and Chief Investment Officer at Aoris Investment Management - who believes that being a boutique manager has provided Aoris with a considerable advantage in the global equities managed accounts space.

“What gives us an edge is that we have a single strategy, and managed accounts is just one way in which clients can access that strategy. We’re not a firm that has a strategy of owning lots of stocks. We’re very transparent with the investments in our portfolio,” he says. “It’s a commonsense approach, so when people see the stocks in the portfolio and read our investment philosophy, it makes sense to them.”

Sitting at the heart of PPM’s approach to investing is its investment philosophy, with two elements underpinning the business’s outlook to investing: the return on capital that companies generate; and risk management.

“We have a strong focus on the return on capital that companies are generating, because that’s how we earn our return for our clients,” says Hugh. “And the second element to our investment philosophy is how we manage risk.”

Hugh says there are two risks that the team at PPM want to manage. Firstly, by looking for companies that are financially very strong and able to withstand periods of difficult economic conditions. And secondly, by searching for companies where valuations are not aggressive.

“The reversion to the mean in valuations is brutal, so by avoiding excessively priced stocks - particularly in speculative times - provides a substantial advantage,” he says.

PPM assiduously applies these two elements of its investment philosophy across its portfolios, which comprise of about 20 stocks in developed markets that have a long history of operating performance.

It’s a similar approach shared by Insync Funds Management, with its Chief Investment Officer, Monik Kotecha, adding that Insync’s foundational premise behind investing is that share prices follow the sustainable earnings growth of a business.

Insync looks at two key attributes that help it to identify businesses that can deliver this sustainable and high earnings growth well into the future. These are companies with a: very high returning and profitable business model (across Insync’s portfolios, the average return on investor capital is 40 per cent); and which have a long runway of growth ahead of them.

“The way we seek to identify these companies is through mega trends,” says Monik. “A mega trend is like a giant tidal wave. It can be defined as a gathering wave of change that is slow to form, nearly impossible to reverse, significantly influences the future, possesses an aura of inevitability, and has a far and wide-reaching impact on society.”

Some examples of mega trends include: the move to contactless payments, the sustained rise in expenditure on pets, the acceleration in chronic diseases with the rapidly ageing population, and the adoption of alternative energy sources to combat climate change.

“Insync invests in companies that can continuously reinvest their cashflows at very high returns, which we believe generates the best compound earnings growth and shareholder results,” says Monik.

However, he acknowledges that due to Insync’s very specific metrics and process around investing, it means that its investable universe is relatively small, sitting at about 150 very profitable businesses with strong tailwinds behind them.

“So, from a managed accounts perspective, we have a diverse portfolio of 30 stocks that are typically industry leaders across 16 global mega trends,” says Monik. “And while there is diversification within the portfolio, we also seek to understand the correlation and covariance between these stocks to ensure that we’re managing the risk, while also trying to maximise the returns at the same time.”

Aoris Investment Management’s approach to investing is to also own high quality, wealth creating businesses. Aoris Managing Director and Chief Investment Officer, Stephen Arnold, defines ‘high quality’ as being businesses with a long and proven track record, which operate in growing markets, and are themselves growing faster than their markets.

“We like to invest in companies that are ‘all weather’ businesses that generate high rates of return in all economic scenarios. We also like companies with conservative balance sheets, and which have management that operates the business conservatively,” says Stephen. “By putting all these factors together, it gives us confidence that we own a business that in five or 10 years from now, will be significantly more valuable.”

As a consequence of setting the bar high for its stock selection, Aoris only maintains a maximum of 15 businesses in its portfolio. By doing so, Stephen says it allows the business to strike the right balance between price and company quality. Aoris also maintains a single strategy approach to investing, which is applied across multiple implementation options, including managed accounts. Stephen believes this approach clearly differentiates Aoris from most other global equity managers.

Despite periods of falling in and out of favour with managers, thematic investing continues to be a widely used approach amongst global equity managers. Identifying thematics and mega trends is fundamental to Insync’s approach to investing as a means of selecting companies with a long and sustained runway of growth.

Monik explains there is a major difference between themes and fads versus mega trends. While there are hundreds of fads and themes, which tend to be shorter term in duration, there are much fewer mega trends. These mega trends are large, durable and seemingly unstoppable long-term trends, with highly profitable industry structures.

As an example, Monik refers to the rise in expenditure on pets (or as he calls it, ‘pet humanisation’) as one of the 16 mega trends in the Insync portfolio.

“We are increasingly treating pets as humans,” says Monik. “Gen Z - those typically born between 1997-2012 - is the first generation that has grown up treating pets as humans. Prior to COVID, pet expenditure was growing at about 5 per cent per annum, but that has now increased to 7 per cent per annum.

“And what has really given us confidence about this mega trend is that there are going to be 1.8 billion Gen Zs in the next 10 years. They are going to be the largest generational cohort that treats pets as humans, as well as representing the largest segment of the working population. Gen Zs are seeking to spend much more on pet expenditure than all previous generations.”

A stock that Insync owns which ties in with this mega trend is IDEXX Laboratories - an American multinational corporation engaged in the development, manufacture, and distribution of products and services for the companion animal veterinary, livestock and poultry, water testing, and dairy markets.

“The return on investor capital for IDEXX is close to 60 per cent. That’s almost four times the market average,” says Monik. “So, when investing, we’re always mindful that share prices follow the sustainable earnings growth of a company.”

Similarly, when it comes to thematics, PPM also looks for industries where there are likely to be long-term excess returns. One such industry it likes is healthcare. Hugh believes the growing wealth of people living in developed countries will enable them to spend more on their health as they age. 

“When investing in companies, what we’re also looking for are the barriers to entry and the ability to maintain rates of return on capital. One of the areas we think is very attractive in healthcare are hospital franchises,” says Hugh.

PPM is currently invested in Universal Health Services - an American Fortune 500 company that provides hospital and healthcare services. This U.S. business is not only attractively priced, but also has a long history of high and consistent return on capital.

As a thematic, Aoris likes the beauty and personal care space, and maintains a position with the French company, L’Oréal.

“We like mature businesses. L’Oréal is a very broad business, and with breadth comes robustness. It operates in every beauty channel and category globally,” says Stephen. “What we have seen is that through the pandemic, the best businesses have pulled away from their peer group at an accelerated rate, and this has been the case with L’Oréal.”

In 2021, the global beauty market recovered by 8 per cent, but L’Oréal grew by 16 per cent. And in 2022, while the market has grown by 6 per cent, L’Oréal grew by 12 per cent and with profit margins that are higher than what they were one year ago.

As a company, Stephen says L’Oréal epitomises the qualities Aoris looks for when identifying companies to invest in. These qualities are: durability; consistent high levels of profitability; a market leading business; and the ability to generate long-term wealth.

As part of its single strategy approach to investing, which Stephen believes gives the manager a competitive edge, Aoris continues to target returns of 8-12 per cent per annum over a 5-7 year market cycle. In fact, Stephen reports that the portfolio has actually delivered above that target since its inception.

Monik believes that if you’re investing in profitable businesses that are linked to sustainable mega trends, it means the manager doesn’t have to keep shifting investments and allocations around. It’s this relative stability around the investment process, as well as strong narratives around each stock and mega trend, that resonates with investors. This approach, says Monik, provides Insync with a competitive edge over other global equity managers.

It’s a similar story at PPM, where Hugh says the simplicity of the company’s investment philosophy provides the business with a definite advantage.

“We’ve stuck to our investment philosophy for over 25 years because it works,” he says. “However, sticking to your philosophy is not as easy as it might sound, particularly in periods when the markets are going against you in a relative sense.”

He adds that having a simpatico connection with clients is also critical to avoid being dragged into areas that, as a business, you don’t want to be in due to client pressure. “The ability for the client to actually understand what they’re buying is really important, and it’s something we spend a lot of time with clients on.

Hugh MacNally is a Director and Founder of Private Portfolio Managers;

Monik Kotecha is Chief Investment Officer at Insync Funds Management; and

Stephen Arnold is Managing Director and Chief Investment Officer at Aoris Investment Management.

The session, ‘Boutique management within global equities’, was moderated by Nigel Douglas - Chief Executive Officer at Douglas Funds Consulting.