Portfolio Manager Q&A - Joe Maginot

Following a strong 2023, the S&P 500 is up another 6% this year to date. What risks do you think investors need to consider as we progress through the year? And how do you and the team approach managing risk in both rising and falling markets?

As in any given year, there will always be things to worry about. Right now, investors are grappling with whether inflation will come down, when the Fed will cut rates, and how that will impact employment levels and consumer spending. While these are all risks investors need to consider, when we think about controlling risk within our portfolios, it has to start from the bottom up, looking at the securities we own. We believe the best way to manage risk is by investing in the right companies at attractive valuations. If you can invest in companies that can absorb a wide range of external shocks over various economic and market environments, you should do well over the long term.

The recent market environment has been selective, to say the least. Can you share an example of how your investment process helps you identify opportunities in different market conditions?

We want to invest in the highest quality companies out there. The companies with the most attractive growth rates, that participate in growing industries, and are well managed. Often, those companies aren't priced at bargain valuations. So, typically, something has to happen to cause that disconnect, or the market has to sour on those companies. It’s typically something happening in the industry at large, the broader economy, or at the company specifically. One example that comes to mind is Lowe’s, which has been a long-term holding in the portfolio. The rise in interest rates over the last 12 to 18 months has really depressed activity in the housing market. Lowe's typically benefits from housing turnover, as homeowners often invest significant amounts in repainting and enhancing the appearance of their homes when preparing to sell them to potential buyers. Then, when the property is sold, the new homeowner often begins their own renovation projects, redoing the previous enhancements to suit their preferences, such as repainting walls or installing new flooring.

With most homeowners having mortgage rates much lower than current levels, people are hesitant to sell and move, which has depressed the level of activity in the housing market. As a result, the market has soured on companies like Lowe’s, which we still think is an extremely well-run company that generates terrific business economics. We believe Lowe's can do well, even if the underlying environment stays depressed, and that they will continue to return capital to shareholders through dividends and, as importantly, share repurchases. So that's an example in today's environment where the company is certainly out of favor, but we quite like the long-term prospects.

Can you elaborate on the key factors you consider when evaluating the quality of a company?

We invest in companies that generate very attractive economics for the owners of the business. In other words, we want attractive and persistent returns on capital, but just as important, we want companies whose products and services are becoming more relevant within the global economy. We want the company to grow with at least the nominal growth of the broader economy. Secondly, we want companies with great balance sheets because that allows them to invest counter-cyclically and oftentimes gain share despite a downturn in their end market. Such as the Lowe’s example I just shared. Then, the last piece is management. Simply put, we want the management team to be in the same boat as us, rowing in the same direction.

Has your approach evolved, considering the increasing role of AI in today’s market?

We’re very risk-focused investors; we don’t think all returns are created equally, but rather, it’s how much risk you take to generate those returns. The proliferation of AI has really forced us to re-underwrite all the companies that we thought had exposure to potential disruption from this. The key question we asked ourselves was: is this a technology that will be subsumed and integrated into the existing technology platforms and companies out there, or will this technology represent a platform shift, where all the companies that benefited in the old world, so to speak, will become obsolete.

For example, we have investments in payment technology companies. AI could be used by malicious actors to make fraudulent transactions. We think payment companies will have to continue to invest in best-in-class authorization and fraud prevention, and we think the incumbents are in the best position to make those investments. Over time, we think it will enhance their competitive positions.

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