01 Oct Overcoming the Asset Size Barrier to Return and Scaling Our Hidden Champions Fund
“If a red ant were 8 inches high, the geometrically proportional weight of its body would crush its external skeletal structure. And if an Indian elephant were 15% larger, its body weight would require such bone and muscle strength in its legs that its weight would make it simply too heavy for the muscles to lift and the beast, unable to move, would starve.”
– Charles D. Ellis, leading American investment consultant and founder of Greenwich Associates
“Size is the enemy of performance.”
– Warren Buffett at Berkshire Hathaway AGM 2016
“Charlie and I operated mostly with 5 positions. If I were running 50, 100, 200 million, I would have 80% in 5 positions, with 25% for the largest. In 1964 I found a position I was willing to go heavier into, up to 40%. I told investors they could pull their money out. None did. The position was American Express after the Salad Oil Scandal. In 1951 I put the bulk of my net worth into GEICO. There were various times I would have gone up to 75%, even in the past few years. If it’s your game and you really know your business, you can load up.”
– Warren Buffett, 25 February 2008
Fortune selling. Selling what sells, not what will work best for investors over the long term. Investors are often seduced to part with their hard-earned money during “hot” times when they are pitched with supposedly strong streaks of historical returns or/and popular and “noisy” themes.
Just as opportunistic “entrepreneurs” spend resources to build casinos to take advantage of gamblers, arbitrageurs create investment products to predict and feed noise trader demand.
These can be Chinese reverse mergers, penny oil & resource stocks, thematic stocks (e.g. Iskandar property, Myanmar plays, Korean film production, social commerce platform), junk bonds – anything that is popular and often overpriced at the moment.
After bringing in new money, these opportunistic “entrepreneurs” proceed to hire more analysts to cover more stocks and fund managers to trade and “diversify” into an ever-increasing number of companies without enough understanding of their business economics and quality of management.
Performance results then falter from this “desk-count” investing approach as asset managers start chasing lower quality companies just to put money to work when compared to prior years in which early investors made the “easy money” from a smaller fund size. Thus, often, the fund may do well in 2, 3 or 5 years, and then returns start to falter. New money may go into the fund just when returns are beginning to deteriorate. A fund should have a system in place such that a new client coming in at any time is not put at a disadvantage.
Fund size overloads the organisational capacity to produce superior returns i.e. it gets tougher – and riskier – as the business gets bigger, akin to an individual star fund manager Sisyphus pushing up a boulder that grows bigger the higher and faster he or she pushes it up the increasingly steeper slope, only to watch it roll back.
Market volatility and chaos, mania and panic – they would be our friends if clients really understood and appreciated our investment process to invest in high-conviction stocks since the underlying business fundamentals of the companies stay intact but stock prices, in the short term, have diverged from the intrinsic values, presenting great mispricing opportunities for long-term investors.
In fact, we find our Hidden Champions are resilient and grow stronger with each punctuated crisis as their unique, scalable business model, product innovations, and service excellence enable them to win over customers and gain market share over their unfocused, distracted or/and contented rivals who tend to “stray” as they find it easier to seek “growth” by engaging in private business interests outside of the listed vehicles, particularly in property development.
Investing in the Hidden Champions is “all-season”, which allows us to protect, preserve, and guard the assets of our clients in good and bad times, for a Hidden Champion is born every day, even under the most austere of conditions and environment. A healthy seed can withstand adverse conditions for extended periods of time, waiting for the right combination of conditions to grow.
As emphasised, we aim to be a Top 20 Shareholder disclosed in the Annual Reports of the companies we invest in as a demonstration of our conviction and transparency in the investment process. We are a Top 20 Shareholder in 7 world-class wide-moat companies, out of the 18 portfolio stocks (we added 4 stocks in April after the Financial Year Ended) and we are looking to accumulate more, up to becoming a substantial shareholder with a 5% stake as they continue to deliver in their business fundamentals. At a 5% position in our portfolio stocks, our Hidden Champions Fund’s capacity build-up that is immediately executable is over S$551 million.