The following article appeared on Livewire on April 16, 2021.
Lakehouse Capital chief investment officer Joe Magyer has harboured a curiosity for investing from an early age – his earliest memories filled with nostalgic recollections of summers spent at the Lakehouse his grandfather built on luminescent Lake Burton, northeast of Atlanta, Georgia.
While his cousins and brother were out swimming, playing with BB guns and other “wild things American kids do”, Magyer was inside the cabin with his grandfather, where he finessed his flair for finance.
This early education on the intricacies of investing has undoubtedly paid off. Lakehouse Capital’s Australian Small Cap Fund has returned 71.8% over the past year (as of March 31), and 23.9% per annum since its inception in mid-November 2016.
For some perspective, the fund’s benchmark, S&P/ASX Small Ordinaries Index, has returned 52.1% and 10.5%, respectively. That is an outperformance of 19.7% and 13.4% – and that’s after fees and expenses.
The Lakehouse Global Growth Fund – launched a year later – has enjoyed similar success, returning 48.1% over the past 12 months, and 25.6% p.a. since inception. In comparison, the MSCI All Country World Index has returned 24.2% and 10.9% over the same time periods.
The secret to this success is a “fascinations-based approach” rather than a traditional filtering system, which Magyer believes is the key to long-term outperformance.
In this CIO Profile below, Magyer takes you through his three guiding pillars – enduring IP, network effects, and customer loyalty – and outlines how he applies these to an investment case.
Plus, he outlines how he is positioning his portfolio with inflation in mind, and provides three global stock ideas which speak to his investment philosophy – Monster Beverage (NASDAQ:MNST), Visa (NYSE:V) and Sansan (TYO: 4443).
Note: Watch the interview by clicking the video or read an editorialised version below. This interview was filmed on 31 March 2021.
Joe Magyer’s three keys to success
Magyer believes there to be three key factors that can contribute to long-term outperformance: trading less, backing your winners, and searching for “asymmetrical outcomes”.
“We’re long-term investors; we believe in putting time on our side in a very evidence-based way,” Magyer says.
“The truth is that when you look at study after study, they all show the same thing, which is investors who trade less on average have better performances than those who trade a lot. And that’s true across different time horizons, markets, asset classes.”
He believes this to be all the more true given many of Lakehouse’s competitors are increasingly looking towards shorter-term tactics in their pursuit of benchmark-beating returns.
“I think that makes the value of a long-term perspective that much more useful,” Magyer says.
His second tip is to back your winners and focus on a high conviction approach to portfolio management.
“Again, it’s evidence-based so it’s intuitive in the sense that if you own dozens and dozens of companies, you are probably not going to know them very well,” Magyer says.
“The evidence shows those fund managers who are on average more concentrated outperform those who aren’t. So it’s really just a matter of backing our best ideas and making sure we’re putting the odds in our favour.”
Last but not least, he recommends investors look for companies boasting “asymmetric outcomes”, which Magyer defines as “multiple ways to win and few ways to lose”.
These are companies that possess pricing power with customers and suppliers in growing markets, boast competitive advantages like strong brands or network effects, have aligned and experienced management teams with strong track records, and are trading at attractive valuations.
A “fascinations” approach to finding winning stocks
While Magyer says there are “plenty of really good opportunities” on our local bourse, he notes that 98% of the world’s equity market value is outside of Australia.
To tackle this ginormous universe, Magyer and his team employ a somewhat unusual gambit to finding winning investments – “a fascinations-based approach”.
“When we were assembling the team, we asked ourselves ‘What is the big goal that we’re trying to achieve here?’ And that’s long-term outperformance by backing a group of high conviction companies that we think can reinvest at attractive rates over the long-term,” he says.
As it turns out, companies that boast the traits of “asymmetric outcomes” (competitive positions, aligned management teams, really good unit economics etc.) tend to have similar business models, Magyer says.
While there isn’t necessarily a correlation around what sector or country these companies are based in, Magyer says they do tend to have one or more of the below:
- Unique and enduring intellectual property or IP;
- Network effects;
- Or extremely loyal customers.
“So when we built out the team and started to focus on how we were going to put ideas in the top of the funnel and work them through, we decided to base it around those business models that we think are aligned with long-term outperformance or at least puts you in the best place to get that outcome,” he says.
“Every idea that comes to the table, comes through the lenses of those business models. It’s less running traditional screens and more about identifying truly differentiated businesses with those unique models and working our way through the ecosystem around them.”
Magyer points to Japanese-domiciled Sansan (TYO: 4443) as an example of a new global holding, a business that at its core is a contact management system starting with business cards.
Magyer outlines a handful of key factors which he believes point to the future outperformance of Sansan.
- Business cards are still a very big cultural element of Japanese business, even despite what’s been happening with COVID-19.
- Sansan has developed an AI solution that allows users to snap a photo of a business card – with the information then collected and stored in a database.
- This is valuable as it becomes a Salesforce-like type offering, which not only keeps up with “who knows who, but who’s met who, who should talk to who, and it becomes more of a system of record,” Magyer says.
- Sansan also boasts the largest professional network in Japan, Eight, which is larger than LinkedIn in the country.
Why there is more upside potential for companies with intangible assets
Lakehouse Capital typically invests in companies with intangible assets, with the firm’s five largest Aussie holdings being EML Payments, Netwealth, Pro Medicus, Pinnacle Investment Management and Tyro. Its largest global holdings are Facebook, Sansan, PayPal, Adyen and Monster Beverage.
“Businesses where it’s based on hard assets as your advantage … those things are harder to hang on to, and over time they tend to get eroded, they are a little more open to disruption and they tend to be more cyclical with worse returns on capital,” Magyer says.
The only business with “tangible” assets on his top holdings list is Monster Beverage (NASDAQ:MNST) – which is set apart by its strong and recognisable brand.
“The reality is that business is still very capital-light because the value in the business is really the brand at its core,” Mayger says.
- While it’s not Monster and vodka, it’s “Red Bull and vodka”, Monster has been consistently gaining market share from Red Bull for many years globally.
- Plus, the “brand speaks to a lot of people”, and the business has “fantastic margins” with “excellent returns on capital”, Magyer says.
How growth investors should position their portfolios in a Value market
Magyer says it’s important for investors to have a clearly defined investment philosophy and process, and to stick to thier guns throughout good times and bad.
“You have to know there are times when your approach is going to be more successful, but just be comfortable with the fact that you are going to have periodic bouts where things may not necessarily be going your way,” he says.
Right now, as I am sure you are well aware, we are seeing a strong rally in cyclical, Value-orientated stocks – which Magyer says historically have had “volatile”, “low returns on capital” and have “not generated a lot of wealth over the long term”.
“We’re very comfortable not owning those companies over a long time for that reason; they don’t aline well with our time horizon,” he says.
However, there is a “lot of range” within the Growth universe itself, Magyer says.
“When you’re working with a global mandate, as we are, you’ve got tens of thousands of rocks that you can turn over and there’s a big universe of companies where you can always find something new,” he says.
“So yes, you might be running into valuations being high in one part of the market, one sector or one geography, but it’s a big world and there are a lot of different opportunities.”
Additionally, Growth investors should focus on “letting their winners run”, with Magyer noting that if investors consistently take “quick profits” they will be left “owning the businesses that did not work out and some cash”.
And while you want your winners to run, he warns you “have to let that happen naturally and you have to be conscious of valuations”.
Magyer has taken profits on a few different positions though, particular holdings within the mid-cap Software as a Service (SaaS) arena.
One such company is M3 Inc (TYO:2413), which Magyer describes as “basically a Facebook for doctors”.
“When we were invested it was selling at about nine times forward revenue, which I appreciate for someone out there who buys conventionally cheap stocks may sound expensive but it’s a very high-quality growth company in a market where interest rates have been near zero for two decades,” he says.
“Over the course of the time we owned it, we averaged up when the thesis was proving itself out, then later took some money off as valuation started to get stretched and ultimately fully exited when it was selling at 36 times forward revenue, at which point we just couldn’t justify hanging into the position anymore.”
A global stock pick for an inflationary environment
Investors have a lot of reasons to be concerned about inflation, Magyer says, pointing to ultra-accommodative fiscal policy, global monetary policy and QE, historically low-interest rates, and cashed-up consumers as key signals already flashing red.
“I don’t know how many more things you need to stack up to be concerned about it,” he says.
“The way we think about inflation is, all the companies that we seek out have pricing power as one of the core traits we are looking for – so that’s inbuilt protection in terms of what we own. Beyond that, more than half the companies we own have business models directly tied to the value of what flows through their business – so payments, marketplaces, advertising.”
These types of businesses “clip the ticket” on the value of money flowing through, helping to build protection against inflation.
He points to Visa (NYSE:V) as a key example of this. Visa is one of Lakehouse’s core long-term holdings and Magyer topped up the fund’s exposure to it recently.
- Visa boasts strong network effects as the world’s largest payments provider.
- In terms of inflationary protection, if inflation runs away – particularly if it’s because of a strong economy – Visa is well placed to take advantage of that.
- Post COVID-19, more purchases are being made globally on card rather than cash which also benefits the payments giant.
“A lot of people ask: ‘What does Buy Now Pay Later (BNPL) mean for Visa? Is it a threat?’ But, it’s actually a revenue positive for them because almost all of those transactions end up flowing through cards and instead of one purchase it’s split into four. So they really just get more bites of the cherry,” Magyer explains.
“So, it’s a business that we think is structurally really strong long-term, but we feel really good about the next couple of years as well.”
Why individual investors and portfolio managers can benefit from a low turnover approach
A low turnover approach has two major benefits, Magyer says. The first, is that trading less on average leads to better outcomes, so you can increase your odds of “a good outcome just by being patient and not overtrading”.
The second, is that you will really know the companies you own, he says.
“During COVID-19, I saw an interview with a fellow fund manager who was touting that everyone on their team had worked around the clock, basically through the whole stretch to try to re-underwrite all their investments,” Magyer recalls.
“And while admirable and it sounds great because everybody loves hustle. I would say, respectfully, if they had a tighter handle on some of their companies from the start, they might’ve been able to conceptualise those things better.
“Part of that is having a higher conviction portfolio, where it’s just tighter and there are just fewer investments, but part of that is turnover driven.”
The typical global manager in Australia will have around 60 holdings, while Lakehouse will have around 20.
“If you’re thinking about how hard it is to stay across 60 companies, and if your turnover is something like 100% a year – which is common with a lot of active managers – imagine your portfolio manager who has to basically relearn the investment case for 60 companies every year, right?” Magyer says.
“You’re just not going to know those companies well, you’re not going to have a lot of conviction, and when things get challenging you’re probably not going to hang in there, which just kind of feeds on itself.”
One thing investors can’t ignore
Magyer’s factoid that he shared with you, our valued readers, is that over the long-term approximately 37% of active managers outperform their benchmarks.
“I think that’s fascinating because once you get inside the machine, and you’ve met tonnes of fund managers, what you come to learn is they’re all very smart, all very well-educated, great training. They’ve got Bloomberg terminals, FactSet, they’ve got research tools, company access, that individual investors do not have,” he says.
“You’ve got analysts supporting you who are wicked smart, hustling, trying to climb the ladder themselves. So on paper, these people are all set up to succeed, and yet most of them don’t. And I think a good question to ask is why?”
Well, he argues that most strategies and investment products aren’t designed with performance for the client front of mind, instead focusing on corporate risk.
He also points to high holding numbers as a key reason for this underperformance.
“Research consistently shows that investment managers best ideas on average really do perform the best. So the number one weighted position in the fund delivers the best performance, followed by number two and so on,” Magyer says.
“It’s intuitive and it makes sense. But then why do people stretch to 60 plus holdings? I’ve never met a client who was like quick, tell me your 60th best stock idea.”
He argues that if investment managers were more willing to “back themselves” they could end up with better results.
For individual investors – the clients of these funds – Magyer recommends they actually ask their managers how many companies are held in a fund – and more importantly, why?