Kurt Dupuis:
Welcome to The Whole Truth, where two wholesalers help financial professionals build great practices and thrive in a rapidly changing industry. We'll bring you the stories and voices from those on the front lines of this change, and we'll have some fun along the way.
Steve Seid:
We're building a community of financial professionals who are growing ,forward thinking and want to get better. Thanks for listening and contributing to the discussion.
Disclosure:
The views expressed herein are those of the participants and not those of Touchstone Investments. We are joined by Thomas Trentman, CFA, Sr. Portfolio Manager and Jack Mayer, CFA, Sr. Manager, Portfolio Specialist of Sands Capital Management, LLC a sub-advisor of Touchstone Securities, Inc.
Steve Seid:
And welcome everybody to the whole Truth from the Bay Area, California. I am Steve Seid.
Kurt Dupuis:
And from Atlanta, I'm Kurt Dupuis.
Steve Seid:
How are you man?
Kurt Dupuis:
I'm doing great. We typically record on a Friday. This happens to be a Friday, so the end of a long week, sun shining, feeling good about life. How about you?
Steve Seid:
Yeah, I'm good. Everything's been really good. New Noel Gallagher song out. For those who don't and aren't listening to Noel, that's like my favorite person ever. He was the old lead songwriter for Oasis, so look up that new Noel Gallagher song. It's just, mm, it's epic. Do you like Oasis, Kurt? Have we had this conversation?
Kurt Dupuis:
We've had this... I'll talk about this more in Costanza Corner, but yeah, I'm nowhere near the fan you are, but yes.
Steve Seid:
Oh man, he's doing good work on his solo stuff. Anyways, I don't know how he got down this path, but I took us there.
Kurt Dupuis:
Aren't I the one that sent you that link to this Oasis cover band here in Atlanta called BROASIS?
Steve Seid:
Oh, you did. You're right. That's right.
Kurt Dupuis:
Come on, man. I know you.
Steve Seid:
That's right. See, sometimes I have the memory of a goldfish, I swear, man. It's crazy. So on a completely different turn, let's talk about the episode. We are beyond thrilled to have Sands Capital on the podcast this week, this episode. A couple things I want to say upfront about it. One, this is not a podcast about investments. We're not looking to do the typical, "Hey, let's go talk about our wholesalers, about how they do what they do." That's not what this is. We're looking to ask some very specific questions that are on the mind of our audience lately, or that we find to be on the mind of our audience lately. Specifically, Sands Capital runs three portfolios for us, all growth equity, they run domestic large growth called Sands Select Growth. And then we have two international portfolios as well an emerging markets in an international developed.
Let's talk about the things that have been on your mind, the focus of this episode. We have Tom Trentman on, who is very long time senior portfolio manager for the Select Growth Portfolio domestic. And what we wanted to ask Tom about was, how do we even think about growth at this point? Depending on when you're listening to this, we're recording this in early 2023. Growth’s had a nice rally, but boy, it's been... If we think about and we look back the past 10, 15 years, it's been a rollercoaster. It's like growth is the only thing that works. Growth, growth, growth, then interest rates pop a little bit and all of a sudden, we're on this rollercoaster and so it's just been, since '08, and these boom-bust, cycle in growth equities. So we wanted to ask him about that, how to actually think about that particular space?
And then the second part of the interview gets into emerging markets and we had Jack Meyer on, who's a senior portfolio specialist at Sands. And, specifically, the question we want to ask about emerging markets is, do we still want to even think about it? I mean, emerging markets is this place that we always have super high optimism about. We've been hearing about the growth in population and this huge middle class and this buying power. And then we look back and the returns have been, eh. You're much better off staying in domestics. So we ask him the hard questions like, should we even care about emerging markets at this particular point? So that's what this episode's about. It's about asking some challenging questions to some really, really intelligent people, so we're thrilled to have them on the show.
Kurt Dupuis:
Yeah, I think what I was reminded of was... It's a basic fundamental tenet of thinking about growth and where growth comes from. Zooming way out, you buy growth because you believe in optimism. You believe in the human species finding new mouse traps and making existing mouse traps more effective. So we talk about the biotech space and how medical outcomes are vastly better than they were a couple decades ago, or the emergence of AI and the technology that's going to be used to house and fuel all that. And then the emergence of tech and financial services, how there's a lot of these companies that are quasi commercially-driven, just a good reminder of all that stuff. And coming from really smart guys, that this is all they do, all they do is growth. There's some great stories in here about the depth of their research when they're investigating these companies. Just great, all around interview that's not product-centric, but just space centric.
Steve Seid:
Yeah. We got and talked about some really, really interesting thematics, which I don't know about you, Kurt, but I just get really revved up when I talk to these guys. So really excited for everybody to hear this conversation.
Kurt Dupuis:
Yep. So when we get back, we will get to our interview with Sands Capital, so make sure you like this episode, hit subscribe, hit download, send to a friend, send any questions, comments, or concerns to Steve Seid at thewholetruth@touchstonefunds.com. So without any additional fodder, here's our interview with Sands Capital.
All right. Well we are so excited to have a few of the folks from Sands Capital joining us today. And Tom, we'll get to you in a second. And we have met and we've been on some client calls where we've met but Jack, you are a new face, at least for me, at Sands. So, we always feel like people do a better job at introducing themselves than we do, so can you tell us a little bit about your story and background?
Jack Mayer:
Sure. So, thanks for having me, Kurt. My name is Jack Mayer. I'm a senior manager and I'm a head of the portfolio specialist team here at Sands Capital. And so, what my team is really tasked with is serving as a connection point between the PM teams, our client relations teams, and our marketing groups. And so, we're positioned as these internal subject matter experts on the portfolios and so, we have a dual mandate with that positioning in terms of supporting client retention and business development, but also supporting the PMs so they can focus on what they do best in finding companies and managing portfolios. I've been at Sands Capital since 2016 and my prior experience was on the other side of the table at Morgan Stanley Wealth Management and JP Morgan Private Bank.
Kurt Dupuis:
Gotcha. And for those that are not familiar, could you give us an overview of Sands as a firm?
Jack Mayer:
Yeah, happy to. So Sands Capital is an independent, staff owned investment management shop based right outside of DC and we are exclusively focused on investing in growth equities. So we opened our doors in 1992 and back then, we focused solely on US large cap public growth equities, but we've since taken our philosophy and approach and we've applied it across growth stages. So everything from venture capital to public equity, as well as geography. So everything from US to emerging markets.
Kurt Dupuis:
Yeah, right outside of DC. Their offices are absolutely amazing, I love visiting it. Although I will tell you what's a little distracting because I was there not long ago, the whole being in DC thing is major. There's helicopters that are flying by, you see the snipers on the top of roofs, it's a different world yeah….
Kurt Dupuis:
The Washington Monument.
Steve Seid:
Yeah, the whole thing is...
Kurt Dupuis:
Just hanging out by the Potomac.
Steve Seid:
Yeah. Yeah, it's a trip. So, talk about your process, if you would, at a high level and then follow that up with the investment edge. So when you're investing in an active manager, it's really important to know what is it that they actually have that gives them an edge relative to the market. So if you could talk about those two things.
Jack Mayer:
So everything at Sands Capital first starts with our mission, and that's simply to add value and enhance the wealth of our clients with prudence, over time. But what does that mean in practical terms? That means what we're really trying to achieve is out-performance over rolling, long-term periods. And when you think about our philosophy, what we've observed over long-term periods is three key things. The first is that when you have a period of five or more years, typically, it's the earnings growth of the company and the business fundamentals itself that explains movements in the stock price.
Second is that when you look at the market, most of the gains accrue to a select few group of businesses. And then the third thing is that in the near term, stocks fluctuate and they move around for a lot of reasons, and a lot of the time, it's unrelated to the actual business operations. And so what we do is, we apply our investment criteria to find, or I should say, to seek businesses that are capable of sustaining above average growth for long periods of time. We then take those businesses and organize them into concentrated conviction-weighted portfolios, and then we also make sure that we don't conflate volatility with risk.
Steve Seid:
So to be specific, what do you think the investment edge is, to state that specifically?
Jack Mayer:
Yeah. So in terms of the edge, I think I would bucket it into two categories. And so, from a first category, which I would classify as behavioral, I think it's a culture of shared ownership, it's a focus on the long-term and decision-making to support long term endeavors, and then a focus on really what matters most. We want to get a really small number of very important things right, and one of our portfolio managers has this great saying, that he may have stolen, that, "Much of what can be measured doesn't matter, and much of what matters can't be measured."
From a process perspective, which is that other bucket, I think that our philosophy naturally exploits three market efficiencies. Short-termism is the market seems to be myopically focused on today or this quarter, the asymmetry of equity market returns. Everybody talks about the broad market, but they fail to realize that the upside is unbounded while the downside is capped at 100. And then linear thinking, which is that failure to understand exponential growth potential, especially when it comes to earnings growth over time. So that's what I would classify as our edges.
Steve Seid:
Well, I just want to comment on one of the things you said, which is that... I think you said the rewards accrue to a few select, really good companies over time, which is interesting. And I know we're talking about active and passive here, but that's not... Right now, the academic community, for example, has concluded that you should just own everything.
Jack Mayer:
We believe that we have our criteria and our process and our philosophy that tilts the odds in our favor of finding those businesses. We certainly don't find them all of the time, but if we're right a little bit more often than not and we're weighting our portfolios in those investment cases where we have the highest conviction, over the long-term, we hope that we will succeed in our mission.
Kurt Dupuis:
So Sands Select, the U.S. was first, what came next and in what order?
Jack Mayer:
Yeah, that's right. So we opened our doors, as I said, in '92 with our main Select Growth, which was U.S. large cap growth focused. And then sometime during the mid aughts, we found that we were increasingly doing research overseas to both examine the opportunities for our domestic companies, for our U.S. companies that had overseas operations, as well as the competition. And what we found was that there was an increasing number of these X-U.S. businesses that met our criteria and enough so that we could create a portfolio that mirrored the characteristics that we wanted in our Select Growth portfolio.
And so, we launched our global growth strategy in 2008 and continued to apply that thinking to other opportunity sets in the public equity space. And so, we launched that global strategy, then our emerging markets growth strategy. We now have an X-U.S. strategy, and then we've also taken that same kind of thoughtful expansion approach in terms of growth stage. And now we have venture capital and growth equity strategies as well. Now, while each of those has a different opportunity set, I would highlight that they all are underpinned by the same principles, philosophy and team, and they are truly complimentary in terms of just helping us broaden our perspective about the ecosystem, competition, opportunities, et cetera.
Steve Seid:
That's great. Let's transition to Tom now. So Tom, jump on in. We want to start to talk about the Select Growth strategy, which is predominantly large growth. Introduce yourself and then we're going to start firing some questions about the space, which has been a roller coaster, if you would, in the last, call it 10 years.
Tom Trentman:
That's a nice little euphemism there. Yeah, so I joined Sands Capital in 2005. So over the last 18 years, I've spent some time as a tech analyst, tech PM and now, co-PM on Select Growth. And yeah, so I cut my teeth really learning our process in the tech sector, how to think differently about companies, how to take that long-term perspective, and ultimately, just expanded from a narrow purview on, say, internet companies into broader tech and now the larger U.S. market.
Steve Seid:
And so, just a quick overview of Select Growth, what does a portfolio look like? How do you guys approach that portfolio?
Tom Trentman:
Yeah, so if you look at Select Growth, so I mean as Jack said, that's the original strategy of Sands Capital. The view is that we want to own the 25 to 30 best growth franchises and we select them via our six criteria. And we want to take a long-term focus as business owners, rather than paper traders or stock traders. So we're trying to think about what is the business today, where will it be five and 10 years from now, and how is that a differentiated view than what others are seeing when they look at those same companies? And we want to be concentrated in the very best ideas. 25 to 30 gives you some diversity of drivers and company types, but we're not selling good ideas to buy lesser ideas.
Steve Seid:
Excellent. And so, let's reflect a little bit on the growth space. We're recording this at the beginning of 2023. Some of the growth names have started to come back a little bit this year, but obviously, the last 18 months, with rising rates, has just been a crazy environment and an extreme environment. But having said that, I look back over my career, there've been a few of these. 2008 and then growth dominates, and then you have the '15, '16 era where high growth is getting smacked down. And then, of course... It seems to go on these, what I would call, pretty extreme cycles lately where it's all growth and then growth gets punished and then it's all growth again. I guess I wonder how you guys think about that, what you think about when we go through these periods?
Tom Trentman:
Yeah. So as you mentioned, I mean, there are cycles to the broader market backdrop, and this is the most pronounced period, but we've been through a lot of periods like this before. And the downside in growth usually comes when the macro fears are overriding fundamentals and durations are dramatically shortening. And this has been a pretty extreme version of that when interest rates go up 800, 900 percent from near zero to where they are today. But if we think about what happens through these cycles, our focus is, again, back to that, what's our process, our six criteria, and being selective and focusing on concentrating the best ideas and staying calm and always forward-looking as we think about where the opportunities are. And ultimately, if you look over long periods of time, the fundamentals do shine through, the earnings growth drives our long-term returns. If fluctuations and multiples can adjust much faster in the shorter periods of time. But over the long run, it's really those sustainable companies proving out their earnings, that drives the value.
Steve Seid:
I know you guys are pretty calm because you're long-term, but on the PM team, be honest, there's got to be days where you're just like, "What is this?" When this company that's doing really well and the market is just absolutely annihilating it for, I don’t know, interest rates or whatever, or for short-termism, what do you guys say to each other? Is it really like a, "No, we're good."?
Tom Trentman:
It's definitely not fun getting kicked in the teeth every day, and that's what the last year has been a lot of. Again, it's having the conviction in your process to not get off your game when that happens.
Steve Seid:
Yeah.
Tom Trentman:
I mean, there's no two ways around it, it's not fun. You certainly don't go through periods of this where you don't see things that you got wrong and things you could have done better. But having the conviction and the belief that the core of what we do makes a lot of sense, and we just keep applying our process and we’ll come through on the other side.
Kurt Dupuis:
So, I have a story. I started at Touchstone in 2017, which I think prior to the last 12 to 18 months, that '14 to '16 was kind of a tougher spot for Sands. And I remember thinking, "What have I gotten myself into? This is one of the top funds that we talk about," And then proceeded the next several years to be proven wrong time and time again as it kind of had a nice run there. But what I saw then and what I see now is, people tend to time this thing awfully, right? Because there is volatility and we could talk about the behavioral aspect of investing, but it seems like something like this, people really get wrong. And I'm just curious because you deal with such a wide swath of clientele, do you see that on the institutional side in some of your foundations as you do in the retail side?
Tom Trentman:
Yeah. So, I mean, what you're describing is natural human psychology. We all like feeling smart and what's working feels smart and you get a lot of trend following behavior, and ultimately, that's a lot of what causes the cycles we were talking about earlier. The key is to step back and recognize that and then have the conviction in a process, to stick through those periods. The institutional clients, the ones that are a good match for us, understand where we play in the markets and how these cycles work and they understand that there are these cycles to take advantage of. And if you have the conviction and the manager, just as we have the conviction in our individual portfolio companies, then you don't overreact and get put off your game at the absolute worst time or trend follow and make mistakes at the worst time. So there's the natural idea of rebalancing and we are a role and larger asset allocation and it makes sense when things are going well, we'll see rebalancing away and when things are going poorly, that's the opportunity and that's rebalancing towards us.
Kurt Dupuis:
I'm curious what you would say... I mean, I don't know what the cocktail parties are like in the DC area, but when you talk to folks that are not clients and someone would question, "Why don't you just index this space?" How would you think about answering that?
Tom Trentman:
Well, the nice part of being in DC is that very little of the cocktail conversation is around work so you get a little bit of break. You'd probably get too much politics on the other hand politics I'm sure.
Kurt Dupuis:
Yeah.
Tom Trentman:
Maybe I'd rather talk investing. But I think to your point around indexing, so yeah, I mean, indexing is the way to take accountability out of investing. If you own the index, you're going to do a little bit worse than the index with your fees, but you're never going to be an outlier, you're never going to be better, you're never going to be worse. It's kind of a CYA approach and again, it can work pretty well. And it's especially going back to that idea of the worst thing you can do, and I think there's been studies of this, the average mutual fund under-performs by some amount, but the average mutual fund investor under-performs by a far greater degree. And that's because they're trend following, they're buying high, selling low. And it comes back to that lack of conviction in what's going on.
Indexes don't change. They are going to be what they are. So it is a good way to control the psychology and, for the layperson, again, to not get caught up in hype cycles or get pushed out when there's fear. But we think by taking an active approach, we can do better than the index, we can find better companies, we can find the opportunities, we can use that long term perspective that the market is often lacking and especially at times like this where there's a lot of fears and uncertainties that really shortens timeframes and that's to our advantage. And the index has done very well. I mean, I don't know exactly where it is, but it's been into the 20th percentile of the universe for a long, long, long time. And if you look at how it's done that, well, it's gotten even more concentrated.
Steve Seid:
Right. No, absolutely. And I think that's a great point of how concentrated the index has actually gotten. It's almost active at this point, in terms of weights.
Tom Trentman:
Yeah. I mean I think it got all the way up to about 50% here.
Steve Seid:
Isn't that crazy?
Tom Trentman:
And now it's back down to 43, but yeah. It's sort of like two concentrated portfolios. I think our top 10 is usually in the 55 to 60 range. When the index was at 50, that's pretty notable.
Steve Seid:
Pretty crazy, right? Yeah. And clearly, you haven't seen anything else like that where it was that concentrated, in your history.
Tom Trentman:
No, I think when you do get very strong markets, often at the index level, that is because large weights are performing, so you tend to see the concentration increase towards the end of bull markets. But I believe that this was the most... I mean it's certainly the most concentrated we've seen in the last 20 years. The last time it was approaching these levels would've been the late 2000s.
Steve Seid:
Got it. This is going to seem like a value manager question because we talk about value traps and things like that. How do you avoid the trap, again, over the last 18 months, where these stocks are correcting aggressively and going... I really like this company at, I'm making up the number, a hundred. It just got its valuation crushed in half.
Tom Trentman:
Yeah. When stock prices are going down, usually it's not a vacuum, usually there's some sort of news, usually something bad has happened. And it gets back to that idea of, have you done your homework and do you have conviction that you actually know what the business is and what's happening to it in order to stay the course and retain that confidence? And if you don't, you will always get forced out at the bottom when the market is telling you you're wrong. Now the flip side, when the market's telling you you're wrong, you better darn know why you're right. And that gets back, again, to the research we're doing, the depth of it, the long term focus we have, but really, our analysts are experts in their space. We don't meet other folks in the industry who know our companies and our industries better than us.
And, again, that gives you the conviction that you know what's happening and understand these changes and can put them in context. Now, certainly, you know, you don't want to put blinders on and just say, "Oh, the stock's down. I loved it at a hundred, fifties even better, I'll triple down." I mean, bad things do happen, so that's what we did systematically, to make sure that we weren't just anchoring to views we had when the world's changed. So we went back through and studied the unit economics and why exactly do we believe it, and looked again at, why do we have confidence in the market growth penetration for various companies? Has the competitive landscape changed? What are the managements doing as far as operational discipline? Where are they too lax? Are they adjusting? And then the whole re-underwriting process. Again, it goes back to having the confidence to say, "Yeah, this is painful. The market is certainly doubting us."
Kurt Dupuis:
One of the things I've been most impressed with Sands over the years are the anecdotes about the depth of research. So, I've heard stories about interviewing end customers to see what their experience is with the company or interviewing the entire supply chains, suppliers to larger companies to understand their relationship and business dynamics with it. I wonder, and Jack, maybe you can chime in also, but what are some of your favorite anecdotes when you talk about depth of research, that you would point to?
Jack Mayer:
It's rarely when you have a conversation that it's just like, "Oh, I hit the 'aha' just from this." It's really the mosaic you're putting together. I was talking with another colleague this morning about some consumer panels we were doing with buyers in various regions of Brazil and the difference you were seeing in one region versus the other, and how that affected the competitive landscape of the companies based on the services that were available in those individual companies, and then how we could generalize that to, what does this mean for the signal on competitive advantage?
Steve Seid:
Yeah, I'm nerding out right now, so I'm going to go down this path a little bit with you, if you don't mind.
How do you dedicate your time? I mean, here you are, you got an enormous team, like the depth of your team, I think, I haven't seen matched in any other strategy I've come across. But you're investing globally, so you could be running around to every different part of the globe researching. So is it simply like, a company specific, "We're interested in this, we think everything makes sense, now we got to go on the ground and actually start to do on the ground research." How do you direct your time in that kind of research?
Jack Mayer:
Yeah. So as with most things at Sands Capital, it comes back to our six investment criteria. So leadership, sustainable above average growth, leadership in a promising business space, significant competitive advantage, clear mission value added focus, which is really speaking to management, financial strength and rational valuation. So if we think about where are we spending our time, usually, the first three to four of them are where you're going to... Well, we talk about what matters or the linchpin of an investment case. So it might be something about, how is this market going to develop, how is our view on the competition a little different and how is the moat stronger, wider than everyone else thinks? Or how is something changing that isn't perceived today? Say, an evolution from on-premise software to software as a service and how leadership today doesn't reflect leadership to the future.
So as we start with that criteria, usually, again, you'll find out companies meet all six of the criteria, but there's a differentiated view around one or two of them that we can really flesh out. And once you identify that's what you need the answer, that's how the time is spent. So if it is building conviction that the market adoption will happen, that's where we'll spend our time. If it's proving that the market adoption we've got no real questions about, but can they hold a competitive advantage as that market develops or does it just end up being as capital flows in, that gets competed away, we'll spend our time on that competitive advantage. So it's really, again, taking the six criteria and then knowing what matters within them and then building a specific view around that linchpin for the case.
Steve Seid:
Got it. And there's sometimes the view, like with large cap equities specifically, that it's hard to maybe have a different case than what is because so many people are covering these companies versus some company that's in the emerging markets which may be less covered. Is that a fair observation or is that not? In other words, can you find these different types of viewpoints in large cap just as easy as you can when you go overseas?
Tom Trentman:
Yeah, so there's no doubt there are more people looking at the larger cap companies. You know, you just look at how many analysts cover them on the sell side and it'll be far greater for a large cap company than it will be a small cap or something more obscure. And that's where it gets back to the structural advantages that Jack was pointing out. So it's not so much that no one else is looking at it, but they're looking at it differently. And by looking at the long term, we are, by nature, setting ourselves up to have a contrarian view because most of the market's looking very short term.
So if we can focus on what's happening five years from now and how's that going to shake out, then we're playing a different game than the vast majority of people looking at those companies that are trying to figure out what's going to happen with earnings over the next six to 12 months. And so, it's just playing that different game and then being able to think about where are we going over the long term as opposed to trying to compete with everyone on the short term.
Steve Seid:
Let's talk about interest rates for a second, if you can. As you mentioned, the tightening cycle was very, very fast and in some ways, the quickest tightening cycle and the most robust that we've seen almost ever, but certainly in decades. And so with that, I've heard from our clients, our prospects, our friends, hey, these growth companies, they were really expensive. A lot of that had to do with low rates that were elevating their multiples. This period, just bringing them back to a rational valuation, it seemed pretty harsh to me, like a couple hundred basis points and all of a sudden these valuations almost went in half. Do you view the collapse in multiples as rational giving interest rates? I know you don't invest based on interest rates, but I'm curious how you guys view that.
Tom Trentman:
Yeah, so if you go back to that broader cycle idea, obviously, when rates are low, that pushes assets prices up, the discounts rates lower, and so multiples are higher. And we got to a level that was pretty extreme relative to the history of interest rates and thus the discount rates. So rates go up, they're normalized, it happened in a very compressed period of time, but you're normalizing the discount rates for assets and you'd expect them to come in. However, when you do it over a very compressed time period, it's the longer duration assets that take more of the hit. So if you think about that more of the value is in the out years and further out in the DCF1 rather than near term, so the change in the discount rate affects it because you're discounting it for a longer period of time. But that gets overdone because you add it with just... It's not just mechanical like that, you also add that uncertainty level.
So if you look right now, the debate is, "Well, the market multiple is back to averages," But it's not obviously cheap. We're not at seven times earnings for the S&P2 like we were in various points in the seventies. We look at our companies, what that's missing is really the understanding of, what are they showing today versus what are they showing in five years. And going back to that idea of the companies that are investing for the future that are under-earning today, shortening the time horizon and looking at the next one or two years is overly punitive because that company, what they're doing today is investing for the future and what they'll be doing five years from now is harvesting that future.
And that's where, if we look at our portfolio today, we're really excited about the valuations. They've been reset, the companies are performing, we think we're in this separation phase where the baby's been thrown out with the bath water and now we'll be seeing where are the durable franchises, where are the companies that do adapt to the new world that aren't just easy money ideas but have sustainable growth, have real competitive advantages, have margins. And that's not immediately apparent today, but if our companies develop as we think they will, that P/E3 in five years looks very, very different than the P/E right now and they're great opportunities.
Steve Seid:
That is really, really interesting. I want to ask you about some other, I don't want to say competitors, but sometimes people view the Select Growth, particularly, as more an aggressive growth strategy that sometimes can be compared with innovation strategies. There's a couple of popular ones that have taken on... We all know who's come up in the marketplace. How are you similar than some of those innovation strategies? Would you call yourself aggressive growth or innovation strategies and how are you different? Hopefully you understand my question here.
Tom Trentman:
Yeah. That is from the external perspective. Managers and companies are sort of put in a style box, so to speak. That's not the starting point for us, we're not setting out to be, quote, unquote, "aggressive" or own a certain type of company. What we're looking for is, again, where are the opportunities on a three and five year basis, where the market is not optimistic enough and doesn't understand, and as our view on the six, 12 months might not be different, but as you get 3, 4, 5 years from now, you'll see that the results are coming in much better than expected and the stock prices rise to those higher earnings and that arbitrage of the results over the longer time horizon is the value created. If we think about... So us versus other investors, so if we think about that five year period, there are companies that can defy the fade and that's how they can win over the five year period. Again, the individual company matters more.
If you think thematically and don't do the depth on the companies, there'll be plenty of them that don't really live up to the hype. Whereas if you start with the company and it's individual prospects and then recognize the theme that it's in, that helps give you conviction that it's inevitable and going to happen. Again, you can have the confidence to own much bigger weights, own them for the long term, and again, be comfortable with that long-term view.
Steve Seid:
Yeah, that's great. Last question on Select, and then we're going to turn overseas, if you guys don't mind. As we sit here beginning of 2023, in the large growth space or even go down cap if you'd like, what gets you most excited? You mentioned a couple of things just there, but what really, really gets you excited when you look into the future about growth investing right now? You mentioned cloud computing, you mentioned some of the things in biotech. Are those the areas that are getting you really excited? You know, you hear people talking about AI and all these things. What are you guys most excited about thematically, as a firm right now?
Tom Trentman:
So if you look thematically, so some of the themes that we're exposed to have been going on and, again, they're just long-term secular trends. So take software as a service, that's one of the highest conviction trends. We're actually excited right now that a lot of the... There are some slowdown in the software space and a lot of folks are, "Oh my gosh, maybe it's not secular anymore, maybe it's cyclical, maybe it's more penetrated, maybe you're closer to the end." And we sit back and look, we're about 10 years into cloud computing, we're about 15% penetrated. We've got a long, long, long way to go. So the worst macro fears get, the better we feel about that long term view. But one of the interesting things is sort of the evolution within that trend. So if we look at our exposure in software over the years, we started with just doing what old software did, better.
So you went from software you bought in a disc or you've kind of downloaded on a server and you ran servers and you moved to getting it as a service and that's just a better way to consume it, but it was the same thing you were doing before. Now we're actually, if you look at what's happening in something like cloud analytics, you're doing things that you just couldn't do before. You're going from looking at batch processes and analyzing data, from 30 day lag to real-time decision making driven off the data you're looking at. The trend of cloud computing is the same, but where the leading edge of it and where the excitement is, is evolving. So that's one that, again, we're just in the heart of that. Something like artificial intelligence, that's one where there's certainly a lot of buzz. Chat GPTs really taken the world by storm and kind of opened people's eyes to it.
What we find with those is, again, that's where you've really got to be the most selective. There can be a lot of hype around an early stage trend like that and the focus is on finding the sustainable company that will drive that. So yeah, we have an investment that's very levered to that directly, but I think you're still a ways away from seeing that flow into just general business and, I guess, I'd put that as earlier stage. It's sort of the inkling of the idea, as opposed to the heart of the adoption. And then if you go into some of the other sectors we're invested in, I think a lot of the opportunities are really the intersection of spaces. So if you look in the financials world, the intersection of technology and financial services, that's creating a lot of opportunities. For example, you see software companies that are monetizing through payments. So by embedding payments, they're creating a better service and it's that intersection that is really creating the value.
So we've got a number of investments in that intersection of financials and technology. And again, maybe it doesn't sound like the sexiest thing, but the way that it's changing what businesses can do and how you interact with your customers and what's available, is pretty interesting. And actually, this doesn't have anything to do with the trend, but one of the fallouts of that that's exciting if I'm thinking about the quality of business standpoint is you get these natural ecosystems where you get a customer doing one thing and then you have a long list of other products and sort of services you can wrap around that and that again, just expands the moat. So that's one where that intersection is actually causing an improved business model in the process.
And then in something like life sciences, it's always just changing the standard of care. We've got some investments that are looking at the genetic understanding of disease and new ways of treating diseases based on genetics. So something like gene therapy. And even then, if you look at, we've been sequencing genes for a long time, we haven't solved all the medical problems yet, and so you've got to go to the bleeding edge of, what does it mean to understand the genetic underpinnings of a disease? And it's not just knowing the genes, but it's getting finer tuned of, what are different cells expressing, even in the same tissue? And where are those different cells located and how is the difference between what one cell is doing and the other cell doing important relative to the average of the tissue sampled? And it takes a finer degree of analytics to get that, and we have companies that are pushing that forward.
Steve Seid:
That space... I hope you don't mind, I'm going to ask one follow up question on that space because it is really exciting. There is the comment or the thought or maybe the hope that we're close to some breakthroughs there, in areas like cancer. Is that optimistic? Where are we on some of this in terms of close to breakthroughs in the area of those?
Tom Trentman:
Yes. So, I think if you just look back at where we've come over the last 20 years, it's been pretty impressive in that field. I mean, you look at the treatments for cancer that are available today. One area that might not be close to home unless you've got friends or family members, but genetic diseases. That's an area where, if you look at what was available for a lot of genetic diseases 10, 20 years ago, it was not much. You're kind of in trouble. And if you look at the way that... Again, we've been able to use this technology and target these small subsets of the population of some terribly debilitating disease, there's been real progress there and that some of our more recent investments that have been very successful, have been companies making a difference for some small portion of the population that has, again, some awful disease. But the biology and the human disease is super, super complex. I think it's pretty clear at this point, there are very few, if any, silver bullets.
So it's just constant application of the technology, thinking of new ways to adapt. And we've gone and we've seen the original... Our pharmaceutical industry was small molecules, so they were sort of man-made molecules that could target diseases, but they run into problems because those small molecules can interact with a whole lot of things you didn't intend, right? So you solve some things, but you really create a lot of side effects in others and some diseases couldn't be attacked. Then you move to proteins and proteins gave you a whole nother class. And we had some investments, again, in cancer companies that were incredibly successful and now you're moving forward to something like genetics. And then you continue to see... We had a small molecule drug investment a couple of years ago, so that was certainly not when small molecules were invested, but they found a way to change how you would target whether the drug would work based on the genetic understanding of the cancers, used a drug that, on average, wasn't that effective, but if you had a certain set of genes in your cancer, it was super effective.
So that combination of old technology meets new technology and now you unlock something is pretty powerful. So again, it's, in some ways, a constant grind. I don't think I would say we're on the verge of a silver bullet and solving all of these things. But again, using and recombining all of these opportunities, again, we'll just keep making progress on the medical front.
Steve Seid:
I can probably ask you a million more questions, so I'm going to have to hold myself back here. For the audience that's listening, if you have not read through... We produce a piece they help us with, obviously, called “Why We Own”, which is every company that they own and why they own them. You'll definitely see some names that you know, particularly in Select Growth, but you'll see some interesting names that maybe you haven't really thought that much about and it's just a great piece to go through. Well Tom, I really, really want to thank you for coming on, for sharing these insights, for doing what you do. We really, really appreciate it.
Tom Trentman:
Yeah, absolutely. Happy to chat. This was great.
Steve Seid:
All right, Jack, so we're going to transition to you now. You okay to jump into emerging markets a little bit?
Jack Mayer:
Yeah, let's do it.
Steve Seid:
Okay. So, again, with this podcast, we weren't necessarily going into like, "Hey, this is Sands and this is their process." I wanted to ask something specific for the Select Growth, for large growth. We want to talk about growth investing and the volatility and some of the stuff that's happened there. With emerging markets, I do want to reflect on the space because it's a space that always seems really exciting. We've been talking about population growth and look at what's, what's happening with the emergence of the middle class for a really, really long time, seems great. And yet when you look back at how the space is actually done and performed, it's lagged for so long. It's just been a long time. So I guess the question is, in your mind, as we sit here today, why do you want to own EM? Why now? Why shouldn't you be frustrated that it hasn't done better as a space?
Jack Mayer:
I have to agree with you, the returns for emerging market equities haven't been anywhere near what you could get elsewhere in the world. And so, if I look at the MSCI, emerging markets index4 over the past decade, it's been about 2% a year. That compares to the US, which was about 10% a year and even 5% a year for developed X-U.S.. So definitely get why investors would even question, why bother. But once you look beneath the surface and beyond those kind of index level returns, you definitely see that there's some diamonds in the rough. So when you look at the past decade, yes, on a cumulative basis, the index was maybe 20%. By my count, there were 80 companies that returned over 200%.
Steve Seid:
Oh wow.
Jack Mayer:
Yeah, so I don't think that the answer is to swear off the asset class completely, but instead, to really take a more selective approach to try to find those special businesses and avoid the others that are kind of holding you back.
Steve Seid:
Okay. Well yeah, good points there. I agree, there's definitely some really exciting specific companies and I think that's an amazing way to think about it. Again, thinking and reflecting on the space, the other thing that tends to be, not troubling, but that I'm trying to wrap my head around is, theoretically, you own international equities for potential for return enhancement, but also diversification, that may be even more important over time. And yet when we go through these periods, you think about last year, you think about 2008, they tend to be correlated on the way down. So I guess the question is, do you think this correlation is going to break both on the upside where they trade less like each other and what's going to cause that?
Jack Mayer:
So, I definitely think that when you introduce an emerging market equity allocation to a portfolio, diversification can be a benefit, but I don't think that's the main reason to own EM equities. At the end of the day, there's still stocks and all stocks are going to have some degree of correlation, especially during a risk off environment when everybody is just going to kind of more safe havens. But what they do offer that's different, importantly, I think, is access to earnings growth drivers in particular, that you're not going to find in other geographies. And over time, that access over the long run should enhance the return of your broader diversified portfolio.
Over the past, call it the pandemic era, we've certainly been in a more macro driven environment and Tom mentioned index concentration that we're seeing in the U.S., we're certainly beginning to see elements of that in the emerging market space as well, especially on a country basis. And so, I don't know what's going to kind of change this macro market, but I do know, over time, earnings growth is going to likely determine who the winners are as it has in the past. And so that's where that selectivity is really going to be key, especially for long-term investors.
Kurt Dupuis:
So it's tough to talk about this space without talking about, probably, a couple of the behemoths in the space. And you actually answered part of that right there because I think it's worth noting, talking about a country like China and EM in the same breath is not saying, "Oh, we love China." I think what you're suggesting is, are there a few businesses that fit your criteria and fit what you're looking for? But that doesn't mean you're devoid of opinions about China or some thoughts about it as a country and its economic development and where the opportunities are. Can you share those with us? Kind of, what's your macro of China?
Jack Mayer:
Absolutely. And so, I would say that, of course, we're bottom up fundamental investors, but we certainly do have views about different geographies and that doesn't form the attractiveness of a business space and whether or not it's going to be more supportive of earnings growth. And you can't talk about emerging market equities without talking about the elephant or dragon in the room, which is China.
Steve Seid:
I see what you did there.
Jack Mayer:
Today, it's about a third of the index. It was as high as maybe 40%, could be higher if you include A-shares and Hong Kong shares as well. But we, at Sands Capital, in our emerging markets strategy, maintain an underweight to China. And that's for the simple reason that we find it to be a less attractive operating environment for businesses. The geopolitical and regulatory situation, especially over the past two to three years, has just made it increasingly difficult for a lot of businesses that traditionally met our criteria, to make their own weather. With that said, going to my earlier point, it's still a massive part of the opportunity set. You can't just completely sidestep it. And so, what we've done in our portfolio is seek to maintain some exposure, but through businesses that are either isolated from these exogenous issues or that are on the right side of policy.
And so, to give some examples of businesses that might be more isolated, these tend to be companies that are focused on domestic demand. So, whether it's a sportswear manufacturer or a food retailer that's really focusing on Chinese consumers, those are areas that we found some criteria meeting opportunities. And then in terms of the right side of policy, the government has been very clear that they're committed to promoting life sciences innovation. And so, we found a couple contract service providers in the space that we also think meet our criteria as well.
Kurt Dupuis:
So I'm not sure what animal would be the marker for India, but can we talk about India? It seems like everyone's talking about India these days. From all the big wires, the sell side analysts, you're seeing articles and Barron’s all the time. It seems like everyone's going bananas for, which is probably not the right moniker, for India. But what is going on there?
Jack Mayer:
I'm going to butcher this quote, but the great Jim Grant says something like, "Successful investing is about having everyone agree with you later." And I would like to point out that we've long had a big exposure to India.
Steve Seid:
That's right, that’s right.
Jack Mayer:
In our portfolios. But all of the secular tailwinds that we talk about, about liking an EM, in India, they're in one place and in a place that has over a billion people. And so, these are things like upward mobility, the formalization and consolidation of industry, digitalization, pro-growth reforms. And so those are kind of the structural drivers, but then you're also getting this near term tailwind with supply chain, reconstitution away from China, which might be driving a new Cap-Ex cycle. And so, there's a lot of things to like about the country.
That said, to your point, people have seemed to kind of catch onto this. And so when you look at the broader base indexes, the valuation's stout. This is not really a secret. And so, for investors looking to find opportunities in the space, like I've been saying, selectivity is really warranted. And some of the areas that we found opportunities include private sector banks and financial service providers, quick service restaurants, and branded consumer goods. And these are businesses that have their earnings growth underpinned by some of those more structural drivers that I was mentioning earlier.
Kurt Dupuis:
So correct me if I'm wrong, but those two countries, China and India, I mean they're a good 40-50% of bench? But is that the range?
Jack Mayer:
I'd say yeah, that's about right.
Kurt Dupuis:
But there's a lot of other countries. Can we show some love to some other countries? Where are some other green shoots coming from outside of those two?
Jack Mayer:
So we have a good amount of exposure in Latin America as well, but there are some new areas that we've begun researching over the past 12 and 18 months that are pretty exciting that you might not necessarily find huge exposures in the index. And so, as I mentioned, we're not necessarily top down investors, macro driven investors, but we're increasingly finding businesses that might meet our criteria kind of in the Middle East or Gulf region. And there, you have what is a more constructive macro outlook as government policies are aiming to diversify those economies away from hydrocarbons. And that's kind of giving rise to entire new industries and business spaces, and in some cases, businesses that just weren't really viable before. And another trend that we're kind of watching, we're not alone in this, but the reorganization of supply chains could be a really big deal.
And it's making geographies, and industries within geographies, attractive for the first time for a lot of growth investors. And so, to give you one example, we've been looking at some opportunities in the industrial real estate space in Mexico because in some cases, it's directly related to more manufacturing activity as companies seek to relocate their supply chains for near-shoring purposes. That's another example of something that you might not necessarily find in a big way in the index, but might be an opportunity looking ahead.
Steve Seid:
Yeah, that's great. And maybe what we'll do is, we'll close... You know, you talked about some of the places you're excited about from a geographic perspective. What about thematics? Like, you mentioned a few things, but as you look across the EM space, what are some of the things that you guys are really excited about?
Jack Mayer:
I think one of the biggest ones has to be adoption of financial services and financial service digitalization. And so, when we first started our dedicated EM strategy a decade ago, our underweight to the financial services sector was the largest underweight in the portfolio. There was just not stuff we would own that met our criteria. If you fast forward to today, it's our largest absolute weight.
Steve Seid:
Yeah.
Jack Mayer:
And so, what you have in this space is, most of the world's un-banked and under-banked population is found in emerging markets. And today, there's now increasing government support to drive adoption of different financial services products. There's new business models that are enabling access and removing frictions that previously existed. And this is happening throughout the emerging world, whether it's Southeast Asia, central Asia, India, Latin America.
And so, the types of businesses that we're finding, some of them are domestic, kind of local champions, and others are more regional players. Others are kind of layering financial services into super apps and adjacent e-commerce businesses to kind of help drive adoption that way. But it's an exciting theme. I think it's one that's very important for emerging markets. It's going to drive more broad based economic activity, and not only should it really benefit those select few businesses kind of driving the shift, but it's also driving a net benefit to society by bringing in people and driving financial inclusion.
Steve Seid:
Yeah, that's definitely an interesting change. I was noticing that because I was going through Top Holdings the other day with a client of ours and they're like, "Yeah, you guys have a lot of financials that are creeping up." So it is kind of interesting and something that we haven't seen from you guys in the past. Well, Jack, want to say huge thanks for coming on the show today. Thanks to Tom as well, Tom Trentman. It was really, really good to hear your perspective on two areas that I think we're hearing a lot from our clients that are really thinking through, which is how to think about growth and then also, internationally, what makes sense, what to be excited about. I mean, all things are top of mind. So thanks so much for coming on the show, man. We really appreciate it.
Jack Mayer:
Yeah, absolutely. Appreciate the opportunity.
Steve Seid:
We will be right back shortly with our Costanza Corner. This is The Whole Truth. Stick with us.
And welcome back to our Costanza Corner, where we like to leave on a high note. Kurt, you're up.
Kurt Dupuis:
Could you have said that any more low energy? We like...
Steve Seid:
It was that low energy?
Kurt Dupuis:
To end on a high note...
Steve Seid:
Was I bad? It sounded very calm and collected to me, but I guess it's just a low energy. Okay, I'll try to get revved up. Okay, I'm getting fired up. Go ahead.
Kurt Dupuis:
Okay.
Steve Seid:
I'm excited.
Kurt Dupuis:
Okay, so little bit of a two-fer. So I'm going to stick in the vein of us finding just funny George Costanza quotes. But first, a personal update that I think is a high note. So I told you how I'm basically in a band now. Have I told you about this?
Steve Seid:
Yeah, I mean, I know you've been messing around with that. You were playing on street corners and all kinds of stuff.
Kurt Dupuis:
Open up the guitar case, people throw their pennies in. No, so I've been playing with this friend down the street. She sings, plays guitar, and she has another friend who's a violinist and a really awesome violinist. I think I've finally convinced them that we're ready to take this show on the road. So I think when the weather warms up a bit, we're going to do a little outside, friends and family concert, get confidence levels up and start doing a couple little local things. We're right there.
Steve Seid:
Oh, that’s great.
Kurt Dupuis:
Open for band names but right now, we're thinking about The Hamstrings since we all play stringed instruments.
First time we got together there was some pulled pork, so there's a ham reference in there. So unless we have a better idea, that's what the name's going to be.
Steve Seid:
Sounds good to me, man. Sounds totally good to me.
Kurt Dupuis:
And to end with... I can't look at these George Costanza quotes and not crack up laughing, so...
Steve Seid:
I can't wait.
Kurt Dupuis:
Here's the quote of the day from George Costanza. We'll end it here on a high note. Quote, "I can't die with dignity. I have no dignity. I want to be the one person who doesn't die with dignity. I lived my whole life in shame. Why should I die with any dignity?" And so that's our show. Thanks for sticking with us.
Steve Seid:
I've got nothing to add.
Kurt Dupuis:
This is The Whole Truth.
Steve Seid:
See ya.
Kurt Dupuis:
You can find The Whole Truth and subscribe for free on Apple Podcast, Spotify, or your favorite podcast app. We'd love it if you took the time to rate and review the show on Apple Podcasts, it helps others find the show. And for more episodes of The Whole Truth, go to www.Touchstoneinvestments.com/the whole truth. That's Touchstone Investments.com/The Whole Truth, all one word.
1DCF is an acronym for Discounted cash flow, which refers to a valuation method that estimates the value of an investment using its expected future cash flows.
2S&P 500® Index is a group of 500 widely held stocks and is commonly regarded to be representative of the large capitalization stock universe.
3P/PE is an acronym for Price-to-Earnings Ratio, which is the ratio for valuing a company that measures its current share price relative to its per-share earnings.
4MSCI Emerging Markets Index is a free-float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets.
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