- Buying companies with a global leadership position within their industry can be a smart investing play.
- The manager of a $5.7 billion fund that focuses on doing that explained to the insider why.
- He also picked out 10 companies that exemplify what he looks for in a stock pick.
Rather than massive capitalizations or dominant market shares, the primary reason companies are brought into the $5.7 billion Brown Advisory Global Leaders fund is their ability to problem solve.
For co-managers Mick Dillon and Bertie Thomson, their selection process relies not on their view of what constitutes leadership, but that of the end customers.
“If you are the best solver of your customer’s problem, they will think of you as the leader. They will keep coming back, generating a really great business over time. While it might sound flippant, if you haven’t got a customer, you haven’t got a business.”
Global Leaders contains a breadth of names, from largest position Microsoft, to other household names one might expect to demonstrate the duo’s criteria: companies with competitive advantages; strong management teams; pricing power; higher-than-industry margins; and high return on invested capital.
Seeking such characteristics, it’s perhaps unsurprising that Alphabet, Roche, Tencent and Unilever feature among the fund’s top 10 positions.
Running a portfolio of 30-40 names, with 32 currently held, one might question whether trades can get crowded or creep towards ‘expensive’ territory. Yet Dillon stresses that valuations are critical, both as the fund manager but also from the customer perspective, noting the distinction between price and value.
“Price is a first point of comparison for so many of us, but if you do a really good job for your customer, they start paying for value.”
He gave the example of distribution. “It’s got to be in stock, right?”, recalling early-pandemic days of empty shelves, as toilet paper and flour saw their true value soar as supply became scarce.
The pandemic sparked a new wave of ideas for the Brown Advisory team that had previously fallen short of their price targets. One area under more recent scrutiny is healthcare.
“We really like healthcare companies because they genuinely help people, but our issues have been over valuations,” Dillon said. Having been underweight healthcare for years, we’re finally starting to see some of these companies come into ranges where we can see double digits on internal rate of return [IRR, which can indicate future profitability] over five years, which we find very interesting.”
Pricing power and margin strength are two sought-after fundamentals, especially at a time of rising inflation. Seldom are these better exemplified than at cosmetics giant Estee Lauder.
Hitting all faces of manufacturing, distribution and consumption, from labor shortages, raw materials, wages, logistics and petrol, the manager sees the problem as not just whether companies can pass on the higher costs but whether their customers can afford them.
Take a US-based paint manufacturer that produces antibacterial paint for hospitals for example. “Talk about solving somebody’s problem. What’s the biggest risk in a hospital? Reinfection rates. But if their costs go up, and they manage to pass it through, can the hospitals actually afford to pay more?”
While that company piqued their interest, its limited ability to truly pass on the higher costs means it remains outside the portfolio.
Dillon explained the importance of price elasticity of demand, and gross margin – the latter of which for Estée Lauder, is 75%, he said, meaning if production costs increased by 10%, it would only have to push through 2.5% to cover the cost of goods sold. While people will still trade down, any planned price hikes will feel less extreme.
“How much will people notice a 4% price rise on a face cream when petrol prices have doubled?” he asks.
Alongside Visa, Mastercard, Deutsche Boerseand other financial names featuring in the portfolio – despite ongoing debate over the sometimes-unhelpful nature of sector classifications – one name came up when pressed for a ‘favorite’ holding.
While Dillon’s respect for microlender Bank Rakyat Indonesia was palpable, he would still resist falling in love with the stock if the price moved beyond his comfort levels. As such, while the bank has been in the portfolio since inception, it has been bought or sold multiple times since 2015, on price alone.
“It’s a terrific business. They offer working capital loans to set up small businesses in rural villages in Indonesia. They’ll set up kiosks in wet markets in Jakarta, take the money from the stallholders, lend it out to people to set up, Say a motorcycle repair shop, so they can buy some inventory to solve other people’s problems. From an ESG perspective, it’s just golden. From an investor’s perspective, we’re happy to be making money.”