Vin Walden is the co-portfolio manager, along with Brian McMahon, of the Thornburg Global Opportunities Fund (THOAX). THOAX sports a terrific record. Within Morningstar’s World Stock category, as of August 4, 2015, it ranked among the top 3% of funds for five years; top 1% for three; top 2% for one year; and top 4% YTD. Both Walden and McMahon have managed the fund since it was introduced in 2006.
I spoke with Vin on August 25. Some of the questions in this interview were submitted by financial advisors who are members of our online community, APViewpoint.
What is the overall structure of the fund and the process that you use for selecting securities? What is unique about your approach?
The structure of the fund is based on three principles.
Number one, it’s globally flexible. For diversification and defensive reasons, as well as for opportunistic and offensive purposes, we use our global flexibility to search for good value and opportunities. We are always diversified in at least 10 countries. We think that is robust geographic diversification. And we opportunistically will consider an investment in smaller markets like Canada or the Netherlands. We have benefited a lot over the years because of that geographic flexibility.
Our second principle is the focus of the portfolio, whereby we hold 30 to 40 equities. We consider this number to be the sweet spot for robust diversification, and still have an impact with our security selection and with our ideas. We don’t want to over-diversify or “de-worsify,” as Peter Lynch called it. With 30 to 40 names, we can keep a close watch on our companies, keep the quality high and improve our “batting average” – the percentage of successful investments.
The third principle is value investing. After many years of experience – and studying market history and successful practitioners over the past 100 years – we have a fervent belief that value investing works. If you buy good assets at low prices, that’s a good starting point for long-term success.
So geographic flexibility, a focused portfolio and a value philosophy are the core principles at a portfolio level of how we structure the fund.
Can you describe the process you use for determining the intrinsic value of securities and the criteria that you use for buying and selling securities based on that intrinsic value?
Our security selection is multifaceted. There are many, many factors that go into it in our assessment of companies. But essentially we do a qualitative assessment of the strength of the business. We combine that with a more quantitative view of the valuation of the business. Our quantitative appraisals are predicated on cash – cash earnings and the outlook for cash profits.
A third element that we employ is thinking about the prospects for changes – catalysts, if you will – that could take place in the company or the industry in a foreseeable time frame. Our investment horizon is generally three to five years. We try to peer into the future and speculate on what could or might happen that would improve the fortunes of our investments.
We combine those factors. We use a proprietary checklist of considerations that we go through to evaluate the quality or strength of the company, the valuation of the company and then the path to success. When we get all those things right, we are very interested in making an investment.
Our checklist considerations have been built over many years. It includes factors such as the governance structure of the company: Who owns the company? Is there a controlling shareholder? Is there a family? What’s the agenda of management and the board over the long term? The competitive landscape is very important; we think about the competitive strength or entrenchment of the company using the framework developed by Michael Porter. It includes simple things like how many competitors does the company have? Over time, is that going to be a bigger or a smaller number? We think about the margin structure of the company and how its income statement could respond to a period of adversity, as well as the impact vis-à-vis its capital structure and balance sheet. Is the balance sheet appropriate given the degree of cyclicality in the business?
We then try to develop a holistic assessment of the business. Ultimately, it comes down to those three elements: the quality of the company, the price of the company and valuation and its path forward, or what we call the “path to success.”
The statistics of the portfolio show an average weighted exposure to large-cap growth, and if we look at the regressions, they show a negative exposure to the value factor. How is that consistent with buying stocks that are below their intrinsic value?
That’s a good question. There are a number of reasons for that. As a starting point, this is a very competitive industry and a lot of people are trying to do well in the markets all the time. The markets can be pretty efficient and good at recognizing that a lower quality company deserves a lower valuation multiple. Therefore, if you simply choose stocks on the basis of statistical cheapness, you could encounter problems in buying companies that appear to be cheap when they are actually just troubled or low-quality businesses.
What we find is more effective is an emphasis on high-quality businesses with good prospects for the future. Often those companies are classified as growth companies – companies that either are growing or could grow over time. A benefit of that is we have long holding periods for our investments. We have companies that we have owned for five to eight years in the portfolio. If you have less activity over time in the portfolio, then you can spend more time making better decisions and doing research that leads to better outcomes. You can also build a strong knowledge base about your companies over time. And of course, there is a dramatic tax efficiency benefit of holding investments for multiple years instead of having a short-term horizon and incurring short-term capital gains tax.
For all of those reasons, we are generally drawn toward higher-quality companies. Those are sometimes classified as growing or growth companies, and sometimes they look statistically more expensive.
I have a question about your geographic diversification. A little more than 50% of the fund is invested in U.S.-domiciled companies. Is it a coincidence that this aligns with the MSCI World index, which is 52% U.S., or does that diversification vary through time?
Our U.S. weighting has varied considerably over time. Currently, according to my report at the end of June, the U.S. weighting was 43%. Historically, the range has been as low as 35% and as high as 55%.
An important consideration when thinking about that is that many of our U.S. companies are global companies. They happen to be based in California or wherever, but they are active globally. Many of them derive a majority of their revenues and profits outside of this country. U.S. companies on balance tend to be a little bit more globally active than companies in some other regions. A good example of this is Google. We have owned Google since 2008 and it’s based in California, of course. But a majority of Google’s revenue now is overseas.
The U.S. weighting just falls out based on our bottom-up process. Recently the U.S. weighting, including global companies like Google, is about 43%.
Can you discuss your approach to currency exposure and whether or not you hedge any of it? What is your outlook for the dollar and how is that affecting the portfolio construction?
Our approach to currency and to macro forecasting more broadly is predicated on the belief that we are not currency specialists or forecasters. We want to be careful and humble with respect to those sort of expectations. Therefore, we keep our fund diversified by currency and geography. Sometimes we hedge the currency, i.e. buy insurance, to mitigate the impact a currency could have on our outcomes.
Over time currency has had a very modest positive effect on the portfolio in the scheme of things. The general approach is to be sure to keep our geographic and currency diversification and then consider from time to time hedging if the insurance is inexpensive and it is a good investment itself.
How much of the portfolio is hedged now?
Approximately two-thirds of our non-U.S. exposure.
Does that reflect a view that the dollar is going to continue to be strong?
No, not necessarily. When it comes to macro issues, we have access to the same data that anyone could have. We don’t have any special insights. Our approach is really grounded in bottom-up microeconomic analysis. We are not too good at forecasting GDP or interest rate trends or things like that. As Peter Lynch once said, if you spend 13 minutes thinking about macroeconomic expectations and forecasts, then you have wasted 10 minutes. Our approach is to stick to the micro and analyze companies on a one-by-one basis.
That said, the U.S. economy is stronger than many others in the OECD and we are certainly at a different point in the interest-rate cycle. Our best guess would be that a stronger dollar is plausible and if we can be prepared for that, then fine.
Let’s talk about the three minutes of the 13 that you do spend thinking about macro issues. There are a lot of issues now, including Greece, China’s devaluation of its currency and the weakness of its economy, commodity price weakness and the Fed rate hike, which you just mentioned. Do any of those affect the way you are managing your fund?
Yes, a bit. You could say that we are “macro aware,” but not “macro focused.” We try to have our eyes open and, especially, to recognize the mega trends or the more extreme macro themes, which certainly include the slowdown in capital spending in China and the impact that it is having on commodity markets and commodity-centric economies and currencies.
For instance, if we recognize a country where the outlook for inflation and the currency is very dynamic and volatile, then our strategy is to avoid those situations. There are some situations where macro can be very important. If we recognize that, we step aside.
What are some of the regions or industries where you are seeing exceptional values now? Can you discuss a few of the holdings in your fund that are representative of the type of thinking that goes into your security selection?
We analyze everything on a bottom-up basis and we evaluate companies iteratively on a continuous basis. We arrive at some themes and indications of good long-term value in certain areas. Recently, we are very active in healthcare, and we are very active in communications infrastructure globally. We have multiple investments in these categories.
In healthcare, we’ve invested in some specialty pharmaceutical companies where we think the management and the business strategy is distinctive in a good way. Two companies that are indicative are Express Scripts, which is a pharmacy benefits manager of pharmaceutical purchasing for corporations in the United States. It has a very good business model in a highly consolidated industry. It has a history of very good capital allocation, including dividends and share buybacks along the way. The second healthcare investment for us is Concordia Health in Canada. A key element of its business strategy is to be very careful and frugal about spending on science, including research and development. We have a general view that a lot of drug and pharmaceutical R&D spending is wasted, and you can do a lot better than your peers if you just recognize that and try to be more careful with your R&D spending. You can have a more profitable and efficient company as a result. That’s Concordia Health.
In the communications infrastructure side, we have several ongoing important investments in Europe. One of them is in the data-center business in a company called Interaction (INXN). Interaction operates 37 data centers around Europe in 11 countries. These data centers are big industrial facilities where customers house servers and computing equipment that stores, processes and distributes huge amounts of data. The niche for Interaction is they operate what are called “carrier-neutral facilities” located in major business centers. Its assets are near major business centers like Amsterdam, Frankfort and London. It is independent of the telecom companies.
It serves customers where connectivity and signal latency are very important. Its assets are like Internet traffic hubs. The key element of the service it provides is direct connectivity within its facilities among different customers. For example, it would allow Barclays Bank to connect with the London Stock Exchange to connect with Visa to connect with J.P. Morgan in a low-latency, highly reliable, highly secure fashion for those clusters of customers that need to exchange lots of data in real time.
The drivers of the business are the move toward cloud computing, mobile computing, Internet traffic, more and more connectivity and especially high-speed connectivity. This is a promising industry with very strong network effects. In Europe the industry appears to be one or two years behind the U.S. as far as its evolution and the adoption or popularity of these kind of data center services. We’ve held our investment in Interaction for many years and have seen it grow at a healthy rate. Even through the European recession, the company grew at a double-digit rate, and we believe that growth could continue for some years to come.
One of our AP Viewpoint members noted that the expense ratio on your fund is 1.41%, which is above average for actively managed funds. Can you comment on what goes into determining your expense ratio?
Our expense structure is not our key differentiator. We are not trying to be a low-cost commodity-type service. What we are trying to do and what we have done is deliver a lot of value to our investors over the years. In fact, our NAV is near an all-time high. This year, last year and over the long term, our investors have done very, very well.
Just like investing in a company, investing in a fund should take into consideration the total prospects and the outlook for the future and whether you are paying nominally less or more for a high-quality differentiated company. The important thing is to buy a high quality differentiated company or product. Whether you are paying 10-times earnings or 10.5-times earnings, that’s not the primary or even secondary consideration. We have the luxury of a long time horizon, and we are at an advantage to provide a very good result, net of all costs and expenses.
That has been our experience so far. Our customers have been very happy, and we couldn’t be more pleased with that.
We are talking a day after one of the more volatile days in the market than we have seen in a long time. Much of the financial media has tried to explain that volatility through what is happening in China. What is your take is on that? Do you have any exposure to China, and do you think this might create values for you with the market drop, which was a worldwide event?
The market is emotional from time to time, so pullbacks and corrections of 10% or more every year or two are completely normal and to be expected. People will get emotional. There are people who are leveraged investors who might get margin calls. They might be using stop-loss strategies. They might become forced sellers for whatever reason, and therefore they are not able to focus on the long term.
But we always are focusing on the long term. We have no leverage in the portfolio and always have plenty of liquidity. In general, we welcome market declines and opportunities to look for new things and to improve the overall risk-reward of our portfolio. During the last several days we’ve been buying more of many of our investments and continuing to focus on the long term.
That’s the framework that has served us quite well over the years.
Are there any final thoughts you’d like to offer to your investors and our readers?
The main points to emphasize are the market can be very competitive and emotionally challenging for people to navigate. It is a challenge to select a good asset and a good strategy; it’s also a challenge to stay with it during the inevitable tough periods. Therefore it’s important for investors in our fund to have the luxury of a long time horizon and to stick with it.
It is not appropriate for someone with a short time horizon to be invested in this fund or in equities broadly. The most critical element for success is having the benefit of a long time frame so that the fundamental analysis can play out in our companies over time and create value for us.
It’s really the long-term time frame – more than anything else – that I want to emphasize.
Read more articles by Robert Huebscher
Vin Walden is the co-portfolio manager, along with Brian McMahon, of the Thornburg Global Opportunities Fund (THOAX). THOAX sports a terrific record. Within Morningstar’s World Stock category, as of August 4, 2015, it ranked among the top 3% of funds for five years; top 1% for three; top 2% for one year; and top 4% YTD. Both Walden and McMahon have managed the fund since it was introduced in 2006.
