Boutiques Connect | Seilern Investment Management

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  • 08 mins 23 secs
'Combining risk and return is ideal for quality growth businesses' claims Peter Seilern, Founder, Chairman and CIO, Seilern Investment Management. In this video, he also discusses diversification, his 10 golden rules of quality growth investing, and why it pays to know more about the businesses you’re invested in.


Boutiques Connect
Peter: We are investors in so called quality growth businesses. Now, what are quality growth businesses? They offer the investor the best combination of risk and of return provided the investor can adopt an attitude of long-term thinking, which specifically means an unlimited time horizon. The combination of risk and return is an ideal combination in quality growth businesses, and quality growth businesses should indeed be viewed not only as an asset class in their own right, but should be used as an investment philosophy by a much wider range of investors out there, be it individual investors or institutional investors, but they need to have the unlimited time horizon and not be disturbed by dates. For example, quarter end, year-end, these are actually not related to the unlimited thinking time horizon thinking of the investor.
We value first and foremost the businesses because the share price is a reflection of the general quality and expectations of that business. So, whereas a lot of investors concentrate on the share price and they know the share price off by heart and all the rest of it, which we also do, we know the share price off by heart, but we know the underlying businesses through and through. Knowledge reduces risk. I define risk or investment risk as that which can catch the investor unawares and cause a permanent loss of capital. The more you know, the less there is a chance that you'll be caught unawares. So, by concentrating much more on the underlying businesses and getting to know them through and through, you increase your knowledge and you reduce your risk, all the more, so, if the underlying business fulfils what we call our 10 golden rules of quality growth investing, these 10 golden rules are extremely stringent. You can't have rules if you don't follow them, so we have the iron discipline of following those rules, but all of those rules. So, the 10 golden rules have to be fulfilled in their entirety, and not only in their majority, and that is what will enable us to obtain a more profound knowledge of the underlying businesses. The problem with this very stringent and very disciplined approach to quality growth investing, to risk, to return to the long term time horizon is that out of 50,000 O.E.C.D. listed stocks, there are only a couple of dozen, a few dozen that fulfilled the stringent 10 golden rules that we have in place. So, we end up with having a universe of somewhere between 50 and 70 quality growth businesses, and these will be the best businesses available in the world on the basis that only the best will do, and then we will construct a portfolio of approximately 20 to 25 companies selected out of this list of 60 or 70 universe companies.
Now, many people will say that a 25-stock portfolio is high risk or incredibly high risk. That is the established wisdom, which I disagree with. The reason I disagree with it, is that as Warren Buffett used to say, diversification is protection against your own ignorance. A lot of people think that if you have a very large, widely diversified portfolio, you won't be hit if one stock goes down and causes an individual permanent loss of capital. Now, of course, strictly speaking, that is true. But that's not good enough for the quality growth investor. So, we seek out the best and then we construct a concentrated portfolio of the best and we make sure that our knowledge of this concentrated portfolio, that the knowledge is as deep as possible in order to avoid any surprises. I can give you very clear examples of what quality means and what growth means in our sense, in our understanding, but just to take the most important, starting with quality, it's the balance sheet of the company that we invest in, the businesses balance sheet, and we have a ratio called ‘nets debt to free cash flow’, which works out how long it would take the business to repay its net debt from its free cash flow. Our tolerance level is very low, such indeed that today the figure for net debt to free cash flow in most of our portfolios is slightly on the positive side. The reason why I am very much averse to debt is because although it looks tempting to borrow up and gear up a balance sheet during times when interest rates hover between the zero and the negative in that sort of twilight, it is actually very, very dangerous and therefore, irrespective of whether interest rates are high/low in real terms or in nominal terms, you must not have an indebted balance sheet, and I'll tell you another reason why, because if interest rates should start going up, then the stock market will immediately stop valuing that business based on its economic value but value that business instead on the risk of its default, the default risk, and that's a completely different cup of tea. So, the most important quality ingredient is the balance sheet, and the growth, obviously, growth means growth. It means non-cyclical, perennial, long term growth, which is easily forecastable because of the position that this company enjoys in an industry which has to be growing in the first place and enjoys in such a way that its own growth is superior to the industry growth, so that this combination of proper growth, wrapped in a strong balance sheet, differentiates the growth investor from the quality growth investor and of course, also differentiates the quality growth investor from the Value investor, which is another proposition entirely. So, there you have your two main ingredients. Now, of course, that means that there will be sectors that we favour and there will be sectors that we avoid. Unfortunately, I must tell you that we avoid a lot more sectors than we favour, and even the word sector is slightly misleading, but we will none the less address that. So, if you take sectors like banking, like oil and gas, like commodities, like insurance and there are lots of others. These are all sectors that we shun altogether because they fulfil neither the quality ingredients. Another, for example, important quality ingredient is a return on invested capital. I have never found a bank that produces a return on invested capital on a durable basis that comes anywhere close to what we look for. But another reason why we avoid all these sectors is that they don't have any pricing power. Whether you look at a commodity producer or a bank or insurance company, they are, if you like, the victims of events over which they have no control, a bank, their business will be dictated by the price of money. An oil producers business will depend on the price of oil. An insurers business will depend on whether there is a hard market or a soft market, and so on and so forth. That means that pricing power is another very important ingredient in a quality growth business. They're able to raise or maintain their prices, even in a disinflationary or even deflationary environment like the one we're in the moment. So, the pricing power or a price setter rather than a price taker is very, very important.
If you want me to give one or two examples off quality growth businesses, which have achieved a moat around their business, which is going to be very, very difficult to replicate and break, then take, for example, companies like MasterCard or Visa, we are living in a time where cashless payments are growing in importance and in size, and even today there is an enormous percentage of transactions that are still carried out in cash, and that is bit by bit going to spread around the world, as it already does. And those two companies are at the forefront of this cashless payment trend, if you like, which is irreversible. Another one is the aging population, the aging population, of course has all sorts of reasons behind it, but it produces opportunities for quality growth businesses to cement their positions. Whether it's a company like Straumann, which is a Swiss company which produces dental Implantations, which, of course will be needed more and more by the aging population. That's another example. Or whether you look at a company like Striker, which produces hips and knees, artificial hips, prosthetics, that is also a trend which is not going to go away, and so, we have investments in companies which are very well positioned in this arena and which are proper quality growth companies. If you wonder whether your investment with Seilern will produce the same unlimited time horizon that exists in the mentality of the fund managers and the analysts and, of course, the underlying companies, the answer is a most emphatic yes, I think the proof of the pudding is, for example, in the turnover of the portfolio, or the average holding period of each stock or each business in the portfolio, which is long. It goes 8/9/10 years or beyond, and so the bear market or a crash doesn’t really bother us. A black swan is something which is quite welcome sometimes because it hits all asset classes very often and produces a very interesting buying opportunity for the quality growth investor, and that's something that one needs to seize on.
Seilern was started in 1989, in other words, just over 30 years ago and has always been doing the same thing but getting better at it all the time. The reason I set it up was because life in the nineteen eighties in the financial markets was very confusing. There were more and more styles around, and I wanted to go back to basics, and I wanted to put into practice this philosophy of mine that only the best will do. Why invest in something else? If you can invest in the best.
I am not as passionate as I was, I'm more passionate than I've ever been, and I suppose that my passion is augmented by the simple fact that quality growth investing works, the track record that we've achieved for our clients, whose portfolios obviously are the number one priority of what we do. The track record is one of superior returns with inferior risk, and I rather like that and that will continue. Every single person of our team is a convinced quality growth investor, Tassilo Seilern, who is a member of my family, and his colleagues around him, they are the succession and they're all young, and we take them in young on purpose so that they're not distracted by the noise around them and by the plethora of investment styles that exist. So, they are very much the future for our clients.
In the characteristics of the quality growth portfolio, looking back over 30 a track record are that actually the economies of the world, they move at different speeds at different times. Sometimes it goes up, sometimes it goes down, sometimes it's easy, everything is growing, and sometimes it's more selective. Clearly, when the economy is more selective and when there are more headwinds, it is obvious that the quality growth portfolio is going to outperform because of the perennial nature of the underlying businesses and because of the long term growing stream of earnings, which, furthermore compound, so, a weak economy with sluggish earnings out there is quite a good background for a quality growth portfolio.

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