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Simon recently spoke with a $35 billion global asset manager about how they're navigating the market volatility. The key takeaways are to think long term, tune out the noise, and focus on investing in the right companies.
December 8, 2022– By Simon Erickson
Sustainability is overlooked by the market. Sustainable companies are undervalued most of the time.
The financial headlines have done a great job of continually reminding us what a crazy year 2022 has been. It feels like every news show, podcast, and article has been quick to point out the calamity being caused by uncontrollable inflation and the financial chaos that will accompany an upcoming recession.
Is that really the case though?
The media’s job is to get your attention. Viewership ratings are more important to them than accuracy. Their hyperbolic language, exaggerated market forecasts, and consistently slamming the “Buy button” come across like endlessly screaming into a megaphone.
Perhaps there is instead a more diligent way for investors to interpret this unusual Year of the Tiger. Are financial metrics like inflation and interest rate increases causes for sounding the alarm — or are they just reflections of the normal expansion and contraction of the global economy? Are consumers really running for the hills and burying their heads in the sand — or is unemployment under control and are luxury brands still thriving?
And how do those who are managing billions of dollars and investing it into equities actually feel about the status quo?
To answer those questions, we’ve brought in a team of experts. 7investing CEO Simon Erickson recently interviewed Comgest CEO Arnaud Cosserat and two of his portfolio managers, Rick Mercado and Richard Kaye. Comgest is an independent global asset management firm based in Paris, who manages $35 billion and has a knack for finding long-term growth opportunities.
In the discussion, Arnaud, Richard, and Rick shared their thoughts about the macroeconomy and why it doesn’t have a significant impact on their decade(s)-long investing time horizon. They believe 2022 has given patient investors an opportunity to buy great businesses at very attractive prices. Investing is less about jumping in and out of the stock market, and more about “finding quality and managing risks”.
The team dug into the semiconductor industry and described several of the long-term trends that are driving it forward. Generous government subsidies and an increasing content of chips required in electric vehicles and in telecom infrastructure are leading to aggressive expansion of the semiconductor supply chain. The Netherlands’ ASML (Nasdaq: ASML), Taiwan Semiconductor (NYSE: TSM), and Japan’s LaserTec (TSE: 6920) might be good investing opportunities who are capitalizing on these trends.
Elsewhere, Comgest also sees an opportunity for retail, especially strong brands who are built to endure. Italy’s Ferrari (NYSE: RACE) has a captive customer base and a strong order backlog, America’s Costco (Nasdaq: COST) has a membership model that provides resilience against inflation, India’s HDFC Bank (NYSE: HDB) is capitalizing on a vast increase in mortgages, and Japan’s Don Quijote (TSE: 7532) is the country’s largest discount retailer.
Investing internationally also carries its share of risks, including the ever-evolving relationship between corporations and governments. The team discussed the rising geopolitical tensions between China and Taiwan, as well as how “long-tail” risks (i.e. unlikely events that would have significant impacts if they occurred) influence their investing approach.
Lastly, Simon and the Comgest team discuss how investors should think about valuation. Several stocks are selling at lower multiples this year than they did in 2021. But are they attractive yet for investors who have a ten-year time horizon?
I truly enjoyed this conversation with Comgest, who I’ve found to be incredible thorough in their analysis of business models, diligent and objective about assessing risks, and methodical about piecing together multiple data points collected from all across the globe.
Publicly-traded companies mentioned in this podcast include AMD, ASML, Costco, Dassault Systemes, Don Quijote, Ferrari, HDFC Bank, Hennes Mauritz (H&M), Kose, LaserTec, Novo Nordisk, NVIDIA, Primark, Sysmex, and Taiwan Semiconductor. 7investing’s advisors and/or its guests may have positions in the companies that are mentioned.
Don’t miss out on future conversations like this! 7investing will be publishing upcoming interviews with the CEOs of PubMatic, Rocket Lab, and more. Join 7investing’s free email list to get our podcasts and investing insights delivered directly to your Inbox.
Simon Erickson, Arnaud Cosserat, Richard Kaye, Rick Mercado
Simon Erickson 00:01
Good morning, good afternoon, and good evening, everyone. Welcome to our 7investing Podcast today! I’m 7investing founder and CEO Simon Erickson and it’s our mission to empower you to invest in your future. 2022 has been a tricky year for investors, it’s been challenging. We’ve had supply chain issues, we’ve had interest rate, right rises, we’ve seen inflation, we’ve seen COVID, we’ve seen a whole bunch of different things. But that does not mean that they’re not opportunities for equity investors out there. And in fact, they’re not just within America’s own borders. There are also international opportunities as well.
Simon Erickson 00:35
And that’s why I’m very excited to welcome to the podcast today Comgest, who is an independent global asset management firm that’s based out of Paris. They manage more than $35 billion. With us today is their CEO and Chief Investment Officer, Arnaud Cosserat. With him also are his portfolio managers Rick Mercado and Richard Kaye. Arnaud, welcome to the program. Thanks for being part of the 7investing podcast.
Arnaud Cosserat 00:58
Hi, Simon, thank you very much for having us.
Simon Erickson 01:01
And Rick and Richard, thanks for being here as well, a good evening to both and good afternoon to both of you as well.
Rick Mercado 01:07
Thank you, Simon, pleasure to be here.
Simon Erickson 01:10
We’ve had, like I mentioned, quite an interesting year for investors. I think that most people would consider 2022 to be challenging. I want to talk about several of the opportunities that actually are out there for investors. But perhaps before we start, since we do have you on the show, everyone might not be familiar with Comgest. Arnaud, could you kick us off by telling us a little bit about your firm and the types of companies you’d like to invest in.
Arnaud Cosserat 01:33
Alright, thank you. Thanks, Simon. Yes, we can. Comgest is an asset management company born 37 years ago, we manage $35 billion in long only equity. We’re investing in all equity markets worldwide through an investment platform of 50 experts who are all united by the same investment approach that we call quality growth investing. It’s a very long term and concentrated investment approach. Around 30-40 names only very low turnover, average holdings over more than five years.
Arnaud Cosserat 02:05
And I would say that is maybe there are 2 differentiating factors, when you look at us. The first one is for investment beliefs and strategy are very clear, tested and proven for more than three decades now. And to be the same product. So same approach on the same people behind the portfolio, sometimes three generations of people overlapping. So it’s, been all very, very consistent. It’s all about financials prevailing in the long term. The fact that we focus on few companies are outstandingly delivering sustainable growth in the long term. And the way we generated outperformance for our clients over the last three decades was first of all by doing time horizon arbitrage, meaning taking advantage of short term market inefficiency to be long term position encompasses the long in the long term and then leveraging the power of compounding. So a company that can grow double digits over an extended period of time is gold.
Arnaud Cosserat 03:01
And as a result of that, we’re very selective very long term, we can keep exposure to companies for 5, 10, sometimes 20 years. And the reason why we can do that is the second big differentiating factor for us, which is we have a broad partnership. The broad partnership is a cornerstone of Comgest because it enables us to be who we are and what we do. We have 210 employees and 170 are shareholders. They buy shares in Comgest every year with our own money, sometimes it takes them a lot of time to to build a significant stake in the company. And being long term, you know, is a luxury that you can only afford if you’re independent. And if you’re incentivized to think long term. And I think the broad partnership is kind of a skin in the game. It’s incentivized to take extra focus on on the long term and be very, very demanding when it comes to selecting the right lower risk companies, high quality companies we’re focusing on it also. It’s also a great asset because it fosters a culture of collegiality within the company and everything we do. It is teamwork. And that’s Comgest.
Simon Erickson 04:15
I love it. I love the long term focus. I love the time arbitrage that you mentioned. But gentlemen, I have to bring up that it’s been an interesting year. Right? We we are certainly fans of long term investing for individual investors here at 7investing. But it seems like you can’t get past the headlines that are that are flashing in front of our faces every single day. Inflation, interest rates are going up, the Fed…everything else. How do you all think about the macro right now? Is this influencing the investing that you do? Is it influencing the types of companies you’re looking for? I’ll open that up to whoever wants to answer at first. But I would like to know how the macro impacts you all as portfolio managers or as Chief Investment Officer.
Arnaud Cosserat 04:49
So I’m sure Rick and Richard can reach out; we have a lot of examples. But we are bottom up stock investors because first we focus on quality companies. I mean, we are more interested in companies that are well protected against exogenous factors. And of course, no business operates in a void. But some are far more far more autonomous than others. Notably, because it creates a market of their own or through innovation, for example, because the the end customers are not too dependent on economic cycles.
Arnaud Cosserat 05:19
For example, if you take the European portfolio and Novo Nordisk is the world leader in diabetes, they have been selling a lot of new products over the last 30 years and going from one generation to the next to clients. They are far less sensitive to the economy in general, because it’s a must have product. You need to treat your diabetes when you’re faced with this type of consideration. So I’m sure we can reach out; we’d like to share with you this. And so for example, of course, the changing economy and the monetary aggregates have a shorter market impact on the way the stock behaves, but they rarely have an impact over five or 10 years. And at the moment, you’re right, we’re talking a lot about inflation. And suddenly, we’ll talk more about deflation in 2023 or 2024. Nobody knows that inflation will happen. And we don’t know what is the final destination. We don’t know what cost it will have on the economy. We don’t know if we’re going to have a hard landing or soft landing or landing at all. Suddenly, the final destination is very much impacted by the same deflation stories of the last decades, you know, demographics, productivity, poor productivity. But at the same time, there are some new midterm challenges, like the globalization for example, in a multipolar world and the need for economic bloc’s to be more autonomous. And the ecological transition, which will profoundly transform our industry, the way we produce, the way we travel, the way we consume, and might be more inflationary look at the Inflation Reduction Act in the US right now. That’s an example of that. So get back to Rick to reach out. I’m sure they’re going to have a lot to say about that.
Rick Mercado 07:10
Yeah, it certainly is interesting times. Like we’re grappling with pandemic with inflation, recession, stagflation, lock downs, pretty much everything that you can name. What I would say, though, is that it’s often in times like this that you really do get your buying opportunity. So I might step back and highlight when it comes to the quality growth investment philosophy. If you think about a recessionary environment, quality tends to outperform. Your stocks are typically more economically resilient, they tend to have net cash position. So they tend to do quite well in those sorts of environments. In an inflationary period, there’s been some good research has been done in this area, I think it’s six out of the last eight inflationary periods, quality has actually outperformed. And if you overlay that with a valuation measure, it’s seven out of the last eight periods, it’s outperformed. And that’s because it’s companies that typically asset-light, they have high margins, they have strong ability to pass on inflation to their end consumers.
Rick Mercado 08:10
Where the philosophy is having a little bit of a tougher time is more around the rising bond yield environment. Certainly in a rising bond yield environment, the growth part of the equation certainly does suffer, at least in the short term. And yet, when we think about this, we get a lot of good opportunities here. So for example, the Global Fund, it’s been running for 30 plus years now. And to your question, does this actually affect the way that we go about investing? It pretty much tells them like whether it’s an exogenous shock, or pandemic, and so the game plan pretty much remains the same. We follow a small amount of companies in a lot of detail. And quite often what happens when you have one of these exogenous shocks? Is that the valuation dislocates away from natural fundamental outcomes. [There is background noise of cheering.] I’m guessing Japan might have just scored,…
Simon Erickson 09:01
[Laughs] Something just happened in the World Cup there.
Rick Mercado 09:06
But yeah, so if you look at the last three years, for example, it’s like a number of cycles compressed into one. And yet, in that time, we’ve been able to buy stocks, been waiting for sometimes for over a decade to buy and see that valuation come into line. So HDFC, it’s a mortgage provider in India, that’s a great example for us. At Comgest we’ve covered that name since 2009. It made its way onto the global universe. So the list of companies that we would like to invest in at the right price in 2014. We watch that company while it was invested on in the Indian portfolio. We watched them navigate through different economic environments, different competitive environments, systemic shocks, interest rate changes, and so on and the company delivered extremely well. So when the pandemic finally hit in 2020, the market sold off dramatically and we had a lot of conviction around that management team, their ability to execute. And their valuation is back down to compressed multiple levels. So in one way, it’s like, you’re able to capitalize on this very powerful research platform. Because of that partnership, we can be very disciplined, we can be very patient. And yet when the times look too bleak, as we’re able to find alpha producing opportunities that will hopefully deliver performance for our investors over the long term.
Simon Erickson 10:30
Richard, anything you’d like to add? Those are some fantastic answers from Arnaud and your colleague Rick there.
Richard Kaye 10:36
Again, thank you ever so much, Simon for that. And your questions really strike a chord. I cover Japan, you just heard Japan doing very well in the World Cup [laughs]. I apologize for the background noise there. It’s funny, because the World Cup in a sense is microcosm, you’ve got a team that’s not playing a sport that’s familiar. They’ve come from nowhere. They can’t beat a lot of people that have been doing this game for 100 years. And they’re doing amazingly, and that’s kind of a Japan story. If you’ve gone to Japan, 10 years, 20 years ago, and you said, hey, I want to invest in growth companies, people would have no lost love for you because Japan hasn’t had any sort of growth 10 or 20 or 30 years. We’ve had slow growth, we’ve had inflation, as you mentioned just now. We’ve had a lack of resources, we’ve had three nuclear armed neighbors and no army of our own. We’ve had earthquakes, we’ve had tsunamis, and Japan has still grown. And you’ve still had companies in Japan, which have actually performed better as share prices, even dollars, than an awful lot of the S&P. If you look at some active funds, and we hesitate to say if we look at our own active fund on Japan, you can see we’ve beaten a lot of world indices, including the S&P500, quite consistently over many years. Even in dollars.
Richard Kaye 11:55
And how do you do that, even if you’re not in a growth economy? The reason is what Rick and Arnaud mentioned. You invest in companies, not in a macro story. We invest in, for example, one of the world’s biggest diagnostic medical companies, it’s a little company called Sysmex that my wife, in my wife’s hometown, where they figured out how to do blood testing more quickly and more accurately than anybody else on the planet. And they’re now the world’s biggest blood testing company. So when Americans need to get diabetes related blood checks, when Chinese who have as you know, a major dietary change problem right now need to go get their blood checks, they use this Japanese company. And we have come to me in another portfolio, exact same area of Japan, the western Japan, they make sensors that are used to measure curvature on car hoods. They are used in the design of semiconductors, it’s it used to be a small company, they don’t say an awful lot. During my tenure, the company has gone up seven or eight times. That is company, and Sysmex also, the blood testing company, is something that has nothing to do with a macro story. It has to do with a competitive spirit of a specific group of people who want to beat the world in their specific field. And they don’t care about everything that’s against them. And Japan, because of its context, is very good at making companies like that. And our job at Comgest is to find those companies. And that’s what we try to do with our fund for the 15 years that we’ve run at Simon.
Simon Erickson 13:33
I do want to talk about several of those industries. Some that are cyclical, some that are less cyclical. You mentioned health care, and I do want to talk about semiconductors here in a minute. And I would like to talk a little bit about the European consumer discretionary companies.
Simon Erickson 13:44
But before we jump into that, I would like to ask– just very briefly — a very quick question. You have such a global team, Arnaud. Even on this call, you know, in Japan, you are I believe in Europe, and all over the world. Can you talk just a little bit about perhaps the culture of the different regions and the portfolios that you are constructing? Is there a preference that guides the capital allocation strategy of companies in different areas? What I mean is, do certain areas of the world prefer to pay out higher dividends and to share that out in cash with its shareholders? Versus, of course, a lot of us in America know the Silicon Valley mindset to plow it right back in and step on the accelerator and go for the growth. In addition to being an interesting macro, like we just talked about, could you perhaps give our listeners a bit of flavor on the different regions you are investing in, and the preferences of investors in those regions?
Arnaud Cosserat 14:38
We have six teams of 50 investment experts that cover all markets worldwide. So we have a global team, so the global and global emerging market teams. We have an Asian equity team that is based in Hong Kong since 1994, and Singapore. We have original team, so like Europe, and Asia, and we have also a country teams. So we have a Japanese equity team based in Tokyo recharges base over there. And a US equity team that is based in Paris.
Arnaud Cosserat 15:17
Strangely enough, we’re not in the US. And I mean, it’s interesting to manage from a remote location from the US. Sometimes it’s good to be away from the noise and focus on 12 hours focused already on the long term. We work hand in hand, because we address the same sectors, most of the time, we were looking for high quality companies, that means companies pricing power, with innovation, with creation of strategy of their own market, their own growth and sustainable growth. So we have, of course, a preference for high value added type of businesses like health care, stuff like tech software, retail customer, and we all share data among the 50 of us in a very collegial way. And of course, I would say, the one who is better placed to ask you to to answer your question about where do you allocate capital is the global team because they are the only one who manage the global portfolio? Each team manage a different portfolio, an Asian equity portfolio, a Japan equity portfolio, a European equity portfolio, and Rick is the only one who knows the difference between all those different allocations. Rick?
Rick Mercado 16:29
Thank you, Arnaud. Yes, sir. Certainly. So again, the philosophy is very much focused on growth. So similar to your sentiments about the US Simon, quite often, the companies that we’re investing in, they are often reinvesting it into those growth opportunities. We want to see them doing that, because it says to us about secular growth theme are the opportunities to keep increasing returns, to keep getting market share, and so on, that continues to take place. So we haven’t seen too much differentiation, at least between the stocks that we cover in close detail, whether they’re in Japan, in the US, China, and so on from that perspective.
Arnaud Cosserat 17:10
And the truth is, we’re looking for global leaders. And most of them, I mean, we have a few domestic companies in the fuse regions, but we have a lot of international leaders, and it happens that they have a Japanese passport or European passport, it doesn’t matter. This could vary global companies with global footprint.
Simon Erickson 17:29
Let’s talk about some global companies that do require a lot of capital. That is the semiconductor industry. This is a capital intensive business. You know, we mentioned I think, Rick, you mentioned just a little while ago about an asset light model. This is not a typically an asset light model, at least for the companies that are manufacturing semiconductors. This is a very cyclical industry, as we already know. But it’s also one that produces very, very high returns. And it’s very, very hard to compete against those fabrication facilities that are global. And then of course, we’ve got the designers. We’ve also got the NVIDIAs and the AMDs of the world that you’re producing the world’s most complex and complicated chips. Maybe I’ll just open it up and ask you all what you think about the semiconductor industry? Is this of interest to you, being that it certainly has seen its share valuation multiple contraction this year?
Arnaud Cosserat 18:16
Yeah, right, they are at the center of many things in our life, actually. It’s every aspect of our lives requires semiconductors: internet, PC, video games, and now the way we speak through computers. It’s one of the most globalized supply chains as well, there is a lot of fragmentation due to the specialization. The rise of a specialization model, where you produce somewhere and your IP somewhere else, you know. And so it’s very much impacted by globalization, the globalization and geopolitical changes.
Arnaud Cosserat 18:52
And it’s in the race for net zero as well. A formidable solution enabler. Without competence, we couldn’t do anything. And you know, the whole thing about the Moore’s Law, I mean every two years, has this number of integrated transistors on your integrated circuit that doubles and enables far less power components, conception, better speed, etc, etc. So this, this law is still untouched. It’s been verified since 1965. And it gives rise to a lot of opportunities for us, be it in the integrated device manufacturers, the fab companies or the foundries for example. One company that’s very dear for us in Europe is ASML, which is a worldwide leader in lithography, which is the lithography to print semiconductor on a silicon wafer. It’s a monopoly company. It’s a company that has a monopoly on the next technology, which is called UV ultraviolet. YouTube ultraviolet; we’re talking about here about 20 to 30 years of investment in r&d, and they’re only what they are the only show in town. So it’s one of the biggest positions in our portfolio, and it’s less cyclical than the market. Maybe we’ll come back to market cyclicality and does that change over time. Why is it less cyclical? It’s because they’re selling must have product to reach the next nodes, the next miniaturization level in the industry. And so, there is a long waiting line to get their product. So if TSMC steps out of the line, they need to come back later. And so it’s far less dependent on the cycle than chip companies themselves.
Rick Mercado 20:48
Yeah, and we certainly, you’re absolutely right, that it is a capital intensive industry. Quite often that is where they derive their competitive advantage. So TSMC is out I was speaking to, they require about the run rate as being $40 billion per annum. So just think about being able to replicate that sort of manufacturing, it’s almost impossible for a new player to enter the industry could have that sort of capital and catch up on that IP and that scale advantage that they’ve already accrued. That’s quite important to us. I think it was BCG, they recently put out a study. And it said that if a country wanted to replicate a supply chain that TSMC has in Taiwan, locally, it would take about $1 trillion. So we’re talking absolutely phenomenal, large amounts of money, which pretty much gives us a lot of conviction around that competitive advantage standing for a long time.
Rick Mercado 21:43
The second point that you asked about was the cycle. It’s certainly a cyclical industry. Again, we are very much focused on the long term. So I think at the most recent ASML capital markets day, they said, We’re on track to being a $1 trillion industry by 2030. And you think about that the drivers behind these long term trends, the megatrends, and they’re still very much in place, despite having a short term readjustment. So things like the shift to electric vehicles, and electric vehicle requires two times as much content as a internal combustion vehicle. The shift to 5g requires four times as much content as a 4g base station in terms of volume and content within it, and even renewable energy. So one megawatt of solar power capacity requires 4000 euros of semi content, and one megawatt of wind power capacity requires 3000 euros of semi content. So well, very good numbers. And, you know, in our view, very much moving in one direction despite these short term machinations. One of the other things that we’d like to also point to is that, you know, Richard spoke about the phenomenon in Japan, for example, we quite often get these overlooked companies, so amazing companies with tremendous market positions, which generally don’t garner as much attention on the global investor base. So LaserTec is the name that we like there. It’s currently on our watch list, currently owned by Richard and their team in Japan, they have 90 to 100% Market cap positions. They’re not generally well known outside of Japan, we were able to spend three hours with him in Japan a couple of months ago, but that’s tremendous company, you know. I know, Richard knows a lot of detail as well. So a lot of opportunities, a lot of short term noise and uncertainty. But long term trends very much intact.
Simon Erickson 23:40
Great points, gentlemen. ASML is certainly a fantastic company. There’s no doubt about it, with the backlog that they have for the extreme ultraviolet, like you mentioned. $150 million per machine, and $350 million when they get the high end numerical aperture ones out the door this next year. No doubt about that; a fantastic company. And then you also mentioned Taiwan Semiconductor TSMC. My goodness, what they’ve built over the past several decades is certainly incredible. And now, of course, producing the most complex chips for the entire world.
Simon Erickson 24:10
When we talk about semis, I have to bring up the controversial question, though. And you all already know where I’m going, which is the geopolitical question. This is so important that there are now governments getting involved with the businesses and telling some of these companies where they can and cannot sell their products. ASML was brought up earlier. We know that it’s on the exempt list, for you cannot sell the extreme ultraviolet machinery into China, based on the US patents that are within some of those machines. Taiwan Semi has got its own geopolitical tensions with the relationship with China, Intel, and Taiwan. And we know that they’re now building a $20 billion fab right outside of Phoenix, Arizona here in the United States. Enter Intel, as well. You know, one of the the integrated chip makers, it’s doing design and fabrication all under the same roof of the same corporate umbrella. And it’s now just been pushing its own design capabilities and opening up its foundries to producing those for others.
Simon Erickson 25:04
So my question is, when you’re looking at semiconductors: it’s a fantastic business with a long backlog, very capital intensive, hard to compete with these companies. But there’s also geopolitical risks. How do you assess those when you’re allocating actual dollars and cents into these companies?
Arnaud Cosserat 25:20
Here, we’re talking about tail risk. Of course, it’s a little known unknown, because we’re talking about a China invasion of Taiwan. And, of course, if this were to happen, I think the semiconductor industry will not be this, the only one hurt. I mean, it would be a massive, massive crisis with impact far beyond the industry alone. Think of all the US or European companies doing business with China. I mean, that’s — for as a company like ASML, is concerned that it will be absolutely essential for any other companies to rebuild a capacity elsewhere in Europe. I mean, you were talking about the plants in the US or in Europe? It will, they will have to accelerate those plants. Why? Because I mean, you we all know that Apple’schips are all shipped. I mean, all these channels are from China, you know. And they’re all produced in Asia. So there wouldn’t be any Apple phones anymore; anywhere. So I know that they’ve already contingency plans to rebuild some capacity somewhere else. I’ve been in India. But it’s, it’s right in the moment where we are, as we speak, that they are trying to react, it takes a lot of years to to rebuild. So I think somehow it would be, of course, a big issue for for the sector. But it would also give a lot of opportunities for some of the companies in this sector.
Richard Kaye 26:55
I mean, very much along agnostic observations there. And picking up on Rick’s observations earlier, semiconductor industry inevitably is a global industry, because the products are global. And it’s becoming less and less an issue in the sense where the things are made. You yourself mentioned Simon, if TSMC is scared about being in one island in the middle of the sea, it can build fabs in other countries, including the US, including actually in Japan. And companies like ASML provide the enabling technology across the world. Rick mentioned, we have a number of these similarly indispensable companies in Japan, they’re often slightly less known. But they’re just as profitable. And some of them actually have had even more spectacular growth from a lower base because of the exposure to only the most leading edge areas of tech, not of semiconductor technology. And again, they are shipping globally. And they understand the China risk, but they’re able to calibrate it very well. And some of these companies that we speak to even now, when you raise the China question to them, Rick mentioned a company called LaserTec was involved in miniaturization inspection. They’ve said, well, actually, yes, we have something like four years worth of orders backlog for years. And that includes all the China risk and everything else you could think of. We’re still very comfortable in our report.
Rick Mercado 28:22
It is certainly a good question there. Like, if you look at the global portfolio, we were at about almost 6% exposure, just with TSMC, at the start of 2021. And over the course of 2021, that came down to about 450 bps [basis points] of exposure. And then in 2022, we reduced it even more so to about 350. Certainly, when we first began reducing it, it was more to do with valuations rather than geopolitical risk. But certainly that geopolitical risks has faded in our minds. From a bottom up perspective, we love the company, we would love for it to be a 6% position again. And yet, you know, the last five years has certainly taught us a little bit of humility around, there are certainly these big tail events, that wouldn’t seem like they should be the course of action to take place. And yet certain things have taken place. So we do exercise something already in. You know, there are certain things like politics, we don’t profess to being able to see into a crystal ball. Now that said, we do have a phenomenal team in China who are based on the ground. They get to travel around the country, even when it’s in lockdown. And we do very much at least a global team rely on their insight, both from a cultural perspective, a regulatory perspective, political perspective, and so on. There’s been occasions in the past like the Online Education Center. We’ve never been invested. There wasn’t even in our universe when the market was quite surprised by what transgressed in that industry. You know, our colleagues kindly pointed out that two years ago, the government had already flagged that that was not an area that they where positive about. So having that on ground inside is certainly an edge for us. So we rely on quite keenly.
Simon Erickson 28:26
How about risk mitigation? Rick, can I ask you just a bit, when you’re talking about companies that have such backlog in place already? Does that diversify away some of the risk of such a cyclical industry that the semiconductor typically is? Are you diversifying away some of that risk with the ASML or the ones that have such a long backlog in place?
Simon Erickson 30:07
Yeah, certainly. So what we do like about the ASMLs and the Lasertecs is there is a long wait time, the backlogs are in place for years, as Richard was saying, for Lasertec. I think it’s one year for ASML. That does give us some confidence that, even if there was a geopolitical situation, these companies would be somewhat off buying them. At the same time being realistic, they’re all going to be impacted somewhat if there was to be, you know, one of these extreme situations to take place.
Simon Erickson 31:01
Now, let’s talk a little bit about the consumer. You know, it’s been fun talking about chips. But let’s talk about what the consumer is doing out there. We’ve certainly seen a lot of inflation here in the United States. We’ve seen interest rates going up. And that’s kind of put a little bit of a press on the financial services industry and on consumers’ pocketbooks. Is it the same in Europe Arnaud? Or is the European consumer also feeling the press of the macro economy right now?
Arnaud Cosserat 31:24
Yes, of course. We are seeing conflicting elements. On the one hand, you see a lot of companies passing over inflation to end clients and the consumer is in the first line for a lot of rising prices. Energy, of course, is a big thing. I mean, we’re talking about customer data is five to 10 times above the normal. But at the same time, we’re talking about markets where, like the US, the level of employment is pretty, pretty high. And that means that as long as the the unemployment level doesn’t rise, people still have enough leeway and enough money to to pay for for goods. So I would say it’s at the moment, we don’t see any big evidence that there is a big recession somewhere.
Arnaud Cosserat 31:25
I mean, of course, in Europe in case of recession will be in the first line, essentially, because of the energy costs. And we are still waiting for those signs. We’re talking about consumer companies in Europe. There are a lot of things to say because, like everywhere in the world, in Japan or in the US, there are a lot of companies that sell products that are very linked to the history of the country, the culture of the country, you know, the how they developed over time competencies. And of course, we have great luxury goods. In Europe, we have fantastic luxury good companies like Hermes, like others. Those unique brands, unique companies have a few century legacy behind them, it’s very difficult to replicate. And the consumer has a very low elasticity to price increases. Actually, those companies have raised their price by five or 10% every year in last few years. And actually the demand has not changed. So that’s one of the main unique positions in the consumer goods and discretionary consumer groups that we have in the portfolio.
Arnaud Cosserat 33:39
And think about companies like Ferrari as well. Ferraris is a unique company. It’s continuing to sell very well. Actually, they had to cut the waiting line because they couldn’t deliver products on time. It’s a bit like their Hermes bag, you know, the bag which suffers two years waiting line you know, for consumers. And at the other end of the spectrum, we have the low cost textile companies, fast retail companies like we have a few ones like Inditex [Zara], like Primark, like H&M. And those companies are selling to a very cheap product. So they benefit also from time to time from the crisis because when there is a crisis, people tend to buy cheaper goods, and they like the fast retail companies for the reactivity to trends, but also the fact that they’re selling articles with price points of below 10 Euro, for example. So that’s two examples of companies that can withstand the crisis. Extreme position in the range, you know.
Simon Erickson 34:56
Yes, indeed. Though I might say that Ferrari might be one of the most fun delivery jobs to have in the world. When you’re delivering the car to the end consumer, that might be one of the best jobs to have globally. Ferrari and H&M, two great ideas. Any thoughts on the Southeast Asian consumer or the Japanese consumer right now? Richard you’re in Tokyo, right?
Richard Kaye 35:19
Yeah. Let me go with that. Thank you, Simon, very much. The Japanese consumer is surprisingly resilient. Similar to Arnaud’s comments on the European consumer, perhaps, maybe different perceptions. Remember that Japan’s inflation rate is still very mild. It’s about 3% only, and most of that is thanks to imported oil. It’s certainly not a domestic demand driven story. Remember that Japan’s the only major developed economy with a significantly accommodative monetary policy right now. We have a central bank that does not run away and raise interest rates, is very anxious to support whatever recovery we can have in Japan. And remember that Japan is also going through its post COVID sort of period of young love if I may say, that people coming out again, enjoying themselves again. And it’s doing something like nine months stages in the Western world, because Japan is just a much more cautious country.
Richard Kaye 36:13
And so all of those things actually make Japan’s OECD forecast for next year, I think the highest in the developed world. Japan will be the highest growth economy among major economies. The figures are not big, but the relative status is nice. And against that backdrop, showing up the consumer in Japan is doing fine. We have high end offerings similar to alcohol on Europe, they’re the perhaps less well known companies and they’re less valued because of that. But they’re great opportunities because the exact same opportunities, and high spending resilient consumers who want distinctive luxury brands like Kose, some of the high end offerings that we have in the cosmetics space like a [???], which offers high end skincare, anti wrinkle ointment for women, medically patented technology for this. First in the world, we understand those things are some very well, and they’re pretty recession proof, because people will pay for that in any environment.
Richard Kaye 37:16
Similarly to that, I’ve known the Europe fund, we’ve bifurcated our consumer exposure assignment to give us a little bit of exposure for those who do want to trade down. We have a couple of discount stores in the fund, and I hope this will make you laugh, we have a stock called Don Quijote. In fact, there’s one right next to my house. And it’s open 24 hours. And if you if you want to buy anything, if you want to buy cornflakes, if you want to buy printer toner, if you want to buy shoes, if you want to buy a television, you can probably go and buy it at Don Quijote because they sell almost everything at a great price. And they, as I said also were they’re discounted, they benefit from periods of slightly weaker consumer spending. They’re all suggesting an engaging, entertaining place to shop. And those two ends of the consumer spectrum that we have in the fund. The more luxury areas like coasts, a wellness cosmetics, the slightly more consumer sensitive and price sensitive areas like like Don Quijote, they’ve worked quite well, in the in the consumer brands we have in Japan.
Simon Erickson 38:28
Yeah, fantastic. Richard. Rick, anything you wanted to add global perspective on the consumer out there?
Rick Mercado 38:33
So in addition to Arnaud and Richard, I think globally we have is we’re we’re spoilt for choice. So we certainly do have luxury players. So we can play into we have discount players as well. HDFC, which I mentioned earlier. So they’re the leading Indian mortgage provider. They just put it up there last quarter, and they had 20% growth in the mortgages that they have under management. So obviously, in a world with inflation, potential recession, and so on, they’re doing just fine. They operate to a different cycle to the rest of the companies in our universe in the US gone through over 10 years of a cyclical downturn. Inventory is now cheap policy is accommodative, the structural growth trends are still very much in place. So even as the rest of the world is going down, and root word looks like the consumer is going to be more and more pressured. That part of the, you know, the market in India is still doing very, very well.
Rick Mercado 39:30
And then the other example I would point out is also Costco. So when you’re going to spend obviously be very familiar with, you know, at the start of the podcast, I highlighted that quite often when you get these macro shocks, you get the opportunity to buy a great company, Costco, they make most of their profit from the membership stream. It’s generally very resilient. It’s quite resilient. And yet the shortcut that the market tends to take is that it’s a bond. So in April 2021, when bond yields finally started rising, the shortcut for the market was all that sell out of this name. And yet we said, the valuation is there, we’re probably going to get a price increase in the next five years, it’s going to resonate even more with the consumer. So we got to buy that one at a very good valuation, as the market was concerned about bond yields. But it was completely dislocated to where that fundamental valuation should be.
Simon Erickson 40:23
Fantastic. Just to recap, a couple of fantastic names that were mentioned by the team: Arnaud mentioned Ferrari and H&M, kind of the both sides of the spectrum that you can invest in the high premium or the discounted side. Richard mentioned Kose and Don Quijote for the Asian consumer. And then Rick also just mentioned HDFC and Costco. All great ideas from the retail perspective.
Simon Erickson 40:46
One last topic that I wanted to chat about was what you just mentioned, Rick, which was valuation. You know, this has been such an interesting time, because we’ve seen the multiples of so many companies reset in 2022, much lower in terms of whatever metric you want to look at for most companies than they were a year ago. Certainly, we’ve gone from a euphoric market to a non euphoric market here today. But for you all, gentlemen, as you’re allocating capital, and you have client assets, how do you think about allocation and valuation? Are you looking at historic multiples? Are you discounting cash flows back a blend of both of those? How do you think about when is the right time to buy a company from a valuation perspective? Arnaud, let’s start with you on this one.
Arnaud Cosserat 41:29
All right. You know, valuation, I’m always answering, valuation is always dependent on your investment horizon. If it is six months, you know, anything is possible. P/E can go up or down. Nobody knows. If it’s five years, or 10 years, which is where we invest. Yes, that’s make sense to think about the P/E. And usually when you’re investing in a company that can deliver 10% returns in a very sustainable manner over the next five years, most of the time they are undervalued. Most of the time.
Arnaud Cosserat 42:06
Sustainability is overlooked by the market, because the market is very short term by nature. It’s very myopic. And they don’t try to think about in terms of sustainability. And where we differentiate is, by focusing on sustainability. The most extreme example I would give you is there is a company we’ve held in the portfolio on Europe, which is a world leader in computer aided design and computer aided manufacturing, it’s called Dassault Systemes. We’ve held it, it IPO’d in 1996 and we’ve held it for more than 20 years. 26 or 27 years of listing. And there was a time during the TMT bubble, remember in the early 2000s, and then suddenly, the price went up to 105 times earnings. We had sold it at 60 times earnings. I mean, 60 times earnings means you’re looking beyond the five next five years, or 10 or 20 years. The thing is, if you had been a dumb investor, and even you had bought at 100 times earnings in March 2000, you’d be better off today than investing in the market. The stock delivered twice the return of the market the next 20 years. So not great returns. I mean, we’re talking about 6%-7% returns against 3% of the market. But still, meaning that if you have a great company, it’s a matter of time horizon.
Arnaud Cosserat 43:27
So we don’t pretend we are bold to predict the next 20 years. We focus on the next five years. And if possible, the next 10, which is already a lot. And usually we are more valuation tolerant than the market in general.
Arnaud Cosserat 43:45
So at the moment, I would say the correction of growth companies — not the quality companies, but the growth companies — have corrected a lot in the last few years. I think there’s a lot of money to be made. I think we we have interesting, interesting opportunities. I mean, remember, it’s the first time we’ve seen it — I think it happened three times in the last century, where the three major markets which are equity markets, government bonds, and corporate bonds are down all together by close to 15-20%. It has only happened three times in 100 years. There was no place to hide. Even the Bitcoins. Which are now 65% written down. No, no more safe havens that are credible.
Arnaud Cosserat 44:30
So I think it’s a good moment to invest. I mean, I would recall the words of Warren Buffett you know, “you need to be greedy when the market is ahead of itself.” And you know, hopeful when it’s a bit pessimistic that’s fantastic.
Simon Erickson 44:51
I love that quote, Arnaud. “sustainability is overlooked by the market, most of the time.” That’s one that we should be putting on our refrigerators as investors. Fantastic one there. Richard, any other thoughts on valuation or how you’re allocating right now?
Rick Mercado 45:06
Yeah, so certainly we run a game plan. So every stock that we follow closely on that playlist, we certainly have run a recessionary scenario, or whatnot. And there were warnings where we would love to buy. You know, a couple of months ago we were very close to the trigger levels. We call it the “back the truck up” levels, where we feel like here is a phenomenal company that we would love to own for the long term. And we’re finally coming close to the point where the valuation might actually make sense, kind of similar to the points about dislocation we were talking about. So in one sense, you know, the market feels very vulnerable, very pessimistic. And yet, we’re cautiously optimistic, because these are the times we get to secure that future alpha. We do get the question a lot from our investors. So we did everything for us is bottom up. But we do look at things from a top down level, just to provide our investors with a little bit of insight. We looked at the multiple of our portfolio over its 30 plus year history. You know, at the end of 2021, the portfolio multiple was at 30 times, which was pretty much at the high end.
Simon Erickson 46:15
30 times earnings?
Rick Mercado 46:17
Simon Erickson 46:18
Exactly. Got it.
Rick Mercado 46:19
12 months earnings. And then looking at the low end, it bottomed out at about 15 times. Today, we’re at 20 times. So very much it feels like it is skewed to the upside, because say what’s going to happen in the next year or so that’s certainly not where our edge is. But we feel like the skew is maybe to the upside. And then on top of that, we look at the forecast earnings growth over the next five years for our portfolio. We’re forecasting 13% earnings growth. So even if we see those four, five points of multiple compression, we would need to really underperform on that forecast earnings growth, which is the product of our bottom up process, we would have to deliver 4% earnings growth over that five year period in order to deliver a negative fundamental return. So valuation compression plus earnings, not playing out as we would expect it to. So certainly it is a theoretical exercise. But as I was saying before, it does feel skewed to the upside.
Simon Erickson 47:23
That’s fantastic. Maybe just one comment for anyone listening to the show: a reminder that you can make money in stocks generally in three ways. One is fundamental growth, where the earnings are higher this year and next year than they were in the previous year. Two, the valuation expands rather than contracts, where the market is willing to pay a larger multiple today than it would be yesterday. And three is dividends. You know, we haven’t chatted a whole lot about dividends, but that’s the third way you can make money in stocks as well.
Simon Erickson 47:48
Richard, how about any context on Southeast Asia? Are valuation multiples also contracting there? You said that inflation is a little bit tamer?
Richard Kaye 47:57
Yeah, yeah, sure is inflation is tamer in Japan. But the interesting thing in your question, Simon is that if you were an alien from space looking at the Japanese market, if you are aliens from space that look at this kind of thing. They would probably think it’s pretty much like the US markets. Why? Because we’ve had this rotation to what some people call value stocks. We’ve had this rotation to banks, to oil companies, to energy companies, which are all premised on the idea ultimately, of inflation. So even though we don’t have inflation, the things that should be responding to inflation actually have gone up in this markets. And, of course, I think that’s wrong, because of what we said earlier about not really having inflation, that is the prime minister said prices to go up. Also, the effect on valuation is that we’ve had a significant compression in the value creation of companies, which are still doing a great job. We have some companies which have been growing at more than 20% through through the last few years, throw COVID at them, take COVID away from them, throw a global recession, throw global war at them, they’re still growing at 20%. Plus, I’m talking about some of other internet companies that are offering unique services. But those things are seen in multiple compression in some cases of 70%.
Richard Kaye 49:18
And you can’t explain that except by talking about this, this fake inflation idea that some people have had in Japan. Which I think, again, is simply a replication of patterns they’ve seen in the US markets which they’re imposing on Japan.
Richard Kaye 49:33
So yes, multiple compression has been a big problem. It’s been driven by a mistaken understanding of of our economy here in Japan, of our market. And of course the opportunity is massive. I’ll throw a few last numbers out there and then I’ll round up on this one, I mean we have a 19% earnings growth for our companies this year. The premium we have to the market here is the lowest we’ve had in 15 years, the market here in Japan. Don’t let me mince my words, it’s full of a lot of dinosaur companies that don’t cover their cost of capital don’t respect investors, and a lot of them are very cheap and they should be. But our premium to those is the smallest you had in 15 years and we’re growing at 19%. We see a 17% earnings growth over the next five years, we’re pretty sure about those numbers. So yes, the opportunity for us we think is, is screaming, and we’re not we’re not sitting still with it. As you know, we’re adding to the companies that have fallen most.
Simon Erickson 50:26
Fantastic. Maybe in the last segment that I’d like to chat about, it seems like a year and a half ago, there was so much euphoria in the market, right? Do you guys remember in February of 2021, when the dumb ape NFTs were selling for millions of dollars? And everyone was coming public with a SPAC — a special purpose acquisition company — and valuations were through the roof?
Simon Erickson 50:52
And here today, we are at completely the opposite. We’ve gone 180 degrees, the opposite direction now. Now, one in five Americans are closing down their investing brokerage because they’re just terrified to invest in the stock market. Certainly everyone on this call knows or would assume that’s a mistake. That investing is a long term endeavor. You know, you can invest in good markets or in bad markets. Or inflationary markets or NFT markets. There is always opportunities that are out there globally.
Simon Erickson 51:20
Arnaud, I would like to start with you on just kind of the final thoughts for investors today. Where do we stand as stock market investors? And what would be something you’d like to pass along to our audience of individual investors — who love to invest in growth stories, like the companies that you’re investing in? What’s something you’d like to tell them today about the state of the market?
Arnaud Cosserat 51:40
I think they need to separate the wheat from the chaff. They need to be very conscious about that growth is not sustainable growth, that quality is the main difference when you invest. It’s about risk. It’s about risk first. And that means yes, there was a lot of extreme in the last two to three years around pure growth, high growth, high fliers. Some bets on many companies that didn’t make any money. Zero margins, negative cash flows, growing like crazy, mostly financed by rounds of private equity, etc. Which was a bit blind, you know. There was blind faith in growth.
Arnaud Cosserat 52:23
I think that’s where we differentiate from the market. We always put quality first. So it’s, I mean, our approach is growth, not only quality. When we invest in companies, we want to see how they monetize their opportunities. How they transfer into strong and sensible margins for investors in the end. And that’s quality. Quality is about a lot of things, but it’s about a proven way to monetize their business and to make money for the stakeholders and for the shareholders. And so that’s why I think the main message would be make sure you have some visibility as to when a company is going to convert it and to punch it into cash. And that’s pay attention to the quality to the risk of those companies. To how high the moats are. How unique the business models are. How unique their products and brands are. And that’s that’s where you differentiate in the long run.
Simon Erickson 53:36
Yeah, fantastic. A fantastic reminder too that “growth” doesn’t mean necessarily mean “overvalued” or “unsustainable growth.” There are plenty of great businesses growing sustainably that are still growth companies too.
Simon Erickson 53:48
Rick, anything you’d like to add to that as well. Final thoughts for our listeners?
Rick Mercado 53:53
Yeah, I’d summarize someone else’s wisdom. It’s that quote which is, “In the short term, the market is a voting machine and in the long term, it’s a weighing machine.” Having a very stable team that’s pulling these companies for decades, it certainly does make the job of weighing up those earnings and future prospects a lot easier. You know, Richard in Japan and Arnaud and his team in Europe, having that partnership approach, not only with ourselves, but also with the companies we invest in. It means that we’re able to speak to these companies in very candid terms of the required short notice. Right. I think having that long tenure in this type of investing, it certainly does serve as well in being able to weigh out those earnings.
Simon Erickson 54:36
Yep. Richard, I’ll give you the last word. It’s got to be near midnight over there in Tokyo for you. I’ll let you close everything out.
Richard Kaye 54:42
I’m very grateful for that. And I’m very much going to copy my colleagues’ comments, Simon. I want especially to pick up on the tail end of Rick’s comments that you have to trust the people you’re investing in. The people that are listening to your podcast now. That they have a lot of opportunities with different stocks and with different funds. But you’ve got to trust the companies that are running and the people that are running those companies. Ultimately, it’s a human business here. And if you’re putting money with managers, you have to trust the managers and trust that they trust the people who are running the companies that they invest in.
Richard Kaye 55:17
Ultimately, that’s what it all is, when we’re talking about the sustainability of the stores. Do you want to be with these people that you’ve put your money with? And what we tried to do on the ground in Japan, I’ve known Europe and met with all the countries you visit throughout the world is actually meet the people look them in the eye and say, “Do we trust these people that they’re doing some exciting and is hard to imitate?” And we think that when the answer that question is, yes, we can be with those people for a long time. And that’s been the basis we’ve invested in Japan over 15 years. It’s what I’ve known Rick have done in their various geographies, and it’s been quite a successful formula.
Simon Erickson 55:54
Absolutely. Once again, for everyone listening, Comgest — that’s C-O-M-G-E-S-T – is a global asset management firm managing over $35 billion in offices all over the world. Thank you to Arnaud, to Rick, and to Richard. Gentlemen, it’s really been a refreshing pleasure chatting with you today. I really appreciate you being part of the 7investing podcast.
Arnaud Cosserat 56:14
Thank you very much.
Simon Erickson 56:16
And thanks everyone, for tuning into this edition of our 7investing podcast, where it’s our mission to empower you to invest in your future. We hope you have a wonderful week and we’ll see you next time!
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