Mawer managers in for the long haul

While in Calgary, managing editor Melissa Shin sat down with two portfolio managers from Mawer Investment Management to speak about their process and strategies: Paul Moroz (left), who manages the Mawer Global Small Cap Fund–and winner of the 2011 Best Global Small/Mid Cap Equity Fund award at last night’s Morningstar Canadian Investment Awards–and Grayson Witcher, who manages the Mawer U.S. Equity Fund (right).

Do you hedge exposures?

Witcher: No. The only currency exposure we have is $USD. In all asset classes, over the long term it doesn’t benefit clients. Plus, there are costs to hedging.

Moroz: Same story. If you have a UK company that trades in Europe but sells in Asia and reports in $USD, it becomes tricky. What do you hedge? They might also be employing hedging strategies themselves. So we don’t.

Are you averse to active trading?

Witcher: We have a bottom-up process. You’re not going to see much day trading. If there’s some change in the share price and we don’t think it’s warranted, you might see us adding or reducing our position. We like to be nimble on that front, but it’s not a day-trading thing. We find value, we buy it and then we hold it for ten years.

On the U.S. fund the average holding period is 10 years, which is vastly different from the average investor. We’re trying to buy a company and hold it forever.

Moroz: Partly that’s costs too. Imagine you’re the client. Every time you buy or sell, there are the direct costs of paying the broker, out of pocket. Then there are the indirect costs of liquidity, the bid-ask spreads of the stock, the market impact costs. From a small-cap perspective, those costs are extremely high.

Turnover rate in our funds is 10%-20%, which is tax-efficient for the unitholder.

What is your investment process?

Moroz: Three things: Good companies, strong managers running those companies and attractive valuations. With the company, there has to be something special – a competitive advantage that’s consistent for a long time. That might be a switching cost, a barrier to entry, or a low-cost producer. [We want managers with a] high level of integrity who take risk out of the business and earn a high return on capital. With valuation, you’ve got the million-dollar Mercedes problem. A Mercedes is a really nice car, but it’s not worth a million bucks. We can have a great company but it has to be priced right.

We have a fair value range. We trim holdings towards the high end of the range, and take on holdings at the bottom end of the range. It’s simple in concept, but difficult to execute consistently.

What are some opportunities and risks in the U.S.?

Witcher: The U.S. is an entrepreneurial society. The opportunities over time are fairly consistent. The U.S. is the largest economy in the world, so it has a breadth of companies you cannot find elsewhere. This means that while the number of investment opportunities and aggregate size of those opportunities may vary over time, we should be able to find a portfolio of attractive investment at all times.

When you look at the companies we own, 40% of revenues are from outside of the U.S., so you’re not only betting on the American market.

Some of the great opportunities are through productivity. You’re seeing smart technologies: smart grids, cloud computing. Mergers and acquisitions will likely provide some great investment opportunities over the next five years as some companies hold significant cash, generate strong recurring cash flows and can currently finance acquisitions at very low interest rates. Companies that sell essential items, such as Procter & Gamble or Kraft, will likely see stable demand in North America and other developed markets and will benefit from the rising middle class in emerging economies.

The risks – there are a lot of pretty obvious ones, such as the debt load. If you can solve those issues, it’s just about the balance of power between the BRICs and how that transition works.

We don’t construct our portfolio to bet on whether the US will be a superpower or not in the future. These top-down views won’t necessarily impact our portfolio positions. China is going to be a much stronger country in 20 years, but I don’t know who will have the upper hand.

For example, Nike gives you exposure to both because they sell globally. They’re doing well in China; better than a lot of local shoe manufacturers. You don’t have to make a top-down call in your portfolio. You can say, “I’ll invest in this great global brand, and I’ll benefit from the rise of the Chinese consumer, and also benefit from US and other markets globally.” It’s a win-win for us.

What are some global opportunities and threats?

Moroz: There’s a great mean reversion going on where there’s a shift in economic power from west to east. We don’t know the ultimate trickle-down effect.

Investors have to remember that while it’s difficult to carry an umbrella when it’s sunny outside, it’s even more difficult to put on shorts and a t-shirt when it’s pouring. And it’s raining pretty hard now.

The offset to a lot of the negative news is valuations. A lot of bad news is priced in.

Tell me about your Canadian exposure.

Moroz: We’ve put a constraint on Canadian content: for large-cap funds, it’s 10%. For equity exposure in balanced funds, it’s 50/50. Why? If you’re not going to hedge, there is some logic to having Canadian assets, because if the client’s end liabilities are in Canadian dollars there should be some match.

In global small caps, we’re sitting at 17% to 18% Canadian. A lot of that exposure is actually back-door U.S. exposure. You’re paying 20-times earnings for a small-cap stock in the U.S., so if you can find ways to get that exposure for a lot less, it makes sense to do so.

If you were to examine head-office versus currency or operations exposure, we’re closer to 10% Canadian.

Give me an example of the type of companies you own.

Moroz: All companies we own are boring [laughs]. One is Retail Food Group, an Australian-based franchisor of quick-serve restaurants. Mostly it sells coffee, doughnuts, and snacks and meals – it’s like the Australian Tim Hortons. It earns a 7% royalty off the top from all its franchisees, so it’s a profitable, cash-generative business.

They’re set up in malls across Australia, and malls generate foot traffic. Average transaction value is $7.50. It’s a resilient business model. And guess who comes up with the capital to expand the business? The franchisee. So they can afford to pay a larger dividend and still expand the business, and in fact, the dividend yield is 6%.

The other competitive advantage is Retail Food Group controls the leases for five-to-seven years in each mall outlet. So they have a lot of negotiating power against the franchisees. So no one else can sell coffee and donuts there, and we think people will be buying coffee and doughnuts for a long time.

Mawer’s investment philosophy

Cash limit: Soft at 10%

Risk controls: Maximum 6% in one security; maximum 20% to industry, not GICS sector

Melissa Shin

Melissa is the editorial director of Advisor.ca and leads Newcom Media Inc.’s group of financial publications. She has been with the team since 2011 and been recognized by PMAC and CFA Society Toronto for her reporting. Reach her at mshin@newcom.ca. You may also call or text 416-847-8038 to provide a confidential tip.