Brian Christiansen – High-Conviction Growth Investing at Sands Capital (EP.361)

30:31But being thoughtful about macro in your portfolio construction is important as well. What are some of the things you're doing in your investment process better and differently today than 15, 20 years ago? One of the things is the globalization of our research platform. One of the reasons why we ended up launching global and emerging markets was also to enhance our research capabilities, even just for that U.S. strategy. So if you looked at a Nike or a Starbucks, which were businesses that we owned in that 2006 portfolio, for example, two of the biggest incremental areas for growth included Asia with China and then LATAM with Brazil.

31:19So having the capability to go do that work on the ground for all of our businesses, including our U.S. businesses, is one of the ways that we've really sort of evolved our research process over time. A second thing related to that concept is it's one of the reasons why we originally got into our private equity strategies. So we did our first investment in a private business back in 2010, and it was in the DNA sequencing space. And one of the reasons for it was because we felt like we had owned Illumina in the public markets at the time, and most of the innovation was actually happening in the private markets from a competitive advantage standpoint.

32:09And so to really sort of understand emerging technologies, we felt like it would give us an advantage if we were active in the private markets. And so we actually made our first investment in a business called Complete Genomics off our partner balance sheet back then at the time. So the window in the private markets, which are the next generation of either public equities that you'd like to own or could be competitive threats to the public equities that you already own, that capability has helped widen our aperture and helped increase our understanding of innovation wherever it's happening, public and private.

32:47Our macro frameworks are something that we really innovated and incorporated into our research process before we launched our first multi-geography portfolio with our global growth strategy back in 2008, early 2009. So we're definitely a learning organization. And over time, we're always trying to look for ways to enhance our ability to deliver on our mission and be smarter about the application of our criteria across our opportunity sets. How do you describe your competitive advantage? I really think there's four things. One is our investment philosophy and process. We apply that private equity-like approach to investing in public equity markets.

33:36We think there's that very small group of businesses that can grow for much longer or faster than the market anticipates. And it's those types of high quality growth businesses for which we want to exclusively focus on. Because not that many of them exist, that's why we want to build concentrated conviction-weighted portfolios where we own the business for the long term. So our average time horizon for owning a business is well over five years across the firm. The way that kind of works in practice is when we make mistakes, it's often a shorter time horizon of, call it two to three years. And our big winners end up being some of our longest tenured investments where we own businesses for 7, 8, 10, even 15 plus years to really capture the earnings compounding of that business over many years.

34:35So after our investment philosophy process, I think team structure is also what we believe one of our areas of differentiation is. Our team looks a lot more like a private equity team structure rather than a traditional public equity team structure. So our team's organized by sectors where the team goes very deep in understanding business model expertise. but then we're also able to do very deep due diligence in those businesses to localize that knowledge. We do that through extensive travel on the ground, obviously meeting with the management teams, meeting with competitors and suppliers, doing consumer survey work or consumer panels to really combine that global business model expertise with that local sort of on the ground knowledge, which is required for investing in businesses in global and emerging markets.

35:36And we're able to deploy a tremendous amount of resources in doing that type of work because we have such a strong ratio of investment professionals to businesses owned. So we have over 60 investment professionals and we own about 130 public equity businesses across our flagship strategies. And that's an incredible ratio of investment professionals to businesses own. And again, those businesses don't turn over very often given that low turnover approach. So that too helps us deploy the time and the research activities and resources required to build that high conviction view to own a business for a very long period of time.

36:20And then after investment philosophy and team structure, I think the governance of the firm is a little bit different at SANS. And what I mean by that is we are 100 % independently owned organization. We're owned by the employees who show up and work at SANS every day. And we have a very broad partnership in terms of employee ownership. So it's not just concentrated in only a handful of very senior investment professionals, but actually north of 40 % of our 200 employees are actually partners in the firm. And I think that's enabled a few things in my view. One is it's allowed us to chart our own course and not be encumbered by sort of a parent company's interest.

37:03That broad ownership structure also breeds entrepreneurship and an ownership mentality. I think that's one of the reasons why we've been able to evolve and be very entrepreneurial throughout the 17 plus years I've been at the firm. It's also allowed the firm to make some of the biggest investments in itself during challenging periods for the industry. So during the financial crisis, for example, or more recently during the pandemic, those were times where we took the selective opportunity to actually go out and hire high quality talent and invest in various different divisions within the firm.

37:43So when you wrap all that up and then couple it with that long tenured client base, where there's that strong alignment with our investment philosophy and process and time horizon, I think all of those things contribute to what we think are edges versus other investment firms or investment organizations. So we've seen a big change in the growth end of the private markets starting about two years ago. We'd love to get your perspective on the opportunity set and how you're thinking about it these days. Yeah. So we do have a separate team that works on our private equity strategies, both global innovation, which is primarily technology-focused businesses.

38:27And then we have our life sciences strategy. But you're absolutely right. There was a lot of capital that went into that space, particularly into late stage technology, private businesses. But I think one of the things that our team had done incredibly well is stay very, very disciplined. And actually, they put the brake on deploying capital when valuations had gotten too elevated and went well over 12 months without deploying additional capital during that timeframe and have been very, very patient. And I think having an approach, again, of concentration, selectivity, and then being disciplined from a valuation perspective, I think is going to serve the strategy well and the clients well when we're looking out over the next three to five years.

39:18And then we do a look back on results the last couple of years. As we've had this wave of capital moving to passive strategies in the public markets and more and more competition from hedge funds and active managers, I'm curious how you've seen that competition impact either the pricing of securities or the research process you go through. It's interesting. I remember looking at this data a little while back. When I joined Sands back in 2006, I still remember it was something like 40 % of trading volumes in the US at that time were still being driven by fundamental investors. If you fast forward to today, it's maybe 10 % of the market that's still doing that.

40:07The other thing is, is there's a lot of algorithmic trading all being driven by similar factors. Factor exposures can really swing short-term stock prices around quite meaningful. So one of the ways that we've thought about it philosophically is that if anything, that time arbitrage opportunity, the fact that there's even fewer people that are doing the type of work that we do with the time horizon that we do it creates more opportunity or alpha generation. But it also makes the path potentially a lot bumpier. And it's one of the reasons we think that we've been seeing so much more volatility in the market as well.

40:51It's not uncommon now to see 40%, 50 % downward or upward stock moves in companies based on events that you historically didn't think would drive that type of short-term volatility. So being aware of those dynamics are things that we have incorporated in our research process. We think over the long-term, it creates opportunity. It's just, you have to survive that path along the way. I'd love to hear an example of that dynamic in one of the stocks that maybe you bought or owned in the portfolio. A recent example is Adyen in our global growth strategy. Adyen is a leading global online merchant acquiring platform.

41:45Essentially, with a single API, it can allow companies to accept all sorts of different payment types, including places like Europe, parts of the emerging markets, the U.S. developed markets with a single line of code. And then one of the things that they've done is created an offline merchant acquiring business that allows companies to have a single view online and offline of their customer base. And they've created a backend tech infrastructure where we think that they have a cost advantage versus the vast majority of their competitors. And it's a business that was very fast growing. In 2022, despite it being highly free cash flow generative and having strong operating margins, when we saw that growth to value violent rotation with a sharp increase in inflation and interest rates, one of the big things that we saw was that the fastest growing businesses, which have a disproportionate amount of their values, have accrued into the compound.

42:54of growth in the out years when you're doing that traditional DCF calculation, saw the biggest valuation pullbacks in 2022. And then one of the things that happened in 2023 is that when they reported, there were some incremental concerns around competition in the US market, competitors like JP Morgan Chase or PayPal's Braintree or Stripe. And we'd always viewed the US market as more of a commodity-oriented market within that larger payment ecosystem anyways. You have a single currency. That's very different than the complexity of payments in Europe, for example, where you have far more cross-border transactions.

43:36You have a lot of different currencies, a wide variety of different countries, longer tail payment types. That's really the type of bread and butter environment where Adyen is able to solve issues for its clients and get a meaningful revenue generation. Essentially, what happened was that they had this intermediate term guidance of low to mid-20s revenue growth. And because their near-term growth was slowing down below that, and now the market was anticipating that they'd only be able to achieve high teens revenue growth, which is still very strong in an absolute sense, the stock was down 50 % on earnings because of how skittish the market was.

44:19The market was just punishing companies that were missing expectations, even if it wasn't by large variances. So that was a great example where we really leaned into our conviction. The analysts did a fantastic job of going through the thought process. Has anything changed here? Do we continue to have very strong conviction relative to our original investment case? Do we think that that competitive intensity is going to expand beyond the U.S. to Europe and other geographies? Or do we think it's more isolated and contained to the U.S.? And when we kind of went through that entire thought process, we realized that we had as much conviction in Adyen as we did before and decided to bring the weight back up to a large bucket weight and essentially double the weight size and take advantage of the market significantly overreacting.

45:11And it appears that we're sort of off to the races again with Adyen. So hopefully that gives you sort of an example of some of the dynamics that we're seeing in the market. What are some of the biggest challenges you see in the business and in performing going forward? Well, one of the biggest challenges that we're obviously getting a lot of client questions and we're thinking a lot about internally relates to the concentration of the value creation that's happening in the Russell 1000 growth related to the Magnificent Seven. So it's been a very, very narrow market over the last number of years now, really.

45:52And our sort of response to that is we don't look at the Magnificent Seven as just one group of businesses. We think each one is very different. If you were to take something like Apple over the last five years, a big driver of Apple's growth has actually been valuation driven rather than earnings driven. But then if you take something like Microsoft, for example, it's seen some multiple expansion, but the predominant driver of the exceptional stock price in Microsoft for the last five years has been earnings. And we think that's a much more sort of sustainable driver long-term. So we just go company by company and develop our thesis.

46:35And at the firm-wide level, we own five of the seven across our various different portfolios. But two of them, in this case, Apple and Tesla, are companies that we have not embraced. And we still very much have high active share across our strategies. And we have a collection of businesses that we think are going to definitely be able to meaningfully add value when we're looking out over the next five years. But that hurdle rate in terms of the fact that the Russell 1000 growth has been in the, call it the top 10th, 15th percentile of active management for US growth investors, it's been a high hurdle to beat.

47:12So Tesla is like a notorious battleground stock. You mentioned not in your portfolio. I'd love to just through your lens of your six criteria, walk through why you don't own Tesla. I own two Teslas, so I drive one and my wife drives one. It's a fantastic product, but all great products don't necessarily translate to great businesses. Going back to our six criteria, the first five criteria help us decide, is this a high quality Sands Capital-like business? And then the six criteria helps us decide if we can actually make money in the stock long term. And so you need all of those things to line up.

47:49At this valuation, we think that you need much more than just car volumes, time, price, equal revenue and earnings. You have to bake in a lot more for many of the adjacencies, including its autonomous fleet. And depending on where you are on those expectations, the size that things like the autonomous fleet, the energy storage business, their budding insurance business, all these other areas that they've been expanding into and growing, the amount of value that you have to ascribe to those to kind of make the math work for us, we've been hesitant. We also think that we're probably in a pretty difficult digestion phase for EVs, overall electric vehicle volumes, in probably the next 12, 18 months, given the late impact of higher interest rates and the wealth effect that that has on consumers and in their purchasing power.

48:46right now we're at a point where EVs are still more expensive than ICE and cars. And at those higher interest rates, we think those are headwinds to adoption over the short and intermediate term. The final thing that I'd say is before 2019, 2020, financial strength was one of our biggest concerns because that criteria doesn't prevent us from embracing unprofitable businesses per se, But we want the company to be able to finance itself from its own balance sheet or cash flow. So for example, Amazon's an unprofitable business that we invested in very early on. And one of the reasons for that is because despite it being unprofitable, it actually had a phenomenal working capital cycle.

49:30Customers would pay up front. They'd pay suppliers 90 plus days later. They were able to self-finance their growth. And it's one of the reasons why you didn't see Amazon coming to the market serially to raise additional equity capital throughout those years. Whereas Tesla pre-2020 was a completely different story. They were unprofitable and had a challenging working capital cycle. And it's one of the reasons why Elon Musk, in my view, had such big public targets for the business was because he had to sell the dream because he was relying on raising equity capital to finance the dream. Now, that all changed.

50:08Either great timing, luck. Those two things often go hand in hand. But in February 2020, right before the pandemic, they did the final raise. I think it was a couple billion dollars. And that was the last capital they needed to flip to free cash flow positive. And that's when you saw a big amount of wealth creation in a short amount of time in the stock. But since then, our main challenge has been around valuation. I'd love to ask you, Brian, what are some lessons that you've learned from CEOs of your portfolio companies? That's a very interesting question. There's a couple things. One is around talent management.

50:49And the reality is, is that some of our most impressive management teams, interestingly, in charge of some of the biggest wealth creation opportunities that we've seen are entrepreneurial or family run. If you go throughout history, Amazon with Jeff Bezos is a great example, or Walgreens, that was entrepreneurial and family run, or Walmart is also a fantastic example of that, or many of the tech platforms, for example, Google. I'm also a portfolio manager on our emerging market strategy. And when you think about the amount of wealth that's been created by the Tata family across a whole number of different companies, one of which we own, which is Titan, the leading gold drawer franchise in India, or Asian Paints, which is a lot like the Sherwin-Williams in decorative paints in India.

51:46They have over 50 % market share and a very under-penetrated market. Dr. Reddy with Apollo Hospitals in India, they run not only the largest for-profit hospital system in India, but also the largest retail pharmacy company in India. Dr. Reddy was inspired by the Frisk family who had built HCA here in the US. So these entrepreneurial family-run businesses, some of the biggest lessons that we've learned from them, and I think also comes naturally given that Sands Capital is an entrepreneurially built business, employee -owned with Frank Sands and the Sands family still very much in control of the business.

52:30And as our CEO and CIO is very active in building the business over the long term, our best managed publicly traded businesses are ones that are able to maintain that long term lens, are able to invest heavily in their people, in R &D, in innovation for the long term, are able to attract some of the best talent that's available in the marketplace. They also do a fantastic balance between growth and experimentation in either new geographies, new areas, new products, and new services. But they stay very disciplined in capital allocation or some sort of framework that determines how much time, energy, resources do they spend on their current business versus those new adjacencies.

53:22And often what they do is something like Nubank, for example, which is a business and a management team that we admire, building one of the most attractive digital banks, not just in Brazil, where it's a leader, but really when you're stack ranking it up globally. And they have a very disciplined framework for how they think about capital allocation to new adjacencies. And they're taking their current foothold in Brazil and actually expanding into new markets like Mexico and Colombia, but they're doing it in a very rational sort of disciplined way. But I'd say it's a lot of little things as well.

54:02I find myself constantly in a long-running list in my Evernote, keeping nice little management tidbits from all the different management teams that we're meeting across the world. Brian, I don't want to let you go without asking a couple of closing questions. What is your favorite hobby or activity outside of work and family? Yeah, so I'm definitely into fitness, given the demands that are on an investment professional in today's environment where there's information coming at you at all times, 24 hours a day, seven days a week. having an activity that allows you to stay physically fit and just sort of escape a bit from all the noise, I think is helpful.

54:49And working out is definitely one of those for me. Similarly, I absolutely love reading. I mean, one of my favorite activities is just to have a cocktail in my hand sitting at the beach where the nature is just incredibly powerful, the sight of it, the sound of it, the smell of it. And then with a really good book in my hand, I mean, there's nothing better on earth than that in my mind. What's one fact that most people don't know about you? I grew up in a very international environment, I guess I'd say. So my wife actually originally grew up in Russia. My mom was actually born in Cuba, left Cuba when she was 11 years old back in the 60s.

55:35My brother was actually born on the naval base in Naples, Italy. We lived on the naval base in Guantanamo Bay, Cuba when I was a kid at one point. So this idea of the world just being a much bigger place than my immediate surroundings, I mean, that concept was pretty ingrained in me at a young age. And I think all that moving around and having all that different cultural exposure made my personality pretty adaptable and flexible in a lot of different team environments, in part just because that was the only way to survive when you were moving every two and a half years and plopped into a different school and a different neighborhood.

56:15And I think a lot of that is probably one of the things that attracted me to investing in emerging markets and global investing as well. It's just sort of being able to continue to find a way to pique that interest by meeting people and traveling all around the world. What's your biggest pet peeve? Probably people that have too strong of opinions on too many things. And the reason for that is it starts making me nervous about someone's judgment and then being susceptible to an overconfidence bias. I'm a big fan of Phil Tetlock and his work on super forecasters. One of the things that's really interesting is as a growth investor, where you're trying to predict the future and you have these concentrated conviction-weighted portfolios, these opportunities are nonlinear.

57:08So the reality is, is you have to have courage to be an investor and you have to have courage to be different. And when you have courage to be different, that means a lot of people are going to disagree with your viewpoint at times. But you also have to be willing to sort of update your views based on new pieces of information. And I think sometimes overconfidence biases prevent people from being able to do that effectively and just sort of look at rational data when new data is coming in. I just feel like if you have really strong opinions on too many things, the chances of you being able to rationally update your thinking on things is probably pretty low.

57:47Which two people have had the biggest impact on your professional life? Well, one of them is definitely Frank Sands Sr. He was just definitely one of those people who he was just very thoughtful and articulate in how he communicated. He also used silence strategically in order to emphasize a point. Words really, really mattered to him. That's something that I've picked up from him and sort of rubbed off on me. It was really important to him, for example, if he heard someone say investment products at SANS, he would just get so frustrated. very professionally, but he would be one of the first to correct you that we offer investment strategies.

58:30We do not sell investment products. By the time I met him in 2006, he'd already had a very enviable investment track record. He started Sands Capital when he was 50 years old. So talking about taking risk. And he had three kids and was willing to go start on his own. Incredible track record, great human being. I just feel privileged to have had the opportunity to be mentored by him. And despite all that professional success and personal and financial success that he'd had, he was just so down to earth to talk to, which I think is very, very rare. How about a second one? I would definitely go with my wife.

59:15I still remember maybe 10 years into this business thinking, man, having a supportive partner or spouse, it is a huge, incredible force multiplier for anyone's career. And she also works full-time. We have three girls, 10, 7, and 3, two big dogs. It's a pretty busy Christensen household, particularly given how much I'm on the road for research travel. And so I admire her energy, her devotion to our family, her investment in each one of our successes, her sense of humor. And honestly, it would just be hard for me to imagine being able to do what I do, be successful doing what I do without her, like hands down, without a doubt.

1:00:01So she would definitely be the second. What's the best advice you've ever received? Two things. One is someone told me, if you can avoid it, try not to enter a career, which is relying on billable hours for revenue generation, because it just means in order to make more, you automatically have to work more. Ideally, if you can find a role where you're paid based on your judgment and that value creation that's delinked from hours worked, you can have a better quality of life. Another one that was partially related to the investment context, there was a Yale alum when I was doing coffee chat interviews, and he shared with me that most students, they either tend to flock to startups or really large, established brand name corporations that they felt like would be great stepping stones just for their resumes.

1:01:02They actually felt like there was just this enormously attractive sweet spot with smaller, well-established, fast-growing, boutique-style businesses, ones that are not startups in the sense that they're large enough where they have an established track record, value proposition, You know that they can pay the bills. They can certainly invest in their people. But it's still small enough where you're fast growing and you can make an impact on the P &L of the firm, even as a young person. And if you're able to do that as a young professional, you're often given more opportunities for career development to take on stretch roles than you would in a much more larger established firm.

1:01:45And it's interesting. I feel like that's in part been the hallmark of my experience at SANS. Brian, last one. What life lesson have you learned that you wish you knew a lot earlier in life? One of my strengths has always been grit. Put your head down and work really hard at something. And I think that's a powerful thing. And I wouldn't want to give that up. But the flip side is what I've also learned is how helpful and powerful relationships can be in a professional setting and spending enough time to work on those relationships. You can combine the really hard work and grit, but with strong relationships, it's an incredible, powerful combination.

1:02:36Brian, thanks so much for sharing this story of your path at SANS. Absolutely. Thank you very much, Ted. It was a pleasure. Thanks for listening to this sponsored insight. Sponsored episodes are paid opportunities for another 12 managers a year to appear on the podcast. If you're interested in telling your story in front of the largest audience of investors in the industry, please email us at team at capital allocators.com to apply for one of the slots.

1:03:14Thank you.