In short
Podcast Notes: Capital Allocators – Episode 51: Paul Black - Gratitude, Fun, and Growth Stocks
Overview
- Podcast Host: Ted Seides
- Guest: Paul Black, Co-CEO and portfolio manager at WCM Investment Management
- Focus: Insights into growth stock investing, cultural aspects of businesses, and personal anecdotes from Paul Black's career journey.
Key Points
Introduction to Paul Black
- WCM Investment Management: A global equities manager with $26 billion in assets, previously a $200 million firm in 1989.
- Paul’s background includes working at Wells Fargo Bank and Bank of America before joining WCM.
Early Career and Learning
- Paul shares his entry into the investment business, highlighting the importance of learning from mistakes and the serendipitous nature of his career path.
- Key Lessons:
- Importance of resilience: "Most of life is learning from your failures."
- Early missteps included focusing on fast-growing companies without understanding their long-term sustainability.
Growth Stock Investing
- Defining Growth Companies:
- Unique perspective: Growth investing requires optimism about the future, as opposed to the more pessimistic approach of value investing.
- Importance of identifying companies with strong competitive advantages ("widening moats").
Competitive Advantage and Culture
- Widening Moats:
- Emphasis on not just identifying high-quality companies, but also understanding the trajectory of their competitive advantage.
- Case study: Nokia's decline despite perceived quality and strong market presence in 2007.
- Cultural Assessment:
- Culture is a critical factor in a company's success. Companies with alignment between core values and competitive advantages perform better.
- Example: Comparison between Costco and Sam's Club, highlighting how culture impacts performance metrics.
WCM Culture and Philosophy
- Core Values: Gratitude and Fun
- These values stem from a history of challenges and are integral to the firm’s operations and success.
- Focus on learning from mistakes rather than punitive measures fosters a healthier work environment.
Challenges and Evolution
- Discussion of challenges faced by WCM, including a significant loss of assets during periods of poor performance.
- Importance of introspection and adapting strategies based on past experiences.
- Downside Protection: Emphasizes the need for robust portfolio construction and understanding competitive dynamics.
Active Management Insights
- Paul argues for the potential of active management to outperform the market, suggesting that many managers fail due to a lack of differentiation in strategy.
- The importance of understanding that market conditions can shift, affecting the performance of managers.
Global Growth Opportunities
- Interest in companies with a strong growth trajectory, particularly in emerging markets like China.
- The significance of cultural optimism in driving business success.
Final Thoughts
- The episode closes with personal reflections from Paul on the importance of balance in life and the ongoing pursuit of passion in the investment business.
Key Takeaways
- Learning from Mistakes: Emphasizing the importance of resilience and continuous education in one’s career.
- Growth vs. Value Investing: Understanding different investment philosophies and their implications for portfolio management.
- Cultural Impact on Performance: The necessity of aligning business practices with a strong, positive culture for long-term success.
- Active Management: The conversation highlights the need for active managers to focus on unique strategies to stand out in a crowded field.
Conclusion The conversation with Paul Black sheds light on the intricacies of growth stock investing, the importance of corporate culture, and the personal philosophy that drives success in the investment industry. His insights encourage listeners to appreciate learning from failures and to recognize the value of gratitude and enjoyment in their professional lives.
Written by AI. May contain mistakes. Listen to the episode to check what was said.
Transcript
Automatic transcript. May contain errors.0:04Hello, I'm Ted Seides and this is Capital Allocators. This show is an open exploration of the people and process behind capital allocation. Through conversations with leaders in the money game, we learn how these holders of the keys to the kingdom allocate their time and their capital. You can keep up to date by visiting CapitalAllocatorsPodcast.com. With so much of the institutional world focused on value investing, including my own training, I was pleasantly surprised to learn about a large, high-performing growth stock manager located in a nondescript building in Laguna Beach, California. My guest on today's show is Paul Black, portfolio manager and co-CEO of WCM Investment Management, a$26 billion manager of global equities that he joined when it was a$200 million boutique in 1989.
1:05Paul's early career included positions at Wells Fargo Bank and Bank of America. Our conversation starts with Paul's trial-by-fire entry into the business and turns to growth stock investing, including defining a great growth company, searching for widening moats, assessing a culture that's tied to competitive advantage, creating a positive culture within WCM, learning from mistakes, identifying tailwinds and protecting the downside. Paul embodies the principles he preaches and offers some tasty food for thought. Please enjoy my conversation with Paul Black.
1:50Paul, it is great to be here with you. I know we've been trying to do this for a little while. Why don't we start with how in the world is there this$25 billion asset manager in Laguna Beach that I had never heard of before? Thank you, Ted. It's great to be here. And we wonder the same thing, frankly. You know, WCM Investment Management, who's heard of us and how is it that there's a$25 billion firm that most people don't know about? And my answer to that is I really don't quite get it because we don't even believe where we are right now. So how did you get here? Well, I'd love to say it was a lot of hard work.
2:33It was a lot of good fortune. It was a lot of learning from past mistakes and making almost every single one of them that you could possibly make. But using that as a source of strength to get better and better and better and better. And anyone that doesn't believe that most of life is learning from your failures just doesn't quite get it or they're too young to get it. So how did you get started in the business? Well, I started, interestingly, even how I got involved with stocks, I think it's kind of fun. You know, when I was younger, I got a small inheritance from my grandfather when I was about 18 years old.
3:06And at the time, I thought, you know, I kind of like the thought of investing. I met an EF Hutton broker, and he told me to start buying South African gold stocks. Now, this is when gold was about$300 an ounce. So I think I bought 500 shares of a company called Eastry Fontaine, South African gold miner. And I was in college at the time, and I'm not kidding. I would open up the Wall Street Journal every morning. And when gold was going from$300 to$800 an ounce in those periods from 78 to 82, I would literally look at the Wall Street Journal and say, you know what, I just made, the stock would be up a buck a day.
3:45I'd make$500 a day owning 500 shares of this South African gold miner that was highly levered. And so that kind of got me hooked. I knew nothing about it, but obviously when you're making that kind of money in a short period of time, it gets your attention. And that's when I actually shifted my major from marketing to finance and ultimately went to work for Bank of America up in San Francisco in 1983 when B of A was the biggest bank and most successful bank in the world. It's a short few years later that it almost went bankrupt, which is a whole different story. But got into the private equity group, the private market group, the private banking group, ran portfolios.
4:26At 25 years of age, I was put on a desk to run$200 million of other people's money. I was given the Wall Street Journal, a bunch of research value line, I would say, okay, go to it, which is terrific for me, but it wasn't terrific for the clients because I really knew nothing about investing. But over the next five or six years, I learned a lot. Again, again, by learning what not to do. Yeah. So what'd you learn in those early years and what mistake, what do you think the key mistakes were that you made back then? I remember one of the trades I made in portfolios because I've always, I've loved growth and growth investing.
5:02At that time, I liked growth for growth's sake. So I was taking people out of IBM stock and putting them into digital equipment because digital equipment stock was a much more rapid grower at the time. Well, we all know what happened to that story. So I learned very quickly that the most rapidly growing companies, although they're kind of sexy and fun, ultimately they can be massive destroyers of capital. And really what I learned is how much I really didn't know over those five years and how much I needed to kind of educate myself to get much better at this business. And was that the process?
5:37Were you educating yourself or were there mentors around you that you learned from? You know, it's a good question because I always, I've wrestled with that throughout my life really. Are there guys that I can point to that are mentors? And there really wasn't one or two mentors from the investment side. It was really self-taught. You know, I, I spent a lot of time reading the classics, the stuff that Buffett talks about common stocks on common profits by Phil Fisher, one of my favorites. You know, obviously you read the chapters on margin of safety and Mr. Market, intelligent investor, but a lot of other books along the way.
6:08And that's really how I've kind of wrestled through the investment problem. Some mentors, certainly on the business side that have been really influential, just kind of keeping me in the game and keeping me accountable. That's been a big part of what's happened over my life. So what happened after those five years? After those five years, Bank of America was sold, or the private bank was sold to Wells Fargo Bank. Spent a couple of years there. Really just didn't enjoy the bank, trust department, private bank world. When you're one of 90 ,000 employees, it was very hard for me to figure out how I'm going to move the needle.
6:44And I wanted to move the needle. It didn't matter if I did a brilliant job or I didn't do a brilliant job. I still got a 3.2 % raise. So I wanted to have more ability to control how I was compensated and how I grew professionally. So I was fortunate enough to run into a gentleman named Kurt Winrich. And interestingly, like most things in my life, at least, I think most people's lives, it was very much serendipity. My fiance at the time actually taught Kurt's five-year-old son in preschool. One day I'm going to the zoo, if this is interesting. I'm going to the zoo in the back of the car Kurt's wife was driving with the kids.
7:23And I asked her, I said, what's your husband doing? Oh, he's a portfolio. I said, oh, I'm a portfolio manager, and I'm looking for a job at that time. She said, okay, great. Kurt then gave me his brochure. Fortunately for me, he hired me in 1989 to join a$200 million money management firm down in Southern California. And that was really kind of the beginning of the journey that Kurt and myself and our other partners have been on for a lot of years. Let's turn a little bit to growth investing. Let's talk about a lot of, you know, we all know growth and value. All know the disciplines of value investing.
8:00Hear about it a lot of the time and certainly the conversations I have. What is it about growth stock investing that works? You know, I think in part, it's a different perspective on the world. To be a growth investor, you have to be optimistic. You have to be optimistic about the future. You know, value to me is a little bit more pessimistic. You're trying to buy these assets at a compelling price based on their value today. You know, with the hopes that it'll keep kind of plugging along and then ultimately there'll be a regression to the real value. For growth investing, I like it because I tend to see the world more positively.
8:35I think it's consistent with where I am kind of psychologically. And to me, optimists rule the world. I think optimists are the ones who ultimately get it right. Because if you look back through history, Buffett says it all the time, never bet against America. I'd say never bet against great growth companies with superior cultures that are highly competitively advantaged. So let's dive into that a little bit. You mentioned great growth companies. What constitutes a great growth company? A couple things for us. And it's very different, I think, from what most people do. And I'll kind of start like this.
9:13One of the things that we wrestle with, a lot of people now are wrestling with whether active management can outperform. I think there's a lot of evidence to suggest that it can. But to me, most managers try to buy high quality businesses with strong economic advantages or competitive advantages, selling at a discount to intrinsic value. I think one of the reasons that active managers underperform consistently is because everybody's doing the same thing. They're all approaching the market from the same perspective. What we have found is more times than not, if you're just looking for high-quality, wide-mote businesses selling cheaply, today you're going to find yourself in a lot of value traps.
9:50The poster child we always use in the firm is Nokia in 2007. If you and I would have gone to Wall Street and met with the 25 different analysts that covered Nokia, and ask them, hey, is that a high-quality, wide-mode business selling at a discount to intrinsic value? They'd be absolutely. Everybody had a buy recommendation on 2007. What's not to like? 53 % market share in phones, one of the great top three brands in the world, no debt, really high quality, returns on capital of probably 30 % for the prior five years selling at$0.60 in the dollar. We fast-forward today, and we ultimately know what happened.
10:25And our question is, was that really a high-quality business? How do you define high quality? To us, it would not be a high-quality business because the truth is, while it was a wide economic moat, that economic moat was clearly deteriorating. It was clearly losing its edge and being disrupted, obviously, by the iOS from Apple and then also from the operating system from Android that allowed a lot of companies, cheap China manufacturers to make phones. So we've made the mistakes in the past of buying high-quality wide moat businesses cheaply. and what we learned because of our mistakes of significantly underperforming the market is you've got to stay focused on the direction of the competitive advantage because everybody's business i don't care who it is every organization you're either getting stronger versus your competitors or you're getting weaker and what you want to do is you want to be able to make the case through pattern recognition and other tools around moat typologies is how we classify it that the company that you're looking to invest in has a strong likelihood of growing its competitive advantage over the next 5, 10, and 15 years.
11:31And if you get that right, by the way, I will tell you that any valuation work you do is going to look ludicrously cheap 5 and 10 years out. So that's a huge part of what we do that's different around how we look at competitive advantages. And then the second one I think that's really significant and very different is we put a huge premium on a corporation's culture. And that doesn't mean, hey, we just want shareholder friendly management teams, which usually means they're good capital allocators. What we want is we want to understand the DNA of the business. We want to know what the core values of the business are and how those core values relate to the competitive advantage.
12:10Because if you can buy a company where the core values of the organization are aligned with its competitive advantage, Like, for instance, in retail. What do the core values of great retailers need to be? It's got to be about taking care of your people. We use the example of Costco versus Sam's Club. Those are two companies in the same industry. The stores look the same. But you look at the financial metrics of Costco, they're twice on every metric what goes on at Sam's Club. Same store sales are 4 % or 5 % at Costco. There may be one or two at Sam's Club. Sales per square foot at Costco,$1 ,000,$500 at Sam's Club.
12:44Employee turnover at Costco, 12%, 50 % at Sam's Club. ROIC is a 12 versus four for Sam's Club. What accounts for that? To us, it has to come down to the culture and the values of the business, where in Costco, they truly care about their people. They want happy employees. In retail, you want happy employees because you and I are going to go in there, and we're going to get a great experience, and we're going to come back and spend more. It's reflected, and by the way, that whole value side comes directly from the top. Founder of the company, Jim Senegal, owned a lot of shares but never made more than$300 ,000 a year.
13:17How different is that from companies, other companies where the CEO is making$20,$30,$40 million or in the case of some CEOs where they get fired and they get a golden parachute of$200 million? That doesn't usually bode well for the long-term cultural success of the firm. So to us, the distinguishing characteristic in any investment has got to be determining what those core values are, what animates that culture, and making sure there's an alignment. Let's dive in on both of those. So on the first, on moats, how do you define and then measure what the company's competitive advantage is? Lots of different ways.
14:00First of all, what indicates historically with money managers, what indicates a moat is obviously some level of return on invested caps. So most managers out there are always screening for some kind of hurdle, a 10%, 11 % hurdle on ROIC over the prior five years. What we've actually found more valuable than just the level of the ROIC is the direction. There is a one-to-one correlation between the direction of the ROIC over a five-year period of time and stock performance. You know, so if you break the market down into five quintiles from the top quintile where they have the most rapidly rising ROICs to the bottom where they have the declining ROICs, there is a one-to-one relationship between the best performing stocks on the top and the top quintile and the poorest performing stocks.
14:46And is that starting from a certain baseline, absolute level of ROIC from which you want to see growth after that? And that makes a good company? No, no. I mean, we prefer a company, frankly, that would have maybe five years ago had a 4 % ROIC growing to 5, 6, 7, 8. That's a much better investment than a company that's at a 12 % ROIC that might be stagnant over that period of time and not growing. So there's a huge advantage to getting that correct. There's a lot of other ways that people talk about moats. Buffett talked about brands when he went from being sort of a classic Ben Graham investor to a Phil Fisher investor.
15:22How are the other ways that you think about what competitive advantages get incorporated into the kinds of businesses you like? They're the obvious, right? Disruptors, low-cost providers, obviously in Amazon. But we've actually developed a number of what we call typologies, moat typologies, that we think are a little bit different. One of them, for example, is an outsourced R &D company. We have found when you look at various companies in different industries that we can classify them in certain ways where you don't have to just be specifically in one industry. For instance, there's a company called Core Labs in the portfolio.
15:58which is basically ultimately an outsourcer of measuring the core samples in gas wells and oil wells. They were once a part of an integrated oil company, but because they weren't an essential element, they got spun off on their own. And interestingly, so now what they do is they sell their services to all the big drillers and integrated oil companies. And over time, because that's an outsourced R &D process, we can look at that company versus other outsourced R &D companies and maybe other industries. For instance, Christian Hansen, which is an enzymes company that creates enzymes and biologics for the use in yogurts and cheeses.
16:42And very simple business that an analyst that's just looking at maybe the material sector might look at Christian Hansen and see it's really very richly priced. But if you think in terms of it being an outsourced R &D company, our argument would be those types of businesses deserve higher multiples. Because what they ultimately do, they start at the low end. They're a very low cost part of the process. But then they kind of climb the value chain. And they start adding larger and larger services to the point now where Christian Hansen, if you look at Danone or Yoplait or any of the other yogurt manufacturers, they're really branding companies now.
17:18And Christian Hansen is the company that develops the taste and the texture and the caloric content. If you can kind of look at the world more in a generalist sense, you can kind of see these relationships. Core Labs, just looking at the energy sector, looks expensive. Christian Hansen, just looking at the material sector, looks expensive. But if you look at them really as outsourced R &D companies like we do, you can say that, hey, their margins ought to grow from 25 to 30. So what most people will see as being expensive, we can actually make the argument they're not. And so you have these businesses with growing moats.
17:52And then you also mentioned you started talking about culture. Similarly, how do you go out and really assess a company's culture? I think that's one of the most fun parts of our job because nobody does it. You know, it's interesting. If you look at, if you read Phil Fisher's book, Common Stocks and Uncommon Profits, which again is one of the classics. It's interesting. I think he has a 25-point checklist on how to analyze a company. And interestingly, of the 25-point checklist, probably 15 points are all qualitative elements, which is just the reverse of what most people on Wall Street do. Most people spend 95 % of their time crunching numbers, running DCF models, which, by the way, has zero competitive advantage because you have thousands upon thousands of people doing the same work.
18:46Where we can get a massive competitive advantage is by doing the things that other people are not. And so when you're trying to assess a culture, really one of the best ways, if I wanted to assess GM's culture and get a, you know, one of the best things to do is not just talk to the CEO or the CFO, but it would be, hey, let me talk to people that have left on good terms. Of course, you talk to the suppliers and you talk to vendors and you talk to competitors. It's always good to talk to competitors. Who do you respect? Who do you not respect? But if you can talk to people that used to work there that have left on good terms, you usually get a pretty good picture.
19:18Now, what you're doing, by the way, is you're building a mosaic when you're going after culture. A lot of people don't do it because you can't quantify it, right? You can't put it in a box and score it and come up with a scale and a number ranking. You really have to build a mosaic. One of the things we've done is we actually have worked with a guy named James Heskett, who was a Harvard business professor. wrote a book called The Culture Cycle. It's actually one of the more interesting books we've read on culture, and there are a lot of them out there. But he's really the person that helped us understand that when you're assessing a culture, you've got to look for the strongest companies are going to be companies where the culture, as I said earlier, and the values are aligned with the competitive advantage.
20:00We've worked with him. We've hired him as a consultant. He helps us with a series of questions to try to ferret out what the culture is about. Because, you know, you just can't walk into a business say tell me about your culture now you can and i'd argue if somebody goes on for 30 minutes on culture it's important to them some people you ask them talking about culture oh you know what you know we work hard you know okay you really haven't put a lot of thought into it but these series of questions you know what are the and what are those types of questions one question that you and i were talking about earlier is what would you tell a friend about how to be successful in your company?
20:37What are the three things you'd tell them to be successful? What's really hard for some new hires to get used to? What are some difficult scenarios? Tell me about your failures. Where have you made mistakes? Most people don't want to talk about their mistakes. They just move on as if their career was just filled with success. I remember years ago, real quick story, We were meeting with John Mackey at Whole Foods, the founder of Whole Foods, who, by the way, I think is brilliant. Went into his office in Austin, Texas. And before we got to meet with him, there was just an incredible, there was this incredible energy.
21:14And I hate to use the word vibe coming from California, but there's this incredible vibe. Right. And people, you could tell people are really happy. They were talking. They were smiling. And I asked Mackey about it. I said, you know, I tell you, it's incredible. You know, the feel as you come in here. He said, you know what that is? He said, that's an absence of fear. And I thought, okay, absence of fear, that probably means that you can take risks here at Whole Foods and not be afraid of getting banged on the wrist, but you're going to be encouraged to take risks. Probably pretty good for somebody that's selling a lot of consumer products.
21:46You figure out different ways to do it. And, you know, over the long term, we'd argue that, you know, if you're allowed to take risks in a business in a healthy way, that's probably going to lead to better returns and better outcomes. And have you ever tried to map out other sort of companies that you think have good cultures, companies that have less good cultures, and use in any way kind of data to convince you that your instincts are right, that the companies with better cultures will all perform over time? A bit. This is our argument. Our argument is there aren't that many great cultures with alignment to their competitive advantage.
22:25But when you find them, you hold them for a long time, 10 years. So when I look at our portfolio now, I'd say we're not perfect on the culture side, but I would argue there are probably right now five or six names in the portfolio where we really believe there's this perfect alignment between values and culture. And they just so happen to be our largest positions and they've performed very well. Right. And what does it mean, maybe give an example of culture aligning with competitive advantage? I always talk about Walmart 40 or 50 years ago. How in the world did Walmart compete against Mervyn's, JCPenney's, Sears, these big, big successful department stores?
23:07How did they grow up in that period of time and actually come to dominate the market? To me and to our firm, that was culture. That was a guy, gifted guy, Sam Walton, who really embraced the notion that, you know what, you got to bring people along. You got to get people excited. You got to make people happy. You got to, in those days, it's different now, but you got to pay those people well. You got to tie them into the bottom line. And he kind of built this culture where people just loved coming to work and they had a lot of fun doing it. And as a result, they took on these old, stale, kind of bureaucratic, centralized organizations.
23:44And that works for a retailer. But do you really need happy employees to run a railroad? Probably not, right? You're probably not all about, hey, I want a bunch of yahoos running around throwing parties. You want people that are highly accountable, probably think a certain way, more linear, because it's all about delivering an on-time product in an efficient, cost-effective manner. So in Canadian National or Canadian Pacific Railroads, you're going to pay people more than you would in a retailer. But you know, high levels of accountability, there's a high cost of failure there. So probably a lot more in different stresses, very different corporate culture you need for that than you need for a retailer.
24:26We found there are different cultures for different businesses that are effective. So let's turn both of those to that point on WCM. How do you think about your moat and your culture and how that impacts your business? It's a great question. And it's something we've thought a lot about. Can I go back in time a little bit? Sure. Let me tell you, our firm was actually founded in 1976. And I kind of see the founder's still alive. He controlled everything in the firm. You know, 1976, that was two years after ERISA. That was when it was a brilliant time to start a money management firm. You should be able to build a multi-billion dollar money management firm just by showing up every day.
25:09But he was tough. He controlled 100 % of the equity. He made most of the money. Most importantly, he made all the decisions in the business and on the portfolio. And I think, as you'd guess, what happens, a lot of talented people in this business, and you can attract them to a money management firm because it's stimulating and usually it's fiscally rewarding. But there was this constant revolving door of talent that would come in, realize very quickly there was no place for it to go, and leave. So for 20 years, actually 22 years from 76 to 1998, the firm never grew over$200 million. Never. In the perfect time to launch a money management firm.
25:45We'd argue right now that that's because it was an extremely unhealthy culture. I've got some great stories. Let me tell you one that sticks out in my mind, and I think it just completely illustrates kind of the unhealthiness of the culture. So I was hired to kind of help raise assets, sales, marketing, and I was fortunate because I didn't really know what I was doing because I had come from portfolio management. About six months into the job, the founder came to me and he said, hey, Paul, why don't we go to one of the local beaneries, break bread, and let's talk about the firm and where we're going.
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26:21I said, hey, that's great. I'd love that. I'm getting attention from the founder. I'd love it. So the next day, we walk out of the building. He's got a brand new Nissan NSX, the fastest production sports car in the world at the time. $90 ,000 car. We get in that car. We drive around the block and down the block and pull into a Taco Bell. No kidding. I'm not kidding. We get out of this$90 ,000 production sports car and we get in line. Founder goes first, buys his tacos, pays for him. I go next. I buy my own tacos and I pay for him. We then walk out and, you know, in Taco Bell, the seats are small and you're literally about a foot away from the person that you're sitting across from.
27:14And the founder asked me, he said, so Paul, what is it that you need to really grow this firm, to really make it go? And I said, you know what would be great? It would be great if we had some investment performance. Because we were in the bottom decile for every time period. So it would be great if we had some investment performance. Well, you know, you probably don't want to say that to the lead portfolio manager and founder of a company. that meeting was over and as we walked out the door he said as he's getting into his 90 000 sports car hey paul you don't mind walking back to the office do you i said probably not walk back to the office in 95 degree weather wearing a suit he took off in his sports car and that was completely emblematic of some of the issues in the organization i'm not saying he was a guy.
28:08I'm just saying he was a little bit out of touch. Were you surprised that the door wasn't locked on you when you made it back to the office? Yeah, I really was. So it was just a classic example. Every day the founder would come in, say hello, go back to their office, close the door, and never to be seen again. And the only way you could communicate with the founder, he had a mail slot in his door. He literally had to take a piece of paper and write a note on it and put in the mail slot. So, you know, not conducive to, that's why we're so, our offices are wide open. There's no hierarchy. Fun is a huge value because that wasn't fun.
28:48And you know what? You didn't get the best out of people because they were not having fun. There were four of us that bought out the original founder in 1998. And I'm not kidding, not even tongue in cheek. What we decided was, hey, what did the founder do? Let's go 180 degrees the other way. And we'll probably build a doggone good culture, right? So what does that mean? That means, you know what, first of all, we're going to share the wealth. And secondly, we're going to be transparent about pay. It's not going to be opaque, but we're going to be, and third, we're going to hire this young talent.
29:17And when we figure out that that talent's really adding excess returns to the portfolio, it's going to, they're going to own equity and they're going to own a decent amount of it. As a result, we've grown from$200 million to$26 billion in assets under management. Great products. I think we do something very different in terms of how we approach competitive advantages and the work we do on culture. But to me, it's the core set of values in our firm that were born out of a tough experience that come down to two things. What are most people's core values? Oh, integrity, dependability. We're not going to steal from our clients.
29:55And that's kind of like that's permission to play. You know, you've got to have those, right? That's obvious. We have two core values. One is gratitude and the other is fun. And those two core values really do reflect who we are. And I'm convinced that those core values and living those core values has led to our ability to make mistakes and be free to analyze those mistakes. Not so that somebody can be punished, but so that we can learn and get better. Gratitude, again, stealing from Buffett. You're born in America. You won the lottery. I mean, come on. You've got to be grateful for that. And I've had clients ask me, well, how's gratitude help us as your clients?
30:38And I think what it does is hopefully with gratitude, there's a level of humility to know how fortunate you've been. You're again allocating capital in this day and age and you get paid handsomely to do it. Not so maybe 100 years ago. If there's a level of humility, hopefully there's also a recognition that, hey, we may not be the smartest guys out there. We may not work the hardest because everybody on Wall Street works hard and smart. But you know what we can do? We can care more about our people. And to me, that's an enormous competitive advantage because the evidence is overwhelming again that small teams perform better.
31:14And I think if those small teams are healthy, and they're grateful, and they're having fun, you're going to have a better chance of getting great results out of that. When you look at this landscape for active management, I touched on it a little bit earlier. You said there's evidence that active management works. I've been the poster child that that's not the case. So why don't you talk a little bit about what you've done and what you see? One basic premise I have is that when you start in this business, it has everything to do with what you ultimately believe about markets. If you started, let's say, in 1972 and you ran portfolios from 72 to 74, it's highly likely that you come out of there writing a book about how you can't beat the market.
32:02If you started in 1983 like I did, even though we had a little blip in 1987, you probably, since you've had a pretty robust market in the U.S. and even globally for a lot of years, you probably have a sense that active management can outperform. I went out recently and went through a database and said, you know, what's the reality here about how many people, how many active managers beat the market? So we looked at all active managers in the database. There were 2 ,000 that had at least a 10-year track record. And of those 2 ,000, 50 % of them beat their respective markets, whether it's EM, small cap, bonds.
32:39What was that time period? That was 10 years. Which 10 years? 10 years ending December of 2017. Oh, okay. Yeah. Tough 10 years. Yeah, tough 10 years. and fully 50 % now okay people are going to argue out there there's a survivorship bias absolutely but let's let's tone it down make it call it 25 % do you think that most people that are allocating capital should be able to find one out of four managers that has a good shot at beating the market I think so and here's the reality the reality is on one hand I get people going passive because for the most part, managers don't do anything different to justify an active management fee.
33:20Most managers are all about protecting their assets. So they're going to run a hundred stock portfolio. They're going to buy the high quality, wide moat business selling at a discount. And you know what? And then they're going to wonder why they don't outperform. And frankly, there is a big, I know it's hard for the Northeast to see, but there's a lot of groupthink in the Northeast. And there is beauty to being removed from that. So if you set the premise right from the beginning, which is, hey, let's run a more focused portfolio of 30 names. That gives us the best chance of outperforming. You'd mentioned that Firm, over time, has gone through some tough periods and a lot of introspection and learned from them.
34:01Why don't you tell a few stories about those periods? Yeah, one of them, Firm founded in 76 in 1994. before, the firm was still a couple hundred million dollars. And there was a transition between the founder and the son, who's my partner now, where the founder of the firm just decided one day that he's done managing money and kind of told the son, Kurt, that he had to take over the portfolio the next day. Well, having never run money before and all of a sudden having to run$200 million of it didn't really quite have a solid repeatable process in place. Firm performed very badly for a year, lost a lot of money, probably went down to about$150 million.
34:42If you ask Kurt now, he'd tell you that he was getting his resume out. Here's a business owner, right? And you know what's hard about that? He's the son of the founder, and he feels like he's driving it into the ground. It was a huge learning experience in terms of, one, Kurt came from an engineering background, so he was trying to quantify a subjective process, and he saw everything through numbers. And if you ask Kurt now, he'd say, even though I'm an engineer and I get numbers and it's not about that, the competitive advantages is all, in our case, is on the qualitative side. That was a big lesson.
35:14And then we were running in 2000 to 2007 a large-cap growth strategy, U.S., and good, solid companies. We did a couple things wrong. One, we really believed in this wide-moat stuff. So we were buying these wide-moat businesses. And we really believed in evaluation. You've got to get them cheap. So we were buying Yahoo instead of Google. And this is in a 20-stock portfolio, right? Yahoo instead of Google, eBay instead of Amazon, and Dell instead of Apple. Why? Because they were wider moats, and they were cheap. And we thought, how can we not lose? Well, we got murdered. Those three stocks murdered the performance of the portfolio.
35:55A very hard time. We ultimately got fired from$4 billion of money that we had raised because people trusted we could do well for them. And, you know, it's interesting. What I find is that people don't want to believe that money managers make mistakes, and they certainly don't want you to learn in a sense. They don't want to believe that you didn't know before, but now you know. You know, we're supposed to be omniscient, right? And what we have found is that over time, there are a few people that actually look, look, they don't look at those periods of time where we almost bury the firm as failures.
36:31They look at them as sources of strength. And that's how we see the world too. Some people might feel shame in them. We feel like, man, how about that for an education? How about that for learning a very different way of approaching the markets? So again, good humility, which makes you grateful that you survived and showed up to live another day. And those periods of time have been huge for what we're doing now on the global equity side. Yeah. So you spend a lot of time now in international markets. What are the differences in how you think about culture in other countries? That's a good question because it is different.
37:12What we do think in part, you know, we have a hard time being a growth manager, finding a lot of great companies in Japan, in part because of the cultural issues. You know, there's, I think it's changing a lot, but historically it's been hard for us to find names there where we think the cultures are healthy. You know, there's a lot of, you know, you still have the cross ownership of shares. You know, you still have a very paternalistic society and paternalistic companies. They're not very transparent. So it's very difficult for us to find names for that reason in Japan. We do have a number of them, but in general, it's difficult.
37:44In other parts of the world, interestingly, what I have found is when you look at compensation structures, which is another way of looking at culture, how do they pay people? I think it's great outside the U.S. you don't see guys making$30 or$40 million while their CFO makes$500 ,000. You just don't see that. You see a lot more reasonable equity payouts and or salary payouts in those companies, which I like a lot because I think ultimately that benefits everybody. It benefits shareholders. But you're right. In emerging market, we own Walmart in Mexico about five or six years ago. I think it was.
38:21There was a big New York Times piece on kind of the bribery or the so-called bribery that Walmart was engaging in to get space. Now, interestingly, what most people haven't heard is the end of that story, which is it was just big. It just blew up and Womax was in flames. Nothing came out of it. Nothing was proved. Emerging economies, they operate a little differently than a lot of European and North American countries. And things that we would see as being kind of under the table are just normal. So there is this part where you've got to understand that and just make sure that it's reasonable.
39:01If you could turn back to growth stock investing as a concept, in the ETF world and all the factor, the blowing out of sort of factor products, you hear about value products. You don't hear about growth products. So the notion is supposed to be that value stocks work because they're boring and nobody pays attention to them. And growth stocks, you do get the Google or the Amazon every now and then, but on average, that the growth stocks underperform because people are optimistic and they price them too high. Where does that break down? Or is it more that there's a subset of that growth stock universe that you've been able to identify?
39:39Because it's clearly worked for you guys. Yeah, I think there's a subset. We're not buying fad names or real high price names. We're not how many years ago, 15, 20 years ago, there were a bunch of multi-billion dollar momentum shops. And I can't really think of one right now that is still in existence. So when you think of growth in terms of momentum, I completely agree. They were all down here. It was all San Diego. No, they were. It was all Nicholas Applegate. That's right, Nicholas Applegate. Duncan Hurst. Turner Investment Partners. There was a firm, a great firm called Duncan Hurst that came out of Nicholas Applegate.
40:17No, I actually came out of Security Pacific Bank. Yeah, they're gone. They're gone. And I'll never forget, actually, one year when I met with a gentleman at Duncan Hurst, and he was telling me, he was a marketer, and he said, hey, you know, I'm so good at closing business now. He said, I win all these deals. And I said, does it have anything to do with the fact that in 1991 you were up 90 %? Maybe. But he thought it was about him. And that gets to my point about humility. He thought it was about him. Like, let's not confuse the issues. So a lot of times in the growth stock universe and the way you approach investing, you're looking for certain tailwinds in trends and sectors.
40:56What are the things today that you're excited about? It's hard to bet against China. It really is. Now, we're not loaded up in China. We've got a couple of names in the portfolio. One of them is Tencent. It's really, really hard to bet against China. I know people don't always believe the numbers that come out of China. I was there in 1981 as a student. And in 1981, there wasn't a car on the street. There wasn't one building. There weren't any hotels. There weren't any restaurants. People were driving black bikes everywhere. You come back today, they buy more cars per year than the U.S. does. There are beautiful buildings across Shanghai and Beijing and other major cities.
41:40So I don't know what the growth rate is, but it's extremely high. It's extremely high. And a quick little story about one of our ideas around investing kind of globally is we really like to own businesses in countries that are optimistic. And it goes back to my earlier comment, the optimist win. I was in China four years ago, and we met with a group of doctor students, medical students. And I asked the question, what motivates you? What gets you up in the morning? And they said, you know what motivates me? These are 20-year-old students. What motivates us is to be like America, to be as successful financially as America is.
42:21And I thought, what a contrast to, you know, I thought about 20-year-old kids in the States, and what do they want to do? They want to figure out the next video game that they can beat or win. And I thought four or five years ago, I said, that's a very powerful, optimistic, doesn't mean they're going to, but I sure do like that energy. And you go over, there's a lot of energy, a lot of positive energy in China. On the other hand, you go down to Latin America, you go to Brazil, you go to Argentina, not as optimistic because they've had years of corruption. They've had years of volatility and interest rates and currencies.
42:55And interestingly, a couple of years ago, we were down there. We met with 12 companies. Ten of those companies complained about the macro. It's really hard for us to operate. You've got this corruption. You've got the real getting clobbered. you know, interest rates are rising, inflation's out of control. We can't really, we just can't make it happen. A lot of excuses. There are two companies that never mentioned the macro. What'd we do? We came back, we bought those two companies. You know, they knew that they had a significant edge in spite of what was going on around them. And those are the kinds of companies that you want to own.
43:28So, so in general, we are looking for those, those businesses where there's obviously a growing competitive advantage, but also a belief within the organization that it doesn't matter what the external situation is like, we're going to run right through this. Yeah. And then when you get down to either the sector level or the subsector level, are there particular tailwinds that you have as kind of themes through what you're looking for? Yeah, I think you're always looking for that. You certainly want to have tailwinds. It's just an acknowledgement that that's how life works. I think anyone that doesn't acknowledge that it's just not being honest right it's like you know j paul getty you know someone asked him how do you make a billion dollars in oil so it's really easy you know you get up really early you work really hard and you strike oil and there's this this notion that he was fortunate you know he drilled the well in the right places and he was fortunate so i think having tailwinds is essential to success obviously there are demographic talents i think i think a big advantage we have is that we tend to own businesses in the growthier sectors like technology health care and consumer.
44:29And if you think about the emerging middle class throughout the globe, this is just one aspect of it. But as people get wealthier in Brazil and Indonesia and India and China, of course, what are they going to do with their money? They're going to buy products from the companies we own. So if you think about a beautiful big picture tailwind, you can do what Jimmy Rogers did, which is said, hey, you know, he drove around China and Asia on his motorcycle and he came back and said, oh, yeah, you got to buy emerging economies. And you do that by buying commodities. We'd argue it's a way better idea to buy companies that sell products as these people get richer.
45:05That's a beautiful tale, and that's not going away for 15 or 20 years. That's just something you can really take advantage of. How do you think about downside protection in the portfolio? That's a really interesting question because I've said a couple of things today. We're growth investors. We run 33 stock portfolio. First thing everyone's thinking is volatility, right? Wow, you guys must, you probably capture 140 % of the market when it's going up, but you get 110 when it's going down. And interestingly, that's not the case. Everything we do in this portfolio is to manage on the downside for all the reasons we know about.
45:43How do we do that? I think one way we do that that's real important is being right more times than not on the direction of the competitive advantage. Because in difficult periods of time, if you can own the company that isn't constrained by the financial markets and can allocate their capital into the spaces where their weaker competitors cannot, what you find is that really those companies hold up really well. Of course, we do the basic portfolio construction of diversifying among sectors and industries and making sure we never have more than 4 % or 5 % in any one name. Those are obvious. But at the end of the day, everything we manage is to do well in tough markets.
46:23I'm surprised, frankly, how well we've done in the rising markets. Where we really expect to do well is in tough markets. Very, very counterintuitive. But to me, it goes right to the heart of what we're doing differently around the issues we've raised. So in the evolution of the business, you mentioned going through a tough period of time and having $4 billion of money come out. And as an allocator looking at something like that from the outside, you say, well, yeah, but at that point in time, as you said, you guys were doing some things wrong. Yes. What's been the patterns that you've seen of what you would consider more positive allocator behavior and less positive allocator behavior?
47:05You know, unfortunately, even the so-called sophisticated capital allocators tend to do what everybody else does, which is when they do a search for a manager, they tend to find the guys that have done the best, you know, most recently with the argument being because they've done well for 10 years, they're going to keep doing well. Well, you know, lots of things can change. To me, a better way to look at it, and I know you've done this yourself, is to really figure out the people in the organization and whether they're the right people to continue to generate the kinds of returns. And then, of course, you need a process.
47:40But the allocation behavior still, you know what? Most individuals still chase money. They still chase performance. We tell them all the time, look, if we've done particularly well, we completely understand you taking money away from us. And why don't you put it into a strategy, like maybe a value strategy that hasn't done well, but you believe in the people in the process. That's brilliant. It's so simple. But nobody does it. And even today, nobody does it. So what's going to happen now? What are the public funds? A lot of public funds now are moving to passive right at the bottom of the cycle.
48:10And, you know, it's just like seven years ago. Everybody had to be in hedge funds and long shorts with a little leverage. And now what's happening today? You know, they're getting fired time and time again. it's probably a great time to build a long short hedge fund. And so after a 10 year period of time, a great performance in long only, people load up on long only. So their behaviors really, I don't think in general have changed and I don't think they will. So I imagine one of the questions you must get a lot now is you're at 26 billion, not too long ago and years ago, but you were a lot smaller.
48:45How have you managed the change within the portfolio at$26 billion compared to when you were a few billion? Interestingly, and we keep track of this, our average market capitalization today versus 13 years ago is about the same. It's$76 billion. Our median market cap's about$35 billion. 13 years ago was about$35 billion. So we never generated returns by kind of creeping down. So it was large cap stocks, even when you were a lot smaller. Yeah. And you know, the beauty of kind of owning your own firm and being a part of it and having a group of people, there's 40 of us here, is you don't have to run all the money in the world.
49:25I mean, if we found out all of a sudden that we were sacrificing returns, we'd close the product immediately. Yeah, this is our goal. We love taking on the big guys. Like you said, who is this firm in California that's adding 500 basis points per year over any time period versus all the big guys we know about? It is fun to do that. So that's more fun than raising more assets. And we want to make sure we keep ourselves in a position to continue to do that. Paul, it's great. I think we need to turn to some closing questions. Oh boy. What was your favorite sports moment? I'm a Pat fan. So there's been a lot of them, but my favorite was with my son, who's now 13.
50:07So he was probably 11, being with my son, who kept asking me during the Atlanta game recently, two years ago, hey, Dad, can they win? I'm like, no, I don't think so. Actually, what I said to him, I said, you know what? Yeah, I kept telling him, yeah, Jake, they can win. They can win. Hey, Dad, third quarter, it's 28 to 3. Dad, can they win? Like, yeah, Jake, they can still win. and then they came back, and they won. I mean, one of the most extraordinary, and my son takes it so seriously. I mean, he was literally weeping at that last part of the game. And then they won, embraced, really one of the great moments.
50:54Of course, being a Boston fan, I mean, 2004, when they won the World Series for this time, phenomenal. But sharing it with my son, highlight. Yeah. What teaching from your parents has most stayed with you? showing up never ever give up you know i've thought about that a lot there's a lot of times when i would have wanted to quit you know when we especially when we tried to bury the firm but you know what if we would have quit we would never be here for this period for this ride right now so many what is it woody allen said 95 of life is showing up i i absolutely i think it's 99 just keep showing up keep doing what you're doing and you know what you'll be there when good things happen.
51:36It's huge. It's a huge, huge lesson. What information do you read that you get a lot out of that other people might not know about? I'll tell you a great one. I just opened it this morning. There's a gentleman named Nick Murray, and he's actually kind of an advisor to financial advisors. He writes a monthly newsletter, but what I love about it is he always, his basic thesis is how negative the press is, how pessimistic the press is, and how really, you know, again, he's a big fan of the optimist wins over time, but we don't see that out in the world. We see only the problems. So he keeps you focused on what's actually working.
52:12And then he always has great resources, great books that he's read, a couple of blogs. I just went to a, there's a, there's an, it's funny as I'm talking about optimism again, but there's a, there's an optimist blog I just went to today that was kind of talking about the short-term negative perspectives versus long-term kind of wealth creation. Those are two that are real, real valuable to me. And of course, I read the Wall Street Journal, but those are two. And then we have a lot of guys that have various podcasts that I listen to. Of course, I listen to capital allocators. I do my work and get a lot of good information.
52:47Yeah. What life lesson have you learned that you wish you knew a lot earlier in your life? I think that notion of keep showing up, I wish I would have got that earlier because I think it would have been easier to endure through some very difficult periods of time. I wish I would have learned that early in my business career. Because, you know, again, I didn't pull the trigger on moving or leaving the bank, but I really wanted to. And I'm glad I didn't, because I wouldn't be where I am now if I had pulled the trigger on any of those things. So I would have liked to had somebody tell me, Paul, keep showing up.
53:25That's why I kind of preach that all the time in this firm. How do you advise that to your kids when, you know, when we were growing up, it feels like there was a lot more stability in people's career paths. And now there's seems like there's a lot more mobility. So does showing up mean the same thing that it might have, you know, 20 years ago? That's a really good question. That's a great question. I think it does because when I say keep showing up, I could have left the business. You know, I was thinking, oh, I love camping. I'll be a camp counselor or something. You know, I actually was talking, you know, I could have left the business, but you know what?
54:04I always loved the business. I just didn't love the vehicle in the form of a bank that I was doing it in. So keep showing up, keep pursuing what you're passionate about. And you know, that's how I found WCM Investment Management. Yeah. All right. Last one. You know, it's your, you're waning days. You are, uh, at this point, probably a camp counselor who knows, maybe the camp counselor, WCM. What advice would you give yourself today? I'd probably argue that as much as you love the business, remember there are other parts to life and make sure, you know, whether that's being healthier or whether that's spending more time with my family, my wife, my kids.
54:48The problem for me is I just love this business so much. I'm not trying to run away from anything. I love it, and I love the people in this business. So I probably would say get a little bit more balance there, Paul. A little bit more balance, because I think in 20 years, I'm going to say, okay, I don't have to do all that. I can get other people to do that, and just kind of slow it down a little bit, because we're running pretty hard right now. Great stuff. Thanks, Paul. Thank you, Ted. Thanks for listening to the show. To learn more, hop on our website at capitalallocators.com, where you can join our mailing list, access past shows, learn about our gatherings, and sign up for premium content, including podcast transcripts, my investment portfolio, and a lot more.
55:35Have a good one, and see you next time. This testimonial will be provided by Ted Seides and Capital Allocators, who have been compensated a flat fee by WCM. This payment was made in connection with capital allocators testimonial and production of podcasts, and does not depend on the success or level of business generated. The opinions expressed are solely those of capital allocators and may not reflect the opinions of others. Investing involves risk, including the possible loss of principal. Past performance is not indicative of future results. Please visit wcminvest.com for WCM's ADV and further information.
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Our conversation starts with Paul’s trial-by-fire entry into the business and turns to growth stock investing, including defining a great growth company, searching for widening moats, assessing a culture tied to competitive advantage, creating a positive culture, learning from mistakes, identifying tailwinds, and protecting the downside.
Paul embodies the principals he preaches and offers some tasty food for thought.
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