Organic Investing at Its Best
We choose to define Organic Investing as going back to the roots of investing. This means investing in fundamentals, in solid businesses with strong environmental, social and corporate governance. This means ignoring all those wonderful products brought out by brokers over the years such as Exchange Traded Funds (ETF’s), tactical asset allocation and other financially engineered creations (such as the Mortgage Backed Securities which imploded during the financial crisis). Instead we focus on only owning the best companies around the world.
These types of companies have serious moats around their main businesses which puts them in a strong competitive position regardless of the macroeconomic environment. They also have strong balance sheets to weather any storm. More importantly they have management bench strength that can adapt to a changing environment and deal with adversity when it arrives. Last but not least, they have stable earnings to reinvest back into their business or grow their dividends or both.
The world is a very dynamic place that is undergoing many structural changes. The big winners of yesterday may not be around tomorrow. It is essential that we understand the strategic direction of every company in the portfolio and research them thoroughly. This is the number one principle in investing. It is not gambling. It is not trading. It is committing capital to the people that have the resources and experience to build strong businesses that will be substantially bigger in the future. Only then will the valuations of these businesses build over time generating strong returns for their investors.
Of course this runs contrary to today’s massive popularity of ETF investing – there are thousands of ETFs for every part of the index and for every index on the planet – but our question to you is why would you need to own any, or all of that? Do you really want to own everything that is in an index or a sub-sector of one? Not every company is created equal and many companies fail miserably. Buying an index means buying the failures as well. In many cases the indexes themselves are heavily invested in unpredictable sectors such as energy and mining, resulting in highly cyclical and volatile results. Over the short term they will have their moments in the sun but longer term we can do better than that.
For years we have watched as more and more money gets placed with index managers. The reasoning was if investment managers can’t outperform the index let’s just invest in the index at a lower price. That can work in stock market rallies driven by large asset mix rotations, such as a move out of bonds into stocks or from one region of the world into another as we’ve experienced in recent years. It doesn’t however work in markets where there is no rising tide and economic growth is sub-par. In these markets the better companies deliver superior investment results. In the short term stock prices and company fundamentals can move in different directions but over the longer term the two are highly correlated and this is what our approach captures. Good money management is about understanding and protecting your capital longer term. Short term trading is all about speculation with winners and losers. Investing is about building wealth like the Rockefellers or the Gates families: it takes time and over many market cycles. It is all about defining risk and being patient. In rising markets everybody looks like a genius – it is during the more difficult times – when preservation of capital is the priority that active managers do the heavy lifting. But not if you sell at the bottom. Human’s are emotionally programmed to buy at the top , which is the day it never looked better, and sell at the bottom which is the day it never looked worse. Acting in a contrarian manner at these points in time is where an active manager with the experience to gauge these opportunities from past experience can add a lot of return.
The world is in a very uncertain place. We are witnessing a lot of geopolitical upheaval (the Middle East, North Korea, Russia, Latin American, western populist movements affecting elections to the detriment of the economy etc). We have a very unstable leader of the Free World in place picking fights with all its trading partners and trying to eliminate basic freedoms of speech and the rights of its citizens to a clean healthy environment. We have a Canadian Prime Minister who has never made any money himself but somehow is very comfortable using the hard working Canadian tax payer’s money to ensure everyone around him is over paid with lots of benefits that the private sector cannot even dream of having. To add insult to injury he also throws our hard earned funds away on other country’s causes so that he may have his photo taken and be popular overseas. We have a provincial leader who is more focused on how we label people than on the fact that our youth is struggling to find employment, our infrastructure is a disaster and our farmers cannot stay in business thanks to poorly thought out energy policies.
We also have to deal with the fact that technology (and Artificial Intelligence in particular) is about to disrupt the traditional labour force as we have known it since the last World War. Unfortunately, global governments have not prepared for this by changing the education system so thousands of graduates are being prepared for “yesterday’s” careers. Likewise, most companies are ill prepared for the changes that are about to sweep the world at an alarming speed. Those that are prepared will do extremely well but it will only be a handful – the rest will either be in denial, or think they can change at the last minute, or just not care because the guy at the top has been making so much money he is more concerned with short term profits than long term existence. Our government’s solution to all this is just to create a larger welfare society by talking of guaranteed minimum incomes without a thought of who is going to be working extra hours to fund that in the future.
Cyclical recoveries will still happen around the world but they are different. Capital investment is not as large when technology is involved. It requires less labour and a lot less manufacturing plants and equipment – just think of all the commercial space that will be available as more and more people work from home, and as more people shop online rather than visiting physical stores. What will become of all that space? Maybe something else will come up that will need that space. Maybe not. In the meantime the disruption will be massive.
The bottom line is that the number of truly competitive investable companies keeps shrinking every day. Our organic investment approach leads us to turn every rock on a daily basis to ensure we are positioned only with the very best. This may be the difference between surviving and imploding at some point when all that index investing goes the same path as the Mortgage Backed Securities market did in 2008. When comparing our portfolio’s performance to our peers it is very satisfying to see that our strategy has placed us at the very top, but we can never rest on our laurels as the world is a changing place and we must not be left behind. Hard work is the foundation of organic investing at its best.
The Summerhill Team