There is a big debate in the investment management industry on whether fund managers should have significant amounts of their own money invested in their funds.
On the one hand, putting their own cash in aligns interests with shareholders, which in theory should keep them from making poor decisions. On the other, some argue their salary and bonuses are already linked to their portfolio’s success, so there is no need.
Mick Dillon and Bertie Thomson seemingly take the former view, piling almost all of their own money into the Brown Advisory Global Leaders fund, which they co-manage together.
Dillon said: “Bertie and I have only two investments. We are partners and shareholders at Brown Advisory and we invest in Brown Advisory Global Leaders and that’s it. We’re all in: my wife's money's in, my kids money's, everything is invested. I'm a big believer in people who eat their own cooking and put their money where their mouth is.”
Of course, this comes with its own concerns, such as whether the fund is risky and if it is suitable as a one stop-shop. Dillon had an easy response, however: “Clearly, I don't think it's that risky or I wouldn't have everything in it.”
His confidence comes from his companies’ fundamentals, with an average return on capital more than twice that of the broader market. “They typically grow faster than their industries because they are taking market share,” he said.
Although valuations are “maybe 15-20% more expensive than the benchmark on a one-year view”, over the longer term, "you're going to compound something that's twice as good as the benchmark for return on capital and is growing slightly faster, and you only paid 15% more".
Fortunately for the managers, Brown Advisory Global Leaders has delivered top-quartile returns over three and five years and pulled ahead of both its sector and benchmark since inception in November 2017, as the chart below shows.
Performance of fund vs sector and benchmark since inception
Source: FE Analytics
Below, Dillon tells Trustnet about his rules for selling and how he works with behavioural coaches to make better decisions.
What is a global leader?
For every investment we ask: how does that company help its customers solve a problem or achieve their goals? Frankly, how do they make their customers’ lives better?
When you get a business whose customers are happy, who come back again and again because the business is solving a problem and creating value for them, that company will have a long relationship with its customers. Ultimately, that’s what creates a ton of value for shareholders.
We have a team of investigative analysts who talk to customers to understand why they want to come back. Our favourite piece of feedback is when a customer says, ‘it’s not cheap, but it represents good value’. That tells you it’s not about being the cheapest on the market, it’s about solving customers’ broader problems.
What do you look for in a stock?
We look for a 20% or higher return on capital, which means these companies are efficient at turning revenues into cash flow. Then lastly, it has to be cheap. We want double-digit returns in the strategy on an absolute basis. With every investment, we need to believe we can make 10% a year for five years, so over 50% compounding.
What’s has been your best investment recently?
General Electric (GE) is already up more than 70% since we bought it in April/May last year. It has a 70% global market share in narrow-body aircraft engines. Its engines are more fuel efficient than anyone else’s, which saves money for airlines and is also great for the environment. Its after-market business, which sells parts to maintain planes, is incredibly valuable for customers and profitable for GE.
And your worst?
Not investing in Nvidia. In October 2022 we did a full investment review of Nvidia. At the time, it was within 5-10% of what we thought was a five-year, double-digit annual internal rate of return, so easily a 50% upside.
But we didn’t invest because we wanted to buy it 5-10% cheaper and we fundamentally mis-calibrated what artificial intelligence (AI) was going to do for that business.
How do you work with behavioural coaches?
We sit down with a behavioural coach once a quarter who uses data and analysis to help us avoid classic behavioural mistakes. We've got a whole bunch of processes now to use in different scenarios. I think of them as game plans.
One of our rules is, if an investment falls 20%, we either have to buy more or get out. About 70% of the time it works, so it's not perfect, but the odds are in our favour. That changes the psychology in the room from a negative event where we've lost money, to a positive event where I can tell you with 70% certainty that we'll make a good decision today.
In February last year, Google did a disastrous product demonstration and was considered an AI loser. We had to do a drawdown review on it; either buy more or get out. We bought more.
At the drawdown reviews we ask, will I care about this issue in five years’ time? I don't think I'm going to care about Google’s bad product demo.
We think it’s highly unlikely that anyone will disrupt Google’s search or cloud businesses. The transformer technology that enables generative AI – the ‘T’ in ChatGPT – was invented at Google.
How has working with coaches impacted your sell discipline?
If we're selling for a broken thesis, more often than not, we're right and the stock continues underperforming, so our rule is to get out within a week. That came from working with the coach.
When we sell on valuation, we always sell too early, but that's okay because we're going to take that capital and put it somewhere else.
What do you enjoy doing outside of investing?
I grew up on a farm in rural Australia so I like anything outdoors to switch off. I enjoy cycling, surfing, hiking, even gardening.