Tye Bousada, co-founder and portfolio manager of EdgePoint Wealth Management Inc., says the award-winning firm's investment strategy is based strictly on the best diversified business ideas.
"It doesn't mean we try and diversify by where head offices are located, to look well diversified on pie charts geographically," says Bousada. "And it doesn't mean that we try and diversify by sector so that we can show that we're diversified according to some sector categorization."
The global mandate for EdgePoint's best-ideas approach is EdgePoint Global Portfolio, which holds a concentrated portfolio of about 30 stocks. Its holdings can include small, mid or large-cap companies. The fund's strong performance led to its co-managers, Bousada and Geoff MacDonald, being named the recipients of the Morningstar Foreign Equity Fund Manager of the Year award in 2014. Subsequently, Toronto-based EdgePoint won the Morningstar Analysts' Choice Steward of the Year award at the 2015 Morningstar Awards.
As the year unfolds, "we're going to make mistakes," says Bousada. "If you're truly diversified by business ideas, you only have one of the 30 ideas impacting the portfolio."
Though EdgePoint Global Portfolio holds a hefty 77% weighting in U.S. equities, Bousada argues that "geographic pie charts" are an extremely misleading way to characterize the fund. "All I care about is the fundamentals of the business," he says, downplaying the importance of where a company serving a global market happens to be domiciled.
For example, one of the fund's top 10 holdings is Wabco Holdings Inc. (WBC), a provider of truck parts, braking and security components for large rigs. Bousada estimates that 58% of Wabco's revenue is generated from Europe, and 28% from Japan, China and Brazil. That leaves only 14% of their revenue in the U.S., where the head office is located.
TE Connectivity Ltd. (TEL), a manufacturer of engineered electronic products, is another U.S.-based example among the top 10 holdings. In terms of revenue, 35% of its business is in Europe, 33% is in Asia, and only 32% in the Americas, says Bousada.
Also based in the U.S., but with a globally diversified business, is Flowserve Corp. (FLS), a manufacturer of flow-control equipment. Bousada says 20% of this holding's revenue comes from Europe, 21% from Asia and 13% from the Middle East.
When choosing stocks, the five-member EdgePoint global team looks to invest in a business that is going to be bigger in the future, without paying for that growth today in terms of the current share price. Strong balance sheets and strong free cash flow are essential.
EdgePoint's research process is based on using its own financial models and on conducting its own qualitative and quantitative analysis. Along with making assumptions on what may happen to some of the drivers that will affect future profitability, the managers ask how a company's profit margins are going to be protected.
Among the many other questions they raise is whether the management team is capable, and whether there is a succession plan in the event of executive turnover. The team's research conclusions include coming up with what they think the business will be worth in the next five years.
When the EdgePoint managers have conviction in the intrinsic value and future value of a business, they'll generally hold the stock through market ups and downs. For example, Wells Fargo & Co. (WFC), a U.S.-based bank which is among the fund's top holdings, has been in the portfolio for about five years.
"Despite ups and downs with the economy," says Bousada, "Wells Fargo assets have outgrown their economy over the last five years." He believes that growth continues to be in place, the economy is picking up steam, the bank's margins are increasing and their expense ratios are going down. "People are very fearful of the U.S. economy still," says Bousada, "and because of that the valuation is lower."
The Japanese-based Shiseido Co. Ltd. (SSDOF), primarily a women's cosmetics company, is another illustration of the diversity of business ideas in EdgePoint Global Portfolio. Bousada says the company is one of the largest cosmetic companies in the world but it has also been one of the least profitable.
Management changes at Shiseido proved to be a catalyst for EdgePoint to invest. The company's new CEO has had an incremental focus on profitability. "He eliminated 28 brands that weren't making money, he started emphasizing e-commerce, and he started running the business for shareholders," says Bousada. "If he's able to hit his goals, which are four years into the future, we see the potential to make mid-teen types of returns."
In positioning the fund, the recent market volatility is considered an opportunity. "We believe that volatility is the friend of the investor who knows the value of a business," says Bousada, "and it's the enemy of the investor who doesn't. Most people know the value of the car that they own, but they don't know the value when it comes to a business on the stock market. It's our job to know the value of that business. Right now we feel we're able to add a lot of value."
