Ticker Symbols

ARTRX (Inv Class) APDRX (Adv Class)

Investment Advisor

Artisan Partners Limited Partnership

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Global Profit Cycle Hunting

May 5, 2020

Artisan Global Opportunities Fund

  • AUM

    $3.1 billion

  • Inception Date

    Sep 22, 2008

  • Portfolio Holdings

    45

  • Portfolio Turnover

     

Q: How has the fund evolved over the years?

A: The genesis of the Artisan Global Opportunities Fund goes back to our 1997 team inception. Back then, we managed (and still do today) a domestic mid-cap growth product that focused on investing in companies with franchise characteristics benefitting from accelerating profit cycles that were trading at discounts to private market value. Increasingly, we found ourselves spending time on research outside the country. Many companies we were following were almost forcing us to look overseas due to their business activity, source of sales growth or supply chains. While going through our analytical process, we found opportunities regardless of geography.

The Global Opportunities Fund launched during the financial crisis in 2008 as an offshoot of all that research. Overall, we invest in high-quality, growth-oriented businesses with a profit catalyst and differentiation in the global marketplace. The Fund represents our unique perspective of what we have been doing in the U.S. for over two decades, but stretched over a global scale, up and down the market cap spectrum. We are not a product shop; we are an investment firm. We only launch investment products or vehicles that we believe are an integral part of someone’s asset allocation and make sense over the long haul.

Q: What makes the fund unique? How does it differ from its global equity peers?

A: First, this is a highly concentrated portfolio with about 45 securities. Importantly, the top 20 securities in the portfolio represent more than 60% of the capital. That’s an appropriate concentration for a portfolio of best ideas. It is an all-cap fund that is not unique, but it has different composition from our global equity peers. Although our portfolio has a typical conglomerate of large-cap names, the concentration typically has a more mid-cap bias.

The second differentiator is that we look for businesses where we understand the drivers of the profitability. In many cases these are businesses driven by one or two elements, not by a broad portfolio of products or services.  We want to expose our clients to the best businesses across the globe that are exposed to big emerging trends in innovative and disruptive parts of the global economy.

Finally, our capital allocation process is unique. In this concentrated portfolio, the capital weight is built throughout the life cycle of an investment. We expand our positions as we build conviction, the valuation opportunity arises, and the original thesis develops. An early position in the portfolio might be at the modest 50 or 75 basis points. But once the business and the thesis begin to develop as we had envisioned, we can invest up to 10% of the capital in a single security. It’s a high-conviction portfolio that allows our best ideas to drive alpha over time.

Q: How do you define ‘global’ and ‘opportunities’?

A: Global means that we can go anywhere if an opportunity presents itself. The team has been purposefully built to enable success in different regions. We have developed a deep and experienced research platform with extensive experience across industries, sectors and geographies. As global investors, we build a global perspective.

The word ‘opportunity’ is related not only to the qualities of the businesses, but also to the point of entry. We aim to own businesses only during a period (which may last three- to five-years) of accelerating profits. Our strategy is not to buy and hold a stock forever. It is to buy and build during that opportunistic growth phase. The highest quality businesses globally are always on our radar, but the ownership period is during the takeoff of their profit cycle.

Q: What core beliefs drive your investment philosophy?

A: At the core, we look for companies with exemplary franchise characteristics, reasonable valuations and accelerating profit cycles. These tenets have not changed in the last 23 years. Our first filter is the analysis of the quality of the business. We look for companies that have at least two of the following characteristics: a low-cost production capability, possession of a proprietary asset, dominant market share and/or a defensible brand name. If a company doesn’t go through that first funnel, we will never expose our clients to it. The second tenet is the reasonable valuation. We are never self-prescriptive; all we look for is reasonableness. At any point in time, given the ebbs and flows in the market, there is an appropriate range of valuation for a business. Lastly, we need a thesis or a catalyst that makes sense for taking a small entry position. We must know the thesis and if the catalyst is powerful enough to move the stock for the next three to five years.

We describe ourselves as profit cycle hunters. Unlike most growth managers, who focus on the top-line and a certain level of growth, we focus on the rate of change in these businesses. In most basic terms, stocks follow profits. We believe that investors oftentimes misunderstand the earnings power coming from modest top line acceleration combined with the incremental nature of the income statement.

We are highly sensitive to permanent loss of capital and we avoid businesses with average quality or below-average balance sheets. We believe that permanent loss of capital occurs due to not giving enough respect to the quality of the business. We always have a sense for the reward, but we are highly sensitive to the risk as well.

Q: What is your investment process?

A: We seek to compound assets by exposing portfolios to growth while avoiding permanent capital loss. We believe it is possible to achieve that goal through a repeatable investment process emphasizing being right more often than wrong and being right in a bigger way than when wrong.

The two core elements to the Growth Team’s process are security selection and capital allocation. Security selection is aimed at being right more often than wrong. It is designed to find companies that have durable franchises, trading at reasonable, understandable valuations, on the cusp of an accelerating profit cycle. Capital allocation is designed to emphasize being right in a bigger way than when wrong. The team initiates small positions in companies that it believes are in the early phases of profit cycles and focuses the majority of portfolio capital in its highest conviction ideas. The team overlays this process with broad diversification. To the team, broad diversification means having broad knowledge of the economy rather than having investments in every industry across the economy.

The team believes the combination of these elements increases the likelihood of participating in rising markets with downside protection in difficult markets over a full market cycle.

Q: What are the key qualitative factors that you take into consideration?

A: We are very sensitive to the balance sheet and the free cash flow. We look for businesses that are reasonably asset light. They should generate or should have the potential to generate enormous amount of cash. Therefore, they will be self-funding, which is positive during an economic downturn or a credit crisis. We don’t want the balance sheet to impede the business.

The management teams are also important as they need to drive growth and generate free cash flow. I have been recognizing and following the best managers our there for a long time. When they quit jobs, I pay attention to where they are going and why. In general, good managers do good things. We also track new ideas.

From a protection standpoint, it is difficult to own the fourth or fifth player in an industry that’s not consolidated. We’d prefer to own the number one or the number two players, when they are gaining market share for a reason.

Q: Would you describe the research process in detail?

A: For the purposes of our team research, the analysts and the portfolio managers are constantly on the road. We are probably at the office half of the time, usually around the earnings reporting season. Once it wraps up, we set a specific research agenda. We meet with a huge amount of companies, consultants, competitors.

Once we find an interesting idea, we collect a standardized research packet. It includes the franchise, relevant operating metrics, key issues, balance sheet, management and scenario analysis. We don’t believe in a single point estimate. Instead, we want to know the range of outcomes. So, for every business we estimate the bear, the base and the bull case scenario and the probability for each of these outcomes. We update these scenario analyses every quarter at minimum or on an as needed basis as circumstances dictate.

Once the package is collected, the covering analyst presents the idea to the entire team where we   pick it apart. We look for the things the analyst might have missed; we challenge the valuation, the quality and the risk metrics. Ultimately, we decide whether the research is qualified or not.

After the name is research qualified, the work has been done and the business is eligible to be purchased for our clients’ portfolio. It doesn’t mean that we would automatically own it; it means we would put it on our watch list as available for inclusion. It is up to me and the lead analyst to determine when, if, and in what size we would put that stock in the portfolio. I spend much of my time on the stocks that are already in the portfolio and determining the appropriate position sizes.

Q: Could you give some examples that illustrate your thought process?

A: We look for stocks that can be big, but there is a difference in our hurdle rate, depending on the business model volatility. For example, today the largest position in the portfolio, at 5.5%, is a company called IHS Markit. At one point it was a 9% position. We view this as a stable business that has roughly 85% of recurring, subscription-based revenues. The EBITDA margin is 39% and is expanding by 75 to 100 basis points annually. In addition, the company is buying back up to $1 billion of stock every year. Traditionally, there has been little volatility in the business model. With bottom line growth of 10%, we typically handicap the range of outcomes to be 8% at the low end and 12% at the high end. As a result, I believe I can put a lot of capital behind that stock with conviction.

On the other hand, take ASML, a semi-conductor capital equipment company which is also best of breed. A specific investment thesis might be a new product cycle in which the average selling price would go up by 50% over the course of the next business cycle. This is an equally good franchise, but the range of outcomes for the future 12 month is dramatically wider. It could be plus 30 or minus 30, depending on the economic backdrop. I could still own that business, but not as such a large position due to the volatility.

Q: How do you go about constructing your portfolio? How important is diversification?

A: Given our pursuit of the world’s best global growth companies, it’s a pretty rare occurrence that each of our sector analysts does not have at least one good idea, even in the toughest of times. In good times, when good ideas are plenty, it is my job to understand their relative strength to determine how much capital to allocate and to be mindful of economic exposures in the portfolio.

The capital weighting within the portfolio is the judgment factor. Developing an investment thesis and buying a stock is one thing but optimizing the weight of each individual security is another. Our ultimate goal is to be right in a bigger way than when wrong – we do not want to place too much capital at risk before the investment thesis begins to develop. When we enter a position, we fully expect to see evidence of our investment thesis within a couple of quarters. From our perspective, it is fine to take a risk in a valid thesis with 50 to 75 bps and wait to see if it develops. Once the thesis begins to unfold, we go fast and make sure that we allocate plenty of capital in our high conviction names to get paid for all the research that we have invested. If the investment thesis doesn’t take off within a reasonable timeframe, if the profit cycle is approaching completion and/or if the company is approaching full valuation, we move on from our campaign.

We make sure that we spend an appropriate amount of time in all geographies. That means that every year there are multiple trips to Latin America, Asia and Europe, as well as an appropriate amount of time spent in the US. We find a handful of good ideas everywhere, so geographic diversification tends to care of itself as well.

Q: How do you develop and improve your decision-making process?

A: Naturally, the process leads to self-reflection, which in turn leads to improved outcomes. The Global Opportunities portfolio gets measured every single day and over a long period of time. We can look at the attribution and where the results come from. More importantly, the individual team members also need to go through self-reflection and self-improvement.

We have developed a measuring scheme, where each analyst has his or her own portfolio. At the end of every year, the analyst goes through the portfolio to understand where the returns were generated. We have an internal notes system, called due diligence manager system. At the end of the year, there are lengthy self-reflection notes about what held back personal performance, the rationale behind investment recommendations, analysis of mistakes, etc. The volume of the notes can go back to 10 years ago. We can examine our rationale at the time, the decisions and recommendations we were making. It’s an incredibly helpful way to ensure that the team members have the appropriate horizon.

In our daily research meetings, we throw out ideas to be discussed from a variety of angles or perspectives. On the one hand, I would call our development process inefficient, because it requires enormous amount of time for meetings and the entire team has to suffer through everybody else’s ideas. For example, the healthcare analyst has to listen to the consumer analyst and vice versa. On the other hand, there is an awful lot of learning through that process. The sector analysts get exposed to a variety of business models. That’s great learning across the entire spectrum.

Q: What drives your sell discipline?

A: The first reason to sell a stock would be the valuation. We think about the value of a business as the private market value. What would Warren Buffett pay for this business today? We use our scenario analysis to calculate it. Once the equity value approaches 100%, we would sell the stock because there’s nothing left. Even if we love the business, it must go. So, valuation protects us.

Other reasons to sell would be either deteriorating fundamentals or if the profit cycle begins to plateau or deteriorate. Even if the valuation is reasonable, we would trim the position or sell it completely. It goes back to our investment philosophy of being profit cycle hunters. We want to own a business during its profit acceleration period. When the cycle begins to turn and the company begins to face headwinds, we would sell the stock regardless of its valuation.

Q: How do you define and manage risk?

A: We are in the risk-taking business. We invest in public equities in a long-only strategy and our clients expect us to be fully invested.  Upon initial purchase, we seek to purchase names at healthy discounts to what we believe they are worth based on our assessment of private market valuation.  To mitigate the risk, we focus on the quality of the businesses and the balance sheets. We only invest in businesses with strong fundamentals. Importantly, our capital allocation process mitigates the risk even in great businesses.

Let’s illustrate this with two identical businesses, one in the US and one in Brazil. They may be of equal high-quality in terms of the franchise and the cash flow characteristics. However, the risk associated with emerging markets is higher because of the currency, liquidity, government interference and the different political regime. We need to be sensitive to the different risk characteristics by geography. So, I would own a 10% maximum position in the U.S., but a 4% maximum position in Brazil. That’s an example of managing risk via capital positioning.

The same refers to companies with low business model volatility, such as IHS Markit versus ASML. We can own 10% in the less volatile business and 3% to 4% in the other one. The quality and the balance sheet are also important for the capital allocation.

Overall, we strive to invest in differentiated and well-managed high-quality businesses. Our team of sector specialists have domain knowledge, while the portfolio managers leverage this knowledge with some judgment and experience on top. We typically own 45 or so businesses in a well-diversified portfolio with concentration in the top 20. We always keep an eye towards the outcomes, not towards an index, as we are agnostic to a benchmark. With that type of active share, we believe we can add a lot of positive outcomes over time.

Annual Return 2019 2018 2017 2016 2015 2014 2013 2012 2011
ARTRX 35.60 -9.07 31.18 4.73 7.75 2.35 24.30 29.78 -6.56