Animal Spirits Podcast - Talk Your Book: Finding Growth Stocks Around the Globe

Episode Date: October 18, 2021

On today's Talk Your Book we spoke with Rob Forker of Polen Capital about investing in international small cap growth companies. Find complete shownotes on our blogs... Ben Carlson’s A Wealth of Common Sense Michael Batnick’s The Irrelevant Investor Like us on Facebook And feel free to shoot us an email at [e-mail] with any feedback, questions, recommendations, or ideas for future topics of conversation. Learn more about your ad choices. Visit megaphone.fm/adchoices

Today's Animal Spirits Talk Your Book is brought to you by Poland Capital. Go to Poland Capital.com to learn more about their international small growth fund that we're going to talk about on today's show. Welcome to Animal Spirits, a show about markets, life, and investing. Join Michael Batnik and Ben Carlson as they talk about what they're reading, writing, and watching. Michael Batnik and Ben Carlson work for Ritt Holtz Wealth Management. All opinions expressed by Michael and Ben or any podcast guests are solely their own opinions and do not reflect the opinion of Ritthold's wealth management. This podcast is for informational purposes only and should not be relied upon for investment decisions. Clients of Rithold's wealth management may maintain

positions in the securities discussed in this podcast. Welcome to Anno Spirits with Michael and Ben. One of the themes we've talked about a little bit over the years, for one of the reasons we're not worried about all the money moving into index funds is because the majority of the money that's going into index funds is probably coming out of closet index funds that were active. All right. They chart to higher fee. They basically tracked the index. Now they're just doing so in a more tax-efficient, lower-cost way. So I think what we're going to see more and more of going forward is a barbell in the fund world, where we have index funds on one side, index funds in ETFs, really low fee beta in the future is probably going to be free or you're going to get

paid for it. And on the other side, we have niche funds in highly concentrated funds that hold fewer stocks. That's where we're headed, right? If you're in the middle, you're out of luck. If you're on one of the ends at the barbell, you're probably going to do just fine. It's the way it should be. Yes. So looking at Poland Capital's small cap growth fund, international growth fund, which we're going to talk about on the show, I haven't heard of a single top 10 holding. No. Well, there's probably few small caps internationally that you know of

and even fewer growth ones, right? It's a category that not many people pay attention to. And we get into that on the show as well, that these companies aren't covered as much by regular investors or by analysts. So you would think, and I really do, believe this, that if there is one remaining source of alpha, there's no information edge in U.S. markets and certainly in U.S. large markets, but when you have companies overseas that have literally zero analysts, and you can't win there, game over. Yeah, that's one of the few places where there's information edge. And it's funny because there shouldn't be an information edge

anymore with some of these big companies and they still do stuff that you don't think they should when you have 60 or 70 companies following Apple or Amazon or whatever. So this is an interesting space, because you don't hear much about such a niche in international in terms of like smaller growing companies that are going to be big for. And so we talked to Rob Forker today, who is a portfolio manager and analyst at Pullen Capital and also a listener to the show. Kudos to him, not to brag. He said he's been a show listener for years. I don't know if he really has or he's just patting us on the back, but we'll take it. Well, not to step on Rob's material, but the most interesting point that he made is work on remote and the U.S. being the model that the rest of

the world is copying in terms of, oh, this is the square for Japan. This is the this for that topic, for that country, for that sector. Right. They now have a model to use in other countries, which, yeah, I think is great. So, no further ado, here's our interview with Rob Forker of Poland Capital. We are joined today by Rob Forker. Rob is a portfolio manager and analyst for the international small growth fund. Rob, the other day, I was talking to Josh during one of our YouTube videos. And I mentioned that European tech had its worth day in six months, eight months, whatever. It was like down 4%. And Josh said, European tech, what even is that? Like, what are the companies? I said, you know, I don't. And so I'm sure a lot of that is my naivete, but let's be real,

there's no apples, there's no Amazon. This is as far as I know in Europe tech. So maybe that's a good place to start. Why is it that, again, from the outside looking at it, it seems like European and technology companies have lagged versus what we've got going on over here? Yeah, so first and foremost, I respect Silicon Valley a lot. There's some unbelievably powerful and impressive companies either, but there are a lot of unbelievably impressive companies outside of Silicon Valley. They're just smaller companies, and you haven't heard of them. And that's changing right before our eyes.

So we own some companies in Europe. We own some companies in Japan. We own some companies in Canada that we think are at the forefront of technological shifts and changes. And so what is true today might not be true tomorrow. So we think tech, that gap between Silicon Valley and, frankly, the rest of the world is narrowing. And you're starting to see it in small cap. Well, I guess given the fact that work has gone so remote, it stands to reason that maybe 2020 was a watershed moment in shrinking the gap between Silicon Valley and the rest of the world. Yeah. I mean, here's my perspective. The reason Silicon Valley has been so impressive for so long

is human capital. So it's been a race to the talent. Well, now with the hybrid world and anybody can live anywhere and more restrictive measures on where people can work or enter, that playing field has leveled a bit. And so I think it stands to reason that companies in other regions of the world are doing better. What is the addressable market here? If we're talking small cap stocks outside of the U.S. and then you narrow it down to growth. How many stocks are we talking here? Yeah, so the benchmark is the MSEI Acqui XUS small cap. It's kind of a mouthful and translated to English. That's basically 4,300 companies. It includes developed and emerging markets. Within that 4,300, we think when we apply our five guardrails, which is how we measure quality, you get

that investable universe closer down to 500. So it's still a vast array of companies. And within technology, about 40% of our portfolios in technology stocks and We think these, again, companies are at the cutting edge of a lot of secular change. So what is, I mean, obviously, it seems like all you can hear about the last 10 years is large cap growth stocks in the U.S. You don't really hear much about small unless they reach that threshold. So what are some of the areas that these international companies are focusing? Obviously, that's a huge subset of companies.

But what are some things that these companies are doing that maybe would surprise people in the U.S.? Yeah, so one company we own is called Samarji. It's out of Japan. It's basically a point-of-sale system. operator. So what they're basically riding is the wave of cash to cashless. And Japan is far behind other developed countries on this journey. And this is both incentivized obviously by consumer behavior, but also the government. The government wants its citizens to use more cashless instruments. Samarji helps small retailers with that point of sale system. Honestly, think of it as the

square of Japan. And so the retailers have efficiencies when they have it at their storefront and the consumer has a better experience. This happened 10 years ago in the U.S. It's really just happening in Japan now. And the pandemic only accelerated that trend. There are a lot of stories in the portfolio and, frankly, in the world about that sort of dynamic, which is to say the mousetrap has been proven in the U.S. And it's being carried over to other countries where the adoption curve is slightly behind,

but everyone knows the winning recipe. When you're looking at companies overseas, whether it be, Japan, continental Europe, whatever the case may be, how much awareness do you need to have of the macro economic forces I play and the cultural forces and the demographic forces? It seems to me like that would be a big, big thing to consider when you're doing your analysis. Yeah, cultural and demographic are huge, and we spend a lot of time understanding that. If you don't understand cultural norms or behaviors, you don't understand what the consumer or businesses are going to do in that local market. So that is a huge, huge aspect of what we do.

We also need to know the culture of the company. So we need to understand how the board is comprised, management incentives. I mean, that is a huge part of identifying quality companies is that cultural aspect. Demographics matter. They don't matter as much in small cap, which is to say it's the law of little numbers. So you can have a company like Samarji in Japan that has quote unquote bad demographics, which is to say a shrinking population. and that company can compound its growth at over 40% per annum because it's so early on in the

adoption curve of these changes. Macro in general is important, but it's actually not that important in international small cap. The reason really is that we don't invest in countries where the rule of laws in question, that's a hard line for us. And at the end of the day, we think the driver to international small cap companies is idiosyncratic decisions the company makes. Which countries does that take off the top line right away for you? What are some bigger countries that you don't invest in?

There are a lot of countries where we don't think the rule of law is consistent and can be frankly dangerous. A country to highlight would be Russia, where we don't know the rules of the road, the rules of the road are changing and that's a place we don't feel comfortable deploying other people's capital. When I worked in the endowment world and foundations and we were doing manager selection and talking to different managers, to add to the portfolio. One of the things you would always hear from international managers was the

importance of boots on the ground. People love to talk about boots on the ground. How much has that changed with technology? And obviously, when we're dealing with a pandemic, the whole boots on the ground thing was taken off the table, right? You couldn't travel to some of these places. So how much does that matter to you in terms of getting to some of these countries going to see the actual companies versus how technology is sort of flattened the world and made it easier to just track these things from your home? Yeah, I love that question. So we don't think it really matter. at all. And this is probably less about a broad statement about boots on the ground and perhaps a bit more about our investment philosophy. So our investment time horizon five years. We think and act like

owners. There's always data points in the marketplace, but most are noise. And honestly, it can create a lot of bad behavior if you constantly react to those data points. Now, that doesn't mean you can be complacent. And we're always asking those questions to ourselves as a group and a team, whether something has changed. But at the end of the day, we're most concerned with identifying these companies that can be two to five times bigger in our investment time horizon and up to 10 times bigger over the long term. And these companies are part of secular change. So those breakouts are as easy a spot in Boston as we think they are anywhere else in the world. Rob, anything that has a potential to go up 10x has a high likelihood of getting cut in half at least one time along the way or worse.

Sure. When that happens, and I'm sure you could point to a a lot of experiences where that did happen. How do you maintain your composure and not freak out like Will Ferrell and old school? It's a great point. I mean, no stocks are linear and up and to the right. That isn't a thing. And so I think that's where the team comes into play. I mean, we have a team of eight in Boston. We all come from a diverse set of perspectives and opinions, and we got to lean on each other to make the right decisions for our clients. The other thing we do, which I love, is we write a premortem, Michael, so this kind of gets what you're teasing out here. When we make any investment, we write a couple paragraphs, and it starts with the

following. The investment we just made is down 70 percent, and here's why. And so it's an unemotional state of saying you've failed. So the question of failure is not out there. We have accepted that we have done a very bad job at our job. And you envision creatively in a very negative way what could have happened. And so when you do that, it sort of risk 2.0. So you're thinking about some scenarios that may be tail risk, but you're thinking about them. And we think it leads to better behavior as the company inevitably can have volatility. Just two follow up points on that is that one, there's a big difference between a company falling 70% from the point that you bought it at versus it falling 70% after it already went up 5x. We anchor to the purchase price, obviously.

No doubt. And then number two, companies don't get cut in half for no reason. It might be an overreaction, but there's always a catalyst of some sort. So how do you, I know this is not a fair question because it's really unanswerable, but how do you know if like this is it, the business is busted versus no, no, no, really and truly investors are overreacting? Yeah, I agree. I mean, stocks do not get cut in half for no good reason. And the market's not that dumb. And I don't want to say it ever it is. I think it gets back to the team, though. So when we have an investment where the competitive advantage may have narrowed relative to peers, and frankly, what they offer the marketplace is less valued, that's where we do a team review.

And so that's where you get everybody in the room, it's frankly like a war room, and you talk about what is potentially disrupting this company. I mean, here's the beauty of what we do. We're looking for disruptors. Our portfolio is littered with disruptors. So I think we're pretty good at identifying the disruptors of the disruptors. I think that's a key edge on what we do. When you get a stock at that point, and this has happened to a bunch of growth stocks in the

U.S. right now, the stock market is close to all-time highs, and there are stocks in the U.S. that are down 40, 50, 60 percent from their highs because they're also up more than the market. At that point, as a portfolio manager, do you have to say we either double down or get out? Is there an option to wait? So if a stock's cut in half and you still have conviction to hold it, do you have to almost rebalance into that pain? No. And I love that question. I totally get where it's coming from. I think price is a really

important component. I'll be the first to say that. But I think fundamentals matter a whole lot more. And so when you have a longer term time horizon of five years, those movements can be very painful. But what matters most? And the question we frankly asked ourselves in March 2020 and April 2020 all the time was, is this company going to be stronger or weaker in five years? And when you get that mindset going, I think it really leads to better decisions. Teach me. What do you say? Teach me.

I'm weak in mind. No, you're not. No, you're not. And by the way, I have to take this after. I've been listening to you guys for years. I appreciate the humility, but I don't agree. Yes, stocks go up and down. That's what we all signed up for.

I think you've heard this from other folks, but the stock prices are way more volatile than the business fundamentals, way more volatile. And so these movements that go up and down, just if you back out, and zoom and say, are they on track? Okay, they missed the quarter by two cents. Who cares? If you're playing for much, much more, again, that's just noise. So let's talk about the portfolio. Needless to say, this horse has been beaten to death over the past few years of the shift from active to passive. And I think that if you're going to go with an active manager, in my opinion, you want an active manager. You don't want a closet indexer. And so that leads

us to your portfolio, which is high conviction, 99% active share. Maybe you could tell us what that means in a second and 25 to 35 portfolios. Talk to us about that entire process top to bottom. Yeah. So 99% active share. Look, it means we look a whole lot different than the index. And we think that's great. We think that's a strength.

So there are no Googles or Microsofts here as of yet in this index. The index is 4,300 companies, as we mentioned before. These are small companies that we think can be very big over time. The beauty of what we do is we're just looking for the best 25. to 35 companies in that 4,300 company universe that we can own and own for a long time, again, thinking and acting like owners. You will never see us write in a letter. Companies we don't own, whether they went up, down, or sideways. We don't care. What we care about is the companies we own because they drive the returns for our clients said differently. We're benchmark

agnostic. And that's not just the way we believe is the best way to invest, but it's mathematically sensible. These companies have nothing to do with our returns. We talked about this a little bit before the show, but it's probably worth highlighting. We're the most concentrated manager in the world in our category per Morning Star Data. We love the way we invest because it's that high bar of we only want the best. We are happy to pass on pretty good or okay. We just have no interest in owning those companies. So again, it gets back to that 99% active share.

There are passive options. They are not very good in this category. They are high-priced, and the tracking error is very bad. Are those indexes worse in foreign markets that they're in the U.S.? How do you view that? Yeah, much worse. So there are transaction costs with international investing, and so they have to put those fees into the passive ETF, so that's one reason.

And then secondarily, it actually gets back to the active share, but the biggest benchmark company in the index is like 26 basis points. the cost of owning all those companies to replicate the index is prohibitive, and so there are shortcuts taken, and it leads to an inferior product. I think concentration is in the eye of the beholder. So if you're an index fund holder, you could own thousands of stocks. And I've talked to managers in the past who say, we're concentrated and they own 300 stocks or 150.

And I think I've seen the studies that say, like, once you get to 1520, 2530, that's where you get some sort of diversification benefit where you're not completely reliant on any one company. How did you all get comfortable, though, holding? So in your latest report, it said your holdings were 28 holdings. Michael said it's 25 to 35. How do you get comfortable with that, especially in a space like small caps, which tends to be more volatile than large caps even?

Yeah, so we think the margin of safety on all the companies we own is the quality of the business. So we think that matters a whole lot more than any other factors. Like you said, Ben, we own 28 companies today. Over time, we think we'll own 25 to 35. basically these companies are at the forefront of secular change. And maybe it's worth backing up and talking about our five guardrails. And the reason I'm going to do this is everybody talks about quality. It's become a very overused term in the industry. So we think

about five guardrails and they are, we're looking for real organic revenue growth, high end or improving margins, high returns. So I think return on equity, abundant cash flow and a strong balance sheet. That sounds easy. It's not. So a lot of companies in the index have none of those characteristics. So, Rob, do you screen those out quantitatively? Exactly. Yeah. So we put a screen on, that's how we get to the 500 or said differently, invert it. 3,800 companies in the index do not have those five characteristics, which is a lot. When you talk about like growth, what are we looking at for the inclusionary screens, whether they're quantitative or qualitative or combination of the two. Are we looking at earnings growth? Are you looking at user growth? Like,

what sort of metrics are we looking at? So international investing is a little tricky with data. So there's incomplete data. There's foreign exchange. There's a lot of noise. And it's also probably worth highlighting that we look at valuation last in our process. And that's not only because we think that leads to better behavior as a team, but also because valuation is just flat out wrong most of the time. It'll highlight the inefficiency of the asset class. So of those 4,300 companies, 700 have no sell side coverage. So there are no estimates. A typical company in the index has about five analysts. Compare that to the Russell 2000, which is over 20. And you've got Apple, which you all tell me, but I think they have 65 analysts covering that company. So it's also

insane to do valuation first because you don't even know what the E is. And then philosophically, I don't believe it's right to talk about a company's valuation. When you don't even know what they do. Right? Like, how do you know what it's worth? You're just quoting someone else's flawed earnings estimate. So I think the best way to understand the value of a company is to spend the time to understand it, go through R5 guardrails, but then more importantly, read the annual report, talk to the company, study the industry. Those are the steps that one needs to take to get that full view of what a company is or isn't worth. Are you looking for like really high abnormal astronomic growers, which have a, I'm guessing, a high tendency to mean

revert? Or are you looking for companies that have a sustainable growth rate of, call it high 20%, but not 150% you over year? Like, what are you looking for? Yeah, we're looking for durable high quality. So it's what you're getting at. Like, to quote Jim Collins, sorry, the 20 mile march. We want companies that are good and good for a long time. So we would absolutely rather have a company compounding at 10, 15, 20% for 5 to 10. years than that 150%. I like to call them sugar high companies, and there were certainly plenty of them in the last 12 months. That involves a level of timing that we're uncomfortable with. And I'm not sure anybody can do that for the record, but that's not our game.

Our core competency is we want to find companies that are durable, high quality for a long time. Buying stocks, I think, is always way easier than figuring out whether you should hold or sell a stock, because if you're buying a stock that's falling, you think, okay, I find some value here. If buying a stock that's rising, you think, okay, this is going to continue to arise. The whole sell discipline idea, you don't see many books written about how or when to sell a stock, because it's really hard to know. It's easy with hindsight, but at the time, you don't really know. So how do you determine this? Like, when is it time to either sell a loser or when is it time to sell a winner and potentially roll into something newer? I mean, is it as simple as

company fundamentals? That seems like the hardest question to answer for me as a portfolio manager. Hard question, hard answer, and I completely agree with you. So when we sell a company we mainly sell it for a few reasons and it's probably worth going over. But one is what you're alluding to, which is that the competitive advantage has deteriorated, easier said than done. There's a lot of noise in the marketplace. The second reason is market cap. So the beauty of international small cap is that these companies can grow to be much larger than their current size. And then the third is actually there are a lot of takeouts. So again, a beauty of the asset class, they get either taken private or be swallowed up by a larger corporate. But to get back to the heart

of your question. That's why the team's so important. And look, it's really, really difficult. You have to get everyone in a room and you have to talk about whether what you're looking at is noise or it's the death nail. I will say one beauty of the way we invest, and this gets back to owning 25 to 35 to 35 companies, is we're okay with saying we don't know. And sometimes it's impossible to know. There's too much going on and you look at the facts and it's clear is mud. And the best thing for our investors is to move on because the world's a really big place and we can redeploy that capital to a better idea. Where the risks are less, the probability of success is much higher. And that's a good outcome. And sure, like, we'll look silly if we sell it

and it goes straight up and that's incremental turnover, whatever. But that's just optics. We have to do what's best for the client. Rob, how are clients coming to you to Poland capital? Is this mostly the institutional investors? Is it RIAs? Is it a combination? All the above. So the firm is approximately 40 years old. We started primarily with the RIAs. We've since grown out our institutional business more in the last five to 10 years. So we're now a balanced firm in terms of asset. And I assume that means separately managed accounts and the mutual fund as well. Exactly. So you have an option for both. I'm just curious. Who do you find is more, obviously, you can't bucket everyone, but who generally is more patient as an investor with

your fund that could be highly volatile? Is it individuals or is it more institutions? Is it hard to say? There are a few family offices that have already invested and there are more that are studying the company and I think it gets back to a longer term time horizon. The endowments have also chatted with us plenty. No one has invested quite yet, but the endowments are very curious. I mean, in some ways, you could argue the way we invest is almost like cheap private equity. So it's extremely low fee. It's liquid. And we own a lot of companies, by the way, that private equity owns as well. And sometimes the private equity companies buy the companies that we own. And then, yes, high net worth for sure. And the high net worth individuals,

they are often cross-sell. They own other polling strategies and have been very happy for a prolonged period of time. I mean, what I think we've observed thus far is that we're delivering on the Poland mission statement. So we're preserving and protecting capital in this asset class, which can be a bit more volatile. And you've seen it thus far. The annualized returns of the strategy are over 30 percent. Upside captures 107 percent. Downside capture 70 in standard deviation, even though it's a concentrated fund is lower than the category. And so that resonates with those that say, look, I know the category is perceived to be risky, but we think the way you do it minimizes a lot of those risks and enhances the opportunities, which is to say these small

companies in Japan and Germany, et cetera, that you've never heard of that can compound it over 20%. Rob, if people want to learn more about the company and the strategy, where can we send them? Our website. Our website is got a lot of content and would love to have folks visit it. it's pulling capital, and then the team has a landing page, and there's a fact sheet and videos, letters, et cetera. All right, Rob, this is great. Thank you so much for coming on today. Thank you.