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HVS 1Q22: Interview With WCM Investment Management

By Jacob Wolinsky. Originally published at ValueWalk.

WCM Investment Management Vltava Fund Commodities investor Volksbank Hedge Fund Booster. Stock Investing Investment Portfolio Commodities Hedge Funds Fortescue Metals Group commodity-focused hedge funds Sustainable investing US Rate Hike Lowell Capital

Hidden Value Stocks issue for the first quarter ended March 31, 2022, featuring an interview with WCM Investment Management, discussing their investment approach.

Interview With WCM Investment Management’s Andrew Wiechert

Andrew’s primary responsibilities are portfolio management and equity research for WCM’s global value strategies. Prior to joining WCM in 2007, Andrew began his investment career in 2006 at BNY Mellon Wealth Management. Andrew earned his B.S. in Economics and Management Science from the University of California, San Diego, where he graduated with honors. DREW FRENCH Portfolio Manager & Business Analyst Drew’s primary responsibilities are portfolio management and equity research for WCM’s global value strategies. Drew’s investment career began when he joined WCM Investment Management in 2013, first as Portfolio Associate, and later as Marketing & Communications Manager. Drew earned his B.A. in Communication from the University of California, San Diego.

Q1 2022 hedge fund letters, conferences and more

Could you give our readers a bit of background on WCM?

Drew: Absolutely, Rupert. WCM is a 76-person investment management firm based in Laguna Beach, CA. We manage ~$107 billion in assets (as of 31 December 2021), predominantly focusing on institutional client relationships. Our primary goal is to generate long-term, sustainable excess returns for clients through a culture of innovation, close alignment of employee incentives with client objectives, and a flat power structure that fosters meritocracy and critical debate. To this end, we strive to mitigate risk for our clients, focusing our attention on downside protection, low volatility, and low turnover.

The firm was founded in 1976, but we didn’t adopt our institutional focus until the current management team bought out the original founder in the late nineties. The single most important lesson we learned during our transformation from a $200 million RIA to $100 billion institutional asset management firm is how critical a role corporate culture plays in the success of an organization. We have been incredibly intentional about building a culture focused on our core values of having fun, showing gratitude, and serving others. We believe it’s people that ultimately drive results, so we want to foster a culture that empowers our people and encourages them to think different and get better. We have also been committed to passing down equity to the next generation of investors and leaders at the firm. Today, over 50% of our employees have an equity stake in the firm, and we have 11 principal owners with an equity stake of 1% or more.

Our Global Growth Equity Team is responsible for the majority of our assets under management, managing strategies across international, global, and emerging markets. My co-PM, Andrew Wiechert, and I are responsible for WCM’s Global Value Equity enterprise, along with Sachin Kashyap, a business analyst dedicated to our team.

Why do you believe your approach differs from that of other value-focused funds?

Andrew: You know, Rupert, I’m confident that there isn’t another value manager approaching markets the same way we are here at WCM. Back when we launched Focused International Value in 2011, we approached the market with the belief that international indices are structurally inefficient, and that we could exploit these inefficiencies from several angles.

First, we believe our portfolio possesses a significant structural advantage. If you look at the benchmarks outside the US—and this is especially true in emerging markets— they’re filled with basic commodities, poorly run banks, and utilities. It’s our firm’s view that as emerging-economy consumers gain higher disposable incomes, they will do what developed-economy consumers have done for decades: expand their use of technology, seek out higher quality, branded consumer goods, and demand more comprehensive healthcare. Fortuitously, our bottom-up process for identifying great investments naturally leads us to emphasize discounted, high-quality businesses in these same sectors (e.g., consumer, technology, health care, and niche industrials). In other words, our process drives toward the sectors and industries benefitting from where the world is headed. This means our portfolio not only looks materially different than the benchmark, but that it also stands to meaningfully benefit from the global, emerging middle class. This positions our portfolio in front of a multi-decade tailwind, where the sources of real value creation will come from the sectors we emphasize. This is in stark contrast to many traditional value funds, who tend to bargain hunt in more cyclical sectors or industries that tend to be facing long-term headwinds. To be clear, we don’t believe value investing needs to be—or should be—a sector bet on these typically lower-quality subsections of the market.

Second, and more importantly, we believe our process has a significant stock-selection advantage. This derives from our framework for identifying successful businesses that we can purchase at discounted-entry points. While we know valuation is critical to identifying investments with the best risk/ reward profiles, we are also convinced that quality wins over time. And while our frontend valuation discipline certainly produces an attractive opportunity set, we believe our focus on identifying businesses with strengthening competitive advantages (“economic moats”) and superior corporate cultures is what truly propels the probability of outperforming over the long-term. Moreover, we believe pairing our valuation discipline with our long-term time horizon and our emphasis on quality ends up highlighting unique businesses that are easily overlooked by other investors. We believe there is a false dichotomy between value and growth investing that has been growing over the past several decades. As both camps become more entrenched in their way of investing, we believe our process allows us to exploit the growing opportunity set in between.

Third, and perhaps most importantly, we believe we have a temperament advantage. This derives from our efforts to build a culture at WCM that fosters humility, absence of fear, audacious / different thinking, and continuous learning. As we’ve done that, we’ve come to believe that a culture which attracts and keeps the best people is not only important to the success of our firm, but that it is important to the success of any organization, and, in particular, to the businesses we want to own. Ultimately, it is great people that keep a business squarely in front of the important “tailwinds”, and it is great people that nurture the competitive advantage to grow year after year. We think that building these concepts into our own culture and into our process is why our small team has exhibited the judgment and temperament necessary for long-term success.

You say you start the idea generation process with a “series of quantitative screens.” Could you offer our readers some idea of the sort of metrics you’re screening for in this initial step?

Andrew: There might be some doubts about this after the last 10 years or so, but we believe valuation is absolutely critical to the risk/reward profile of any investment, and we believe that price is going to be a much more important factor for returns in the next 10 years than it has been in the past decade or so. This belief is why we’ve always put valuation at the front-end of our process, as it ensures that we’re fishing in the right pond—e.g., the top three deciles of the most undervalued stocks in the non-US universe. That said, we don’t think there is anything magical about our screening process. By design, they are incredibly simple and focus only on the factors we think best represent value across all sectors and industries.

Our initial criterion consists of simply eliminating companies with a market cap less than $2 billion. This initial step alone reduces the entire non-U.S. universe to about 2,000 names.

Our secondary set of criteria consists of a simple six-factor screen that ranks the remaining international universe based on:

  • Valuation (P/E, P/B, P/CF, Dividend Yield);
  • Financial strength (Price/Net Assets); and
  • Relative strength (EPS estimate revisions).

This screen limits our universe to~600 names for consideration. Our next step, we would argue, adds the most value to the “narrowing” process, and to our subsequent returns. This step includes seeking businesses with:

  • Favorable and long-term economic tailwinds;
  • High or rising return on invested capital (“ROIC”). This suggests the presence of an economic moat;
  • Low or no debt. We don’t have a precise standard on this but generally speaking, we use a net debt/EBITDA threshold of about 2.5x;
  • High or rising operating margins;
  • History of consistent and sustainable earnings, revenues, and free cash flows; and
  • Relative price strength.

This set of hurdles narrows the universe to a very manageable list of ~200 names. From this narrowed universe, we are actively following ~100 names for consideration.

From this list, we construct a portfolio of 40- 50 high-quality businesses that we believe are attractively valued, are supported by longterm tailwinds, are growing their competitive advantages, and are aligned with superior corporate cultures.

Lastly, the final portfolio is diversified not just across sector, industry, country, currency, and revenue, but also across our own distinct sub-categorizations—our traditional, transitional, and opportunistic value profiles. While growing economic moats and superior corporate cultures are barriers to entry for all three of these profiles, the criteria we seek beyond these factors will depend on the value profile we assign to the company. For traditional value, we primarily seek strong operators with more predictable earnings and free cash flows. For transitional value, we are primarily looking for signs of inflection points in the business (e.g., a narrative shift, product mix shift, or cultural turnaround). Ultimately, we believe these names have the potential to transition from value names to growth names during our holding period. Lastly, for opportunistic value, we are seeking high-quality businesses that experience a short-term period of what we believe to be unjustified multiple compression, thereby giving us and our investors a deeply discounted entry point.

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