Hidden Champions Fund FY16 Investment Letter: Our North Star Investment Strategy to Navigate Turbulent & Fragile Markets
“ Governing with excellence can be compared to being the North Star: The North Star dwells in its place, and the multitude of stars pay it tribute.” – Confucius, Analects 2:1
Your funds in listed Asian equities have achieved a -4.7% 12-month rolling return (in SGD terms) against declines of 11.3% for the MSCI Asia Pacific Index, 11.7% for the Australia All Ord Index, 12% for the Nikkei 225 Index, and 17.6% for Singapore’s FTSE STI Index over the same period.
This outperformance is buttressed by an 11.2% absolute positive return (in SGD terms) from our investment cost of the revamped portfolio in the second-half since September 2015 against market index decline, powered by a double-digit gain from our high-conviction top position, ASX-listed Sealink Travel Group, which comprised around one-third of our portfolio NAV. We are also a Top 15 Shareholder in this world-class widemoat company with dominant market leadership as the largest provider of nation-wide tourism and transportation services generating record profitability with a visible long runway ahead to compound growth with resilience.
We aim to be a Top 20 Shareholder disclosed in the Annual Reports of the companies we invest in as a demonstration of our conviction and transparency in the investment process. As detailed in Table 1, we are a Top 20 Shareholder in 7 worldclass wide-moat companies out of the 18 portfolio stocks (we added 4 stocks in April after the Financial Year ended which were up 10.8% as of 29 April). We are looking to accumulate more and becoming a substantial shareholder with a 5% stake as they continue to deliver in their business fundamentals.
This outperformance is possible because of our multi-manager team-based investment process implemented in September 2015, led by our analyst team comprising of Kelvin Seetoh, Jackson Yeow, Sim Zhipeng, and Joshua Zhang. This teamwork greatly strengthens our ability to invest with high conviction in wide-moat companies, making an architectural shift from time telling to clockwork with a build-to-last structure for our shareholders. As Jim Collins, author of the Built to Last and Good to Great, puts it aptly, “Imagine you met a remarkable person who could look at the sun or stars at any time and state the exact time and date. But wouldn’t the person be even more amazing if, instead of telling the time, he or she built a clock that could tell the time forever?”
“ You look at all the successful companies, what is the key? Their brainpower. The thinker, good management, good innovators… Successful CEOs are like gems you find on a beach. There are many pebbles, many beautifully colored ones, but they are all stones. Now and again, you will come across a real precious gem, a real emerald, pick it up, polish it. He must have a set of qualities that fits with the job, has energy, drive, ability to interact with people, ability to get people to work with him in a team.” — Lee Kuan Yew, founding Prime Minister of modern Singapore, in Hard Truths to Keep Singapore Going
We would like to express our heartfelt thanks to our 8IH team as all of us put forth energy when and where it was needed and yet were careful stewards of organisational energy by painting a vision so beguiling and inclusive that it riveted the attention and harnessed the energy of everyone into something exponentially valuable. This teamwork culture resembles the Angklung, a traditional Indonesian musical instrument made from joint pieces of bamboo. The tubes are carefully whittled and cut by a master craftsperson to produce certain notes when the bamboo frame is shaken or tapped. Each tube of the Angklung produces a single note or chord, so several players must collaborate in order to play melodies. It symbolises how humans cannot stand solitary; one needs others in life. Angklung is Harmony in a Bamboo Orchestra.
Hidden Champions: Our North Star Investment Strategy to Navigate Turbulent & Fragile Markets
“Explorers depend on the North Star when there are no other landmarks in sight. The same relationship exists between you and your right life, the ultimate realization of your potential for happiness. I believe that a knowledge of that perfect life sits inside you just as the North Star sits in its unfaltering spot… Your life follows your attention. Wherever you look, you end up going.” — Martha Beck, author of Finding Your Own North Star
The clock that we are building together as a team to tell the time forever is the Inner Compass and systematic investment process that leads us to our North Star to navigate increasingly turbulent and fragile markets to the Hidden Champions.
Our approach to value investing is to invest in the Hidden Champions, agile creatures darting between the legs of multinational monsters who are dominant global players in sophisticated, hard-to-imitate niche products and valuable critical niches that are largely invisible to the average consumer. The Hidden Champions create maximum benefits for a target customer group, solving their most burning problems better than any competitor. This innovation strategy requires a deep knowledge of customers’ needs, which is gathered through direct customer contact. Successfully solving these problems would then create a “success spiral”. A key source of their wide-moat is their sustained commitment and even obsession to customers’ needs, which is only possible in our view when there is a purpose and values system guiding the firm.
The Hidden Champions have their roots in the esprit de corps of Germany’s Mighty Mittelstand, the more than 3.5 million small-and-midsize family enterprises that form the backbone of Germany’s resilient export-driven economy, employing more than 78% of workers and contributing more than half of the country’s GDP. The Mittelstand traces its roots to the Middle Ages when the country that is now Germany was divided into hundreds of states. Competition between them created a number of industrial regions with their own educational institutions, banks, and political administrations. The Mittelstand had to export early on with a global-orientation to their business model, given that some German states were smaller than two football fields.
Mittelstand enterprises that became well-known giants include BMW, Audi, SAP AG, Adidas, Hugo Boss, Robert Bosch, Siemens, consumer giants Beiersdorf and Henkel, dialysis giant Fresenius, pharmaceuticals giant Bayer, chemicals giant BASF, industrial gas specialist Linde AG, truck and engine maker MAN SE, and so on. There are also lesser-known, quiet, resilient, successful compounders, including commercial kitchen equipment company Rational AG, eyewear specialist Fielmann, specialty chemicals specialists Brenntag and Lanxess, high-end cleaning equipment Kärcher, Würth group (the “Fastenal of Europe”), auto gasket maker Elringklinger, flavour and fragrance specialist Symrise, lab solution specialist Sartorius, medical vision technology specialist Carl Zeiss Meditec, packaging and bottling machine maker Krones, wound medical products Paul Hartmann, and so on. From a value investing perspective, investing at an earlier stage in the long-term growth trajectory path of Hidden Champions in Asia will prove rewarding, as highlighted in an investment case insight into Rational AG, which we also shared in 8IH’s inaugural value investing educational programme in Shanghai.
Investment Case Insight into an Archetypal Hidden Champion: Rational AG
Why are Hidden Champions “hidden”? If they are “hidden”, will they become successful companies? Aren’t the successful ones