The following speech was presented by Richard Rooney, President and CIO, at this year’s Client Day. It has been lightly edited and condensed for this blog entry.
Value investing is not a popular strategy these days. That is not unusual in late bull markets when it has been a while since the strategy has outperformed. Our very first Client Day, in April of 2000, took place at a particularly difficult time. Burgundy’s returns were further behind the index averages than they have ever been before or since. Our client gift at a previous event that year was a Burgundy logo Swiss Army Knife, and I remember telling Tony that it was probably a bad time to be distributing weapons to the clients.
The tech bubble was at its height. Value investors were being told that they were dinosaurs with insufficient imagination to foresee the kind of changes that internet-enabled businesses would unleash on the economy and society. Value investors responded that the valuations of these companies made no sense, and that a return to the realities of economics would lead to dreadful losses.
This was one of those rare cases where both sides were correct. Huge amounts of money were lost by technology investors, especially in the early years of the bust. Technology indexes took 16 years to return to the levels they had reached at the time of that first Client Day.
On the other hand, profound changes did occur in the world economy in that period, far beyond anything I could ever have imagined. Technology became ubiquitous and enormous new businesses emerged. Traditionally great businesses like broadcast media and daily newspapers were crippled by the internet and are no longer viable investments today. The world has changed beyond recognition in the last 18 years, and not just in economic terms. The sociopolitical changes have been huge as well. A great many of those Burgundy Swiss Army knives were confiscated at airports in the aftermath of 9/11 when all the rules changed.
The key takeaways from Burgundy’s Client Days are often about the consistency and persistence of our key investment principles. This year’s line-up was designed to show you how those principles are not inconsistent with adaptation and change.
The two bedrock principles of quality value investing are Margin of Safety and Circle of Competence. Your Circle of Competence includes the industries and companies where you have gathered sufficient information to assess the risks and opportunities inherent in the businesses. The Margin of Safety is the difference between the price of the company’s stock and the value of its business that we calculate as a result of our analysis. At Burgundy we believe these two concepts are inseparable. A reliable estimate of Margin of Safety cannot be arrived at without knowledge of the business; while buying equity of companies within your Circle of Competence without carefully valuing those businesses is reckless. Great companies are only great investments when the value you get is greater than the price you pay.
When I addressed our first Client Day in April 2000, Burgundy had developed a Circle of Competence that virtually excluded technology. My undertaking to you at that time was that we would change this and devote resources to learn about technology companies, find sustainable business models that we could invest in, and make sure that we were able to keep up with a rapidly changing economy.
Eighteen years later, at our nineteenth Client Day, I think we can show progress in developing our skills as technology investors. In April of 2000, we had almost no technology investments at Burgundy. Today, information technology is the heaviest weighted industry group in Burgundy’s U.S. and Asia portfolios, second largest in Emerging Markets and third largest in Europe. Clients can look at their portfolios over the last decade and see substantial holdings in companies like Microsoft, Google, Apple, Oracle, and SAP, as well as less familiar names like Kakaku, Naver, Linx and Obic. All of these businesses have strong and defensible moats and generate large amounts of free cash flow to return to shareholders or reinvest at high rates of return in their own businesses. And our portfolio managers and analysts know them as well as any investment professionals out there.
We are unlikely to be leading edge in technology investing, since emerging technologies take time to develop their business models and we need to understand the business model before we can invest in any company. It must be solidly within our Circle of Competence. That said, however, we do feel that our long experience in assessing the sustainability of businesses gives us a strong niche as investors in technology, while our grounding in value prevents us from being swept away by the kind of New Era thinking that major technology success stories so often engender. An additional advantage of our approach is that companies like Apple, Google and Microsoft are usually fast followers and early acquirers of potentially disruptive new technologies. So while we may miss out on the early excitement, our powerful companies tend to capitalize on the long-term opportunities in these technological advances.
So Circle of Competence is not a static thing at Burgundy. As technology changes social norms and economic balances of power, we can and do migrate away from obsolescent businesses that can no longer serve their customers, to powerful new businesses that have exploited technology to create new moats and castles. I feel we have generally done a decent job of migrating our Circle of Competence towards new technologies, while remaining true to our valuation discipline. The companies we have invested in have repeatable business, high margins, abundant free cash flow and high returns on invested capital. They are conservatively financed and run by rational people. So the businesses we invest in may be different from two decades ago, but the characteristics are quite familiar.
One of the best ways to ensure that we can keep up with a rapidly changing world is to hire people who are comfortable with these new technologies. While there have been few changes in the cohort of portfolio managers at Burgundy, there have been very significant additions to our analytical ranks. These are young professionals for whom the technological background of change is second nature. They will have a much more intuitive understanding of new possibilities and business models than their older colleagues.
I am going to close with quotations from two great nineteenth century statesmen. As usual the quotes will be wildly out of context, but that is just how I roll.
Benjamin Disraeli once defined a true conservative as someone who wants to change things just enough so they can remain the same. I feel that is a pretty good summary of our attitude towards our investment Circle of Competence at Burgundy. We have dramatically changed the industry focus of our investments over the past two decades, but the fundamental things we look for in an investment are the same as ever.
Right at the moment we are not producing the best returns in our history. Late in the economic cycle, our approach tends to lag the markets, and that is as true in 2018 as it was in 2000 and in 2007. We find ourselves in the frustrating position of asking for your patience, just as we did at those times.
Otto von Bismarck, founder of united Germany, once said that Russia is never as strong or as weak as you may think she is. By the same token, I would say that Burgundy investment professionals are never either as smart or as stupid as the market makes us appear. Right now we do not look to be at the smart end of the spectrum, with a few honourable exceptions. But we are an experienced, capable group and we will do the job for you, never fear.
Article by Richard Rooney, Burgundy Blog