The Exchanges

Q So I've talked a couple years ago with Paul and then last year with Mike about the concept of moat trajectory and how you think about it. I'm curious, how do you start by thinking about what the sources of moats are?

A We think of economic moats as having the following moat sources. So number one will be, I would call intangible assets. Which is really a catch-all for a number of different things. Could be a brand, trademark, commercial relationships, customer relationships, even regulatory protection and all that. So that's number one. Number two will be some sort of a cost advantage, driven by scale or something else. It doesn't have to be scale, but something that causes you to produce something at a lower cost than somebody else. Number three, it will be switching costs, fairly self-explanatory. Number four will be network effects. And number five, which is really the least important mill source, I think, is efficient scale. And that's the idea that You have a very niche market that perhaps can only support one player. And if somebody else were to get into it, you will destroy the economics for both. Therefore, nobody will want to get in there. But the reason that doesn't really work that well is because you have to rely on other people to be quote unquote rational, which doesn't always happen in the real world. But either case, we found that almost all the competitive advantages in the world is some manifestation of a combination of some of these five.

AI assessment note: “We think of economic moats as having the following moat sources.”

Q As you're describing these sort of sign posts, call them, of like what an expanding mode is, it seems like a lot of it is qualitative. And if you're looking at a business today and the same business three years out, how do you calibrate some of those things that are clearly qualitative in a business?

A Almost everything we do is qualitative. We're not really big on modeling or anything like that, and even modeling out market shares and whatnot, this is sort of like a finger in the air type of thing. We don't really put a whole lot of stock in that. For almost all businesses, there are usually a lot of countervailing forces, and you have to have a good judgment as far as your, how to balance out these forces in order to come out with a final determination of whether the multradictory is positive or negative. And sometimes it's actually very difficult. Let me just give you one example that I think a lot of people would know. Let's say Visa. So as we know, there is a very powerful tailwind in terms of digitalization of payments. These networks have been very entrenched for decades, very difficult to change. Obviously, the stocks and all that performed very well over time. But there is also countervailing forces to that. So one, in developed markets, the runway to further digitalization is probably narrowing. Who uses cash nowadays? I haven't used cash in forever. So that is somewhat going away over time. In emerging markets, there are a lot of new competitive forces to that. So emerging markets, longer term, it's probably going to be a much stronger tailwind driver because you're starting at a more nascent stage and those economies are growing faster. But if you look, let's say,…

AI assessment note: “you have to have a good judgment as far as your, how to balance out these forces”

Q I'd love to apply this broad framework. You're talking about Mo trajectories and the subtleties and making the decisions to a lot of the work you're doing in emerging markets and say, particularly with China. Topical for lots of reasons these days. How have you approached taking the WCM framework And applying it to investing in China?

A I will say how we think about moats, for instance, it's fairly universal. The same moat sources that apply elsewhere in the world also apply in China, and I think most people agree with that. Now the difference is that we have to calibrate a bit more when it comes to certain of these forces that affect moat trajectory. There's differences in China versus the rest of the world. Let's say, for example, The consumer is actually a bit more fickle in China, I think, versus the rest of the world. There's very few good FMCG or fast-moving consumer good companies in China. You see the brand turnover, at least outside of the prestige or luxury space, is very fast. And unlike the rest of the, let's say in the US, for example, in which distribution is difficult, is more bricks and mortar, And consumers have been ingrained in terms of buying certain brands for decades. China is not really like that. You have these KOL driven things that can find audiences on ByteDance, on Taobao, or whatever it is. Consumers are very eager, oftentimes I think, to try new things as well. So it's much easier for new brands to kind of appear, just as an example. So the same mental models you use to assess some of these developed market things, it doesn't really necessarily apply in China. But there's also lots of places where you can use pattern recognition, and using more of a global mindset to assess compan…

AI assessment note: “The same moat sources that apply elsewhere in the world also apply in China”

Q What are some of the examples of those?

A Just to throw a few things out there for you. We're investors in a company called Hunson Technologies, and what they are is a near monopoly maker of critical financial software for brokerages, banks, the stock exchange, and things of that nature. Obviously, extremely sticky business with 99.9 renewal rates and pricing power And the regulatory tailwind because the financial market opening up more compliance and things of that nature generates a lot of opportunities. For them longer term. Obviously a fairly profitable business as well, just one example. We're invested in this company called Angel East, which has like a 40% market share in East, in China. And it's actually a big company, just East, but they make a lot of East. And in China, there's this nice tailwind of people eating more bread over time, because bread is like a new thing, it's not rice, because bread is a newer entrant to China, so that's actually consumption is going up over time, And some of the byproducts from yeast is actually pretty useful in animal and human nutrition. It was actually being used as a sodium substitute if you want to eat less salt or flavorant in that sense. That's just another example. Actually, a fairly profitable business. I kind of mentioned earlier that we were involved in some of these pharmaceutical services companies in China when it comes to an Asimcam or a Wuxi We're investors in a…

AI assessment note: “We're investors in a company called Hunson Technologies”

Q So how does the rubber meet the road? Internally at WCM when it comes to that decision process, and each individual may have a slightly different view of something like Visa.

A Yeah, for sure, and it's something that's hotly debated, I will say. All these digital payments companies, I come at it from a more jaundiced EM view, obviously, and I see all these things playing out on EM, and I surface these things. And there's guys here that come at it from a more developed markets view of the business, and they stress some of these more initiatives that Visa has in place in order to extend its growth trajectories. Right now, I don't think there's a very clear resolution. But the fact is, because we have a very broad view across the world, we can surface all of these data points, and hopefully at some point, there will be an emerging consensus as far as what's going on. It's very important for everyone to have a very open mind about things, and that's part of the culture that we have at WCM. There's people who love to visit for years and years and years and years, but you gotta change your mind. And if you see enough data points that are out there to contrary to your view, you have to change your mind. And that's the way it kind of works here.

AI assessment note: “because we have a very broad view across the world, we can surface all of these data points”

Q We haven't talked a lot about culture, which is obviously an important part of how you go about analysis. How do you apply that lens of culture tied to competitive advantage in Chinese businesses?

A A lot of the things we look for are really very similar to what we do globally. So our approach to culture is that, number one, there has to be alignment between the culture of the business and what it needs to do in order to grow its competitive advantages over time. And obviously, those things that need to do, those behaviors and values in a business is going to be very different depending on their longer-term aims. But nevertheless, I think that is a universal truth. That framework of thinking about businesses, I think, is a universal truth, and we do that in China as well. Now, the difference in China, of course, is that you're dealing with these first-generation founders for the most part. Companies in China are very young. Which is actually kind of easy to forget when you consider the scale of some of these businesses, but they're very young, and the founder is generally a person in their thirties to fifties. They're still many years away, I suppose, of going to the second generation or finding a professional successor. And also Chinese companies in many cases tend to be much more centralized in terms of power. So you do have to take into consideration a lot more, I think, that founders Their proclivities, their strengths and weaknesses, and so on when you make a bit of a culture call, because that founder does have a greater sway, I suppose, on the culture and effectiven…

AI assessment note: “the difference in China, of course, is that you're dealing with these first-generation founders”

Q When you bring this all together, what do you see as the biggest risks in your investing in China?

A A very common thing with a lot of our companies is that we're invested in the leading champion or whatever it is of a particular industry. Now the thing in China is that it's far more competitive. Than other markets. There's a lot of really hungry intrapreneurs that are rising all the time in order to take the crown away. And customers are even in the B to B space a bit more fickle than you've seen elsewhere in the world as well. So the risk we're always fighting against for almost all of our investments is commoditization. When you have a robotics company or whatever it is, there's like literally hundreds of robotics companies in China chasing that. If you're going to invest in semiconductors, there's hundreds of companies and semiconductors doing that. It's almost like nowhere else in the world when you have that level of competitive intensity. So making that culture call correctly actually is pretty important in China, arguably even more important than elsewhere in the world, especially those traits of adaptability. Can you really roll with the punches? When the environment is fast changing, when a competitive landscape is fast changing, and oftentimes if we make that bet wrong, then you probably have issues.

AI assessment note: “the risk we're always fighting against for almost all of our investments is commoditization.”

Q How do you make those assessments about management teams when it's a different culture, sometimes different language, and you're not there on the ground with them, so it can be harder just to get access?

A Sure. Well, I am Chinese, so that tends to help a bit, but it's hard. It just comes down to, a lot of it is experience of having spoken to Hundreds of management teams all over the world having a baseline of what a good management team is like, and how they behave, and so on. A lot of it, honestly, is track record as well. What we really like to see is management teams that not only survive, but thrive through adversity. Like, they've been through multiple rounds of very adverse conditions Fierce wars when it comes to competition. Major disruptive threats and have emerged stronger than they were before. That is typically a powerful endorsement of the culture and management quality of that business. There's nothing like it.

AI assessment note: “a lot of it is experience... A lot of it, honestly, is track record”

Q And as you walk through those, a big part of what I've heard about WCM is this concept of not having a moat, but a growing moat, an expanding moat. How do you think through when you're looking at a company, what of those factors are the things that are driving that moat to be growing over time?

A This is actually a really complex question. Because it's one of the things that's easy to think from a very high level, but putting into practice is a bit difficult. So I'll give you a very, very high level litmus test, and this is the way I think about it. So if you can imagine a business that is today, and then you close your eyes, and you think about what the business looks like, let's say three years from now, a decent length of time from now. And the question you ask yourself is like, alright, in the future, is it a better or worse business than it is today? That's a very high level question you kind of ask yourself, and it tends to reasonably guide you in the right direction. But in practice, when you get down to the nitty gritty, there's also many other ways to look at the problem. So for example, you can start with most sources themselves if you want. Let's say that you're a network effect company. Are you constantly adding no's to that network? You're getting, becoming more, is your ecosystem growing, denser, better, however you want to put it. That's one way. If you're looking at switching costs, are you getting more embedded into your customers? Is your customers more and more reliant upon you? They're more and more loyal, so to speak. If you're looking at a brand company, how is that brand evolving from a consumer perception standpoint? So you can kind of go down th…

AI assessment note: “you can start with most sources themselves if you want. Let's say that you're a network effect”

Q So just to use that one example, if you pull the thread a little bit on Visa, Where do you come out?

A It's actually a debate that we've been having internally, so I can't actually tell you for sure. My personal opinion, which doesn't necessarily reflect the views of WCM as it were, is that the trajectory is narrowing here. The story is getting tougher to believe in today than it was, say, three, four years ago. A lot of that is honestly coming from my own seat in emerging markets, and seeing the massive, massive growth in some of these new rails in places like Brazil and India, and see how well they work and how quickly consumers adapt to it, and really leapfrog the card rails. Makes me nervous. Now, developed markets, consumers are a bit more sticky in their habits, so it's not gonna be as quick of a change. But the runway is also getting a bit narrower in developed markets. I'm sure the card rails are trying to extend that through some of the initiatives as far as getting into like B to B payments, for example, which are going to be helpful. But nevertheless, I think the trajectory is worse than it was several years ago, and that makes us nervous.

AI assessment note: “My personal opinion... is that the trajectory is narrowing here.”

Q Ah, that's great. I want to ask you one last question before we turn to some closing questions, and let's bring it full circle back to WCM. It's safe to say the firm's been on a great trajectory the last couple years. I'm curious if you take the moat trajectory lens and turn it on your own business, how do you think about WCM's moat trajectory today?

A That's a great question, Ted, and it's obviously something that we've thought a lot about in the last five or 10 years. So I guess first of all, what is the moat of a money management business? And as you know, that this is an industry where most sources are rather tenuous. It's really, really hard to create a money management business that lasts 10 years, 20 years, 30 years, or, or even longer. I think we have some things that are structural that are going for us. We have a pretty solid brand. We have really good distribution channels, distribution partners, and things of that nature. We have a great client base that are aligned with us in terms of how they think, and that is an asset that cannot be overstated in the investment management world. However, we don't have any of these things if we can't continue to deliver Great performance for clients in the long term. And this is obviously really, really hard to keep up for an investment management business. It's not like an industry where anything is patented or anything like that. Knowledge is free. That's out there. And a lot of people have been learning lessons that we've learned years ago. Broadly speaking, you can tell that there are a lot more quality growth investors out there than 10 or 15 years ago. So how do we perpetuate the track record that we've been able to accumulate for not just like one or two years, but rathe…

AI assessment note: “I think we have some things that are structural that are going for us.”

Q I know there's a history of Morningstar trained analysts somehow finding their way to WCM. You fit right into that, but why don't you tell a little bit of your story and how you got to WCM in the first place?

A Yeah, absolutely. It's quite serendipitous, I will say. I joined Morningstar right out of undergrad in I was very fortunate to land there. At that point, the Morningstar Equity Research Department was still very, very new. They were just really trying to figure it out. And it was very good because as a young analyst, I didn't have a senior analyst to report to. I was given a ton of responsibilities right off the bat, essentially, which is insane for like a twenty-one-year-old. I was basically the primary coverage on a number of different companies, and the best thing about Morningstar is that they gave you a very nice framework to think about things, and they looked at the universe in a very consistent way. Of course, number one is the moat, and had a very, I still think to this day, a very, very good way of looking at that, that is actually applicable to virtually all the companies that are out there. Regardless of industry, how they divided up the moat sources and things of that nature, how they characterize companies as white moat, narrow moat, no moat. That mental framework, that way of looking at the world is awesome. So I joined Morningstar as a fresh green analyst, and I was actually on the natural resources team, which is ridiculous because it's the first thing from anything I do now, of course. So I used to cover, believe it or not, coal companies. And like ethanol com…

AI assessment note: “It's quite serendipitous, I will say. I joined Morningstar right out of undergrad”