The Exchanges

Q And how about something that you exited at that time?

A So one of the challenging things in investing is to sell great companies where there's nothing presumably wrong aside from maybe evaluation and things slightly eroding on the edge. Costco was probably one of the most difficult positions to move on from. We'd done quite well, as did everyone who had owned the stock for any point in time. It got to a point where you used to say, hey, Costco, I'll buy it at 20 times earnings, trim it at 30. But then it went to 35, to 40, to 45, into the fifties, and you began to ask, can you underwrite solid double-digit IRR with Costco? So you ask that question in the vacuum, but then we're also benchmarking every position relative to our focus list, and we start to do work on this company called Three Eye Group, which is based in London. It's a private equity company, but it's basically a holding company, and they made this prolific investment in a retailer called Action. Which, it's basically Costco early days. Huge store runway, an incredible culture. They appeal to scarcity, they rotate two-thirds of the items, and it's worked in every geography they've gone in. Even the areas like Germany, where no global retailer has had success, they've been able to crack that market. They'll probably end up in the U.S. eventually as well. So very early in the store runway, trading low 20 times earnings with higher growth than Costco. So you put those two …

AI assessment note: “Costco was probably one of the most difficult positions to move on from.”

Q What's another example of one that cuts through different industries, but works if you look at it as its own typology?

A One that we find ourselves owning more and more is what we call niche industrials. And so these are companies that operate in a niche, have a significant market share, but in an industry with limited scale. So it doesn't invite multiple competitors. There tends to be a complicated route to market, could be an engineer to engineer sale. And oftentimes there is that climbing the value chain element to them. And niche industrial would make you think they should be industrial companies, but in fact, many healthcare companies. We owned a company called West Pharmaceutical, which is a pharmaceutical packaging company, and for us, what it is effectively, it's a niche industrial. It's a low cost of goods, extremely high cost of failure product, 75 cents for a rubber stopper or plunger that goes in a syringe for a drug that costs a thousand dollars plus a dose. What makes our business model unique is the packaging is Part of the product from a regulatory standpoint. So if you want to switch suppliers and switch from West to a competitor, you have to refile for approval. So that's going to take years of testing and trials, and you're not going to take a chance on a fly-by-night operator in China to save a few cents. So that's one where a similar concept, we looked at it, I think, at fifteen-ish percent margins when we bought it, and we said, look, other similar niche industrial companies…

AI assessment note: “One that we find ourselves owning more and more is what we call niche industrials.”

Q And not a traditional business school path, if I remember right. So what happened when you got there?

A I guess one of my claims to fame is I'm a business school dropout. It's one of those life events, Ted, where you just realize pretty quick it's not for you. I had an instinct that I was doing business school because it was perceived as the right thing to do as opposed to it actually being what I wanted to do, and that's never really been the compass with which I operate, so it was tough. I mean, there's a lot of sunk costs, a lot of relationships, one of those decisions if you ask a lot of people, you'll quickly be talked out of it, so I just found my own Went with my gut, and I quit school about 10 to 12 weeks in.

AI assessment note: “I quit school about 10 to 12 weeks in.”

Q What have you found been the most effective practices to learning from mistakes through feedback on the team?

A I think feedback quality is the biggest challenge in investing, and I think concepts like deliberate practice have become popularized, like how do you get better at golf, just get out there, you take a lot of swings, you course correct, you embed the feedback. The problem in investing is that feedback quality is poor, at least for our flavor for investing. You're long-term, you're not making that many decisions, takes a long time to get the feedback, multiple years if you're right or wrong, and then there's just a ton of noise and randomness in that time period. If you have any kind of formula around feedback quality, I think investing would score among the poorest of any professions. You have to be mindful of that challenge and make sure you are generating feedback that has high signal, which means generate lots of feedback, and then carving out time to reflect on that feedback and looking for patterns. So you don't want to just act on an individual mistake, because you can actually compound that mistake. But if you see patterns where it seemed to be getting this type of investment wrong, Let's explore why. And maybe it's an individual mistake. Maybe it's a team mistake. That can double up into a conversation. And one major initiative we actually completed recently to address this feedback quality problem in investing is building out a fully fledged proprietary journaling app …

AI assessment note: “building out a fully fledged proprietary journaling app that's custom made for investing”

Q What have you learned from some of that reflection?

A The main thing I've learned is you do these return on the time audits and they start to look similar. You start to see the gravitational pull that despite knowing these things about information gathering, everyone tends to have the same regrets. I spent too much time following news or I was a little bit inefficient with how I traveled. I caught up in the day-to-day and didn't spend enough time on the R&D work. Another one we learned about is mode trajectory is about detecting change, and if you're zoomed in too much, you're gonna be slow to see change. So I think one of the reasons why specialists are struggling with the notion of mode trajectory is you're in a vacuum. You're in an echo chamber. You're just covering a sector. You're doing travel with fellow analysts. You're talking to management teams. If I'm a newspaper analyst and the internet came along, I'm going to be the last person who recognizes the disruption just because I'm caught in an echo chamber. We found that we were, for instance, doing too much in the way of earnings updates, that once a quarter we publish updates on every earnings announcement, and from a team return on time standpoint, it started to become clear that was very low. People were spending a lot of time publishing those, everyone was consuming those, In reality, generally speaking, not much changes in a given quarter. The worst impact was we were…

AI assessment note: “The main thing I've learned is you do these return on the time audits”

Q So what are some examples of compounding knowledge as opposed to expiring knowledge a little bit easier to understand?

A Picking stocks is effectively just a series of judgment calls. You're taking a lot of information, you're overlaying your own opinion, and you're making a judgment on that specific security at a given point in time. And that's how most shops and most analysts tend to operate. A compounding knowledge approach would be saying, yes, let's do all that bottom-up micro work, but are there fields of knowledge out there that can structurally elevate the odds that you make a series of those judgments, more than one? So you could think about Corporate culture. If you understand a company's culture, you can overlay that culture onto each of those judgment calls over a period of time. So maybe that boosts your batting average by a few percentage points, but that can compound significantly over time. As we think about mode frameworks, how to think about competitive advantage, that's another field of compounding knowledge. If you can build patterns around it, that's more evergreen, that's more scalable, and you can apply it to multiple judgment calls.

AI assessment note: “So you could think about Corporate culture... moat frameworks, how to think about competitive advantage”

Q What'd you do on that process infrastructure to get to the point where you had the breadth of ideas?

A There were a couple of key tools we developed. The one was pulling the thread on what was the core issue on portfolio construction. Mo trajectory and culture is the pillars we talk most often about, but portfolio construction has been a key driver to the consistency of WCM's performance over a long period of time, not just find the best ideas, making sure they fit together. One of the conclusions was the portfolio was too correlated, but the root cause of that was the research pipeline had become too correlated. We developed tools and a common language over prioritization as a lean team. How do you prioritize which idea to work on next? I think if you just let your team tend to be a decentralized organization, they'll naturally chase what's working. In 2000 twenties, let's look at another software as a service stock. And there was endless IPOs. It was very easy to run into that problem. And flash forward to today, it's very easy to chase the next data center. Theme stock. But now I think we have guardrails and tools such that if we see three analysts trying to bring up another data center theme stock to own, we'll pull up our construction and say, we own enough of this. Unless you're really convinced it's better than an existing idea we own in that category, we're going to redirect efforts elsewhere. So I think having those guardrails as a forcing function to making sure you ha…

AI assessment note: “having those guardrails as a forcing function to making sure you have that breadth”

Q What was it like for you guys and as a firm going through that period, the stress, the uncertainty for the first time in a while, and things have been going so well for so long?

A It's a very rich topic as far as how to invest in managers react to disappointing performance. I'll avoid the euphemism of volatility. Culturally, I think we were in a good spot because Mike and I have always led the research team in a pretty even keeled fashion. So in 2020, 2021, there was no high fives in the office. Main thing, we would tamp things down and warn people that market moves in cycles. We're not this good. 2022, you have the currency really like. Go to the team and act inspirationally. Having a team where we've hired several people in recent years, it's very important from a cultural standpoint to set that tone and make sure we're in a position where people see that we're operating from a business standpoint, from a position of strength. There's no reason we can't make the best judgments. A lot of the other business considerations a manager might have during a time like that we did not have. So it was just chopping wood, figuring out What to do, because oftentimes playing the long game is the right strategy, the market's myopic, stick to your knitting, but there are occasions where long-termism is a lazy crutch. There was no, like, epiphany moment, but as we put the pieces together, we realized this was one of those moments where there was so much change at play that we needed to sensibly adapt to what was going on.

AI assessment note: “Culturally, I think we were in a good spot because Mike and I have always led”

Q wealth management firms moving to Ridgeline gain a decided advantage. That's why customers call it miraculous, game-changing, and an awakening. If that's not how you would describe your investment management tech, request a demo at ridgeline.ai. And now, back to the show. As you've grown both in assets and the organization over the last bunch of years, how have you taken some of those ideas to make the team better?

A That's an interesting thought. Well, the third unstated core value of the research team, this think different, get better, is make the team better, and all the leaders say we all intrinsically prefer a team-based approach. We believe it leads to more durable outcomes, and it just happens to be more fun, and I think what I've found is if you have a culture where people optimize for themselves and their own career path, you really just introduce a bunch of Unspoken friction into the process that just bubbles underneath the surface and gets in the wake of judgment. So insecurities, biases, fear, career standing, porn scoring, all this friction and noise. Whereas if people are waking up thinking about how can I make the team better? Am I truly rooting for my colleague's success? All of a sudden that friction melts away and it shifts the mindset from a zero-sum one where your views are competitive to almost a win-win one. What views can be additive, because all you're trying to do is collectively push the ball forward to get the best possible outcome. So that's been something in the last few years we've really started to highlight more is try to wake up every day and take that team mindset, perspective take, what's in the team's best interest as opposed to just focusing on your own silo.

AI assessment note: “the third unstated core value of the research team... is make the team better”

Q So once you showed up, how did you plug in to what was happening?

A I just learned on the fly. So it was similar to Morningstar in that you're given a lot of responsibility, and it's up to you to define your own career path. What I've learned to love about investing, Ted, is I view it to be a platform for self-discovery. It's effectively a mirror. It can reveal your policies, your insecurities, your temperament, what type of teammate you are, what type of communicator you are, just so much about you, if you allow it to be. I was someone who had always been pretty introspective and reflective. I would try things, I would get feedback, I'd iterate, and I'd take these fledgling concepts we had around our philosophy of investing, and I just, with the help of Mike, Paul, and others, just really try to build on those and turn intuitions into a more formal framework.

AI assessment note: “I just learned on the fly. So it was similar to Morningstar”

Q What are some of these other guardrails that you put in place so that you are spending your time on the right things?

A We signal, we message, we have artifacts in the office. If you walk over to our conference room, you'll see two airplane seats, and the reason for that is we found our best ideas are not standing in front of a screen. They are going on travel in the group, flying back home, sitting across from each other with no Wi-Fi, and just chatting, downloading on the trip, chatting about what we can improve on, talking about the team. These are conversations that just would not happen in the office, despite everyone's best intentions. Thinking about things creatively as far as how should we travel to really maximize insights through constraints, through modeling, through reflection week and audits, and then thinking about how do you generate feedback to get better? It's great conceptually to say we have a get better mindset or core value. How do you go about doing it?

AI assessment note: “We signal, we message, we have artifacts in the office.”

Q So what'd you do when you came to that discovery?

A I went on a journey. I really just got very introspective, started to read a lot about How people spend their time in various professions, and what are some of the mistakes people make, and try to draw analogies with what is it about investing where people are not spending their time wisely? What are these unwritten rules or norms that are causing people to succumb to groupthink? And I started to see patterns where there are certain industries where there's some creativity involved, where it's difficult to connect cause and effect, that you just get these rules. People try to minimize career risk, and people try to sound smart. So you can think about groupthink and fixed mindset. It's interesting because in some ways you would think investing should be a clean slate. People should operate very differently. There's no one way to do things, but really I went on a journey of unpacking the why. Why do people behave the same? Why is there so much groupthink? Why is there so much fixed mindset? And then Can we create a team, a culture, organization that can insulate ourselves from some of those forces?

AI assessment note: “I went on a journey. I really just got very introspective, started to read”

Q How have you thought about continuing to foster the talent that you want inside the organization?

A The matching function of external talent with WCM is a tricky one, in part because of our history of being under the radar here in Laguna Beach. I think the big catch is we have quite a high bar. We've been told that by recruiters time and again. Hiring's the field of compounding knowledge. The more you do it, the more you should get better at it. It's a discipline. If you asked me a year ago, what are the hardest qualities to find? In the investment team, I'd point to things like True self-awareness. People who could live in cognitive dissonance while still having an opinion. Serving others. Active curiosity versus passive curiosity. But one thing I've been thinking a lot more about lately is blend or combination of creativity and what I'll call investment empathy. Creativity is shockingly hard to find in the investment community. People who can Truly live a few years in the future and envision how today's fundamentals and narrative can evolve. There's just such a reflexive tendency to drag current or recent results forward in perpetuity, and when you do get creativity, it tends to be this too much of a vague, long-term, here's how the world's going to be in 2065 type thing. Creativity is one, but that needs to be balanced with this concept of Investment empathy, which is, can you see the world through the eyes of an analyst who's covered this company for ages, for decades, wh…

AI assessment note: “The matching function of external talent with WCM is a tricky one”

Q As you started working through learning with this team of people around you, how did you form what became the core of the research effort?

A It's kind of a build-your-own-plane-as-you-fly-it type mentality. I guess we had intuitions around how a team should operate philosophically, a few concepts, mode trajectory and culture, but it was really how do you build processes and a high-performance team around that. One of my other claims to fame is I did have pretty big setbacks early on. Internally we joke about one of my midlife crises was going to a Young Brands Analyst Day back in 2010, so I was three years into the job. And this was in New York. We owned Yum at the time. And at that point, the firm wasn't doing well. This was after market hours. One of the stocks I'd recommended and we owned was down, I think, 35% after hours. I was not in a good mood. And so I went back into the analyst day and Taco Bell, which is one of Yum's properties, was presenting. And Taco Bell gave the presentation, talked about financials and whatnot. But then they started to preview their product pipeline. And so they put a commercial about their next gen product. I guess it was a chalupa at that point in time. And it was just a moment, Ted, where time froze. You know, I looked around the room and I just saw a lot of smart people wearing suits, acting the part, taking notes about this commercial, which you just reflect on that Taco Bell at the time. I'm going to have these numbers wrong. It was 20% of Yum's profit. This product was going …

AI assessment note: “It's kind of a build-your-own-plane-as-you-fly-it type mentality.”

Q What are some of the things today that if you look back five years ago, you would say are cringeworthy from how you were doing things five years ago?

A Oh, there's so much. We have a big believer in leading with vulnerability. We did an offsite several years ago where Mike Trigg and myself, we got up, and we just talked about every mistake we made over the last 10 years, and that was, it was like a fifty-point PowerPoint deck, and showing about these mental models that were just, you just looked at them like, what were we thinking? Individual stock picks. And I think just doing that and having that vulnerability, it just gets people in the right mindset. I'll give you a very live example, Ted. We're doing a reflection week now, which I talked about. One of our newer analysts, Dave Hange, he just wrote a beautiful piece about how he struggled with vulnerability, because he viewed vulnerability as imposing on others, taking rather than giving. And a lot of his identity growing up was being scrappy, self-sufficient, having grit, figuring stuff out on their own, don't impose. But now he's seen other people show vulnerability, and he's viewing that as courageous. It makes him want to help them more. So he wrote a really interesting piece How to reconcile that. When I'm doing it, I feel like I'm a taker. When I see other people doing it, I view them as a giver. I think really leaning into that vulnerability is critical and something we as leaders always try to do and probably overdo it sometimes. But I think if you want to build a h…

AI assessment note: “We have a big believer in leading with vulnerability.”