17 December 2019

    Boots on the ground

    Our US trip & the importance of fundamental research

    Ashley Gardyne

    Chief Investment Officer

    Ashley Gardyne

    Chief Investment Officer

    The 24-hour news cycle, political controversies and market volatility create dangers for investors. The danger is often not so much the events themselves, but our response to them. Our recent US trip reminded us of these pitfalls and why fundamental research and a long-term perspective are the best protection.

    I travelled to the US earlier this month to catch up with our portfolio companies and hunt for new investments. I happened to be in Washington during Trump’s impeachment hearing and it was hard to escape the constant media coverage of the hearings and the US-China trade negotiations. Developments like these can impact market sentiment, and if investors aren’t careful, they can also impact rational decision making.

    Risk aversion is human and inescapable, but combined with the 24-hour news cycle it can hurt your portfolio

    Psychologists have found that we feel a loss about twice as severely as we experience a gain, which can result in a behaviour known as risk aversion. On a daily basis share markets tend to fall as often as they gain, and because investors feel the pain of loss more acutely than the thrill of a gain, this volatility can cause people to stay out of the market. The anguish of watching a portfolio balance fluctuate is simply too much to bear, even if the long-term prognosis is good. Political and economic headlines contribute to this sense of risk - and our aversion to it. This results in many people never investing and missing the potential for significant gains.

    To illustrate this point, 2018 ended with huge concerns about the trade war, slowing global growth, and a hawkish Federal Reserve. These concerns caused panic in markets and the US S&P 500 Index fell almost 20% in the last quarter of 2018. Some of these concerns still exist, but despite these fears markets have rallied strongly in 2019, with the S&P 500 Index up 26% as I write.

    Fundamental research and a long-term perspective help insulate investors from fear and market volatility 

    Political headlines and market swings rarely impact a company’s day-to-day operations or decisions. The companies we met in the US were not worried about economic headlines or the latest twist in the Trump impeachment saga. Successful investing is dependent on making good long-term decisions. Deciding which headlines are irrelevant and which will have a fundamental impact. This requires in-depth fundamental research: broad reading and analysis; speaking with industry experts; and regular meetings with management.

    On our US trip we met with management of our portfolio companies, their competitors, political lobbyists with views on industries we invest in, and University professors with relevant subject matter expertise. Factory and store visits can also provide perspective. This research helps us build a better view of the outlook for our portfolio companies and what could cause them to stumble in the future.

    Our conversations with management and industry insiders also take us away from a focus on news headlines and day-to-day market movements. It helps us focus on what is important: finding a few great companies and holding them for the long term. Some of the best illustrations of this are in our New Zealand Growth Fund, with our 20-year investments in companies like Mainfreight and Ryman Healthcare.

    A software juggernaut deep in the heart of Texas

    While in Texas I caught up with our portfolio company Tyler Technologies. Tyler is the leading provider of software to the local government sector and a relatively rare business that we believe should have at least a decade of strong growth ahead.

    Tyler has a great track record, having grown revenue by c.15% per annum and earnings per share by over 20% per annum over the last decade. Despite being the industry leader Tyler only has 13% market share and we see steady market share gains over the long term.

    Most of the Tyler management team have been with the company for well over a decade and they approach business decisions with a long-term perspective. Tyler invests considerably more than its competitors in new product development, which has allowed the company to continually extend its product lead over competition. We see the results of this investment not only in the company’s growth rate, but also in an extremely high client retention rate of 97%. These R&D investments come at a time when many private equity backed competitors are cutting R&D budgets to temporarily boost margins in the hope of flipping their businesses for short-term gain. 

    We see Tyler delivering mid-teens earnings growth over an extended period, with the potential for upside from a faster than expected shift of clients to Tyler’s cloud-hosted software service.

    The returns Tyler ultimately deliver for shareholders will be a function of the strength of its software offering, the stewardship of its management team, and the pace at which local authorities upgrade their IT systems. The latest twist in the trade war, impeachment trial or economic data point will prove largely irrelevant.