Scott Morrison, CFA is the Chief Investment Officer of Wealhouse Capital and the portfolio manager of Voyager Fund, a global, long-only small-/mid-cap fund.
Q: Why did you launch Voyager Fund?
SM: I am a big believer in entrepreneurship and intrapreneurship. You see a lot of both coming from smart and hungry management teams from these growing companies, many with large amounts of inside ownership. I really believe one of the best features of Voyager is that investing in these small- and medium-size companies allow us to invest money alongside their management teams and employees. On average, our portfolio will have an above-average amount of companies that are owned and operated by founders and major shareholders, which drive their teams to outperform and move the needle. We always like to see leaders, alongside their employees, that have “skin in the game.”
Q: Is the evolution of passive investing and Exchange Traded Funds (ETFs) a negative or positive for this fund?
SM: Huge positive. As a result of the growing popularity of passive investing, there is a very powerful secular trend towards more and more money being run by fewer and fewer investment firms. This is leading to a lot of great small- and mid-size companies being overlooked by the investment community at large that has nothing to do with the quality of these companies. As a result there are many great companies with very promising futures trading at very attractive valuations, since they are not being covered well by sell-side analysts and/or large enough yet to qualify for ETFs.
Q: How has the macro picture changed for small-caps since you ran small- and mid-cap funds in the 90’s and early 2000’s period?
SM: One of the unintended consequences of central banks having monetized so much debt globally is that this is leading to a crowding-out effect for traditional fixed income investors. As a result, more and more money is also flowing into private equity. Private equity investors are now facing more and more competition for investment opportunities. This means private equity money is paying higher and higher prices, and so are the fees. As a result, this is the first time in my career I have seen so many private asset transaction taking place at premiums to where small- and mid-cap public companies are valued in the public markets. By default, one could argue that private companies should trade at a discount since the private equity players typically add a lot of debt to the business and often find it difficult to exit these investments. So, we would argue that taking companies public as an exit strategy is only going to get harder and harder, as the world moves more and more towards passive investing.
Q: Can you give us evidence that your investment thesis is playing out thus far?
SM: Absolutely. In 2019, we saw 5 of our holdings taken over. For example, a railway holding company we owned called Genesee Wyoming was taken over by Canada’s largest private equity firm Brookfield Asset Management. As we started 2020, we saw the number one small- and mid-cap research firm in Switzerland close down shop. Switzerland is traditionally a country blessed with many successful, best-of-breed leading companies and now they will have lost research coverage. Lastly, we are seeing significant mergers and acquisition activity between large mutual fund complexes such as Standard Life buying Aberdeen in the UK, Franklin Templeton taking over Legg Mason in the U.S. and CI Mutual Funds having taken over Sentry in Canada. As Warren Buffet once said “if a money manager stands before you and says that, as they gather more assets under management, it will not impact performance, stand back their nose is going to grow.” We believe these firms increasingly cannot justify the time and effort to invest in smaller companies and thus we will face less and less research and investment competition down market.
Q: Can you talk about the importance of meeting managements as part of your investment process?
Scott: Meeting managements is a very important part of our process. It allows us to better understand a company by hearing how their team answers our questions on the future prospects of their business plans. We always want to see and hear tangible evidence that their interests are aligned with shareholders before we decide to invest. Over 25 years I have been very lucky to have met so many very smart management teams. We have a database of questions and years of experience benchmarking answers to those questions that help us determine which will be the future outperformers.
Q: What are your investment strengths?
SM: I have always had passion for finding small- and mid-size companies that will become mid- or large-size companies. To accomplish this, I believe you need to work hard and smart at identifying businesses that will change the way we live by adding value to the lives of their customers, which leads to winning market share from their competitors. There are a lot of different ways to make money. One way is to anticipate change before our competition does. The bigger the change the more money there is to be made for your investors. Ideally we want the portfolio to have companies where the change is underappreciated by other investors. That change can come in the form of a new business strategy, a new management team, a new technology, a new acquisition, a new geography to sell in or new market segment to attack etc.
Q: What skills and advantages do you feel you bring to Voyager versus other fund managers?
SM: I have travelled extensively throughout Canada and around the world, meeting many difference companies over the past 25 years. I was very fortunate to work for some of Canada’s largest mutual fund companies earlier in my career and on funds with both domestic and global mandates. I have run generalist large-cap and small and mid-cap funds, as well as sector funds in global technology and global consumer. As a result, I have been to Silicon Valley more times than I can remember dating back to the mid 1990’s, and perhaps to more food, beer, cosmetic, shoe, auto plants, etc. from around the world. As a generalist, I have travelled across China and watched how they developed into an economic power house since entering the World Trade Organization in 2000. And of course, I travelled domestically and met so many of our own great Canadian companies. It goes without saying since I am Canadian, I have been to my fair share of paper and forest plants, oil and gas tours, and even down mine shafts. This cross-section of experience allows me to better understand how one should value risk across different types of business. On top of this, I, and my research colleagues, have hosted thousands of meetings in my offices as a money manager for over two decades now. This face-to-face research process has allowed us to build up what I call our “Approved List”. I believe the fact that I have been a generalist enables me to better recognize when one sector may be getting too much attention, while another is shaping up to be a good contrarian investment opportunity. We are truly bottom-up investors based on our wide-reaching research and we get to see trends that have important macro implications, which we can plan for in our portfolio construction.
Q: Can you give us an example of a recent contrarian idea?
SM: Last year we allocated about 20% of Voyager to companies based in the United Kingdom and Ireland, the two areas most impacted by “uncertainty and fear” around BREXIT. I took four separate trips to see companies in cities such as Birmingham, Dublin, Liverpool, Manchester, London, etc. Our thesis was that most money managers were afraid that BREXIT would go through and disrupt the economic well being of the UK. We felt that valuations were at a level where a lot of bad news was already priced-in and that the UK and Ireland would do just fine longer-term as highly desirable places for companies do and grow business due to a highly-educated and entrepreneurial set of cultures. We made sure we only invested in companies with proven management teams and rock solid balance sheets to fund future growth inside and outside the UK if they so choose. We get very excited when we see the prospects for increased demand and decreasing supply. We believe the companies we bought will benefit for years to come from the BREXIT overhang as competitors and new entrants fear the unknown.
Q: Can you highlight some areas that you are avoiding?
SM: By throwing too much undisciplined capital at a hot space you will eventually see a lot of money lost. For example, we have seen excesses being developed in fairly new areas such as ride sharing platforms, direct to consumer discretionary products (i.e. mattresses), crypto currencies, etc. The good news is that you are actually seeing the public markets being a little more discerning than back in the late 1990’s when looking at some of these unprofitable business models with too many players. I am calling them private market “air pockets”. For example, last year I loved the article from Business Insider in late September that said “How WeWork spiraled from a $47 billion valuation to talk of bankruptcy in six weeks.” In the end, there are technology companies and there are non-tech companies who are good at using technology in their business plan to generate misleading narratives. WeWork was an over-levered, overvalued, poorly run real estate company financed with deep pockets at Softbank.
Q: What happens now that the bull market that started in 2009 has come to an end? Are you invested in the fund personally?
SM: Personally, this is a great opportunity to pivot some of my family’s more balanced investments into this long-only “approved list”. We were conscious that this economic cycle has been very long and we made sure we adhered to our approach to anchor the portfolio in companies that are very well-capitalized. I would also highlight that we seeded the fund in 2018 when the U.S. Fed was raising interest rates and we felt they may push the world into a recession. They ended up back-tracking and hence the markets made new all-time highs in 2018 speaking to the difficulty in trying to forecast recessions and interest rate cycles. This fund is being structured to avoid trying to time the markets and investors should be aware there will be drawdown risks. And yes I am invested in the fund and allocate some of my family’s savings into it every month as part of a dollar cost averaging personal finance strategy, since I do not know whether further drawdowns will happen.
Q: How much of the fund will be invested in early stage and speculative companies?
SM: That is not my style. I am a big believer in working our investment checklists and building a portfolio that is cemented with the vast majority of its companies that generate free cash flow or are soon on a path to do so. This is not a fund for an investor who wants to own a lot of junior resource companies that are trying to poke a hole in the ground to find the next big resource discovery. This will not be the fund investing phase I and II biotech companies hoping to find the cure to some disease. We will own proven business models and invest alongside proven business teams.
Q: How will you diversify the fund for risk management purposes?
SM: We will not go over 25% in any one sector or 10% in any one investment position. As well, we will diversify the portfolio by geography which then leads to different currency exposures. We will also diversify the fund by market caps ranging from sub-$100-million to as high a $15 billion in free float. We will also anchor the portfolio (80+%) in companies that have super strong balance sheets and generate free cash flow, which will allow them to have the flexibility to buy back stock during market dislocations. We may buy some companies with above amounts of leverage, if the company dazzles us on other factors on our check list AND if it has a very, very plausible business plan to bring back debt to below-average levels in a reasonable time frame. As a result, we may own some companies that we believe have long runways of opportunity to compound on past successes – some people call these quality companies and we will also on occasion own some turnaround opportunities that are out-of-favor and overlooked because either the business has a short-term cyclical or the management tripped despite the business is structurally sound for the long-term. My mentor, Gerry Coleman, taught me to look for companies that sell-off for what you believe may be 2-3 quarter issues, because most investors don’t have the patience to wait. Patience was the biggest value he taught me about hunting for value for clients.
Q: What is your view on ETF’s?
SM: I grew up in the mutual fund management industry and completely understand why they have come to gain in popularity. Many of the money managers I worked alongside were “closet indexers” whereby they tried to mirror the index. Trouble with that strategy was: I worked for some firms that charged 2-3% for that product. Therefore, you would always underperform the index. However, ETFs have their disadvantages as well, especially as they gain in popularity because by default, they will always be putting the most money in the biggest companies. Eventually the most money will go to the wrong companies at the worst times, since when you study history, there will come a point where the largest companies can hit the wall from the law of large numbers perspective. In the case of the largest companies today, Voyager represents a diversification tool against future regulatory risk for these very large companies, and, if we do a good job we will own some of tomorrow’s big companies, since Voyager companies can grow their earnings and free cash flow at higher absolute rates.
Q: Can you sum up why investors with a higher risk tolerance should consider Voyager Fund?
SM: We have built up a portfolio of quality companies that we feel have been overlooked. This portfolio is made up of very profitable companies with rock solid balance sheets and very wise and passionate management teams. I have put a lot of my own family’s money in this fund because I believe over the long-term, these companies will growth earnings and free cash flow and make my family better off.
Q: Why do you feel the Voyager Fund makes sense for a portion of clients investments?
SM: If you believe in entrepreneurship then this fund should be considered. I am an entrepreneur, who loves finding other entrepreneurs, who share the same desire to do right by their employees, customers and shareholders. This fund will give you the opportunity to invest alongside a global basket of these type of companies. The Voyager Fund gives you the opportunity to own a piece of tomorrow’s successful mid- and large-cap companies.
Scott Morrison, CFA founded Wealhouse Capital Management in the summer of 2008. He is an asset management veteran of over 25 years, who has previously manage notable funds for industry titans such as Mackenzie Financial, CI, and Investors Group. As a keen supporter of non-profit work, Scott sits on the Finance Committee of the Centre for International Governance Innovation (CIGI).