Monthly commentary - Mackenzie Ivy Team

Portfolio Manager Monthly Insights

Hussein Sunderji, CFA
Vice President, Portfolio Manager

The Search for Quality

The Ivy team’s investment philosophy is predicated on owning high-quality businesses at reasonable valuations. We take a long-term view of a business, learning as much as we can to enable us to build conviction, while still being open minded to evidence that may confirm or dispute our investment thesis. The team aims to build a well-balanced, concentrated portfolio of such businesses, with the goal of generating attractive long-term risk-adjusted returns for our clients. 

Why Quality?

The global macro environment is highly dynamic and can be fraught with surprises and shocks that, by definition, few people see coming. At the same time, the pace of technological change is accelerating, which requires companies to be well attuned to potential shifts and either invest ahead of them or not fall far behind.

Our view is that high-quality businesses are best equipped to not only navigate different types of environments and shocks, but also in many cases come out stronger on the other side. We, and our clients, can sleep better at night knowing that regardless of what events may transpire, these companies will be among the best positioned to continue to thrive over the long-term. While these businesses may not always provide the highest return during shorter periods, we have greater confidence that they will endure and therefore provide an attractive return over the long-term, with fewer bumps in the road.

We are, however, very aware of the fact that we will make mistakes periodically in our assessment of business quality and a company’s ability to navigate the changing environment around it. This is why it is paramount that we remain open minded, intellectually honest, and ready and willing to reverse course when we have made a mistake.

Elements of Quality

The following are a few key elements of the Ivy team’s definition of quality.

Competitive Advantage

We seek out businesses that have a clearly identifiable and sustainable competitive advantage. This helps provide confidence that the business’ earnings power is sustainable well into the future, which in turn helps support our view of intrinsic value.

Union Pacific (UNP) is an example of a business that we believe has a strong competitive advantage, through its best-in-class rail network. This network was built over a long period through consolidation and organic investment and would be very difficult to replicate or supplant. This affords UNP strong pricing power and has resulted in an attractive margin profile. The strength of UNP’s competitive advantage helps give us confidence in its long-term earnings power.

However, just having an advantage is not enough – we need to have confidence that this will persist well into the future. This is where corporate culture comes into play. 

Corporate Culture, Management, and Capital Allocation

A strong corporate culture is a key ingredient in supporting a sustained competitive advantage. Analysis of corporate culture is more of an art than a science, as corporate cultures come in many varieties and are not always easy to define and articulate. We look for signs that a company and its management prioritize the long-term health of a business over near-term profits. This can require courage, especially in the face of investor pressure to maximize profits (and share price performance) in the near-term. We seek to be aligned with management teams that shows signs of this courage.

Sound capital allocation is another important management trait we look for. There can be a temptation for management teams to deploy the cashflows of a high-quality business in areas that might stray from the core or pursue empire building. By no means do we suggest companies not explore new areas for growth; however, these areas should be adjacent to the company’s existing lines of business and have high probability of success and with good returns.

It is also beneficial if a management team can think and operate countercyclically. For example, opportunistically investing in areas that have attractive long-term potential, at a time when others are unable to do so. Or, resisting the urge to invest at a time when their peers are rushing to do so, creating over-build.

Of course, a company needs to be set up and wired to think and operate this way; this is where a strong balance sheet can provide immense benefit. Not only can a strong balance sheet help a company weather an economic storm, but it can also enable businesses to invest countercyclically, thereby strengthening the business in the long-term.

Berkshire Hathaway is an example of a business that we believe has a very good corporate culture, and a management team that operates with a long-term mindset. The company’s insistence on maintaining a fortress balance sheet, sometimes at the expense of short-term gains, has enabled them to act countercyclically and deploy capital at opportune times, when others were unable to do so.

Texas Instruments (TI) also has a track record of prudent and countercyclical capital allocation. The company exited its wireless operations many years ago, a decision that was challenged by many industry observers at the time. Instead, it decided to focus its resources in the areas of analog and embedded processing, where it had a stronger advantage. This decision enabled TI to opportunistically acquire manufacturing assets at bargain prices during semiconductor downturns, strengthening the company’s long-term competitive position.

Monitoring Quality

Union Pacific, Berkshire Hathaway, and Texas Instruments are all examples of high-quality businesses that are owned in various Ivy funds. We believe these businesses possess a strong competitive advantage, with corporate cultures that should help sustain these advantages over the long-term. High-quality businesses often exhibit common attributes, such as high returns on capital, an attractive margin profile, stable growth, and good free cashflow generation. These metrics can be used when screening for quality, or monitoring the persistence of quality, in a business.

The elements of quality highlighted above are not exhaustive. The high-quality opportunity set is ever evolving – new companies enter, while some leave, which further underscores the importance of being open minded, intellectually curious, and willing to reverse course when needed.

Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated.

The contents of this document (including facts, views, opinions, recommendations, descriptions of or references to, products or securities) are not to be used or construed as investment advice, as an offer to sell or the solicitation of an offer to buy, or an endorsement, recommendation or sponsorship of any entity or security cited. Although we endeavour to ensure its accuracy and completeness, we assume no responsibility for any reliance upon it.

This document may contain forward-looking information which reflect our or third party current expectations or forecasts of future events. Forward-looking information is inherently subject to, among other things, risks, uncertainties and assumptions that could cause actual results to differ materially from those expressed herein. These risks, uncertainties and assumptions include, without limitation, general economic, political and market factors, interest and foreign exchange rates, the volatility of equity and capital markets, business competition, technological change, changes in government regulations, changes in tax laws, unexpected judicial or regulatory proceedings and catastrophic events. Please consider these and other factors carefully and not place undue reliance on forward-looking information. The forward-looking information contained herein is current only as of December 12, 2024. There should be no expectation that such information will in all circumstances be updated, supplemented or revised whether as a result of new information, changing circumstances, future events or otherwise.

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