Becoming an “archer” – striving for excellence over perfection

Intelligent investing is akin to archery, aiming for targeted returns with minimal variability. The requisite skills of an investor share much common ground with those of a consummate archer – mental focus, agility and concentration for extended periods of time, consistency and accuracy shot after shot, technical skills and domain knowledge, mental toughness to be able to handle the pressure of competition, adaptability to shoot in variable conditions, and self-discipline in continually honing one’s prowess. As such, I often like to refer to the investors that embody these attributes par excellence as “archers”.

Warren Buffett of Berkshire Hathaway is perhaps the most acclaimed exponent of the “archer” principle in the current era. The investing landscape has evolved since the original Buffett Partnership days – a time in the history of the discipline when mechanistic processes aimed at guiding stock selection through relatively facile lenses of optical cheapness and “value” served as a viable means of generating alpha. Yet, with the dizzying advancement of technology and accompanying mass availability of information, investment analysis has become a more level playing field. Coupled with the sheer quantity of high-quality talent and brainpower entering the profession in droves every year, we can say that the space is close to fully democratized, for all intents and purposes.

Consequently, the sources of investment “edge” that were traditionally assumed to be the “philosopher’s stone”, notably, informational and analytical advantages, have been diluted to a greater or lesser extent. The latter, although meaningfully competed away since the advent of the internet, and more lately AI, can still be a genuine source of unique insights (albeit necessitating a very high degree of skill), but the former has almost completely vanished.

For better or for worse, it seems that a sizable contingent of investors remains singularly focused on endeavours to harness informational and analytical advantages. Although there is credible mileage in sharpening the analytical toolkit, industry-level data points to a stark picture – most active managers fall short of generating consistent alpha, suggesting that their focus is potentially misplaced or misdirected. In the pursuit of “omniscience”, where perfect knowledge of all things can become an idol of sorts, the investor can frequently “miss the wood for the trees”. Rather, it can be argued that the third leg of the investment edges tripod is more imperative now than ever before – the “attitudinal edge”.

An attitudinal edge comprises of taking a view that differs from consensus, the most powerful exposition of which can be via time arbitrage. For an investor able to employ their analytical skillset to identify high-quality business models that can exhibit duration of returns for periods longer than the market anticipates, and then purchase those businesses at reasonable valuations to hold for the long-term, the scope for superior investment outcomes can be compelling.

This approach necessitates long periods of inactivity in the portfolio at times, since stock price performance does not typically proceed in a linear fashion. “Doing nothing” can be one of the most challenging and counterintuitive actions from a psychological standpoint for investors, but we ultimately believe that the miracle of compounding should not be unnecessarily thwarted due to the temporary vicissitudes of “Mr Market”. This is where we feel that we differ from the crowd as investors.

The Global Sustainable Equity Team deploys significant time and resource into the meticulous analysis of companies through a thorough underwriting process, yielding what we believe is a high quality investable universe of stocks, with financial metrics that are, on average, better than the broader market. The objective is then to allow these wonderful businesses to reinvest in themselves and compound capital over time – in the absence of a clear thesis breach, the aim is to not be hyperactive or over-reactive to short-term mood swings in the market.

Cultivating an attitudinal edge exacts a pursuit for excellence over perfection. All too often, investors become fixated on becoming all-knowing about every aspect of a business, which can be an impediment to the investment process; being detail-oriented is commendable and important, but we would argue that more channelled attention to detail can enhance returns on time invested, since there are invariably a small handful of critical factors that drive any single stock’s performance over the long-term. This is where we endeavour to direct our human capital, which involves taking a big picture view as well as a micro-level understanding of the thesis. This has the potential to yield investment conclusions that are highly differentiated from the consensus of the market.

To highlight this point, we have gravitated towards seeking out opportunities that are as close to being “sure bets” as possible; the adage of “following the money” has been instrumental in this approach. Consider a business such as Core & Main – a specialty distributor of water, wastewater, storm drainage and fire protection products, among others. The typical investor’s System 1 thinking, a la Daniel Kahneman, may cause them to arrive at the initial (and in our view, erroneous) conclusion that all distributors are akin to traditional retailers, largely devoid of wide moats and competitive advantages, and therefore do not present an attractive investment opportunity.

However, if one were to allow System 2 thinking to kick-in, with the investor’s focus directed towards the critical factors, it becomes evident that the key moat in this industry is scale, driving superior product availability and exclusive distribution rights for products. This places Core & Main and Ferguson – the two leading players in the US by a considerable margin, each with high-teens market share – at a significant competitive advantage to the largely fragmented competitor set in the US context.

If we then “follow the money”, with much needed US municipal water infrastructure spending backed by government programmes like the Infrastructure Investment and Jobs Act set to scale up markedly, the largest players in the market will be disproportionate beneficiaries, given the wider array of touchpoints across states for the businesses. This allows them to beget further scale, setting into motion a positive flywheel where the size of the moat for these businesses becomes wider over time.

In the domain of rail, the International Union of Railways estimated that over $2 trillion¹ of investments in infrastructure modernisation are planned or under construction, reflecting the fact that rail is an alternative sustainable form of transportation, and it is gaining popularity as a medium for transporting people and goods within urban settings. “Following the money”, key suppliers into the rail ecosystem, such as Knorr-Bremse and Wabtec, seem well-positioned to ride this wave of upgrades. Elsewhere, if we address the advent of the Fourth Industrial Revolution, with the proliferation of AI as a powerful force for the next generation of technology, “following the money” unearths Nvidia as a large beneficiary, achieving its dominance by becoming a one-stop shop for AI development, from chips to software to other services.

Another example might be undue investor attention placed on a temporary overhang for a company. This can lead short-term oriented market participants to be myopically focused on the minutiae of the near-term issue(s), causing them to underweight, or worse, completely miss the potentially vibrant future of such a business beyond their exceptionally curtailed investment horizons. We believe HDFC Bank in India is an instantiation of this dynamic. Cautious sentiment surrounding a recent merger with its parent company has resulted in the stock underperforming its sector, even though the bank has sector-leading metrics, gaining up to 20% incremental market share in deposits in the last few years. Furthermore, if we “follow the money”, we learn that private sector banks in India continue to win market share at the expense of public sector banks, a trend which is displaying persistence; HDFC Bank, as the largest private sector bank in India, may naturally be a key beneficiary of this ceding of market share by the public sector banks.

Perhaps more topically, employing the “follow the money” approach within the renewable energy space, we posit that a large and long cycle of investments in grid infrastructure is a prerequisite to enabling more meaningful renewables deployment. Consequently, we are positively disposed to the grid upgrade secular theme, in which we believe companies such as Prysmian, a leading supplier of cables and interconnectors for transmission grids, stand to potentially reap the rewards of a sustained wave of capital expenditure (capex) in this domain. Companies such as Schneider Electric and Legrand are also poised to capitalise on this overarching secular theme of electrification.

It is important to note that even though such companies may embody cyclical characteristics, weighing the short-term economic cycle against the longer-term opportunity is paramount. Investors must be willing to look-through near-term volatility if they are to be sanguine about prevailing secular trends. In the same breath, it is necessary to see evidence of financial resilience in these companies so that they are well-equipped to navigate any such volatility. Moreover, by integrating a sustainability and ESG framework into the analysis of companies, we believe that it is possible to effectively shortlist businesses that combine attractive fundamentals and best-in-class management teams that manage operational risks well. This includes ESG risks and in our view, the combination of these factors is more likely to lead to a compounding of value over time.

This type of differentiated thinking that can create an attitudinal edge can work in the investor’s favour when the goal is excellence rather than perfection, the latter of which is a fool’s errand, since companies and markets are in a constant state of flux, subjected to a multitude of exogenous shocks and variables that cannot plausibly be neatly modelled with precision. Our ethos is centred on this axiom and, as such, we are confident that our investment process is conducive to the “archer” principle.

Becoming an “archer” is simple but not easy. Its attainment is predicated on embracing a certain, often uncomfortable mindset and a willingness to deviate from the crowd, which is by definition “unnatural”, and hence it is commonly relegated to the realms of mythology. Fittingly, we can consider the Olympian deity in classical Greek and Roman mythology, Apollo, who was reputedly renowned as a master archer, in concluding the crux of the message being conveyed here:

¹ International Union of Railways, Analysis of Regional Differences in Global Rail Projects by Cost, Length and Project stage

² Greater You, Episode 12: Persuit of Perfection: A Fast Track to Mediocrity?

References made to individual securities do not constitute a recommendation to buy, sell or hold any security, investment strategy or market sector, and should not be assumed to be profitable. Janus Henderson Investors, its affiliated advisor, or its employees, may have a position in the securities mentioned.

JHI

JHI