Why volatility is EdgePoint’s friend

The go-anywhere mandate, which holds about 30 mostly U.S. stocks, has a 5-star Morningstar Rating, and its Morningstar Analyst Rating is Silver. Bousada emphasizes that the investment process is very much a team approach, crediting teammates Geoff MacDonald, Ted Chisholm, Frank Mullen and Andrew Pastor. Bousada and MacDonald were the recipients of the Morningstar Foreign Equity Fund Manager of the Year award in 2014 675181. Subsequently, EdgePoint won the Morningstar Analysts’ Choice Steward of the Year award at the 2015 Morningstar Awards 724612.

Over the past six months, cash in the portfolio has surged from about 2% before the Nov. 8 election of President Donald Trump, to 14% currently. The increase represents taking profits on many investment ideas that performed well, and from new money flowing into the portfolio.

Among the recent winners was JPMorgan Chase & Co., an example of “upside volatility” after a run-up in some U.S. financial companies. Held since late 2009, JPMorgan has been trimmed to a little less than 1% of the fund’s assets.

An example of how the team takes advantage of downside volatility was how it responded to the scandal-driven plunge in the shares of U.S. financial-services company Wells Fargo & Co. in September 2016, after revelations that it opened phony customer accounts. EdgePoint added to the position it has held since 2009, making Wells Fargo the top holding.

“In mid-October,” says Bousada, “the company appointed Tim Sloan as CEO, a long-time employee who we believe will be a good torchbearer for the company going forward. Our thesis that Wells Fargo is a big bank that can outgrow the U.S. economy remains intact.”

Bousada says the investment philosophy and career success that EdgePoint managers have enjoyed is based on two critical factors: how they approach risk and how they approach growth. Bousada defines “real risk” as permanent loss of capital, not stock-market volatility.

The managers look at risk from the perspective of a company’s revenue growth, margin contraction, barriers to entry coming down, risk in management succession, and myriad other factors. An “enormous” amount of fact gathering goes into the research process, which includes extensive time spent with the management of companies.

At EdgePoint, there’s also a personal aspect to risk. The 59 partners in the Toronto-based firm have a collective interest in realizing returns on the $160 million of their own money invested in the portfolios. “When we buy a business,” says Bousada, “that business is literally charged with feeding, sheltering and clothing our family.”

In researching businesses from a bottom-up perspective, “we pay no attention to sectors,” says Bousada. For example, among the fund holdings are Generac Holdings Inc. and Aena SA, which are both classified as industrials, a sector that currently represents about 32% of the portfolio.

These two businesses could not be more different, says Bousada. U.S.-based Generac focuses on power generators in retail, commercial and construction markets. “In the U.S.,” he says, “3% of homes have back-up power. Generac has a 70% market share of those 3% of homes.” Every incremental 1% penetration is a $2-billion opportunity, according to Bousada. “It’s a very underpenetrated market and this company has the dominant position.”

On the commercial side, Generac makes back-up power for companies like department stores and grocery stores. “If their residential business only grows at 3% and the industrial side only grows at 4% a year, and their multiple doesn’t change,” says Bousada, “then we should get very healthy double-digit returns from here.”

Aena, purchased about a year ago, manages the state-owned airports and heliports in Spain. Bousada says that when Spain went through a very significant recession and had to raise money, one of the best assets they had to sell was Aena, so the government divested 49% of the company. “The Spanish economy is in a terrible way” says Bousada, “but things seem to be getting better.” As more domestic people travel to Spain a little more, “we think that the business of their passengers can grow. Looking forward, if they can grow their passenger business at around 3% or 4% a year, they can continue to generate a double-digit return from here, so it’s pleasing.”

Though the fund’s country weighting is a hefty 72% in the U.S., the domicile of a business’s head office is misleading, says Bousada. “A lot of the businesses that we own in the U.S. have global businesses. For example, we own a business called WABCO Holdings Inc., which makes components for large trucks, such as brakes. Two-thirds of their business goes to Europe, yet they’re classified as a U.S. business.”