CIO Insights 4Q2023

We are often asked whether we talk to or meet company management (CM) at our portfolio firms. Our research efforts include the reading of management discussion and analysis (MD&A) sections that form an integral part of regulatory filings. Occasionally we may also consult conference call transcripts. However, we do not actively communicate and exchange views with CM, for five principal reasons.

First, our aim is to stay as objective and hands-off as possible when looking at the merits and drawbacks of the companies we analyze. Personal interaction may introduce unwarranted subjectivity into our analysis, hence potentially hampering a rational analytical assessment. For instance, CM understandably tends to put a positive spin on the firm’s perspectives as well as on the quality of the work they do as professionals. Furthermore, whether we “like” or “dislike” CM should not have a bearing on our fundamental view of a business.

Second, it is crucial to realize that valuing a company is an entirely different endeavor than running it. The role of CM is to steer the business on behalf of all stakeholders on a day-to-day basis. Its budgeting process usually encompasses the next 12- to 36-months. We as long-term shareholders, on the other hand, must make a judgement of a firm’s worth, which is the present value of net cash it generates over its lifetime. Indeed, for the type of going-concern investment cases that are of interest to us, the tenure and relevance of our analytical time frame often outlasts the planning horizon of the CM in charge at present.

Third, we overwhelmingly invest in situations where industry characteristics are mature and straightforward enough for us to comprehend without having to rely on explanations that go beyond the mandatory filings issued by a company. For example, the long-term prospects and the value we derive from basic businesses such as a globally diversified manufacturer of glass bottles, an engineer of large infrastructure projects or a provider of electric utility services rarely depends on the near-term operational issues that CM is dealing with at any point in time. Moreover, in case there is a new material fact that may affect a company’s long-term value, notification regulations for publicly traded securities require that it must swiftly be communicated to the market. To be sure, there are things we’d like to know that go beyond regular disclosures. However, in most cases these are items that are not shared with outsiders either due to competition (e.g., trade secrets) or regulation (e.g., mandatory quiet periods ahead of earnings releases and other major announcements).

Fourth, as a matter of principle we never take an activist stance. In other words, we don’t try to influence CM with the goal of boosting a firm’s stock price. Even though we search for, evaluate and value equities based on a full ownership assumption (private market value), we define our role and purpose solely as outside passive minority shareholders. Our formal interaction with companies is limited to the ordinary proxy voting process, in which we usually accept the recommendations issued by the board of directors.

The fifth and final reason has its roots in the procedural context of our investment discipline, which consists of two pillars: (1) the impartial valuation of each firm based on its estimated normalized long-term earnings power and (2) the “democratic,” well-diversified approach to portfolio construction featuring roughly equal-weight position sizes. Given this methodology, statistical forces render it unlikely that a systemic performance advantage could be extracted through regular interaction with CM.

In sum, it is certainly possible that on a sporadic basis we could gain a worthwhile insight by talking to CM. In the case of our overall decision-making framework, however, it has been our experience that on average and over time it does not constitute a reliably exploitable source of return for the portfolio.

Sincerely,

Gregor Trachsel
Chief Investment Officer SG Value Partners AG