The fund:

Managers:

The call:

In February we spoke with Matthew Page and Ian Mortimer of the Guinness Atkinson funds. Both of their funds have remarkable track records, we’ve profiled both and I’ve had good conversations with the team on several occasions. Here’s what we heard on the call.

The guys run two strategies for US investors. The older one, Global Innovators, is a growth strategy that Guinness has been pursuing for 15 years. The newer one, Dividend Builder, is a value strategy that the managers propounded on their own in response to a challenge from founder Tim Guinness. These strategies are manifested in “mirror funds” open to European investors. Curiously, American investors seem taken by the growth strategy ($180M in the US, $30M in the Euro version) while European investors are prone to value ($6M in the US, $120M in the Euro). Both managers have an ownership stake in Guinness Atkinson and hope to work there for 30 years, neither is legally permitted to invest in the US version of the strategy, both intend – following some paperwork – to invest their pensions in the Dublin-based version. The paperwork hang up seems to affect, primarily, the newer Dividend Builder (in Europe, “Global Equity Income”) strategy and I failed to ask directly about personal investment in the older strategy.

The growth strategy, Global Innovators IWIRX, starts by looking for firms “doing something smarter than the average company in their industry. Being smarter translates, over time, to higher return on capital, which is the key to all we do.” They then buy those companies when they’re underpriced. The fund holds 30 equally-weighted positions.

Innovators come in two flavors: disruptors – early stage growth companies, perhaps with recent IPOs, that have everyone excited and continuous improvers – firms with a long history of using innovation to maintain consistently high ROC. In general, the guys prefer the latter because the former tend to be wildly overpriced and haven’t proven their ability to translate excitement into growth.

The example they pointed to was the IPO market. Last year they looked at 180 IPOs. Only 60 of those were profitable firms and only 6 or 7 of the stocks were reasonably priced (p/e under 20). Of those six, exactly one had a good ROC profile but its debt/equity ratio was greater than 300%. So none of them ended up in the portfolio. Matthew observes that their portfolio is “not pure disruptors. Though those can make you look extremely clever when they go right, they also make you look extremely stupid when they go wrong. We would prefer to avoid that outcome.”

This also means that they are not looking for a portfolio of “the most innovative companies in the world.” A commitment to innovation provides a prism or lens through which to identify excellent growth companies. That’s illustrated in the separate paths into the portfolio taken by disruptors and continuous improvers. With early stage disruptors, the managers begin by looking for evidence that a firm is truly innovative (for example, by looking at industry coverage in Fast Company or MIT’s Technology Review) and then look at the prospect that innovation will produce consistent, affordable growth. For the established firms, the team starts with their quantitative screen that finds firms with top 25% return on capital scores in every one of the past ten years, then they pursue a “very subjective qualitative assessment of whether they’re innovative, how they might be and how those innovations drive growth.”

In both cases, they have a “watch list” of about 200-250 companies but their discipline tends to keep many of the disruptors out because of concerns about sustainability and price. Currently there might be one early stage firm in the portfolio and lots of Boeing, Intel, and Cisco.

They sell when price appreciates (they sold Shire pharmaceuticals after eight months because of an 80% share-price rise), fundamentals deteriorate (fairly rare – of the firms that pass the 10 year ROC screen, 80% will continue passing the screen for each of the subsequent five years) or the firm seems to have lost its way (shifting, for example, from organic growth to growth-through-acquisition).

The value strategy, Dividend Builder GAINX is a permutation of the growth strategy’s approach to well-established firms. The value strategy looks only at dividend-paying companies that have provided an inflation-adjusted cash flow return on investment of at least 10% in each of the last 10 years. The secondary screens require at least a moderate dividend yield, a history of rising dividends, low levels of debt and a low payout ratio. In general, they found a high dividend strategy to be a loser and a dividend growth one to be a winner.

In general, the guys are “keen to avoid getting sucked into exciting stories or areas of great media interest. We’re physicists, and we quite like numbers rather than stories.” They believe that’s a competitive advantage, in part because listening to the numbers rather than the stories and maintaining a compact, equal-weight portfolio both tends to distance them from the herd. The growth strategy’s active share, for instance, is 94. That’s extraordinarily high for a strategy with a de facto large cap emphasis.

Bottom line: I’m intrigued by the fact that this fund has consistently outperformed both as a passive product and as an active one and with three different sets of managers. The gain is likely a product of what their discipline consciously and uniquely excludes, firms that don’t invest in their futures, as what it includes. The managers’ training as physicists, guys avowedly wary of “compelling narratives” and charismatic CEOs, adds another layer of distinction.

  The conference call

The profiles:

While we need to mechanically and truthfully repeat the “past performance is not indicative of future results” mantra, Global Innovator’s premise and record might give us some pause. Its strategy is grounded in a serious and sustained line of academic research. Its discipline is pursued by few others. Its results have been consistent across 15 years and three sets of managers. For investors willing to tolerate the slightly-elevated volatility of a fully invested, modestly pricey equity portfolio, Global Innovators really does command careful attention.

The Mutual Fund Observer profile of IWIRX, August 2014.

The fund strives for two things: investments in great firms and a moderate, growing income stream (current 2.9%) that might help investors in a yield-starved world. Their selection criteria strike us as distinctive, objective, rigorous and reasonable, giving them structural advantages over both passive products and the great majority of their active-managed peers. While no investment thrives in every market, this one has the hallmarks of an exceptional, long-term holding.

The Mutual Fund Observer profile of GAINX, March 2014.

Web:

Guinness Atkinson Funds

Fund Focus: Resources from other trusted sources

• IWIRX
• GAINX