Mick Dillon & Bertie Thomson

Tell us about your firm Mick Dillon (00:19): Brown Advisory is an independent investment firm, we're a global business, our headquarter is in Baltimore, just north of Washington DC in the US, but we've got big offices all around the globe. Our job as investors is to create value for our clients. We have clients, big institutional clients, we have clients who are high net worth individuals and private clients. We work for a lot of endowments and foundations and charities as well. We have about $170 billion of assets around the world. (00:49): The number one thing I would say about Brown though is that we are an employee owned firm, and every single employee in Brown has some equity in the business. And that's important because it means that the employees are aligned with our clients. If we do a good job for our clients, then everyone does well, and that alignment is incredibly important, because our whole ethos is clients first, it's actually part of our mantra, is thoughtful investing, and internally we say clients first. So it's very important to us as Brown to sit there and think on a long-term view. And by being private and by being employee owned, we think it enables us to think in a differential way. How do you invest your clients’ money? (01:33): The first thing we do at any business is look at how they help their customer. How do they create great customer value so that those customers are happy and they come back? We believe the most important person in any business is always the customer, because at the end of the day, when you create a business, you are there to serve your customer's needs. And if you do a really good job of that, then the shareholders will also have a really good outcome in the long run as well. So that's where we start. All of our analysis is thinking about the customer. We are very much long-term focused. Everything we look at is over five years, and we're trying to understand how these businesses and industries develop and why it is that those happy customers will still be coming back in five years time. That customer outcome though, it's got to result in a great outcome for the investors too. (02:20): And so for as much as we want the happy customers, what we really want to see for an investor is a company that has a high return on capital that's compounding over time and creating value for the investors as well. So we really want this win-win between the customers or the clients and the investors in our investments as well. We run a very concentrated portfolio. As I said, we're very long term, we're very low turnover in this strategy. And I would also describe as very much as fundamental bottom up investors. So we're thinking always about the companies first, the customers and the companies first, and then how we create the portfolio from that. I said that it's a very concentrated portfolio. What we're looking for ideally is our performance over a very long period of time. What are your key differentiators? (03:09): Oddly, one of the key differentiators is actually looking at the customers. MBA school teaches people that the shareholder's first in that shareholder primacy is most important for investors, but the reality of business is that the customer is the most important person in any business. And this might be slightly facetious, but if you haven't got a customer, you haven't got a business. So you've got to look after that customer first and then the whole ecosystem, and ultimately as shareholders, we are last. We have analysts called investigative research analysts who go out that's pure primary research, they go out and interview the customers, do customer surveys, and our ideal goal is to get into the mind of the customer and understand why do they keep coming back? What is the value created that means that they're willing and happy to come back again and again and to tell their friends, and to recruit other customers into the business? (04:00): That alone, it turns out, is a really interesting differentiator. There's a couple of others as well. One is that we actually split our investment process in two. One is what I've just described, which is this finding these great companies, and that's part of our investment selection process. But there's this totally separate capital allocation process, which is all about buying, selling, sizing. When do you buy, how much do you buy? When do you sell? These capital allocation decisions, that's the portfolio manager's job. And they're very, very different decisions to, "Is this a good company?" So we split the process into two, and when we split it, we are getting at two different inefficiencies in the market. The first one is time. I've already said we look at everything on a five-year view. If you can abstract yourself from those one or two years, and you can think on a longer term timeframe, you can have a very differentiated view into your investments and to how you think an industry and a business will develop. (04:50): The second part is all about behavioural economics, and this is where the capital allocation comes in. Behavioural economics has becoming more and more important in this industry. We've seen Nobel Prizes getting awarded for behavioural economics, and the way that manifests for us is we actually work with a behavioural economics coach who analyses all of our decision making, in particular, this buying, selling, sizing, to help us get better over time. And it's just like any sports team works with a coach on how they do their past completions or whatever the sports terms are. And it's the same thing. We're looking for marginal gains every year on how we can get better at capital allocation and investment selection. And that coach's job helps us come up with rules around loss aversion or regret aversion or risk aversion, all these behavioural economics that we find in the literature. And how do you bring that in reality into investing? (05:41): So as a team, we split the process in two, we were looking at two different inefficiencies in terms of time and behavioural economics, and we work with a coach over time to help us get better. I think these differences are very uncommon in the market. We just don't find many people who are doing that customer outcome view, they're splitting the processes, they're working with the coaches, and that primary research. So I think there's quite a few things that I would say are different for us. What do you mean by growth and value? (6:12) When we look at and think about how do you create growth and value in the market, the number one thing that we are looking at is part of our four key tests. We break every business down in this way. The first one is what is the fundamental business qualities? Does it have moats or barriers to entry or competitive advantages versus its peers within that industry? (06:33): We then need to see that narrative or that story around the business reflected in the numbers. And so then we're looking at return on capital or gross margins or market share. The third test for us is all about management quality. The management are so important. If you own a company that has 25% return on invested capital and they can reinvest all of their profits back into the business within five years, you've got twice, that 2X return on your original invested capital, 200%. So what the management do with the money is incredibly important for how we think about five-year views. Because our average return on invested capital is over 20% in this strategy. The last thing that we look at is value and thinking about valuation. And for us, everything is we want five-year double digits or 10% or above rates of return. (07:22): Why? Because that means that over five years you're going to compound more than 50%, and over most five years, that materially outperforms the market. And so for us, we are looking at everything on a long-term compounded view, but it's all about that differentiation of the companies themselves and the results of what they do for the customer leading to the valuation at the end of the day. What are the characteristics of the stocks you buy? (07:49) A lot of the companies that we invest in have really interestingly similar characteristics, despite a wide dispersion in terms of the industries. We can invest anywhere, we can invest in any sector or any country. But some of the common things that we find are when we... As an example, financial market infrastructure. Economies of the world need stock exchanges, they need companies that are going to support the financial market infrastructure globally. (08:15): Be it ratings agencies, be it payments companies, we invest in all of these types of companies globally, and we find financial market infrastructure has a real durability about the customer relationship and the outcome that they provide for that customer, that means that they're going to be there for really, really long periods of time. Many of the stock exchanges globally are hundreds of years old. The one in Amsterdam is 400 years old. So these are very, very durable businesses over long periods of time. We also like as an example, in software, we like companies that are called vertical market software, meaning I solve a problem for architects, or I solve a problem for tax and I can help you complete your tax returns, or for small businesses, I can give you your accounting software. So we really like companies that have niche markets in software, but really create a tonne of value for their customers. (09:06): Again, why? We want those customers to come back. Other businesses that we find really interesting is when there's some unique intellectual property or content, and again, you can use that proprietary data or information to create value for your customer again. So a lot of the businesses that we invest in, actually have something, it comes back to that looking for a unique customer outcome. My favourite question to every company we ever meet is, what do you do for your customer that nobody else can do? Because the second you start going down that route, such as, "I solve a problem for architects," or "I help the financial market infrastructure through the London Stock Exchange group," the second you go down that route, then you know you've got a durable business, and then you can understand, well, what are the cash flows look like on a long-term view. (09:54): Because at the end of the day, as an investor, what matters is how much cash are you going to put in, what's it going to cost, and what's the cash that you are going to get out in five or more years time? Because that's the essence of valuation, that's the essence of value creation, and that's our job as investors is to look for those opportunities, be it in different geographies or business models or companies. But at the end of the day, it's to create those double-digit returns over time, which is what we look for, because that creates excess return for our investors.