Institutional investors have been observing the increased appearance of independent asset managers (“fund boutiques”) for years. The value investors among these owner-managed companies often have a very unique view on the selection of investments. Markus Hill spoke on behalf of IPE Institutional Investment with former strategy professor Dr. J. Carlos Jarillo of SIA Funds AG about topics such as competitive analysis, strategy, and the patience factor.
Hill: You have a profound international academic background with teaching practice and have been successfully managing equity funds for many years. Which area did you originally deal with intensively in theory?
Jarillo: I have always had a keen interest in all issues that touched on corporate strategy. This was also one of the reasons why I did my Ph.D. at Harvard Business School. Harvard stood out in this field, and Michael Porter’s lectures on competitive analysis had additionally strengthened my interest at the time. There was one question that kept me very busy at that time: How is it possible that a company A can be more profitable than company B, even though both are in the same industry? It was interesting to be able to work out over time exactly what the “recipe for success” of company A could be. In the course of my later career, I discovered that this information can be very valuable when managing portfolios.
Hill: What conclusions have you drawn from your academic time for practical application?
Jarillo: During my time as a professor of corporate strategy, I have always maintained an active dialogue with companies from a wide range of industries. One insight from the intensive exchange with “practitioners” was that often one thing is said and the other is done. Particularly when you look more closely at topics such as mergers, financial incentive systems for management and profitability, you can come to interesting conclusions. Things that are officially announced to substantiate business decisions with great implications for the future of companies can sometimes deviate from the unofficial views of decision-makers. If you have observed such things frequently, you, as a value manager, also look at the world with different eyes. The topics of competition and profitability are becoming increasingly important, for example, often going far beyond the classic thoughts on “economic moat”. If you leave well-trodden paths, you may come to alternative investment decisions. At the time, these thoughts also motivated me to switch to the real world.
Hill: In your book, which is a review described as a practice-oriented supplement to Michael Porter’s standard work, you emphasize the term “strategic logic”. What exactly does the conclusion from “strategic logic” to the maxim “strategic investing” mean? What is the relationship between entrepreneurship and investment?
Jarillo: My idea was that the strategic investor needs to distinguish between strategically well-positioned companies and strategically badly positioned companies in advance. If a value investor is now in a position to buy such a well-positioned company at a very attractive price, I call this “strategic investing”. It is important to see oneself mentally as the owner of this company and not as a speculator. For me, this mindset is the “ownership approach”, which can be found in a pronounced form with entrepreneurial investors or with many family offices. This approach can also be viewed separately from the investment shell. Direct investments, participations, or even fund variants that differ from classic, liquid investment funds can be assessed similarly. Long-term corporate profitability is the main focus of the investment decision, not the daily published share price: from “casino investor” to classic value investor!
Hill: Portfolio investments in long-term attractive companies are a cornerstone for convincing performance, risk management is another success factor. How important is portfolio diversification for investors in the field of value investing?
Jarillo: In my opinion, there is often a misunderstanding among some investors. One would perhaps have to look at two levels of motivation here. On the one hand, as an investor in a portfolio, I spread my risks, for example, on active funds, passive funds, and liquidity. This is already a risk management level. The normal case is that it is difficult to predict which of the two management approaches will “win” in any given year. On the other hand, investors should be aware that they often encounter very concentrated portfolios in the area of value funds. Risk management here is often carried out within the fund by following one’s own few values very intensively, “in a more concentrated manner” and reacting promptly if action is required. At the overall portfolio level, investors are well-advised to spread their investments across different value funds with different management approaches. As with the “race” of active vs. passive, one does not know who will be ahead at the end of the year.
Hill: Casino mentality and greed versus patience, calmness, and long-term thinking – are value investors the successful investors in the long run?
Jarillo: My opinion is that value investing does not work without a long-term entrepreneurial approach. The short-term volatility in various value funds alone shows that great conviction and patience are required. If the fund manager succeeds in attracting more investors to invest in a “quiver” of excellently positioned companies, a foundation for success is laid. If it is communicated that the current, volatile stock market valuation does not signal the need for action daily, then calm and composure are often the result for the investor. This calmness characterizes many investors who are successful in the long term. Astonishingly, investor behaviour is quite common in the real estate investment segment. I am not saying that fund managers should immunize themselves against new information situations. What I am saying is that the new information is evaluated according to whether the original valuation of the investment still corresponds to the original fundamental valuation and whether there are also new, temporarily undervalued “bargains” on the market. Against this background, I have to say – as a value manager, admittedly biased – that value investors are ahead in the long run!
Hill: Your position is clear. Of course many “investment paths” lead to Rome. The universe of possibilities (active, passive, value, growth, etc.) is vast. Various value investing events will take place in Frankfurt this spring and summer. On the one hand, you will present in Frankfurt, on the other hand, there will be the ACATIS Value Conference in Frankfurt (29.5.2015) and the Value Intelligence Conference in Munich (11.6.2015) again this year. Many value boutiques will also be holding roadshows in Frankfurt and Munich. Competition stimulates business. Many thanks for the interview.
Event announcement: Frankfurt am Main, 5.5.2015: Lecture by Prof. Dr. J. Carlos Jarillo on “Strategic Investing” (Competition Analysis as the Core of Company Analysis), short intro “Value Investing, Fund Boutiques, and Independence” (Markus Hill)