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“TALKING FINANCE”- INTERVIEW REPOST FROM THE CONSTANT INVESTOR

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Interview Transcript from podcast “Talking Finance” by James Brandis 

Carlos Gil is the Chief Executive officer and Chief Investment officer at Microequities Asset Management. He believes that being a very good investor is about discipline and being emotionally removed when the market creates havoc and pushes emotional buttons – something we all struggle with.

James Brandis –  Can you give us a quick introduction to Microequities? You are focused on microcaps, is that right?

Carlos Gil – That’s correct James. Microequities is a specialist asset class investor, and we specialise in what we call microcap companies, and for those listeners that are not acquainted with what a microcap company is, it is a company that has a market value of under $300 million. To give you a rough idea, there are roughly 2300 publically listed companies on the ASX and about 1500 to 1600 of those would have a market value of under $300 million.

JB –  And it says on your website you’re value long term investors, but I would have thought if you are focusing on microcaps you are more interested in growth. Does that differentiate you from other funds that focus on microcaps?

CG –  I guess the general misconception when we speak to investors and we tell them about microcaps, the immediate assertion is that microcaps are these high risk speculative businesses that have unproven business models, and whilst that is certainly true of a significant subset of the asset class – at Microequities, we don’t focus on the speculative unproven business models, we only invest in businesses that have proven profitable business models, typically with a minimum of two consecutive years of operational profitability, and what that does is it tells us immediately that the business model underpinning the economic activity has proven itself from an economic rationale perspective. We are first and foremost a value based investor. But really what drives the intrinsic value of any investment upwards is, as you know, growth and certainly growth is a necessary requisite for any business that we would entertain allocating capital to and turn in to a business partnership, but we will only enter in to that business partnership, we will only deploy capital if we can capture the equity at a large premium to the prevailing market price and that really is a fundamental doctrine that is common to all value based investors, and we are first and foremost a value based investor. But certainly growth is absolutely necessary in order for us to invest in a company.

JB –  You mentioned business relationships, and I saw that mentioned a couple of times on your website. Is that just the way you view your relationship with the companies that you invest in after doing that research, or is there something more formal there?

CG –  No, it’s how we approach investing, and that’s really, really important, because I think that with the advent of modern technology and the way that the financial media deals with equity investing and how a lot of industry participants think about equity investment, the concept has really been deracinated from what it is at an essential level, i.e. when you are buying shares in the ANZ bank or Woolworths or Qantas, what you are really doing is that you are entering in to an economic, legal and commercial business partnership with those companies. The fact that in today’s modern age you can sever that relationship at a click of the mouse or a swipe of your iPhone does not remove itself from the fact that the underlying relationship that you had previously entered in to was a business partnership. How we conceptualise, conceive and actually execute our investments, aligned and centred on the principle that we are entering in to a business partnership with all the investments that we undertake. Once you embrace that at a conceptual level, it necessarily takes you on a very long term investment journey. And we don’t just talk the talk in terms of long term investment, we walk the walk, so most of our investments, typically we enter into those business partnerships and we have very long investment tenures with the majority of our portfolio business partnerships.

JB – Does that give you a closer relationship with the executive management team of those businesses where you might for example give them advice based on the research that you have done about that company and their industry?

CG –  it gives us close relationships with managements because before you enter in to any business relationship, aside from making an evaluation regarding the financial principles of the business, the business model and making an assessment on the likely future growth pathway of that business. A really crucial element if your friends and colleagues asked you to enter in to a business partnership would be to evaluate the people that are going to be running that business partnership from both a competency and an ethical viewpoint, and hence part of our due diligence process necessarily entails meeting and getting to know the executive management teams and making those assessments from a competency and an ethical moral compass alignment. And so it’s part of our process, but by nature, because we are such long term investors, and we meet with the management teams over long periods of time we inevitably build very strong, constructive relationships with them, and how we perceive an investment, we own for example a company called Superloop which bought our previous business partnership called BigAir Limited. At Microequities our telecommunications and data services are provided by BigAir which is now a subsidiary of Superloop. We own WebJet and whenever we travel interstate we use the phenomenal, fantastic services of WebJet. So we try and procure as much business and recommend clients to the businesses that we have partnerships with, and it is really, it sticks to how we go about our thinking and our investment drivetrain around our equity investments.

JB –  It is interesting that you mentioned Superloop. They are one of our top stocks listed on our top stocks page recommended by one of the analysts and stock pickers that we speak to regularly. Have you go some recent notes on Superloop that you can refer to? How are they going?

CG –  Look it is early days. Our investment with Superloop is underpinned by a strategic viewpoint of where we think Superloop will be in 5 years from now. The fact that Superloop is headed by some superb executives in Bevan Slattery who has a phenomenal track record and is quite a visionary in the telecommunications and technology space, and obviously Jason Ashton who we’ve known for 8 years, that’s how long we have been business partners in BigAir. And the fact that we are supporting their overall vision and strategy of what Superloop is likely to become in terms of being this integrated telecommunications provider across the Asia Pacific region, providing best in class fibre connections and a superb network from a redundancy perspective and also underpinning that network with excellent service. So we understand their vision and we are supportive of that. It is early days but I will say that the recent announcement regarding the Vocus deal that they have done, we think is a formidable deal that will really help Superloop enter and provide a very compelling call to market proposition in regional Australia, and we think it gives Superloop and BigAir a chance to really carve out significant market share from Telstra, who as you know obviously is the leading player in regional Australia. So it gives them just a phenomenal call to market capability. So it is a very exciting deal for Superloop.

JB –  yeah, Alan Kohler spoke to Bevan Slattery not long ago, and it did sound like an exciting venture. Back to your investors, one of our constant investor members recommended that we speak to you because Microequities has delivered him a 120% return in the last 3 years, so he is obviously a happy customer. Are all your customers enjoying that sort of return?

CG –  Well we have got 3 funds that we are managing. Our flagship fund, which is the deep value microcap fund has been running for 8 years, and that fund has achieved a compound annual return net of fees of 25.46% which equates to a 514% return over the 8 years. All of our funds have delivered strong returns. Our most recent fund we launched, which is our global value microcap fund has only been running 14 months, and in spite of very significant strong currency headwinds, has delivered about an 8% compound return. But really if you removed the currency headwinds, on a local currency basis, we would be reporting very strong double digit returns to our investors. And now we know that eventually that currency headwind, the appreciation in the Australian dollar will turn in to a tailwind when the Australian dollar eventually starts to fall. What that will do is it will remove the mask of our underlying performance and we will be able to show our investors the really strong local currency gains that we have been able to attain in that fund. But overall we are very pleased with the performance of our funds across the 3 main funds that we manage. Just to give you a little bit of an idea of Microequities we manage right now about $330 million which in itself is quite and inane number, it doesn’t really tell you anything. If I say $500 or $200 million it doesn’t really mean much. What is important about that figure is that by far the biggest cohort of clients that Microequties has is the management staff and team at Microequities and the board of directors. We own $39 million of product, so we are very strongly aligned with our fellow investors, we continually top up and purchase additional products in our own funds, that is where we have a significant amount of our personal wealth tied up. That gives everyone in the investment management team a very acute focus on downside risk, which is as or even more important to Mocroequities than upside reward. Ultimately all investments are understanding the relationship between upside reward and downside risk, and what we try and do when we are investing is to pay as little downside risk as possible. All investments carry risk, but we try and minimise and mitigate those risks and capture as much of the upside potential as we can. And if we get the equilibrium of that relationship right most of the time, we know we are going to make money. One of the key elements, one of our or key pillars by which we mitigate risk is by being a highly disciplined value based, focused investor. When we buy businesses, we’re buying those businesses at significant intrinsic value premiums to their market values.

JB –  I was interested in your approach to investing. My simplistic view of being a fund manager, I would imagine I would create a team that helped me research the best companies to invest in, that I wanted to put my money in, then I would share that with other people who could get on board and join the ride, as we grow wealth together. Is that your sort of approach to investing? Or is that too simplistic?

CG –  Well, our approach is pretty much…. We ask ourselves whether we want to be a partner in this business within a 5 year vantage point, and if we would be very comfortable with the risk reward profile and the people that we are going in to business with. When we are putting forward an investment we are putting our own money at risk and I think that keeps you extremely sharp in terms of being acutely aware of the risk parameters of any investment.

JB – So what’s your investing background? What sort of career path did you follow to get to where you are right now with Microequities?

CG –  I was a lucky teenager and when I was 16 I bought my first industrial microcap company in Australia. At that point in time it was a private hospital chain of I think about 16 hospitals. That was my first foray. I had my life savings (which at the time was $2000) and I put all of that money in to that investment. I made a decision right there and then that I wanted to be a professional investor and I dedicated my adult life to professional investment, I held various roles in the finance industry before I decided to found Microequities back in 2006.

JB –  Do you still hold that first stock?

CG –  No, that company got taken over, I think by Ramsay Healthcare, as do a lot of our microcap companies. One of our most common exit pathways is through merger and acquisition activities. That company got taken out at a very good premium and I did OK out of that investment.

JB –  And what got you started at 16? Did you have a mentor guiding you in to investing?

CG –  Look, I was an average student until I was about 13 or 14 when in our high school, economics was offered. I really excelled, I was top of the class in Economics and it caught my attention and I became really interested in commerce and business and became a much better student in all other disciplines as a result of my interest in economics. I felt I had a natural understanding for understanding market economics and what drives business. That is really what took me on a path of investing, which I found fascinating. I thought that picking up an annual report and reading about the insights and nuances of business was fascinating reading, and I really just was lapping up as much information as I could. I then went to do an economics degree at Sydney University, went in to finance and that has sort of been my journey.

JB –  And what sort of finance roles did you move through to get to where you are now?

CG –  I started in stockbroking, then I went into portfolio management for discretionary managed accounts and my last post was in Europe, I was head of international equities at Banesto bank, which is a large bank owned by the Santander group, which is a US top 50 company. I got homesick, I wanted to return back to Australia and really didn’t want to work anymore for a 3rd party. I had 98% of my personal wealth tied up in Australian industrial microcaps and thought of starting Microequities with the idea of professionalising research and getting far better insight in to the companies that I was investing in whilst I was in Europe. So I did that and the idea was to eventually evolve that business in to a funds management business witch we did in 2008.

JB –  Seems to be going well.

CG –  No, it is never easy, starting a business is never easy, and I think, you know, that a lot of successful entrepreneurs, when they start a business they suffer blind optimism, and you have got to have blind optimism, because if you ask me now, knowing all the challenges that we have had to face, whether I would start that business from scratch again, I would say absolutely not. I would think it would be highly improbable to get to where we are and in all the loops, it is not easy starting a funds management business. It is a highly, highly competitive landscape, and you know, at the beginning when we started, even though I had a very strong personal track record, I didn’t have a demonstrable track record that I could show our potential investors. I really was attracting investors by referring them to my personal investment experience and the investment doctrine and really, as I like to say now, winning those investors in the early years was jungle hand to hand combat.

JB –  Yeah, I love the idea of blind optimism, you can get so far with blind optimism, but if you know a little bit about something it can often hold you back and stop you from moving forward.

CG –  That is exactly right. I mean, with the benefit of hindsight, if someone was telling me now that they wanted to start a funds management business, I think I would try to rationally persuade him from it. We certainly underestimated the challenges that we had to overcome. We went out raising capital essentially near the GFC which was a phenomenal time to be investing capital, but a horrible time to be raising capital and it was incredibly challenging, but look, we have been on a very strong growth tangent since we started and we haven’t had a year in which we haven’t grown by at least 50% in terms of our funds under management.

JB –  Wow, that is great. You mentioned that you enjoyed reading annual reports as a young man, which I imagine that this set you apart from your peers. Have you read any other books along the way that have stuck with you and guided your investing style?

CG –  No, people ask me if we’re Warren Buffet disciples, we’re not. I have always focused on value. Buying something at a large discount to what it is worth always was an intuitively logical premise for any purchasing, whether it is an asset or buying shaving cream at Coles and Woolies. We have always been value investors and it came natural to us. Most of the investment experience I picked up along the way and cast my own doctrine. I really am not a disciple of other investors. I think, you know, there is always going to be a common nexus between all investors that uphold a value doctrine but really are our process and our understanding of what to look for and how to make assessments on the quality of underlying business models, how to assess risk, really has all been self-taught and proven through many years of investing, it is not derived from the workings of other people. The other really important thing is, you can read a book on Warren Buffett or you can read a book on Benjamin Graham or you can read hundreds of other books published. Most investors will capture the intellectual elements and the rationale that underpins that process, and that is good, but that is really not what is going to set you apart to being a great investor from a mediocre investor. What is going to set you apart is your ability to maintain yourself rational and uphold those investment principles at times where you’re hard wired to make emotional based decisions. And hence most investors typically fall when scenarios come up and the markets provide inputs that make them make emotional based decisions and not rational ones. They deviate because of the hardwiring of the human psyche, they deviate from the premise of their doctrine, they leave their values. And that’s really the hardest thing. Being a very good investor is about discipline, and about being emotionally removed when the market creates havoc and pushes emotional buttons that all humans have. And hence what you really need to do is to sever your emotion and make sure that you are maintaining yourself in a very disciplined, principled form, and that provides the framework for making investment decisions. And for us it is easy because, you know, we are not in the buying and selling business, our model is about ownership, and hence most of the time we are not doing anything, we are just monitoring and reading information about potential investments that we might take some day, we are not making a decision on whether we should sell out of our existing businesses, we typically don’t make many sell decisions a year, very few.

JB –  It sounds like you have discovered the Zen of investing

CG –  Well you know, I have observed a lot of investors and our own investors, and we have a constant program in place to educate them, to let them know that it’s inevitable that during the course of a long term investment journey there will be years where they are going to face negative double digit market based returns and that should be absolutely assumed from day one whenever you are making an equity investment. But luckily the market and equity markets will provide you, for that one year of double digit negative returns, it will provide you with 3 to 4 corresponding years of double digit positive returns and hence it really does require a long term investment journey. What unfortunately happens, is in those really tough years where there are double digit negative returns, a lot of investors make emotional decisions and they run for the exit, and unfortunately that really is their folly and they make really poor investment decision on the back of that. They become reactionary.

JB –  And Carlos, what does your downtime look like. Do you ever switch off from finance; do you have any other passions that you pursue?

CG –  I love jogging, because it is very therapeutic, so I do long distance running. I like films, I watch a lot of films and spend time with my family. Simple pleasures, I guess.

JB –  Yeah, a simple way to switch off and relax, that sounds good. Well thanks Carlos. It has been great to learn about Microequities and your approach to investing

CG – Terrific. Thank you James, thanks for having me on the show.

MAM

Microequities asset management has been specialised in Microcaps for over 10 years. We invest in ASX listed companies with a market cap below $250m and global listed companies with a market cap below US$300m. We are long term value investors looking for highly undervalued businesses that should meet a very demanding investment criteria from our Microcap specialist investment team. We manage funds exclusively for wholesale & sophisticated investors as defined by the Corporations Act 2001.



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