The Aussie fund with no banks or miners

-- | 07/08/2018

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Glenn Freeman: I'm Glenn Freeman from Morningstar. And in this edition of "How We Invest Your Money" I'm speaking with BlackRock's Charlie Lanchester, who built their Concentrated Industrial Share Fund from the ground up. Which has some quite surprising characteristics in terms of not holding any of Australia's big four banks, and none of the resource companies.

Charlie, thanks for your time today.

Charlie Lanchester: Thanks for having me.

Freeman: Now we are talking about Australian equities and it's now about three years since you joined BlackRock to create this fund. And right from the start you ruled out the big four banks and the resources which are some of the biggest sectors within the Australian index. What's your decisions making behind that?

Lanchester: Sure. Look it was a great privilege to come to BlackRock, the world's largest fund manager but with a blank sheet of paper. To design an Aussie equity product that I really believe in and certainly one that myself and the team can all invest our money in with confidence. So that was really the starting point. We've ruled out resources and banks as you have mentioned and really there are number of reasons for that. On resources we believe that that's very much a global sector. Best analyzed by people who are specialized in that field. In addition, we think over the long-term resources have been very volatile and that the companies that to run these businesses have not been particularly good investors of capital. That’s something we think about a lot when we buy industrial businesses. We are looking for management teams that reinvest capital wisely and that really doesn’t fit very much in the resource sector. So that's that.

But secondly we did exclude the top five stocks by market capitalization which are currently the four banks and CSL. And really this was around concentration risk, particularly the four banks. The last thing that an Australian retail investor needs, in particular, it's me to go out and buy them another bank share. They are over exposed to the sector and not only through their bank holdings often directly. But also, through their investment properties which is effectively the same trade. And it's a trade that we do see some risk in and we might talk about that a little bit later. So, we leave out those stocks that’s about half the market and really focus on the other half of the market and try and uncover the next CSL. The next ResMed, those sorts of companies that can reinvest capital and grow over time.

Freeman: That’s interesting what you are saying there about the resources stocks and there is lot of short term bullishness out there with commodity prices being strong. But in Morningstar's view the analysts quite hold a similar view to you over the longer term there actually -- you can't just place a bet based on the fact that the iron ore price is high right now.

Lanchester: No, look it's very difficult to pick and I think really, it's commodity – the commodity prices as you point out which drive the share prices and we're just being honest and saying that we don’t really have that crystal ball to predict those commodity prices. Maybe other people can do that, but we would rather just pick solid companies putting money back into their businesses growing more steadily over time.

Freeman: You mentioned about the concentration risk and your investors really don’t need you to go out and buy another bank for them they have already got that covered. How much – how concentrated are Australian investors – and how do you try to address that in your portfolio.

Lanchester: Well, look we build a portfolio from the bottom up we are stock pickers at heart. We run a very concentrated fund 20 to 40 stocks, currently I think around 29 stocks. So, we are having a go and the top 10 stocks makeup close to 50% of the fund. So, we are very index agnostic. I mean our view is that indexes are backward looking, they tell you which companies have done well over the last 20 years. We are trying to find the companies that are going to well over the next 10. And so we're able to find some more interesting companies. Our top 10 holdings when you look at them from the BlackRock website will look very different to any other Aussie equity manager.

Freeman: So how do you actually go about picking the companies that make it into the portfolios. I mean, it's you've got to choose like you say between 20 to 40 companies.

Lanchester: Look at BlackRock we are lucky enough by virtue of our index business that we have to be on the register of every company in Australia. Which gives us incredible access even though we are relatively small and new and nimble fund. We are able to get in and talk to every company in Australia. So that’s a huge advantage in a competitive space. in terms of the process we're absolutely focused on not losing money. That is what equity investing is about you have to first and foremost guard against the pitfalls and you are going to have to avoid the blowups. And so we have an investment process that focuses on five quality filters first and foremost. They are around management, they are around debt, we don’t like businesses with lots of debt. They are businesses that make a profit which sounds simple, but there is a number of businesses that don’t make a profit in the ASX 300. It must have a sustainable competitive advantage that we can easily explain. And we look at some ESG issues to avoid companies that really ignore environmental, social and governance issues. So that is at the heart of our process and that excludes may be about 40 or 50 companies from the index that we just simply won't go near.

This report appeared on www.morningstar.com.au 2021 Morningstar Australasia Pty Limited

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