How One Fund Harnesses Changing Trends

Gregg Warren: Now, I have heard from our fund analysts that you guys actually have an analyst whose specific job is to look at disruption.

Dennis Lynch: Yes.

Warren: To look at changes in competitive dynamics whether that’s to identify opportunity sets or to identify names to avoid. Can you tell us a little bit about how this process works, and perhaps give us an example of situation where it helped to avoid a disaster and maybe where it helped to identify a great opportunity?

Lynch: We have one person, I actually believe we just added a second person and we call the position it's a little hokey, but disruptive change research. The idea behind it is that the rest of the team tends to focus on industries and sectors where conventionally most investment teams and industry participants have people following or covering certain areas and they become very knowledgeable in those areas. If the world is very stationary or not changing very quickly than that expertise can be very useful to having somebody oriented around consumer or healthcare or technology. But sometimes the world can change very quickly, and in those cases experts or expertise can actually become almost a negative. It's very hard if you are a sector expert or industry expert and you've built that expertise up over a long period of time to suddenly realize that because the world's changed very quickly, that your expertise is no longer useful. And in fact again it maybe a hindrance.

So as an example when we first started with this position about 12 years ago, I believe, the first project was on Internet media. And at the time in many of our portfolios we had some conventional media companies including radio station companies. Companies that historically, on a backward-looking basis, looked like great businesses, local monopolies with high regulatory advantages. Owning a station was something that was a scarce resource. Then there was also this great thought that those companies would benefit from the time spent on listening to those radio stations. There wasn’t enough actual advertising to reflect the amount of time being spent listening to radio. So that seemed like a great thesis and it seemed almost Buffetesque, wide moat. Some really good characteristics. As a result, those companies had very significant debt on their balance sheets as well. Because people thought that this is a stable situation and it could be leveraged and the equity returns would be higher as a result.

So again backward-looking, everything looked pretty great and we had those types of exposures. When we first started with this project on Internet media research, or research project on Internet media--excuse me--it helped us really understand that there is this new alternative regardless of the time spent on radio, and some of the positives there. The alternatives that were being produced in the Internet space made those less relevant. And that plus the debt situation made those positions very tenuous. So we wound up taking some losses actually in selling those positions, but subsequently many of them have gone down pretty dramatically.

So the idea though generally is to have somebody whose focused on topics like disruptive topics like that one, maybe more recently electric cars or artificial intelligence or bitcoin. And it's somebody who doesn’t initially have lot of skin in the game. And these are topics that might affect multiple industries or sectors and someone who can go from topic to topic and give a fresh assessment of a very big and highly changing area, and hopefully that augments or supplements some of the research we are doing with our experts and our expertise. So that we don’t fall into the trap of thinking that it's not too late or that we know the situation so well. And in the radio station example, the radio station analysts are the last people that are going to tell you that it's over. It takes a very specific personality to be able to say, hey wait a minute--my expertise is useless now, or less useful. So that’s why we like having that variable, and I think it helps lead to hopefully us avoiding situations that are more tenuous than they appear.

Warren: Just before we leave here, when we think about sort of where your portfolio is, looking at your holdings, is there any one name within your holdings right now, for investors out there, that is attractive to you on price/fair value basis, and where three to five years from now investors would be happy having invested in it today? If you were to take one name within your portfolio, which one would that be?

Lynch: I think Amazon is still the one idea if I had about one stock, it would be Amazon. It's the thing that's unique about Amazon is that in addition to having these powerful network effects and things that occur with Internet businesses, long tail inventory that they can show without initially owning the inventory. The real scale benefits they get on that from the Internet being their primary interface with customers. In addition to all that great stuff, they also have this off-net or offline physical infrastructure, logistics platform, and the combination of both of those things I think is very powerful for their retail business in particular, which gives us a lot of confidence it's going to be hard to disrupt what they have built.

In addition, on top of all those great qualities they have a capital allocator that although he's been misunderstood at times, has done just such a great job in building the business and willing to experiment, willing to fail. I mean they have done some things like Fire Phone that don't work. But guess what, because of their nature and as long as they keep the costs of experimentation low, which is a real big part of their culture, they can experiment a lot. And it leads to other things like more recently Alexa or the Amazon Echo product which is really taking off and really a step ahead in the artificial intelligence sort of theme that people are starting to talk more and more about. So this is the kind of company that has so many great qualities in the sense of it being strong competitive advantage both from Internet-type characteristics but also real-world type scale. And then you have this great capital allocator in charge of the whole thing. So from my standpoint if I had about one stock it would be Amazon.

Warren: Perfect. Thank you so much for your insight, Dennis, and thanks for joining us today.

Lynch: Thank you.