- Alex Umansky, who manages five mutual-fund portfolios for Baron Funds, saw his $US199 million Fifth Avenue Growth Fund smash benchmarks in 2017 with a 40.6% return.
- That same fund has also destroyed the Russell 1000 Growth and S&P 500 index benchmarks since 2011.
- In a wide-ranging discussion, Umansky shared some of his investing secrets, including the rationale for his biggest stock picks, his unique approach to diversification, and how he views market turbulence.
Look no further than Umansky’s $US199 million Fifth Avenue Growth Fund for evidence of this. With a massive 40.6% return in 2017, it destroyed the red-hot Russell 1000 Growth index and ranked it in the top five of all large-cap mutual funds tracked by Kiplinger.
Similar outsize success can also be seen if you zoom out several years. Since Umansky joined Baron in 2011, the Fifth Avenue Growth Fund is up 163%, compared with 156% for the Russell 1000 Growth index and 141% for the S&P 500.
A big part of what makes Umansky so effective as a stock picker is his long-term time horizon – coupled with the level of conviction he has in his investment choices.
He’s so sure of himself, in fact, that he doesn’t even worry about weak patches. In his mind, they are just an opportunity to buy more, which is why he wouldn’t be opposed to the sort of market meltdown that might make other investors queasy.
And based on his track record, how can you argue otherwise?
In an interview with Business Insider, Umansky shared his secrets for beating the market, and he went into great detail about his process. It was part of a wide-ranging discussion that also included a deep dive into the way Umansky thinks about investing,which you can read about here.
This interview has been edited for clarity and length.
Joe Ciolli: Can you break down the main holdings in your portfolio and why you’ve given them the largest weightings?
Alex Umansky: Facebook and Alibaba were bought on the IPO. Amazon was in the portfolio when I took it over in late 2011. Google was either there as well, or I bought it as soon as I took over. They all became large positions around 2014.
I would argue that all four are plays on digitization. We realised probably 10 years ago that the world is transforming itself. It was very obvious with commerce, when brick-and-mortar started to go online. You can easily see it in advertising. It used to be radio and TV and billboards and newspapers – analogue advertising – and then search appeared and Google became the main provider. You had this shift from analogue to digital advertising, and Google and Facebook were the big beneficiaries.
But we see it everywhere. We see the digitization of banking and finance. There’s digitization of healthcare, which is happening very rapidly. Basically, the expansion of the digital footprint is happening at the individual and business level. The digital footprint of everything is increasing very rapidly. All of these companies are playing a prominent role in the digitization transformation.
Ciolli: So is digitization the core tenet of your whole portfolio strategy?
Umansky: That’s a good question, and I certainly can’t say no. Our process is looking for big ideas. We’re looking for companies that have the ability to be materially larger than they are today, which requires large and growing end-markets and requires what we call “platform businesses.”
These are companies that have built successful, recognisable brands, as well as ecosystems around them that incentivise other companies to come in and cocreate value. More than half of Amazon’s sales come from third parties. Facebook is the obvious platform. These are all platform businesses. Visa and Mastercard are de facto digital railroads. They build the payment platform, and there’s a massive ecosystem around them that help them create value for both consumers and merchants. In healthcare, it’s really the same concept that’s playing out.
Ciolli: You have some interesting views on diversification. Can you outline your approach?
Umansky: Diversification is one of the archenemies of active management. I think diversification has been massively value-dilutive for active managers over the last decade or so. These are companies that have been around for many years, have a huge sell-side analyst following, and they’re relatively transparent. By and large, the majority of them should be priced properly by the market.
When creating a portfolio, before investing in any stock, we ask ourselves what the market is missing – why is it mispriced? Until we have an answer to those questions, we will not make an investment. People tend to extrapolate short-term results, but we’re long-term investors. We really don’t care about short-term performance or results. We care more about insights and perspectives and understanding if we have a differentiated view.
Ciolli: Say we have a market rotation, and the market flips upside down. Is it accurate to say that you’d stick with the core companies that you like from a long-term growth perspective, regardless of what it does to your annual performance, because you’re more concerned about the big picture? You’re not going to reshuffle your portfolio because of a shift in sentiment?
Umansky: That’s 100% correct. That’s absolutely accurate. And we don’t need to look further than what happened in the fourth quarter of 2016. We saw a very powerful shift where growth companies were put on sale, and there was a pretty violent move, which caused us to have a bad year. The election of President Trump caused a significant shift where a lot of value stocks were being bought on the theory that tax reform was going to help them. We had a disastrous fourth quarter, and we did nothing about it. Part of the reason why we did so well in 2017 is because we did so poorly at the end of 2016. Our stocks were on sale in a meaningful way.
Look at Alibaba – when Trump was running, he was talking about the trade imbalance between the US and China, and threatening meaningful sanctions against them. Obviously, Alibaba doesn’t sell anything in the US – it’s really a play on China itself. Regardless, every Chinese company sold off. Where we could, we bought more. We absolutely didn’t react to that change. Once the market stabilised and people understood that it would take more than White House policy to do what he wanted to accomplish, then the market reversed course.
Ciolli: So you’re not worried about how your top holders will perform in a down market, when they’re not leading indexes higher? Are you concerned about what might happen if they start trading on speculation?
Umansky: You’re describing sentiment. Over-diversification is a big enemy, but that doesn’t mean you shouldn’t have any at all. We define risk a little bit differently. Most investors define risk as volatility – market risk. We’re a long-only, large-cap portfolio, and we can’t really protect you from that market risk. However, we do focus extensively on company-specific risk. Company-specific risk is really managed by understanding fundamentals, the business model and valuation. We believe that our ability to collect unique businesses that sell into different geographies and industries is really what gives us the necessary diversification.
In other words, a typical financial portfolio will have a certain number of names per sector. We prefer to own companies that sell into those industries and do it globally. We think if we’re able to collect these unique businesses with large and growing end-markets, that over time we’ll achieve very good diversification of company-specific risk. We don’t think you need more than 30, 35 names to accomplish that. Anything above that and you’re really trying to dampen the effect of volatility. Volatility, in and of itself, is not value destructive. You need it to create opportunity or to upgrade the quality of your portfolio.
Our time horizon is really forever. As long as fundamentals remain intact, and we believe the company still has the opportunity to reinvest excess capital at higher rates of return, we’ll stay the course and continue to invest in the company. Do they get ahead of themselves? Sure. But it’s not something we normally worry about.
Ciolli: Have you ever run into a situation where your clients took issue with your long-term buy-and-hold approach?
Umansky: Yes, in 2014, when Amazon became the largest position in the fund. It was an interesting year, because the market was up double digits, but Amazon was down 21% that year. Even though we preach long-term investing, we took a lot of questions from clients about Amazon, because people were worried their business model was dysfunctional. At the time, Amazon was the largest and most controversial holding we had. Since then, the stock is up roughly 100%, so we’re certainly not anticipating a return anywhere near that for the next three years.
However, our conviction in the company is significantly higher now than it was in 2014. Because it became more transparent, and we have more data points to analyse, our conviction is higher today than it was at significantly lower prices.
Ciolli: Lastly, is there any advice you can offer to someone just getting into investment management?
Umansky: The best advice is to do the work. There are no shortcuts. In terms of investing, I’d recommend buy and hold. Always buy quality. Find the highest-quality businesses and management teams you can, buy, then put it away. Don’t try to time it. Don’t try to be cute. And take it seriously. It’s funny to me how many retail investors want to buy stocks. I always think – if I had a toothache, would I want to do it myself? No, I’d want someone who’s informed and who hopefully went to dental school to do it. Everyone thinks they can invest at a high level and achieve good results, and people just need to be real and rational in understanding.
Know yourself. You have to know who you are, because if you don’t, the market is an expensive place to find out. You have to know your temperament – how will you react to stress or volatility. Most people don’t react rationally, because they haven’t done the work. The problem with an itchy trigger finger is that it’s detrimental to a person’s ability to generate returns.