Letter #266: William de Gale and Algy Smith-Maxwell (2023)
BlackRock PM & Founder of Blue Box Asset Management and Founding Director of Jupiter Merlin | Technology Sector
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William de Gale is the Founder of Blue Box Asset Management and the Lead Manger of the Blue Box Global Technology Fund and Islamic Blue Box Global Technology Funds. Prior to Blue Box, William spent 20 years at BlackRock and its predecessors Mercury & Merrill Lynch covering the tech sector, as a PM from 2000 and the PM of BlackRock’s offshore global technology fund from 2008-2017. Before BlackRock, William served in the British Army. He started his career in finance by qualifying as a Chartered Accountant with Coopers & Lybrand.
Algy Smith-Maxwell is a Founding Director of the Jupiter Merlin Fund of Funds and a Director of Research for the Jupiter Independent Funds team, which manages over £7.5bn across a seamless range of risk profiled funds. Prior to joining Jupiter, Algy was a fund manager at Lazard Asset Management. Before Lazard, he was a fund analyst at Henderson.
In this conversation, William and Algy discuss what actually is a technology, the underlying investment case for having a portfolio of stocks invested in just one sector, William’s investment strategy and process and how long it took to develop, portfolio management, when to add or trim stocks, where people go wrong investing in technology, time horizons that make sense, finding businesses that are focused on delivering shareholder value, valuation markers, adjusted numbers, concentration, diversification, portfolio construction, semiconductors, portfolio turnover, active share, advice for budding fund managers, and more.
I hope you enjoy this transcript as much as I did!
[Transcript and any errors are mine.]
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Transcript
Algy Smith-Maxwell: Welcome to Algy's investment podcast. This episode is going to focus on the technology sector, a sector which is changing the world every day. My guest today is William de Gale. He spent 20 years at Blackrock before setting up his own fund, and launching the Blue Box Global Technology Fund. His performance has been extremely good, and his investment strategy is very simple. William, thank you very much for joining us today.
William de Gale: Thank you for having me.
Algy Smith-Maxwell: And I think the first question I've got to ask you is: what is a technology company?
William de Gale: So it's pretty simple, really. It's much simpler than people think. A technology company is a company that sells technology. And that's one of five things. It's basically hardware, software, semiconductors, IT services, or networking equipment. And that last one could be part of hardware; it depends on your definition. And if you sell anything other than those five categories, you're not a technology company. You're basically using technology to do something else, and in generally a new and exciting way. But people get very confused by that. So people think that Uber is a technology company, but Uber buys technology, it sells rides. It's a consumer transport company. Tesla buys technology, it sells cars. So it's a consumer discretionary auto stock. Alphabet, Google, buys technology, it sells advertising. It's a media company. So none of those are actually technology companies. But people get very confused on that point. If you separate that out, all sorts of things suddenly become clearer. So it's really important to us that we are very clear on what a technology company is and what it sells.
Algy Smith-Maxwell: And what is the underlying investment case for having a portfolio of stocks invested in just one sector?
William de Gale: So I think, at the moment -- and this is quite a long moment, so it's probably several decades long -- technology is essentially the key to surviving and winning in every other business. So in our view, there was a change in the way that technology operates, about 15 to 20 years ago -- so from around 2005 onwards -- where human beings began to remove themselves from the loop. So systems used to require, in the 20th century, a human being to interpret the analog world that we live in, a world of sort of continuous variables, because the digital computer didn't understand continuous variables, it's all ones and zeros. So you'd have a human being, normally with a keyboard, typing the data in, and then another human, or the same one, looking at a screen, a digital output or a printout, and then using that to make decisions that would affect the real world. So the human being was the input and output device for the system. But from around 2005, the computer began to come out of its box and interact directly with the real world. And it means that human beings have been taken out of the loop, out of the system. And if you take the human being out of the loop, then processes run millions of times faster. Because we were by far the slowest part of that system. And if process can all run millions of times faster, then hundreds of times more applications become viable -- things that were simply impossible in 2000 are now just sort of very difficult. And the tech sector is all about very difficult -- that's what the sector does. So at the moment, we're working through a virtually endless range of possible applications, which have become possible because of the direct connection systems, the real world. And each time you have a new application that's enabled, it may enable a range of further applications. And again, and again and again. So you have wave after wave after wave of first, second, third, fourth, fifth order effects. And it just takes a very, very long time -- decades -- to work your way through the system. And it's all depending upon using technology -- what's basically enabling us to use technology in new ways -- in every aspect of our lives. So technology at the moment isn't really a sector like all the others. It's not an economic vertical, it's an economic horizontal, because in every other industry, it's how you win or how you lose. So it's gone, for the moment, gone beyond being a sector, and it's essentially stealing the growth from the entire market. And that's been the case now, since around 2006, 2007. There's been no growth in profits outside the tech sector, amongst global companies -- worldwide, large cap companies, no growth, collectively in profits -- since around 2006, 2007. Apart from the tech sector. And all that growth has gone into a single sector. So it's really -- and all the growth in the market for 1/10th of the market cap rather than an industry or sector like all the other ones.
Algy Smith-Maxwell: Can you give me a thumbnail sketch as to what your investment strategy and process is?
William de Gale: Yes. So essentially, what I've just said about technology being the key to everything that's going on in every other sector means that I have identified a common theme that underlies everything that's going on. So every new application of technology depends upon the direct connection systems, the real world. And that direct connection is enabled by a relatively small group of companies. And it doesn't matter what the next disruption is going to be, whatever the new way of disrupting an industry, the new application. It doesn't matter what that is. All of it--it will depend upon directly connecting systems the real world. So if you look for the companies that are enabling that direct connection systems in the world, or supporting it, or directly benefiting it from in some way, they will be major beneficiaries of the next round of disruption, as well as the last one, and the one before. So we can concentrate on a fairly small group of companies, stick with them, and basically get most of the benefits of whatever comes next. Because the companies that are disrupting, the exciting coming to the change in the world, are very seldom the businesses that actually make any money out of it. That the companies that are spending money on technology. The companies that make the money are the ones that are receiving the money, that are supplying the technology for that disruption. Both the disruptors, and the incumbents, have got to spend money on this new disruptive application or they'll go out of business. And that money is being spent with the tech sector. So we just focus on those companies that are providing the key technology that's enabling all the disruption that we see around us. And it's the same companies again and again and again.
Algy Smith-Maxwell: And then how long did it take you to figure this out? Is this something which has evolved over time, or have you known for the last 25 years this is the best way of investing in technology?
William de Gale: I started my investment career in 1997, with the inflation of the tech bubble. And at that point, I was part of a very successful team that invested in the way you're meant to invest in tech, what everybody says, which is basically you buy the most exciting stories, the biggest growth rates, and you ride it up, and you just try and bail out before anything too horrible happens. And of course, we all know what happened as a result of that--middle of 2000, the market fell apart, and it was an absolute catastrophe. And luckily, I survived that, from a career point of view, because I wasn't quite senior enough to get fired at that point. And what I learned from that is that really doing what everybody else is doing, and just hoping you can get out before everybody else decides to is not a great strategy. Therefore, for a while, it wasn't altogether clear what you should do. And I'm a tech analyst, I'm responsible for providing tech investments for a big global equity team. So I had to find some sort of theory. And around 2005, it occurred to me that there was a new category of company arising, which was basically using technology in a new way--an example would be--and the particular one I noticed first was companies using global positioning, GPS, for commercial purposes, and adding other positioning technologies as well. So for example, putting a device in the cab of a digger on a construction site so that the hole went in the ground in exactly the same place, because apparently, a huge portion of the costs of a really big construction project are correcting the errors from early stages, because things weren't quite in the right place. And they have to be moved, and moving it once it's done is very, very expensive. So if you can get the hole in the right place to start with, and all the holes in the right place in the long road, everything coming together in the right order, your construction process becomes much more efficient. And that was essentially being done by the device in the cab, not by the human. The human in the cab could sit there with his arms crossed as a sort of safety driver, while the machine worked out where to put the hole. And I sort of identified this as a category which I called Computers Come Out and Meet the Real World. And that category on my universe sheet, so my list of all the companies that I theoretically cover in the tech sector, that box of Computers Come Out to Meet the Real World just got bigger and bigger and bigger and bigger. There are more and more companies which I felt were actually doing essentially the same thing, or supporting it in some way, or whatever. And there was one other thing which I noticed in about 2007 when what was then probably still just Merrill, but about to become Blackrock, we were starting to use very, very primitive machine learning to assist us in stock selection. They basically fed a vast amount of data into the machine about every characteristic and every stock price movement of every stock they could think of--I mean, huge amounts of data. And then they suggested to the machine various sort of themes, like growth or value or quality or whatever, that it might try and select for. And it would be allowed to tweak the algorithms to find the best approach and come up with names that it thought, on the basis of history, should do well going forward. Now, the first problem the system was, It loved the letter A. So we found that after a while it actually was just selecting companies in alphabetical order. That took a surprisingly long time to notice, I might say. The second thing was, the growth category--it seemed very odd; it wasn't selecting high growth stocks. And we suddenly realized it was actually selecting, consciously, against ultra high revenue growth. And it's absolutely right, because even though that's what everybody tells you you need to go for in tech, high revenue growth companies are dreadful investments, they really are. The chance of them outperforming over a long period is very, very low. And that really set me thinking about what's everyone expecting me to do? What are they doing? And why should it work? And in most cases, what people are expecting to work in tech simply doesn't. The rules of investment in tech are exactly the same as in every other sector, and yet everybody's treating it as the exception. So in every other sector, growth is defined as growth of earnings per share, but in tech, it's defined as growth of revenue. And that's insane, because you can grow the revenue as fast as you like--you just pay your customers to take your product, where it was what Lyft and Uber have been doing for years, what WeWork was doing. You pay the customer to take your product--they'll take as much as you give them. That's not a business, that's a charity. So looking at revenue growth just doesn't really help you--it's profit growth in the end.
Algy Smith-Maxwell: Say a stock price has got a target--you got your target price is $100. And it's a wonderfully boring, clunky tech business that everybody wants to help enable them to be more profitable as a business. When will you trim? And when will you add? Is it a 10, 15% premium, or?
William de Gale: So the first point is we won't ever have a target price. So thinking about an absolute value, an absolute price, for a technology stock, is in my experience, a big mistake. Because the problem is, what the nice thing is, if you'll get it right, is that these are essentially intellectual property business models. And if you've got an intellectual property business model, you can sell whatever it is you sell a gazillion times over and you still got exactly what you started with. So the marginal return for success can effectively be infinite--or something virtually infinite. If you get it wrong, the marginal return for failure is absolutely horrific in the tech sector--you just disappear. So the range of returns is absolutely enormous. The range of growth rates is absolutely enormous. And also, the most important thing is you have no idea how long that success is going for. So the timing factor is almost infinite as well. It could be you become obsolete next year, or in 20 years time. And that will make all the difference when you're being ludicrously overvalued to actually an absolute bargain. So those three factors, the return, the growth rate, and the timing, are so unknowable that I can--I love building models, I used to spend a lot of time building very exciting, very sophisticated models of companies, and it's basically a complete waste of time, because I can tweak those--essentially three assumptions--and give you whatever valuation you like. So if you start building your investment cases on absolute valuations, all that does is give you increased confidence in a decision which you've probably already made. And that's very dangerous, because you're basically making yourself more confident, but not necessarily more accurate. So in my view, you should have a clear idea of where it's going. Is the trend strongly up for a long time, and to what degree of risk. So there's a reward, there's a risk, but we're not putting any numbers on it. The upside is somewhere between big, huge, and unbelievably vast, and the risk is pretty risky, quite risky, not very risky at all. And that's about as precise as we will ever get. And as long as we're still in roughly the same box, we'll stick with that stock. But what we'll do in order to manage the weights here, and to make sure we don't have a stock will run away with us is, we give each stock essentially a rating--a fixed target weight. So it'll be an A, which is 5% weight, down to an E, which is a 1% weight. And that probably doesn't change. That might be the same for 10, 15 years. But at any moment, it might be a C+ or a B--. And those pluses and minuses are essentially our short term adjustments to those long term target weights. So if a stock has done particularly well for a while, we'll just make it a minus--we'll take some of the money out--more than just the amount of outperformance. And don't just take it back to its long term target weight. We'll take it below that target weight. If one of our stocks has lagged for a while, we'll look at it. Is this risk? Is there something going on we don't understand? We'll just get rid of it. That's not all you want. But if it's volatility, so we think actually, this is just natural fluctuation, news flow, cycles, whatever, it'll all work out fine, then you make it a plus. So you don't just take it back to that long term target, you take it a little bit over the target weight. And an example would be Nvidia. So Nvidia, I mean, it's just one of the most important stocks in the world. It's also a very retail-y, extremely exciting, volatile stock, which lots of people love to trade. It's a very, very good business. It's phenomenally profitable. And it's the center of actually everything. So we bought our current Nvidia position in November 2019. So it had a very bad year for the crypto blow up before last, as it were. We bought, let's say, a 3% position. So it's a C rated stock, in the middle of our range. And it had a market cap of $160bn at that point. Then at the end of 2021, it had a market cap of $800bn. So that's in two years and one month, it's increased in value by a factor of five. We still had a 3% position, because you just kept on taking the upside out. Now, it could go up by a factor of five again, but that will make it a $4tn company, and we've never had one of those. Apple's moving in that direction, but it's pretty tough to go to a $4tn company. So the chances are, if anything, it's probably going to go down rather than up, which is indeed what it does. And then we can keep adding a bit more money, and we take it back to 3%, we take it back to 3%. And then this year, it started going back up again, in fact late last year, like a rocket. And it's up 175% this year, and we've probably got about 3.5% in Nvidia. So we don't unbalance the portfolio with success. You just keep on taking profits, because it's very difficult to tell when that sort of company is about to lose--the wind's just going to go out of its sails.
Algy Smith-Maxwell: That is just a great example for budding investors who are wanting to do it themselves. And risk management is half of the secret to what we do.
William de Gale: The only thing is though, I'm talking as an institutional investor running hundreds of millions of dollars. And if you're running a portfolio of tens of thousands of dollars or pounds, it's much harder to do this, because the trades involved will be tiny, and they might not be economic. So the bigger the portfolio, the more concentrated the portfolio, and the more volatile the names are, the more relevant this strategy will be. But if you're just trading five tech names in a 10,000 pound portfolio, you really have to wait for Nvidia to go up an awful lot before it's worth taking 1000 pounds out of it.
Algy Smith-Maxwell: Where else do people go wrong investing in--
William de Gale: Oh, everywhere. Haha.
Algy Smith-Maxwell: In technology. What do you think is a flawed strategy? It's such an exciting sector to be invested in, and we all get buzzed up at dinner parties thinking, Oh, I must own that, and then you go, then you get wigged out and rubbish, it's already done its job.
William de Gale: So that first point--must own that--that's the biggest error in tech. So Fear Of Missing Out, worried about what you don't own, worried that you miss the big winner of whatever it is--that's the biggest destroyer of returns for investors in the tech sector. So you must never worry about what you haven't got. What you need to have is the long term winners, the steady big long term winners, not the winners in any individual year, because the winners in any individual year are generally outnumbered by the losers, who were the winners in the year before and the year before and the year before and the year before, and they're all going down. And no one talks about the stocks that are going down. So you don't get the impression of quite how many of these angels of previous years are underperforming at any moment. And people concentrate on ones that are doing really well. Actually, if you own none of this really exciting companies, you're probably already ahead of all your peers. But in general, the biggest exception to don't own something that everybody likes is, the moment where everybody likes it, in principle, and over the long term, but they're very worried about some short term risk. And that's the best possible moment to buy that company. Because--
Algy Smith-Maxwell: Can you can you give me an example?
William de Gale: Well, the classic one is Arm. So Arm, back in 2008, early 2009, everybody was very worried. So the market--the world's going through recession, companies are missing right, left, and center, and Arm, at the moment, hasn't downgraded, it hasn't missed. And what Arm does is basically sell the design for the absolutely crucial central element, a processor core, for a huge number of the chips, the silicon chips, transistor, semiconductors, that run almost every mobile device in the world--originally mobile phones, but now almost everything that uses a battery, would be based, or have at least some Arm cores in it. It doesn't ever produce anything physical, it just lets you use its design. And it collects--it basically charges you a license fee and it collects royalties. And those royalties are collected one quarter after the product that has the Arm core in it has shipped. So therefore, Arm's results, historically, were always one quarter behind everybody else. So if everybody else had a great quarter, Arm will probably have a great next quarter. And if everyone had a disastrous quarter, like late 2008, everyone assumed that the next quarter for arm would be a catastrophe. Now Arm was an extremely popular company, it was the most exciting tech company in the UK, probably in Europe. It was quite a rare commodity as a result, because we don't have any many huge tech successes in Europe. So lots of people wanted to own it, so therefore it was very expensive, extremely well known. But at this point, towards the end of 2008, and the beginning 2009, all the other tech companies had blown up. And there was just its expectation that when Arm reported in probably middle of February 2009, on the December quarter, it'll be awful. And everyone was saying--I noticed everybody, both within Blackrock where I was working, and out the sell side, the brokers were saying the same thing: great company long term, is going to have a very tricky quarter. This is probably the time to buy it. And that was just a win-win situation. Because if the company beat expectations, or at least reported a reasonable set of results, it was going to go off like a rocket, because expectations were so low. But even better, if it missed, everybody was going to buy it anyway. So it'd be down for about half an hour, and then it would go through the ceiling even faster. It just seemed like a win-win situation. So that was the perfect opportunity to get into Arm, where it was probably a little bit less expensive than normal, but it had a very high chance of getting back to being very expensive very fast, after a certain hurdle had been passed. And indeed, it actually had a perfectly good quarter, and then it turned out to be completely central to the smartphone revolution, which happened over the next few years. And the stock was up, I think, more than 600% over the next few years. And then I made the mistake of selling the entire position, which is what I shouldn't have done--I should just have kept trimming it and held a core position for it. And that was one of my formative experiences, I must admit.
Algy Smith-Maxwell: What time horizon do you think that common sense says they need to be committed to invest for to enable the strategy to actually do what it says on the tin, because you can get the short term timing wrong as an investor, and you have to wait for its turnaround.
William de Gale: Yeah. In this sector, a 15% trend is such a strong trend that over a three year view, you're very unlikely to be on the wrong side of it. So if you think about the mathematics of it, if you've got a 15% long term trend, and that's an enormous if, but that is my base case, because I think we have got one, if you're a 15% long term trend, but you have a big correction, let's say this market, the tech sector, goes down 30%, proper worried about a recession type stuff, to get back to the middle of that trend, so where you started from as it were within the trend, within three years of the start of the correction, requires 115% upside from the bottom. And that's an enormous amount. And people get so worried about being 50% up, and panic in it is clearly over done, they're just not thinking about the mathematics. 15% trends are so strong that just--it's all going to be fine, on a three plus view. But if you need the money for something, then you need be able to get it out, because not having money you need when you need it is extremely expensive as well. So really, what you need to be looking for is investing in something where you have real competence in the long term trend where you expect to be able to leave the money for three years and it should be absolutely fine, but you have the ability, if you really need it, to get that money out. Because otherwise, from a sort of personal finance point of view, you can end up being stuffed. And that's not good news.
Algy Smith-Maxwell: You've obviously had plenty of experiences when the value is being created for everybody else apart from the shareholder. Is it difficult to find businesses that actually are focused on delivering shareholder value? And when it comes to value, can you talk a little bit about valuation, and what sort of valuation markers you're attracted to? Whether it's return on capital employed, or whatever it might be.
William de Gale: So worrying too much about absolute valuation in tech is basically going to make you make the wrong decisions. Because the facts on the ground change so fast with success that you will always be left behind. And the average US tech stock has seen a 900% increase in its profits since 2007. And that's the average tech stock.
Algy Smith-Maxwell: That's staggering.
William de Gale: The good ones--that's a pretty impressive curve, when you see it. The really successful ones are way more than that. But who back in 2007 would have put 900% in their forward model? If they had, their boss would have told him to go away and do it again. And don't be so stupid. But that's the average stock, that's not successful stock. The returns for success in the tech sector are enormous. At the moment, success is very easy to come by, because everything depends upon technology. The problem is, the scarce resource in tech in the last few years has not been investors, as there's hundreds of thousands of us, and trillions of dollars trying to get into these businesses. The scarce resource in technology is software engineers. And software engineers love options. They're quite rational people, particularly on the West Coast, in Northern California. They love options, because they recognize that's the only way they get to be rich without setting up their own business, which is very risky. They don't want to do that. You're never gonna be a billionaire with stock options, but you might be a multimillionaire if you're lucky. And that's good enough. To be perfectly honest, I'd much prefer to be a multimillionaire than a billionaire. So they love options. They're the scarce resource. We investors are telling management, You can use as many options as you'd like, because we're not even gonna count them. And the result is massive, massive stock dilution going on, which reduces--it's an enormous headwind to the returns of the outside shareholders, which is basically us, and our clients. And everyone just completely ignores that. So you've got to look to see who's actually--who owns the value, that this business is great. And first of all, is the company creating any value? And lots of businesses are not creating any value at all. Secondly, who does that value belong to? And I've got to have a reasonable proportion of that coming to my clients, or I'm just not interested. And the easiest way to do that, if you're a professional investor, is basically going to Bloomberg. And Bloomberg has a forward estimate page. So you go to the estimate page. So you look up whatever company--let's say Palantir's estimates, earnings per share for next year. And you can toggle between GAAP earnings per share, so the full accounting one with all the nasty costs in there, basically the value this business creating, and the adjusted number, the pro forma number, the nice softer number with the nasty stuff removed that people don't want to think about. And if the pro forma numbers, the one that most people are using to look at that company--if that forward earnings per share changed a lot between the gap and their pro forma, in general, that business is not being run for outside shareholders--it's being run for someone else. And it might be going to insiders, management, engineers, in stock options. It might be going on acquisitions, because acquisitions in tech are ludicrously overvalued. It might be going on restructuring expenses, which again, people just ignore--it's a one off so we can ignore it. But if it happens every other year, it's not a one off, it's just a cost of doing business. And these are the ways that profits get diverted away from the owners of the company within the tech sector. And none of them are illegal, none of them are wrong--they all have good reasons for doing them. But what is wrong is to ignore them. And that's what most people do. So every time you pro forma something away, you're basically saying, I'm going to ignore that. And amazingly, the stuff that people choose to ignore is probably 98% bad. So there's very few good things that are ignored.
Algy Smith-Maxwell: And so people constantly adjust those numbers up, up--always up. Never down. Interesting.
William de Gale: There are a few things you should adjust for--things like if there's been a change in the tax regime or something. So you've got to make an adjustment to your back tax in previous years, but that all comes out of this year's profit. Get rid of that, because that's not anything to do with this year's profits. But if it's a cost of doing business, then it should be in the numbers, you should leave it there.
Algy Smith-Maxwell: So be aware of adjustments to performer numbers.
William de Gale: Yup.
Algy Smith-Maxwell: How many holdings do you have in your fund?
William de Gale: 30 to 35.
Algy Smith-Maxwell: And if if you didn't have the the regulatory limitations on you, would you have less stocks? Or does that feel comfortable--
William de Gale: No. I think, below 30, I don't--just I would feel uncomfortable, I wouldn't feel fully diversified, I see no need to have a 10% or more position, as no point in having a less than 1% position. And it's quite a flat portfolio, 3% seems about right for most of the stocks, so we end up with roughly 33 stocks.
Algy Smith-Maxwell: And I noticed that the bulk of your portfolio is in large caps. But within that, you've got over 50% in companies with market caps of between $10-100bn. And that seems to be a real sweet spot for you.
William de Gale: That's definitely my view. I think that is the sweet spot of the market. So we don't really go below 10bn--we can go down to 1bn, but to be honest, we don't really. I think the smallest stock we got a moment is more than 10bn. But a $10bn company is a vast business--I think in the UK market it would still be classified as megacap. You've got all the information, all the liquidity you could possibly want as an investor. But if it gets it right, in the tech sector, it could turn into a mega cap--and that's an increase of 30x or more, and that--I class a megacap as being 1% of the S&P 500, so it's a moving target, it's not a fixed number. At the moment, it's around $300bn. So you could go from 10 to 300, with success in the tech sector. It won't happen overnight, but it can happen surprisingly fast. So that 10-100bn range, you've got all [bunches] of large cap investing, but you've got the potential for vast changes in valuation, which are no longer available to megacaps, because they're there already. How much bigger can they get? But it's not a popular market cap range in the market. So people tend to focus on the very biggest companies, the megacaps, or the very smallest, the small-cap, mid-cap market. It's not they don't own stuff in the middle, but they're not really as interested in stuff in the middle, and I just think that's missing the best bit of the market.
Algy Smith-Maxwell: You've got over 43% of the portfolio currently in semiconductors. And it had a hell of a run--
William de Gale: We keep trying to bring it down below 40; it just keeps on going up. It's a nice problem, but--
Algy Smith-Maxwell: What are they? And how do you use that exposure?
William de Gale: Yes. So a semiconductor is a silicon chip. It's a series of transistors etched into a silicon wafer, which is then cut up into little squares and packaged. It's basically the brains or the memory of every IT device in the world. We're all familiar with the concept of silicon chip, I think. And this stuff is very difficult to make. It's very capital-intensive to make in many cases, but it's absolutely vital. So every bit of electronics, every bit of technology that any of us possesses, has at least one semiconductor on it, and it's probably got tens or even thousands of them.
Algy Smith-Maxwell: And do lots of technology investors or technology funds not own semiconductors?
William de Gale: Well, some of them don't at all--in which case I don't think they're real technology funds. So for example, ARK Innovation ETF doesn't really own any semiconductors at all. It's not interested in semis. But then, actually, ARK doesn't really invest in tech companies. Most of all invests in our companies that buy technology and sell something else, the disruptors. Most global tech funds that I'm up against own semis, but I don't think any of them would own quite as much as we do. People are frightened of semiconductors because it is a cyclical industry, particularly the memory market, and some bits of it are still relatively not creating much value. So a lot of the industry used to be very value destructive in the 90s--people still remember it like that. And the memory market is still a bit like that. The rest of the industry is actually a pretty good industry now, but it is cyclical--it's just got a very strong underlying trend. So it's a very strong growth cyclical. Now that to me, is a fantastic market to be in, because not only have you got the growth, the long term trend, but you've got the cyclicality, the volatility--and because you believe in the trend, you can trade against that volatility, you can increase your return. So we've got a concentrated portfolio of generally dow, profitable businesses that--
Algy Smith-Maxwell: Well, I think that fascinating, but maybe most people think they're dow--
William de Gale: Which have focused on generating returns for the shareholder.
Algy Smith-Maxwell: What is your turnover over the--it's gonna vary from one year to the next, but what does it sort of averaged out at?
William de Gale: So it averages out at 30% a year. But as you say, it does vary quite a lot. So 2020, very volatile year--different types company did well at different points in the year. So lots and lots of opportunity for trading against that volatility with our pluses and minuses and stuff. So our turnover rose from the normal 30% to almost 50%. But I did sit down and work out what the returns would have been if we'd had essentially a buy and hold strategy through the year. And that trading added between 4-5% of the value of the fund over that year. So that definitely paid for itself.
Algy Smith-Maxwell: That's actually quite an important thing to mention.
William de Gale: But the next year, it fell to below 20%, because everything just went up in a straight line. And over the three calendar years, the last three calendar years, it averaged out at 31%. So almost exactly in line with what we say.
Algy Smith-Maxwell: Active share--a little bit of a techie word here. We both know what it means. It means how far away is your portfolio positioned from the index. So what percentage of your portfolio is not represented by the index? What's your active share?
William de Gale: I haven't calculated it recently, but I think it's probably around 70%, 65-70. And we can get an idea of where that's coming from by thinking about how a tech index is constructed. So the tech industry is very, very concentrated because it's got these enormous megacaps--the seven biggest technology companies in the world, the ones we would class as megacaps are 1% of the S&P 500 or more, of, for example, the MSCI broad global tech index--it makes up essentially 50--I think it's 49.6% the last time I added it up--so effectively 50% of the index is in those seven names. And our exposure to those seven names--we don't really own--we own probably three of them, and we won't own more than 6% of any of them. And we probably own 2-3% of some of them. So we probably own about 15%. So that's 35% active share immediately. And of course a lot of other stuff we either do own, the index doesn't own, or we don't own and the index does. So I think we'll find the active share is somewhere 65, 70%. Something of that sort.
Algy Smith-Maxwell: What advice have you got for budding fund managers--people who just want to be fund managers. Any any words of wisdom?
William de Gale: Whatever your stage is, you probably want to stop practicing. And maybe not with real money, but at least with theoretical money. It's not quite real, because you haven't got transaction costs and stuff in there, but it gives you a reasonable impression. Whereas if you just think to yourself, Oh yeah, I knew I wanted to buy Nvidia a month or two back, and then it's gone up a lot--you might credit yourself with more skill and more luck than you actually had. What you're trying to achieve is an almost impossible balance between arrogance and humility. So every time you trade, every time you buy something or sell something, you're basically saying, essentially, I know something about the market, this stock, the future, that I think everyone else or most other people have got wrong. And that's a pretty arrogant thing to say, because there are hundreds of thousands of people doing it, and some of them are incredibly well equipped, lots and lots of experience. But if you never did anything, you'd never invest. So you've got to have a bit of humility to think that actually you don't know the right answer. There is no right answer. You're just balancing probability, risk and reward, and trying to work out where the correct line is. But you've got to have your actual arrogance to go out and do it, say Okay, on this occasion, I think I am probably right. So let's go and give it a go, and then be brave and do it. But you just got to try it, especially when the numbers get bigger, you've got to think about risk management, portfolio construction, so--how do you stop one--almost half the decisions you'll make, even the best investor, almost half the decisions they make will be wrong. You've got to make sure that those wrong ones aren't sufficiently important that they destroy the good stuff you're doing with the right ones. So you've got to balance the portfolio, think about the risk profile of the portfolio as a whole. And that's what I was saying earlier about taking the upside away from your winners, because you don't--however good that story is, you don't want to unbalance the portfolio, you don't want a single stock that if something goes wrong, it just completely destroys your returns.
Algy Smith-Maxwell: I've seen it time and time again, when a fund manager's performance track records in built on one or two stocks. William, I've so enjoyed talking to you. I hope for those who are looking to come into our industry they've got some enthusiasm to actually have a go, and keep an eye out for when you do get lucky breaks, because they do happen. And I'm looking forward to many years of you being a great success and delivering fantastic returns for investors.
William de Gale: Thank you, Algy. Much appreciated.
Algy Smith-Maxwell: Thank you.
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Wrap-up
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