Welcome to Inside Active, podcast about active managers that goes beyond sound bites and headlines, looks deeper into the processes, challenges and philosophies and security selection. I'm David cone I, lead mutual fund and active Research at Bloomberg Intelligence. Today my co host is Gina Martin Adams, chief equity strategist at Bloomberg Intelligence. Gina, thanks for joining me today.
Thank you for having me, David, I'm delighted to be here.
Well, it's been an interesting few days in the market. Last week you published one of your This Week in Charts notes just noting the effect of the tariffs on the market the last week or so. How do you see them affecting earnings going forward?
Yeah, good question. I think that's the million dollar question that equity markets investors are grappling with at this moment and time. One of the things that we've done a lot of work on is just how much the S and P five hundred in particular has exposure via cost
of goods sold to overseas suppliers. How much their factory base, for instance, is also located overseas and this is a primary risk, with the secondary risk being maybe as they attempt to pass on price increases, consumers push back of it, and we see downside impacts to the economy. So it's pretty complicated, is the short answer. Broadly, what we're seeing already is earnings expectations have shifted from at the start of the year. Analysts we're forecasting thirteen percent growth for
large cap stocks are now forecasting nine. The moving parts of macro, what would lead you to believe that we're likely to get closer to zero percent earnings growth over the next twelve months, just considering how much slowdown we've already seen in new orders and consumer confidence, so we're
seeing downside revision momentum emerge. I do think right now it's just a question of will we ultimately end up in a recession as a result of the slowdown that has already started, or will we see just more of slower growth going forward and that's going to impact the earnings out look materially well.
Definitely be interesting to watch, and so I think this is a great time to welcome our guest, Harouki Toyama, to Inside Active. Haruki is head of MidCap and large cap equity at Madison Funds and a portfolio manager for the firm's large cap in MidCap funds tickers m n VAX and mr AX. Harouki, thank you so much for joining us today.
Well, thank you for having me.
Before we start talking about the funds in the market, how about we start by just telling us a little bit about your investment background, how you got your start in the industry.
Sure, so that goes back quite a ways, I guess. But back when I was in college, I was a music and artistic toy major and had some pressure to maybe perhaps study something that had more of a career, a better career outlook, So I added economics. I had taken one class, and I was interested, So I ended up studying economics. Now, the interesting thing is I was much more interested in political economics and macro and so on.
But I ended up after school getting a job at a financial advisory firm that got me really interested in the markets and stock markets specifically, And so that's how I ended up in the business. And I have to say, what really drew me in was I happened to stumble upon the writings of Warren Buffett, and it sort of clipped with me that investing in stocks is really you shouldn't think of it as financial markets or pieces of paper that you trade.
You should think of it.
As a fractional ownership in actual companies. And that really clicked with me psychologically. I just felt like it felt right to me. It was a good fit with how I would like to invest, just thinking long term. And so I ended up going back to business school to really study more of the micro side of economics, right, businesses and finance and accounting and strategy and so on, and then end up in Boston for a long time. And then I've been here in Madison for a couple of decades.
The great well, let's actually talk about Madison. Is there an investment philosophy the equity managers adhere to at the firm.
Yeah, at a high level, what we like to think of a couple things. One is, again we have a deeply held philosophy that we're not investing in pieces of paper that we trade. We don't buy something looking to get out or hope that someone pays a much higher price a month for now, six months, an hour, or even one two three years from now. We think of it as truly taking an ownership stake in a company.
So at a high level.
We think of it as, hey, if you had to buy a company hole and you could only buy five ten companies, and you had to buy it and leave it to the next generation of your family, would this be the kind of company you want to own? So that's our real high level screen when we look at companies, and so everything else we do follows from that. And so we're very risk averse, right, because we don't really feel like we can get in and get out before
everyone else sees bad stuff happening. So we try to buy resilient companies, right, So we're not looking to reposition ourselves just because things are changing in the environment or outside conditions, whether it's macro rates, terrorists for example. Right, we're looking to buy companies anticipating that lots of bad things will happen in the next five, ten, twenty years, and so the resiliency is probably the most important thing we look forward. Of course, we want growth, so that's
at a high level. And because of that, we were not overly diversified or two major strategies, owned sort of thirty companies give or take at any point in time, and we're very long term. We own companies on average seven nine years.
Great.
Now if we, you know, focus specifically on the large cap fund, is there a process you follow to select securities?
Absolutely, and the process is less of a checklist that you follow each time, but it's it's number one. Your first screen is is this a high quality business?
Right?
We care about valuation, of course, and we do that research sort of together at the same time in parallel. But again it all comes down to what is the quality of this business? And we really ask ourselves two main questions. One is how good is the business model itself? Is this structurally a good sound business?
Right? So does it have durable growth?
Because again we're not just thinking about the next one, two, three years, We're thinking about five, ten, fifteen, twenty plus years out right, We're thinking about.
Does it have a mote?
If we had to really internally, if you listen to our conversations, we are bously consider a lot of factors with quality, but probably first among equals is does a company have a true mote?
Right?
So this is the more and buppet sense of if a company's profitability is a castle, everyone else is trying to take away those profits right directly or indirectly, And so how good is your mote to protect those profits. And it's not just competitors, right. Your customers, right, they want more from you for less, right. Your vendors they want to give you less in some ways and charge you more, right. And they're external factors where there's governments
and so on. So we think about all those things, and we want companies to have the widest and deep at most most possible because that's what really allows us to have confidence and what the profits may look like five ten, fifteen years out right. We don't want to own a company for even a day if we don't think we want to own it for years.
Right.
So that's what our number one approach and number one topic is when we look at a company, do we feel comfortable right making some general sort of broad projection that profits will be quite a bit higher in five, ten, fifteen, twenty years than they are today. And once we do that, then we think about valuation. Now, valuation is obviously hugely important. We don't want to pay up too much. We're very disciplined about that, and it plays into maybe which companies
we look at. We don't ignore valuation because we want to look for companies that might be actionable in the near term in terms of making investment. So we kind of look at things that we think maybe close to discount of value.
But that's how we are postings.
Can we take in a little bit more into that quality factor, because I think it's really fascinating, particularly at this point in time, to think about quality and an
environment where trade relationships are changing. We're certainly seeing some pretty big disruptions to the potential margin outlook from a multitude of companies as a result of trade policy shifts, right and the ability of companies to take advantage of globalized supply chains coming under a lot of fire here, Are you changing the way that you look at quality
at all? Are there certain metrics that you rely on that you're thinking of of changing, or how do you see your definition of quality potentially challenged or changed by this big macro shift that is now underway.
Yeah, that's a great point, Jane. And so we have a couple of frameworks from mind. One is the first question is, of course we try to make predictions and understand what the regulatory in this case tariff environment will be, but we also understand that no one really knows, right will this particular tariff.
For gam last six months? Will it last six years? Right?
So we don't want to necessarily assume that it will be there forever because then you're always swinging around what you think about companies. Right, So you're asking, do we make a permanentciation? The answer is yes, to the extent it matters. But going back to my very first point, when we try to buy a company, we're already considering some of these factors in place.
Right.
It's not that we're saying what would happen if terrafs went up fifty percent?
What would happen?
But it's how resilient is that company's model to something like tariffs? And so the main issue, for example is probably two or three factors matter most. How resilient is your supply chain. So that's something we've already looked at.
Right.
If a company is way too dependent on one or two countries or certain tariff regimes in place for cross border flows, we would have already considered that as a risk factor and already put that in valuation.
So this shouldn't change things a whole lot.
Probably the most important thing really is how good is the pricing power of a company, and how good.
Is that position relative to its competitors. Right.
So one example I'll give you. We own a company called pack Car. They're one of the largest Class eight and medium duty truck manufacturers in the US. They already have had a philosophy for a very long time of build locally for local demand. So for the US trucks that they sell, over ninety percent of what they sell
is actually manufactured in the US. And the most important thing is their main competitors have a much much higher percentage of trucks that they manufacture outside of the US, especially in Mexico.
Right.
And so obviously and demand will get hurt, right if the economy slows, Right, So that's sort of an overall macro impact on a company like pack Are, But their competitive position will actually improve dramatically, right, So we try to kind of balance those things. What does it mean for profitability? And obviously from Amerco situation, it's possible that the reduction and demand will overwhelm any competitive advantage that improves.
But when you really think about five, ten, fifteen years, you have to make some assumption that trucks are necessary in this country. I'm not really sure that truck demand to be suppressed at a very low level forever, So you have to mix them with some that our economy
will adjust over time. And when that happens, sort of the unit demand will come back to some sort of normalized level, and that packer will actually be in a more improved competitive position and their profits may actually be higher. We try to run some numbers. It's not exact science obvious here. So those are the kind of things that
we've thought about in advance. Now you do have when you own a portfolio thirty stocks, there are some companies that perhaps are in somewhat of a less advantage position, or maybe the end demand and we think may overwhelm those issues, and maybe they can't quite pass on prices as much. Fourth, So you have to make those adjustments. But generally speaking, our portfolio is already pretty resilient.
Right And when you think about this notion of a moat, and I hear this moat word a lot with the mag seven for example, in large cap stocks. But I'm curious how you think about the differences between investing in mid caps versus large caps with respect to the moat? Are there great examples of moat some high quality companies in mid caps that you're finding these days that you know investors maybe just don't appreciate.
Yeah, that's a good point, and so one of the most that the bigger you get, it's very possible that scale, right becomes an important mode. So that's probably a big difference between when you look at super large caps. So when you talk about the maximum and we're talking about megacaps, right, we're really talking about the biggest ten, twenty thirty companies in the world.
At that level, there's.
A certain amount of scale and network effect that becomes a tremendous mode. So you want to be careful investing in even a MidCap, which we call it in our business, we'd like to call it MidCap. By standards of the world and economy, these are giant companies, right, but they become really small compared to the alphabets and so on,
So you have to consider that an account. So if we see a MidCap and they compete at some level directly with some of these megacaps that have superior scale and global and already have a position, we'd be much more wary. So what we try to do in midcaps are find companies where they don't have that sort of competitive landscape, right, they're not competing against much more scale companies and within the universe or within the industry they
operate in. Our midcaps tend to be the scaled advantage competitors, right, And so that's how we think about it. It's not a direct place, it's not just a larger the better. Therefore Beta and Amazon will beat everybody up, right, So we'll get an example, so were we'd be much warrier about investing in a retail company because they do compete against Amazon, right. It takes much more money and brand and so on to have.
The logistical infrastructure. So absolutely it is harder.
To compete agains an Amazon if you're sort of a mid sized retail competitor. On the other hand, we've owned a company, let's call it called copart for a long time. They're the leading auctioneer of salvage cars. So when you get in the wreck, right, the insurance company hire someone to come toll your car away. Copart runs all the auctions to sell these wrecked cars. That's a very local business because you don't want to have to toll your
car for hundreds of miles. So there's all these regional sites where copart holds weekly auctions to sell these wrecked cars. That's not a giant, scaled market. You're not competing against, right, an Amazon that has a location in France or Seals in UK and therefore is much more scale. Brand doesn't matter as much, right, as long as you can efficiently sell those cars at an auction, you do well. And
it's already a dominant player in its field. The industry happens to be a duopoly and co part is a larger of the two, so it's already scaled. So we've actually seen bigger competitors try to get into the market and spend literally hundreds of millions of dollars to break in, and they can't. So that's kind of what we look for.
Okay. Interesting speaking of mid caps, it was so intriguing to me that in the month of March, large caps and small caps under performed midcaps, and I just wanted to get your perspective on this. Is this just a cork of the data? Was there something really interesting happening in mid caps? What's behind that trade?
Well, that's an interesting point. You know, when we look at monthly performers data of industries, we don't we try to.
Read too much in it.
Things can change, there's lots of factors that can influence it, so we really don't read into that sort of short term data. What is interesting if you really look at the long term data, right, we do like the midcaps space in the sense that they tend to perform as well or maybe somewhat better than large caps right over time, just like historically small caps did for a while. But we do think midcaps are a little bit more of
a sweet spot. They tend to be larger and more scale than have proven themselves over time, right, and they tend to have better access to capital markets and so on. They tend to be resilient, so unlike small caps, they've kind of gone past that phase of worrying about whether they're going to survive or thrive in downturns, and yet
they still have a lot of growth runway. So we think what's interesting if you look at the past thirty years of Russell mccap data, and so the Russell indices, as you know, the Russell MidCap is Z takes the one thousand largest stocks by market cap in the US and the bottom eight hundred are defined as midcaps. So if you compare those bottom eight hundred, to say, the top two hundred, which we can think.
Of as large caps.
Right, if you look over the past thirty years, a total return has been pretty similar. Russell miccaps are actually ahead by about half a point perhaps, But then you can divide that thirty years call into two periods. In the first fifteen years, so the period end in two thousand and nine, let's call it. Russell mccaps outperform those top two hundred by quite a bit, two two and a half points right now in in your since that's reverse, large caps have outperformed by two two and a half points.
And so these things run in cycles, and these cycles sometimes can last a long time, but over time they're going to be similar, and we think very often people neglect that fact and they sort of they may perhaps run to what's been working, such as the megacaps the last call it ten fifteen years. They may run to perceive safety of large caps, but over time they tend to wash out. And so we think the caps are definitely an attracted place to be interesting.
So that leads me to my next question, and is that is, how do you navigate volatile or down markets like what we have today. You know the S and P five hundred now testing an official bear market. Small caps really struggling so far this year. Does that make you think in terms of capitalization concentration in your portfolio a little bit differently? Do you find yourself leaning into
mid caps for opportunity? How do you think about down markets like what we have in the spring of twenty twenty five.
Yeah.
Point, So there's two things. One is, we are purely opportunistic, so we'll look around and if the larger stocks or larger companies are somewhat cheaper, we look at them one by one, right, and so we'll go after that whatever opportunity arises. And again, we don't tend to have a lot of turnover. We own thirty year stocks. Then we may buy a handful of new companies a year, so we only need one or two really great ideas in the giving year to really make it work for us.
The other point is, I'll go back to that point of resiliency. Don't We don't necessarily trade a lot in these times. We hope to find opportunities to find and purchase and make new investments. But hopefully if we did it right right, we own a portfolio companies that we like, right, and regardless of what the market is are in the economy is doing. Hopefully, we have companies that are resilient
and can weather through this. And in fact, by definition, a lot of our companies tend to have better balance sheets and better competitive positioning. So over time, these downturns are good for them. They will come out of it in a stronger relative positions. Right, if they have to compete against the company with a weak balance sheet barring a lot of money, their CFO, their CEO is now
spending a lot of time talking to their bankers. Right, They're spending a lot of time plugging holes and having to sort of be a little bit more defensive and careful. Right, whereas the kind of companies and we invest and can play more offense. And so what you tend to see is that coming out of the downturns, our companies come out in a better relative position. And so do we do make sure and like you said, think about what the opportunity set may be and how we're positioned. But
hopefully we've done it right entering the downturn. And there's not a whole lot to do except to look for opportunities.
You mentioned, you know, CI our CEO and CFOs and kind of brings up my question of do you look at management teams? Is that part of your research and if so, what are you really looking for?
So that's a great point. When I started off earlier and talked about what we're looking for, I think I mentioned perhaps two main pillars, and one was about the structural advantages of a business. The other point was about management. So what we want, at least, at the very least, we want a structurally good business, and we want a management team that's going to be a wonderful caretaker of
the advantages that company has. Right, we want to management team that's always thinking about widening and deepening that mode so they can add value on top of the advantage of the company company has. Now, this is important to us in the sense that it's a very qualitative assessment.
So we think it's the kind of area where us as fundamental investors can really differentiate ourselves because a lot of other things that can be quantified in terms or returns on equity and growth rates and so on, are a little bit easier to grasp, or they're tangible. They can be quantified right, somethings computers can do better, but this is the kind of stuff that's very qualitative, and so we put a heavy emphasis on this. And the one area we think we tend to emphasize more than others,
we want to see aligned management teams. We love to invest in what we call owner operators. So we love to see the top decision makers and the governance of the company. So whether it's a CEO, major board members, major shareholders, right, but especially the CEO, top C suite people, board members, we love it when they actually own a significant stake in the company because we're not obviously not in the room with them as outside investors when they make decisions.
We don't make those decisions.
For them, right, So we want them to be on the same side of the table as us. So we want them to think long term. We don't want them to think about quarterly earnings.
Right.
So I mentioned earlier Copart for example, their chairman and CEO combined own about ten percent of the company, and they're very long term. The chairman founded this company back in the nineteen seventies, and so their time horizon is not three months, it's not one year, it's not even three years, they're thinking five ten plus years out, and so they're willing to sacrifice current earnings if they think those investments will pan out and result in a higher.
Value for the company. Right.
So we love that sort of owner operating alignment, and I'd say at least half of our portfolios tend to be invested in owner operators. And then when you take sort of incentives and other alignments in place, it's a pretty large majority of our companies run by management teams with very aligned incentives.
So it's a very important part of.
What we do. Can you tell us a little bit about if you know, you talk about being opportunistic in times like this, are there any sectors or themes that are really catching your eye right now?
Yeah, it's a great point, right So, right, so there's a whole lot of things. Again we look at companies one by one, but there's certainly industries and areas where you see a lot more stress, certainly in the financial market.
So there's a bunch.
But just to give you a couple examples, anything that might be consumer big ticket oriented obviously right now, right you have a huge amount of pressures, which is the prices for a lot of the stuff that consumers brought by, especially discretionary, may be going up. At the same time, you may have just general economic stress, right, so consumers may end up with lower spending power stress balance sheets or recession may or may not becoming certainly some slower
growth economic and the nutriment is likely. So you see a lot of those stocks come down. We're spending some time there. There's some interesting factors. Obviously this is recently. More recently, interest rates are coming down a little bit because the fears of recession. So it's possible some of those areas such as housing that may be related to big ticket consumer may see a little bit of a release valve. But certainly those stocks are coming down, so
we're taking a look. You certainly have a lot of companies I mentioned retail or distribution right where it's a very simple sort of passed through business. You buy stuff at wholesale, you sell at retail, and now all of a sudden, the cost of goods and your wholesale is going on quite a bit, and so a lot of those companies are getting hit. And so that's where we're really sitting and looking at, well, how much pricing power
do these companies have to pass through any increases. So those are the kind of areas we'd be looking at, right, And so you.
You know, you keep mentioning about the concentrated portfolio. You know a lot of managers have you know, these best ideas portfolios, but in terms of you know, how do you mitigate risk with a concentrated portfolio if you know, say some of them are some of the stocks are heading in the same trend.
Yeah, So a couple of things we do. Even though we're concentrated, we make sure we're what we what we say adequately diversify, right, so we do have some limits. We think about all the different risk factors that may be contained, and so we don't really just think about say industry or sector concentration. We go way more granular than that. You have lots of different companies that may be in totally different industry, but they may be exposed to similar risks.
Right. Tariffs are a great example.
You could have an industrial company, it could be a consumer company, but if they're buying a lot of their goods overseas, they're exposed to.
The same risks.
They may be in totally different sectors, right, Or you may have a healthcare service company that relies on government or Medicare payments, and then you may have a defense contractor that sells to the DoD quite a bit, two totally different industries, but yet if there are federal budget cuts, they're exposed to that factor, right, So we look at that way and make sure we're adequately.
Diversified from that standpoint.
The other thing I'd mentioned is that we're very careful about trying to mitigate risk in every level of our process, and so we want each investment we make to stand on z own. Now, obviously you want to be diversified, and you can't. You can't avoid every single risk out there. But again going back to the comment I made about if this is one of the five to tenk companies you had to own for years, would you do it? And so that already puts a mentality in place as
we research companies. You know, it makes you think a little bit less about Hey, they're the real high level tail risks. But we're going to own enough companies that I'm okay taking this risk. We try to avoid it as much as we can, right, So we're already thinking about buying companies that are so resilient, and so many different scenarios to begin with that you're already mitigating a huge amount of risk one by one in each company that you're invest in.
Now in terms of you know, we've talked about what you look for in companies to buy is in terms of selling positions? Is it valuations, better opportunities or just you know, the business factor isn't there anymore?
Yeah, So the two main reasons that we sell or either valuation or the fundamentals aren't as good as before.
Something has changed.
Structurally, and very often there are a combination of two. I'd say we tend to buy companies. As you can tell by a holding period, we tend to buy companies that we help to own for many, many years. Valuation is tricky in getting out because if we do this right, the management team teams in the structural soundness of the business tend to be better than we hoped.
Right.
So when we make financial projections when we make an investment, we tend to be fairly conservative. But management teams can add a lot of value beyond that that you can't anticipate.
Right.
They can buy backstock at operation of times, they can make wonderful acquisitions, they can enter into new areas that you may not have anticipated and do well.
Right.
So there's a lot of optionality investing with a good management team with a structurally sound business. And so we're very careful about not just automatically saying this is the multiple that we will get out and so on, because things change overly years.
Right.
So what we say is, once we find a really good company, we tend to hold on unless it's approaching or get into those bleed valuations Truki.
As you know, David and I are both part of the Bloomberg Intelligence team at Bloomberg, So I would be remiss if I didn't ask you if you use external research, and if you do, what do you find you know, where do you find yourself leaning in, where do you find it most valuable least valuable? Sort of just give us an assessment of the research landscape if you don't.
Yeah, So we use whatever we think can be an input to us. So we do all of our own internal research. So we use a lot of external research, but external research meaning does it give us insights into that companies and the company's fundamental business model management R Right, So we don't use research in the sense of telling us what to buy, their opinions, people's ratings on the stocks.
We do all that, right, that insights sort of valuation, decision to buy, sales, and we do all that internally. But we do you know, when we try to research a company, obviously, we're trying to research anything about that company, the people that run it, the people that work with that company, the industry around it, and so we talk to anybody that we think we have insights into it, right, and so we're talking to lots of people that work for competitors, We talk to people that used to work
at the company. We certainly talk to sell side analysts or consultants that may have a deep knowledge of that company industry. And so we're trying to gather as much intelligence, like you said, and information as we can and hopefully get some insights as well as well as develop our own.
Great So we just have one more question before we let you go. You mentioned earlier you know you're a big fan of Warren Buffett, and I imagine you probably read a lot of his you know, notes that he puts out. But do you have some I guess favorite financial books.
Yeah, it's a good question. So we read a lot. I'd say it helps. It helps to read a lot of financial history. Certainly I enjoy it. Maybe that's just sort of my my predilections a little bit, but I love reading about history of the financial markets, the financial systems, the banking system. There's so many great ones out there. Maybe I highlight a couple that may be listener known to some. There's a book called The Richest Man who
Ever Lived. It's about an industrialist in Europe from a few hundred years ago named Jacob Fuger, written by a friend of mine, Greg Steinitz. That's a wonderful book. There's another one called The Exchange Artist, by another friend of mine, Jane Kominski, but goes back to sort of the free wheeling days in the US when the banking system was still forming. And so there's a lot of interesting things
about the monetary system. You know, back when paper money was sort of seeing as very dubious, and you couldn't when people paid you with paper money, you weren't sure if there was actually someone behind that money as you so it's all right. So those two are kind of
interesting from a financial market standpoint. I'd say there's a lot of good business books, right, because again we're trying to buy businesses, and so I think it helps a lot to read books that sort of tell you the history of particular businesses and you learn.
A lot more about that business and industry. It makes sense.
Well, this is great, Harouki, thank you so much for joining us again.
Sure, thank you very much. Pleasure to be.
Here, Gina, thank you for bringing my cost today.
My pleasure, so lovely to meet you, Haruki. Thank you for for joining us, and thanks David for hosting untill.
Our next episode. This is David Cohne with Inside unt