Hassan Elmasry, founder and managing partner at Independent Franchise Partners, LLP, is one of the successful money managers bravely leaving Wall Street to venture out on their own. After nearly 15 years as a managing director at Morgan Stanley, where he ran the Global Franchise and American Franchise equity strategies, since June of 2009, he has been running his portfolio at Franchise Partners LLP in London.
Money Management Executive caught up with Elmasry in his native Chicago to ask him about stocks and strategies he likes in the slippery slopes of today's market.
MME: How difficult is it to be long-only in this unpredictable environment?
Elmasry: I don't think it's any more difficult than usual. Every market cycle or investing environment feels uniquely challenging when you are in the thick of things. Fortunately, we have practiced our investment discipline and tested our decision-making tools over a few market cycles and have been able to generate attractive returns with below average volatility over a full market cycle.
Right now, our free cash flow valuation tools in particular are indicating very attractive valuations in the kind of ultra-high quality, wide-moat type companies that we focus on, so we are feeling reasonably confident about the long-term compounding potential from our strategy.
MME: Can you give a little insight into recent changes to your holdings?
Elmasry: We are genuinely "buy and hold"-oriented investors. Stocks in our portfolio have an average holding period of seven or eight years, so things don't change dramatically overnight.
Our overall approach is to focus on very high-quality companies, those that can sustain very high returns on capital due to the presence of a hard-to-replicate brand, patent or other intangible asset, and let the compounding power of that franchise work to our advantage over time. With that long-term perspective in mind, it's fair to say that the market action during the depths of the financial crisis two years ago created a once-in-a-lifetime fire sale in equities.
We took advantage of that to build positions in several phenomenally powerful franchises like eBay, Experian, Estee Lauder, Harley Davidson, McGraw Hill, Moody's and Starbucks. More recently, meaning over the past year, we have initiated positions in Campari, JNJ, Mead Johnson and Novartis.
MME: What about starting an asset management firm in this weak economic environment? Good idea? Bad idea?
Elmasry: Well, for us and our clients I think it was not a bad idea. From day one, we have been able to offer a stable team with a well-practiced investment discipline and backed up with a robust operating and compliance platform. After just a little more than a year after launch, we are managing a little more than $2 billion in assets for a range of pension, endowment, foundation and sovereign wealth plans from around the world.
The initial reception for what we have to offer has been good.
MME: What do you mean when you use the term "franchise"?
Elmasry: When we say franchise we aren't really talking about a chain of fast-food restaurants or other retail format. We are using the word more in the original Latin root, where to "frank" meant a license to mint currency or print money. We are looking for those kinds of businesses that, by virtue of a hard-to-replicate brand, or patent or trademark or other intangible asset, are able to coin profits on a sustainable basis without having to tie up a lot of capital in physical assets. If purchased at attractive valuations, these businesses should be outstanding long-term compounders of wealth.
MME: What is your interest in franchises? How did that come about?
Elmasry: It dates back to my experience working with Andy Brown and Dominic Caldecott and William Lock at Morgan Stanley. They had made the observation that that companies with unique, intangible assets can have structural advantages when it comes to fending off competitors and compounding their free cash flow. When you combine that with a strong valuation orientation, the result has been a concentrated stock portfolio with an attractive return profile with below-average volatility.
MME: What drives your investment decisions?
Elmasry: Two things really. We are looking for companies that demonstrate a very specific type of quality and also attractive valuation characteristics. We focus exclusively on companies we believe have a demonstrated potential to be excellent long-term compounders of wealth because of the presence of that dominant intangible asset. They earn very high returns on their own invested capital and can grow their free cash flow without requiring substantial investment in physical assets. In addition to that exacting quality standard, we are also value investors. We typically follow a small list of high-quality companies for a long time and wait patiently for a chance to buy one of those great business at an attractive valuation.
MME: What do you do about companies in industries subjected to radically changing consumer behavior?
Elmasry: We typically try to avoid investing in industries that are susceptible to dramatic changes in consumer or producer behavior, or where there is a high risk or product obsolescence or technological change. In our view, those kinds of risks are not compatible with a long-term buy and hold approach.
Our largest position is in British American Tobacco (BAT), the world's second-largest tobacco company. We have held that stock for over 10 years, and it has been our largest position for more than eight years. Half of their revenues come from developing economies, where there are reasonable volume, pricing and mix improvement opportunities over the long term.
You could make a similar investment case around our position in Unilever or P&G, or any of the other consumer oriented companies that have a good exposure to emerging economies.
The bottom line is that we invest in companies that we think are going to survive come hell or high water. They enjoy reasonably predictable revenues, have good category and geographic exposure, and have opportunities to improve productivity and operating margins. We buy them at attractive valuations.
They're not likely to be the most exciting companies most of the time, but if you buy them cheaply, they tend to be good long-term compounders of wealth.
That's not necessarily a dazzling result in a bull market, but in a crisis and over the long term as well, it suits our clients.
MME: Are you able to interact any differently with your clients at Franchise Partners than you were at Morgan Stanley?
Elmasry: We set out on our own because we wanted to be able to offer the franchise discipline from a very focused, investor-owned/employee-owned and independent partnership. And we thought that the natural alignment that would come from being a small firm-focused on a single, tested discipline-would appeal to our clients. We only do well if they do well.
That kind of clarity and alignment is a very meaningful signal to clients.
MME: Can you talk about who are the investors who you now want and how you're going about finding them-and also about not getting the wrong types of investors and strategies?
Elmasry: Mostly it has been through word of mouth. Because we are a relatively small investment organization, we don't have an internal sales and marketing operation behind us so most of our clients have found us through a referral.
When we were at Morgan Stanley, we were managing about $10 billion for a range of retail, intermediary, and institutional clients from all around the world.
We worked hard to be very forthcoming with them and explain clearly how we invest. We also tried hard to help frame their expectations for how the strategy might behave in different market environments, especially that we hoped to earn reasonable returns (not necessarily the best) when markets were rising but that we aimed to do a better than average job of protecting their capital during falling markets.
The real proof in the pudding for us as businesspeople-not so much as investors but as businesspeople-really came in 2007 when we had seen five years of steadily rising markets and we had generated a nice absolute return for our clients. Nonetheless, we didn't look particularly smart in a relative sense.
We had some pretty interesting conversations with our clients at the time because the one-year, the three-year and the five-year numbers looked mediocre or worse, but there was a clear understanding that if or when markets were to roll over, we would hopefully do a better job of protecting their capital on the way down.
In 2007 we didn't lose a single client out of a batch of around 30 institutions.
I think that focusing on that type of client and delivering a message that they can digest that fits their temperament and their objectives is really important if you're trying to build a sustainable business.
MME: Would you consider offering a mutual fund to a different type of clientele?
Elmasry: We don't have any current plans to offer a mutual fund for retail investors, but we should have a pooled vehicle for institutional clients in the not too distant future.
MME: What is the right balance, are you finding as a proprietor, of focusing on investing and running your own business to your own liking?
Elmasry: At Franchise Partners, we are very committed to the idea that we want to work in a very investment-focused environment, so we have outsourced most of the labor-intensive operations functions. This has dramatically simplified our life. It is possible to buy a truly state-of-the-art trading system from one of several serious third-party providers. The same for back-office administration, attribution, compliance, etc. You don't have to own and manage those operations in house to deliver a top-quality service at the standard of a discerning institutional client. On the contrary, our experience has been that you can often upgrade the quality of the platform you are operating on by buying the service from a globally competitive service provider.
And then culturally, the even more important difference is the cultural shift that happens when you go from being in a very large firm that is predominantly focused on collecting assets, to a smaller firm that is more focused on investing and serving its existing clients.
At the margin, that makes a huge difference in how you allocate your time from day to day.
Hassan Elmasry, CFA
Managing Partner, Independent Franchise Partners, LLP
Assets Under Management
Highly concentrated, long-only global and U.S. portfolios that focus exclusively on well-established public companies whose competitive dynamics are dominated by: strong brands, patents, trademarks, licenses and other intangible assets.
Portfolio's Current Concentration
Tobacco, food manufacturing, beverage, household and personal care, pharmaceutical, medical equipment and professional publishing industries.
University of Chicago - Booth School of Business
University of Chicago - The College
Independent Franchise Partners
Human Rights Watch