Overexposed and Underestimated

We know what you’re thinking; how could any Janus fund possibly qualify as “overlooked?” Their returns are the stuff of legend, as are the critical headlines the company suffers from time to time. Good or bad, one could argue the amount of publicity they receive has them dangerously close to overexposure.

The Janus Triton Fund, though, with its solid performance and relatively low assets under management, certainly qualifies. Co-portfolio managers Brian Schaub and Chad Meade are joined at the hip, so much so that “work wives” jokes invariably fly around the company’s Denver headquarters; but, whatever … the partnership works.

Schaub has been with the company for 10 years; Meade for nine. Nine years ago, when Triton Portfolio became available, the pair approached the CIO at the time and requested they be allowed to co-manage.

“We take a very collaborative approach to managing money,” Schaub says. “I think there are two primary benefits to that. First, it creates checks-and-balances where if I haven’t dotted all the ‘Is’ or crossed all the ‘Ts,’ Chad is there to back me up, and I’ll do the same for him. Also, if we don’t agree on a stock, we have a rule where we won’t buy it. In most cases, when one of us disagrees, it ends up being a bad investment anyway.”

All well and good, but two managers who think alike with the same investment philosophy could cause problems. How do they guard against the echo chamber?

“I’ll turn the question around and say that one of the key ingredients in any successful investment process is discipline,” Schaub says. “Having the two of us as co-managers with a similar philosophy and process, if we can be disciplined to the process and not stray from it in difficult times, that will serve our fund shareholders in the long term. The benefit of the discipline the co-manager structure creates far outweighs concerns of being stuck in our ways.”

The discipline to which Schaub refers applies to smaller-cap companies that they believe have the opportunity to mature into the mid-cap space over time. What differentiates them from traditional small-cap offerings is that they are able to capture that entire return as the company migrates from a small cap to a mid cap. The primary tenet of their investment philosophy, according to Schaub, is the concept of “sustainable competitive advantage.” Small companies that demonstrate success inevitably face competition so they believe it’s important to put together a portfolio of companies that can successfully defend their turf against competition.

“Our ideal scenario is to buy a company with, say, a $1 billion market cap and own it all the way up to $10 billion in market cap,” he adds. “Competitive advantage can come in many different forms, but some of our favorites are maybe a company has a patented portfolio that provides a nice barrier to entry, or maybe a company has created a database that would be difficult or costly for a competitor to recreate.”

Common characteristics of companies with a sustainable competitive advantage include high barriers to entry, pricing power and differentiated products. If companies pass on price increases every year, it tells Schaub and Meade they’re doing something unique or differentiated that is difficult for a competitor to recreate.

Once they’re comfortable with competitive advantage and its sustainability, the team moves on to look at the addressable market.

“I think you probably hear people say they look for large addressable markets, but what differentiates us is that our ideal company has low market share today in a large market, but has the ability to materially increase market share over time,” Schaub says. “If we can find a company that’s going to grow from 5% market share to 20% market share, it’s a fourfold increase in revenues. That’s much more exciting to us than owning a company who’s the market leader today with 70% market share going to 75% market share. An ancillary benefit of our focus on companies with small markets is that it creates long-duration growth. In the market environment today there are many investors who focus on short-term data points. We can find companies we think we can own for three, five or 10 years. In many cases those companies with long duration growth are undervalued by other investors.”

Besides competitive advantage and market share, the duo adds the quality of the business model to the list. To them, a high-quality business model means companies that have predictable recurring revenue streams and high operating leverage, so as the top line grows and margins expand, the bottom line grows at an even faster clip.

“Management teams who are saddled with low-quality business models have to spend too much time thinking about what happened yesterday,” Schaub says. “When you can find quality business models, I think it really allows you to invest with management teams who have the luxury of thinking strategically about their business and planning out for the next five to 10 years.”