How Aziz Hamzaogullari and his team generate long-term alpha

Lightly edited transcript

Louise Watson: Hello and welcome to Navigating the Noise, a podcast by Natixis Investment Managers Australia, where we bring you insights from our global collective of experts to help you make better investment decisions. I'm Louise Watson, Country Head for Natixis Investment Managers in Australia and New Zealand. And today, I'm joined by Aziz Hamzaogullari, who is a portfolio manager as well as the founder and Chief Investment Officer of the Loomis Sayles Growth Equity Strategy Team.

I first met Aziz in his adopted home of Boston at Harvard University, where he was speaking to visiting Australian investors, but Aziz is originally from Turkey. He has been in the US for many years and earned his CFA in the US and his MBA at George Washington University. He has more than 30 years’ investment experience, and he joined Loomis Sayles in 2010 from Evergreen Investments. Outside of his investment responsibilities, Aziz is also a member of the executive committee and a board member at Loomis Sayles. Aziz, it is an absolute pleasure to be talking to you today. Welcome to the podcast.

Aziz Hamzaogullari: Well, it's my pleasure, Louise. Thank you very much for that introduction, and I look forward to our conversation.

Louise: Me too. And I mentioned a small part of your very impressive bio earlier, but I think it's always interesting to find out where our guests start out. Can you tell us a little bit more about the early days of your investing journey? Why did you become interested in investing and decide to pursue it as a career?

Aziz : Great question. Actually, I was very fortunate in that very early on when I was really young, when I was in middle school actually, I started working in my family business with my uncle. Their core business was textiles, and with the earnings that they had, they would invest in private companies. And when I was in middle school, basically, I started working for him in summertime. And during that time, he was the one who gave me the insight that... I had some skills that really apply as well into investing.

Actually, I just prepared a report that he told me to prepare, just a translation, and without knowing, I did some analysis. So he looked at it and said, "Son, I think your calling is investing." And basically, when I was 12, 13 years old, I sort of knew what I wanted to do. And so, from point A to point B it was like a direct line because I had a mission in life. And again, I was very fortunate that I had a mentor very early on.

And also is important is that unlike many people today where they may be watching CNBC stock charts and looking at stocks as symbols, or something to trade, my introduction to investing was really through a private equity lens because it was actually private equity investing that I was first introduced to. And that really appealed to me, the long-term time horizon, and understanding the businesses that you invest in, and having a structural view to the world.

Louise: Yeah, this private equity approach to investing is really interesting, and that tells us a lot about why you may have joined Loomis Sayles in 2010, which was a renowned fixed-income powerhouse. Why did you, as an equities manager, choose to work at Loomis Sayles above other investment firms you could have chosen?

Aziz: I really was very much attracted to Loomis as an investment organisation. What I mean by that is, in our profession, if I were to generalise, there are two types of investment firms. One is an investment-centric organisation another one is a sales-centric organization.

And when I looked at Loomis, I didn't see a fixed income or an equity shop but rather an investment-centric organisation with some key differentiators, like a long-term time horizon in terms of how they make decisions, having a very horizontal structure rather than a hierarchy, which really makes it much easier for an investment professional. Having an investment-centric decision-making process, meaning focusing on your core competencies, rather than what is hot in the market today. And actually the best proof statement for that is when I joined Loomis in 2010, the prior 10 years, we were really dismal in equity investing. And actually if someone told you that over the coming 10 years, active management will be under pressure and passive management will be in favour, someone may have told Loomis wouldn't invest in a team like ours, but the approach was - not if the space was hot or not, but did we have a differentiated way of investing and can we really add value to our investors by offering something unique and different than others in the marketplace?

So, those attributes, especially having an alpha focus, having a horizontal organization, having an investment-centric and long-term thinking, and last but not the least, an organisation that really removes all the, what I call, alpha killers. Alpha killer is any activity that you participate in that doesn't really help you generate alpha, and Loomis is really good at that.

Louise: Yeah. This culture that has allowed you and the team to succeed is something I'd like to talk more about, Aziz. And I understand you are a sports fan, and I'm wondering whether you take any inspiration from high-performing sports people and teams and how do you apply that to your own team at Loomis Sayles and the culture you've built there and within the team.

Aziz: So yes, I actually am a sports fan. I grew up playing basketball at school and school team, and I went to tournaments and enjoyed that. And one of the things that really I find in successful organisations or investment teams, or sports teams, is having a process and, more importantly, which this is very, very important, having individuals that truly have a passion for what they're doing.

So taking it from sports world, I really think that great athletes, regardless of how much you pay them, they would play the game in the same intensity because they only have one gear, and they have incredible passion for the support that they're doing. For example, Michael Jordan, which I think, arguably the best player ever that played basketball, I really think that if you paid him a dollar or a billion dollars, he would play the game the same way because he only knew one way of playing. When I applied to this our investment team, there are three attributes that I really seek in our team members.

And the first and foremost, again, having a passion for investing. This is something I cannot teach to someone, either they have it or not. Second, having a very independent thought process that is different than the marketplace. So meaning looking at the same set of factors but coming with insights that are different and unique. And, last but not least, having a team orientation, which is that a team is better than one. An outcome of that, we have zero turnover among our investment analysts and a very stable investment team that we were fortunate to work with for the last 18-plus years.

Louise: Let's drill down a little further on this one, Aziz, because I think this is a really interesting component of your team. And let's look at the investment philosophy and process. It's a very highly competitive asset class, global equities and growth strategies in particular. What do you think sets your team and your investment philosophy apart?

Aziz: There are really six key drivers to what I call our alpha thesis. And our alpha thesis is basically the same question that we ask to our companies that we invest in. We always ask them, what's your competitive advantage, and why is it sustainable? And we ask the very same question to ourselves and say: "What are the key differentiators, the key drivers for our alpha generation in the long term?" And there are really six key drivers.

First and foremost, our time horizon. We call this time arbitrage, and the proof statement for that is our portfolio turnover. In our long-dated 18 years of large-cap growth strategy, it is around 12%. In our global growth strategy, it's below 10%. So that's the proof statement that we really take a structural long-term view, and we believe that's a key differentiator. The second important differentiator is having a deep understanding of the businesses that we invest in and the process through which we do that is our seven-step research framework. And the outcome of that is a high conviction portfolio, around 35 names or so in our portfolio, historically between 30 and 40 names.

The third key driver is our starting point is always quality, not the benchmark weight of the company in the index. And we are really seeking differentiated business models to invest in for the long term. And the outcome of that is very high active share versus our competition but also versus our indices. And the fourth driver is really investing in sustainable secular growth businesses. And the outcome of that is a portfolio of companies that are growing at a much higher clip than the overall GDP, worldwide GDP. And if you look at our global portfolio or large-cap portfolio, you will find that cash flow growth is 20+%.

And another key driver is valuation. Yes, we are a growth manager, but we pay a lot of attention to the margin of safety. And the outcome of that is we typically had, historically, really good downside protection, low down-market capture in drawdowns. Last, but not least, are a differentiated approach to risk. We take an absolute approach to risk by focusing on active risk management. And the outcome of that is really good risk statistics like information ratio and Sharpe Ratio in our strategies. So those six differentiators really lead to our alpha generation.

Louise: And the time horizon and quality you mentioned is key. You're a growth manager, but you tend to make long-term investments in large-cap stocks, and your investment process starts with a quality lens, which may seem a bit unusual. Can you explain why this is?

Aziz: Absolutely, you're right that our starting point is the quality. And for us, high quality means a business that will be very difficult to be replicated by someone else if they had time and capital. And the reason this is very, very important is that when you look at empirically, for historical tens of thousands of companies, and how the companies perform over time, what you find is less than 1% of the time, companies are able to maintain higher returns on invested capital for longer than a decade. And the reason for that is, 99% of the time, with time and capital, you can replicate whatever that business is.

So, the reason that we start with the quality is, without the quality, regardless of the growth rate, if the industry is growing 10%, 20%, or 30% if you don't have the quality aspects, that growth will not be yours because you'll be forced to share that or will be defeated in trying to capture that growth by someone else. So, if I were to make a bond analogy, in order to value a bond you have to know the duration, and you need to know the coupon. And in equity investing, the duration is determined by the quality of the business, how long this business will be sustaining itself in terms of returns.

And the coupon is determined by the growth rate of the company. But that growth rate is really dependent on how defensible your business is. And, last but not the least, once you have the quality and the growth, which is the bond equivalent of the maturity date and the coupon, then you can value the business. So that's why we always start with the quality of the company, and if it doesn't meet the quality characteristics, then at that point, we stop and do not further pursue the opportunity.

Louise: Let's bring this lens now to some of the names in the portfolio. And you've been a long-term investor in many of the world's largest and most successful technology companies. And over time, you've owned six of the Magnificent Seven, such as Nvidia, Meta, and Amazon. They've enjoyed incredible growth in recent years, but in general, it becomes harder for companies to continue to grow quickly the larger they become. Do you think there's still plenty of room for growth in these names?

Aziz: So you're making a great point in that, in the future growth prospects are very, very important. And if you look at our portfolio, actually you will find that Google, Amazon, and Microsoft we owned them for 18 years now, 18-plus years. And in case of Meta, we owned it since its IPO, and Nvidia since 2019, early 2019 when we made a purchase, and Tesla is the most recent edition, 2022, when the market went down, and so did Tesla and we took advantage of it. But the future growth is really always dependent on where you are in terms of penetration versus your market opportunity.

So in case of Google and Meta, they're really driven by shift to online advertising. And that has been in place again for 18-plus years that we have been investors in Google and 12 years in Meta. And when I look at the future growth prospects, the shift to online advertising is still very much intact because if you look at the total ad spending globally, it's trillions of dollars, and out of that, only still one-third or so is online spending, whereas consumers spend more than half their time in online.

So, as a result, we still see a lot of growth. Similarly, with Amazon, with e-commerce penetration, we think there's way more growth left. When we invested in Amazon 18-plus years ago, the penetration for e-commerce was around 2 or 3%. Today, it is, 10 to 20% depending on the region that you're looking at worldwide. And we still believe that there's tremendous growth left, and similarly, AI and in media, there's more growth left. And so, with Tesla, EV penetration is very, very early stages, and we believe many years of growth left in these companies.

Louise: Yeah. You mentioned the early stages of investment in AI, and many of these mega-cap technology companies are heavy investors in AI. How successful do you think they will be at turning this investment into revenue and profit, and how long do you think it'll take for that to happen?

Aziz: You are making actually a great point also about how significant these investments are. Actually, if you look at Magnificent Seven, collectively they account for roughly 40% of the top 1,000 companies research and development in the United States. So, meaning that these seven companies are accounting for 4 out of $10 put into research and development in US. And for most of these companies, whether it be Amazon or Meta or Google, they have been investing in AI for many, many years, and they're already monetising.

For example, in case of Meta, their introduction of video product that they have, it's all driven by AI. What it feeds to consumers, it's all driven by AI, and they're already monetising that. And in general, what I think about AI is that AI is the biggest structural shift that we have seen in three decades since the internet revolution. And the impact of it will be tremendous interest of productivity gains for all the companies.

But the direct beneficiaries will be a handful of companies, no different than how it was for the internet revolution. Though every company benefited in terms of productivity gains, the direct beneficiaries were really few businesses that were able to provide the products and services, as is the case with Meta or Amazon or Nvidia or Microsoft or Google.

Louise: It's certainly a fascinating opportunity set, and our investors are really captivated by how AI is impacting these names. And we've talked a lot now about the importance of time horizon, and you tend to make long-term investments. You think about it in terms of decades, and holding onto your losing stocks for too long can have a large impact on performance. How do you know when to sell one of these stocks, and how do you ensure you're sticking to this discipline?

Aziz: I agree, self-discipline is very, very important. And the way we go about it is, at the very outset of our investing, we really put down all the key drivers for our investment thesis for a particular business. And each quarter, as these companies report their numbers, we look at what we thought would happen versus what actually is happening, the predicted value versus the actual observation. But the key is understanding your key assumptions and if there's a structural change or not in those key assumptions.

So, in 18-plus years, we sold around 57 companies from our portfolio. Out of those, roughly half of them because they reached intrinsic value. So everything worked out. We invest in the company, and the investment thesis worked out, and as a result, we sold it. Around 25 to 28% of them, we sold it because we found a better investment opportunity. And 16 companies, out of those 57 companies were actually actual mistakes. So, in 18 years, we made 16 mistakes, and we have a list of these companies and we also know what happened after we sold them.

And happy to report that those companies we identified as mistakes and sold them, 87% of them meaningfully underperformed our portfolio. And actually that's also the case for those companies we said that reached intrinsic value, 88% of them underperformed our portfolio. The point being is that not only we identified these mistakes, but we acted on them, and then we kept track of it to understand if our thesis in our mistakes were correct or not. Meaning also you don't want to make the mistake of selling a company, thinking that it's a mistake and then it outperforms your portfolio.

In our case, again, 87% of those companies that we sold meaningfully underperformed our portfolio, which is one way of having a discipline about your mistakes. No different than the sports team, when they lose a game, or a win a game, they should watch the tape and understand what they made good decisions in and where they make mistakes. Similarly, our investment team, we do the same, and we have a list of these companies and understand what the mistake was and what to learn from it.

Louise: Mistakes are a fact of life, but it's your response to them that counts. So they were really interesting observations there. On some of the more specific names, Aziz, can you tell us some of the things that you've learned from selling out of those names?

Aziz: Absolutely. So the biggest thing we learned is having a clear process around recognising a mistake. And that happens only when you have a collaborative investment approach like we do as a team, which is that at the point of an analyst introducing their investment thesis, the entire team sits down and talks about all the key assumptions. And as time passes and as we realise the difference between what we assume is going to happen and what's happening, that's when we trigger the process of, and saying, "Maybe this is a mistake. We thought the company's going to gain market share, and they're losing market share. We thought they're going to expand their margins, and that's not happening."

A great example of that I can give you is that way back in 2008, we sold Citigroup. And that was a decision because once we understood that the downside risk was much bigger than what we thought, our analysts and us, we all as a team got together and understood that we underestimated the structural downside in this business and we got out of it in September of '08. Since then, that business underperformed our portfolio relatively by 750%, but only that we took the proceeds and invested in business like Visa, which truly outperformed not only Citigroup but our overall portfolio.

Louise: Company management obviously plays a critical role, and it's an important part of the way you evaluate a company. And a number of large companies have announced changes to CEOs in recent times, for example, Disney, Boeing, and Starbucks. Does this change your view of a company, and what is your process when a key person leaves in one of the companies you own or considering buying?

Aziz: Great question. Actually, when you look at our portfolio, vast majority of our portfolio have, roughly half of them, have founder driven businesses. So founders are still involved, and so they're still managing the business. Other half is professional management, like in the case of Boeing, Starbucks, or Disney. And in those cases in the last 18 years, we had situations where there was a management change.

And in each one of those situations, what we ask ourselves is that: “Fundamentally and structurally, is this still a good business or not, and if anything changed with the change in personnel?” And specifically, in a company like Boeing, it's a duopoly between Airbus and Boeing. So the change in the CEO didn't change that structurally. Disney is a great franchise with a library of movies and other important assets that would be very, very difficult to replicate by someone else.

And Starbucks, actually, is a great brand. So in each one of these cases, actually, we thought the changes were necessary, but the fundamental question we ask ourselves is that if the business structurally is still sound and good and if we still find this business attractive or not.

Louise: Let's pivot now towards the change happening in the financial industry, and the astronomical growth of passive funds has had a huge impact on our industry. How do you see the industry evolving from here, and do you expect the role of active managers to change at all?

Aziz: So when you look at any profession, whether it be you go to a doctor for a surgery or you are going to find a person to cut your hair, you always want to find the top 10%, I would say, in the profession. Especially if you're going to have a surgery with a doctor, hopefully, you will do your research and find the skillful person.

I think, in our industry, what happened is that over the years, number one, active managers became more passive. What I mean by that is the active share actually declined meaningfully among active managers, and like any other profession the managers that are underperforming or not doing a good job, lose to the passive investing. And if you look at actually passive share in each category, it has been increasing. And I think that the future will be, really, managers that really, really differentiate themselves and offer something that's unique. Actually, the less the number of active managers, because it's a zero-sum game, the more opportunities there is for the remaining active managers.

So the way I see it is that, it is no surprise to me that if you're a manager that's underperforming and when you look at the statistics in either, whether it be in large-cap space, global growth space, there are managers at that top quartile and adding value, and there are managers that are below average. So I think those below-average managers will continue to lose to active managers that are adding value. And I am excited with my teams for future opportunities and adding alpha for our investors.

Louise: Change is the only constant in life, and it's hard to talk to a US-based fund manager without talking about the US election, given the intense interest in the Presidential Race around the world. You've been investing for a long time. In fact, I think there may have been two presidents called George Bush during your investing career. How much do you think the change of president will have on markets and your investment decisions?

Aziz: Yeah, so this is very interesting because what I find is that investors position their portfolios for a certain outcome, but that certain outcome is usually never long-lasting because it's the fundamentals of companies that fully win over the long term.

So, for example, when President Clinton was elected in 1992, the expectation was that that would be really, really bad for healthcare companies. And from November of 1992 to January of 1993, healthcare companies actually underperformed, and they were the worst performing sector. However, during the entire first term of President Clinton and second term of President Clinton, healthcare actually was the second-best performing sector, doing much, much better than the index. So, for example, in following years of the first term of President Clinton, healthcare stocks were up around 22%, and tech companies were up around 26.5% versus benchmark being up only 16.5%.

In the second term, similarly, healthcare stocks were up another 22%. The lesson here is that whatever people think is going to happen, and they react to, is overcome by structural drivers for these businesses, as evidenced by this one example. But there's so many other examples with President Obama, President Trump, and President Biden's time where people tried to position their portfolios but at the end of the day, it was the fundamentals that really won.

Louise: And finally, Aziz, your upbringing, many years’ experience in markets, has clearly made you very humble. And I'd like to close out our podcast by talking about a recent award. Awards aren't just about recognition but a celebration of your hard work and persistence. And in fact, you were recently inducted into the Hall of Fame by FE fundinfo, a leading global financial company, and you are one of only 46 managers to receive this honour. What does recognition like this mean to you?

Aziz: It's really a great honour, and it's really humbling. And I always say our team and us, we exist because of our investors, and we serve for our investors bringing in alpha generation.

And at the end of the day, what I see, how we add value is that whether it be a retirement pension fund or a college fund or an endowment fund, at the end of the day, whatever we do has a real impact on the outcomes of finances for our investors.

And I'm very much honoured and humbled by this recognition. And, of course, it's not just me, it's our entire team that deserves this recognition. And I was very, very thankful and honoured.

Louise: Well, thank you, Aziz. It has been fascinating to gain more insight into the way you see markets and investing and to learn more about the Loomis Sayles Growth Equity Strategies Team. And if you enjoyed this episode, please click follow on your favorite podcast platform to be notified of future episodes, and tune in again to hear more from our global collective of experts.