Wealth Management: Blog - Meet the Manager: Jay Creel and John Dowling, Bares Capital

Sophie Kilvert - Client Adviser

Based in Austin, Texas, Bares Capital is at the heart of the growing tech ‘hub’ often viewed as an emerging Silicon Valley. Having held Bares in our portfolio since the Summer of 2016, I recently spoke with Portfolio Managers Jay Creel and John Dowling. Together with our conviction in the individual equities we hold in portfolios, we are always looking for expertise beyond our own research capabilities. We therefore work with third-party fund managers who can offer specialist knowledge in specific areas of the market and are aligned with our own investment philosophy.

In this deep dive into the Fund, Jay and John provide an insight into their hands-on approach, the Fund’s stock selection process and the stringent criteria which must be met to earn a place in their small, high-conviction portfolio. Taking a closer look at some of their holdings, they delve into the stories behind these companies, mostly mid-cap tech-centric disruptors with long runways for growth. Discussing the threats and opportunities presented by the pandemic, we look ahead to the long-term trends which may present further opportunities.

Understanding Bares’ investment approach

With between only 8-12 positions typically held within the Fund, a company must present certain characteristics to earn a place in Bares’ portfolio. Like our own approach, they look for businesses with strongly growing intrinsic value, capable of driving long-term returns. They specifically search for businesses with a sustainable competitive advantage, high-integrity management and underappreciated growth opportunities.

While our investment approaches broadly align, Bares' specialism in the US market - particularly its thriving tech industry - allows our clients to invest in a number of smaller, high-growth businesses which we would not ordinarily be exposed to. With 20 years’ worth of experience in this area, Bares can identify investment opportunities amongst mid-cap businesses with the ability to displace larger competitors.

Out ‘on the front line’

Integral to this research process is their boots-on-the-ground approach, which helps create a full picture of a business. When investigating an investment opportunity, Jay stressed the importance of moving beyond their initial desktop review to the ‘front line’, visiting companies’ headquarters with senior management, attending major trade shows and conferences, and even meeting with suppliers, customers and competitors to get a greater sense of the landscape as a whole. Over the last 20 years, they have been travelling across the US, adding to their research files.

 A closer look at Bares’ positions

While this research process maintains open to investing in businesses of varying sizes, both John and Jay mostly focus their research on smaller, mid-cap companies, which get less attention than the larger names and can grow to become multiples of their current size. They often look for companies which they feel are misunderstood from a pricing perspective, such as Align Technology.

As a dominant global provider of modern orthodontic treatment systems, Align created the ‘clear dental aligner’ brand Invisalign, as an alternative to traditional wires and brackets. For both teens and adults alike, the advantages were plenty: no wires cutting your mouth and a much more discrete appearance. But with Invisalign only being used for mild-to-moderate cases, orthodontists were held back from building their practice around this solution. Align’s subsequent investment in research and development, coupled with widespread clinical validation, means that Invisalign can now address more complex cases and with greater predictability than the traditional method, where doctors are still required to rely solely on their own judgement.

When some of their initial patents expired in the third quarter of 2019, Align’s share price dropped by 40% as copycats emerged. But against this backdrop, John revealed, Bares established an initial position based on their past research, strong in their conviction that new entrants faced a long road ahead to match Align’s success. Believing that the share price would respond accordingly to the company’s enduring competitive position, they seized the opportunity to invest.

Wayfair is similarly a consumer-driven business, but still a smaller name with growth potential. As an online marketplace, Wayfair operates a platform through which goods are sold and distributed. But where larger marketplaces like Amazon offer a variety of goods, Wayfair specialises in home goods and furniture, affording them a level of competitive expertise. Within this e-commerce space, John highlighted the importance of selection, platform experience and logistics capabilities. As an online marketplace for furniture, décor and home goods, selection is crucial, as home furnishings reflect every individual’s personal taste. The platform experience must also reflect the needs of the consumer, who often begins the buying process without a clear idea of what they want. They require a marketplace with a browsing-based orientation, rather than a search-driven approach. With the need to ship bulky products, there are naturally implications for warehousing and delivery. Creating a purpose-built platform that solved these characteristics has allowed Wayfair to build up 18 million distinct items sourced from over 12,000 suppliers, with a world-class browsing experience.

The results of this model have been powerful, with over half their orders received from loyal customers who have bought from Wayfair three times or more. As growing volumes attract more suppliers, the company has invested in its platform, which has made it more attractive to consumers and harder for competitors to catch up. Yet with less than 15% of home goods purchased online, this shift to e-commerce is still very much in the early stages, with what John hopes will be a long runway ahead for Wayfair.

The effects of COVID-19

Even amidst the pandemic, Wayfair has continued to perform well. As we are all confined to our houses, home goods have become a greater priority for consumers, driving Wayfair’s share price higher. But this accelerated shift can also be seen amongst other companies in the Fund, for example Workday, with the modernisation of corporate IT infrastructure, or Square, with the shift of merchant payment processing solutions and peer-to-peer payments moving to low-cost, next-generation providers.

Looking at the portfolio more generally, Jay believes their companies are positioned to withstand the economic uncertainty of COVID-19, with over 80% of the portfolio invested in “mission-critical” businesses such as Enterprise Software. While we may be witnessing declines in near-term earnings, we should not conflate these with a permanent loss of earnings power. As cash-generative companies with strong balance sheets, Jay remains confident in these companies’ resilience, believing their selective qualitative characteristics add to their strength.

In fact, mid-March pricing lows moved in Bares’ favour, where the market-price-to-intrinsic-value relationship opened up greater opportunities for them. Feeling the mid-March drop in prices did not reflect underlying business fundamentals, they were able to increase their commitment to their long-term investments.

Looking ahead

As we begin to look ahead to life beyond lockdown, both Jay and John remain excited about the ongoing modernisation of corporate technology systems. As they continue to invest in situations where next-generation providers are displacing incumbents or creating new markets, they are confident that these businesses are attractively valued with great growth potential.

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The value of investments, and the income from them, can go down as well as up, and you may not recover the amount of your original investment.  Past performance should not be taken as a guide to future performance.  This content should only be used or reproduced with the express written permission of Rothschild & Co.