3 ASX stock picks from an award-winning manager (and one factor that unites them all)

After 32 years as a successful fund manager, David Pace from Greencape Capital has narrowed down his philosophy to the following core tenet;

“We’re looking to back better than average people, 

into better than average businesses”.

By his own admission, Pace considers this pretty simplistic and is “at pains to say that there’s not a lot of IP in our process”.

Don’t let that fool you. Where there is IP, it’s incredibly valuable. Again, it relates to the ability of Pace and his team to recognise exceptional leaders and management teams that add value and operate with honesty and integrity.

“The IP is in the information that we gather, and the work and effort we put into gathering that information so that we can make those judgement calls - that's where the IP is,” says Pace, noting that “everybody makes a judgement call on management”.

That ability to gather information and turn it into actionable insights saw Greencape recently win the Morningstar Fund Manager of the Year Award in large-cap domestic equities. That award was partly in recognition of the 700+ basis points of outperformance above the index the Greencape High Conviction Fund delivered in calendar 2023. 

Whilst happy to win the award, Pace was more interested in championing his team and sharing the success with them when asked about it, in another example of the people over process mantra that Pace seems to live by.

"Our competitive advantage is the quality of the individuals and the culture we've built", adds Pace for good measure. 

Growth at a reasonable price

Greencape’s investment style can be considered growth-at-a-reasonable price (GARP), with Pace seeking companies with sustainable growth engines trading at reasonable valuations. While the market looks "reasonably full" in the near term, he believes there is still value to be found, particularly for investors willing to take a longer-term view.

"If you think with enough term, you can always find value, particularly in companies that have a track record in winning and growing and particularly growing beyond Australian shores," he explained.

As for how easy or otherwise it is to find GARP right now, Pace says, “It’s not there unconditionally”, adding that “It's not there for companies that are valued on revenue multiples that are generating no earnings or no cashflow, but it's there for legitimate companies with strong competitive moats with sustainable margins and returns”.

Pace notes that sometimes as an investor you need to think “with a bit more duration… and this is one of those times”.

A question of risk

When asked what he’s worried about, Pace quipped that he’s “worried about everything”.

He elaborates by saying that if I’d asked him 10 weeks ago, he would have said that one of the major risks is that the world is baking in a best-case scenario for interest rate cuts.

“That's clearly now flipped on its head, not in totality, but is unwound to a large extent. 

I think the risk is from here is that we potentially enter an economic scenario of stagflation where inflation is increasing and economic activity is waning”.

An onset of stagflation is a nightmare scenario for economies and investors, and it would invariably lead to pain for share markets. While Pace is certainly not hoping for stagflation, he adds that the only silver lining would be that any prolonged market weakness would suit his investment style, which focuses on duration, allowing him to pick up great businesses at better prices.

“The more stressful times for me as a fund manager - I've been doing this for 32 years - is when you can't see value. When you can see value, it's great”.

Focusing on quality management teams

As noted above, Pace and his team focus primarily on backing people and if he doesn’t believe in management or the board, it’s a non-starter; “that is unequivocal” he declares. 

"If we can't back management, if we can't back the board, and we think leadership is at odds with the best interests of shareholders, then we won’t invest”.

Adding some colour to the focus on management, Pace shares that one of his pet peeves is private companies masquerading as public companies. He points to companies that won’t talk to the market, treat shareholders with disdain, and use the company balance sheet for non-core investments. He highlights a couple of stocks in the retail space that have a history of doing this, one of which he previously held stock in but, upon trying to get in touch with the chairman, was met with a wall of silence.

Whilst I’ve spoken to managers in the past who have a keen focus on management, I’ve not seen the same passion that Pace has for the people – and, therefore, qualitative – side of the equation. I was keen to know when in his 32-year career he shifted from the numbers (i.e. head in the spreadsheets, data, balance sheets and income statements - where all fundies start) to the people.

For Pace, it wasn’t a night and day thing, but he did share that “the further on in my career that I've gotten, the more qualitative I've become. I still look at models… but I've become really qualitative and a massive backer of people.”

"It's ultimately about people, but it's also understanding what drives people', adds Pace.

"We’re looking for people with integrity and honesty, even if they make hiccups. We're not looking for infallible people. 

We're looking for people that we can trust who have added value over time and who treat their people well”.

The other nugget that came from the conversation about people, which I’ve not heard a fund manager mention previously, is to pay attention when a CEO “is moving on to that last payday”. Pace has seen it numerous times, where otherwise fantastic CEOs become more focused on juicing their final pay packet than on running the company with the same diligence as they had previously.

“You really need to be sceptical when the CEO is moving on. That last payday… something happens. Your level of scrutiny needs to go up threefold in the last part of their tenure. I've been heartbroken by a couple of CEOs in how they've orchestrated earnings growth into their final tenure”.

High conviction names in the portfolio

It would have been remiss of me not to ask Pace for a couple of stocks he likes, and he was only too willing to oblige.

He recently added ResMed (ASX: RMD) to the portfolio, calling the opportunity “a really good example of capitalising on short-term fear”.

In talking about ResMed, Pace pulled back the curtain a little further on his approach, sharing that when chasing conviction on an idea, the first thing he does (if its a global business), is get on a plane.

"So myself and Ryan Green, we both did two trips, three months apart, penetrating those supply chains, and seeing different participants", said Pace.

"Together we were able to form a view that, if anything, GLP-1s would help to underwrite the addressable market because they're most effective with highly obese people and they bring them into the moderately obese or obese camp”, potentially making them better patients to be on CPAP.

Pace was buying the stock in the $23-26 range once the investment decision was made. RMD is currently trading just shy of $33, having jumped around 15% on its 3Q results released in late April. 

“The key story there is margin coming back into that business”, noted Pace.

In the healthcare space, Pace also likes CSL Limited (ASX: CSL) – it’s his largest position right now. He acknowledges that it had a tough 2023, but his view hasn't changed, nor has his valuation.

“There were a couple of catalysts that we had hoped would go our way that didn't. They had a product called CSL112 in phase three that didn't get up. This is the nature of what they do. They invest a billion dollars in R&D every year. Some products get up, some don't”.

Pace adds that the good thing about CSL today, as opposed to 12 months ago, is that “we aren't relying on any of those catalysts anymore". 

"It's very much an organic growth story where we can very comfortably see 15% earnings growth for the next three to five years, and that's embedded in the business and the margin growth”.

The final name Pace talks to is James Hardie (ASX: JHX). It’s another significant position in the portfolio, second only to CSL in size. Pace shares that he has owned Hardie’s “in some way, shape, or form” for the last 32 years – across two different organisations.

Most recently, Pace was buying the business after three consecutive downgrades, during a transition period for the building products maker when new CEO Aaron Erter was getting his feet under the desk.

“He's got that place humming now, " says Pace, adding that the construction cycle has also worked for them.

“This is one of the best businesses I've had the privilege of owning”, says Pace. “It is such an exceptional business with now three generations of exceptional management. 

One thing I've learned is the best jockeys tend to end up riding the better horses, because the business attracts really good talent, or the good talent builds good business and builds that competitive moat”. 

Once again, it’s all about the people for Pace. 

A specialist in Australian equities

Greencape believes equity markets are inefficient; investor sentiment and short-termism can mask observable dynamics, leading to mispricing of stocks. This can present significant investment opportunities. To learn more, visit Greencape's website or fund profiles below. 

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Greencape High Conviction Fund

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Greencape Broadcap Fund

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