Steve Johnson shares his key ingredient to investing success

I’m hardly spilling any secrets if I say the finance industry has had more than its fair share of drama and poor behaviour. Just within Australia, we’ve had banking enquiries, financial advice enquiries and investment scandals. Money is a sensitive topic after all, critical to our wellbeing.

Perhaps that’s why CIO and founder Steve Johnson believes that honesty and transparency is critical to the longevity and success of Forager Funds Management. It’s something he believes his investors have responded positively to since 2009.

It’s a modest view – investors want returns at the end of the day - Johnson still has a client that started with a $100,000 in one of his funds that now stands at more than $350,000. The point is that trust is critical in tough times.

“From the day I started the business, we’ve done one thing consistently and that’s tell people when we stuff things up and make mistakes,” says Johnson.

When you’re playing in the often more volatile small and mid-cap space, great successes alongside mistakes are part of the game after all.

He notes that there’s often a view that being open about mistakes encourages investors to leave, but he has typically found the opposite – that his clients reward transparency with loyalty.

“[Loyalty] is super important in funds management because if you lose the money at the worst possible time, you’re out there selling stocks and those things can very, very quickly compound into permanent problems,” he says.

In this episode of The Pitch, Johnson shares Forager’s journey and philosophy since founding. He also discusses the rise of passive investing and why it forces active managers to really focus on sections of the market where they can add value, like small and mid-caps.

Please note, this interview was filmed on Tuesday 11 June 2024.

Edited transcript:

Forager has been around since 2009. What is the secret to this longevity?

From the day I started the business, we've done one thing consistently and that's tell people when we stuff things up and make mistakes, and that can be quite painful. It can actually be detrimental in terms of clients either leaving us or not coming to us when they hear about some of those mistakes.

But my experience has been that people reward that transparency and honesty with long-term loyalty. We run concentrated portfolios of stocks. We've been through the inevitable periods of underperformance throughout our history, and that loyalty from our client base has been really important. In fact, I'd say it's been the key ingredient to us surviving that long and something that really sets us apart.

LW: A strong trust relationship between you and your clients.

It's super important in funds management because if you lose the money at the worst possible time, you're out there selling stocks and those things can very, very quickly compound into permanent problems.

What changes have you seen in the industry in the past decade?

There's been a lot happen and I'd say the rise and rise of index funds and passive money has been far and away the biggest change.

They've been around for decades, but even 10 years ago, they were a pretty small percentage of the market. Now in the US, more than 50% of the US market is passive funds, and here in Australia, it's rapidly growing towards those sorts of levels.

That's been a huge change and for the most part, it's been a really good thing for investors. At that large blue-chip end of the market, there's plenty of research that shows it's almost impossible for active management to outperform, and investors are paying lower fees and getting the same sort of results pre-fees. 

I think it's been a good trend, but for those of us that are at the active end of the universe, it's meant we need to really stick to our knitting and stay at that small undercover end of the market.

Has Forager’s investment philosophy and strategy had to change?

It hasn't had to change at all.

We started doing small cap stocks, unloved parts of the market. The changes have just reiterated for me how important it is to stick with that as a strategy and double down on it.

I think the large end of the market is being done really well by index funds and we need to stick to where we can add value and we need to remain nimble enough and small enough to take advantage of those opportunities. It's easy in this industry to grow too big to execute on that strategy.

One benefit for us has been that the rise and rise of index funds and algorithmic trading has generally led to larger momentum swings. 

We've seen these huge money coming into the market, money coming out of the market indiscriminately, and for those of us that are nimble and able to move around, it's helped in terms of creating those opportunities.

What would you say Forager’s philosophy is in a nutshell?

Being opportunistic, and I know a lot of fund managers say that, but we are flexible and we will go to where the unloved and underappreciated opportunities are.

Do you have any tips for investors who want to focus on that small and mid-cap section of the market?

I think really understand yourself is the first point about picking an investment strategy and how you are going to invest money. If you are wired for doing small cap research, then you're going to want to do a lot of work. You're going to want to be heavily, heavily involved in your portfolio.

Every time I'm walking down the street, whether I'm talking to friends or I'm at a party, I'm talking to people about businesses and looking for opportunities for us to put into the portfolio.

I think that's actually an important attribute for small cap investors to have, that they're actively engaged with what's happening in the world and then what's happening out there with particular businesses as well. It's often where you get those uncovered, unloved ideas is finding a business that is not even on the radar of the investment banks and research houses yet.

Can you share a few highlights from Forager's journey?

It feels like it's been a long one already, but we have a long way to go.

I still, today, talk to clients that have been with us right from the start and someone that put a hundred thousand dollars into either of our funds that's now turned into more than $350,000. It's what we are here for to add value to their portfolios, but that power of compounding working its magic, making a real difference to people's retirements is the thing that I'm most proud of.

And then I would also say just the team that we've been able to build at Forager, that has not been easy either. There's been some mistakes and missteps along the way, and I think a lot of work from me over the past five years in terms of trying to put in place a philosophy and a framework that's written down that smart people can come in and execute, still be themselves, still use their own attributes, but deliver a consistent product that works for our clients. All of our senior resources have been together more than five years now. It's working really well together, and I'm really excited about what the next 15 years is going to bring.

If you'd like to find out more about Forager's philosophy and investing style, please visit the website here.