By: Kelly Ward
One of the tools we use in our investment selection
process is conviction, and this refers to the confidence
or certainty we have in the investment case,
which itself is made up of quality, risk,
and value elements.
The higher the conviction is,
the more the investment case can be lent on,
and this can be built up over time through our interactions
with management and the certainty we have
that they can deliver upon their strategy, our understanding
of the business and industry drivers of revenue
and performance, and the certainty we have in
the cash flows of the business.
Low conviction may arise from uncertainty about the
future economics of a business.
This could be for a wide array of reasons such
as regulatory changes, unpredictable commodity cycles,
fluctuating foreign exchange, a new entrant
or disruptor into the market,
and any other scenario in which a binary positive
or negative outcome may arise.
Where a business doesn't have primary control over its
destiny and a high buffer
to prevent against unforeseen circumstances,
low conviction may be the result.
Notably, low conviction is not inherently a negative thing
as it prevents speculation in an uncertain investment case.
Having a low conviction in a business which has been
thoroughly researched, but whose future is
uncertain is a positive thing.
As we are declining to speculate,
risk and conviction go hand in hand in order
to determine appropriate portfolio positioning.
Many of the high risk factors the business may exhibit such
as legal challenges, regulatory changes,
possible corporate action would also give rise
to a low conviction, as the future outcomes
of these scenarios would be uncertain.
By reducing our exposure
to investments which are less predictable, we aim
to avoid major investment errors through this
and using our quality framework, we aim
to achieve strong investment performance
through investing in more predictable, moderate risk,
high quality businesses.