Skin In The Game: Boutique Fund Management

Since starting out with a few friends and family clients in 2007, boutique fund management company Pie Funds now works with over 2,000 clients and has generated over $640 million of wealth for them along the way. Core to this has been the simple philosophy of outperforming the markets by investing in growth companies and it also has an internal culture of success with smart, insightful analysis as well as skin in the game for Pie Funds staff, directors and shareholders, who also have their money invested alongside their clients.

We talk to founder Mike Taylor about the success of Pie Funds, future opportunities in New Zealand and the evolution of the markets.

 

Can you take us back to the beginning of your journey with you alone in an office?

I was in an office with some barred windows at the top, so it felt a little bit like a prison cell. But actually I didn’t mind working by myself in that environment. You’ve got to be quite autonomous if you want to start your own business and you need to be a bit of an activator.

The early days were quiet; phones weren’t ringing and I was just observing everything that was going on around me, which was the financial crisis of 2008 at the time. I thought it was a bad time to start a business, but as it turns out, my investing style and what has become the investing style of Pie Funds and the JUNO KiwiSaver Scheme, is that we actually do really well during market volatility and big sell-offs.

If you can imagine a puzzle with all the pieces in place and then you add volatility throwing all the pieces up into the air, no one knows what to do. That gives people who have an understanding of markets and investments, the idea to pick up all the pieces and put it all back together. You can do it faster than everyone else, so you can make more money.

If you look back at the catalyst for you starting, did you see opportunity at the time or was it just coincidence?

It was just a coincidence. I thought it was the end of the world. I thought, why has this happened to me at this particular time? It’s so unfair. It’s only with hindsight that you can look back and see that it was an opportunity.

I only had 10 clients, most of them were friends and family and it wasn’t really a viable business model. I was just trying to not lose too much money, otherwise I wouldn’t be able to go to the Christmas barbecue in 2008.

If we can paint two pictures, what’s the situation now? What does the organisation look like?

Significantly different. Back then, I had $3 million that I was managing. Today, we have around $1.7 billion. We have about 40 staff, people working in two locations in New Zealand, and someone in Australia and two people in the UK. We’ve got a KiwiSaver business, financial advice and fund management service. It’s a significantly larger organisation.

When you compare now to then, how do you reconcile that in your brain? Had you any idea that you would go from the office with the barred windows and a few million dollars, to the scale that you’re at now?

No, I wasn’t an entrepreneur that came in with a massive, big vision to have this empire. I just had a hobby that I was good at and I wanted to turn it into a job. I thought maybe I’ll have one fund and maybe one employee, and it will be good. It’ll be better to get paid to do what I love, rather than doing a job that I didn’t love so much.

What were some of the stepping stones along the way that allowed you to turn a hobby into the scale that you’re at now?

You have to be a bit of a risk taker to be willing to leave a steady paid job to go out on your own, where you don’t get paid. Some people just don’t have that mindset. I’ve got a really good team that works for Pie Funds that could potentially just leave and start their own business.

The milestones along the way was that we always wanted to be really good at what we do. What sets us apart is performance and service. Back in the mid-2000s, I felt that there weren’t that many options available for investors and the options that were available to people, the fund managers on average are typically underperformers, I describe them as ‘serial underperformers’. And then the service level that people were getting, usually from banks, wasn’t really up to scratch unless you had millions and millions to invest.

What was behind that under-performance? Was it apathy?

There’s a couple of factors. The first is there’s a culture of performance. We built a culture of high-performance and people striving to be successful. When you’re in a bank, your objective is just to merely beat the market index. That’s it. If you beat that, you get paid. Whereas our objective is to make as much money as we can in a given year for a client.

The larger and larger your organisation becomes, the harder it is to maintain your standards of performance and service, because there’s more and more people who are trying to do that for you. Also actually more money doesn’t necessarily make it easier. More money can sometimes make it harder to find ideas.

Thirdly is skin in the game. Never give money to someone who hasn’t got skin in the game because you’re sharing in the upside and the downside. Our portfolio managers all have their own money in the funds that we manage. They’re not only trying to grow the wealth of others, but they’re also trying to grow their own wealth and they don’t want to lose money either. We’re actively trying to protect that on the downside.

I think that’s what separates us. If you do have a large institutional mandate or an institutional fund, then typically you won’t have your own money in there. And again, so long as you’re tracking the index, it doesn’t matter so much if it goes down because you can say, ‘Oh, the market fell 30%. The fund I manage only fell 29%, so I did a good job.’

What have been some of those key strategies that have helped you do that?

I think investing doesn’t have to be complicated. Effectively, you’re trying to find a business that’s going to perform well in the medium to long-term that other people haven’t appreciated the full value of. Sometimes you can buy things that remain undervalued forever. The easier the business is to understand, the more likely it is to, not only perform well, but also to be picked up by other investors in the market.

A good example of that in our local market has been A2 Milk and Xero, when it was listed here. They’re good businesses that everyone can understand. It’s accounting software, it’s milk, couldn’t get any easier than that. Both businesses are growing and moving up into the right.

Once their business model was proven, then the valuation that people are prepared to pay for that business goes up. In the beginning, someone might want to pay 10 times or 20 times its earnings. As it becomes more and more popular and people realise that it’s quite unique, the multiple that people are prepared to pay for that business goes higher and higher.

 

If you look at the NZX compared to the ASX, is there a disconnect with the market and the reality of the opportunity? Is that something that you have to factor in?

I think it will be better for more companies to list on the NZX as opposed to staying private. I suppose the reason why some shift to Australia is that, because we’re in a system that’s self-fulfilling, if we keep losing companies to Australia, there’s less that will list here. So people move to Australia because there’s greater liquidity and greater awareness of their business.

Are you having to compromise a little bit if you go on the NZX? Do other markets create more liquidity?

They do. More profile for the company. If you look at the pool of investment money from around the globe, some people can’t invest in New Zealand, or they can’t invest in Australia. Most people are able to invest in the US.

The ultimate for a company is to be listed on the New York Stock Exchange, that’s what people strive for. Then several tiers down is the ASX. Further below that is the NZX. We’ve only got 5 million people here, so we are a small niche market at the end of the day.

With the FMA giving the NZX a little bit of a slamming over of some of their security measures, is there much more complexity these days in terms of some of the hacking that doesn’t necessarily reflect on the value of the businesses that are part of markets, but could still affect the performance of markets?

Regulation is good for investors, but it can make things, as you just described, a little bit trickier. A good example of how that played out recently was in the States, where the retail investors tried to beat the hedge funds. But the problem is, they may beat them in the short term, but ultimately, a lot of people will get burned. I think that’s why you need regulation, to protect investors.

When you look at something like GameStop, what is your initial take on that? Is it a little bit of a wake-up call for those large hedge funds?

Yes, but ultimately the price of a stock doesn’t determine how well the company’s performing. Whether hedge funds short the stock or owns it, actually shouldn’t really matter.

More of a moral question is, should short selling be banned? Maybe, but I think if it wasn’t a hedge fund, it would be someone else and the fact that a herd of investors are able to manipulate a price up to where it is, it feels a bit wrong. It’s so artificial, and what goes up, comes down and so all the people that have bid it up will then start losing money on the way down.

If we look at retail investors, do you see that there’s some potential issues with that as well, where there’s this little bit of a frenzy with people who don’t have the same sort of analysis and insight that you guys might have?

It’s sort of like a revolution, retail investors taking over the market. I think it’s fair to democratise investing, it’s equal for everyone to have the opportunity to invest. I like that side of it. The downside is that there’s a lot of risk in investing and I think people aren’t aware of that risk.

People have bought GameStop when it’s up 1200% and then when it falls, they could lose savings that they’ve put away to buy a car or deposit for the house. It’s money they can’t afford to lose. That’s the risk.

If we can improve investor education, which having things like KiwiSaver really does help, then ultimately that’s better for the long term. Because we do want to democratise investing so everyone can invest and make money from big businesses, we don’t want to leave it just to a small group of the wealthy.

Like anything in life, the way to learn is to make a mistake. You can’t come across any investor in life who hasn’t made a mistake and lost money. When people lose money through their Sharesies or Robinhood account, they’ll get a wake up call that things don’t always go up and they’ll learn from that. Everyone learns from their mistakes. So long as it’s just not too painful for people.

You talk a lot about not only the successes that you’ve had along the way, but you’re very open about some of the mistakes. Can you talk about the importance of that and has that been part of your success as well?

When you’re a new investor, you think, ‘Why should I make a mistake? I don’t need to make a mistake. I can get everything right.’ But the reality is, if you’ve got a batting average seven or eight out of 10, you’re doing really, really well.

You can’t expect to get everything right and we know that. What we do when we make a mistake is, we first of all try to cut the loss as quickly as we can, once we identify that it is a mistake.
What early investors or young investors will do is that they buy something and they’ll have a view; ‘I’m going to buy Apple because I think that they’re going to ship X number of iPhones.’ And when they don’t ship that number of iPhones and the stock goes down, they say, ‘Yeah, but I still really like Apple. I’ve got a phone, I’ve got a MacBook.’ And so even though their investment thesis no longer stacks up, they hold onto the position because they’ve got an aversion to taking a loss.

What you try to do as a professional investor is take your emotions out of it to say, ‘My thesis was this, that hasn’t played out, so I need to sell.’ You see your mistake and you go back and say, ‘Well, why didn’t Apple ship that many phones? What did I miss in my analysis originally? Oh, it’s because of that.’

You’re trying to collect knowledge along the way all the time and then if you can keep applying that knowledge to the next idea, then you theoretically get better at what you do.
Is that still a battle for you, to take the emotions out of it?

I’ve always been quite a conservative investor. For me, when things start to look a bit shaky, I always want to cash up, but the reality with that is that you need to be fully invested 80 or 90% of the time to capture the upside, because a 2% down day doesn’t necessarily signal the next big bear market.

One of the challenging things for us in 2020 was that we actually did cash up and short the market when COVID first came out. But we were a little bit early into it, we were concerned back in January when it was breaking out in Wuhan, so we started shorting the market, but it kept going up.

We were initially losing money and it wasn’t until when it broke out in Italy, that the market started to get a bit concerned in late February. And then, as you know what happened after that, we did make a lot of money.

But then, from April onwards, we had to say, do we still remain cautious, or not? And that’s the challenge because you’ve got your emotions. When you’re sitting at home in lock down, everything feels really scary, the world’s going to end, I’m queuing for toilet paper; should I be going back into the market? Because your emotional brain is saying, ‘stay out, stay out,’ but actually your logical brain is going, ‘This will pass. I should probably use this as an opportunity.’

The economy just did its own thing and went the other way. Did you have a sense that some of the talk and some of the sentiment happening at the time was not really reflective of reality?

Yeah. I bought the house that I’m in now during lockdown, because my view was that rates would stay low and that would stimulate the market. I didn’t have a view as to what would happen with COVID in New Zealand or how that will all play out, but I thought that low interest rates will be very stimulatory for property.

It was hard to see a GFC style event, because this was not banking, credit crunch related, it was not a stock market event, like ’87. It was just we had a virus that was going around. We spent quite a bit of time trying to work out, how bad is this virus, even though we’re fund managers. Is this an Ebola or is it a bad flu? So after we determined that, it helped us to decide that we think that this will pass and that now’s a good time to get into markets.

In addition to that, the reason why I thought it was not wise to be pessimistic beyond April was that there was a lot of money getting thrown into the system. Huge amounts coming from all the central banks, as well as governments, which we hadn’t had before.

It was unprecedented at the speed that it was coming through. So it was very hard to be bearish, with things like property in April and May when all this money was sloshing around.

What is your feeling for 2021? Are you still optimistic?

Yeah, absolutely. If we survive last year, then surely we will thrive this year. We may not be able to get our passport out yet, but I think the ingredients for a positive year remain.
We’ve still got the low interest rates for housing, unemployment has remained low, obviously with the exception of those involved in the tourism industry, and people saved a bit of money during the eight weeks of lock down and they’ve got that spare capacity to now use that in other parts of the economy.

When you look at New Zealand, where are the sectors that you see growth in?

New tech is always a place to go in terms of earning a multiple of your investment over a period of time. That’s where you make the big money. There’s not a large amount of new tech ideas on the NZX to look at, so we tend to focus further afield for our ideas generation. But you can make good money by having a counter cyclical view of something or picking something ahead of the curve.

If you had a belief that borders would open back, then you could make an investment in travel and tourism companies on the belief that from 2022 onwards, things would recover. You might even say, people have been locked at home now for two years, so probably the first thing they’re going to want to do is go on holiday to the Gold Coast, or Americans are going to come down here and check New Zealand out.

Those things could be really positive for those types of companies from 2022 onwards. But you do have to take a view, it’s not going to be handed to you on a plate saying, this is exactly what Air New Zealand or Tourism Holdings will earn next year. You have to make an educated guess.

With the perspective that we now have with the GFC, do you see anything happening now that we will look back on one day and go, ‘what were we doing?’

I think possibly what we’re doing is that, by lowering interest rates to zero, we are creating a moral hazard because the cost of borrowing is so low that people feel they can take risks over and above what they’d be comfortable with.

Let’s say term deposits are now 0.85%, most people will not bother with that, so then they need to go out and take more risk than they might otherwise do. Are they going to buy a property? Are they going to go into shares? They’ll go into something which is inherently much more risky, so that is the biggest problem.

It’s not necessarily as specific as products that were created, which then collapsed. It’s more about that fact we are encouraging people to take risk by dropping interest rates to where they are. That’s kind of what they want to do because that’s how you stimulate an economy to revive it and get started again. You encourage people to borrow and to lend and to start new businesses. But when the money’s free, there’s not so much incentive to pay it back.

With so much focus on levers and monitoring the economy, do you get the sense that we will necessarily have the recession ups and downs that we’ve had previously?

We previously would run hot and cold and they could move interest rates up and down quite a significant amount. Going into the GFC 2008, I had a floating mortgage at 11%. Now I’m on fixed 2.5%, so there’s just not as much room to play with anymore and it seems that the only way out is to just keep giving more money.

Also I think politically, we’re in a situation where nobody likes recessions, nobody wants to be in one, so we’ll do everything we can to avoid them. Whereas I think possibly in the past, people accepted that we would just go through them. That’s what life is. Now we don’t want to feel any pain, so we always expect to be bailed out.

Is it important for proper economic function to have a recession that clears out all the old dead stuff to allow for something new?

Yes, that’s survival of the fittest, however, it’s not popular. I agree with the view that those who rip investors off and conduct business in a semi illegal way should be brought to justice. But it’s hard for people who don’t have investment knowledge and put money into finance companies because their broker or advisor told them to and then they lose it all. It’s harsh, particularly with life savings. It’s good to do a cleanse, but maybe not a massive one.

How would you describe the culture that forms the foundation for Pie Funds?

People are really passionate about what they do. Typically, the people that I’ve employed to work at Pie Funds or Juno have come from much larger organisations and want to come to a smaller firm where they can really be themselves and bring that passion, which was possibly squashed a little bit in a larger company, and really flourish.

Lots of our staff always say that they work with a real A Team and there’s nobody at the company who they feel is dragging the chain.

How do you maintain that boutique feeling as you grow?

There was definitely a period where we hit a few cultural wobbles when we hired 25 to 30 people in a short period of time. We had to sit back and reestablish who we are and what we want. I think any organisation will go through those phases, if they’re going from one person to 50 or a hundred or a thousand. You have to say who you are and what you believe in.

I think even for a company like us, there were periods where the vision was a little bit lost for new people coming in. So we spent quite a bit of time in the last 12 months working on that to make sure that everyone who’s there now, who maybe wasn’t there five or 10 years ago, really understands what the company’s vision is.

How do you describe that vision?

We’re focused on service and performance. We exist to make money for clients and to deliver that performance with really good service, it’s the only reason we’re there. If we’re not doing those two things, then we’re not true to label.

Surely that should be what every fund is about. Why is that not necessarily the case?

If you look at the KiwiSaver market, a good 80 to 85% of the money is managed by banks. I would say that possibly at a high level, they might say to the shareholders that’s what they’re focused on, but it’s pretty hard for a junior employee to buy into ANZ’s or BNZ’s corporate goals, because they don’t really feel that.

Sometimes you get bigger companies that have a vision that people can understand. If you use Tesla as an example, or even Apple, people really love the product and so they can really get behind the message and the vision. It’s pretty hard to say that people love mortgages and they’re behind that. I think that’s the difference in why it gets lost.

Have you noticed a shift, even since 2007, in the driver for people looking to invest? Is it becoming an intergenerational thing?

Yeah, definitely. When I first started investing, the people that would’ve had money then were Baby Boomers, and they would always talk about the 1987 stock market crash. That’s pretty much all they could remember, and it’s why they didn’t invest in shares and why they turned to property from the late 1980’s onwards. That cohort of that population has actually done really well out of property, so who can blame them for turning their back on shares.

The new generation that’s come through, of millennials who have perhaps not been able to get on the property bandwagon, have had to turn to other forms of investment.

I think shares and investing has come of age in the last five years, so not only are they able to access it themselves more easily – they don’t have to sign up to a brokerage, they can just do it on their phone with Sharesies or Robinhood apps -, but also they’ve got their own retirement savings that they’re looking after themselves too, which is completely different to what the culture was 15 years ago.

When you’re doing your wrap-ups, I’m blown away by the level of analysis. Do you take credit for setting up those systems or has it really evolved?

It’s definitely an evolution. I always say that you should try and hire people that are smarter than you, that’s why the organisation continues to grow, evolve and flourish.

I think what’s happened is that we took the original formula that I had, the secret herbs and spices, and we’ve added to that and expanded that and evolved it over the last 13 years.

It’s easier said than done in a lot of ways to hire people that can show you up in certain areas and a lot of people don’t do that. Was that tough on your ego?

I think hiring people that are smarter than you allows you to fulfill your dream. If you want to take all the credit yourself, then you’re a slave to your own success because it means that if you stop doing what you’re doing, then the business doesn’t grow anymore.

Ultimately, what you want to do as an entrepreneur is build a business up, so it doesn’t need you anymore.

As you brought smart people in, were there things that you hadn’t considered, or seen before when you were working by yourself?

Yeah, definitely. In the early years, I had to come up with all the ideas and all the strategy myself. So reaching a point where I could step back, allow people to make decisions and actually realise, ‘Oh, that’s actually probably better than what I would have come up with.’ It’s a good feeling when the student becomes the master.

You’ve got a very global outlook. Are you excited by any markets in developing countries?

Yeah, one market that we’re looking at is Vietnam. Vietnam is currently classified as a frontier market, not an emerging market, and yet its economy is bigger than a lot of emerging markets, like Malaysia, for example.

Vietnam has been rated as the country that’s had the second best response to COVID, behind New Zealand. It’s got a younger population, it’s got a much higher growth rate, and actually as a result of COVID, a number of people realised that they couldn’t just rely on China solely for their supply. So more companies are using Vietnam now.

In your end of year wrap up, you were talking about the importance of value, as opposed to just focusing on growth. Does that indicate that you’re getting slightly more conservative going into 2021?

No. We’re remaining fully invested for the moment, it’s just that we’re cognizant that the market is paying more and more for growth and so growth is getting more expensive. It’s just something to be aware of because at some point the music stops and when the music stops on highly valued companies, prices can fall.

We’ve just mentioned GameStop. It ran from $12 to $400. Today, it’s back under $100. So, things that run up rapidly, without fundamental valuation support, let the air out of the bubble and it goes back.

What’s the best piece of advice you’ve ever been given?

Probably just to keep going. If I take the GFC, when Pie Funds first started; starting with 10 clients and $3 million and a year later, still only having 10 clients, but only maybe $2-2.5 million.
Most people would’ve thought, you should probably just pull up stumps, but actually having the tenacity and the resilience to keep going and seeing that a lot of things are happening because they’re outside my control, the world will eventually heal. If I can keep doing well, then build it and they will come.

We experienced the same thing when we launched our KiwiSaver business two years ago. It took awhile for momentum to get going, but once we’d established a track record and performance and people started hearing about us, new members came.

It’s having that resilience in the first year or two of starting something.

Has there been a crossover between some of your successes as an investor, and then the long-term thinking of running a business, such as not panicking when things are down and just sticking it for the course?

Not consciously, maybe subconsciously. I haven’t thought about the two crossovers to be honest. The only thing I’ve really realised in being an investor is that founder-led businesses tend to be much more successful than those that are run by a corporate management team.

A founder is able to always bring back the ‘why’ to the business; why are we here? Why are we doing this? They can keep the company on brand, because typically a corporate will always be focused on the bottom line with a hired management team.

So rather than the psychology, I’ve thought about it more as what I can do to help Pie is be there as that founder with the vision and making sure we stay on brand, as opposed to being the guy who’s in the weeds and focusing on the bottom line.

Find out more about Pie Funds by visiting their website.

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