Maggie: [00:00:07] Welcome back to another episode of the Hearts and Minds podcast. I'm Maggie O'Neill, head of Marketing and Operations. Thank you for joining us today. So what is the Hearts and Minds podcast? It's a series of interesting and curious conversations with the brilliant minds that are part of the Hearts and Minds ecosystem. The team is lucky enough to work with extraordinary individuals, and we want to invite you to join these conversations to learn more about their investing and impact. Today, I'm joined by Hearts and Minds CIO Charlie Lanchester for another conversation with one of our fund managers. Hey, Charlie.
Charlie: [00:00:37] Hey, Maggie. Great to be here again.
Maggie: [00:00:38] So today we're joined by not just one, but two very impressive managers from Magellan. Can you tell us a bit more about our guests, Alan Pulen and Elisa Di Marco?
Charlie: [00:00:47] Yes, it was great to have Alan and Elisa here today. Both are portfolio managers at Magellan in their own right, but also cover the stocks that we hold in the Hearts and Minds portfolio. Alan has been with Magellan since 2012 and is currently the head of financials and manages the high conviction there. Tassie born Alan started off as an economist at the RBA and truly loves analysing companies, financial companies in particular. Elisa is the portfolio manager of the Magellan Core International Fund and is also head of ESG in Magellan. Elisa is very intellectually curious, which comes across in the podcast. She studied finance and economics at uni and went off to do a PhD in finance as well. So she also understands that part of the market incredibly well. While she enjoyed her time at APRA, stress testing banks, it's clear that she also loves markets and picking stocks.
Maggie: [00:01:33] Yeah, it was fascinating to hear about both of their career journeys, especially the moment that they stepped up to managing client money. So it's really interesting to hear how people got to where they are.
Charlie: [00:01:41] Indeed, it's a question I love to ask from managers because I think everyone remembers the day they first had a portfolio to manage. It's stressful, but also very exciting. And no story is the same now.
Maggie: [00:01:52] A very memorable day in your life, I'd imagine. Yeah, and it's great to also learn about Magellan's approach to high conviction investing. It's obviously very much fundamental to who they are as managers and learning the process that they use to select their three stocks that go into the HM1 portfolio, as well as navigating the financial markets, focusing on the long term and how to avoid that short term noise that can often cloud judgement and is only getting louder and louder these days.
Charlie: [00:02:16] Yeah, look, I think their model is very well suited to Hearts and Minds and I find it particularly interesting to hear their perspective on quality versus valuation and also what they think of Hearts and Minds and the philanthropic purpose behind what we do.
Maggie: [00:02:27] Well, on that note, let's dive into the conversation.
Charlie: [00:02:34] Welcome Alan and Elisa to Hearts and Minds podcast. Thank you for being with us.
Elisa: [00:02:38] Thanks very much. Pleasure to be here.
Alan: [00:02:39] Thank you.
Charlie: [00:02:40] In this podcast series, I'm speaking to a lot of our managers and no one career path is the same. One of the things that we do have in common, though, is that they've all been successful in making a shift from analyst to fund manager. And today, I'd love to start off by delving into a bit about your biography in the funds management world and when you made that step up and what it felt like maybe starting with you, Alan.
Alan: [00:03:00] It's a good question because I've actually always been interested in stocks. I was one of those kids in high school, in university, who, you know, kind of fell in love with the stock market, realised that if you really want to create long term wealth, that this was the best way to do it. This is the best way to invest your money. But, you know, I didn't come from a household where we did stock trading or anything like that. We didn't really have that background. And coming from Tasmania, there's no real funds management industry down there as such. So I always thought it was, you know, something fascinating, something I could do personally. But as a career I would have loved to do it, but I really had no idea how to get there. So I actually studied economics in university and I thought that's a good background in terms of how markets work, how the economy works. But I ended up at the Reserve Bank as an economist for the first part of my career. The first six years I always knew I wanted to get into markets, didn't quite know how to get there, but that did provide a really good grounding in markets. I covered banks for the Reserve Bank, so I've got a really good understanding of how balance sheets work for banks, how they actually operate. And then an opportunity came up to go to Mapple-Brown at it, a value boutique here in Australia. Great little fund manager, value fund manager, and that was my introduction to being an equity analyst and they obviously very focussed on valuation. So I knew the fundamentals of how kind of financials worked. They added the whole valuation, how to think about markets, how to think about the nuances of equities that you just can't learn from a book. So that was fantastic. And then over a decade ago, the opportunity came up to go to Magellan. And Magellan, of course, combines quality and value and those are the way I tend to think about stocks. It was a perfect match and you're looking at the best stocks globally. So really a great opportunity as an analyst. And I went there as an analyst in the financials team. I was there for about four or five years doing that and then the opportunity came up to step up as a portfolio manager, working on one of our kind of seed products, a sustainable fund based in the US. And that really was ultimately bringing it all together for me. So I loved analysing stocks. I still analyse stocks by the way, because I find it really interesting. I think you never want to lose those skills, but this was then putting it all together, you know, taking that view of macro geopolitics where it's the value in the market, where do you want to be leaning into? Where do you want to be leaning out of, as well as combining it with that bottom up kind of stock analysis and understanding the fundamentals of each stock to craft a portfolio that's going to deliver the kind of risk and returns that you've promised for clients. So it really was a great opportunity to bring all that together. And ultimately, what I've been thinking about at high school never thought I would get to do. I'm now doing, you know, for a job, something I would enjoy doing. So it was amazing.
Charlie: [00:05:52] Yeah. Look, it's a big step up, isn't it, that first day when you're actually in control of a portfolio with no one, you know, you don't have to go to anyone to buy a stock. It's you're in charge and it doesn't suit everyone, actually. And a lot of very good analysts never really make that step up. But it sounds like it would have been a very exciting day for you that day. What was it like?
Alan: [00:06:09] Oh, yeah. No, it's really exciting to get that opportunity to show that you can take that bottom up knowledge and combine it with, you know, there is a lot more to think about a portfolio level in terms of portfolio construction, risk, aggregate exposures. But given my I guess economics background, you know, thinking about markets as a whole, thinking about those big risks, it really suited how I think about investing and the opportunity to, I guess to put your skills to work to deliver good outcomes for clients was just something that was a great opportunity. And of course, more recently I've been looking after the High Conviction Fund at Magellan as well. So just a fantastic opportunity for me to deliver for clients, which is great.
Charlie: [00:06:53] Yeah, right. Well done. And we'll come on to that High Conviction Fund a little bit later. So maybe turning to you, Elisa, you're in the hot seat now. I know you've got, I think, a background in financials as well, but what was your journey?
Elisa: [00:07:03] Yeah, So I was always interested in companies and I think a big part of that is family upbringing, that we had a lot of small businesses. So I was like, Alan, I studied finance economics at university, then did a PhD in finance. I just wanted to keep that kind of intellectual curiosity and that, that love of research. So then I went to sell side really like markets love research and I was covering banks and an opportunity came up to work at APRA and do the bank stress testing. So it was super interesting project, absolutely loved it. But I kind of really learnt at that point that I need to be markets like that's what we're really where my passion was. And it was actually Alan about eight years ago that hired me into Magellan. So thanks Al, and I was in the financials team and I've covered a range of stocks over that period from banks to diversified financials. And the opportunity came up probably about four years ago to work as part of the ESG team, but also the core series team at Magellan. And so the core series, I'm not sure if many have heard of it, but it's really a differentiated product offering that Magellan has recently come out with that is lower cost, but just leveraging that important investment process that Magellan has been nurturing for over 15 years, and that's just how to identify quality company. And to Al's point, it really kind of fits in with how I believe in investing should be, and that's finding those companies that can continue to generate those sustainable and attractive returns. So it's been quite a journey and learnt a lot along the way. And I really love what we get to do on a day to day basis.
Charlie: [00:08:30] And what's your favourite part of the job when you look at it?
Elisa: [00:08:33] Oh it's so hard. Depends on its markets, so you never know what's going to come at you on each day. But I've really loved looking at ESG more in depth over the past four years. It's always been part of our role because ESG risks a like all risks and we should be looking at them. But it's been a great opportunity to engage with companies and talk to them about how they're approaching the management of a particular risk. And then it's taking those learnings and talking to a related company and trying to encourage them to either take on best practice or to drive a different change.
Charlie: [00:09:03] And what is Magellan's approach to ESG that makes it different to the rest of the market?
Elisa: [00:09:07] Yeah, so our approach is very practical. So as I kind of just touched on briefly as it were, my thinking about an ESG risk, it's no different to any business risk and how we're managing those risks. We're looking at, well, what is the exposure of this company and what is the impact? And we want companies to be focussed on those material exposures, not on just having hobbyhorse or trying to drive impact in every particular area. It's really what can impact cash flows. And so that's kind of, I think, really quite unique about our approach to integrating ESG into our portfolios and our analysis. Then the next part is how we engage with our companies. We have these concentrated portfolios and that means that we have really strong relationships with companies because we've been looking at them and investing in them for well over a decade, which means that we're able to talk to our companies, not only to learn about them, but then to influence them, to try and drive that positive change made in ESG topics or in other aspects of their business.
Charlie: [00:10:03] Great. That's really interesting. Alan, so you ran the High Conviction Fund you mentioned before.
Alan: [00:10:07] Along with Nicky Thomas.
Charlie: [00:10:09] That's right. It's a dual role with Nicky that is perfect for Hearts and Minds for our core managers, of which you guys are one. We're asking for three high conviction positions and in fact, congratulations. Your positions have been, I think, one of the better performing or not best performing fund managers within our stable. So congratulations. They've been good picks and we're going to, in the second part of this podcast, do a deep dive into two of those stocks. But maybe zooming out a little bit, what approach do you take to making those high conviction positions, what sort of businesses you're looking for, and how do you come up with them from a global suite of thousands of stocks?
Alan: [00:10:43] Yeah, I mean, it's a good question. There are obviously, you know, thousands and thousands of equities out there. And we zoom right down into, as I say, you know, 10 to 20 key stocks in the High Conviction Fund. And it really goes down to Magellan's DNA. What we're focussed on, we've always run fairly concentrated portfolios. We don't believe in overly diversifying because you end up spreading from really high quality companies into lower quality companies if you spread too far. So we think we can achieve adequate diversification with a suite of high quality companies, and that's what Magellan is all about. Quality and value is our key kind of characteristics. And in terms of quality, I could go on a long time here, so cut me off. As soon as I go too far. But you know, if you're familiar with us, you'll know that economic moats kind of form the core of that quality view. The easiest company does not have sustainable competitive advantages? And that allows it to earn high returns on capital. Now, normally in capitalism, back to my economics background, that should encourage competitors to come in lower prices and compete those gains away, and it ends up being a poor investment. So we're really looking for those companies that have those competitive advantages that really allows them to maintain that pricing power, that monopoly type positions perhaps, and earn excess returns, not just now, but we look forward not, you know, three years, five years, we look forward ten, 20 years. What's the position of this portfolio of this company going to be 10, 20 years from now? Will it still be earning excess returns? Will it still be a good investment over that long term time horizon? So when we talk about economic moats, we're talking about things like network effects, strong brands, economics of scale. But most of our key companies actually combine a bunch of these things together to form almost kind of impregnable businesses over time. That will constantly be attacks because they do earn such good returns, but they have those defences in place where we're confident. I can't tell you where a stock is going to be a month from now. I have no idea. Right. That's just short term noise. But we can tell you with high confidence in three years, five years, ten years, they're going to be worth a lot more than they are today. And that's a difference between being an investor by being a speculator, I'd say he's just focussed on perhaps a short term upward trend or something. So we're really focussed on those high quality companies and their economic moats.
Charlie: [00:13:08] Look, that's a great summary and he definitely didn't go on too long. So well done. Well done then. Elisa, I'm going to ask you the harder question. When you make these high conviction picks at Magellan, you know, occasionally you're going to get them wrong. No one gets it right all the time. How do you avoid anchoring to that investment case that sounded so good at the time and you that really made sense. You know, how do you reflect and pivot and change a position within a portfolio?
Elisa: [00:13:34] Yeah, it's a really important part of the Magellan process. And I think really come down to the fundamentals that Alan has outlined and that importance of quality within our portfolio construction process. So when we're thinking about companies, we try and avoid that anchoring bias. And a big part of that is that we're having discussions within the team, be it sector teams, with the portfolio managers and then at our investment committee, where we're really trying to challenge our view as to, well, why do we think that this company is quality? Why do we think it can continue to earn those excess returns through time? And so as part of our investment process, we are continuously monitoring our companies. And the big part is just what Al had mentioned there, is that these companies are earning the best margins in the index. People want to really try and take some of that time, those strong economics. And so we are asking ourselves the questions of, well, what has this industry structure changed? Has the strength of this business been deteriorated because a particular competitor has has come to the market, that there will be times where the answer is yes. But a lot of the time it's just like, no, we're very comfortable with where this business is at the moment. We're very happy with the quality of the business. And I think it's that consistency in approach and the discipline to keep reviewing whether or not this business is quality. And that's a really big part of the portfolio construction within all of our portfolios and very much so within the core series products, the ones that I'm the portfolio manager of because we don't have a valuation piece within how we look at, how we're constructing the portfolio, it's just about our view on quality. So that continuous monitoring of, well, do you meet our definition of a company that can continue to earn these excess returns is a really important part of ensuring that we're investing for the long term.
Charlie: [00:15:15] Fantastic. And do you want to add anything to that?
Alan: [00:15:17] I was just going to add like it's exactly right and we've got a great team at Magellan. Like we get along really well because we're all stock nerds basically, but it's a very intellectually curious team in that we're not afraid to. We like discussing stocks and we like having different views and challenging each other. So, you know, and we do have absolute experts in what they're doing within the team. So you've got multiple people who know these stocks really well and can have a real debate on, well, is this actually a challenge to the economic moat, you know? Does AI and ChatGPT challenge the moat and search for Alphabet? Things like that are constantly being debated within the team. So there's always a good little bit of pushback.
Charlie: [00:15:57] That's good. I mean, I do think one of the hardest things in financial management is having that self-discipline when a stock's down 30%, but actually something has changed and it's time to move on to another one. But it sounds like you've got a great team in place and you know you do that when appropriate. Maybe moving on to heart to mind. You know, one of the things that attracted me to this new role is the philanthropic angle and giving back to medical research, which is a whole new area for me to look at. And it's a fascinating area. What was it that drew you to Hearts and Minds when you first learned about it?
Alan: [00:16:29] Well, I think it was a lot of it, frankly, came around the office, just walked around the office before the IPO and said this is something we're going to participate in. And so I've been invested since the IPO. I took up some shares then, and it's just such a great idea. One, you get obviously concentrated stock picks, which is what I like as an investor. You know, you can get top stock picks from a bunch of really good investors, you know, peers we respect and then you get getting the philanthropic part of it. I was sure I was going to mispronounce that. So happy I didn't. But you know, that's just such a great angle to know that you're actually doing good. You're getting a high quality investment and doing it off the back of it. So it's a real win-win as an investor.
Charlie: [00:17:15] And Elisa, what's your impression of Hearts and Minds?
Elisa: [00:17:19] What I'm like I think is amazing about what Hearts and Minds is doing is that you're having an impact. And that's a really important part of when we as investors, what we want to be able to do. So that's when we think about ESG investing in Magellan. It's all about how we can have an impact, our companies able to have an impact in the sphere that they're in. And Hearts and Minds is giving investors the opportunity to invest, but also then to have that positive cause going forward. And I know personally my father benefited many years from the research from Victor Chang, and that's a big part of what Hearts and Minds is been able to do.
Charlie: [00:17:55] Well, thank you both for being part of it. It is a wonderful structure and I think gives great longevity to some of these organisations. In terms of the listed investment company structure that we've got that we can keep giving every year with with a certain amount of conviction. So thank you both for being part of it.
Alan: [00:18:09] Thank you.
Maggie: [00:18:11] Well, plenty of great insights in that first half of the conversation, don't you think?
Charlie: [00:18:14] Yeah, look, absolutely. I think it's very clear that the two of them work incredibly well together and there's a lot of camaraderie there.
Maggie: [00:18:21] It's great to observe, actually. And as you know, they call themselves this. I feel very comfortable saying it, but there are close teams of stock nerds, particularly financial nerds.
Charlie: [00:18:29] Yeah, look, absolutely. It was never my favourite part of the market to analyse that, but they certainly know what they're talking about.
Maggie: [00:18:35] Well, I know that you're not in the hot seat, but I thought I might turn the question back to you, saying how can you out of here have other people's stories? Tell me, like, what was your first day like when you stepped up to manage other people's money?
Charlie: [00:18:45] Yeah, look, good question, Maggie. I remember it clear as day. I was at Perpetual at the time Peter Morgan had left and set up his own business. And not long after I was given a small slice of the famous perpetual industrial share fund to manage, we had a great culture going back in the day at Perpetual at that time, and I really enjoyed that first day of actually being in control of a fund.
Maggie: [00:19:03] I can imagine a massive day. Well, I don't know about you, but I'm really looking forward to this next half. The conversation where you talk about the HM1 holdings that we have that Magellan have recommended both financial names, which is not surprising given it's Alan and Elisa's bread and butter. What stocks are we covering today?
Charlie: [00:19:19] Yet today we dive into MasterCard and Intercontinental Exchange or ICE and it was great to learn more about these businesses. I think everyone will have heard of MasterCard but perhaps not so much Intercontinental Exchange and I think both Alan and Elisa really distil what it is about these companies that make them good investments in a very easy to understand way. So I really enjoyed the company.
Maggie: [00:19:38] Yeah definitely. And the opportunities they're saying ahead too. Well, without further ado, let's jump into it. Here is Elisa and Alan.
Charlie: [00:19:49] Welcome back, Elisa and Alan. I might start Elisa with MasterCard. This is a company everyone knows. We know what it does to global payment business. But what attracted you to MasterCard initially? And what about the business is there that investors are missing?
Elisa: [00:20:05] Yes. So MasterCard has really been a staple of the Magellan portfolios for probably coming on a decade now. And the reason why we like MasterCard and also say Visa, we like them both is that they are the really only true global payment networks. So with respect to MasterCard, they've got 100 million merchants that are connected to their network. There's about 3 billion individuals that have or businesses that have MasterCard cards that they're using on that network, and they operate in over 200 countries. So that's like that breadth is really hard to replicate. So what MasterCard is in the business of is really enabling global commerce. Then you just think of your own payments experience and that when you pull out your MasterCard, you can use it anywhere around the world. And what's amazing with MasterCard is that it's not just that you can do that is that you can do it securely and you can do it really fast. Something that people probably haven't heard of is that there's around 200,000 transactions that go through their network every second on average. So it's really incredible what the MasterCard network has been able to deliver. So that's kind of a bit of a background on MasterCard. But why is it do we like it and why have we been invested in it? And why are you hopefully invested in MasterCard? And there's two main reasons. One is the quality of the business kind of touching back on what we've we've talked about already. And the other is those structural tailwinds. So just touching briefly on, well, why is it a quality business? So some of the attributes we're looking for when we're thinking about, well, what makes a quality company is does that company have a strong brand scale and network effects? They're just a few or an industry structure. There are a few of the things we look at, but it's really network effects. That is why MasterCard has been so strong for so long and continues to generate those really strong excess returns. And that's because, as we mentioned, that breadth of network that they're able to connect so many individuals with so many merchants seamlessly around the world. Now, to replicate, that means that the barriers to entry are really high. We've had a lot of competition that we keep looking at. Is it different FinTechs? Is it Afterpay? Is it governments like they're coming in and trying to compete with MasterCard and it's the strength of their network, but also that power of innovation that really makes this business high quality and that they can continue to generate those strong returns. The final thing is structural tailwinds. So that's a big part of why we're in there, and that's that strength of returns that they've been able to generate. And that's really how they've continued to invest in their network. And I'm sure you all can remember times when you're paying with cash a lot more. So we've moved from cash to card and now to e-commerce. And a big part of that is the power of MasterCard.
Charlie: [00:22:44] And one of the risks, obviously, some people would think about would be digital payments using their blockchain technology that everyone was certainly very excited about a little while ago, being able to process, as you mentioned, 200,000 transactions every second is a pretty big thing. But how do you see that digital risk in the future?
Elisa: [00:23:00] Yes. So it's something that they're very much embraced. And a big part of MasterCard as a business is them enabling us to use digital transactions. So we look at it very much as an opportunity for them. And the reason why it's an opportunity is because of that consistent investment and innovation that they have made. And a big part of why MasterCard is so strong is that e-commerce opportunity where they've invested in the the fraud and the security of their business and tokenization is the word that they use and how they've been able to create that security around their products, which has been really important on how they can continue to enable these digital transactions.
Charlie: [00:23:36] Yeah, look, it sounds like the moat is getting wider, if anything, not not narrower.
Elisa: [00:23:41] Well, yes, we'd say stable because they're already such a wide moat business. So you can you get wider than wide? And so there are threats, but it's just monitoring those threats and really understanding the ecosystem. And why is it that consumers and businesses keep using Visa and MasterCard? That's really that's kind of what's protecting their moat. And as long as they continue to innovate that they can defend the economic moat that they've generated.
Charlie: [00:24:05] And what about regulatory threat? Governments you've mentioned, I think before tried to intervene. So what are the regulatory threats to MasterCard, given the excellent margins that they make? Yeah.
Elisa: [00:24:13] So there's several different ways that the regulators are looking to kind of take away the competitive strengths that MasterCard have. And one of the ones that we spend quite a lot of time on is how central banks are intervening with what we call Real-Time Payments. So this is a network that central banks are developing to essentially try and compete with the likes of Visa and MasterCard. And so what's happening is you have tens of networks that are popping up around the world. It's being done by each central bank in each country. And so the US, the dominant market for MasterCard and Visa is one that, only I think it was last week or perhaps was a week before now, where their central bank Real-Time Payment Network, called Fed now has just gone live. But the Fed have been talking about this for well over half a decade on how they would be constructing this network and what it may mean. And so we've been monitoring this development for a really long time. And we monitor every jurisdiction on how they real time networks have coming out. But the challenge with putting in a competing network is that network effect and the scale. So, so far, there's around 30 banks that have connected to the Fed now, and there are thousands of banks in the U.S. So you can imagine that its ability to compete is really so far away because you need to be able to use it at every store for consumer to even think about changing the way it pays. And then the other element is that for that network, only banks can connect. And so individuals will still be using their banks and then they might use that network from time to time. But you really need to have that ubiquitous and strong consumer experience before any threat can be there. And that power of what Visa or MasterCard continue to offer, even just think about how you use your Uber account all over the world. That's because it's being powered by the networks and that they can use it in every different country.
Charlie: [00:26:00] And obviously, MasterCard is a huge business not based here in Australia. How much stored you put on management and do you ever get to meet the management?
Elisa: [00:26:08] Yeah, no, absolutely. So we've been looking at MasterCard, as I mentioned, for over a decade, and we've got really strong relationships with management. We speak to the Investor Relations team typically every quarter, and then we speak to management usually each year. And it's a really important part of our investment process because it's only when you're talking to management that you can really kind of test them on their their latest strategies and how they continue to defend that moat. It's hard to get the sense from just reading transcripts. It's when you really talk to them and you can get the sense of how important it is that they continue to innovate and protect that consumer experience. And then also how they're thinking about the risks, what's happening with how they're going to be defending their payments and growing their payments in Latin America, where they've had quite a lot of success with their real time payment network? And how are they trying to drive change and differentiate themselves? And a big part was about their fraud and security, which is they have big value out in that jurisdiction.
Charlie: [00:27:02] Yeah, fantastic. It's such a privilege to have that access. That's wonderful. Maybe turning to you now, Alan, another financial stock in the portfolio, Intercontinental Exchange, probably not one that's as well known to our listeners. Maybe tell us a bit about what that does, that stock.
Alan: [00:27:17] Yeah, that'll be obviously a little less familiar than MasterCard. They mainly serve businesses rather than individual consumers. So less well-known but equally strong in terms of what they do in their economic moat, although quite a different source of economic moat, which is interesting. There are different flavours to economic moat. Some come from fine to some from scale, and this one's a little bit unique, but equally as strong we think. So for your listeners, they might be familiar with the New York Stock Exchange, which ICE owns. So that's a cash equities exchange, but that's actually a very small part of that business. What it mainly is, is a derivatives exchange business, and the economics of derivatives exchanges are actually incredibly powerful. They tend to be monopolies in key contracts, and there's a reason for that. So when you're doing an equity, a cash equities trade, you trade the equity, it gets settled across and you're kind of done, you own the equity and that's it. For derivatives, it's quite different when you open a position, you it's essentially you have an open position and you've got to mark that to market. You can take gains and losses within the clearinghouse. And if you can't close out that position, you're up for an unlimited loss effectively. So you have to be able to close out that position in the linked clearinghouse. So all the trading tends to congregate on a key contract, say, Brent oil or sugar or European interest rates. Well, that tends to congregate onto a single exchange. So you're not having multiple exchanges doing equities like you do in the US. You can trade on New York Stock Exchange, but you can trade on Nasdaq, you can trade on CBOE. It all goes to a single exchange and you end up with a monopoly because the ICE control both the execution and the clearing of that contract. And you have to be able to close out that position in the clearing house because it's an open position. So you always trade on the linked exchange where all the liquidity is. So it's a little bit more complex and more difficult to understand, but it is equally as powerful in terms of the economics because nobody can compete against that. You cannot compete against liquidity in the exchange and you cannot compete against the linked clearinghouse. So you've always got a double moat kind of driver there. And so you do end up with virtual monopolies in these kind of these key contracts and you end up with margins of 70, 80% on some of these kind of exchanges, the derivatives exchange business. And it's a lot lower in the cash equities business, which is. A much smaller part. So incredibly attractive. That's kind of the original driver of the investment in ice. But also they're an incredibly innovative company. I mean, this is a company that started, you know, 20 to 30 years ago with Jeff Sprecher has electrified those derivative markets, taking it from open outcry into the digital world, created huge amounts of extra liquidity, added to the economic moat, and then went and bought, you know, the New York Stock Exchange, hundreds of years old. Right. It's just amazing what they've done. And they're now turning their attention to the mortgage market in the U.S. So the mortgage market is still very analogue. It's still like you need wet signatures. You still need to, you know, physically look at documents a lot of the time or scan them in by hand. And they've said, well, with digitised these financial markets, we've seen the advantages that that has in terms of, you know, lower costs for consumers, higher liquidity for us, high market share for us and great returns for investors. And I said we can do this to the mortgage market as well. We can make this far more efficient. We can save consumers a lot of money and therefore, you know, all the mortgage originators and services will use our technology to do that. Not only that, then they produce data off the back of that, and data is the new oil. They already make about $2 billion a year from the data that they're getting from fixed income markets and their exchanges by selling that to market participants and other people. So if they can digitise the US mortgage market, not only will the users pay them for their technology to do that, but they'll drive a lot of value from the data that they get off the back of that as well. So they're just, you know, very innovative company, wide economic moat, some good growth prospects from that digitising the mortgage market. It's a real all rounder.
Charlie: [00:31:37] Sounds fascinating. How do you think about the valuation of a stock when there's so many moving parts like that?
Alan: [00:31:43] Well, we've always got a couple of key valuation metrics. I mean, we will look at a variety, but the total shareholder return that we expect and we do that by doing detailed forecasts of the profitability going forward. And then we apply what we think is a fair P E multiple to that kind of four years out. And that gives us a three year kind of valuation at that dividend yield you expect over that period and that gives you an expected total shareholder return from that stock. And we also use a traditional discounted cash flow valuation for that long term kind of value as well. And so we expect this to deliver, you know, a low double digit return on our base forecasts. But there is a bit of an upside skew there as that mortgage market comes through. And we've given them a little bit for that. But certainly potentially they could earn additional returns from that. So, you know, we do look at a variety of valuation metrics. You do tend to get a point in time because that's how valuations work. You get a DCF or you get a TSR. But we really try to think about the range around those outcomes. That's a central outcome. What is the range around that? Is there a downside? Is there an upside? And this is one where there is an upside, I think to that base forecast, which is always nice to see a skew to the upside when so many stocks obviously have a tend to have a skew to the downside. So we think it's attractively valued on both those metrics. You know, it trades on the headline P E of slightly above the market, but you know, low twenties, which is for a much higher quality company than the market is pretty attractive.
Charlie: [00:33:17] Fantastic. That's a great summary on both of those stocks. Thank you. So through our conversations with our partners, both investors and scientists, a common theme amongst all of our guests I think is an innate curiosity. I think, Elisa, you mentioned that earlier, and so I sort of a bit of a fun question. At the end of our podcast we have what is it that's piquing your interest at the moment? And it can be anything doesn't have to be market, could be a life hack, could be anything you like, maybe starting with you, Elisa.
Elisa: [00:33:42] Yeah, sure. I think this year I've got a lot of friends and family that have travelled to Europe and it's really kind of seeing all those news reports come back, not from the fun they're having, but from the extreme heat that's going on. And so I've just found it quite interesting to really just kind of like read a little bit about what's going on and largely speaking, climate change and and that you've got the polar caps. They're not as cool as they used to be. And then we're not getting this thing called the jet stream coming through. And it's just it's a reminder of the importance of all the work that that we're doing as consumers in terms of the choices we're making on a day to day life, be it with the energy we use or for products that we're purchasing, but also the work that we're doing as investors in talking to our companies and making sure that they're trying to reduce their emissions and then invest for the future. Be like Nestlé with regenerative agriculture and what that could do to our coffee crops and the importance for them to invest so that they have coffee crops into the future. So personally very important too, I have I have morning coffee, so we want to make sure that it's a sustainable commodity. So I think, yeah, that's always, I find quite interesting just reading about different real living. Samples of, well, what we're doing is is really important.
Charlie: [00:34:51] Look, fantastic. It Is great that investors like Magellan are keeping the pressure on because I think it will be corporates that make the difference even more so than governments. And turning to you, Al, what's piquing your interest at the moment?
Alan: [00:35:02] Yeah, it's a good question. And this kind of goes back to what you were discussing at the beginning. You've got to have an intellectual curiosity kind of in this game. If you're if you're just doing it as a job, you're not going to do it very well. So what's really good as a portfolio manager is I've broken out of my, you know, financials box where a lot of my analysis was earlier done and really being able to look at anything around the world, you know, advertising markets, you know, consumer goods in Europe. And something that I found absolutely fascinating and still do is kind of the semiconductor industry. Now, there's a lot of people talking about A.I. at the moment, so I'm not going to go into that. It is fascinating, but I'm sure a lot of people are talking about that. But underlying that is the incredible power of semiconductors and what's happened there over the last 50 years. That's what allowing all this kind of AI stuff to really take off. Now, the power that we have that, you know, goes all the way back to Moore's Law in 1965, that the number of transistors on a chip would double kind of every two years or so. And it's really held up more or less until the last decade. It's starting to slow a little bit, but only a little bit. And it's just amazing kind of that process in terms of manufacturing that chip. And, you know, we look at ASML, which is I think another stock within the Hearts and Minds portfolio. We look at companies like TSMC and just what they're doing to drive that processing power at a fundamental level is fascinating. It costs 15 to $20 billion to produce one of these semiconductor fabs now. Just incredible scale. One of Asml's machines is $200 million and there's now like $20 billion transistors on the latest M2 chip. So just diving into how they're achieving this, because we go into a lot of depth on all our research, I find it absolutely fascinating.
Charlie: [00:36:49] Yeah, good to get away from just financials, I'm sure. Okay, wonderful. Well, look, thank you for being with us today at Hearts and Minds. It's an absolute pleasure talking to you and good luck over the next year or so. Thank you.
Elisa: [00:37:00] Thanks very much.
Alan: [00:37:01] Thanks so much.
Maggie: [00:37:03] And that concludes another fantastic conversation on the Hearts and Minds podcast. Today we were joined by Magellan portfolio managers Alan Pullen and Elisa Di Marco. Thank you for listening to today's episode. We hope you enjoyed it as much as we did. We are very grateful to Magellan's foundational support and their true commitment to sharing high conviction stocks for the HM1 portfolio. Thank you to Alan and Elisa for joining us in studio today and the whole team at Magellan for your support. It was fantastic to learn more about your investment approach and love of financials. We'll be back next week with another episode to ensure you never miss a conversation. Please subscribe wherever you're listening to this podcast right now, and better yet, send it on someone in your network, a friend, a colleague who you think will enjoy this conversation. Your support is much appreciated. Until next time, stay curious.
