Market Watch: Coming of Age

Zhang: Nobody has ever asked me this question before! It is such a critical question. A lot of it is about instant gratification. That creates anxiety. I am sure you can cite so many unhealthy behaviors, based on behavioral science. I go back to what Benjamin Graham said: Over the short-term, the market is a voting machine. But over the long term, the market is a weighing machine. Short-termism also creates opportunities for investors like me. We are investors, not traders. The power of compounding should outshine any short-term trading, in my experience. If you sell a stock with a gain of 20%-30%, then you have to find another one. We look for exceptional small companies and don’t find that many. We look for gems. That’s why I run a focused portfolio. To use a garden analogy, we are planting the seeds to see the flowers blossom in three to five years. Eventually it will be beautiful. We spend a lot of time differentiating. A lot of people react and over-manage to quarterly results. We spend a lot of time understanding the bumps in the road. It is very important to let the market serve us. I actually get excited when there is a big disconnect between the fundamentals and the stock price. Owning a relatively small number of companies enables us to become experts on those companies. That leads to high conviction, bigger position sizes and potentially more alpha generation. MarketWatch: Can you name a company held by the fund that you are particularly excited about? Zhang: Veeva Systems (VEEV, US) was the fund’s top holding as of Jan. 31. The company started in 2007 and went public in 2013. They provide cloud-based software for the pharmaceutical and life- sciences industries. They started with customer relationship management (CRM) software through a long-term partnership

We have a combination of high quality and high growth. Our estimated three- to five-year compounded annual EPS growth rate for companies in the portfolio is 19% compared to 14.3% for the Russell 2000 Growth Index. The weighted median net margin for our companies was 11.1% for 2017, compared to 5.8% for the index. Our ROIC [return on invested capital] number was 14.7% versus 11% for the index. We generally don’t invest in biotech companies, because we are trying to avoid companies that face binary outcomes. MarketWatch: Such as clinical trials for drugs? Zhang: Yes, that’s a good example. MarketWatch: Can you describe any painful lessons you have learned about selecting companies for investment? Zhang: Very early in my career, I used to think if a company had a fantastic product that anyone would be able to run it. I knew of a company that had great products but didn’t know how to sell them at a profit. This particular company just wanted to grow for the sake of growing. They basically were selling at a discount. I talked to the CEO, who was supposed to be a visionary but didn’t know how to sell. We sold the stock and later on the company was acquired at a minuscule price. It is about being differentiated — knowing how to sell and to do it profitably. I am very wary of hyper-growth companies. We have to make sure companies have sustainable growth with profitability. If they are not currently profitable, we have to see a clear path to profitability. MarketWatch: Do you believe the problem of “short-termism” among investors and the financial media has gotten worse? It seems money managers are being held to impossible standards, as long-term strategies can take years to play out.

with Salesforce.com (CRM, US) and are now the market leader for CRM in the life sciences industry. Soon after their IPO, Veeva invested in Vault, which is a content-management platform that was initially for the life- sciences industry. A lot of key people in 2015 were skeptical that Vault could be successful. But I felt it was a very critical area and that Veeva was a very innovative company. I believe in their ability to make it successful. We started to invest in 2015 because we thought they had the potential to be dominant in that life-sciences CRM space. The total potential market for Vault, just for life sciences, is over $4 billion. Now they are expanding into other regulated industries through Vault. They call it Quality One. It is for industries, such as chemicals, cosmetics and manufacturing. Another new product coming to market is called Vault Safety. So total TAM [total adjustable market, or potential market size] for the company is about $9 billion. The company’s revenue is still less than $700 million. The company has a GAAP operating margin of 23%, which is the highest in the SaaS industry [software as a service], which includes Salesforce.com. They have no debt. They have $762 million in cash. We expect the margin to continue to expand because Vault has higher margins. Vault is now providing 39% of total revenue and that has continued to grow very rapidly because the potential market for Vault and Quality One is a very fragmented, paper- based market waiting to be disrupted. This is why it is our top holding. Veeva is a cross between health care and technology. It represents our portfolio and my philosophy very well.