The word “people” deliberately includes us, other investors, prospects, stockbrokers, jour- nalists, and company directors. The market often overemphasises the short- term. Only 5-10% of the value of any company depends on the next year’s earnings unless the company has too much debt. Yet the near-term outlook dominates the discussion between company executives, investors, stockbrokers, and the media. The market also tends to over-extrapolate trends too far into the future, whether it be deflation, inflation, pandemics, the demise of bricks and mortar retailing, and many event- or news-driven perceptions, fads, and even memes which come and go. Behavioural psychology and investing Finally, investors prefer moving as part of a crowd in endeavours that have made money for others in the past, rather than investing in un- popular companies experiencing difficult trad- ing conditions – an uncomfortable alternative. These well-documented behavioural biases create the opportunity for investors with a pro- cess to moderate their own behaviour and ben- efit from others’ greed and fear. Our philosophy, process, and culture are all aimed at minimising our exposure to these bi- ases. We commit to clients that we will invest their funds as we do our own and co-invest our entire domestic equity exposure to ensure this. Such an investment process is orderly and con- sistent; through fundamental research we iden- tify undervalued companies where the market has become too pessimistic. We do this by fo- cusing on a valuation range rather than a single scenario. From this, our best ideas arise when

community outcomes. We see this approach becoming more widely adopted as ESG ma- tures from its purely exclusionary origins. “Activism” is a label with positive or nega- tive connotations depending on who you are talking to. We think of ourselves as “acting like owners” and expect company directors to do the same – for example, by having their own “skin in the game” via share ownership and seeking ASX approval for material transactions in the spirit of the regulations. Portfolio company directors are generally surprised by how wide our valuation range is. However, this is the brutal truth of any compa- ny with volatile input prices, high fixed costs, and debt: if more directors adopted our hum- ble approach when valuing companies, there would be less value-destructive M&A activity. In summary, forecasting is difficult and mar- kets are efficient, making it difficult to consist- ently “beat the market”. Investors should focus on identifying human behavioural bias and de- termining what is priced into the share price to improve investment returns over the long-term. The word “merlon” is instructive as to our name and method. A merlon, in medieval ar- chitecture, is the solid part of a crenellated em- battlement, the strongest point that protects the defenders.

we can surmise, through reliable evidence (and experience), that the worst market concerns are already factored into the share price. This also has the benefit of limiting the risk of permanent loss. This concept of a range is grounded in humility and recognises the diffi- culty in forecasting. Our best investments over the past decade traded at or even below our downside scenarios, including Ampol, Blue- Scope, News Corp, Origin, Pacific Brands, Qan- tas, TradeMe, Virtus, and coal and oil producers. Company directors are equally vulnerable to behavioural bias of greed and fear, jettisoning out-of-favour segments and doubling down on

expensive acquisitions. This leads to procycli- cal capital allocation. When Boral acquired US-listed Headwaters in 2016, we noted publicly on our website that the company had paid 38x free cash flow, only to see the business sold for $1.2b less four years later. Headwaters was a “roll-up” and the fact its own share price had climbed 10x since GFC lows was overlooked when it was acquired. Regarding Environment, Social and Govern- ance (ESG) factors, we favour active owner- ship over divestment and engage proactively through formal letters to portfolio company directors to improve investment, business, and





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