Yuri Khodjamirian on making a profit from monopolies

Yuri Khodjamirian, chief investment officer at Tema ETFs, joins Opto Sessions to discuss the firm’s Monopolies and Oligopolies ETF. He outlines how the ETF offers superior quality stocks which, by delivering mission-critical value to their customers, have attained a highly durable position within their markets.

Yuri Khodjamirian is chief investment officer at Tema ETFs, a newly launched platform offering actively managed thematic ETFs.

Tema’s approach hinges on identifying gaps in the thematic ETF market: themes that lack representation within other ETFs, where the active management approach that Tema favours can make the greatest inroads.

“We’ve actually built a tool to scan the whole market to see where the white space is in terms of thematics,” Khodjamirian tells Opto Sessions.

This is what makes its ETFs stand out: they are, almost by definition, centred around themes not represented elsewhere.

One of the most intriguing is its Monopolies and Oligopolies ETF [TOLL], an ETF that focuses on companies whose dominant, long-term share of their market provides them with both a significant moat and often unexpected growth opportunities.

TOLL

The one-line pitch Khodjamirian gives for TOLL is “better quality, globally”.

“The quality factor is something that’s consistently seen across factor studies, as contributing positively to returns.” He cites a recent study by AQR Capital Management that demonstrates that high-quality stocks tend to outperform over different cycles and geographies.

Fundamentally, the fund’s aim is to augment this tendency of high-quality stocks to outperform the market with the long-term durability that comes from companies, or small groups of companies, which dominate the market share of their industry.

“It’s very similar to the strategies that the likes of Egerton Capital or Chris Hohn pursue — they don’t say it explicitly, but these are the kind of businesses that they invest in as well,” says Khodjamirian.

TOLL focuses on companies that have attained their monopoly not by price-gouging or other forms of malpractice — “we're absolutely not that fund; we actively avoid companies that have done this kind of stuff” — but by offering sustained and indispensable value over a prolonged period of time.

“The point is that these businesses provide this incredible, mission-critical value to their customers, that they just cannot operate without. This value accrues over time and gives them the competitive advantage. They sort of chip away, and the space — like in a bike race — just opens up over time.”

For example, the ubiquity of Visa’s [V] services combined with the minimal transaction fees it charges on individual transactions gives it an incredibly strong position in the market, which over time means it becomes the structural underpinning of new markets.

“It's really telling that all of the fintechs that have tried to disrupt payments actually end up taking Visa’s rails,” he says. “Recreating that is just pointless. That's why Visa has very strong financials, because it just accrues this value over time for customers and for itself.”

Additionally, establishing this dominant market position gives such businesses strong pricing power. “The reason the ticker for Monopolies is TOLL is this idea that you’re getting a toll by providing this bit of infrastructure.

“It’s explicit in toll road operators, which are also in the portfolio, because it’s written in the regulation that you can raise prices by RPI — or whatever consumer index you use for inflation — plus a little bit.”

Monopolistic businesses don’t necessarily have an explicit mandate to raise prices like this, but they have one key advantage over non-monopolistic businesses: “If you look at some businesses, they say they can raise prices, and they usually do in periods where their costs are rising. So they’re just passing the costs on. But as soon as those costs fall away, the price is going to drive back down. Whereas, with the businesses within the monopolistic industries, because of their market position, that never really happens.”

Moody’s

Tema has four key criteria that stocks must meet to be included in any of its ETFs: strong operating base, sound balance sheet and cash flow, an appealing valuation and an edge over its competitors. TOLL is no exception, and Khodjamirian feels that its largest equity position at present, Moody’s [MCO], illustrates these concepts.

Moody’s operating base is built on its effective monopoly of the credit ratings space, as well as its database which, according to Khodjamirian, is the world’s largest proprietary database of public and private companies.

“You have this incredible thing where they see all the credit decisions that get made,” says Khodjamirian, “and they have all the information on the companies. And then they combine that together to provide tools for other people to make better credit decisions. That's unbeatable, right?”

Moody’s balance sheet and cash flow are similarly solid: Khodjamirian claims that Moody’s “cash conversion is at 90% of this business over time”.

The valuation case is one of the most intriguing aspects of Moody’s from an investment perspective. There is, he believes, a “sort of cyclical kind of bearishness” due to rising interest rates, with the general assumption that lenders will be reluctant to issue any debt.

“They forget that we issued loads of debt that needs to be refinanced,” says Khodjamirian. “We have this huge refinancing wall coming.” This misplaced pessimism makes this stage of the business cycle, in Khodjamirian’s view, “historically the best time to buy Moody’s”.

Tema’s behavioural edge, he says, is understanding this aspect of Moody’s current valuation: the pessimism which has deflated the stock is due to a cyclical headwind, and not a structural issue that is likely to hinder the stock’s long-term performance.