Henry Ellenbogen’s Playbook for Durable Growth
"Investing in small-cap growth stocks is an immensely creative process, where creativity and success are defined by the ability to see what others—most market participants—don’t see."
When Henry Ellenbogen took over the $8.6 billion T. Rowe Price New Horizons Fund in 2010, it had a 50-year record of investing in small growth companies. By comparison, Ellenbogen had only nine years of experience as an investor. He combined his experience in internet companies with fund’s broader mandate and invested in companies ranging from Netflix to Vail Resorts. He also created a private investment program to participate in late-stage venture investing and invested in companies like Twitter and Atlassian. By the time left in 2019, the New Horizons Fund had $25 billion of AUM and beaten the market with a total return of 375% (~18.9% CAGR). Today, Ellenbogen runs his own firm, Durable Capital (initially raised $6 billion), and manages $13 billion in public equities plus privates.
These are my notes on his investing playbook after reading his shareholder letters at T. Rowe as well as articles and interviews and listening to his 2020 podcast appearance. All quotes are his unless otherwise attributed.
"I had a science background as an under-graduate, and I started to think that companies are like biological organisms. They are either fundamentally healthy or out of balance. If they are in balance with employees, customers, and shareholders, they can grow and thrive. If not, they can seem like they’re doing well for a time, but eventually they’ll get out of balance."
Performance and chart courtesy of Ycharts.com:
Eliminate the “false dichotomy” of public vs. private market investing: Ellenbogen looks for the best durable growth companies across both public and private markets. He believes in the synergy of having the same team cover both markets.
Real winners are rare: Ellenbogen’s mission is to find the companies that can compound for the long-term. Once he finds one the biggest mistake would be to sell too early. Instead, he is comfortable averaging up and the flexible fund structure allows him to buy more stock after a private investment goes public. This flexibility was part of his pitch when building his private markets franchise, reframing the disadvantageous perception of being a mutual fund and not a venture firm.
Looking for Act II: Ellenbogen looks for growth companies that can have a second act after exhausting the potential of their initial market or product. While this is impossible to predict, he emphasizes management teams that make the necessary investments and create the culture and processes to scale the company long-term. He looks for the intellectual honesty required to effectively navigate difficult transitions.
Example: Vail Resorts
It’s a people business: Investing in private companies is a game of access and relationships. An important piece of Ellenbogen’s pitch is his willingness to stand by founders in tough times.
Data-driven investing: Ellenbogen and his team focus on KPIs at their portfolio companies as well as in assessing their own performance.
“Deeply human” investing: Ellenbogen analyzes his investment practice like a business and is thoughtful about the game he plays in a highly competitive market.
Learning the craft
Ellenbogen left Harvard College at age 19 for a stint as Chief of Staff to Representative Peter Deutsch (and was called the "boy wonder of Capitol Hill" by the New York Times). He returned and completed his JD/MBA. In 2001, he joined T. Rowe Price to cover media and internet stocks. Ellenbogen was appointed portfolio manager for the Media and Telecommunications Fund from 2004-09. In 2010, he was made portfolio manager for T. Rowe’s storied New Horizons Fund which he managed until his departure in 2019.
He had a front row seat for the bursting of the dotcom bubble. While the market turned very skeptical of internet companies, Ellenbogen had no scar tissue and could see that the internet was about to upend the media landscape. Despite “obvious misallocation of capital” the investments in capacity during the boom were about to fuel a revolution.
In 2006, he wrote about his investment in Google:
"In contrast to analog distribution, such as radio, TV stations, and cable systems, which are highly regulated, closed systems constrained by geographic boundaries and regulatory franchises, Internet companies compete in an open environment where innovation and quality of product are vital to success."
"Once it builds a market-leading service, the company must relentlessly utilize its scale advantages to improve and innovate at a faster rate than its competition."
And about investing in Tencent in 2005:
“The company was gaining market share in the largest online market in all its core product categories—instant messaging, casual games, and a content portal. Furthermore, Tencent Holdings was demonstrating an ability to leverage its strength in one area into organic growth in related areas. The management team’s focus on long-term financial results was penalized by investors looking at the short term in the second half of 2005, as an investment in product development led to temporarily disappointing margins…”
In 2009, he wrote:
“Our first investment in the company was in the fall of 2005. We visited the company in China with locally based analysts who had been following the company since before its initial public offering. The company stood out from its peers for several reasons: its dominant relationship with users in its 74% share instant messaging business; its success in leveraging this relationship into adjacent businesses in the casual games portal business and entertainment portal—a financial model that provided strong returns on capital while funding innovation; and a management team focused on expanding market share and innovation, not maximizing margins.”
He later called the expansion from an initial core growth market a company’s “second act.”
In 2007, he wrote about his investment in Amazon:
"Over the past three years, Amazon aggressively invested in its platform, customer experience, and new services. The company was penalized by the market. During this period, we examined the underlying investments, modeled the potential opportunities, and marked progress. We came to the conclusion that the investment was prudent and, when combined with the existing franchise, would ultimately produce positive financial returns. … we intend to remain investors as we believe the company will continue to gain share of its market and generate high returns on capital while investing for the future, allowing us to compound wealth at an attractive rate."
In 2009, he picked up on what Nick Sleep called "scale economies shared":
“The company has maintained its low-cost pricing philosophy and customer focus while generating strong financial returns. In its core business, its virtuous cycle of increasing scale with product and shipping vendors leads to better selection and prices, which it passes along to consumers—resulting in better value that leads to greater share of wallet and customer loyalty. In addition, Amazon.com’s financial model allows it to invest in new products and services such as the Kindle, permitting greater gains in market share while its competitors are cutting costs or services.
The fund beat the S&P in 15 out of 18 quarters but also experienced a fierce 46% drawdown during the financial crisis. "Some people would say it was better relative to its peers,” Ellenbogen told the Wall Street Journal, “but I was still not proud of that performance.”
Ellenbogen joined the New Horizons Fund which dated back to 1961, another decade when growth stocks were very popular. The fund’s long history also provides us with these unique long-term valuation charts:
The fund had been run by Jack Laporte for 23 years. Ellenbogen called Laporte “instrumental” to his joining T. Rowe and thanked him for his mentorship. "If our industry had a hall of fame,” Ellenbogen wrote about Laporte, “he would be in it, but even that would understate his impact.”
Over the decades, Laporte and his predecessors had invested in “emerging growth” companies ("small-cap companies that have the potential to be much larger over time") such as Xerox, Texas Instruments, Wal-Mart, Starbucks, Paychex, and Medco Health.
“Investment ideas frequently arise from change within an industry or individual company, so ‘change’ in some form is an important factor in most of our investment decisions” Jack Laporte
On at least two occasions Laporte described his biggest investment mistake as selling a winner too early. He bought Starbucks at the IPO but sold the stock a few years later out of concern over rising coffee prices. At the time of his retirement, he also reflected on selling Walmart too early.
It seems he may have been able to pass along this valuable lesson to Ellenbogen.