Have you heard of The Children’s Investment Fund? More commonly referred to as TCI, it is a famous long-only hedge fund from the UK with over $50 billion under management.

TCI’s long record of strong returns (not to mention its profit sharing fee structure) has made its founder Sir Chris Hohn a billionaire several times over. Most of this has gone to Hohn’s charitable foundation, which – as TCI’s name suggests – mostly funds medical procedures for poor children.

As an investor, Hohn is mostly known for two things. Number one, running a concentrated portfolio of long-term holdings. And number two, an aggressive brand of activist investing that regularly saw him prod CEOs without mincing any of his words.

Hohn’s duality – tough talking activist on one hand and philanthropic superhero on the other – makes him rather interesting. Add in his track record, and investors tend to tune in when he speaks.

Because of this, Hohn’s recent spot on a panel at Norges Bank Investment Management’s investment conference and subsequent appearance on the firm’s podcast garnered a lot of attention. As well as some interesting detours into matters of spirituality, both cameos featured strong insights into TCI’s investment process.

Ruthless disqualification

TCI’s investment process centres on identifying companies of a suitable quality to buy and hold for the long-term.

Hohn said that TCI will not even think about valuing a company’s shares until they are absolutely certain that it meets their bar for quality. And it’s a high bar – he says that only 200 or so companies worldwide meet it.

This will partly be down to the TCI’s size. With a huge and concentrated portfolio, even a small position by TCI’s standards would be larger than the total market cap of many companies. It also comes down, though, to most businesses and industries simply not being that attractive to him.

Automakers, retailers, insurers, commodities and tobacco were rattled off as industries that Hohn wouldn’t consider buying into. Banks are also a no-go. Their opaque and highly leveraged nature, he says, can make things go very wrong, very quickly.

Above everything, Hohn seeks to avoid uncertainty over a company’s long term value. No matter whether that stems from doubts over its competitive position, or uncertainty over long-term demand for its products.

When asked about TCI’s investment in Alphabet (NAS: GOOGL), for example, Hohn described it as his fund’s “riskiest” position. Perhaps because of the possibility that Google’s previous stranglehold on online searches could weaken in the presence of AI alternatives.

Hohn’s number one criteria

When it comes to what Hohn does like to see in an investment, the number one thing he seeks can be explained in three words: barriers to entry. He likes to invest in companies where the emergence of effective competitors seems unlikely.

While this is rare, it can take a few forms.

TCI holds big positions in aircraft engine manufacturers Safran (PAR: SAF) and GE Aerospace (NYS: GE). The protection here? The complexity of the product, an installed base of engines to service, and the huge potential costs of failure.

In a world where other moat sources (like network effects) have become awfully fashionable, Hohn highlighted two sources of protection that he thinks are forgotten sometimes – irreplaceable physical assets and good old scale.

For irreplaceable physical assets, look no further than the fund’s holdings in two Canadian railways and select airports. Meanwhile, Microsoft (NAS: MSFT) was mentioned as an example of scale helping a company face new threats – in this case, the rise of Zoom.

Might any ASX companies fit Hohn’s philosophy?

Given his words on the banking industry, the big four would probably be a hard pass. You’d also have to assume that Wide Moat rated Woolies (WOW), Endeavour (EDV) and Wesfarmers (WES) would fall foul of his distaste for retailers.

Casting the net wider and working back from his affinity for irreplaceable assets, I considered the railway network that Aurizon (AZJ) owns on a lease until 2109. Irreplaceable? Yes. But would Hohn like the reliance on long-term demand for coal? I doubt it. By contrast, this ASX listed company seems to boast several of the qualities that Hohn looks for.

Irreplaceable assets with pricing upside

One subset of business that Hohn talked about regarding irreplaceable physical assets were airports. And not just any airports – specifically those with strong unregulated businesses in addition to regulated income from landing fees et cetera.

Auckland is home to one such airport. Like other airports, Auckland International (AIA) derives its moat from efficient scale. New entrants would rack up huge costs to enter a market that is 1) limited in size and 2) can be served adequately by the existing assets or extensions to them.

Our AIA analyst Angus Hewitt estimates that Auckland Airport gets around 50% of its revenue from aeronautical activities, where overall returns on investment are approved by the regulator every five years.

The other half comes from retail space (including duty-free), car parks, hotels, and property. Crucially, pricing here is unregulated. This allows the airport to exercise their monopoly power more than they can on the aeronautical side of things.

As for certainty of demand, you are essentially betting that people will continue to fly to, from and around New Zealand. Passenger levels on both international and domestic flights could fluctuate for any number of reasons, but I think that’s a pretty safe bet.

Tourists are still going to want to visit. Kiwis will continue to live in Australia and fly home every now and then. Having lived in NZ for a year, I also know that flying is the best way to travel anything more than a moderate distance internally. Trains hardly exist!

Quality at a slight discount?

Our analyst Angus Hewitt thinks that Auckland Airport’s huge investments in a new terminal building and recent pushback from the regulator on pricing may have distracted investors from the value of AIA’s unique assets.

“We believe the market is unjustifiably pricing either lower returns on regulated expenditures or weakness in unregulated businesses” he wrote in a recent report, “this presents an attractive entry point into a rare, high-quality, essential infrastructure asset.”

Angus thinks the airport’s shares are worth AUD 8.45 per share, compared to their recent market price of around AUD 7.15.

Closing thoughts

The point of this article wasn’t really to deliver a stock idea, though. It was to look at how a successful investor goes about investing.

One part of Hohn’s approach that really stuck with me is the emphasis put on vetting a company’s suitability for investment before even thinking about whether the stock price looks attractive. Hopefully I can keep that in mind next time I hear about an interesting company and reflexively pull up its price chart on Google.

For some pointers on building a solid set of investing criteria, look at step number four in this guide by my Morningstar colleague Mark LaMonica.

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