I thoroughly enjoyed this video recently. It’s a short talk given at the Mises Institute’s Mises University 2016 event. The speaker has researched and written extensively about Alexander Hamilton and the early efforts at establishing a central bank in the United States during the “American System” period through the 1830s.
Major take-aways from the interview:
- Referring to Klarman, finding ideas and doing the analysis is a small part of investing; the two most critical factors to succes in any investment as a minority shareholder are corporate governance and capital allocation
- Good corporate governance means a dominant shareholder who treats minority shareholders like an equal business partner: even aside from egregious fraud and legal violations, you can face situations where dominant shareholders use the company like a piggy bank or to promote personal agendas
- Once you’ve cleared the corporate governance hurdle you must consider capital allocation: many times companies follow the same strategy that got them from 0 to a few hundred million in market cap, which will not work to get them to the next level; often by this time the dominant shareholder is sufficiently wealthy and loses interest in capital allocation to the detriment of minority shareholders
- India’s investment universe:
- Indian GDP close to $2T
- Indian market cap $1.5-2T
- 80-85% of India’s market cap is represented by the top 150 firms: mega-cap banks, steel producers, etc., that trade on ADRs and everyone knows of outside of India
- Thousands of listed companies below this with market caps ranging from $2-3B to a couple million dollars
- Rahul finds the next 1200-1300 companies below the top 150, with market caps ranging from $50M-$2B, to be the most interesting opportunity
- Corporate governance is binary: either a company gets it, or it doesn’t
- Case study: 1998, invested in a sugar manufacturer trading for $20M generating $20M in annual earnings with a 14% tax free dividend yield, virtually debt free, strong moats, dominant player in its field, grew from $20M to $900M market cap, the owners were very focused on growing capital, no grandiose desire to build empires, not trying to grow the top line at all costs or gain rankings, just allocating capital wisely
- Every investor is looking for shortcuts and binary decisions, ie, “Should I invest in India or not invest in India?”; the reality is it’s a lot of work, it’s about turning over as many stones as you can– what Buffett has done well is finding people who can compound capital and then staying with them through market cycles
- You can do what Buffett did in any market but you must dive into it, get your hands dirty, do the work it takes and then maintain the discipline to stick with what you’ve found
- Home-market bias: most people are going to allocate most of their capital in their home-market, because by definition anything that is not familiar or proximate is considered risky; consequentially, “locals” will disproportionately benefit from economic and financial gains in their local markets
- India can not and likely will not become a dominant allocation in a foreign investors portfolio; without devoting 100% of your time and energy to understanding that market, or having someone invest on your behalf who does, you will likely not understand the culture, motivation and habits of the people in that market
- “It is imperative that in any market you go with people who understand it and are focused on it full time because investing is ultimately bottom-up”
- Accounting, financial reporting and investor relations practices are modeled off the US and UK so they’re similar; however, many businesses are run by one or two entrepreneurs and they’re often too busy to be available to speak with outside investors, but persistence pays off when they realize you’re interested in learning about their business
- Access to capital in Indian markets has improved, meaning it has become easier for Indian companies to scale
- Why does India have high rates of capital compounding? India is a 5,000 year old civilization and has had borrowing, lending and private markets for capital that entire time meaning people are aware of capital compounding; that being said, India has companies and management that understand ROC, those that don’t, and those that are essentially professional Ponzi-schemes, issuing capital at every market peak and then trading for less than the issued capital at the trough because they’re constantly destroying wealth
- Rahul sees the government as incapable of providing the public infrastructure needed by the growing economy; he sees the economy turning toward a “private-public partnership” model that is more private than public– enlightened fascism?
- As companies rushed into this private-public space, a lot of conglomeration and corporate mission-creep occurred, resulting in systemically low ROC for companies in the infrastructure space as most as poorly run; failure of top-down investing thesis
- “I’m looking for confirmation in facts, not in other investors’ opinions”
- I can comment on whether valuations for individual companies make sense, but I can’t make a judgment on the value of a broad market index, I just don’t think that number means anything
- Risk management: develop assumptions about the company’s business and then periodically analyze what the company is doing relative to original investment hypothesis; if your assumptions prove to be wrong or something changes drastically with the company, that is when you hit a “fundamental stop-loss” and corrective action needs to be taken immediately, even if the stock has done well and the price has risen
Click here to watch the video (wear earphones and bring a magnifying glass)
UC Davis/Farnam Street Investments presents Toby Carlisle, founder and managing partner of Eyquem Investment Management and author of Quantitative Value, with Wes Gray.
Normally I’d embed a video but I can’t seem to do that with the UC Davis feed. Also, these are PARAPHRASED notes to the Q&A portion of Toby’s talk only. I ignored the “lecture” portion which preceded because I already think I get the gist of it from the book. I was mostly interested in covering his responses to the Q&A section.
The video is extremely poor quality, which is a shame because this is a great talk on a not-so-widely publicized idea. I wish there was a copy on YouTube with better audio and zoom, but no one put such a thing up, if it exists. I hope Toby does more interviews and talks in the future… hell, I’d help him put something together if it resulted in a better recording!
I had trouble hearing it and only thought to plug in some earbuds near the end. Prior to that I was contending with airplanes going overhead, refrigerator suddenly cycling into a loud cooling mode as well as my laptop’s maxed out tinny speakers contending with the cooling fans which randomly decided to cycle on and off at often the most critical moments. I often didn’t catch the question being asked, even when it wasn’t muffled, and chose to just focus on Toby’s response, assuming that the question would be obvious from that. That being said, I often conjoined questions and responses when there was overlap or similarity, or when it was easier for me to edit. This is NOT a verbatim transcript.
Finally, Toby recently created a beta forum for his book/website, at the Greenbackd Forum and I realize now in reviewing this talk that a lot of the questions I asked there, were covered here in my notes. I think he’s probably already given up on it, likely due to blockheads like me showing up and spamming him with simpleton questions he’s answered a million times for the Rubed Masses.
Major take-aways from the interview:
Q: Could we be in a “New Era” where the current market level is the “New Mean” and therefore there is nothing to revert to?
A: Well that’s really like saying stocks will revert down, not up. But how could you know? You could only look at historical data and go off of that, we have no way to predict ahead of time whether this “New Mean” is the case. I think this is why value investing continues to work, because at every juncture, people choose to believe that the old rules don’t apply. But the better bet has been that the world changes but the old rules continue to apply.
Q: So because the world is unknowable, do you compensate by fishing in the deep value ponds?
A: I like investing in really cheap stocks because when you get surprises, they’re good surprises. I find Buffett stocks terrifying because they have a big growth component in the valuation and any misstep and they get cut to pieces; whereas these cheap stocks are moribund for the most part so if you buy them and something good happens, they go up a lot.
A: If you look at large cap stocks, the value effect is not as prevalent and the value premia is smaller. That’s because they’re a lot more efficient. There’s still only about 5% of AUM invested in value. But the big value guys portfolios look very similar; the value you have as a small investor is you don’t have to hold those stocks. So you can buy the smaller stuff where the value premia is larger. The institutional imperative is also very real. The idea of I’d like to buy 20 stocks, but I have to hold 45. That pushes you away from the optimal holdings for outperformance.
A: The easiest way to stand out is to not run a lot of money. But no one wants to do that, everyone wants to run a lot of money.
A: The model I follow is a bit more complicated than the Magic Formula. But there are two broad differences. I only buy value stocks, I only buy the cheapest decile and I don’t go outside of it, and then I buy quality within that decile. ROIC will work as a quality metric but only within the cheapest decile. ROIC is something Buffett talks about from a marketing perspective but I think in terms of raw performance it doesn’t make much sense. There’s definitely some persistence in ROIC, companies that have generated high returns on invested capital over long periods of time, tend to continue to do that. If you have Warren Buffett’s genius and can avoid stepping on landmines, that can work. But if you don’t, you need to come up with another strategy.
A: Intuition is important and it’s important when you’re deciding which strategy to use, but it’s not important when you’re selecting individual stocks. We can be overconfident in our assessment of a stock. I wonder whether all the information investors gather adds to their accuracy or to their confidence about their accuracy.
A: All strategies have those periods when they don’t work. If you imagined you ran 4 different strategies in your portfolio, one is MF, one is cheap stocks, one of them is Buffett growth and one is special situations, and you just put a fixed amount of capital into each one [fixed proportion?] so that when one is performing well, you take the [excess?] capital out of it and put it into the one that is performing poorly, then you always have this natural rebalancing and it works the same way as equal-weighted stocks. And I think it’d lead to outperformance. It makes sense to have different strategies in the fund.
A: QV says you are better off following an indexing strategy, but which market you index to is important. The S&P500 is one index you can follow, and there are simple steps you can follow to randomize the errors and outperform. But if you’re going to take those simple steps why not follow them to their logical conclusion and use value investing, which will allow you to outperform over a long period of time.
A: Not everyone can beat the market. Mutual funds/big investors ARE the market, so their returns will be the market minus their fees. Value guys are 5% of AUM, can 5% outperform? Probably, by employing unusual strategies. Wes Gray has this thought experiment where he says if we return 20% a year, how long before we own the entire market? And it’s not that long. So there are constraints and all the big value investors find that once they get out there they all have the same portfolios so their outperformance isn’t so great. There’s a natural cap on value and it probably gets exceeded right before a bust. After a bust is then fertile ground for investment and that’s why you see all the good returns come right after the bust and then it trickles up for a period of time before there’s another collapse.
A: I think the market is not going to generate great returns in the US, and I am not sure how value will do within that. That’s why my strategy is global. There are cheaper markets in other parts of the world. The US is actually one of the most expensive markets. The cheapest market in the developed world is Greece.
Q: Did you guys ever try to add a timing component to the formula? That might help you decide how to weight cash?
A: Yes, it doesn’t work. Well, we couldn’t get it to work. However, if you look at the yield, the yield of the strategy is always really fat, especially compared to the other instruments you could invest the cash in, so logically, you’d want to capture that yield and be fully invested. I think you should be close to fully invested.
Q: What about position sizing?
A: I equal weight. An argument can be made for sizing your cheaper positions bigger. I run 50 positions in the portfolio. In the backtest I found that was the best risk-adjusted risk-reward. That’s using Sortino and Sharpe ratios, which I don’t really believe in, but what else are you going to use? If you sized to 10 positions, you get better performance but it’s not better risk-adjusted performance. If you sized to 20 positions, you get slightly worse performance but better risk-adjusted performance. So you could make an argument for making a portfolio where your 5 best ideas were slightly bigger than your next 10 best, and so on, but I think it’s a nightmare for rebalancing. The stocks I look at act a little bit like options. They’re dead money until something happens and then they pop; so I want as much exposure to those as I can. I invest globally so the accounting regimes locally are a nightmare. IFRS, GAAP to me is foreign. You have to adjust the inputs to your screen for each country as a result of different accounting standards.
A: Japan is an interesting market. Everyone looks at Japan and sees the slump and says it’s terrifying investing in Japan but if you look at value in Japan, value has been performing really well for a really long time. So, if the US is in this position where it’s got a lot of govt debt and it’s going to follow a similar trajectory, you could look at Japan as a proxy and feel pretty good about value.
A: I’ll take hot money, I am not in a position to turn down anyone right now. It’s a hard strategy [QV] to sell.
A: Special situation investing is often a situation where you can’t find it in a screen, something is being spun out, you have to read a 10-K or 10-Q and understand what’s going to happen and then take a position that you wouldn’t be able to figure out from following a simple price ratio. It’s a good place to start out because it’s something you can understand and you can get an advantage by doing more work than everyone else. It’s not really correlated to the market. I don’t know whether it outperforms over a full cycle, but people don’t care because it performs well in a bad market like this.
Q: What kind of data do you use for your backtests?
A: Compustat, CRISP (Center for Research Into Securities Prices), Excel spreadsheets. You need expensive databases that have adjusted for when earnings announcements are made, that include adjustments that are made, that include companies that went bankrupt. Those kinds are expensive. They’re all filled with errors, that’s the toughest thing.
The Harvard Business School presents Seth Klarman, founder and president of the Baupost Group
Major take-aways from the interview:
- I don’t think a lot about being a leader; our goal is to be “excellent” and to be proud of what we do
- Main principle for leadership or management-style: “Do unto others…”
- Big believer in leading by example; you can’t expect other people to do things you’re incapable of or unwilling to do yourself
- Sometimes organizations are stuck, people want to do more but they haven’t been asked the right way; don’t overlook the power of re-anchoring via leading by example
- Leadership stems from credibility — credibility stems from being “right” over time and from having knowledge — and from moral values
- Two important moral values for leaders:
- Football field test; play the game from the center of the field, not near the sidelines, where it is easy to go out of bounds without intending to do so
- WSJ test; live your life in a way that you would not be embarrassed to have it reported on the front page of the WSJ
- Every quarter, I sit down with the non-investment team members of the firm and explain the current investment strategy; the idea is to help the rest of the firm understand why the firm is doing well or poorly; this creates a culture where everyone is on the same page
- You want to create a culture where everyone is willing to stay late to finish a job if they have to, where people will spend time double-checking for mistakes; people paying attention to detail at every level of the firm is important
- Leaders don’t take credit, they give credit; be quick to give everyone around you credit, it is empowering to those people
- Turnover is a hidden cost of business; it can take so long to get someone up to speed, train them properly, get them to the point that they can contribute; treating employees properly and caring for them is a smart business decision
- If you have someone who is not getting the job done, other people are probably carrying their weight and working extra hard for them, and this isn’t fair; good leaders need to be fair
- Get a good mentor; find a place to work where they care about you, that will nurture you and be interested in your development; if you can find one it sets you on the road to success
- An experience SK feels good about as a leader: the time the leaders of the firm decided to buy the entire firm playoff tickets for the Red Sox game that ended up being a historic game– an order of magnitude different from handing over a $1000 bonus
- A mistake SK made as a leader: tolerating a “difficult person” for far too long, because they were a talented individual; it poisoned the well, tarnished the moral character of the firm, led to some financial losses; focused too much on the short-term pain rather than the long-term benefit of that decision
- A leader is not afraid to fail, is not afraid to be wrong or to lose money in the short-term; a leader always adheres to their principles and standards
- JP Morgan: “I can do the work of a year in 9 months, but not in 12”; it’s important to set time aside to refresh, relax, reflect
- Marathon, not a sprint; don’t focus on the short-term because it causes anxiety and makes you hyperactive in an effort to compensate for short-term poor performance
- You can’t be a leader if you burn out; find balance, seek a variety of interests
- Working a couple years at an intense pace (80hrs+/week) is okay if it’s for a specific purpose; ideally, if you are going to work that hard, do something entrepreneurial, then you’re doing it for yourself and the benefits, if any, accrue to you
- Understand that if you plan to compete by being willing to work 100 hours a week, you’ll be beat by people willing to work 110 hours
Hugh Hendry interviewed by Steven Drobny at the London School of Economics, 2010
Major take-aways from the interview:
- How he got his start: began at an eclectic asset management firm in Edinburgh, which rotated its young associates; began at age 21 in the Japanese stock market the year after it peaked in 1990; the next year rotated to UK large companies; the next year US equities; moved to London in 1998/9 and no one would employ him because he was a jack-of-all-trades, master of none
- 1929/1930 marked a “revulsion with debt” period, which changed very slowly, ultimately eradicated from society in 1973/74; then the opposite cycle occurred, with society massively leveraging; during this upswing, it has paid to be optimistic and the financial economy has become the economy; we appear to be on the verge of a generational shift again, where farmers will reign over hedge fund managers
- Macro opportunities are created by the interactions of economics and the abilities of politicians to try to fudge them
- “The best trade is the one where you don’t fear the consequences of being wrong”
- China’s economic development strategy is not unique, it’s just large-scale; economy is being directed toward sovereign-profit, not corporate-profit
- Pursuing sovereign power over economic power results in building your economy on foundations of sand; Japan tried the same thing and it appeared to work until it was revealed to have not worked; Confucius saying, “Wise-man not invest in over-capacity”
- China is like the sun, you can’t get too close or you’ll melt (can’t short equities in China, HK, or commodity futures or equity derivatives in the West); used the “satellite”, bought CDS on a basket of Japanese industries, as Japan is very reliant on trade with China– steel, for example
- If we’re going to have hyperinflation and the dollar loses its value, you need something profoundly negative to shake the course of economic growth globally, because only if that happens will the central bankers respond with this dramatic decision of hyperinflation
- Slowdown in China, economic restructuring in Europe would be the economic equivalent of a meteor hitting Earth
- Market call: the Yen and the USD could appreciate greatly, because there is so much borrowing in those currencies, if asset values take a hit, you have a shortage of dollars or Yen to pay against the collateral values of that lending; combined with calls on the Nikkei at 40,000, 50,000 (want to be very long equities at that point)
- Good hedge fund managers give great weight to the consequence of their actions and are fearful of them, so they won’t be hurt too much if they’re wrong
- Being plasticine: we spend so much time trying to see the future, we’re deluding ourselves because we have no chance to see the future; better to be careful and flexible, avoid dramatic injury and maintain optionality to respond to whatever the future holds
- Be a centipede, not a mountain climber; have a hundred legs so you can let one or two go if you have to do so
- Strategically, it’s not rational to try to outsmart bright people; bright people are encouraged to be logical in their constructions; my business franchise is trying to get opportunities from the arcane world of paradox, disciplined curiosity, the toolset of the maverick
Hugh Hendry interviewed in a panel discussion at the 2012 Milken Institute Global Conference
Major take-aways from the interview:
- Global economy is “grossly distorted” by two fixed exchange regimes: the Euro (similar to the gold standard of the 1920s) and the Dollar-Renminbi
- China is attempting to play the role of the “bridge”, just as Germany did in the 1920s, to help the global economy spend its way into recovery
- Two types of leverage: operational and financial; Germany is a country w/ operational leverage; Golden Rule of Operational Leverage, “Never, never countenance having financial leverage”, this explains Germany’s financial prudence and why they’ll reject a transfer union
- Transfer of economic rent in Europe; redistribution of rents within Europe, the trade is short the financial sector, long the export sector
- Heading toward Euro parity w/ the dollar, if not lower; results in profound economic advantage especially for businesses with operational leverage
- “The thing I fear” is confiscation: of client’s assets, my assets; we are 1 year away from true nationalization of French banks
- Theme of US being supplanted as global leader, especially by Chinese, is overwrought
- Why US will not be easily overtaken: when US had its “China moment”, it was on a gold standard…
- implication, as an entrepreneur, you had one chance– get it right or you’re finished
- today is a world of mercantilism, money-printing, the entrepreneur has been devalued because you get a 2nd, 3rd, 4th chance
- when the US had its emergence on a hard money system, it built foundations which are “rock solid”
- today, this robust society has restructured debt, restructured the cost of labor, has cleared property at market levels
- additionally, “God has intervened”, w/ progress in shale oil extraction technology; US paying $2, Europe $10, Asians $14-18
- Dollar is only going to go one way, higher; this is like early 1980/82
- “I haven’t finished Atlas Shrugged, I can’t finish it”: it’s too depressing; it reads like non-fiction, she’s describing the world of today
- The short sale ban was an attack on free thought; people have died in wars for the privilege to stand up and say “The Emperor has no clothes”; banned short selling because truth is unpalatable to political class; the scale and magnitude of the problem is greater than their ability to respond
- We are single digit years away from a most profound market-clearing moment, on the order of 1932 or 1982, where you don’t need smarts, you just need to be long
- Hard-landing scenario in Asia combined w/ recession in Europe would result in “bottoming” process, at which point all you need is courage to go long
Read More Than You Know: Finding Financial Wisdom in Unconventional Places
Read Think Twice: Harnessing the Power of Counterintuition
Intelligent Investing with Steve Forbes presents Michael Mauboussin, chief investment strategist, Legg Mason Capital Management, author of Think Twice
Major take-aways from the interview:
- 9%, 7.5% and 5.5-6%; the rates of return, respectively, for the S&P500, mutual funds and mutual fund investors, on average– why the discrepancy?
- Mutual funds underperform the S&P500 on a total return basis due to fees; mutual fund investors underperform the funds mostly due to timing– most individuals buy when funds have done well, sell when they’ve done poorly, exposing themselves to underperformance and missing out on subsequent over-performance
- Curiously, institutional investors underperform as well; the culprit is overactivity– people believe “if you work hard, you’ll be rewarded”, so institutional investors try to “earn” their returns by moving money around constantly
- Increasingly, investment returns have to do with luck and not skill; all activities in life fall along a continuum between pure skill and no luck (running competition) to pure luck and no skill (the lottery); the “Paradox of Skill” states that the more skillful competitors are, the more uniform their results become and the more important luck is to explaining differences in results
- How to accurately judge a manager’s returns? Sample size is important: the more decisions the manager has to make over time, the shorter time horizon can be used to judge them; the fewer decisions they make over time, the longer the time horizon used to judge them
- Focus on process, not outcome; in investing– analytical process of ideas, behavioral/psychological process, and organizational process (constraints w/in the organization that impede performance)
- Investing boils down to two activities: handicapping (looking at market assumptions via price and then backing into the scenario that would have to occur for that price to be reasonable, and judging the probability of it occurring) and bet-sizing (waiting until you have a strong advantage and then betting big)
- Expectations-based investing process: back into the cash flow assumptions that justify current market price; financial/strategic analysis of the company and its industry to see if the company is likely to do better or worse than the market implies; then decide to buy, sell or do nothing– what’s built in? what’s likely to happen? then “over-under” rather than “I know precisely what those cash flows will be”
- Systems that are entirely skill-based don’t revert to the mean at all; aside from fatigue, running a race 5x will result in the same, highly-skilled winner each time
- The extent to which a system is not all-skill is the extent to which it can mean-revert, but the question is, what mean? A highly skilled person might come down off a peak but they will not revert to the mean of more normally skilled individuals, for instance (tall parents tend to have tall children, but they might not be as tall as the parents — mean reversion — but you also don’t expect them to go down to the height of the average population)
- Investing is not all-luck, but it is luck-leaning on the continuum; the best way to judge managers is by process, not performance
- “Buy cheap and hold”: consider the story of Bob Kirby and the “Coffee Can Approach” [PDF]
- What can older investors do in today’s interest rate environment? Follow Jim Grant’s advice, “Roll back the calendar 30 years”, ie, nothing, they’re screwed
- “Patience is the key” to great investment returns
Intelligent Investing with Steve Forbes presents Joel Greenblatt, adjunct faculty member at Columbia University, co-CIO of Formula Investing
Major take-aways from the interview:
- 70% of active managers can not be passive index funds like the S&P500 due to high costs, high fees
- Unfortunately, for the 30% who beat the index over the last 3, 5 and 10-year periods, there is no correlation with how they do over the next 3, 5 and 10-yr periods
- A disadvantage to standard index investments is that they are market-cap weighted; the more overpriced something is, the more of the index it represents, the more underpriced something is, the less of the index it represents
- A superior alternative is equal-weight indexes, for example, in the S&P500, Stock #1 is allocated the same amount of capital as Stock #500; errors are therefore random rather than systematic
- Greenblatt’s firm created a “value-weighted index”: the cheaper something is, the more weight it gets in the index
- Key metrics for analyzing a business
- High adjusted FCF
- Returns on tangible assets
- Why do good companies sell cheaply? People are worried that earnings power over the next few years will not be as good as the past so they’re willing to sell at a discount; institutional investors will systematically avoid uncertainty and provide you opportunity to buy cheap
- Most business schools are teaching Efficient Markets theory, not Benjamin Graham; good news for value investors because it means you have less competition
Intelligent Investing with Steve Forbes presents Mohnish Pabrai, managing partner, Pabrai Funds
Major take-aways from the interview:
- Attitude is the most important attribute of any investor
- The value investor’s attitude advantage is the ability to wait for the right opportunity
- “All man’s miseries stem from his inability to sit in a room alone and do nothing” channeling Pascal into an investor appropriate format: “All investment managers’ miseries stem from an inability to sit alone in a room and do nothing”
- Ideal investment industry: gentlemen of leisure who go about their leisurely tasks and when the world is severely fearful is when they put their leisurely tasks aside and go to work
- People think entrepreneurs take risk; in reality, they do everything they can to minimize risk– low risk, high return bets
- Pabrai Funds has a “moat” by mirroring Buffett’s 25% performance after 6% hurdle because it aligns his interests with his clients; total fund expenses are 10-15 basis points, with Pabrai’s salary and staff paid for out of performance fees
- Shorting makes no sense because maximum upside is a double and maximum downside is bankruptcy
- Do not talk to company management because they are high charisma sales people and will pitch you on optimism, not realism
- Big fan of the Checklist Manifesto, has a checklist of 80 items he looks over before making an investment
- Pioneers are the people who get filled with arrows