The transcript from this week’s MiB: Graeme Forster, Orbis Investments, is below.
You can stream and download our full conversation, including any podcast extras, on Apple Podcasts, Spotify, YouTube, and Bloomberg. All of our earlier podcasts on your favorite pod hosts can be found here.
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This is Masters in business with Barry Ritholtz on Bloomberg Radio.
[Barry Ritholtz] This week on the podcast, I have an extra special guest, Graham Foster’s pm at Orbis Investment Management. The firm runs about $34 billion. I’ve been intrigued by Orbis for quite a while. They have a truly unique approach to investing. They’re also owned by a foundation, something that’s rather rare in the finance industry. And they also have a unique approach to feeds when they’re generating alpha, when they’re outperforming their benchmark, they take a performance fee. And when they’re not generating alpha, when they’re underperforming, they actually return fees. I, I don’t think anybody else in the entire industry does anything like that. Fortunately for them, they’ve been outperforming for decades. So it isn’t very often they have to return fees. This is one of those really intriguing models. I’ve, I’ve written about them before. I’ve interviewed other partners at Orbis before. They’re, they’re really an intriguing firm. I found this conversation to be absolutely fascinating, and I think you will too. With no further ado, my discussion with Graham Foster PM and partner at Orbis Holdings.
[Barry Ritholtz]: So you have a fascinating background. I want to get into that before we start talking about asset management. A degree in mathematics from Oxford, a doctorate in mathematical epidemiology and economics from Cambridge. What is that? Mathematical epidemiology, I’m assuming that’s probability and statistics of viral disease
[Graham Foster]: That’s exactly right. So I, I did a math degree at Oxford, which is more pure math. And then I was looking for something more applied. You know, pure math can be very theoretical and detached from the real world, and it’s getting worse. It gets further and further away the D P U go. And so I wanted to move into something useful. Mathematical epidemia epidemiology is a study of disease spread through modeling. You know, how do you understanding the spread, how do you treat the spread, when do you treat the spread? You know, things that va the vaccination programs and it’s all the mathematics around that. So it was very relevant then and even more relevant recently with all of the, you know, the infectious diseases we seeing.
[Barry Ritholtz]: 00:02:31 So, so let’s talk test your theoretical mathematics. I was, for something wholly unrelated, I’m diving into some set theory and I come across a paper that makes the claim that some infinities are larger than other infinities. Now my naive assumption was infinite men. Infinite. But is that the sort of stuff you were studying undergraduate?
[Graham Foster]: 00:02:54 That was a number, that was number theory, pure number theory. And that was one course I did not take. But that is a fascinating field, that’s for sure. There’s many different types of infinities. Okay.
[Barry Ritholtz]: 00:03:06 [Speaker Changed] Apparently it, it’s, I just assumed if it’s infinite, it’s infinite. And whether it’s all numbers or even numbers. Yeah.
[Graham Foster]: 00:03:14 [Speaker Changed] That, that is a incredibly complex area of mathematics to the point where you, you spend weeks and weeks proving that one isn’t equal to zero. Right. That’s how fundamental you, you get right back to the axioms. And you do a lot of work with infinity
[Barry Ritholtz]: 00:03:29 [Speaker Changed] And then economics, which is a little bit squishier. What made you add economics to your, to your graduate degree?
[Graham Foster]: 00:03:37 [Speaker Changed] Well, that was really an add-on, but you know, if you, you’re thinking about the spread and control of disease, given this is academia, you know, the big focus is on how do you do it. It’s not really on what does it cost. Right, right.
[Barry Ritholtz]: 00:03:51 [Speaker Changed] Which some people actually care about.
[Graham Foster]: 00:03:53 [Speaker Changed] Yeah, some people do. Right. That is, that’s quite a relevant question. So a big part of the thesis, which we sort of started, you know, around one year in, after getting the kind of the basis right, was how do you treat this was, this was in agricultural systems, so how do you treat disease, when do you treat, and how much is it gonna cost? And it’s basically an optimization problem.
[Barry Ritholtz]: 00:04:18 [Speaker Changed] Hmm. We’ll, we’ll talk a little bit more about fees and costs later. So let’s talk about your first jobs out of school. I’m assuming mathematical epidemiology was an, the career you followed. What’d you do after Cambridge?
[Graham Foster]: 00:04:32 [Speaker Changed] Yeah, I mean, academia should be meritocratic, So it’s a little more political than that. It’s very, very political. And you know, the deeper you go within a field, the less the people who are funding the research understand about the research. So it gets very bureaucratic and you spend a lot of your time, in my view, trying to build your funding to do your next project. And so, you know, one reason for looking for an exit, if you like, from academia, you know, which has its positive elements, right? Academia, you get the feeling, the fulfillment of doing something that’s, you know, good for the world in theory, theoretically.
[Graham Foster]: 00:05:19 So, but one that that that sort of looking for something meritocratic was one reason for like, and, and I, I started during my PhD getting into game theory and decision making under uncertainty and all these interesting areas, which were a bit tangential,
[Barry Ritholtz]: 00:05:38 [Speaker Changed] Although maybe not so tangential. I read something you had mentioned Schlansky’s book, the Theory of Poker, A professional poker player teaches you how to think like one, obviously decision making under uncertainty with probabilistic odds and an inherently unknowable future. Is that poker, is that investing sounds like both.
[Graham Foster]: 00:06:01 [Speaker Changed] It’s the same thing, right? It’s the same skillset. And, and, and so during my PhD I started playing a lot of cards. Use Omaha and poker and gin, and then backgammon, all these games. Interesting from the sense that luck or uncertainty play a big role. And that’s interesting. I thought that was, that’s an interesting element of those games. And, and one of the things that drew me into that wasn’t just the intellectual side of it, how do you make decisions under uncertainty? It’s the uncertainty itself and what that does. And you know, if you, if you’re a chess player, it’s almost pure skill. If you’re a poker player, I think it’s, you know, maybe 40% skill, 60% luck over short periods. And what that does is it draws in a lot of people to the game that maybe, you know, don’t appreciate that that kind of the, the rigor that goes into the decision making.
[Barry Ritholtz]: 00:07:00 It’s like people who play the lottery, why do people play the lottery? They know it’s a ne negative expected value game, right? Do they, maybe they do, maybe they don’t, but they see the, the, the, the potential to win the big, the big jackpot, right? And they also, you know, they get little wins here and there through the lottery, right? It, it gives them a buzz. It’s, it’s why do people go to the casino? They gamble. So, so gameplay with large elements of uncertainty, draw people in who aren’t necessarily suited to the rigor of the activity. And if you think about what’s similar to poker in that regard, it’s investing very, very similar, massive levels of uncertainty. In fact, more uncertainty in the investment world than in poker world. ’cause you’re making these long-term decisions and getting very little feedback from, from your actions until years and years down the road.
[Graham Foster]: 00:07:45 So it draws people in. So they’ll have big wins, you know, they’ll buy a stock, it’ll go up, I can do this. And they keep going and they keep playing and they keep going, right? And so it’s, it is a game that a game, it’s a field that drives a lot of inefficiency. And I think that inefficiency sustainable. And so that’s, you know, one of the reasons that drew me in, the other reason that drew me in was, you know, I think how the relationship we, you and I, everybody has with money is heavily dictated by their up upbringing. Upbringing for sure. And so if you have spent, you know, your childhood making compromises because you’re always bumping up against the barrier of not not having enough money, it changes the way you look at money your whole life.
[Barry Ritholtz ]: 00:08:26 [Speaker Changed] 100 Percent.
[Graham Foster]: 00:08:27 [Speaker Changed] And so I didn’t wanna spend my life in academia where, you know, the money’s not bad depending on what you do. But you, I would always be in that situation of sort of bumping up against that barrier. It limits your choices in life if you don’t, if you have that constraint,
[Barry Ritholtz]: 00:08:40 [Speaker Changed] No doubt about that. So I love where you’ve taken this, and I wanna, I wanna stay with the idea of poker and casino and, and uncertainty. Some people look at a casino as entertainment and hey, we’re gonna spend X dollars, pick a number, 500, 2000, whatever it is. And that’s, you know, that’s what a night out at a, at a Broadway play would cost. Here’s what I’m gonna spend that night. I, I think that’s a small percentage of people and other people, it, it’s not a coincidence that the one arm bandits, the tho those machines that pay out the most with the lights and the bells are right by the entrances right there to, to capture people a lot. It was kind of fascinating because I always thought you paid $2 and we’re coming up on 900 million as we speak, is the current lottery
[Graham Foster]: 00:09:35 [Speaker Changed] 900 million?
[Barry Ritholtz]: 00:09:36 [Speaker Changed] Yeah, they, they changed the lottery a couple of years ago. So there are some blank numbered balls in it in order to create these billion dollar payouts. And they go on longer and longer and obviously more profitable for the states that run the lottery. But to me it’s like you pay $2 and you get to fantasize about what you would do with a couple of hundred million dollars. That’s the $2 that the lottery is worth for me. I don’t think the average person who’s plunking down 20 or a hundred bucks every week thinks of it the same way. I think they’re just junkies at this point and very addictive manipulation of, of dopamine for, for people.
[Graham Foster]: 00:10:16 [Speaker Changed] I think that’s absolutely right. And I mean, it, it, it’s two sides of the same coin really. Because, you know, you’re, you’re paying your $2 and you’re dreaming of the big jackpot is a, there’s an element of that in, in your, in your right, you know, pulling the lever. I used to go to casinos when I was in college and I would see people, they were almost, they would have these cards and it would be the membership card for the casino, and it would be attached to their belt and it would be plugged into the slot machine and it would look like they were one and the same, right? They were connected by connected by a feeding tube. Yeah, that’s right. And they would sit there all day ified. That’s an addiction. That’s absolutely an addiction, but it’s the same mentality of that little buzz you get when you win something or the dreaming of the big payout.
[Graham Foster]: 00:11:03 And I think the lottery’s fascinating because, we’ll, I’m sure we’ll talk about this, but we did a study recently where we took a thousand investors, hypothetical investors, and we said, okay, if they’ve got a 50 year time horizon in terms of their investment time horizon, and you’re simulating a return profile from, let’s say the ss and p five hundred’s bell curve of returns over the last a hundred years. So you’re, you’re sampling your returns each year for these a thousand investors over the next 50 years. And you see a, a wealth path for each of those investors. And what you get at the end is a very, very uneven distribution of wealth. That’s a, that’s a function of returns. That’s a function of the capitalism. It’s a function of log normal returns that we see in, in stock markets. And it’s exactly the same.
[Graham Foster]: 00:11:54 You see the, exactly the same non-linear wealth distribution in real life. It’s a very uneven outcome. Right? Right. Very, very wealthy people and a lot of, you know, earn, what is it, 0.1 of the world, earn 50% of the wealth or something, just some crazy number that is a function of capitalism. It’s not a, it’s not a bug. It’s part of the system. And I think it’s an essential part of the system. And a little bit like the way the lottery, you see these big, big payouts right at the top right. You need to see them or you won’t play and you need to, it needs to be the 900 million and you need to see the winner and you need to see them change their life. And all of the, the, the joy and inverted commas they get from that, that’s why you play, because you see that big payout and we see Elon Musk and we see Warren Buffet and we see these people at the top of the capitalist pyramid and we think, huh, play the game because we can see them. They’re very visible. And I think capital isn’t a big function of capitalism, is having those big winners and then everyone, you know, wants to take part in that.
[Barry Ritholtz]: 00:12:53 [Speaker Changed] So, correct my bias. ’cause when I look at lottery players, your odds are more likely that you’ll be hit by lightning than winning the lottery. And I see the opposite fathead long tail distribution in capitalism. Maybe my bias is, is just because I’ve been lucky in my career, but it seems like winning in capitalism is easier than winning in the lottery. And I don’t mean being a billionaire run down the list. Gates, Arnot go through all the people L V M H, Bernard go down, everybody who’s a billionaire. Yeah, that’s a little bit of a marketing for capitalism, but go to school do well in a profession you could have a fairly comfortable life without a whole lot of risk, assuming you have just a modicum of skills and, and diligence.
[Graham Foster]: 00:13:48 [Speaker Changed] A hundred percent. So on the lottery side, it’s pure randomness, okay? And it’s a negative ev game, right? You, every time you play, you lose a little bit, lose a bit of money in probability space, right? If you are, if you’re playing cards, you’re playing poker, there’s more skill. And if you’re very good at it, you can eek out win a positive ev outcome and grow your wealth in a very lumpy fashion. In capitalism, it’s the same, right? There’s a lot of skill, there’s a lot of luck. And you, if you work hard and you do everything you could possibly do, you probably climb the ladder and you can push yourself a little bit to the right in that distribution of wealth over time.
[Barry Ritholtz]: 00:14:24 [Speaker Changed] Second quartile is not unattainable.
[Graham Foster]: 00:14:27 [Speaker Changed] Absolutely not. No, that’s right. But I mean, oh, and it, and it’s, you know, the pie grows as well. The more people work, the more productive they are is the other element to it. Really
[Barry Ritholtz]: 00:14:36 [Speaker Changed] Quite interesting. So you mentioned the, the 50 year study. I’m kind of intrigued by your thoughts on investor longevity and, and this quote I pulled of yours is delivering excess returns over long periods of time in order to achieve extraordinary results as an investor. Is, is your focus all right? How, how does one do that? Sounds easy. Just it’s sound easy. Outperform the market over decades and you’re a winner.
[Graham Foster]: 00:15:06 [Speaker Changed] It sounds incredibly easy. And if you, if you write it down on paper, you can run the numbers. It’s there, it exists, it’s clear. Three things that matter. Number one, longevity. I talk about that study that was a, a study of randomly selecting returns from the s and p 500 and you, and, and that, that group of 1000 investors gives you that very nonlinear outcome in terms of wealth. What that tells you is if you change your inputs a little bit, like you said around if you work hard, et cetera, et cetera, you can push yourself a little bit to the right on that wealth distribution. If you do that because it’s nonlinear. You can get, you can get big, big improvements in your end wealth. Massive improvements. So there are really three key inputs to that. One is longevity, right? Just sticking with it. Warren Buffet, what, what’s the statistic? 95% of his wealth that’s generated after the age of 65. Impressive.
[Barry Ritholtz]: 00:16:01 [Speaker Changed] Impressive.
[Graham Foster]: 00:16:02 [Speaker Changed] ’cause he’s stuck at it, right? And he’s pretty smart as well.
[Barry Ritholtz]: 00:16:06 [Speaker Changed] He, he never tapped into his capital to go get on the hedonic treadmill. He’s been just let it
[Graham Foster]: 00:16:15 [Speaker Changed] Compound over. Just let, let it compound over time, you know, watches his pending and just stays in the game. Another good ex, if, if the, the best example of this is endowments here in the us phenomenal institutions and they’re set up to be perpetually around. They stick around. So if you take the MET Museum, I’m sure you’ve been to the Met Museum here in, in New York. They’re endowment I think is around five to 6 billion, right? Phenomenally large number for a single institution in Central Park. And you know, I’m sure they’re a very intelligent and diligent investment committee. But the key, the key thing for them has been longevity. You know, 130 years of compounding has got them to where they are today. Stick around is the big, is, you know, that’s the key.
[Barry Ritholtz]: 00:17:05 [Speaker Changed] The, the rule to be tax exempt in the US is you have to disperse 5% of the foundation. And if you look at long-term returns for stocks and bonds, that’s not a tough target to make. You give out 5%. You don’t have to pay any tax and just let the rest ride. Exactly. That’s a great structure that that’s not a bad. I think the Guardian also has a foundation that owns it, that has a few billion dollars and Rolex a lot of people don’t realize is owned by a private foundation. The founder gifted everything to the foundation and same sort of situation. Those have compounded over the centuries and have managed to amass a huge amount of, of capital.
[Graham Foster]: 00:17:49 [Speaker Changed] It’s, I mean there’s no, it’s just simple. It’s just math stick to it over long periods of time. And it’s much harder in practice ’cause you have to put that longevity into your process. The second is excess returns. If you can just increase your excess returns a little bit each year, massive difference. It makes a massive difference over 50, 60, 70 years even just a percent. So, you know, our sister company in South Africa, Africa have done 8% above the benchmark. Wow. For 50 years.
[Barry Ritholtz]: 00:18:16 [Speaker Changed] That’s insane.
[Graham Foster]: 00:18:17 [Speaker Changed] So that’s a 300 to 400 time time sort of out improvement in your end wealth. Phenomenal amount of compounding over a long period of time. And the third, the one that nobody talks about is risk management. Risk management. And so that’s not just, we talk about risk management in terms of buying at a big discount to intrinsic value and then that gives you that capital sort of buffer. You know, the last thing you wanna do is buy by above intrinsic value because then you know, that’s where you get capital impairment. But the big, you know, the thing, the risk thing that we don’t talk about that people should talk about is, is just variance volatility. It’s, people say, oh volatility, you can just, it just goes up and down, that’s fine. But it makes a big, big difference to your long-term outcomes if you can just avoid those big losses.
[Barry Ritholtz]: 00:19:06 [Speaker Changed] E especially if you have to put money to work on a regular basis. Then the volatility and, and the valuation makes an enormous difference.
[Graham Foster]: 00:19:14 [Speaker Changed] It makes an enormous difference. And so when you run that simulation of, and you get that distribution of wealth, what you notice about the people at the top end is they avoid those big negatives. ’cause if you lose 50%, then you’ve gotta double to get back to where you were. And if you’re compounding at 7% a year, which is what markets have done, it takes you about 10 years to get back to where you were. That’s a long time. It’s a long time. And so watching your downsides, very important. So those two things, longevity, a little bit of excess return and, and risk management would be the key. So
[Barry Ritholtz]: 00:19:42 [Speaker Changed] Let’s talk a little bit about Orbis and what makes it so special. You joined in 2007, what led you there?
[Graham Foster]: 00:19:51 [Speaker Changed] So, I mean, it was interesting ’cause ’cause the background I had in mathematics really had a decision to make, do you go quantitative route or fundamental route? And it might, you know, surprise you to imagine that I thought the future was more on the fundamental side. And I came to that conclusion because if you think about what the quant side does and what the fundamental side does, they’re both trying to find the signal in the noise. Signal in the noise. There’s all this noise, all this noise, all this noise. What’s the signal? What’s the core signal? Right? That’s absolutely what the quant teams are doing around the world. What the quant funds are doing is they’re analyzing tons and tons of data. They’re looking for the, the, the little signal that drives price moves. And, and hence that’s how they generate their returns. As I thought about, you know, what, what is gonna sustain over the long term?
[Graham Foster]: 00:20:34 What is the ultimate signal in markets? What is the ultimate signal? And for me, what is a stock? What is a bit, what is an equity? It’s a piece of a business. You own a piece of a business, right? And so the ultimate signal in terms of determining where a price goes over the long term is the value of that business. That’s the signal, right? That’s the signal that won’t go away because it’s the base of the whole, you know, efficient allocation of capital. It’s the base of the whole market. It’s not the little signals that you’re trying to pick up day-to-day to figure out where a price is gonna go. That’s, that’s the thing that should sustain. So that’s what drew me to the fundamental side thinking. The fundamental side will sustain over long periods of time. Now the fundamental side can adapt, it can bring in more and more technology to help it to assess that core variable, which is intrinsic value, which is the true underlying value of the business. And I think that’s what will happen. I don’t, it’s, it’s interesting as to why the quant side doesn’t try to figure out what intrinsic value is. And I think the problem with it is the prices move much, much faster than intrinsic value of the business. In order to figure out what the value of the business is, you have to see it evolve. You have to see his cash flow come through over years and years and years and years. You
[Barry Ritholtz]: 00:21:43 [Speaker Changed] Getting the data on a quarterly basis,
[Graham Foster]: 00:21:44 [Speaker Changed] You did. Exactly. And if you’re in a quant fund and your clients say, you know, you’ve underperformed for the last three quarters and I don’t quite understand the black box, how do you retain, how you drive that alignment between the client and the business? And, and so you need shorter term returns, you need less volatility so that you can’t sustain that. So I think that’s why the QU side doesn’t focus on that fundamental side too. So that’s, you know, why did I choose Orbis? Is because if I looked at, when I looked at Orbis, when I looked at the sister company, Alan Gray, which goes back to 1973, you know, they’d sustained this long, very long period of excess performance, six, seven, 8% excess return over the market over very long periods of time. And they’d done that, you know, at Allen Gray. They’d done it for 34, 35 years and obvious they’d done it for sort of 16, 17 years when I joined.
[Graham Foster]: 00:22:29 And very few companies can sustain performance over that length of time with it being a pure fluke. Right? So isn’t that so the fascinating part was what, you know, what drove that and that’s what drew me in. And you know, when I went to interview at Orbis versus other firms, they’re just so different in the way that they interviewed. It wasn’t, you know, they were trying to pull out not just iq, I got a ton of IQ questions, right? Right. You gotta interviews. It’s like, can you answer this puzzle? Tell me about this mathematical thing. It’s all iq, but investing is, I don’t know, 20% iq.
[Barry Ritholtz]: 00:22:58 [Speaker Changed] IQ is table stakes. It’s a lot more than just, it’s much intelligence.
[Graham Foster]: 00:23:03 [Speaker Changed] More than, and you look at, what did Warren Buffet say? You give away IQ points so you can get some of these other things. ’cause the other things are even more important. You think about two people gonna look at the same data and come to very different conclusions. And that’s rationality, that’s judgment. How do you assess judgment? That’s a different thing. That IQ that’s, you know, unbiased assessment of data is a different thing, right? So that’s your decision making and that’s where we try to pull that out at interviews. What about emotional intelligence? The biggest returns you can make are at the most extreme points in markets. It’s like sitting down at a poker table. There’s one hand a night that really matters. You need to make the right decision in that hand. And that dictates whether you go home happy or you go home sad.
00:23:41 And it’s exactly the same in, in markets. And you need a varied level, unemotional, you know, way of going about things. Very. And, and to be able to make good decisions at those extreme moments is absolutely critical. Those three variables. Iq, rq, eq, intelligence, rationality, and emotional intelligence. And so that’s what Orbis was trying to draw out. You can’t draw it out or interview. So that, that’s where you have the, the systems we have in place to assess people over time what they’re good at, what they’re not good at. But that’s really what drew me to the firm. Huh.
00:24:13 [Speaker Changed] Really, really quite intriguing. So, so your fee structure is very different when you outperform the market. You take a performance fee based on that outperformance above beta. What happens when you underperform the market?
00:24:31 [Speaker Changed] We refund the fee. So what happens is, let’s say you outperform by 5% in the first six months of the year. That fee on the performance that we generate for our clients, a proportion of that our performance goes into a bucket or a, or an escrow account if you like. And then if we subsequently underperform by 5%, let’s say over the next six months, so you’re flat on the year, the client shouldn’t have paid a fee, right? Right. And that is the case. So we re refund the fee back from the bucket. It goes back to the client. And
00:25:02 [Speaker Changed] And this isn’t a theoretical construct, this is literally the cash is pulled aside, held in escrow on the client’s behalf. And you guys have been doing this just about 20 years. Just
00:25:14 [Speaker Changed] About 20 years. Yeah. So it leads to much stronger alignment with the client and has a lot of positive outcomes. And number one is it reduces the volatility a bit. We talked about the importance of risk management and volatility. When we’re underperforming, we’re refunding the fees. That reduces the volatility to an extent. It also aligns clients and improves client behavior. ’cause one of the key things, another, another, another problem with the industry is it’s all very well saying you can outperform the market, but what you have to be able to do is outperform on a dollar weighted basis. So that’s a combination of you doing good things and generating returns, but also the client acting in a way that’s not pro-cyclical. I e not investing more money after good performance and pulling out after bad performance. And it’s chronic in the industry to see the dollar weighted return for clients be much below the actual return of the funds that they invested there. There
00:26:09 [Speaker Changed] Was a Wall Street Journal article a couple of years ago about John Paulson who, whose funds had just crushed it during the financial crisis. They were short mortgages, they were short derivatives, they put up outrageous returns when they were a relatively small funds. And then all this cash flows in and now they’re running $40 billion buying gold. And not only are they not outperforming, they’re pretty substantially underperforming, assuming I’m remembering this article right. It might not even been the, it might have been Barron’s, I don’t remember where I read it. But the net take was exactly what you’re saying on a dollar weighted average net net his fund was a money loser over its career. Even though it put astonishing numbers up in the beginning of its its life when it was, you know, a billion or two, not 20, 30, 40. I, I apologize if I’m getting the precise source wrong, but it was a pretty substantial Yeah,
00:27:13 [Speaker Changed] It’s a common, very common story. Really, really common. And it’s how do we
00:27:17 [Speaker Changed] Avoid that?
00:27:18 [Speaker Changed] How do we avoid that? You build alignment into the, into everything you do. You try to build alignment. So you, you’re trying to find clients that really understand you, number one, so that they know the type of volatility that they’re gonna get. They’re not gonna make, you know, when when we, we get to, we get to those inevitable tough periods. They understand that, they recognize it and you know, we’re always communicating with them to sort of help them through those periods. And the second is the fees. You know, if you’re refunding fees to clients in those periods of tough performance that really does align you, they say, okay, you’re suffering. We’re suffering. That’s okay. Everyone’s suffering. And, and you, you get a much stronger result in terms of clients sticking with you through those cycles.
00:27:59 [Speaker Changed] How, how substantial are, are the fee refunds? Is it, is it a meaningful amount of money? How, how big a difference does this make to clients who are, who are happy that they’ve outperformed for a few quarters and now they’re looking at a few quarters of underperformance? I
00:28:14 [Speaker Changed] Mean it’s to the ex to the extent that, well it really depends on the extent to which we’ve outperformed. ’cause we’ve outperformed a lot by a lot. There’s a, there’s a point where the firm itself needs to take some cash flow Sure. To keep the lights on. But you know, in regular cycles, a little bit of outperformance, a little bit of underperformance, you’re just refunding that fee. Huh,
00:28:36 [Speaker Changed] Really, really interesting. So this should be taking the industry by storm. Everybody else should be stealing your idea. How, how widely dispersed is the concept of fund managers returning a percentage of the fees when they underperform?
00:28:53 [Speaker Changed] Well, when we put this in place, we thought this was it. The floodgates were gonna open, right? Everyone was gonna follow. And the reason why they follow is be, it’s such a tough thing for a manager to do. And so the client, you know, we should, we should get a lot of clients sort of saying, okay, finally an aligned fee. And it would be so popular with clients that it would be very difficult, difficult for other managers not to follow. And we’ve not seen that, which is interesting. And I think one of the reasons is it’s very difficult for the manager to sustain that type of fee because you’re transferring the volatility from the client to the manager, right? So it means the manager has to do things like reserve and it has to be a stronger balance sheet and therefore you’re not, you’re not paying out dividends to partners. So you have to make that decision to reserve and you, you know, you’re just taking on more volatility as a business.
00:29:49 [Speaker Changed] I, I’ve also been kind of astonished at seeing some pretty famous fund managers go on TV and, and refuse to admit error. This is a drawdown, ah, we were a little early or whatever it is. No one comes out and says, oh we were wrong about this. How significant is that a factor in getting a fund management company to say, Hey, we stunk the joint up and here are your fees back for this quarter.
00:30:17 [Speaker Changed] I mean it’s enormous and I, you know, one of the key things as a, an investment firm is you have to recognize your errors and you have to learn from them. And you have to have a robust system internally to make sure that you know, those biases, those errors you’re making are picked up and addressed so you can do better in the future. And I think if anything, we are on, on the other side. So we’re too, we’re too explicit about the errors we make, right? And I mean, but it is endemic in the industry because the industry is incentivized to grow assets and hence admitting errors is not something that you want to do on tv.
00:31:00 [Speaker Changed] Let’s talk a little bit about some of your strategies. You have three separate strategies. I’m familiar with global equity, global with exclusions and global balance. Tell us a little bit about the approach. Am I, am I summing them up correctly, more or less?
00:31:17 [Speaker Changed] Yeah, so we we’re really focused in terms of what we do. We equity investors typically, so a company analyst, we look for intrinsic value of businesses. We look to buy at a significant d discount. Our main product, our flagship is global. That’s been running since 1990. We actually have a, a market neutral hedge fund associated with that, which is really beta neutral. Market
00:31:36 [Speaker Changed] Neutral meaning long, short or
00:31:37 [Speaker Changed] Yeah, it’s long. The, the stocks we like and short market in. Got it. So a very, very simple way to extract the alpha plus the cash rate from the strategy. And so those are the two of the longest standing strategies. Then we launched the Japan strategy, which, you know, there’s very interesting things happening in Japan now in 1998. We’ve got an EM strategy, we’ve got an international strategy which we launched in 2009, which is non-us. Those would be the main ones. We do have multi-asset strategy called balanced, which we launched in 2014 15. Balance
00:32:05 [Speaker Changed] Stocks and bonds or stocks
00:32:07 [Speaker Changed] And bonds, stocks and bonds and others where you can hold commodities and currencies and things in this.
00:32:12 [Speaker Changed] Speaking of commodities, they seem to be doing pretty well. And here we are about to start the fourth quarter of 2023. What do you, what do you, how do you approach commodities if you’re bottom up fundamental equity investors? Commodities is a totally different beast.
00:32:29 [Speaker Changed] Yeah. Commodities are tricky, right? But what you can do in terms of, as an equity investor, you can say what is a normal sort of commodity price deck for your business? And then say how much free cash flow can that business generate on that, on that typical price of oil or gas or whatever it is you’re looking at. So that’s one of the, you know, things we’re looking at is what is a normalized pricing, what sort of free cash flow can you generate and how can you grow from that base? And that gives you a rough value for the business. And commodity industry is very fruitful ’cause it’s so volatile. So you get massive swings in the price of the shares, you get massive swings in the market cap of the companies and you don’t get that much swing in the true underlying value in the businesses. So that’s been a, an area that we’ve been investing in for a long period.
00:33:20 [Speaker Changed] Let, let’s talk a little bit about unpopular or ignored stocks. How do you define those and how do you go about finding ’em?
00:33:30 [Speaker Changed] So this word contrarian is interesting, right? Because we, we talk about contrarian investing and everyone wants to be a contrarian.
00:33:38 [Speaker Changed] I love that line.
00:33:40 [Speaker Changed] Everyone wants to be looking in areas that nobody else is looking and, and buying into fear, selling into greed. And, you know, a better way I think to describe what we do is just differentiated thinking. So not not necessarily looking for things that are bombed out, although that can be very fruitful in terms of, you know, thinking about which areas are potentially oversold or, you know, there’s too much fear around them. But we, you know, more fruitful way is looking for apathy. People have just lost interest or just a differentiated view on a business. That’s how I would describe our style is just assessment of intrinsic value. So that’s deep company work.
00:34:23 [Speaker Changed] So if you’re looking at intrinsic value, does that make it easier to determine, hey, this stock is inexpensive for a good reason and this stock is inexpensive ’cause people are failing to see the value there. Meaning some, some stocks are cheap for a reason and others are cheap because people seem to be missing the underlying value. Well
00:34:45 [Speaker Changed] That’s, I mean, our job is to figure out the difference between those two.
00:34:48 [Speaker Changed] So, so how do you do that?
00:34:50 [Speaker Changed] One of the key things, one of the differentiators potentially of the firm is that all of our analysts run paper portfolios. So they’re, all of our analysts are working in niches. They could be a Japan analyst or UK analysts or financials analyst. And their job is really to know the company as well, Ted, under the pieces pieces, build them back up again, figure out what they’re worth. And through that process they determine which stocks are potentially mispriced and then, then they recommend a list of those into a paper portfolio and you track the performance of that over time. And it’s quite a useful mechanism to have that for the, for the analysts themselves. ’cause they, it’s a learning mechanism as a recommendation mechanism for portfolio managers and thinking about how to allocate capital. And what we find over time is, you know, the top three or four ideas coming from key analysts who really deep in the weeds generate a lot of outperformance. And that’s the key. It’s just being close to your business, really tearing it to pieces, understanding what it’s worth and buying at a good price. And that’s really the lifeblood of the firm.
00:35:49 [Speaker Changed] So let, let’s talk about again, another quote, the great misallocations in the market that skilled active managers can take advantage of. How often do these misallocations come along and how easy or difficult is it to identify them in, in real time?
00:36:07 [Speaker Changed] I think a lot of people forget that as an investor you’re a price taker, you’re just waiting, you’re just waiting, right? For prices to give you the opportunity to buy the discount to the, the true worth of the business. And so the critical component in terms of managing a portfolio or finding great ideas is flexibility. Because you are, you know, you, you’re not dictating what the market does, you’re just waiting. So having the ability for capital to move to the most dislocated ideas is absolutely essential. So if you go back and look at the history of our funds, sometimes we’re very, very heavily invested in one country. Sometimes we have zero. That’s exactly how it should be because inefficiencies aren’t static. They move right? And they evolve.
00:36:51 [Speaker Changed] So flexibility in order to be opportunistic, to take advantage are investors and clients patient enough for you to, you know, Warren Buffett famously said, the nice thing about investing is there are no cold strikes. You can sit there with the bat on your shoulder and just wait for your pitch. I, I don’t know how familiar you are with US baseball, but that that normally it’s a cold game of cold balls and strikes. Buffet says you could watch a hundred pitches go by until the one you like is there are clients patient enough to say, Hey, why are you sitting around in cash there? Aren’t there opportunities? How, how does that work?
00:37:29 [Speaker Changed] So we, the, the tough part of what we do is we have to run a portfolio of equities for our clients. And what we’re trying to do is just find the best ones and there’s always the best ones, right? The market is, market’s very rarely narrow. So narrow that everything is efficiently priced and there’s no opportunity. And if that is the case, then that’s okay, you can just hold something that, that yield gives you 7% a year over time and that’s fine. But there’s always opportunity and it’s just a question of finding it and it, you need a lot of depth that comes from the analysts looking at these different niches and you need a lot of breath. You need to just turn over a lot of stones and cover a lot of ground.
00:38:09 [Speaker Changed] So, so let’s talk about that. ’cause over the past, you know, either one or or multiple years, it’s been pretty much, you know, it started out as fang. Now some people are using the phrase magnificent seven. The the seven largest tech stocks have been driving about 25% market cap of the s and p 500 driving a lot of value creation. Can you look outside of those seven or is it, that seems to be the only game in town here.
00:38:40 [Speaker Changed] I’m not even sure what’s in the seven. Can you tell me what’s in the seven?
00:38:43 [Speaker Changed] Amazon? Apple, Tesla, Nvidia, maybe Facebook, maybe Microsoft, something like that. That’s, I don’t really pay much attention to be honest. I don’t pay much attention to them. Yes. Oh, did I leave out Google and I’m sure there’s something else I’m forgetting. That’s not how I wanna invest. However, exactly. If you are looking for opportunities and those seem to be driving so much of the index returns, how challenging is this environment? It’s or do you just pile into the, those seven,
00:39:17 [Speaker Changed] That’s what I mean a lot of people have, right? That’s the, that’s the challenge. So two points I’d make one fang to magnificent. Seven, it changes, right? The basket changes and, and, and it’s just the next big thing two or three years ago is NFTs and all this sort of, and now it’s AI and, and you and and large language models and there’s always something comes up bust and then it sort of emerges from the ashes and they’re all relevant new technologies but you just don’t want to get caught up too much in the hype.
00:39:44 [Speaker Changed] You forgot the metaverse between NFTs and AI was the metaverse. The metaverse, exactly. And I know that created a lot of value, right?
00:39:50 [Speaker Changed] Yeah, that’s right. I’ll give it time. Who knows. So there’s 3,500 investible stocks or more in the world for us, we treat them on a unit basis, right? In any one of those 3,500 stocks you could see a big, big mispricing. And so the chances that we end up in the biggest seven stocks in the world are quite slim on that basis. Because what’s the chance you’re gonna have the most inefficiency in the biggest seven stocks?
00:40:13 [Speaker Changed] Those, those are probably the most efficient stocks. They’re
00:40:16 [Speaker Changed] Probably the most efficient. Now the two, the problem as you say you have to deal with is if they go through a long period of performing very well, then you, you know, you have to stack up against that, right? And that’s the issue we’ve had in terms of if we look at the world on an equally weighted basis, we’ve added a lot of value for clients over the last 10 years. If we look for a cap weighted basis, it’s been much harder, right? Much harder. Either because we missed those opportunities either with fundamentally mispriced and we missed them. And I think there’s a little bit of that in there. Or they just did well, right? Their randomness and, and you know, they hit, had a few hits also all the, all the valuation went up right to, to fairly extreme levels. So one of a combination of those three things have happened over periods of time. The last five years have been a good example of that. The late nineties. A good example of that, you go back to the late sixties, you saw exactly the same dynamic. So you go through these periods and you just have to be patient. As long as you’re generating a good absolute return for your clients, I think, you know, our clients are happy and they recognize you go through these big cycles.
00:41:12 [Speaker Changed] So you’ve talked about finding your edge, what makes your approach unique to you and, and the advantage you have? How do you find your edge? What can investors do to identify their own strategic or tactical advantage?
00:41:29 [Speaker Changed] So I mean, edge is a tricky one, right? And everyone tries to define their edge, everyone’s trying to look for their edge. And I think it, if it was so simple as to say, hey do this and then you’ve got an edge, then everyone would do it and it wouldn’t be an edge. So it has to be a number of things and you have to balance, you know, across a number of different variables. I would point to a few things. One, we talked about how, and this links to the, you know, the second part of the question, how does that, you know, an everyday investor develop an edge and how, how should they think about investing? It’s those three things. It’s the three key variables. Number one, longevity. And that really comes down to ownership structure. You know, the really tough part of this business is succession. You build an asset manager, you build Bloomberg, you build any organization, how do you handle succession? And in asset managers it’s really difficult because you usually have a founder. Founder builds the business up. If they’re successful, then what then what, you know, next
00:42:24 [Speaker Changed] Generation comes along,
00:42:25 [Speaker Changed] Next generation. But how do they take the, you know, take the ownership from the founder? Do they have to borrow money to buy ’em out, right, more out, do they need to go public, you know, sell to, and, and then that leads to other disruptions.
00:42:39 [Speaker Changed] Private equity, there’s
00:42:40 [Speaker Changed] Could be, there’s a lot of different ways, but very few of them are sustainable perpetual solutions. ’cause you’re gonna, you know, if you’re selling to the next people, then you take, they have the same problem, et cetera, et cetera. So the one thing you need to build into your organization is longevity. And so that’s one thing we’ve done through the ownership, through the charitable foundation, which owns the business into per perpetuity. Giving, giving you that stability and enabling the business to embed that long term philosophy.
00:43:10 [Speaker Changed] Al also a, I mentioned orbiss fee structure is unique. Having the, an investment manager owned by a charitable foundation, fairly unique. I don’t know many other companies that operate. The closest thing is Vanguard is a mutual, theoretically owned by their shareholders. But this is even more specific. This foundation owns the asset manager in perpetuity.
00:43:35 [Speaker Changed] Exactly, yeah. And, and it’s mutually beneficial. One, you get that very long-term time horizon from an owner, very stable, which is essential when you’re making long-term investment decisions. Two, the, the foundation gets the, the cash flow from the business to a degree to facilitate its philanthropic work. So you get that nice symbio relationship and the incentive of the foundation is to make sure that underlying investment business is healthy and sustains over very long periods of time. So that’s, it’s very much embedded in that the trustees of the foundation that we need healthy underlying investment businesses because that’s what drives the dividends, that drives the philanthropic activity over time. So long-term ownership is key. The other is excess returns I talked about the paper portfolio system is quite unique to what we do. And every analyst having that ability to express themselves from very early on in their career and learn and we can learn about them and all their foibles and all their biases over time, which is quite a big deal.
00:44:34 ’cause then you get to sort of draw out what is a person’s superpower, how can they contribute in the best way to the firm. Okay, so that would be the, on the, on the return side. And then on the risk side, the fees really help with that as we talked about. ’cause they, they make the, the return series for the end client, smooth them out smoother, right? And, and having less variance of return is, is important. You know, one of those three critical variables. The fourth one of course is client alpha or dollar weighted alpha, right? And that’s alignment as well. The fees help with that.
00:45:04 [Speaker Changed] So, so let’s talk about what’s going on in the world. We’ve been in deep into this rate rising environment and this inflationary environment. How does that affect your ability to do your job? What do you need to do to adjust when the era of low rates and free capital suddenly goes away?
00:45:26 [Speaker Changed] Well, I mean that’s the key. You just hit on it. It’s been free capital. And so we’ve seen a giant capital misallocation on the basis of rates being too low, long yields being too low. And, and there’s been a raging debate even in that period. Are rates too low? Aren’t we an inherently deflationary environment, right? Aren’t we, demographics and technology and et cetera, et cetera, et
00:45:48 [Speaker Changed] Cetera. Just, just because we’re in a deflationary environment doesn’t mean that rates have to be on an emergency footing on zero. You can have two or 3% fed funds rates and still have technologically induced deflation. Why, why are they mutually exclusive?
00:46:06 [Speaker Changed] A hundred percent agree. And the other element is you can, there’s a specific variable you can look at that tells you that it was a giant inefficiency and that is the term premium, right? Which is now getting into the media a bit more. We see more and more about the term premium. So the term premium is embedded in the long bond, right? And the 10 year yield of A A A J G B or or a or a, a treasury or a bond. And it is the extra return you should get for taking on time risk effectively, right? ’cause that long bond should embed the expected inflation rate, the expected path of short-term real rates and something else. And that’s something else should compensate you for the uncertainty and all those other variables, right? Because you don’t know what inflation’s gonna do. You don’t know what real rates are gonna do. So you need an extra bit of compensation and that’s, that’s back, that’s backed out. It’s like a risk premium, like an equity risk premium. You can back that out. And that term premium has been negative never before in history of tracking this, this variable. Has that gone negative in the sixties? It was very low in the nineties, it was very low. It’s gone negative over the last five years. Absolutely incredible. And that tells you there’s a huge mispricing in duration, a huge mispricing on the long end of the curve.
00:47:18 [Speaker Changed] So meaning are, are you saying the long end of the curve is, is now attractive and cheap?
00:47:26 [Speaker Changed] I would no,
00:47:27 [Speaker Changed] You’re saying the
00:47:28 [Speaker Changed] Opposite. I’m saying the opposite. And the reason is because that term premium has been very negative over the last five years and still isn’t positive. It’s risen from very, very negative levels. But it’s still not positive. That has to be, in my opinion, positive people disagree on this point. It has to be positive because it has to compensate you for taking time risk. That’s the real time risk is the term premium. And I think it’s fascinating. If you go back to the sixties and you look at when it was very low through the late sixties and you go back to the late nineties, also very low, you see exactly the same dynamic that we’ve seen over the last five years and is all the long duration stuff goes up, right? Up, up, up in the early seventies you had the nifty 50, right? In the late nineties you had the tech mania, right?
00:48:10 And then we’ve had all sorts of, you know, a bubble to an ex extreme proportions, especially on the long duration end. Especially on the long duration end. So that’s led to this huge justification within asset markets where the long duration businesses have been trading at extraordinary multiples and the short duration businesses, which are typically the very cashflow, generative low growth ones, right, have been extremely depressed. And you could see that dynamic in the late sixties, see in the nineties. And it led to a very interesting thing, which was the companies whose share prices were very low stopped investing like the energy companies in the late sixties and the late nineties, they just stopped. They reduced CapEx enormously because the share prices were telling them, don’t go out and grow, just pay out your cashflow to us. ’cause we are not, we’re not giving you any kind of rating, right? And, and it was the opposite for the high growth businesses. Those very high ratings were saying, okay, go and raise more capital. Your cost of capital’s very low. Go and grow.
00:49:09 [Speaker Changed] So, so we’ve had this distortion caused by free capital and low rates. Where is the biggest misallocation in allocations? A year ago, summer of 2022, we saw people piling into private credit and private debt and private equity. It, it felt like a crowded trade, a little bilious and a year later nothing’s blown up, but clearly not, not as attractive of a sector as it was. How does this impact public equities?
00:49:43 [Speaker Changed] So what we’ve seen is the, the top of that dynamic has happened. So in 2021 was the equivalent of March, 2000, right?
00:49:52 [Speaker Changed] And the top of of of the.coms.com
00:49:55 [Speaker Changed] And, and the early seventies, the top of the nifty 50, I think. So we’ve passed that point. So we’re just in a, a gradual corrective process. We’ve seen it before. We saw it through the seventies, we saw it through the two thousands. And we’re just in that moment. And if you look at that gap between the valuations in the long and short duration end, it’s closed, but it’s not closed by very much. I think, you know, listen to Cliff Asne, a qr, he say, okay, it was at the 99th percentile. No it’s at the 70th or the 85th or some such, right? We measure so
00:50:21 [Speaker Changed] Cheaper but not outright cheap.
00:50:25 [Speaker Changed] This is the relative attractiveness of the shorter end, the shorter duration end of the equity space. So this is more like the real economy, slower growth businesses. They are on a relative basis, cheap, very, very cheap versus where they had normally not cheap versus 2021. That was the most extreme point. So that leaves us sort of in a place where I think you just see the con this dynamic continuing to play out. I would be concerned about duration still.
00:50:50 [Speaker Changed] Now you could buy a one year bond and you’re practically getting the same yields, but you’re taking a risk that, hey, maybe rates go lower if there’s a recession next year, how do you, how do you operate around that uncertainty?
00:51:05 [Speaker Changed] So that’s the cycle and that’s the, you know, your short term versus your long-term view on a long-term view. You’ve gotta embed the term premium into that long yield on a short term view. If you’re smart and not smart enough to do this, you can sort of try to play around recessions and slow downs and rate cuts and, and you’ll, you know, you might make a bit of money on the duration end like that. But I, I still see that as the big dislocation within the equity market.
00:51:29 [Speaker Changed] So let’s talk about equities. So value overgrowth is, is it, for a while, value had come back with a, with a vengeance that seemed to have stopped for a while and, and since, I dunno, the lows in October, 2022, growth has done really well. How do you, how do you look at those two spaces? You sound more like a value investor than a growth investor. So let’s start with that and then we’ll look around the world. So, so what do you look at, what do you think of in terms of how value stocks appear versus growth stocks? So
00:52:03 [Speaker Changed] I would, I would have value stocks are synonymous with short duration and I still think they look very cheap. So your value stocks are attractive. And getting back to that a Q r measure, they’re pretty, the dispersions are still very wide. I think this is a, a cycle which is reflexive. Once you get to the top, it starts to roll. And you know what the reason for that is? Getting back to those, those short duration old economy businesses, the lower growth ones, the value stocks if you like, because they’ve had such low valuations through this cycle, they haven’t invested, that drives not enough stuff into the real economy because you, you’re not producing enough and it’s like not enough primary energy and, and et cetera, et cetera. And that drives this kind of inflation impulse through. And we saw that in the seventies and we saw that in the two thousands.
00:52:55 The two thousands it wasn’t quite as strong ’cause you had a big labor arbitrage with China, but the underlying inflation was reasonable. And what that does is it pushes up the term premium. And as the term premium’s going up, then this normalization of the relative valuation gap between the value stocks and the growth stocks starts to close and you get that at the same time as these businesses are generating very, very healthy margins as well. Because pricing’s good, pricing’s good. And they, they’re using that free cash flow not to reinvest in the business because they’re still worried about the low share prices. They’re just paying it all out. So it’s all going to the bottom of line. It’s all, it’s all coming back to shareholders. That’s where you we’re getting a lot of yield in the portfolio,
00:53:31 [Speaker Changed] Huh? Interesting. What about geographically? Where, where are you looking around the world that’s attractive.
00:53:37 [Speaker Changed] I don’t think there are any big geographical inefficiencies today. Japan’s very interesting ’cause they’re going through a big co corporate governance change, which is getting in the news. Right?
00:53:45 [Speaker Changed] Right. It it’s also, look over the past couple of years, the Japanese stocks have seemed to really come alive since the pandemic. What, what’s driving it? Is it this corporate governance or is it just the, they’ve been underperforming since 1989. That’s a long time to run a pretty poor basis. They’re still below the, the, their bubble peak, which is kind of hard to imagine 30 years later. Imagine, I think it took us 13 years to recover the nasdaq.com collapse down to about 1100 from 5,000 and we passed that. The Nikkei is still way below where it was. What, what’s happening in Japan.
00:54:34 [Speaker Changed] So, I mean the, the, the reason why we’re still way below that, that 30 year ago peak is because it was just absolutely extraordinary. There’s never been a bubble like it
00:54:41 [Speaker Changed] Four x the.com or five x the.com, something
00:54:45 [Speaker Changed] Like that. Yes. Yeah. Some, some multiple.
00:54:46 [Speaker Changed] Crazy.
00:54:47 [Speaker Changed] Absolutely crazy. And it was, you know, the, the lower quality businesses there were were the ones that were getting the most expensive. It was the one, it was a balance sheet bubble almost based on the price of land. So that was one reason why we talk about, another reason is the corporate governance in Japan has been awful. Too much cash on balance sheets, unproductive cash, too many cross shareholdings. They all hold bits of each other. No,
00:55:11 [Speaker Changed] No activist shareholders in Japan.
00:55:13 [Speaker Changed] No. It’s very difficult to be an activist shareholder in Japan because it’s a very consensus society and, you know, foreign shareholders coming in and doing the evil deeds aren’t particularly welcome. What do you have to do in Japan is you have to build a relationship with management over a long period of time. So we’ve been investing in Japan since the early nineties. We meet with management twice a year. A lot of different management teams across the economy. We talk to them, we understand them. We try to figure out, you know, try to help them with their business. We try to understand, you know, the reasons for why they’re doing what they’re doing. We gradually try to help them on the capital allocation side, nudge them to, okay, is it sensible to hold shares in all these other businesses? ’cause you know, as an investor like us, number one, we’re just, we’re not just owning you, we’re owning everything. We’re just like, own an index. And in terms of capital efficiency, it’s horribly capital, capital inefficient. Because you know, as soon as they start selling those cross shareholdings, that money starts coming out to shareholders. This gets reallocated to businesses on the basis of the growth potential. Right. And so it’s really positive for the economy to unwind all of these and to use all this idle cash. Omics was the start of that.
00:56:24 That was what, 2015? Something like that?
00:56:27 [Speaker Changed] Yeah, almost a decade ago. Yeah.
00:56:28 [Speaker Changed] So that was the start. And that was really good start. But recently we’ve seen some meaningful change.
00:56:35 [Speaker Changed] So let’s, let’s stay with Japan a little bit. When, when you look at activists in the US you have companies like Apple doing dividends and share buybacks. Even Berkshire Hathaway doing a share buyback. I i, I kind of always felt that it wasn’t so much the activists that drove those as the threat of an activist that’s missing in Japan other than omics. Would, would this have happened or would they just have continued to all cross own each other and very unproductively sit with these assets on the balance sheet?
00:57:15 [Speaker Changed] I don’t think this is activist driven. I don’t think it’s the threat of activists or the presence of activists that are driving this change. I think it’s very internal in Japan. Yeah. And it had to be internal. It had to come from the institutions within Japan. This
00:57:28 [Speaker Changed] Is a generational change, isn’t it?
00:57:30 [Speaker Changed] I think so. Yeah. You’re seeing people, the Tokyo Stock Exchange have come out and told businesses that they really need to trade above book value. Why do you trade below book value? It’s extraordinary. You know, you’re not, that implies that the market thinks you don’t create any value as a firm. You’re trading
00:57:44 [Speaker Changed] Create negative value.
00:57:45 [Speaker Changed] You’re creating negative value.
00:57:46 [Speaker Changed] Exactly. Right. The replacement value, the, what is that q the replacement value of the company is less than what they’re actually trading at. That, that, that seems sort of
00:57:57 [Speaker Changed] Absolutely extraordinary. And some of these book values are understated. So I mean it’s remarkable the valuation. So it’s coming from the internal pressure, it’s coming from the regulator, it’s coming from the government, it’s coming from the stoke to stock stock exchange. And when that starts to bite for one or two companies, you start to see it proliferate. Because business in Japan is all about not sticking out too much. It’s about consensus. It’s about doing the right thing, you know, societally as well as for your business. Right? And so once you start seeing it start to roll, then it snowballs. And I think we’re just start the front end of that now. How
00:58:32 [Speaker Changed] Long will that take to play out? Is this a decade type of I think
00:58:35 [Speaker Changed] It’s a, yeah, it’s a decade because it takes a long time to unwind cross shareholders. It takes a long time to, you know, move the narrative and for that to continue to go. But what, what we’ve seen is because we’ve been meeting with these management teams for decades now, we can kind of like benchmark it. What, what does the change look like now versus five years ago, which is five years? ’cause it’s been gradually improving over time. This is a step change. This is when we go and meet with management teams now it’s a meaningfully different conversation. It’s a different tone now. The activists are jumping in there. I don’t think that’s particularly helpful because it’s happening by itself. Right. And if you know, you, you, you’re coming as an activist waving your flag going in the newspaper. You almost sort of like, you risk this delicate situation, right? Breaking what is quite a nice trend.
00:59:23 [Speaker Changed] How significant is the currency offset with, you know, yen versus the dollar has been a, a tough trade. How important is a currency hedge on on a Japanese investment if you’re not a, a local in Japan? So the
00:59:37 [Speaker Changed] Currency hedge is very helpful. So you know, you look, we, we own a business called impex, which is one of the biggest energy companies in Japan. They’re now paying out much more of their earnings than they used to. So that’s nice. You’ve got a 4% dividend yield and a 5% buyback yield. So it’s a 9% total yield in yen and they’re still paying out about half the amount that a shell or a or BP does. Impex
00:59:55 [Speaker Changed] Impex.
00:59:56 [Speaker Changed] Yeah. So it stands for International Petroleum Exploration or something like impacts. It’s been around for a long time and they’re mostly L N G and they have these big L N G fields off the coast of Australia supplying all of Asia with liquified natural gas. Huh. So what’s interesting there is you get that 9% yield but it’s in yen if you hedge to dollars of course ’cause you’ve got that big, big interest rate spread today, right. You know that nine goes to 13.
01:00:26 [Speaker Changed] Wow.
01:00:26 [Speaker Changed] And so that’s cash yield. Real cash yield. Now there’s some, you know, nuance there in the sense it’s kind of a dollar business as well. So if Right. Changes in the end will impact the underlying business. But that is a good solid yield that you’re getting in your And what’s the return of market spin over the long term? 7%. Right. And that 7% has come from growth and yield a little bit of yield, a little bit, little bit of growth. That’s where your return comes from. If you can get a 13% pure cash yield with an inflation protected, which is inflation protected is real, real
01:00:55 [Speaker Changed] Cash ’cause of the price and natural gas will rise and fall with inflation. Exactly. Exactly.
01:00:59 [Speaker Changed] That is phenomenal. Right. So why, you know, that’s where it comes back to ai. Do you need to make a decision on NVIDIA’s future here at this valuation or can you go out there and find these types of opportunities? So the risk of course is the magnificent seven keep rising and the market does 20 and you are doing 13. But a 13 is, is a great return, it’s a great rate return
01:01:20 [Speaker Changed] That that’s a low, that’s a pretty, sounds like a lower risk sort of trade even if it’s not matching what the biggest AI funds are are doing. What about the rest of the world? Let’s talk a little bit about emerging markets. What’s appealing there?
01:01:38 [Speaker Changed] Emerging markets are dominated by China. That’s the problem you have, right? As an emerging market investor,
01:01:44 [Speaker Changed] There are actually specific indexes and funds that are EM X China, just the way there are developed world X U s. So if you don’t want to be the US develop dominates developed world, China do dominates the em arguably, are they even really still an em? That’s a whole nother discussion. But outside of China, well let’s start with China. Is China investible or are they attractive?
01:02:12 [Speaker Changed] China’s investible I think, and it’s a question of risk premium. What risk premium do you get for investing in China? You know, the big issue you have is think about, think about Alibaba today. It’s come down a long way, right? It looks quite interesting. It looks very cheap on a standalone basis. If it traded in the US I think everyone would be all over it at this valuation. The problem is, is you know, if you think about if you had a spare 200 billion lying around, okay, would you go and spend that on buying the business outright as a long-term investment buying Alibaba for the next 30 years? And right. As a long-term investor, you have to think that way. ’cause you’re buying a piece of a business, right? That’s your, you know, that’s how you have to think. And so when I think about it in those terms, it’s okay. You need to be aligned with the, the, the overall system. And that’s the problem you have when investing in China is, it’s just that there’s a lot of uncertainty around, as we know, the geopolitics and the friction in terms of the different ideologies of the us.
01:03:12 [Speaker Changed] I mean they’re, they’re ceo C E O disappeared for eight, nine months ’cause he seemed to have gotten into a little bit of a disagreement with Xi. And to me it, I don’t know how you put capital at risk in a country where the government can say, we’re we’re not happy with your operations and so we’re gonna throttle you for the next four quarters and then we’ll, we’ll see how you behave after.
01:03:38 [Speaker Changed] I agree. Yeah, you have to be very, very careful if you’re looking broadly at emerging markets. Korea’s very interesting, obviously sits right next to China. But if you look at Korea, historically, they’ve often been a Japan fast follower. You know, think about the export markets that Japan built in the sixties and the seventies. Autos, electronics, Korea really just followed that model and did it wonderfully well. And so the noises we’re getting out of Korea are very similar to the noises we’ve been hearing out of Japan over the last five to six years. Corporate governance, reform of balance, sheet efficiency, capital allocation, all the things that put this big discount on Korea and put the big discount on Japan prior to, you know, the last few years exist. And so Korea’s, I think Japan a few years ago and, and you, and you’ve got more upside
01:04:27 [Speaker Changed] There. We, we’ve been hearing a lot of noise about India lately. Any thoughts on the subcontinent there another billion people waiting to move to the middle classes. What, what’s happening there?
01:04:40 [Speaker Changed] India is a, an in really interesting area in terms of the geopolitics, in terms of the, the population story in terms of the, you know, the per capita wealth growth potential. But it’s also a pricey market. Those, those businesses are not priced cheaply. And so you pay up for the promise and that makes it less interesting in my mind. Whereas if you go to an Indonesia, which is similarly low per capita wealth, similar growth rate, similar productivity growth
01:05:10 [Speaker Changed] And lots and lots of people,
01:05:11 [Speaker Changed] Lots and lots of people, you pay, you know, five, six times earnings. Some of these businesses you’re getting sort of 10, 11% dividend yield yields out with sort of low team growth rates. If you go back to 2005, when I joined Orbis, the bricks was all the rage. Right? Right. Bricks, bricks, bricks was the, was the AI of the time. Bricks,
01:05:30 [Speaker Changed] So, so Brazil, Russia, India, China, none of none them have done especially well since then.
01:05:37 [Speaker Changed] They haven’t in terms of their stock market now, in terms of their economies, their economies have grown recently. Well yes, Russia aside and South Africa is in there as well. Right.
01:05:45 [Speaker Changed] And Russia was actually seeing some growth until they decided to invade Ukraine. That’s became a
01:05:52 [Speaker Changed] Pariah. So the, the, the story around emerging markets in 2005 is absolutely right. You had growth rate in population that’s come true. You had productivity growth. That’s come true what hasn’t come true. Investment returns. Why has that not come true? Because everybody wanted a piece of them. Everybody wanted a piece of them. So whilst the earnings growth has been good for the economy overall, the per share earnings growth has been absolutely awful because the number of shares has gone up and up and up issued capital for all this capital coming in. What have you got today? You’ve got apathy. Nobody wants to invest in Indonesia, which is great on two sides. You get cheap valuation, but you also get the businesses that are in Indonesia and dominant, they don’t have any capital to compete with. So their growth rate on a per share basis is actually higher than it was when everyone was excited 20 years ago. So I think that, you know, there are really good opportunities. Brazil’s another example in emerging markets, you’re seeing cheap assets and, and you know, reasonably good backdrop.
01:06:50 [Speaker Changed] Huh, really interesting. Before I get to my favorite questions, let me just throw a a a modest curve ball since we’ve been talking. So internationally, you’re based in Bermuda. How does that affect your outlook? Does it affect your outlook? If, if so, how is that a location, an advantage or, or a disadvantage? I, I would be afraid. It’s beautiful and sunny every day. I would just throw money at the market all the time and not worry about anything.
01:07:18 [Speaker Changed] Yeah. The outlook’s very nice because we’ve got this lovely view from the, of the bay. The, the decision to set up in Bermuda was the founder’s original decision based, not on tac everyone assumes tax. It’s based on the fact that it was well developed and
01:07:37 [Speaker Changed] Big financial hub. Big
01:07:38 [Speaker Changed] Financial hub and extremely convenient. So where’d you, where’d you get to combine those two things? Convenient in the sense that, what are the frictions in Bermuda? Very little. You can live right next to the office, right? Live right next to the kids’ schools. Right next to the dentist. Right next to the, so anything you need to do is right there where there’s, there’s very little friction in your life if you live in Bermuda. And so, but when you, if you want that, typically you can’t combine that with international business of the highest quality. But Bermuda is one of the few places,
01:08:09 [Speaker Changed] Well they’ve been a giant financial hub for decades insurance. And I know Caymans are really thought of more as the hedge fund venture capital space. But Bermuda has been a huge financial hub for a, for a long time. And what are you, two hours to New York and 45 minutes to Miami?
01:08:26 [Speaker Changed] Exactly, yeah. Two hours to most of those sort of East coast cities in the US and only six hours to London as well. Not
01:08:32 [Speaker Changed] Too bad. Not not, not too shabby at all. So, so let’s jump to my favorite questions that we ask all of our guests starting with tell us what you’re streaming. What have you been watching or listening to these days?
01:08:46 [Speaker Changed] So we, my wife and I just started watching after party. Have you heard of
01:08:50 [Speaker Changed] That? I saw the first season. Oh,
01:08:52 [Speaker Changed] You, okay. So it is not brand new then. All right. I have no idea when these things come out, but that was good.
01:08:57 [Speaker Changed] Yeah. Fun.
01:08:58 [Speaker Changed] Yeah, it’s fun. It’s very well written. It’s a little bit of music. Great script. Ted Lasso. We enjoyed succession, you know, all the, all the big ones. The ones that I think maybe you wouldn’t have heard of. ’cause I’m British and I like these sort of niche comedy Right. Series afterlife with Ricky ve Love
01:09:16 [Speaker Changed] It. Oh,
01:09:16 [Speaker Changed] Okay, good.
01:09:17 [Speaker Changed] By the way, that was a huge hit in stage.
01:09:18 [Speaker Changed] Oh, is that right? Okay.
01:09:20 [Speaker Changed] Well he’s had a co the office and then he’s had a few on H B O and Afterlife. Very touching, very well done. It was very, very He’s delightful.
01:09:31 [Speaker Changed] Yes. Really great comedian. Really great writer. Another one, it crowd. Have you ever heard of that? Now this is a proper geeky comedy.
01:09:37 [Speaker Changed] Let’s go. It crowd.
01:09:39 [Speaker Changed] It crowd. It’s about an IT department in the basement of a business in some London suburb. You, you have to, you have to, you know, be, be very geeky to enjoy that one.
01:09:48 [Speaker Changed] I if you, if you, this sounds a little bit like Silicon Valley. Did you, did you see that? Oh, I never saw that one. So that was on H B O and, and it’s geeky in tech. And if you like Silicon Valley, I, I’ve been re recommending to people on Apple tv Mythic Quest, which is about a game developer, same sort of geeky, quirky characters. Lots of cursing, lots of fun.
01:10:16 [Speaker Changed] Sounds good. That does sound good. And Red Dwarf was the other that Red Wolf is very, very old British sci-fi comedy. It’s been one of my favorites. If you watch it for the first time, you’ll think, wow, this is dated. Right? Because you know, when you see the spaceships, you can see the string attached to it. Right. But the the one-liners are just great. There’s, there’s a lot of those.
01:10:39 [Speaker Changed] So, so when I first moved out of the city, I used to get B b C television and it wasn’t available on cable. I had to get satellite partly because I, I was a junkie for a doctor who, and there were a couple of other sitcoms. Like coupling was hilarious. Yes, absolutely hilarious. I remember that. You, you, you, you watch friends afterwards and you realize how milk toast it is compared to how nasty and funny and raunchy coupling was. But Dr. Who is now going through another, is it big set of changes? It, so I’m, I’m no spoilers, but I, I’m, I got most of the season teed up and I’m just gonna plow through it over the holidays.
01:11:21 [Speaker Changed] That’s, I didn’t realize that was so popular over here.
01:11:23 [Speaker Changed] I don’t know how popular it is amongst a certain group of sci-fi geeks. It’s required viewing. Okay. But they, it’s been really interesting and, and they’ve continued to keep it fresh and intriguing. So, so let’s go to our second question. Tell us who your early mentors were who, who helped shape your career.
01:11:46 [Speaker Changed] I, I struggled with this one, you know, for knowledge. I always, my philosophy’s always been to go to people who really know about the specific thing you wanna understand better. So that’s papers and it’s books and it’s just finding experts. But I think the key, so I had to look up what is mentor, what is a mentor? And I think the key thing there is trusted, is trusted counselor that you go to because you know they have your best interests at
01:12:12 [Speaker Changed] Heart. Right?
01:12:13 [Speaker Changed] Right. And that for me is very much close friends, family. It’s my brother, it’s my close colleagues. It’s, you know, the, the gray family and orbit, Adam Carr, et cetera. People who, you know, have your back basically.
01:12:31 [Speaker Changed] Got it. Let’s talk about some books. What are some of your favorites and what are you reading right now?
01:12:38 [Speaker Changed] Well, I went through, I go through phases. So I mean, I went through a long phase of, of factual books, learning books. So Bernstein’s books, he’s a financial historian against the gods. William
01:12:47 [Speaker Changed] You Bernstein? Yep. Oh, Peter Bernstein. Peter
01:12:49 [Speaker Changed] Bernstein. Yeah. Against the Gods and Power of Gold and all those good ones. EB was one I picked up earlier, which is, you know, understanding the role of Chance in Life. Fool by
01:12:57 [Speaker Changed] Randomness.
01:12:58 [Speaker Changed] Yeah. Alchemy of Finance by George Soros, you know, the, all the, all the classics. Jim Rogers books and then fun business books like Rogue Traders. Such a good book written by Nick Leason and brought down Barings Bank. Right. Fascinating story of how you can slip into those types of situations, right? Not starting out as somebody who, who in any way wants to cause harm or a bad person, you just end up taking a little bit too much risk and then you step into some gray area and then you step a little bit further to try to get that loss back. And it, it snowballs. Fascinating story. That’s rot. And then there’s a whole bunch of stuff like bad Blood and all those sort of, that
01:13:39 [Speaker Changed] Really, those are really fascinating. You know, we talked earlier about the theory of poker. Did you ever read Annie Duke’s thinking in Betts?
01:13:47 [Speaker Changed] Yes. I mean that’s, that is exactly aligned with how I think everybody should think about investing and poker. You know, it’s, it’s, it’s all about thinking about the process rather than the outcome. And that’s what poker teaches you, right? ’cause it drums that into you over and over and over and over again that it’s the process, not the outcome. ’cause the outcome is so different, right?
01:14:06 [Speaker Changed] The outcome is semi-random. It’s
01:14:08 [Speaker Changed] Semi-random.
01:14:09 [Speaker Changed] Michael Moison talked about the, the impact of, of, of luck and skill in, in investing in sports and business. And it turns out at a professional level, the, the skill, it’s very counterintuitive when the skill level is that high, sometimes a random bounce, a little bit of luck has an outside impact because everybody’s playing at such a high level.
01:14:38 [Speaker Changed] Exactly. Yeah, exactly. Yeah, that’s dead. Right.
01:14:40 [Speaker Changed] Really, really quite interesting. And our, our final two questions. What sort of advice would you give to a recent college grad interested in a career in investment fund management, et cetera?
01:14:54 [Speaker Changed] I found this one, I find all your questions hard, but this one I found hard as well in the sense that the more I, you know, have interact with people I work with and other people, you, the more you recognize that everyone is so different. Everyone has such different characters, such different traits and advice to one person is completely useless when applied to another person. You have to tailor it so much. So the one thing I came up with, which I think is universal, is not things like fol your passion, which you know, is powerful for some, but not others. It’s act with integrity. It’s that old adage of, you know, trust is hard earned but easily lost. Right? That’s the, and if you act with integrity through your career, through your life and interacting with everybody around you, then I think you can’t go far wrong.
01:15:49 [Speaker Changed] And our final question, what do you know about the world of investing today? You wish you knew back in the early nineties when you were first getting started
01:15:58 [Speaker Changed] And, and this can’t be by Apple.
01:16:02 [Speaker Changed] Well, it’s not, you know, by Apple in this universe, if you, if we get to put you, if I put you in a time machine and send you back to 1990 Yeah. That’s how
01:16:11 [Speaker Changed] I,
01:16:12 [Speaker Changed] You don’t know if it’s the same exact universe. Oh, that’s
01:16:14 [Speaker Changed] True. Oh, now we’re into parallel universe
01:16:15 [Speaker Changed] Get into multiple theories. That’s the problem with time travel is, you know, the butterfly effect and everything else. So not simply, by the way, if you would’ve bought Apple, I think from 1990 to 2004, you were flat. That’s
01:16:31 [Speaker Changed] Absolutely right. Yeah.
01:16:31 [Speaker Changed] Which is, which is kind of crazy. That’s
01:16:33 [Speaker Changed] Absolutely. And, and the little things that went right there that led them on this path to your cheat, to your parallel universe point. So I struggle with this. Again, I, I think maybe this is a cop out. I wouldn’t tell myself, you know, if I was had a time machine, I would tell myself absolutely nothing. And I think the, the values in a struggle, basically you internalize lessons if you learn them yourself, right? Even
01:16:57 [Speaker Changed] If it’s you, it’s the path, not the destination.
01:16:59 [Speaker Changed] It’s the path. It’s exactly, exactly right. So I think I would just say, look, you know, make the best decision you can at the time with all the information you have and have no regrets. Right.
01:17:09 [Speaker Changed] I, I like that. Graham, thank you so much for being so generous with your time. We have been speaking with Graham Foster. He is portfolio manager at Orbis Holdings. If you enjoy this conversation, well be sure and check out any of the previous 500 or so we’ve done over the past nine years. You can find those at iTunes, Spotify, YouTube, wherever you find your favorite podcasts. Sign up for my daily reading list@rithu.com. Follow me on Twitter at Barry ritholtz as I patiently await access to my actual account at ritholtz. Follow all of the Bloomberg family of podcasts on Twitter at podcast. I would be remiss if I did not thank the crack team that helps put these conversations together each week. My audio engineer is Rich Ani. My director of research is Sean Ruso. Atika Valbrun is our project manager. Anna Luke is my producer, I am Barry Ritholtz. You’ve been listening to Masters in Business on Bloomberg Radio.
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