Ladies and gentlemen, welcome to the business Brew.
I'm your host, Bill Brewster. This episode features Mark
Cooper of Mac Alpha Capital. Mark is a former teacher of
applied value investing at Columbia.
He has a focus right now on international small cap value,
but he's a go anywhere investor and I think quite a good guest.
You can tell he's got some teacher in him.
He's got some chutzpah and some charisma.
So I think it's a great episode to listen to.
I hope you all enjoy it. This episode is sponsored by
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occur. All right.
Ladies and gentlemen, thrilled to be joined by Mark Cooper.
Mark, how you doing today? Good.
Bill yourself. I'm good, little, little
technical difficulties getting started, but I think now we're
we're off to the races. Yes.
This this will be this should not be too unfamiliar to you.
You teach at Columbia. Am I correct or have taught?
I did teach the a second year course, Applied Value Investing
at Columbia Business School for 21 years, but I stopped teaching
my last class. I thought it was last fall.
So this is the first time in quite a long time and I haven't
been teaching. And you did what with the the
new value investing book it did. Do you co-author it?
Did you help write it? How did?
What's the official title? Yeah, Well, they, they, it's the
updated version of Bruce Greenwald's value investing
book, From Graham to Buffett. Beyond the Second edition, which
came out to think about this about five years ago or so,
there were two of the original authors, Jed Con and Bruce
Greenwald authored again and three other Columbia professors
including myself, Aaron Belissimo and Tano Santos as
well. So we are the five of us kind of
co-authored the book, but it's not a significant update from
the book from like 20 years ago. Yeah, yeah, I I liked
competition demystified too. But Once Upon a time, I was in
like a little executive class that Bruce taught and he said
that one's perfect. It doesn't need to be updated,
which is a nice that way to feel about something that you've
done. I've I've yet to feel like I've
done something perfect. Yeah, I think he's correct.
I think that that's a phenomenal book and definitely has a lot of
influence on the way we think about the world and how how we
think about investing in companies.
So. Yeah.
So, so that's a natural transition.
I mean do you want to talk a little bit about yourself and
your firm and what y'all do? Sure.
Happy to do that. So Mac Alpha Capital was founded
almost six years ago, January 2020 and we launched with
outside capital in September 2020.
We have two main strategies, 1 is long only and one's long
short. Our long only strategy focuses
on international small cap stocks and our long short can
really go anywhere, do anything very different than many of
their long short strategies. We can talk about it in more
detail later, but we really are focused on international small
cap value stocks on the long side because as we'll talk as
well, we think it's the best opportunity in the world right
now by far and the best that we've seen in that space in at
least 50 years. And then we are also short some
stocks in the long short strategy where we are trying to
take advantage of what we think is exceptionally high valuations
of companies that historically have not earned their cost of
capital and don't exhibit any characteristics of having
competitive advantage. And those are primarily in the
United States and primarily in the small cap growth area.
That makes some sense. I could argue that some people
would say that there's some large cap growth that fits that
as well. As well we we tend to stay away
from that area and we you know part of what we think is our
competitive advantage is being in the small cap space where we
don't have to compete with the likes of the big multi Strat
shops and try to kind of out guess or out predict the
quarter. So we use our smaller size and
longer time horizon as competitive advantage and and
really try to go where there is less competition, but an area we
do think is ripe for generating alpha through deep fundamental
research. So do you mind talking a little
bit about, I realize being focused on small is part of what
makes you different, but do you want to go into a little bit
about what you do that is proprietary or unique to you?
Sure. So yeah, I mean we, we chose
small caps because we do see a once in a generation if not
significant longer opportunity in the space.
So that we did have that option really with our strategies to to
look in different areas. But we do think it's an area
that's that's right for generating exceptional risk
adjusted returns. So I mean talk a little about
the firm. So again, we were founded six
years ago. We have 3 fundamental analysts
in addition to myself, the three partners that founded the firm.
We all met at MIT over 35 years ago.
So we've known each other for quite a long time.
And Tom and I worked together at JP Morgan in the 1990s.
His background is much more fixed income and risk focused.
He was primary previously Chief Risk Officer at Alpha Dyne Asset
Management, which is a $10 billion global macro hedge fund.
You know, I think we I got a very unique education at MIT and
the background is interesting and it goes to really understand
how we think about managing the portfolio and portfolio
construction and risk management very different than a lot of we
think long only and long short managers.
But. So in terms of when I started my
career, so Tom and I met in a finance course at MIT in
19891990, which was Andy Lowe's first class.
He taught at MIT at the graduate level and Tom was getting his
PhD in physics and I was an undergrad and we met in that
class and, and one of the things that was kind of unique in MIT
at the time, pretty much every class in my mind was really
fixed income or derivatives oriented.
There really weren't any classes geared towards the equity
market. And while I was an undergrad, I
was in ROTC. So I was in ROTC to pay for
college. I graduated and spent some time
in the active duty and then the reserves.
But I went to, came to Wall Street to work at JP Morgan.
Not surprisingly, I, I'd known about equities and I'd, I'd read
about Warren Buffett and I'd been investing in equities a
little bit as a teenager with money I'd save from kind of
mowing lawns and shoveling snow and driveways and bailing hay
and summer jobs, etcetera. And invested a little bit at
that time and knew a little bit about kind of Ben Graham and the
value School. But I did read Intelligent
Investor in 1991 when I was at my Officer Basic course in the
military and continued to kind of focus on equities.
But my day job at JP Morgan was I was a portfolio manager in
fixed income originally. And it was really proprietary
trading initially. So trading the bank's capital to
make money for the bank and kind of asset and liability
management. And so that changed a little bit
about how I think or have thought sense about portfolio
construction because I was dealing with at the time fixed
income markets were were pretty liquid even given our size.
But after a couple years I moved to the commodities department
and was focused on precious metals primarily and then
eventually currencies. But it was, it was fixed income,
commodities, currencies and derivatives all that.
But it, it really made me think a lot, the asset and liability
business made me think a lot about duration mismatch and the
basically, you know, we invest in liquid securities for the
most part, even a small cap space.
But we think a lot about the horizon and our investment
horizon tends to be on the long side, about three to four years.
But we also know there's a lot of investors out there who were
willing to invest like that and then provide daily liquidity to
their investors. We think that is a recipe for
disaster. Eventually it works really well
till it doesn't, right? So your investors come calling
for liquidity and they need short term liquidity.
The analysts will no longer have a three or four year time
horizon. So that's one way we kind of
structured the firm differently as opposed to a daily liquidity
vehicle, right. But having a longer term time
horizon, not having to out compete those multi strap firms
is one of our choices. We make the other.
How do you structure that like you know, quarterly redemptions
or lock up? So we, we have an initial 15
months off lock up and then quarterly redemptions with
quarterly notice. And you know, so it, it, it
definitely will try to prevent any issues where we want to make
sure the analysts are thinking long term all the time.
And you know, as as many firms and I've worked at some
exceptional firms, you know, the time horizon gets pretty short
around now, right. People are starting to think
about the next 45 days or so. They're not too much worried
beyond that. We want the analysts thinking
all the time about long term as opposed to worrying about a
great idea. But maybe I'm concerned it's
going to get marked to market against us the next two or three
months, you know, or the next two weeks or a month.
How's it going to affect my bonus this year, things like
that. So we we think about those
structures and how to make the firm better from a cultural
perspective. But that's the other big thing
we learned at JP Morgan was performing construction risk
management really mattered because we had leverage and
concentration in these other asset classes and we were quite
large relative the size of the market, especially in the
precious metals market. So given the factor commodity
positions were so large, you really had to do your deep
research ahead of time because you couldn't change your mind
and do a 180. And just get out, right?
And and get out and, and do it efficiently without being very
expensive. So even going back over 30 years
ago, I was really thinking long and hard about doing the
research ahead of time and recognizing that we had to
because the structure of portfolio had to do things
differently than many. We couldn't, we, we couldn't be
a short term trader in that regard.
It was not going to work. That's a that's a bit of a
structural disadvantage now, in a way.
Versus being able to. Yeah.
I mean, given, given the choice, you'd rather be nimble, right?
But I'm sure that there was. Some benefits, absolutely.
You'd rather be nimble and, and we are today, but at the time we
were so large, you couldn't be that nimble.
And yeah, it's a structural disadvantage.
But I do definitely believe that we've used the, you know, we
kind of used the longer term time horizon as an advantage
where myself and the analysts aren't so focused on, OK, how
much money did we make today or lose today or this month or this
quarter? Try to do the right thing long
term, because I think it does, is I think that more and more
investors and the data is I think pretty clear on this,
right? The holding periods for equities
have gotten shorter and shorter over time.
You know, time horizons used to be measured years and now
they're in months. And with more and more trading
volume going shorter and shorter term, we choose not to compete
in that space. And traditionally, I think we
tend to be on the other side of many of those trades, right?
So we tend to be buyers when things are selling off and
selling when things are going up.
So hopefully we end up paying less in bit offer and crossing
those spreads and trading against the market as opposed to
with it on a short term basis and try to use it
opportunistically. Yeah.
How, how have you, what have you seen the evolution of the
market? I, I mean, I'm hearing what
you're saying. I'm curious how you've, how
you've seen it evolve over your career.
Does it feel different these days?
I was talking with somebody on Tuesday that said, you know,
it's still kind of easy to buy things, but selling things
sometimes is very liquid and you almost have to like, I don't
know, go to lunch at lunch hour because the volume is just kind
of not there. Curious for your thoughts on
that. Sure.
I'll, I'll share my perspective and I think it's, I think it's
kind of human nature that we all like to complain like it's so
much harder today than it used to be.
It was always easier before. So it gives us all excuses when
things aren't better. But I do think there is some
reality to that, right. So the increased, the increased
amount of quad, the increased amount of passive investing, I
do think has changed it, right. And maybe I'll address it
slightly differently than the, the conversation we had earlier
this week. But we do think that, you know,
traditional value investing and, and we are value investors and I
believe that, but there's a unique aspect of the way we do
it. Value has not worked pretty much
for the last 1518 years, right? It used to be, I think in, you
know, maybe what was even taught at Columbia a long time ago, you
like a stock, you think it's worth 100, it trades at 70.
That meets kind of your margin of safety.
You just buy it and you buy kind of a full position there.
What I think happens now, I think the market tends to trend
a little bit more short term. So maybe you want to buy it at
70, but it might matter how it got to 70, right, If it went to
70 kind of slowly over time or kind of straight down, maybe the
shorts are pressing a little bit more, maybe the trend following
maybe the the algos, etcetera, the the quads are pushing it.
So maybe you want to buy it at 70.
But one thing we've gotten, I think we've changed a little bit
the way we enter and exit positions because what I think
you see is the short term momentum matters more.
So while I'd be heavy buying the whole position at 70, you know,
I used to kind of, this is a a question I used to ask all my
students at class. So you're in your first job, you
recommended stock, same situation.
You think it's worth 100, It trades at 70.
You recommend buy it. It goes from 70 to 60.
What do you do? Most people kind of reflexively
answer, buy more goes from 60 to 50.
What do you do? Most people will still say buy
more. Maybe a couple people at that
point are going well, I recheck my analysis.
I recheck my analysis. Yeah.
As a value investor, you say you want to buy more.
That works in theory. I think depending on where
you're working, if you're at a faster money hedge fund or maybe
even a lot of lawn only firms, you do that your first, you
know, that's your first recommendation, you might be out
of a job pretty quickly if that stock ultimately goes to to
31st. And you might be right and I'm
not saying the analysis is not right, but the mark to market
could be pretty severe in the short run.
And if you bought a full position at 70, you know if you
be feeling pretty bad a month or two later if it's down another
3040% or more. Yeah, yeah, it's, you know, the
longer I have these conversations, the more it, it
may sound silly to say out loud, but the more I realize that
there are a lot of institutional imperatives that stand in the
way of what is otherwise theoretically good behavior.
So setting a business in a firm up to be able to take advantage
of the correct behavior. Right.
Seems to be important. And Bill, we think that's very
important. We, we, we focus a lot on the
culture of the firms we invest in, but we think having the
right culture in our firm is important.
And a long after I graduated in Columbia over 20 years ago,
early in my career, I started kind of keeping a list of things
that I thought, you know, basically I call them problems
to solve. And it was a basically an Excel
sheet thinking about issues we saw in the markets.
But you know, I know you're also kind of a fan of Charlie Munger
and he's been a big influence on the way we think.
You know, we're not, we don't get paid for difficulty, right.
But my view was if we could think about how to improve the
firm structurally, reduce what I call friction cost or alpha
drags within the firm, if we could do that from a structural
perspective, from the way the incentives are aligned and the
way people are treated and the behavior you incentivize, maybe
we can generate extra alpha that way.
And in my mind, that's also, I mean, it's, it's important
because I'd prefer to be working with people who are aligned more
directly. But I think you get, if you can
do that structurally, maybe that alpha of 25 basis points a year
or ten basis points a year or whatever we're talking about,
maybe it can become more permanent if you will.
And so part of our desire and and Tom and Gemma and I talked a
lot about this as as well as the other analysts who set the firm
up, is that something we want to do and we want to eliminate as
much as possible those friction costs that occur at most firms.
Yeah, that makes sense. How much does does do technicals
work into your process given that you're sort of an ex
trader? Do you do you look at those at
all or not really? I we pay attention to the
markets and technicals, but we don't, there's not, we don't
make decisions based on them. We're aware of what's going on.
I'm aware of kind of the price movement in stocks.
I care, we care a lot about absolute valuation, just kind of
thinking if, if we buy a firm and the valuation is X, what are
what's our expected return look like over the next, you know,
full cycle. But we, we also pay attention to
absolute in the market relative to the market relative to the
sector relative where the stock's been historically.
We want kind of as much information as possible to frame
our decisions right. And they, I think kind of the,
and maybe I think I got this from Howard Marks, but you
really want to know the environment you're investing in,
right? So how you behave might be very
different today than what it would have been, you know, 10
years ago or 50 years ago. So an awareness of that history
is important. We like, we tend to own
companies and have a lot of history.
We've got some companies that go back in the portfolio that have
been around their origins of at least 100 years ago or older.
And so, you know, and a lot of our companies have been public
for. At least 10 to 20 years.
So we got a lot of financial history and we want to see how
companies have behaved through cycles because we we're strong
believers in history. But the one thing we think
hasn't changed, we think our change very little is we think
human nature is very slow to change.
And why is that important? We believe that most of the
financial mistakes that have happened historically, and I'm
talking about the extreme mistakes, the bubbles, the
crashes, etcetera, that we've, you know, that we've all read
about over the last 500 years or longer will likely happen
through our lifetime. So we don't think that the human
beings, if we were sitting here having this conversation 2000
years in Roman times, people would still be driven by those
same desires that they had then. People want to be famous, they
want to be thought of as being an expert on something.
They want, you know, they want, they want to be wealthy.
They, you know, the desire for love, recognition, whatever that
hasn't changed. And so I think that leads to
cycles rhyming pretty significantly, right?
Cycles repeat for a reason. And, and we think it's because,
you know, the, the, the instruments are which people are
investing in change, but the desire to avoid pain and, and
get rich quick really hasn't changed pretty much for the most
part, we don't think. So if I'm, I'm going to set you
up with a hypothetical and let's see, let's see how you answer
this. So hypothetically, let's say
that, but there were 7 to 8 stocks that were driving most of
the market. And historically, they were some
of the best businesses that people have ever seen.
And people that avoided them generally sort of lost assets
under management. And then there was another
basket of stocks that was trading pretty cheap, but it's
really hard to raise assets buying those.
Do you think it might be possible that people would
overstay their welcome in the first basket and avoid the
second basket and or do you think that you want to keep
dancing in the first basket? I mean, I think that.
This is all hypothetical. Hypothetically, of course, I
think that is a real problem. And I think that pretty much
every professional investor probably struggles with that, no
matter kind of, you know, and, and, and we know, right, if, if
you haven't owned a good chunk or at least a few of those names
in the first basket, you're getting pressure to own them.
Why didn't you own this? You know, and I, and I hear it
from some of our investors who, you know, institutional
investors, they talk about the same issues they get.
Or if you have wealth management firms or Raas who have clients
who, you know, they, they want to be, you know, everybody wants
to be, yeah, you know, have the popular conversation at the
cocktail party, right? And they want to have owned
what's been working. And while we understand that,
and we're not immune to that, let me be clear, right?
But we are acutely aware of it. We try to study behavioral
finance a lot and try to, again, put up organizational processes
to minimize the risk that we will do something that we think
ultimately we're going to regret, like following the herd
in that situation. It, it does, you know, it, it's
hard to resist, it's absolutely very hard to resist.
But when things get to be as extreme as they are in certain
areas of the market today, we definitely think it's best to
avoid that. You know, and, and you're,
you're seeing some of that come out and just in the last few
weeks a little bit more. You know what really sucks?
It sucks to stay at the party too long, but it really sucks to
leave the party early and be able to look in the window and
see everybody continue to party. Yeah, that hurts.
Yeah, that that. Then you want to walk back in
the party at the wrong time. Yeah, Well, again, I I'll go
back to Charlie Munger, Right. What's he say?
He he talks about envy as it's the worst of the deadly sins,
right. It's one of the seven deadly
sins, and he says it's the worst one because it's the only one
you can't have any fun with. Yeah.
That's right. And you know, and, and
obviously, you know, being really smart is no, no panacea
here, right? We know that Isaac Newton lost a
lot of money in the South Sea and the Tula Bulmania.
You know, a lot of people don't like to see others doing really
well and, and not be involved. You know, I from our
perspective, we have, we have a specific mandate for our
international small cap strategy.
So that's pretty clear. And I think our investors, our
institutional investors and our individual investors would
eventually not like it if we strayed too far from that
mandate. But we're, we're, I think we're
staying well within our, our lane there, if you will.
We do have the ability to go in our long short strategy kind of
anywhere we want and do anything we want.
We haven't changed our view where we think the best
opportunity is on the long side over the last few years, despite
it being a very difficult environment for what we're
doing. And we haven't, you know, you,
you kind of alluded to the fact or mentioned, you know, could we
be short some of the larger companies that we don't think
have a competitive advantage? Yeah, I mean that that could be
possible, but we've chosen not to not to stray to that area.
We think there's a a better environment.
And historically we've got a lot of data to back up what we're
doing and how we search for our ideas on the short side.
And we think we're in an area that ultimately will be right
for poor performance. And as I like to say, if a
company's going to go to 0 eventually, if it starts out big
enough, it's kind of got to go through maybe 10 billion, five
billion, 1,500,000,000 market cap on its way to zero and, and
we do believe. Well, it's dying smart.
And what we think, we definitely know that, you know, in times of
stress in the market, liquidity dries up.
And if companies have traditionally more difficulty
accessing liquidity, which small companies traditionally do, and
that affects how we think about buying our long positions.
We want to make sure they generate free cash flow
throughout a cycle because they can't be dependent on
governments to lend them money or bail them out when things get
bad. If you've got.
How this is fake news, you got to ask Sam Altman.
Man, you can spend a couple trillion and the government's
the insurer last resort. Yeah, that's, that's the latest
I I saw that in the last 24 hours as well.
So. I'm just saying if that if the
top happened when he said that, it would be poetic.
Right. Well.
Not not that. Not that I'm trying to make you
call tops or anything. And it's.
Interesting to look at what's going on.
When we, when we talk about all this, I want to be clear, I
don't want what I what I think is going to happen.
I don't want to happen because I think what happens is not good
for the country as a whole. I think it's bad for the
economy. I think it's bad for a lot of
individuals. A lot of people are going to
lose a lot of money. If we're correct that this what
we think is a bubble. And I mentioned this, I was at a
conference early this summer, I had a family office event and I
mentioned a bubble. And people looked at me like I
had three heads. They thought I was crazy.
And now it's like, it seems like every day I'm seeing multiple
instances of people calling it a bubble.
So it feels like things have changed a lot that are they the
recognition of maybe there's a bubble has definitely changed a
lot in the last six months, but but we don't want it to happen.
But again, what we want and you know, it's like, I want certain
things to be different, but we have to invest in the
environment we're in. We can't change it.
So we want to do the best we can for our investors.
And, and we think that there's clearly some bubble
characteristics, you know, and we can talk about that more, but
we see a lot of this in the small cap space where the
valuations of some small cap companies that have never earned
their cost of capital, that don't generate a lot of free
cash flow trade well in excess of what they did 25 years ago in
March of 2000 at the peakofthe.com bubble.
And they are more levered today. So for example, in March of
2000, there were, according to our data, there were about there
were 400 companies in the United States that traded over 10 times
sales. And I don't know if you remember
the famous Scott Mcneely quote about 10 times sales about the
implications of that. And I'm, I'm happy to read it if
you want for the for the listeners because it's pretty
shocking. And he said it pretty well about
the implications of when you pay 10 times sales for a business.
What does it really mean? Yeah, sure, read it.
So, so Scott Mcnealy was the CEO of Sun Microsystems, which was
one of the, you know, the darlings of the Internet bubble.
Eventually I think they got bought by Oracle, I believe.
But at at the peak valuation around, you know, early 2000,
the the stock hit over 10 times sales.
And a couple years afterwards, I think he was quoted in I think
Bloomberg or business week or whatever saying the following,
at 10 times revenues to give you a 10 year payback, I have to pay
you 100% of revenue for 10 straight years in dividends.
That assumes I can get that by my shareholders.
That assumes I have 0 cost of goods sold, which is very hard
for a computer company. That assumes 0 expenses, which
is really hard with 39,000 employees.
That assumes I pay no taxes, which is very hard.
And that assumes you pay no taxes on your dividends, which
is kind of illegal. That assumes with 0 R&D for the
next 10 years I can maintain the current revenue run rate.
Now having said that, would any of you liked about my stock at
64? Do you realize how ridiculous
those basic assumptions are? You don't need any transparency.
You don't need any footnotes. What were you thinking?
Was he he should have been issuing equity?
Was he issuing equity while this was going on?
I don't know. I don't know if he if he did
the. Purpose of at the at the market
offerings, right? Like you might as well just flip
it to the to people that'll buy it.
We'll talk about this later. I just had a discussion with
another company in October row 8th that had a significant row
in their stock. I told them they should issue
equity and they told me I didn't understand finance.
I said, I said, you know, and you might think Scott Mcneely's
comments are disingenuous to say after the fact that he said it
two years later. He didn't say it before, right?
But in fact, the math is valid, right?
He, he, you know, obviously to generate any kind of return,
real return paying that kind of multiple, the business is going
to grow substantially and. I mean, that's, that's what
people are betting on, right? And they're betting on, but
they're betting on growth rates, which historically have not ever
occurred or you know, the base rate would be extremely
different than their their basic assumption, right?
And it's. Actually tough thing about the
Mag 7 is they have they have defied the base rates at massive
scale. Absolutely.
And it's not that different for what Sam Altman said recently.
So he was raising money. They're raising money for open
AI recently, right? I think their most recent
valuation was 500 billion. And according to Verge, he told
reporters he said something that he said, you know, people are
over excited about AI models and someone will lose a phenomenal
amount of money. And then last week he was
interviewed and was asked a question about how you going to
pay for this stuff, which is a question we asked in our most
recent letter. And where's the money come from?
And he didn't really answer the question.
And then this week we're talking about a government backstop for
funding, right? So he, he will be able to look
back and say, I told you some people are going to lose money
if that in fact occurs. But the last week he seemed to
take instant, you know, with the short sellers or, or in fact,
it's a, it wasn't public and he wishes it was public so short
sellers could lose money. And again, you know what what
we're talking about, though, in my mind, this is not PhD level
finance. It's common sense and basic
arithmetic, right? The, the, the base rate
expectations when you own a company that has that high of a
valuation isn't good, surely, just like in 2000.
So the basket I talked about in 2000, there were 400 of those
companies. The median return of that basket
from March OO to March O one was down 79%.
The average return over like the next three years was down like
90. And a few of those companies did
survive and became very good stocks for the next 10 or 20
years, right? But on average, they went down,
you know, 8090% first, right? You know, and today we see a
basket. The basket's a little smaller,
but probably a lot of the listeners know that the number
of public companies, United States is about half of what it
was in 2000. So there's.
Yeah, I thought this is an interesting way of thinking when
you said this to me the first time.
Yeah, a percentage. Versus how many are listed.
Yeah. So now there's about 300
companies that trade over 10 times sales.
And again, 10 times sales is the minimum, right?
The the high could be thousands of times, right.
But today the average valuation of those three, those that
basket of 300 is 3X what it was in 2000.
And they have a lot more leverage.
They've got 50% more leverage on average.
So all I'm arguing is from a purely data perspective, from
math perspective, the current starting conditions is a lot
more favorable than they were 25 years ago at the prior
peakofthe.com bubble. Yeah, you know.
Yeah, the, the, the, the thing about the, the big cash flow,
generative mega cap tech that are investing.
I, I think it gets tougher because you, you can have a
legitimate argument about like how much should you capitalize
the spend? Because if they're sort of
overspending, does it really matter if they cut it off and
it's two years and the numbers are kind of nuts, but the amount
of money they make is nuts. Part of me though looks at, at
what you're saying about and not you, but but the fact pattern
around open AI and the fact that so much private money is willing
to fund CapEx on what appears to be non unproven economics.
Though I, I did hear that a model is the, the argument was
the model is profitable after a year.
The the issue is you have to spin up a new model every year.
But that reminds me a lot of the the textile mills of Berkshire
Hathaway, right? So I don't know, man, it's going
to be an interesting time. And, and there's questions
regarding, you know, the depreciation rates for the
chips. And I think Microsoft had a
quote this week saying something about they've got data centers
they can't use because they, they're basically just have, you
know, chip sitting idle and, and rock sitting idle because they
can't get the power. We, we do think, I mean, we're
happy to talk about that as well.
Oh, it's not, it's not our primary focus.
We do think there's some issues there, you know, and again, you
know, I hope that AI does a lot of beneficial things for society
and and I kind of think it will, but it doesn't necessarily mean
that investors today are going to get a great return on
investing those companies. My issue generally, and again,
we do not have positions long or short in any of the MAG 7 or the
leaders of, you know, the kind of the AI spend, right?
What we do believe though is our companies being a customer of,
you know, if three companies are competing to produce the best
model and maybe only one of them wins.
So it's great for them and maybe it's bad for everybody else in
theory, but the customers probably benefit across the
board. So can we buy businesses that
are going to benefit no matter who wins, right?
Because I think it's very difficult, at least for us, we
don't think choosing the winner is, is possible.
And I don't think there's, you know, when you get massive
change like this in a business, it is extremely difficult to
pick the next winner, right? That's, that's, you know, a
little bit of the crux of what Bruce talks about, right?
We don't have any historical examples of understanding what
the competitive advantage is and who does win.
And I'm sure we don't know how to do that.
So we will try to stay within our circle of confidence and
stay out of that, trying to make that bet because I don't think
we can do it any better than anyone else.
Yeah, no, that makes sense. And I didn't.
I didn't mean to make this conversation a negative Mag 7.
I actually happen to think the to the extent that you think of
them as a planet. The moons around the planet are
where a lot of the froth is, more so than the big boys seems
to me. And I think I mean from from our
perspective too, it does look like, you know, yes, some of
those companies are spending, talking about spending a lot of
CapEx it relative to what they used to.
So their free cash regeneration may be very different than it
has been historically. Returns on capital might be
different. They may be much more capital
intensive. But what we look at at a high
level, there's companies that are much smaller in nature who
were much more questionable in terms of do they have any
competitive advantage and are they likely to be a winner at
least the the most of them. MAG 7 as you mentioned, you know
they have generated a lot of cash flow in the past and you
know don't look like they get based on current earnings and
cash flow generation don't look as expensive.
Yeah. And they have, they have like
tangible distribution advantages that you that you can actually
articulate, right. I I think some of the other
things that have like AI in the name or were AI enabled, some of
that stuff seems kind of nuts to me.
But what when we look at it and we look at a lot of history and
I talk about this more, but we see a big opportunity,
international small cap value and we look back to kind of the
the biggest 10 of the biggest companies around March of 2000.
We do think there's a lot of parallels to the2000.com bubble.
Obviously, yes, AI is different than the Internet, but you know,
AI is probably not that different.
We could have had the same conversation about railroads
probably 150 years ago and radio and autos 100 years ago.
And you know, with the story of the graduate was plastics,
right? I mean that, you know, and, and
it was the Internet and, and maybe this is faster, not sure,
but some of you know, those, those great companies and some
of them were great businesses in 2000.
You know, the average return from the peak, most of them were
down 50 to 50% or more after three years and at some point
traded down much more significant than that.
So you know, and and we've talked to investors who listen
to what we say about international small cap value
when they see the opportunity. But like you said, they are,
they're afraid to leave the party early, right?
And you started. Hurts, man, everybody else is
having fun you're sitting out there, you're. 100% correct.
It's, you know. Hopefully you're not as hungover
at the end. Right.
But but it's, it definitely makes it difficult for people to
make that switch and the and the pushback we've gotten for
probably a better part of a year or so as well.
When it turns, then I'll do it. But they want to wait till it
turns. We started to see international
work, right? Yeah, well that's what I was
going to say. The turn that no ones paying
attention to is actually international value as a factor
has done reasonably well over the last five years.
Yeah. And it it and we're seeing, you
know we're seeing it start to work.
And according to our data, we've got a long term history.
We have charts on each of the factors, international, small
and value that go back. The minimum is almost 50 years,
the longest is 55 years. And and that's where we think
the data gets a little questionable.
So we don't go back further, although I've seen other
people's work that are similar to what we do.
And it would suggest that going back to the depression, you'd
get the same results. We've got an outlier.
We got outliers today where international relative to the US
is the cheapest it's been in 55 years at least maybe well, not
quite as cheap as it's been because it's rallied a little
bit this year. So it, we're just a little bit
off the lows of, of where we've been for the last 55 years.
So we're probably, you know, in the the cheapest 1 percentile
for international stocks, right? And a lot of US investors, and
there's a lot of other very smart people who've written
about this as well, you know, have said, you know,
international diversification hasn't worked for most of the
last 30 years. But does that mean international
diversification is not? A good thing to have over time
and you know, I, I'm a big sports fan and a big hockey fan
and I like the the Wayne Gretzky quote you skate to where the
puck is going so we can talk about what's happened the last
year or two or longer. But investing and I think Bill
Miller's had a very similar comment to this too, is, you
know, all the analysis, all the data you've got as fact as
history and all the values derived by what's going to
happen in the future, right. So we want to skate to where the
puck is going and we it's not about calling the top.
It's not about saying you might not make money in some of those
businesses, but we think the asymmetry for where we're
looking at and where we're investing is much better than
that, where the downside seems to be extremely, extremely
limited and the upside could be quite large.
And that's that's international. The value factor as we look at
it is the cheapest it's been in 50 years and small versus large
is also quite interesting. Our analysis there, we actually
use US small versus large. We just get better data that way
versus looking at it from a international perspective.
Cause a lot of the, even the international small cap indices,
MSCI has one that's only been around for less than 20 years.
So it's really hard to get good historical data.
But we that would show the international, sorry, small caps
are not the cheapest they've ever been relative to large caps
using U.S. data. But again that chart use so it
says that around 2000 small caps were a little bit cheaper than
they are today. We think there is a problem
because the data series is different now what I pointed out
before about the extremes today because you have a greater
percentage of companies that trade it much more extreme
levels that skews the whole data.
So the the data set, so the average today doesn't look as
cheap as it did before. That makes sense.
Yes, that does make sense, but I follow.
If you can buy. So we also believe that these
time series valuation again is not a short term signal.
Most people know that, but we do think it's a good indicator of
long term future returns. And if you look today, you can
see that the Schiller PE for the S&P 500 is about as high as it's
ever been, right around 1999 levels at somewhere around 4544
times cyclically adjusted earnings for the S&P 500 that
would be anywhere near those levels.
And even the only times it's been near these levels were
around the peakofthe.com bubble from like 97 to O2 is suggestive
that the S&P 500 will return close to 0 total return over the
next 10 years. And I've had investors say to
me, well, that's OK if I get 0 the next 10 years.
And so that I asked him, I said, well, it's if it's zero from
here and it doesn't change at all, you might be OK with your
allocation. What if it goes down 50 or 80%
first? That usually gets people's
attention, right? It's it's 0 might be OK.
Yeah, well, it's a long duration 0 and you don't know the path.
But it, but if it goes down 405080 in the meantime, that's a
lot more concerning to people from, you know, and Speaking of
somebody who lived through it, you know, it's definitely
something that worries us. And, and we look at it.
And so we look at kind of the environment we're in today where
we think we ultimately get meaner version in these factors.
We see no reason why we will not.
And we think that that gives a massive tail when what we're
doing. And if we go back to 2000, the
other kind of parallel is one of our advisors to our firm, one of
my mentors, the legendary value investor Jean Marie Aviard, who
is I mean such a fine gentleman, but he was a great phenomenal
investor. For people who don't know when
he was at Sock Gen. before in the Seventies, 80s and 90s and
then first Eagle from the late 90s on, you know, we we saw a
long period of underperformance leading up to the.com bubble
peak for international small cap develop stocks and his
performance from 2000, 2002 as the NASDAQ was losing 73% of
your money. Cumulatively, he outperformed
by, I think 45% a year. So a small allocation to away
from what everybody loved into something that was unloved at
the time because he he had made money through his investors all
the way through the 90s, but he was lagging the performance of
the S&P and the NASDAQ, which is what you kind of talked about
right at the beginning. Everybody watching the, you
know, the party go on and on, right.
And, and Jean Marie is famous for saying I would rather lose
half of my investors because he had a lot of investors leave and
the capital went down. But I don't lose half my
investors than half of my investors money.
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Right, he was making people money, but they were, they saw a
better get wit get rich quick scheme somewhere else or they
thought, and it worked until the peak of 2000.
And then, you know, he was up 150% or so and the market was
down 75%. And trying to, you know, part of
the reason we are, we structure the proper way we do and choose
the companies we choose as we try to minimize the downside
risk because we just believe the math of coming back from
significant losses is very difficult.
So it's psychologically damaging to the analyst.
It's, it's hard to be a portfolio manager and it's hard
for the investors, right? Because investors can say they
have a long time horizon, but inevitably something comes up
and they might need the money sooner.
So the path of returns matters as well.
Yeah, no doubt and so. Well, it matters the compounding
too, the math of the returns. Matters, but but recovering from
those losses, right? So if you go down 75% versus
someone like John Marie who made 100% or whatever at that point
in time, trying to, to catch him over that period of time and
over the next 5-10, fifteen, 20 years is extremely difficult.
He's got such a massive head start, right?
And it's, it's better for your investors.
And I, you're probably familiar with Dalbar.
Dalbar is an institute which does a lot of studies on
individual investor behavior. And they've done studies that
show that most, you know, most investors massively underperform
their underlying investments, Meaning, you know, they buy a
fund after it's done well, sell it after it's done poorly,
right? And so they typically the long
term studies I've seen, I think they get maybe 1/3 of the
underlying performance. So let's say the index does X,
the manager does X and the investor does 1/3 of X, right?
And so the managing that path, I think helps us, allows us to
sleep better at night, allows our investors to be comfortable
with what they own and hopefully they stick with us through
inevitable bad period, which will obviously happen, happens
to nearly everyone, right? But that path does matter and
hopefully it allow them to stay the course.
So if we achieve X, we want our investors to get X.
Will be very disappointed if they come in and leave at the
wrong times. Ended up much worse than that.
Now why? Why can I not, you know,
passive, Passive is the rage. Why do I need an active product
in international small cap value?
Why? Why is there no ETF that
satisfies us? The well, I'll bet you in the
next 5 years there will be an ETF that satisfies that today.
I'm not aware of one that does there.
Are there variation? There's not a lot of liquidity
or a lot of volume at trades in kind of ETFs that are even the
space, but they don't really focus on value.
Maybe they're international small, you know, and not
surprisingly, it hasn't been an area that has generally worked
globally for the last 1718 years.
So you haven't had the demand from investors historically.
We're starting to see kind of some of the interest change
whatever from just from our perspective for us.
So if I can extrapolate that to the broader market, I'm sure
there's a lot of interest more broadly.
And as you see money flows and as it worked better, I wouldn't
be surprised to see that happen. But even versus kind of the
other benchmarks, we've tried to structure a portfolio that is
traditionally in a long way portfolio, much lower
volatility, lower beta, lower correlation, right.
With lower Vol and lower correlation, you end up with
lower beta to the market. So that in bad prays to the
market, whether we're talking about like the draw down in late
2018 or 2021, we've tended to lose a lot less than the market.
And that's our goal, right is in those environments, we try to
lose a lot less. And so we can compound ultimate
higher rates is, is the desire. But I don't think there's a lot
of there's not a lot of investors around.
I think a lot of big firms are not in the space.
Another reason we like the area because there's not as much
competition because as you all know, right, most people you
know, if they can scale their business and can be larger, the
incremental cost of running a $10 billion fund versus A $1
billion fund or not that much higher or 100 billion versus 10,
right? So most firms pushed to go
larger and larger, if they at all can, right.
And it it makes sense from their economic perspective, you
understand their incentives. It goes back to their
incentivize to do that. And I think fewer and fewer
people have invested in the space.
And so a lot of the managers who traditionally have been in the
space have struggled and it's been difficult for them and
assets have gone away. Doesn't mean they've lost money,
doesn't mean they're, you know, and you know, and some of the
investors are closed. But I think it's just, it's,
it's hard to, it's been a hard place to be for some time.
Yeah. Well, to your point on sort of
catching up, I mean, that's a that's a bit of the dilemma that
value as a factor has over the past not and probably since
2020, it's probably outperformed.
I haven't looked recently, but the 10 years leading up to it,
it was tough. A lot of people got bled out.
Yeah, we, we still show the way we look at it, we still show
value is still underperforming. So I'm not saying that's the
only way to look at this. That's our data and the way we
define value, but you know, and our portfolio.
How do you define it? Yeah.
So when when we do the long term charts from a relative
performance basis value, we look at value versus growth.
And one of the ways we look at is we'll look at like Russell
1000 value versus Russell 1000 growth in, in our approach, we
are much more quality investors. We tend to focus on again not
surprising given the the influence by Bruce Greenwald,
you know being taught by MTA and for him being hired by him,
working with him. We focus a lot on competitive
and that's the number one thing we focus on, which is more it
leads us to higher quality businesses.
So our businesses, we are value investors, but our portfolio
does not look like a statistically cheap value
portfolio. And if we had, I would argue the
results would be a lot worse over the last 10 years or so
because statistical value hasn't worked very well, right?
But so, so we focus on competitive advantage, number
one, capital allocation #2 and culture of the firms we're
investing in. And so focusing on those areas
leads us to owning better company.
How much higher quality companies.
And everything I would say is currently, we think the
differentiation between the best businesses and the worst
businesses is pretty narrow. So the way I'd like to describe
it is if you, you know, if you were trying to buy 2 products,
you're trying to buy, you're trying to buy a car.
And again, I don't really want to offend anybody, but you say,
you know, historically probably know he's driving one anymore.
You could you could buy a Pinto for the same prices you could
buy, you know, a Cadillac, right?
We'll keep it all American and whatever you.
Know yeah, you'd rather not blow up if it's.
The same price you probably want, most people probably want
to buy the Cadillac, right? You want, you want the higher
quality product at the same price.
If you got to pay up, you know, if you got to pay 10 times more
than maybe you're making a different decision.
But what we see is the valuation compression where we look at
some, what we think are great businesses that are still
extremely cheap on an absolute basis relative to their own
history, relative to the market, relative to the sectors,
etcetera. But we think that the asymmetry
is quite good because we're we're starting to see and, and
there's been, I mean there's been clear evidence of this and
there's been talk about it, but there's more active private
equity involvement globally than there has been a long time.
And so there's a lot more capital earmarked for
international private equity. It's already been raised right.
We know there's issues with private equity markets, but you
know, Steve Schwarzman said recently they plan to put 500
billion into Europe in the next 10 years.
And then you've got long only managers that have also talked
about investing significantly in other areas where we we see a
lot of opportunities in the UK, for example, the UK market is
has some very high quality business, we think and stocks
are very cheap. Where we've seen one of the
biggest wealth management firms in the world and one of the
biggest Canadian pension plans have also talked about putting
significant increases into that country because we see
opportunities, we think they do as well.
But the, the private equity money has started to flow.
We've seen it. We've seen take outs in Japan at
100% premium. We've seen that in the last
year. We've seen a lot with a lot of
strategic buyers. Strategic buyers have a lot of
cash too. And one thing we do believe is,
you know, as growth slows down, people look to deploy that cash
and look to to buy growth and that the corporate balance
sheets, according to our data, they got the most cash they've
ever had extra financials. If you took all the the
companies outside the financials in the MSCI world, they got the
most cash they've ever had. And part of The thing is, you
know, international small cap value stocks are so cheap that
they've got a lot of cash. And you know, when you know, we
know that, you know, the market cap of NVIDIA now is $5
trillion. It's bigger than I think.
You know, it's bigger. Maybe it almost as big as Japan.
Maybe it's, you know, it, it's as big as most every country in
the world except a couple. You know, the entire market cap
of like the EFA small cap index is around 4 trillion.
So if you, and you've got a, you've got a couple trillion in
private equity coffers ready to go and you've got another 10
trillion in cash and the balance sheets of a lot of companies who
want to buy growth. We're starting to see flows into
the space. We're starting to see interest.
You know, our, our flows have been strong this year with new
investors. We're starting to see it from RF
PS pick up. We're starting to see people
talk about it. So a small movement in dollars
into the space, could it be relatively important to changing
the direction of some of these companies in the overall
industry levels? And, and importantly we've seen
and we've seen it from kind of all from wealth management firms
to a pension plans to endowments, foundations,
etcetera. But we've also seen sovereign
wealth funds say they've never invested in the space, but
they're looking now because they see the opportunity is, in their
minds, pretty, you know, pretty astronomical.
It's interesting how when you look across, you know, the, the,
the common refrain, and I think there's a grain of truth to it,
but maybe not more than a grain, is that the businesses in the
United States are on average better than international
businesses. Do you think that is a accurate
statement or do you think that's colored by Valuations are
somewhere in between? Price tends to drive narrative.
Sure, I, I think there's some truth to that.
We do think there's a lot of high quality businesses in the
US and maybe it's our natural bias, you know, to be patriotic.
I mean, I served in the military and, you know, and, and I think
a lot of things good about the US, but I, you know, there's
also been some studies recently. And I think, I think GMO did a
study recently saying that the argument that fundamentals have
been better in the US over the last like 10 or 15 years is
actually, according to their data in a piece they put out, I
think American unexceptionalism they put out in the last few
months argues that Japan's actually been better from a
fundamental perspective. So it's, I think it's hard to
argue that. I don't it it matters for an
investor if you know, so you could say if you believe the US
is better fundamentally, you should pay a premium for U.S.
companies. I can't dispute that.
But I do believe strongly that you know, the most dangerous
words in finance are it's different this time or and
everybody seems to want to the the narrative always supports
the view people have. I think that the discrepancy in
valuations on average and again the average kind of tells us
where to look a little bit, right.
But we still do deep fundamental work on companies and we own
some great businesses within the United States.
So I'm not saying they're all expensive or they're all bad.
There's a lot of very good business we don't own because of
valuation, but there's a lot of really good businesses we do own
and we think they're cheap. But I think that the, the
disconnect today between, you know, perceived quality, real
quality and evaluations is significant.
And I think for a long time, Japan got a bad rap for the
returns on capital of the businesses, right?
And, and a lot of Western investors looked at it and if
they didn't make any adjustments to the balance sheet, yes, the
Roe is low because they've got way too much cash in the balance
sheet. Well, you can adjust for that,
right? Now as an investor, do you think
you're going to ever seen in that cash or not?
Maybe you're never going to see it.
And so you want to you want to adjust for that.
But I think when you do the aggregate analysis, we think
that can be quite misleading at times, right.
From that perspective, if you just look across the board and
say the average are we is, you know, it's, you know, let's say
it's 7 for them and it's 15 for the US.
But the US companies have 40% net leverage and the Japanese
companies are, you know, 20% net cash, right, you can make up.
With US, companies have been buying in shares their equities
artificially depressed. That said, there is very real
rebuttal. I mean, until Japan sort of got
on the companies to return the cash as a minority shareholder,
it's all illusory cash flow until it's not. 100% And I mean
I can. I've had a long experience
investing in Japan. When I was at Pequot Capital as
an analyst, I over 20 years ago to 25 years ago, I wrote a
report saying we were looking at, I was looking at the big
auto companies and we were generally at the time long the
Japanese and short the American auto companies.
But the idea I said, I wrote a report and said something about
the fact that the problem is, is our time horizon is so much
shorter than theirs. They're thinking that this
Toyota thinking decades out and we were worried about the next
calendar year Max for the most part, right.
And we saw it again when, when Abe came back into power in
2014, maybe you know, you, you saw the, the Japanese Stock
Exchange create the index that, you know, basically you had to
have 10% ROV to be part of the, the club.
And so there was a push to get your ROV to that level.
But we try to have a lot of thoughtful long term discussions
with the companies we own. And we we have significant
exposure there and we've talked to a lot of them.
Again, we do it all privately. We're never public about it.
But we had a company said, you know, told me it was a, the son
of a founder running the business.
The company been in existence since 61.
He was talking about, he wanted to do what was right for
Japanese society and they had pretty low returns on capital
and a great business. I thought at the time, I still
think it's a great business. And I said, I said to him, I
said, what if you want to do the best for Japanese society?
They had a lot of employees that I thought were extraneous here.
A private equity firm would go in and fire 95% of their
employees and just move on. He, he was not going to do that.
I said, well, in my mind what you can do if, if you can
improve your returns on capital and improve your free cash flow
generation, you can afford the luxury of having extra fat in
your organization, right? If you think that you don't
really need, you automated your factory so you don't need these
200 workers anymore, but you don't want to fire them.
You want to let them retire with dignity or, or whatever your
kind of perception is there. My point to him was the best
thing you can do to have control of your company and to do best
for Japanese society, if that's your goal is to make it a Better
Business. If you can go from being a 5%
ROV business to a 20% ROV business with significant
improvement in free cash flow, you will have the flexibility to
make that decision. But if you have 5% ROV, we know
you also can't grow that business at 15% a year either,
right? Without borrowing money you
cannot do that self funding. Yeah, that, that makes sense
because you can only grow as much as your ROV times how much
you can deploy, right? Reinvestment rate, right.
So, so that was kind of the discussion we had.
There with. How interesting, that's a smart
way to frame it. It, it wasn't.
And, and I think a lot of those companies have been approached
by Western hedge funds, you know, buy back stock, do this,
whatever. And then they're renting the
company for three months or six months or a year and stock goes
up and then they're gone and the company has to live with the
long term ramifications. Interesting.
So wait, just going back to that, what you said to him is
you said if you want to do the best for society, let's say you
can grow 10 but your RO ES only 5, you need to borrow the 5%
that you would need to otherwise.
And if you really think that you can grow 10% and your company is
great, get your RO E to the point where you can, where it
supports your growth and then you can maximize utility.
Yeah, and it's smart, man. I like that way of framing it.
And this thank you. But this was a company that we
thought had a lot of untapped pricing power, right?
Because it go back, you know, you know, again, when were the
last time international stocks were expensive was around 1990,
around the peak of the Japanese bubble, right?
They've been in a bear market for a long time.
There's been very little you've seen mostly disinflation or
deflation, outright deflation there for the last 30 years.
But they have a product, they were, you know, they were 20
times bigger than their nearest competitor.
They had significant cost advantages.
And so I was suggesting they consider raising prices again,
right. You want to, you know, what's
going to flow. How do you improve the bottom
line most effectively? If you can raise prices by a
small amount, still much cheaper than any of your competitors.
I just was saying don't give it all away to your customers.
If you keep some for yourself, then you can do with the company
what you want to do. And and that's, you know, try to
solve that problem, but it wasn't, you know, it would never
work if we went and told them do this, do AB and CI don't know
how to run their business better than they do, right?
We try to, we try to partner with companies and talk to them
about their strategy and try to understand if we had the same
information they had, would we make good the similar decisions,
right. And we have some operating
experience of people in our company today.
We have people that worked at, you know, GE and AT Carney and
Colony and Hawaiian Airlines. We've got some operating
experience, but we don't pretend to think we can run their
businesses better than they do, right?
But we can. And we have helped many
companies from companies that are in the mag seven dozen years
ago about capital allocation to the smallest companies we own
today. That's interesting.
How many, how many companies are in the portfolio at any given
time? Yeah.
Broadly, we're around 80 companies on the long side in
the portfolio and our long short, we have a similar number
of a little bit less, but for today we probably have 6065
shorts. How do you talk to 80 companies?
It's it's difficult. So are, are not, I'm a kind of a
process guy, maybe not surprising kind of given the
quantitative background. I have always believed in doing
things, trying to be more efficient with how we do things,
right. And we have a small team.
The, the way we go about it is we try to take a universe down
in small caps, which is probably about 20,000 companies truly
down to about 5000 very quickly. And then from 5000 to a watch
list on the long side of maybe 4 or 500.
How do we talk to 85 companies? Well, half the companies we own
today, I believe, I say, I think we're still above half.
We've owned or done significant research on at some point in the
last 20 something years. We have companies and portfolio
today. We had one taken out a couple
years ago, but let's see 1 today.
I know I first visited in 2003, aerospace and defence supply
supplier. So I've been through multiple CE
OS with that company. Think it's a great niche
business. I've been following them for a
long time. So we've got a lot of experience
with a lot of companies. Historically, we've travelled to
meet a lot of companies. We've done a lot of travel.
I used to travel 4 * a year to Asia and probably 6 times to
Europe. So we do visit companies.
But going back to your question, how do we do it, We really try
to use technology to be very efficient, to minimize the time
spent in gathering information and have time for the analyst to
think about what the data tells us and, and to do our analysis
and do our primary research. So we really, you know, some,
some firms brag about, I look at 100 stocks and then we choose
one. We, we kind of probably do as
well or more because we end up buying kind of less than 1/2 of
1% of the universe. But our idea is we don't want to
spend a lot of time looking at most of those businesses.
So businesses have characteristics that we're not
going to like, IE we don't think we can predict, you know, that
this is under massive change. We can't predict what it's going
to look like in the future. Businesses haven't earned their
cost of capital, businesses that have a lot of leverage,
businesses that have opaque balance sheets or maybe off
balance sheet liabilities which we can't really evaluate.
We tend to stay away from those. We stay away from kind of pre
production mining companies or pre production biotech
companies, right. So we're eliminate, we do our
first filtering is to eliminate a lot of the universe and then
really only focus on the tails, right.
And we want to be in the the tail where we get the
combination of a great business at an exceptional valuation
opportunity and, and we, we tend to watch those until they become
attractive. But we do deep fundamental
research on all of our companies.
We've got extensive models. We talked to companies, we
talked to people in our networks quite a bit to understand
suppliers and customers and competitors to get a real good
view of the landscape. Do you want to talk a little bit
about portfolio construction? I know it's a a topic you're
passionate about. Sure.
So from portfolio construction perspective, we, we do think we
do it differently than most. And and why do I say that when I
talk to other adjunct professors at Columbia or whenever I'm in a
Columbia event, a lot of people will come up to a lot of value
investors, fundamental investors and the first questions like
what's your best idea? And while we think that's
necessary, like you, you want to have a best idea, but the best
idea is not that important to us in somebody else's portfolio, in
a portfolio traditionally like a Bill Miller portfolio where he
had 20% of his portfolio in one name, best idea might be really
important. Our best idea tends to be much
smaller in nature. You know, our, our biggest
positions tend to be in the three to 4% range depend on the
fund. So you know, in our average
position is today, you know closer to like 1 1/4% in that
range on the for the long always strategy and they're a little
bit bigger on the long short side.
But, but in that order of magnitude, we believe our
process works really well and we believe we can identify value.
We don't necessarily believe we can identify a catalyst.
Do we think a lot of people saying there's a catalyst, it's
like they're trying to create a story around what they want to
happen. But but we can, we can use the
data to identify value. When we think about portfolio
construction and again, this does go back to the days of JP
Morgan being concentrated levered portfolios.
We, we think about and I, I thought about this a lot from
those days and I think I learned a lot from the quads at that
period of time from the CTA is trying to think about how to
manage risk. And I think I've always thought
about it differently from a portfolio perspective as an
equity investor, as an equity investor over the last 25 years
to say, you know, can we add a stock to the portfolio, even a
long one portfolio? Can you add a stock to the
portfolio that actually reduces your risk?
Most people say that's not possible, but I'll give you a a
simple example. Well, if you're, if you were
long a lot of Japanese exporters and they benefit from a
weakening yen, if you actually were also long a Japanese
importer that benefited from a strengthening yen, you might
actually owning those two stocks might reduce your currency risk
there, right? Does that make sense?
Yeah, for sure. So, and, and we think a lot of
investors do the traditional well, what's your, what are your
sector weights? What are your country weights?
That's your exposure. We're willing to be very
different than the benchmark and we pride ourselves on this and
we believe in this. I think Peter Bernstein said the
quote right. The only way to be different in
the long run and produce superior returns in the long run
is by willing to be different and look stupid in the short
run, right? So we are, we're benchmark
aware. We know what the benchmarks
doing, but we never have a discussion about, oh, I like
this stock, the weight, the benchmarks are 1%.
We like it supposed to be 1 1/4 or 1 1/2.
That never comes up. I couldn't tell.
Maybe once a quarter if I see like the top ten names of the
benchmark, I can tell you, but I can't tell you I would doing the
bad. I can't name one of the the any
of the top ten stocks in our benchmark because I don't really
care. I don't I don't know it, it
matters. It matters to somebody else if
they want to look at us relatively speaking in the short
run. But there are sectors we're
likely to be underweight pretty much systematically.
We have been for a long time and like I'll mention a couple
financials, real estate and utilities and and why might be
that. That's your underweight.
We're underweight, traditionally very underweight those spaces.
Why is that? And some value investors, a lot
of value investors like financials, they like real
estate. Well, go back to what's our big
focus. Our number one focus is a
competitive advantage. I don't believe that there's a
lot of competitive advantage in small cap financial companies,
real estate or utilities. Most of them haven't earned
their cost of capital. Most of them have a lot of
leverage. We don't like the valuations of
real estate overall. That's another reason not to
like real estate. And there are exceptions, right?
But traditionally we're very underweight those areas because
again, you know, as a former JP Morgan employee, I'll say, you
know, I think JP Morgan, I respect him a lot as a bank.
If you want to go borrow money for your Business Today, and JP
Morgan offers to lend you money at X, and you go to a bank
that's not quite as perceived to be as high quality, and they
offer to lend you that same amount of money, same terms, but
the rate is half of X, I'm willing to bet you and most
everybody else will go borrow money from somebody else.
Now, JP Morgan is a lot more than lend money like that, but
you get the idea, right? They're lending a commodity.
That commodity is the same no matter who it is, right?
And small banks especially, so, you know, we tend to stay away
from that. We think the opportunity set is
much bigger and broader in small caps.
We're not forced to own those names.
Yes, some of them are quote UN quote cheap and we've seen it in
for a while. There's been cheap European
stocks for a while. It concentrated a lot in the
financial area and that's just not an area we ended up owning
financial services or companies that are, you know, supply them
with product, but not traditional banks, if you will.
So it does lead to a slightly different focus in a portfolio
from a construction perspective. That's number one.
Number two, when we launched the firm, Tom and I, so again, Tom
is another part of the firm who is Chief Risk Officer at Alpha
Diet. We talked a lot about how much
we're willing to risk on being wrong and you know, we believe
we've got, you know, a very good process, one of the best
processes to identify value. The risk is that you don't you
can't see the idea to fruition because you run into bad luck in
the short run. And I think that a lot of people
you know they they believe in concentration.
And this is 1 where I probably differ from a lot of kind of
Columbia associated professors where I believe there you do
have benefits of diversification that people do not truly
appreciate. Jean Marie Aviard did appreciate
it. On the other hand, one of my
other mentors, Bruce believes strongly in concentration as do
a lot other portfolio managers. But we think we get the benefit
of a broader portfolio that's diversified that allows us to
have lower correlations to the market, lower volatility, while
not impacting our ability during alpha.
If we had 1000 companies with the alpha go down, yes, that's
too big. The the analysis we've done in
our history over the last 25 years would suggest we think
somewhere around 80 is fine. And there's a little, there's
some arguments coming out now in the academic community arguing
that number should be bigger, but especially in small caps, if
you had a 10 or 20 stock portfolio, in my mind, you
really can't have a real institutional quality business,
right? It's, it's too volatile.
But you know, we think we get the benefit.
So we, we put together a portfolio that for our time here
and at our previous firm has about 80 companies, 80 long
companies are all small caps. Most people would agree that
small cap companies are more volatile than large caps.
You look in the US, the S&P Vol probably is somewhere between
historically somewhere between 17 to 20%.
The Russell 2000 Vol with over 2000 companies small cap
companies is probably 25 to 30% volatility, if not more.
The NASDAQ is kind of in that range.
We put together a portfolio of 80 small caps with a volatility
historically of somewhere between 10 and 13 by and we're
again, we're willing to be more concentrated in sectors than
some. So we're not just trying to
again, not, we're not trying to minimize volatility, but it's
the nature of the companies we choose and the way we think
about their interaction and their correlation, how they fit
the portfolio. And, and that's one thing I
think we do differently. We, I did it intuitively before
at previous firms, but we've been able to adding Tom to the
team here has allowed us to quantifiably analyze this and
we've reduced our correlations of volatility with the
portfolio. So what's led to historically
the firm I was at previously we tended to own have a lot of
cash. That was kind of a nature of the
firm desire to have a lot of cash as a reserve.
What we've been able to do here is take the cash down in our
long way portfolios. We're much more fully invested
say close to 100% ninety 9798 versus historically 75, but we
still show as low a beta as we did prior.
Yeah. So what it allows us to do is
suck upturns but but still preserve more capital on the
downturns. Sorry.
Yeah, no cash drag sucks. Yeah, absolutely.
That's, I mean, that's probably. In the environment where we
think that the the ability to compound at you know, we, we
think ultimately our you know our companies will grow value
because of the the free cash they generate due to revenue
growth margins etcetera. Oh and the returns on capital
and reinvestment at a very high rate, kind of worst case
probably low to mid teens plus we get set worst case.
We think worst case from here crazy is is crazy.
But then you add in the fact of the money flows, we talked about
the meaner version evaluations, you kind of get Charlie Monger's
Lollapalooza effects, you get some crazy returns.
So from our viewpoint, we don't want to be, we don't want to
have any cash. We think that cash drive will be
significant. In fact, when we we look at our
long short portfolio, we actually have managed that more
recently, not throughout our entire history, but this year
being over 100% net long. But even, but even in that
situation with a little bit of leverage because our companies
tend to be very under levered. Our shorts are so unique and
different that our beta to the S&P has been somewhere under .1
this year and our beta, the NASDAQ has been zero and beta
like bitcoins negative. So it it'll our, our structure
of our long short portfolio is very different than most long
short funds. So we we managed to a higher net
exposure or lower gross. Yeah, OK.
But it's but it's very different than anything we've ever seen.
Oh, a higher net and a lower gross.
Interesting. But it allows us to take our
long ideas which we think are kind of it up, you know once in
a lifetime opportunity, get a little bit more leverage to make
more money there. But we think our shorts are kind
of once in 25 year opportunity to make significant absolute
returns on the short side, right.
It's been very difficult for people to make money in short
side for the last 25 years. You know, there's been periods
of time where they've been able to do it, but not consistently.
And obviously the environment's changed a little bit now where
you can earn a short stock rebate etcetera.
But that allows us a different approach from that perspective.
Yeah, but, and I would I mean, we can talk more about the
portfolio construction. I'll just say one other thing
and I'll stop. But it it's, you know, when we
start looking at new ideas, we do independent risk analysis to
understand how they will fit in the portfolio.
So if an analyst wants to look at stock A or stock B, we before
they do any work, we can understand quickly how is the
stock behaved in the past, how does it fit with our existing
portfolio. And that understanding we think
helps Lee has LED us to a portfolio that's very different
than other investors in our space.
So we're very different than even other small cap
international investors. But more importantly, for a
broader portfolio, it's a great, you know, effectively we think
we're a positive expected tail hedge for most people because we
think we won't make positive returns.
So it's the insurance policy that will pay you at the end of
the day because it behaves so differently than everybody else.
But it's, it's not, you know, so it doesn't have the same
characteristics of going up and down with the market like
everybody else. Well, that's interesting man.
If if people listen to this and are interested, how can they
reach out to you? Sure, we have a website
somacalphacapital.com. Mac Alpha Capital is the name of
the firm. They can, they can e-mail me or
e-mail the firm and and we will be happy to get in contact with
them. But thank you very much.
Yeah, well, hey, thank you. Thank you for for chatting.
This is enjoyable. And I don't know it's it is an
interesting environment to look at.
And statistically, it is hard to deny that international looks a
lot cheaper than the US, though that the equal weight S&P
doesn't look like crazy crazy, but it doesn't look crazy cheap
either. Right.
So, all right, thanks again. Thanks for your time.
Thank you, Bill, and thanks for everybody listening.
Appreciate it. All righty, take care.
Thanks. Bye.
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