Animal Spirits Podcast - Talk Your Book: The Acquirer's Multiple

Episode Date: July 8, 2019

On this episode of Talk Your Book, we talk with Toby Carlisle, portfolio manager of the new Acquirer's Fund ETF about deep value investing. Find complete shownotes on our blogs... Ben Carlson’s A Wealth of Common Sense Michael Batnick’s The Irrelevant Investor Like us on Facebook And feel free to shoot us an email at [e-mail] with any feedback, questions, recommendations, or ideas for future topics of conversation. Learn more about your ad choices. Visit megaphone.fm/adchoices

Today's Animal Spirits Talk Your Book is presented by the Acquirer's Fund. Welcome to Animal Spirits, a show about markets, life, and investing. Join Michael Batnik and Ben Carlson as they talk about what they're reading, writing, and watching. Michael Battenick and Ben Carlson work for Ritt Holt's Wealth Management. All opinions expressed by Michael and Ben or any podcast guests are solely their own opinions and do not reflect the opinion of Ritt Holt's wealth management. This podcast is for informational purposes only and should not be relied on. upon for investment decisions. Clients of Rithold's wealth management may maintain positions in the

securities discussed in this podcast. Ben and I sat down with Toby Carlisle, author of the acquirers, multiple, deep value, quantitative value, and concentrating investing. And we spoke with him about his new ETF, ticker ZIG. Z-I-G. Yeah, it's called the Acquirer's Fund. That's a pretty good ticker. It's a great ticker. It's a great name. And this is a long-term. short deep value ETF. And it's pretty awesome. I think that something like this can exist inside of an ETF. And so the idea is it's called a 130-30 fund for those who don't know. That means it goes long, 130% and short 30%. So you actually get a 100% net exposure, even though you're getting 160% gross exposure because you're going short. So kind of the extra 30% on the long side is

cancel out by the 30% of the short side. And yeah, this is interesting because he's done a lot of almost like forensic accounting work on a lot of these value signals. And so what do you think, after talking to him, what do you think is the difference between just a simple value factor and like a deep value factor like this? Oh, that's a good question. I don't know if we necessarily got into this, but I would say, let's say that you rank, you take whatever universe you're playing in, whether it's the Russell 3,000,

or the S&P or the 2000, and you sort them based on various value ratios. Price to sales, I guess that's a bad one to start with. Enterprise value to EBITDA, whatever it is. And let's say that you were to define value as the bottom 30% based on those multiples. Maybe deep value is something like the bottom 10%, like the cheapest of the cheap? Yeah, which means like this is the space that you fish in when you want to see potentially big returns, but you could also see potentially big losses, and you're probably going to see more volatility. I would think it's safe to assume that these deep value stocks have

already gotten crushed, which is why their ratios are so attractive. And these are stocks that nobody, if you're like a Peter Lynch investor or a story guy, like you would never buy these names ever, because they are all probably very damaged businesses. Well, the reason he's looking at them, the reason it's called the Acquires Fund and the reason he wrote his book, the acquires multiple is because he's looking at them, trying to look at them from the perspective of a private owner, so like a private equity fund that would come in and buy these companies. And so I think that's part of the draw to it as well, is that these companies get beaten down so bad that they become attractive to people who want other companies that want to come in

and buy them out. So I think that this was fortuitous timing from Toby because if he launched this, I don't know, say five years ago, this would probably be in trouble because this strategy, like everything else on the value has had such a rough few years. Yeah, so the timing could be okay if value ever does have a comeback and it's not completely dead. And I assume when value does well, something like this, which is almost like a supercharged value will do even better because you're getting, you'd hope that that spread between growth and value would widen in that scenario and then the shorts would help you even as much as the long as you're doing well. So here's our interview with Toby.

Again, if you haven't followed him on Twitter, he's a great follow, a great guy, and he's got a great Australian accent, which is nice because now we have three accents on the show. We have Long Island, Midwest, and Australian, I think he kind of wins. So here's our interview with Toby. I'm sitting here with Toby Carlyle from, what's your title at the Aquarius Fund? Is it the everything? Yeah, the everything portfolio manager for the purposes of this one. So I am really excited about this. Finally, some innovation. in the ETF space. So this is a portfolio, 130% long, 30% short. And before we press recording, I don't know why. I just assumed, I was Tony Toby, I assumed that the 100% long was S&P, with 30% of his favorite stocks overlaid, or not his favorite, I should say, what the screen determines to be the best stocks and 30% short. But it's actually, that's not the case.

So why don't you explain what this fund is? It's a deep value fund. It's a 130% long undervalued deep value names listed in the US and it's short 30 names also listed in the US. So I look for on the long side, it's very traditional kind of deep value portfolio looking for undervalued on my favourite metric, which is the acquirers multiple, which is the metric that... You wrote a book about that, didn't you? Right, I did by the same name, fuddly enough. It's the metric that activists and private equity firms use to try to find undervalued stocks because it's a little bit agnostic to the capital structure, looks at operating income on one side.

So a company could be not profitable at the bottom line, but still be generating lots of operating income that could be direct to paying down debt or buying back stock. And so then that's what we go and look at, what they do with the cash flow? So do they buy back debt? Do they pay down debt, buy back stock, make sure they've got matching cash flows, make sure it's trending towards a net cash balance sheet on the long side. So they're pretty solid businesses throwing off cash. buying back stock or paying back debt. And that's what I like on the long side. Toby, we've always

had this discussion about where did the 6040 portfolio come from and no one really knows the answer. So why is it that funds like this go for the 13030? Is there a reason for that mix? Why did you settle on that as a mix for going the net and gross exposure? Well, I tested a variety of different exposure. So as you increase the 150, so 150 becomes your exposure on the short side, about a third of your portfolio of the gross portfolio. So 50 on 150. You know, there are funds Joel Greenblatt runs similar funds that his exposure is 190, and there are a number of funds around there like that, which are closer to sort of half, that you're about half short. But 13030 is about a quarter of the portfolio gross is short. And so the reason for doing that,

it provides enough downside protection when the market moves down without sort of compromising too much when the market moves up. And so you're 100% exposed when the market moves up. But it's sort of at the more conservative end. I think it's the most conservative way of constructing a portfolio like this. So I don't love having any margin debt in there, but I think that if you're going to do it, this is the way to do it. And it does seem to, in the testing that I have done and in the live portfolios that I have run, it seems to be the best way to structure the portfolio. So value, as everyone listening probably knows, has gotten crush relative to growth. What about deep value? Yeah, deep value. So the more growth that you have in

your portfolio, the better you have done. So a more traditional Buffett-style portfolio, which is a different method to the way that I like to run the portfolio. So the difference is Buffett is famous for saying he likes wonderful companies at fair prices. And what he means by that is he likes companies with a sustainable high return on invested capital. And I prefer companies. He says he prefers those to fair companies at wonderful prices, which is where I find myself. And so that seems crazy to do something that Buffett says that he doesn't do. But when I test it, and so Joel Greenblatt wrote a great book, the little book that beats the market. In that book, he comes up with this thing. He calls the magic formula, which is a quantitative expression of what Buffett

does, high return and invested capital companies, and low EV to EBIT, which he calls earnings yield, I call the acquirers multiple. And he finds the blend between those two, and he finds that that beats the market. So Wes Gray and I wrote a book that came out in 2012 called quantitative value. We tested that. We threw everything that we could think of at it. We weighted the positions by market capitalization, looked at the highest cutoff was the 40th percentile of the NYAC. So there was nothing small than that, which is about $1.4 billion in 2011, which is a bit bigger than that now. So what we find is that you get better performance, you get better risk-adjusted performance, the less of that return and invested capital that you have in there.

But those portfolios that are constructed by the Buffett style guys, franchise value investors, they tend to have a little bit more growth in them. And so they would have done a little bit better, although to the extent that they are kind of mapping to the value portfolios they've not done as well. So deep value has been crushed along with value. You can measure that a number of ways so that FAMA French data, which is free online, you can go and check that data out. You can look at any number of different ways of constructing that.

So I've done two cuts recently. to look at market capitalisation, waiting free cash flow to price, which is imperfect, but that's the data that they have. So that data goes back to 1951. It's the longest and deepest period of underperformance in the data. And so we can do the same cut with price to earnings and equate in the portfolios. It turns out basically it hasn't outperformed growth for about 13 years. But if you go back in the false data set, it's outperformed by 9% a year on average, which is an extraordinarily wide outperformance. These are desal portfolio, so the 10%. But 13 years. It's extraordinarily long period. I mean, even died in the world value

investors might be questioning. You've got to be asking a question. And I guess the obvious question, maybe this is music, this question is music to a value investor's ears, but have these new growth companies like Amazon and companies like Facebook that are so, that are able to just really break the traditional business model, have they disrupted valuation analysis? Or is that like the topiest question ever? No, I think that's a good question. That's the real question that if you're a value investor, you should be asking yourself. I think it's sort of arrogant to dismiss that question. Absolutely. No, you have to ask that question. That's the question. And so I think there are two responses to that. One is that you can look at the value.

valuation of the most expensive decile and the cheapest decile. So the value desal, so when I say desal, I mean the 10%, the smallest portfolios, the cheapest portfolios versus the most expensive portfolios. And that spread between those valuations has been getting wider and wider and wider. If that wasn't changing, and that's sort of what's driving the underperformance, because it's a relative performance, one portfolio relative to the other.

So the expensive keep getting more expensive and the cheap keep getting cheaper. Right. And so at some stage, and that's happened multiple times through the data, it's happened probably 10 times since 1951. There's never been one this deep. And, you know, the last material one was in the run-up to the dot-com peak. And so I think it's likely, because this is what's happened in the past, that there has been mean reversion.

At some stage, there's just an absence of value in that, or there's just, there's not much holding up that most expensive side. So when I look at those portfolios, so let's address those names in particular. Facebook is a pretty good business. I mean, Facebook is a phenomenal business, but Facebook has been a value stock at multiple times through that process, true of Amazon, true of Google. It's not that these stocks never get into value territory. It's just that the most expensive are extraordinarily expensive.

And the other risk that they have now is that it looks like there's going to be some DOJ antitrust enforcement against some of these companies. And I think that that could be the tipping point, because for many of these software-as-a-service-style businesses, the argument has been that they'll get to scale and they'll never be able to be headed by any other competitor. And I think that now they're at that point where maybe the DAJ steps in, create some antitrust. That's a tough, that's a tough short thesis, though. Well, I wouldn't short them on that basis. So let's talk about it for a second. So what's been harder over the past few years, going long value stocks or short expensive stocks?

So I don't short on the basis of valuation. I heard Jim Chaynor say this. I saw him speak about 2010 at a value investing Congress in New York and he said, I don't short on valuation. And everyone was like, oh, I think everybody else knew that. But for me, it was like, it was the first time I'd ever heard that. And it completely blew my brains out. Michael definitely shirts based on valuation. I showed an Amazon based on valuation in 2010. But how else could you do it? I mean, it kind of, when he said that, and it took a long time for me to kind of figure out what he was talking about. And now I understand what he was talking about then and I sort of retooled my process about five years ago. So it's not symmetrical. Your

longs and your shorts are not symmetrical. No, they're not. It's not a factor portfolio. So what I'm looking for on the short side, basically where the narrative has completely diverged from what's going on in the financial statements. So in the financial statements, they're carrying a lot of debt, they're negative free cash flow. They're issuing stock just to stay alive or they're raising debt just to stay alive. Sounds like a company that has been in the news lately. I have been talking about Tesla right up to the point that I formed the portfolio. And when I formed the portfolio, because there are other risk factors that you have to consider with shorts, and one of them is the short interest in the stock, because then

you're sort of subject to what the other short sellers are doing. And so we didn't include it in that portfolio, but it had been in the two portfolios up to that point. So I don't short on the basis of valuation. I'm sort of shorting on, I'm looking for financial distress, statistical earnings manipulation, statistical fraud, things that suggest that. all is not as it seems on the surface, but the message that the company is putting out

is still very positive. And so Tesla is a very good example of that. And I think that that is now broken. And I think Josh tweeted maybe a month ago that Tesla was a better short at lower prices. Right, $1.99 than it was a $2.90. Yeah, short it when it breaks, when the confidence is gone. And I think that that's exactly right.

That's the last step that I have. I just want to make sure the stock's not up over 12 months because I think that that demonstrates that the market is getting tired. of funding the story and they're they're no longer desperately trying to buy the stock and that keeps you out of stuff like Netflix although I think that Netflix has probably got a very good underlying business but every year it's up because the earnings are growing so rapidly every year it's up 30 percent. Hey Toby do you have any hard and fast rules on shorting stocks in terms of the borrow rate? Do you have like a cap that you look at or do you kind of take it on a case by case

basis? How does that work? We just screen out the most heavily shorted and then we look at we have an expected return and we look at how much the borrow costs. And with a margin of safety, we're trying not to short the most heavily shorted because the borrow is too expensive. Right, because that's the problem with a company like Tesla, right? Is that it gets so expensive to short? Is it even worth it sometimes? Which is why it wasn't included in the most recent portfolio, which is a shame because I'd been talking about it and I was looking for, and it hadn't broken in the like the week before, in the days before I formed that portfolio, it wasn't in there. And this is the portfolio that's in the ETF. And by the way, the ETF is zero.

Zig, Z-I-J. The ticker Z-I-G. And what is that? Where'd you come up with that? I was just looking for, because it's so hard to cut through, there's so much stuff out there. I just wanted something that was a single syllable sound that would kind of stick in your head and was a thing that people, like Zieg and Zag are things that people. So I thought you'd be able to remember Zieg, and I also have Zag for something else.

So you were talking about the portfolio in Shorty, and a lot of it, you're talking about qualitative stuff, how the story doesn't match the fundamentals. Is there any discretion involved on the short side, or is this 100%? quantitative. It's not 100% quantitative. I have the very final step as we do this, because I was a merges and acquisitions lawyer for about a decade before I started working in finance, and one of the things, one of the jobs that junior lawyers have to do, and I was pretty junior the whole way through, was you're responsible for diligence, which means you go through and you look at all of the documents to try and find out what's in the business. So I don't do that

on the primary documents. Now I do that on the financial statement. So we look at the management discussion analysis, look at the notes, see if there's anything in there. And that's an asset or a liability that should properly be included in the financial statements because it's one of the problems with a quant approach you're using ratios and they can be fooled by different business different financial statements different businesses so insurance often fools that financials often fool that they're difficult to sort of incorporate into the model so what I do is I have this final step where we use this off-the-shelf machine learning product just looks through the financial statements to see so I don't want to be shorting something that some

other investor who's going through them would say, look, there's this gigantic asset that you're not including in your short thesis, and that would make this a very attractive company. So if it's attractive on that basis, then I'm not short. If it's unattractive, then, or it's very unattractive, then I'm happy to be very short. The model does a very good job at separating out attractive and unattractive, and it mostly agrees with this little machine learning process that we use, but very occasionally there's something that sneaks through one or the other, and I just exclude that from the portfolio. So it's 30 short positions.

So the long side is rebalanced quarterly. That's 100% quantitative. No, no, no. The long side's the same process for the long side. So that's sort of quasi-discretionary as well? It's got this final step. So the term that everybody uses is quantum mental. I kind of hate it.

And I've written a lot about this thing that I call, well, it's called in the literature, the broken leg theory. It kind of demonstrates the idea that, you know, we know that John goes to the movies, Friday night depending on what kind of movie. So we have this little algorithm that says he likes action movies, he won't go if it's raining, various other inputs that you could put into this model. And let's say one Friday afternoon, you discover that he's got a broken leg. Surely you're allowed to override the model, whatever the output is, because it doesn't consider that bit of information. And the answer is you don't. You shouldn't. And the reason is that we...

Except when you should. Well, the reason is that we find too many broken legs. And it's particularly true in deep value stocks because they all have broken legs. That's why they're cheap in the first place. So it says that this index is constructed. So if I'm reading this wrong, this is an index product? Is this? No, that's true. So this is a passive investment, huh? So if it's an actively managed ETF, it's taxed like a mutual fund, whereas if it's a passively managed in ETF, it has this way of not generating capital gains on a flow-through basis, provider that it's managed properly. So you buy this at one price and you sell it at another price and that's your capital gain rather than getting flows. And the way that you do that is

you have to have an index. So all of the work that I'm discussing is done in the creation of the index, which is then traded by the fund. Getting to that, this is sort of remarkable. So these long, short, deep value strategies used to be a two and 20 type strategy and a lot of them are still delivered this way. So you're doing this for 94 basis points. How is this even possible that you could do that? It's 79 basis points in management fee after we have a little fee waiver for the start. And then And there's 15 basis points of dividends in the shorts that are counted against my expense ratio, which makes it look a little bit more expensive than it otherwise is. There's no reason for 2 and 20.

I think it's going to be extremely difficult for hedge funds to outperform at a 2 and 20 level. There's a trend in the entire financial services industry towards lower and lower fees. And I think it's sort of inevitable. There's no reason why I can't create a product like this that is perfectly liquid, run at a pretty low management fee. I think that's a high management fee for an ETF, but it's a low management fee for the strategy. Yeah, absolutely. We can do it at that price. And I want my first, the first ETF that we put out, not that we're going to put out a lot, I think maybe two, because I would like to do this internationally as well. But I just want

the first ETF to have the best chance of massively outperforming. And so that's why I built it the way that I have. In terms of portfolio management, and if people are thinking about this fund in a portfolio. Does it have a place where do you have a typical, say, market cap that you shoot for? Is this more of a mid-cap fund? Is it more on the large end and maybe not the mega-caps? How do you think about this in terms of where it would fit into a diversified portfolio? It's roughly the same universe as the S&P 500, which is a combination of S&P indexes, but it's the largest 1500 stocks. Which is the largest 25% of all stocks? 25% by market capitalization. I think it's roughly 90%.

percent by number. So there's 10 percent of stocks that are smaller than that that represent a very small amount of market capitalization. Have I said that right? Or something like that. So, you know, if you're looking for performance, I personally think that the best place to look for it is in that part of the market. It's kind of mid-cap where there's a lot of attention from private equity. There's a lot of attention from activists and they're creating these events all the time. And so I'm trying to use metrics that are fairly similar to what they're doing and I'm trying to get in front of those guys before they create that catalyst. I've seen some research that says that they get the same performance as small cap,

which is good performance, but they get at about 15% less risk where risk is defined as volatility. So you get a little bit of the best of both worlds. It falls out that the smallest market capitalisation is about $2 billion. So they're pretty robust companies that should be able to survive a downturn. And the average market capitalisation is about $10 billion. So they're pretty big and liquid too with good management teams in there. So you talk about the acquires multiple and obviously that that's probably a big hopefully part of the strategy for at least a piece that some of these companies do get taken out. People talk a lot about buybacks these days, but mergers and acquisitions seem to sort of dwarf those in terms of numbers. Is that sort of another reason behind the strategy

that they're just companies seem to buy other smaller companies more often these days? Is that part of the strategy? Absolutely. And that's, I'm hopeful. that they will get that kind of attention. I think that the market has been a little bit quieter recently, but I think that it's ramping up a little bit. The problem is that on the long side, the cheapest companies in the US are still about 50% more expensive than they have been on average.

It's just that the most expensive companies are multiples of where they have been in the past. So I think my expectation is that the long side, the returns will be better than anywhere else in the market, but still not spectacularly good, but on the short side, they'll be very good. And just to get back to Ben's earlier question, I think maybe you misunderstood or he misanswered in terms of where this goes in an investor's portfolio.

Right. How do you think about that? Or are you sort of agnostic? Like, is that not your sort of role? It's a little bit outside what I do, but I have had conversations with allocators who like the fact that it is extremely concentrated. So there are lots of other products out there where basically they give you the market portfolio and then they put this on the edges.

of it. That's not what this is. No, this is concentrated. It's highly concentrated exposure to that to value. So you could allocate a small amount of capital to this and then you can allocate the rest of your portfolio to VT or two. So I guess mentally this is the, this is in an alternative bucket. This is not your stocks. This is really something a little, I mean, obviously it's stocks, but this is not, this is different. Right. It is, it's literally alternative. The returns are going to look pretty much nothing like the stock market. It still has some beta and it's still going to be exposed to what the market does, but it is going to have its own idiosyncratic return profile. But I mean, the market, I'm making this up, obviously. The market could be up 6% and this could be

down 7, and vice versa. Or is that impossible? That's not impossible. Anything's possible. I mean, it does have its own idiosyncratic return profile. So what I mean by that is that it has wide tracking error to the market. So what you're saying is true. That's important. I mean, people should know what they're getting into. Absolutely. This thing has a potential for massive outperformance, but the opposite is also exists. Matter of fact, if you, launched this five years ago, do you know what the returns would have been? I'm guessing they would have underperformed. Yeah, it would have underperformed where the market is, although it's still, it's still well into positive charity. You know, I can look in the back test. I need to be careful about how I described these,

but I have seen how it has performed because I've been running this portfolio myself. And the performance has been fine for me, but it's not like being exposed to the S&P 500, which is the best performed asset in the world. Let's get back just real quick to the shorting stuff. How do you know what to cover? Is that quantitative or do you have some discretion there as well? Because it's one of those things where, you know, who knows where testes goes. But when something really goes in your favor, you don't want to take gains too quickly because you're shorting because you think that these companies are full of, you know what, and they're probably a zero. Well, I think about it as a portfolio. So I think as the portfolio's function is twofold. I hope that it generates some alpha. But it's also there to act as a hedge for the portfolio in the event that we do get some sort of cataclysmic drawdown.

And in that cataclysmic drawdown, it needs to stand up. So you can't be taking positions off. You can be rebalancing, but it needs to have that exposure. And my experience has been that these kind of junkie companies have been so far in the portfolio, they've been the things that have been generating the returns. Oh, yeah? the junkie stuff on the short side. The junkie stuff on the short side.

Yeah, not the junkie stuff on the long side. So you spoke earlier about Buffett and he, at least his mentor and maybe Buffett earlier in his career, was known for buying cigar companies that were just really garbage companies but were so, so cheap, that they were trading. In some cases, less than the cash that they had on their balance sheet. Obviously, that sort of opportunity is gone. Does not exist anymore. So what do deep value stocks look like today? Well, that's how, when I started out, I started out, I started out. in about the fourth quarter of 2008 writing this little blog called Greenbacked.

And the whole focus of Greenbacked was net-nets. Because when I was a lawyer in the early 2000s, I had seen after the dot-com crash that all of these net-nets came out and I'd not had any money at all to buy them. So I hadn't bought any of them, but sort of watched it. And I watched guys come in and take them over. And I thought, if this ever happens again, I'll do that again. So in 2007, eight, they actually reappeared.

And so I did it in size, but I realized that it's not, you can't run a business on that basis because they're just not around regularly enough to buy. So I wanted to find something that was a similar philosophy. So I think one of the nice things about this is it does look at the balance sheet. We're looking for net cash on the balance sheet. They've got very solid balance sheets and that's part of the process is to examine the, you know, look at the assets and the liabilities, which I think some of the more the franchise style investors who are doing DCFs, it's less relevant to them what the balance sheet looks like. And I think sometimes they miss, there's some weakness there.

It's like trying to fire a cannon out of a canoe. You know, you need that balance sheet strength there to be able to power the business forward. So the portfolio looks like there's some undiscovered balance sheet value there with a pretty solid business also generating cash flow. So these aren't, they're not necessarily garbage companies. Isn't that how they become deep value? Is that like... Yeah, I jokingly call them garbage.

I jokingly call them junkie companies, but they're not really... they're solid businesses like they're generating cash flow. The thing is they're just not growing at a rapid rate and they're not in sectors that people love. They're in very unloved sectors and they look like they might be being outcompeted. But I look at the financial statements and I think the financial statements tell a story that the business is still doing very well. It's just that the narrative has sort of run away from them. So, I mean, you talk a lot about digging into these companies' financial statements. How much does your time as a lawyer dictate how you sort of came up with a strategy in terms of like the forensic accounting behind it?

The whole genesis for it was that I was working in mergers and acquisitions. And just because when I started working, there was a lot. I had, I started working on April 2000 as a lawyer, which was right at the very peak of the dot-com boom. So I thought that I was going in to do sort of venture capital deals and to do IPOs. And the market just collapsed. And it turned into mergers and acquisitions and sort of activist defense. Although we didn't have a, we didn't know that they were activists at that. that time. They were sort of corporate raiders from the 80s who'd reemerged, who were these

older guys. And I couldn't figure out what they were doing. I didn't know why they were buying these really junky-looking stocks. So I watched that all fairly closely. And then it turned into the, I don't know if you recall, but the early 2000s was like a big private equity boom as well. So there were lots of LBOs. And I could see these guys targeting these companies and taking them private. And I could see an equivalent company listed on the stock exchange. And it's a lot of work to take something private. Like there's, you've got to paper the debt, You've got to paper the equity, you've got to take, you know, that stock exchange rules, SEC rules.

There's a whole lot of things that you have to go through to get these companies private. And then you've got this very illiquid asset that if you've made a mistake in your analysis, you kind of stuck with it. And I could look at an equivalent company on the stock exchange listed, doesn't have a takeover premium in it trading much more cheaply than the one that we've just taken private. And I would think, well, if I take a position in that one, there's a chance it goes private. private or it's going to do as well as this other thing that's already gone private and don't have to pay the takeover premium. And if I make a mistake, I'll just tip it out tomorrow.

Toby, anything else do you want to cover? I think that that's a pretty fair representation of what I try to do in the fund. It's a startup firm. It's a startup fund. But I've been doing this for about a decade. I've written multiple books, quantitative value, deep value, which came out in 2014, concentrated investing. And we'll like to all these in the show notes. The acquire is multiple, the most recent one. I have read, wait, what are the books? Quantitative Value requires multiple. I read those. There was a third. I wrote Deep Value, which came in 2014. I wrote Concentrated investing, which just nobody ever, has never been read by anybody. I don't think I've read deep value. Deep Value was the one that quantitative value, Wes and I got every bit of industry and academic

research that we could find and tested it again. And I just noticed there was this weird phenomenon where things that looked more junkie did better. By the way, you spoke about this earlier, but I remember you guys were not able to replicate the magic formula results. Did you ever speak to Greenblatt about that? I have never, but, you know, there's many, many different ways. So back testing is sort of almost as much of an art as it is a science. And where's sort of... Which means it's more bullshit than anything else.

I mean, there are a lot of ways that you can get. You know, Richard Feynman's line about, you must be very, you know, I'm mangling the quote now. That literally happened to me the other day with this exact quote. Is it, you must not fool yourself? Is that what you're the easiest person to fool? Yeah. The first rule is you must not fill yourself because you're the easiest person to fill. So there are lots and, you know, there are all of these different rules about testing.

First of all, you want to try and find something that's genuinely going to work. So we took, we did take his idea. We weren't trying to replicate what he did. We were trying to put it to a higher standard. So we tested it, market capitalization weighting makes it harder because there was one of the criticisms of that magic formula early was that they're all microcaps and it's uninvestable. So we thought, well, market capitalization, wait it, and we'll test that. And then we'll test it in a very big liquid universe, and it did outperform even under those very strict conditions. So I think it's a good strategy.

It's just that the less return on invested capital you have in your portfolio, the better you do. And, man, 13 years. And 13 years. But, you know, backtesting's come a really, even since I started back testing about a decade ago, back testing's come so far. Like, the stuff that's available now that you can subscribe to for, 50 bucks a month is or free. And whether that's made it harder or the edges disappear as a whole separate sort of conversation. I think it's behavioral. Maybe. I mean, I think I'm probably in that

camp, but it is going to be, it's definitely getting harder. Yeah. You make one little tweak to a back test and it can completely change your result. So it does, the more you do it, the more it makes you realize it's not really as easy as you think it is to even create a back test that could be used in the real world. You're always looking for the worst case back test. So one of the smart things at Corey Hofstein, who's all of our friend, but he's done some great work on timing luck. Right. And so that's basically, you know, if you test something that rebalances at the start of the year, it captures that January effect.

And if you don't get that March 2009 low, that really does impact your returns massively. So it could be the same strategy, different rebalancing, and one manager is a genius, the other manager is fired. Right, it makes a huge difference. But that's, if I rebalance quarterly, which is what I do, that eliminates 75% of your timing luck. And there's lots of other things that you can do that I do in order to try to get the performance of the strategy to match the underlying performance of what I expect the back test to do.

Well, hopefully the drought is over. It's been a painful 13 years from many investors. Toby, thank you so much for coming on. This is great. My pleasure. Thanks so much for having Fels. I really, really enjoyed that. So I'd be curious to follow this fund and see over the next few years. Let's just make a Herculean assumption that this is the top for the growth value environment that we've been in, where growth is doing so well and value is just really, really sucking wind. I wonder if more alpha would come on the short side than the long side. Like in other words, let's say that today's environment reverses will growth shorts like really, really expensive crappy stocks that have

had the benefit of expanding multiples, will that provide more to the portfolio than value stocks on the long side? That's interesting. And you wonder if the case for value historically has been just avoiding those really expensive high growth stocks, isn't that where a lot of it comes from, too, just avoiding those traps that are overpriced and kind of kill you for underperforming. That does make kind of make sense. Do you think that we're going to see more of these funds popping up? In terms of long short, or what do you mean? Yeah, long short.

Like long short in the ETF wrapper. I think it makes sense. And that's one of the other things that is pretty crazy. I mean, if you would have told someone, I don't know, 15 years ago that you could have something like a hedge fund structure, like this in a tax-efficient wrapper that could go long and short for you using this kind of quantitative analysis, they would have just jumped at the opportunity. It's pretty crazy that you can get this. And it's not in a hedge fund illiquid strategy. You can trade it at all times. Yeah. So excited to see how this strategy does and whether it gains traction from investors.

We'll link to all of this in the show notes. Toby on Twitter and the funds and everything else like that. Thank you for coming on and we'll see you next time. Thank you.