We Study Billionaires - The Investor’s Podcast Network - RWH014: The Resilient Investor w/ Matthew McLennan

Starting point is 00:00:00 You're listening to TIP. Hi there. My guest today is Matthew McLennan, who is co-head of the global value team at First Eagle Investments. Matt oversees an enormous amount of money, about $90 billion on behalf of millions of investors. After 14 years at Goldman Sachs, Matt joined First Eagle back in 2008, when he was handpicked to be the successor to a legendary investor named Jean-Marie Eveyard. In my book, Richer, Wiser, Happier, I wrote a whole chapter about Jean-Marie, and Matt, describing their distinctive approach to a challenge that all investors face. Namely, how can we build wealth in a durable way over many decades in such an uncertain and wildly unpredictable world?

Starting point is 00:00:43 This question of how to become a truly resilient investor seems particularly relevant right now. As we've seen very dramatically this year, everything can turn upside down in an instant, with a long and glorious bull market, suddenly giving way to a vicious bear market. a brutal war in Ukraine and runaway inflation. Over the last few years, I've spent a great deal of time with Matt discussing this question of how to invest prudently for the long term in a world that's full of these unpleasant risks and surprises. We first spoke about this for my book and have continued

Starting point is 00:01:18 since I became a senior advisor to his investment firm last year. One lesson that I've drawn from all of these discussions is that really the first priority for investors should be simply to say, survive and stay in the game, even in extreme conditions, instead of fantasizing about getting rich quick in the short term. As Matt once told me, you want to be structured to participate in the march of mankind, but to survive the dips along the way. This is a simple but really important truth that applies both in markets and life. You have to position yourself to survive the dips. In today's conversation, Matt shares some invaluable insights about this philosophy of what he calls

Starting point is 00:01:59 resilient wealth creation. Thanks so much for joining us. You're listening to The Richer Wiser, Happier Podcast, where your host, William Green, interviews the world's greatest investors and explores how to win in markets and life. Hi, folks, I'm absolutely delighted to welcome today's guest, Matthew McLennan.

Starting point is 00:02:31 Matt, it's lovely to see you. Thanks so much for joining us. It's great to see you too, William. Thanks. I wanted to start by asking you about your early years, which were unusual to say the least. Can you tell us a bit about growing up in Papua New Guinea and then really off the grid in Australia?

Starting point is 00:02:48 Well, my parents went to New Guinea really for adventure. They were Australian and our Australian living in Brisbane today, but they were adventurous souls, and my father was a land surveyor, and he got a job up there helping to mine, survey the mining communities. And my mother and father went up there thinking they were going to live this particular adventure and there was one E-type jag I heard up in Papua New Guinea that they planned to buy,

Starting point is 00:03:13 but they had me instead. And my first six years were really up there before the independence of Papua New Guinea in the 1970s. And, you know, it was an amazing place to be a child, very free, walking through the markets and a sense of adventure. When we moved to Australia, we wound up living in a little town called Montville. And Montfort was a thriving metropolis of about 400 people. and we had a beautiful little home on a block of land that my parents had found.

Starting point is 00:03:41 It was their dream block of land, but like their dream in Papua New Guinea, reality turned out to be a little different from what was envisaged. The home didn't get connected to the power grid for the first seven years. So we had this beautiful little cedar home that they helped build, and there was a rainforest on one side, and again, a fairly idyllic place to grow up. And it was a house full of books. While we didn't have electricity, we had gas lamps and a cast iron stove. And if you wanted to shower, you could put a black plastic bag out in the sun and heat it up and hang it under a tree with some burlap around it to take a shower.

Starting point is 00:04:14 So it really was living in the sticks. And it wasn't until I went to high school in Brisbane at a boarding school because there was no high school in my town that I got to experience the big city. So it was an unusual but a very happy childhood. You told me a great story once about your father deciding that you should get a TV. Can you tell us that? Well, we're all very excited about the notion of having television. It's one thing to have books, but occasionally as a kid you want to watch some television. And my father got a television and he hooked it up to the car battery.

Starting point is 00:04:47 So we had a night in watching television, which was very exciting. But the next morning when my father went to go to work, he reversed out and dragged the TV through the front door behind him. So that was the end of the television experience, at least for a while. And, you know, it was, but those kind of little mishaps, sort of amusing sort of punctuation marks on a childhood. And, you know, I sort of remember it fondly. We even had a koala come into our house once. And the house was built around these eucalyptus stumps. And the koala came in one night and climbed up.

Starting point is 00:05:22 And my grandfather, who was a doctor, realized the koala wasn't very well and wrapped him in a blanket and took off some ticks and nursed him back to health. He was back out in the forest the next day. So it was a childhood full of little surprises. Can you tell us more about your grandfather? Because we've talked about him in the past, and my sense is that he was a very formative figure in your life and also a really quite remarkable figure. He was a formative figure for me. And I guess everyone is the beneficiary of having various mentors in their life. And he was one of the first mentors for me outside of my parents, obviously.

Starting point is 00:05:58 And he was an interesting man because he was a doctor. And but aside from being a doctor, he had a, like my mother and father really, had a bit of a spirit of adventure. And he went to live in Antarctica in the 1950s. And the Australians, the Russians and the Americans had to share a common base for survival back then. It was in the early stages of the Cold War. But he lived in Antarctica for 18 months.

Starting point is 00:06:22 And, you know, I think that was an incredible experience for him because he was a philosophical person by nature. He went to discover the truth in his own words and realized that he couldn't, that, you know, however much he thought it was asymptotic in nature. And he could approach various truths but never really touched them. And that left an impression on me. And he came back and when he retired from his medical practice, he developed the real passion for gardening, which passed on to my mother. And, you know, I learned a lot from that as well. I remember you telling me once that he said you're an idealist and you believe in an absolute truth and you need to learn that there's only relative truth. Can you talk about that? It seems

Starting point is 00:07:03 like an interesting insight to have been given early on as an investor. It was. As a child, you know, I always liked puzzles and trying to crack the code and whatever it was, solving a Rubik's Cube or figuring out how to win at any given game. And I think he he could see very clearly that, you know, I like to get to an absolute truth, like the proof of a mathematical equation. And, you know, he introduced me to this notion that life is actually more complex than the sort of simple games or truths that I was trying to unravel and that much of truth is unapproachable. And in fact, it wasn't until I was in college and many years later reading other works that, you know, I realized that this was a sort of a whole field,

Starting point is 00:07:51 scientific methodology and I became pretty interested in Carl Popper who wrote about the notion of falsification and Carl Popper had a term for this. He said that, you know, things aren't true. They just have verisimilitude, the appearance of truth. And but I think having had that notion instilled in me early on was useful because it sort of sowed a seed for becoming at peace with the notion. There are certain forms of uncertainty that you just can't unravel. And And you need to sort of respect those spaces a little bit. And I think it has informed how I've approached investing in later years. But it's also popped up in different forms of work.

Starting point is 00:08:33 I mentioned Carl Popper, but I remember Fisher's work when he talked about the difference between risk and uncertainty, you know, risk being something that you can narrowly quantify with statistics and uncertainty being where you don't even know what the range of distributional possibilities are. And going on to folks like Steve Wolfram in the field of complexity, which we can no doubt talk about later, but having that seed planted by my grandfather, that sort of metaphysical source of angst, if you will, was actually a good thing with the passage of time, however disappointing it was for me at the time to realize that I couldn't learn all of these absolute truths. How did you end up as an investor, given that you had all of these very

Starting point is 00:09:15 broad interests? You've always been very interested in history and literally. in science. You've been very involved with public health as a philanthropist. And your parents were kind of adventurous, right? And your mom was an artist, among other things. It never struck me that the world of money was the paramount thing in your family. How did investing become a way to bring together all of these disparate interests in the world? Well, I think, you know, in some ways, there were various motivating forces at work. One may argue being of Scottish, origins originally way back when, that there may be some atavistic tendency there with money, but that's probably just wishful thinking on my part. And then there was necessity. I mean,

Starting point is 00:09:56 I think despite the fact that I had a really fortunate childhood in terms of being very happy and being exposed to a lot of thinking and life experience, you know, we didn't have a lot of basic necessities. And so I think there was a motivational force of wanting to live a more comfortable life, not for material purposes per se, but for a sense of personal freedom, not feeling encumbered by one circumstance. And, you know, that had some motivating force to it for me. And then, you know, my grandfather, who I mentioned before, he would invest in the stock market on the side. And I remember in high school, I just became interested in stock markets. And for all of the wrong reasons initially, you know, they were, this was the time back in the early

Starting point is 00:10:41 80s when you had, you know, the early days of the leverage buyout booms and people were creating fantastic wealth. And there were a lot of sort of speculative enterprises that were being formed that were sort of rolling up other businesses. And it seemed like that there was this sort of mystical elixir that one could learn about. And at the same time, in about grade 11, I had a, I had a math teacher who wanted to create an investment club at high school. And he figured out he had discovered the pattern and the roulette wheel to quote, Fred Swede from where are all the customers yachts. And as Fred Swed said, you know, for every new person who thinks they've discovered the pattern

Starting point is 00:11:19 and the roulette will, it's unfortunate for them because they haven't. And he had studied Elliott Wave theory. And I thought, well, here's something interesting. He can look at the passage of historical prices and figure out what's going to happen next. And all of this seemed to have this kind of allure to someone who wanted to have freedom in life. And at the same time, my grandfather, who was this sort of long-term philosopher, gardener, you know, collected wine, what not. You know, he gave me a small amount of shares in a company,

Starting point is 00:11:49 which was a small but fairly dominant regional bank. And, you know, time took care of any illusions that I had because the investment venture with the math teacher went to zero pretty quickly. He certainly couldn't see the future. And employing leverage when you can't see the future is a dangerous thing to do. And meanwhile, this little company compounded out quietly, almost unnoticed, never into a large amount of money because it was a few hundred dollars, but it got me thinking. And, you know, as I sort of sifted through all of this in my mind, I thought, well, I really have to learn about this in a more disciplined way.

Starting point is 00:12:24 And that's when I chose to study finance and accounting at college and, you know, got exposed to some more empirical elements in the world of finance. you start to read about other investors. And meanwhile, all of these wheeler dealer entrepreneurs were blowing up in the market because financial conditions got tight in the late 1980s. And so I think it was just having the benefit of seeing certain schemes unfold and then unfurl. And then certain simple truths play out over time for the patient. Before you joined First Eagle back in 2008, you spent a big chunk of your career at Goldman Sachs. I think ultimately about 14 years. years and ended up managing a global investment portfolio there. And you obviously had to navigate

Starting point is 00:13:09 some pretty treacherous periods during the late 90s with the dot-com bubble and maybe earlier, I guess also with the Asian financial crisis. What did you learn from those experiences at Goldman about what it takes to be a resilient investor and build enduring success? Well, the late 90s were difficult as a value investor. And I, you know, I'd had the benefit of some interesting mentors at Goldman as well. You know, Paul Farrell had worked with Lou Simpson at Ico, who taught me the Buffett way of thinking, you know, Mitch Cantor who'd worked at Bernstein, who was a deeper value investor, who really got me to think about how businesses normalize over time. And so I had these value influences on me, and I was just getting my own legs as an investor.

Starting point is 00:13:49 But then the late 90s ended up being just a woeful period for value investors, rather like the period we've just been through, history does rhyme sometimes. Focusing on cash flows and price was not a profitable thing to do in the, internet bubble. And it was very challenging emotionally. I was obviously quite a bit younger at the time and you know, you're trying to navigate a period. But I think what it's solidified for me is this notion that sometimes if you've got a disciplined mental model, you need to be willing to be short social acceptance for periods that are quite a bit longer than you'd feel comfortable with. I mean, when one grows up and one goes through grade school, you get essentially promoted each year to the next

Starting point is 00:14:31 grade, you get your grades every semester. And even in the early stages of a career, you typically get annual feedback and your annual bonus. But investing is a lot more like gardening where the seeds you planned intellectually or the business investments you make often play out over five to 10 years. And I realize that the timeframe that, you know, one had to sort of apply to assessing the feedback loop was quite a bit longer than conventional timeframes. And you You have to learn to manage that emotionally, which I think was a good lesson to learn relatively early on in an investing career because those things repeat themselves. And I saw a lot of people leave the business because, you know, they weren't willing to sort of stick it

Starting point is 00:15:15 out, if you will. And I think that was a really formative moment for me. And I have a friend who was a very successful trader. And he used to trade exotic options. And he said to me once, as he retired from the field, he said, he said, as he retired from the field, He learned the hard way that prices often have a way of causing the greatest amount of pain to the greatest number of participants before they settle at the right level. And maybe that makes sense.

Starting point is 00:15:38 You know, if markets are in equilibrium, prices force out the weakest hands over time before settling at a stable level. And I guess all of those experiences back then were formative to sort of disentangle the mental model and approach from the near-term results. Do you think it helped in a sense that you had had such an unconventional childhood that you weren't naturally someone who was part of the tribe? You were probably by your own wiring, but also by your own conditioning, you were outside the herd. And so maybe it was easier to think for yourself than it might have been for many other people. I think there's some truth to that, William.

Starting point is 00:16:19 I think that I definitely came in with an outside perspective. And I think as well, I take comfort in the purity of ideas. And so, you know, I think the combination of coming at something from the outside and seeking purity and ideas, even if you'd recognize by that point, there weren't any absolute truths. You know, I think it was those two things that were very helpful in enduring an environment like that. And indeed, you know, when I spoke to Jean-Marie, who hired me to First Eagle many years later, he said, you know, one of the things that gave him comfort about hiring someone like me was that I had endured an experience like the late 1990s. It was almost that kind of a condition precedent to feeling comfortable that

Starting point is 00:17:06 you'd have the stamina to do it again. Yeah, and that period had been such hell for him, right? I mean, I write about this in my book, Richard Wiser-Happier, the degree to which he was sort of at war with the world, at war with the market, a war with his bosses who, you know, who, you know, were like, why don't you get this new paradigm and buy, and buy dot-com stuff? And he said, I definitely have to face those pressures. I mean, I was dragged in front of one of the partners for lunch, and he's like, well, you know, why aren't you buying these hot IPOs? It's free money.

Starting point is 00:17:42 And I tried to explain the fact that it's a sucker's game, the IPO market, because you spend all of your, you know, your time researching businesses that haven't proven their incumbency. And secondly, you know, you tend to get the smallest allocations of the best businesses. And so there's a lot of adverse selection at that market. And so, you know, I'd spend a lot of time thinking about why I didn't want to spend my time, you know, focused on that. But it seemed like there was free money to be had. And I remember a conversation with the Retirement Committee at Goldman Sachs where they were sort of questioning, you know, whether there would be any mean reversion in this dot-com era, whether everything had changed. And I recall back then saying

Starting point is 00:18:22 that, look, you know, you can look at enterprise value to cash flow or revenues. And yes, some businesses will live into high valuations. But one of the metrics I couldn't get around was the enterprise value per employee of some of these newly listed companies was quite large. In fact, I said to the partner at the time, I said, you know, would you pay 30 times as much per human for this business as the market cap of Goldman Sachs. You know, you feel like you've got good people. Would you pay 30 times as much? And by the way, in a labor market where unemployment rates were below 4%,

Starting point is 00:18:55 so how are they going to hire the people to live into that valuation, even if they can find the best people? And so I guess looking at strange things like that gave me the conviction to stick it out, but it was a trying time. So you mentioned before that you found solace in the purity of ideas. Were there particular ideas that you were clinging to particular principles that you'd learn maybe because Paul Farrell had introduced you to the writings of Buffett-a-Monger? I mean, what were the sort of main tenets that you'd figured out that kind of protected you

Starting point is 00:19:29 from the craziness and irrationality of the late 90s? Well, you know, it's interesting. If you're a bond buyer, you know that you've got a contractual principle that's due to you in five years time or whenever the bond matures. And I think that gives bond buyers a lot of peace of mind that they can endure short-term vicissitudes and in quarterly reports and the like. And I think it's difficult as an equity buyer because what you're buying is ostensibly a perpetuity.

Starting point is 00:19:53 But I think what gave me the conviction, the more I thought about it, was that, you know, ultimately you're buying access to a cash flow stream. And, you know, if the business were cash flow generative and it was stewarded by management teams that were willing to distribute at the lion's share of those cash flows to you, that ultimately arithmetic would work, that sentiment could shift around the multiple relative to that cash flow a lot in the short term, but ultimately the math would converge upon the arithmetic of the cash flow. And so I think that gave me a lot of comfort, you know, but even so, it wasn't absolute because you saw companies that had highly inflated valuations that were

Starting point is 00:20:35 able to use that currency to go and acquire other businesses that were cash flow generative. So they could turn hope into reality. And, you know, that's always a bit distressing when you see that as a value investor. I think by and large, it was just the nature of the fact that, you know, if you bought a real business and it had a real cash flow stream and you had a long enough time horizon, arithmetic was pretty powerful. It's almost like a law of gravity, right? That if you, if you had the right time horizon, things would shine through. Can you talk a bit about time horizon? because one thing that you've explained to me over the years is this idea really of defining what our goal is as investors.

Starting point is 00:21:12 And obviously there are so many people who come into the market and see it just as this kind of casino where they're rolling the dice as fast as possible, hoping, you know, expecting that they'll make 30% in a month on crypto or whatever it is and chasing into whatever hot asset there is. And it seems to me that a certain point, you decided in a very clear-minded way that your goal was different, that you were pursuing something that was much more long term. I don't know if I'm articulating this properly. No, it's actually a really interesting question because I'd say that as more time has passed in my career, my time horizon has continued to grow longer. And, you know,

Starting point is 00:21:55 I'd say, you know, to give you an analogy, if you felt that you were going to pursue a quantitative strategy that had a small edge. Imagine you were flipping a coin that was slightly biased. Well, then you'd want to flip that a lot of times, you know, to magnify a weak signal. It's akin to having a short-term horizon for investing. And a lot of people are very focused. They're obsessively sort of trading the quarter, if you will, and trying to pick up on sentiment shifts. And I guess the more I thought about it, the more I realized that that field is, because it it offers the allure of large returns, if done successfully, it attracts a lot of competition. Whereas, you know, you look at what Buffett's done, he looks to buy forever. And so, you know,

Starting point is 00:22:37 he's very focused on the limiting arithmetic of the investment. And in a sense, he's looking to make one good decision as opposed to a series of decisions. The more decisions you make, the more difficult is to make excellent decisions. If you're selective with the decisions you make, the odds of making an excellent decision go up. And so I kind of realized gradually over time that having a longer time horizon put me in a less competitive space for the market. There are less people willing to think about the next five to 10 years. Most people are much more focused on the next 12 months or the next quarter.

Starting point is 00:23:13 And so part of it's just thinking through those things. And then I think you've got to realize as an investor where you can be most comfortable in your own skin. The things that I like to analyze in the business were the nature of its market position, how it had evolved over decades, the likely longer-term trajectory of that business, and the longer-term decisions that management were making. And the potential alpha from all of those things plays out over a long period of time, not a short period of time.

Starting point is 00:23:41 Valuation mean reversion often takes five plus years if you bought a good business at a time of an issue. you know, the impact of a free cash flow generative business producing some form of accretion through share repurchase or M&A or better dividend yield takes time to play out. Or a management team that is a good steward of capital, that compound accretion tends to take time to play out. And so the things that attracted me tended to be longer term variables. And, you know, if I true to myself, I was less good at trying to pick up on the short term scatter pattern and mosaic and predict near-term earnings surprise. And so I went to where I felt most

Starting point is 00:24:21 comfortable. And if you'll permit me one sort of sort of digression here, I mentioned that my grandfather was a gardener and he passed that skill on to my mother. And this little home that we built, she was an ardent gardener in this home. And as a child, I always wondered why she went to the effort because there was always some issue. You know, there was a, there were drought conditions or the bamboo route would spread to somewhere where it wasn't meant to be or there was some weird fungus or virus. She was always having troubles. Whereas there's a gentleman who lived next to us who mowed his lawn every week and

Starting point is 00:25:04 it just looked pristine and clean. And we had another house behind us at the bottom of the rainforest where he just lived amidst the rainforest. And I only realized the wisdom of my mother's long-term strategy when I came back to the house some 20 years later with children, my children. And the garden had really grown into this resplendent, beautiful space. It had been selectively curated over time, you know, whereas the house next to me was still being moan, the lawn was still being moan every week. But there was nothing to show for all of this activity. It was like the active manager turning over the portfolio once a week.

Starting point is 00:25:42 And the gentleman who had had his house down the hill behind us had some fire damage, I heard at some point. And so, you know, the passive strategy of just letting the forest go around you wasn't necessarily the safe strategy. My mother had worked in all these fire buffers and things like that. So selectively curating something and letting time take its course is something that doesn't seem like a very well rewarded activity in the short term, but, you know, when you step back and let time play out, it can be very rewarding. Yeah, it's interesting because it's not sexy

Starting point is 00:26:17 and it doesn't appeal to our yearning, for instance, gratification, but because of that, there's so little competition and it has the virtue that it actually works. It's a combination of less competition, and I think patience as well, it encourages you to wait for ideas that are truly stacked in your advantage. And I think that's an interesting perspective that I try to convey to new analysts who join our platform because when an analyst shows up, they're tempted to produce a new idea every week. And like, actually, no, I'd like you to do a lot of work every week, but I'm really looking for one or two ideas every year or two that are exceptional. And it's just a different way of thinking. I'm curious also whether there's a parallel

Starting point is 00:27:04 between gardening and that kind of selective curation over decades, and your interest in both wine collecting, which you obviously inherited from your grandfather, and also I think in collecting art, which you used to do seriously. I don't know if you're still collecting old masters and the like, but are there parallels, are there things that we can learn from the sort of selectivity and curation in wine and art that apply in the stock market as well?

Starting point is 00:27:33 I think so because, you know, when I look at a business in the stock market, I'm most often attracted to something that survived the test of time that has some form of advantaged incumbency. And I think the same can be said if you're a wine collector or an art collector. You know, if you're a wine collector, there's certain terroir that is just advantaged where people may have been growing vines there for over a thousand years. and where the cumulative effect of that is that the ecosystem around that plot of land has very complex soil and has unique geographic exposures, but it also has the sort of software benefit in inverted commas of cumulative learning of how to tend those particular vines in that particular location that's often passed on from generation to generation.

Starting point is 00:28:26 And so, you know, when I initially started collecting wine, I was looking for good value propositions, and I still enjoy a good value whenever I can find it. But over time, I realized that there are certain wines that are just fundamentally advantaged. And those wines tend to also age themselves well. And it's interesting from an investment standpoint, what can happen if you let time and quality combine, because if you think of the analogy of an ice bottle of wine that matures gracefully over 30 or 40 years, as it matures and its real quality goes up, the real quantity goes down because bottles of that wine and that particular vintage get consumed every year. And so there's a reason the equilibrium

Starting point is 00:29:08 price for a fine bottle of wine can go up exponentially over time. Quality improves, supply goes down. And I saw that analogy with businesses, because if you own an advantage business over time, with the passage of time, an advantage business tends to benefit for from kind of brownfield concentricity, the ability to invest around the fringes of your business with marginal economics that are much better than someone who is trying to get into the business with greenfield investment. And so time aids the intrinsic value of a good business. Meanwhile, a good business is producing free cash flow, so it could be shrinking its shares outstanding, rather like bottles of wine disappearing for any given vintage over time. And the real value

Starting point is 00:29:52 could compound up over time. And the same can be said for art. There's a lot of enthusiasm for contemporary art, just as there is a lot of enthusiasm for growth stocks. People want to own the new new new thing. But if you think about the big movements in art, they tended to proceed big movements in physics and mathematics and language, often by a couple of generations. Sometimes artists were intuiting how to perceive things long before it was converted to words and symbols. But there are obviously a lot of false starts along the way in the world of art. I think it's going to be very hard to predict which contemporary art becomes an old master in a hundred years time. But you can buy art today from a master that was painted four or five hundred years ago that survived the test of time.

Starting point is 00:30:38 And it may look mundane relative to the sizzle of the contemporary art market, but it's more likely than not to maintain its relevance if it has done so already for four or five hundred years. And so I think the appeal of identifying incumbency in those collectors, the Bulls market has sort of bled across to the way I think about looking for businesses. I think we should talk in some depth about how to be a resilient investor and how to succeed over many decades. But it seems like we should mention first this idea that in a way forms the intellectual backdrop of your approach, which is just a respect for entropy and the fact that we live in a world where, you know, things fall apart, the center cannot hold, as Yates said. talk about your fundamental respect for entropy as a kind of ironclad law of life and how that

Starting point is 00:31:31 shapes your approach to looking for things that are likely to endure in a world where not much does endure? No, it's a good question, William. Entropy is probably one of the few absolute truths. It's a second law of thermodynamics that any form of order is essentially transient. And perhaps it's the fight against entropy that's sort of gotten me interested in old master art or great wine that can survive for generations and from vineyards that have been planted for generations or a business that has a slow fade rate, you know, relative to the typical business.

Starting point is 00:32:07 But if you think about the economy as an ecosystem rather than as machine, productivity happens every year, productivity growth. And, you know, over the last century, we've grown productivity close to 2% a year. But the dark symmetry of productivity is that the existing pool of companies won't control the future profit pool in perpetuity. New businesses get created that chip away at the margins at existing incumbency. And so entropy is a fundamental principle in investing. And when you go through business school and learn about asset pricing, you really only talk to think about beta risk or systemic risk. But idiosyncratic risk is interesting to think about as well. And in fact, entropy is a form of systemic risk because change in the economy, the overall improvement

Starting point is 00:33:01 in the economy imputes that existing companies will grab a smaller share of the future pie, given enough time. And so, you know, I've focused a lot on this question. And, you know, The paradox of it is that buying businesses that have been around for a long period of time that have demonstrated persistence in some ways can be a safer strategy than trying to buy a business that's growing a lot today. Because many of the businesses that are growing a lot today are in industry verticals where market share positions move around a lot. And so by definition, your ability to capitalize their terminal earnings in any given

Starting point is 00:33:38 period of time is low because easy come, easy go, as it would relate to. to market share shifts. And so, you know, we do like to try and focus on businesses that have a stickiness to their market share over time, high customer retention rates to try and sort of slow the curve of entropy, you know, and it's, you know, we approach it with a great deal of humility and respect. And we, you know, we, we recognize that even our favorite ideas are going to get disrupted at some point or another. So in a way. And I think it's important because, you know, When people think about a growing business, they tend to think, well, if the stocks, if the business is growing revenue is 10% a year, I'm growing my intrinsic value 10% a year.

Starting point is 00:34:19 And it's not actually the case because trees don't grow to the sky. So that rate of growth will fade and says, you know, markets become penetrated. And secondly, even if you dominate a market, substitutes get created. And so you have to recognize the fact that as a business matures, it will trade at a lower multiple than it does when it's growing. And so the fact that there's fade rates to growth and that the ultimate multiple of a mature business is going to be less than a growing one means that the growth in intrinsic value is going to be a lot less than the growth in revenues today. Let's take a quick break and hear from today's sponsors. All right. I want you guys to imagine spending three days in Oslo at the

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Starting point is 00:39:01 Back to the show. So in a world of entropy where things tend toward disorder over time, how do you actually build a portfolio filled with businesses that are truly resilient? What qualities do they need that are likely to make them less perishable? Well, you made an interesting comment before about sort of knowing where you're going. And I remember Seneca saying, you know, if you don't know to which port you're sailing, no wind is favorable. And I think, you know, for me as an investor, I like the idea of resilient wealth creation a lot. And I recognize that's not for everybody.

Starting point is 00:39:39 Some people are investing for a different reason. Some people are investing because they want to max out rather than grind it out. And sometimes you'll come to surprisingly different conclusions depending on what your sense of travel is. So if your goal is to get large outsized returns, then it's going to drive you more towards portfolio concentration, the use of leverage episodically. and the desire for control so that you can influence the underlying companies that you're investing in. And many of the great fortunes that have been made have those three elements in place. On the other hand, the combination of concentration and leverage and the time sync of control,

Starting point is 00:40:22 devastating if the laws of entropy work against you in an unanticipated way, if there's a new product that disintermediates what you focus on. And so you might have bought what you thought was a great business, but then the world changes. And if you're concentrated and levered and all of your time has sunk into controlling that business, then you're in a sort of troubled spot. And so my friend, Guy Speer has a, Matt, my friend who mentioned someone who had a hedge fund where I think he had one stock in the end. And he, he's so believed in it and was so totally wrong that he now runs a cafe or a bar somewhere in the US. And so, yeah, the idea of resilient wealth creation resonates really deeply for me.

Starting point is 00:41:06 I have this sheet on my, this screen on my computer with this low-tech list of the investments that I own. And literally the phrase at the top is resilient wealth creation, because I'm trying to pound into my head the fact that I don't need to be in a hurry. It's just not the goal. Well, and if you think of the difference, the place that it can lead you to, if that's the port to which you're sailing, the first thing is that. that you become far more at peace with the notion of diversification.

Starting point is 00:41:34 And, you know, I mean, William, you introduced me some time ago to Tom Gaynor at Markelle. And I think he described it well. He discussed this notion of emergent position sizing. And that is that every investment you go into you think is going to be a sound investment. But, you know, the future plays out in different ways. Some businesses are the victims of entropy. Some are transient beneficiaries of substitutes. of substitution going in their favor. And so having a diversified portfolio is something that we're

Starting point is 00:42:06 actually quite at peace with. And it's an expression of humility. It's an acknowledgement that there's only so much we can know. And going back to the discussion on Carl Popper or Wolfram and complexity, I've become convinced that there's only so much one can know. And so diversification is an acknowledgement, a humble acknowledgement of that fact. But it's also an interesting strategy because if you're willing to invest globally as we are, diversification doesn't mean that you look like a passive representation of the market. We might own 100 securities out of a universe of 5,000. And so you can still selectively curate the garden, to use the analogy of before, but to do it across industries and across countries in a way that gives you a degree of

Starting point is 00:42:53 resilience. And to the extent that you've paid decent cash flow multiples and you've identified what you think is incumbency for individual businesses, it helps produce an error-tolerant approach because if the starting free cash flow yield compensates you for the cost of capital and a certain number of these businesses end up doing reasonably well, then you're able to cover the costs of those that don't do as well. The other thing I'd say, other than diversification, is I guess the opposite of leverage is to travel a journey with deferred purchasing power. And so if you look at our portfolios, we have roughly 20% in a combination of cash and gold and diversified foreign short-term foreign sovereign bonds.

Starting point is 00:43:36 And so I guess it's a recognition of the fact that a non-linear system like the economy is going to have episodic periods of crisis. And, you know, hopefully the businesses we own well positioned to endure those. But if we have some net cash and gold, we can put it to work. in very distressed environments and convert it to the ownership of enterprise on very advantageous terms episodically. And the willingness to kind of wait with some amount of your portfolio, I think has been a kind of an important element of how we've generated resilience historically. The final thing I'd say is that when you have a portfolio with 100 or so investments,

Starting point is 00:44:10 it would be foolish to think that you could play a control or influence role in all of those investments. And what we've done instead is we've essentially created an ecosystem of managers who act like owners. And so it's more about the ecosystem that you're self-curating than you having to have control. One of the things that's also really unusual about your portfolios that very much fits with this idea of long-term selective curation like a gardener is there's incredibly low turnover. I was looking at one of your portfolios. I think it's 7.2% turnover.

Starting point is 00:44:45 One is 10%. So we're talking owning stocks for 10, 12 years or more. Can you talk about that? Because it seems like a lot of the portfolios run by other fund managers that are very diversified. They tend to be kind of obtuse investors who are over diversified and then trade too much and have too high expenses. Yours is very different. It's like very thoughtfully diversified and at the same time incredibly patient. You're buying stuff and then you're holding it. Well, part of it's a reflection of the way in which we invest because if you think about an investor who's trying to trade every quarter, by definition, they're going to have a lot of turnover in their strategy or if they're looking for the hottest new growth story, that changes every year. So by definition, you're going to have to shift to wherever the pocket of momentum is in any given short-term period. So if you're trying to trade short-term surprise or you're

Starting point is 00:45:39 trying to trade shorter term momentum, it leads you into the territory of being high turnover. On the flip side, if we go back to our discussion about collectibles, whether it's wine, art, or businesses, if you're identifying incumbency, it shouldn't change that quickly if you've done a solid job of identifying a business with staying power. And so, you know, a big part of what we do is to try and find businesses that, you know, are going to be around for the next generation and buy them at an advantage price and let the arithmetic. play out. And by holding them for a decade, the arithmetic starts to dominate the short-term changes in sentiment. And that's, I think, a really important principle when it comes to long-term

Starting point is 00:46:23 investing that if you're going to go for incumbency and you value arithmetic, you have to give it the right time rise. And rather like it would be crazy for my mother to plant and then sort of tear down the garden every year. Some trees take a long time to grow. You've spoken to me in the past about mundane but really persistent businesses and how mundanity is often more beautiful than the kind of hot, sexy stocks that most people are falling in love with and chasing and then dumping and trying to trade in for the younger, prettier model. Can you talk about what you mean by mundane scarcity and persistence? What's interesting to me, and the beauty of mundanity at its core or apparent mundanity

Starting point is 00:47:05 is that it rarely leads to excesses. If the goal is to buy a quality business, the only way you're going to make money is through some identification of asymmetry between price and prospects. It's not enough to buy a quality business because if the whole market views it as a high quality business, it will be priced for low returns. And so it's really the search for unpriced quality that's critical.

Starting point is 00:47:31 And so there has to be an engine for quality, but there usually has to be an issue. And that's where scarcity is kind of the engine and mundanity is often the issue. And so let me just sort of define this construct of scarcity value a little bit more. And I think it was sort of obvious in the context of our discussion before. If you're buying a wine from the best block of land in Burgundy or you're buying an old master's painting from someone who painted only very few paintings, that concept of scarcity is very intuitive and easy to understand.

Starting point is 00:48:03 When it comes to business picking, I think you have to disentangle two forms of scarcity. One is scarcity in the world of real assets and the other is scarcity in the form of intangible assets. Now, real asset scarcity, I think, is also pretty easy to understand. Imagine a really well-located piece of real estate, like the vineyard. It could be an apartment right in the center of the city. It could be a beachfront apartment or, you know, it could be a timber land on the edge of a city where there's option to either grow the timber or sell part of that land for higher and better use in any given year. Scarcity in the world of real assets could also be a company like a gold miner, for example,

Starting point is 00:48:44 that owns very large-scale mines at the low end of the cost curve. So scarcity in the world of real assets is usually locationally driven. On the other hand, scarcity is manifest in the world of intangible assets. And usually that's companies that have strong market share positions. It's the most valuable form of intangible asset. A company that's had 40, 50, 60 percent market share that's been stable for decades is a scarce intangible asset because that large market share position gives them the ability to have a degree of pricing power through the cycle, reduces the volatility of their cash flows,

Starting point is 00:49:20 improves their margins. But it also gives them the scale to outspend competitors on R&D, product development, density of their sales force so that they can provide more duration to that. advantage. And so, you know, when we're thinking about scarcity in the world of investing, it's typically a well-located physical asset that's of a long-duration character, or it's a company that's got a good market share position in a stable industry that's doing the things that it needs to do to perpetuate itself into the future. Now, those kinds of businesses often trade at high values. So the reason we sort of refer

Starting point is 00:49:55 to mundane scarcity as attractive is that if you want a shot at buying quality, at a reasonable price, it can't have too much obvious allure. And so, you know, that's the key that what is often mundane to the average investor ends up being beautiful to the long-term compounder, because it means that you can buy in at a reasonable multiple of cash flows, you can benefit from that scarcity over the long term. And if the business never scales the heights to an outsized valuation, you can hold it indefinitely with a margin of safety. And so it enables you to make a single decision and therefore have a very long average holding period. I remember during that first period of COVID when the markets were tumbling, I interviewed you around then. I think for Barron's,

Starting point is 00:50:39 if I remember correctly, and you had been buying, I guess all the restaurants were closed around the world suddenly and you were buying a company, I think in Japan, that made ice machines for restaurants. So it was something where you kind of knew, knew that it was eventually going to be good, that we're going to go out to restaurants again. And so it had a kind of mundane scale. but at the same time was out of favor. Is that a pretty good example of what? It's a good example. I mean, the company you're referring to is in ice machines for commercial establishments, whether it's restaurants or hospitals or schools. And there's actually a fair amount of precision processing that goes into an ice machine because, you know, you don't want bacteria to creep in

Starting point is 00:51:19 there. It needs to be reliable. It's at the core of a decent customer experience in a restaurant or any catering facility. And you want it to be reliable. And therefore, having the network of aftermarket support and Salesforce helps embed that business. And they've, you know, concentrically expanded that business into strong position in commercial refrigerators and ovens. And so businesses that you think are lacking in a certain amount of appeal can be quite stable over time. And because the business has good economics, you know, you don't have to worry at a time like COVID that they're going to go out of business. Their customers may be suffering for a time, but the customers will come back and restaurants change all the time. But the need for

Starting point is 00:51:58 ice machines doesn't change. And so having a niche like that can, you know, be quite helpful for the patient investor. I was struck also. I was discussing with someone from First Eagle was saying, yeah, like good examples of this are like this company in Switzerland that makes elevators. And I think there's a Japanese company that makes bike components. It's these are wonderfully unexotic, unsexy and yet weirdly central kind of necessary things. Can you talk about a couple of these other businesses that embody that resilience? Let me just comment on the two that you mentioned. You know, in the case of the bicycle components, you know, we've owned a stake in a company called Shimano for a couple of decades now.

Starting point is 00:52:39 So it's truly been a long-term holding for us. And Shimano has over 50% of the market for high-end bicycle brakes and gears. And people know the brand of the brakes and gears more than they know the brand of the bicycle. I went to a farmer's market with my daughter. once and she found some old comics that were on sale there from the early 70s. And it was, I think they were advertising the Browning bicycle company, but the big feature of the ad was the Shimano brakes and gears. And so this is a company that has basically devoted itself to perfecting a single process and getting to global distribution scale one local market at a time.

Starting point is 00:53:19 And what's great about Shimano is, you know, the bicycle brakes and gears is the key part of the business. They're also big in fishing tackle, another extraordinarily exciting market. But the bicycle brakes and gears are 80% of their market, but the business has really, you know, compounded out at a high single digit clip over decades because they've added more value to the bicycle brakes and gears. And, you know, people are, as they become more energy conscious and whatnot, are adopting healthier habits. And so bicycling is certainly one of them and recreationally, having some fishing tackle is not such a bad thing either. And this business has compounded out gradually.

Starting point is 00:54:02 And meanwhile, management of being good stewards. The second great intangible asset of the business, aside from market share, is the extent to which management act like owners in their stewardship. Because management accretion can change on a compound basis your investing experience. Do you think of a typical business trading at 10 times cash flow, the management team is going to reinvest the enterprise value of that business every decade. So management quality is a key and tangible asset. And here, the businesses family run, the Shimano family, they're a lot of shareholder and they run the business for the long term. And over the last 20 years, they bought back

Starting point is 00:54:38 about 40% of the stock. They don't have any debt. They have net cash. So rather like the ice machine company, you don't have to worry about financial contingency. So that's another good example. And you mentioned the elevator company. This is a Swiss company, not a Japanese company like the other two, but the company that my colleague was probably referring to there was Schindler. And Schindler is the second largest elevator and escalator company in the world behind Otis. They've been around since the late 1800s, so they benefit from favorable incumbency. And even though there are a handful of large makers of elevators and escalators, they tend to be more concentrated in given geography.

Starting point is 00:55:17 So Schindler is particularly strong in Europe. And the beautiful thing about this business is that, you know, the stock, you know, this is a newer investment for us because everyone's worried about what's going on in China and the construction cycle globally. But the money is really not made on new elevator installations. It's made on the maintenance of existing elevators. Typically, an elevator needs to be maintained for 20, 30, 40 years after it's installed. And the majority of their EBIT comes from these long-term maintenance arrangements that are very sticky. And this is a lot of a company that like the other two truly thinks about the long term. Not only did they have these long-term annuity-like maintenance agreements for their business, but over the last decade, they've doubled their R&D relative to EBIT to focus on embedding technology better in the elevator. So if you use the internet of things and sensors, you can maintain the install base of elevators much more reliably and cheaply than just doing it all manually. And so being ahead of the curve there. And like the other companies I mentioned, they have not

Starting point is 00:56:20 debt, they have net cash and management's been willing to buy back stock in the past. You have the Schindler family behind this, they own close to 40% of the company, the Schindler's and the Bonnarts together. And so you have this long-term stewardship of a sort of a stable cash flow-generative business that's out of favor right now because everyone's focused on the construction cycle in China. And so whether it's an ice machine maker or a bicycle brakes and gears company or an elevator company with long maintenance agreements, these kinds of businesses, essentially like eclectic royalties on small slices of world nominal GDP.

Starting point is 00:56:55 And it comes back to the point before that I made about diversification. These families have done well concentrating. But to the extent that we invest other people's money and we want to provide for resilience long term, if we can have a portfolio of these kinds of businesses scattered around different industries and parts of the world, it surely provides for a more resilient experience than just betting on one. I don't see the elevator being disrupted anytime soon, but who knows? You talked to me when I was interviewing you for my book, you talked to me about this beautiful image of seeing the global markets as a piece of marble and then chipping away pieces that you

Starting point is 00:57:36 don't want, really whatever promotes fragility. And it seems to me a really important idea. And I'd love to get a sense from you of what kind of countries you chip away and say, that's too risky, what kind of sectors you chip away. And then we can talk about specific types of business where you're just like, no, it would bring too much fragility to the portfolio. Well, it really starts bottom up for us, I would say. First of all, we do have a strong preference for businesses that have already demonstrated some form of incumbency.

Starting point is 00:58:12 As Bruce Greenwald, who's one of our senior advisors, said, something is likely to be around as long as it's been around. It's like the envelope principle in physics. And so, you know, just the simple starting point that, you know, we're looking for businesses that are time tested. And, you know, this is an important starting point. The second thing is that price does matter. I mean, it's not enough to find something good. You have to find something that's good that's better than people think it is. And so, you know, the situations that get us most excited are when we find a kind of blue chip business that's had a lost decade. You know, so it's, you know, if someone comes to me with an idea and says,

Starting point is 00:58:49 oh, it's a great business, but it's also trading at a decade high valuation, it's less likely to be appealing. And so, you know, when you think about incumbency, it's like prime numbers. You know, if you look at a sequence of numbers, only so many of them primes. And there's actually a rule in math that can show you the frequency of prime numbers. But if you had, you know, a sequence of three or five thousand numbers, probably only a low double, digit percentage of those numbers will be primes. And I think it's the same for business. So immediately by trying to focus on the equivalent of prime numbers or businesses with the,

Starting point is 00:59:21 you know, advantaged incumbency, you're taking out 80% of the market. And then if you're saying, I want to focus on the subset of those that have, haven't gone through the best decade, you know, there's an engine and an issue. Then you're taking out at least another half of the market. And then, you know, when we speak to the analysts, there are other sort of of splitting questions, I sort of call them. And what do I mean by a splitting question? If I gave you a dictionary, William, and I said, you know, find a word, you wouldn't go through the dictionary sequentially word by word. If I told you serendipity was the word, you know, it's kind of towards, you know, the back third of the dictionary, you'd flip it open there and you'd,

Starting point is 01:00:00 you'd get closer. It might take you four or five parsings of the dictionary to get to the page, not 800 pages being turned sequentially. And, you know, what I try to go to the analyst and do and say, like, what are the handful of splitting questions that can find us the one in a hundred investment opportunity that makes most sense? So, part of its incumbency, part of its price. And then, you know, there are some other questions we would ask. Like, we would look at what we call a cash audit. You know, how was the business lived and breathed over the last decade? You know, has its balance sheet really grown out of measured clip? You know, can we understand how the business got to where it's at? There's a lot of businesses that you can't. And that, that takes

Starting point is 01:00:41 out part of the universe. And then of those remaining businesses, some of them are run by very expeditionary management teams who don't have much of an equity stake in the business and are much more like bankers or bureaucrats than they are like owner managers. And so by asking a handful of questions, bottom up, we basically say no to 90 plus percent of the universe. And I think that's a really important way in which we approach markets is asking the right. splitting questions. And then occasionally, you know, there are some macro observations where, you know, you cast a wary eye as to what can go wrong. And, you know, I think it's a combination of bottom-up splitting questions and the odd top-down insight that helps steer you away from trouble.

Starting point is 01:01:29 I love this quote. You've mentioned Karl Popper, the philosopher, a couple of times. And there was an article I was reading again of yours last night that you'd written, I think, for the CFA society many years ago, where you quoted a wonderful line from Popper where he said, the main difference between Einstein and an amoeba is that Einstein consciously seeks for error elimination. And it seems like that's really central to your approach, constantly seeking for error elimination. What you were just saying, it's like you're looking for what's wrong with these businesses as well, right? Whether their business model can be substituted easily, whether management is diluting you or has the wrong capital structure or whether you're overpaying. Can you talk about, you know,

Starting point is 01:02:09 about this idea of consciously looking for what's wrong, which is a very Charlie Munger-esque kind of approach to life? Yeah, I mean, we don't have any perfect investments. Like, if you were to look throughout portfolio, and I always get stressed out when someone asks me the question, give me your best idea, because I just don't have one. I wish I was smart enough or had enough conviction to do so, but we're very focused on what can go wrong. And, you know, sometimes it helps to look at things indirectly.

Starting point is 01:02:39 I don't know if you ever saw. There was a documentary. It got mixed reviews, but I thought it was an interesting one called Tim's Veneer, Vermeer. It was about an inventor Tim Jenison, I think his name was, who was trying to recreate a Vermeer painting. And he had an interesting theory, which was that, you know, because everyone's been mystified for centuries, how Vermeer could so perfectly capture the shading of light. And Tim Jenison had this idea that maybe Vermeer used a camera obscure. And so when he was painting, he had a superimposed image and he could compare the likeness of the edge of what he was painting to the actual colour palette of the image and do it very closely. So rather than trying to paint the image directly, he looked at it with reference to another image. And the

Starting point is 01:03:28 reason I go down this discretion is that, you know, we've long been owners of gold. And, you know, gold is somewhat paradoxical because people say, well, why do you own this useless? lump of metal. And the paradox of gold is its utility is in its uselessness. If you were to look at a periodic table, it is the equivalent of the best block of land because it has this unique combination of inertness and density on the periodic table. And the inertness, which makes it useless in some ways is also what makes it a natural perpetuity. It doesn't chemically react. it's what gives it permanence. And it's also what gives it its low beta characteristic because it's not primarily used in the

Starting point is 01:04:12 industrial cycle like copper or oil or iron ore. And so it has an innately low correlation to the business cycle and a long duration. And that's what's made it, you know, nature's hedge asset, if you will. And the reason I mention gold is that people say, well, you know, gold is useless because it doesn't have a yield. well, I just pointed out that it is useful as a hedge. And even though it doesn't have a yield, because it's in scarce supply, coming back to incumbency and scarcity is a theme today.

Starting point is 01:04:43 There's less than one ounce of it per capita in the world that as the supply of money has gone up over the last 50 years after the breakdown of the Bretton Woods Agreement, gold hasn't offered a yield, but it has accreted in line with world money supply. And so it has offered a return. And it hasn't suffered from beta risk. It hasn't suffered from, you know, management dilution risk. And, you know, it hasn't suffered from entropy. You know, it's still in the periodic table occupies its position of incumbency.

Starting point is 01:05:17 And the reason I go through this whole digression on gold and Tim's Vermeer is that it's useful to think about how a business stacks up relative to a lump of gold. And it's interesting to me that, you know, most businesses have some fade risk. You know, they have a generational half-life. Secondly, most businesses have beta risk. You know, there's a risk that, you know, you'll buy them, and then you'll find yourself at the bottom of an economic cycle, and you might be a fourth seller at the worst time.

Starting point is 01:05:47 And most businesses have some form of agency risk, you know, managements on average make decisions that are diluted. I think there's only a small number of managers that are truly, accretive in nature. And so there's a reason businesses need 5% free cash flow yields. It's to compensate you for fade risk, beta risk, and management dilution risk. And otherwise, you know, if you had none of those risks, you could just own a business and it would pace with nominal GDP. But the fact that it has shortfall risk is why you need a free cash flow yield. And so I think looking at something relative to the image of something else can be useful. And there was a final

Starting point is 01:06:26 paper I'll mention on this, William, is that there's a professor by the name of Bessonbinder who did a study of all stocks in the CRISP database since 1926 and found that the average stock had actually underperformed T-bills and that most of the risk premium in the stock market had come from a small number of stocks, thus the importance of some element of diversification. But the irony is that gold has outperformed T-bills. And so most stocks, crazy as it would seem, on average, underperform gold. And that's a kind of counterintuitive thing to get your mind around. But if you see that as a kind of paradoxical truth, it forces you to ask basic questions

Starting point is 01:07:08 about whether you're getting satisfactory factory compensation for the fade risk, the beta risk, and the agency risk of an individual company. You've had a pretty significant positioning gold for over a decade as a potential hedge against financial catastrophe and massive market meltdowns and the like. And a lot of people obviously have been touting Bitcoin, although a little bit less loudly lately, as a potential hedge against financial chaos and the vulnerability of manmade currencies. Can you talk about why you believe gold is a much better thing to own as part of a resilient or weather portfolio than Bitcoin?

Starting point is 01:07:52 Well, if we go back to the discussion on incumbency and old masters and vineyards that have been around for a thousand years, you know, gold has survived the test of time. It does exist. It has a unique incumbency on the periodic table in terms of real assets. It's got unique chemical attributes. And it will exist. So inherently, there's a duration to gold that is longer than most things. that we would look at.

Starting point is 01:08:22 The second thing I would say is that gold is not legal tender today, but it's a perpetual call option on being money. And as such, you'd expect it to be at its most valuable when the quality of human-made money is at its weakest. And what we've seen since the Bretton Woods Agreement broke down in the early 70s is that while T-bills have compounded out at 5%, money supply in the US has grown at 6%. And gold has compounded out at around 8%.

Starting point is 01:08:49 So what's happened is that even though it doesn't offer a yield, because it's in scarce supply, it's met the rising tide of money supply. And it's in fact accreted a little bit because the quality of human made money, the alternative, has gone down. We have larger mid-cycle fiscal deficits and lower mid-cycle real interest rates. And so gold, from a very long-term standpoint, has served a powerful hedge role in our portfolios. And the question is, you know, has gold met its match in Bitcoin is gold like everything else subject to a different form of substitution?

Starting point is 01:09:26 It may be dominant in the context of the periodic table, but is there this new invention that renders useless? Well, the simple answer is we don't know. What I will say is that Bitcoin is 13 years old, like gold that exists. And I think it should be taken seriously because it is the largest. compute network in the world. It dominates even the scale of the Google server network by order of magnitude. And so Bitcoin is an interesting, you know, as a man-made creation, but it's kind of had some sort of emergent reality to it, if you will. And there's a vibrant

Starting point is 01:10:06 ecosystem that's formed around it. And its incumbency is valuable. The fact that it was first and the fact that it has attracted the most market cap and the greatest compute power, from a second order standpoint, makes it more secure than any competing cryptocurrency. So being first matters. And Peter Thiel has this great expression. He said, every moment in business happens only once. And so the fact that it was first and is at scale means that it is the most secure distributed blockchain.

Starting point is 01:10:39 And really what you're buying is title to that digital asset as a. service, right? And so I think, you know, one has to take it seriously. Having said that, even if it's on a path to being as important as gold long term, right now, I think it's rational that it trades at a discount to gold. You know, it's young. It's only 13 years old. It hasn't been around for thousands of years. So I'd say the fact that it exists doesn't mean it will definitely exist, but it's the leading contender to potentially exist in the crypto space. And so, you know, Bitcoin, if gold is a perpetual option on being money, Bitcoin is an option on an option, right? It's an option on being digital gold, right? But right now,

Starting point is 01:11:31 because of the early stage of its adoption, it doesn't trade like gold. You know, gold has a very tight inverse correlation with real interest rates. You know, when stocks have had lost decades, gold has tended to have its best decade. So it has a demonstrated track record as a potential hedge asset. Bitcoin, because it's younger and it's been in an adoptive phase, has traded much more like a growth equity. Now, if it succeeds in its destination, its trading character should become far more mundane over time and much more like gold. But right now it trades like a growth equity. So the fact that it faces unknown risks, you know, agency risks, as we discussed before, like the minor community has to continue to exist, or it cannot be

Starting point is 01:12:15 dominated by a pool of over 51% of minors for Bitcoin to exist. The fact that it has to survive unknown challenges, there may be a state that plants malware in the A6 chip for Bitcoin. We just don't know, it has to survive what is going to be the test of quantum computing, which is going to change the efficacy of the underlying hash protocols for Bitcoin. So there are a range of different challenges that Bitcoin has to endure, and we're just going to have to let time play out. But until it does, it should trade at a discount to the aggregate market cap of gold. Having said that, two things can coexist at once. Ovens and microwaves coexist, you know, when most wealth before the Industrial Revolution was stored in real assets, land,

Starting point is 01:13:03 art, precious metals, livestock. And then we created all these financial assets, which were essentially the crypto of the time, they were virtual claims. The original companies were beneficial claims of trusts on underlying assets. And so this was kind of arcane and abstract at the time. But financial assets came to coexist alongside real assets. they didn't disrupt totally, they coexisted. And if digital assets are another concentric circle around financial assets and real assets,

Starting point is 01:13:34 it doesn't mean that real assets will disappear. And it doesn't mean that all financial assets will disappear. I think what we're going to see is the emergent coexistence. And I think what Bitcoin might have done is increase the demand for private money. I think people have questioned the quality of the monetary architecture after COVID, with inflation, with low real interest rates, with big fiscal deficits. And if Bitcoin were to face any of these existential challenges, money that's invested there could look for other forms of private money, such as gold.

Starting point is 01:14:06 And so if I were just a Bitcoin holder, I'd want to own some gold as a potential hedge, Bitcoin's existence. But I could also understand if you held a lot of gold, why you might want to own a small amount of Bitcoin as insurance against it actually working and taking away some of the monetary market cap of gold. Final thing I'll say is that gold will always have some value. It's a base layer of value for jewelry and as a perpetual item of adornment, which Bitcoin won't have if it doesn't have value as a monetary medium.

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Starting point is 01:17:59 My sense is that you feel like the U.S. dollar maybe at some kind of major turning point where it's at risk of losing its status as the world's reserve currency. And I wonder if you could talk about that a bit because obviously, as you just mentioned, there are all of these kind of fault lines in the economy. And it's very hard for us to judge what's temporary and what's permanent. And lots of people have been seeking safety in the dollar as this kind of safe haven. And so weirdly, despite all of the reckless fiscal behavior and monetary behavior, the dollar seems to be an amazingly strong.

Starting point is 01:18:36 Can you unpack this a little for us and explain why you're worried about? about the US dollar long term? Let me start out by saying that, you know, having grown up in Papua New Guinea and Australia, I'm enormously grateful to be able to live and work in America. I mean, it's is the ultimate sort of pluralistic melting pot of different ideas and markets and property rights. And I think there's no question of my mind that the US is going to be an important economy for decades to come.

Starting point is 01:19:04 And, you know, I want to be part of us and I want my children and their children to be part of this narrative. Having said that, there are windows of time where there's a difference between a good economy and a good currency. And one of the challenges we face is that all of the characteristics have made up for the inherent resilience of the United States may be pretty fully priced right now. When we look at the world of equity markets, US equities are nearly 70% of the world equity index. But we're 5% of the world's point. population. So at some point, the relative merits of, you know, US equities ought to be recognized, but are they being over-recognized? It's a fundamental question. You know, the market

Starting point is 01:19:51 trades at a premium to the rest of the world. Margin structures have been higher than the rest of the world here, arguably benefiting from the easiest policy. And so when you come back to investing, it's like going to the races, you know, you're not betting on the best horse necessarily. It's It's the horse that's better than the other people think it is. And if you look at the world of equities, people think the U.S. is the best, and they're really reflecting that in valuations. But it's not just equities. It's the currency.

Starting point is 01:20:20 The U.S. dollar makes up nearly 60% of world's currency reserves. And, you know, that's just not a sustainable equilibrium long term. And the dollar has been the sort of risk off currency of choice, particularly in, in in this last crisis because our energy independence is manifest relative to say Europe or parts of Asia. But what that means is in real terms, the dollar is pretty much at a generational high versus key currency crosses, whether it's euro or sterling or the yen or the Chinese currency. So the US dollar doesn't offer much value. It's already fully stocked in the reserve mix of, you know, international monetary authorities. And there was a risk.

Starting point is 01:21:07 that unfolded in the wake of the Russian invasion of the Ukraine, and that is that we sanctioned the ability of the Russians to access their dollar reserves. So if I'm China today, am I as incentivized to accumulate dollar reserves as I was before, if they were sanctioning? Perhaps the Chinese might be more inclined to buy a real asset like gold. Secondly, the US, for all of its advantages, runs a trade deficit in excess of 4% to GDP, which is expanding. all of the major currency crosses the Eurozone, Japan, China and current account surplus.

Starting point is 01:21:41 Over time, currencies with large trade deficits tend to be on a depreciating trajectory, not an appreciating trajectory. And so you might ask, well, if the currency is expensive in real terms and has a trade deficit, why has it been strong? And I think what explains that in the short term, other than risk perception going up, is that the US has offered some interest rate carry to some of these other regions of the world. But what's important to note is that we have far higher wage growth in the United States than we do in most of those other areas. And so in real terms, the interest rate carry is not that attractive.

Starting point is 01:22:16 And so, you know, I have a fundamental question in my mind over the next five to 10 years about the equilibrium value of the dollar. I think if you're not offering real rate carry, if your mid-cycle fiscal deficits are larger than most of your trading partners, if your current account deficit is large and growing while theirs is in surplus and the currency is expensive and you're already 60% of the reserve mix, one should be open-minded just from a position of prudence that the relative rating of the dollar may adjust downwards over time. And I think this is irrespective of concerns that people might have about the evolving political equilibrium in the United States. But I think it's just an obvious statement in some ways that the dollar has been preeminent, but it may be more than adequately reflected in

Starting point is 01:23:04 relative prices. You have such a global perspective on the world, given your role in managing this global value team. And so you invest in the US, but also in many other places. When you go around the world, I know you went recently to Tokyo and to Seoul, when you look in other markets, what are the valuations like, what are the opportunities like, what are the risks Like, and if you're a sensible, long-term, prudent investor who wants to position yourself well for the next 10 years, not chasing these kind of hot pockets of thematic growth, but just positioning yourself to get the, you know, good valuations, good risk reward. Where do you want to be? Where do you want to be making sure that you're investing, at least part of your portfolio? Well, I think it's prudent to consider diversification from a couple of different angles. I mean, we just, talked about currencies. You know, if the dollars at a generational high, knowing nothing else, it makes some sense to use this window of uncertainty in foreign markets to plant some seeds

Starting point is 01:24:09 internationally. Just because one doesn't know for sure what's going to be the dominant currency in 20 or 30 years' time, odds are it could be the United States, but it may not be for one reason or another that we can't even imagine right now. And a time where the currency is expensive is a decent time to be looking overseas. Secondly, I mentioned that U.S. in general terms, we're trading at a premium. The S&P trades at just under 20 times the trailing 12 months of earnings, whereas the stocks and the EFA are more in the 12 to 13 range. Now, that's a pretty big valuation differential. If you invert those and think about them as yields, an 8% yield versus a 5% yield is a big spread. The US has to really do a lot better

Starting point is 01:24:50 than the rest of the world to make up for that valuation differential. And so not only is the currency multiple expensive, but you're getting a much lower, earnings yield in the United States than you are getting internationally. And, you know, I would just make the third point that as greater market as the United States is, and I think it's a wonderful market and one that I'm personally grateful to be a part of, it doesn't have a monopoly on good businesses. Now, if you think about the businesses that we were kicking around before, William, they're all outside the United States. There are certain industries where the leaders, the incumbents outside the United States. And that's okay. You know, there's some great artists

Starting point is 01:25:32 in the United States, but some of the greatest art came from Italy. There's some great wine on the west coast of the United States, but Burgundy has some pretty nice wine too. And so, like anything, where you're looking for incumbency and uniqueness and the metaphysics of quality, as it were, there are going to be manifestations of quality that exist in different parts of the world. To give you an analogy, if you're Exxon, drilling in the United States may be attractive, but there's going to be pockets of oil elsewhere around the world. And there may be windows of time in the United States where, from a regulatory standpoint, it's not that attractive to drill. And so the simple fact that the U.S. doesn't have a monopoly on good businesses, coupled with

Starting point is 01:26:15 the reality that foreign currencies are pretty depressed and foreign markets have low evaluations, means that I think one should be open-minded to having some amount of their assets invested internationally, just out of sheer prudence. And I think that gives us the peace of mind to be looking around the world of different opportunities. And it comes with a healthy... Is part of the challenge, Matt, that we always have this kind of recency bias where we assume that the next period is going to resemble the most recent period.

Starting point is 01:26:47 And so everyone has become so convinced that the U.S. is the place to be, that in a way you have to have the faith you were mentioning before, that the arithmetic will work out in the end. You have to have the patience to actually stay long enough in these foreign markets that eventually you'll be right because the arithmetic will work. But in the short term, it's really painful behaviorally actually to say, no, I need to underweight the US and overweight these markets that haven't really been working well that have been disappointing for so many years. And one doesn't even have to go so far as saying overweight, the rest of the world and underweight the United States. I think it's just an open-mindedness

Starting point is 01:27:24 to maybe owning some businesses internationally. Think about if you're a property investor, most of us spend our time thinking about the dream house we'd like to own in the city in which we live that's within our budget criteria. But imagine that you were geographically flexible and you could figure out your dream property in the 100 best cities of the world within your budget constraint. Invariably, something would be happening somewhere in the world that would let you find that dream property at the right price. Whereas if you just focused on your one city, you might wake up in 15 years time and say, gosh, I never got the property I wanted at the price I wanted. And then the values have drifted up over time. And so I think just opening yourself up to the

Starting point is 01:28:06 possibility of investing with a broader universe almost increases the probability that you will deploy capital for the long term rather than sort of waiting for the pipe dream, you know, in one local area. And your question as well on sentiment, it's a good one. And I have no easy answer for that. It almost goes back to our discussion about value being out of favor in the late 1990s. And, you know, it's very difficult to predict exactly when that turning point would come. But by the time it comes, you know, it's often difficult to change course, right? right. And so I think trying to predict turning points is something that a lot of people do. But if we go back to the gardening analogy, it would be almost the same as trying to predict the

Starting point is 01:28:56 weather every day. And I think predicting the weather is much more difficult than understanding the climate. And so, you know, I think that if you're creating the garden, you want things that can work across a range of different weather expressions given your climate. rather than just be geared to one particular type of weather. And so sentiment to me is kind of like weather. And when it changes, it can change pretty abruptly. And I think when you focus on the arithmetic and you focus on doing what's right for the long term,

Starting point is 01:29:32 it's basically saying, you know, we're trying to adjust to the climate that we live in and get that right. Yeah, one thing that you said when I was interviewing, doing you for my book, which really had an impact on me was when you talked about just you want to be more willing to commit capital to investments when risk is obviously being well priced, such as in late 2008, 2009. And it strikes me as a very similar to Howard Mark's attitude of just accommodating yourself to reality as it is. And so at a time when when foreign markets

Starting point is 01:30:06 appear to be offering, you know, risk appears to be being priced better, it's just sort of logical to make sure that you're fully diversified there? It's an interesting one because if we go back to the weather and the climate analogies a little bit, we actually deployed some capital in the United States a couple of months ago because the weather was bad. And what do I mean by that? Well, trading breadth was very narrow in the markets. Risk perception was very high, you know, implied volatility and options are gone up, credit spreads have gone up a lot. And there are a certain number of individual companies where the arithmetic made sense. But the climate still didn't remain

Starting point is 01:30:41 not attractive. So we didn't get fully deployed. And by the climate, I'm thinking of more structural measures of valuation. You know, where are P.E ratios relative to inflation? Where's the price of the equity market relative to an objective marker such as the price of gold? And after this recent rally in stocks, you know, valuations still look reasonably full. And so while sentiment was bad, from a secular standpoint, the risk reward doesn't look that great. Internationally, on the other hand, you had both bad weather and arguably a little bit more favorable climatic readings. You know, the valuation of markets was already resonant with what you'd expect in a recession, not a soft landing. And currencies are at generational lows. And valuation of the MSCIA

Starting point is 01:31:27 I hadn't gone anywhere for a decade. You know, stocks have gone through a lost decade and derated relative to gold. And so, you know, you're not just getting a bad weather day, but from a more secular standpoint, the risk reward is starting to stack up a little bit better. And it's not to say if we have a global crisis, you know, there's real problems in China. Europe's got to make it through this winter with potential gas shortage. And the US has to absorb a recession, in my opinion. All of those things playing out may lead all risk assets to law valuations at some point. You know, our crystal ball is foggy at best. It's hard to predict these things. But, you know, just because we see relative value internationally, it doesn't mean it will manifest it

Starting point is 01:32:09 itself in positive absolute returns in the short term. But what we can say is if we own a business, like the ones we talked about, with a reasonable mid-single-digit free cash flow yield that's got a track record of growing it a mid-single-digit clip and this returning capital to shareholders and that doesn't have balance sheet contingency, health long enough will get, you know, decent arithmetic relative to owning a bond with a low single-digit return. One thing that's really notable to me about your portfolios is that you seem to have very low exposure to China. And I was talking to Howard Marks on the podcast a few months ago, and he was saying a lot of people will say, well, I've got China covered with a 2% allocation. And he said, but look, if China is important and it's going to be the world's biggest economy, a 2% allocation just isn't going to move the needle.

Starting point is 01:32:56 He's like, it's not enough just to say you participate it. And I'm wondering how you think about China and how you balance caution and courage and weigh the tremendous opportunities, but also kind of the really unpleasant risks that we've become more conscious of, I think, in the last year or so. Well, it's not clear to me that China will become, and even if it does sustain its position as the world's largest economy. And I think a lot of people are presuming that will happen, but it's not clear to me, that that happens. You know, I think one of the things that's interesting is if you look at a list of emerging markets and 50 years ago and look at a list today, very few emerging markets actually emerge. And there's a whole host of reasons for this. And in fact, there's an interesting book on this called Why Nations Fail by Robinson and I think Asimoglu, MIT economist. And one of

Starting point is 01:33:54 the tales of a country that's managed to sort of grow up. and benefit from capitalism and the spread of property rights and all those sorts of things, there's an inherent pluralism and a political process that gives voice to multiple constituencies. And historically, at least, if you haven't had that, it's been difficult to sustain growth to develop market levels. And ultimately, if you have some form of authoritarian regime, it's impeding to the very notion of creative destruction. Because if there's a rent-seeing, seeking regime, it has to retard at some point in time, creative destruction to preserve its own existence. And so I think if you would ask, if Hayek still lived and you would ask him, will

Starting point is 01:34:39 try to become and sustain its position as the world's largest economy, I think he'd be very wary of making that prediction. And so I think that China is beset with quite a few problems right now, despite the fact that there are opportunities. You know, there's a self-inflicted wound with the COVID policy response in the lockdowns. There is dramatic adjustment going on in the real estate sector and that market is very overbuilt. And, you know, they had a clamp down on the entrepreneurial class, which has really led to sort of a de-rating of that sector. Now, it doesn't mean that we won't find select opportunities. You know, we do have some investments in Hong Kong property holding companies that traded less than 50% of the underlying private market value of

Starting point is 01:35:28 their real estate. And where Hong Kong may not be as vibrant as it was before, it came under the influence of the Chinese Communist Party, but it's likely to still have some relevance to say Shanghai and Beijing as a capital export center for China. Likewise, we've made some small investments in some of the internet platform companies in China that have very entrenched market position and where we were able to deploy capital at a single digit multiple of EBIT and where we have a lot of latency in potential margins and valuation.

Starting point is 01:36:10 But these are very small and select investments. I will make the point, though, that China is so big that you can't avoid it. You know, they're the largest producer of many goods and one of the largest consumers. consumer of many commodities. And so if China goes through a tough adjustment here, I think the world will feel it, just as if the United States goes through a recession or Europe as a whole goes through a recession. And so, you know, I would say that we've been cautious on China. And bottom up, we've, you know, many of the companies we've looked at just haven't had the free cash flow conversion or the management discipline that we've looked at. But we're open-minded. But it's,

Starting point is 01:36:47 you're right to say that it's been a very small part of our portfolio. And you seem pretty concerned as a fan of Thucydides and his views on history. You seem pretty concerned about some kind of mounting inevitability to a conflict between the U.S. and China sort of echoing the Spartan Athenian kind of conflict that we saw thousands of years ago. Well, I think if you read Thucydides, I think what's compelling about it is that it was written before 400 BC, and a lot's changed since then. Obviously, technology is dramatically different today from what it was back then.

Starting point is 01:37:27 On the other hand, human behavior and human wiring hasn't changed that much. And I get the analysts and our team to read the book because it shows you the common mistakes that people make, hubris, dogma, acting with haste. And I use that as a template to get people to think about doing the opposite with their temperament, having humility to accept uncertainty, being a patient investor, being flexible, not dogmatic about just investing in one particular part of the world or one particular industry. And so, you know, I think there's a lot we can learn from Thucydides. And I think what he sort of showed us is that the fear of war is often the cause of war.

Starting point is 01:38:06 And, you know, especially when you have two competing regimes. And I certainly hope we don't see that emerge. but Nancy Pelosi's visit to Taiwan and the response, you know, is clearly flashing some warning signs here that I think, you know, we can't ignore it in totality. One of the things that's striking to me that's very distinctive about you, Matt, is you're reading these books like Hucydides, you're reading Stephen Wilfrum on physics and complexity and the like. You're drawing ideas from all of these places and kind of thinking through these ideas about gold and resilience and entropy and the like. And I'm curious about how you actually gather and synthesize this data. You've talked to me about how you have, I think, in your phone and your iPad, like thousands

Starting point is 01:39:02 of pages of ideas and mental models that you've written over the years and you're constantly refining. And you mentioned the phrase once to me of it's like raking your Zen Garden. Can you talk about how you do this, this habit? Because it's such a, it's such a distinctive part of the way you operate in life. So I think the first thing is you have to create time to reflect. And, you know, that's easier said than done. We all have busy schedules. You know, we could all spend all of our time doing a subset of our jobs. And so first of you just have to, in the mental hierarchy of things, acknowledge that some time spent on reflection is important. And in fact, as I think about it, you know, what if I were a client, what would I want Matt or any of the

Starting point is 01:39:50 team members to be spending their time on? And I, you know, I'd want them to be spending some meaningful amount of their time on reflection so that they're seeing the world through a different prism. The second thing is that it doesn't happen linearly, even though I try to religiously schedule some time for reflection on certain days of the week or certain times of the day, reality intervenes frequently. And so you have to squeeze it in while you can. But it's, and it's not even linear in that context. So I might go through some years where I'm reading voraciously. I read, you know, many books in a year. And then I go through other years where I get into four or five books, but I don't complete any, and I'm actually spending most of my time to your point before

Starting point is 01:40:30 raking the Zengarde and trying to order my thoughts. And, you know, I do keep many notes that essential attempts to sort of distill what I've learned from different works and tying it together in a philosophy that makes sense. And, you know, sometimes I'll wake up at 5 o'clock in the morning and I'll just spend two hours trying to refine one element of a mental model. And so, you know, part of it is creating time to absorb new ideas, many of which have come from great people that you never got the chance to meet, but you can at least read their books.

Starting point is 01:41:10 And the other part that's equally important is to synthesize, you know, and it's the same notion, if you're going to visit a company that you're going to Tokyo and visiting a bunch of companies, you have to spend the time preparing for it and the time to make sense. sense of what you've learned after the fact. And so it's not enough just to read a lot. You have to try and think about it and distill it. And, you know, it's both of those things. And then sometimes you just get stuck.

Starting point is 01:41:35 You feel like you're, you're not necessarily making a leap forward in your understanding. I don't know if you've gone through the process of learning another language, often it feels like you get this window of stasis. And then all of a sudden, in a nonlinear way, you take a stair step function. up and you're seeing things in a new light. And so I think often when you're feeling stuck, it makes sense to do something different, you know, to travel somewhere, you know, to do something physical. You know, I like to pay backgammon against the computer from time to time.

Starting point is 01:42:07 And sometimes it, you know, it takes doing something different. A friend of mine, Josh Wastkin, said sometimes the embodies to withdraw before the flame comes back up. And so I think it's a combination of all those things. prioritization of reflection, realizing that it's not just about reading, but equal measure must be spent to synthesis and making sense. And then the final thing, recognizing that it's a kind of a step function process where you need time to step outside.

Starting point is 01:42:40 And Lord Denning, one of the great English judges said, you know, let not our vision be clouded by the dust of the arena. Sometimes you're just too much in the thick of something to make sense of that. it all and sometimes you've got to leave the snow globe, let it settle, and then come back. And so, you know, those are the ways I try to do it. And it feels rather imperfect. You know, I've been at this for decades now and I feel like I'm just beginning and I feel like I'm so far behind in so many dimensions that it's humbling. Is there a particular mental model that you feel like in the last six months or so

Starting point is 01:43:14 is starting to take shape and you're starting to think to have this sort of beautiful sense of revelation where you're starting to think, oh, that's what this means. Is there, is there something that's really striking you as more important than you'd ever realized before? Yeah, so, I mean, I'd say a couple of thoughts there. One, when I made the comment before that very few emerging markets have emerged, and I've been thinking about this a little bit. And, you know, the process of trying to reflect on this and discuss it with our sovereign analysts and to read a little and discuss it with people I respect, you know, it has me sort of thinking about the absence of inevitability. I mean, we all went through that, there was that passionate chasing of the bricks

Starting point is 01:43:58 theme. And I, you know, we were always pretty skeptical at first Eagle because what we were seeing top down and the narrative wasn't matching the bottom up opportunity set. But I started to think more about it. And some things aren't inevitable, you know, the existence of, you know, certain preconditions need to be met. I guess other things have appealed to me. We talked about entropy, you know, and fade. That's been a big source of intellectual inquiry from over the last decade. But the first law of thermodynamics is about the conservation of energy and matter. And that's a little different because that implies something very different. It implies sort of deep symmetries. And like one of the thoughts that's been occurring to me lately is this sort of this notion of symmetries that exist in financial markets that have to kind of coexist for the whole to make sense.

Starting point is 01:44:56 And so I've been spending some time thinking about deep symmetries, for example, a negative relationship between real interest rates and risk premium or, you know, between nominal expenditure growth and financial asset valuation. you know, thinking about symmetries that have to obtain for the whole thing to make sense, you know, that's an interesting area of inquiry. Now, these are all kind of big picture observations for want of a better word, but then sometimes it's tempered with smaller, more practical revelations. You know, we talked about the cash audit in a business. And, you know, sometimes you do something a lot and you don't step back to really reflect on why it's so powerful. And, you know, that's been something that I've been going back to with a number of our whole.

Starting point is 01:45:39 and sort of thinking about that. And so there's a whole host of little things. There's no one big game changer. And I think that's often the way it is. It's kind of messy and tangled. And, you know, you're trying to incrementally improve in a lot of different dimensions. There was something you told me recently that made me think that there's something here I don't understand where you've clearly thought about this a lot and I need to unpack this, which

Starting point is 01:46:04 was I'd send you an article about, I think it was from the New York, it was terrific article about philanthropy. And we were discussing that by email. And you said something about the purpose we all serve is to help the universe perceive itself through our efforts to be excellent at something or to master the appreciation of quality in different dimensions. And I was thinking about that there's something really interesting there about, like this idea of the pursuit of excellence and fulfilling our own potential in some way as an attempt to kind of contribute to the mosaic of human potential. But I'm so far from understanding this.

Starting point is 01:46:40 Can you talk us through that for a couple of minutes? Because it seems like kind of an important idea. Well, you know, I guess I sort of come at this from a simple perspective. If we go back to Wolfram and complexity theory, something that was just like a blinding revelation to me when I read that his book, A New Kind of Science, was that, you know, he was studying deterministic systems. So what do I mean by that?

Starting point is 01:47:05 Think of an Excel spreadsheet where a cell could be different colors based on the behavior of cells around it. But there's an underlying formula. And he did thousands and thousands of simulations of what the patterns would be for different formulas. And, you know, what he found was really interesting, which was that only a small fraction of the formulas produced linearity. And most of science is built on regression and looking for linear relationships.

Starting point is 01:47:34 but this is the minority of reality. And then there was a bigger subset, but still small, where there was some sort of nested cyclicality to the pattern, but not 100% neat. So I think like the business cycle, we know there's an ebb and flow, but we can't call it precisely. And then the vast majority of the patterns of these cellular automata

Starting point is 01:47:53 and these spreadsheets were a fact, they looked like they were random, but they were driven by a given formula. And what's interesting is if something is linear, you can predict it in the future with a small number of observations. If something has a nested cyclicality with more observations, you can kind of predict the skew in it, but not necessarily exactly where it will be. But if something's truly complex, it would take you more observations

Starting point is 01:48:19 than actually exist in reality playing out to backwards induce the formula. And he came up with this notion of the computational irreducibility, that basically, even though there's a formula behind the pattern, it's effectively random unless you know the formula, because it would take you more steps to observe it than to figure it out. And so the reason I mention this up front is that number one, there's a realization that there's a lot that we can't know unless you actually know. And secondly, I start to think about the price mechanism, you know, and sometimes the stock price is a lot smarter than the weighted average. IQ of the people trading it because if you think about it, you and I are trading a stock and we each have a mental model for how the world works. Some of my model is truth and some of its noise, you know, back to the different patterns we're talking about before. But by definition,

Starting point is 01:49:16 the noise in my mental model, on average, should be uncorrelated with the noise in your mental model and the truth should be correlated. So sometimes the price is a more powerful reflector of the truth than any one person who's trading that security, if you have enough people trading it. And I got to think about this more broadly and, you know, thinking about, like, what are we here for? And, you know, if the universe is this grand experiment that's unfolding, in a sense, it's trying to perceive itself. Like, you know, you're looking at a cellular automata stream and unfold, even though there was a starting. formula to the outside person, it's, you know, it looks random, but to someone who knows the

Starting point is 01:50:03 formula, it's very ordered. And, you know, it's my belief that if individuals commit themselves to excellence in a certain dimension, if they're trying to appreciate beauty, whether it's in art or whether it's in athletics or whether it's in the world of investing or any other field, what's happening is that we're increasing the probability that some part of our mental model is true. And by definition, that will be correlated with other people who are exploring the same truths. And we're spending less time on the stuff that's noise, that's uncorrelated. The aggregate effect of having 7 million people do that on the planet is that, you know, obviously the system gets to a higher and better and more perfect level.

Starting point is 01:50:47 But from a kind of, from a universal standpoint, if life is a form of kind of self-referencing, experiment, then that experiment reaches its highest and best actualization if the different forms of life spend their time trying to be excellent at something. And so it was that long, torturous process that I sort of came to this belief system, which is probably totally BS to most people, but nonetheless, it helped me make the decision to commit to excellence in a few dimensions. It's interesting also because so many thoughts came up for me as you were speaking about that, like, you know, the fact that in a way it harks back to your grandfather talking about your

Starting point is 01:51:32 search for absolute truth in a world of relative truth. You know, we're always sort of looking for these deep patterns. And it seems like you're always faced, your approach to investing and life, it always accepts the fact that things are incredibly complex. complex and nuanced, and we're always sort of inching towards some sort of truth, but not really sure and having to be humble. Does that make any sense, what I'm saying? It makes a lot of sense. You know, and I think there are some investors who've done a great job seeing the world as more of a machine. And I'm thinking of like Ray Dalio at Bridgewater,

Starting point is 01:52:09 for example. I'm more inclined to view it as an ecosystem than a machine. So there's a lot of non-linearity to the way in which I look at the world and a lot of self-referencing feedback loops that create complexity, that ultimately compromise your ability to predict things with certainty. But it's not a hopeless cause. If you study Warfram and you take the way the conclusion that a lot of life is unpredictable, there's something you can actually do about that. You can structure your affairs to endure.

Starting point is 01:52:43 And whether it's through diversification or having deferred purchasing power, or having a potential hedge or bottom up looking for businesses that are likely to have lower fade rates by virtue of their incumbency and likely to be more persistent by virtue of management teams that actors stewards. So it's not a hopeless message. It's just sort of recognizing that the world and the ecosystem we inhabit have fundamental unpredictability. And so, you know, you can build a structure that's resilient in the face of that. And if you happen to find something that's simple and predictable, well then go at it, get concentrated, take leverage, create a lot of wealth. But for many of us, we may not be fortunate enough to have that

Starting point is 01:53:28 blinding insight in a lifetime. And so it's more a question of structuring oneself to endure and to participate in the march of humankind. Yeah, that was something I quoted in my book that had a huge impact on me, where you said you want to be structured to participate in the march of mankind, but to survive the dips along the way. And as I pointed out in the book, that strikes me as a really useful mantra for investing, but also for life, that there's something about just recognizing the fact that we live in this kind of very mystifying, unpredictable, constantly changing kind of Darwinian world. And you want to position yourself to survive. And also when you're going through these really difficult periods, both personally or professionally,

Starting point is 01:54:14 to kind of know that you just need to survive the dip. Yeah, and be positioned to pick up one or two spectacular opportunities during the dip. Yeah. You also said something really powerful to me. I quoted in the notes on additional sources and resources in the book, where you sort of talked about the fact that once you accept the fact that the world is kind of flowing and changing in this very complex and unpredictable way, It means you need to say, well, okay, so I can accept all of this flux and complexity and uncertainty.

Starting point is 01:54:53 And let me focus on my own internal equanimity because I can't really control this external stuff, but I can control my own equanimity. Can you talk about that a bit? Because that actually seems to me a really profoundly important observation. I think it's it's it is very important because acknowledging that you can't control an external environment, you know, you need to have a centered sort of internal locus. It's almost like the stoics, right? And and you know, you can have some influence like you, you know, you can invest in a way that you could endure a lot of different states of the world. That's, that's an important starting point. But the other thing is a lot about, you know, knowing, knowing yourself. You know, you don't,

Starting point is 01:55:36 You don't want to be forced to be in a moment of anxiety at the bottom of the market, and therefore you have to sell and convert a temporary impairment of capital to a permanent impairment of capital. You don't want to have so much margin debt that you're forced to convert, you know, temporary to permanent impairment of capital. So there's certain exogenous things that you can do. But then on the internal side, you know, I think there's a kind of a basic level of excitement that once sort of sees in exploring the universe and travel and new ideas and interesting people.

Starting point is 01:56:15 And then there's also, I think, a balancing consideration that as extraordinary the experiences may be that you have in your life, you're going to get humbled. You know, you're going to make mistakes. You're going to be double-crossed by individuals sometimes. you're going to be, you know, do you going to do things that are silly? And, you know, I think just the recognition that we're all sort of groping in the dark a little bit, you know, I think it's, I don't know, it's in some ways liberating to do your best work. Yeah, I totally agree.

Starting point is 01:56:53 Well, I could talk to you about that question for another couple of hours, so I feel like I better let you go at this point. But, Matt, thank you so much for joining us today. I've learned a great deal from you over. the last few years and today as well, not only how to think about investing, but how to think about life. And I've also just really enjoyed getting to know you personally and to become personal friends. So thank you so much for everything. I really appreciate it. Likewise, William, your question is always giving me plenty of food for thought. And it's

Starting point is 01:57:22 the French have this expression, Les Frida Scalia, the spirit of the staircase. You know, usually it's when the husband and wife are having an argument in the kitchen and they turn around and they think about what they should have said as they were going up the staircase. I'm sure I will reflect deeply on your questions and perhaps have better answers next time we meet in person. But thank you for getting me thinking with these questions and for your friendship as well. It's been a real delight. And you can always come back on the podcast. I'll always be thrilled to have you.

Starting point is 01:57:48 So hopefully we'll get to do round two in next year. That'd be lovely. Thank you so much, Matt. Take care. Terrific. Thanks for you. All right, folks. Thanks a lot for listening to this conversation.

Starting point is 01:58:00 with Matthew McLennan. If you'd like to learn more from him, you may want to check out chapter four of my book, Richer Wiser Habier, which is all about Matt and his famous predecessor at First Eagle, Jean-Marie Eveyard. They share some really valuable lessons about how we can reduce our vulnerability and bolster our resilience, both in markets and life. I'll be back very soon with some terrific guests, including Annie Duke, a former poker star who wrote a best-selling book called Thinking in Betts, and also the Nobel Prize winning economist Robert Schiller. Until then, please feel free to follow me on Twitter at William Green 72, and do let me know how you're liking the podcast. It's always a pleasure to hear from you. For now, take good care of yourself and stay well.

Starting point is 01:58:42 Thank you for listening to TIP. Make sure to subscribe to We Study Billionaires by the Investors Podcast Network. Every Wednesday, we teach you about Bitcoin and every Saturday we study billionaires and the financial markets. To access our show notes, transcripts or courses, go to theinvestorspodcast.com. This show is for entertainment purposes only. Before making any decision consult a professional, this show is copyrighted by the Investors Podcast Network. Written permission must be granted before syndication or rebroadcasting.

We Study Billionaires - The Investor’s Podcast Network - RWH014: The Resilient Investor w/ Matthew McLennan

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