We Study Billionaires - The Investor’s Podcast Network - TIP402: Investing Mastermind Q4 2021

Starting point is 00:00:00 You're listening to TIP. Dear listener, it's time. Today I present to you the quarterly investing mastermind meeting. I love these discussions with the best in the business, Tobias Carlisle, West Gray, and Jack Taylor. Today we'll be discussing ESG investing, investing in international markets, and how we ask investors to think about benchmarking our performance, and much, much more. I hope you enjoy the discussion as much as I did. Here is the 20-21-Q-4 mastermind meeting.

Starting point is 00:00:33 You are listening to The Investors Podcast, where we study the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected. Welcome to The Investors Podcast. I'm your host, Dick Bruterson, and today we lined up the A team for you, ladies and Jans. I'm here with Toby Carlisle, Jack Taylor, and Wes Gray. Welcome back on the show. Hey, Stig, what's up? It's been here, as always. Great, guys. It's always good to have you here on the show.

Starting point is 00:01:13 And I wanted to start out with a very, I want to start out with a very, I want to say, timely question. ESG seems to be all the rage in the investment world right now. And if someone's sitting out there and like, yeah, I know I live on the rock, what is ESG? Is there any rage at all? So that stands for environmental, social, and governance. And so over the years, we've gotten multiple requests about, you know, defining what is ethical to invest in or not. And it's such a tricky question because it quickly turns into

Starting point is 00:01:42 political, heated debate, which is not where I want to go with the question at all. I guess there's already enough polarization going on. So perhaps we shouldn't go that route. But, you know, Warren Buffett, a billion that we started a lot. He's been asked multiple times about this if you go back and what the annual shareholders meetings. And he talks about how this is a individual choice. And he mentioned the example of him and Charlie. They had the opportunity to invest in tobacco company, which were a really good business deal, but they decided to walk away from it because the deemly wasn't the right thing to do. But then, in the other hand, Buffett also acknowledged that, you know, he doesn't mind investing in Walmart and you can go to

Starting point is 00:02:22 Walmart and buy cigarettes. So with all of that being said, I want to throw back over to the group, and I don't know if we can start with you, Jake. How do you think about ESG, if at all, whenever have you en masse? It's not a large component, I guess, of my process, but what I would like to say is that what makes a good company? You want a long, sustainable business that will last a really long time. And as an investor, that's also what I'm looking for. I want a really long duration business that I can know and understand and own and earn similar to the results of the business. Well, the really good businesses, the good operators, the good management,

Starting point is 00:02:59 they've been thinking about all the stakeholders for a long time. So there's nothing really new about ESG. Japan has this thing they call the Five Joys in business. And those were the suppliers, the employees, the regulators, the communities that the businesses operate in, and then the shareholders. And so everyone is part of this ecosystem. And the good management, we're already managing to create win-win outcomes for everyone in the ecosystem.

Starting point is 00:03:28 And so there's really nothing that new to me about ESG. It's just kind of a fancy name. And honestly, I think a little bit of a marketing ploy in that there's this saying that like if ducks are quacking, then Wall Street will feed the ducks. Right. And so if everyone's asking for ESG, then like, okay, here you go. We're going to put this, we're going to call this ESG and you're going to get it. So I don't find it.

Starting point is 00:03:53 I kind of feel like it's a much ado about nothing. And then we chat another 30 basis points if you call the ESG. Because that is how we're seeing that ESG is being promoted, which is not the same as saying that I don't believe it's important to invest in other companies. It is really important to me. You just also need to see the other side of how can this be used against you. Wes? I have a two-sided brain, but I'll explain that.

Starting point is 00:04:18 So on personal investments, on things that we create to generate returns and what we invest your own money in, you never should tie emotions to investing, in my opinion. So for our own stuff, we don't involve it. We buy cheap, high quality, or we buy winners, period. It's evergreen. Now, on the business side, because remember, we launch ETFs on behalf of other people, I'll tell you with certainty, this is a huge deal, massive market, going to have probably huge effects on asset pricing. And there's, investing, unfortunately, is going to, get political if it hasn't been already. And I foresee very near-term future where people actually identify with their portfolios politically. And they'll expose that, show that I think

Starting point is 00:05:08 we're going to see a whole new world of emotional involvement inside of portfolios, which I think is awesome as a factor investor who's an old school, like, let's just try to make money guy. But it's going to be interesting, I think, over the next three to five years here. Toby, if I threw it over to you, because I know, like, with the way deep and sick, the tickets for your EJF are constructed, you know, there are different rules that have to follow to be a part of the portfolio. Do you have any kind of ESG filter in? Is it something you considered? How do you think about this? They're not ESG funds. They're not explicitly set up to be ESG funds. They do score okay, according to Morningstar along some of those lines, but that just might be the investment style

Starting point is 00:05:54 sort of manifesting as lowish sort of carbon, that sort of stuff. I think it's usually a bad idea to mix your personal biases in with your investing. If your objective is returns, if your objective is something else to express your political opinions, then by all means find the fund that achieves that end. I think that the research is a little bit mixed, But the pitch for ESG is that it lowers the cost of capital and therefore you can starve the worst industries and you feed the better industries and that should lead to more money flowing to better things. The problem is that, you know, we poll 10 people and we'll get five people diametrically opposed

Starting point is 00:06:34 to the other five people about what good ends are. There's a MAGA ETF out there that you can buy and there are probably political ones on the other side of the spectrum that you can buy and they both think that they're doing the moral thing by investing in those. The mixed research seems to be that when you increase the cost of capital for something, you get better returns out of it. So that's still going to attract people who want those vice-type investments to go into those. So the pitch would be that you reduce the cost of capital for things that score high on whatever ESG components that you seek, and therefore they do better because they have a lower cost of capital while they're operating their business.

Starting point is 00:07:13 but then on the other hand, when you increase the cost of capital for something, you lead it to have better forward returns. So that's why the vice portfolios will continue to exist. I think that it probably all cancels itself out. I agree with Wes that there's enormous interest in it and as a marketing tool, if I just wanted to be 100% market or I'd just start rolling out portfolios that appeal to particular political groups and charge more for them, but that's not what I do. So I watch it, but I'm not involved in it at all. Perhaps let's talk about how it influences financial markets. And I also think it's important to say that there's no such thing as a universal accepted standard for what is ESG.

Starting point is 00:07:57 Just like the four-offs might have some kind of idea of what value investing is, or at least what it has been historically. But there's no like a strict rulebook saying you can only invest in stocks with a PE lower than 15 or whatever that is. It's sort of like the same thing with ESG. You look at different sources. I just looked one up here from Bloomberg, who said like in 2025, a third of the assets would be in ESG funds in the States. So it's something we need to consider one way or the other. So I guess my question to you is, which impact does the rise of ESG have on the financial markets?

Starting point is 00:08:32 And does it change the way you invest? And I'm not so much talking like ethical reasons, but are you more thinking, oh, but this is what the herd is doing? This is the way the market is doing so I need to position myself accordingly. Is there a such a thing as that? And Wes, I can't help but throw it over to you. You're not just looking at fundamentals in your funds. You're looking at other things as well. So I think there is a massive opportunity for the following trade in ESG.

Starting point is 00:08:58 Don't buy things that already look ESG and pretty because they already have that low cost of capital and the gains are gone. And your go forward basis, as Toby highlighted, is going to be lower expector. returns. But if you wanted to try to have your cake and eat it too, you would go after the ugliest, nastiest ESG firms you could possibly find and then go active on them in an ESG sets, right? Try to turn Monsanto into whatever, like, I don't know what the top ESG firm is, but some, you know, some firm that's really clean. Patagonia or something. Yeah, Patagonia. Yeah, try to turn Monsanto into Patagonia because you would take the cost of capital from, say, 15% to like zero effectively.

Starting point is 00:09:45 And you'd get a massive like quadrupling or 10x evaluation. And so I think you're going to see. And we're talking a few people that actually like operators looking at this. I know there's already some in hedge fund space. But that's a huge arbitrage opportunity is for people that can kind of take ugly and make it pretty and then make the spread in the beauty contest. I think that's going to be a big theme. Let me ask you guys this question. Are we one bear market away from not ever hearing about ESG again?

Starting point is 00:10:13 Yeah, I was going to say it's a little bit more of a bull market special than it is something that people are going to be concerned about. We've had a very, very long bull market and people, everything looks easy at the top. So just add a few more layers of complexity in to get yourself where you want to be. I mean, I actually somewhat disagree a little bit on that. there's an element of that, like the sentiment component because people have the luxury to invest more emotionally. But also, I do think there's a real component of true lower cost of capital. And obviously, going into a storm, all else equal, you know, if you have a lower cost of capital, you can take on MPV projects with, you know, easier.

Starting point is 00:10:53 You can keep your boat going where, you know, if you believe that cost of capital spikes during a bomb out, well, if you already had high cost of capital, now you just can't get any. projects funded. And so I do feel like there's some sort of weird like margin of safety in some sense because I believe that the lower cost capital is a real economic phenomenon in the marketplace right now. I believe that that is real. I think Jake was just saying that is the interest in it at a peak because we've made so much money for such a long time. And if you if you go back to the bottom to people like ESG is probably the first thing that goes overboard. Yeah. When it's outperforms as well, It's had like this great relative performance streak in general, which we all know is fleeting

Starting point is 00:11:37 and won't exist in the future. So you're right. You're going to get a shakeout on the performance chasers, but I do believe there's true believers out there too. Can we unpack that cost of capital a little bit more? I'm curious about, so when I think about the mechanics of actually like a company getting dollars in the door to deploy into new equipment and employees and all these things, the stock market's a secondary market.

Starting point is 00:12:01 The money is not going. When I go buy a share of Apple, it's not like Tim Cook gets that dollar, right? Like, I'm just trading places with someone that already owns that share. So how is it actually lowering the cost of capital for these businesses? So when you like, if you basically do like M&A activity or, you know, you go raise capital from the street, you need to fund different projects. Yeah, remember, inside of Apple, they run their own capital allocation. They have like $100 billion.

Starting point is 00:12:29 And so to the extent that you can fund higher impasse, PV projects that are above your cost of capital, you're going to add a creative value to the shareholders eventually. Whereas if I'm in a, I don't know, I'm Monsanto, right? If I've got a billion dollars, my project, if cost of capital is a lot higher, and so the bogey to try to beat that is really hard. And if I just can't find any projects to invest in in real money terms, I can't add real economic value to my share price and assuming the stock market's somewhat efficient, like it should be able to account for that, especially if there's, you know, if we're in like a bad regime where some people just can't now fund projects, how you're going to add any

Starting point is 00:13:10 economic value is argument. So you're right, but there is internal real decision making presumably going on at these firms, I would say. There's two issues though, right. There's, to what extent can head office get itself into an ESG type framework? And I think most firms have probably gone through that exercise and tick almost every single box that they can. And if they haven't, then maybe there's some avenue for activism there. But there's probably not much at very big firms. The problem is going to be for the companies that have their core business is something that ESG doesn't like. And so, for example, the oil drillers, there's just no way other than getting out of that

Starting point is 00:13:50 business that you can improve your ESG score, your environmental score there. So I don't know, we're sort of, we're voting without dollars to starve those industries of capital, but we're still consuming it on the other end. So I just see them sort of doing very well, shareholders in those businesses doing very well. You mean in the in the dirtball businesses? There's some that are just, you know, I just give Exxon or Chevron or one of those as an example. A head office can get themselves a green logo and go and tick all the boxes, but underlying business is the issue. And there are lots of businesses like that. You can come up with a pretty annual report and a nice green logo and you can run all the ads that you want,

Starting point is 00:14:35 but you're ultimately not solving the problem that people are upset about. The one thing that's also interesting that I've been thinking a lot more about is existential threat, because on one hand, I'm a huge believer, okay, let's go buy Monsanto. Exxon, all the dirt balls, because to Toby's point, you can't put too much lipstick on the pig. It's still a freaking pig. But hey, if the pig's fat and I can buy it cheap and I can clip that coupon, that free cash flow, it could be a great investment. However, I could foresee pretty near in the future here.

Starting point is 00:15:10 You can have a situation where it's even though it may not be rational from a societal perspective that it's like, nope, we're cutting it off. or nope, we're going to tax it a million percent, i.e. just turn the business off. So there is kind of this risk premium. You also need to put in those things. And I don't know how well it's priced into like an Exxon where it looks great on the dividend yield. But what if there's a chance that's not zero, that it goes to zero, right? That could be a real value play that is actually a value trap. Alluding to a little bit at the start by saying there's a tension between, you know, the cost of capital and those existential threats exactly like the ones that you're discussing.

Starting point is 00:15:53 And on the other hand, lower cost of capital, higher cost of capital, having knock on effects on the returns. I think the oil and gas are probably a little bit safer from those things because we actually still do need them, consume them, basically everything that we make almost immediately. The bigger risk probably tobacco, and that's probably what tobacco, they could just decide that society is no benefit there. For consumers, probably for the farmers, there's a benefit, but for the consumers, there's none so that they could just switch that off. 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 height of the summer. You've got long days of daylight,

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Starting point is 00:20:33 All right. So going to the next question here in our outline for today, I want to talk a bit more about international investing. I guess this is the case for many of our listeners. We are exposed to a lot of U.S. equities, and we do know as value investors that look at least historically relatively expensive. What kind of data, if any, would you need to see all the next, say, decade to convert to investing significantly sums outside the U.S.?

Starting point is 00:21:02 Jake, why don't we throw it over to you? My personal approach is much more to go wherever I find value. So we're already looking internationally and have been for a long time. Granted, I don't always feel like I understand cultural things as well as I probably do in the U.S. So there has to be an even bigger delta on price for me to feel comfortable often or even higher quality. I'm finding a fair amount of things internationally to do that makes sense at the moment, especially probably relative to the U.S. But I would, just for fun, like we talked about different numbers.

Starting point is 00:21:37 I went back and I reread in 2003, Warren Buffett came out with this article with Carol Loomis in, I think it was in Fortune, where he's talking about the trade deficit. And he had this idea where if we could balance the trade somewhat for the U.S. by requiring these like voucher system, basically, it's always interesting to take the numbers that he points to at that time period and like what he's concerned about. and then roll forward the, you know, like, what have the numbers done since then? And is it even more concerning? So real quick, I could give you some of those. I looked them up recently. So he's talking about how in the U.S., World War II to the early 1970s, the U.S. was a powerhouse.

Starting point is 00:22:18 We were a trade surplus. Everyone else in the world, their factories were all bombed out. Like, we really set our reputation as a premier country at that time period. And net investment, which means like how much of other countries' assets do you own versus how much of foreigners own U.S. assets. We were positive $37 billion in 1950 and then positive $68 billion in 1970. So we owned more of the world assets than they owned of ours. Late 1970s trade reversed and the deficit was running at 1% of GDP. But net investment was still moving up because we were getting returns on our investment

Starting point is 00:22:55 of our foreign ownership. So by 1980, it peaked at 380 billion, we owned of net of what the rest of the world owned of the U.S. Well, when Buffett wrote this article in 2003 when he was concerned, the trade deficit was running at 4% of GDP and net investment was $2.5 trillion to the negative. So foreigners owned claim checks like bonds of the government and our corporations. They own real estate. They owned equities. So 50-ish trillion is what Buffett came up with of a total kind of.

Starting point is 00:23:26 of net wealth of the U.S. So that equates to about 5% of national wealth. If you pictured us as like a family, we sold 5% of the farm basically to overconsume effectively. So today, when I looked up some of these numbers, the net international investment position in the U.S. is negative $14 trillion, on a roughly call it $140 trillion of total wealth. And that number, my personal bias is that that number is probably inflated by very low interest rates. But anyway, that's 10% of net wealth now that basically the rest of the world owns of our productive capacity because we've wanted to consume so much. And the trade deficit in the last 12 months has been $835 billion. And that's, if you call US GDP roughly $20 trillion, that's actually a similar

Starting point is 00:24:16 kind of 5% GDP of the deficit is 5% of GDP. So all the numbers kind of basically doubled from when Buffett was concerned about them in 2003, maybe even a little bit more. So all of which is to say, our sort of like premier catbird seat in the U.S. as being the best place. And I would say our fiscal house is in less order than it was 20 years ago, even when Buffett was concerned about it, which just means that like any rich family, the more that you've sold off the farm, like sort of the less that you probably have to look forward to as far as consumption. At some point, you can't just always be running deficits forever and not have to balance it at some point. So perhaps, who knows when, but that isn't a potential argument for wanting to maybe have more international

Starting point is 00:25:01 exposure. Yeah, I'm the only one who really doesn't have much international exposure, which is funny because I guess I'm the only one with an accent. Yeah, I run two domestic US equity funds because they were the two. The first one was the easiest one to set up for me and I just invest in my own funds. So it kind of makes it, if I was to sit down with a financial planner and show them what I had done, they would say that it's a bad idea and that I should get more international exposure. And I 100% agree that everybody's got a home country bias. What are the chances that the US is the country that outperforms over the next, like, whatever useful,

Starting point is 00:25:39 whatever life I've got left 40, 50 years, whatever it is, the rest of the world, it's lowish. There's just so much competition out there. So it should have more international exposure, but at some point, I think I'll have an international fund, and then that would be how I would get that international exposure. But it's not yet. Yeah, so I don't do it. But theoretically, it's a good idea.

Starting point is 00:26:00 Wes? Yeah, I mean, I think Toby kind of nailed it there. We usually show a chart of like the last 100 year history of U.S. equities versus international equities, like five-year rolling performance. and it literally looks like a sine wave or like a yo-yo. And obviously we're on the far right side of that graph where the U.S. has been winning for 10 years and the international has been bombing out. But if history is any guide, you know, valuations matter.

Starting point is 00:26:29 Right now develops 20. US is 30. To Toby's point, deep values under 10 PE. International, it's even cheaper. So I'm a big fan of international diversification. And like Toby, you know, we in our own cooking. Our cooking just happens to already have international cooking, so it's a lot easier for us to do that. But yeah, if I didn't have an international cake baked up, I didn't trust anyone else that I'd probably be a U.S. only cake eater as well.

Starting point is 00:26:58 So I get where he's coming from, but I personally globally invest in like deep value around the globe. I will say this for the U.S. just to make a counterpoint on the other side. The US has been still remarkably successful, even over the last decade, of producing these phenomenal consumer franchise businesses that really the rest of the world just hasn't done other than China. China sort of seemed to be able to produce comparably big, comparably kind of great consumer franchise businesses. I just don't face any of them because I don't speak Chinese.

Starting point is 00:27:32 I don't use any of them other than like, I've had a look at Alibaba's US website and it's kind of interesting, but I haven't bought anything on it. That's going to be the limitation. I think if you want to get some exposure, you've got to kind of get over the political issues in China, which are significant and to get access to the businesses, which seem to be pretty good. Whereas when you look at the US, you have increasing political issues, but not as many as in China. And you can get access to these very good businesses. And that's why the index looks the way it does, like the top four or five businesses in an index in the S&P 500 are pretty spectacular businesses that they're expensive. but they're not as bubbly as we've seen at like a dot-com bubble top. It's a really good point. And it always goes back to what does it truly mean to be diversified? And do you want to invest in something you don't truly understand?

Starting point is 00:28:22 And I think at least for the followers, we're most comfortable with the U.S. market. And, you know, if you look at what total mild cap compared to the rest of the world, it's like at 50 odd something, then you could, of course, also look at the GDP of the U.S. It's probably close to 22 or something like that. So it's also like, what is your benchmark? It's hard. And I guess that's a segue to the next question here because I wanted to talk about different investment strategies. And I'm going to miss up this quote so Wes can set me straight here. But during this, Halls Wes have said multiple times something along the lines of be religious

Starting point is 00:28:55 and be religious about having many religions. And, you know, as value investors, we taught early that value investing works because it doesn't work all the time. Like I could give Toby a jab here with value investing for him coming on the show and saying, oh, what's going on value right now? But, you know, it is, if you look at the historical data, you know, that is true. There have been long periods where value didn't work, which is why it's upperformance in the long run. So you need to stick with that strategy, especially whenever it's out of favor. So let me throw it over to Wes now that I've started sort of quoting you. Do you have anything in your investment strategy that is a timeless principle that never changes, a religion that never changes?

Starting point is 00:29:36 if I can use that phrase. Investing, in my opinion, is 100% behavioral game. And so it's really important to find something you believe in and get religious about it at some point because religion helps reinforce discipline, right? Because if you don't follow it, you feel like you're going to go to hell or something, right? So it's like this weird mental game where you don't want to ever be too dogmatic about anything, but in the context of investing, it's really important to be dogmatic about something.

Starting point is 00:30:10 But then you have the other issue, whereas investing is not just behavioral, it's also math. And there's this thing called diversification and not having all your eggs in one basket or philosophy or ethos, because a lot of times people think they're diversified, but they're not. And so to the extent that it's possible, and from a psychology standpoint, it's incredibly challenging. Like, it's very hard to be a Muslim and a Christian, devout, hardcore simultaneously. But in theory, if one is able to do that in their head, a lot of times you can gain benefits of owning two different religions that, you know, on any individual case-by-case basis. But to the extent you can do that, I think that's important. But to the extent you can't,

Starting point is 00:30:54 Like, if you're a value investor, and that's the only thing you can ever believe in, period, and anything else is just a bunch of baloney, i.e., your ability to be disciplined at the time that's, quote, quote, not working falters, it's not worth it. And so for me, going back to your original question, what are timeless principles? It's simple. Fear is a human condition. I think value captures that in the sense that you got to buy stuff that everyone hates. It's ugly. It's nasty. you know, why would you want to do that? So I like value for that reason. But then I'm also a big believer in greed. And people are crazy and they're speculative and they're maniacs, right? Well, that's called momentum. And we can all talk about, you know, why that's crazy and it's against the Fish and Mark hypothesis.

Starting point is 00:31:42 But if you've ever met anyone in a sentiment-driven market, like right now, to deny momentum is like to deny that you need water and oxygen to live. It's just you're wrong. So I'm the unbeliever in fear and greed, basically. It's that simple. I agree with everything that Wes just said, then. I wouldn't disagree with anything at any point that he's made then. Although, the only thing, I saw an online poll that said, do you need air and water to survive? And 97% of people said yes.

Starting point is 00:32:13 So it's like a three percent of people out there clicking no. So I want to meet those people and find out what they're doing. I don't know. I agree with everything Wes says. I'm constitutionally a value investor, so I may need at some stage to put some money into Wes's momentum funds just to balance myself out. But I'm not yet at that point. I think that things have a value and I think of myself as like a business guy rather than an investor. I'm an entrepreneur more than I'm an investor and I just look at these businesses as

Starting point is 00:32:45 as businesses rather than as bits of paper that trade. And I try to buy on the basis of the returns that I'm going to get. And then if the position goes against me, then I'm still, I'm still in the mindset of an investor. I look at the, of a business guy, of an entrepreneur, I look at the performance of the underlying business. I have read all of the research on momentum. I've read Wes's book on momentum. I'm 100% intellectually there with momentum. It's just that last sort of emotional step that I can't make, which is why I will probably have to outsource it to Wes at some stage, but not yet. But that's sort of, I think that behavioral errors are the most,

Starting point is 00:33:24 are the thing that causes most people to underperform, and most of that is just a lack of conviction in their own strategy. So you need conviction in what you're doing. You need the religion. You need a code, as I always like to say. Toby, do you have any kind of threshold for pain or any kind of data where you're saying, I need to step away from value as my main strategy?

Starting point is 00:33:46 And the reason I'm asking is that we have a lot of value investors following the show, and a lot of them have been through a lot of pain, you know, with everything that's been going on, the financial markets. And like they hear all these things, to see all these billionaires doing X, Y, C, they hear about whatever. And a lot of them are, they're changing what they do. They're changing how they, how they think about things because it's been, perhaps because it's been too long now. I believe in being rational.

Starting point is 00:34:12 I believe in rationality. I'm a Bayesian updater of like that every. every year that we get some more data that favors some other aspect. I try to include that. But you've always got the tension of when something looks worse, it's often the point that it's about to perform best and vice versa. But you need to be Bayesian about it too. You have to be including the additional bits of data that come in and thinking about whether that changes it. But I don't really suffer from FOMO. I wish everybody the very best in the market. I hope everybody does really, really well and crushes it. I'm playing my own game, which I really

Starting point is 00:34:45 enjoy, keeps me intellectually engaged. It's really fun. And I'm a business value guy at my core, so that'll be the last thing that goes. Jake, timeless principles in your portfolio? Yeah, I mean, I think both of the answers that they gave are quite satisfactory. For me, it's very similar, a little bit, probably more sort of Toby, where I like the brain damage of figuring out businesses, and it keeps me engaged with the world and kind of solving puzzles. And, you know, I never forget that I always own a business, and it's always important to me. Cash flow always matters. And then also, what is done with that cash flow inside the business, the capital allocation

Starting point is 00:35:26 matters tremendously as well. And then, of course, kind of the typical margin of safety. Like, I just want to get way more than what I feel like I'm paying for. I want to get a deal. Like, I want to feel like I'm getting away with something. And then probably the last thing would just never lose sight of, like, what is my edge in this? And I don't have a better analytical.

Starting point is 00:35:45 edge. I'm not smarter than anybody, but I do think I have a good shot at, I'm hiding here in Folsom, California, away from a lot of the noise, and I, you know, go on my walks and I listen to Warren and Charlie talk, and I insulate a lot. And that gives me, I think, a potential behavioral edge where the lower the price goes, the less of a good analyst I need to be. So the more margin of safety I have, the less smart I actually need to be. So I try to keep that front and center all the time. And then just be patient and recognize. I'm not going to get all of them. I'm going to pick some things that are wrong, but this is a probabilistic game over a long career. I think I'll do just fine as long as I stick to my principles and where I think I've got a little bit of an edge. And eventually,

Starting point is 00:36:28 it'll work out just fine. So Wes, continue talking about which type of validation are you looking for before saying this is a, I haven't invested like this before. You know, just like you, I remember you're coming on here on here the show some years ago and you're like, I started out as value investor, I saw all this data validation for momentum. I needed to do something about that. What type of data validation you're looking for before you change your mindset? Well, for me, basically, I had to write an entire book. I needed to maybe compliment another religion because I can't disagree with anything these guys say because in my DNA, I am fundamentally a value investor. I get it. Why do I think that value works, right?

Starting point is 00:37:13 Fama told me it's because they got all this extra risk, blah, blah, blah. Then I start thinking, you know what? I like Ben Graham's answer better because it makes more sense based on empirical observation of the marketplace. Mr. Market can get crazy. And fundamentals, it makes sense. Like if something makes $10 a year and you know it's going to keep making $10 a year, you always have that center of gravity and the price will bounce around it.

Starting point is 00:37:40 You know, I can exploit that. What I came around to believe in is my fundamental belief is people lack discipline, period. That's my first principle. And that's why I believe in the value religion. That was my first principle. Then I started thinking, okay, Wes, if that's your first principle that you think people are crazy and lack discipline and that's why you believe value works, then fundamentally, why don't you apply that core first principle and see if it exposes?

Starting point is 00:38:12 itself anywhere else in the marketplace. Oh, there's this thing called momentum. And there's this thing called people are maniac, sentiment driven, phoma, whatever you want to call it. There's reflexivity and prices, right? Like, prices keep moving. Now you've got lower cost of capital. You could reinforce buy cheaper stuff than the other guy.

Starting point is 00:38:31 My first principle that also shows up in another religion called momentum. And then once I got my head around the fact that they're not really different religions, they're just ways to exploit human behavior differently in a disciplined way. Then I was able in my own head. So in some sense, I really do have one religion. But another way to think about it, sub-religion is one is value, one's called momentum. But in my head, honestly, they're the same thing. And if I have the ability to be to Jake's point, the key edge is discipline.

Starting point is 00:39:06 And, you know, we've always, we've talked about like the diet thing, right? I learned us in the Marine Corps, everything in my whole life. Okay, you want to lose weight? Exercise more, eat less, period. It's fundamental, right? It will happen. Why are there 10,000 diets? Why are there 10,000 programs?

Starting point is 00:39:24 Why are there 10,000 YouTubers telling you all the 50 million ways to achieve something that's fundamental. Eat less, PT, more. Have discipline, right? Same thing, investing. Be disciplined. think long term, focus on fundamentals, great. Let's buy cheap stocks everyone hates and let's buy winners.

Starting point is 00:39:45 Who knows when one's going to work versus the other? I really believe that this is what I came to the conclusion. I could change my mind, but this new market is only reiterating my faith in my religion that people are stupid and don't have discipline. It's crazy to me. It doesn't really bother me whether, I think that this, I was like, where's very much Ben Graham, prefer Ben Graham's explanation. But I think that there's also a large component of it that Famer and French are probably right. There is a big risk component

Starting point is 00:40:15 to value as well. It's a little bit of both. But I'm at the point where I really don't care what the reasons are why something, if it's cheap, in the sense that I can calculate some yield and some growth component to it. And it looks like it's more than the risk that you're taking on and more than other alternatives. And I think it's a good thing to do. And that's why I don't find it hard to be a value guy through these periods of time because I can put these positions on and I can see that there is an expected return in them. And it's to the point that we've all been making when prices are lower expected returns do tend to be higher.

Starting point is 00:40:53 And I just know that even though it can go against you for a long period of time, and honestly, this one's been a lot longer than I would have planned at the start. I still think that the underlying theory is sound, the logic to it is sound. It's just a matter of time and patience in the market and eventually. Like Wes says giving the example of losing weight. Like that's, I just put it the other way around. I think you need to eat less than you burn. And if you do it that way, it compounds over time.

Starting point is 00:41:21 It takes three or four years. The investing is exactly the same. You've got to get up every morning and do your exercise and you've got to be careful with what you eat and you've got to do it for years. But at the end of that, you see a result. true in the markets as well. Let's take a quick break and hear from today's sponsors. No, it's not your imagination. Risk and regulation are ramping up and customers now expect proof of security just to do business. That's why VANTA is a game changer. Vanta automates

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Starting point is 00:45:09 I would say that I have, as I've gotten further into this game, moved further and further away from secular anything, whether it's interest rate driven, macro, anything, GDP related. I think it's all interesting stuff, and it no doubt matters, but I just don't feel like I could know it. It's too hard to figure out. And like any complex adaptive system, the initial conditions are recognizable. Here's where we are. Where exactly it ends up in the end state is incredibly difficult because there's so many

Starting point is 00:45:45 little ways that it can go that will create feedback loops that then move you way further a field than you ever would have thought imaginable. So I really, I do less and less of that stuff and I just try to think more and more about these businesses that I own. I know they're impacted by all of it. I know it's important and it would be awesome to know it, but I just, I just can't wrap my mind around it enough to feel like I'm actually helping my analysis by trying to untangle some of those rats nests. So it's less and less a part of my process. Toby, any interstellar trends you're looking at? I'm not necessarily talking about the macro picture,

Starting point is 00:46:20 but in general, any consumer behavior that are changing that we should be aware of? Well, one consumer behavior is that consumers started consuming value stocks in about September last year, and they started consuming my kind of value stocks in about February this year. I really don't because I'm pretty systematic and pretty quantitative about it. So I buy good things when they get cheap. I care that they're cheaper than they're good, but I tend to lean on the year. So, you know, it's funny, though, I do think it's funny how often value gets in front of macro trends that people start talking about subsequently. So I was buying home builders last year, had home builders for a little while.

Starting point is 00:47:01 And now that's become like a story where we've evidently we've underinvested in homes. People locked in, they're doing, looking for houses to buy houses of experience. exploited that homebuilders are going to do a lot of work. Homebuilding at some stage is going to transition into momentum. But it started out as value and I didn't buy it because I had any insight into the consumers. I just thought it looked like it was at a cyclical low and it looked cheap on that cyclical low and so I bought it. And I think that often that's what happens with value. I don't really know why it's there. I just know that it is very cheap and subsequently the macro picture sort of colors itself in and I don't know if that's real or if that's just

Starting point is 00:47:38 The media picks up on the story, analysts pick up on the story, and they add a narrative to it, and it's appealing. I try not to do too much, sort of picking where the consumer is going to go, just play the field as you find it. So one of the most popular guests we have here on the show, that is Colin Roach. And he often talks about how there is no such thing as passive investing, because even passive index funds are still measured against a constructed benchmark, which you might say are actively constructed because someone still decided this is what it should be. And, you know, each investment strategy also has his own risk profile. We can't all compare to the S&P 500

Starting point is 00:48:15 if we do something completely different. So starting with you, Toby, what is your benchmark, if any, for your investment strategy? And why is that your benchmark? How do you think about that? I have benchmarks that are value benchmarks, but I think about it a little bit more broadly. I think it should be like S&P 500 or even the globe. I use S&P 500 right now, but even the global total market would be appropriate if you were if I had some international exposure. I agree with Cullen. It's kind of a funny. S&P 500 is set by a committee and they actively decide to include or not include Tesla based on some things. They did the same thing with Google. And then it's market capitalization and float adjusted, which float makes a whole lot of sense

Starting point is 00:48:57 for people who are trying to run index tracking funds. Float doesn't might not make a whole lot of sense for the average punter out there. So I think his point is fair that even passive indexes aren't really passive. I wouldn't want to come up with another one, so I think that they're doing okay. Just like whenever Buffett talks about accounting rules, it's like gap is just so silly, but I don't want to go up with it with like gap version 2.0. I could have a go out a few of the gap rules and fixing things out. I wouldn't run investment gains and losses through the P&L. Yeah, that's a good point. I mentioned Colin Rhodes before, and we had him on. He's he was launching a new ETF and we talked about how to invest in ETFs.

Starting point is 00:49:34 And he mentioned, Wes, that he set it up through Alpha Architect. And so I was just wondering, like, whenever he, because all ETSs have to choose a benchmark, or is it you, is it the SEC, or you choosing one yourself? Like, how does this benchmark thing work whenever you go to an ETF website and you see, oh, it's benchmark towards that index? So anytime you have a registered fund, i.e. like a mutual fund or an ETF, ATF, in your prospectus, you have to have some benchmark. It's basically what is something that is broad, base, inappropriate, like with some sort

Starting point is 00:50:10 of risk profile, right? So if you do US stocks, well, SB 500 is probably in the ballpark. And then there's nuance within that. Well, I'm doing value stocks that are only the midcaps in S&P. You know, you can get nuance. But technically, all you need is a broad base benchmark that roughly approximate the same risk profile that you choose to take. in your investment product.

Starting point is 00:50:32 That's a mandatory requirement. Any time you want to learn about a fund, and people think about it less or more, depending on who you're dealing with, but you technically have to have it. Just read their prospectus. It'll have like a benchmark outline in the prospectus. I go so many different places,

Starting point is 00:50:51 different sizes of companies, international or U.S., picking one benchmark. And it changes all the time, too, depending on where the opportunities are. So I do not fit well into any kind of style boxes. Therefore, it's hard to have a well-defined benchmark. I would probably choose a some, because a lot of times the money that I manage is like someone's entire net worth. So, you know, if I was just running a fund that was a little sleeve of someone's net worth and they were using me for some specific, you know, style or size, then I would say like, okay, I should be compared to that specific. benchmark because that's really the opportunity cost of that sleeve is what they would have put it in

Starting point is 00:51:34 otherwise. But for me, you know, managing entire net worth of a lot of people, I think more actually of like a global like the MSCI for both equity and bonds in some kind of mixture, sort of just like planet Earth return. If you could go anywhere and kind of buy anything and you owned everything, what would it look like versus that? So I think that's probably a little bit more appropriate it for my style. But, you know, the U.S.-based investor, you could make the argument that, hey, I don't want you to manage it for me. I'm just going to stick it in the S&P 500 and pay no fees at all. And I think that's a perfectly reasonable thing to do, especially over long time periods. I don't know how well it'll do over the next five to seven years. I think just as a base rate

Starting point is 00:52:18 bet from today's prices, I would be a little pessimistic as far as that it won't look like the last 10 years. But in general, I think that the, The other question that is, I think, missing in all this is over what time frame? So we have a benchmark, right? And over one day against the S&P 500, what do you look like? Okay, well, like that is obviously just total random noise. Over one year, okay, well, maybe a little bit more information in that, but I still put that not that much different than one day.

Starting point is 00:52:50 That's closer to me to one day than it is actually like 10 years. So it's this catch-22 where unfortunately, in order to untangle luck versus skill, you need a pretty large data set of time and maybe even like sort of multiple market environments. You know, if you're just in a one-way market like we've been in the last, call it 12 years, I'm not quite sure that you can say full cycle how good of an investor someone is. If they've, you know, like the bet has been to be balls to the wall risk. And that has been the way to bet for the last 12 years. but I think we all kind of intuitively know that that will come at a cost someday and that maybe it's not, you know, a foolproof plan. So I think the time horizon is also for this game needs to be measured over much longer periods than probably people are typically comfortable with. And it's unfortunate. I don't have a better answer, but I do think that benchmarks can lead to short-term thinking that I think actually leads to a sub-optimization.

Starting point is 00:53:47 I had a look recently at the, you know, John Husman has that. this method of calculating expected returns over the next decade, and he uses the Schiller PE, and then he assumes a long-run average Schiller PE, and he assumes that you mean revert to that over a decade, and we can pull up the dividend yield of the S&P 500, and then he puts all of these things together, and you can track it on a day-by-day basis, so I have this, I just have this little web scraper that pulls this data, and then I chart it, and I just was looking the other day, for the trailing 10-year return on the S&P 500, it's like 16% including dividends, which is like, that's about as good as it gets. And the Ford return is now negative on the

Starting point is 00:54:31 index, but that includes, it's negative 0.1%, but that includes 1.3% in dividends. So the index will be negative about 1.2% for the next decade on an annual basis, you know, based on assuming that the mean reversion, assuming we go back to the average, assuming it takes a decade, all those sort of things. I will say it's been remarkably predictive, that little chart, as simple as it is. But I just think there's never been, well, there's not never been, but the times when there have been as wide a disconnect

Starting point is 00:55:02 between the trailing 10 year and the Ford 10 year, you know, they're all notorious kind of dates in that chart. It's not a prediction. It's just an observation. Does that mean revert profit margins, or interest rates or anything else that are kind of tipped all in one direction? It doesn't include those things.

Starting point is 00:55:23 So you can come up with a more... So you have more ways to lose. There are more ways to lose than it looks like on the surface, but I already sound crazy enough saying negative returns, so that's all we'll say. Wes, I'm curious to hear how you think about risk in comparison because like Toby just said,

Starting point is 00:55:41 the S&P 500, you know, 16%. And you're like, oh, that's great. Then, you know, Jake might come in and say, and I'm just using Jake in his sample here. But he might come in and say, well, you know, I achieved 14%. But I did it with a lot less risk. And we discussed the whole thing multiple times here on the show. We don't really consider standardization to the best measure of risk. We don't really are not too big of a fan of the shop ratio.

Starting point is 00:56:07 So can we look at this any other way that, you know, you compare the S&P 500 with what it is? and then you compare XYC, JX, portfolio, lower return, but perhaps also low risk. How will you make that comparison? There's thousands of papers you can reference on this, right? In the end, I think you've got to just use common sense, which is dangerous thing to do at some level, and say like, okay, let's just break it into the biggest muscle movement's possible. U.S. stocks or maybe global stocks that I think Toby made. mention that, that's kind of like one risk bucket. Global bonds might be a risk bucket. Maybe

Starting point is 00:56:51 commodities could be a risk bucket as a third one. And then whatever you think your average allocation is to those broad buckets you can access almost for free, if you're dynamic, it is what it is. But if we're talking like a 20, 30 year benchmark to Jake's point, like, hey, you're going to try to beat that over the cycle. If on average, you believe that you're, your process is going to be 50% stocks, 30% bonds, and 20% commodity-like investments. Well, even if you're dynamic, let's just use that as your baseline benchmark, and we're going to assess it over a 20-year horizon. I think doing anything beyond that, it gets crazy.

Starting point is 00:57:32 I think it's too much noise, not enough signal, and you lose kind of the forest through the trees a lot. So I just picked the broad asset class that you're vaguely going to be investing in. It's probably going to have the same rough risk return. And if you can beat that, great. You should probably do your process. If you can't, probably buy the Vanguard fund equivalent. And most important point, though, is Jake's point is benchmarks are awesome in theory, because in theory they enforce discipline, but they're terrible in practice because of the short-term nature of them.

Starting point is 00:58:08 And they force humans to be back to being humans again. So I'm a fan, but I'm much more fan of understanding the learning process, which everyone is here, I'm sure. All right, Jens, it's always a pleasure having these quarterly meetings talking about investing. I think I don't only speak for myself, but for all the listeners when I say that I always learn a ton from our discussions. And can I say, especially when we disagree, I tend to learn even more. So before I let you go, I'd like to give all of you the opportunity to tell the audience where they can learn more about you. Wes, please go first. Alpharchitect.com or on Twitter at Alpharchitect.

Starting point is 00:58:47 Toby? My website is Acquireasmultable.com or Acquiresfunds.com. My Twitter handle is Greenback, G-R-E-N-B-A-C-K-D, where I post four or five times a day. All right. Yake. So this great resignation, I guess, has been happening in the U.S. Where I guess four million people quit their jobs in July. And with that comes a lot of orphan than retirement accounts.

Starting point is 00:59:13 And this happens to be something that my firm does a lot of is people leave a job. They have this account. They're not even paying attention to it anymore. Those long-term retirement dollars tend to be a pretty good fit for a value approach, I think, maybe even more so than a after-tax brokerage. So I put together, I had the team put together a little special thing for the audience. So if you go to orphanaira.com backslash TIP, there's a little special in there. And because I like to talk to every single new investor to make sure that it's a good fit,

Starting point is 00:59:48 we only have a kind of a limited amount of bandwidth that we can onboard people in a typical month. So there's six spots for whenever this airs that month that we have time to be able to bring on board. So if you want to get in there, I would suggest don't wait. So that's where if people want to get some help with an orphan retirement account. All right, perfect. It's been handed off.

Starting point is 01:00:12 All right, jens. I look forward to doing this again next quarter. Thank you so much for your time. Thanks, Dick. Good seeing, everybody. Cheers, everyone. Thank you for listening to TIP. Make sure to subscribe to Millennial Investing by the Investors Podcast Network

Starting point is 01:00:28 and learn how to achieve financial independence. To access our show notes, transcripts, or course. go to the investors podcast.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 - TIP402: Investing Mastermind Q4 2021

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