We Study Billionaires - The Investor’s Podcast Network - TIP532: Insights From A Reclusive Investment Firm w/ Graeme Forster

Starting point is 00:00:00 You're listening to TIP. We have a very special guest today, and that is Dr. Graham Forster. Graham is the managing director of Orbis, which currently manages around $30 billion. Graham attained a master's in mathematics from Oxford and a PhD in mathematical epidemiology and economics from Cambridge. In this episode, you will learn, Graham's journey from mathematics to value investing, exploring legendary quant investors like Jim Simons along the way, how Orbis's founder, billionaire Alan Gray's investing flexibility led to his success, how Graham balances the macro with a

Starting point is 00:00:34 bottom's up approach, a thesis which Graham calls the great misallocation, how good and cheap companies can outperform especially during bare markets and a whole lot more. Orbis is a global investment management firm, but they're not big self-promoters, so you won't find many interviews with someone like Graham. We're lucky to have him and it was a delightful discussion, so without further delay, here's my conversation with Dr. Graham Forrester. 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, Trey Lockerbie. And like I said at the top,

Starting point is 00:01:24 I am here with Graham Forster from Orbis, Graham. As far as I can tell, you don't do many of these, so I am very excited to have you and getting the word out about you and Orbis and what you guys are doing because it's really interesting. So thanks for coming on the show. Thanks, Trey. It's good to be here, you're right. We don't do many of these, so it's exciting for me as well. I wanted to start off here by talking a little bit about you personally and then talking a bit about what you do at Orbis, but I find your background pretty interesting. You got your master's in mathematics from Oxford, your PhD from Cambridge. I'm kind of just genuinely curious about your interest in mathematics and how that ultimately led you to investing.

Starting point is 00:02:01 Yeah. So, I mean, I was going to go down the academic route. It wasn't until really my second and Deere doing a PhD that I kind of wavered on that. And the reason was really that I'd always seen academia as a meritocratic endeavor where, you know, you are doing the noble thing, you know, analyzing things that really matter. In reality, I think actually it was, I don't want to disparage the academic field. I think it lost its way a little bit in the sense that as it got bigger, it grew more bureaucratic and the allocation of funding in the academic sphere becomes difficult, the more niche you become. So, you know, as you get more specialists, which is inevitable in academia because you're going deeper and deeper,

Starting point is 00:02:46 therefore you need to be more and more narrow. It becomes more difficult for people who are allocating funding to understand where their money's going, because they don't understand the science itself. So it's really hard to understand the benefit of one project versus another, and it ends up being very political. I started to realize this in the second year of a PhD. At the same time, I was kind of exploring what to do next. And I came across a few books. They got a lot of good secondhand bookstores in Cambridge.

Starting point is 00:03:17 If you ever go, it's a wonderful place to walk around and explore bookstores. Even though you can get everything digitally nowadays, it's nice to walk around an old crusty book store. And so I came across two books. was by a guy called David Schlansky. I'm pronouncing that right. It was a yellow book, I remember. It's called The Theory of Poker. And I read that book so much, it was all tattered, but even more tattered than it was when I bought. So that, you know, the poker is in all of its forms, hold them, stud, draw is the art form of making decisions under uncertainty.

Starting point is 00:03:55 And that was utterly fascinating to me in the sense that you can use mathematical ability, you can use your psychology and it's risk-taking decision-making. With information you don't have, you have to infer, and you have to recognize that the world is inherently unshidden. This is even a closed system of the game. So I got the book and I started playing. That was one element of, okay, what is something that's quite like this? How can I capture the essence of this,

Starting point is 00:04:21 but do something a little bit more reputable, well, professional? And so that was one. And another book that sort of popped out of the bookshelf around that time, which I think had been written in 2001. I don't know why I picked it up, but it was a book by Talib, who's now very well known as a North Sanger. And whatever you may think of him, he did write some sensible things. And the book I picked up at that time was called Fooled by Random Nassar, I recall.

Starting point is 00:04:45 And that really sets something off in my mind. A little bit like I was listening to some of your podcasts, which are really great. And there's one you're talking about a chap called Guy Speer, who I do not know. I've not studied his work or his track record. But it's something he said or you said about him was that when he discovered value investing, it was like a light went on in his mind.

Starting point is 00:05:08 Very similar for me, but even earlier in the sense that it was reading this book, which is about the role of stochasticity in our lives and how risk is many more things can happen than will happen. This is for every decision we make as humans. And I've always had this sense, was at the sense that we think deterministic, the world is inherently stochastic,

Starting point is 00:05:33 but people think deterministically. When I was growing up, I used to watch football matches. I was a big Wrexham fan and a Manchester United fan. And when Manchester United won 1-0, they were the greatest team on the planet, and they could do no wrong. And it could have been just the luckiest goal.

Starting point is 00:05:49 They were scored. And then next week they lose 1-0, you know, sack the manager, get rid of half-f players, just the bipolar nature. And the misunderstanding of us, effectively what is stochasticity and sort of like bleeding deterministic thinking on top of that is just pervasive in how humans work, how human brains work. And so, you know, what Taleb did was sort of break down that and just talk about how in reality we live in a very stochastic world. And of course, that is very kind of related to poker.

Starting point is 00:06:19 Many more things can happen. You're making decisions that are probabilistic. You're not making decisions. There is going to be an outcome. there's going to be a result, right? But that's not the point. The point is the decision you make is that needs to be on the, it's the basis of how good is that decision in probability space rather than in outcome space. And that's very, very aligned with investment decision making. And that's sort of what brought me to thinking about the investment world.

Starting point is 00:06:47 I love that idea about imperfect information, what you're kind of describing there earlier. I think one interesting thing about being a leader or a director, a lot of people look to you for perfect information, but we're all operating off of imperfect information, but need to be making the best decisions in light of that. That's fascinating, right? Because I mean, I speak to a lot of managers, big businesses, and you know, you're almost look, I almost look for uncertainty in there, you know, what are they saying? How confident are they? Are they definitive? This is going to happen. I'm, you know, that's going to happen. Or are they displaying humility and uncertainty and recognizing that the world is inherently uncertain and therefore, you know, they're building that

Starting point is 00:07:26 into their business and a degree of cautiousness. And you see a range and a lot of the kind of CEOs in the world are a little bit semi-psychotic. They have that super external personality of they've got to project. And like you can see why, right? They have to project that determinism. They have to project that strength, that certainty, because that's, you know, almost is perceived that that that you bring people with you if you have that level of confidence and conviction. But that might not be, you know, the right way to run the business. So, you know, you have to balance up the two. One of my favorite poker quotes from Buffett or might have been Bridge or whatever he was referring to at the time, but if you can't spot the Patsy in the first 20 minutes at the table,

Starting point is 00:08:09 then you are at the Patsy. And I find that so interesting with investing as well, because as I'm initiating, you know, an investment, my last thought that goes through my mind is who's on the other side of this? Am I the Patsy on this side of the trade? And, and, and, you know, really questioning yourself on that. And it brings me to this idea, what you're referring to of poker about position sizing and reading from Anish Papry, who I think has since walked away from this idea of using the Kelly formula, using it in terms of investing, borrowing it from poker. Curious to know how you look at position sizing once you found a good investment and do you use any kind of formulaic approach. So I'd love to say that I do. Because I'm a big fan of the Kelly

Starting point is 00:08:49 Criterion, which is essentially edge over odds. you know, what odds you're getting versus the edge that you have, which is a concept using gambling. But the way that works well is in binary bets. You either win or you lose. That's the kind of the core of where it was developed. And if you have those binary situations where you either win or you lose and you know the odds, but you also, that's the odds is what you've given. That's basically the price that you're given.

Starting point is 00:09:15 But you also have a differentiated view, your edge. You think the odds are actually this because the world is stochastic. many things can happen. And therefore, when those two things differ, that's where, you know, if the odds you're getting are much better than you think is in reality should be. Then you, the Kelly criterion gives you how much of your total wealth can you put into this single position, this single bet. And it works very well with binary.

Starting point is 00:09:44 And that can be shown mathematically. In reality, if you are running a betting strategy, you know, you need to know your edge with pretty good accuracy to implement this well. And that's difficult, right? And we all fool ourselves, I put the odd wager on a sports game and saw myself into thinking I'm an expert in what the outcome might be. That's one difficulty, right? You have to get an idea of your edge. In investing in portfolio management, scaling a position, it's doubly difficult because it's not a binary outcome. There's a whole range of outcomes, right? You could generate a 10% return or 20% or et cetera.

Starting point is 00:10:19 You have basically a probability distribution in there. But what you can do is use the concept of the principle of the Kelly criterion. And that is effectively, you know, to your point around, am I the path to see at the table, what is the equivalent of that in the investment world would be, what is my differentiated view here? What do I think about this that other people that perhaps don't understand or have I turned the problem on its head and thinking about it in a different way? and if you can point to a situation where you feel like you have a very tangible,

Starting point is 00:10:51 differentiated view, and you're sort of on the basis of that, your intrinsic value of the business is that much higher than the market price. And you know, you have conviction in that. So the range of outcomes is narrow. Then that's a big position. I tend to think of positions in those terms. Is your discount intrinsic value large? Is your distribution of outcomes narrow?

Starting point is 00:11:10 It could be up to a 10% position and you scale down from there. And then the outcome is that. the portfolio, so it's very much a bottom approach. The only other element to that is correlation across the different position. So that's your broader risk management framework comes in. Determining your edge is so much easier said than done. And so I'm just really curious to know maybe an example. I don't know if you can refer to an actual investment or recent example of this, or just a general example. But I wouldn't know the first place to start as far calculating my edge and something. So I'm just, could you give us an idea of, if you're starting

Starting point is 00:11:49 from scratch like me, where would you even begin to look to determine your edge? So it's hard. And a lot of people, I would start out by saying a lot of people have different approaches to how they go about investing. And I think the more I spend time in this field, the more you recognize that somebody's approach has to be tailored to their character. And this kind of manifests in different ways. But we can have this whole discussion around what character is and different personality types and how they evolve and whether they're kind of like rigid or people can be flexible within that. And I think, you know, that all of those things are interesting. But I think it comes down to, you know, what you're good at, what you feel your strengths are

Starting point is 00:12:32 and really sort of pushing on those strengths. There's this narrative around becoming a well-rounded individual. I think in investing, it helps to be pointy. It helps to have really sort of sharp edges and really leveraging on those things that you really do well. And then you can find those instances of, actually, because my mind works in this way, I can think of this particular situation differently to the, you kind of, but everyone has a different way of thinking. I work with people here who are excellent at looking at things differently. So that people isn't, there's a narrative, right?

Starting point is 00:13:02 It can be even like an Amazon or a Google, aren't yet? And they look at that business and say, well, okay, this is how the market sees it, but actually this is how I see it. A good example, a few years ago, if I can remember this correctly, because I'm going back to 10 years or so, was, you know, Amazon was viewed a certain way and that the issue was always, well, they don't make any money, right? They don't make any money. They're growing very quickly.

Starting point is 00:13:26 Right. This was 10 years. So, I mean, this was a trillion dollars ago in terms of market cap. And, you know, the narrative here that we developed was that's true. But, I mean, you have to look at the way that they account for certain things. So if you are building a retail ecom network, how should you account for your marketing expense? Because, you know, marketing is typically expensed. If you're a store on the high street, you definitely expense your marketing, right?

Starting point is 00:13:58 Because it's like you're just putting it out there and hoping you can get some people through the door. If you're an online platform and you're spending money on marketing, bring people in, and then they sign up. And then they get Amazon Prime. and then they're kind of part of your network and they're sticky. So is your marketing an expense or should it be capitalized? Is it something that's an investment and it's going to endure for a long period of time? So I think that's more of a common narrative now, but that wasn't how the business was thought about historically. If you look at it that way, actually, they're earning a lot more money than people thought they were earning.

Starting point is 00:14:33 So it's different ways. People have different skill sets in what they look for. But that edge, you know, it typically comes in the form of trying to understanding the news flow, how people think about something, and then, you know, how do I think about it, kind of coming at it from a different perspective. That's one way. Another way is just to value a business, just pure, good old, you know, what are the pieces of the business worse, right? That's the more mechanical way to do it. And then you can do that for a lot of different businesses and you find maybe four or five of a hundred look like they're very, very, very,

Starting point is 00:15:07 discounted. And then you can sort of say, well, why? Why am I getting this valuation and put the price this way? What's the narrative? And then you can sort of say, well, do I disagree with that? So getting to the why is, I think, you know, you can do it in a few different ways. I'm curious to know if your background provided any edge, you know, as we went through this global pandemic and your expertise on just understanding the compounding of nature of how those things can unfold, were you looking into things? I mean, there was a lot of talk around the vaccine companies at that time, Johnson, Johnson, Pfizer, but during all these companies at how they were going to potentially capitalize on this, you know, if you're looking at in that

Starting point is 00:15:48 light, did that become an area of interest to you as far as providing you any sort of edge when you were looking at investments? So, I mean, this is why investing is endlessly fascinating, right? One minute, you're looking at Amazon, your next minute, you're looking at the shipping business, the next you're looking at a global pandemic. And how do you approach global pandemic, you know, in terms of your investment strategy? And we are very long-term thinkers. We don't like thinking in terms of what's happening in the short term. A pandemic, we know, will come and it will go.

Starting point is 00:16:17 But it can be very damaging. So the way we approached it was to try to model it, which like, I mean, I guess everyone else was trying to do, you know, all over Twitter. Everyone had their own sort of there. But there was one nice bit of clean data that was coming out early in the pandemic, which was from the cruise ship, sitting off the coast of Hong Kong somewhere, which they wouldn't let back in.

Starting point is 00:16:37 And the nice thing about the cruise ship was you knew exactly who was on board. You knew how many people got infected. You knew the demographics, roughly. They didn't tell you that, but it's a cruise ship, so you can infer the demographics. And you knew, you know, sadly, the mortality rate of that ship, you know, over the life of the infection as it went through. So we did a fair amount of work on trying to model

Starting point is 00:17:01 effectively the key thing was not necessarily the rate of spread. The rate of spread looked fairly aggressive, fairly obviously aggressive. The key thing was how deadly was the virus. And we could pick that up. It was very hard to pick up from Wuhan. It was hard to pick up as it spread into different bits of Asia and into Italy. But it was easier to do if you had that closed system. So with that data, we sort of came with up to a sort of mortality rate of around 1% within that population,

Starting point is 00:17:30 which was skewed old, but it was a very high mortality rate, very high, versus your seas not flu at half a percent in a really bad year, so 20 times as bad as a really bad flu. So that was a good sign of, you know, let's do something. Where we kind of fell down was how aggressively we did something. And, you know, because it wasn't just the disease you had to guess, it was also the response, because it wasn't really the disease that necessarily caused the economic disruption.

Starting point is 00:17:59 It was the response of governments. And so that's the piece. We didn't think it was possible that they would go as far as they did to close down, you know, all sorts of global. And Sweden of all countries was the most open, you know, which was bizarre. So how it just sort of, again, back to Tallinn, it shows how unpredictable events are, number one, distribution of outcomes. And even if you get one thing right, you need to get the next thing right. And then the uncertainty compounds get this very, very broad range of outcomes. And so, hence why you need a reasonably devout devouted a defined portfolio, you need to take a long-term view.

Starting point is 00:18:38 And so we spent a lot of our time modeling that, made some changes in the portfolio, but got the response wrong, governments around the world. And then by the time we saw that response, it was almost kind of too late. It was getting impounded in stock prices to an extreme degree. The positive around that period was in any panic, in any panic, you see enormous disqualness. dislocations in market, you see mispricings to the extreme. You know, all of that efficient market hypothesis stuff goes completely out of the window. If you ever believe it anything like that, right through those periods, you get these enormous dislocations.

Starting point is 00:19:10 So while it was a really difficult period personally and for, you know, for all of society, it was a very ripe period for investing because you had such meaningful misprudencings. Let's take a quick break and hear from today's sponsors. All right. guys do imagine spending three days in Oslo at the height of the summer. You've got long days of daylight, incredible food, floating saunas on the Oslo Fjord, and every conversation you have is with people who are actually shaping the future. That's what the Oslo Freedom Forum is. From June 1st through the 3rd, 2026, the Oslo Freedom Forum is entering its 18th year bringing together activists,

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Starting point is 00:23:22 Go to Shopify.com slash WSB. That's Shopify.com slash WSB. All right. Back to the show. Where did you tend to focus your attention in any particular industry at that time? I'm just kind of curious where your thought process took you as far as, okay, with all this, that directs me to where? Yeah, well, I mean, there was already a meaningful dislocation before COVID within the market.

Starting point is 00:23:52 And it fell along the lines of real economic businesses versus digital economy because, you know, we've been through this long period. I'm sure we'll get into this, but through a long period of very, very low rates, low term premiere. And that led to this big, large dislocation. And so when the pandemic was interesting because it was the perfect storm for businesses that were already very discounted, you know, your energy businesses, your metals, your industrial businesses, your anything that was an old economy or low growth, typically was they were kind of linked to the real economy. And when the real economy closed down, not only did their earnings go away,

Starting point is 00:24:26 some of their revenues went away. We own Rolls-Royce, the engine manufacturer. They make money on planes flying around the world per hour. When all the planes stop flying around the world, they don't have any revenue. It wasn't even in any of their risk models that this could possibly happen ever, or hours. And so, you know, what do we spend our time doing

Starting point is 00:24:46 through that period? We spent our time trying to understand the results. of businesses, how long could they last if the economy stayed shut? And what was their kind of recovery potential, if you like? So the price you're paying for the risk you're taking in terms of the longevity of the lockdown versus the upside. So again, your probability distribution had gone wider, fatter tails, but there were these big, big dislocations.

Starting point is 00:25:13 So we were just going through business by business, underwriting the existing businesses we held, rapidly going through a lot of other stuff that was down a lot. Mostly, we're looking at aerospace stuff. We were looking in the energy space. Oil went negative, incredible period. The likes of Glencore, which is a big commodity trading business, was falling. And that was interesting because we thought, you know, they were primed to make a lot of money out of the volatility of commodities around the world. They were one of the few companies that could store the oil on the ships that was being sort of pushed out of the

Starting point is 00:25:47 of Texas and there was nowhere for it to go, which is why it went negative. And so Glencore could just buy that or even get paid for it to take it, store it on these big ships that they'd hired, which, you know, so you had, which was actually getting expensive, renting these ships. And the share price was down. So it was actually, you know, it seemed like a very positive development in certain companies when the share price prices weren't reflecting that. And there was a lot of instances of that ilk during that period.

Starting point is 00:26:15 That's fascinating. You mentioned Alan Gray earlier, the sister company to Orbis, but founder of both companies is billionaire Alan Gray. And I'm kind of curious what it's like to work under someone like Allen and what you've come to learn about him and what has made him successful in building this massive multiple businesses with offices all over the world. Yeah, I mean, Alan was extraordinary. So he started out his career in the US, Fidelity. I think he was at Harper Business School before that. He's from South Africa. So he came kind of over in this kind of rich period of stock picking, especially at Fidelity,

Starting point is 00:26:53 through the 60s and the 70s. That was where it was place to be, you know, working with some of the well-known names coming out of that era. But, you know, once he had developed his, you know, skill set, his style, if you like, as an intrinsic value-focused investor, you know, his mission really was to take that back to South Africa, where, you know, the investment landscape, as you can imagine, was incredibly inefficient, massive opportunities for a value investor in a market like that at that time. And also, not just from the stock picking perspective, from the perspective of building a business where most of the asset managers,

Starting point is 00:27:33 well, there were no asset managers at that time, your assets were managed by insurance companies and those products were sold, going back to that notion of investment products should be bought and not sold, they should be bought on their merits. So his theory was he could start investing with a few of his friends, some money, his money, and build a track record in a market that was very inefficient. And incidentally, starting in 1973, which if you recall was the peak of the Nifty 50 bubble in the US, of course, markets weren't quite as global then as they are now. Today we see very similar dynamics across all markets.

Starting point is 00:28:10 Back then, it wasn't quite like that. But again, you know, an if big inefficient market than the US led to even bigger inefficiencies in South Africa, a great period to start as a bottom-up intrinsic value-focused investor. And, you know, they over 50 years, which, you know, took, Alan was running that firm up until 1990 when he left to found Orvis, which is basically the global equivalent to doing exactly the same thing, same philosophy, same process. So it's 1973 to today. So it's the 50th anniversary, Alan Crino, not many investment firms last that long.

Starting point is 00:28:45 Over multiple generations of stock pickers and chief investment officers, they've delivered around six, I think, six or seven percent gross alpha in US dollars, I think around 16% a year. Over 50 years, so $10,000 invested would be, I think, calculating it around $16 million or something today, just absurd wealth creation. And, you know, the two things, number one, edge to deliver the great returns. Number two, you need longevity because time is the other secret. I might talk about Warren Buffett.

Starting point is 00:29:20 I think the statistic is 90% of his wealth came after his official retirement age, age of 65. It's longevity, it's key. And if you can deliver excess returns over very long periods of time, you get these extraordinary results. And, you know, it's a hugely inspiring in the way. way he went about things. In terms of him as an investor, I worked with him in Bermuda here for a good few years. And what mostly stood out was the flexibility he had. He could look at a lot of different businesses, a lot of different industries. You couldn't really pin him down. Was he a value investor? Not really. Was he a growth investor? Not really. It's kind of an event driven. Not really.

Starting point is 00:30:03 did he put a lot of weight on this factor or that factor, you know, management or not really, right? He was very flexible in the way he thought. And, you know, I think that's absolutely critical and it's just lost today, especially, you know, you go through these periods like the last 10 years where everything's been about compounding, compounding, find the next great compounder, find the next, you know, Amazon, pretty difficult to do. But if you have that mindset of this is how you invest, you need a great management team, they need to be able to invest, a high rate return, right? But if that's your narrative, that's fine.

Starting point is 00:30:36 But you cut off a lot of potential ideas in the world. Because there's only a subset of companies that fit that narrative. If you just go for companies that have great management teams, it's only a subset. If you just go for companies that have a net net balance sheet versus the price you pay, you basically find nothing, maybe a few things in Japan and Korea. So if you only have those specific things that you look for, you know, you cut down your opportunities at massively and inefficiency is generally are quite hard to find. Therefore, you need

Starting point is 00:31:04 a big wide opportunity sense. It's much better to be flexible and it's much better to have a very open mind, an open mindset. I care about intrinsic value. I will buy highest growth stock in the world if it's price below intrinsic value and vice versa. And that's what Alan was like. It's all over the shop. And so it's

Starting point is 00:31:20 great. The flexibility he had and I learned and also a lot from. That's really interesting because I think where people run into trouble is when they take these methods or strategies or philosophies and turn them actually into their religion, right? I mean, Buffett himself, as you kind of highlighted there, who unbelievably, by the way, I think it's more like 99% after his retirement age, which is just, you know, hard to wrap your head around. But I remember he said he's not a value investor. He's just an investor, right? He didn't

Starting point is 00:31:51 want to put a label on it because it's just about laying out capital today to get more in the future. And so I find that really interesting and it makes me kind of curious about you as well, giving your background and having that flexibility. Because when I looked you up, what came to my mind was someone more like Jim Simons who takes his mathematical background and turn it into probably the most successful hedge fund ever in terms of performance. But again, is not so much the value investor type who lets things compound. It's more quant-driven in and out and actually keeps the fund size quite small intentionally.

Starting point is 00:32:23 I'm curious what your thoughts are about that size. of investing versus value investing and kind of how you found your path? Yes, a good question. But early on, I would have said maybe a more quantitative approach was right, given my background. And I looked into that. And I looked into Jim Simons. And I was there was a book written about it recently, wasn't it?

Starting point is 00:32:46 It was quite a well-written book and fascinating his path through that fund and founding Renaissance. and interesting that he was quite a fundamental investor himself as well on and off, despite his background. What put me off from a more pure quantitative endeavor was two things. Number one, I actually think, and this has been very, this has hit home over the last few years, especially, that you need, it's a societal good to have active, intrinsic value-focused investors very, very active in markets.

Starting point is 00:33:24 It's a societal good, and it's almost like, you know, it's almost a really sort of negative thing to say because of the negative press that financed us has had over the last two decades or more. But I think it is critical because if prices get out of line with the underlying value and underlying dynamics of businesses or commodities, then you get huge misallocation of capital because decisions are made on prices. Prices are the key signal of the economy. And so I think there's a, again, it's going to sound ridiculous. There's an altruistic element to investing. And I think we've lost that. When I joined Orbis, 2006-ish, there was a very active management scene. It was coming out of that 2000 to 2006 period where a lot of active managers did very well

Starting point is 00:34:08 because there was a big dislocation in the market that closed. But then over the last 15 years, that's kind of gone away. Passives have come up. There's fewer analysts on company calls. I think there's fewer people doing what we do. So that was, I entered into my mind. If you're a quantum investor, you know, there's an argument that you're improving efficiency, but you're not really, you're not investing like you're buying a portion of a business.

Starting point is 00:34:32 You're not really understanding the fundamentals of that business. It's signals driven. So, you know, I don't think it quite lines up with that as an objective. The second thing is I was always paranoid about what happens if your signal disappears. You know, you back tests to the moon, get all these nice little signals. You can use linear and nonlinear techniques. You can bring AI into it. It could just evaporate.

Starting point is 00:34:54 If you don't have a fundamental basis for why something works, I think it's really hard to put a lot of money behind it, in my view. And if you look at all quant funds across the space, I don't think they've been wildly good, you know, really a mixed bag in terms of the alpha generation and the accessory of turn generation. Renaissance themselves would admit that they have a range of performance profiles within their funds.

Starting point is 00:35:17 And there's one particular fund that shot the lights out. It seems to do it every year and it's capped, as you say. It's incredible. I don't know how they do it, whether it's the technology they have, the data they have, or the information flow, maybe how quickly information is flowing. I don't know how they do it, but across the quantitative space, it didn't look to me like there was any particular edge of going in that direction versus the fundamental direction.

Starting point is 00:35:40 And the advantage of going the fundamental direction, I could come into Orbis and I could look at a track record of 8% gross alpha since inception. And I could look at a track record of 8% gross alpha since inception in the sister company, Alan Gray limits in South Africa, and I could analyze that. What decisions had we made on what basis? How would we deliver such ridiculously high excess returns over such a long period of time? And if I could learn that, right, then I've got something that's sustained, that should sustain. Why should it sustain?

Starting point is 00:36:09 Because it's sustained for 50 years. And it's based on, you know, the fear and greed of human beings and the fallibility of, you know, the markets are not efficiently priced. We've seen that very clearly over the last four or five years with all the mean stocks and everything else that's gone on. And that's why it's interesting. That's why it keeps you. I also find it more interesting, right?

Starting point is 00:36:29 Because you're, you know, you're looking at things more fundamentally, really trying to understand things from the axioms rather than data mining and then let the portfolio run and then tweak. That's a little bit less interesting to me. Now, you threw out this allocation there a minute ago. I was reminded of your thesis called The Greatness Allocation. And I would like for you to share with us kind of that cycle that you define or describe in that article because I think it's a great framework for more of a macro view, even though we're talking about value investing in micro things, but just having, reminding ourselves that we do need probably an idea of the bigger picture to some degree and why things are happening the way they're happening. And you've kind of developed this framework. Can you talk to us about the cycle that you've described here? Yeah, I mean, as you say, Tray, we're bottom up. So we look for mispricings from company to company.

Starting point is 00:37:21 But it's interesting when you go through certain periods when we start seeing opportunities in similar businesses and similar stocks. And over the last sort of four or five years, maybe even longer, we were seeing much more opportunities in what we would describe as short duration businesses rather than the long duration businesses. Short duration businesses being ones that are generated a lot of free cash flow and paying it out. You're getting high dividend yields, high free cash for yields, but they're not necessarily reinvesting those and growing very quickly. But, you know, if you put an IRA on that investment versus the intrinsic value of what we think, the intrinsic value of that business, it was much higher than we were seeing on the other side in those long duration businesses where there was an expectation for high free cash flow at some point in the future, but trading very, very high multiples. So the portfolio was skewing over to the short duration end. And essentially, you think, why is that the case?

Starting point is 00:38:09 As we've seen it before, we saw it in the late 90s. We saw it in the August portfolios in the late 90s. If you go back to 1973, if Alan had launched not in South Africa but in the US, I strongly suspect he would have been nowhere near that nifty-50 area. And he would have been exactly the opposite and done wonderfully well for the next sort of decade as that unwound. So we've seen it three times. And each of those periods, there was a commonality and that was the term premium.

Starting point is 00:38:36 And term premium is not a commonly known, understood sort of thing. When I say term premium, it applies to like the bond world, like a 10-year treasury. People think of the yield curve initially. Well, term is time. Premium is the premium you get on the long yield versus a short yield. It's actually not the typical definition, or at least it's not the academic definition that comes from the central banks and whatnot who calculate this. Central banks are actually one of the core institutions that actually calculate this number.

Starting point is 00:39:04 But I think it's really interesting variable. What it is is the price of time. I call it the price of time. And now there's a book that's just come out by Edward Chancellor, I think has been on your show as well. Very smart chap. And I need to read this book. I'm waiting for the hardback to arrive in Bermuda.

Starting point is 00:39:21 It's been very slow. It's all sold out. So it's obviously doing very well. But he terms the interest rate as the price of time. And I think there's a good rationale for that. But I think of the price of time as more than term premium. Why is it the price of time? So if you get a 10-year yield on a bond, you can break that out into, let's say, three bits.

Starting point is 00:39:39 It should embed expectations for the path of the real interest rate over time, because if the real interest rate is expected to go up, you should have a higher long yield because the expectation for that should be embedded in that yield. It should also embed the expected inflation rate because this is a nominal asset. So you don't want to be eaten up by inflation. So if it was being priced correctly, it should price in that inflation rate expectation. round. So the real year expectation and an inflation rate expectation. But there should be an extra bit you get on top of that. And that bit is called the term premium. And the reason you should get that bit is because you're willing to hold the 10-year bond and not just sort of buy, because you can buy one-year bond and roll it every year and you get the real rate move and you

Starting point is 00:40:23 get the inflation expectation move. So if you're willing to hold the 10-year, you should get something a bit extra, right? You should get compensated for taking on time risk. That's real-time risk. And the reason why you should get that is because the expected path of real rates isn't a path going back to this Talib idea. Many more things can happen than will happen. It's a distribution, right? Real rates could go through the roof. Well, they could go negative. Inflation could go to 20% or it could go to minus 5, unlikely. There's a distribution around these things. And so if there's uncertainty, and that's basically taking time risk, stop happens in time, you should get compensated. So that term premium should definitely be positive, in my opinion.

Starting point is 00:41:05 And it's been positive in the whole of history, but it's been negative for the last five years, which is absolutely crazy in my view, right? So you can point to that as a real inefficiency, real inefficiency in markets that this has gone negative. So the price of time has been negative. That's capitalism turned on its head. Now, if you go back to the late 60s, it was very, very low as well because she had financial repression after the Second World War, and that lasted for a long period of time as they were trying to bring down the debt in real terms. And so that, I think, that low-term premium in the 60s contributed to this massive misallocation

Starting point is 00:41:37 of capital in the late 60s, which drove all the money into the new economy stocks. Why does it drive the money into the new economy stocks? Because if you're not pricing time or time is priced negatively, then a dollar in 10 years is actually maybe worth more than a dollar today, right, in this bizarro world of a negative term premium. So in that world, it's almost rational that you price these growth on new economy stocks. And the new economy stocks in the 60s and the 70s were like the Xeroxes of the world. They were inventing the personal computer, the forefront of all of these different innovations.

Starting point is 00:42:09 They traded it 70, 80 times earnings. Now, they were earning. So it wasn't crazy, crazy, but I mean, it was very, very punchy multiples. So that low term premium drove a big gap between the new economy, the old economy. The term premium was very low in the late 90s as well after the Asian financial crisis, green span cut rates aggressively. And the term premium went very low. And I think that drove the tech bubble. Again, you see this big divergence. And we saw that obviously recently. Negative term premium, QE, massive QE all around the world.

Starting point is 00:42:37 Every central bank can think of huge QE and negative term premium, not even low, negative, phenomenal. And you get an even bigger dislocation in the market between new economy and old economy. So the way I think that, you know, and what does that do? If the share price is a misprice, then the management teams do all sorts of wonky things. Do they not? Because they act on the basis of their share price. if your share prices in the sky, that that's the market telling you, go out and grow, just go and throw money at stuff.

Starting point is 00:43:04 You know, like if you're Netflix, just grow your subs. It doesn't really matter about what you earn. You know, if you grow your subs, you eventually dominate the whole world. You charge what hell you want, right? There's the narrative. And that has a massive distortionary effect on what management teams are doing, because that management team decides to build their own content and just, you know, throw so much money at that because they can lose as much money as they want.

Starting point is 00:43:25 They stop putting films through theatrical release. They're just sort of straight to their platform because any incremental sub doesn't matter if they're giving up hundreds of millions of dollars at the box office. Any incremental sub was worth more than that. Disney did the same. So you see all these sort of pervert, I think perverse kind of capital allegation decisions through periods where the term premium goes negative. And that is bad for the economy, isn't it? And where we're seeing it, right? I mean, there's in shortages, through COVID shortages in raw materials on the energy side, on the metal side.

Starting point is 00:43:55 And we've seen it to a fairly extreme degree, and that was happening before Ukraine kicked off. And I think we'll be, you know, continue over the next sort of five to ten years because the capex levels in primary energy is at the low as we've ever seen. And so, you know, that leads to kind of a more inflationary dynamic, which is what we saw in the 70s and it's what we saw in the 2000s. We don't think of the 2000s as inflationary, but it was. We just had that big outsourcing of labor to China at the same time, which kind of balanced off, but you know, in terms of the commodity push through, it was quite an inflationary period,

Starting point is 00:44:29 inflation expectations, was sort of above two and a half, three percent over that period. So it leads to, it's like a cycle because once it busts, once it breaks, we're in a sort of process of breaking, you know, it becomes self-sustaining. It's a function of not having enough of what we need that drives inflation, that drives the term premium up, that drives rates up, and that drives the destigations to close. We saw that through the 70s, in 73 to 1980, big dislocations closed through the 2000s. And that was the birth of the hedge fund. The birth of the hedge fund was 2000 to 2008 because they had so many inefficiencies to play

Starting point is 00:45:05 with that industry boomed. They could charge whatever the hell they wanted. And then, of course, once all the inefficiencies are closed, they were in a bit of trouble. And so they've kind of waned over the last 10 years. That's the natural cycle. And I think we're quite early in the cycle of that unwinding. It just takes time. Let's take a quick break and hear from today's sponsors.

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Starting point is 00:48:47 And it's interesting to hear you say it's bad for the economy, right? Because it seems like it's so great for the economy in the short term, but you see all these side effects. So we've referenced the 1950s a couple times. It's reminding me of Morgan Housel, who wrote the book, The Psychology of Money. One of his great insights, in my opinion, is that he says, you know, why do we reflect on the 1950s as a sort a golden era. And not only were we reflecting back then, they knew it was sort of a golden era. There are these articles written about, this might be the best time in history, you know, everything was kind of going great after this war and the economy was growing. But his insight is that, you know, due to the highest tax rate being 91% and a few other things, there was actually

Starting point is 00:49:25 not much of a wealth disparity like there is today. And so people's circumstance versus their expectations were more in line. And so since then, the income, per household per capita in the US has gone up three times, but people are still feeling poorer than the 1950s because there is the asset inflation I think you're talking about. That's been a result of these policies. It's separated the circumstance from the expectation. So people have a better circumstance, but the expectation is so much greater given these wealth disparities.

Starting point is 00:49:58 It's very interesting. And I think what we'll start to see and what we've seen in these previous cycles is you start to see more of a labor, a push. to from the capital being the main driver and everyone focusing on that to more focus on labor policies. And I'm surprised it hasn't happened sooner because your average voter should be really angry. Their real wages have been diminished for so long. And it's just been especially over the last decade. And I think it's been covered up a little bit in the sense that you know, you've had a kind of deflationary wave, partly as a result of money, free money getting thrown up businesses that are

Starting point is 00:50:36 giving you free stuff, you know, free delivery of food and all the rest of it. And so it feels like, you know, even though your wages haven't been going up, you've had a little bit of a free lunch, but that's sort of come to an end. And now we're kind of going into the period where I think you're going to start to see more union action, and people can start demanding more in terms of raw wage, keeping up with inflation. And I don't think the political, the central banks are sort of in tune with this. There was the leader of the ECB, the English central bank, came out. and said, don't ask for a pay rise. There's all these bizarre dynamics going on, but I think we'll look back in five years.

Starting point is 00:51:12 This is more of a turning point in terms of real wages starting to rise in a more concerted way, which should be good. That's positive. It's really positive for society. Central banks worry about it as they think it might become unhinged. But if you run, you know, real wage is negative. That's really corrosive for society as well. So you need that return to the power of labor versus capital.

Starting point is 00:51:34 I think we'll be a big theme going forward. And because all of these countries are operating off the same currency type policies, it's a global phenomenon we're seeing. And you mentioned there's different dynamics playing out. We're currently seeing China actually easing, for example, and opening up more as the U.S. is actively tightening. And so I'm kind of curious because I'm so myopic on the U.S. as I live here and I just focus on this market.

Starting point is 00:51:58 But I know at Orbis, really where you guys have really shined are these international, global and emerging strategies. So you're looking all over the world. And I'm kind of curious how you see someone like the U.S. feds policies affecting the rest of the world and how it derives your strategies when you look at places outside the U.S. We try to be, as we just talked very broadly about these macro variable in the great misallocation cap. But we do try to be very, very bottom up. And, you know, that's critical. You look at, we launched child Japan strategy in 1998.

Starting point is 00:52:29 And the topics has done 3% a year in yen. So in dollars, it will be even lower, you know, since that point. It's been awful, right? As an index investor outside of the US where these big caps and drove the index is high. But as a stock picker, you know, Alan used to love Japan because it just had so many niche opportunities of very, very discounted securities where we could go and meet with management teams and help them to understand, you know, the capital allocation framework a little bit better and work with them to maybe improve some of the, you know, decision-making,

Starting point is 00:53:02 especially on the capital allocation side, and then you start to release some of this excess capital, sitting on their balance sheet, or improve some of their dividend policies or investment policies. And it's been fabulously successful over long periods of time. And so you look at some of these indices and you think, well, is there any return outside of the US? There is return. This return is individual securities, massive inefficiencies. Now, does the interest rate environment affect it? It affects everything because it's the price of money.

Starting point is 00:53:30 it's so dominant as a variable in determining asset prices. And that's where we just have to weather those swings. And we just sort of say, okay, we're owning this business with a sufficient margin of safety and sufficient discount to what we consider to be intrinsic value that actually through an interest rate cycle, whether interest rates go up next week or down next week, we feel fairly confident, right, within a probabilistic framework that we are going to generate excess returns in this business over time. And that's the best we can do, right? because these big macro variables are very difficult to predict.

Starting point is 00:54:03 Everyone's looking at them. What edge could you possibly have? And that's just sitting there with Jay Powell's and having a cup of coffee. That price of money you highlighted is, according to data you were writing about in this article, a different article, but you were saying about, you were talking about how the data shows the entire 2022 decline can be explained by just simply higher bond yields. I mean, I'm generalizing to a degree, but versus a few other factors.

Starting point is 00:54:30 Could you talk about what you were seeing in that and how you're kind of deriving what we saw in 2022 and how you're summarizing it? Well, it's, I mean, it is hard to disaggregate, but there's two, I mean, very simplistically, there's two ways you generate investment returns. One is earnings growth and the other is the change in the multiple on those earnings. And a change in the price, the cost of money should necessarily impact the multiple you pay for an earnings stream or a cash flow stream. So when the rate went up, you'd expect to have a fall in a multiple. That's logical, especially given market sort of price off spot rates and nobody's really thinking in terms of, well, the term premium is running negative 1%. You're probably going to go back to normal at some point, which means you've got to put another 2% on the long yield. Nobody's really thinking like that.

Starting point is 00:55:21 So you get this change in the multiple on the basis of the change in the yield on bonds and on that and on the interest rate. And I think, I do think a large portion of the move, the fall in equities in 2022, it would probably be attributed to that, you know, they should, and that's rational. Now it's a question of, well, what next? Do we see earnings reset to some lower level? I don't necessarily, or we don't necessarily worry about the ins and outs of the next quarter, the next year, we're going to see, you know, a recession or things going to get worse from here in terms of economic growth. What I would worry about more structural changes, you know, if you're look at the US, for example, margins are very high, and that's a function, lower labor cost,

Starting point is 00:56:03 lower tax rates, lower interest cost, things that could change structurally. If some of those things start to change, then margins will start to compress. And actually, you might see a longer term, a more impactful margin reset in the US and earnings dropping. And I mean, again, this is a very, very broad argument. We do look at things from business to business. So we don't worry too much about these big picture dynamics. Talk to us a lot. Talk to us a lot of the, you know, these big picture dynamics. little bit about how 2002, although it was very uglier in the markets, was simply kind of wiping out some of the gains just from the year before. So what about the decade before? Just given the move in 2022, was it enough to determine a correction? Historically speaking, if we're comparing to other

Starting point is 00:56:45 eras, is there further to go if you had to guess? Yeah, well, I think markets are still quite expensive. And again, if you have this dynamic of a low-term premium, it just leaves, it leaves, it leaves, a shadow of froth, I would say, and it takes time for mindsets to kind of reset to a, actually, what is a more normal world? When you go back to the 70s, multiples are much, much lower than they are today, much, much lower. And, you know, that was normal then. And then when the inflation started to recede in the 80s, it took a long time for investors

Starting point is 00:57:17 to kind of get over that shadow of the previous decade. And I feel like, you know, we're going to be in this phase where we've had free money for long period of time and that casts a shadow. So people anchor to valuations they've seen over the last decade. Those aren't necessarily real. They might be the aberration. And actually, you should be anchoring on one of the other previous decades where you're in a more normal monetary environment, for example, and a more normal labor environment

Starting point is 00:57:42 as well, maybe a more normal tax environment. All these things you've got to think about. So you could see, you know, I do think the last decade is not a good template for the next. But again, all these things depend on expectations. If everyone in the market believed that, then the prices would be reversed. would reflect and then actually you might get a repeat of the last decade. I think it's not very likely. Yeah, there was some recent data actually showing that even though the last quarter in the US

Starting point is 00:58:08 the inflation was a little bit hotter, the consumer consensus was projecting the inflation to go down by like 2.7 I want to say if I'm going on from memory boost. Even though the number came out a little higher than expected, there's a disconnect between the consumers and the CPI, which is kind of interesting. that I don't find people discussing very often. But when we were talking about the price of money and when bond yields go up, growth stocks, usually the first or I'd say the most affected from something like that for the reasons you've kind of described.

Starting point is 00:58:39 And you've put out some cool research around good and cheap companies and how they can still perform during bear markets. What have you seen in the data just as a, I guess, is sort of a general overview of how good and cheap are still persevere through times where markets can get ugly. I mean, you can, for classic example,

Starting point is 00:59:02 this is the early 70s where you just wanted to be in reasonable cheap businesses. Just away from the pizzazz, as Alan used to call it, just get away from the areas that were everyone is pouring over. We like apathy.

Starting point is 00:59:16 We like areas that just, you know, they're not in the spotlight because they are falling like a knife. They're not in the spotlight because they're the next big thing. They're just not in the spotlight. Nobody's talking about them. Nobody's thinking about them.

Starting point is 00:59:30 And that's where you start to see really interesting opportunities. And in bull markets and bear markets alike, you know, the bear market of the 70s, it was boring real economy businesses with high free cash yields that really excelled. If you didn't own those businesses, you really did very poorly in real terms. In the 2000 or 2007 period, very similar, you know, that very, very wide dislocation. just a tedious retailer on 10 times earnings. You've done exceptionally well from 2000 to 2006. And again, it looks very similar today.

Starting point is 01:00:01 We're finding businesses in a range of different sectors where you have good valuation underpin, which could be the yield. Maybe you're getting 5, 6, 7 percent dividend yield. So not a free cash flow yield, dividend yield. So they have more cash that they could pay they want to do. That's the margin of safety. but that dividend yield growing in inflation-like rates. So if you've got like a 5% dividend yield and a 4% inflation-like growth, you've got 9% off the bat.

Starting point is 01:00:31 And is 9% that bad in this market? It's probably quite good, especially a good sort of solid 9% like that, where your growth rate's pretty predictable and your dividend yield is high. And then if you can pick those up with massive optionality on top, where there's two or three things that could happen that lead to not your 9%, but more like 4%. 50% upside, then you have a very asymmetric situation where your downsides very low. You're upside, especially if you can get a lot of these different options in your portfolio. And that comes back to the Kelly criterion, your little tiny little edges left, right and center in the portfolio. And I think that's kind of where we're positioned today in those types of opportunities.

Starting point is 01:01:12 And you are physically positioned in Bermuda. You were referring to Alan describing pizzazz right with these markets. and I'm reminded of Buffett moving back to Omaha to kind of get away from the noise. Do you find that being physically in Bermuda similarly helps you keep distance? I mean, even though you're so close to New York and some other, obviously, markets, does it help you kind of keep a clear mind looking out of the stars as we described earlier? It's fabulous, really is. There's very few places like it because you almost want to be in a library-like atmosphere.

Starting point is 01:01:45 So you can just think and develop a view. independent view, you can read, you're not surrounded by different opinions being thrown out you left, right and center. But to be in those types of environments, it's almost like you're out in the country. Now, it's no easier in the modern world of remote working. So Bermuda isn't so unique anymore. But in terms of having a good, solid financial center in a very, very small place, that's hugely efficient and convenient. So if I want to get to work, I can walk. five minutes, pop and see my kids at school doing a sports day. Everything is so efficient and so no time is wasted.

Starting point is 01:02:27 There's not a minute. Every minute I spend, I mean, they're doing something productive where I'm enjoying my family. If you're living in big city with all the noise, it is hard to focus. Also, it's inefficient, right? You've got a lot of commute, you know, getting from place to place. It's really difficult. I do love London, love New York. It's big cities.

Starting point is 01:02:46 They've got a buzz about them. But I don't love living. there. Well, Graham, this is so much fun. I really appreciate you coming on the show and sharing a bit more about your philosophies and strategies here. I really hope we can do this again. Thank you for the book references as well. We'll provide them in the show notes. Before I let you go, is there any other resources where people can go to to to find more about you or Orbis or Al and Gray or any other resources you want to share before we go. Thanks, Trey. There's a lovely discussion. In terms of resources, as I said earlier, we have very little social media presence. We have very little social media presence.

Starting point is 01:03:18 are reclusive, I would say, but if you go to the August website, www.orgas.com, and you can choose a region you want on that website, and you can get all of that information on the funds. One thing I should have mentioned was that one thing that Allo was passionate about was almost some democratizing investment, because, you know, if you are an ordinary person, right, you're working in some field, you need advice, right? You need advice and handholding when it comes to your finances.

Starting point is 01:03:48 And one of the issues with the industry, in my opinion, is the layers of fees you pay to get that advice. You've got the advice and then you've got the actual fees you pay on. So Alan was a big believer in going direct to a firm to go to the website and you can invest directly. You can't do that in all regions based on what we have at that moment. But it is our plan over the long term to develop that ability with new clients to have a much more frictionless way to invest in. excess return strategies. So if you go to the website, there's a lot of information around Orbis and both on the institution and the retail sign.

Starting point is 01:04:27 Graham, I really appreciate the time. Thanks again. Thanks, Trey. Thank you. All right, everybody. That's all we had for you this week. If you're loving the show, don't forget to follow us on your favorite podcast app. And if you'd be so kind, please leave us a review.

Starting point is 01:04:40 It really helps the show. If you want to reach out directly, you can find me on Twitter at Trey Lockerby. And don't forget to check out all of the amazing resources we've built for you at the investorspodcast.com. You can also simply Google TIP finance and it should pop right up. And with that, we'll see you again next time. Thank you for listening to TIP. Make sure to subscribe to millennial investing by the Investors Podcast Network and learn how to achieve financial independence. 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

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