Current Investment Opportunities w/ Tobias Carlisle (TIP454)
Stig Brodersen (00:00:58): Welcome to The Investor’s Podcast. I’m your host Stig Brodersen, and I’m here with Tobias Carlisle. Tobias, what a day to be having this interview. Thank you so much for joining the show. Tobias Carlisle (00:01:08): My pleasure, Stig. I always love chatting
to you. It’s great to be back. Stig Brodersen (00:01:13): Toby, it’s May 27th, and the S&P 500 is down 15%, the NASDAQ is down 25 year to date. But before we get to all that, it’s just crazy what we’re seeing right now in the markets. First things first, I saw that you
rang the bell on the New York Stock Exchange the other day. I have to ask, what was the occasion? Tobias Carlisle (00:01:34): It was the third year anniversary of the listing of the Acquirers Fund of ZIG. If you know anything about ETFs, you might know that the big dates for ETFs are the third year, to get to the third year. The average ETF fails by the third year. It was good to get through. I thought we’d have a celebration, so I
took my wife and kids, and some extended family and the team and everybody. We all went to New York. You can’t otherwise get into the stock exchange. You can’t walk the floor. You can’t do any of those things without some sort of special invitation.
Tobias Carlisle (00:02:04): By virtue of the fact that we’re listed there, you can do those things, so we went in. You get this great tour around the whole building. It’s a really beautiful old building. They point out where there was a terrorist attack in 1909, when they tried to drive the horse buggy full of explosives through one of the walls and blow it up. Apparently the damage is still on the outside wall because JP Morgan didn’t want it cleaned up. He wanted some sort of reminder of it on the wall. Then we rang the opening bell. That day was the worst day for the stock market
since June 2020, so I’m sorry everybody. That was partially my fault. That was the terrible slippery finger on the opening bell caused that. Stig Brodersen (00:02:43): I can’t help but wonder because we do see this on CNBC or whatnot and someone does ring the bell. Do you have any kind of specific criteria for what it takes? I know in your specific case you said it was like three years after the ETF was listed. Is there any kind of… You need to meet this checklist? Tobias Carlisle (00:03:02): It’s fine. It’s not easy. Any IPO has precedence, so you have to be very flexible about when you can do it. Then we’d been
negotiating for a little while, for a day. It’s been helpful that for a long time, the stock market was so strong. There was so many IPOs that it was hard to get… There was just an IPO every single day and we needed this sort of volatility. The fact that the stock market is down 15, 20%, whatever it is, since the start of the year, that was helpful to us because it meant fewer people were going public. That’s one of them.
Tobias Carlisle (00:03:33): Then being listed on the stock exchange is another one that helps unless you’re sort of some very prominent person. I’m not at all. I just got it because of the listing. I just thought it’d be fun. I just wanted to take the kids and show them. We walked the floor. They’re all too young to know
what’s going on, but I just wanted to give them the experience. We did a whole lot of touristy stuff in New York as well. We went and saw Lady Liberty and went, and looked at the Empire State Building, and the Brooklyn Bridge, and the Highline and all of these really fun little things for kids to do. It was mostly like a kid’s vacation, but the rest of it was ringing the bell. It was fun. Stig Brodersen (00:04:06): You were there with your beautiful family. You were looking into the camera, and I don’t know what they told you, but it looked like they were saying, “You need to look into the camera. Then at some point in time, Dad
is going to like push a button and then just clap, just smile and clap.” The kids are like, what is going on? It was just a great, great video and I guess a really fun family memory already. Tobias Carlisle (00:04:28): Yeah, it was cool. I tell you there’s all of that like clap really hard, pretend you’re really excited, and you start the clapping off. It’s a little bit artificial, but it’s fun. But then it’s very loud. The bell is very loud, it gets going. It’s a beautiful old building. Then they’ve got… Everybody knows what the floor looks like with all of those computers and with all of the guys in the blue jackets. CNBC’s booth is this right there in front with whoever the morning crew
is at the day. It was cool. It was a really fun experience, one I won’t forget in a long time. Stig Brodersen (00:05:01): Easy to understand why it looked amazing. Toby, we are here to talk about these current market conditions. The markets are just so volatile these days. Now, we actually seen a small rebound in the market. The DOW just
rose for the fifth, sixth straight day. The S&P 500, NASDAQ are poised to stop their seven-week losing streak. I have to ask you, what is your 30 FT thousand view of the financial markets right now? Tobias Carlisle (00:05:30): The way that I think about the market is on a valuation basis. If you look at any of those very long-run valuation metrics of the market… I’m talking about like the Shiller PE, The CAPE, cyclically adjusted PE, Tobin’s Q, which is the replacement value of assets over the market value of those assets or Buffett’s measure, which is GNP, Gross National Product on total market capitalization.
By any one of those metrics, we’re still very, very expensive. That doesn’t mean anything. Tobias Carlisle (00:05:55): I would’ve the same thing in 2016 at the bottom, in that drawdown. I would’ve said the same thing in 2018 in that drawdown. I would’ve said the same thing in March 2020 at the bottom of that drawdown. The fact that it’s still very expensive doesn’t stop it at all from bouncing and going to brand new highs from here. I have no idea what direction it’s going to go. I just think that the role of valuation is it gives you some sort of expectation for what you can earn over the longer run.
Tobias Carlisle (00:06:26): At the top, before we had this fall off, it had got to virtually… You had baked into the returns a negative return on the index, and then you were going to get some very small, positive return by virtue of the dividends that you were going to receive, which were well below what they are on average in any case on a yield basis. But all of that means that over a decade, you’re probably not going to earn very much in the index. Tobias Carlisle (00:06:51): Having said that, I don’t know where we are in this drawdown, but the thing that characterizes the very big bear market drawdowns… You can look at this in a 2000-2002. That’s what I would characterize as sort of a mega bear. That’s the way some people describe it to distinguish it from flash crashes. We would say that March 2020 was a flash crash. It went down very quickly, but it also recovered very quickly. Not many people took advantage of it. Buffett didn’t buy anything on the
way down. If you go back and look at 2000-2002, 2007-2009, the thing that characterizes those drawdowns is that they had many, many bounces and the bounces are very big. Tobias Carlisle (00:07:34): We’re talking like a 25% bounce off the bottom. That then turns into a lower low, and it happens 14, 15, 16, 17 times. It’s that constant sort of bounce to a lower low that is the thing that ultimately just destroys your confidence in your ability to invest or your desire to be in the market. That’s
why most people tend to be, “Just stop the pain. I’m getting out. It’s March 2009. We’ve been going down for two years. We’ve seen 17 lower lows. This thing’s going to keep on going forever. I want to pull my money out now.” Tobias Carlisle (00:08:10): Then it’s at that moment of maximum pain for maximum people that the market finds its bottom and rockets. Knowing that it’s impossible
to predict on any metric that you can think of… It’s just impossible to work out where the market’s going. The best idea is to sort of follow whatever your personal investment plan is. I’m young enough that I’m fully invested in the market. I’m fully invested in the market all the time. I hold cash for beyond my living expenses, not much. Everything else is in the market because I think that the stuff that I’m invested in, I can see the embedded returns, the expected returns out of those things. I think they’re quite good. I think that they’re better than…
Tobias Carlisle (00:08:48): Value has trailed for a long time. When I look at my stuff, I think that it’s… I do think that there’s this portion of the market in the cheapest decile of the market in the US because that’s where I’m looking. That’s where I’m talking about. Those stocks are so far away from the index. They are as far away from… They’re further away from the index in terms of evaluation than they were in 2000 at the peak and 2009 at the trough. I know that sounds funny to describe them that way, but that’s really the way I think about it. I’m looking at
the valuation of the portfolio relative to the valuation of the index, and they have never been as far apart as they are right now. Tobias Carlisle (00:09:29): The ratio is significantly higher than even the MSCI. I think, on that basis, there’s a very good chance that the very undervalued stuff has a good run here. It may look something like 2000 where the index is soft for a long period of time, but value, which is disappointed for so long, actually starts to get its run.
I think that’s already underway. I don’t think that has to happen. I think that’s already started happening. I think if you look at most value portfolios, including mine or if you look at the french data, the Fama-French, the french data is available free online. Tobias Carlisle (00:10:06): It’s not super easy to manipulate, but I know there are lots of young guys out there who are able to manipulate this stuff. If you go and grab that data… I do this all the time. The data’s out there for free.
You can have a look at how wide the spread is, and you can see that the spread started closing in about September 2020, September, October, November, depending on which ratio you look at. They all find their bottom around that point. Since then, they’ve been outperforming the market. Tobias Carlisle (00:10:29): That’s my expectation that even though the market is very expensive, we don’t know where it’s going to go, the only way that you can approach one of these problems like this, where you don’t know where the market’s going to go, is to start valuing stuff. If you look at these things on a valuation base, I think there’s some very good value out there. There are very good businesses with rock solid balance sheets. If this is not the bottom, it’s no sin to hold these good businesses when they go through a period like this provided that it’s the sort of business that… It’s not the sort of business… It’s not say a credit card company where it’s squeezed on both sides, and it might find that it has people unable to pay through a period of time like that.
Tobias Carlisle (00:11:07): You should be wary of that sort of business model, but for most businesses, people don’t change their behavior that much when there’s a stock market crash. For most people, it’s not relevant to them. People will still be buying Domino’s pizza through this stock market crash. People have some odd behaviors when stock market crashes go on. People can’t buy big luxuries anymore, so they buy little luxuries. They call this the lipstick effect. People may spend more money on small luxuries. Tobias Carlisle (00:11:35): You might find that there are some luxury businesses out there, ostensibly luxury businesses… Even though the units of product that they sell are cheaper than the very big ticket items. They might not even know that there’s
a recession going on. They may just print money through this whole thing because people take those little… Starbucks might have that. Some of the makeup companies may see that. You may see that in the consumer discretionary. Tobias Carlisle (00:12:02): That’s the way I think about it, that while there is this big risk that we do have this very big drawdown. I think it’s probably likely that we do continue on down from here, but I don’t know. I think that it’s not
really relevant for most investors. You should be going through and looking at the underlying businesses in any case. Stig Brodersen (00:12:20): There’s typically always a good narrative. You turn on CNBC, and they’re always, the market went up by 0.4 or went down by XYZ. They’re always like, “Oh, it’s because of this.” The thing is we don’t know. We don’t know if 12% of the reason was because of SPACs or the drawdown or because of the interest rate. We probably have an idea of that, but how much of that is it? That’s
one of the challenges for all investors. Stig Brodersen (00:12:45): I do want to say that it feels emotionally different than March 2020. Let’s just leave the whole pandemic aside. That in itself was different. I remember I was asking myself, “So what’s a pandemic really?” I think
most of us know that now, but it certainly feels different in many ways. The drawdown at the time was much faster and was also more event driven. It seems today like someone that is value driven… And I’m not talking about value investing, but simply because of the valuations right now. Stig Brodersen (00:13:17): Of course, some of that could be attributed to a rising interest rate also, but it certainly seems like some of the… I don’t know if the right term is easier money, is gone. I was sitting there reading this memo by Howard Marks. I subscribe to his write up. It’s actually wonderful. He talked about how the
average SPAC that was de-SPACd since 2020 by completing the acquisition, is selling at $5.25. If you might remember, these day prices would be $10 for something like that. Just to give you one of many, many data points of what’s going on, is probably also why you see this sell off in tech. Keep in mind though, whenever we talk about tech we always discount these cash flows and in tech, definitely not all tech, but generally in tech, the cash flows are further out. Whenever you discount that back to today, you just get a low valuation. So it does make sense that tech stocks are selling off faster than other stocks. But of course you can also again, point to the valuation.
Tobias Carlisle (00:14:23): Yeah, I think I tweeted a few times when the SPAC burn took off, that I remember 2009 pretty vividly 2008, 2009, because the same thing happened, all the SPACs traded down below their issue price. And the game became, can enough people in an activist sort of sense, buy this SPAC to force them to not do a deal and return the cash because if a SPAC has a $10 in cash behind and it’s trading at $5. If they can’t complete a deal by the two year window that they get to do that, they have to return the capital. That’s a pretty easy double in this market, $5 to $10. You have some… They’re heavily incentivized to do a deal because they get 20% of the capital in the company. They really, really want to do a deal. Tobias Carlisle (00:15:12): The investors outside really, really don’t want them to do the deal. You can see a little bit of fireworks. That’s almost certainly
about to start happening. I just think that it’s funny how I don’t think that I’ve been in the markets for that long, I’ve been watching for about 20 years. I think it’s amazing to me how regularly the cycles come around and how short everybody’s memories are. SPACs were just, it’s just cash at a premium to cash, but it’s cash dressed up as equity trading at a premium to cash. And when people see that in the market and they trade at a premium, that’s your signal that probably it’s getting too frothy and there’s a downward coming. Stig Brodersen (00:15:47): Yeah, I think that’s a good point. We tend
to have this linear way of thinking. I mentioned, in March 2020 before we had this idea of, this happened last time so there’s a high probity that it would happen again. That’s generally not the case. History does rhyme, but it doesn’t mean it has to rhyme on the
last recession. So, or the last bear market or, or whatnot. Tobias Carlisle (00:16:07): When people are paying a premium for cash that says that the market’s too speculative. Now they’re paying a discount for cash, which says that probably the market’s expectations are too low, but you know, $5 for $10. It doesn’t really make any sense. There’s some risk in them, whether they do a deal
or not. But if it traded at $8, then it’s already accounting for the 20% dilution. At $5, you’re in a pretty good position. Your worst case outcome is that they do a deal and you get diluted, and it’s now worth $8 in the acquisition provided that they do a sensible acquisition. If $5 is probably too cheap, it’s some indication that the market is becoming disconnected from underlying values, and we may be closer to a bottom than not. Tobias Carlisle (00:16:46): But I really think it’s impossible to tell for the reasons that you highlighted before that they can be talking about, somebody said something and it gave the market confidence. One of the Fed chairs came out and said something
and it gave the market confidence. But what really happened was that some big hedge fund was blowing up and covering it’s shorts and it looked like a big rally. That’s what makes investing so difficult because it’s really chaotic. It’s sort of closer to chaos than it is to some sort of orderly, sensible, logical thing. Everybody’s doing different things for different reasons. The sum of all of those is the trajectory of the market, but we don’t really know why anybody’s doing anything underneath.
Stig Brodersen (00:17:27): Buffett has taught us that we should focus on micro and not macro. In other words, we should focus on the individual company. That being said, even individual businesses have to consider that interest rate is creeping up right now. Even if they don’t have say debt, they have to refinance shortly. They still have to take notice of the macro environment. Perhaps the company has customers, suppliers, who are positioned differently than they are. But I want to throw that over to you Toby and say, so we are going from this low interest environment into this high interest rate environment.
What are the core two or three most fundamental changes for us as value investors given this new scenario? Tobias Carlisle (00:18:06): Let me just, just to be painful, let me challenge the first assumption. Cash is a commodity and the price of cash is the interest rate. You limit the errors that you make your best guess for where a commodity price is going to be in 12 months time, is where it’s trading now. I know that doesn’t make any sense at all because they wiggle around so much, but that’s the point that you’ll make the fewest errors in guessing where a commodity will be, by guessing it will be where it is now. Because it could be up and it could be down and you don’t know on the average of all those guesses about where it’s trading. That doesn’t apply at the very extreme.
When oil was negative $37, it was probably more likely that oil was going to be positive in a year or so from there. Tobias Carlisle (00:18:47): When interest rates were exceptionally low, probably more likely that they were going to go up. Having said that, the fact Europe had negative rates meant that we, it wasn’t clear that the US for example, could avoid negative rates. That was a discussion that was going on for a long time, whether America would go into negative rates, and America may still go into negative rates. I don’t know where it’s going to go, but it does seem more likely now, given that the inflation numbers over here are running so hot, that the Fed at least can’t lower rates. They may have to raise rates from here. The rates are approaching their long run mean, they’re
still lower than their long run average, but they’re getting closer to their long run average. When that happens, Buffett says it acts like gravity, the stock market. Tobias Carlisle (00:19:37): The reason is if you’re doing a discounted cash flow analysis, or you are doing any kind of… I don’t do DCFs, but I still know that the 10 year is, I think of the 10 year as the hurdle rate, it’s pushing up about three, the long run average is about six. It’s been as low as 0.3, I think got in the depths in March 2020, 0.3 to three. That changes your assessment of val… If you were
just to plug that naively into a DCF that changes… A tenfold increase in the interest rate, should reduce your valuation by something like 10 times, a doubling of the rate should reduce your assessment of value by about half. If you look at the long run average and you plug that in, that’ll reduce your DCFs again. If you look at where they got to in 1982, which was the absolute peak of interest rates in the US under Paul Volcker, there aren’t very many companies that are going to be worth book value. Tobias Carlisle (00:20:36): If that’s the case, there will be some, but there aren’t just… There aren’t going to be very many, it’s going to be the best of the best that are worth more than book value in that environment. Most companies
will be worth less than book value in that kind of environment. Because with the way that I think about valuation, if there’s something out there that earns 3% with no risk, other than duration risk, which is the wiggling around of the price. If interest rates go from three to six, the 10-year will halve, and something else that’s got a 3% free cash flow yield on it should halve as well. Because it’s no longer worth book, it’s worth half book now. Or it’s worth half where it’s trading at least. That’s the way I think about it. The risk is really to the valuation of everything your freights go up, but then you have other factors in there that make it a little bit more complicated because banks will learn a little bit more money.
Tobias Carlisle (00:21:27): They’ll get a better spread between what they’re lending and what they’re earning. Although they’ve got a pretty good spread now, from the difference between my checking account and my credit card, it seems to be pretty wide in. They’re doing okay, I’m not about them. Then businesses that are highly levered will struggle too, with too much debt. That will be harder for them. They’ll have to roll the debt or hold that debt for a long period of time. It’s not a simple matter
of saying that everything will come down. It is a little bit more complicated because higher rates do help some businesses. They do hurt some leverage businesses and they change valuations. It is going to be very, very complicated when it happens, but on balance,
I think that valuations inevitably have to come down. Stig Brodersen (00:22:11): Yeah, it certainly looks like it. I could just say that here in Europe, the boss at the European Central Bank, she said that we would stop having negative interest rate in around September. That was her expectation right now. So… Tobias Carlisle (00:22:29): What does inflation look like in Europe? Stig Brodersen (00:22:29): It’s around 7% right now. So… Tobias Carlisle (00:22:30): Oh so it’s hard. Stig Brodersen (00:22:31): Yeah, it is running pretty hard. The economies
here in Europe are just structured very differently than in The States and the labor market isn’t as tight. So I’m not surprised that they’re doing what they’re doing now, but I do expect that you won’t see it to the same extent as you see in The States, our economies aren’t doing as well. No surprises there. That’s probably why you would see higher interest rates, but not as high as in The States. Also of course, why you see such a weak Euro right now with the capital influence into the state. Hey, so Toby, I wanted to talk to you about
positioning in these, market conditions. You would read a lot about bear market these days and they say, “oh, it’s when it’s down 20%”, there’s not like a big difference if it’s like 19.9 or 20 point whatever. Stig Brodersen (00:23:21): But we did see an intraday last week of the S&P 500 in bear territory. Most investors would probably say it’s more, it’s more mental, more than a specific number, which was what you were getting at before Toby, about losing that confidence in the market. But regardless, I’m looking at one of your
funds like ZIG, and you are a deep value investor. I can see that the correlation short-term has been quite significant, which is more or less the case for all assets. Whenever something happens, things go down at the same time. What is the correlation between something like the S&P 500 and deep value over time? Tobias Carlisle (00:24:00): Anything that is… So ZIG is a long-only product, that is a change since December last year and we’ll talk about that in a little bit, but it’s a long-only product. That’s a little bit more concentrated, but it still holds US assets. It’s not going to offer a wildly divergent performance from the S&P
500, just by virtue of the fact that they’re drawing from the same pool, essentially, although ZIG buys smaller companies in the S&P 500, but everything is pretty tightly correlated. Particularly when you go through an event like this because this is one of the things that investors will say, that correlations go to one, which means when people are panicking they don’t sell what they want to sell, they sell what they can sell, and just anything gets tipped up. That’s why it’s such a great opportunity if you are a… That’s what creates the great opportunities for value. Tobias Carlisle (00:24:54): I think value typically does… The two times that value seems to really stand out and the times that value doesn’t do very well, the tail end of a BALL market is terrible for value investors because I’ve observed this, that value tends to sell off before the market does. Value will have this sort of sell off.
I think partly that’s what’s happened over the last few years. I think the market has looked expensive and toppy, and the market value sort of sold off and then recovered a little bit, and then sold off again and recovered a little bit, and sold off again. March 2020 was a great example of that, where value got sold harder than anything else.
It was a really unusual thing because my portfolio tends to be net cash. The companies in there tend to have more cash on the balance sheet than debt. Tobias Carlisle (00:25:36): The market itself tends to be more debt than cash. That should have a higher, if you think about the equity as a portion of the capital structure, I don’t want to make this too complicated for everybody, it gives it a higher beta. It gives it a high, it should move more. The market should… Something that is levered
should move more than something that is unlevered from financial theory. My portfolio was moving more than the rest of the market. There was… It was just general sort of… It’s possible that it was like, the stuff that was going to be online was going to do better in a pandemic type world, and the stuff that’s more physical bits was going to be more difficult in that kind of world. But whatever the thesis of the market was, the beta on my ETF at that time was higher than the market.
Tobias Carlisle (00:26:21): It went down more, it ended up being at the bottom. It was down about the same amount, roughly about 37% each, and then they bounced off there, but we didn’t bounce as hard as the rest of the market did. That set of circumstances persisted until we got all the way through to September 2020, and of that sort of last quarter of 2020, which was when there started to be a little bit of differentiation where value started working again. I think we saw what was a little bit of a crash, what is typical behavior of value versus the market that we tend to sell off first. In that instance, we sold off more, but I don’t think that’s ordinary behavior. Then the recovery was slower, but it did eventually kick off and then value started performing very well.
Tobias Carlisle (00:27:07): That was one of the things that helped value for a while there from September 2020. It was only a very short burst and it sort of stopped working again about April 2021. At the time ZIG was long-short. ZIG’s shorts really started working last year because I tend to be short of the stuff that… I don’t mean to pick on Cathie Wood, but I tend to be short more Ark’s type, her ETF Ark, those sort of holdings were the sort of stuff that I tended to be short. The stuff that didn’t have the momentum in. So a lot of the performance last year in ZIG was as a result of the short book going down a lot. That helped disguise the fact that the longs were a little bit
soft. Now we’ve got to a point, I think where the longs again were soft going into this until sort of April, and then since April… Tobias Carlisle (00:27:58): This is only the end of May so it’s not a very long period of time, but I think we’re now in the teeth of the drawdown, and in the teeth of the drawdown value starts looking better again. When everything’s selling off, value seems to hold together a little bit better value will find a bottom first and it will bounce harder. That’s the typical behavior from value because these are the
things that have been sold out the most. I’m very optimistic about my biases, that I would like a crash, because that’ll be the thing that will help value. I also think we just, generally, it’s better for humanity if things trade closer to what they’re worth so that everybody participates on the upside and you don’t have these huge crashes, which we’re probably overdue for one. Tobias Carlisle (00:28:43): To get back to normal valuations, it’s a long way down still from here. I think that I try not to think too much. I’ve said this
before, but I try not to think too much like a stock market operator, trying to predict all of the wiggles and what everything’s going to do. I try to think more like a business owner, which is looking at the cash flows and so on, but I’ve been doing it for so long. I spend a lot of my time looking at backtests as well. I have an idea of the typical behavior of the market and value. I think that we’re seeing pretty typical behavior now where value has started out performing a little bit as the crash gets underway. The other thing that I’d point out is that this was, Ken Fisher pointed this out, and I’ve said something similar in the past, but Ken Fisher said that the first two-thirds of a bear mark, you see about one-third of the drawdown. In first two-thirds in time, you
see one-third of the drawdown in magnitude. Tobias Carlisle (00:29:42): The last third of time, you see two-thirds of the drawdown in magnitude. That just that sort of waterfall type looking shape. But through then, you’ve got these wiggles, you have the market bouncing all the way down, you have the 17 bounces or whatever it’ll be. I think we’ve gone through the two-thirds of time that give us the one-third of drawdown. Probably what we have in front of us is the one-third of time that gives us the two-thirds in drawdown. What I used to say is, what I have noticed on average, looking back at the S&P 500 to, I think, back to 1850 or something like that. The typical length of time for a bear market is about 18 months. The first
12 months, nothing much happens. You’re basically almost back at all time highs 12 months into it. Tobias Carlisle (00:30:29): And it’s that last six months that really terrifies people. That’s the really hard sell often. So 2008, 2009 was about 20 months
from top to bottom. The selling really didn’t get underway until Q4 2008, Q1 2009. I sort of think that’s, we’ve probably not… If this turns into a mega bear, we haven’t really seen the big selling yet. I think it’s probably about to kick off anytime soon, but if it’s just a regular old market, we probably rally back from here. I have no idea what’s going to happen. I just find it helpful to think through these scenarios, so I don’t
panic when we get the really hard sell off. I’ll say, well, this is sort of what we were hoping for, now we’re going to get some good valuations that’ll help performance on the other side, this is a good thing. Definitely don’t sell all your positions out because you think it’s going to go to zero.
Stig Brodersen (00:31:18): So Toby, keeping that in mind and knowing the performance of last year, and you said some of that performance came from the shorts. Also your… I wouldn’t say your expectations, because that probably wouldn’t be reasonable, we don’t know what’s going to happen in the future. I can’t help but play devil’s advocate here and say that ZIG transitioned from a long-short to a long only and to active management. Why is that? Given what you just said there before?
Tobias Carlisle (00:31:45): It was a philosophical change. I’ve had this… I think that the pandemic had this impact on me that I realized that really it’s possible to do very well in the market, provided that you stay in the market for long enough because I’ve been watching. Value’s been underperforming for a very long period of time. It’s been miserable, being a value investor, particularly the way that I practice.
I shouldn’t say this, there are some guys out there who are at the much growthier end of the spectrum and they did seem to do better and they understood that market better than I did. I didn’t understand that market. It took until September 2020 when we saw that finally turn around, and I probably didn’t realize that it was happening until 2021, that we were actually starting to outperform all of a sudden. Tobias Carlisle (00:32:28): That had this sort of profound impact on me, where I started thinking that really the key to this business and Buffett has been saying this for a long time. I just haven’t been listening to him or hearing what he was saying and a lot of other investors too, the key to performing over the very long term is staying in the market for a very long period of time and not blowing up. You just have to survive.
If you can survive any market, there’s always… There’s so much luck and opportunity in the market, you just have to be alive to capture it at the time. I started going through all of the sources of risk in my portfolios and all of the sources of risk in my life. One of the things that I found in the portfolios and I thought what other ways that people have blown up in the past? Too much debt is an obvious one. Tobias Carlisle (00:33:18): People blow up with too much debt, overpaying.
You can overpay it. You can be down 90%, we’ve just seen that happen to a whole lot of companies. You can have a business model that is akin to picking up pennies in front of a steam roller. I think some of those credit businesses, I don’t want to name them because some of them look cheap. They kind of- they do decisions to make, but I think that on balance, I’m
probably going to avoid them because they have a lot of embedded liability in there. They may be unable to collect on some of these credit cards, those sort of businesses. The other thing that’s in there is of course being short because the short has unlimited loss potential. Now I shorted very small. I rebalance regularly. I’m in stuff that has no momentum and I’m in stuff that has no intrinsic value, shocking financials.
Tobias Carlisle (00:34:02): But I realize that when you go through a market where AMC rallies, the way it does or the AMC and GME rally, the way that they do. That took out Melvin Capital and Gabe Plotkin has been a good investor and that fund is now wound up. I just started looking at all of the potential sources of risk and I realized that being a little, even shorting, even though I think that there was about as little risk in the shorts as you could possibly have put in, there was still some risk in there. I just thought I’ll just eliminate every source of potential risk in a portfolio. The switch from passive to active was really, it’s just a change in form rather than a change in substance. That’s just me rather than passing… The way that you run an active, a passive fund, is you have to create an index and you give that to an index provider and then the index provider provides that to a sub advisor who trades the portfolio with active management.
Tobias Carlisle (00:34:56): You just cut out the index provider or the way that I invest, I cut out the index provider and my sub advisor and I just deal with each other, the way that any other fund is run, the way that Ark is run, any other fund, any traditional sort of mutual fund or hedge fund or managed account where I can trade the portfolio. I don’t do any trading personally, but I give them the portfolio to trade. That’s really no great change, but it’s worth mentioning just because there have been some tax reasons why you couldn’t be an active fund in the past and they’ve now taken away those reasons.
It’s an active fund that has all of the capital gains, tax advantages of a passive fund. Stig Brodersen (00:35:34): How does that work in practice Toby? Whenever you say that you don’t do any of the trading yourself and you ask someone else to do it, is it specific ‘please buy 50,000 shares in Disney, but only up to this price? How does that work in real life? Tobias Carlisle (00:35:49): You could, I could hire in a trader and I could do that trading myself. It’s just, I don’t have any great expertise in trading and I don’t particularly like it. I’m not a very good trader. I know there are people who are very good at getting the low or the higher of the day or getting the debt price.
I’m not that person. I do all the wrong things when I try to trade. I’m better at finding a firm that does it professionally, that has all of the market depth and all of the experience and expertise and they just know how to work a position and get it on or off. I have a firm called Toroso that does my… They’re my sub-advisor, that’s all disclosed in the prospectus. I tell them what I want the portfolio to look like. Tobias Carlisle (00:36:29): Then they trade the portfolio to look like the model portfolio. Then over the course of over a period of time, the model portfolio
starts deviating from what the fund’s portfolio looks like. At that point, I’ll go back to them and I’ll say, I’d like you to trade the portfolio back into this, we want to have this much of this and this much of this and this much of this, and we’ll need to sell some of this out. Then they will trade the portfolio back into line with what I regard as sort of the optimal portfolio at that time.
Stig Brodersen (00:37:00): Let’s say that, just using Disney as an example, let’s say it’s trading at 105 and you think that’s it’s a good position. You want to build a 2% position in it or whatnot. Then for whatever reason, the price goes up to 120, do they just call you and be like, “are you still sure Toby?” Or do they just execute the trade because that’s what they’re being asked to do? Tobias Carlisle (00:37:22): They execute the trade. There’s never that much movement in a position, but in that event, yes they would send me a note and say, this has moved a lot, what do you want to do? Or it’s received a takeover bid, what do you want to do? Because that’s happened, that happens all the time. Something gets… Particularly because of the way that I invest, I tend to be in stuff that’s financially cheap. If companies have a strategic reason why they want to own it, there’s a high proportion of, there just tends to be a high proportion of trades in the portfolio. There are a few
takeouts. Stig Brodersen (00:37:53): Interesting. I would like to start with a quote here for the next question, by Sir John Templeton. He famously said the four most dangerous words in investing are ‘this time it’s different’. Keeping this in mind,
what I want to say is different compared to all of the markets. We now have a level of inflation that we haven’t had in a long time. It seems like the Fed is between the rock and hard place. Stig Brodersen (00:38:19): They can of course, ease monetary policy to support the financial markets, but inflation will run hot if they do. It can also hike
rates to fight inflation, but then financial markets will tank everything else equal. Whenever I think about deep value, which is where you’re an expert Toby, I’m thinking that inflation is on one hand, less of a worry because you want to buy very cheap stocks where the cash flows do not have to be discounted from far in the future. But the other hand, many deep valued stocks also have a lot of tangible assets that you do not want to hold in time of inflation. SO you have your pros and cons. How is deep value performing in inflationary times? Have you decided to tweak your portfolio due to some of those concerns? Tobias Carlisle (00:39:05): Yeah, that’s a good question, thanks for that. I don’t change what I’m doing depending on what I think the macro backdrop is. Because what I’m trying to find are things that are so wildly mispriced, that it really doesn’t matter what happens in a macro sense. Just to talk about my process a little bit, the
first thing that I do is go through and eliminate anything that has the potential for a total loss of capital. I do that in lots of different ways. One of them is statistical. I just go and look at, do these things have reasonable Altman Z-Scores? Do they have financial strength? Do they have any indications of fraud? Do they have any indications of earnings manipulation? Honestly, that cut would… The companies that I’m putting in the portfolio are so far away from that process that, that’s never impacted any position that would ultimately end up in the portfolio. Tobias Carlisle (00:40:00): It’s almost like that’s just like a tea ceremony part of it that I do. Manipulation is this sort of question of, how are they treating all the things that they have discretion over in the financial statements? What are they doing with these line items in these financial statements? Are they always sort of giving themselves the benefit of the doubt or are they trying to be fair and balanced? A lot of things, the manipulation score is this sort of continuum. I can see some companies
a little bit more aggressive in the way that they account for stuff than other companies. On balance, you kind of want the ones that are treating you as partners. You want the ones that are… You want the kind of business that you don’t have to read every footnote in the financial statements to see how these guys are tricking you. Tobias Carlisle (00:40:42): You want the ones that are run by people who are trying to help you along as much as, as they are, but that’s, that’s a big part of the process. Then I go through all of the other, the 1001 ways that people have died in the west. I go through and I find all of the ways that anybody has been blown up in
the past and I eliminate all of those ideas. Then from the pool that’s remaining, I’m looking for the best risk adjusted return. That’s a question of how undervalued, how good is the business, how much cash is being thrown out. Is there a near-term potential for something to happen in the business to make it appear much better than it ordinarily is? That sort of process is partly looking at how fast can this business grow? Tobias Carlisle (00:41:27): How much money can this business throw off? It’s partly also, is this trading a sufficient discount. Those two things together, that’s
the process more than it is looking at what sort of business will do well, in an inflationary environment. Having said that, Buffett’s early advice where he wrote that… I think he was comparing the performance of his portfolio to gold. He said that for the period of time that he had looked at, gold had done comparably well to all of these other portfolios, to all these other really high quality businesses that he had bought. I think that there’s reasonably good chance that something like that happens in the future too, that it doesn’t matter how good the businesses you buy, are you going to struggle to keep up with commodities? That might… You might hear and think, well a really good place to be then is in commodity businesses.
Tobias Carlisle (00:42:13): I do think that they do provide some ballast, but when you have a business that’s reinvesting in lots of capital all the time to earn anemic returns on that capital, inflation destroys those businesses. They will trade at a big discount to what they’re worth. What you want in that kind of scenario is a business that has better returns on its invested capital than… It needs to be better than inflation. It needs to be better than the tenure. It needs to be with a big margin of safety, multiples of them I would say. But that’s sort of already part of the process. I prefer that kind of business over a comparably valued business that doesn’t have those same qualities in it. The thing that makes me deep value is I really try to pay a big discount to those
things, but I am… Tobias Carlisle (00:43:02): I know I’ve said in the past that you need to be careful with return and invested capital because it is highly mean reverting. I continue to believe that is the case. There are definitely some businesses that can resist that mean reversion and have very robust businesses, that it doesn’t really matter what happens, we’re all going to go out and continue to use those services. They are going to survive through whatever comes and they’re currently available at a price that allows us to participate along with management, because they’re a discount. They’re not trading at a big premium.
That’s the big problem, I think, for a lot of investors who’ve been through this last market cycle. They think that the stock price performance is the thing that generates all of their returns. The problem with that view is… Tobias Carlisle (00:43:47): Because they have that view they’re looking for the very best businesses. They’re looking for really high growth and really high returns
on invested capital, when all else being equal that’s not really what you’re trying to find. What you’re trying to find is a price that you can pay that can generate enough returns for you as a holder of those business. The example that I give is the early 2000s. We all remember 1999 and 2000 as sort of dot com, it’s the dot com bubble. That’s what everybody says. But really the dot com was a little bit of a side show. The main event was companies like Walmart getting way too expensive, Microsoft getting way too expensive, GE getting way, way too expensive. Then from 2000 to 2015, the underlying businesses, they don’t know what the stock price is doing. The underlying businesses of Walmart and Microsoft
and GE were great. Tobias Carlisle (00:44:37): They did really, really well for that 15 years. The stock prices went nowhere and there were two big drawdowns in the interim. There was the 2000, 2002 drawdown. There was the 2007, 2009 drawdown. That could easily happen again
for many of these businesses. Yeah, they’re great businesses. I don’t disagree with anybody. They’re really, really good businesses, but at a price. If you overpay for these businesses, you’re not going to get sufficiently good returns. What you should be doing as an investor
is finding the best risk adjusted opportunity in the market, which is eliminate all the donuts, try and find the things that are going to generate sufficient return going forward, and then try and buy them at a discount. If you do those things, it doesn’t really matter what happens in the market. You are going to be okay. Stig Brodersen (00:45:22): Yeah. The thing that’s very important, what you said there, it’s about purchasing power. It’s so easy to be blinded by nominal numbers. That’s just not how the world works. At least not whenever you go down to the supermarket
and look at the prices that you now see. Toby and I did a mastermind discussion about gold, physical gold, not long gold. I’ll make sure to link to that in the show notes. This is not, to value investors here, talking about that you should buy gold instead of equities. That’s not what we’re saying. We are not supposed to say you should buy gold, but the point is more that what’s the real return. That’s what you need to look at. Let’s talk for example, about Buffett. Buffett had fantastic track record, like really outperform
the S&P 500. I think that you also referenced in one of your podcasts here recently, Toby. I think it was Chris, Chris Bloomstran who sent a note to Buffett about, what was it? How much that the Berkshire had to decline in value before they, it was on par with the S&P 500? Tobias Carlisle (00:46:19): It was astronomical. It was like 99.8%. It’s so far ahead. Yeah. Stig Brodersen (00:46:26): Yeah. It’s absolutely amazing. It’s astonishing, but you should also keep in mind that whenever you hear about a track record like that, and I don’t want to bash Buffett any kind of way, I should be the last person on that planet to do that. He’s actually the very reason why Preston and I started this podcast, but he’s also invested in a inflationary time. It’s easier to get higher nominal returns
in inflationary times because you just get a rising tide. That’s just something to think about. Always think about real returns. Tobias Carlisle (00:46:58): I’m concerned that I talk a little bit too abstract sometimes. I’m just trying to, in a concrete sense, what you’re trying to find is a return on invested capital, that is well above what the company is, what the company’s cost of capital is. You need to understand what those… If people who understand those terms, that is, nobody will disagree what I’ve said there that’s the case.
If you don’t understand what those terms are, then do you know that’s probably one of the first things you need to go and understand? The return on invested capital over the cost of capital of a business. The margin between those two things is how you make money in the stock market. The wider that margin is and stays the more money you make for a longer period of time. The risk, and this is what I’ve always said, that the risk for return on invested capital is, it’s highly mean reverting. Tobias Carlisle (00:47:39): If you think about a cost of capital, it stays low and a return on invested capital that is high, but mean reverting low, that will crush the value of the company. What you want is a low cost of capital and a stable or rising
return on invested capital. It’s a quirk of the market sometimes, that those things are found in the businesses that are struggling at the time. They already have… The return on invested capital is close to the cost of capital and so they’re not worth very much, but through some sort of business cycle improvement that starts widening out and all of a sudden the value starts being created. That is really what the value of a business is. It’s the
difference between the return on invested capital over the cost of capital. Because there are many businesses that don’t earn any margin and those businesses aren’t worth book value. They aren’t worth the capital that’s in them. Stig Brodersen (00:48:30): I’ve noticed that in ZIG, you have a lot of financials in that portfolio. Tobias Carlisle (00:48:36): I think that there’s still some fear about financials from the 2007, 2009 crash, because that global financial crisis was really concentrated in the banks and some of the other financials and the insurers. Now people… When I was talking before about the types of business models that you want to avoid, that ‘pennies in front of steam rollers’ business models, banks are certainly in that class of business and so are insurance companies. You need to be exceptionally careful with those sort of
businesses, that for one thing that they can survive. This is the kind of the devil of it though, that they are very, very good businesses when they get the right conditions. We’ve been going… They’ve been going into a headwind and they’ve been trading at a big discount because of this general fear about the business model and the behavior in sort of the first decade of the millennium.
Tobias Carlisle (00:49:34): I think that they’ve now all got religion. They’ve got much better balance sheets than they had before. They’re much better capitalized than they were before. There’s been some consolidation. There’s a good prospect of them earning more as interest rates go up, or even if interest rates just stay where they are. I think that they are going to be much more attractive looking businesses as we, as we go forward. I think that you need to be careful going through them, that you’re
buying the ones that can survive. There are lots out there that will be too heavily exposed to drilling in some area, or they’ll be too heavily exposed to commercial real estate in another area, and if they’re small and that’s a big part of their loan book, then they are at very high risk of seeing some sort of material impact to their asset values. So I think you need to be very careful, but my portfolio is, I think it’s the sort of the best of the breed. I think that they’re all really undervalued. I’m kind of… I
do think that there’s return in financials from here. Stig Brodersen (00:50:39): I wanted to talk a bit more about your fund and writing in ETF. I’ve always been fascinated with that. Actually, I don’t know if you know this, but Pres and I actually talked about setting up an ETF, I want to say it was like four or five years ago, and we were talking back and forth and we weren’t super serious, but we were looking into it at the time. I think it was around the time that you were also thinking about starting your own. So we had some back and forth in that, and one reason why… I just remember vividly one reason why I didn’t like it was, I noticed all of that red tape.
Stig Brodersen (00:51:10): I’m not good with red tape. I was saying to Preston “it makes sense for Toby, he’s a lawyer. He can handle it, but I’m curious more about the inner workings off an ETF. For example, ZIG. You have an expense rate
of 89 basis points. I was curious about how that works in practice. Me included, but also a lot of our listeners, they own an ETF one way or the other, and I don’t really know how we pay. I’m pretty sure we do otherwise it wouldn’t be there. But do you sell stocks equivalent to that expense ratio once a year, continuously? What happens with that money? Is that reinvested back into the fund in your name? Is it fees to the exchange or lawyers? How does this business work? Tobias Carlisle (00:52:03): There are lots of different ways of setting up an ETF. You can have… You can be in many different roles in relation to the ETF and sort of be the person who is representing the ETF. You could be a sponsor of an ETF, which they don’t really have any of the legal obligations of. The main legal obligation falls on the advisor and I am the advisor. My company Acquires Funds, LLC is the advisor
to the Acquirers Fund. What that means is that it’s responsible for all of the compliance, all of the trading. It is the responsible entity for that ETF. Responsible entity is actually a legal term. It’s not the RA, but it is responsible for that ETF. But you could be… They’re what they call white label ETFs, where all of the backend is done by somebody else.
Tobias Carlisle (00:52:52): Then the sponsor is just sort of the face of the ETF, and they don’t really have any of those obligations. But as you point out, I was a lawyer for a decade. I’ve been in capital markets and I have some familiarity, at least, with exchange listing rules and just general compliance. It’s still very
burdensome and I pay. So the way that it works is that the fee is calculated on a daily basis. There’s a small amount of cash that accrues and it’s paid out on a monthly basis, and from that payment, I have to cover the exchange, the fees to list on the exchange, the audit fees for the fund, all of the compliance in the back end, the custody of the assets. That there’s a… The cost to run an ETF is very significant. It’s several 100,000 dollars a year. Tobias Carlisle (00:53:44): And that has to be covered from the fee and to the extent that the fee falls short of the cost of the ETF, I pay for it. For the first 18 months of ZIG’s life, it was well short of that. I was just paying that amount
of money out of pocket, which is why a lot of people get venture capital backing when they do these things, because the sums are very large. I just saved up for myself and paid for it out of my own pocket. I don’t necessarily recommend that to everybody because you need a reasonable path to getting to break-even. I thought that I could get to break-even before my money ran out, and it turns out that was true. I was a little bit lucky in that sense, but you have to think about that when you’re setting these up.
Tobias Carlisle (00:54:25): Can you… The costs to set them up, have come down a lot, but they’re still pretty significant. Then the cost to operate them are way more significant than the cost of set up and that’s really what cuts people to pieces. That’s why, you get to three years and you’re still not making money and you wind up the fund. That’s why the average fund winds up in three years, because they’re super expensive. It’s a lot of work in a compliance sense. Then there’s
also additional stuff on top of that marketing, trading the portfolio, all those sort of things. Its a … A fund is a full time business for about three people, I would say, to do it properly. You can outsource a lot of stuff and sort of reduce those numbers, but you really need, I think, the kind of the bare minimum that you can get away with is probably two or three who are going pretty hard. Stig Brodersen (00:55:15): What is the break-even AOM on a typical ETF? I know that depends because you might have expense ratio that’s higher or lower. I guess that’s the first part of my question. The other part of my question is, is the expense
ratio, is that the only income you have from running an ETF? Tobias Carlisle (00:55:32): The break-even… For the typical fund, the break-even is 30 to 50 million dollars or above that. For ZIG it’s much, much lower than that because I have a slightly higher fee which will come down over time, but I have a higher fee and I do most of the work myself. So I don’t have to engage a lawyer for some things, I do them myself. I don’t do a lot of paid marketing, I do a lot of that myself. I run the portfolio myself, I’ve set up the strategy, all of that stuff is me doing it and I don’t pay somebody else to do it. So the revenue for my fund, the
break-even for my funds is much, much lower than that. It’s still pretty high. It’s still a scary proposition out of the gate. I want to set up some other funds too. Tobias Carlisle (00:56:09): I want to, as we’ve discussed previously, I’d love to do a global fund. I’d like to do it in Europe. So it’s a UCITS structure rather than ETF, but that still makes me nervous. A
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