Best of The Long View: Investing
Some of the top moments in our conversations with investment managers, writers, and thinkers.
On this week’s episode, we’ll feature some of our favorite clips from interviews we’ve done with investment managers, writers, and thinkers over the past year.
Here are the complete episodes that are referenced in this week’s episode.
“David Giroux: What Are the Market Inefficiencies We Can Exploit?” The Long View podcast, Feb. 2, 2021.
“Hamish Douglass: On the Hunt for Super-Compounding Stocks,” The Long View podcast, Feb. 23, 2021.
“John Rogers, Jr.: ‘Be Willing to Talk about These Uncomfortable Issues’,” The Long View podcast, Apr. 6, 2021.
“William Bernstein: ‘We’re Starting to See All of the Signs of a Bubble’,” The Long View podcast, Mar. 9, 2021.
“Jason Hsu: China Is ‘the Last Great Remaining Alpha Reservoir’,” The Long View podcast, Apr. 20, 2021.
“Jason Zweig: Temperament Is Everything for Most Investors,” The Long View podcast, June 29, 2021.
“David Herro: ‘We Are Not at All Afraid to Vary from an Index’,” The Long View podcast, July 13, 2021.
“Robin Wigglesworth: The Rise of Indexing and the ‘Renegades’ Who Ushered It In,” The Long View podcast, Nov. 16, 2021.
“Bob Seawright: There Is No Such Thing As a Passive Investor,” The Long View podcast, Nov. 2, 2021.
“Meb Faber: ‘To Be a Good Investor, You Have to Be a Good Loser',” The Long View podcast, Sept. 7, 2021.
Jeff Ptak: Hi, and welcome to The Long View. I’m Jeff Ptak, chief ratings officer for Morningstar Research Services.
Christine Benz: And I'm Christine Benz, director of personal finance for Morningstar, Inc.
On this week’s episode, we’ll feature some of our favorite clips from interviews we did with portfolio managers and investors in 2021.
T. Rowe Price manager David Giroux is a rarity--an active manager who has consistently trounced his benchmarks and category peers. We asked him why, for all of his success, so many active managers have failed, and here’s what he said.
Giroux: Well, I think there's a couple of factors. I think benchmark hugging is clearly one thing. And I think about this industry, and this is an industry that tends to, even if you're average, you can still make an incredible living being average in this industry relative to schoolteachers or a doctor, a number of other professions. This is a very high-paying profession that we're in. And so, I think a lot of people look at it and they say, I want to take a little bit of a bet, but I don't want to take a lot of bets. If I don't take a lot of bets, I can never get fired, right? And so, that all encourages benchmark hugging, if you will.
I think the other thing, again, I would say--and this comes from experience—is I think a lot of portfolio managers, they're not in the weeds on their companies. They let their analysts be in the weeds, and they try not to be in the weeds. And again, from my experience, I think that's a mistake. I think the last thing I would say, and it really goes back to kind of this macro outlook, almost this tyranny of the consensus macro outlook, is I think, most portfolio managers, whatever the consensus macro is, they assume that's going to play out and they're always investing in concert with whatever that macro outlook is. So, Wayne Gretzky always talked about, I want to skate towards not where the puck is, I want to skate to where the puck is going to be. And what you find is, if you're always getting to where the puck is, or always investing in concert with what the macro sentiment is, you're buying financials in Q1 or Q2 of 2018, you're buying defensive stocks in March of this year. You're buying defensive stocks in Q4, December of 2018. Being able to be a contrarian on that also, I think, it really destroys a lot of values. So, I think all those things come into play. But I think it's a combination of all of those things.
Magellan Global Equity manager Hamish Douglass has made a fortune investing in the stocks of some of the world’s largest, most dominant firms. We asked him why these names, which are very closely followed and sit near the top of major indexes, would have been undervalued to begin with. Here’s the perspective Hamish shared on values hiding in plain sight.
Douglass: So, your question is why can the market be so wrong, sometimes, on some of the world's most researched companies. You'd expect if they're the largest companies and have the most people following them, they're the companies, if any, are going to be efficiently priced and it's going to be some obscure small cap or something that wouldn't be efficiently priced. But that's just not what we observe. We have earned some extraordinary returns in some of the world's largest companies. We bought, in 2014, Microsoft at $28 a share. We bought Apple when it was $94 a share. We've made enormous monies in Alphabet and Visa and Mastercard and Facebook, and I'm only picking the super large-cap ones. I could give you other companies that aren't large caps were to happen.
So, why is it that sometimes something happens in a company? A good example I would give you: Microsoft, when we bought it. They clearly missed the shift to mobile. And people thought that Windows operating system was dead and was being priced for that. And we saw something very different of what was going to happen around their office franchise and ultimately to the cloud. And actually, the stickiness of the operating system in terms of how difficult it would be to get the operating system out of enterprise here. And I would argue maybe something similar is happening at SAP at the moment--is they're shifting away from an on-premise model with their clients to a cloud-based model, which is disruptive in the short term.
And so, why does this happen from time to time? And I would say the real issue when these events happen, why markets misprice is something I would call is duration arbitrage here. The market then gets very good at assessing what's likely to be transpiring, and I would say often in the next three to six months, but really isn't focused what will change in maybe three to five years. And Apple, which was just such a great point in case when we were doing it, the market was incredibly focused on the iPhone cycle and the sales that were happening in the next few quarters. And they were in between upgrade cycles and the share price was coming down. And we were very focused notwithstanding there was volatility in the short-term iPhone cycles that the installed base was increasing and our view as recurring services revenues were increasing as a share of the company as a whole, and in five years would become material and that would lead to a large re-rating of Apple as that happened over time, notwithstanding we saw that the market saw what was happening and likely iPhone sales in the short term. And the reality is, we were right on that and the market was, because they were focused short term, just weren't able to see the longer term. And I would say occasionally--and it's important, occasionally--when the market is looking at the six-month view but something fundamentally could be changing in a five-year view, we occasionally see a very different picture, because we're looking through different lenses. We're looking through a telephoto lens and the market is looking through a standard lens. And sometimes a picture is quite different between the cameras you're looking at the same stock through. And I would say there, there are actually very, very few investors who are really taking that five-year view. People talk about it, but their behavior is very, very different.
John Rogers, Jr., the founder and chairman of Ariel Investments, knows a thing or two about business quality. It has been a cornerstone of his firm’s investment philosophy for decades. But quality is in the eye of the beholder, and with technology and other innovations transforming industries faster than ever, we asked John whether he thought “economic moats” that protect firms from competition are as durable as they used to be. Here’s his take:
Rogers, Jr.: I think your question is right on. We spend an inordinate amount of our time--we have two meetings a week with our portfolio management team and with our analysts. And a good bit of that time is trying to figure out how sustainable the moat is. Those are all of our questions--I shouldn't say all of our questions--but a good majority of the questions are trying to test the hypothesis over and over again. To your point, are there changes in this technological revolution that's going to impact our moats? Is it because of all the M&A out there, the companies that are left that are smaller are not going to be able to maintain their moats? Just certain industries are changing and evolving just in general where their products are not as relevant anymore and new competitors have been able to figure out ways to come in and make a difference? So, the job is harder, and the pain is greater if you're wrong. If you're wrong on guessing and doing your research and looking into the future about the strength of the moat--we talk about this all the time: It can catch up to you so fast that what you thought you had some time to figure out, whether the new world was going to really impact your moat, it just boom, it happens so rapidly, the moat disappears overnight and then your company is all of a sudden half of the price it was before.
So, it just means the rigor of your research is more important than ever. The relationship with management teams is more important than ever. Having experienced analysts and portfolio managers who know where to focus is key. Because otherwise, you're exactly right, the damage that can be done to your portfolio is so dramatic these days if you get it wrong.
Author and investment advisor, William Bernstein, has seen a lot in his years researching investments and studying investor psychology. We wanted his take on portfolio diversifiers and what happens when they catch on with investors. Is discovery the worst thing that can happen to an asset that you’re counting on to diversify a portfolio? Here was Bill’s take.
Bernstein: Yeah, the moment that a particular strategy becomes useful as a "diversifier," it becomes a risky asset that correlates with everything else. And so, it loses its diversification value. My favorite way of explaining this is to talk about David Swensen's famous book Pioneering Portfolio Management. And what people didn't understand when they read that book, which is a magnificent book, is that the keyword in the title wasn't “portfolio management,” it was “pioneering.” You want to be the first person to the banquet table and get the prime ribs and the lobster. And by the time everybody else knows about the strategy, you're getting the tuna noodle casserole. That's all that's left. And that's what's happened to the traditional alternative asset classes, venture capital, private real estate, hedge funds, commodities futures. That table has been picked over and overvalued and you are last in line when you're investing in those things.
This year, Christine and I took a closer look at investing in China. And who better to guide us on that topic than Jason Hsu of Rayliant Global Advisors? Jason boasts years of experience investing in Chinese stocks using various quantitative methods he and his team have developed. In this clip, he walks through his firm’s process for sifting through the many Chinese state-owned enterprises to find a needle in the haystack.
Hsu: So, this is really how the research related to the topic on state-owned enterprises in China. China and many other emerging-markets economies have a disproportionately large number of stocks, by capitalization or by number, which are state-owned enterprises. Now, the historical bias is state-owned enterprises are just bad because they aren't really for-profit entities and you should just exclude them out of the portfolio. Now, if you do that with the emerging markets, you would exclude a lot of companies and certainly, in China, excluding state-owned enterprises would eliminate 50% of the market cap. That's eliminating a lot of companies. So, you don't want to do that without having deeper insight into what you're eliminating.
So, when we look deeper into state-owned enterprises, we realize that's not a homogeneous group of companies. There are things that are centrally connected and there are things that are regionally connected. And to figure that out precisely, you actually need to read the biographies of the board and senior management team. What we discover is, if you have a state-owned enterprise that's primarily city-level, town-level party officials, you're not surprised. Oftentimes, these firms are run quite poorly, and statistically, they're about 6% behind the market in return on average. This is where you tend to find a lot more corruption and this is where you tend to find these businesses are much more engaged in or focused on ensuring employment rather than profitability, and often they survive because of large government subsidies.
And when you look at centrally connected enterprises, they tend to be incredibly well run. In fact, they outperform the broad market by 2% per annum. And, in fact, the biggest telltale sign is, if there's an upgrade in the leadership, meaning someone who is very senior has been appointed from Beijing to run the show, you can expect there's often going to be government policies given to the particular industry or the specific firm and oftentimes, the assigned official is often a turnaround expert who is basically the A Team and they really instantly upgrade the operational efficiencies and capabilities of the firm as well. So, having that biographical information tells you a lot about both how the shop will be run and also some insight into forthcoming government policy and policy support.
Author and Wall Street Journal columnist Jason Zweig has been a hero to Christine and me for a long time. So we were thrilled to have the chance to interview him earlier this year. Jason shared his wisdom on a range of investing, behavioral, and personal finance subjects. One question we asked Jason is why people seemed to be so dismissive of expertise amid a trading frenzy in things like meme stocks and cryptocurrencies. Here’s his take.
Zweig: Well, obviously, we can't disentangle that from broader trends in society. And we've seen this in the political realm and the economics, obviously, in public health. And, I think some of it comes from the fact that anybody can Google anything and get a superficial understanding of even the most complicated issues, and that's a new phenomenon. For most of human history, knowledge was the ultimate scarce good. And, a 1,000 years ago, 10,000 years ago, even a couple 100 years ago, most people knew almost nothing about the world outside the confines of their own home or village. But today, of course, you can, with Google and other online tools, you carry an encyclopedia in your pocket that didn't exist a couple of decades ago, even a decade ago, for that matter.
But some of it, I think, also comes from the tendency of experts to overstate the certainty of their knowledge and to be overconfident and also not to communicate clearly. If you look at COVID, it's almost the test case for why people distrust experts. The whole controversy about wearing masks, for example--the CDC gave mixed signals. And most people don't understand that one of the things that expertise means is to change your mind when new information comes in. And people confuse consistency with knowledge and expertise. And they are under the belief that if you are an expert, you know the answer, and you never change the answer because you know it; when, in fact, to be an expert means that you change your mind frequently as new information comes in. That's what a good Bayesian does, or for people who don't know what that means, that's what a person with common sense and good judgment does when new information comes in.
So, one of the key tests for whether somebody is an expert is whether they're willing to say, I don't know, or I believe, or this is probable or likely, rather than giving answers that are all about certainty.
Oakmark International manager David Herro is kind of the prototype for a gutsy, contrarian value investor. We asked David how the competitive landscape for value investing has changed with other players like private equity funds elbowing their way in, and how he’s had to adapt to those changes. Here’s what he said.
Herro: The competitive landscape sure has changed. Because when I look when I first got into this business in 1986, it was mostly the big pools of money were pensions, defined-benefit pension plans, trust companies, insurance companies, long-only, buy-and-hold types of investors. Yes, you always had the traders on the side, stock flippers. But the big way to money it seems gradually has changed through the years to where today the big way to money is on hedge funds and people using leverage and index funds and funds that represent everything from cryptocurrencies to SPACs to whatever. So, the competitive landscape certainly has changed.
And, actually, it's brought more volatility and more imperfect price discovery, which, actually as a long-term value investor, is better for us. Because when you have more volatility and more size, chasing themes and ideas and less chasing fundamentals, for an investor who focuses on fundamentals, it actually becomes a positive. Now the negative is, in the short term, this might really cause you to look silly. You might really be out of sync, and your clients who may be impatient or have a shorter-term investment horizon may not appreciate the fact that we are trying to take advantage of these market imperfections and volatility to enhance medium- and long-term return, because they are worried that they're not going to get the short-term return. And so, it's a two-edged sword. On the one hand, it provides more opportunity--the changing nature of who's holding assets, and what's causing volume creates more opportunity for the bona fide long-term investor. But on the other hand, it might create some severe downward price dislocation, as you saw with value investors in 2018--and '98, by the way--but in 2018, and in the first quarter of 2020.
And instead of investors thinking, “My manager is a good solid long-term investor with a good track record. I'm going to give them some more money to take advantage of this situation” They often become scared and sell right at the wrong time. So, the good news, is it provides more opportunity for long-term investors. I think the bad news is sometimes this comes with more volatility, price dislocation, which, again, provides you a tool to harness to exploit market imperfection. But, on the other hand, it's painful while you're going through this. And at times, your client base doesn't appreciate the short-term negative price performance.
The rise of index investing hardly seems like a topic that could be made into a ripping yarn, but author and Financial Times correspondent Robin Wigglesworth made it just that in his excellent book, Trillions: How a Band of Wall Street Renegades Invented the Index Fund and Changed Finance Forever. In the book, Robin tells the story of “John B. Armstrong,” who in 1960 wrote a paper defending active fund managers and ridiculing the concept of indexing. Who was John B. Armstrong? In this excerpt, Robin reveals Armstrong’s true identity.
Wigglesworth: Well, drumroll, boom, boom, boom: It was Jack Bogle. At the time he was a senior vice president at Wellington Group, one of the biggest mutual fund companies in America. And although he wrote under the pseudonym, his views on passive were well known. And this paper that he was ridiculing was the Edward Renshaw paper I mentioned recently. And he just thought this was absolutely preposterous. But it just goes to show that, I think even Bogle once described himself as a hedgehog, somebody who always has one really big idea in his head. But he did change what that idea was. And I think one of the more remarkable transformations we've seen in the history of the investment industry was Jack Bogle's conversion from being an active fan to a passive one.
Christine followed that up with a question asking Robin whether he thought Bogle would have gone on to become the larger-than-life champion for indexing he eventually became if he hadn’t have been forced out of Wellington. Here’s Robin’s take:
Wigglesworth: I think there were some parts of his later career that were very much always there. He always cared about low costs. And this was something that he did talk about in his master's thesis, or bachelor's thesis, at Princeton that first got him his guard at Wellington, when he talked about the importance of keeping costs low. And that was something that he did talk about even in his career at Wellington as an active manager and as an up-and-coming wonder boy in the investment industry. He also did flirt with the idea of neutralization before Vanguard was set up. I found several press clippings where he talked about this. Though, admittedly, mostly, in the context, or obliquely, in the backdrop was his fight with his partners at Wellington at the time. So, I'm not sure if he would have neutralized Wellington if he’d had the chance. But it at least was something that he was thinking about long before Vanguard ever sprung into his head.
On the indexing--I think that's an open question whether he’d do this. I think it might have appealed to the innate cheapskate in him. He was a very proud self-admitted Scottish-American cheapskate. One of his old friends once told me his favorite drink was an $8 bottle of Cabernet Sauvignon. I thought that really summed up Jack quite well. So, indexing might have appealed to him anyway. But pretty much everybody who knew him back in those days was very clear that Jack Bogle did not believe necessarily in indexing at all when they launched the first index fund at Vanguard. It was purely a corporate ploy to basically stick two fingers up to his nemesis at Wellington who had sacked him so brutally. And it wasn't really until the 1990s that he kind of became that messianical fan of indexing that we know now. So, I think, possibly, he wouldn't have gotten into indexing if he just stayed at Wellington. But it's entirely possible that that would have been a very different arc of history. And Vanguard would not exist, and Wellington would just be a really big well-respected active mutual fund manager today ala Capital Group or T. Rowe.
Bob Seawright is the author of the excellent “Better Letter” newsletter and chief investment officer at Madison Avenue Securities. Bob has written insightfully about how to improve investment decision-making, with one of his insights being that we can improve by being more honest with ourselves about the things we make worse. So we asked Bob what’s an everyday example of something he does, or refrains from doing, because it keeps him from making something worse. Here’s what he said.
Seawright: Well, I have no online access to my investments. And I look at the statements only twice a year. Because I know from the literature and I know from past experiences, the more I look at it, the more I pay attention to it, the more I am going to be inclined to trade. And one of the clearest evidences in the literature--Terry Odean at Berkeley, for example--the more we trade, the less well we do. And so, I'm conscious of that. I make it hard to do that by not giving myself online access so I can't look at those little red or green lights all the time. And I don't even look at the statements all that often.
Author, blogger, and investor Meb Faber of Cambria Investments is a renaissance man, with investments in a wide variety of ventures and other interests that run the gamut. We asked Meb about the mix of investments he makes, some being highly idiosyncratic and demanding a lot of subjective judgment and others, like the Cambria ETFs, being rules-based and quantitatively driven. How does he set that mix of investments to strike the right balance?
Faber: There's two parts to it. The first is, I think it's important to be kind with yourself and not extremely judgmental about the investing process. At the same time, also important to be open-minded. So, we all make a ton of mistakes. We say to be a good investor, you have to be a good loser. Because the average market, over time, there's only two states: you can be at an all-time high or you going to be in a drawdown; there is no other in between. And most markets spend the vast majority of time in some form of drawdown. And that's OK. You have to be a good loser; you have to be used to all the noise and just negativity that involves public-market investing.
That having been said, it's important to be open-minded, so to realize when things change. Also to be open-minded and realize the challenge of this time is different seduction. But a good example--go back to 1980s, there was a very real, specific structural change in markets that people have not accounted for still to this day. And that was companies started buying back more stock. They had safe harbor from getting trouble for doing it. So, they started buying back stock starting in the ‘80s. And now starting in the late ‘90s, buybacks account for more of the ways that companies distribute cash than dividends do. Now there's a ton of misinformation when it comes to buybacks. We could do an entire podcast on that topic alone. So much that we did a post called "FAQ for lawmakers," gurus, investors, and so on, about buybacks and dividends.
Buybacks are the exact same thing as dividends, as long as stocks trading at intrinsic value. That's finance 101, you can't argue that fact. If you do, I can't help you. I can help you--call me, email me, we'll talk about it. But that is a fact. The beauty of buybacks is it gives investors discretion on timing; they're more tax-efficient. Look at Warren Buffett. He says the only time his company has paid a dividend was he was in the bathroom back in the 1960s or something. And he's buying back a ton of Berkshire stock today. So, he gets it. He says there's nothing better a company can do when a stock is trading below intrinsic value--and that's the key phrase--than buy back their own shares.
You have to avoid companies that are consistently issuing shares, you have to avoid companies that are just buying back to mop up the share issuance. But, in general, you have to look at cash distributions holistically. That's totally changed. That wasn't the case 50 years ago. And so that was a very real structural shift, that how many hundreds of investing strategies are still based on dividends. And it's totally insane to only use one tiny bit of information in a world where there has been a real shift. And you could show historically speaking with both simulated returns, as well as real-time returns--we manage a whole suite of these funds for almost a decade now. We call it shareholder yield. So, combining both, also tilting toward value, is a better approach than dividend investing. But people, whether it's because their income depends on it, or they just have blinders on, haven't shifted their focus.
And, so, it's good to be open-minded and say, "I'm going to absorb information, add it to my investing process as things change." Another good example, now that we have ETFs--far superior vehicle than mutual funds, but ETFs didn't exist in the ‘80s--incorporate this new information. That doesn't mean you're waking up tomorrow and say, "I got to sell everything and buy gold or an ether rock." It just means be thoughtful about it. Most of these decisions I used to liken it to Peyton Manning playing for the Broncos--who knows who the quarterback is going to be now--but he comes to the line of scrimmage. He knows exactly what he's going to do. The defense shifts, he's got his three audibles. It's not like he shows up and says, "Let's just wing it." That's the worst thing you can do.
So, having an investing approach, writing it down, being thoughtful about it, but also saying, "I'm not going to be just set in stone. As new information comes online, I will incorporate it if it's additive and thoughtful." But you also try to set up that criteria, too. And then for people that want to do a little discretionary trading or playing around, it's sort of an all-time nightmare for me. It sounds like such a drain and attack on your mental well-being and health. But putting a little bit over there, 5%, 10%, I think that's totally fine. I think if that keeps you behaving in the rest of your portfolio, that's A-OK with me.
Thanks for listening this past year. From all of us here at The Long View, best wishes in the year ahead.
(Disclaimer: This recording is for informational purposes only and should not be considered investment advice. Opinions expressed are as of the date of recording. Such opinions are subject to change. The views and opinions of guests on this program are not necessarily those of Morningstar, Inc. and its affiliates. Morningstar and its affiliates are not affiliated with this guest or his or her business affiliates unless otherwise stated. Morningstar does not guarantee the accuracy, or the completeness of the data presented herein. Jeff Ptak is an employee of Morningstar Research Services LLC. Morningstar Research Services is a subsidiary of Morningstar, Inc. and is registered with and governed by the U.S. Securities and Exchange Commission. Morningstar Research Services shall not be responsible for any trading decisions, damages or other losses resulting from or related to the information, data analysis or opinions or their use. Past performance is not a guarantee of future results. All investments are subject to investment risk, including possible loss of principal. Individuals should seriously consider if an investment is suitable for them by referencing their own financial position, investment objectives and risk profile before making any investment decision.)