Jake Taylor (02:55):
Well, the really good business is the good operators, the good management, they’ve been thinking about all the stakeholders for a long time. There’s nothing really new about ESG. Japan has this thing they call the five joys in business and those were the suppliers, the employees, the regulators, the communities that the businesses operate in and then the shareholders.

Jake Taylor (03:19):
And so everyone is part of this ecosystem and the good management, we’re already managing to create win-win outcomes for everyone in the ecosystem. There’s really nothing that new to me about ESG. It’s just kind of a fancy name and honestly, I think a little bit of a marketing ploy in that… There’s this saying that if ducks are quacking, then Wall Street will feed the ducks.

Jake Taylor (03:45):
If everyone’s asking for ESG, then like, “Okay, here you go. We’re going to call this ESG and you’re going to get it.” I don’t find it… I kind of feel like it’s a much to do about nothing.

Stig Brodersen (03:56):
And then we charge another 30 basis points if we call the ESG because that is how we’re seeing that ESG is being promoted, which is not the same as saying that I don’t believe it’s important to invest in ethical companies. It is really important to me. You just also need to see the other side of how can this be used against you. Wes.

Wes Gray (04:14):
I have a two-sided brain, but I’ll explain that. So on personal investments on things that we create to generate returns and what we invest our own money in, you never should tie emotions to investing in my opinion.

Wes Gray (04:30):
For our own stuff, we don’t involve it. We buy it cheap high quality or we buy winners, period. It’s evergreen. Now, on the business side, because remember we launch ETFs on behalf of other people, I’ll tell you with certainty, this is a huge deal, massive market, going to have probably huge effects on asset pricing and there’s…

Wes Gray (04:52):
Investing unfortunately is going to get political if it hasn’t been already. I foresee very near term future where people actually identify with their portfolios politically and they’ll expose that, show that. I think we’re going to see a whole new world of emotional involvement inside of portfolios, which I think is awesome as a factor investor who’s a old school, like let’s just try to make money guy, but it’s going to interesting, I think over the next three to five years here.

Stig Brodersen (05:25):
Toby, if I throw it over to you, because I know with the way [inaudible 00:05:30, the tickers for [inaudible 00:05:31] are constructed, there are different rules that have to follow to be a part of the portfolio. Do you have any kind of ESG filter in? Is this something you considered? How do you think about this?

Tobias Carlisle (05:41):
They’re not ESG funds. They’re not explicitly set up to be ESG funds. They do score okay according to Morningstar along some of those lines, but that just might be the investment style sort of manifesting as lowish sort of carbon, that sort of stuff.

Tobias Carlisle (05:58):
I think it’s usually a bad idea to mix your personal biases in with your investing if your objective is returns. If your objective is something else, to express your political opinions, then by all means find the fund that achieves that end. I think that the research is a little bit mixed, but the pitch for ESG is that it lowers the cost of capital and therefore you can starve the worse industries and you feed the better industries and that should lead to more money flowing to better things.

Tobias Carlisle (06:28):
The problem is that we poll 10 people and we’ll get five people diametrically opposed to the other five people about what good ends are. There’s a mega ETF out there that you can buy and there are probably political ones on the other side of the spectrum that you can buy. And they both think that they’re doing the moral thing by investing in those. The mixed research seems to be that when you increase the cost of capital for something, you get better returns out of it. That’s still going to attract people who want those vice type investments to go into those so that the pitch would be that you reduce the cost of capital for things that score high on whatever ESG components that you seek and therefore they do better because they have a lower cost of capital while they’re operating their business.

Tobias Carlisle (07:13):
But then on the other hand, when you increase the cost of capital for something, you lead it to have better forward returns. That’s why the vice portfolios will continue to exist. I think that it probably all cancels itself out.

Tobias Carlisle (07:26):
I agree with Wes that there’s enormous interest in it and as a marketing tool, if I just wanted to be 100% marketer, I’d just start rolling out portfolios that appeal to particular political groups and charge more for them. But that’s not what I do. I watch it, but I’m not involved in it at all.

Stig Brodersen (07:46):
Perhaps let’s talk about how it influences financial markets. And I also think it’s important to say that there’s no such thing as a universal accepted standard for what is ESG, just like the four of us might have some kind of idea of what value investing is or at least what it has been historically, but there’s no strict rule book saying you can only invest in stocks with a PE lower than 15 or whatever that is.

Stig Brodersen (08:11):
It’s sort of like the same thing with ESG. You, you look at different sources. I just looked one up here from Bloomberg who said like in 2025, a third of the assets would be in ESG funds in the states. So it’s something we need to consider one way or the other.

Stig Brodersen (08:26):
I guess my question to you is which impact does the rise of ESG have on the financial markets? Does it change the way you invested? I’m not so much talking like ethical reasons, but are you more thinking, oh, but this is what the herd is doing or this is way the market are doing, so I need to position myself accordingly.

Stig Brodersen (08:43):
Is there a such a thing as that. Wes, I can’t help but throw it over to you. You’re not just looking at fundamentals in your funds, you’re looking at other things as well.

Wes Gray (08:51):
Sure. I think there is a massive opportunity for the following trade in ESG. Don’t buy things that already look ESG and pretty because they already have that low cost of capital and the gains are gone and your go forward basis as Toby highlighted is going to be lower expected returns. But if you wanted to try to have your cake and eat it too, you would go after the ugliest nastiest ESG firms you could possibly find and then go active on them in an ESG sets. Right.

Wes Gray (09:24):
Try to turn Monsanto into whatever. I don’t know what the top ESG firm is, but some firm that’s really clean.

Jake Taylor (09:33):
Patagonia or something.

Wes Gray (09:34):
Yeah. Patagonia. Yeah. Try to turn Monsanto into Patagonia because you would take the cost of capital from say 15% to like zero effectively and you’d get a massive like quadrupling or 10X in valuation.

Wes Gray (09:49):
And so I think you’re going to see, and we’re talking a few people that actually like operators looking at this. I know there’s already some in hedge fun space, but that’s a huge arbitrage opportunity is for people that can kind of take ugly and make it pretty and then make the spread in the beauty contest. I think that’s going to be a big theme.

Jake Taylor (10:07):
Let me ask you guys this question. Are we one bear market away from not ever hearing about ESG again?

Tobias Carlisle (10:14):
Yeah. I was going to say, it’s a little bit more of a bull market special than it is something that people are going to be concerned about. We’ve had a very, very long bull market and people, everything looks easy at the top. Just add a few more layers of complexity to get yourself where you want to be.

Wes Gray (10:31):
I actually somewhat disagree a little bit on that. There’s an element of that like the sentiment component because people have the luxury to invest more emotionally. But also, I do think there’s a real component of true lower cost of capital and obviously going into a storm, all else equal, if you have a lower cost of capital, you can take on MPV projects with easier… You can keep your boat going where if you believe that cost of capital spikes during a bomb out, well, if you already had high cost of capital, now you just can’t get any projects funded.

Wes Gray (11:05):
I do feel like there’s some sort of weird like margin of safety in some sense, because I believe that the lower cost capital is a real economic phenomenon in the marketplace right now.

Tobias Carlisle (11:17):
I believe that is real. I think Jack was just saying that is the interest in it at a peak because we’ve made so much money for such a long time. If you go back to the bottom to people like ESG is probably the first thing that goes overboard.

Wes Gray (11:30):
Yeah. When it’s outperformed as well. It’s had like this great relative performance streak in general, which we all know is fleeting and won’t exist in the future. You’re right. You’re going to get a shakeout on the performance chasers. But I do believe there’s true believers out there too.

Jake Taylor (11:46):
Can we unpack that cost of capital a little bit more? I’m curious about… So when I think about the mechanics of actually like a company getting dollars in the door to deploy into new equipment and employees and all these things, the stock market’s a secondary market.

Jake Taylor (12:01):
The money is not going… When I go buy a share of Apple, it’s not like Tim Cook gets that dollar. I’m just trading places with someone that already owns that share. How is it actually the cost of capital for these businesses?

Wes Gray (12:15):
If you basically do like M&A activity or you go raise capital from the street, you need to fund different projects. Yeah. Remember inside of Apple, they run their own capital allocation. They have like a hundred billion dollars and so to the extent that you can fund higher MPV projects that are of your cost of capital, you’re going to add a creative value to the shareholders eventually.

Wes Gray (12:38):
Whereas if I’m in a… I don’t know. I’m on Santo. If I’ve got a billion dollars, my project, if cost of capital is a lot higher and so the bogie to try to beat that is really hard and if I just can’t find any projects to invest in in real money terms, I can’t add real economic value to my share price and assuming the stock market’s somewhat efficient, like you should be able to account for that. Especially if there’s… If we’re in like a bad regime where some people just can’t now fund projects, how are you going to add any economic value is the argument.

Wes Gray (13:12):
You’re right, but there is internal real decision making presumably going on at these firms, I would say.

Tobias Carlisle (13:20):
There’s two issues [inaudible 00:13:21]. To what extent can head office get itself into an ESG type framework? I think most firms have probably gone through that exercise and ticked almost every single box they can. And if they have haven’t, then maybe there’s some avenue for activism there, but there’s probably not much at very big firms.

Tobias Carlisle (13:39):
The problem is going to be for the companies that have their core business is something that ESG doesn’t like. For example, the oil drillers. There’s just no way other than getting out of that business that you can improve your ESG score, your environmental score there.

Tobias Carlisle (13:56):
So I don’t know, we sort of… We’re voting with our dollars to starve those industries of capital, but we’re still consuming it on the other end. So I just see them sort of doing very well, shareholders in those businesses doing very well.

Wes Gray (14:13):
You mean in the dirt ball businesses?

Tobias Carlisle (14:17):
There’s some that are just… I’ll just give Exxon or Chevron or one of those as an example. Head office can get themselves a green logo and go and tick all the boxes but underlying business is the issue. And there are lots of businesses like that. You can come up with a pretty annual report and a nice green logo and you can run all the ads that you want, but you’re ultimately not solving the problem that people are upset about.

Wes Gray (14:40):
The one thing that’s also interesting that I’ve been thinking a lot more about is existential threat because on one hand, I’m a huge believer, okay, let’s go buy Monsanto, Exxon, all the dirt balls, because the Toby’s point, you can’t put too much lipstick on the pig. It’s still a freaking pig, but hey, if the pig’s fat and I could buy it cheap and I can clip that coupon, that free cash flow, it could be a great investment.

Wes Gray (15:05):
However, I could foresee pretty near in the future here, you can have a situation whether just even though it may not be rational from a societal perspective, that’s like nope, we’re cutting it off. Or nope, we’re going to tax it a million percent, i.e., just turn the business off.

Wes Gray (15:23):
So there is kind of this risk premium. You also need to put in those things and I don’t know how well it’s priced in to like an Exxon where it looks great on the dividend yield. But what if there’s a chance that’s not zero that it goes to zero, right? That could be a real value play that is actually a value trap.

Tobias Carlisle (15:43):
Alluding to a little bit at the start by saying there’s a tension between the cost of capital and those existential threats exactly like that, the ones that you’re discussing. And on the other hand, lower cost of capital, higher cost of capital, having knock on effects on the returns.

Tobias Carlisle (15:59):
I think the oil and gas are probably a little bit safer from those things because we actually still do need them, consume them basically everything that we make almost immediately. The bigger risk probably to tobacco and that’s probably what tobacco… They could just decide that [inaudible 00:16:14] there’s no benefit there for consumers. Probably for the farmers, there’s a benefit, but for the consumers there’s none so that they could just switch that off.

Stig Brodersen (16:23):
All right. Going to the next question here in the outline for today, I want to talk a bit more about international investing. I guess this is the case for many of our listeners we are exposed to a lot of us equities and we do know as value investors that look, at least historically relatively expensive. What kind of data, if any, would you need to see or the next say, decade, to convert to investing significantly sums outside the US? Jake, why don’t we throw it over to you?

Jake Taylor (16:54):
My personal approach is much more to go wherever I find value. We’re already looking internationally and have been for a long time. Granted, I don’t always feel like I understand cultural things as well as I probably do in the US.

Jake Taylor (17:10):
There has to be an even bigger delta on price for feel comfortable often or even higher quality. I’m finding a fair amount of things internationally to do that make sense at the moment, especially, probably relative to the US, but I would just for fun like we talked about different numbers. I went back and I reread in 2003, Warren Buffet came out with this article with Carol Loomis in, I think it was in Fortune, where he’s talking about the trade deficit and he had this idea where if we could balance the trade somewhat for the US by requiring these like vouchers system, basically, it’s always interesting to take the numbers that he points to at that time period and what he’s concerned about and then roll forward, what have the numbers done since then?

Jake Taylor (17:55):
And is it even more concerning? Real quick, I could give you some of those. I looked him up recently. So he’s talking about how in the US, World War II to the early 1970s, the US was a powerhouse. We’re a trade surplus, everyone else in the world, their factories were all bombed out. We really set our reputation as a premier country at that time period and net investment, which means like how much of other countries assets do you own versus how much of foreigners own US assets?

Jake Taylor (18:26):
We were positive 37 billion in 1950 and then positive 68 billion in 1970. So we owned more of the world’s assets than they owned of ours. Late 1970s, trade reversed and the deficit was running at 1% of GDP, but net investment was still moving up because we were getting returns on our investment of our foreign ownership.

Jake Taylor (18:46):
So by 1980, it peaked at 380 billion, we owned of net of what the rest of the world owned of the US. Well, when Buffet wrote this article in 2003 when he was concerned, the trade deficit was running at 4% of GDP and net investment was two and a half trillion dollars to the negative. Foreigners owned claim checks like bonds of the government and our corporations, they owned real estate, they owned equities. So 50-ish trillion is what Buffet came up with of a total kind of net wealth of the US.

Jake Taylor (19:18):
That equates to about 5% of national wealth. If you pictured us as like a family, we sold 5% of the farm basically to overconsume effectively. Today when I looked up some of these numbers, the net international investment position in the US is negative 14 trillion on a roughly call it 140 trillion of total wealth.

Jake Taylor (19:41):
That number, my personal bias is that that number’s probably inflated by very low interest rates. But anyway, that’s 10% of net wealth now that basically the rest of the world owns of our productive capacity, because we’ve wanted to consume so much. The trade deficit in the last 12 months has been 835 billion. And that’s, if you call us GDP, roughly 20 trillion, that’s actually a similar kind of 5% GDP of the deficit is 5% of GDP.

Jake Taylor (20:11):
All the numbers kind of basically doubled from when Buffet was concerned about them in 2003, maybe even a little bit more. All of which is to say our sort of like premier catbird seat in the US as being the best place and I would say our fiscal house is in less order than it was 20 years ago, even when Buffet was concerned about it, which just means that like any rich family, the more that you’ve sold off the farm, like sort of the less that you probably have to look forward to as far as consumption. At some point you can’t just always be running deficits forever and not have to balance it at some point.

Jake Taylor (20:44):
Perhaps, who knows when, but that isn’t a potential argument for wanting to maybe have more international exposure.

Tobias Carlisle (20:52):
Yeah. I’m the only one who really doesn’t have much international exposure, which is funny, because I guess I’m the only one with an accent. Yeah. I run two domestic US equity funds because they were the two, the first one was the easiest one to set up for me and I just invested my own funds. So it kind of makes it…

Tobias Carlisle (21:11):
If I was to sit down with a financial planner and show them what I had done, they would say that it’s a bad idea and that I should get more international exposure. I 100% agree that everybody’s got a home country bias. What are the chances that the US is the country that out performs over the next like whatever useful, whatever life I’ve got left, 40, 50 years, whatever it is, the rest of the world.

Tobias Carlisle (21:32):
It’s low-ish. There’s just so much competition out there. I should have more international exposure, but at some point, I think I’ll have an international fund and then that would be how I would get that international exposure. But it’s not yet… I don’t do it, but theoretically, it’s a good idea.

Stig Brodersen (21:50):
Wes.

Wes Gray (21:51):
Yeah. I think Toby kind of nailed it there. We usually show a chart of like the last a hundred year history of US equities versus international equities, like five year rolling performance. And it literally looks like a sine wave or like a yo-yo.

Wes Gray (22:07):
Obviously, we’re on the far right side of that graph where the US has been winning for 10 years and the International’s been bombing out. But if history’s any guide, valuations matter right now develops 20, US is 30. To Toby’s point, deep values under 10 PE. International it’s even cheaper. I’m a big fan of international diversification and like Toby, we’re in our own cooking.

Wes Gray (22:33):
Our cooking just happens to already have international cooking. So it’s a lot easier for us to do that. But yeah, if I didn’t have a international cake baked up, I didn’t trust anyone else, then I’d probably be a US only cake eater as well. So I get where he is coming from. But I personally globally invest in deep value around the globe.

Tobias Carlisle (22:56):
I will say this for the US just to make a counterpoint on the other side, the US has been still remarkably successful even over the last decade of producing these phenomenal consumer franchise businesses that really the rest of the war world just hasn’t done other than China. China’s sort of seemed to be able to produce comparably big, comparably kind of great consumer franchise businesses.

Tobias Carlisle (23:19):
I just don’t face any of them because I don’t speak Chinese. I don’t use any of them other than like I’ve had a look at Alibaba’s US website and it’s kind of interesting, but I haven’t bought anything on it. That’s going to be the limitation. I think if you want to get some exposure, you’ve got to kind of get over the political issues in China, which are significant and to get access to the businesses which seem to be pretty good.

Tobias Carlisle (23:42):
Whereas when you look at the US, you have increasing political issues, but not as many as in China and you can get access to these very good businesses and that’s why the index looks the way it does, like the top four or five businesses in and an index. And the S&P 500 are pretty spectacular businesses that they’re expensive, but they’re not as bubbly as we’ve seen at like a dotcom bubble top.

Stig Brodersen (24:04):
It’s a really good point. It always goes back to what does it truly mean to be diversified and do you want to invest in something you don’t truly understand? And I think at least for the four of us, we are most comfortable with the US market and we…

Stig Brodersen (24:16):
If you look at what total market cap compared to the rest of the world is like at 50-odd something, then you could of course also look at GDP of the US which is probably close to 22 or something like that. It’s also like, what is your benchmark? It’s hard.

Stig Brodersen (24:29):
I guess that’s a segue to the next question here, because I wanted to talk about different investment strategies and I’m going to mess up this quote so Wes can set straight here, but during this calls, Wes has said multiple times something along the lines of be religious and be religious about having many religions.

Stig Brodersen (24:48):
As value investors, we taught earlier that value investing works because it doesn’t work all the time. Like I could give Toby a jab here with value investing for him coming on the show and saying, “Oh, what’s going on with value right now?”

Stig Brodersen (25:01):
But if you look at the historical data, that is true. There have been long period to where value didn’t work, which is why it’s outperformed in the long run. So you need to stick with that strategy, especially whenever it’s out of favor. So let me throw it over to Wes. Now that I’ve started sort of quoting you. Do you have anything in your investment strategy that is a timeless principle that never changes? A religion that never changes, if I can use that phrase.

Wes Gray (25:28):
Investing in my opinion is 100% behavioral game. It’s really important to find something you believe in and get religious about it at some point, because religion helps reinforce discipline. Because if you don’t follow it, you feel like you’re going to go to hell or something.

Wes Gray (25:48):
It’s like this weird mental game where you don’t want to ever be too dogmatic about anything, but in the context of investing, it’s really important to be dogmatic about something. But then you have the other issue whereas investing is not just behavioral, it’s also math. And there’s this thing called diversification and not have having all your eggs in one basket or philosophy or ethos, because a lot of times people think they’re diversified, but they’re not.

Wes Gray (26:14):
And so to the extent that it’s possible and from a psychology standpoint, it’s incredibly challenging, it’s very hard to be a Muslim and a Christian devout hardcore simultaneously but in theory, if one is able to do that in their head, a lot of times you can gain benefits of owning two different religions that on any individual case by case basis.

Wes Gray (26:40):
But to the extent you can do that, I think that’s important. But to the extent you can’t, like if you’re a value investor and that’s the only thing you can ever believe in period and anything else is just a bunch of baloney, i.e., your ability to be disciplined at the time that’s “not working” [inaudible 00:26:57], it’s not worth it.

Wes Gray (26:59):
And so for me, going back to your original question, what are timeless principles? It’s simple. Fear is a human condition. I think value captures that in the sense that you’ve got to buy stuff that everyone hates, it’s ugly, it’s nasty. Why would you want to do that. I like value for that reason, but then I’m also a big believer in greed and people are crazy and they’re speculative and they’re maniacs, right?

Wes Gray (27:25):
Well, that’s called momentum and we can all talk about why that’s crazy and it’s against the fish and mark hypothesis, but if you’ve ever met anyone in a sentiment driven market, like right now, to deny momentum is like to deny that you need water and oxygen to live. It’s just… You are wrong. I’m the unbeliever in fear and greed basically. It’s that simple.

Tobias Carlisle (27:49):
I agree with everything that Wes just said there. I wouldn’t disagree with anything at any point that he’s made. Although, the only thing… I saw an online poll that said, “Do you need air and water to survive?” And 97% of people said, “Yes.” That’s like 3% of people [inaudible 00:28:05]. I want to meet those people and find out what they’re doing. I don’t know. I agree with everything Wes says. I’m constitutionally a value investor. So I may need at some stage to put some money into Wes’ momentum funds just to balance myself out. But I’m not yet at that point.

Tobias Carlisle (28:23):
I think that things have a value and I think of myself as like a business guy, rather than an investor. I’m an entrepreneur more than I’m an investor and I just look at these businesses as businesses rather than as it’s a paper that trade.

Tobias Carlisle (28:39):
And I try to buy on the basis of the returns that I’m going to get. If the position goes against me, then I’m still in the mindset of an investor, of a business guy, of an entrepreneur. I look at the performance of the underlying business. I have read all of the research on momentum. I’ve read Wes’ book on momentum. I’m 100% intellectually there with momentum.

Tobias Carlisle (29:04):
It’s just that last sort of emotional step that I can’t make, which is why I’ll probably have to outsource it to Wes at some stage, but not yet. But that’s sort of… I think that behavioral errors are the most are the thing that causes most people to underperform and most of that is just a lack of conviction in their own strategy. So you need conviction in what you’re doing. You need the religion, you need a code as I always like to say.

Stig Brodersen (29:26):
Toby, do you have any kind of threshold for pain or any kind of data where you’re saying, “I need to step away from value as my main strategy.” The reason why I’m asking is that we have a lot of value investors following the show and a lot of them have been through a lot of pain with everything that’s been going on the financial markets. They hear all these things, they see all these billionaires doing X, Y, Z, they hear about whatever.

Stig Brodersen (29:51):
A lot of them are… They’re changing what they do. They’re changing how they think about things because it’s been… Perhaps because it’s been too long now.

Tobias Carlisle (29:59):
I believe in being rational, I believe in rationality. I’m a Bayesian updater of every year that we get some more data that favors some other aspect, I try to include that. But you’ve always got the tension of when something looks worse, it’s often the point that it’s about to perform best and vice versa.

Tobias Carlisle (30:18):
But you need to be Bayesian about it too. You have to be including the additional bits of data that come in and thinking about whether that changes… I don’t really suffer from FOMO. I wish everybody the very best in the markets. I hope everybody does really, really well and crushes it. I’m playing my own game, which I really enjoy. It keeps me intellectually engaged. It’s really fun. I’m a business value guy at my core, so that’ll be the last thing that goes.

Stig Brodersen (30:44):
Jake, timeless principles in your portfolio?

Jake Taylor (30:48):
Yeah. I think both of the answers that they gave are quite satisfactory. For me, it’s very similar, a little bit, probably more sort of Toby where I like the brain damage of figuring out businesses and it keeps me engaged with the world and kind of solving puzzles.

Jake Taylor (31:04):
I never forget that I always own a business and it’s always important to me. Cashflow always matters. And then also, what is done with that cash flow inside the business, the capital allocation matters tremendously as well.

Jake Taylor (31:18):
And then of course, kind of the typical margin of safety. I just want to get way than what I feel like I’m paying for. I want to get a deal. I want to feel like I’m getting away with something and then probably the last thing which is just never lose sight of what is my edge in this?

Jake Taylor (31:32):
And I don’t have a better analytical edge. I’m not smarter than anybody, but I do think I have a good shot at I’m hiding here in Folsom, California, away from a lot of the noise and I go on my walks and I listen to Warren and Charlie talk and I insulate a lot.

Jake Taylor (31:48):
That gives me, I think, a potential behavioral edge where the lower the price goes, the less of a good analyst I need to be. The more margin of safety I have, the less smart I actually need to be. I try to keep that front and center all the time and then just be patient and recognize I’m not going to get all of them, I’m going to pick some things that are wrong, but this is a probabilistic game over a long career.

Jake Taylor (32:11):
I think I’ll do just fine as long as I stick to my principles and where I think I’ve got a little bit of an edge and eventually, it’ll work out just fine.

Stig Brodersen (32:20):
Wes, continue talking about which type of valid are you looking for before saying, this is a… I haven’t invested like this before. I remember you coming on here on the show some years ago and you’re like, “I started out as a value investor. I saw all this data validation about momentum. I needed to do something about that.” Which type of data validation are you looking for before you change your mindset?

Wes Gray (32:44):
Well, for me, [inaudible 00:32:46], I had to write an entire book. I needed to maybe compliment another religion because I can’t disagree with anything these guys say, because in my DNA, I am fundamentally a value in investor. I get it.

Wes Gray (33:00):
Why do I think that value works? Farnam told me it’s because they got all this extra risk, blah, blah, blah. Then I started thinking, “You know what? I like Ben Graham’s answer better because it makes more sense based on empirical observation of the marketplace.” Mr. Market can get crazy. And fundamentals will make sense. Like if something makes $10 a year and you know it’s going to keep making $10 a year, you always have that center of gravity and the price will bounce around it. I can exploit that.

Wes Gray (33:32):
What I came around to believing is my fundamental belief is people lack discipline, period. That’s my first principle. That’s why I believe in the value religion. That was my first principle. Then I started thinking, okay, Wes, if that’s your first principle that you think people are crazy and lack discipline and that’s why you believe value works, then fundamentally, why don’t you apply that core first principle, see if it exposes itself anywhere else in the marketplace.

Wes Gray (34:04):
Oh, there’s this thing called momentum and there’s this thing called people or maniacs, sentiment driven, FOMO, whatever you want to call it. There’s reflexivity in prices. Prices keep moving. Now, you’ve got lower cost of capital. You can reinforce, buy cheaper stuff than the other guy. My first principal that also shows up in another religion called momentum. And then once I got my head around the fact that they’re not really different religions, they’re just ways to exploit human behavior differently in a disciplined way, then I was able in my own head…

Wes Gray (34:40):
In someone’s some sense, I really do have one religion, but another way to think about it, sub-religion is one is value, one, it’s called momentum. But in my head, honestly, they’re the same thing. If I have the ability to be, to Jake’s point, the key edge is discipline.

Wes Gray (34:56):
We’ve talked about like the diet thing. I learned this in the Marine Corps, everything in my whole life. Okay. You want to lose weight? Exercise more, eat less, period. It’s fundamental. It will happen. Why are there 10,000 diets? Why are there 10,000 programs? Why are there 10,000 YouTubers telling you all the 50 million ways to achieve something that’s fundamental? Eat less, PT more. Have discipline.

Wes Gray (35:25):
Same thing in investing, be disciplined, think long term, focus on fundamentals. Great. Let’s buy cheap stocks everyone hates and let’s buy winners. Who knows when one’s going to work versus the other. I really believe… This is what I’ve come to conclusion. I could change my mind, but that’s… This new market is only reiterating my faith and my religion that people are stupid and don’t have discipline. It’s crazy to me.

Tobias Carlisle (35:52):
It doesn’t really bother me whether… I was like Wes, very much preferred Ben Graham’s explanation. But I think that there’s also a large component of it that Fama and French are probably right. There is a big risk component to value as well.

Tobias Carlisle (36:07):
It’s a little bit of both, but I’m at the point where I really don’t care what the reasons are why something… If it’s cheap in the sense that I can calculate some yield and some growth component to it and it looks like it’s more than the risk that you’re taking on and more than other alternatives, and I think it’s a good thing to do and I… I don’t find it hard to be a value guy through these periods of time because I can put these positions on and I can see that there is an expected return in them.

Tobias Carlisle (36:37):
It’s to the point that we’ve all been making, when prices are lower, expected returns do tend to be higher. I just know that even though it can go against you for a long period of time and honestly this one’s been a lot longer than, than I would’ve planned at the start. I still think that the underlying theory is sound, the logic to it is sound. It’s just of time and patience in the market and eventually.

Tobias Carlisle (37:01):
Wes, says giving the example of losing weight. I just put it the other way around. I think you need to eat less than you burn. If you do it that way, it compounds over time, it takes three or four years. Investing is exactly the same. You’ve got to get up every morning and do your exercise and you got to be careful with what you eat and you’ve got to do it for years. But at the end of that, you see a result true in the markets as well.

Stig Brodersen (37:24):
Let’s focus on the long term. Jake, do you see any secular trends for the next decade? I have to ask, if you do, if that’s something you would share with us and how you positioned yourself.

Jake Taylor (37:36):
I would say that I have, as I’ve gotten further into this game, moved further and further away from secular anything, whether it’s interest rate driven, macro, anything, GDP related. I think it’s all interesting stuff and it, no doubt matters, but I just don’t feel like I could know it.

Jake Taylor (37:57):
It’s too hard to figure out. Like any complex adaptive system, the initial conditions are recognizable. Here’s where we are. Where exactly it ends up in the state is incredibly difficult because there’s so many little ways that it can go that will create feedback loops that then move you way further a field than you ever would’ve thought imaginable.

Jake Taylor (38:20):
I do less and less of that stuff and I just try to think more and more about these businesses that I own. I know they’re impacted by all of it. I know it’s important and it would be awesome to know it, but I just can’t wrap my mind around it enough to feel like I’m actually helping my analysis by trying to untangle some of those rats nest. It’s less and less a part of my process.

Stig Brodersen (38:42):
Toby, any secular trends you’re looking at? I’m not necessarily talking about the macro picture, but in general, any consumer behavior that are changing, that we should be aware of?

Tobias Carlisle (38:52):
Well, one consumer behavior is the consumers started consuming value stocks in about September last year. They started consuming my kind of value stocks in about February this year.

Tobias Carlisle (39:03):
I really don’t because I’m pretty systematic and pretty quantitative about it. I buy good things when they get cheap. I care that they’re cheaper than they’re good, but I tend a lean on the… It’s funny though. I do think it’s funny how often value gets in front of macro trends that people start talking about subsequently.

Tobias Carlisle (39:24):
I was buying Home Builders last year, Home Builders for a little while and now that’s become like a story where evidently we’ve under-invested in homes. People locked in, they’re looking for houses to buy. Houses have exploded. That home builders are going to do a lot of work. Home building at some stage is going to transition into momentum, but it started out as value and I didn’t buy it because I had any insight into the consumers. I just thought it looked like it was at a cyclical low and it looked cheap on that cyclical low and so I bought it.

Tobias Carlisle (39:52):
I think that often that’s what happens with value it you… I don’t really know why it’s there. I just know that it is very cheap and subsequently, the macro picture sort of colors itself in. I don’t know if that’s real or if that’s just the media picks up on the story, analysts pick up on the story and they add a narrative to it and it’s appealing. I try not to do too much sort of picking where the consumer’s going to go, just play the field as if on it.

Stig Brodersen (40:16):
One of the most popular guests we have here on the show, that is Cullen Roache. And he often talks about how there is no such thing as passive investing because even passive index funds are still measured against a constructed benchmark, which you might say are actively constructed because someone still decided this is what it should be.

Stig Brodersen (40:37):
Each investment strategy also has it’s own risk profile. You can’t all compare to the S&P 500 if we do something completely different. Starting with you, Toby, what is your benchmark, if any for your investment strategy and why is that your benchmark? How do you think about that?

Tobias Carlisle (40:54):
I have benchmarks that I value benchmarks, but I think about it a little bit more broadly. I think it should be like S&P 500 or even the globe. I use S&P 500 right now but even the global total market would be appropriate if I had some international exposure. I agree with Colin, it’s kind of a funny… S&P 500 is set by a committee and they actively decide to include or not include Tesla based on some things. They did the same with Google. And then it’s market capitalization and float adjusted, which float makes a whole lot of sense for people who are trying to run index tracking funds.

Tobias Carlisle (41:26):
Float might not make a whole lot of sense for the average punter out there. I think his point is fair that even passive indexes aren’t really passive. I wouldn’t want to come up with another one. I think that they’re doing okay.

Stig Brodersen (41:39):
Just like whenever Buffet talks about accounting rules is like, gap’s, just so silly, but I don’t want to go off with gap version 2.0.

Tobias Carlisle (41:47):
I could have a go at a few of the gap rules and fixing things that I wouldn’t run and gains and losses through the PNL.

Stig Brodersen (41:54):
Yeah, that’s a good point. I mentioned Colin Rhodes before and we had him on cause he was launching a new ETF and we talked about how to invest in ETFs. He mentioned Wes that he set it up through alpha architect. I was just wondering like whenever he… Because all ETFs have to choose a benchmark or is it you, is it the SEC or you choosing one yourself? Like how does this benchmark thing work whenever you go to an ETF website and you see, “Oh, it’s benchmarked towards that index.”

Wes Gray (42:24):
Anytime you have a registered fund, i.e., like a mutual fund or an ETF, in your prospectus, you have to have some benchmark. It’s basically what is something that is broad based inappropriate like with some sort of risk profile? If you do US stocks, well, S&P 500 is probably in the ballpark. And then there’s nuance within that.

Wes Gray (42:44):
Well, I’m doing value stocks that are only the midcaps and S&P. You can get nuance, but technically all you need is a broad base benchmark that roughly approximates the same risk profile that you choose to take in your investment product. That’s a mandatory requirement.

Wes Gray (43:01):
Any time you want to learn about a fund and people think about it less or more, depending on who you’re dealing with, but you technically have to have it, just read their prospectus. It’ll have like a benchmark outline in the prospectus.

Jake Taylor (43:16):
I go so many different places, different sizes of companies, international, or US, picking one benchmark. And it changes all the time too, depending on where the opportunities are.

Jake Taylor (43:27):
I do not fit well into any kind of style boxes. Therefore, it’s hard to have a well-defined mark. I would probably choose a… Some, because a lot of times, a lot of the money that I manage is someone’s entire net worth. If I was just running a fund that was a little sleeve of someone’s net worth and they were using me for some specific style or size, then I would say like, “Okay. I should be compared to that specific benchmark because that’s really the opportunity cost of that sleeve is what they would have put it in otherwise.”

Jake Taylor (44:02):
But for me managing entire net worth of a lot of people, I think more actually of it like a global, like the MSI for both equity and bonds in some kind of mixture, sort of just like planet earth return, if you could go anywhere and kind of buy anything and you owned everything, what would it look like versus that.

Jake Taylor (44:21):
I think that’s probably a little bit more appropriate for my style. The US based investor, you could make the argument that hey, I don’t want you to manage it for me. I’m just going to stick it in the S&P 500 and pay no fees at all. I think that’s a perfectly reasonable thing to do, especially over long time periods.

Jake Taylor (44:40):
I don’t know how well it’ll do over the next five to seven years. I think just as a base rate bet from today’s prices, I would be a little pessimistic as far as… That it won’t look like the last 10 years. But in general, I think that the other question that is missing in all this is over what timeframe. We have a benchmark. Over one day against the S&P 500, what do you look like?

Jake Taylor (45:06):
Okay. Well, that is obviously just total random noise. Over one year, okay, well maybe a little bit more information in that, but I would still put that not that much different than one day. That’s closer to me to one day than it is to actually like 10 years. It’s this catch 22, where unfortunately, in order to untangle luck versus skill, you need a pretty large data set of time and maybe even like sort of multiple market environments.

Jake Taylor (45:32):
If you’re just in a one way market like we’ve been in the last call it 12 years, I’m not quite sure that you can say full cycle, how good of an investor someone is if they… The bet has been to be balls to the wall risk and that has been the way to bet for the last 12 years. But I think we all kind of intuitively know that that will come at a cost some day and that maybe it’s not a foolproof plan.

Jake Taylor (45:54):
I think the time horizon is also for this game needs to be measured over much longer periods than probably people are typically comfortable with. It’s unfortunate. I don’t have a better answer, but I do think that benchmarks can lead to short term thinking that I think actually leads to a sub optimization.

Tobias Carlisle (46:14):
I had a look recently at the… John Husman has this method of calculating expected returns over the next decade. He uses the [inaudible 00:46:23] and then he assumes a long run average [inaudible 00:46:27]. And he assumes that you mean revert to that over a decade and we can pull up the dividend yield of the S&P 500 and then he puts all these things together and you can track it on a day by day basis.

Tobias Carlisle (46:39):
I just have this little web scraper that pulls this data and then I chart it. I just was looking the other day for the trailing 10 year return on the S&P 500, it’s like 16% including dividends, which is like… That’s about as good as it gets. The Ford return is now negative on the index, but that includes… It’s negative 0.1% but that includes 1.3% in dividends.

Tobias Carlisle (47:06):
The index will be negative about 1.2% for the next decade on an annual basis based on assuming that the main reversion, assuming we go back to the average, assuming it takes a decade, all those sort of things.

Tobias Carlisle (47:18):
I will say it’s been remarkably predictive, that little chart, as simple as it is, but I just think there’s never been or there’s not never been, but there are times when there have been as wide a disconnect between the trailing 10-year and the forward 10-year. They’re all notorious kind of dates in that chart. It’s not a prediction. It’s just an observation.

Jake Taylor (47:40):
Does that mean revert profit margins or interest rates or anything else that are kind of tipped all in one direction?

Tobias Carlisle (47:48):
It doesn’t include those things. You can come up with a more-

Jake Taylor (47:52):
So you have more ways to lose.

Tobias Carlisle (47:54):
There are more ways to lose than it looks like on the surface, but I already sound crazy enough saying negative returns. That’s all we’ll say.

Stig Brodersen (48:03):
Wes, I’m curious to hear how you think about risk in comparison, because like Toby just said, with the S&P 500, you have 16% and you’re like, “That’s great.”

Stig Brodersen (48:12):
And then Jake might come in and say, I’m just using Jake as example here, but he might in and say, “Well, I achieved 14%, but I did it with a lot less risk.” We discussed the whole thing multiple times here on the show. We don’t really consider standard deviation, the best measure risk. We don’t really are not too big of a fan of the Sharpe ratio.

Stig Brodersen (48:35):
Can we look at this any other way that you compare the S&P 500 with what it is and then you compare X, Y, Z Jake’s portfolio, lower return, but perhaps also low risk. How do you make that comparison?

Wes Gray (48:49):
There’s thousands of papers you can reference on this right. In the end, I think you’ve got to just use common sense which is a dangerous thing to do at some level and say like, “Okay. Let’s just break it into the biggest muscle movements possible.”

Wes Gray (49:06):
US stocks or maybe global stocks that I think Toby mentioned that, that’s kind of like one risk bucket. Global bonds might be a risk bucket. Maybe commodities could be a risk bucket as a third one. And then whatever you think your average allocation is to those broad buckets, you can access almost for free, if your dynamic is what it is, but if we’re talking like a 20, 30-year benchmark to Jake’s point, like hey, you’re going to try to beat that over the cycle?

Wes Gray (49:39):
If on average, you believe that your process is going to be 50% stocks, 30% bonds and 20% commodity or commodity-like investments, well, even if you’re dynamic, let’s just use that is your baseline benchmark and we’re going to assess it over a 20-year horizon.

Wes Gray (49:55):
I think doing anything beyond that, it gets crazy. I think it’s too much noise, not enough signal and you lose kind of the forest or the trees a lot. So I just pick the broad asset class that you’re vaguely going to be investing in. It’s probably going to have the same rough risk return.

Wes Gray (50:14):
If you can beat that, great. You should probably do your process. If you can’t, probably buy the Vanguard fund equivalent. Most important point though is Jake’s point, is benchmarks are awesome in theory because in theory they enforce discipline, but they’re terrible in practice because of the short term nature of them and they force humans to be back to being humans again.

Wes Gray (50:39):
I’m a fan, but I’m much more a fan of understanding and knowing the process, which everyone is here I’m sure.

Stig Brodersen (50:46):
All right, gents. It’s always a pleasure having these quarterly meetings, talking about investing. I think I don’t only speak for myself, but for all the listeners when I say that I always learn a ton from our discussions. Can I say, especially when we disagree, I tend to learn even more.

Stig Brodersen (51:02):
Before I let you go, I’d like to give all you the opportunity to tell the audience where they can learn more about you. Wes, please go first.

Wes Gray (51:10):
Alphaarchitect.com or on Twitter, @alphaarchitect.

Stig Brodersen (51:14):
Toby.

Tobias Carlisle (51:15):
My website is acquirersmultiple.com or acquirersfunds.com. My Twitter handle is @greenbackd, G-R-E-E-N-B-A-C-K-D, where I post four or five times a day.

Stig Brodersen (51:25):
All right. Yay.

Jake Taylor (51:27):
So this great resignation, I guess, has been happening in the US where I guess 4 million people quit their jobs in July. With that comes a lot of orphan than retirement accounts. This happens to be something that my firm does a lot of is people leave a job, they have this account, they’re not even paying attention to it anymore. Those long term retirement dollars tend to be a pretty good fit for a value approach, I think. Maybe even more so than a after tax brokerage.

Jake Taylor (51:57):
I had the team put together a little special thing for the audience. If you go to orphanira.com/TIP there’s a little special in there. Because I like to talk to every single new investor to make sure that it’s a good fit, we only have kind of a limited amount of bandwidth that we can onboard people in a typical month. There’s six spots for whenever this airs that month that will… We have time to be able to bring on board.

Jake Taylor (52:28):
If you want to get in there, I would suggest don’t wait. But so that’s… That’s where if people want to get some help with an orphan retirement account.

Stig Brodersen (52:36):
All right, perfect. It’s been handed off. All right, gents. I look forward to doing this again next quarter. Thank you so much for your time.

Tobias Carlisle (52:44):
Thanks Stig. Good seeing everybody.

Jake Taylor (52:46):
Cheers everyone.

Outro (52:48):
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Outro (53:07):
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