Matthew McLennan (00:02:49):
Well, my parents went to New Guinea really for adventure. They were Australian and are Australian living in Brisbane today. But they were adventurous souls and my father was a land surveyor and he got a job up there helping to survey the mining communities. My mother and father went up there thinking they were going to live this particular adventure. There was one E type Jag I heard up in Papua New Guinea that they planned to buy, but they had me instead. My first six years were really up there before the independence of Papua New Guinea in the 1970s. It was an amazing place to be a child, very free walking through the markets and a sense of adventure. When we moved to Australia, we wound up living in a little town called Montville. Montville was a thriving metropolis of about 400 people.

Matthew McLennan (00:03:38):
We had a beautiful little home on a block of land that my parents had found. It was their dream block of land, but like their dream in Papa New Guinea, reality turned out to be a little different from what was envisaged. The home didn’t get connected to the power grid for the first seven years, so we had this beautiful little cedar home that they helped build and there was a rainforest on one side and again, a fairly idyllic place to grow up, and it was a house full of books. While we didn’t have electricity, we had gas lamps and a cast iron stove. If you wanted a shower, you could put a black plastic bag out in the sun and heat it up and hang it under a tree with some burlap around it to take a shower. It really was living in the sticks. It wasn’t until I went to high school in Brisbane at a boarding school because there was no high school in my town that I got to experience the big city. It was an unusual but a very happy childhood.

William Green (00:04:28):
You told me a great story once about your father deciding that you should get a TV. Can you tell us that?

Matthew McLennan (00:04:35):
Well, we are all very excited about the notion of having television. It’s one thing to have books, but occasionally as a kid you want to watch some television. My father got a television and he hooked it up to the car battery. We had a night in watching television, which was very exciting, but the next morning when my father went to work, he reversed out and dragged the TV through the front door behind, and so that was the end of the television experience at least for a while. Those little mishaps are amusing punctuation marks on a childhood, and I remember it fondly. We even had a koala come into our house once. The house was built around these eucalyptus stomps and the koala came in one night and climbed up. My grandfather, who was a doctor, realized the koala very well and wrapped him in a blanket and took off some ticks and nursed him back to health and he was back out in the forest the next day. It was a childhood full of little surprises.

William Green (00:05:36):
Can you tell us more about your grandfather? We’ve talked about him in the past and my sense is that he was a very formative figure in your life and also a really quite remarkable figure.

Matthew McLennan (00:05:47):
He was a formative figure for me. I guess everyone is the beneficiary of having various mentors in their life, and he was one of the first mentors for me outside of my parents obviously. He was an interesting man because he was a doctor. Aside from being a doctor, like my mother and father really had a bit of a spirit of adventure. He went to live in Antarctica in the 1950s and the Australians, the Russians and the Americans had to share a common base for survival back then. That was in the early stages of the Cold War, but he lived in Antarctica for 18 months.

Matthew McLennan (00:06:23):
I think that was an incredible experience for him because he was a philosophical person by nature. He went to discover the truth in his own words and realized that he couldn’t however much he thought it was asymptotic in nature. He could approach various truths but never really touch them and that left an impression on me. He came back and when he retired from his medical practice, he developed a real passion for gardening, which passed on to my mother, and I learned a lot from that as well.

William Green (00:06:53):
I remember you telling me once that he said you are an idealist and you believe in an absolute truth and you need to learn that there’s only relative truth. Can you talk about that? It seems like an interesting insight to have been given early on as an investor.

Matthew McLennan (00:07:08):
It was as a child. I always liked puzzles and trying to crack the code on whatever it was, solving a Rubik’s cube or figuring out how to win at any given game. I think he could see very clearly that I like to get to an absolute truth like the proof of a mathematical equation. He introduced me to this notion that life is actually more complex than the simple games or truths that I was trying to unravel, and that much of truth is unapproachable. In fact, it wasn’t until I was in college and many years later reading other works that I realized that this was a whole field scientific methodology and I became pretty interested in Karl Popper, who wrote about the notion of falsification. Karl Popper had a term for this. He said that things aren’t true, they just have very similar truth, the appearance of truth.

Matthew McLennan (00:08:04):
But I think having had that notion instilled to me early on was useful because it sow the seed for becoming at peace with the notion. There are certain forms of uncertainty that you just can’t unravel and you need to respect those spaces a little bit. I think it has informed how I’ve approached investing in later years. It’s also popped up in different forms of work. I mentioned Karl Popper, but I remember Fish’s work when he talked about the difference between risk and uncertainty. Risk being something that you can narrowly quantify with statistics and uncertainty being where you don’t even know what the range of distribution possibilities are. Going on to folks like Steve Wolfram in the field of complexity, which we can no doubt talk about later, but having that seed planted by my grandfather, that metaphysical source of angst, if you will, was actually a good thing with the passage of time, however disappointing it was for me at the time to realize that I couldn’t learn all of these absolute truths.

William Green (00:09:11):
How did you end up as an investor given that you had all of these very broad interests? You’ve always been very interested in history, in literature, in science. You’ve been very involved with public health as a philanthropist. Your parents were adventurous and your mom was an artist among other things. It never struck me that the world of money was the paramount thing in your family. How did investing become a way to bring together all of these disparate interests in the world?

Matthew McLennan (00:09:39):
Well, I think, in some ways, there were various motivating forces at work. One may argue being of Scottish origins originally way back when that there may be some atavistic tendency there with money, but that’s probably just wishful thinking on my part. Then, there was necessity. I think despite the fact that I had a really fortunate childhood in terms of being very happy and being exposed to a lot of thinking and life experience, we didn’t have a lot of basic necessities. I think there was a motivational force of wanting to live a more comfortable life, not for material purposes per se, but for a sense of personal freedom, not feeling encumbered by one circumstance. That had some motivating force to it for me.

Matthew McLennan (00:10:26):
Then, my grandfather, who I mentioned before, he would invest in the stock market on the side. I remember, in high school, I just became interested in stock markets and for all of the wrong reasons initially. This was the time back in the early 80s when you had the early days of the leverage buyout booms and people were creating fantastic wealth. There were a lot of speculative enterprises that were being formed that were rolling up other businesses. It seemed like that there was this mystical Alexa that one could learn about. At the same time, in about grade 11, I had a math teacher who wanted to create an investment club at high school. He figured out, he’d discovered the pattern in the roulette wheel to quote Fred Schwed from Where are All the Customers’ Yachts? As Fred Schwed said, “For every new person who thinks they’ve discovered the pattern in the roulette wheel, it’s unfortunate for them because they haven’t.

Matthew McLennan (00:11:24):
He had studied Elliot Wave theory and I thought, “Well, he’s something interesting.” He can look at the passage of historical prices and figure out what’s going to happen next, and all of this seemed to have this allure to someone who wanted to have freedom in life. At the same time, my grandfather, who was a long-term philosopher, gardener, collected wine, whatnot, he gave me a small amount of shares in a company which was a small but fairly dominant regional bank. Time took care of any illusions that I had because the investment venture with the math teacher went to zero pretty quickly. He certainly couldn’t see the future in employing leverage when you can’t see the future is a dangerous thing to do. Meanwhile, this little company compounded out quietly, almost unnoticed never into a large amount of money because it was a few hundred dollars, but it got me thinking.

Matthew McLennan (00:12:17):
As I sifted through all of this in my mind, I thought, “Well, I really have to learn about this in a more disciplined way,” and that’s when I chose to study finance and accounting at college and got exposed to some more empirical elements in the world of finance and start to read about other investors. Meanwhile, all of these wheeler dealer entrepreneurs were blowing up in the market because financial conditions got tight in the late 1980s. I think it was just having the benefit of seeing certain schemes unfold and then unfold and then certain simple truths play out over time for the patient.

William Green (00:12:56):
Before you joined First Eagle back in 2008, you spent a big chunk of your career at Goldman Sachs, I think, ultimately, about 14 years and ended up managing a global investment portfolio there. You obviously had to navigate some pretty treacherous periods during the late 90s with dotcom bubble and maybe earlier, I guess, also with the Asian financial crisis. What did you learn from those experiences at Goldman about what it takes to be a resilient investor and build enduring success?

Matthew McLennan (00:13:26):
Well, the late 90s were difficult as a value investor. I’d had the benefit of some interesting mentors at Goldman as well. Paul Farrell had worked with Lou Simpson at Geico, who taught me the Buffett way of thinking. Mitch Canter, who’d worked at Bernstein, who was a deeper value investor, who really got me to think about how businesses normalize over time. I had these value influences on me and I was just getting my own legs as an investor. But then the late 90s ended up being just a woeful period for value investors. Rather like the period we’ve just been through, history does rhyme sometimes. Focusing on cashflows and price was not a profitable thing to do in the internet bubble. It was very challenging emotionally. I was, obviously, quite a bit younger at the time and you’re trying to navigate a period. But I think what it solidified for me is this notion that sometimes if you’ve got a discipline mental model, you need to be willing to be short social acceptance for periods that are quite a bit longer than you’d feel comfortable with.

Matthew McLennan (00:14:26):
When one grows up and one goes through grade school, you get essentially promoted each year to the next grade, you get your grades every semester. Even in the early stages of a career, you typically get annual feedback and your annual bonus. Investing is a lot more like gardening where the seed you plant intellectually or the business investments you make often play out over 5 to 10 years. I realize that the timeframe that one had to apply to, assessing the feedback loop was quite a bit longer than conventional timeframes and you had to learn to manage that emotionally, which I think was a good lesson to learn relatively early on in an investing career, because those things repeat themselves. I saw a lot of people leave the business because they weren’t willing to stick it out, if you will. I think that was a really formative moment for me.

Matthew McLennan (00:15:20):
I have a friend who was a very successful trader. He used to trade exotic options and he said to me once, he said, as he retired from the field, he said he learned the hard way that prices often have a way of causing the greatest amount of pain to the greatest number of participants before they settle at the right level. Maybe that makes sense. If markets are in equilibrium, prices force out the weakest hands over time before settling at a stable level. I guess, all of those experiences back then were formative to disentangle the mental model and approach from the near term results.

William Green (00:15:57):
Do you think it helped in a sense that you had had such an unconventional childhood? You weren’t naturally someone who was part of the tribe, you were probably by your own wiring, but also by your own conditioning, you were outside the herd, and so maybe it was easier to think for yourself than it have been for many other people?

Matthew McLennan (00:16:18):
I think there’s some truth to that, William. I think that I definitely came in with an outside perspective. I think as well, I take comfort in the purity of ideas. I think the combination of coming at something from the outside and seeking purity and ideas, even if you, I’d recognize by that point there weren’t any absolute truth. I think it was those two things that were very helpful in enduring an environment like that. Indeed, when I spoke to Jean Marie who hired me to First Eagle many years later, he said one of the things that gave him comfort about hiring someone like me was that I had enjoyed an experience like the late 1990s, was almost like a condition precedent to feel uncomfortable that you’d have the stamina to do it again.

William Green (00:17:08):
Yeah, and that period had been such hell for him. I write about this in my book, Richer Wiser Happier, the degree to which he was at war with the world, at war with the market, at war with his bosses who were like, “Why don’t you get this new paradigm and by dotcom stuff?” He said this will roll with themselves.

Matthew McLennan (00:17:33):
I definitely had to face those pressures. I was dragged in front of one of the partners for lunch and he’s like, “Why aren’t you buying these hot IPOs, it’s free money?” I tried to explain the fact that it’s a sucker’s game, the IPO market, because you spend all of your time researching businesses that haven’t proven their incumbency. Secondly, you tend to get the smallest allocations of the best businesses. There’s a lot of adverse selection in that market. I’d spent a lot of time thinking about why I didn’t want to spend my time focused on that, but it seemed like there was free money to be had. I remember a conversation with the retirement committee at Goldman Sachs where they were questioning whether there would be any mean reversion in this dotcom era, whether everything had changed.

Matthew McLennan (00:18:21):
I recall back then saying that, “Look, you can look at enterprise value to cashflow or revenues, and yes, some businesses will live into high valuations,” but one of the metrics I couldn’t get around was the enterprise value per employee. Some of these newly-listed companies was quite large. In fact, I said to the partner at the time, I said, “Would you pay 30 times as much per human for this business as the market cap of Goldman Sachs?” You feel like you’ve got good people, would you pay 30 times as much? By the way, in a labor market where unemployment rates were below 4%, how are they going to hire the people to live into that valuation even if they can find the best people? Yeah, I guess looking at strange things like that gave me the conviction to stick it out, but it was a trying time.

William Green (00:19:10):
You mentioned before that you found solace in the purity of ideas. Were there particular ideas that you were clinging to? Particular principles that you’d learned maybe because Paul Farrell had introduced you to the writings of Buffett or Munger? What were the main tenets that you’d figured out that protected you from the craziness and irrationality of the late 90s?

Matthew McLennan (00:19:33):
Well, it’s interesting. If you’re a bond buyer, you know that you’ve got a contractual principle that’s due to you in five years time or whenever the bond matures, and I think that gives bond buyers a lot of peace of mind that they can endure a short-terms vicissitudes and quarterly reports and the like. I think it’s difficult as an equity buyer because what you’re buying is ostensibly a perpetuity. But I think, what gave me the conviction the more I thought about it was that ultimately you’re buying access to a cashflow stream. If the business were cashflow generative and it was stewarded by management teams that were willing to distribute the lion’s share of those cashflows to you, then ultimately arithmetic would work. That sentiment could shift around the multiple relative to that cashflow a lot in the short term, but ultimately the math would converge upon the arithmetic of the cashflow.

Matthew McLennan (00:20:25):
I think that gave me a lot of comfort. But even so, it wasn’t absolute because you saw companies that had highly inflated valuations that were able to use that currency to go and acquire other businesses that were cashflow generative, so they could turn hope into reality. That’s always a bit distressing when you see that as a value investor. I think, by and large, it was just the nature of the fact that if you bought a real business and it had a real cashflow stream and you had a long enough time horizon, arithmetic was pretty powerful. It’s almost like a law of gravity that if you had the right time horizon, things would shine through.

William Green (00:21:03):
Can you talk a bit about time horizon? Because one thing that you’ve explained to me over the years is this idea really of defining what our goal is as investors. Obviously, there are so many people who come into the market and see it just as this casino, where they’re rolling the dice as fast as possible, hoping, expecting that they’ll make 30% in a month on crypto or whatever it is and chasing into whatever hot asset there is. It seems to me that a certain point you decided in a very clear minded way that your goal was different, that you were pursuing something that was much more long term. I don’t know if I’m articulating this properly.

Matthew McLennan (00:21:42):
No, it’s actually a really interesting question, because I’d say that as more time has passed in my career, my time horizon has continued to grow longer. I’d say, to give you an analogy, if you felt that you were going to pursue a quantitative strategy that had a small edge, imagine you were flipping a coin that was slightly biased, well then, you’d want to flip that a lot of times to magnify a weak signal. It’s akin to having a short term horizon for investing, and a lot of people are very focused. They’re obsessively trading the quarter, if you will, and trying to pick up on sentiment shifts. I guess the more I thought about it, the more I realized that that field is, because it offers the allure of large returns if done successfully, it attracts a lot of competition. Whereas, you look at what Buffett’s done, he looks to buy forever. He’s very focused on the limiting arithmetic of the investment.

Matthew McLennan (00:22:43):
In a sense, he’s looking to make one good decision as opposed to a series of decisions. The more decisions you make, the more difficult it is to make excellent decisions. If you’re selective with the decisions you make, the odds of making an excellent decision go up. I realized gradually over time that having a longer time horizon put me in a less competitive space for the market. There are less people willing to think about the next 5 to 10 years. Most people are much more focused on the next 12 months or the next quarter. Part of it’s just thinking through those things.

Matthew McLennan (00:23:16):
Then, I think you’ve got to realize as an investor where you can be most comfortable in your own skin. The things that I like to analyze in a business were the nature of its market position, how it had evolved over decades, the likely longer term trajectory of that business and the longer term decisions that management we’re making. The potential alpha from all of those things plays out over a long period of time, not a short period of time. Valuation mean reversion often takes 5+ years if you’ve bought a good business at a time of an issue. The impact of a free cashflow, generative business producing some form of accretion through Sherry purchase or MNA or better dividend yield takes time to play out. Or a management team that is a good steward of capital, that compound accretion tends to take time to fly out.

Matthew McLennan (00:24:06):
The things that attracted me tended to be longer term variables. If I’m true to myself, I was less good at trying to pick up on the short term scatter pattern and mosaic and predict near-term earning surprise. I went to where I felt most comfortable. If you’ll permit me one digression here. I mentioned that my grandfather was a gardener and he passed that skill on to my mother and this little home that we built, she was an ardent gardener in this home. As a child, I always wondered why she went to the effort because there was always some issue. There were drought conditions or the bamboo root would spread to somewhere where it wasn’t meant to be or there was some weird fungus or virus. She was always having troubles.

Matthew McLennan (00:24:58):
Whereas, there’s a gentleman who lived next to us who mow his lawn every week and it just looked pristine and clean. We had another house behind us at the bottom of the rainforest where he just lived amidst the rainforest. I didn’t realized the wisdom of my mother’s long-term strategy when I came back to the house some 20 years later with children, my children. The garden had really grown into this resplendent beautiful space. It had been selectively curated over time. Whereas, the house next to me was still being mowed. The lawn was still being mowed every week. But there was nothing to show for all of this activity. He was like the active manager turning over the portfolio once a week.

Matthew McLennan (00:25:43):
The gentleman who’d had his house down the hill behind us had some fire damage I heard at some point. The passive strategy of just letting the forest go around you wasn’t necessarily the safe strategy my mother had worked in all of these fire buffers and things. Selectively curating something and letting time take its course is something that doesn’t seem like a very well-rewarded activity in the short term. When you step back and let time play out, it can be very rewarding.

William Green (00:26:15):
Yeah, it’s interesting, because it’s not sexy and it doesn’t appeal to our yearning for instant gratification. But because of that, there’s so little competition and it has the virtue that it actually works.

Matthew McLennan (00:26:27):
It’s a combination of less competition and I think patients as well. It encourages you to wait for ideas that are truly stacked in your advantage. I think that’s an interesting perspective that I try to convey to new analysts who join our platform, because when an analyst shows up, they’re tempted to produce a new idea every week. I’m like, “Actually, no. I’d like you to do a lot of work every week, but I’m really looking for one or two ideas every year or two that are exceptional.” It’s just a different way of thinking.

William Green (00:27:01):
I’m curious also whether there’s a parallel between gardening and that selective curation over decades and your interest in both wine collecting, which you obviously inherited from your grandfather and also, I think, in collecting art, which you used to do seriously. I don’t know if you’re still collecting old masters and the like, but are there parallels? Are there things that we can learn from this selectivity in curation in wine and art that apply in the stock market as well?

Matthew McLennan (00:27:34):
I think so, because when I look at a business in the stock market, I’m most often attracted to something that’s survived the test of time, that has some form of advantaged incumbency. I think the same can be said if you’re a wine collector or an art collector. If you’re a wine collector, there’s certain terroir that is just advantaged, where people may have been growing vines there for over a thousand years and where the cumulative-

Matthew McLennan (00:28:03):
Over a thousand years. And where the cumulative effect of that is that the ecosystem around that plot of land has very complex soil and has unique geographic exposures. But it also has the “software benefit” of cumulative learning of how to tend those particular vines in that particular location that’s often passed on from generation to generation. And so when I initially started collecting wine, I was looking for good value propositions, and I still enjoy good value whenever I can find it. But over time, I realized that there are certain wines that are just fundamentally advantaged, and that those wines tend to also age themselves well. And it’s interesting, from an investment standpoint, what can happen if you let time and quality combine because if you think of the analogy of a nice bottle of wine that matures gracefully over 30 or 40 years, as it matures and it’s real quality goes up, the real quantity goes down because bottles of that wine and that particular vintage get consumed every year. And so there’s a reason the equilibrium price for a fine bottle of wine can go up exponentially over time.

Matthew McLennan (00:29:13):
Quality improves, supply goes down. And I saw that analogy with businesses because if you own an advantage business over time, with the passage of time, that an advantage business tends to benefit from brownfield concentricity, the ability to invest around the fringes of your business with marginal economics that are much better than someone who is trying to get into the business with greenfield investment. And so time aids the intrinsic value of a good business. Meanwhile, a good business is producing free cash flow, so it could be shrinking its shares outstanding, rather like bottles of wine disappearing for any given vintage over time. And the real value could compound up over time. And the same could be said for art. There’s a lot of enthusiasm for contemporary art, just as there is a lot of enthusiasm for growth stocks. People want to own the new new thing. But if you think about the big movements in art, they tended to proceed big movements in physics and mathematics and language often by a couple of generations.

Matthew McLennan (00:30:14):
Sometimes artists were intuiting how to perceive things long before it was converted to words and symbols. But there are obviously a lot of false starts along the way in the world of art. I think it’s going to be very hard to predict which contemporary art becomes an old master in a hundred years time. But you can buy art today from a master that was painted 400 or 500 years ago that survived the test of time. And it may look mundane relative to the sizzle of the contemporary art market, but it’s more likely than not to maintain its relevance if it has done so already for 400 or 500 years. And so I think the appeal of identifying incumbency in those collectibles market has bled across to the way I think about looking for businesses.

William Green (00:31:01):
I think we should talk in some depth about how to be a resilient investor, and how to succeed over many decades. But it seems like we should mention first this idea that in a way from the intellectual backdrop of your approach, which is just a respect for entropy and the fact that we live in a world where things fall apart, the center cannot hold, as Yates said. Can you talk about your fundamental respect for entropy as an ironclad law of life and how that shapes your approach to looking for things that are likely to endure in a world where not much does endure?

Matthew McLennan (00:31:37):
No, it’s a good question, William. Entropy is probably one of the few absolute truths. It’s a second law of the thermodynamics that any form of order is essentially transient. And perhaps it’s the fight against entropy that’s sort of gotten me interested in old master art or great wine that can survive for generations, from vineyards that have been planted for generations, or a business that has a slow fade rate relative to the typical business. But if you think about the economy as an ecosystem, rather than as machine, productivity happens every year, productivity growth, and over the last century, we’ve grown productivity close to 2% a year. But the dark symmetry of productivity is that the existing pool of companies won’t control a future profit pool in perpetuity. New businesses get created that chip away at the margins at existing incumbency. And so entropy is a fundamental principle and investing. And when you go through business school and learn about asset pricing, you’re really only taught to think about beta risk or systemic risk. But idiosyncratic risk is interesting to think about as well.

Matthew McLennan (00:32:53):
And in fact, entropy is a form of systemic risk because change in the economy and the overall improvement in the economy imputes that existing companies will grab a smaller share of the future pie given enough time. And so I’ve focused a lot on this question. And the paradox of it is that buying businesses that have been around for a long period of time, that have demonstrated persistence, in some ways, can be a safer strategy than trying to buy a business that’s growing a lot today because many of the businesses that are growing a lot today are in industry verticals where market share positions move around a lot. And so by definition, your ability to capitalize their terminal earnings at any given period of time is low because easy come, easy go, as it would relate to market share shifts.

Matthew McLennan (00:33:44):
And so we do like to try and focus on businesses that have a stickiness to their market share over time, high customer retention rates, to try and slow the curve of entropy. And we approach it with a great deal of humility and respect, and we recognize that even our favorite ideas are going to get disrupted at some point or another.

William Green (00:34:09):
So in a way…

Matthew McLennan (00:34:09):
And I think it’s important because when people think about a growing business, they tend to think, “Well, if the business is growing revenues 10% a year, I’m growing my intrinsic value 10% a year.” And it’s not actually the case because trees don’t grow to the sky. So that rate of growth will fade and markets become penetrated. And secondly, even if you dominate a market, substitutes get created. And so you have to recognize the fact that as a business matures, it will trade at a lower multiple than it does when it’s growing. And so the fact that there’s fade rates to growth and that the ultimate multiple of the mature business is going to be less than a growing one, means that the growth in intrinsic value is going to be a lot less than the growth in revenues today.

William Green (00:34:53):
So in a world of entropy where things tend toward disorder over time, how do you actually build a portfolio filled with businesses that are truly resilient? What qualities do they need that are likely to make them less perishable?

Matthew McLennan (00:35:08):
Well, you made an interesting comment before about knowing where you’re going. And I remember Seneca saying, “If you don’t know to which port you’re sailing, no wind is favorable.” And I think for me as an investor, I like the idea of resilient wealth creation a lot. And I recognize that’s not for everybody. Some people are investing for a different reason. Some people are investing because they want to max out rather than grind it out. And sometimes you’ll come to surprisingly different conclusions depending on what your sense of travel is. So if your goal is to get large outsized returns, then it’s going to drive you more towards portfolio concentration, the use of leverage episodically, and the desire for control, so that you can influence the underlying companies that you’re investing in. And many of the great fortunes that have been made have those three elements in place.

Matthew McLennan (00:36:04):
On the other hand, the combination of concentration and leverage, and the time sink of control, devastating if the laws of entropy work against you in an unanticipated way, if there’s a new product that disintermediates what you focused on. So you might have bought what you thought was a great business, but then the world changes. And if you’re concentrated and levered, and all of your time has sunk into controlling that business, then you’re in a sort of troubled spot. And so…

William Green (00:36:33):
My friend Guy Spier has a friend, or mentioned someone who had a hedge fund where I think he had one stock in the end. And he so believed in it and was so totally wrong that he now runs a cafe or a bar somewhere in the US. And so yeah, the idea of resilient wealth creation resonates really deeply for me. I have this screen on my computer with this low tech list of the investments that I own. And literally the phrase at the top is resilient wealth creation because I’m trying to pound into my head the fact that I don’t need to be at a hurry. It’s just not the goal.

Matthew McLennan (00:37:12):
Well, and if you think of the place that it can lead you to, if that’s the port to which you’re sailing, the first thing is that you become far more at peace with the notion of diversification. And I mean, William, you introduced me some time ago to Tom Gayner at Markel, and I think he described it well. He discussed this notion of emergent position sizing. And that is that every investment you go into you think is going to be a sound investment, but the future plays out in different ways. Some businesses are the victims of entropy, some are transient beneficiaries of substitution going in in their favor. And so having a diversified portfolio is something we’re actually quite at peace with. And it’s an expression of humility. It’s an acknowledgement that there’s only so much we can know. And going back to the discussion on [inaudible 00:38:05] or Wolfram and complexity, I’d become convinced that there’s only so much one can know. And so diversification is an acknowledgement, a humble acknowledgement of that fact.

Matthew McLennan (00:38:15):
But it’s also an interesting strategy because if you’re willing to invest globally as we are, diversification doesn’t mean look that you look like a passive representation of the market. We might own 100 securities out of a universe of 5,000. And so you can still selectively curate the garden to use the analogy of before, but to do it across industries and across countries in a way that gives you a degree of resilience. And to the extent that you’ve paid decent cash flow multiples and you’ve identified what you think is incumbency for individual businesses, it helps produce an error tolerant approach because if the starting free cashflow yield compensates you for the cost of capital, and a certain number of these businesses end up doing reasonably well, then you’re able to cover the costs of those that don’t do as well. The other thing I’d say other than diversification is, I guess, the opposite of leverage is to travel a journey with deferred purchasing power.

Matthew McLennan (00:39:16):
And so if you look at our portfolios where we have roughly 20% in a combination of cash and gold and diversified short-term foreign sovereign bonds. And so I guess it’s a recognition of the fact that a non-linear system like the economy is going to have episodic periods of crisis. And hopefully the businesses we own are well positioned to endure those. But if we have some net cash and gold we can put it to work in very distressed environments and convert it to the ownership of enterprise on very advantageous terms, episodically. And the willingness to wait with some amount of your portfolio I think has been an important element of how we’ve generated resilience historically. The final thing I’d say is that when you have a portfolio with 100 or so Investments, it would be foolish to think that you could play a control or influence role in all of those Investments. And what we’ve done instead is we’ve essentially created an ecosystem of managers who act like owners. And so it’s more about the ecosystem that you’re self-curating than you having to have control.

William Green (00:40:18):
One of the things that’s also really unusual about your portfolios, that very much fits with this idea of long-term selective curation like a gardener is there’s incredibly low turnover. I was looking at one of your portfolios, I think it’s 7.2% turnover, one is 10%. So we’re talking owning stocks for 10, 12 years or more. Can you talk about that? Because it seems like a lot of the portfolios run by other fund managers that are very diversified, they tend to be choose investors who are overdiversified and then trade too much and have too high expenses. Yours is very different. It’s very thoughtfully diversified, and at the same time, incredibly patient, you’re buying stuff and then you’re holding it.

Matthew McLennan (00:41:04):
Well, part of it’s a reflection of the way in which we invest because if you think about an investor who’s trying to trade every quarter, by definition, they’re going to have a lot of turnover in their strategy. Or if they’re looking for the hottest new growth story, that changes every year. So by definition, you’re going to have to shift to wherever the pocket of momentum is in any given short-term period. So if you’re trying to trade short-term surprise or you’re trying to trade shorter term momentum, it leads you into the territory of being high turnover. On the flip side, if we go back to our discussion about collectibles, whether it’s wine, art or businesses, if you’re identifying incumbency, it shouldn’t change that quickly if you’ve done a solid job of identifying a business with staying power.

Matthew McLennan (00:41:49):
And so a big part of what we do is to try and find businesses that are going to be around for the next generation, and buy them at an advantage price and let the arithmetic play out. And by holding them for a decade, the arithmetic starts to dominate the short-term changes in sentiment. And that’s, I think, a really important principle when it comes to long-term investing, that if you’re going to go for incumbency and you value arithmetic, you have to give it the right time rise. And rather like it would be crazy for my mother to plant and then tear down the garden every year. Some trees take a long time to grow.

William Green (00:42:27):
You’ve spoken to me in the past about mundane but really persistent businesses, and how mundanity is often more beautiful than the hot, sexy stocks that most people are falling in love with and chasing and then dumping and trying to trade in for the younger, prettier model. Can you talk about what you mean by mundane scarcity and persistence?

Matthew McLennan (00:42:50):
What’s interesting to me, and the beauty of mundanity at its core, or apparent mundanity, is that it rarely leads to excesses. If the goal is to buy a quality business, the only way you’re going to make money is through some identification of asymmetry between price and prospects. It’s not enough to buy a quality business because if the whole market views it as a high-quality business, it’ll be priced for low returns. And so it’s really the search for unpriced quality that’s critical. And so there has to be an engine for quality, but there usually has to be an issue. And that’s where scarcity is the engine and mundanity is often the issue. And so let me just define this construct of scarcity value a little bit more, and I think it was obvious in the context of our discussion before, if you’re buying a wine from the best block of land in Burgundy, or you’re buying an old master’s painting from someone who painted only very few paintings, that concept of scarcity is very intuitive and easy to understand.

Matthew McLennan (00:43:53):
When it comes to business picking, I think you have to disentangle two forms of scarcity. One is scarcity in the world of real assets, and the other is scarcity in the form of intangible assets. Now, real asset scarcity I think is also pretty easy to understand. Imagine a really well-located piece of real estate like the vineyard. It could be an apartment right in the center of the city, it could be a beachfront apartment, or it could be a timber land on the edge of a city where there’s optionality to either grow the timber or sell part of that land for a higher and better use in any given year. Scarcity in the world of real assets could also be a company like a gold miner, for example, that owns very large scale mines at the low end of the cost curve. So scarcity in the world of real assets is usually locationally driven.

Matthew McLennan (00:44:42):
On the other hand, scarcity is manifested in the world of intangible assets. And usually, that’s companies that have strong market share positions. It’s the most valuable form of intangible asset. A company that’s had 40, 50, 60% market share, that’s been stable for decades, is a scarce intangible asset because that large market share position gives them the ability to have a degree of pricing power through the cycle, reduces the volatility of their cash flows, improves their margins, but it also gives them the scale to outspend competitors on R&D, product development, density of their sales force, so that they can provide more duration to that advantage. And so when we’re thinking about scarcity in the world of investing, it’s typically a well-located physical asset that’s of a long duration character, or it’s a company that’s got a good market share position in a stable industry that’s doing the things that it needs to do to perpetuate itself into the future.

Matthew McLennan (00:45:40):
Now, those kinds of businesses often trade at high value. So the reason we refer to mundane scarcity as attractive is that if you want a shot at buying quality at a reasonable price, it can’t have too much obvious allure. And so that’s the key, that what is often mundane to the average investor ends up being beautiful to the long-term compounder because it means that you can buy in at a reasonable multiple of cash flows, you can benefit from that scarcity over the long term. And if the business never scales the heights to an outsized valuation, you can hold it indefinitely with a margin of safety. And so it enables you to make a single decision, and therefore have a very long average holding period.

William Green (00:46:23):
I remember during that first period of COVID when the markets were tumbling, I interviewed you around then I think for Barron’s, if I remember correctly. And I guess, all the restaurants were closed around the world suddenly, and you were buying a company, I think in Japan, that made ice machines for restaurants. So it was something where you kind of knew that it was eventually going to be good, that we are going to go out to restaurants again. And so it had a kind of mundane scarcity, but at the same time, was out a favor. Is that a pretty good example of…

Matthew McLennan (00:46:53):
It’s a good example. I mean, the company you’re referring to is in ice machines for commercial establishments, whether it’s restaurants or hospitals or schools. And there’s actually a fair amount of precision processing that goes into an ice machine because you don’t want bacteria to creep in there, it needs to be reliable. It’s at the core of a decent customer experience in a restaurant or any catering facility, and you want it to be reliable. And therefore, having the network of aftermarket support and sales force helps embed that business. And they’ve concentrically expanded that business into strong position in commercial refrigerators and ovens. And so businesses that you think are lacking in a certain amount of appeal can be quite stable over time. And because the business has good economics, you don’t have to worry at a time COVID that they’re going to go out of business. Their customers may be suffering for a time, but the customers will come back. And restaurants change all the time, but the need for ice machines doesn’t change. And so having a niche like that can be quite helpful for the patient investor.

William Green (00:47:57):
I was struck also, I was discussing with someone from First Eagle who was saying, “Yeah, good examples of this are this company in Switzerland that makes elevators,” and I think there’s a Japanese company that makes bike components. These are wonderfully unexotic, unsexy and yet weirdly central necessary things. Can you talk about a couple of these other businesses that embody that resilience?

Matthew McLennan (00:48:24):
Well, I’d love to just comment on the two that you mentioned. In the case of the bicycle components, we’ve owned a stake in a company called Shimano for a couple of decades now, so it’s truly been a long-term holding for us. And Shimano has over 50% of the market for high-end bicycle brakes and gears. And people know the brand of the brakes and gears more than they know the brand of the bicycle. I went to a farmer’s market with my daughter once and she found some old comics that were on sale there from the early seventies. And it was, I think, they were advertising the Browning bicycle company, but the big feature of the ad was the Shimano brakes and gears. And so this is a company that has basically devoted itself to perfecting a single process and getting to global distribution scale, one local market at a time. And what’s great about Shimano is the bicycle brakes and gears is the key part of the business. They’re also big in fishing tackle, another extraordinarily exciting market.

Matthew McLennan (00:49:19):
But that bicycle brakes and gears are 80% of their market. But the business has really compounded out at a high single-digit clip over decades because they’ve added more value to the bicycle brakes and gears. And people, as they become more energy conscious and whatnot, are adopting healthier habits. And so bicycling is certainly one of them. And recreationally, having some fishing tackle is not such a bad thing either. And this business has compounded out gradually, and meanwhile management have been good stewards. The second great intangible asset of the business, aside from market share, is the extent to which management act like owners in their stewardship because management accretion can change, on a compound basis, your investing experience. If you think of a typical business trading at 10 times cash flow, the management team’s going to reinvest the enterprise value of that business every decade.

Matthew McLennan (00:50:15):
So management quality is a key and tangible asset. And here, the business is family run, the Shimano family, they’re a large shareholder and they run the business for the long term. And over the last 20 years, they bought back about 40% of the stock. They don’t have any debt, they have net cash. So rather like the ice machine company, you don’t have to worry about financial contingency. So that’s another good example. And you mentioned the elevator company. This is a Swiss company, not a Japanese company like the other two, but the company that my colleague was probably referring to there was Schindler. And Schindler is the second largest elevator and escalator company in the world behind Otis, they’ve been around since the late 1800s. So they benefit from favorable incumbency. And even though there are handful of large makers of elevators and escalators, they tend to be more concentrated in given geography. So Schindler is particularly strong in Europe.

Matthew McLennan (00:51:10):
And the beautiful thing about this business is that the stock, this is a newer investment for us because everyone’s worried about what’s going on in China and the construction cycle globally, but the money’s really not made on new elevator installations, it’s made on the maintenance of existing elevators. Typically, an elevator needs to be maintained for 20, 30, 40 years after it’s installed. And the majority of their EBIT comes from these long-term maintenance arrangements that are very sticky. And this is a company that, like the other two, truly thinks about the long term. Not only do they have these long term annuity-like maintenance agreements for their business, but over the last decade, they’ve doubled their R&D relative to EBIT to focus on embedding technology better in the elevator. So if you use the internet of things and sensors, you can maintain the installed base of elevators much more reliably and cheaply than just doing it all manually.

Matthew McLennan (00:52:05):
And so being ahead of the curve there, and like the other companies I mentioned, they have no debt, they have net cash, and management’s been willing to buy back stock in the past. You have the Schindler family behind this, they own close to 40% of the company, the Schindler and the Bonnards together. And so you have this long-term stewardship of a stable cashflow generative business that’s out of favor right now because everyone’s focused on the construction cycle in China. And so whether it’s an ice machine maker or a bicycle brakes and gears company, or an elevator company with long maintenance agreements, these kinds of businesses, essentially like eclectic royalties on small slices of world nominal GDP. And it comes back to the point before that I made about diversification.

Matthew McLennan (00:52:49):
These families have done well concentrating, but to the extent that we invest other people’s money and we want to provide for resilience long term, but if we can have a portfolio of these kinds of businesses scattered around different industries and parts of the world, it surely provides for a more resilient experience than just betting on one. And I don’t see the elevator being disrupted anytime soon, but who knows?

William Green (00:53:14):
You talked to me when I was interviewing you for my book. You talked to me about this beautiful image of seeing the global markets as a piece of marble, and then chipping away pieces that you don’t want, really whatever promotes fragility. And it seems to be a really important idea. And I’d love to get a sense from you of what kind of countries you chip away and say, “Nope, that’s too risky,” what kind of sectors you chip away, and then we can talk about specific types of business where you are just like, “No, it would bring too much fragility to the portfolio.”

Matthew McLennan (00:53:50):
Well, it really starts bottom up for us, I would say. So first of all, we do have a strong preference for businesses that have already demonstrated some form of incumbency. As Bruce Greenwald, one of our senior advisors, said, “Something’s likely to be around as long as it’s been around.” It’s like the envelope principle in physics. And so just the simple starting point that we’re looking for businesses that are time tested, and I think this is an important starting point that the second thing is that price does matter. I mean, it’s not enough to find something good, you have to find something that’s good, that’s better than people think it is. And so the situations that get us most excited are when we find our blue chip business that’s had a loss decade. So if someone comes to me with an idea and says, “Oh, it’s a great business, but it’s also trading at a decade-high valuation,” it’s less likely to be appealing. And so when you think about incumbency, it’s like prime numbers. If you look at a sequence of numbers, only so many of them are primes.

Matthew McLennan (00:54:52):
And there’s actually a rule in math that can show you the frequency of prime numbers. But if you had a sequence of 3,000 or 5,000 numbers, probably only a low double-digit percentage of those numbers will be primes. And I think it’s the same for business. So immediately, by trying to focus on the equivalent of prime numbers or businesses with the advantaged incumbency, you’re taking out 80% of the market. And then if you’re saying, “I want to focus on the subset of those that haven’t gone through the best decade,” there’s an engine and an issue, then you’re taking out at least another half of the market. And then when we speak to the analyst, there are other splitting questions I call them.

Matthew McLennan (00:55:33):
And what do I mean by splitting question? If I gave you a dictionary, William, and I said, “Find a word,” you wouldn’t go through the dictionary sequentially word by word. If I told you serendipity was the word, you know it’s towards the back third of the dictionary. You’d flip it open there and you’d get closer. It might take you four or five parsings of the dictionary to get to the page, not 800 pages being turned sequentially. And what I try to go to the analyst and do and say, “What are the handful of splitting questions that can

Matthew McLennan (00:56:03):
find us the one-in-100 investment opportunity that makes most sense?” So part of it’s incumbency, part of it’s price. And then there are some other questions we would ask, like we’d look at what we call the cash audit: how has the business lived and breathed over the last decade? Has its balance sheet really grown at a measured clip? Can we understand how the business got to where it’s at? There’s a lot of businesses that you can’t, and that takes out part of the universe.

Matthew McLennan (00:56:32):
And then of those remaining businesses, some of them are run by very expeditionary management teams who don’t have much of an equity stake in the business and are much more like bankers or bureaucrats than they are like owner-managers. And so by asking a handful of questions bottom-up, we basically say no to 90-plus percent of the universe. And I think that’s a really important way in which we approach markets, is asking the right splitting questions. And then occasionally, there are some macro observations where you cast a wary eye as to what can go wrong. And I think it’s a combination of bottom-up splitting questions and the odd top-down insight that helps steer you away from trouble.

William Green (00:57:19):
I love this quote. You’ve mentioned Karl Popper, the philosopher, a couple of times. And there was an article I was reading again of yours last night that you’d written, I think for the CFA Society many years ago, where you quoted a wonderful line from Popper where he said, ‘The main difference between Einstein and an amoeba is that Einstein consciously seeks for error elimination.” And it seems like that’s really central to your approach, constantly seeking for error elimination, what you were just saying. It’s like you’re looking for what’s wrong with these businesses as well, whether their business model can be substituted easily, whether management is diluting you or has the wrong capital structure or whether you are overpaying. Can you talk about this idea of consciously looking for what’s wrong, which is a very Charlie Munger-esque kind of approach to life?

Matthew McLennan (00:58:07):
Yeah. I mean, we don’t have any perfect investments. If you were to look through our portfolio … And I always get stressed out when someone asks me the question, “Give me your best idea,” because I just don’t have one. I wish I was smart enough or had enough conviction to do so. But we’re very focused on what can go wrong. And sometimes it helps to look at things indirectly. I don’t know if you ever saw it, there was a documentary, it got mixed reviews, but I thought was an interesting one, called Tim’s Vermeer.

William Green (00:58:35):
No.

Matthew McLennan (00:58:36):
It was about an inventor, Tim Jenison, I think his name was, who was trying to recreate a Vermeer painting. And he had an interesting theory, because everyone’s been mystified for centuries how Vermeer could so perfectly capture the shading of light. And Tim Jenison had this idea that maybe Vermeer used a camera obscura, and so when he was painting, he had a superimposed image, and he could compare the likeness of the edge of what he was painting to the actual color palette of the image, and do it very closely. So rather than trying to paint the image directly, he looked at it with reference to another image.

Matthew McLennan (00:59:17):
And the reason I go down this discretion is that we’ve long been owners of gold. And gold is somewhat paradoxical because people say, “Well, why do you own this useless lump of metal?” And the paradox of gold is its utility is in its uselessness. If you were to look at a periodic table, it is the equivalent of the best block of land, because it has this unique combination of inertness and density on the periodic table. And the inertness, which makes it useless in some ways, is also what makes it a natural perpetuity. It doesn’t chemically react. It’s what gives it permanence. And it’s also what gives it its low beta characteristic because it’s not primarily used in the industrial cycle, like copper or oil or iron ore. And so it has an innately low correlation to the business cycle and the long duration. And that’s what’s made it nature’s hedge asset, if you will.

Matthew McLennan (01:00:15):
And the reason I mention gold is that people say, “Well, gold is useless because it doesn’t have a yield.” Well, I just pointed out that it is useful as a hedge. And even though it doesn’t have a yield, because it’s in scarce supply, coming back to incumbency and scarcity as a theme today, there’s less than one ounce of it per capita in the world, that as the supply of money has gone up over the last 50 years after the breakdown of the Bretton Woods agreement, gold hasn’t offered a yield, but it has accreted in line with world money supply. And so it has offered a return. And it hasn’t suffered from beta risk, it hasn’t suffered from management dilution risk, and it hasn’t suffered from entropy. It still, in the periodic table, occupies its position of incumbency.

Matthew McLennan (01:01:07):
And the reason I go through this whole aggression on gold and Tim’s Vermeer is that it’s useful to think about how a business stacks up relative to a lump of gold. And it’s interesting to me that most businesses have some fade risk. They have a generational half-life. Secondly, most businesses have beta risk. There’s a risk that you’ll buy them and then you’ll find yourself at the bottom of an economic cycle, and you might be a forced seller at the worst time. And most businesses have some form of agency risk. Managements, on average, make decisions that are dilutive. I think there’s only a small number of managers that are truly accretive in nature.

Matthew McLennan (01:01:49):
And so, there’s a reason businesses need 5% free cashflow yields. It’s to compensate you for fade risk, beta risk and management dilution risk. Otherwise, if you had none of those risks, you could just own a business and it would pace with nominal GDP. But the fact that it has shortfall risk is why you need a free cashflow yield. And so, I think looking at something relative to the image of something else can be useful.

Matthew McLennan (01:02:14):
And there was a final paper I’ll mention on this, William, is that there’s a professor by the name of Bessembinder who did a study of all stocks in the CRSP database since 1926, and found that the average stock had actually underperformed T-bills, and that most of the risk premium in the stock market had come from a small number of stocks, thus the importance of some element of diversification. But the irony is that gold has outperformed T-bills. And so most stocks, crazy as it would seem, on average, underperform gold. And that’s a kind of counterintuitive thing to get your mind around, but if you see that as a kind of paradoxical truth, it forces you to ask basic questions about whether you’re getting satisfactory compensation for the fade risk, the beta risk and the agency risk of an individual company.

William Green (01:03:07):
You’ve had a pretty significant position in gold for over a decade, as a potential hedge against financial catastrophe and massive market meltdowns and the like. And a lot of people obviously have been touting Bitcoin, although a little bit less loudly lately, as a potential hedge against financial chaos and the vulnerability of manmade currencies. Can you talk about why you believe gold is a much better thing to own as part of a resilient all-weather portfolio than Bitcoin?

Matthew McLennan (01:03:42):
Well, if we go back to the discussion on incumbency and old masters and vineyards that have been around for 1,000 years, gold has survived the test of time. It does exist. It has a unique incumbency on the periodic table in terms of real assets. It’s got unique chemical attributes. And it will exist. So inherently, there’s a duration to gold that is longer than most things that we would look at. The second thing I would say is that gold is not legal tender today, but it’s a perpetual call option on being money. And as such, you’d expect it to be at its most valuable when the quality of human-made money is at its weakest.

Matthew McLennan (01:04:27):
And what we’ve seen since the Bretton Woods agreement broke down in the early ’70s is that while T-bills have compounded out at 5%, money supply in the US has grown at 6% and gold has compounded out at around 8%. So what’s happened is that even though it doesn’t offer a yield, because it’s in scarce supply, it’s met the rising tide of money supply. And it’s in fact accreted a little bit, because the quality of human-made money, the alternative, has gone down. We have larger mid-cycle fiscal deficits and lower mid-cycle real interest rates. And so gold,, from a very long-term standpoint has served a powerful hedge role in our portfolios.

Matthew McLennan (01:05:07):
And the question is, has gold met its match in Bitcoin? Is gold, like everything else, subject to a different form of substitution? It may be dominant in the context of the periodic table, but is there this new invention that renders it useless? Well, the simple answer is we don’t know. What I will say is that Bitcoin is 13 years old, like all that exists … And I think it should be taken seriously, because it is the largest compute network in the world. It dominates even the scale of the Google server network, by an order of magnitude.

Matthew McLennan (01:05:46):
And so Bitcoin is interesting as a man-made creation, but it’s had some sort of emergent reality to it, if you will. And there’s a vibrant ecosystem that’s formed around it. And its incumbency is valuable. The fact that it was first and the fact that it has attracted the most market cap and the greatest compute power, from a second-order standpoint, makes it more secure than any competing cryptocurrency. So being first matters. And Peter Thiel has this great expression, he said, “very moment in business happens only once.” And so the fact that it was first and is at scale means that it is the most secure distributed blockchain. And really, what you’re buying is titled to that digital asset as a service, right? And so, I think one has to take it seriously.

Matthew McLennan (01:06:38):
Having said that, even if it’s on a path to being as important as gold, long term, right now, I think it’s rational that it trades at a discount to gold. It’s young, it’s only 13 years old. It hasn’t been around for thousands of years. So I’d say the fact that it exists doesn’t mean it will definitely exist, but it’s the leading contender to potentially exist in the crypto space. And so Bitcoin, if gold is a perpetual option on being money, Bitcoin is an option on an option, right? It’s an option on being digital gold. But right now, because of the early stage of its adoption, it doesn’t trade like gold. Gold has a very tight inverse correlation with real interest rates. When stocks have had loss decades, gold has tended to have its best decades. So it has a demonstrated track record as a potential hedge asset.

Matthew McLennan (01:07:38):
Bitcoin, because it’s younger and it’s been in an adoptive phase, has traded much more like a growth equity. Now, if it succeeds in its destination, its trading character should become far more mundane over time and much more like gold. But right now it trades like a growth equity. So the fact that it faces unknown risks, agency risks, as we discussed before, like the miner community has to continue to exist, or it cannot be dominated by a pool of over 51% of miners for Bitcoin to exist, or the fact that it has to survive unknown challenges; there may be a state that plants malware in the ASICs chip for Bitcoin. We just don’t know. It has to survive what is going to be the test of quantum computing, which is going to change the efficacy of the underlying hash protocols for Bitcoin. So there are a range of different challenges that Bitcoin has to endure, and we’re just going to have to let time play out. But until it does, it should trade at a discount to the aggregate market cap of gold.

Matthew McLennan (01:08:40):
Having said that, two things can coexist at once. Ovens and microwaves coexist. Most wealth before the industrial revolution was stored in real assets, land, art, precious metals, livestock. And then we created all these financial assets which were essentially the crypto of the time. They were virtual claims. The original companies were beneficial claims of trusts on underlying assets. And so this was kind of arcane and abstract at the time, but financial assets came to coexist alongside real assets. They didn’t disrupt totally, they coexisted. And if digital assets are another concentric circle around financial assets and real assets, it doesn’t mean that real assets will disappear and it doesn’t mean that all financial assets will disappear. I think what we’re going to see is the emergent coexistence. And I think what Bitcoin might have done is increased the demand for private money. I think people have questioned the quality of the monetary architecture after COVID with inflation, with low real interest rates, with big fiscal deficits.

Matthew McLennan (01:09:47):
And if Bitcoin would’ve faced any of these existential challenges, money that’s invested there could look for other forms of private money, such as gold. And so if I were just a Bitcoin holder, I’d want to own some gold as a potential hedge … Bitcoin’s existence. But I could also understand, if you held a lot of gold, why you might want to own a small amount of Bitcoin as insurance against it actually working and taking away some of the monetary market cap of gold. Final thing I’ll say is that gold will always have some value. It’s basically a value for jewelry and as a perpetual item of adornment, which Bitcoin won’t have if it doesn’t have value as a monetary medium.

William Green (01:10:25):
My sense is that you feel like the US dollar may be at some kind of major turning point where it’s at risk of losing its status as the world’s reserve currency. And I wonder if you could talk about that a bit? Because obviously as you just mentioned, there are all of these kind of fault lines in the economy. And it’s very hard for us to judge what’s temporary and what’s permanent. And lots of people have been seeking safety in the dollar as this kind of safe haven. And so weirdly, despite all of the reckless fiscal behavior and monetary behavior, the dollar seems to be amazingly strong. Can you unpack this a little for us and explain why you are worried about the US dollar, long term?

Matthew McLennan (01:11:09):
Let me start out by saying that having grown up in Papua New Guinea and Australia, I’m enormously grateful to be able to live and work in America. I mean, it is the ultimate sort of pluralistic melting pot of different ideas and markets and property rights. And I think there’s no question in my mind that the US is going to be an important economy for decades to come, and I want to be part of this, and I want my children and their children to be part of this narrative.

Matthew McLennan (01:11:37):
Having said that, there are windows of time where there’s a difference between a good economy and a good currency. And one of the challenges we face is that all of the characteristics that have made up the inherent resilience of the United States may be pretty fully priced right now. When we look at the world of equity markets, US equities are nearly 70% of the world equity index, but we’re 5% of the world’s population. So at some point, the relative merits of US equities ought to be recognized. But are they being over-recognized, is the fundamental question.

Matthew McLennan (01:12:17):
The market trades at a premium to the rest of the world. Margin structures have been higher than the rest of the world here, arguably benefiting from the easiest policy. And so when you come back to investing, it’s like going to the races. You’re not betting on the best horse, necessarily. It’s the horse that’s better than other people think it is. And if you look at the world of equities, people think the US is the best, and they’re really reflecting that in valuations. But it’s not just equities, it’s the currency. The US dollar makes up nearly 60% of world’s currency reserves, and that’s just not a sustainable equilibrium, long term. And the dollar has been the sort of risk-off currency of choice, particularly in this last crisis, because our energy independence is manifest relative to, say, Europe or parts of Asia.

Matthew McLennan (01:13:11):
But what that means is in real terms, the dollar is pretty much at a generational high versus the key currency crosses, whether it’s Euro or sterling or the Yen or Chinese currency. So the US dollar doesn’t offer much value. It’s already fully stocked in the reserve mix of international monetary authorities. And there was a risk that unfolded in the wake of the Russian invasion of Ukraine, and that is that we sanctioned the ability of the Russians to access their dollar reserves. So if I’m China today, am I as incentivized to accumulate dollar reserves as I was before, if they were sanctioning? Perhaps the Chinese might be more inclined to buy a real asset like gold.

Matthew McLennan (01:13:55):
Secondly, the US, for all of its advantages, runs a trade deficit in excess of 4% to GDP, which is expanding. All of the major currency crosses, the eurozone, Japan, China, are in current account surplus. Over time, currencies with large trade deficits tend to be on a depreciating trajectory, not an appreciating trajectory. And so you might ask, “Well, if the currency is expensive in real terms and has a trade deficit, why has it been strong?” And I think what explains that in the short term, other than risk perception going up, is that the US has offered some interest rate carry to some of these other regions of the world. But what’s important to note is that we have far higher wage growth in the United States than we do in most of those other areas. And so in real terms, the interest rate carrier is not that attractive.

Matthew McLennan (01:14:43):
And so I have a fundamental question in my mind over the next five to 10 years about the equilibrium value of the dollar. I think if you’re not offering real rate carry, if your mid-cycle fiscal deficits are larger than most of your trading partners’, if your current account deficit is large and growing while theirs is in surplus, and the currency is expensive, and you’re already 60% of the reserve mix, one should be open-minded, just from position of prudence, that the relative rating of the dollar may adjust downwards over time. And I think this is irrespective of concerns that people might have about the evolving political equilibrium in the United States, but I think it’s just an obvious statement in some ways that the dollar has been preeminent, but it may be more than adequately reflected in relative prices.

William Green (01:15:33):
You have such a global perspective on the world, given your role in managing this Global Value Team, and so you invest in the US but also in many other places. When you go around the world, I know you went recently to Tokyo and to Seoul, when you look in other markets, what are the valuations like? What are the opportunities like? What are the risks like? And if you are a sensible, long-term prudent investor who wants to position yourself well for the next 10 years, not chasing these kind of hot pockets of thematic growth, but just positioning yourself to get the good valuations, good risk reward, where do you want to be? Where do you want to be making sure that you are investing at least part of your portfolio?

Matthew McLennan (01:16:20):
Well, I think it’s prudent to consider diversification, from a couple different angles. I mean, we just talked about currencies. If the dollar’s at a generational high, knowing nothing else, it makes some sense to use this window of uncertainty in foreign markets to plant some seeds internationally. Just because one doesn’t know for sure what’s going to be the dominant currency in 20 or 30 years’ time, odds are it could be the United States, but it may not be, for one reason or another that we can’t even imagine right now. And a time where the currency is expensive is a decent time to be looking overseas.

Matthew McLennan (01:16:53):
Secondly, I mentioned that US equities, in general terms, were trading at a premium. The S&P trades at just under 20 times the trailing 12 months of earnings, whereas stocks in the EAFE, are more in the 12 to 13 range. Now that’s a pretty big valuation differential. If you invert those and think about them as yields, an 8% yield versus a 5% yield, there’s a big spread. The US has to really do a lot better than the rest of the world to make up for that valuation differential. And so, not only is the currency multiply expensive, but you’re getting a much lower earnings yield in the United States than you are getting internationally.

Matthew McLennan (01:17:29):
And I would just make the third point, that as great a market as the United States is, and I think it’s a wonderful market and one that I’m personally grateful to be a part of, it doesn’t have a monopoly on good businesses. If you think about the businesses that we were kicking around before, William, they’re all outside the United States. There are certain industries where the leaders, the incumbents, are outside the United States. And that’s okay. There’s some great artists in the United States, but some of the greatest art came from Italy. There’s some great wine on the West Coast of the United States, but Burgundy has some pretty nice wine too.

Matthew McLennan (01:18:07):
And so like anything where you’re looking for incumbency and uniqueness and the metaphysics of quality, as it were, there are going to be manifestations of quality that exist in different parts of the world. To give you an analogy, if you’re Exxon, drilling in the United States may be attractive, but there’s going to be pockets of oil elsewhere around the world. And there may be windows of time in the United States where, from a regulatory standpoint, it’s not that attractive to drill. And so the simple fact that the US doesn’t have a monopoly on good businesses, coupled with the reality that foreign currencies are pretty depressed and foreign markets have low valuations, means that I think one should be open-minded to having some amount of their assets invested internationally, just out of sheer prudence. And I think that gives us the peace of mind to be looking around the world at different opportunities, and it comes with a healthy-

William Green (01:19:04):
Is part of the-

Matthew McLennan (01:19:04):
Go ahead.

William Green (01:19:05):
Is part of the challenge, Matt, that we always have this kind of recency bias, where we assume that the next period is going to resemble the most recent period, and so everyone has become so convinced that the US is the place to be, that in a way, you have to have the faith you were mentioning before that the arithmetic will work out in the end, and you have to have the patience to actually stay long enough in these foreign markets that eventually you’ll be right, because the arithmetic will work? But in the short term, it’s really painful behaviorally actually to say, “No, I need to underweight the US and overweight these markets that haven’t really been working well, that have been disappointing for so many years.”

Matthew McLennan (01:19:42):
And one doesn’t even have to go so far as saying overweight the rest of the world and underweight the United States. I think it’s just an open-mindedness to maybe owning some businesses internationally. Think about if you’re a property investor. Most of us spend our time thinking about the dream house we’d like to own in the city in which we live that’s within our budget criteria. But imagine that you were geographically flexible and you could figure out your dream property in the 100 best cities of the world within your budget constraint. Invariably, something would be happening somewhere in the world that would let you find that dream property at the right price, whereas if you just focused on your one city, you might wake up in 15 years’ time and say, “Gosh, I never got the property I wanted at the price I wanted.” And then the values have drifted up over time. And so, I think just opening yourself up to the possibility of investing with a broader universe almost increases the probability that you will deploy capital for the long term rather than waiting for the pipe dream in one local area. And your question, as well, and sentiment is a good one, and I have no easy answer for that. It almost goes back to our discussion about value being out of favor in the late 1990s. And it’s very difficult to predict exactly when that turning point would come. But by the time it comes, it’s often difficult to change course, right?

Matthew McLennan (01:21:11):
And so, I think trying to predict turning points is something that a lot of people do. But if we go back to the gardening analogy, it’d be almost the same as trying to predict the weather every day. And I think predicting the weather is much more difficult than understanding the climate. And so, I think that if you’re creating a garden, you want things that can work across a range of different weather expressions, given your climate, rather than just be geared to one particular type of weather. And so sentiment, to me, is kind of like weather, and when it changes, it can change pretty abruptly. And I think when you focus on the arithmetic and you focus on doing what’s right for the long term, it’s basically saying we’re trying to adjust to the climate that we live in, and get that right.

William Green (01:22:06):
Yeah. One thing that you said when I was interviewing you for my book, which really had an impact on me, was when you talked about just you want to be more willing to commit capital to investments when risk is obviously being well-priced, such as in late 2008, 2009. And it strikes me as very similar to Howard Marks’ attitude of just accommodating yourself to reality as it is. And so at a time when foreign markets appear to be offering … risk appears to be being priced better, it’s just sort of logical to make sure that you’re fully diversified there.

Matthew McLennan (01:22:41):
It’s an interesting one, because if we go back to the weather and the climate analogies a little bit, we’d actually deployed some capital in the United States a couple of months ago, because the weather was bad. And what do I mean by that? Well, trading breadth was very narrow in the markets, risk perception was very high, implied volatility and options had gone up, credit spreads had gone up a lot. And there were a certain number of individual companies where the arithmetic made sense, but the climate still didn’t remain that attractive, so we didn’t get fully deployed. And by the climate, I’m thinking of more structural measures of valuation: where are PE ratio relative to inflation? Where’s the price of the equity market relative to an objective marker, such as the price of gold? And after this recent rally in stocks, valuations still look reasonably full.

Matthew McLennan (01:23:27):
And so, while sentiment was bad, from a secular standpoint, the risk reward doesn’t look that great. Internationally, on the other hand, you had both bad weather, and arguably a little bit more favorable climatic readings. The valuation of markets was already resonant with what you’d expect in a recession, not a soft landing. And currencies are at generational lows, and valuation of the MSCI EAFE hadn’t gone anywhere for a decade. Stocks have gone for a lost decade, and derated relative to gold. And so, you’re not just getting a bad weather day, but-

Matthew McLennan (01:24:03):
And so you’re not just getting a bad weather day, but from a more secular standpoint, the risk reward side is to stack up a little bit better. And it’s not to say if we have a global crisis, there’s real problems in China, Europe’s got to make it through this winter with potential gas shortage, and the US has to absorb a recession, in my opinion. All of those things playing out may lead all risk assets to law evaluations at some point. Our crystal balls foggy at best. It’s hard to predict these things, but just because we see relative value internationally doesn’t mean it will manifest it itself in positive absolute returns in the short term. But what we can say is if we own a business like the ones we talked about with a reasonable mid single digit free cashflow yield that’s got a track record of growing at a mid single digit clip and that’s returning capital to shareholders and that doesn’t have balance sheet contingency held for long enough will get decent arithmetic relative to owning a bond with a low single digit return.

William Green (01:24:59):
One thing that’s really notable to me about your portfolios is that you seem to have very low exposure to China. And I was talking to Howard Marks on the podcast a few months ago and he was saying a lot of people will say, well I’ve got China covered with a 2% allocation. And he said, but look, if China’s important and it’s going to be the world’s biggest economy, a 2% allocation just isn’t going to move the needle. He’s like, it’s not enough just to say you participated. And I’m wondering how you think about China and how you balance caution and courage and weigh that the tremendous opportunities but also kind of the really unpleasant risks that we’ve become more conscious of I think in the last year or so.

Matthew McLennan (01:25:42):
Well, it’s not clear to me that China will become, and even if it does sustain its position as the world’s largest economy. And I think a lot of people are presuming that will happen, but it’s not clear to me that happens. I think one of the things that’s interesting is if you look at a list of emerging markets and of 50 years ago and look at a list today, very few emerging markets actually emerge. And there’s a whole host of reasons for this and there’s, in fact, there was an interesting book on this called Why Nations Fail by Robinson and I think Acemoglu MIT economist. And one of the tells of a country that’s managed to sort of grow and benefit from capitalism and the spread of property rights and all those sorts of things. There’s an inherent pluralism and a political process that gives voice to multiple constituencies.

Matthew McLennan (01:26:37):
And historically at least if you haven’t had that, it’s been difficult to sustain growth to develop market levels. And ultimately if you have some form of authoritarian regime, it’s impeding to the very notion of creative destruction because if there’s a rent seeking regime, it has to retard at some point in time, creative destruction to preserve its own existence. And so I think if you were to ask if Hayek still lived and you were to ask him, will China become and sustain its position as the world’s largest economy? I think he’d be very weary of making that prediction. And so I think that China is set with quite a few problems right now despite the fact that there are opportunities, this self-inflicted wound with the COVID policy response and the lockdowns. There is dramatic adjustment going on in the real estate sector and that market is very overbuilt. And they had a clamp down on the entrepreneurial class and which has really led to sort a derating of that sector.

Matthew McLennan (01:27:43):
Now it doesn’t mean that we won’t find select opportunities. We do have some investments in Hong Kong property holding companies that traded less than 50% of the underlying private market value of their real estate. And where Hong Kong may not be as vibrant as it was before it came under the influence of the Chinese Communist Party, but it’s likely to still have some relevance relative to say Shanghai and Beijing as a capital export center for China. Likewise, we’ve made some small investments in some of the internet platform companies in China that have very entrenched market position. And where we were able to deploy capital at a single digit multiple of EBIT and where we have a lot of latency in potential margins and valuation. But these are very small and select investments.

Matthew McLennan (01:28:39):
I will make the point though that China is so big that you can’t avoid it. They’re the largest producer of many goods and one of the largest consumer of many commodities. And so if China goes through a tough adjustment here, I think the world will feel it just as if the United States goes through a recession, all Europe as a whole goes through a recession. And so I would say that we’ve been cautious on China and bottom up many of the companies we’ve looked at just haven’t had the free cashflow conversion or the management discipline that we’ve looked at. But we’re open minded. It’s right to say that’s been a very small part of our portfolio.

William Green (01:29:17):
And you seem pretty concerned as a fan of Thucydides and his views on history, you seem pretty concerned about some kind of mounting inevitability to a conflict between the US and China sort of echoing the Spartan Athenian kind of conflict that we saw thousands of years ago.

Matthew McLennan (01:29:39):
Well I think if you read Thucydides what’s compelling about it is that it was written before 400 BC and a lot’s changed since then. Obviously technology is dramatically different today from what it was back then. On the other hand, human behavior and human wiring hasn’t changed that much. And I get the analyst on our team to read the book because it shows you the common mistakes that people make. Hubris, dogma, acting with haste. And I use that as a template to get people to think about doing the opposite with their temperament, having humility to accept uncertainty, being a patient investor, being flexible, not dogmatic about just investing in one particular part of the world or one particular industry. And so I think there’s a lot we can learn from Thucydides and I think what he showed us is that the fear of war is often the cause of war, and especially when you have two competing regimes. And I certainly hope we don’t see that emerge, but Nancy Pelosi’s visit to Taiwan and the response is clearly flashing some warning signs here that I think we can’t ignore in totality.

William Green (01:30:52):
One of the things that’s striking to me that’s very distinctive about you Matt, is you, you’re reading these books like Thucydides you’re reading Stephen Wolfram on physics and complexity and you’re drawing ideas from all of these places and thinking through these ideas about gold and resilience and entropy and like. And I’m curious about how you actually gather and synthesize this data. You’ve talked to me about how you have, I think in your phone and your iPad, thousands of pages of ideas and mental models that you’ve written over the years and you’re constantly refining. And you mentioned the phrase once to me of it’s like raking your zen garden. Can you talk about how you do this habit because it’s such a distinctive part of the way you operate in life?

Matthew McLennan (01:31:47):
So I think the first thing is you have to create time to reflect. And it’s easier said than done. We all have busy schedules. We could all spend all of our time doing a subset of our jobs. And so first you just have to, in the mental hierarchy of things, acknowledge that some time spent on reflection is important. And in fact, as I think about it, what, if I were a client? What would I want Matt or any of the team members to be spending their time on? And I’d want them to be spending some meaningful amount of their time on reflection so that they’re seeing the world through a different prism. The second thing is that it doesn’t happen linearly. Even though I try to religiously schedule some time for reflection on certain days of the week or certain times of the day, reality intervenes frequently.

Matthew McLennan (01:32:37):
And so you have to squeeze it in while you can but, and it’s not even linear in that context. So I might go through some years where I’m reading voraciously, I read many books in a year. And then I go through other years where I get into four or five books but I don’t complete any. And I’m actually spending most of my time to your point before raking the zen garden, and trying to order my thoughts. And I do keep many notes that essential attempts to sort distill what I’ve learned from different works and tying it together in a philosophy that makes sense. And sometimes I’ll wake up at five o’clock in the morning and I’ll just spend two hours trying to refine one element of a mental model. And so part of it is creating time to absorb new ideas, many of which have come from great people that you never got the chance to meet, but you can at least read their books.

Matthew McLennan (01:33:37):
And the other part that’s equally important is to synthesize. And it’s the same notion if you’re going to visit a company that you, you’re going to Tokyo and visiting a bunch of companies, you have to spend the time preparing for it and the time to make sense of what you’ve learned after the fact. And so it’s not enough just to read a lot. You have to try and think about it and distill it and it’s both of those things. And then sometimes you just get stuck. You feel like you’re not necessarily making a leap forward in your understanding. I don’t know if you’ve gone through the process of learning another language, often it feels like you get this window of stasis and then all of a sudden in a non-linear way you take a stair step function up and you’re seeing things in a new light.

Matthew McLennan (01:34:21):
And so I think often when you’re feeling stuck, it makes sense to do something different, to travel somewhere, to do something physical. I like to play backgammon against the computer from time to time and sometimes it takes doing something different. A friend of mine, Josh Waskin said sometimes the ember needs to withdraw before the flame comes back up. And so I think it’s a combination of all those things, prioritization of reflection, realizing that it’s not just about reading but equal measure must be spent to synthesis and making sense. And then the final thing, recognizing that it’s a kind of step function process where you need time to step outside.

Matthew McLennan (01:35:07):
And Lord Dening, one of the great English judges said, Let not our vision be clouded by the dust of the arena. Sometimes you’re just too much in the thick of something to make sense of it all and sometimes you’ve got to leave the snow globe, let it settle and then come back. And so those are the ways I try to do it and it feels rather imperfect. I’ve been at this for decades now and I feel like I’m just beginning and I feel like I’m so far behind in so many dimensions that it’s humbling.

William Green (01:35:36):
Is there a particular model that you feel like in the last six months or so is starting to take shape and you’re starting to think to have this sort of beautiful sense of revelation where you’re starting to think, oh, that’s what this means. Is there something that’s really striking you as more important than you’d ever realized before?

Matthew McLennan (01:35:57):
Yeah, so I mean I’d say a couple of thoughts there. One, I made the comment before that very few emerging markets have emerged and I’ve been thinking about this a little bit. And the process of trying to reflect on this and discuss it with our sovereign analysts and to read a little and discuss it with people I respect, it has me sort thinking about the absence of inevitability. I mean we all went through that. There was that passionate chasing of the bricks theme and we were always pretty skeptical at First Eagle cause what we were seeing top down and the narrative wasn’t matching the bottom up opportunity set. But I started to think more about it and some things aren’t inevitable. The existence of certain preconditions need to be met. I guess other things have appealed to me. We talked about entropy and fade, that’s been a big source of intellectual inquiry for me over the last decade.

Matthew McLennan (01:36:54):
But the first law of thermodynamics is about the conservation of energy and matter. And that’s a little different because that implies something very different. It implies sort of deep cemeteries. And one of the thoughts that’s been occurring to me lately is this notion of symmetries that exist in financial markets that have to coexist for the whole to make sense. And so I’ve been spending some time thinking about deep symmetries. For example, a negative relationship between real interest rates and risk premier or between nominal expenditure growth and financial asset valuation. Thinking about symmetries that have to obtain for the whole thing to make sense. That’s an interesting area of inquiry. Now these are all kind of big picture observations for want of a better word, but then sometimes it’s tempered with smaller, more practical revelations. We talked about the cash audit in a business and sometimes you do something a lot and you don’t step back to really reflect on why it’s so powerful. And that’s been something that I’ve been going back to with the number of our holdings and thinking about that.

Matthew McLennan (01:38:08):
And so there’s a whole host of little things. There’s no one big game changer. And I think that’s often the way it is. That’s kind of messy entangled and you’re trying to incrementally improve in a lot of different dimensions.

William Green (01:38:22):
There was something you told me recently that made me think that there’s something here I don’t understand where you clearly thought about this a lot and I need to unpack this. Which was I’d send you an article about, I think it was from the New Yorker, it was terrific article about philanthropy and we were discussing that by email and you said something about the purpose we all serve is to help the universe perceive itself through our efforts to be excellent at something or to master the appreciation of quality and different dimensions. And I was thinking about that. There’s something really interesting there about this idea of the pursuit of excellence and fulfilling our own potential in some way as an attempt to contribute to the mosaic of human potential. But I’m so far from understanding this. Can you talk us through that for a couple of minutes because it seems like kind of an important idea.

Matthew McLennan (01:39:12):
Well I guess I sort of come at this from the simple perspective. If we go back to Wolfram and complexity theory, something that was just a blinding revelation to me when I read that his book, A New Kind of Science was that he was studying deterministic systems. So what I mean by that, think of an Excel spreadsheet where a cell could be different colors based on the behavior of cells around it, but there’s an underlying formula. And he did thousands and thousands of simulations of what the patterns would be for different formulas. And what he found was really interesting, which was that only a small fraction of the formulas produced linearity. And most of science is built on regression and looking for linear relationships, but this is the minority of reality. And then there was a bigger subset but still small where there was some sort of nested cyclicality to the patent but not a hundred percent neat.

Matthew McLennan (01:40:11):
So I think the business cycle, we know it, there’s an ebb and flow, but we can’t call it precisely. And then the vast majority of the patents of these cellular automata in these spreadsheets were effect, They looked like they were random but they were driven by a given formula. And what’s interesting is if something as linear, you can predict it in the future with a small number of observations. If something has a nested cyclicality with more observations, you can kind of predict the skew in it, but not necessarily exactly where it will be. But if something’s truly complex, it would take you more observations than actually exist in reality playing out to backwards induce the formula. And he came up with this notion of the computational irreducibility that basically, even though there’s a formula behind the patent, it’s effectively random unless the formula because it would take you more steps to observe it than to figure it out.

Matthew McLennan (01:41:09):
And so the reason I mentioned this upfront is that number one, there’s a realization that there’s a lot that we can’t know unless you actually know. And secondly, I start to think about the price mechanism and sometimes the stock price is a lot smarter than the weighted average IQ of the people trading it. Because if you think about it, you and I are trading a stock and we each have a mental model for how the world works. Some of my model is truth and some of its noise, back to the different patterns we’re talking about before. But by definition the noise in my mental model on average should uncorrelated with the noise in your mental model and the truth should be correlated. So sometimes the price is a more powerful reflector of the truth than any one person who’s trading that security if you have enough people trading it.

Matthew McLennan (01:42:01):
And I got to think about this more broadly and thinking about what are we here for? And if the universe is this grand experiment that’s unfolding in a sense it’s trying to perceive itself. You’re looking at a cellular automata stream and unfold, even though there was a starting formula to the outside person, it looks random, but to someone who knows the formula, it’s very ordered. And it’s my belief that if individuals commit themselves to excellence in a certain dimension. If they’re trying to appreciate beauty, whether it’s in art or whether it’s in athletics or whether it’s in the world of investing or any other field, what’s happening is that we’re increasing the probability that some part of our mental model is true. And by definition that will be correlated with other people who are exploring the same truths and we’re spending less time on the stuff that’s noise that’s uncorrelated.

Matthew McLennan (01:43:04):
The aggregate effect of having seven million people do that on the planet is that obviously the system gets to a higher and better and more perfect level. But from a universal standpoint, if life is a form of kind of self-referencing experiment, then that experiment reaches its highest and best actualization if the different forms of life spend their time trying to be excellent at something. And so it was through that long torturous process that I came to this belief system, which is probably totally BS to most people. But nonetheless it helped me make the decision to commit to excellence in a few dimensions.

William Green (01:43:48):
It’s interesting also because so many thoughts came up for me as you were speaking about that. The fact that in a way it harks back to your grandfather talking about your search for absolute truth in a world of relative truth. This, we are always sort looking for these deep patterns and it seems like you are always faced, your approach to investing and life. It always accepts the fact that things are incredibly complex and nuanced and we’re always sort of inching towards some sort of truth but not really sure and having to be humble. Does that make any sense what I’m saying?

Matthew McLennan (01:44:27):
It makes a lot of sense and I think are some investor’s done a great job seeing the world as more of a machine. And I’m thinking of Ray Dalio with Bridgewater for example. I’m more inclined to view it as an ecosystem than a machine. So there’s a lot of non-linearity to the way in which I look at the world and a lot of self referencing feedback loops that create complexity that ultimately compromise your ability to predict things with certainty. But it’s not a hopeless cause If you study Wolfram, you take away the conclusion that a lot of life is unpredictable. There’s something you could actually do about that, you can structure your affairs to endure. And whether it’s through diversification or having deferred purchasing power or having a potential hedge or bottom up looking for businesses that are likely to have lower FED rates by virtue of their incumbency and likely to be more persistent by virtue of management teams that act as stewards.

Matthew McLennan (01:45:27):
So it’s not a hopeless message, it’s just sort recognizing that the world and the ecosystem we inhabit have fundamental unpredictability. And so you can build a structure that’s resilient in the face of that. And if you happen to find something that’s simple and predictable, well then for all, go at it, get concentrated, take leverage, create a lot of wealth. But for many of us we may not be fortunate enough to have that blinding insight in a lifetime. And so it’s more a question of structuring oneself to endure and to participate in the march of humankind.

William Green (01:46:05):
That was something I quoted in my book that had a huge impact on me where you said you want to be structured to participate in the march of mankind, but to survive the dips along the way. And as I pointed out in the book, that strikes me as a really useful mantra for investing but also for life. That there’s something about just recognizing the fact that we live in this kind of very mystifying, unpredictable, constantly changing kind of Darwinian world and you want to position yourself to survive. And also when you’re going through these really difficult periods, both personally or professionally to kind of know that you just need to survive the dip.

Matthew McLennan (01:46:45):
And be positioned to pick up one or two spectacular opportunities during the dip.

William Green (01:46:52):
Yeah. You also said something really powerful to me. I quoted in the notes on additional sources and resources in the book where you sort of talked about the fact that once you accept the fact that the world is kind of flowing and changing in this very complex and unpredictable way. It means you need to say well okay so I can accept all of this flux and complexity and uncertainty and let me focus on my own internal equanimity. Because I can’t really control this external stuff but I can control my own equanimity. Can you talk about that a bit? Because that actually seems to me a really profoundly important observation.

Matthew McLennan (01:47:34):
I think it is very important because acknowledging that you can’t control an external environment, you need to have a centered internal locus. It’s almost like the stoics, right. And you can have some influence, you can invest in a way that you could endure a lot of different states of the world. That’s an important starting point.

Matthew McLennan (01:47:57):
But the other thing is a lot about knowing yourself. You know, don’t want to be forced to be in a moment of anxiety at the bottom of the market and therefore you have to sell and convert a temporary impairment of capital to a permanent impairment of capital. You don’t want to have so much margin debt that you’re forced to convert temporary to permanent impairment of capital. So there’s certain exogenous things that you can do. But then on the internal side, I think there’s a kind of basic level of excitement that one sort of sees in exploring the universe and travel and new ideas and interesting people. And then there’s also I think a balancing consideration that as extraordinary the experiences may be that you have in your life, you’re going to get humbled. You’re going to make mistakes, you’re going to be double crossed by individuals sometimes. You’re going to do things that are silly. And I think just the recognition that we’re all sort of groping in the dark a little bit I think is, I don’t know, in some ways liberating to do your best work.

William Green (01:49:18):
Yeah, I totally agree. Well, I could talk to you about that question for another couple hours, so I feel like I better let you go at this point. But Matt, thank you so much for joining us today. I’ve learned a great deal from you over the last few years and today as well. Not only how to think about investing, but how to think about life. And I’ve also just really enjoyed getting to know you personally and to become personal friends. So thank you so much for everything. I really appreciate it.

Matthew McLennan (01:49:44):
Likewise, William, your questions always give me plenty of food for thought and it’s the French have this expression l’esprit de l’escalier, the spirit of the staircase. Usually it’s when husband and wife are having an argument in the kitchen and they turn around and they think about what they should have said as they were going up the staircase. I’m sure I will reflect deeply on your questions and perhaps have better answers next time we meet in person. But thank you for getting me thinking with these questions and for your friendship as well.

William Green (01:50:11):
Ah, it’s been a real delight and you can always come back on the podcast. I’ll always be thrilled to have you. So hopefully we’ll get to do round two next year. That’d be lovely. Thank you so much, Matt. Take care.

Matthew McLennan (01:50:22):
Terrific. Thanks William.

William Green (01:50:24):
All right folks, thanks a lot for listening to this conversation with Matthew McLennan. If you’d like to learn more from him, you may want to check out chapter four of my book, Richer Wiser Happier, which is all about Matt and his famous predecessor at First Eagle, Sean Mackey [foreign language 01:50:38]. They share some really valuable lessons about how we can reduce our vulnerability and bolster our resilience both in markets and in life. I’ll be back very soon with some terrific guests, including Annie Duke, a former poker star who wrote a bestselling book called Sinky and Bets, and also the Nobel Prize-winning economist Robert Shiller. Until then, please feel free to follow me on Twitter at William Green 72. And do let me know how you’re liking the podcast. It’s always a pleasure to hear from you. So now take good care of yourself and stay well.

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