Episode #126: Karen Finerman, Metropolitan Capital Advisors, “‘Out-of-Favorness’ Is Appealing. The Difficult Part is Timing”
Guest: Karen Finerman. Karen began her career as a trader at First City Capital, a risk arbitrage fund. She later joined Donaldson, Lufkin and Jenrette where she became Lead Research Analyst for the Risk Arbitrage department. In 1992, she co-founded New York-based hedge fund Metropolitan Capital Advisors, where she currently serves as CEO. Her first book, Finerman’s Rules: Secrets I’d Only Tell My Daughters About Business and Life, was released in June 2013. She is also a panelist on the CNBC program, Fast Money.
Date Recorded: 10/05/18 | Run-Time: 52:32
Summary: The episode starts with an interesting connection – Karen and Meb’s wife both attended the same high school in Los Angeles, and apparently, it’s the only high school in the U.S. with a working oil rig on campus. From here, Karen gives us a brief walk-through of her history after graduating Wharton, heading to Wall Street, where she eventually launched her own hedge fund.
Meb asks about the framework she used in the hedge fund as she launched. Karen tells us they were fundamentally focused. Coming out of the savings and loan crisis, there were many smaller banks that had been unfairly stigmatized. Many were absurdly cheap with great balance sheets. Karen was able to take advantage, and developed an expertise in the space. She notes it was interesting how badly the market could mis-price an entire sector. She continues by telling us her strategy was mostly long focused. Her shorts were generally idiosyncratic, intended to hedge the portfolio. Beyond that, tax efficiency was a big focus.
Next, Meb and Karen dig into her methodology for evaluating specific investments. Karen gives us the details, mentioning fundamentals, growth at a reasonable price, users that tend to be inelastic on price, and various other details, culminating with a specific example of a company she likes.
Meb asks what Karen is seeing now. She tells us she’s a little spooked by the tariff situation. Perhaps a big exogenous risk. She then changes gears, going into details about a specific company she likes – Alphabet – noting what she finds attractive (and where she feels they could improve). But overall, she’s very impressed.
The conversation gravitates toward “selling”. After all, buying is generally the easier part – it’s when to get rid of an investment that can be tough. Karen tells us that if an investment hits their target return, they’ll lighten their position. These leads into a conversation about investment theses and how that plays into selling.
The years 1999 and 2000 come up, with Karen telling us she feels her group did the right thing then, avoiding getting sucked into the bubble. The new metrics at that time (stocks trading at a multiple of eyeballs) just didn’t make sense to her. She notes there are some similarities today, as there are certain companies that are losing lots of money despite posting growth numbers. This dovetails into a discussion of Tesla. It turns out Meb and Elon Musk shared a few words about short-selling on Twitter on the morning we recorded this podcast. Surprising no one, Elon is not a fan of shorts. Listen in for the details.
There’s way more in this great episode: the ETF-ization of investing… Karen’s book… How to address the great investing education problem… and of course, Karen’s most memorable trade – actually, she shares two, a good one and a bad one. On the good side, there was an undervalued convenience chain in which Karen got involved at the right time and enjoyed a nice payday when Diamond Shamrock showed up at the buyer’s table. The bad trade relates to when United Airlines was supposed to go private. Karen didn’t factor in the possibility that the deal would collapse. Just how bad was the damage?
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Links from the Episode:
- 0:50 – Welcome Karen to the show
- 2:07 – A look at her career path
- 3:49 – Starting her first hedge fund
- 5:02 – Her hedge fund’s original approach to investing
- 9:37 – Karen’s methodology for analyzin’g an investment
- 12:08 – Traditional holding period
- 13:57 – Current trends in Karen’s investing strategy
- 19:41 – The criteria for selling a position
- 22:16 – What has changed in her market approach over the years
- 26:14 – The pulse of investors today
- 30:05 – Difference between a good company and a good stock
- 30:59 – Howard Marks Podcast Episode
- 31:20 – Why Elon Musk should not be on Twitter
- 31:38 – Tom Barton Podcast Episode
- 33:18 – At a time when hedge funds are having a rough go, what keeps Karen going
- 38:10 – Practical advice from Karen’s book and her time on CNBC
43:04 – Favorite investing secrets
- 46:27 – Most memorable investment
- 51:46 – How can people connect with Karen: Fast Money on CNBC
Transcript of Episode 126:
Welcome Message: Welcome to the Meb Faber Show where the focus is on helping you grow and preserve your wealth. Join us as we discuss the craft of investing and uncover new and profitable ideas all to help you grow wealthier and wiser. Better investing starts here.
Disclaimer: Meb Faber is the Co-founder and chief investment officer at Cambria Investment management. Due to industry regulations, he will not discuss any of Cambria’s funds on this podcast. All opinions expressed by podcasts participants are solely their own opinions and do not reflect the opinion of Cambrian Investment Management or its affiliates. For more information, visit cambriainvestments.com.
Meb: Hey, podcast listeners, we’re recording this on a Friday. Today we have an awesome show for you with the Co-founder of New York City-based Hedge Fund, Metropolitan Capital Advisors. She’s also a New York Times Bestselling Author, but you probably know her also as a panelist on CNBC’s program Fast Money. Welcome to the show, Karen Finerman.
Karen: Thank you for having me.
Meb: Karen, you know, I know you’re a New Yorker through and through now, but I think you were originally a Cali girl. And I’m based here in Los Angeles with the company, and we have a common bond. My wife, I think, is a fellow alum of probably the only high school on the planet that has a oil rig on it where, I think you went to high school.
Karen: Yeah. Oh, she’s an alum of Beverly Hills High School.
Meb: More importantly, did you see they just took the rig out of production. It was doing like almost a million barrels at one point, I think. But it’s down, I think in the era of clean energy and everyone probably assuming they got cancer from it. I think it went out of commission this year.
Karen: I did not know that. Okay. Thank you for updating me, always surprised me one loan rig, how that could really be efficient.
Meb: I know. All right. Well, let’s jump into the episode. So from Cali to New York, you know, and in running hedge funds, let’s go back in time a little bit. I want to hear a little bit about the progression there. I know you were a Wharton alum as well. Maybe walk us through how the career path took you from Wharton to starting your own fund.
Karen: So, I graduated Wharton in 1987 and everyone just was headed straight to Wall Street. And so, I started at a boutique risk arbitrage firm that was controlled by the Belzberg family, they were Canadian raiders at the 80s. And we started that, I came on there right after school, and that was from 1987 till 1990 when the Belzberg empire kind of imploded somewhat. And then, I found myself looking for a job. I started on the trading side but I felt like going to the research side was where there was more value-added. And so, I found a job on the research side at DLJ on the risk arbitrage desk, and I did that from 1990 to 1992 and my old partner from the Belzberg firm and said, “Hey, why don’t we start a hedge fund?” In 1992, which was a fantastic idea because you could have been the worst hedge fund manager in the world in 1992, and you were going to make a lot of money because the opportunities were just everywhere. And so, the biggest, best decision we made was starting right then.
Meb: Well, that’s the old Julian Robertson advice that he…young hedge fund manager asked him, “Hey, what’s the best advice?” He says, “Get lucky and start at the right time and have some good performance out of the gate because then everybody will think you’re a genius.” So that’s good timing, 1999, but did you start your first job by the way, pre-crashed, or is this post-October 87?
Karen: I started pre-crash. I started about two or three months before the crash, and then the crash happened, and I thought, “Wow. This is really a volatile business, not really having a sense of the crash.” And I keep a picture of Quotron. I don’t know if anyone still has Quotrons. But it use to be, you know, your monitor and all your stocks. And I keep a picture on my library bookshelf of the screen at the end of the day of the crash. And it has all the blue chips that were down, you know, 20%. And it really was quite extraordinary to look at. The thing that was even more extraordinary was how quickly the market came back. And then there was a lot of opportunity right after that. And that was important to see that bounce back and see that things can change quickly.
Meb: Yeah. Well, I started my career… In kind of a similar inflection point which was graduated college in 2000. And so, that was right during the internet bubble popping. And we’ll get to that in a minute I’m sure. But it’s interesting because like, early 90s, you know, this is kind of early on in the days of hedge funds. What was kind of the original style and structure? What was kind of you all’s framework of the portfolio? And how did you all approach investing in general?
Karen: So we were sort of fundamentally focused, and at that time there was a lot of… We were coming out of an S&L crisis, Savings & Loan crisis. And there were a ton of very small banks that were tarred with that brush of being called a savings and loan. And they were ridiculously cheap, ridiculous. And they had pristine balance sheets, even though everyone assumed that anything that was a Savings & Loan must had terrible balance sheet. So we had a lot of exposure to that area, and that worked out very, very well. And it was sort of another example of being lucky at the right time, but then we sort of developed an expertise in that area. And that was interesting to learn how badly the market could mis-price a whole sector. And that was helpful sort of in the future when we would find other sectors that were tremendously out of favour. So that out of favourness is appealing. The difficult part is, trying to time how much exposure you’re going to have to a really out of favour sector because it can always get more out of favour. And it was lucky and smart, both, but I gotta say a little more luck than smart.
Meb: That’s the best advice. I love it to be lucky. But so, talk to me. I assume this is kind of structured, your traditional long-short equity. Are you guys long only? Were you doing shorting at the time too? And so, maybe kind of walk us through how, you know, you guys thought about the framework of finding a good investment. So talk to us a little bit about the portfolio construction and how you actually went about putting it into practice.
Karen: So, we were very, very long-oriented. That’s our nature, that’s my nature to be optimistic and long-oriented. And so, the short, we had very few idiosyncratic shorts. Almost all of our shorts were intended to hedge the portfolio. So, we would be either buying S&P puts, or shorting spiders, or, if we had a more smaller cap-focused fund, then we would have a more, like a Russell-type of hedge, and we tried to also be very tax-efficient about the way that we hedged. And in general, we tried to be really, really tax-efficient because, you know, we were big investors in the fund. So, all of the tax implications of the trading of the fund would flow through to us and all of our investors, most of whom did care about taxes. So you can maximize your after-tax returns by just thinking about taxes a little more actively. And so, that would be part of both the long and the short focus on taxes.
But in terms of construction, we really wanted to be long. That was our bias. That has been my bias all the way through, and every once in a while we’ll find an occasional short that was sort of a hoping to be an Alpha generating short as opposed to a hedge. But I find shorting more complex, unlike along that goes against you, the position sort of get smaller and smaller. Because if the short goes against you, obviously it gets bigger and bigger. And then there’s a whole other layer of, “Oh, what about if the borrower gets difficult?” Or you could be, you know, you could get bought in. So, I don’t know if you’ve watched Tilray in the last couple of weeks. That’s extraordinary squeeze. That’s a dangerous game.
Meb: Yeah. Shorting’s hard. And on top of that, I feel like all the best shorts I know, I have like something slightly askew in their head. And my good friends that are pure shorts are like totally crazy. But it’s interesting because there’s, in many ways some similarities of the skill set it takes to analyze a company. But so many of the shorts you have to be extremely sceptical. But the position management, man can be so hard as well. And in this cycle that has been certainly a graveyard for a lot of funds. So, all right. So, talk to me a little bit about when you’re looking at potential investments, what’s your methodology? Are you looking for growth at a reasonable price? Are you looking for sectors that are coming into favour? Are you looking for old school buffets, cigar butts? Do you guys do quantitative screens? How do you go about building the portfolio?
Karen: Well, it’s migrated somewhat from just, you know, the cigar butts, buying 50 cent dollars to growth at a reasonable price. And it’s fundamentally driven. So, I don’t want businesses that are too small, even though they could trade very cheaply, just because I think a business that’s too small has some existential risk that larger companies don’t. So, anything micro-cap is just absolutely not going to be for us. Plus a very difficult to trade in and out of. So we look for companies that can have above average return on invest in capital, companies that have good market position that provide a product that is important to its user, and that they would be somewhat inelastic, that their user of their product would be somehow inelastic on price. So a couple of things that we’ve done wrong that I learned a lot from was owning a company that has one very large customer. That’s a big mistake because if they ever lose that customer, they’re cooked.
So we want to understand who uses the product, how widespread that is, and how important the product is to the user and how much of a cost it is to the users ultimate cost. So, for example, there’s a company called Coats that makes tiny threads that you use in the back of collars, and it’s very, very, very high quality. And for the manufacturers of those, it’s a very low cost to them, but it’s excellent quality. So there’s somewhat inelastic to price because it doesn’t really move their overall price. And that’s the kind of setup that we really, really like.
So I’m somewhat afraid of commodity type businesses because they can really find their margins crushed. And that’s happening so much more quickly than it used to. We also are very focused on management too. We have to like the management, very often if the management leaves, that is a big signal for us to reassess the position.
Meb: What’s kind of your traditional holding period? Is it, you know, a lot of these are trading around the positions, is it positions you’re holding for months, years, or is it more kind of weeks, quarters? And is it… varies by, you know, the kind of investments you’re making and etc.
Karen: Yeah. It varies by the kind of investments we’re making. If we, you know. Sometimes we’ll be looking at…in the energy space, we’ll be looking at companies, for example, the position this company goal are that is involved in the liquefaction of natural gas offshore? And these are very big projects and they take a long time to get done, and our holding period, there has to be… Our perspective has to be, “This is going to be a multi-year holding. And most of our holdings, we tend to want to hold them for more than a year for tax reasons as I said, so we don’t really trade around. It’s very hard to time to market. So to time on the right on the way out, and all the way in, and have to make up the difference that you’re going to pay in taxes from trading around is too difficult for us.
We really don’t try to do it. We will do some, we’re pretty proficient with options, so we will look at selling some out of the money calls that don’t affect our holding period, but we generally have longer-term thesis that we are patient, and we’re going to give them time to play out. And [inaudible 00:13:38] if the risk on position. I do still have a little bit of a junkie for the action of a deal. So, the deal happens, you know, however it might happen, activist might come in for sale, something like that. That timing is going to be relatively short term.
Meb: It’s funny you mentioned the old school buyout space, which now everyone seems to just label private equity. It seems like a much more palatable term. But there seems to be a lot of, you know, a lot of media coverage, there’s a lot of money washing around these days, some of these funds have just raised enormous amount of capital. As you kind of look around, you say you don’t do a whole lot of timing and macro, but it does end up playing out a bit, and some of the sectors that are attractive on whether it be valuations, or just setups that plays out in your portfolio. As you kind of look around, you know, the U.S. today or your portfolio, and I don’t know how much you guys do in an international if any, what’s kind of some of the things you’re seeing, the themes in your portfolio that might be current or that you’re certainly thinking about or got an eye on?
Karen: Well, so, a couple of things. I am a little bit spooked by this tariff situation. The trade, I don’t know if they’re not calling it a trade war yet, it’s guess it’s more of a skirmish at the moment. I am a little concerned about that as a big exogenous shock that could be out there. But we do look internationally, but only it really developed markets. So we might have exposure in the UK, or France, or Germany, but not really much beyond that. The businesses that I like right now, I mean, I think it’s gotten crushed the last month or so. I think alphabet is an absolutely superb business with tremendous cash flow. And they don’t get enough credit for the underlying business. It’s masked somewhat. They’re trying to make it a little more clear, but it’s masked somewhat by all the spending they do on their moon short bets. So that would be Waymo [SP], Varley [SP] which is health, NEST [SP], things like that.
And it’s really an extraordinary business. I’m disappointed with their capital allocation. They have a hoard of cash that’s among the largest in the world, and they really do nothing with it. And they don’t get the credit for it. So I would like that to change. But the power of that business is really extraordinary, and to have it be still such a big grower, you know, revenue growth, it was the mid-20s last quarter. That’s extraordinary. That’s extraordinary. And I think that if it were to just become public today, if it’d be private all along and became public today, it would trade much higher than it does now. For whatever reason, it’s seen as relatively old and boring. But I think it’s tremendous value. And, you know, I’m patient. And I think value will out.
Now, something like Facebook is a lot of similar dynamics that we like about Alphabet, which is still hard for me to call Alphabet. I’ve always feel like it’s Google. I don’t know why they ever changed the name. But, anyway, Facebook has obviously a number of idiosyncratic issues. It is the poster child now for bad behaviour companies that have your data. And every once in a while we see companies that are in the cross-hairs. Do you remember when Goldman Sachs was, you know, the evil empire, and it was just a… Any ire towards Wall Street seemed to be very, very focused on Boldman Sachs.
Meb: Vampire Squid.
Karen: Exactly. The vampire squid. And I think there’s tie, I little bit of a little bit of vampire squid taint still there, but nothing remotely like what it was. Although interestingly the stock hasn’t really done very well but that’s a different issue. So Facebook is sort of an idiosyncratic one. I’d have Division there lately, not been good, not been good. But I think that’s also an extraordinary business. And I think there will be a new poster child for some other ill of society soon. I don’t know when exactly, but soon. So I feel like if they can put up decent numbers and the bar has gotten lower and lower and lower in the last few weeks, we could see a good recovery there. So those kinds of companies, l really like.
Then I also, I liked some of the banks. I feel like it has never been as good an environment for banks in many ways. Not all the ways, but just in terms of the strength of their balance sheets. The valuations are still really attractive. I think, you know, for me, I like the big money centre banks, J.P. Morgan, Citibank, Bank of America. I think that as interest margin, as interest rates move, they should be able to increase their net interest margin and their profitability. Although Wall Street seems to think that banks are a giant 2-year, 10-year spread. I think that’s wrong. So it was on the way down when the curve flattened. That was bad for banks. And now I think people think, “Oh it’s good for banks, it’s a curve. Steepens [SP] and rates go up.” That’s true. But it’s not a giant 2-year tenure bit. But, so I like those. I think some of the, I don’t know why they’re so out of favour at the moment. I’m not really worried about it. I think, you know, they’re buying back their own stock. I think their earnings are real nicely… They pay an okay dividend. I try not to really be focused on the dividend though. That’s really an afterthought.
So those are sort of two big areas of the portfolio and I always kind of like industrials. I like the sort of meat and potatoes businesses, that’s interesting to me.
Meb: And so, how do you like, you know, so you get all these portfolios into your portfolio and one of the challenges, you know, as we all know is some of the behavioural tendencies to then fall in love with the company. How do you approach selling? Because different people are different, you know, so some, it’s just like, “Hey, it’s the inverse of my buying rules. When the valuation gets high, or when something happens.” What’s kind of your criteria for kicking them out for the names that you have in the portfolio?
Karen: So, that is a great question because it’s really hard to be completely, to not have your emotions play into that at all. But a few rules we have. So one of them is going into a position, we sort of think, “Okay. It’s trading at X right now and we think it could be worth X plus 20%, 25%, let’s say. And so, if it gets to 20% we’ll lighten some of the position. And, you know, you kind of have this ladder of you’d be out by X plus 40%, let’s say. That’s normally the way it works. However, sometimes other things happen. So, for example, let’s say you had a thesis about a company that is no longer true. So, for example, let’s say Facebook, they report their next quarter earnings revenue has stalled dramatically. That’s problematic. So stock will be down, clearly, but I would be lightening position in that scenario because the thesis is no longer holding.
So if another time we have a thesis, let’s say we love the management team, and for some reason management leaves, that’s problematic. We’ll probably stall in that scenario. And then there’s just a little bit of emotion that gets into it. You know, you like to hang onto your… I like to hang most to I guess, like to hang onto the winners, feels good to look at a position every day that kind of moving in the right directions. So, I’m not 100% disciplined. I talk about it, but in reality I’m not 100% disciplined.
Meb: See, that’s why I’m a quant, is I don’t even know half the time what the stocks are in our portfolios. So, it’s easier for me to be rules-based, because I fall in love with everything. I would fall in love with every stock we owned. I have all the behavioural biases. So, like every single one I have, I’m the poster child. But that’s why I’m a quant, because I know better. You know, one of the things what, not to date you, but for hedge funds…
Karen: You can date me, that’s okay.
Meb: …I mean, you’ve survived, and, you know, there’s been three or four very different market environments since you started managing funds. I mean, you had the roaring 90s culminating and this kind of market cap internet bubble. There was all sorts of different Russian crisis and Peso crisis, and then the mid-2000s brick, and global finance. I mean, you’ve seen kind of at all different interest rate environments, different inflation environments, kind of everything.
What’s kind of changed in your approach over the years? Has there been anything where you said, “You know what? We’ve kind of shifted away from X, Y, Z.” Or has it been kind of consistent? Through the cycles, is there anything that’s kind of changed or any scars that have caused you to say, “Hey, look, maybe we’re going to shift to do something different?”
Karen: Lots of scars. I mean, to me, one of the most difficult years… I find a straight up market to be very, very difficult because that’s a difficult market to…especially if you’re hedge, it’s a difficult market to outperform. And so, that’s sort of a difficult time. I think our best year in terms of really thinking clearly and doing the right thing was 99 and 2000, particularly 2000. We never got sucked into the internet bubble. We just didn’t understand. I mean, there was this whole new set of metrics that defied anything. Certainly, Graham and Dodd, right? That would have been…and I mean, the idea of looking, trading at a multiple of eyeballs was ridiculous for companies that were just losing tons of money. And so, it was interesting to see that all the old rules were kind of getting tossed out the window is not, you know, old school are not relevant anymore. But that didn’t make sense to us.
So we really did not get involved in anything that was really value-oriented at the time. Anything very mundane Brick and Mortar businesses, things like that, were trading ridiculously cheaply. And so, we built a very big portfolio of those kinds of businesses. And then when the bubble burst, the money flowed to those value-oriented businesses out of the bubble. And so, you had a big… So we weren’t long anything that was going down so dramatically, and we were long things that were going up very nicely. That was a really good time for us. And I see now some similarities. Some of these businesses that go public and they’re losing a lot of money, and the market doesn’t seem to care because the growth is really there, and it doesn’t even seem to matter if they don’t even have a path to profitability that would allow that current price to ever be reasonable. I don’t really get that, but it’s happening.
Meb: It definitely seems like you have some echoes, the late 90s, you know, some of the statistics you see that pop out, whether it’s valuation, whether it’s percent of companies, IPOing that are unprofitable. I saw a good chart the other day that had number of stocks trading in the Russell 3000 that are trading for more than 10 times revenue, had numbers, like a lot of echoes. And it’s hard to kind of, to my younger millennial listeners, it’s hard to really describe times in history that were like the late 90s without having lived through it because you don’t really…I mean, look, I love a good bubble more than anyone. But you don’t see…and maybe you could comment on this. You know, one of the challenges we’ve seen over the past couple cycles is, and maybe this is the reason, is because of the bear markets, people, you haven’t seen the sort of mania sentiment you normally see after eight, 10 years of a romping stomping bull. I mean, last year we had the first time in history where the stock market was up every single month. So particularly from your perch, you know, at CNBC but also running a fund, you have both sides of both sentiment and the institutional as well as individual retail world. What’s kind of your take on the pulse of investors? Do you see areas where people were euphoric? Do you see people just having a general disinterest? What’s the general mood that you can kind of ascertain from general sentiment?
Karen: Well, I definitely feel like there’s cold stocks that are not dissimilar to me from the 90s, and these multiples of revenue for a company that makes no money. I find that a curious metric that somehow is an anchor for valuations that I don’t really understand at all. And I think that will change. I don’t know when but it will change. But I think that Tesla is an interesting one to me. One of the things that being on CNBC has made me change my thinking a little bit is, we look at a lot of grass. We have a lot of charters come on, and I never really understood that as a tool. And it occurred to me that it doesn’t matter if I understand it or not. If enough people believe it to be so, believe it to be valuable, then it will be. You know, if everybody thinks, “Oh, it’s creating a floor here. It’s 30.” Then there will be a floor at 30, which to me was, it didn’t make sense originally because I thought, “Well, that’s not based on any fundamental or anything.” But now I get if enough people believe it doesn’t matter, it will work for some period of time.
So I was never really open to that kind of thinking at all. But I do think there’s somewhat of a place for it. You know, one very interesting thing in the march… So, Tesla, it’s fascinating company, trades at a, I don’t know, is an infinite multiples, the negative, you know. They burn money and it’s a cold stock, and you have to really, really be drinking the cool-aid, interesting, it’s a great product. So there’s definitely a there, there in terms of valuation when I look at something like that. And then I look at GM, right? So GM, I didn’t know that there were 505 stocks in the S&P until recently. I just learned that. I thought there were 500, but there’s 505.
Anyway, GM is third from the bottom in terms of PE, which I find fascinating because GM is obviously a real business, right? And yet, you know, I understand the bear case of the ownership of cars is changing, and, you know, we’ve passed peak auto, and you can throw out a bunch of different bear cases. But to me, the multiple of Ebitda to and change, the price-earnings ratio at five something with a yield of, I don’t know, four of something, four and a half or so. That’s kind of astounding when you have Tesla trade at an infinite multiple. And that to me, I don’t think those two things can co-exist forever. They have to diverge some way. I mean, converge rather in some way. That kind of Tesla cold stock is 1999esk to me.
Meb: I think it’s a good example for investors to always remember the distinction between a business and a stock to where, you know, there’s a lot of examples where you could have the world’s crappiest business, but the stock is just too cheap, in which case it’s actually could be a reasonable buyer and vice versa. You could have, I mean, I think consumer reports gave Tesla the highest rating it’s ever given a car. But if the company’s trading it at a way too high of evaluation, that’s the difference between stock and a business. That was the lesson I learned pretty early from losing a lot of money, but as most would, I think it’s really important one.
Karen: Absolutely. It’s super important the idea. Those are two different things in your scenario where they talk about Tesla being the highest rated car ever. One shouldn’t jump to the conclusion then that you can buy it at any price and that’s fine.
Meb: We recently had Howard Marks on the podcast and he said something along the same lines where basically, you know, an investment is kind of what you pay for. It’s not actually the asset itself, but whether it’s over undervalued. This is kind of a funny, timely mention because Elon Musk responded to a tweet I had today. And so, the…
Karen: Oh, really?
Meb: I got the…
Karen: What was what?
Meb: Well, he was talking about how short-selling should be illegal. And let me preface this by saying I have no position in the stock. I love Elon Musk, but I clearly think that he should probably just not be on Twitter, you know. And so, he said short-selling to be illegal and we just had one of the world’s old school, you may remember 1980s short sellers, Tom Barton on the podcast who has teamed up with a Fast Bach brothers and they… And I said, “Look, you know, I love Elon and Tesla, but I think he’s 100% wrong here,” because, you know, shorts do the market a very good service. And they expose so many frauds, there’s so much fraud in our world of these companies, and it’s probably less now with the disinfectant of the internet. And so I said, you know, “The shorts, I think they actually have a very serious role.” And then it went on two or three more tweets and somehow got into a short lending discussion and everything else. But got to see an insight into, my god, there’s like 10,000 crazy people responding. It’s almost like the old message boards on Raging Bull on Yahoo Finance back in the day. I mean, just nothing brings out crazy people more than Tesla on both sides of the fence. And I read about five of them and I was like, “Oh, dear God. I’m just going to sign off. I’m signing off for the rest of the day.”
Karen: Oddly, it’s the crazies is just starting from the very top down. I totally agree with you, they should give him a play school phone where he can press the buttons, but it doesn’t actually send any messages or anything. It’s astounding to me.
Meb: There’s no upside.
Karen: Yeah. No upside. I mean, he’s talking about being in production hell and then delivery hell. Why does he spend any time at all on Twitter?
Meb: I look at my save draft folder every once in a while, just for a reminder, it’s like the who’s who of the worst Tweets that I’m so happy I never sent. So, I think we would all be better off just not participating in Twitter at all. Okay. We can talk about Tesla all day, but I got a bunch more questions I want to ask you. So running a fund, particularly during this past 10 years has been, I think we mentioned earlier, just an absolute graveyard for funds where the S&P has just steam-rolled so many of the most storied names and, and hedge fund world, where one after another you see them shutting down, or turning into family offices, and the S&P has outperformed every single asset in the entire world since the financial crisis. What’s keeping you going? I mean, you know, this has been like a nearly impossible benchmark to be fighting against. And for someone who’s got so many irons in the fire, not just through work and a fund, and TV and a whole family and gaggles of children. What’s kept you going? Do you just love it?
Karen: I don’t know. I find it endlessly fascinating. I like the intellectual challenge. It’s interesting though. The burden of losing money for people is really, really hard and tiring. I think the under-performance feels terrible. Feels way worse than outperforming does feel good. But, I don’t know. I find the markets just fascinating. And I mean, you can always learn new things. I like learning about new businesses. That’s interesting to me. The frustrations of the evolution of the hedge fund business has changed so dramatically and I think it will continue to change. And then there’s the ETFvisation of investing which is real, which I didn’t used to think was going to be as massive as it is. That’s an interesting evolution in the business. And the specificity of some of the ETFs is interesting. So investors have a lot of places to go. I don’t know. It’s interesting to see, like I’m on the board of the Wharton School, which is where we both went, and they put out interesting data every year on where their undergrads go to work. And that’s really been shifting. It’s, you know, they’d say the last couple years a lot more students have gone to Google than to Goldman Sachs. And that didn’t used to be the case. So the lustre is clearly off of hedge fund business and Wall Street. And there’s still interest there, but it’s waned considerably.
Meb: It reminds me of the parallel… I mean, so. I graduated in 2000, of course, which was the peak of, I was a biotech guy, but most of my friends had all moved out to San Francisco in 1999, 2000 and there was so many conversations. I remember it just like it was yesterday where they’re like, “You guys gotta move out to San Francisco. There’s jobs everywhere. There’s so much going on.” And then, of course, what happened it imploded and over the next three years. But, you know, these things kind of go in cycles that tends to be…there’s so many of these sentiment indicators that are kind of happen in line where, you know, where are all the MBA students going into. Are they going into consulting? Are they going into tech, are they going into finance? And it kind of goes with the times for sure.
Karen: Does this feel the same to you?
Meb: My comment on this cycle is the, you know, over the past 20 years, I think part of this is because of the two big bear markets. I think a lot of people have in general lost interest in the equity market. I mean, the late 90s, you’d go to a gas station CNBC would be playing. You’d go to every TV and every single place, and over the past, you know, I think people, especially on the individual level, you know, just got, kind of got punched twice in, “Oh, wait,” particularly bad because it was widespread. You know, you mentioned late 90s market cap, weighted tech.” So it was a little bit contained whereas, is in 08, kind of affected a lot more main street with real estate and everything else. I feel like a lot of people have lost interest, which is why you haven’t seen the pure mania kind of upside on this cycle. You see in places like cannabis, you mentioned Tilray as well as, of course, with the Crypto space.
It doesn’t mean that it doesn’t change what people do. If you look a lot of the traditional metrics of percent invested, percent cash, these are all things you still see that are kind of peak sort of times. But, you know, chatting with my friends, chatting with parents, chatting with investors, they don’t have that same sort of involvement. And maybe it’s just a lot more exciting stuff going on elsewhere. I don’t know. I spend a lot of time thinking about this, doesn’t impact anything we do because I’m a quant. But I think about it a lot and like to gossip about it. Talk to me, but you probably have a pretty good purge to from being on TV as much as you do, but also, want to talk a little bit about your book and some of the practical implications. You have, an advice for people as well.
So you had written a book called “Finerman’s Rule: Secrets I’d Only Tell My Daughters About Business and Life.” and this is a topic that’s particularly been on my brain the last few years. One, because I’m a new father and have a son.
Karen: Oh, you are?
Karen: Very nice.
Meb: Thank you, and it’s been a lot of fun. But second, because I really struggle with this concept of investor education. You know, they don’t teach it in high school, mostly they don’t teach it in college or personal finance. And I waffled between thinking it’s a really noble pursuit. We can make a difference to also thinking people are just going to be people and humans and stupid and do dumb things over and over again. Talk to me a little bit about some of the practical advice and suggestions that came out of this book and certainly your time on CNBC too. One of the things that I talked about in the book, there’s five children, four girls, and a boy. And my mother really gave particularly the girls the message, “You have got to have your own money. You know, you need that financial independence because that will give you power.” And I think she just assumed my brother knew that. That in itself is interesting. But it’s frustrating to see people make really dumb mistakes. Like, talking about this over and over again. I mean, I remember meeting this one girl who she would do hair and makeup for us and occasionally, we would talk about financial planning and she said, “You know what? I think just the universe is going to have a plan for me.” That was not a good idea at all. The idea that it’ll just come to me is so ridiculous, and yet, a lot of not just women, a lot of men and women feel like, you know, later or something will happen that’ll help me out, or, I don’t know. That’s astounding to me that people don’t see that this is something they have to proactively do in their lives.
I think you’re hitting on this point of it not being at high school or even college is so important. It’s such a glaring error that we make in our educational system, and I know there’s a bunch of people looking to change that. The Council for Economic Education does a great job, but it’s ridiculous. We’re setting, you know, generations up for failure. And, you know, my audience for the book was a lot more women. I try to get them to realize they need to do something proactive and people are scared of, “Oh, I don’t know how to pick stocks.” You don’t have to do that. Right? But there’s this mistaken belief that you do. I think the robot advisor evolution is actually a good one because I think it makes it more, people will feel that it’s a more approachable way to start to think about building some sort of net for themselves. Just full disclosure, I’m an investor in Ellevest, which is Sallie Krawcheck’s venture to help with, not just women, anybody, but it’s focused on women start to think about how do we plan for our financial future. It’s ridiculous that we don’t.
Meb: In automated platforms, I think, for someone who’s implemented them both personally as well as for clients. I mean, it is such for the vast majority of people, such a huge improvement over what most people do on their own. And I think one of the slight behavioural nudges that it benefits, is you can kind of start to systematically include little bits that that caused people to behave better. I remember Betterment had this situation where people would go and try and change their portfolio. And then Betterment started doing a pop up that said, “Okay, you can do this, but FYI, this move will cause you to have to pay $1,500 in taxes with capital gains. Are you sure you want to do this?” And then it caused like 80% of people to abandon it.
So it’s, I think, a awesome, awesome development and I think it’s a one-way street where the world will probably never go back most of the world to kind of traditional ways of investing. But it’ll also be interesting to see if the software kind of side can really prevent people from doing dumb stuff when times get bad, you know, during the bear markets, where traditionally the hand-holding helps. Remains to be seen. we may never have a bear market again. So, I don’t know. We’ve got a little bit of time left and then we gotta, sadly, let you go onto your weekend plans. Any other favourite secrets from the book that you think are particularly pertinent or useful in sort of today’s world that you thought was really important to share when you put pen to paper?
Karen: Well, there’s the being lucky, as you said. That’s a big part of it. I think it’s all right to focus a little more on women?
Karen: Okay. So one of the things that I’ve noticed, we always have a lot of women analysts. So, I ran into a friend of mine, a hedge fund manager, and I said, “Hey, why do you have no men on your team?” And he said, “The reason is, I have a limited amount of capital to deploy. And when a man comes in to pitch an idea, he talks about how much money we can make. And when a woman comes in to pitch an idea, she starts with all of the things that could go wrong.” And he said, “So, I’m kind of a sucker for the upside. So what do I need the women for?” And I thought that was very interesting because I know what he’s talking about. Women like to present an idea, say all the things that could go wrong, to a sort of a risk assessment. But also, it’s somewhat laying risk onto the portfolio manager, because there’s the thinking, “All right. If I told him,” It’s usually a him, “If I told him all the risks beforehand, then if something goes wrong, you know, it’s not all on me, or it’s on him.” And I think women view that as minimizing their risk in the workplace and it’s not. It’s the opposite. You know, if you want to advance, you got to put yourself out there. You’ve got to take some risks, and not pounding the table on ideas is taking some risks, because you’re not going to advance. You’re not going to get your position on the sheets. And, you know, if you don’t have that, then it’s hard to say what your value is to an organisation.
Meb: This is probably why most of the academic literature shows that women are better portfolio managers than men. Because they’re much more reasonable on the analyst side. But, it’s funny. You know, you see this in the investment advisory community too where we’ll talk to individual investors and I say, “Look, man. You need to have low expectations right now in the cycle of 5%, you know, U.S. stocks I think are low single digits.” But the challenges is, a lot of investors simply will just go around a five advisors and find the one that promises them 20% returns because it’s them telling them what they want to hear too. So, there’s a couple of challenges on that. You know, we spent a lot of time, we’ve mentioned this a few times on the podcast, and from someone who’s probably, I don’t know, 95% of followers are male.
I had a Tweet a few months ago where I said, “You know, I spend half the time being pretty bummed out about that fact that there’s a lack of women in the investment and particularly finance world.” And then I said, “I spend the other time I have waffling and saying, you know, what? Good. Maybe they’re doing something more interesting in science or something else.” I don’t know. I have a hard time with that.” And particularly in the quant side, it’s probably even less, but I don’t have any good solutions. Karen, it’s already an hour. I would love to talk to you for two more, wind down with a question or two. Looking back on your career, what has been the most memorable investment or trade you’ve ever made? And this could be good, it could be bad, it could be seared painfully into your memory, it could be a very positive, thoughtful, wonderful memory. Anything come to mind?
Karen: Well, certainly on the downside, and on the upside as well. But so on the downside, way back in the day, United Airlines was going to go private in an LBO, which is in hindsight, not a very good idea for an airline with big capital needs to go private. So, we have a deal, 300 bucks a share. I thought a one by two put spread was really interesting way to hedge this. Without needing to go into the, you know, walking us of a 1X2 put spread, the point of it is, we paid two two and a half bucks to put the spread on, the deal broke and we paid $80 to get out of that trade. That trade is so bad. The idea that we could have…if it worked out, we were going to make 10 times their money, maybe about eight times the money. And if and it didn’t work out, which I didn’t factor in this scenario at all of it collapsing and the stock collapsing, and the market collapsing, that we would need to pay 35 times our money to get out. That’s a lesson you hopefully only need to learn once about understand…first, making sure you know what the risk-reward is, and being in an asymmetric trade, you’ve gotta find asymmetric trades that go the other way where the risks is very minimal and reward is quite compelling. That was so bad. I will never forget that trade. I hope it’s the worst trade I ever make. I hope I don’t come up with something worse in the future. But that was a really important trade about understanding downside, which has also led to my not really being a short-seller. Because that, you know, infinite risk is really hard to price in.
Meb: You haven’t flown United Airlines since.
Karen: I mean, that was terrible, terrible. And then one of the upside, we did find a company that we thought was a great little company. It was called National Convenience Stores, and it was a chain of gas stations and mini-marts,
you know, together where you can get your gas and go buy candy bars and whatever. And they had just renovated all of their locations and they had extraordinary locations because they build [SP] them from way back. And this is the smallish cap company and we thought, “Wow. This absolutely is way too cheap. This should be sold to somebody else. Somebody big. It would be…” we traded a huge multiple premium rather to where it was trading right then. And we decided we were going to launch a proxy fund. And so, we sent a letter into the board, and the very same day, not coincidentally because we had met with them before this, Diamond Shamrock put in their own slate. And it was a very heated auction, and the company went from nine, I think it ended up being sold for 27 or 28, and we earned a lot of options and a lot of stock, and that was a really great one because it was a really good business with not a lot of downside at all. They had just spent a lot of money to upgrade. We thought on its own, this is a great investment. And then on top of it, the idea that it can be taken out, or maybe we could even help with that was really one of our most successful investments ever.
Meb: I love it. Well, people, you know, it’s funny, they always think of black swans being negative, but there’s times when everything seems to just line up in your favour when you get positive surprises too. And that’s…
Karen: May I tell you one other quick black swan?
Meb: Yes. Have at it. Yes,. Let’s hear it.
Karen: Okay. So, we were in this goller [SP] which is it changed it’s sort of business a couple of times. But way back, they were just transporting liquid natural gas on carriers, and the business was growing nicely and we thought it was attractive. And then, this is a black swan. We did not see it at all. Fukushima happened, and Japan, very quickly switched to natural gas, And the way shipping business works, your costs really don’t change a lot. But day rates as they move up, and you have a levered asset like a ship, and daily rates move up sharply. You’re going to have a windfall like you can’t believe. And so, that was a very sad black swan for Japan, of course. But as an investment, it was a black swan we didn’t anticipate from anywhere. And it happens sometimes.
Meb: Yeah, That’s one of the big key lessons. I mean, I learned it in my first blowup trade where a lot of people think they think about all the different outcomes, you know, and then discount them or whatnot. And then there are certain ones that, of course, you’d never even think about that happen all the time. You know, like things like this is certainly a possibility for both good and bad. I love it. That’s great. Karen, this has been so much fun. Where can people track you if they want to follow all your goings on? What’s the best places?
Karen: Probably CNBC. That’s the most, we talk about it on Fast Money, which is…I’m not a Fast Money girl, but it’s fun to be on the show. Anyway, really nice to talk to you. Thank you so much for having me.
Meb: Thank you so much, Karen. We loved it. All right, listeners, we will put all the show notes, podcast, transcript as well as links to Karen’s book and everything else good we talked about today at mebfaber.com/podcast. You can find all the archives there as well as on all the great players, iTunes, Breaker, Stitcher, and Overcast. Thanks for listening, friends, and good investing.