Episode #191: Simon Hallett, Harding Loevner, “Wherever We Can, We’ve Added Something That’s Based Upon Behavioral Finance”
Guest: Simon Hallett is partner and co-CIO of Harding Loevner. Prior to joining Harding Loevner in 1991, he spent nearly a decade in Hong Kong, serving as Director and Investment Manager of Jarding Fleming Investment Management, Investment Manager at Kleinwort Benson, and as Account Executive at Dominion Securities.
Date Recorded: 10/28/19 | Run-Time: 1:11:35
Summary: Simon and Meb start off the conversation with a run-down of Simon’s firm, Harding Loevner, cover its quality growth investment approach as well as its long-term focus. Simon gives some insights into “short-termism” and what it takes and the incentives in place to keep everyone at Harding Loevner focused on long-term investing.
Simon walks through the investment framework at Harding Loevner in detail. From a high level, they care about growth, quality, and price and beyond that, Simon walks through the details and what it looks like as ideas work their way through the process.
Next, Simon and Meb get into skill vs. luck. Simon emphasizes the role process plays in skill vs. luck, and the post-investment review he and his team go through to analyze the role skill vs. luck played in the outcome of a position.
As the conversation winds down, Simon and Meb touch on behavioral finance, and Simon discusses introducing behavioral aspects to the investment process wherever they can. He mentions he think there is a behavioral edge in any market.
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Links from the Episode:
- 0:40 – Welcome to our guest, Simon Hallett
- 2:28 – An overview of Harding Loevner and their investment strategy
- 4:50 – Focus on behavioral finance and taxes
- 6:49 – Getting investors to settle in for the long term
- 9:40 – Harding Loevner investment process
- 11:16 – Sell discipline
- 12:54 – Undervaluation of opportunity costs and what’s not in the portfolio
- 17:35 – Advice for when markets are underperforming
- 20:13 – Dealing with long termism and the conversations with clients
- 22:37 – Star managers and volatility
- 24:30 – The marketing of funds
- 26:59 – Skill vs luck
- 31:01 – Harding Loevner hiring process
- 34:48 – Behavioral finance as part of the process at Harding
- 40:10 – Why people like predicting
- 43:50 – Expectations and the unexpected
- 47:28 – Power of a structured written process
- 48:48 – Shifts in the fund marketplace and what that could mean moving forward
- 52:02 – Opportunity for edge in foreign markets
- 54:51 – How analytics have made it into football
- 1:01:03 – Resources Simon loves
- 1:01:22 – Michael Mauboussin books
- 1:01:33 – Thinking, Fast and Slow (Kahneman)
- 1:01:46 – Keith Stanovich books
- 1:02:16 – Jim Ware books
- 1:02:29 – A Long Petal of the Sea (Allende)
- 1:03:15 – The Knowledge Project with Shane Parrish
- 1:03:17 – Masters in Business with Barry Ritholtz
- 1:03:19 – Invest Like the Best with Patrick O’Shaughnessey
- 1:03:23 – EconTalk podcast
- 1:04:15 – The Intelligent Investor: The Definitive Book on Value Investing. A Book of Practical Counsel (Graham)
- 1:05:11 – Most memorable investments
- 1:07:30 – Is it Time to do a Templeton? (Faber)
- 1:09:10 – Connecting with Simon: hardingloevner.com or firstname.lastname@example.org
- 1:09:35 – Any predictions for the next 10 years
Transcript of Episode 191:
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 podcast participants are solely their own opinions and do not reflect the opinion of Cambria Investment Management or its affiliates. For more information, visit cambriainvestments.com.
Meb: Hey podcast listeners, we’ve got a great show for you today. Hope everyone is fat and happy and well-rested from Thanksgiving. I know I am. Our guest is a partner and the co-CIO of Harding Loevner. Before that, he spent nearly a decade in Hong Kong as a director investment manager of Jardine Fleming, also Kleinwort Benson and Dominion Securities. In today’s episode, we get into some key aspects of Harding Loevner’s process and the great deal of care that is involved in defending against short-termism and staying highly focused on long term investing. We then dive into the influence process has on skill versus luck in investment outcomes, as well as considerations he and his team make to address behavioural biases. Stick around because we then discuss becoming an owner of a football team, introducing quantitative analytics and the similarities that are shared between running a team and an investment shop. Welcome to the show, Simon Hallett. Simon: Thanks so much, Meb. Glad to be here.
Meb: Welcome. You’re in person, which is great here in smokey California right now. You’re a Pennsylvania guy, but originally a Brit.
Simon: Originally a Brit yep, from Southwest England.
Meb: I spent some time in the UK this past year and a fair amount of time in the pubs trying to get some boots on the ground understanding of what in the world is going on with Brexit. And the more time I spent in the pub, the more confused I got.
Simon: That’s normally what happens in English pubs.
Meb: And I don’t think that anyone that’s tried to, my local friends would try to explain to me what was going on with Brexit and it got more and more confusing. As a quant, it doesn’t, of course, make any sort of input into our process, but we were at our largest fund, buying stocks as they continue to get cheaper and cheaper. It’s been interesting to watch.
Simon: It’s certainly been interesting. I wish I could say that I’m in a position to explain it to you clearly.
Meb: Well, I mean I can’t explain American politics either, so it’s perfect. They’re…politicians are gonna politic. Harding Loevner, talk to us. I don’t know if a lot of our listeners are familiar, some may be. This is a big money manager, asset manager. What’s the story?
Simon: The story is 30 years old, founded in 1989 by Dan Harding and David Loevner who had been portfolio managers at the Rockefeller family office, Rockefeller and Co in New York decided to break out on their own. I joined a year later and today actually we’re about to celebrate our 30th anniversary, which has recently passed.
Simon: Thank you. Today we manage about $65 billion across global equity. We’re essentially a long-only, bottom-up, fundamentally-driven research house having a global equity product, a non-U.S. equity product, emerging markets and then a couple of subsidiary products such as international and global small caps and a frontier emerging market product. We’re mostly institutional but we have quite a strong distribution in the United States as well.
Meb: Very cool. Old school stocks. I love talking about it. You know, as the year winds down as the decade winds down, it’s been a pretty bang-up decade for U.S. stocks depending on the domicile, probably not as good of a year for most other countries or regions. Walk us through a little bit of how things work at Harding. Are you guys a value shop or are you a growth shop or are you a what?
Simon: We think of ourselves as a quality growth shop. I recognize that that’s a label that’s fashionable these days with some good reasons, some bad reasons. But from the day we opened the firm’s doors, we’ve focused on what are core high-quality growth companies. Look very long duration growth companies, not so much the kind of tech superstars, the biotechs and so on. But to me, the classic Harding Loevner holding is Nestle, which we’ve actually owned continuously through the life of the firm for 30 years now. So it’s high quality, long duration growth, and we find those companies through doing boots on the ground research and we hold them for long periods. Our portfolio turnover is about 15% a year, so we’re really old fashioned.
Meb: It’d be fun to know what the bagger status on that is. We did a fun podcast with Chris Mayer, who wrote a fun book, kind of a culty book called ”100 Baggers.” An interesting takeaway was it’s…to really get the massive gains these 10, 100, 1,000 baggers, most of the time it takes, people were surprised, but it takes a long time. For many it takes a decade or two decades to really have the massive compound outperformance and so many investors, myself included, I feel like it’s so hard when you have a gain to wanna sell it after it’s up 100% or God forbid, 200% or 300% or 400% or 500% but so many of these just compound away.
Simon: Yeah, absolutely. But that’s one of the founding tenets of behavioural finance, isn’t it? That we become risk-averse in position of gains, and we tend to sell too early. Actually, our background is as taxable investors, obviously the Rockefeller family, but also my background in the UK back in the late ’70s. That ability to compound without having to realize capital gains was at the core of our belief that long term investing was the way to capture market inefficiencies, and it was appropriate for tax-exempt as well as taxable clients. But it really stems from the wish to defer capital gains.
Meb: Which is interesting because a lot of managers, hedge funds, active managers tend to be tax agnostic in the way they manage their portfolios with the thesis being that, hey, the clients aren’t gonna notice that much. And if they do, they’ll notice it when they file their taxes and may not even attribute it to us. But in reality, and we talk a lot about this, taxes may be the number one consideration when you look at a lot of these strategies, particularly if run in a manner that’s not tax-aware.
Simon: couldn’t agree more. I mean I think there was a very good article written about 25 years ago by Rob Arnott and Rob Jeffery called, “Is Your Alpha Big Enough to Cover your Taxes?” And just at the very crude level, I mean obviously when interest rates as low as they are now, the value of the deferral of long term gains is much less. But that cross between short-term and long term is a killer. There’s absolutely no way you’re gonna generate enough alpha to cover short-term taxable gains. So tax awareness is very, very important. At root, I think, you know, having a holding period that’s longer than 12 months is at least one way of helping to minimize taxes, though obviously, you can manage them more precisely than that.
Meb: It’s so easy to talk about a long term approach and so hard for people to actually do it. And I struggle with this a lot and try to design it in, but particularly for the individuals and the advisors out there that operate on timeframes of months and quarters. I mean a year is an eternity. It’s a struggle. I don’t know if you have any thoughts about it or ways to correlate the two and align them?
Simon: Well, I think the way we align it is making sure that our clients know that we’re long term investors. That short-term performance is driven by luck, not skill. And we have a whole series of little wrinkles in the investment process that I think makes us focus on the long term rather than short-term, including obviously, how we compensate our people. Our people need being paid every year so they get annual bonuses, but most of our people are partners in the firm, the senior investment professionals are partners in the firm where quite clearly as a long-only, equity-only shop, the long term results for the partners is gonna be very, very closely aligned with that of the clients. At the more trivial level, we don’t keep Bloomberg machines around the office. We have two.
Meb: That’s as many as we have. I’m gonna give our guys a hard time and say, “We gotta get rid of one of these.”
Simon: I would, we have them in…
Meb: I don’t even have one. I have a login, I think. So listeners, if you’ve been emailing my Bloomberg address, I should log in cause it’s got probably a decade of unread mail. Simon: Right. But I don’t…I’m not even sure that we have individual logins, but we just try to defend our people against short-termism. But the trouble is that this industry is one where a lot of the incentives are about transactional activity and very few incentives to just to be long term holders. The most sensible comment I ever saw about this was actually from one of my colleagues who was at a trustee’s meeting of an endowment, which we’ve acted for a number of years. And he was talking about Nestle and how we’ve owned it for 30 years and the trustee said, ”Why the hell should I pay you guys X basis points a year to own Nestle the whole time?” And his answer, my colleague’s answer was ”Because you wouldn’t have done.” And of course, Nestle has compounded, if you tax the dividends, the reinvestment’s compounded overall long term periods at about 12%. So that ability to withstand the call to action from market commentators and so on I think is a very, very powerful one. And you can really only build that I think over time. As you say, it’s very, very difficult to defend against it. I think Warren Buffett or Charlie Monger always say it’s like baseball except you get as many strikes as you like. The trouble is everybody in the bleachers is yelling swing you bastard, swing. So we make sure that our people know that we’re in this for the long term, that we don’t like to see specific trading and so. And then we defend ourselves by not having CNBC on in the office.
Meb: Well that’s the one I can align with. We have a TV but it usually only comes on during sports. Talk to me a little bit about y’alls process. So all right, it’s growth and it’s quality. What’s the kind of investment framework? How do you guys go about putting together portfolios?
Simon: It’s very standard. We care about growth, we care about quality and we do care about price. So over the life of the firm, we’ve been described as growth, as value, as GARP. Today we’re, I think pretty clearly what’s become known as quality growth managers. But we do pay attention to price. So it’s a very standard kind of process. I think what’s more interesting about it is the details rather than the actual structure. But it’s a very standard structure. You know, we start off with a universe, we define that universe pretty objectively and it’s… life at Harding Loevner has got a bit more systematic, if you like, over the last 30 years as you can imagine. So we have quantitative metrics for identifying quality companies. We bring them into our research universe, we do the research, we do valuation work. The portfolio managers are then essentially given a list of qualified companies that have been researched and valued. And from that, they build relatively concentrated portfolios. So we have portfolios mostly between 60 and 80 names, but it’s very much a standard qualified, do the research value-buy, and then control for risk. We use a pretty standard multifactor risk model to identify risks. But in most of our portfolios, most of our traditional portfolios anyway, the strategies that we’ve run for 30 years or so, risk control is a kind of post-hoc part of the process after the bottom-up portfolio construction.
Meb: As you guys establish positions, and this is a very, as you mentioned, traditional sort of value-added research process, what’s the sell discipline or how do you think about the portfolio as a whole? Two different questions, kind of.
Simon: Two different questions. Yeah. Yeah. When we think about the portfolio as a whole, we have kind of two levels of risk controls. One is a series of parameters that the portfolio managers absolutely have to stick by, which would control for position size, control for geographical sector and industrial limits. And then the second level of risk controls, which we’ve been looking at more closely over the last 10 or 12 years, has been using a multifactor risk model. Mainly, as I say, with a view to making sure that we’re not taking on unintended risks. We can now identify better where we’re overexposed to momentum, which is not part of the investment process where we’re short Asian value for example. And actually would be quite a good example that over the last couple of years from time to time the risk models have told us that we’re massively short Asian value. So we would then go to the portfolio managers and say, “You know, you’re short Asian value.” They would come back and say, “That’s because we don’t own Chinese banks. We think they’re not very good quality. They don’t meet our criteria.” But in the past, we’ve actually sent our bank analyst off to China just to go and reconfirm that. So we’re getting more sophisticated in our use of risk models. Portfolio managers now will have available dashboards that show the impact on the risk model and the forecast of the risk model before they make any transactions.
Meb: Well, you know, it’s interesting because you have a quote here which I’ll read. I think this is you. It’s from a letter to shareholders, so it may not be you, but it sounds like something you might say.
Simon: Probably me.
Meb: It says, ”The management of risk is central to the practice of portfolio management. Success requires understanding its sources. What you don’t know can hurt you. Embracing it, investors are ultimately paid for taking risk and controlling it to remain within desired boundaries.” Is that you, by the way, maybe?
Simon: Maybe. Definitely maybe.
Meb: The part I think is interesting, you mentioned what you don’t know can hurt you, as a part of that risk management process is that, if you were to ask the vast majority, I think of even professionals, what the essential output of that takeaway was, people would say, oh, I built my portfolio and here it is. And you say, well, do you know X, Y, Z, most people would not know any of those things. They may have a feeling about it, but specifically, and at least say, hey, you don’t have to… The example I give, because we talk a lot to, the listeners by the way go crazy because I’ve mentioned this a million times, but we talk a lot for example, about U.S. investors versus the global market portfolio, U.S. investors typically allocate 80% to the U.S., when out of the percentage of the world it’s only half, and I say look, you don’t have to change it. You can continue to put in 80 if you want, but you should be aware that you’re making a big active bet and almost no one is. So I think this is a really interesting, as you drill down into specific themes and exposures, at least to let people be aware of it.
Simon: Absolutely. I completely agree. I think that this is actually associated with the undervaluation of opportunity costs. There’s that old Wall Street saying that what you don’t own can’t hurt you, but it can. Like it or not, we are in a world where we get measured relative to benchmarks. I happen not to object to it. Actually, I think it’s a perfectly reasonable way of seeing if people are doing a good job. And if you don’t own something that’s big in the benchmark and meets your criteria, then it costs you, it costs your clients. So what you don’t know can hurt you very deeply. The trouble is that people underestimate opportunity costs. Pretty well-established I think.
Meb: The key is just picking a really easy benchmark
Simon: That always helps. I know you’re only joking, but benchmarks are always easy to beat with hindsight. When we started the firm in 1989, the non-U.S. equity index was dominated by Japanese equity and Japanese stock markets were dominated by Japanese banks trading at 10, 12 times book. With hindsight that made the MSCI ACWI ex US easy to beat, but you had to take the active decision not to own Japanese banks and that wasn’t always an easy decision to take.
Meb: Much like late ’90s not owning tech. You know that vacuum hoovered a ton of people in because of this benchmark situation where if you didn’t own them, I mean I think the classic example is Buffet underperformed the NASDAQ in one year by like 150 percentage points, not basis points, 150 percentage points in, like, one year, a lot of people can’t handle that pain.
Simon: Correct. So again, I think that comes back to building firms and cultures that can withstand pain. Whenever we have one of our town hall meetings, we try to remind people that the assets under management at Harding Loevner have fallen in half three times in the life of the firm, in a very short period of time. So you have to build a firm that can last that kind of volatility. I mean, sometimes it’s the market, sometimes it’s our own errors and sometimes it’s we’re out of fashion
Meb: Or boneheaded investors. I mean that’s one of the hardest parts even as a large shop. We see it across every big shop. We just had on the podcast Ben Inker from GMO, where they very famously talk about the pain of the late ’90s and 2000s and assets going down a bunch. And the struggle for us being a public fund manager is there’s not a whole lot you can do about it. You can try to educate people, but at the end of the day, it’s their choice. So I say here as always, that’s the agony and ecstasy of being a public fund manager. Don’t get too excited on the way up as assets are coming in and don’t get too despondent when it’s washing out, because it will.
Simon: Absolutely. As long as you have confidence in your process and you think that your style can add value over long periods of time, but you have to be able to build a firm that can withstand the volatility and you have to have people who are prepared to withstand the volatility. You know, we’ve gone through periods of being out of fashion. Actually, I remember one of our marketing people saying, basically criticizing and saying, you’re sticking to your guns too long. The world’s changed. And actually said to me, ”Would you rather be rich or right?” And I said, ”I’m sorry, I’d rather be right.” But it can be expensive sometimes.
Meb: For someone who’s been around and has kind of been through three cycles where assets went down, do you have any advice or tips for the firms out there that either if you’re about five different styles right now, you’re struggling. Or if almost anything relative to the U.S. market cap at this point, you’ve probably unperformed in some fashion. If you’re a financial advisor doing a client review at the end of the year in 2019 and you have, I don’t know, emerging markets, God forbid you still have commodities at this point, really foreign or a number of things other than U.S. or real estate clients are probably saying, why do we own this? From the firm building standpoint, from the management of the culture and the people, because it’s easy to say, yeah, let’s have a long term view. How do you kind of build a structure that makes this any easier, if that’s possible?
Simon: I think equity ownership is a very important part of it. Hiring the right people, hiring people who share your vision about the long term. It’s pretty easy to know whether people wanna take a short-term view on stocks and so on, but we’ve always taken a long term view about everything. Most obviously, you see it in the portfolio turnover, but we’ve taken a long term view about how we manage the business, how we manage the firm. We sold a stake to AMG. We’re an affiliate of Affiliated Managers Groups as of 2008, so we’re now 11 years into it. We’re having our first retirement this year. So the reason we did that was to think about succession 65 next year. David Levin is a little bit older. When we first started, we hired our friends. I think that actually may be a quick answer and it caused problems to some extent. We hired our friends in the early days because we trusted them. We knew that they had the same kind of standards of integrity and so on that we had, that they shared the same kind of vision about doing fundamental research, creating portfolios from the bottom up and so on. And of course, we then realized by the end of the ’90s that we were all the same. And of course, that’s a terrible, terrible culture for good decision making by groups. So we’ve hired carefully and we already had that foundation of people who shared that common vision. But I’m not gonna tell you, you can’t do it in the short-term. I mean, it takes time and it takes surviving. Survival is the main thing and that means being financially cautious the whole time. So, you know, we know where our breakeven is and it’s, essentially we’re fine if our assets under management fell in half.
Meb: We say often the biggest compliment you can give a company in our space managers survive because it’s particularly this cycle for the hedge fund world has been an absolute graveyard. I mean, just one after another after another. Talk to me a little bit about if you have any thoughts on dealing with long term-ism and having these discussions with clients. So whether it’s institutions or advisors or whomever it may be, even when you’re talking to them in the beginning or when you’re going through underperforming periods, any strategies, thoughts, suggestions on how to deal with them?
Simon: I don’t think I’ve got any.
Meb: Or how to pick them, if you can?
Simon: Yeah, I don’t think…no, it’s an interesting thing. Look, our track record is very good. Our short-term performance is good. Our medium-term, long term is all good, so it gets relatively easy. But we still lose a very significant portion of our assets at the gross level every year. Turnover amongst clients, even for a firm like us, which I think has a reasonably strong brand, we’re known for being long term in approach. We’re known for doing what we do thoughtfully and very, very consistently and for being very process-oriented. So if anybody is gonna keep assets, I thought it would be us and we don’t manage to do it. So heaven forfend, I should give other people advice about it. But you know, we keep trying, but it’s very, very difficult when you’re facing an industry that is yelling at you the whole time act, act, act. And when we all have biases towards action, it’s one of my biggest hobby horses. So I’ve been in this industry 40 years and started off after a brief sojourner at a bank managing money or assisting somebody managing money for private clients in London in the late ’70s. So it’s been a fantastic 40 years to be a long term investor. It’s been a fantastic 40 years to be an investment manager, but I’m not so sure that it’s been a great 40 years for the clients. And I think our industry has done a poor job of educating people about the benefits of long term investing, about the benefits of compounding reasonable returns over very long periods of time because the industry is driven by transactional commissions, some fees, the incentives are all wrong. And I think one of the things that I’m proudest of is that we have stuck to our guns and for those clients that have been with us for a long time, they’ve had very good returns. But to be honest, our time-weighted and our dollar-weighted returns are a little bit better than the industry’s, but not a great deal.
Meb: It’s tough to watch where you see a lot of these behavioural gap. The Morning Star talks a lot about it on the spreads, particularly with the volatile fund managers that often become star managers that do really well and good some periods and terrible in others and you see just the money wash in and washout and it’s always just such a bad job of the timing.
Simon: Well, that behaviour gap I look upon as the failure of the industry that I’m talking about. I find it shameful that the industry has encouraged…by the industry, I mean the whole of the financial services industry, not just investment management. The role of the star system, which is particularly prevalent in Europe is something that I think is probably on the wane. I don’t know if you followed what’s happened with a guy called Woodford in the UK.
Meb: Tell our listeners.
Simon: Yeah, so this was a person who was a star fund manager for 25 years at a big investment management house, created a big name for himself. The firm that he worked at publicized his name and used him as a magnet for drawing assets. He set up on his own, very quickly raised, I think it was something like $15 billion. Has subsequently underperformed, he suffered like many stars from the rush of blood to the head where he thought that his skills in one domain could be transferred to others. And as soon as performance turned and he was having a tough time, there was a run on his funds. He’s been fired. He’s now in disgrace and so on. But again, I look upon that as partly, I mean he’s a human, so it’s partly his fault, but also the institutional setup that encourages funds to be attracted to so-called superstars is, I think, very dangerous. And I think it’s fair to say that at Harding Loevner we’ve done a good job there. We actually have co-leads on all our strategies. And I don’t think anybody in the marketplace, unless they were a consultant or so on, could name them.
Meb: It’s a weird setup because I mean, look, we have no salespeople, so I can’t talk. But the challenge with you talk to every fund management company, it’s easy for the marketing people to sell what’s working and doing well and they can’t sell the stuff that’s doing poorly. And as we often know, many times the strategies and asset classes go in and out of favour. And so I often tell people that we have one fund that’s just been absolutely atrocious. But as far as strategy and everything else, like, going forward, I think it’s, probably be one of my favourites. But trying to have that conversation with any end investor, it’s just, you know, it’s like they don’t wanna hear it. And so it’s a challenge on the education, but also on the management side for advisors because of their career risk. And that’s where it gets tough because they have to deal with it too. And it’s just at least here in the U.S. I think there’s such a educational gap on investment knowledge, it makes it really almost like an unwinnable situation.
Simon: It certainly seems to be unwinnable. Again, we communicate with our clients. We think, well, we constantly emphasize the long term, but as I say, the impact on client behaviour is not quite what we would have hoped for, let’s say. I should just say that it’s not just in the U.S. It’s our client base is a global one, about two-thirds of our assets under management are from U.S. high net worth and institutional. But outside the U.S. about a third of our AUM is entirely institutional and we have the same kind of short-term performance chasing issues with a lot of them. Not all, but I think there’s a general myth that the retail clients are the short-term trend chasers and the institutions are much more sensible in long term. And frankly, that’s not been entirely our experience. Obviously, there are some exceptions, but we’re all human. You know, humans are herd followers. People like to extrapolate from the past. People overestimate the role of skill and underestimate the role of luck. And I think all this leads to people chasing what’s recently been hot. It’s a huge problem.
Meb: Yeah. We used to talk a lot about, I wish there could be ability to lock people up. Back in the day in the U.S., we used to have pension funds, which you don’t see as much anymore. And so, I almost wish that that would be an option to say, no, no, you’re locked in for 5, 10, 20 years, whatever it may be. But talk to me a little bit about skill versus luck. This is something that’s of particular interest. Maybe we talk about how you guys think about it, how you talk to clients about it. Certainly, I’ve experienced it personally, with our firm and management styles on a couple occasions being very fortuitous in that. Any general thoughts?
Simon: I have to credit Michael Mauboussin, who I think has probably had as much influence on our firm as any individual with the possible exception of Danny Kahneman and I always wanna be careful to acknowledge the role that Michael’s had. We’ve met a couple of times. He’s a friend of one of my partners. And I always say I found it astonishing that you can buy the collected wisdom of Michael Mauboussin with specific advice on how to run an effective investment process for the sum total of about 50 bucks on your Kindle. Best value out there I think. Unusually, we’ve actually done something about it. So the whole of our investment process is about process rather than short-term outcomes, you know, so we don’t, when people have left us, nobody’s ever left because of bad analytic results. People have left because of not wanting to stick to our investment process. So people know that we’re process-oriented. We know that short-term results are driven by a mixture of luck and skill, but we think it’s that process that in the long term adds the value rather than individual skill. So we keep data, we’re old fashioned discretionary managers. We were in the past, but there’s absolutely no doubt that over the years we’ve become more systematic, if I can…I think I may be stealing from you or Michael Mauboussin this time as well. There’s the kind of quantitative versus fundamental, and I kind of prefer to think about it as systematic versus discretionary, where a discretionary manager is somebody who has a great intuition, goes out and buys the stock, and a purely systematic one is somebody more like you who, I’ve heard you say you don’t even know what’s in the portfolio. So that emphasis on process I think is at the root of it and you have to go through individual decisions and look at them. Every time we buy a stock, we believe that it’s going to outperform. Our analysts are incentivized to outperform their sector benchmarks. They’re organized by sector. Portfolio managers are incentivized to outperform the global equity benchmarks or the appropriate one for their strategy. But you cannot look at individual outcomes. This is what Annie Duke, I think, calls resulting. So we will go through and examine good outcomes and bad outcomes and seeing whether they were the result of skill or luck. Quite often when, and our analysts write very structured, but really fairly traditional company analyses outlining the investment thesis. But the company could, a company’s stock could outperform for a completely different reason, luck, or it could be that we’ve got everything about our insight correct, and were duly rewarded with a good result, which would be skill, same when things don’t work out. So we now know that…I think we’ve, I’m not entirely exaggerating, but over most time periods, over every year for the time we’ve kept data, which is nearly 20 years, our analysts in aggregate have outperformed, on average our annual outperformance, no cost involved, so this is not a very sophisticated measure, is about 400 basis points. So something is working. I mean over this period the piece to understand about the dangers of P-mining or P-stat mining, whatever it’s called. But we have had results from the investment process that have been consistent across time and consistent across people. So we’re either really, really good at hiring or we are very, very good at taking, you know, hardworking, sensible, intelligent people and fitting them into a process that helps to add value. And I know how we hire and it says chaos seekers, anybody else?
Meb: What’s the process? Give me some hints.
Simon: Look, you can hire… Actually, something that’s on my mind. I’ve got a couple of ideas about how we can make it better. I think the biggest problem, I was just re-reading some of that Keith Stanovich work on rationality versus intelligence. What’s quite clear is that good investing is about the rationality question, not IQ. People who want a job because they’re smart and hardworking, I mean it’s table money. So finding some way of testing, decision-making abilities I think would be a good thing to be able to do at the hiring stage. But no, I think the only thing we do that is a little bit different is that we have a system whereby people interview independently, a candidate. A candidate comes in, he’ll have 10 meetings with interviewers, each of whom has to give their hire or no hire decision immediately afterwards, and we keep data on how that works, but it doesn’t show any particularly meaningful patterns. What we don’t want is people being biased by each other’s… So independent decision making and then CIOs make their own minds up. But no, we don’t have any particular skills in hiring, I don’t think. But I think the evidence is certainly it’s statistically significant that we can take people who are reasonably well qualified and turn them into effective analysts.
Meb: Putting them in the right structure.
Simon: Put them in the right structure.
Meb: Give them the right tools.
Simon: Very structured. Yeah, and maybe that’s something that I haven’t emphasized enough when I talked about our investment process. It is very, very structured. So it’s that standard for stage, but everything that we can make consistent, we do. So we don’t argue about discount rates. I don’t know whether the equity risk premium is zero or 800 basis points. In the last 20 years, I’ve heard it described as zero and 800 basis points. So I’m not gonna pretend I know what it is, so let’s not argue about it. Let’s just make it consistent. We have certain ways of adjusting for different regions and industries and individual companies. But essentially, it’s laid down. The things that we’re looking for in a company are laid down. The things that the portfolio managers are allowed to do are highly constricted. Our senior portfolio managers are early to mid-60s, they’ve been very successful, they’ve made a lot of money, they have high status in the firm, they’re kind of wise men of the industry now and mostly men. Yet they’re not allowed to buy stocks that haven’t gone through the investment process. They’d be fired the next day. So they don’t, I call this kind of bounded autonomy. And it’s one of the interesting things, I think as you move across that spectrum from discretionary to systematic, that you’re essentially curtailing people’s freedom. And that makes it really, really difficult in an industry that values stars, it kind of values gut feel and intuition. Maybe the biggest management challenge is saying to people, you can’t do that, because they will always think they know better. So I think that that, curtailing freedom, making pre-commitments, writing them down and holding people.
Meb: But I feel like it helps too because it gives you some sort of framework and expectations. Otherwise, it’s kind of like a wild West of, it’s like a kid who has no boundaries. If you’re a parent and most children want to have some structure. Otherwise, they have so much uncertainty about what they should… They don’t know what they should be doing.
Simon: How many children you have, Meb?
Meb: I got a 2-year-old.
Simon: Yeah, yeah, trust me, he won’t want, he’s not gonna tell you he wants structure. And it’s the same with investment professionals. You know, they always want a little bit more freedom to do, and look, rationally they could step back and say, yes, I want to shackle myself to a certain style, to certain objective criteria and so on. But when it comes down to it, they tend to resist it. It’s been a big managerial challenge.
Meb: We talked a little bit about, before we got started, this concept of behavioural finance, which can mean a lot of different things and I think you said you’ve been practising and studying it for a long time before it was even called this. What are your in general thoughts on that as far as a part of the process or how you guys think about it at Harding?
Simon: Well, my general thought is, I’m not sure if I was saying it earlier in the podcast or before we began recording, but my general thought is that this is all known knowledge. It’s all out there in the public domain. It’s part of the CFA Institute syllabus. And yet very few people put it into practice. And I think that’s partly because people don’t want their freedoms curtailed. So you see it in other domains as well. Michael Lewis wrote about this in ”Moneyball” that people knew that there were objective measures of what made a good hitter but preferred to go with intuition and gut feel. I find it, I’m involved in a football team, soccer team, in England and trying to introduce quantitative analytics there is also a struggle because people think they know better. So what we’ve done is really around the edges of the investment process. Wherever we can, we’ve added something that’s based upon behavioural finance or the work of the kind of practitioners or behavioural finance. I’m talking about people like Michael McPherson. I mentioned opportunity costs earlier. One thing that we’ve introduced in the last 15 years that we didn’t do before was show people the opportunity costs of the stocks they cover. So analysts get to cover whatever it is, 20 to 30 companies, but every week we produce a chart showing them how the companies they don’t cover stack up on quality and growth statistics. So in their face the whole time is the opportunity cost of what they’ve chosen to cover. The other end of the investment process when it comes to portfolio construction, we’ve taken the advice of some of the cognitive people and we’ve dis-aggregated, we dis-aggregate the portfolios, they’re given independently two portfolio managers who act independently, don’t have to agree, and then we just mash their portfolios together to provide the model that’s delivered to clients. The reason why we only have two Bloomberg machines is based upon the observations of Taleb back in “Fooled by Randomness,” which is in turn based upon the Kahneman-Tversky work that the utility curve is kinked around zero and we suffer losses more than we suffer gains. If you look at prices every day, it’s roughly 50/50 that they’re up or down. If they’re down, you feel pain. If they’re up, you feel joy, but the pain outweighs the joy. And if you look at prices all day you’ll become too risk-averse. So, you know, the appropriate period for looking at stock prices is probably about a year. And again, one of the challenges of the last 10 years as the internet has become more widely available at the desktop and on people’s phones is stopping them looking at stock prices. So we have health warnings actually by our Bloomberg terminal that say looking at prices too much will make you too risk-averse.
Meb: It’s hard. It’s hard not to look and it’s hard not to get too caught up in some of these things and putting it into perspective when so much of the world around us is going crazy about everything, about every single day. And it’s funny you look back at what happened to Montres. I can’t even name half the events that happened this year probably even last week. It feels like last year. It’s so constant.
Simon: Yeah. The world has always had a lot going on in it. It’s just that we’re much more aware of it now and it’s pushed to us more and I think that that’s part of the discipline of being a bottom-up investor that you have absolutely to step back from that kind of stuff. We talk about this a lot internally. You know, you have to be able to say, I don’t know and I have to give permission to anybody at Harding Loevner who’s asked about what they think about the dollar, what they think about the market. They are absolutely permitted to say they don’t know. And if they wanna give a view, they should put it with health warnings. You know, my forecasts are just as bad as everybody else’s. So we try not to do any forecasts that we don’t have expertise in. Now, we’re experienced investment people. We’ve been around the world a long time. We read a lot obviously, so we can’t stop ourselves having views. But when we tell them to people, we make sure that they know that they’re only views, and you know as I sometimes say, that our views of macro events are free and that’s the appropriate price.
Meb: Well, I like to say, people always love to talk about it and I say, look, my preface is what I’m about to say has no impact whatsoever on what we do. But I will gossip all night if you want about this, that and the other. But just FYI, it’s got no impact on our portfolio design.
Simon: Absolutely. So we have to be disciplined about not letting it impact the portfolio. Now, when you’re talking, I think Barry Ritholtz actually has a good structure for this. I forget exactly what he says, but you know, if somebody asks him, what do you think the dollar is gonna do? His response would be, well, if I give you my view on your dollar, on the dollar, are you gonna do anything about it? Do you know what my track record on forecasting the dollar is? So, you know, this is edutainment, punditry, we see it in many domains, but it’s so prevalent in this industry and should not be.
Meb: Well, there’s something wrapped up in, and I’m trying to remember who said this and I’m blanking on it. But they said the reason people like making predictions so much because good God, that’s all people wanna do all day on Twitter and on TV is make forecasts and predictions despite the horrific track record in general of predicting the future. They said people love doing it because one, they like to be right. So that just checks that box. But then being able to go back in time and say, see, I told you so, it’s like being right squared. I mean, do you see, I was right twice? Not only was I right about the event, but I told you back then, that’s how smart I am. I predicted the future.
Simon: Right, but people never tell you the predictions that didn’t come about. I mean, the fact that people like predicting, I never quite thought of it like this, but there’s a reason why we’re so addicted to gambling, which is essentially a prediction the whole time that… where the results get reinforced by cash payments. Everybody knows rationally that those cash payments net out as negative. Yet gambling is still incredibly popular.
Meb: If you asked every sports gambler you know, and say be honest friend, how much money do you think you’ve lost gambling on sports in your life? I mean, almost to a T, all of them would say, oh, I think I probably break even. Almost every single one I know, I’m very honest, I say, I’m sure my expected return is, like, not even just the VIG. I’m like minus 20 on every bet, 20% it’s so bad. At least I’m honest about it. That’s why I bet $5 per bet. But.
Simon: What’s the pleasure you get out of the bet?
Meb: Oh, a lot. Way more than that. I just like irrationally cheering for the Denver Broncos who are 2 and, by the time this publishes probably 2 and 10, but 2 and 6 this year. I think that, and we could spend a whole, the rest of the podcast on behavioural biases in sports, but I think that part of the behavioural challenges with investing is it takes the worst of those behavioural emotions, very similar to sports betting and plays out where a lot of people, I think they just want something to cheer for, which is why they have such a binary view on so many securities or allocations and going back to the happy hour discussions and gossip say, what do you think about stocks right now? Because they either wanna be in and cheer for them and go out or out hope they crash, go down. There’s no in-between and so there’s no halvsies in that world.
Simon: Again, the interesting thing about behavioural finance in some ways, as I say, it’s interesting to me that very few people have adopted the findings into their investment processes as we have tried to. We could still make a lot more progress. But if you don’t adopt them into the process you are gonna be victim to those biases. Just hear Danny Kahneman talk about his own biases and how difficult he finds it. I was just listening to him the other day actually. He was being interviewed I think on the Farnam Street podcast. Do you mind me mentioning? Can I mention the opposition?
Meb: Yeah. Shane’s great. No, we’re all pod buds.
Simon: Good. And he was saying that he was a consultant and he gave various pieces of advice to these companies that ask the world’s greatest living psychologist in for advice and nobody ever took any notice of him and he appeared completely unsurprised by that. So funny enough in that podcast he was talking about something that we will, he was talking again about pre-mortems, which is something that Michael Mauboussin’s always asked and we actually will be introducing those much more formally into our investment process. We can still learn, but you’ve gotta do something about it. You’ve gotta put those shackles on and people don’t like it.
Meb: We talk a lot about try to, at least with clients about expectations, and we very often we’ll be tied to the client that says, “Meb, I bought your fund, and the last three months. I bought it three months ago and it’s not doing well,” and I say, “You think that’s bad? You should see what can really happen,” and almost always they’re surprised by that statement and I’ll say, “Well, look, this is what’s happened in the past, this is how bad it can get. So we’re nowhere even close to that. And to be clear, at some point it will probably be worse than what’s the worst we’ve seen in the past.” And we always joke, you don’t see many client letters, which is like, it’s okay clients…they always say it’s okay, we’ve seen this before. You never see the ones, it’s okay, we’ve never seen this before. And by definition that’s gonna happen at some point.
Simon: I think that’s right. But it’s also the case that people claim they want diversification, but they never look at the whole portfolio. I think that’s actually one thing that I know my own personal finances, which are mostly the kind of typical investment manager mess. But the one thing I’ve been good at is looking at the whole portfolio and not caring about the individual holdings. I think that’s a very, very important thing that people could do. Clients always come and focus on the worst name in the 50 or 60 stock portfolio, and they kind of assume that somehow that was the result of your stupidity whereas, the great performing ones were the results of your skill. The old joke there are two kinds of fund managers, there’s the skilful and the unlucky. It’s an extraordinary thing, but paying attention to the whole is absolutely critical. And again, that’s something that I think we’ve been quite good at. We get about 53% of our decisions, right, and we’ve got this long term track record by being wrong.
Meb: That’s great because that’s…so many investors, and we talk about this in the trend-following world, expect that that’s the big, I feel like a lot of rookie investors, early investors think that’s the stat they would most care about is percentage being right when reality it’s you wanna be really right when you’re right.
Meb: And the Nestles will outweigh all the ones where you may have just been marginally wrong or only slightly right or…
Simon: Yeah, no. You can clearly build a good track record, about it being right much, much less than 50% as long as your position, size, and the magnitudes are working in your favour. No question.
Meb: I feel like so much of the challenge on the behavioural side is how people frame their investments. Where you see at least I think theoretically a lot of investors behave better in target-date funds where it’s somewhat automated or they view it as almost like retirement or pension. That’s when they start to segment a lot of the investments, that is a problem.
Simon: Exactly, exactly. So I think you think about the whole portfolio and then you pre-commit. Those pre-commitments are extraordinarily powerful. So savings, I happen not to like target-date retirement funds. Last time I looked at them they had crazy amounts of equity for relatively old people
Meb: But everyone’s gonna live to 120 now. So what you think is old is really not that old.
Simon: That is true. Yeah. I wish. But I think, look at the whole portfolio pre-commitments that you can’t get out of are very, very important. You actually asked a bit about our sell-discipline and I didn’t answer because I answered the first question. Part of our sell discipline is that we build in what we call milestones into the investment thesis, which basically say these are the circumstances under which I will at least strongly consider selling the company and there’ll be various targets that we think are reflective of the undiscounted insight that we’re trying to generate. It’s all too easy for an analyst to say, my milepost for this Chinese tech company is Chinese GDP grows more than 10%. There’s no insight there. So make it something insightful.
Meb: Right. Well, and it’s easy to get sucked into that point of trying to move the goalpost once they get there. And so having what you guys have, which is a very structured-written process I think also applies to individuals with a portfolio where we say this, I think one out of 30. Maybe one out of even 50 has an actual written investing plan or call it… institutions call it a policy portfolio that kind of lays out what to do in these situations. And so very similar for you guys in stocks. You say, look, if X, Y, Z happens, we’ll reevaluate or maybe sell it. But the portfolio, so, let’s say you own a portfolio, and let’s say you own gold and it goes up 50% or down 50%, you should have written into your plan, hey, I’m just gonna rebalance once a year, and that’s that. Whatever it may be, it doesn’t have to be complicated, but what you don’t wanna be doing is have this melange of investments and shoot from the hip when…
Simon: No, I agree. Well, again, Danny Kahneman is very clear about this, that you can’t trust your intuitions. And so to me an investment process is about having judgment confined to the place as limited an area as you can and there’s absolutely no doubt, as I was saying earlier that the arc Harding Loevner in our investment process has been restricting people’s freedom as we’ve learnt more effective places in which to do so.
Meb: As the last 20, 30 years, there’s definitely been some shifts in the fun marketplace. I think particularly in this cycle. You’ve seen a lot in the media about the death star Vanguard, just blowing up a lot of traditional businesses. How do you view, if you do at all any shifting landscape or sands on kind of what’s going on in this cycle or even just the last few cycles in the asset management world as we turn our eyes to 2020 and beyond? Are there any general thoughts from y’alls perch?
Simon: I mean I think the biggest thing that’s been happening in the asset management market, investment management market over the last five years has been this active to passive debate. We’re active managers, so bias alert, but we obviously think that it is possible to be a successful active manager that although the arithmetic, Bill Sharpe arithmetic of the industry being able to…unable to outperform after fees is obviously very powerful. But it doesn’t mean that some managers can’t outperform consistently. Whether the clients can find them and stick to them is a separate and critical matter that we’ve kind of touched on. But I think what’s gonna happen is that it’s gonna get tougher. You know, this is the paradox of skill that you know Michael Mauboussin has written about again in “The Success Equation.” And I think he gave it that name, but derived the concept from Stephen Jay Gould the biologist. So the paradox of skill says that as overall skill levels improve and relative skill levels converge, that outcomes will be driven increasingly by luck. Michael uses the example of baseball and why they’ll never be another Ted Williams because the variability amongst performers has decreased. I like to use the analogy of having a sprint with half a dozen clones of Usain bolt. So identical skill, not identical, but one will finish the 100 meters a hundredth of a second ahead of the other because he gets a puff of wind at the end of the race or something like that. So it’d be luck. And of course, the result of a single race will not give you any insight into the results of the next race. And I think that we’re going to face that problem with active managers that… I’ve kind of seen some commentators say that as the dumb money goes passive, that it’ll make it easier for active managers. But I don’t think that’s the case. I think that paradox of skill would suggest that if the variability amongst outcomes is going to increase then there’s gonna be more luck involved. The critical thing is that you just have to keep getting better. And again, I think one thing that I’m proud of is that we recognize that we’re not perfect and we will continue to strive to find places where you can improve. But again, it’s partly a cultural thing. We like to talk about sources of edge and we think that there is an organizational alpha that comes from your culture that enables you to withstand the pain of being an active manager, but you’ve got to keep getting better. You’ve gotta find places that you can distinguish yourself from the opposition.
Meb: This may border the gossip side of the question, so answer as you see fit. But you guys run portfolios with mandates in all sorts of different regions, I believe, not just domestic but global and even emerging, maybe even frontier. Do you believe that there is more opportunity for edge and/or outperformance in some of those markets or regions or not? Any thoughts?
Simon: Yeah, I think that there’s opportunity for edge in any market because markets are still driven by humans suffering behavioural biases who, you know, I think there’s a behavioural edge to be had. And, you know, whether you can allocate that to the way you do your analysis or how you do your decision making, but I think there’s a behavioural edge in any market. I think beyond that I kind of share the kind of common wisdom. I think that the more those kind of smaller, less liquid markets with maybe less sophisticated participants would tend to be more better places to seek alpha. But we’ve found alpha even in the United States. I mean, so it is possible. I share the common wisdom that the less liquid, the smaller, the far-flung have greater opportunities for alpha. But I’m not sure that that’s true. I think the opportunities exist everywhere. So I’m the owner of a football club, soccer club. We’re in the fourth division…
Meb: This isn’t just like eight-year-olds.
Simon: No, no, this is professional soccer club.
Meb: Because I was gonna say I’m sponsoring a local Manhattan Beach team, and all I buy is tee shirts.
Simon: Okay, well that’s, yeah, I buy a little bit more than tee shirts. So we’re in the fourth division of English football, but we have crowds of 10,000, 9,000, 10,000, grounds. We’ll soon have capacity of about 18,000. So, all fully professional team with a, you know, 123 years of history, 133 years of history, proper lower league football club. And I’m just struck, constantly struck by the similarities of running a football club and running a investment team. The decision making suffers from all the same biases, extrapolation of recent results. The fans are yelling at me because we’ve lost on Saturday, but we won the previous Tuesday by the same score. It’s all about spending money effectively and in particular, the irrationality in the market for players is extraordinary. Again, players will get big contracts after outlying seasons. Nobody does proper analytics. They go with their intuition the whole time. And yet what you’re trying to do, it’s very similar to building a portfolio. You’re trying to get a series of underpriced assets and then combine them together in a way that, so that the portfolio has aspects that are superior to some of its parts. It’s exactly the same in a football team.
Meb: You’ve seen this start to percolate. I mean, obviously “Moneyball” was a big influence for a lot of people and you see it where in some sports it’s just so woefully stone ages. I mean, even in football, if I was an owner, I would say, look, here’s the deal coach, you’re gonna get hired, but you have this computer on your arm. And so when you make a decision that goes against the computer, you better have a really strong reason why you didn’t go for it on fourth and one, whatever the reason is because, and you obviously can’t have a computer on your arm. But sort of the odds because it’s such a clear example of just irrationality because that’s the way it’s always been done. And then, and on the management side, on the player side, I mean, that’s just like total emotional wild West. How have the analytics started to make it into soccer? Didn’t John Henry buy a team? Simon: John Henry bought Liverpool, yeah.
Meb: Okay, Liverpool, yeah.
Simon: Yeah. So John Henry bought Liverpool and they just became European champions. I kind of think maybe this is the watershed moment. This is the kind of “Moneyball” moment. Now, having said that, I think even Liverpool people would tell you that they’re not as good at the analytics as they’d like to be. The analytic team says we’re gonna buy X and Jürgen Klopp says, no, you’re not. This is why it’s so similar to running an investment team. But once again, you’re curtailing people’s freedom. And the key thing to me about “Moneyball” was the relationship between Billy Beane and Art Howe. In most sports, the coach is the kind of godlike figure who rules as much as possible. You know, Alex Ferguson being a classic example, Bill Belichick in the NFL. But Billy Beane was Art Howe’s boss and it was very clear that Billy Beane was Art Howe’s boss and Howe had to do what Billy Beane said. Now, clearly, there was some friction, but essentially that’s what got it through. I think that in sports you have to have those kinds of organizational structures in order to make the analytics work because people don’t want their freedom curtailed. It’s very, very interesting. Very similar thing.
Meb: There’s nothing that plays out more with sports than career risk where people don’t wanna go against just the feeling of going against the crowd. It’s so uncomfortable.
Simon: Correct. Well, this is the classic example in soccer actually of analytics here is in penalty taking. So a penalty is where the ball is placed 12 yards from the goal and an attacking player is invited to score past a goalkeeper who is required to remain on the goal line. And roughly 75% of penalties are successful and there’s a stack of data about the optimal place to put it, to put the ball and the optimal place is right down the middle. The reason being that the goalkeeper suffers from an action bias and some kind of career risk. So if the goalkeeper dives left and the ball goes left, it’s like, wow, he was so close to saving it. If he dives left and the ball goes right, it was, well, at least he did something. If the ball goes left and then he just stands in his middle, it’s what the hell are we paying him for? So…
Meb: I don’t think, I mean I don’t watch that much soccer. I don’t know that I’ve ever seen a goalkeeper just stand in the middle.
Simon: There you go. There you go.
Meb: Like, maybe on accident, like they were kind of got, just got flat-footed, but I don’t think I’ve ever, for the most part, they…
Simon: He’s risking his career to succumb to the action bias. No question.
Meb: And by the way, there was a quote that Bill Belichick made within the last couple months where he says where they asked him about analytics and he’s…implied that he wasn’t a big, which is 100% BS by the way. I guarantee you he’s one of the most quantitative coaches because of the decisions he makes. I guarantee you he’s a huge stat user. He’s just BS-ing the world to keep his edge. Plus he’s probably cheating, Boston fans. I mean come on, he’s statistical and statistically cheating. I’m sore right now, but it’s fascinating and it’s fascinating from so many different angles from the actual player acquisition to the management of the game to even the line setting and a lot of the influences that go on with that.
Simon: I think player acquisition is something where it’s got the best chance of taking off, certainly in English soccer, slightly exaggerating about how absent it is. It is clearly a lot of teams now have… My team, we have a data analyst, but he really takes the video and chops it up for the manager to look at. But clearly some of the bigger teams have quite serious analytics departments now. And we’ve got vendors who are providing reasonably serious analytics about certainly the top-level games, maybe not down at our level.
Meb: Good business to be in listeners. Come up with some stat businesses. I mean I imagine in the U.S. I’m sure this probably exists already, but almost applying some “Moneyball” to like high school kids.
Simon: It’s hard to get the data, that’s the trouble.
Meb: Yeah, but that’s what I mean. Like, we’ll go and have a business that records all the games and sell… I’m sure someone does this. I have no idea, it’s a…
Simon: It’s a privacy issue. It’s a genuine issue. I mean, because we, all the clubs in England have academies and getting data on kids at other academies is quite difficult. There are obviously quite clear privacy issues involved.
Meb: So at least here, people often joke that soccer parents are the worst parents as far as yelling at the coaches and refs and everyone else. Is that similar feeling? Do you get some beer bottles thrown at your head when you go to games?
Simon: I’ve yet to avoid it so far. I’ve yet to avoid it so far despite us having a bad year. But football fans, soccer fans can be highly vociferous and it’s not always polite language, always an issue. I don’t know why soccer parents are so bad in this country. I used to coach girls soccer, under six girls soccer back in the, back when my children were under six. It really was quite remarkable how people who knew nothing about soccer would constantly be giving you advice about what to do.
Meb: Yeah. Poor umps, poor coaches.
Simon: It could be because it’s expensive. I mean soccer is different in this country from most other countries. I mean, here I think if you play on a travelling team, you’re spending three grand a year, it makes a big difference. Something to look forward to, Meb.
Meb: Yeah. Yeah. Look, this has been a lot of fun. Let’s touch on a few other things. First, you mentioned a lot of good books, inspirations, ideas. Any other resources that you think are particularly insightful or have really guided some of the beliefs on anything? It could be books, articles, concepts on…
Simon: Books. You know, I’ve mentioned Michael Mauboussin and can’t praise him enough. I mean it’s…if you read his four books, I think, you’ll get a step-to-step guide of how to run an investment process or basically how to make good decisions. “Thinking Fast and Slow” is obviously a kind of nice summary of Danny Kahneman’s work…
Meb: Embarrassingly, I’ve never read that yet.
Simon: But if you’ve read the derivative works, you’re fine. I mean, it’s a good summary.
Meb: Sitting on my shelf.
Simon: I’d recommend it. I’d recommend it to anybody. The work of Keith Stanovich, I think is not as well-known. I read everything on a Kindle, so I don’t see the spines lying around. I can never remember titles. But if you look for Keith Stanovich, you’ll see that he’s written a number of works about the importance of rationality, pure IQ. So it’s basically how to measure. He even has one about actually how to measure good decision making versus brute intelligence. And I think at root that that’s something that’s important. On the kind of cultural side, I’ve always liked the books of Jim Ware, W-A-R-E, who has written a couple of books about the culture, really, of investment teams in particular, which I’ve found influential when I read them 15, 20 years ago. I just read a very good novel called ”A Long Petal of the Sea,” ”Largo Pétalo de Mar” by Isabel Allende.
Meb: Don’t know it.
Simon: It was a good one.
Simon: I like to listen to podcasts. I drive an hour to and from work every day and I’d recommend podcasts when driving to people because I have a theory about bandwidth. I think that if you’re doing an activity that takes up a certain part of your bandwidth, you can then fill the rest of it and your attention doesn’t wander. I find if I listen to podcasts at the kitchen table or on an aeroplane, either my mind wanders or I fall asleep. So driving is perfect, and I find my retention of stuff on podcast that I listened to on the daily drive and my favourites would be the ones that I’m sure that your listeners, I like yours. I like Shane at Farnam Street. I like Barry Ritholtz’s, there’s Patrick O’Shaughnessy. So, you know, the usual, usual crowd. My worldview I get from “EconTalk,” Russ Roberts, which you know, is just a wonderful, wonderfully engaging interviewer. I wish that he would interview more people that he violently disagreed with. There’s a little bit too much same, same, but I do like his way of…I mostly like his way of thinking about the world.
Meb: I don’t have a long enough commute. These two crazies commute from Irvine, so they have like three hours of car per day.
Simon: It’s well worth it.
Meb: They should, I know. Move further away and you have more podcasts. Mine’s dog-walking.
Simon: Yeah. See that’s not, my mind would wander. Yeah, there’s not enough to do. I’ve tried it, you know, jogging and stuff and not enough to do. Driving takes up quite a lot, and so there’s nowhere for your mind to wander. Oh, sorry. I’ll tell you one more book, I forget which edition it is, but this was one of my first introductions to behavioural finance. Again, all investment people claim to have read Ben Graham and I think very few have. But to me ”The Intelligent Investor” is the great book on behavioural finance and you can read, I think it may be the fourth edition, the sixth edition, that Jason Zweig, now at “The Wall Street Journal” edited and his commentary that kind of brings Benjamin Graham’s thoughts about investor behaviour into modern behavioural finance, is just fantastic. Again, that would probably be the one book that I’d recommend. All beginning, when people join us, especially if they’re straight out of college, we give them a Kindle with a reading list on.
Meb: Well, I feel like so many people claim to have read the Graham books. It’s almost like saying, I read Charles Darwin’s… You get the topics, you, from osmosis, know the general theory, but very few people have actually gone and read the text, but it’s probably something people even once a decade, once every five years should revisit.
Simon: Yeah, but that Zweig edition is superb.
Meb: Okay, good. Jason’s the best. Looking back on your career, it’s still going, but what’s been the most memorable investment? You can’t say Nestle. You personally, you at the firm? Good, bad. Anything in between?
Simon: The two great investments I’ve made were both in the early ’80s. I’ve mention three. Two were the classic blood in the streets during the Philippines revolution. After Marcos, before Corazon Aquino took over. We bought a whole bunch of Philippine stocks and you could in those days, buy Philippine Long Distance Telephone in a ADR form, you could buy it for about eight months’ cash flow. And we were buying for fractions of a dollar and a few years later it was trading at over 100. That was highly memorable. The other one, there was another Philippine stock which is similar, the other one goes back to the late ’80s and it’s memorable because it really does demonstrate compounding and so on. And I don’t know what market capitalization of Samsung is today, but today everybody knows who Samsung is. They were the first Korean company to give direct access to their stock in the late ’80s via the issuance of a convertible bond. And so we’re talking 32, 31 years ago roughly, so not two careers. Total size of that issue was 20 million bucks and that just always reminds me of the power of growthing, compounding. On the bad side, talked about the near demise of value shops in the late ’90s, we actually came through the tech crash pretty well as you’d imagine paying some attention to price. And our near-death experience was in ’03, ’04 where we actually wrote at the end of the first quarter of ’03 after non-U.S. markets had been terrible. The bear market here was just about to end. Not that we knew that at the time, of course, but we actually wrote a piece saying we think non-U.S. markets are as cheap as they’ve ever been, buy now. Buy now or we’ll laugh at you and we executed that view appallingly. We were loading up on high-quality companies just as the junk rally began. And I think we underperformed over the next year by about 1200 basis points. That was memorable.
Meb: It’s hard in that sense though, I always think back when you do bounce or come out of the big bears or those markets, the junky stuff, we have an old post back, going back to around the financial crisis. Maybe it was the end of ’08. And said, is it time to do a Templeton? Where he had, during the great depression, I could be getting this wrong at this point, it’s 10 years ago wrote this article, where he bought every stock on the New York Stock Exchange trading below a dollar, below $5. I’m just saying, look, everything has been destroyed. I don’t know who’s gonna make it out of this, but some of these will be 10. 100, 1,000 baggers and most of them will fail, whatever it was. And said, is it time to do this same thing in the financial crisis? And sure enough, some of them went bankrupt, but some of them being in the junkier names had these just massive, massive, massive, massive, huge upside. But that’s the hard part with someone who has discipline and a belief about markets that the really putrid is what can just rocket ship out of the…
Simon: Yeah, absolutely. It’s very, very hard. We actually didn’t have that. It didn’t happen quite so badly in ’08 and I think this is one of the areas where you can exercise judgment. So we’re quality and we’re growth. But we’re having a good year unlike the kind of quant converts to quality as a factor who are having a bad year. You know, we’re emphasizing quality and our portfolios have the objective characteristics of higher margins, higher returns, less volatility of returns, lower leverage and so on and a bunch of other things that we use. But we’re not optimizing on those factors. So there is some judgment and, you know, one of the things that we’ve been doing over the last couple of years is basically dialling down the quality. It’s always gonna be above average. The guys who are optimizing on quality and growth up here are suffering whereas being able to exercise your judgment a little has protected us from that.
Meb: Yeah, it’s interesting. Never a dull day. Where can they find you? Where do they wanna learn more about you guys and what you’re up to? What’s the best place?
Simon: On our website. It’s hardingloevner.com, that’s hardingloevner.com or they can find our phone numbers there or my email address is email@example.com.
Meb: Any final? It’s almost happy hour here time. Any final happy hour predictions? Will not hold you to a single one of these for the next decade now. It’s 2020, next decade. They can be contrarian. They can be crazy. They can be totally buttoned-down.
Simon: If there’s been a fault, well, there have clearly been many. I’ve got many, many faults including investing faults, but my biggest fault as an investor is that I’m incredibly optimistic about the long term, but not today, which is why you need pre-commitments. As soon as you said 10 years, I think, oh, it’s gonna be great, but not today. So I always think the markets gonna go down before they eventually go up and I always think that, so maybe I should predict the opposite. I think markets are gonna go up in the short-term and go down over the long run. I think it’s very hard to see returns being above 4% or 5% over the next decade. So I think it would be kind of helpful to have a correction here and get expected returns back up, but I honestly just don’t know.
Meb: I tend to agree with you, but this is also why I’m a quant, because I say my precondition on being a public markets investor on the, particularly the U.S. side, I’d feel watching news, everything, there’s so much…you feel that bearishness want to creep in, and it’s easy…
Simon: Yeah, yeah, absolutely. Well, and that’s why we say, so we are not quants, but as I say, we’re more systematic. We do stay fully invested. You have to overcome these things. It’s the thing I’ve learnt most I think is just the value of rules and that’s why you’re a quant and that is why we have more rules than we did 20 years ago or 30 years ago.
Meb: Simon, it’s been a blast. Thanks for joining us.
Simon: My pleasure. Thanks very much.
Meb: Listeners, we’ll add the show note links, everything we talked about, books, websites, all sorts of good stuff. You can shoot us feedback, send us questions, criticisms, all that good stuff. Feedback@themebfabershow.com. Subscribe to the show on iTunes, Breaker, Spotify, now, is a great new entrant into the podcast space. Thanks for listening, friends, and good investing.