Episode #216: David Samra, Artisan Partners, “The Primary Driver of Our Behavior Is Finding a Company That Trades At A Discount To Intrinsic Value”
Guest: David Samra is a managing director of Artisan Partners and founding partner of the Artisan Partners International Value Team. He is the lead portfolio manager of the Artisan International Value Fund, which he has managed since its inception in September 2002.
Date Recorded: 2/21/2020 | Run-Time: 55:36
Summary: In today’s episode, we discuss David’s background and what led him down the path of value investing. We cover the characteristics that drive Artisan’s framework and investment process.
With the recent market selloff in mind, we walk through some industries that are offering value right now, from travel and leisure to energy, and where Artisan has been deploying cash.
As the conversation winds down, we talk high-level about the asset management industry and deploying value strategies.
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Links from the Episode:
- 0:40 – Intro
- 1:15 – Welcome to our guest, David Samra and how he became inoculated as a value investor
- 4:44 – Early investments in David’s career
- 8:04 – David’s time with Mario Gabelli
- 11:52 – Early work after leaving Columbia
- 12:46 – Launch of the International Value Fund
- 15:23 – Defining moments of David’s early career
- 18:20 – Investment framework
- 23:20 – Filtering through international companies to land on investment opportunities
- 26:04 – Criteria for searching for opportunities
- 31:01 – Markets David is concerned with
- 32:46 – Regions and countries with the most enticing opportunities
- 35:39 – How sectors will fare coming out of the pandemic
- 39:14 – Changes to David’s perspective
- 42:44 – Thinking differently than the competition
- 48:09 – Opening and closing funds
- 52:12 – Most memorable investment
- 53:55 – Best guesses about re-opening the economy
- 54:25 – Best way to connect: Artisan Partners and Columbia Business School’s Heilbrunn Center Podcast
Transcript of Episode 216:
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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, great show for you today. Our guest is a managing director of Artisan Partners and founding partner of the International Value Team where he’s been the lead PM on the International Value Fund since 2002. In today’s episode, we discuss our guest’s background and what led him down the path of value investing, we cover the characteristics that drive Artisan’s framework investing process, and with the recent market selloff in mind, we walk through some industries and securities that are offering value right now and where they have been deploying cash. Please enjoy this episode with Artisan Partners’ David Samra. David Samra, welcome to the show.
David: Thank you. Thank you for having me, Meb.
Meb: Well, it looks like you’re the only person in your office. I’m the only person in my house, so we got a nice quiet time to chat for a little bit during this quarantine period. And, listeners, it’s around mid-April. It’s tax day, or what used to be tax day, not tax day anymore, but it’s gonna be a lot of fun. I figured, let’s rewind a little bit. I’d like to start, maybe not at the beginning, but closer to the beginning, you were a Columbia Business School guy as well as Bentley undergrad and you also are identified as a value investor. And like Warren talks about, some were inoculated in early age and some maybe later, where did the value inoculation come for you, as a child at the Columbia Business School or after?
David: Well, interestingly, it came in my undergraduate education when I was first introduced to finances as opposed to accounting. I went to a business school for undergraduate education and I ran into a security analysis class. Just like business schools, we did projects on individual companies to go through the process of analyzing them and valuing them and determining whether or not they’ll make a good investment or not. And I don’t know if it was sort of the blue-collar upbringing that I had where we spent a lot of time buying clothes, and buying cars, and ways we were all were looking to spend less money, but I just naturally was inclined to looking at companies that look like they were at a discount rather than buying the sexiest, latest, and greatest thing, and have been interested in value investing ever since.
Columbia Business School, as you know, is the center value investing in this country. They have a terrific value investing program, although it wasn’t in place when I went there, but the Heilbrunn Center for value investing is something that I’m very involved with. I’m still well connected to the school and I have to really attribute part of my investing philosophy to the education that I got in both undergraduate school and graduate school. In undergraduate school, it was really centered and focused, not only on finance but accounting, which, of course, is the language of money, which is extremely important for anybody to have a good basis in investing. And in graduate school, because when I was there, the value investing program didn’t exist and the school had sort of lost its way and became more…the finance program was more of an efficient markets-driven program. My influence came from an adjunct professor by the name of Joel Stern who wrote a book called “Quest for Value.” And although he was also an efficient market person, the one thing that he did teach sort of a dyed in the wool value investor is the difference between a good business and a bad business.
And so, this is akin to, on a much smaller scale, obviously, Warren Buffet meeting Charlie Munger, where Charlie is preaching the differences between buying a cigar butt and buying a great business, and how that compounding of wealth over time is much more meaningful than having to constantly buy and sell securities. And that’s what Joel had brought to the table. What is a high return business, how do you recognize it, and then how do you put an analytical structure around it? And then the question for a value investor comes down to how much do you wanna pay for it?
Meb: And do you remember any of the securities you guys looked at back in undergrad or grad school?
David: Well, the one example that I’ve given in a couple of interviews in undergraduate school was the project that we had was looking at pharmaceutical firms. And back then the pharmaceutical industry was a growth industry. And one of the best growth stocks was Merck, and this one particular project with a partner and we were both to pick an individual equity. He picked Merck and I picked a company called A.H. Robins. And A.H. Robins was a problematic company. It had three main products. One was Robitussin, which has a cough syrup that everybody here in the United States knows about. The other one was ChapStick, which, again, everybody knows about those products, were great, profitable, and growing. And the other one was, unfortunately, an IUD, which had made many women sick and the company was being sued. But if you ran a sum of the parts analysis on the value of Robitussin and ChapStick and looked at what could be the reasonable legal outcome for the issues that they were having with their other products, it was clearly a very, very cheap stock. And that’s what attracted me to A.H. Robins versus something like Merck. It felt like I was getting something for nothing. And today, I still feel the same way. When I approach an equity, I’m trying to get something for nothing, something that the market is not willing to pay for.
And there are very large examples. So, for example, our largest position is Samsung Electronics. And Samsung is a Korean company, obviously, and it’s known best for its handsets, but they make almost all of their money selling memory semiconductors. And the one thing that the market for many, many years hasn’t paid us for is the fact that a third of the market cap is in cash and securities. And the market would assign zero value for that. And if somebody wants to assign zero value to a cash pile, that could potentially be deployed and in many different ways over time, I’m happy to take that deal.
And it’s paying off right now. So, for example, as the market is declining for most companies, especially those that have balance sheet issues, the fact that Samsung Electronics has a very strong, secure excess capital balance sheet, has all of a sudden become very valuable. And you don’t need to go very far to find academic input into the value of strong balance sheet because, of course, Benjamin Graham wrote about that in “Security Analysis” and “The Intelligent Investor.” So you don’t need to go far to find these concepts. They’re out there, but these are things that we deploy, and I continued to look for securities that are offering me something that I don’t have to pay for.
Meb: You know, it’s funny, as I look back, I took his security analysis class as an undergrad as well and I also chose a pharmaceutical company. It’s more of a biotech at that point, and this would have been spring of ’99. So mind, if you remember this name, Human Genome Sciences, and during the course of the semester, I think it went up like 4 times and then down like 70%, and so, it was a tough pick. All right. So, Columbia, you also had the chance to spend a little time with a pretty famous investor. I don’t know if I characterize him as value, particularly, but Gabelli, right, that you have an internship with Mario?
David: Mario is a dyed in the wool value investment. Yeah. I worked with him on Fridays. It wasn’t a very long stint. I worked there for a semester or two, I don’t remember exactly. And the wonderful thing about him for me was, as I mentioned earlier, Columbia had sort of lost its way on value investing. And so by working with him on Fridays reinforced all of the value investing concepts that I had learned to appreciate since my undergraduate education. In addition to that, I just learned a lot more. We would have research meetings on Friday or he would hold research meetings on Friday. And in that half an hour or 45 minutes that I was in that room with him, I learned more than what I was learning in my academic experience. I have a pretty interesting research story about my time there, if that would fit into your paradigm.
Meb: Yeah. Let’s hear it.
David: One of the key competitive advantages that you have as a value investor is your ability to gather information and, hopefully, information that others aren’t spending the time and effort to gather. And at the time, Mario owned a position in a company called Sequa. Sequa was a conglomerate and, amongst other businesses, was providing aircraft engine repair services. And one of their facilities in upstate New York had been raided by the FAA, which was taking down their profit profile. So the whole facility was shut down and Mario had asked me to find out what was going on and when it was going to reopen because the stock price had declined, obviously. So I called around to the investor relations team and the company and they wouldn’t give me any information, and I went and told him what the company said and he promptly threw me out of his office saying that I’m no good and I am not providing him with any meaningful information.
So trying to figure out what to do, and I didn’t have a car at the time, I borrowed somebody’s car and I actually drove up to the facility in upstate New York and walked in and said, “Geez, you know, I’d like to talk to your manager here and a little bit about what’s going.” I had a business suit on and I was trying to interview the person who was running, and then they promptly threw me out, sort of leaving me frustrated. So I walked back to the car and I noticed that there was a coffee truck outside that served donuts and coffee. So I took my tie off. I went over, I befriended the individual who is running the coffee truck, and I started chatting with him, lamenting about the fact that his business was down so much because nobody’s working at the factory. And he said to me, “Oh, don’t worry, they’re reopening in the morning, and my business will come right back up,” which I probably then got into the car, went back to Mario, and gave him the information that I had collected. So it’s kind of an anecdotal funny story, but what it does is it reinforces the notion that if you put in the extra effort to gather information, and I could give you several other interesting anecdotes about early in my career in international investing that operated in much the same way. And we still operate our research staff in that way, always taking the extra step to find information that could help us handicap our outcomes.
Meb: Yeah. I mean, and that’s the thing. And being a quant, we always say that people either have to have a better model or better or different data and the old school fundamental analysis of doing this value-added research, that’s probably a piece of data, a great example that someone else wouldn’t have, you know, chatting up with the coffee guy certainly doesn’t show up in a screen. All right. So out of Columbia, you did a couple of stops in Montgomery and Harris, where were those located? You know, are those traditional value investing shops?
David: Montgomery was…it’s no longer in San Francisco and not a traditional value shop, which is a reason after a few years, I moved on. Harris Associates in Chicago, a terrific firm, and I worked in the international group there with a very famous value investor, David Herro, who still operates the Oakmark International, Oakmark International Small Cap Fund. And I worked there for five years and left there in 2002. By then I had had almost 10 years worth of experience as an analyst and decided that like to try employing my own philosophy, and I found a terrific home here at Artisan. We launched the International Value Fund in 2002.
Meb: And where did the international part come into play? Did you start out as pure domestic and then it eventually, at some part, started to look beyond the borders or was it from the get-go? How did that work?
David: Well, that was serendipitous. I had met somebody during my summer internship at a company in Boston that was running an international product and I was also…I was just very interested in it. I was involved with the international accounting professor at Columbia and I was just very curious and I got to know the international money manager at the summer internship, even though I wasn’t working for him. And when I graduated, he called me and said, “Hey, do you like to come out here to San Francisco to help us start up this organization?” So that put me right in the front lines of international investing at the time when few people were doing it. And it was fascinating because of the fact that few people were doing it. And again, it can come down to information advantage because there was no internet, there were very few English language reports that were out, and there was sparse reporting. Some companies only reported once a year, for example.
So getting on an airplane, which was terrific for me at a young age, I would spend weeks and weeks on the road out there visiting companies, bringing in locals, whether it be in Japan, or in Malaysia, or in Germany, bringing in locals to help me translate financial statements to get information that literally other people did not have, and trying to, again, use that information to handicap potential outcomes. Back then it was a bit of a value investor’s dream. It’s significantly changed now, whereas my job emulates the role of the U.S. value investor because capital markets have developed companies report. Regularly, we have the internet, everything’s in English, you can talk to people, and this current virus is accelerating that process. You can talk to people on the phone basically any time that you want outside of the United States. But yeah, that’s how I got involved in international investing and I just stuck with it.
Meb: It’s fun to think about during the ’90s, in particular, and then the early 2000s, I mean, there’s been so many different cycles of not just booms and busts in the U.S. but also internationally, if you just go one after another, I remember reading the old Jim Rogers’ books, you know, that certainly got me interested in international investing, “Investment Biker,” and what was the other one, “Adventure Capitalist” at an earlier age. Okay. Walk me through any defining moments, and we’ll get to Artisan in a second, of that period of, you know, many people, particularly of the value cloth, talked about the late ’90s as a pretty tough time, not necessarily finding ideas, but just live through the whole indie side of the business or watching the rest of the world go a bit insane, particularly in San Francisco. I had certainly moved out there, the internet winter right after the bubble bust, so I got to see it firsthand. Talk to me a little bit about…
David: The value of investor stream.
Meb: Yeah. Exactly. About that experience, any general takeaways or fun or terrible memories from that period?
David: I think that the most relevant takeaway is that it was a dramatic exhibition of how greed can express itself in the marketplace and how significant mispricing can happen in the stock market. We’ve all read the empirical studies, we all have read about the psychological aspects of greed and fear in such a big liquid market like the stock market and how that tends to amplify things on the upside and amplify things on the downside. However, for most of my career, those amplifications have been in shades of gray. The internet bubble, that amplification was so obvious to people who were very focused on economics. It really is unique in the way that it stands out. And I wasn’t around, obviously, for what happened in the 1970s with the Nifty Fifty, and perhaps it was obvious then, but I wasn’t there.
And even ahead of the financial crisis, I mean, you really had to know what you were doing in terms of staying away from banks. And even in this crisis, everybody was hit upside the head here and there was no…there were a few, you know, what Masayoshi Son was doing, looked bubbly. You could argue Tesla, Netflix. There are few companies that were out there that looked at silly valuations. However, for the vast majority of the stock market heading into this crisis, things looked pretty reasonably priced. Even the Facebooks and the Googles of this world, they didn’t seem insanely priced. They largely reflected the great business and growth aspects of what they are. They weren’t undervalued in any way, but they certainly weren’t at crazy valuations. But the internet bubble, you had companies that would issue press releases and get billion-dollar market caps with no revenues. It was a crazy mania.
Meb: Yeah. We saw little bits and pieces of that maybe in the crypto space with some of the stocks like Long Island Iced Tea, changing its name to Blockchain. So important time, you joined Artisan. Talk to me about the general framework for how you think about the world there. I assume it’s broadly similar, but what are you guys looking for when you’re looking for stocks? What’s the sort of framework for how you look at the world?
David: Well, we have four key characteristics that we look for in the businesses that we invest in. We’re value investors, so the primary driver of our behaviour is finding a company that trades at a discount to intrinsic value. The value of the business is the present value of its future cash flows. Unless you’re buying a company based on theory that it’s going to be liquidated or it’s going to be sold, which are all very hard to find these days, where to handicap, most of the time we spend looking at businesses and trying to understand their market position, their growth profile, and the type of cash flow that we can get out of these businesses for the next few years, discounting that back to today, and looking for a big gap between the price that it’s being offered to us in the market and the value that our research is telling us that the business is worth. And that’s the primary driver of our behaviour.
However, there are several characteristics of value investing, the historical approach to value investing that we don’t like, and we use the removal of these characteristics as a way to manage risk in the portfolio. So the first characteristic that we don’t like of crummy businesses. We don’t like businesses that have low returns on capital, they don’t really grow over time because, as a value investor, you’re usually getting…you don’t get a good price for something unless something is wrong with it. And usually, it takes time for things to repair themselves as we’re all finding out right now, and you as a shareholder face a problem of erosion of your purchasing power because inflation is ever present and you face time value…I call it time value of money risk. Other people call them value trap.
So within this giant world of non-U.S. equities, we first narrow down the universe by only looking at very good companies, companies that have strong market position, good profit profile, or, like the great management team, something that differentiates it and allows it to have the ability to value over time. The second thing that we eliminate, and we talked a little bit about this earlier, is high levels of financial leverage. We believe that our companies have, generally speaking, competitive advantages in terms of the business that they’re in, their market position, their products, their investments behind those products. And we also believe that the balance sheet can be a discrete and simple competitive advantage, and many of the management teams that understand that concept, we think, put us in a very powerful position to generate good returns. We find the excess or even the reasonably acceptable use of leverage to be a false reality of the way that companies should be managed.
I’ve been in this business for almost 30 years now and there’s some sort of crisis at roughly every time. And companies that have strong balance sheets, when they’re going through a crisis like this, can use that money to grow value. They can either take market share by investing back in the business, they can buy out a weaker competitor, or, in the absence of those things, they can buy their own stock back at a very, very cheap price during downturns like this. So we like strong balance sheets. We think they can get into our competitors the competitive advantage. And interestingly, as I mentioned earlier, we usually don’t have to pay for that. The stock market over the last 10, 15 years has really come to appreciate leverage as interest rates go down. So people think, “Ah, you know, rates are cheap, we don’t have to pay so much to borrow.” Well, you actually do because you have to pay that money back, and oftentimes you’re paying that money back at a time that’s extremely inconvenient as many people are finding out today. So that’s two components.
And the third one is having a great management team. And this is where we spend our time. Is this a good business? Do we have a strong balance sheet? Is this a great management team? And then placing some estimate of intrinsic value. What is the value of this business? Whether that’s generally trading in the stock market or to a private market purchaser, and where there’s a big discount, we invest. And if we do our job correctly, at the end of this process, we have a portfolio of undervalued securities of good companies generating cash and management’s making good capital allocation decisions on a day in and day out basis. And we think that’s a powerful combination of those four key variables, cheap stock, good business, strong balance sheet, good management team. That’s our approach to investing. We keep it pretty concentrated. Forty to 50% of the cap total is invested in the top 10 securities, and that’s because it’s very hard to find those factors in combination. Right? You know, generally speaking, when markets are, let’s say, under more normal conditions, you’re looking for a needle in a haystack and so there’s just not a lot of them, so we tend to run a pretty focused portfolio.
Meb: Having done this for a while through different cycles in international investing, what is the process to arrive at those needles? I mean, there’s thousands of securities around the world, if not tens of thousands. How do you guys kind of filter that down to the names that you wanna own and how long is the due diligence process on a new name versus, you know, continuing to own one? How does it all work in practice?
David: The process has several components to it. We engage in screening, we look for things value investors normally look for, low PE, low price to book, high dividend yields. We look for things value investors typically don’t look for, which are good businesses with high returns. And we screen out the bad balance sheets, and that narrows down the universe pretty significantly. And we have regular research meetings within our group and we try to identify securities that we want to do more work on. But at the same time, the most productive way of finding securities for us is by knowing our markets. So as I indicated earlier, we travel a lot and we visit countries. The way that we’re structured here is we’re all generalists with country responsibilities. It’s a little odd, and most of the universe is organized by industry, but we’re generalists, we’re investors. We’re trying to find companies that will generate a good absolute return for us and generate wealth for our clients over time, improve their purchasing power.
So we’re not looking to make relative decisions, we’re looking to find securities that are absolutely attractive to us. And part of that process is getting out there and visiting businesses, which we do regularly. And we have, of course, a tracking system. The information that we gather, we keep it in a very effective database and we identify those companies that we would love to own. And if something happens, management makes a bad acquisition, or the government changes the rules, or company has a profit warning, or there’s an economic downturn in a certain country, we know what the better companies are, and we go then back to those securities when they’re at an attractive price and we start peeling back the onion on whatever the current issue is to determine whether or not we’re really getting a bargain.
Meb: So I think it’d be helpful for any of the listeners or viewers, are there any names in particular that you think would be a useful sort of case study on how you think about the world or an investment that you think is, particularly illustrates one that fits your criteria?
David: Well, I think that today, and this gets back a little bit to the question that you asked, you have a downturn in certain segments of the economy. Some of the segments are holding up, let’s say, supermarkets, generally pharmaceutical healthcare, food companies. There’s a big rush to safety now that has widened that dispersion between, let’s say, growth stocks and value stocks. You know, I think Tesla is up this year. Nestle is blue-chip food stock, that stock is up this year. But one of the areas, for example, that has been beat up pretty bad are obviously airlines, and the airline industry in Europe has a very well run… The largest airline company in Europe is an extremely well-run company with very strong balance sheets called Ryanair. And we know the company very well since we bought the company back in 2007, sort of ahead of another big issue when oil prices were racing up to $150 or $200, which could happen again. Nobody wanted to own an airline stock. So we got involved with the company back then, and we’ve known it for many years, and we continuously visited with that company, and it’s taken significant market share over many years.
And if you fast forward to today, the company, as I said, is the largest airline company in Europe, and that marketplace in Europe, unlike U.S., has yet to consolidate. And what we think will happen as a result of what’s going on today is that consolidation will take place and two things will happen to the survivor. One is they’ll obviously have a larger business, and two is the price discipline associated with the airline industry will change, similar to the way that it changed in the U.S. And we always thought that this would happen with Ryanair. However, given the availability of cheap capital, anybody could get an airplane and the travel industry was generally thought to only go in one way, which was up. We thought it would take an awful long time for that consolidation to happen. Well, that paradigm has just changed, and we think a company like that in today’s environment, strong balance sheet, great management team, significant competitive advantages becomes very interesting in an environment like this.
Meb: How much do you guys think about domicile? You know, I think a lot of U.S. investors are very focused on U.S. investing only. And you’ve seen kind of over the years where a company is located, where its revenue’s located as globalization has kind of come on to be somewhat more complex or complicated or not as clear as just where HQ is. And you have a scenario where a market like the U.S. outperformed so much for the better part of the last decade, which was the opposite of the prior decade. How do you guys think about as far as top-down and countries and currencies versus bottom-up? Does that question make any sense?
David: It does. And it’s important to understand the neighbourhood that you live in and you operate in. If you had all of your money… Let’s just give an extreme example. If you had all of your money in one country, you might be a little bit more nervous if that country was Indonesia than you would be if it was Switzerland. And there are obvious reasons. The economic system is less mature, the political systems are less mature, the healthcare systems are less mature, less able to maintain order and economic growth in the same way that you would be able to maintain those things in the developed parts of the world. So, of course, we understand the neighbourhoods that we’re operating in and the relative risk spectrum. Now, I think domicile also becomes extremely important when you’re managing significant amounts of money because of the legal structures under which a company operates, where we’re allocating, you know, 400, 500, 600 million, up to a billion or more in each equity that we invest in. You have to be very aware of your rights as a minority shareholder, your ability to assert your rights as a minority shareholder, and those rights are extremely different depending upon where the company is domiciled. So it’s not only what are the economic and political constructs that you have to be concerned about, but you also have to be concerned about the legal constructs.
Meb: Which places concerned you the most as you look around the world? Because you hear that a lot from particularly U.S. investors. They’re just like, “The rest of the world, can’t trust the numbers anywhere, dah, dah, dah.” What places would you consider that make you a little nervous?
David: Well, just to point out, that Enron, I think, was probably the biggest corporate scandal in history. Let’s just put that aside for a second. From a legal standpoint, most emerging markets are pretty rough on minority shareholders. Russia’s probably the poster child. But in your ability to impact the companies that you’re involved in as a minority shareholder is pretty hard in most emerging markets. In the developed parts of the world, Japan was the poster child for many, many years, and still is, but is improving dramatically. Since Abe has come into office, he’s slowly but surely started to put legal structures in place. And it’s not only legal structures, it’s also cultural attitudes towards what it means to have outside shareholders and what your obligations are to them. Whereas historically the shareholder was always at the bottom of the list. In terms of constituents for most Japanese companies, it’s probably moved up a tick or two, and that really depends on the company. And the best, just to put a positive spin on it, and I think corporate governance, as I called it, is probably best in the world in places like the UK, you know, the old imperial countries, the UK, Canada, Australia, New Zealand, and even Hong Kong, Singapore, those places have some of the best corporate governance outside the U.S.
Meb: As we ended the last decade, and this quarter has changed things up pretty quickly, what are some of the regions or countries that you guys are finding some of the most opportunity right now?
David: At this point, all markets are down, and we go from a needle in a haystack to just a bunch of needles, and you have to go through the process of looking at each needle with a different eye, right? This is an epidemiological issue where we don’t really have a corollary. We don’t really know what the outcome is, which is why you’ve seen this big rush to safety. If you look at what happened in the financial crisis, the GFC, let’s just use gold, right? Gold took a dive at the beginning of the downturn in the global financial crisis and stayed down for months and months. I think it was seven or eight months. Whereas here you’ve had the spike up in gold, and gold has continued to rise as this problem has gone on, you know, with the amount of borrowing by governments, with the amount of liquidity pumped into the system by the fed, and the potential debasing of paper currencies. And the lack of understanding of how long this will go on and what it really means to the economy has pushed that gap between safety and security. Going into an emerging market at a time like this brings on risk.
I read a number that a place like India has like 100 ventilators, right? And if you’ve ever been there, the density of the population and the way that they live puts a place like that potentially in a position where the medical outcome could be far worse than, let’s say, in a place like the U.S. or Switzerland, for example. We don’t see a geography that really sticks out to get to the core of your question in terms of are there cheaper stocks in one place versus another. We really see this disparity between the rush to buy Nestle and the rush to sell Ryanair. That’s where that disparity is. And, you know, I’m not a big fan of calling things value stocks or growth stocks, and there has been this sort of spread over the last few years, but if there is a spread that you wanna pay attention to, that spread has widened dramatically. You know, a lot of that has come from oil and gas, which is a different analytical structure, but our focus is really on taking advantage of the Ryanairs of this world and selling off the Nestles of this world because, as we come out of this, when we come out of this, those securities that are deeply undervalued should outperform securities that really have had elevated valuations as we go through this.
Meb: And you mentioned energy. I was looking the other day, the percentage of the S&P energy is down to like 3% or something. As you guys look around the world, are there any sectors or industries you think are particularly attractive, particularly problematic? You mentioned a little bit talking about financials earlier. Anything that comes to mind that the people should be kind of keeping either forefront or looking for opportunity?
David: Well, the center of the crisis is in travel and leisure, so that’s a good place to look. Oil and gas, the price of a barrel of oil is about 20 bucks, and our estimate of the marginal cost of production is 65 or 70.
Meb: The local gas station near me is still somehow $4 a gallon. But no…
David: Welcome to California.
Meb: Yeah, totally.
David: So you’re gonna see production come down and eventually we’ll get to supply-demand balance when people start driving again. So that’s a good place to look. Find a company with a strong balance sheet to get you through the other side and a good cost profile. Autos, anything that’s big steel. So companies that make autos, airplanes, agricultural equipment, you know, there is a lot of inventory of all of those things and it’s gonna take time for those industries to really ramp up back their production. And so, those stocks have been beat up pretty bad. You have to be very choosy within financials. JPMorgan’s gonna have a much better balance sheet than, let’s say, a bank in Oklahoma that’s servicing the oil and gas industry. So you have to be very choosy there because we don’t know how long this is gonna go on. But those would be the areas where there are considerable amount of damage done to the securities and which is, you know, an obvious place for somebody who’s value-oriented to go look.
Meb: And so, I think I saw you guys had ended the year with a decent slug of cash but have been deploying it, bitten Q1. Is that mostly into some of the names you guys already owned? Is it things that are just getting decimated? What’s the sort of lay of the land?
David: Yeah. So we came into the quarter with 15% cash, which is the maximum we can carry in our portfolio, and we were generally cautious because last year was a big year. Stock markets were up significantly and earnings hadn’t grown, so the multiples were up. Risk was up. We deployed all of it during the quarter except for 2% and effectively all of it. And it was a mix. It was deploying it in securities that we own, that declined. We sold off some securities that had held up pretty well, and deployed even more effectively firepower, then that would be implied by what we did with cash and it was focused in those three areas. Actually, the three main areas that we deployed it are as follows. So it was areas that were hit hard, so travel and leisure, oil and gas, and third, areas that I would say really terrific companies that historically we would not have been able to purchase because their valuations were too high and represented too much risk, that for one reason or another were hit hard as a result of this crisis and gave us an opportunity to buy what we would call it, very superior companies that have the ability to grow. So those are the three general areas that we deployed. One, our first line of offense, and that’s how we think about cash, our first line of offense is deploying the cash that we have, and our second line of offense is selling off the securities that have held up very, very well, the Nestles of this world, and redeploying that cash into more undervalued securities.
Meb: From someone who’s been through a few different cycles, in thinking about markets in general, there’s often ideas, or whether it’s fiscal or monetary policies, just things going on in the world that look different about every regime. The one we talk a lot about is probably in the finance textbooks when you’re undergrad or I was studying, they didn’t talk a lot about negative yielding sovereigns as being a normal part of finance. Is there anything you’ve changed perspective on over the past two decades, in particular, thinking about markets and investing that is…and as a different way, if there’s not, if there’s something that is particularly on your mind today?
David: Well, I think that the biggest concern that all of us should have is the biggest risk to all of our livelihood is the amount of borrowing that these developed world governments are doing. And I recently read that instead of issuing bills, the UK government is just borrowing straight from the UK central bank. Now, this is Zimbabwe-like behaviour. The possibility that that undermines paper currency and the system that we operate in, the ante keeps going up every time there’s one of these crises, you know, it all started in the last one or maybe even a little bit before that. Negative interest rates, central banks supporting the capital markets, supporting debt issuance, and the combination of that in the corrosive nature of borrowing, right, that exists because interest rates are so low, all of those things are undermining the ability of society to function over the long-term, right?
Your children, and my children, and my grandchildren may end up living in the world because of this that is far less happy, economically prosperous than the world that we live in because of these policies. And there is no this venting voice. There is none. Find somebody in Washington who’s right now or in any government right now, the Germans did it for a long time, right? And the Germans may be the only voice still in the world that are saying, “Hey, you know, we can’t bankrupt our future in every crisis that shows up.” So they’re spending a little bit now. I wanna keep the conversation happy, but if you really wanna worry about something, I wouldn’t worry about this crisis. I think our healthcare system is terrific and we shouldn’t bash it. In fact, our healthcare system is extremely important, and I’m glad to see finally people starting to think about our healthcare system positively instead of negatively. I think we’ll get through this, our healthcare system will perform miracles, irrespectively Santa Claus right now to get us through this, but the consequences of all this borrowing is what really presents a threat maybe to our generation, my generation, but I think almost certainly the next generation or the generation after that.
Meb: Yeah. For me, I think a lot about the pension funds and particularly in a world where bond yield’s 1%-ish, many in the U.S. that are just chronically underfunded, and the social stress, not just financial, but the social fractures that may induce will be. I’m hopeful, but it could be painful. As you look around the finance and investing space, you guys run a very large successful money manager for many years, award-winning. How do you guys think in a world of transition from what you kind of described as a Disneyland of value investing of inefficiency in the ’90s and now the world is so much more efficient? I mean all the quants have the same databases. You know, everyone has the same information so much. What is the main sort of…I don’t wanna say edge, because that’s what everyone likes to talk about, but are there anything you guys think differently than others when looking at the world, anything in particular that comes to mind or anything as you look to the horizon of the next decade? And part of this question, it’s a long question, thinking about the asset management industry in general, where you have all these huge market-cap-weighted funds that are now at zero. Bank of New York now just launched two free funds. Any thoughts there? It’s a broad question. Take it any way you want.
David: Okay. So I’m gonna separate it into buckets. I think in terms of the business of money management, certainly, we’ve been facing fee rate pressure since I’ve been in this business. The popularity of ETFs, and if you open up “Barron’s” on the weekend you can see that the pages and pages of these things has been dramatic and the pricing of those is obviously very low. And people are using them as substitute products. However, all of those ETFs, they don’t think. There’s just an algorithm, right? They don’t think, and they trade based on liquidity. Those are tools, right? They’re not investing vehicles. Those are tools. As a money manager, you have to be able to provide your clients with an investing vehicle. You have to have a philosophy, a process, a system that shows over long periods of time that you can help their purchasing power grow. And I think that as long as you’re able to do that, you will be able to offer value to your clients over and above a passive, non-thinking product. So there is some future for the money management business. However, unfortunately, for the mass market, these ETFs are being fed into their portfolios, which removes that potential client base from your addressable market.
So the money management business, if you’re only active, the pie that you can address is shrinking. That will leave in aggregate the economics of that business to be less attractive in the future that it has been in the past, unless there’s some ruinous item that happens within the ETF industry, which I doubt, and they go away. I doubt that happens. They may diminish in size and presence in the market, but I don’t think they’re going away. I think they’re here to stay. The money management business is going to be increasingly challenged. In terms of our edge, which is a completely different question, you know, as value investors, you have a natural edge. The value of the business is the present value of all the future cash flows.
So if you own a company and you truly believe that this epidemiological issue will be out of the system within two years, right, then you have the rest of infinity in which to discount those cash flows back. The stock market hit because of emotions and because of the liquid nature of what it is, is driven by, oftentimes, especially in times like this short-term sentiment and people are unwilling to look past. All the bank stocks, for example, get sold down dramatically, right? And then JPMorgan, and Wells Fargo, and Citibank, they all come out and report, and shock of all shocks, they increase their provision, right, for credit losses, right? That shouldn’t be a shock to anybody, yet the share price goes down the day it reports. Right? That’s absurd. Everybody knew that that was going to happen. Stock market’s going to go down today as a result of it. But we, as investors, can say, “Yeah, we already knew that that was gonna happen and we know within a certain band of confidence that these companies two years from now are not gonna be dealing with this issue.” They might be dealing with other issues and you can handicap those separately, but this issue will largely be behind them by then one way or another, and our competitive advantage, as value investors, whether it be a banker, or an industrial company, or what have you, is to look past those issues and focus on the long duration of the cash flows and value the business that way and find those discrepancies and buy them.
And quite frankly, over the last five years, and you see this in almost every value investor’s numbers, there has been no real ability to deploy that thinking. The markets have been so elevated and so efficient and so efficiently priced. I’m not gonna call them overpriced, but efficiently priced. A value investor really hasn’t had the ability to take advantage of securities crisis that are grossly out of whack with long-term value. Now you’re getting an opportunity to do that in certain parts of the market. So that’s our competitive advantage as value investors, generally speaking. Whether or not clients want that or at least yes, that’s a different question.
Meb: How do you guys think about your…what I consider to be big money manager, and over the years as you’ve grown, there’s times when your funds are closed and open. How do you guys come to sort of that determination? Is it relative to just how much cash you can deploy with opportunities that currently exist? How does that whole process work? Looking forward to having that problem one day.
David: Yeah. We use four key criteria. So first is asset size, the second is market opportunity, the third is business mix, and I’ll explain that, and then the fourth is velocity of money, and I’ll explain that. So if you have a great market opportunity and a big sell-off, for example, like today where we’ve just reopened the first time since 2011, we’ve reopened the mutual fund. And when you have a big market opportunity, you can deploy significant amounts of capital in a pretty rapid pace. Since 2011, we haven’t had that ability. We’ve been closed. And you only wanna do that up to a certain amount because you start hitting liquidity issues and you wanna keep your investible universe as wide as possible. If I’m looking for a needle in a haystack, the smaller amount of capital that I have, the wider my opportunity set, the more effectively I can deploy that capital.
When everything’s a needle, you can deploy that capital. So that gets to the first two key components, how much capital you have and then the market opportunity. Business mix, as a mutual fund, anybody can put money in and take money out, and there are certain types of clients that tend to be pretty short-term in their focus. And, of course, our value investing philosophy is very long-term in nature, so that gets me long-term assets. I need long-term liabilities to match that up. So try to match the assets and the liabilities. The last one was velocity of money. I don’t want disruption to my existing client base. And so, if money is rushing in too quickly, that has issues, and we shut down the ability to put money in into the fund, and I also don’t want people flooding out of the mutual fund because that causes turnover, taxes, selling your own securities, which has its own issues associated with it, tax issues as well.
And so, we’ll use the combination of these four factors over any given period of time to determine whether or not we’re open or close. And we closed in ’06, ’07, reopened in late 2008, early 2009, we closed in 2011, and we reopened today. Now, we actually had a fifth criteria where, within my group, I launched a global value fund many years ago in 2007 and we had two funds running it, reasonable asset basis for many years. And because of the success of those funds, our asset base grew by the end of 2017 to $40 billion. And we were not serving our existing customers as well in a buoyant investment market with 40 billion of assets. So what we did is we took an extraordinary step putting our reputations and our businesses at risk, is we divided the group between the global value group and the international value group, and went from 40 billion of assets chasing the same liquidity to 20 billion, to separately operated pools of $20 billion chasing liquidity. So that’s a fifth tool that we developed. And all of this, Meb, is designed to make sure that we’re doing the best job that we can for our existing client base, right? The whole objective is to take care of our clients.
Meb: Yeah. It’s hard, you know, public funds and public assets, trying to get investors to behave, and investors of all stripes, not just individuals, institutions, advisors, everyone, and take a long-term view is hard, for certain. You know, one of the questions we like to ask everyone, and we probably could have done this for an entire episode and maybe you can come back and talk about it, but what’s been your most memorable investment as you look back over the years? I’m sure we could probably literally do 10 hours of this, but anything come to mind?
David: Well, the first thing that comes to mind is a company called Lancashire. So I’ve had, I guess, a property-casualty insurance fetish for most of my career, probably because Buffett, you know, is very successful in that business. And there was a fellow named Richard Brindle who was very successful underwriter who was introduced to me by somebody I knew in the insurance brokerage industry who started up a… We were a smaller group back then, started up a billion-dollar, I can’t remember if it was dollars or pounds, new property-casualty insurer based in Bermuda. Richard was extremely talented person. We did our due diligence on him, which was our information advantage. We had access to people that he had worked with. We knew his underwriting capability. And I can’t remember exactly when we bought the stock, maybe it was 2007, but Richard built an incredible underwriting track record of success, and that stock went straight up all the way through… Imagine a financial going straight up all the way through the great financial crisis. And I think we sold the stock at seven, eight, nine times what we paid for it. It was just a phenomenally good experience. Those are the fun ones. Mostly as a value investor, you’re bashing your head against the wall, but every once in a while you run across something like that that’s just absolutely incredible.
Meb: What’s your estimate next time you’ll be going to a live sporting event, or concert, or something under that umbrella? What’s your expectation? I’m not gonna hold you to it.
David: I wish I know. We should ask Dr. Fauci. He’s gonna know way better than me.
Meb: I’m sad, today on my bucket list was to get to see Pearl Jam. Never seen him play, and they, I think, would have been playing tonight in Los Angeles, so…
Meb: Yeah. I am gonna put him on Spotify. David, this has been a blast. The best places, our listeners, they wanna go find out about you guys, your funds, everything else, where do they go?
David: Artisanfunds.com, and type in Artisan International Value. There are a lot of products here so you can’t get confused. And also Columbia Business School, the Heilbrunn Center for Value Investing has a website, and I recently did a podcast there. Not to bring up a competitor of yours, but if somebody is really interested in us and what we do, there’s a podcast there that, I think, somewhat mimics the conversation that we had today. So somebody could…
Meb: We’ll add the links to the show notes. David, thanks so much. I appreciate taking the time during this quarantine.
David: Yeah. Nice to meet you. I like your haircut.
Meb: Podcasts listeners, we’ll post show notes to today’s conversation at mebfaber.com/podcasts. If you love the show, if you hate it, shoot us email@example.com. We love to read the reviews. Please review us on iTunes and subscribe to the show anywhere good podcasts are found. My current favor is Breaker. Thanks for listening, friends, and good investing.