Episode #218: Adam Karr, Orbis Investments, “One Of The Most Important Decisions You Make Is The Price That You Pay”
Guest: Adam Karr is a portfolio manager at Orbis Investment Management and head of the firm’s U.S. division.
Date Recorded: 4/22/2020 | Run-Time: 56:48
Summary: In today’s episode, we’re talking stocks and investment process. We cover Orbis’ investment philosophy, and the relentless focus on companies trading at a discount to intrinsic value through a bottom-up analysis process. Adam offers thoughts on the current environment and why he thinks this looks more like the .com bubble, rather than the aftermath of the global financial crisis.
We get into some of the opportunities in the market today and discuss emphasizing companies with balance sheet strength and thinking in terms of long-term, normalized earnings power.
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Links from the Episode:
- 0:40 – Sponsor: YCharts
- 1:30 – Intro
- 2:18 – Welcome to our guest, Adam Karr
- 7:36 – Orbis framework
- 9:50 – Performance-based structure
- 18:34 – Investment philosophy
- 25:42 – Sponsor: YCharts
- 26:27 – Opportunities today
- 38:42 – Bull case in disruption
- 43:24 – Deciding when to sell
- 49:50 – Most memorable investment
- 53:14 – Resources for investors
- 56:05 – Connect with Adam – orbis.com
Transcript of Episode 218:
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Meb: Hey, hey, podcast listeners. We’ve got another awesome show for you today. Our guest, join the multi-billion dollar asset manager of Orbis Investments in 2002 and leads the U.S-based investment team as director and portfolio manager. In today’s episode, we’re talking stocks, and we cover Orbis’s investment philosophy and the relentless focus on companies trading at a discount to intrinsic value through a bottom-up security analysis process. Our guest offers thoughts on the current environment and why he thinks this looks more like the dot-com bubble rather than the aftermath of the global financial crisis. We get into some of the opportunities in the market today and discuss emphasizing companies with balance sheet strength and thinking in terms of long-term normalised earnings power. Please enjoy this episode with Orbis Investment’s, Adam Karr. Adam Karr, welcome to the show.
Adam: Meb, thank you for having me, and I’m looking forward to it.
Meb: Yeah, man. Where in the world are you quarantining right now?
Adam: So I am sheltering in place in San Francisco. We’ve got a beautiful day today.
Meb: Former place of residence for me. I used to live above the Broadway Tunnel, North Beach, a few couches there and about around the city. I love that place. I almost died a few times trying to learn to surf in Ocean Beach, but otherwise, a beautiful city.
Adam: You gotta come back.
Meb: I know. I do. I do. Once this is all over, hopefully, soon. While we’re recording this sort of mid, late April, I wanna get into a lot of interesting stuff today. First, give us a walk-through. What are you up to? What was the path? You’ve been at Orbis for a while, leading portfolio management duties there, but what brought you there?
Adam: So I’ll talk Orbis first, and then I’ll talk about the longer path. I’ve been at Orbis… I’ve been investing for 25 years, both in the private and public markets for the last 18 years with Orbis. I joined Orbis in 2002. Today, I’m responsible for our U.S. efforts for the firm. I’m one of the five capital allocators or PMs for our flagship global equity strategy, and I also sit on our global management committee, which I had done for many years. My team and I are based in San Francisco today. But I started with Orbis in Bermuda, which is where we’re headquartered, working closely with our founders for a number of years.
But if you take it back, going all the way back, I actually first became captivated with the markets and investing going back to middle school. This is taking it back to the late ’70s or early ’80s. I grew up in Illinois, the south suburbs of Chicago, and I spent a lot of time growing up with my grandfather, who was really my hero, the hardest working person I’ve ever known. He was a janitor, and he was responsible for caretaking a local savings and loan. And I used to go with him every night to help clean the bank, and I’d mop the floors and dump out the wastepaper baskets.
And I guess it was in other people’s garbage that I found treasure. But there was this odd-looking newspaper with these funny looking dot matrix headshots of people, so, of course, that was “The Wall Street Journal,” which wasn’t a newspaper that I would normally have access to. I’d love to pull it out of the garbage and try to understand the stories and was just kind of captivated by it from an early age. On Friday nights, we didn’t have to go to the bank because we could clean on Saturdays and we used to watch Louis Rukeyser’s “Wall Street Week” on Friday nights, and I think it was really from then that it just captivated my interest in markets and investing.
I went to college later. I started as a psych major, just always fascinated in how people think and what makes them tick. And I started to get worried that I needed to be gainfully employed, so I switched my major to econ with a minor in psych. And looking back, it’s interesting. I mean, it was kind of, they didn’t call it this at the time, but I guess it would be behavioural investing, just a wonderful marriage of two things that have always really interested me.
And then after finishing in college, found my way to Wall Street, worked for a firm called DLJ, the old Donaldson, Lufkin, and Jenrette. This is in the early ’90s, just a fantastic place, a really entrepreneurial culture and a lot of the folks there who are from Drexel. DLJ had a merchant bank at the time, and that was my first shot at professional investing and really solidified for me that that was the path forward. And then after DLJ, I went to business school, coming out, helped start a private equity firm and did distressed turnaround investing for about five years. But the public markets just continued to call, and it was in early 2000s, I think in 2002, that I switched from the private market side to the public market side and joined Orbis and been doing that for the last 18 years.
Meb: Oh, man, you touched on a couple of great names and remembrances. You know, one of my favourite fintech ideas from about 10 years ago was kind of Rukeyser 2.0, for someone to take the mantle and kind of run with it. And I think Scaramucci ended up…or Scaramucci ended up buying it and trying to relaunch it, “Wall Street Week.” I’m not sure if it’s still active or not. Always one of my favourite ideas. Content in the financial space has somewhat moved more towards video and podcasts again, but it’s interesting to see. A more important question, has The Journal done a dot matrix on Adam Karr yet?
Adam: I haven’t seen it. I should go maybe, but I haven’t seen it.
Meb: Yeah. We’ll see. We’ll have to frame it when they do. Well, that’s fun. So, ’02, would you have been in Bay Area at that point or whereabouts?
Adam: Yeah. So I was in New York up until that point and then moved from New York to Bermuda, which is where Orbis is headquartered. So I spent about six or seven years there and then in 2008, to build out the U.S. efforts for Orbis, I moved to San Francisco.
Meb: Okay. Because I would have been there in ’02 during the somewhat internet winter when the original bubble that I loved popped in the late ’90s, internet and biotech, and watched the Armageddon afterwards, and of course, a million amazing businesses getting built during that time, which is probably a lot of…rhymes with today. All right. So talk to me about Orbis because you guys are a little different. You have an untraditional structure. Maybe talk a little bit about your sister company and explain how the big framework of the company is built.
Adam: Let me tell you a little bit about Orbis and then we can dig in, perhaps more deeply, in some of the elements of how we’re different. So, Orbis is in its 30th year. We were founded in 1989 by Allan Gray. Allan also founded our sister company, as you mentioned, in South Africa, Allan Gray Limited, in 1973. So what is Orbis? We’re a global equity specialist. Today, we manage about 28 billion in AUM across the globe through a handful of long-only absolute return and multi-asset strategies. Orbis Global Equities, our flagship strategy, represents about 60%, 70% of our total AUM. The vast majority of our AUM is institutional, with some retail in Australia and the U.K.
Our investment approach is pretty simple. We strive to buy assets at a meaningful discount to their intrinsic value. And I emphasize the term “intrinsic value” because we’re not your classic deep value manager, who just buys low price to book multiples. We think more holistically about the true value of each business and really aim to buy where there’s some kind of dislocation. This very much ties to my roots as a private equity investor, thinking about a business holistically as an owner.
We’ve got a deep team of analysts across the firm, almost 40 around the world and we’re of the mind that to generate alpha, you can’t follow the crowd. You have to think and act differently. Our equity strategies are unconstrained, and they often look quite different to the benchmarks as they do today. We typically run pretty concentrated. There are about 60 holdings in our global strategy with active share above 90%. You touched on some of the differences. I think that one critical and really unique aspect of the firm is how we strive to align interests and reinforce our investment philosophy. And that’s, from the beginning, all of our fee structures have been performance-based and in our institutional accounts, we offer refunds in the event of subsequent underperformance. So, Orbis, in a nutshell, we’re contrarian, intrinsic value equity investors.
Meb: So that’s pretty unique, the refund mechanism. And to be clear, you guys have… Is it majority, you know, institutional, separate accounts, sort of private fund business? Do you do any public funds, too?
Adam: So the vast majority is institutional. We do have some retail, as I mentioned, in Australia and in the U.K.
Meb: And what’s the general reaction towards that sort of structure? I mean, are people pretty positive about it? Are there a fair amount of people that just shake their head and say, “I can’t do it. My board doesn’t want it?” Like, is there any general feedback you…? Because it’s curious because this goes back to like the days of the Buffett Partnership 70 years ago when he was doing, maybe not that long, 50 years ago, when he was doing performance-based over a hurdle, sort of ideas and it’s… The world, for the most part, hasn’t adopted a similar model. But it seems fairly obvious, and it makes sense from both sides of the conference table.
Adam: Yeah. It’s interesting. Let me… It probably would be most helpful if I just talked about the principles first and then I’ll talk about some of the mechanics. So in a perfect world, our view is that a client wouldn’t pay any fees until they redeem, at which point they’d pay on the value-add. You’d just agree on what that split would be. In practice, though, that’s difficult because managers need to pay bills. But that’s the key principle behind our approach. So all of our fees are performance-based, and we refund when we subsequently underperform.
The best example for us is what we call our zero-based fee option, which is for institutional clients of size, and so they pay no base fee, zero-based fee, and they only pay a performance fee if we deliver alpha. And the sharing ratio is two-thirds to the client and one-third to us as the manager of the value-add or the alpha. But of those fees that we earn, they’re all subject to a refund if we later underperform. And so from a firm perspective, it’s interesting because it very clearly signals and means that we can’t survive unless we actually generate alpha, and that’s part of the alignment that we think is incredibly valuable. You know, we can’t guarantee that we’re gonna generate alpha, but we can guarantee that we’ll be aligned with you and that we’ll feel the pain with you in those periods when we underperform.
So we first launched the fee, the refundable fee, in 2004, so we have, you know, a decent amount of experience with it now. But I have to say, clients were quite sceptical in the beginning. I think the initial reaction was one of, “Hmm, you know, there must be some kind of gotcha in there. This must be better for you in some way.” And we really spent a lot of time and effort articulating the alignment. Now that we’ve had experience with it, I think our best ambassadors and advocates have been our clients that have been on the refundable fee. And it’s got elements to it that I think are obvious, in the sense that, we don’t have any lockups or gates on our capital. We never have. But what happens in practice is that when we go through a period of underperformance, clients are looking at their statements and they’re seeing those accrued fees that are in their trust accounts that can flow back to them during this period. And number one, that dampens the under-performance, which is good. And number two, it slows their desire to want to redeem and redeem it at a time that usually is an unattractive time to do it. And that’s ideal for both of us. It’s ideal for them, and it’s ideal for us.
And, I mean, one of the things that’s always struck me is just you look at the behavioural gap or behavioural penalty in this industry, and people just obsess over fees to the basis point and will switch managers for a five basis point. The much bigger prize is that alignment and that behavioural gap. I’ve seen studies that say that that can be as much as 2 to 300 basis points between what a manager’s actual track record is and what the clients have realised because they’re buying in at the wrong time and they’re redeeming at the wrong time. And the alignment of this really tightens out, and it is something that we measure as a firm, and it acts as a natural gate to slow that emotion or behaviour in the times when it could be most detrimental. And we as a manager in those periods when we’re underperforming, I mean, that’s when we don’t wanna take redemption so that we can stay in the positions that we have and ride through those periods. So it’s something that we’ve really come to appreciate.
Now, to your broader question, what are the challenges? I think a couple. Number one, it’s different. There are a lot of agents in the industry, and when something is different, that’s more difficult to explain. It takes longer, it looks different, it’s more complex, that can be a challenge. There’s the issue of the, you know, the expense ratio. It moves around quite a bit. That makes it more challenging. And so if you’re an agent for a fiduciary, that’s something that could be more challenging for you.
The more interesting question, though, is, why don’t you see more managers do this? It’s difficult to do. Think about it, I mean, when we first launched in 2004, I mean, we had to go through a multiyear period where we had to reserve on our own balance sheet so that we could create the financial stability to weather through the volatility that it would generate for our own income stream. You know, that could be a difficult thing to talk through in a partnership. And so, I can see why other managers and institutions may not want to do it. But I think our perspective was, difficult in the short term, but in the longterm, it can be quite beneficial. And we saw that. We saw that in 2008 when we went through a period of underperformance. We’ve seen that more recently, whereby if you look at the redemptions that are taking place in the industry relative to what we’ve seen, we feel really grateful for the alignment that we have with the clients.
Meb: Yeah. I mean, it’s having the client-investor alignment and getting everyone on board is probably the number one, most important thing in investing, and there’s ways to try to do it. You know, there’s certainly a lot of modern nudges and systematic ways that the robo-advisors are trying it, but also the most traditional being, of course, a financial advisor. But, you know, many advisors and institutions are susceptible to the same seductions of chasing performance. Most of the academic literature shows that, you know, even the institutions, the hiring and firing decisions are based on one to three-year performance, which tends to be the exact wrong time frame to try to make those. So having the right structure in place to keep people from doing dumb stuff, being the technical phrase, is, you know, probably the most important thing that swamps almost everything else we’re gonna talk about. But it’s the least fun and sexy part for sure.
Adam: There’s one other thing I’ll say, too, which is just, I’m a big believer in incentives, and when I’m looking at a new perspective situation, I wanna understand the incentives. And so, what are the incentives for you as a manager if you’ve got a fixed fee? It’s to grow your AUM. And I think the incentives embedded in that… The penalty for underperforming are much greater than the reward for outperforming and so you’re probably gonna wanna stay closer to the benchmark. And your incentive is gonna be to create the marketing machine around it to grow your AUM because time as a scale in this business is not fantastic.
On the other side, if you do have a performance fee, it’s most traditionally a high-water mark, and that can’t be aligned until you underperform. And then when you underperform, it’s quite asymmetric because the manager is either gonna close shop and start over so they can restart with the new high-water mark or it’s quite a strong incentive for them to take a lot of risks so that they can get back on top, which isn’t a particularly good incentive, either. And so just the inherent incentives of this is something that we think is much better.
Meb: Yeah. And on top of that, you know, you’re quickly having a world that’s barbelling in sorta two different offerings. One, a bank in New York recently announced they have a straight-up, zero-fee, large-cap equity and bond ETFs. And, you know, when you have that sort of world where the beta or market-cap-weighted is free, if you’re gonna charge 50, 100, 200 hundred basis points, you better darn well be pretty weird, concentrated, and different, or at least generating alpha in a way that’s not…like you said, sort of, like, the, a lot of these huge AUM closet indexers because you just end up with the S&P at a much higher cost, which is what nobody wants.
All right. So let’s talk about investing. You know, you guys have a process you alluded to a few times as traditional value investing with a little bit of a contrarian bent, but you also said that you’re not just doing price-to-book investing of French pharma and, you know, 50 years ago. Talk to us a little bit about your framework. How do you guys approach a securities selection?
Adam: Yeah. So I’ll kind of talk about our structure first, and then I’ll talk a little bit more deeply about our investment philosophy. So the number that I alluded to, there’s a number of things about Orbis that I think are relatively differentiated, from our fees to our ownership structure, but it’s really, as I think about it, it’s a number of things working together. No doubt, you’ve heard of the Flywheel Concept from Jim Collins. It’s something that I try to think about or think through or understand as investor when I look at a prospective investment, but it’s also helpful to think about it for our own firm. And for us, that starts with, what’s the value for money that we’re delivering to clients? Which is a combination of the alpha and the client surface…client service.
Going back to our founder Allan Gray, his premise was that, “To generate a meaningfully superior long-term returns, you need to think differently. You need to turn the problem upside down and come at it completely differently.” So that informs kind of how we go at it and how we’ve structured ourselves. So number one is you have to attract and retain independent and unconventional people. I’ll come back to that. Number two, you have to structure the firm, its values, its cultures to reward differentiated thinking. Three, you have to seek and nurture, align clients within line incentives, kind of the fee stuff that I was just talking about. And then four, you have to structure the firm ownership to promote long-term differentiated actions. And all four of those work together as a flywheel.
So let me give you examples. So all of our analysts manage their own paper portfolios. After they’ve been with us for a call of 12 to 18 months, we ask them to manage a paper portfolio. And the point of that is to attract independent people and create an environment where they can express themselves independently rather than the more classic model of trying to “pitch,” you know, a PM on their best idea. It also gives us a mechanism to objectively track all of their decisions. We’re maniacal about process and attribution, and it gives just a wonderful mechanism and tons of data to scrub for the analyst themselves to look at and analyse how they’re making decisions, but for us to think about who’s making the best decisions and put them in positions to manage capital.
There’s also an interesting self-selection element to that, that when I’m recruiting, and I talk about this, you know, you can see a physical reaction from a prospective candidate. You know, some of them, literally, lean in and they’re like, “Really? You do that? I’ve never heard of that anyplace else.” And you can tell that they’re drawn to that, whereas some people, you can tell they’re intimidated by it, which is great to identify that upfront.
Then the second example is in terms of the fees. It’s just really the alignment and making sure that we are able to align with clients that allow us to be in differentiated positions. As a contrarian manager, we’re definitely gonna go through periods where we’re out of sync with the market. That’s a feature of what we do, not a bug, and so creating a fee structure that binds that together is something that we think is pretty valuable.
And then the last piece is just around the ownership structure. We uniquely are owned by a charitable trust established by our founder and his family. So we, the firm, Orbis, will be held in perpetuity, privately, and that’s a luxury. It really structurally empowers us to make and stick with long-term contrarian decisions. It kind of comes back to the discussion around fees and refunding them. Like, that would be a very difficult thing to do for a lot of firms, but given our ownership structure, it puts us in a position to do that. And so it’s those things working together that all reinforce the investment approach that we have.
So I’ll dig in a little bit about, specifically on the investment philosophy. So, as I said, we’re intrinsic value. I guess the first thing and the most important thing is price matters. You know, one of the most important decisions that you make is the price that you pay. We spend a lot of time thinking fundamentally about what a business is worth and taking a longterm perspective. When I say that we’re underwriting to a four to five-year investment or a hold period, we’re not didactic volume managers at all, where we’re just buying statistically cheap stuff. And I actually think that that can lead you to some bad areas, your classic value traps, where you’re seeing secular change. And we believe very much that investment decisions are driven best by bottoms-up research, not top-down macro forecasting. We don’t have a macro firm view. And we try to go to the area, we’re kind of firemen, we go to the areas where we see fires, and we try to see if we can find, you know, really compelling opportunities there.
I’m hesitant to use this phrase because I think it’s overused, but I get asked this by clients often, like, “What’s your edge?” So I try to think about it in three dimensions. The first is analytical edge. Actually, I think it’s most difficult, particularly with acceleration of machines and AI. But I do believe that there is something to cumulative knowledge and pattern recognition, and there’s opportunities to play on that. I mean, one example for us is we’ve invested in managed care companies. We do that pretty much every four years through the election cycle when investors get nervous about their future. But the analytical side is one that is probably the most difficult and continues to get narrower and narrower.
The second pillar is behavioural, and this goes back to kind of what I was talking about my roots in college and where I try to live, and I think would be most enduring as an investor. We’re driven by emotions and fear. No better time than now, as an example. One of the things that I’ve always said to the team is, “It works because it hurts.” I think some of the best investments that I’ve made over time have been the ones that have been the most difficult to make in the moment, and that’s because you’re leaning against those behavioural biases. And, you know, when you’re in the midst of a lot of uncertainty and casts, those are when it can be really powerful.
And then the third piece is what I call structural, and it relates to time horizon. We talk about it as time arbitrage, and that’s just the ability to take a longer-term view. We’re not gonna outsmart anybody calling the quarter or maybe even the performance over the next year, but I think we can play to taking a longer-term view on how a business will evolve. But you do need an ownership structure. You need a client base. You need incentives within your teams to allow you to take those actions. And it’s kind of those three pillars together that we really try to play on as we invest.
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Meb: Yeah. So, you had a great quote, which I’m gonna read and see if you can attribute this to you. So you said, “While it’s helpful, often helpful to ignore the noise, the one thing you can’t afford to ignore is valuations. If you’re gonna identify a good business trading in the low multiple, you can look forward to both earnings, growth, and potential rerating as you slumber. If nothing else, you can reduce the risk of paying too much and waking up with a permanent loss of capital.” Maybe talk to us a little bit about what some of the opportunities are today. You know, are you guys finding a ton of opportunity? Are you not finding much opportunity? And if so, where might it be?
Adam: The headline is, I think right now is an incredibly exciting time to be a fundamental active investor. Now, as I say that, I do expect absolute returns to be lower going forward than what we’ve experienced in the past decade, no doubt. I mean, the S&P is compounded, I think, what, 14% since 2009, well, well above average and so as we look forward, I think absolute returns will be lower, potentially, meaningfully lower. That said, I think the opportunity sell for relative returns, in particular, has improved.
There’s tremendous uncertainty in the world right now and in times of uncertainty, to my point around time horizons, time horizons compress quite a bit. Every company…not every company, pretty much every company that I follow, right now, has withdrawn guidance. No guidance, right? And the investment community loves guidance to the penny. And I think third, this crisis is one that is not caused by credit. This is a health-driven supply shock, and I think everybody is struggling to think through what this means and what’s the right analogue. Is this gonna be a V, or a W, or an L, or a Nike swoosh, I’ve heard some people say? And so people are struggling to find the right analogy, and as an investor, you crave dispersion. And we’re seeing some meaningful pockets of dispersion, and I’ll talk through some of that, which is all to say, I think, you know, now is a fantastic time to be a fundamental bottoms-up investor.
I think the biggest challenge for us over the past, you know, six to eight weeks has just been prioritising. I mean, stage one is all of the obvious trades, sell the airlines, buy Costco. But we’re in stage 2 now, and we had a 35% drawdown in the S&P. We’ve had a 25% rallying back up. Interestingly, we’re only 15% off the previous all-time highs. But, there’s a lot of dispersion in the market, and I think making those relative calls fundamentally bottom-up are where the opportunities are.
And if you think about this relative to past crises, and we invested through the dot-com bubble, we invested through 2008, 2009 and a number of other smaller ones, to me, this is much less like 2008, 2009. And I think in late 2008, you could have kind of bought anything. Everything was really cheap and done well. This is a lot more like the dot-com bubble. And what I mean by that is there was, you know, one segment of the market, the internet companies that were gonna change and revolutionise the world on one side, which were extremely expensive, and on the other side, you had your cheap Staples, your tobacco stocks, that were left for dead because “the world had changed.”
As I look at the environment today, it’s much more similar to that, in that, you’ve got a two-tiered market, a tale of two cities. On one side, you’ve got your large-cap, disruptive growth companies, think Zoom, Amazon, others, and also those with, you know, very high perceived safety and low volatility. And those two categories of stocks are quite richly valued, in our opinion. And on the other side is anything that might be perceived to have economic uncertainty, economic sensitivity. And the dispersion between those two is quite high.
We had a good chart in our last client communication where we look at the gap between the most expensive half of the market and the least expensive half of the market and we just… It’s based on a proprietary model that we have. And we take each stock individually in a footsie roll index, and we look forward, we’d say, take a normalised growth rate, a normalised margin, a normalised multiple, and you have an expected return. You do that for each stock, and you take the bottom half versus the top half. And the spread between those 2 is wide as it’s been going back to 1989. It’s even wider than 2008, 2009 and what we saw in the dot-com bubble. So that dispersion is really wide. I mean, it was wide coming into this. If we were to have this conversation at the end of 2019, I would have said the same thing. But it’s blown out through this COVID crisis because the desire to be in those perceived places that are safe or that will grow with certainty.
One of my favourite examples is Nestlé versus BMW. So both are good companies. Both are excellent companies. If you look, historically, Nestlé is traded at a premium to BMW, and as it should, it’s got a higher return on equity, it’s got more stable fundamentals. But if you look over the past 30 years, that premium that Nestlé has traded to BMW has been about 2 to 1 over a 30-year period. If you looked at the end of 2019, that premium was about 8 to 1, and if you look at today, it’s 11 to 1, right, 11 to 1. And so it’s just blown out, and just investors are planning a steep price for stability, and that’s the dispersion in the market that we see and those are the opportunities that we’re trying to capitalise on and go after.
Meb: Yeah. Having the ability to have a longer time frame and horizon certainly can give you a lot more flexibility. You know, so many investors will reach out to me over email or Twitter these days and say, “Meb, I saw this, that, and the other, a fund did this over the last week or a month or a quarter.”
Man: [inaudible 00:32:45].
Meb: And my response is always, “Oh, you think that’s bad? It can get way worse.” You know? Or even on individual security levels, so many of these things play out over, you know, such long time horizons. I mean, I did a tweet the other day that was very unpopular, right? I said, “Look, you know, there’s probably no more uniform belief in all of investing than stocks beat bonds, but kind of at the depth of the first quarter stock drawdown, you know, long-term stocks and long-term bonds in the U.S…” And obviously, this probably won’t be repeated because of the major move in interest rates over the past 40 years. “I had pretty darn similar returns.” And I said, “Forty years is a long time to wait for an equity premium.” And, you know, it’s the… Some of these ideas, the ability to take a step back and take advantage of other people being shortsighted, I mean, like you mentioned BMW and others, is what can generate a lot of the alpha.
Talk to me a little bit about… Are there any other names or sectors or industries or regions or anything that you guys think are either illustrative of your investing framework or that you think there’s potential opportunity or any potential minefields, too, value traps?
Adam: Definitely some minefields and value traps. So just kind of extending the thread that we were on, you know, we do think that the U.S. looks relatively expensive relative to the rest of the world and emerging markets, in particular. There are a lot of ways to combat that from a valuation perspective. One way is looking at the, you know, the Shiller CAPE in the U.S. today, right now, I think it’s trading 26, 27. You know, that’s on the rich end, but it’s definitely been more expensive. The more interesting side of that is looking at EM, which is trading about 10 times on the CAPE and trading right at it’s kind of trough bottom levels, and that relative opportunity we think is really attractive.
So the MSCI World Index benchmark weight, I think is a little bit over 60%. We’re about half that, so that’s pretty dramatic as a call, geographically, and that’s informed for us looking at opportunities bottoms-up as we look around the world. We’ve got five investment teams around the world. I lead the U.S. team, and we’ve got our EM team in Hong Kong, we’ve got a Japanese team, and Tokyo and London, we’ve got a global team in London. So we’re looking at these companies, boots on the ground in each market and coming to these views. And you can look at that in individual stocks, which we see, but you can also look at it through some of these valuation metrics, which I’m referencing. And so we think that’s a pretty notable one. It reminds me a little bit, it’s not as extreme, but it reminds me, going back when Orbis was founded in 1990, Japan was 50% of the world index at the time and Orbis as a firm and our strategy, we owned zero.
Meb: So that’s a pretty big outlier. I mean, that’s… You know, and it’s so… The biggest challenge of, you talked about this earlier with fear and greed, and then Buffett and Munger often talk about the third one, which is even more damaging, is envy. And, I mean, the ’80s with Japan, you know, being a historian was such, you know, as many as are, it’s so hard to distance yourself from it and not get caught up in it.
Adam: It’s also back to something earlier I’d…it’s hard to do. I think you had a podcast recently where you, I won’t get the numbers exactly right, but the number of individuals that would redeem their manager if they underperformed for a period of two or three years or less, right?
Meb: It’s in the 90 percentile.
Adam: Yeah. Right? So, you know, if you’re offsides, which you absolutely will be, and you will be for a period of time, what’s your tolerance to grind through that? It’s low, unless you’ve got a client base and a structure that allows you to do that. But it can be extremely painful in the short term, and I think that’s part of what also allows it to get more and more extreme. And so we’re seeing that kind of U.S. versus the rest of the world, the EM, in particular, large-cap stocks have led the market. It’s been an extremely narrow market. I think 60% of the S&P return last year was driven by just 4 stocks. That’s pretty dramatic. We’re on the other side of that. It’s been painful in the short term. There is an insatiable appetite for safety and the volatility, which we talked about. So those are the themes.
I mean, how we in the U.S… I’ll speak to the U.S, so we’ve initiated new positions, both in the cable space, a large cable company that also has some theme park exposure, a large branded entertainment company that also has some theme park exposure. And you can see why in a COVID world, people are concerned about what the impact will be to those parks, and that’s fair. I understand that and appreciate it. But what we really try to do is think about, what’s a normalised earnings power for this company? Do they have the balance sheet and resilience to weather through this, not knowing exactly how long it will take? And when you do that, can you buy that asset as a sufficiently wide discount to its intrinsic value? And this crisis has popped out some of those opportunities and so that’s where we wanna jump on it. We won’t get it right in the short term, but if you’re willing to ride through that, we think it can create some meaningful opportunities.
Meb: You know, that’s interesting because that’s an area that so many people would probably say, “Oh, man, that looks so scary. Theme parks, you know, may…” That’s such a great example of something that seems really hairy for many listeners, I’m sure. They’re like, “Oh, my God, I can’t imagine.” That’s just an automatic no for me because my brother drags me, he’s got three kids, and they’ll come, and he’ll want…he uses this excuse to come out to California to go to Disney, and I’m just like, “Oh, man, please, I’ll…”
Adam: I can’t do it.
Meb: “…I’ll agree to one day, and that’s it but…” It’s fun. I’m just kidding. So talk to me a little bit about, I got a couple of following questions, just some things we talked about so far. You know, you guys have been through a few different crisis sort of environments and you mentioned you’re not top-down, but looking at bottom-up around the world and, you know, the challenge of everyone is it feels a little different. I mean, we used to joke, we’ve always wanted to write a client commentary called something along the lines of like, “It’s okay, clients, this has never happened before,” because everyone wants to put it in terms of history, but we have some crazy things going on and, like, not only a world of negative-yielding sovereigns but yesterday, we had the front months…
Man: Yeah. It is.
Meb: …energy futures go negative, which was a bit odd, and fun to watch. Are there any areas, you know, that you guys…? You mentioned that, you know, you are wary of, you talked about the theme parks as being a potential opportunity, are there areas where you’re actually like, “No, actually this seems like something where either we need to do a lot more work on, or we’re staying away from in the meantime”?
Adam: Yeah. So I should step back to… I mean, a main premise and underpin of Orbis and how we invest has been reversion to mean, and reversion, we are of the belief that reversion to mean is an incredibly powerful force. That being said, one of the most important decisions that you have to undertake every time you’re looking at a situation like that is to come to a view as to whether or not something has changed. So I’ll give you an example. As I mentioned, we’re kind of like firemen, and we’re drawn to what we think the epicentre is. And I recall at 18, 24 months ago, the epicentre was in traditional brick and mortar retail, and we were going through a number of those names and our view was, we ultimately came to the conclusion, like, actually this is secular. This is not cyclical. This is not gonna revert to mean. And we were seeing the destruction there. We looked at some of the mall-based REITs and we, you know, even though they were dirt cheap, at the time, they had gotten a lot cheaper since then, we stepped off.
But we saw an interesting, a number of the sporting goods retailers were also getting destroyed, and we came across Nike, and Under Armour, so we really started digging in there. And a really interesting story with Nike, whereby they actually were disrupting their own business model of moving away from any of the wholesale distributors and creating a direct consumer model through their own app, sneakers.com and nike.com. And the more time we spent on that, the more we were like, “This is actually really interesting.” And, in fact, the bear case here, the bear case being destruction in brick and mortar retail and distribution, for them, uniquely, could be a bull case. And we think margins are gonna be higher because you’re eliminating part of a channel, you’re gonna have more full-priced selling, more of the product is gonna be customised, so you’re gonna capture margins for that, and earnings right now are depressed because you’re making all this investment. And so you could have bought, you know, JCPenney’s that was trading at probably five times of your cash flow, or you could have bought Nike, which at the time was kind of traded in this range between, call it 21, 22 times earnings to 35 earnings, and at the time, it was trading 21 and 22 times. So right at the low end of its historical range on depressed earnings, in our opinion.
Now, a traditional value manager might not go for that, but we actually thought it was quite interesting and quite exciting. And so we started on the journey looking at the epicentre, but it led us somewhere else. If you look at some of the areas in energy, natural gas would be an example. There has been a secular change in natural gas with the advent of shale. And so looking at those names over the past, one would have thought they were cheap, but would have missed the secular change because of shale.
And as we look today, this is back to my example on theme parks, what I should have emphasized is, the first thing is we have to build conviction in the balance sheet, that they have the liquidity, they have wherewithal, they have the resilience with uncertainty as to how long this might last and what the impact will be that they can get to the other side. That’s number one. And then two, we’re gonna try to interrogate the question, does this cause a secular change? I think we’ll have a change. It will, obviously, influence behaviour in the shorter to medium term, but we are betting against that it’s a fundamental long-term change, the desire for people to support their families around branded content like that. But that’s the big question.
Meb: That’s an important question. You know, you guys have something that I think is really an interesting process where, you mentioned the paper trading, but also it’s analysis of how a PM or an analyst actually puts on the trades. And so, we talk a lot about what looks attractive, what to buy, what to avoid, but equally as important, of course, is the position, sizing, and when to sell. And so I would love to hear a little bit about your process and, you know, I assume, like many investors, you hold many of these positions for quite a long time, but talk to us a little bit about your sell discipline, but also I would love to hear how your analysis of the investments internally has resulted in any insights. You know, did any of them say, well…whatever they may be for both the team, as a whole, and you, personally?
Adam: Yeah. So it’s a fascinating question, and particularly around sell discipline. So we, I mentioned earlier, we’re maniacal about the process and data attribution in our process. And, you know, the big factor around process and the discipline is to be able to eliminate mistakes, to create objectivity, to have transparency, to use that as a mirror to yourself as an individual in terms of the quality of the decisions that you’re making and to use that as an indicator of skill for us as we’re thinking about where to allocate capital and the individuals to allocate capital behind and something that we believe in really deeply.
The sell-side is interesting, in that, I think, certainly for myself, speaking personally, I would say for Orbis, to a degree and certainly, for the industry, the amount of discipline on the sell side is asymmetric, meaning, we don’t put nearly as much thought, time, and energy, process, attribution to the sell-side. And I’ll give an example for myself, where our quantitative team did an analysis and looking at my own decisions over, you know, a pretty long time period. And, you know, I was systematically selling those companies that might be considered longer-term winners, what might also be called your compounders, your really high-quality companies and, you know, it was very clear in the data. And so, you know, I have this really rigorous discipline going in on the buy decision about buying at a certain discount to intrinsic, how you size the position, how you move that position around over time. But then on the sell decision, not the same discipline.
The beauty of that is having that tangible data in front of me allows me to then really use that when I’m thinking about making decisions, like selling a Nike or a company like that as to, “Look, let me re-underwrite this thesis from the start and underwrite the underlying intrinsic value based on all the new information I have. And what is that gap to intrinsic today? Yeah, it’s already been a fantastic investment for me, but maybe it will continue to be a really good investment.” And to hold yourself accountable to that and have the data around it, I think is something that’s been valuable and… I mean, to have a track record, I’ve never had a hundred bagger, but to have those multi-baggers in your portfolio on behalf of clients, makes a huge, huge difference. And so having a discipline and a process around that to re-underwrite them as you own them over time, I think is something that’s incredibly valuable. In some cases, it’s quite aligned with what I think is valuable, which is, do nothing, right? I mean, a lot of times we would serve ourselves better by just sitting on our hands. I’ve seen that more than a few times.
Meb: You probably haven’t had a hundred baggers because you’re not old enough, yet. You gotta weather a few more market storms. And we actually had a…one of my favourite older books, Chris Mayer, was about 100 baggers, and he did a study of all of them and finds that one of the biggest challenges, you’ve gotta hold them for a while. I mean, I think the average year for these 100 baggers in the public markets was 10 years plus and the fastest ever, yeah, I think… I’m gonna get this wrong. Apologies, Chris. But I think it was five years. It was like Monster Energy.
And Jerry Parker, the legendary trend follower has a great phrase about the challenge of holding the big winners. He says, you know, “Investors are hopeful with losses and fearful with gains.” You know, when you double your money, you’re super stoked. You’re so excited. “Oh, my God, I’m gonna go on vacation, buy another house.” Forget about if it triples 5x, 10x. But the ability to hang onto something, and the example we love giving always is Amazon, where it’s had multiple 50 plus percent declines in one of, I think, darn near 90% or 95% on the way to a trillion-dollar company. So it’s hard, which is the big takeaway.
Adam: The example I love in that is the… What is it called? The 10 can example, where, you know, just a discreet group of companies that, I can’t remember who was attributed, I think it was a capital group guy that would put in his 10 can and then he wouldn’t touch ’em, and it actually ended up outperforming his own performance in his own fund.
Meb: Yeah. The Coffee Can Portfolio.
Adam: Yeah. Yeah. Yeah. Coffee Can. Exactly.
Meb: The interesting part about that is that, and this is one of the features, I think, not bugs of private markets is the illiquidity and the fact that you can’t sell a lot of investments. And one of the reasons, we’ve talked a lot about about, you know, that real estate is such a good investment for so many individuals, not just because it keeps you from spending the money that you’d otherwise put towards your mortgage, but that it is illiquid and it’s something that people can’t look up every day and check the stock prices because if this first quarter has shown a lot of our younger listeners, that it’s incredibly stressful. But at the same time, that’s what, of course, creates the opportunity, too.
Adam: It’s powerful. I mean, it’s…I mean, that’s the lesson for public market investors is to put in place the culture, the systems, the incentives, the structures that will reinforce you leaning against those, you know, emotional factors that are…that are so strong.
Meb: Yeah. I mean, the phrase we love is “Process not performance.” But it’s certainly more exciting and seductive to talk about performance, that’s the fun part, but the process and structures probably outweigh everything else. As we look back over the past 20 years, odd 20 years-ish in public markets, what’s been your most memorable investment?
Adam: Just pulling on the thread of emotions and behavioural biases, I think we know that we experience pain much more than success, so I feel like the most memorable has to be a loser. So datelines, 2/3/2008, right in the middle of the GFC, we had a position in AIG. I’ll never forget. I had just recently moved to San Francisco, and I’m building out our investment team and efforts here. I was in the office on a Sunday evening, and I got a call from our sales rep at Goldman Sachs, and she is probably like 5 o’clock at night, and she said, “Adam, we’ve got our entire trading desk up and running, and we’re trading contingent contracts on whether Lehman files bankruptcy by tonight at midnight.” And then she said, “And we’re here to serve, just let us know if we can help.” And I remember putting down the receiver and thinking to myself just kind of how wild the situation was that we were living and how unprecedented it was.
The next morning we had an investment committee in Orbis to make a decision on adding to our position in AIG, which I think, at the time, was trading at like $2.50 a share or something like that, and we decided to add to the position, and we know the story from there. The government stepped in with senior secured debt to provide liquidity, massive dilution to existing equity holders. It was pretty painful for us. And for me, it was my position. But, it did have a number of powerful lessons, some of which I think are relevant to today.
The first is just the difference between liquidity and solvency. In the AIG situation, we spent a lot of time focused on the credit and the solvency, the quality of the assets, the underlying contracts that they wrote, their credit default insurance against these AAA portfolios, and we felt like they were good, they were money good, but, you know, as they…they were marked to market, so as they had to take marks, they had to post liquidity against that. And posting that liquidity got really sizeable and they couldn’t handle it, and so it became a liquidity issue more than a solvency issue. And I think that’s something that’s been incredibly top of mind for me. And I think it’s quite relevant right now as we’re in the midst of this crisis. All of our companies, we’ve underwritten from the perspective of liquidity, right? You need to know that they’ve got the cash to manage to do this knowing that there’s uncertainty for how long this might last.
The second, which is a little bit trite, but we have to remind ourselves it’s not just being contrarian, it’s being contrarian and right. You know, we had a view that AIG was too systemically important and the government wouldn’t impair them. They did. We were wrong. It was certainly contrarian, but it wasn’t right. And then the last also relevant today is just don’t make an investment on the basis of government intervention or bailout. I think that’s something that’s important today. Just to an earlier question, and you were talking about, are there some areas that you avoid? There are some areas in the market that looked very exposed, and without the assistance of the government will be impaired, the equity will be impaired potentially severely. So if you’re making that investment on the predicate that the government is gonna bail you out, I’d be quite cautious.
Meb: For people that are either within your organisation, but extending to the listeners, are there any sort of resources, in general, that you feel are particularly wonderful for investors at any stage, beginners, pros, whether it be books, whether it be any particularly impactful resources or ideas over the years that you think is something you recommend to people in your firm or outside?
Adam: Yeah. There are lots, but I won’t bore you with that. I’ll mention a couple. The first is “Thinking in Bets” by Annie Duke, which I love. I think just simple heuristics can be really powerful. And, you know, she talks about framing your views as a probability and… You know, for example, someone might say, “Look, I think it’s likely we’re gonna develop a vaccine for COVID-19.” Well, you know, what does that mean? Is that 20%? Is it 50%, 90%? Just asking that question, I think, can be, it’s simple, but very powerful. She also talks about motivated reasoning, which is a bias that we all have of looking for information that supports the view that you have. And being mindful and conscious of that, I think is something that I really try to reinforce with my own investment team to recognise kind of how powerful but sinister it can be in everything we do. So, “Thinking in Bets.” She’s also got a new one coming out soon, I think, called “How to Decide,” which I’m looking forward to.
The second one is “The Art of Learning” by Josh Waitzkin. I really love all things Josh Waitzkin, a chess prodigy character from “Searching for Bobby Fisher.” I think what I love about “The Art of Learning” is just, he’s all about pursuing excellence. He’s done it in a number of different fields, from chest to push hands to foiling, and just, he loves the art and craft of pursuing excellence and breaking it down at a world-class level. And, you know, just geeking out on applying that to investing is something that I’ve always really enjoyed and cherished and that’s something that I give to all of our new analysts.
And then the last is anything by Derek Sivers. I just think he’s an incredibly clear and differentiated thinker and just a natural contrarian. One of…”Anything You Want” is one of his books. He’s got a podcast, a website, TED Talks, and just the clarity of his thinking and the differentiation is something that has always energised me.
Meb: I love it. Great recommendations. I’ve listened to her on a few podcasts, but I haven’t read an Annie Duke’s book. Looking forward to it. But the parallel is certainly of speculation investing, and I don’t wanna say gambling, but playing a game when you know you have an edge or don’t, which is fine, too, but just being aware of it is, I think a great analogy. Adam, where do people go if they wanna find out, follow you, your writing, your firm, everything else? What’s the best place?
Adam: Best place, really simple, www.orbis.com.
Meb: Adam, it’s been a blast. Thanks so much for joining us today.
Adam: Meb, thank you, brother. I enjoyed it.
Meb: Podcasts, listeners, we’ll post show notes to today’s conversation at www.mebfaber.com/podcast. If you loved 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 favourite is Breaker. Thanks for listening, friends, and good investing.