Episode #272: Best Idea Show – Tobias Carlisle, Acquirers Fund, “There Are Basically Three Big Periods Of Value Underperformance And They Seem To Congregate Around These Periods Of Technological Advancement”
Guest: Tobias Carlisle is founder and managing director of Acquirers Funds, LLC. He serves as portfolio manager of the firm’s deep value strategy. Tobias is the creator of The Acquirer’s Multiple. He is also the author of the books The Acquirer’s Multiple: How Billionaire Contrarians of Deep Value Beat the Market, and Deep Value: Why Activist Investors and Other Contrarians Battle for Control of Losing Corporations. Tobias has extensive experience in investment management, business valuation, public company corporate governance, and corporate law.
Date Recorded: 11/4/2020
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Summary: In episode 272, we welcome our guest, Tobias Carlisle, founder and managing director of Acquirers Funds, where he serves as the portfolio manager of the firm’s deep value strategy.
In today’s episode, we’re covering Tobias’ best idea: small cap and microcap value. Value stocks have underperformed but Tobias thinks now they offer a great risk/reward. He walks us through historical data and research from the past 200 years and why that leads him to believe value will outperform going forward. We compare the current setup to prior periods when value underperformed in 2000 and even talk about some of his favorite holdings.
As we wind down, he touches on shorting the market and how it provides protection for long positions if the market falls over.
Please enjoy this special “Best Ideas” episode with Acquirers Funds’ Tobias Carlisle.
Links from the Episode:
- 0:40 – Intro
- 1:42 – Welcome back to our guest, Tobias Carlisle
- 1:50 – Previous appearances:
- The Meb Faber Show Podcast – Episode #158: Tobias Carlisle, Acquirers Funds, “The Way To Get The Best Performance Is To Concentrate Into Industries When They Get Cheap”
- The Meb Faber Show Podcast – Episode #77: Tobias Carlisle, Carbon Beach Asset Management, “In Order To Find Something Genuinely Undervalued…There’s Always Something That You Don’t Like”
- 3:29 – Best idea; DEEP Fund on microcap and small cap value companies
- 4:00 – Deep Value: Why Activist Investors and Other Contrarians Battle for Control of Losing Corporations (Carlisle).
- 5:36 – Overview on value in the market
- 9:31 – The Acquirers Podcast
- 11:39 – Range of their small cap targets
- 11:51 – The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success (Thorndike)
- 14:24 – Predictions for the market
- 19:33 – 2020’s impact on small cap
- 20:14 – Is (Systematic) Value Investing Dead? (Asness)
- 23:34 – Where value crowd falls on price-to-book
- 27:14 – The momentum market today
- 30:39 – The DEEP strategy and some companies they are interested in
- 30:41 – Invest With The House: Hacking The Top Hedge Funds (Faber)
- 41:10 – Nervous About The Market? It Might Be Time for This Strategy (Faber)
- 43:53 – The Meb Faber Show Podcast – The Best Investment Writing Volume 4: Rob Arnott, Research Affiliates – Bubble, Bubble, Toil and Trouble
- 48:05 – Avoiding strange accounting practices
- 48:56 – The landscape for shorting in the markets
- 54:01 – The Meb Faber Show Podcast – Episode #262: Ihor Dusaniwsky, S3 Partners, “When People Say ‘Shorts Only Kill The Stock Price’…No…There’s A Two Way Street In Their Activity”
- 55:40 – Memorable trades over the past few years
- 57:07 – Using SPACs
- 57:47 – The Meb Faber Show Podcast – Episode #263:Best Idea Show – Julian Klymochko, Accelerate Financial Technologies, “The Purpose, And What We’re Really Seeing The SPAC Emerge This Year For, Is To Truly Raise Growth Capital For Growth Businesses”
- 58:35 – Closed-End Funds
- 1:00:58 – Bill Ackman Fund price
- 1:01:50 – Strategy hedge fund in the future
- 1:04:30 – Private investment tax benefits today – Qualified Small Business Stock
- 1:16:19 – The Meb Faber Show Podcast – Episode #177: Alex Rubalcava, Stage Venture Partners, “We Want To Help Build Companies That Are Solving Hard Problems That Matter”
- 1:06:34 – Connect with Toby: @greenbackd, acquirersmultiple.com, The Acquirer’s Multiple: How the Billionaire Contrarians of Deep Value Beat the Market, acquirersfunds.com
Transcript of Episode 272:
Welcome Message: Welcome to “The Meb Faber Show,” where the focus is on helping you grow and preserve your wealth. Join us as we discuss the craft of investing and uncover new and profitable ideas, all to help you grow wealthier and wiser. Better investing starts here.
Disclaimer: Meb Faber is the co-founder and Chief Investment Officer at Cambria Investment Management. Due to industry regulations, he will not discuss any of Cambria’s funds on this podcast. All opinions expressed by podcast participants are solely their own opinions and do not reflect the opinion of Cambria Investment Management or its affiliates. For more information, visit cambriainvestments.com.
Meb: Hey, friends. Today we have another installment of our best ideas series. Our guests, the Founder and Managing Director of Acquirers Funds, serving as a portfolio manager for the firm’s deep value strategy. Today’s episode we’re covering our guest’s best idea, long micro-cap value stocks. Value stocks have underperformed, but our guest thinks now they offer a great risk-reward. He walks us through the historical data and research from the past 200 years and why that leads him to believe value will outperform going forward. We compare the current setup to prior periods when value underperformed in 2000 and even talk about some of his favorite holdings right now. And just to be clear, we recorded this in early November before part of this massive value run-up. I think there’s a lot to go. As we wind down we touched on shorting the market and how it provides protection for long positions if the market rolls over. Please enjoy this special best ideas episode with Acquirers Funds, Toby Carlisle. Toby, welcome back to the show.
Tobias: Thanks, Meb. Always a pleasure.
Meb: Is this number three, number four?
Tobias: It is number three.
Meb: You may be our number one most invited back guest. I don’t know why that is.
Tobias: I invite myself back.
Meb: I was kind of hoping, I’m not going to lie, that you were going to show up in your scary Halloween outfit. Will you tell the listeners what that was?
Tobias: I left Hugh Henry back when he was beating up on all of the Eurozone bureaucrats about how they fly first class and he had the red glasses. And I used to just say to my wife, “This guy is a funny guy. He’s kind of hilarious. And I love his strategy. He’s got that short kind of blow-up type strategy. And he’s had some time in the wilderness because it’s been tough to run short, biased, blow-up type funds through an incredibly long, probably long in the tooth bull market. And I follow him on Twitter and I just… I’ve seen his real vision appearances as well. And I just love the person that he’s evolved into away from the pinstripe and the red glasses into that kind of trucker hat, baseball shirt, long hair, don’t care kind of attitude. And so I had those pieces lying around, including some white sunglasses that you gave me, funnily enough, and kismet all came together, so I threw it on and I looked exactly like he did.
Meb: Did anyone recognize… I mean, you weren’t, like, trick or treating with this because that would be so great if anyone could possibly recognize and identify that that’s, like, only on Fintwit.
Tobias: And that was why I posted it because my kids didn’t get it. They were completely baffled by how it was and what a hedge fund manager. My son thought that was some kind of animal, like, a hedgehog. He went dressed as a bat. And that was not any commentary on Coronavirus or anything like that. That was just because he likes bats.
Meb: We had Captain America. All right. So, despite the fact I feel like we would have exhausted all possible topics of conversation, your fourth, third, fifth time on. We’ll link to those in the show notes, by the way, listeners. Toby, what’s your best idea right now.
Tobias: We’ve recently taken over a fund. I’ve partnered with the Roundhill guys who have some interesting funds. There was a competitor, the old…the deep value fund. We’ve taken that over and we’ve changed the ticker and the strategy. So, the ticker is now DEEP, D-E-E-P, which is a theme for everything that I have done because I wrote a book “Deep Value.” And that’s my investment style. And we have transitioned the strategy from it. It was a very concentrated, large, deep value strategy. Very similar to that strategy that I run in the Acquirers Fund, which ticker is ZIG there. ZIG is long-short, and this was long only. So, now we’ve transitioned it to a small and micro fund.
So, basically, it focuses on the smallest 75% of companies listed in the U.S. We go through those companies and look for cash-rich balance sheets, solid cash flows, buying back stock. So, management is doing the right thing at recognizing the undervaluation taking steps to sort of capitalize undervaluation. And the portfolio tends to be about 100 names equal weight just for the fact that small and micro companies tend to be a little bit more volatile and a little bit more risky, balance sheets aren’t quite as good as mid-cap and large-cap. So, try to have a little bit less exposure to them. Management teams aren’t generally as seasoned or professional as they are in mid-cap and above. And there’s just… There are other idiosyncratic risks in them because they tend to have one line of business and they’re just often earlier on. Sometimes they’ve been around for quite a long time, but they are just a slightly riskier fund, but it sort of cuts both ways that they get very undervalued because they’re not as heavily pursued as mid-cap and large-cap. And we try to capitalize on that undervaluation. That’s the plan. So, they’re about 1% equal weight at initiation. We look after the portfolio on an ongoing basis and I think it’s a good time for it.
Meb: I was kind of hoping you were going to call it the deepest of all value, fun with ticker names. The value conversation is well known, the maligned value investor, not just domestic but global, or really anything other than U.S. large-cap and particularly the tax. Give us the macro backdrop for context listeners who’re recording this the day after the election or probably by the time this gets published three weeks before anything has been resolved. Who knows? I think a lot of the value investors are at least hoping to the horizon and there may be some sort of catalysts that would transition this long period of pain into something more livable. Give us the backdrop. What’s going on right now? Why is this such a good opportunity?
Tobias: There’s a great bit of research done by Mikhail Samonov, Two Centuries. I don’t know if you’ve seen that one, which he looks at 200 years of value outperformance, underperformance. And he stitches together Fama French data set, which starts in 1920 with the Cals commission, which was 1875 to about 1920 or ’25. And the Cals commission one is the famous one that Alfred Cals put the results on punch cards, so, like, an early use of punch cards. And he was trying to figure out if any investors had skill. And he concluded after doing this analysis that no investors had skill, which is kind of an interesting conclusion.
But Ben Graham refers to this data set in some of his writings and he says that he went back and he looked at the performance of the value stocks in there and he found that they generated about 15% a year of outperformance, which is very, very material performance. And then there’s another bit of research where somebody has gone back and looked at the surviving annual reports of companies listed from 1825 to 1875. And they’re not looking at book value because there was very little in the way of financial statements published. The only analysis that they could do on a value basis is the dividend yield. So, dividend is an imperfect yield, but it’s a reasonable rough proxy. If you don’t have anything else, it’s pretty good. High dividend yields might indicate value load and dividend yields make it look more expensive.
So, they track it from… They stitch these three data sets together to track from 1825 to the present day. And they find that there are basically three big periods of value underperformance. And they seem to congregate around these periods of technological advancement, these booms in the States. So, there’s one right at the very beginning of the data set in 1841. And the significance of that date is that’s the invention of the telegraph. And so until that time, information had to travel around the world on sailboats and information got to you as fast as a sailboat was blown across the ocean, which is not very fast. And then the subsea cable came in, they got it almost instantaneously. So, that triggered a value bust relative to the tech boom.
There was another one that ended in 1904. It was down 59%. Value had trailed. They grow their stocks by 59% to that point. And that was at the end of the long depression. And then there was another one most recently. The 2000 bust was not as bad as this one. The 2000 bust was significant, but didn’t kind of approach this one. We’re now at 60%. So, this is the worst bust for value in the data. It’s lagging behind the growth year on-ends by an incredibly wide margin.
So, when you look at things that are sensitive to value, small and micro is particularly sensitive to the performance in value. So, it’s down a great deal. Any back tests that you run including small and micro, or value and small and micro together leads to this decade-plus of massive underperformance.
But it’s not all bad news because when you look at the constituents of those portfolios, their constituents have got cheaper and cheaper. There’s a reasonable argument to be made that somewhere between 2010 and 2015 value had become so popular that it was crowded in too. And there were lots of guys. So, a friend of mine colleague on my podcast, Jake Taylor, wrote an article in 2015 saying it’s the worst value opportunity set in 25 years because that was the data that he had. And basically, his argument was that the dispersion between the overvalued or the expensive and the undervalued was so tight that you really weren’t being compensated for buying these slightly worse businesses, which is value is a handicapping kind of approach. You are getting a slightly worse business, but you’re getting a much cheaper price. So, you’re sort of weighing those two. So, he said, “It’s unlikely that we’re going to have some bad performance.” And that’s exactly what happened. You can listen to AQR’s Cliff Asness says exactly the same thing.
Basically, the upshot of all of that is that value is probably appropriately punished for something like five or eight years of the last decade as it got cheaper and cheaper. But now the spread has gone back to historic wits. When the spread gets very, very wide, what that typically means is that the forward returns for value tend to be better. So, I think that the two best opportunities in the market right now are small and micro value and the spread between the very overvalued and the very undervalued. Because the spread right now is driven by a long side that’s never been more expensive, but a short side that is cheaper than average, but it’s not as cheap as it was in 2000.
And the other thing that happened in 2000 was the stocks that got sold off, they actually had a higher return on assets than the expensive stocks. So, there were actually better companies. Now, they’re not as good, but they’re still better than they’re being priced in the market. So, I think that there’s a huge opportunity long any kind of value, but particularly in the small and micro and particularly in the long short.
Meb: You’re starting to also see value liquidation. You’re seeing capitulation on funds. And like Julian Robertson sort of sighs there was a couple of weeks ago, $10 billion funds shutting down that traditionally had been value investors, not insignificant amount of capital. And those funds shutting down continue to push things in one direction to eventually… Hopefully, there’s a reckoning and a reversal. A lot of investors probably would scratch their head when you talk about large, medium, small means different things to different people. What’s sort of the range you’re looking at when you say small, micro, large, medium that you’re sort of targeting for this fund and as well as ZIG?
Tobias: So, ZIG is the largest 25% and it ends up being about mid-cap. So, $2 billion-plus and above. So, there’s no upper cap on ZIG, but just by virtue of the fact that if something is undervalued relative to its earnings, it tends to be of lower market capitalization. So, it tends to cluster around the $8 billion average market capitalization range, which I think is a good place to be because for ZIG, in particular, the professional activists or professional private equity investors who hunt in that sort of range because that’s a place they can put enough capital to work, they can take that private. And so there’s professional management. They’re well resourced. It’s a good, safe place to hunt for names.
Below that level in a small and micro, so micro might be below about 300 million, the fund itself has a floor of $75 million in market cap and that’s driven by NYC listing standards. And then it’s up to about $2 billion. And all those things are moving around all the time, but that’s roughly the cut-off. As I was saying before, they tend to be… They can be one-product companies. They may be run by the entrepreneur founder who may not have a background in finance. The background might be inventing, it might be engineering. Not that there’s anything wrong with that, but that’s a focus on product and the business rather than a focus on the stock price and valuation. And the reason that that’s significant, so, in a previous life, I was a lawyer and then I was an activist for a while, it was striking the number of times that we would go into a small company that was run by a founder engineer and just say, “You’re incredibly undervalued and you look like, over the next three or four years, you’re going to be materially bigger and you’ve got this opportunity right now. You’ve got some spare cash. Why don’t you do a buyback?” And I would just sort of no one would have said that to us before, we never thought in those terms because they don’t think about that. It’s just you’re so close to the business it’s hard to think about the valuation.
Meb: Well, it’s, like, you guys have talked about this a lot on your podcast about this concept, the book, “The Outsiders” and others, like, the CEO job, the sexy part, what many founders are as they’re product developers, they’re scientists, they’re engineers. They build the company, maybe sales or whatnot. And then you have arguably equally, if not more important, as the capital allocation, particularly, when you get to be public and you can move a lot of these different levers. For value creation, in many cases, that’s equally if not more important. It’s just kind of boring. It’s like talking about fees and taxes to investors. All right. We have the macro backdrop. There seems to be some coincident indicate. You never know how bad this is going to get. It’s painful to watch all my value friends on Fintwit and elsewhere just, like… It’s like body blow after body blow after body blow. It just continues. Do you have any predictions, any forecasts on what might be the, like, final catalyst? Is it the SPAC boom? Is it just weight of things getting too crazy? Any general thoughts?
Tobias: I forget who has the great line about predicting 11 of the last two recessions or something like that, but I feel like I’ve predicted 20 of the last zero value turnaround. So, value does seem to catch these little wavelets every now and again. So, there was one last… There was a huge day, September 9th, where there was the biggest day for value since like 2000, the worst day for momentum since 2001 or something like that. It was like a six sigma event and now it’s not normally distributed, so it’s not actually a six sigma event. But the idea is that it was an unusual event, and then it was fired up the next day by the same thing. Then value had this great run from mid-September to sort of mid-December. And that was glorious just for that short period of time to not be sailing into the headwind like we always are.
I think it’s hard to say because I just think of all the things that the magazine covers universally hating on value, value guys shutting up shop, all of that stuff seems to me to be the anecdotal backdrop is there, but nothing’s ever manifest. But the way that I think about it, so ultimately, I’m a value guy more than I’m anything else. And so what return do you get when you buy a company? The return that you should expect to get is basically the dividend yield plus whatever growth you can extract from that company.
And I would have said, and when I wrote “Deep Value” it came out in 2014, I would have said then that you can just about bank on mean reversion in the stock price too. That third element would deliver the return to you. Now I would say that having suffered through six years of going the opposite direction that it turns out, you can’t bank on mean reversion, but you still can rely on the other two. You do get the dividend yield. Dividends are real once, they’re paid into the account. And the underlying growth should be real as well. You’ve had this growth where the multiple has worked against us the whole way through that.
There’s some great research from a Shaughnessy that pointed out that what traditionally happens with value stocks is the market just overestimates how bad the situation is. So, you buy them and you see the decline in the earnings over the holding period. But it’s more than made up for the fact that because the market has overestimated how bad it’s going to be, you see this multiple expansion and that’s where the return comes from. And the converse is true for the expensive stocks that typically what they see is the market expects huge earnings growth. They see earnings growth, but they get multiple compression because the earnings growth inevitably disappoints.
What we’ve seen over the last decade is the reverse. The earnings growth has been accompanied by multiple expansion. And the earnings declines in value stocks has been accompanied by multiple compression. So, the mean reversion has been working in the other way. When I look at the portfolios now, when I look at ZIG or I look at DEEP, I can see the yield versus the index and the category average. And the yield is materially higher than either of those two. And the growth rates, whether you’re looking historically, whether you’re looking at earnings or sales or cash flow or book value, the growth rates are all higher. So, at some stage, that does shine through. And then probably right at the time that we don’t need it because we’re already getting the return from the yield and the underlying growth, you start seeing the mean reversion in the pricing as well. So, probably they both come together. So, to me, that’s the best catalyst. To be fair, that’s been around for a little while. So, I think value has been unfairly punished for the last couple of years, but it’s now… I think that that delta is getting so big that it’s very hard to ignore it. If you’re an allocator and you’re looking at do you expect these enormous companies to continue to expand at the rates they have or have a better opportunities elsewhere that are lower risk and probably likely more certain return?
Meb: Listeners, you don’t have to believe Toby about this. You can go type any ticker symbol in “The Morningstar” and they often will give you… Not often. They will give you a composite snapshot of the underlying fund holding characteristics. And it’ll tell you price-earnings, dividend yield, all these metrics. You hit the portfolio tab. And we’ve been talking about this to investors for a long time because it’s falling under this category of, like, know what you own. There’s some funds that say they are, like, a certain style or an idea and you type in their characteristics and it spits out numbers to where you say, “Oh, dear, God. This is what I’m investing in? This is totally insane.” And I love Vanguard, but some of their funds are simply just so big, $50 billion. I’m looking at one in particular and its composite metrics for what would be considered to be a dividend fund is just… It makes me nauseous. It seems like the riskiest thing on the planet. So, anyway, don’t believe Toby even though he’s correct. Type it in. Go do the work yourself and you’ll find some astonishing characteristics. For a long time, the U.S. market seemed to me to look pretty similar as far as large-cap, mid-cap, small-cap, and then 2020 came around and just kind of blew an enormous gaping torpedo hole in the hole of particularly small value. You now seem to have a huge dispersion there within the U.S. as well on the small and micro. Is that something you see? Is that accurate? Inaccurate?
Tobias: No. I agree 100%. If you’re investing on fundamentals alone, it’s been probably one of the worst two years. I wasn’t investing in the late 1990s, but the experience is equivalent to those. There’s some great research. So, Cliff Asness’s colleagues have released a paper on value where you can go through. They sort of tried to deal with all of the narratives about why value is sort of irrevocably broken or irretrievably broken. And I’ve sort of pretty successful in my opinion, I’m biased, but then I’ve sort of dispatched with all those arguments.
But the best little part of it, in my opinion, is this part where they say, “Let’s create this test where we’re going to explicitly cheat.” They are cheating. And the idea is that you get next year’s Ford earnings this year. So, you’re going to be investing on information the system doesn’t have. If you can invest that way, naturally, you get a really good Sharpe ratio, you get really good Sortino ratio, you massively outperform because you get the information you don’t otherwise have. But they set it up explicitly to cheat to test the idea of how closely the price follows the fundamentals of the business. And so they find that, as you’d expect most of the time, you massively outperform. There are two periods where the coefficient is around the wrong way and you really underperform. And those two periods are ’99, 2000, and 2019, and 2020. So, as a fundamental guy, it’s been a very, very tough year where they’re already looking pretty interesting and cheap. I thought in February… I mean, like you said, the torpedo came in and just has blown these things so far away from the underlying intrinsic values.
I think part of the reason is obvious that the shutdown and the Coronavirus has impacted everything in a different way. The tech companies clearly… We’re recording this on Zoom, we’re both working from… You’re in the office, but I’m working from home. It’s easy enough to communicate this way. So, there’s lots of companies that really aren’t impacted. The smallest stuff, the stuff that requires manufacturing or requires you to sell in a store or whatever the case may be, clearly that’s impacted more. And because they’re already sort of under-resourced… Well, not under-resourced, they just have less in the way of how the balanced it impacts them more.
Whenever there’s… It’s not a “Morningstar” analysis, but there are other analyses that you can do to look at the fund. So, what’s the factor exposure of ZIG and DEEP? The factor exposure is they tend to be the most concentrated into value of the funds that examine… You can… I think Eric Balchunas has done some work on that. He’s the Bloomberg ETF anchor. You can see in his Twitter feed he talks about it a little bit.
So, it’s clear that we have a very big value exposure, but what we also have is a very big quality exposure. I’m not a quality investor necessarily, but I think it’s very hard to separate out value from quality in the sense that it’s hard to have the value there if you don’t have the quality. And the quality is kind of a little bit of a moveable face. But basically, we’d all agree that it’s cash-rich balance sheets over indebted balance sheets, cash flows as opposed to sort of cash burn and so on, those kind of ideas. And so we’re value guys, but we’re not trying to just fire and shoot the cheapest thing in the market on a price to book value basis because it’s not going to work very well. What we’re trying to find is things that are very, very inexpensive relative to their flows that also possess the characteristics of healthy balance sheets. And so we allow them to survive through periods like this so we can take advantage of that massive undervaluation. Ultimately, it’s a good thing because it should lead to better performance down the road even though it’s incredibly painful to endure it in the period where the prices get pushed away the way that they have.
Meb: And I always wonder. You’ve also seen even… And feel free to weigh in on this. I don’t really have an opinion. A lot of the value crowd have kind of abandoned price to book. I mean, Dimensional, this has been their baby for decades, they got massive, they’ve seen a bunch of outflows, actually, I think this year, partially due to other reasons, but a lot of the value crowd is kind of fallen on two sides on things like price to book. I smile to myself sometimes because I wonder if this is like, again, like reaching an extreme where all of a sudden even the value guys hate price to book and then all of a sudden there’s going to be like a 10-year just monster run for price to book when everyone is like, “Okay. Wait. That doesn’t work anymore.” And then it just absolutely takes off.
Tobias: The theoretical basis for price to book is pretty sound. The reason that historically quants and guys like Walter Schloss and so on, Schloss set a record of 20% a year for like 50 years, something like that. He’s probably not necessarily quantitative in his approach, but probably maybe quantitative in his outcome in the sense that he had quite a few holdings roughly equal weight, and he was just looking for cheap on a book value basis, but other characteristics that might have allowed him to survive for a little bit longer. But the argument for price to book value I find to be pretty sound in the sense that the flows are variable and volatile and move up and down, so, cash flows and earnings and so on move around, whereas book values should be pretty static. The difficulty is that book value for a tech company is going to be very different for book value for a minor or for a bank. So, clearly, there are different types of businesses out there. But I agree 100%. I think it’s to the point where book value has been so thoroughly buried. And you can read the obituary in any number of papers from any… Nobody wants to be associated with it. It’s kind of like a laughingstock.
I’m a contrarian as much as I’m a value guy. It kind of feel like that’s how you set up a scenario where you just go on a 10-year tear for book value. And the crazy thing about this business is how closely narrative follows price rather than the other way around. You sort of expect price to follow the narrative, but it’s never that way. All of the obituaries are written after the underperformance and not prospectively. Then weighing against that is also Cliff Asness has also, in his sort of writings, has said that the underperformance of book value has sort of slightly ended through this period because it’s done a little bit better than all the other value metrics because it’s not such a good value metric. It hasn’t done what value has done, which, like, the best expression of value has massively underperformed through here. That’s how you know that you’re running a good value fund because you haven’t done as well as everything else.
If you’re doing really well through this period, there’s a chance that what you’re expressing isn’t value. You might be expressing something else. I know there are a lot of discretionary guys who’ve… Value guys, in particular, have, who are discretionary, I think they are, potentially they migrate from strategy to strategy. So, book value doesn’t work, so we migrate a little bit to cash flow and then we include some growth and we start including some other quality factors in there, explicitly or implicitly.
So, explicitly if you’re a quant, you kind of know what you’re constructing. If you were discretionary, you may not know. You might just be accidentally expressing preference for growth or for something else. And then the market might change because that’s what the markets tend to do. And if that happens, then all of a sudden, you’re tied to some factor that is underperforming, and you thought you’re a value guy and all of a sudden it turns that you’re a growth and momentum or something like that, which I wouldn’t be surprised if there are a few ships marooned when this turns around and it turns out that the tide was…they were sort of flowing along with the wrong tide.
Meb: It’s funny you mentioned that about momentum. I was rebalancing some of our portfolios and we own both on the value and momentum side in our allocation funds. And I actually thought it was a mistake when we looked at the momentum allocation, I said, “This can’t be right. How do we own so much of this fund?” And it’s this ma… I mean, this year alone there is a 50% point spread. I think it’s up 35 for, like, a momentum ballpark fund and about down 15 for, like, a pure concentrated. You could use Weitz Funds or anyone else who has kind of the two coins, momentum and value. That also has to be at, like, historic spreads. I mean, this run that momentum has had versus value. And momentum being an even more on steroids version of just market cap weighting. Is that sound about right?
Tobias: I don’t track momentum that closely. But I think that momentum is interesting from the perspective of it might be the best way to be a growth investor because the momentum in the stock price matches pretty closely over time the momentum in the fundamentals of the business in the sense that the fastest growers tend to have the fast-growing share price. The problem for fundamental guys is that often that turns around, it just invites competition. But momentum is, I’m not arguing against momentum, incredibly robust strategy. It’s just that… I guess like the expression of value, there are many different versions of momentum. And there are probably as many momentum funds as there are value funds. And there are as many kind of secret sources as there are for value funds as well. So, I think there’s a very wide dispersion. There’s some that have done exceptionally well and there are some that have struggled a little bit.
Meb: My favorite is when value and momentum intersect. And the problem with this last couple years is value has been such a plague that even when you do value and momentum, the value has been so bad that it just infects the momentum and the value and momentum has been as bad, if not worse. And you guys, we have one strategy that’s been absolutely atrocious in the last few years and any time I get too depressed about it because it does that intersection.
There’s a Vanguard fund. A lot of people don’t know this, but Vanguard has a lot of not market cap index funds. They have a market neutral fund, for example. And it’s as bad if not worse and along the same lines of, of course, AQR as well. But just going to show that depending on how you do it, because some people will like buy half value stocks, half momentum stocks and mix them, other people will average the ratings. And so within the sort of practitioner art of putting a portfolio together, depending on how you do it, the value could have polluted the whole ship.
Tobias: It’s such a compelling argument because you say, “Well, we’re going to buy something that’s undervalued, plus it has positive momentum.” So, under one of those constructions rather than you just mixing the two extremes, finding the ones where they intersect. That’s a pretty strong argument. I’ve got this thing that is cheap plus people are buying it, and so it’s going up. So, other people have identified what’s in it. How can that not work? It just turns out if you’ve got an exposure to value, that’s what kills it.
Meb: We’re just going to Martingale in and just every 10% of spread it’s going to…
Tobias: I think you’re out of money. You’re out of bullets?
Meb: That was my cannabis strategy, I said every 50% cannabis goes down, I’m going to double my bet. It’s going to keep getting closer to the wall 50% each way and then soon I’m going to end up with a massive position. So, one of the cool things I used to talk a lot about 13F tracking back in the day and wrote a book on the topic. Listeners, there’s a free download on the website, which is where you can track hedge funds through their holdings. And being a quant I’m a little more distant to holdings but I still love to dig around. And so I was looking at Tobi’s funds and the Acquirers Fund that we mentioned earlier, it’s a lot more recognizable, a lot of the names they hold because it’s larger cap.
But my favorite when I wrote this 13F book is I said, there’s no point to me in tracking managers that all end up owning the same hedge fund hotel names. My favorite people to follow like Seth Klarman at Baupost and others. I would love to when I look at their portfolio and look at their names and say, “I’ve literally never heard of any of these companies.” And so when I was reviewing the DEEP Holdings, it was endearing to see that of the top 20, I think I can literally name one, maybe two. Hold on. Anyway, I figured I’d give this an opportunity for you to chat a little bit about the framework philosophy or case study on a few of the ideas and how they’re kind of representative of what gets into this strategy.
Tobias: Well, let’s talk a little bit about the strategy. So, I used to be a lawyer. I was a mergers and acquisitions lawyer in Australia initially, and then in San Francisco doing tech M&A. And then I went back and I was general counsel of a public company for a period of time and then worked as an activist in a fund with a specialization in undervalued assets situations where there was some complexity. So, folks who have been in the market for a little while might remember that Macquarie Bank used to… And they may still do this, but what they like to do is these reasonably complex structures where they’d take an asset like a port or a rail or something like that and they put that into a trust, which was flow through for tax purposes. And then they would staple to the trust security a unit or a share in the manager.
So, you had this what was called a staple security. They did quite well with that. And then there were a lot of imitators in Australia as well. In this 2007, 2009 bust, anything that is sort of complicated becomes toxic. And so these things traded down way below what they were worth. And what we were doing was buying these things and try to unpick the complicated corporate structure.
So, I am in some ways attracted to things that have a slightly more complicated corporate structure that disguises the underlying value. So, one example of that in the States is Biglari Holdings run by a gentleman by the name of Sardar Biglari. It’s in a fund. The ticker is BH. It’s reasonably well known because he’s a colorful character. He ran a thing called the Lion Fund for about two decades, continues to run it now. It’s owned by Biglari holdings. And this is where we’re going to get into the complexity here.
He’s managed to outperform for two decades despite the fact that the last few years have been quite rough for everybody including him. He’s got a value bent. But basically, what the company is, and he’s got two shares on issue, INB. He controls both. He controls the company. He’s sold into the company his fund. And the fund has the old Buffett partnership 0/6/25. So, he’s now compensated as the manager of a public company with a Buffett partnership-type compensation structure where he gets paid a carry based on a high watermark and performance over 6% a year. The company itself was originally… He’s bought things like Western Sizzlin’, Steak ‘n Shake, Maxim, and they’ve got a cafe somewhere where he likes to go. There are a lot of reasons why this thing is cheap, but basically, it’s now trading at a massive discount to its cash and marketable securities. So, that’s why it’s a deep value because it’s traded down like that.
Meb: Just to interrupt real quick just because I was laughing is that when you originally said this I thought you were saying Big Larry, B-I-G L-A-R-R-Y, almost like his last name.
Tobias: Yeah, Biglari.
Meb: But I thought it was like… It reminded me of an old quant factor name that was popular in screens over a decade ago which was the Big Dog, those like shirts. Do you remember those?
Meb: Any listeners? It was the most preposterous company. And I used to be so angry that it was in our models. I’m like, “I can’t possibly own this. This is the most…” Anyway, it just reminded me of that. But do you know why? The number one reason this company has massive upside is if you go to their website, it looks like it was… And the same thing with Berkshire. It looks like it was made in 1987 pre-internet. Literally, the font is like stretched and look… It is all black and white. It’s so bad.
Tobias: That’s the gag.
Meb: It’s so bad.
Tobias: The guy is a massive fan of buffets. And that’s why the ticket is BH because it’s Berkshire Hathaway.
Meb: That’s funny.
Tobias: And then he’s a deep value guy. And he’s got the A shares and the B shares. He’s got the Buffett partnership for compensation structure. He’s also incredibly dismissive of shareholders. So, all of the transactions are woeful. There’s no question about insider dealing or anything like that. But they still make investors in the company angry. And when they go to the general meetings and they ask him questions, he’s sort of dismissive. He says, “You’re either along for the ride and if you don’t like it, you can just sell your shares.” And he is the one who buys them in the market. And the company buys back stock too. That’s all the reasons why this thing is really cheap.
And also because of the accounting rules, because a lot of their holdings… It’s an investment business now. A lot of… The losses in the investment portfolio run through the income statement, plus they’ve got some debt that needs to be rolled. There’s a lot of issues with this thing, but it is also trading at a massive discount to its cash and marketable securities. And then you’ve got a guy in there who is actually a really good investor. I mean he’s not particularly shareholder-friendly, in both senses of the way, in the way that he sort of runs the company and also in the way that he communicates with shareholders. But he’s heavily incentivized to make this thing work because of his incentive structure and also it’s his name on the door now. And if you’re going to be a buffet acolyte, you got to deliver some returns.
So, I think that the companies that he’s in, the restaurants they’re going to get really beaten up through a period of like this. It doesn’t take much for this company to turn around materially and start outperforming and then all of those investments are going to start running back through the income statement. And this thing will be a much different beast with a little tailwind to value. So, I have a lot of positions like that that they’re complex, they’ve got a lot of value exposure in them. And if they get a little bit of a tailwind, then it’s magnified through the entire portfolio. I have a few others I can discuss too if you want.
Meb: Let’s do a few more while I got you. I’m getting stuck on a rabbit hole of his website, which I may spend the rest of the evening. I mean, it’s incredible. I say the same thing about blogs. There’s like a couple of blogs that go back super far. Like I think Damon Darren is still, like, on blogger. And it’s just… I love it. So, please don’t ever change. The most famous financial professor probably in the world and…
Tobias: Well, name another one.
Meb: Is yours as bad? Oh, name another finance professor?
Tobias: No. I mean, name another financial professor.
Meb: Oh, come on. You can name… I can name 1,000. I used to be in the academic world.
Tobias: I got one for you. I got some.
Meb: Even at NYU… What’s the… LSV quant shop out of Chicago, French Pharma, all those guys. A lot of them actually run money management companies. He’s more corporate finance, but he’s been on the investing train for a while.
Tobias: He’s very dismissive of more traditional value guys. He’s not a fan of traditional value. He’s an advocate for revolving, which I think… I understand why that folks want to make that argument. But I also think you want to be making arguments with the opportunity to see what something looks like through a full cycle. You never want to be in the trough or at the peak declaring something dead or alive because this is a nasty business where there’s always some humility coming right on the train behind you.
Meb: All right. Let’s hear some more before I go down the Biglari rabbit hole.
Tobias: Let’s talk about another night. So, Diamond Hill, the ticker is DHIL. This is a business that you will understand really well because this is just…
Meb: Is that asset manager.
Tobias: That’s the one. It’s an asset manager.
Meb: I know those guys.
Tobias: They got $20 billion in assets. They’ve just declared a huge special dividend. So, I don’t know what the record date is, but I don’t know when this is going to come out either. So, you just… Probably it’s too late for that, but we did catch that special dividend in the fund. It’s an asset manager. It’s got massive returns on equity. It’s way, way too cheap. The problem that they have is that they’ve got a whole lot of value exposure in $20 billion in assets. So, if they start getting some performance, they’re likely to see flows. It remains an incredibly good business.
Just at the other end of the spectrum, this is a very simple to understand business that is run very well. They’re executing little buybacks, special dividends, all that sort of stuff that you want to see, getting rid of the excess capital, which they’re still producing, still cash flow positive through the cycle managed really well. There’s really not much more to say about it other than it’s a simple company to understand. It’s a simple business to understand. They seem to be doing all of the right things.
And I think you’re catching… This is another pretty good example of what I look for, which is something that is at the bottom of its business cycle or it’s in a cyclical trough, but it’s also at a massive discount to what it’s probably worth over the full cycle. And so if you see this thing cycle up out the other side, you’re going to get both the performance and the business as the business sort of improves and you’re also going to get some elimination of that discount in the share price discount to the value. So, there’s two sort of huge ways to win. And you pay to hold these things because the dividends’ so fat. They’re still throwing off cash. They’re great businesses. That’s kind of the thing that I look for in both. So, that’s what ZIG is going to hold that kind of stuff, DEEP is going to hold that kind of stuff, cash flowing, strong cash balance sheets, and buying back stock and paying at the dividends. It should work overtime. How’s it worked so far?
Meb: Diamond Hill was interesting because you can look at some of these stocks, these asset managers, and they go through cycles very much depending on their style being in or out of favor. You have that right now where you see some of these growth managers, tech, disruption-focused, asset managers that just see assets going through the roof and vice versa. And these things… I was looking at the Diamond Hill chart, I mean, it’s at levels and market cap back to like pre-financial crisis, but you can see these every few years kind of like people flowing. And it goes back to this concept we were talking about in our old tail risk white paper about people hedging part of their business and thinking about the risks as an asset manager of trying to sustain these periods, which can last a really long time. I mean, WisdomTree is another one. They’re getting into, like, I think LBO territory where they’re trading at, like, I think two times sales and pretty low relative to their assets, but for probably some of the similar reasons. Diamond Hill is also… They were famous back in the day for having a lot of long-short strategy too.
Tobias: The way that I know Diamond Hill is they have a value index. They have a very broad value index. It could even be 500 stocks. It’s sort of like a replacement for the S&P 500 that’s fairly weighted. That was how I first heard about them. I was looking at other implementations of value and I found theirs and I thought it was kind of an interesting expression. And then I didn’t see them for years until I popped into my screening and very undervalued.
Meb: Yeah. I mean, yeah, they got a $2 billion long-short fund that’s four-star fund. And I remember following this for many years back in the day. I haven’t followed him a long time, but very successful fund manager. I have no idea what the flows would look like.
Tobias: Very profitable well run. It hasn’t been cash-flow negative through the whole downswing. It’s a very robust business. It’s the kind of business that can survive.
Meb: When you start to get to that scale, the margins on the asset management business are some of the best in the world, if you can sustain them. Okay. That’s a good one. You name one I knew. Anymore while I have you? We could do this all night, by the way.
Tobias: I’m probably going to run out of ideas. But in the large-cap fund, I hold Intel. Intel is one of those… To me, it’s sort of a crazy story because the competitors to Intel, AMD and Nvidia, have stock charts that look like ski jumps. You sort of have massive price to sales multiples that are only expanding combined with pretty good growth. But then Intel has this terrible-looking chart, but the business underlying it hasn’t really taken much of a step backwards and it’s forecast to continue to grow. And then on top of that, you’ve got a really great balance sheet. They are doing a little buyback. The risk is that there’s this new generation of chips, they can’t produce the chips. They spend more money than the rest of the industry on R&D. I think that they probably solved that problem at some stage. But once again, you sort of paid to wait, you get the dividend and the buyback and the growth. So, I think sort of the portfolio should follow the dividend and the growth even without the multiple rewriting. But at some stage, these multiples, sort of, I think they have to rewrite.
Meb: We are an Intel holder as well. But it’s funny. This also brings up another interesting topic. If you look at many of these… And Rob Arnott was talking about this recently on the podcast, listeners, if you haven’t listened to it. Some of these high flyers from the ’90s, Cisco, Intel, on and on, are just now… Despite being great businesses, and if you look at their business metrics for the past 20 years, business metrics often grew every year, business is vastly bigger, but because the stocks got so expensive in the ’90s, they are just now getting back to where they were. Intel is still not back to where it was in 2000. I’m trying to look at a chart.
Tobias: In terms of the price.
Meb: In terms of the price. Correct.
Tobias: I found that striking. In about 2015 it was amazing the number of companies that you could go through. And Microsoft was one of these companies that was sort of pitched between sort of 2010 and 2015 as being…that had… They might have been on like 11 times PE. And massively cash flow generated good strong balance sheet. They took a step back in terms of revenue in one of those years. But at that time they were transitioning to this sort of subscription-based SAS model. And that has sort of turned them from something that had just been dead money for 10 or 15 years from the 2000s.
It’s striking the number of times that I come across something like that. Walmart was another one in 2015. It just hadn’t gone anywhere for a decade. And people get tired of holding them because they don’t move, but then you look underneath the hood and they remain very good businesses. I think the message here is not so much to look out for these things that have been dead money for 15 years but to be very careful of things. Yeah, it’s a really good business. I understand it’s a very good business. It’s growing and throwing off cash while it’s doing that. But you got to be careful because the price gets so far ahead of the business that they can spend a decade bumping sideways and you get all this volatility through that period. You catch every bust, you miss out on every single bone, and you find 10 or 15 years later that where you were at the beginning of the millennium. And I think that this market right now is going to be filled with stocks like that, that, yeah, they’re really, really great businesses. There’s no disputing that. But they are also at nosebleed levels of they’re so expensive that it’s going to take the business 10 years to catch up to the stock price.
Meb: And I think these specs are going to be a graveyard. I just pulled up Cisco, another poster child from the ’90s as a good example to where it’s still down 50% from the peak. And it was trading at price to sales ratios, which, by the way, for today’s companies seem totally…
Tobias: Totally reasonable.
Meb: Totally reasonable compared to, like, Zoom and things. Cisco was at its peak at a price sales of about 30-ish, 20 to 40, somewhere in that range, but at the very, very peak, probably 40. That’s now at the price-sales ratio of three. But just goes to show 20 years and it’s still not back to where it was.
Tobias: Well, funnily enough, Cisco is one that I’ve picked up and ZIG. That’s one that we’ve recently added along with another name eBay, which was sort of…
Meb: Oh, God.
Tobias: …the dot-com 1.0 stock.
Meb: The thing about eBay, Toby, its user interface is so bad. It’s like… I understand why some of these companies like Carvana are totally disrupting because, like, I was trying to sell a car on Craigslist. And it was like half scammers, half people trying to like get your contact information for another service. eBay was just as bad. I spent like an hour responding to emails about selling and I’m like, “This…” Whatever I was selling was like $50. I’m like, “This is so stupid anyway.” But a perfect example of separating the business from the stock price.
Tobias: And those problems are fixable. They’re not permanently baked into the stock. And they’ve got the resources to do it. They’ve got the cash flow and the balance sheet to do it. Whether they have the will or not, that’s another matter, but eventually, they get to the point where eBay struggled a little bit, but it’s still a very good business and still high returns on invested capital throwing off lots of free cash flow.
Meb: This is also part of the reason that having a quant screen or framework is helpful. Back to this old example I know you’ve talked about where Joel Greenblatt was talking about his old formula service where he would screen for stocks, but then people could select and anytime they introduced their discretion and started selecting the names out, they always picked out the best performers and added the ones that didn’t do well just like my Big Dog’s example. You start to overlay your wonky opinions like me hating eBay and it’s probably a great idea.
Tobias: We’re not pure quant. We have a forensic accounting analysis of it because in many instances, there are things that they’re just not captured in the financial statements. You need to hunt through the notes to find them. And when you concentrate, in particular, it’s important to have the economic reality reflect what the screen show. It’s very rare that we exercise any sort of forensic accounting discretion to remove anything, but it’s also worth noting that we do it. So, we’re trying to avoid things that, particularly, in the small and micro that have some weird convertible note because they did some silly deal with a hedge fund or sort of in a moment of weakness needing some liquidity and there’s now this convertible note that completely changes the economics of what you’re earning. So, that is, particularly in the small and micro-cap world, that’s important.
Meb: You’re not just a value masochist on the long side, you’re also short which just makes things twice as bad, potential pain. What’s the short landscape look like? Is it just a land of opportunity? Have you gotten just a bunch of scars across your back? What’s that world look like today?
Tobias: Shorting is diabolically difficult because there’s so many constraints on shorting. And where previously if you were shorting you got some rebate and some interest on the cash that no longer exists. Now, it’s really only the performance of the securities that you short. And you can’t be short stuff that’s heavily shorted because then you’re subject to the whims of other investors selling and selling out. You don’t want to get squeezed as Tesla demonstrated over the last 12 months. Really easy to be caught in a really ugly squeeze with Tesla.
The function of the shorts is to provide some protection for the longs in the event that the market falls over. And so I could achieve that by shorting an index. But there’s some inefficiencies being long and short the same names because you always have a little bit of exposure to the long names in your book. Very little exposure. But I also think that you can go through an index and you can pick out the things that are clearly much worse than everything else that are in there. The way that we’re shorting, we don’t short on valuation. That is sort of a consideration. But for some of these things, it’s just impossible to value them because what we’re looking at is something that has statistical indications of fraud, statistical indications of earnings manipulation. They’re in some sort of financial distress because they’re negative cash flow and they have an enormous debt pile there.
And if companies get themselves into that situation, it creates this catalyst where they have to go to the market at some stage and they either have to borrow more money or they have to sell some shares. And typically, when they do that, what you find is that they have to take a big hair cut to do that, which is sort of, that’s how we get some of the performance from the short. So, that’s sort of what we’re looking for.
In addition to that, all their metrics are they indicate that they are massively overvalued. What tends to happen is that they tend to be some of the fastest-growing stocks. So, there’s a risk that we’re short something, and it does continue to deliver. And if it does a little bit better, the market does reward it. But the way that we get around that is we’re looking for stuff that has already started to sort of fall over. We’re not shorting stuff that has an enormous amount of strength in it. We’re shorting stuff that the market is already starting to abandon and so often. I think that it’s precipitating an event in the near term where they have to do something.
We have done okay on the short side. It’s probably generated a little bit more return than I expected it to through what has been a pretty rough market. But the times when it’s really stood up is in March when the market fell over and a lot of value funds were down about 50% through that period of time. We were down roughly in line with the market even though the longs was sort of beaten up as much as every other value fund, but the shorts did so well. They sort of stand up much more than the longs go down and they do provide that protection.
And I think as violent as that was and as far down as that was, I still think that was sort of a truncated… That was not a 2007/8/9 bust. That was not a ’99/ 2000 bust. That was not a mega bust. That was sort of something that we’ve seen. That was just 2015 tail and bust. That was a 2018 bust. That was sort of the smallest scalar we’ve seen. I think at some stage we do get…inevitably, we get another mega bust. And I think that that’s really when the metal of the shorts are shown in the mega bust because some of these names, you can go back and look at what happened to high flyers in 2000, the high flyers in 2007/8/9. Some of those companies were down 80% or 90%. And if you’re short those things and you catch the very big part of that, you’re getting paid enough on that side of the book to sort of bailout the longs and then it creates more money that you can redeploy long because we’re rebalancing all the way through that. And that creates this very interesting return profile for long-short funds if they’re executed properly.
We sort of knew we have to demonstrate that we can execute it properly, but I think that the return profile will be interesting because we’re 100% long net when the market is going up and we’re going to be getting a little bit more payoff from the shorts when the market goes down. I’m sort of eager to show what it looks like through a real bust.
Meb: Well, we’ll have you back on in 2025, 2030, 2040, whenever that may happen. It’s funny, like, the short-sellers are always my favorite people. They’re a little bit wonky. I feel like their brains all work differently. You have the struggle of having to keep both sides in your head. It’s like [crosstalk 00:53:26]
Tobias: Well, value and short.
Meb: Value short, but like the long side. And I’m not sure what to cheer for, but I think you hit on it. And if you talk to most hedge fund managers, I think most will say the same thing you would say, which is that they really deliver when it’s hitting the fan. And that can often happen so fast that it’s nearly impossible. I feel like a lot of people listening just think they can just switch it on overnight and, “Hey, I’ll just wait until the market rolls over.” But that can happen pretty quickly. We actually had just a great podcast dropped today, we’re recording this November 4, with a short-selling analytics company that walks through a lot of the short-selling stuff in depth which listeners you may like. But yeah, having it on, I think, in anticipation of the turn is kind of how you have to approach it.
Tobias: The problem with trying to switch it on and off. There are good reasons why using a moving average over the course of a full cycle does help you. That also delivers a more interesting return profile where it does truncate the very worst busts, but then it also has the same problem like any… There is a cost to it and it gets whipsawed at various times. That’s really the greatest pain with trying to time the shorts is that at the time that you want to put the shorts on, everybody else wants to put the shorts on too. If you’re doing it through options, you got all the vol in those positions. If you’re doing it through shorts, a lot of the move has often happened because just the nature of these beasts is that they tend to sell off a little bit earlier. The market kind of sniffed it out. That’s part of the sort of bust dynamics that individual names start falling before the whole snowball really gets going.
And often it’s these things that just… It may even be them that precipitate the whole fall. I certainly saw that in March this year that the selloff started occurring at some of these high flying end. Unfortunately, it also happened in the value names. So, the value names started suffering earlier than anything else too. I don’t know what that leaves to sort of hold the rest of the market up, but the rest of the market did sort of drift sideways for about a month with everybody saying, “Where’s the vol?” We know that this terrible pandemic is coming our way and it’s just not reflected in the stock market. And of course, it all happened very quickly.
Meb: Do you have any particularly memorable trades over the past few years either on the good side where it worked out or on the bad side where you got taken to the woodshed? Anything come to mind?
Tobias: There have been very few on the good side. It’s been uniformly bad for so long. I’ve almost forgotten… That was one of the things that I used to like… I ran Greenbackd, which is this little blog pulling up net-nets. And one of the things I love about net-nets, it’s basically they don’t trade. They just sit there doing nothing for years and years and years. And then you wake up one day and they’re up like 50% or 100% or 200%. So, one of those was… There was this company that they were looking for. They’re a biotech. They had $2 in cash trading at about 0.70 cents. And there was an activist trying to get them to give back the cash and they had this drug candidate in with the FDA. And I had the holdings at 0.70 cents.
And I thought this is a pretty good…this is a safe… Maybe you don’t get $2 back. Maybe you get $1.50 back. Maybe this is a pretty safe 100% return. This is a long time ago, by the way. This is not any of the funds that I manage. I just woke up one day and the stock was up 10 times. And then by the time I got to the office… So, it was up at $7, by the time we got to the office it was all $11. And this is before you could trade on your phone. So, by the time I got to the office, it had traded all the way up to $11 because the FDA had approved their drug candidate. Just one of those things. The event that I thought was so unlikely was the thing that actually happened and then probably it’s just better being lucky than good, I guess.
Meb: It takes me back, I mean, thinking about all the parallels late ’90s. I mean, I used to very vividly recall professors trading stocks during class. You had all these IPOs that it was like shooting ducks in a barrel that when they hit their lockup expiration would just get hammered. And I feel like with a lot of stuff going on with SPACs now, but on the flip side, you had, in the aftermath, a lot of companies that would straight-up trade below their cash levels. And buying a basket of those is an interesting way to think about getting potential free call options along the way, like, the biotech. We have a podcast that will be out by the time this is public with a concept of doing SPAC arbitrage where you can be buying these SPACs that are trading below the issue price and guarantee a bond yield that would get a potential deal consummation. Anyway, go listen to that one.
Tobias: That was a classic kind of special situation strategy a little bit over 10 years ago when there were all of these…from the last go-around when everybody tried to raise a SPAC, there were all of these zombie SPACs that… And that was… The play was not try and buy this thing before…wise a business and has the huge pop like the IPO type pop. The play then was buy these things in the months before they have to declare that they can’t do an acquisition and then get back. They might trade down… It might be $8.75, and then you get the $10 back if it’s not approved.
Meb: The beauty of the SPAC is it has a finality. We’ve talked many times on this podcast about like closed-in funds, trading at discounts. And the problem with those sort of arbs is it’s not guaranteed to ever close. We talked a lot this year. Listeners, you can go back to Twitter and elsewhere where we talked about Bill Ackman’s foreign-listed hedge fund. It was trading at like a 50% or 40% discount to net asset value back in, I think, March and has had a monster run, but those you can never guarantee. There’s no necessary catalyst in a lot of those that they have to close the spread.
Tobias: My old boss, funnily enough, who just runs his own money now, but he’s a fan of Bill Ackman’s from a distance and saw that they had traded down. It’s exactly what he does. He looks for things that are trading at a big discount to NAV. And so flew to New York, met with them, decided that it was probably likely that they were going through a bad period. And it’s Bill Ackman. There’s a pretty good chance that they’d turn around and they get some good performance. So, I managed to buy it at that big discount and put about 20% of his assets into it. And so it has had a blockbuster run out of that thing as a result of that not knowing that there was going to be the big payoff but just knowing that you could buy that at a discount to NAV that was sufficient to probably pay you.
Meb: I had a theory and I almost never ever, ever talk about positions or securities publicly. It’s more kind of macro level, but I was talking about it on Twitter because I said there’s actually two things that I think the market didn’t understand that were potential tail ends. So, you already had the discount, which is well known, but that happened in all the closing funds. I said with particular, this one is he had placed some hedging trades to where he had protected to the downside the portfolio and had a massive payoff, I think he made a few billion on these hedging trades, lifted them. Also went on CNBC with a very terrible, like, performance and people were, like, just crushing him on CNBC. But I said there’s a non-trivial chance that there is a large discount based on people just not liking him. And I said, “That’s not a rational thing to be doing.” And so I exited way too early, but those type of trades are my favorite. There’s just big fat discounts. But the third thing was they have a buyback program in place for the fun. So, it’s like always eating itself when it’s trading in these net asset values. Anyway, I haven’t looked it up. Well, I’ll have to add it to the show notes. But it’s probably still trading at a discount, but he’s having a monster here.
Tobias: Third Point also has one similar kind of story. They’ve executed a little buyback in that. That’s a UK listed. I forget the ticker.
Meb: The only problem with these, we actually wrote about that one during the last financial crisis. Third Point got to, I think, a 50% discount to NAV. I think the challenge with U.S. investors is that you can only hold them essentially short term or you have to disclose them on your taxes because they’re passive foreign investment companies. So, I think you have to mark to market it each year. It gets a little wonky, but you can often not hold them for a whole year and just call it short-term capital gains. Anyway, do your due diligence, listeners. But, yes, the same thing happens is you can kind of get those often at a massive and theoretically, just hedge them with the opposite side if you wanted to because you can see their holdings. Toby, we could go on for hours. We probably should. But what else? Anything on your brain as we start to wind down 2020, still a month to go by the time this comes out, I imagine? Any general thoughts on the horizon and what you’re looking forward to? Are you going to ever launch a foreign fund and anything else on your brain?
Tobias: The other thing that I would like to do is probably a strategy hedge to what I do. So, probably, I’m never going to do a momentum type fund, but I do like more of the Buffett style investment. I know that… So, people who aren’t necessarily steeped in value, it would be funny to say that the buffet stuff is not what I’d value looks… I know value looks sort of monolithic from the outside, but there are particular behaviors of some of the companies that, so, rather than beginning on a value basis, you’d begin at a sort of look at the defensibility of the business. It’s more of an analysis of how the business sort of performs over the full cycle. So, it’s been a very difficult period for traditional value guys, deep value guys. But I think that if you have a little bit more exposure to sort of growth and probably better businesses that you could have done a little bit better through this period. I’m working now on a book that sort of describes that strategy and then I don’t know how long it’s going to take. Books always take two or three times as long as I think they’re going to write. At some stage that will come out. I just hope that before it comes out there’s a little tail into value to traditional value.
Meb: But focus on public markets. Correct?
Tobias: Investing on the public markets. Yeah. It might not be a public market fund though.
Meb: Here’s my idea for you and I thought about it as you were talking about this, is that, all right, you got ZIG which focuses on large-cap, you got DEEP, so, like deep deeper, and then there’s value…
Meb: We have deepest. And I pulled out… This is an article I wrote back in March 2009.
Tobias: Good timing.
Meb: See if you can get the reference, but there was a quote where it says, “In 1939, with Hitler’s Germany ravaging Europe, John Templeton bought $100 of every stock trading below $1 on the New York Stock and American Stock Exchange. Got him a junk pile of 104 companies, 34 of which went bankrupt. Put a total investment of 10 grand. Four years later he sold it for more than 40,000. So, we’ll do deepest, but it’s going to get to truly, like, sub 75… No. We probably have to do this private fund. I don’t think we can get away with this. The value…
Tobias: Yeah, you can’t.
Meb: …capitulation fund.
Tobias: I feel like I’ve already got value capitulation. Well, I’m truly covered in the existing stuff. I think that what I’d like to see is a little value renaissance. A little value tailwind would be kind of incredible because it’s been a long time tacking into the wind for value. So, that’d be great. And then I think that, eventually, a more Buffett style fund would probably be where I would go.
Meb: Well, I’ll tell you on the area that I think is fascinating on the growth side, which we’ve been talking a lot about, has been on the private side with this sort of sub 50 million because of this QSPS tax hack, which gives you massive… I think it’s one of the most impactful pieces of legislation for investors and start-ups in arguably decades. But listeners, this is for another podcast. But it basically gives you essentially no taxable gains on investments you make in private companies that are small. But being able to put together a basket of those and avoid taxes, man, what a… I mean, I’m assuming you have any return, but if you get even match S&P in that, that’s unbelievable.
Tobias: What’s this definition of small?
Meb: It’s 50 million in… They call it… They’re some, like, accounting metric which means it could actually be… It’s not 50 million market cap. It’s like 50 million in assets or something. But basically, any start-up sub-series A or series B, and then the tax benefit is you get 10 times or $10 million… I can be getting this wrong, but this is directionally correct. Ten times your investment or $10 million, whichever is greater tax-free. I mean, that’s unbelievable. If you hit a home run on one of these, you have no taxes and… Anyway, this is for another podcast. But I mentioned it on Twitter the other day. I said, “I think this is the most impactful piece of legislation tax hack, whatever. How many of you heard of this?” It was like 90% have never heard of it. And so…
Tobias: Yeah. I thought you were talking about the JOBS Act or some version of the JOBS Act. No, I didn’t…
Meb: It came out during the Obama… I think it was in the JOBS Act. It’s called…
Tobias: Part of it. Okay.
Meb: …Qualified Small Business Stock. You guys can google it QSBS. We talked about it on the Rubalcaba podcast years ago. But anyway, you can also now put private companies in your IRAs and elsewhere, but investors certainly look into it. I think it’s a pretty interesting hack on the private side. But you got ETFs. So, those usually defer the taxes too. Toby, this has been fine. Where do people find you? Where do they go?
Tobias: Thanks for having, Meb. I’m on Twitter @Greenbackd. It’s a funny spelling, G-R-E-E-N-B-A-C-K-D or you can search my name. I have a website acquirersmultiple.com. And it has a free screener for “The Acquirer’s Multiple” stocks plus links to all the books that I’ve written, including “The Acquirer’s Multiple,” which I pitched on your show in 2017. Thank you for having me on for that one. And acquirersfunds.com where you can learn about ZIG and DEEP and anything else that we do.
Meb: Listeners, if you send Toby an email or letter, he’ll promise to send you a hand-signed copy with a photo of himself at the telescope of “Acquirer’s Multiple.” Why we mothballed Greenbackd. That is up there with Dama Darren’s. It’s like an old-school blog post blogger design. Shame on you, Toby.
Tobias: I tried to resurrect it. I was putting some podcasts up on there for a little while, but we’re going to do a deal with TheStreet, the owners of TheStreet and I think it’s called Maven or something like that. It didn’t eventuate. They wanted editorial control in a podcast. Who knows what’s going to happen?
Meb: Good Lord. I got fired from The Street many years ago which is hard to do if you don’t get paid. I’ll tell you that story later. Toby, thanks so much. I promise to have you back on when value makes the turn. So, it could be…
Tobias: That will be good. In the future. In a decade or so.
Meb: By the time this podcast comes out, it would probably already happen. Let’s not jinx it. Thanks so much for joining us today.
Tobias: Thanks, Meb.
Meb: Podcast listeners, we’ll post show notes to today’s conversation at mebfaber.com/podcast. If you love the show, if you hate it, shoot us firstname.lastname@example.org. We’d love to read the reviews. Please review us on iTunes and subscribe to the show anywhere good podcasts are found. My current favorite is Breaker. Thanks for listening, friends, and good investing.