Episode #500: Soo Chuen Tan, Discerene – Contrarian, Long-Term Value Investing
Guest: Soo Chuen Tan is President and portfolio manager at Discerene. Before founding the Firm, Soo Chuen was a Partner and Managing Director at Deccan Value Advisors. Prior to Deccan, Soo Chuen worked at the Baupost Group, Halcyon Asset Management, and McKinsey & Company.
Recorded: 8/21/2023 | Run-Time: 1:02:39 
Summary: Today’s episode starts off with lessons from working under the great Seth Klarman at Baupost. Then we spend a lot of time around what the ideal structure is for an investment firm and how to build a true partnership with LP’s – and that even includes giving money back when there aren’t opportunities in the market.
Then we get into his investing philosophy. He answers broad questions like: what businesses actually have network effects? Does it matter if a certain business goes away tomorrow?
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Links from the Episode:
- 1:26 – Welcome Soo Chuen to the show
- 2:03 – Overview of Soo Chuen’s professional background
- 4:43 – Launching Discerene at 33
- 17:32 – Fostering 50-year investment partnerships
- 24:11 – The decision to return capital in 2018 when he didn’t see attractive opportunities
- 26:21 – Current investment strategies in 2023
- 27:40 – Focusing on business potentials in Turkey, China, Argentina, and Japan
- 36:06 – Evaluating investments based on predictability and sustainable competitive advantages
- 44:33 – Reasons for ending long-term partnerships with companies
- 49:53 – China’s valuation rollercoaster
- 55:32 – Investing in specific companies, not entire countries, during high inflation
- 58:28 – Soo Chuen’s most memorable investment
- Learn more about Soo Chuen: Discerene
Transcript:
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:
Welcome, podcast listeners. We got a special episode today. Our guest is Soo Chuen Tan, founder and president of the Discerene Group, which has a fundamental, contrarian, long-term value investing philosophy. Today’s episode starts off with lessons learned from working under the great Seth Klarman at Baupost. We spend a lot of time around what the ideal structure is for an investing firm, how to build a true partnership with LPs, and that even includes giving money back when there aren’t opportunities in the market. Then we get into his investing philosophy. He answers broad questions like. “What businesses actually have network effects? Does it matter if a certain business goes away tomorrow?” This was such a fun episode. Special thanks to former guest, Chase Koch for helping make this episode happened. Please enjoy this episode with Discerene Management, Soo Chuen Tan. Soo Chuen, welcome to show.
Soo Chuen:
Meb, thanks for having me. I’m delighted. I’ve been listening to your show for a while and so looking forward to this.
Meb:
Where do we find you today?
Soo Chuen:
Simon Stanwick, Connecticut. Hang out in my office on Summer Street. It’s a beautiful day.
Meb:
For listeners, we just went through what I would describe as the most hyped hurricane ever here in Los Angeles. As a somewhat East Coaster, the one thing that did shake it up a little bit is the earthquake in the middle of it, which was actually a decent sized shaker, but we survived, so we’re here a little bit more damp. It’s the end of summertime. I’m excited to be talking to you today. We’re going to get into a lot. I want to hear a little bit about your background. You may be new to most of the listeners, so I want to hear a little bit of the origin story. Where do we begin? You want to begin? You worked at Baupost, is that right? Under Seth, is that correct?
Soo Chuen:
Before we dive into the background, just nothing I’m going to say here is a recommendation to buy or sell any security. We’re not going to top up performance and any investment decision should be through customary due diligence documents, legal tax, regulatory experts. I actually had to stop before Baupost. I joined a firm called Halcyon. They’ve changed their names since now called Barden Hill. It was a credit distress firm and frankly, that was my main value proposition. I had zero investing experience before business school. I didn’t come from a traditional banking, private equity, et cetera background, and so my value proposition for a hedge fund was I know law. I was lucky there was a guy at Halcyon called Richard Horowitz who was a mentor in learning just the basics of investing.
I always knew I wanted to be a value investor because I caught the investing bug. I wanted to think in terms of intrinsic value in terms of owning businesses for the long term. Even in credit distress there are different ways to do credit distress. You can buy things and then buy to a catalyst, buy to an exit, or you can buy something and hold it for 10 years. The different approaches to credit distress investing, I wanted to scratch the itch of just being a longer term investor, and that’s why I actually then moved to Baupost. That was my transition, Seth, of course, as a value investor, and I learned that so much of being a value investor is also just psychological, being contrarian. Thinking about greedy when I was fearful, fearful when I was greedy, the structure of the firm was important. Baupost has very long-term capital. It has a client base that allows it to be quite contrarian.
Those were actually eye-opening for me when I went. Then I then joined a startup called Deccan Value Investors. When I joined the firm was one year old and it was my chance to join a firm on the ground floor and see how a firm gets built and firm actually took off and raised a couple of billion dollars. We grew in terms of both assets and people and institutionalized and all of that. There was a lot of learning, not just on investing front, but just observing the business of money management, seeing how a firm actually grows and builds clients and builds a team and creates a process.
It was a different time. We’re talking about the mid-2000s, firms grew a lot quicker during the time, it was the Haiti of hedge funds, so it was in some ways a compressed kind of version of seeing how a firm grows. And obviously, because it was a much smaller team, there was less to hide, you had more responsibility and more autonomy, and it was also a firm that focused more on moss, so the mental model of understanding was helpful too. That was my experience at Deccan. So that was my next stop and then I launched the firm after that.
Meb:
So wait, here’s the great part. You’re like, “This is easy. I’ve seen this growth. It’s a piece of cake starting your own firm.” And then you have the same with every entrepreneur, but we say this for startup fund managers too. Everyone has to have the naive optimism that this is going to work out. And we say naive, because we all know that the majority fail, and this is a tough game that everyone plays, entrepreneurship coupled with capital markets. So, you had this naive optimism. What was the decision there? You wanted to call your own shots, you want to start your own biz? What was the inspiration?
Soo Chuen:
I was naive and I’m so glad I was. I mean, I didn’t notice statistics of fun failures and whatnot at the time, and I had seen, I joined a startup firm and it grew nicely over a very short period, so I didn’t know what I didn’t know. I was 32, I just turned 33 when I started this Discerene. I started the process in the fall of ’09, right after Lehman, and actually the firm got launched in June 2010, so it was kind of a nine-month period. To me it was like Lehman had just happened, things have blown up. Valuations are so compelling. This was a great time to actually invest. That was my thinking. Now, obviously there was a naivety in that process, because what I did in 2010 was say, “Hey, I want to take a blank sheet of paper and say, ‘If I had no constraints on how I would invest, what would that look like?'”
And I wanted to do something for 50 years. I said, I only want to start one firm. I wanted to build one firm. I was 32 at 82 to have a bunch of LPs, a bunch of teammates, a bunch of CEOs and CFOs that we had partnered with over 50-year period. We’re going to throw a big party for octogenarians and nonagenarians, and we’re going to say, “Look at this journey we’ve been on together.” I wanted that. I went to Berkshire Hathaway’s 50th anniversary. That was precisely what he had. And you had a bunch of doctors and dentists who had invested with him and became multimillionaires and they went to the 50th anniversary.
I said, “I want that, so how do I get there?” And so I took a blank sheet of paper and I wrote down, “Okay, here are the principles.” Now, from the investing perspective, I wanted to be fundamental, I wanted to be long-term, I wanted to be contrarian and I wanted to be global. Now, none of these things are new, fundamental, long-term, contrarian, global. You’re just describing value investing. At this point it’s almost elevated music because no one says what short-term traders, and we’re not fundamental, at least in stock picker land. But I was quite specific about what I meant about each of these terms. When I say fundamental, I meant owning businesses, not stocks, and that’s a qualitative distinction. The idea is if you own a business, and it can be a small business, you own a dealership, you own a restaurant, you own a laundromat, that business is going to go through good and bad times.
It’s kind of a given. Any business owner knows that, and it’s weird for any business owner to say, “Oh, well I own this car dealership and it’s going so well. Let me go buy another dealership. Oh, it’s going so badly, let me dump it and I’ll buy it back in two years.” No business owner thinks like that. Business owner thinks through cycle. And the idea is you understand the through cycle economics of the business, there’ll be good years, there’ll be bad years, but the question is how much money you’re going to put in and how much money will you get out over time? And the through cycle economics is not good, then don’t be in the business at all. But if you’re in the business, you expect that it’s going to have good years and bad years. That’s the idea of being fundamental.
Then being long-term is related to that. If you’re going to own a business through good and bad times, well, each business cycle is seven to 10 years. If you’re going to own it for more than one business cycle, we’re talking about a generational time horizon. So 2010, and you can imagine this was a little bit cultural, and you say, “I want to buy and hold businesses well, a generation.”
The third thing was being contrarian, and that I think is a necessary condition. That element of contrarian has gone away a little bit from how stock choose big stocks these days. But the idea of being contrarian is this, if you own a business for 20 years, the returns that you make are going to approximate the returns of the underlying business itself because you’re just owning a business, unless you pay an unfair price or it. You don’t pay a fair price, you pay an unfair price. But you don’t get unfair prices every day, so often unfair prices come from a fog of uncertainty.
Human beings don’t like uncertainty. Uncertainty breeds fear. Fear breeds sell offs. It’s a psychological thing. And the idea is during the points of uncertainty to actually be a provider of liquidity, and that uncertainty can be caused by anything. It can be company-specific. A company messes up, execution on a step, loses a big customer, you name it. It can be an industry. So for example, in 2010 when we launched the industry that was going through convulsions was the U.S. healthcare industry because the Affordable Care Act had just been passed and people didn’t know what that meant for payers and providers in the healthcare system. The uncertainty created these opportunities to buy mispriced companies in healthcare.
It could be a whole country, a recession, or you name it. Or it could be whole like a global pandemic. Whatever the uncertainty that creates fear and creates these sell offs and during those times to use a Buffett term to be the lead underwriter for the business. The idea of underwriting a business is almost an insurance term is, “At this price, sell the company to me, because I’m willing to hold it. Not because I want to flip it to somebody else, I’m willing to hold it at a price. I’m the final buyer of the business.”
Meb:
All of these launch goals sound noble at inception. Was this a easy launch? Like CalPERS receive you to say, “Okay, we hear you. Here’s a billion dollars.” Was this one of those types of launches or was this more like most of us who have to scratch and claw and bleed?
Soo Chuen:
Well, you can imagine this is right after Lehman had happened and what I just described to you was not the flavor of the day. I mean, the world has changed, but at the time it was low net, highly liquid. Hedge funds were not hedge enough to say would be concentrated long-term contrarian, profit of liquidity. And by the way, we also said it would be global and often of question switch on you and which army you’re going to cover the world, on what?
Meb:
The good news is, your comment about being contrarian is like, anything global since your launch has been contrarian, because S&Ps mowed down everything.
Soo Chuen:
Absolutely, you can imagine it wasn’t an easy launch at all. And again, the beauty of being idealistic and young and naive is you don’t realize how hard it is. And so we did it and we launched with $62 million of committed capital and we were frankly just lucky. A few people made the bet on us and it was not obvious. The bet wasn’t obvious at all. I was a partner at my previous one, but I wasn’t a portfolio manager. I didn’t have a standalone track record. I hadn’t built a business, I hadn’t built a team. So it’s not like you lift and experience PM from a bigger place and you back the person with money. It was not that at all. It was really just a bad on me and my good intentions. So, in some ways you look back and go, “Wow, the people who made that bet were pretty ballsy.”
Now, I made it even more difficult because my thesis was, “Look, all these things are easy to say, value investing principles, they’re hard to do, I believe 13 years later, I still believe.” It’s because there’s actually a structural issue with our industry in public markets. Funds have quarterly, annual, if you’re lucky, like two-year lockups. And here I was saying I want to be provider of liquidity for sellers. I wanted to compound over generational time horizon. I want to own businesses for a generation, how do you do that If you have one , two year capital? You just can’t do that.
No matter how well-intentioned you are, inevitably you get on this treadmill of trying to deliver returns on a year-to-year basis, especially in your early years, first year, second year, it’s like prove it to me. You are in a show me period for new funds. And I didn’t want to do that. I said, “Look, I want to invest long-term,” and I was serious about it. So, I said, “Let’s create a structure, which is highly unusual, with three year, five year and 10 year investor level gates. You can imagine, that’s kind of crazy.
Meb:
I like it. Very bold of you.
Soo Chuen:
The shortest is three years. And it’s not a three-year lock, it’s a three-year gate. What that means is, regardless of when investors come in, when they redeem, they get a third at the end of year one, a third at the end of year two, a third at. And that’s true even if they’ve invested with us for a decade when from the moment they put in redemption requests, it’s a third, a third, a third, and then the five years, 20% each year, then 10% each year.
In 2010 that was crazy, because funds who threw out gates got punished. And here we are saying we’re going to have investor level gates. But I also said, “Well, we also want to align incentives in terms of investment horizons.” So we created a structure on incentive allocations that’s unusual. We have three-year claw backs on incentive allocations.
So, any year the incentive allocation gets calculated, one that is paid out that year, one that is paid out the next year, one that is paid out the year after that and the amount is not paid out, it’s subject to claw back. It avoids the heads I win, tails I lose situation where funds make a lot of money on the way up and then you have a drawdown and no GP ever returns the incentive fees to folks. But we wanted to make that even, and make that … And we still have that. It’s 13 years later, we love it. Our LPs obviously love it.
Meb:
I bet they do.
Soo Chuen:
Our accountants hate us, because calculating three year claw back on its interface takes a long time. So there’s a lot of work that got created. So it was unusual. Then we wanted to keep management fees low, so there were a whole bunch of structural design terms that were quite different and quite counter cultural in 2010. Still quite counter cultural today. One thing I wish we did in 2010 that we didn’t do was to create a drawdown structure, which makes us even more unusual. So private equity firms have drawdown structures. We didn’t do that in 2010. We did that in 2018. So in 2018 we actually decided to return a whole bunch of our capital to LPs because we were not finding anything that we wanted to buy. We voluntarily wanted to return capital, but we wanted to call the capital back in the future.
And the way to do that was to create a drawdown structure where you sweep the cash to LPs, but then it goes in the capital commitment pool and then we get to call the capital back in the future for private equity. For prem This is a very standard structure, but for public markets it wasn’t. So we did that in 2018 and frankly with hindsight, looking back, I wish we did that earlier because it’s worked out really well.
Meb:
What year in the timeline were you able to take a breath and be like, “okay, this may work.” I know you had the optimism that it would always work, but how many years in before you’re like, “Okay, I feel good about this. We’re on the path.”
Soo Chuen:
I’m still waiting for that. One of the defining characteristics of a value investor is perpetual existential dread, knowing just how hard it is and knowing nothing’s a given. So, I say only half-jokingly, I think we’re 13 years old now, but it feels to us that there’s a lot of wood left to chop for us to get to where we want to get to. If you are aspiring to be buffered, you’re aspiring to put your head away types, you realize you just have a long way to go. I realize we’re still on this massive journey and we’re early on their journey.
And it’s not that flippant. I mean, it’s genuinely the case. I mean, look around us. There are not many firms that have a 50-year track record. It just doesn’t exist. Failure is almost, almost inevitable in our industry, which is if you kind of say in those stock terms, it should be scary and it should be a motivator. And I think that’s how we thought about it.
Meb:
If you look back, I mean, if I were to talk to all my aspiring investing buddies who want to start a fund, the number one mistake, and it’s number one through five probably is everyone sees the pot of gold at the end of the rainbow. They see what they want to do and they almost never give themselves enough runway where you mentioned 50 years, but God, I mean just think about 10 years. The amount of people that launch a fund in my world and then shut it down a year later. I’m like, “A year? It’s not even a unit of time to even consider. You need to be prepared for a decade. Who knows what could happen in a decade?” You had an interesting comment that you made that we’ve actually used a somewhat similar framework when we’re talking to people about portfolios. And this is, essentially you were talking about the blank slate, blank piece of paper where we often talk to investors and they have so much legacy, mental baggage accounting with their current portfolio.
They’re like, “Should I keep this? Should I sell this? I’ve had this stock for a while or this fund I inherited from my parents, or I got this in a divorce, oh, yada yada. Should I buy or sell it?” And I always say, “Take out a blank piece of paper and this is your ideal portfolio. If they don’t match up, there’s something wrong.” And then taxes are obviously consideration. But let’s go back to 2010. As you had that blank piece of paper, do you remember any of the names in there? What was the initial investments?
Soo Chuen:
One of our largest investments back in 2010 was a company called Wellpoint at the time. It’s changed its name a few times since, but it was a health insurance in the U.S. He owns a whole bunch of the Blue Cross Blue Shield plans. And it was again in the context of what we said about dislocations and we like dislocations. And you can remember at the time the Affordable Care Act commonly called Obamacare. People were worried about that would do to health insurance because you were estimating medical underwriting, you were capping MLRs and stuff like that. So there was a lot of uncertainty because of that. And that was one of the things that when we launched with, we were talking to day one investors and they asked What’s going to be your portfolio?
We talked about that and talked about the work on that. That’s one example. We own another consumer products company. We still own, actually we don’t own Wellpoint anymore. It’s changed since and whatnot. But we own a small little consumer products company in Singapore. So actually one of the first stocks we’ve ever bought, it’s our version of See’s Candies.
Meb:
Which I feel like everyone has that noble goal of holding investments for the long run and then all of a sudden you get a double, put 10 grand in, you got 20 grand, you’re like, “Oh, my god, how can I spend this? We can go on a vacation, we can buy a new house, we can do whatever this investment.” And so are there any best practices in your head, frameworks for how you hold onto those suckers for so long?
Soo Chuen:
You actually have to start, go all the way to just founding principles, almost kind of philosophy rather than process. You literally start with your LP base. What are the expectations? Because you can’t manage a portfolio in a vacuum. That was one of my theories, which is that what institutions bound what rules bound by the mandate that you create. And so what is the mandate? What is it that your LPs expect you to do? What we told the LPs, and I’m really proud that that’s the case today, is that we are literally going to invest it for 50 years. And this is a partnership for 50 years. Obviously, we were not locking the mouth of it, but the DNA was that. And so with the LPs we said, “Look, we’re partners. We’re going through business together.” We forget, funds are actually partnerships. Legally the structure is a partnership.
And back in the ’50s and ’60s, the Buffett Partnership, the Alfred Winslow Jones partnership, they were actually partnerships. It’s almost like people were creating JVs. There’s a general partner, and a limited partner, and then we’ll go into business together. It’s a JV, it’s a business. It happens to be an investing business, but it’s a business. Now, roll forward to 2010 and today. Funds look more like products. People buy this product, they buy that product, you get this stream of returns, you get this exposure, you get this correlation, et cetera, and you buy a product, you get your statements, you get your investor day, you get your chicken dinner, but you’re not really a partner of the funds you’re invested with. And so we said, “Look, change the DNA. Make this an investment partnership. Roll the clock back to 1950 and 1960. And if it’s a truly partnership, then the expectations are different. And expectations are different not just in the output but also the input if you treat your LPs as part of your team. And why not?”
I was 32 and I fancy myself to be thoughtful and hardworking and whatnot, but I’m one person, why wouldn’t you punch above your weight and use your LP base, the endowments and the family offices that were with you that often have far more resources than you and have them be part of your team and travel with you through this process? And what that means is when you’re analyzing a particular investment, whether it’s Wellpoint or a Greek investment that we’re in, you’re thinking of it like a permanent investment. “Do we want to buy this company?” And then because your LPs are traveling with you in that process and part of the decision making, once you make that investment, there’s a different level of buy-in, a different level of expectations, a different level of knowledge that your LP has about the investment itself, because they know how the decision-making process was. They just don’t see the output.
That requires a level of transparency and a way of running the firm that’s different from a typical investment firm. And by the way, it has to work both ways. If you think about LPs as part of our team and they help us and they’re part of working for their returns, we are also partners to them and part of their team and things that they’re worried about. It’s not always about us. It’s not often about us. A lot of LPs today are worried about China. You can bring your resources to bear and help them, so it works both ways. But that DNA, that expectation one, just sets the tone differently in terms of the way you manage the portfolio. That’s one. But two, the team itself, the Discerene team, the analysts of the team, often that tends to drive how decisions are made.
Why is that? If you create a team of analysts who want to come, create P&Ls, generate returns, get paid on those returns, the expectations are very different. You need activity. You don’t want to hire someone and they have nothing in their book for two, three years, because they’re going to leave if they’re not happy. And you have this constant churn in the portfolio because you need activity to justify the ambitions of the people on the team. If instead you create a team structure. And so the first layer of the stool is LPs, the second layer of the stool are the team where people expect to be here for 5, 10, 15, 20 years at the same firm, which is again, quite counter cultural and say, “You’re going to be here for 20 years and therefore when you make an investment you’re going to own that investment for 10, 20 years.” You begin to think differently about the decision-making process itself for making that investment.
The third leg of the stool is partnerships with CEOs and CFOs, and we think about that seriously, and here’s where my McKinsey background comes into play. You become sounding board and counselor to your CEOs and CFOs, and we actually tell them this. They don’t always believe it. We tell them, “We’re now shareholders, our fortunes are tied to yours and we’re married through good and bad times.” And they don’t believe it. No one ever believes it. But then they stock halves from there and we buy more. And we’re not yelling and screaming at them and we’re not asking them, “Why did you miss this number or why did you do that?” Instead, we’re saying, “Let’s talk about the business. Let’s talk about the process. Let’s talk about organization. Let’s talk about the things that you can do,” and travel with them through that.
Especially outside the U.S. that goes a long way, because in the U.S. it’s very common for someone to buy 2% of companies say, “I own 2% of your business.” In Asia, in Latin America, in continental Europe you can buy 2% of the stock. But from a DNA perspective it doesn’t make you a shareholder. It’s only with time if only for a while that they begin to treat you truly like a shareholder, truly like a partner. And then the conversation becomes more real, because a lot of conversations between CEOs and CFOs and analysts are a little bit like kabuki. Analysts are trying to predict a number. They’re trying to figure out whether their earnings are going to be good or bad or whatnot. And the CEO knows that that’s what the analyst is trying to get, but there’s only so much they can reveal. So there’s hinting, there’s signals, there’s tone.
It’s almost like theater and you’re like, “You don’t need a theater. If you own a business, you’re going to have multiple interactions. You’re going to talk about not just the good but the bad, but the challenges, et cetera.” And to change the tenor of that conversation. If you do all these three things, at a DNA level the expectation is that you’re going to own these businesses for a really long time, and that’s kind of a default expectation. Now, you don’t end up owning businesses forever, so the reason is you can be wrong. And once you set a DNA the way it is, the important thing is to create a DNA within a firm where you don’t just get merit to your ideas, it becomes the opposite. You have to create processes to say, “Revisit, revisit. Is our thesis still true?”
Because the default becomes the different, default is to hold it. And then you have to create processes to say, “Well, just make sure that you’re still right. Just make sure that you’re looking for [inaudible 00:24:22] confirming evidence.” And then because we have a drawdown structure, it changes the tenor of our decisions, because in most hedge funds you have to sell something to buy something, because it’s a fully invested portfolio. It’s a portfolio management tool. Here in this ring you want to buy something just call capital. It’s like a private equity firm. You still own everything that you own and then you just call capital to buy something else.
Meb:
I mean, was the first time you sent the capital back, that seems to me like 90% of people would have a very hard time doing that. Was that decision pained? Was it a struggle? What was that like first time you did that? You’re like, “You know what, I’m just going to give some of this back.”
Soo Chuen:
It was not easy. I mean, we were small at the time, so I’m trying to remember how big we were in 2018. But I remember that by 2019 we were a billion in total capital, 400 million was unfunded, meaning 400 million was not called. Only 600 million was called, so in 2018 we were even smaller than that.
Meb:
What are you guys now?
Soo Chuen:
We’re two billion in total assets. So it was hard. But everything’s habit. We’re big students of organizational culture and myth making in organizations and how myths take a life of its own and become part of the culture of the firm. The myth at this arena is we’re very picky about capital. We’re very careful about who we can bring on board. We treat conversations with LPs as partner recruitment processes, not just sales processes. It’s a two-way conversation on mutual fit. And then what we end up doing is if it’s not the right fit, we just don’t accept the partner. And we’ve done that. What that meant is, by 2018 there was a habit of thinking through these decisions. In 2018 cash was going up in the funds, because we were exiting. And we simply couldn’t find things that we wanted to buy, so the reinvestment risk was an issue.
And the luxury of having our structure is you can think in absolute terms, because obviously there are always things that are relatively cheap. In any portfolio that things are cheaper, that things are more expensive you can always buy the things that are relatively cheap. But we didn’t want to change the way we thought about things and to buy things in terms of relative value. We want things absolute value. So, things didn’t meet our absolute hurdle rate. So we’re like, “Well, I guess we should return the capital. That’s the most intellectually honest thing to do.” But frankly, just from a business perspective, we didn’t want to just return it and then have it be gone forever. We kind of wanted to have the kick we needed. We wanted to return the capital but have the right to call it back. And that’s why the decision that we made was to create a structure where the money that was returned became a legal capital commitment that we can call back in the future.
Meb:
Let’s talk a little bit about today. We are at the end of summertime, 2023. You’ve been in business for over a decade, congratulations. What’s the investing opportunity set look like today? Where are you finding ideas? Are you concentrated like Uncle Warren with half your portfolio in one stock? Do you guys short at all, credit default swaps?
Soo Chuen:
We do.
Meb:
Oh, okay. Let’s hear a little bit about what you guys are doing and the way you think about the world today?
Soo Chuen:
We run a long shot and a long one mandate, so two, so different. The longs are the longs and the same, but the hedge fund has shorts and credit default swaps. So, we do everything bottom up. We tend not to have top-down macro views. Or we do, but we think they’re worth what people pay for them. It’s just nothing, so phrased differently. I think we worry top down. We don’t need on the macro, but we always invest bottom up. We call stock by stock by stock. We’ve always been contrarian, so we still are. If you look at a portfolio today, we have a number of things in China, which is super contrarian. China blew up in 2021 and we backed the truck, and so we’re own a few things now. We have a number of investments in Turkey that we’ve held since 2018. You may recall 2018 was a tough year for Turkey. There was a selloff, the lira devalued.
Meb:
We just had Mohnish Pabrai on the podcast and we spent a little time talking about Turkey, which I feel like now that you too have mentioned it, that’s not a word that has entered most investors’ vocabulary over the past few years in China as well. I feel like China on the aggregate, most investors are going to respond to that phrase with a little bit of nausea, revulsion.
Soo Chuen:
Not a positive reaction. We’ve had investments in Argentina since 2012, but we actually backed the truck in 2019 right after Mercury lost and the [inaudible 00:28:46] came back into power. And so we’ve had that since 2019 and still hold it. We have some investments in Japan, but these investments we’ve had since 2011, since the Tōhoku earthquake. So they’re not new, but they’re still in the portfolio. It looks top down. We have this in this country, that in the country, but the actual process of getting there is totally bottom up. There’s a businesses that we like and when they get cheap and the cheapness can come from this macro dislocations and we say, “Hey, we actually really like the business, but for the dislocation we won’t have a chance to get them. And now because of this location, we do have a chance to buy them.” And then we just do.
These are often businesses that we’ve eyed for a long time. Often businesses that we love to own, we study businesses, we call this peacetime project. We just study businesses around the world. And then you have a list of businesses that we love to own, but we don’t get a chance to because we’re valuing business.
Meb:
It’s on your Christmas to-do list. You’re like, “I want this, just maybe not this year.” You got a whiteboard list of names that you’re interested in.
Soo Chuen:
We do.
Meb:
By the way, before we dive in, because you talk about, you’ve just named three countries that I think most people would never, ever invest in. When you do the portfolio allocation risk management, how many names do you own? Is there a max size? I’m trying to think about the diversification.
Soo Chuen:
Typically, we’ll have 25 to 30 names. That’s typical.
Meb:
Okay, so still pretty concentrated?
Soo Chuen:
Yeah, we’re actually higher than that today, primarily because of the bumper crop of 2020. Because of our structure, when we make a new investment, we don’t have to sell anything. We just call new capital and buy it. And so the number of names goes out when you do that. Large positions will be 10 to 15% of the portfolio. Today our top three positions are roughly 30% of the portfolio. Then top 10 could be 60% or so, and then that’s a longer tail. That’s the level of concentration. Average portfolio turnover is really low, low teens 10, 11, 12. So our average holding period is like seven, eight years on steady state.
But that average can go up over time, simply because we’re only 13 years old. By definition, the right side of the tail is locked at 13 years. The longest tenure company’s 13 years, but every year that goes by the right side of the tail becomes more like a normal distribution, so we have investments that we hold for longer. And hopefully over time our goal is to be longer and longer term. To push the boundaries in some thinking about businesses so that we can actually be even more removed from trading instincts in the market.
Meb:
I’m looking at your 13F, as one would do, and there’s a pretty wide dispersion of sectors. You got consumer discretionary, energy, industrials, finance, utilities, telecommunications. You got a little bit of everything. As you look around the world, the opportunity, is it pretty wide mandate as far as what interests you? Is there anything in particular you’re looking around this year where you’re like, “You know what? This theme or this industry is really something that is attracting us?” Or does it often end up more kind of top-down country geopolitics inspiration? How does it filter down?
Soo Chuen:
It’s none of the above. I’ll share with you a little bit about the process. In theory you can look at any company in the world, any geography, any industry. Frankly, any security. We’re not limited just equity. So really you can look at anything. The question then is, “Okay, what do you actually do?” Because I just said, “Average portfolio, 25 to 30 names. Average holding period, eight years.” What that means is in average year we make about four investments, period, across the team. We have a team of eight people. It’s soon going to be nine people on the team, because a new analyst is joining us next month. But what that means is one investment every two years per analyst, period. That’s the average.
Meb:
Is that a pretty good analyst filtering out by the way, in the interview process, be like, “Look, here’s the deal.”
Soo Chuen:
Oh yeah. Because we tell them that.
Meb:
I’m going to take one of your ideas in the next two years, and it might not be this year, so deal with it.
Soo Chuen:
And it could be three years from now, because it’s lumpy. And by the way, it’s not your idea, so I’ll tell you a little bit about that. Because analysts don’t pitch ideas here, so it’s just different. Because we’ve made so few investments, most of the time we’re doing what we call peacetime projects. We’re studying businesses, we’re not making investments. A wartime project for us is you’re actually figuring out what to make an investment or not. But peacetime, you’re studying the business. You’re studying the business, and the end product isn’t an investment. The end product is a memo describing the business. And then we price it and say, “Okay, this is the price at which we’re interested.”
And the price could be very different from what the stock is trading, it could be half of what the stock is trading. We’re not anchored to where that stock price happens to be. But because we make so few investments, most of the time we’re in peacetime, not wartime. Most of the time we’re the analysts that the team are just studying businesses, not pitching investment ideas. And when they study a business, there’s no view. There’s no like, “Oh, I’m studying a business because I’m interested in business.” You’re just given a business to study and you say, “Tell me what you think of it?”
Meb:
It’s like the intent of that to remove a little bit of the psychological attachment for these people where they have a bias as to what they would think about?
Soo Chuen:
Yeah, because it’s not the idea. What we do is there’s a wish list of companies we want to study. In 2010 that list was rather large. We’re now in 20, 23, 13 years later. Ironically, or maybe not, the list is longer than it was in 2010, because obviously you keep adding names to the list of companies that we would love to study, because we’re curious about it. The wish list of companies we want to study keeps getting longer and longer and longer, because again, the worlds are mandated. We can study any business. The question is, “Okay, what do we put on the list of companies we want to study?” Because it could be anything, right? So for example, I’ll give you an example of a project we studied a few years ago. It’s instant noodles in Asia.
Meb:
I had ramen last night. Let’s hear. Keep going.
Soo Chuen:
There you go. It’s interesting, because if you study instant noodles, every Asian country has different instant noodle brands. They don’t consume the same brands. The brand doesn’t travel, even across borders. The top instant noodles companies in Korea are different from top instant noodles company in Japan, it’s top from difference in China, it’s different from Thailand, it’s different from Malaysia, it’s different from Indonesia, it’s different from the Philippines. But it’s really interesting, because it’s like each industry is very local, but in each place the top brand has a very high share. And significantly higher than number two, and then significant higher than number three. The dispersion of market shares, there are a lot of commonalities across countries. Even though the initial conditions are different, the brands themselves are different. And the question is why? See, it’s almost like you ran a bunch of Monte Carlo simulations and you arrive at the same industry structure across multiple different industries, even though each industry is different from each other.
So, that’s interesting. It’s just an observation. It’s interesting. The question is, “So why? Why is that?” If you do a peacetime project, which we did, and by the way, we don’t own a single instant noodle company, but you do a peacetime project. You’re just trying to understand why the industry evolves the way it is. And the question is, “How much of it is structural? How much is necessary? How much is that?” It depends on accidents of history. How much of this. Depends on initial conditions, how much of it. Depends on distribution, et cetera. You do that project, and then the end product of the project is this big writeup describing the industry, describing the players, describing our assessments of different businesses. And then we just shelve it and then you just say, “Okay, at these prices we’ll be interested in these businesses.”
Now, in some cases you may never own them, but that’s okay. That’s kind of the rhythm of our work. The question is, “Okay, so how do we decide what companies to even do work on?” There’s a few things that we try to look for. The first question is, does this business have a reason to exist at all? Now, that’s an odd question because the business does exist, by definition, it’s a publicly traded company. It does exist, but we still ask that question. It’s almost a question a nine-year-old will ask, like, “Why does this business exist in the first place?” The thought experiment we run is, “Well, if the business disappeared from the face of the earth tomorrow, how different would the world be?” And if it’s not very different, we’re not that interested in the business. I’ll give an example.
Meb:
I was going to say, what’s a good example? You read my mind.
Soo Chuen:
Yeah, Lululemon is very successful. It’s very popular. But if Lululemon disappeared from the face of the earth tomorrow, I don’t think the world will be very different.
Meb:
No, they just, well, Vuori, Vuori is the one that everyone, at least a lot of people here in LA are wearing now.
Soo Chuen:
That’s a kind of existential question. That’s the first question. The second question we ask is, and then this is a term of art here, which is, “Does this business pass that Rip Van Winkle test? So the story of Rip Van Winkle, which is, you fall asleep. In our case, we say fall asleep, wake up 10 years from now. So sleeping sickness, your body stuck, you fell asleep. You wake up 10 years from now, can you reasonably predict what the business looks like in 10 years? And I’m not talking about predicting earnings because there’s no way you’re going to predict earnings of any company in 10 years. It’s almost impossible. But can you predict what a business looks like? What does it do? Who are his customers? What product, what service, what business model, what revenue model? Describe the business?
And if you can’t do that, then you have no business trying to own the business for 10 years. And you’d be surprised. I mean, 10 years is actually a long time. It’s not so easy to have that thought experiment and come up with the idea of something that you can reasonably predict what it looks like, let alone the earnings, what it looks like in 10 years. I’ll give you an example, and this may be controversial, but I think we would struggle to describe what Meta looks like as a company in 10 years.
Meb:
They would struggle to describe what it looks like probably.
Soo Chuen:
Yeah. And so if you’re intellectually honest about it, so if you say the interesting value of a business is the net present value is future cash flows. Obviously, it’s hard to predict cash flows of any business in 10 years. But if you don’t even know what a business looks like in 10 years, what does it do? How does it make money? How do you value it? Buffett likes to describe that, “The line between investing and speculation is a gray one.” And we agree, and you can cross it if you stray too far from the craft of actually investing and you run into the realm of speculation. Obviously, some value investors bought Meta because multiple cash flows are slow. But for us, it’s like if you’re intellectually honest about it, we struggle with that answer, to answer that question. And because if you struggle to answer that question, then it just goes into two hot pile.
It doesn’t mean that the company will fail. We don’t have a view. It just means that you don’t know enough just epistemically to actually be able to invest. That for us is an important part. The next question is, is it within our circle of competence? Now, that’s a more personal. For each investor the circle of competence is different. Buffett loves banks, for example, we don’t. I’m a big fan of Buffett, but we are not going to copy his bank investments because we don’t feel like. But at the same token we feel like we’re much more comfortable going into a country like Malaysia or Thailand or whatnot, because of frankly just our backgrounds and the backgrounds of the team.
Meb:
You got any Malaysian stocks today?
Soo Chuen:
We do, yeah.
Meb:
Good. Okay.
Soo Chuen:
And then, I guess probably the most important question is the question of moat, which is the barriers to entry around the business. And we think the word moat, which is another Buffett term. It has become almost like furniture in our industry, because you hear it so much. And sometimes people say quality, sometimes they mean a competitive advantage. Sometimes they say moat. But you hear it so much that it loses its power a little bit and it becomes a fuzzy concept. Sometimes it just means a higher RIC business. But really, if you take a step back, the concept of a moat is something quite specific. What is a moat? A moat is a barrier to entry around the business that allows a business that makes super normal profits to continue making super normal profits over time. And by the way, that’s actually an anomaly. It’s a statistical anomaly.
Because in a properly functioning capitalist society that shouldn’t happen. Profits should attract competition. That’s a signal. A business makes a lot of money. It makes high returns on capital. Other competitions should come in and compete a way that’s super normal returns. And returns go back to normal. By the way, that’s good for consumers, it’s good for capitalism. It’s not how capitalism is supposed to work. To have a business that makes super normal profits to continue making super normal profits for an extended period of time should be unusual. And it should be an interesting phenomenon. It’d be like, “Why is that happening?”
I’ll give you an example. Back in the ’80s there’s a whole bunch of companies that made super normal profits. Pull up the Fortune 500 companies, you look at, there’s a whole bunch of them. Now, in the ’80s, back in ’87 when the markets crashed in ’87, Buffett backed the truck on Coca-Cola. But he could have bought any number of other very successful companies at the time. He could have bought GE, he could have bought Xerox, he could have bought Eastman Kodak, he could have bought DuPont, he could have bought ExxonMobil. He could have bought any number of companies. Exxon, not ExxonMobil, at the time he bought Coca-Cola.
Now, roll forward, we’re in 2023, many of those companies I just described, GE, et cetera, they’re far less profitable. And then unit economies are, those businesses are far less attractive today than they were in 1987. But Coca-Cola is a stronger company today than it was in 1987. Yes, [inaudible 00:41:32] capital are as high as it was. So the question is why. It’s been almost 40 years, so what allows Coca-Cola to continue to enjoy the economics it does when so many other businesses don’t? And what did Buffett see at the time in 1980? A priori, it’s always easy to make investments a posterior, right?
But what he see at the time that allowed him to make that one decision instead of any other one that he could have made. He could very well have bought GE and said, “Look, GE is a great business. They’re number one and number two in every category they operated in. Jack Welch is a wonderful CEO.” But he didn’t do that. So why? Things are actually quite interesting things to study. And if you study it carefully, you realize it’s not as easy as people think.
I’ll give a topical thing. These days people like to talk about network effects as a moat. Businesses that have skill that we get skill. Why? Because it’s positive externalities. And sometimes it seems like meaning additional customers makes it more available to other customers, or sometimes it’s cross sided. Additional customers makes it more available to suppliers. And additional supplies mean more customer to customers. So two-sided network effects.
People talk about platforms, flywheels, any number of metaphors that people use on network effects. So, that has become a thing. And people talk about network effects as an indicator of high quality business or multi-business. Now, the honest truth is that network effects have been around for a very long time. It’s not new. It’s not technology. It’s not because of tech that there are network effects. We don’t think about it, but there’s a network effect to a mall. The fact that lots of people go to the mall makes it more attractive for vendors to be in the mall and more vendors go to the mall, the more people go to the mall, right? Network effects happen everywhere. In fact, if you open up the 1907 annual report of AT&T and you read it, they talk about the network effects of telephone. And how if more people use the telephone, it would be more useful to other people.
So, it’s not a new phenomenon. But if it was simply the case that businesses with network effects are good businesses, then you would think that a singing competition would be a good business. Why? Because American adult comes out. Lots of people watch it, because lots of people watch it a lot of talent want to be on it because there’s a big audience. And then you have the best singers on it, and you attract all the best singers, all the most talented [inaudible 00:43:38] be in the country. And because you have all the best talent, then there’ll be bigger and bigger and bigger audiences. So, it will never be the case that any other singing competition will come in and take share away from American Idol. You would expect that, but that’s not true. That’s not true. That wasn’t true in Clubhouse either when there were network effects are on Clubhouse.
That was not true in dating sites. Match.com didn’t become the whole industry. It’s not true of stock exchanges. Stock exchanges have massive network effects, but trading revenues earned by stock exchange just keep coming down over time. So the mere existence of network effects has not led to win a take on business. It has not precluded competition from coming in across multi-funded different businesses across time. So, clearly there’s something more to it than that. The act of studying that and doing enough empirical case studies and see what we learn about when network effects matter, when they don’t, what are the limits to it, et cetera, become important. And you can only do that if you have the luxury of time. And the thing about investing is people are often on this terminal. So you’re trying to prove out a thesis and all this business network effects, look at this food delivery company is X-percent market share, therefore it’s going to win.
And then you don’t actually have the time to take a step back and say, “Okay, let’s test the counterfactual. Let’s go study 10 different examples of businesses that got really big on a particular thing, but were not able to forecast the market. And why would they not be able to forecast the market?” Establishing the base rate of success for certain industries is important. And so, because of the way we’re structured and because of the time horizon that we can invest in, we can do that in a way that a lot of people can’t.
Meb:
Over the past decade plus, what’s the main way these companies that you want to partner with for 10 years, a year or two or even 10 years later, why do they usually get the boot?
Soo Chuen:
Three main reasons, from the most common to least common. The most common is, we’re wrong. This business is humbling, so you’re wrong a lot. You come up with some theory about the business, you come up with some theory about how the moat around the business works and you think you’ve done the empirical. You think you have a watertight case. And then subsequent developments make you revisit your thesis. A thesis is only a thesis if it’s falsifiable. Otherwise it’s just ideology. If you have a thesis about a business and you describe the thesis very careful about what our thesis is, then that must be disconfirmable. And the question is, what do you need to see for the disconfirm? And if you see it, you’re like, “Okay, well we just saw it.” And then you have to revisit it. And when you revisit it, you go, “Okay, something’s wrong here. We missed this, or we missed that.”
And sometimes it’s about the business. Sometimes it’s about the people. Sometimes it’s about culture. Sometimes it’s about strategy, strategic researcher making and game theory. So we try to kind of isolate what it is, and then we say, “Okay, well we’re wrong.” And if we’re wrong, we have to sell, and we do.
The second reason is Mr. Market gives us a price that we can’t say no to. Then you say, “Okay, well, thank you. We don’t think the company’s worth that and you want to pay that for it, fine.” And by the way, that sometimes is involuntary. So some of our companies have been taken out over time, and it’s not always that you don’t want to sell, but you have to sell.
The third reason is if we want to buy something better. Now, that happens very seldom, because of our structure. Because we often have dry powder, we have falling cash sitting on the sidelines with LPs. We can call capital. To sell something to buy something is something that you have to do when you run out of cash. And we’ve almost never, it’s not never, but almost never run out of cash, so we’ve almost never had to do that. But once in a while you’re like, “Okay, I really like this, but we need to sell something else to buy this.”
Meb:
How often does it, when you’re looking at some of these countries that seem a little farther afield than most investors’ wheelhouse, when is the geopolitical situation ever an invalidator? Because you just mentioned three countries that I think most investors would have just from headlines alone would have said, “No, this is no chance.” We spend a lot of time talking about global investing and I feel like I’ve been banging my head against the wall and people, I don’t feel like it really resonates that much. Largely because U.S. has been the death star of performance for, is that the right analogy?
Soo Chuen:
I think it’s a good one.
Meb:
It just killed everything. Anyway, is there anything that’s an invalidator, or is there things that you look, it’s mostly opportunities. How do you think about it?
Soo Chuen:
I’m also trained as a lawyer and understanding that the privilege of buying a security and saying, “I have rights,” is a privilege. It’s not a given. You buy a bundle of rights, you buy a bunch of protections, piece of equity gives you a bunch of protections. It’s not very strong protections. You have certain rights, governance rights, certain voting rights, et cetera, but you don’t have contractual rights, so cash flows, et cetera. So, understanding at the end of the day that modern capitalism sits on top of rule of law, sits on top of protection of property rights is something that we sometimes forget being practitioners as opposed to theoreticians. But it’s just true. It’s really important. And so because of that you have to be comfortable enough with just the structure, not necessarily the macroeconomics of the particular, like what interest is or inflations are. Just the structure of society in a particular country in order to say, “I’m willing to invest in a particular country at a price.”
Now, once you get over that threshold condition, obviously there’s still all sorts of macroeconomy environments, very different macroeconomies, some more stable than others, some political unrest situations, et cetera. There’s a whole range within our portfolio. The question then becomes, “Okay, what are the risks you’re taking? And then what’s the potential return?” Like I said, we had nothing or almost nothing in China for years and years and years and years and years. And the reason for that is because all the risks of investing in China were always there. It wasn’t like Taiwan wasn’t an issue of 10 years ago, five years ago. It wasn’t like China had different neighbors. It’s not just Taiwan. Everyone focuses on Taiwan today, but it’s not just Taiwan. So you have North Korea, you have the Spratly Islands, you have the LAC, which is the border with India.
You have Russia and Astro again before Ukraine. If you look at geopolitics with China, the issues where China have always been there and dittoed all the other things that people talk about today, which is the surfeit of institutions. China has a lack of well-developed institutions in China for peaceful transitions or power and stuff like that. That’s always been true and it’s always been something that China has had to deal with and continues to have to deal with. An aging population China has always to deal with. Underdeveloped governance infrastructure that China has always had to deal with that. It’s not new. None of these things are new, but all the things that were good about China that people were attracted to. A fast, rapidly rising middle class and educated population, infrastructure that’s probably punches way above its weight in terms of the sophistication of the infrastructure. Now, the way the market interprets the information is different, depending on the recency. Back when the Chinese internet stocks were trading at 50 times earnings were times when people were pointing to all the good things, which were always there and ignoring the things that could go wrong.
Meb:
We see this on Twitter, we’re talking about China more than anywhere, almost has been just this euphoria and depression as far as the valuations over the past 15 years. I mean, I don’t know the exact year, you probably know better than I do, but certainly 2007 people were clamoring for the BRICS and China and India, and at various points it’s been both sides.
Soo Chuen:
That’s true for EM as a whole, it’s not just China. It tells a story, probably the most topical story right now, but it’s true for all the BRICS. When we launched in 2010, we forget because time has passed. But in 2010, the consensus was the BRICS for the future. Asia was the future. Latin America was the future. The consensus was the U.S. was toast, Western Euro was toast, it was sclerotic. Governments were over levered, households were over levered. You have an aging population. Look at the demographic premium that Asia had. Young population, high savings rates, governments were not borrowing, governments were running trade surpluses. Didn’t have a lot of debt on the balance sheet, et cetera. So, the consensus was that it should actually, that’s the future. And that was how portfolios were constructed from the top down. The question we were asked in 2010 is switching, “You’re from Malaysia, you know Asia well.?” And I said, “Yes, I do.” “So why are you running to Greece and buying beaten down companies in Greece? This is not where your competitive advantage is.”
But the story has flipped. The bloom has fallen off the BRICS rows over the last 13 years, and there’s frankly been a hollowing out of the modern investment industry. Back in 2010 there was a lot more active money in EM. Now there’s more passive in EM. And even within active now, it’s all about the growth. People are still in EM and they want to buy crab and coupon and C limited and [inaudible 00:52:09]. If you draw the Venn diagram of active as opposed to passive EM value, that intersection of that keeps getting hollowed out. When I started my career and I made a list of thoughtful investors around the world, it included long only funds that had a lot of money in EM, like Third Avenue and First Eagle and First Pacific, and Southeastern and Brandis, and you name it.
There were a lot of long only investors who literally ventured around the world. But many of those big complexes have shrunk or gone out of our business and the money is being hollowed out of EM. As a result of that, you can see these dislocations in EM. Things sell off for just literally no good reason at all. I’ll give example. Back in 2020, during COVID we were shareholders with this company called Protelindo. We’re not shareholders anymore, but we were shareholders at the time. It’s the biggest tower company in Indonesia. It sold off in March 2020, and it literally, the trading of the stock got halted for a bit because it’s a circuit breaker in the Jakarta stock exchange. And there’s no reason why you should have hit a circuit breaker.
I mean, it’s a tower company. It signs tenure contracts with its customers. The tenure contracts are not related to usage of towers or anything like that. It’s just you get the same rent for your towers regardless of the macroeconomic environment. If you wanted to buy a COVID-proof business, this was one, but it’s not traded out aggressively anyway. And why? Because there’s probably some programmatic flows away from EM, risk off during the time. And if you have a relatively illiquid stock like this and when it sells off, there’s no natural buyer. Who’s the person in March 2020 saying, “I want to buy that stock.” We did, but there are not that many of us.
Meb:
Yeah, I was going to say, you.
Soo Chuen:
Yeah, the universe becomes small and then you have this market failure, this technical selloffs because there’s not enough buyers on the other side.
Meb:
What’s on your list? It can be country, stock, sector area, that’s like your white whale. You’re just like, “All right, this has been on our whiteboard. We want this sucker, we love the business. But son of a gun, it never trades down to valuations we want.” Is there anything in particular that fits that bill?
Soo Chuen:
I mean, there’s so many, right? As value investors, your eyes are often a lot bigger than your ability to pay. You want these wonderful businesses, but you want them at high IRRs. We’re not talking about IRS, and this is my complaint about IR. People talk about IRS, they mean buy and sell, right? And that’s IR. By the way, that’s not an IR, that’s an ERR. That’s an external rate of return. An IRR, which is an internal rate of return is the price I which you pay. And if you own the company forever, that’s the cash on cash return that you make. That’s the original definition of an internal rate of return is a rate of return without an external source of cash. If you can buy a really good business, like a Costco, and make a mid-teens IR on it, perpetually owning it forever, you back the truck, but you very seldom get it.
Often you get it because there’s something wrong in the company. The data Costco will offer the IR to us is when something went really wrong with the business. And then the question you have to ask is, “Well, is that structural or is that temporary? Can we underwrite? Can we not underwrite that?” And often it would not be so obvious. I mean, things are always obvious with hindsight, but at the time it would not be obvious, right? So, when Wellpoint was trading at $29 a share in 2009, it wasn’t obvious. With hindsight it was a lay, but at the time it wasn’t obvious. That’s just the nature of the beast. And at the times, do we have strong enough convictions in your underwriting on the structure of the business to say, “We think you’ll be okay. Notwithstanding the very real risk, the very real issues that is right in front of us, we can underwrite it.”
Most of the time we’re just looking at businesses saying, “I wish we can own this. I wish we can own that. I wish we can own this.” And when it gets to the price where we can actually own it, we’re going to be hemming and hawing. And it’s usually when things are the most uncomfortable that you know that that’s when you should actually make the investment.
Meb:
We’re definitely going to have to have you back at some point, because I got a lot more I want to talk to you about, but I got a few more questions we got to include in this. The first one is, two of the three names of countries you mentioned recently, the immediate disqualifier I feel like for most people they would say, “No, no, that country has really high inflation, it’s uninvestable.” Can you talk to that just briefly on, are there misconceptions there and how should people think about investing in stocks in countries like Turkey and Argentina that most people would say, “Oh my god, that’s crazy. No chance.”
Soo Chuen:
The beauty of what we do is, you don’t actually have to invest in a country, you invest in a particular company. That specific company is what you have to think about. And it depends on the business at the end of the day. If you own a business, often you have inflation, something happens, the currency halves and the inflation’s important in the country. So end start happening is there’s a disequilibrium, so in the country. And so why? Because there’s an equilibrium in which prices are set for a particular product based on certain purchasing power, based on certain cost structure, et cetera. And then there’s an external shock, your currency house, and therefore you have inflation import in the country. But the price that you were charging for the product yesterday is not no longer the same price that you should be charging tomorrow. The new equilibrium has to be set, maybe with less volume, maybe you sell less at a higher price, et cetera.
But that’s a disequilibrium. The question becomes, “Okay, in that disequilibrium, what do we think the earnings power of this particular business is once it goes back to equilibrium? Often there’s an offset, because if a business is moaty, it has elasticity of demand is not that high. So real earnings power goes down for the population, but income elasticity demand is not that high. And so you can raise prices and recover a lot of the earnings power, yet not lose enough volumes for it to make a difference. There could be substitutions into the product. People trading down to a particular product. The second order effect and you get to a new equilibrium from a micro perspective for that particular business. And so in some cases what tends to happen, it’s not like earnings are not affected, earnings of the business will be affected and inflation is not good generally for a country.
Buffett describes it as a tapeworm that destroys value for the overall economy. But two things happen, the stock price also crashes. So the question is, “Okay, what’s intrinsic value?” Increasing value went down by 20%, but the stock price halved or stock price went down 70% in real terms. And therefore a gap got created between value and price. And that’s how we think about it. At the end of the day, all you need to do is make an investment in that particular company and underwrite that business. You don’t necessarily need to care about the whole country. I mean Turkey as an example, right? Investments in Turkey have been actually fine for the last five years and we’re quite happy with how they’ve worked out. But it’s during a time where the Turkish lira has gone down 80% against the dollar, 80. If you just bought the Turkish lira, you’ve down 80. If you bought an index, you wouldn’t have done well. But in the end of the day we just bought those specific companies, and the companies have been fine. That’s how we think about it.
Meb:
I mean, and listeners, I mean I think the macro part I think a lot of people lose on currencies is, real currency returns, net inflation are usually “fairly stable over time.” Keyword being over time. Any given year they go to down 10, 20, 50%, but they adjust for that inflation. That’s why you see currencies in such countries that are high inflation typically decline relative to the dollar, but on average it nets out. And importantly, one of the best tailwinds, macro speaking, is when you have high inflation that comes down in a country that tends to be you actually really want to be investing where there is high inflation, but it’s reversing. All right, what’s been your most memorable investment? Good, bad in between? What’s burned in the brain?
Soo Chuen:
Hot to pick one, I’ll talk about one, which I think was a huge lesson for me. It’s an old company that I followed back in 2005. It’s called CP All Plc, C-P A-L-L P-L-C. It’s a convenience store in Thailand. And this is back even before I started this, right? First I visited that company in 2005, right after the coup d’etat in Thailand at the time. Thailand has had a coup since then, but at the time Thaksin Shinawatra was deposted and had got on a plane. And we saw this little convenience store chain. It’s called CP All Plc, that owns a bunch of 7-Eleven stores in Thailand. And the unit economies are really good and it’s all about distribution. It’s all about saturating the market, it’s all about creating logistics, et cetera. That makes it very difficult for others to replicate.
I got to know the business and got to really like it. The reason why it’s burning my brain is that I failed to see just how powerful the business model is. I really like the business. It was literally trading under 10 times earnings, so it was easy to say, “Look, at this price, you have a big margin of safety.” And it was growing like weed and it was all good and convert little competition and the macroeconomy was very bad. So it was under earning, but we thought it was going to be okay over time. That was the thinking. When I started this screen in 2010, I didn’t buy it. And it’s a mistake that I didn’t buy it because by 2010 when we launched, the stock price was totally different from where it was in 2005, and I thought it was too expensive.
Now, if you look at what the company has done since then, it’s done quite well. Notwithstanding, there’ve been a few missteps since the company has made. If you looked back at what I thought in 2010 and about how the business is going to grow, I significantly underappreciated the levers the company could pull in order to keep growing and to keep improving its unit economics.
Meb:
Hey man, it can be on the whiteboard and you can just say, “We’re waiting for you guys to muck something up and we’ll consider you again one day.”
Soo Chuen:
The learnings are more around the fact that you could be right on the moat around the business, which I think I was, and is not an efficient condition. There’s so much about the business that you can learn beyond just the moat, meaning the barriers to entry around it. And as civilian investors sometimes quite defensive. You think about the downside, anything about a business being protected, but you don’t think enough about what could be and what the lever that could pull are and cultural things and dynamic things that can be changed about the business. Endogenous thinks about the business. So, it’s been helpful to me, because often it’s the question that CPL is something I recall when I say, “Hey, just pay close attention to other levels that you can pay attention to.” Second order effects that aren’t order effects, and stuff like that. And it’s something that was 20 years old at this point, but it’s still an archetype of a mental model that you bring to bear and say, “Think about CP All Plc.”
Meb:
I love it. Little Post-it note. Soo Chuen, this was a tour de force around the globe. Is there anywhere people can find you? You guys got a website? What’s the best place to check in? Where do they go? Where do they find you?
Soo Chuen:
We have a website. It’s discerene.com.
Meb:
Soo Chuen, thanks so much for joining us today.
Soo Chuen:
Likewise, thanks very much for having me. It’s been a lot of fun and it’s been a privilege.
Meb:
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