[00:02:30] Graeme Forster: So, as you get more specialized, which is inevitable in academia because you’re going deeper and deeper, it becomes more difficult for people who are allocating funding to understand where their money’s going because they don’t understand the science itself. It’s really hard to understand the benefit of one project versus another, and it ends up being very political. I started to realize this in the second year of my PhD, the same time I was exploring what to do. I came across a few books while exploring Cambridge, which has a lot of good secondhand book stores. If you ever go, it’s a wonderful place to walk around and explore.

[00:03:15] Graeme Forster: Bookstores, even though you can get everything digitally nowadays, it’s nice to walk around an old, crusty bookstore. So I came across two books. One was by a guy called David Schlansky, if I’m pronouncing that right. It was a yellow book called ‘The Theory of Poker.’ I read that book so much that it was all tattered, even more than when I bought it. The book covered poker in all of its forms, including Hold’em, stud, and draw. It was fascinating to me because it taught the art of making decisions under uncertainty using mathematical ability and psychology. It also involved risk-taking and decision-making with incomplete information. The book made me realize that the world is inherently uncertain, even in a closed system. So I started playing poker and asked myself, ‘What is something quite like this? How can I capture the essence of this but do something a little more reputable and professional?

[00:04:17] Graeme Forster: And so that was one, and another book that popped out of the bookshelf around that time (which I think had been written in 2001) – I don’t know why I picked it up – was a book by Nassim Nicholas Taleb, who is now very well known. I recall the book I picked up was called ‘Fooled by Randomness.’ That really set something off in my mind. Like I was listening to some of your podcasts, which are really great. There’s one where you’re talking about a chap called Guy Spear, whom I do not know. I’ve not studied his work or his track record. But something he said, or you said about him, was that when he discovered value investing, it was like a light went on in his mind. It was very similar for me, but even earlier. I was reading this book about the role of stochasticity in our lives and how the risk is that many more things can happen than will happen.

[00:05:23] Graeme Forster: And this is for every decision we make as humans, and I’ve always had the sense that we think deterministically. The world is inherently stochastic, but people think deterministically. When I was growing up, I used to watch football matches. I was a big Rexton fan and a Manchester United fan. When Manchester United won one, they were the greatest team on the planet. And they could do no wrong. It could have been just the luckiest goal they’ve ever had. And then if they lose one next week, they’ll sack the manager, get rid of half the players. The bipolar nature and the misunderstanding of it effectively, what is stochasticity, and sort of like bleeding deterministic thinking on top of that is just pervasive in how humans work, how human brains work.

[00:06:16] Graeme Forster: What Talib did was sort of break down that and just talk about, in reality, we live in a very stochastic world. And of course, that is very related to poker.

[00:06:29] Graeme Forster: Many more things can happen. You’re making decisions that are probabilistic, you’re not making decisions knowing there is going to be an outcome, there’s going to be a result, right? But that’s not the point. The point is the decision you make needs to be based on how good it is in probability space rather than in outcome space. And that’s very aligned with investment decision making. And that’s what brought me to think about investing.

[00:06:59] Trey Lockerbie: I love that idea about imperfect information, what you’re kind of describing there earlier. I think one interesting thing about being a leader or a director of a lot of people look to you for perfect information, but we’re all operating off of imperfect information, but need to be making the best decisions in light of 

[00:07:14] Graeme Forster: That’s fascinating, right? Because I mean, you, I speak to a lot of managers, big businesses and you almost look, I almost look for uncertainty in their are they, what are they saying? How confident are they? Are they definit? This is going to happen. I’m that’s going to happen. Or are they displaying humility and uncertainty and recognizing that the world is inherently uncertain and therefore, they’re building that into their business so they’re a bigger degree of cautiousness and you see a range.

[00:07:42] Graeme Forster: And a lot of the kind of CEOs in the world are a little bit semi psychotic. They have that, that uber external personality of they’ve gotta project and like you can see why, right? They have to project. Determinism. Yeah. They have to project that strength, that certainty, because that’s almost perceived as bringing people with you if you have that level of confidence and conviction.

[00:08:05] Graeme Forster: But that might not be the right way to run the business. So you have to balance the two. 

[00:08:10] Trey Lockerbie: One of my favorite poker quotes from Buffett, or might have been Bridge or whatever he was referring to at the time, but it’s, “if you can’t spot the Patsy in the first 20 minutes at the table, then you are the Patsy.” And I find that so interesting with investing as well because as I’m initiating an investment, my last thought that goes through my mind is who’s on the other side of this? Am I the Patsy on this side of the trade? And really questioning yourself on that. And it brings me to this idea, what you’re referring to in poker about position sizing and reading from Ed Thorp, who I think has since walked away from this idea of using  the Kelly formula, using it in terms of investing, borrowing it from poker. Curious to know how you look at position sizing once you’ve found a good investment. And do you use any kind of formulaic approach?

[00:09:14] Graeme Forster: Yes. So I’d love to say that I do. because I’m a big fan of the Kelly criterion, which is essentially edge over odds. What odds are you getting versus the edge that you have, which is a concept using gambling. But the bet the way where that works well is in binary bets. You either win or you lose.

[00:09:30] Graeme Forster: And that’s the kind of the core of where it was developed. And if you have those binary situations where you win or you lose and you know the odds, and then, but you also, that’s the odds is what you’ve given. That’s basically the price that you’re given, but you also have a differentiated view.

[00:09:45] Graeme Forster: Your edge. You think the odds are actually this because the world is stochastic. Can happen and therefore and when those two things differ, that’s where you know, if you, if the odds are getting are much better than you think is in  reality should be, then you, the Kelly criterion gives you how much of your total wealth can you put into this single position, the single bet.

[00:10:09] Graeme Forster: And it works very well with binary. And that can be shown mathematically in reality, if you are running a betting strategy. You need to know your edge with pretty good accuracy to implement this well, and that’s difficult, right? And we all fool ourselves. I put the odd wager on a sports game and sold myself into thinking I’m an expert in what the outcome might be.

[00:10:32] Graeme Forster: So that’s one difficulty, right? You have to get an idea of your edge. In investing in portfolio management and scaling a position, it’s doubly difficult because it’s not a binary outcome. There’s a whole range of outcomes, right? You’ve got to generate a1 percent return on, et cetera, et cetera. So you have basically a probability distribution in there.

[00:10:48] Graeme Forster: But what you can do is use the concept of the principle of the Kelly criterion, and that is effectively to your point around am I the patsy at the. , what is the, the equivalent of that in the  investment world would be, what is my differentiated view here? What do I think about this that other people perhaps don’t understand or have I turned the problem on its head and thinking about it in a different way?

[00:11:11] Graeme Forster: And if you can point to a situation where you feel like you have something very tangible. Differentiated view and you’re sort of on the basis of that, your intrinsic value of the business is that much higher than the market price and you know you have conviction in that. So the range of outcomes is narrow, then that’s a big position.

[00:11:28] Graeme Forster: So I tend to think of positions in those terms. Is your discount intrinsic value? Large is your distribution of outcomes narrow. It could be up to a 10% position and you scale down from there. And then the outcome is the portfolio. It’s very much at the bottom. The only other element to that is correlation across the different positions.

[00:11:48] Graeme Forster: So that’s that’s your broader risk management framework comes in. 

[00:11:52] Trey Lockerbie: Determining your edge is so much easier said than done, and so I’m just really curious to know, maybe an example, I don’t know if you can.  Refer to an actual investment or recent example of this, but, or just a general example, but I wouldn’t know the first place to start as far as calculating my edge in something.

[00:12:10] Trey Lockerbie: So I’m just, could you give us an idea of if you’re starting from scratch like me, where would you even begin to look to determine your edge? 

[00:12:18] Graeme Forster: So it’s hard and a lot of people, I would start out by saying a lot of people have different approaches to how they go about investing. And I think the more I spend time in this field, the more you recognize that somebody’s approach has to be tailored to their character.

[00:12:34] Graeme Forster: And this kind of manifests in different ways. But we can have this whole discussion around what character is and different personality types and how they evolve and whether they’re kind of rigid or whether people can be flexible within that. And I think that they’re, all of those things are interesting, but I think it comes down to, yeah, what you’re good at, what you feel your strengths are and really sort of pushing on those.

[00:12:58] Graeme Forster: There’s this narrative around  becoming a well-rounded individual. I think in investing, it helps to be pointy. It helps to have a really sort of sharp edge. And really leveraging on those things that you really do well. And then you can find those instances of actually, because my mind works in this way, I can think of this particular situation differently to you kind of, but everyone has a different way of thinking.

[00:13:20] Graeme Forster: I, I work with people here who are excellent at looking at things differently so that people aren’t, there’s a narrative. It can be even like an Amazon or a Google or and they look at that business and say, well, okay, this is how the market sees it. But actually this is how I. A good example a few years ago, if I can remember this correctly, because I’m going back sort of 10 years or so.

[00:13:39] Graeme Forster: Amazon was viewed a certain way and that the issue was always, well, they don’t make any money. Right? They don’t make any money. They’re growing very quickly. All right. That was, this was 10 years. So, I mean, this was trillion dollars ago in terms of market cap. And the narrative here, We developed was that’s true, but I mean, you have to look at the  way that they account for certain things.

[00:14:02] Graeme Forster: So if you are building a retail e-com network, how should you account for your marketing expenses? Because marketing is typically expensive. If you are a store on the high street, you’d definitely expense your marketing, right? Because it’s like, yeah, you’re just putting it out there and hoping you can get some people through the door if you’re an online platform.

[00:14:24] Graeme Forster: and spending money on marketing, bringing people in, and then they sign up and then they get Amazon Prime and then they’re kind of part of your network and they’re sticky. So is your marketing an expense or should it be capitalized? Right. Is it something that’s an investment and it’s going to endure over long periods of time?

[00:14:42] Graeme Forster: Yeah. So I think that’s more of a common narrative. Narrative, but that wasn’t how the business was thought about historically, if you look at it that way. Actually, they’re earning a lot more money than people thought they were earning. So it’s different ways people have different skill sets in what they look for.

[00:14:57] Graeme Forster: But that edge typically comes in the form of trying to understand the news flow, how people think about something. And then how do I think about it? Kind of coming at it from a different perspective. That’s one way. Another way is just to value a business just pure good old, what are the pieces of the business worse, right?

[00:15:15] Graeme Forster: That’s the more mechanical way to do it. And then you can do that for a lot of different businesses. You find maybe four or five, a hundred look like they’re very discounted. And then you can sort of say, well why am I getting this valuation? And then, put the price this way. What’s the narrative?

[00:15:34] Graeme Forster: And then you can sort of say, well, do I disagree with that? And so getting to the why is I think you can do it in a few different ways . 

[00:15:43] Trey Lockerbie: I’m curious to know if your background provided any edge as we went through this global pandemic and your expertise on just understanding the compounding of nature of how those things can unfold.

[00:15:56] Trey Lockerbie: Were you looking into things? I mean, there was a lot of talk around. The vaccine companies at that time, Johnson, Pfizer. But during all these companies, how they were going to potentially capitalize on this if you’re looking at it in that light, did that become an area of interest to you as far as providing you any sort of edge when you were looking at investments?

[00:16:14] Graeme Forster: So, I mean, this is why Investing’s endlessly fascinating, right? One minute you’re looking at. Amazon, your next buddy, look at the shipping business. Next, you’re looking at a global pandemic and how you approach the global pandemic in terms of your investment strategy, and we are very long-term thinkers.

[00:16:30] Graeme Forster: We don’t like thinking in terms of what’s happening in the short-term. A pandemic we know will come and it will go, but it can be very damaging. So the way we approached it was to try to model it, which like, I mean, I guess everyone else was trying to cut all over Twitter. Everyone had their own sort of there.

[00:16:44] Graeme Forster: But what they had, there was one nice bit of clean. That was coming out early in the pandemic, which was from the cruise ship, I think sitting off the coast of Hong Kong somewhere, which they wouldn’t let back in. And the nice thing about the cruise ship was you knew exactly who was on board.

[00:16:59] Graeme Forster: You knew how many  people got infected. You knew the demographics, roughly. They didn’t tell you that, but it’s a cruise ship so you can see the demographics. And you knew the, sadly, mortality rate. Ship over the life of the infection as it went through. So we did a fair amount of work on trying to model effectively.

[00:17:18] Graeme Forster: The key thing was not necessarily the rate of spread. The rate of spread looked fairly aggressive, fairly obviously aggressive. But the key thing was how deadly the virus was. And we could pick that up. It’s very hard to pick up from Wuhan. It was hard to pick up as it sort of spread into different bits of Asia and into Italy.

[00:17:36] Graeme Forster: But it was easier to do if you had that closed. . So with that data, we sort of came up with a mortality rate of around 1% within that population, which was, which skewed old, but it was a very high mortality rate, very high versus your seasonal flu at half a percent in a really bad year.

[00:17:55] Graeme Forster: So 20 times as bad as a really bad flu. So that was a good sign of let’s do something. Where we kind of fell down was how aggressively we did. and because it wasn’t just the disease that you had to guess, it was also the response because it wasn’t really the disease that necessarily caused the economic destruction.

[00:18:14] Graeme Forster: It was the response of governments. And so that’s the piece. We didn’t think it was possible that they would go as far as they did to close down. The glo all sorts of global and Sweden of all countries was the most open which was bizarre to So how it just. Again, back to Talib, it shows how unpredictable events are, number one, distribution of outcomes.

[00:18:37] Graeme Forster: And even if you get one thing right, you need to get the next thing right then the uncertainty comparison. Get this very broad range of outcomes and hence why you need a reasonably diverse right portfolio. You need to take a long time. And so we spent a lot of our time modeling that, made some changes in the portfolio, but got the response wrong from governments around the world.

[00:18:58] Graeme Forster: And then by the time we saw  that response, it was almost kind of too late. It was getting compounded in stock prices to an extreme degree. The positive around that period was in any panic. In any panic, you see enormous dislocations in markets. You see mispricings to the extreme. All of that efficient market hypothesis stuff goes completely out of the window if you ever bleed to anything like that, right through that period.

[00:19:20] Graeme Forster: You get these enormous dislocations. So while it was a really difficult period, personally and for all of society, it was a very ripe period for investing because you had such meaningful mispricings.

[00:19:33] Trey Lockerbie: Where did you tend to focus your attention in any particular industry? At that time, I’m just kind of curious where your thought process took you as far as Okay, with all this, that directs me to where .

[00:19:46] Graeme Forster: Yeah, well, I mean, there was already a meaningful dislocation before Covid within the. And it fell along the lines of real economy businesses versus digital economy. Because we’ve been through this long period, I’m sure we’ll get into this, but a long period of very low rates, low term premier.

[00:20:03] Graeme Forster: And that led to this big large dislocation. And so when the pandemic was interesting because it was the perfect storm for businesses that were already very discounted. Your energy businesses, your metals, your industrial businesses, your, anything that was old economy or low growth typically was a.

[00:20:21] Graeme Forster: Linked to the real economy and when the real economy closed down, not only did their earnings go away, some of their revenues from the way, yeah. We own Rolls-Royce, the engine manufacturer. They make money on planes flying around the world per hour. When all the planes stop flying around the world.

[00:20:37] Graeme Forster: They don’t have any revenue. It wasn’t even in any of their risk models that this could possibly happen ever or ours. And so what do we do? What did we spend our time doing through that period? We spent our time trying to understand the resiliency. Of businesses, how long could they last if the economy stayed shut?

[00:20:55] Graeme Forster: And what was their kind of recovery potential, if you like? So the price you’re paying for, the risk you’re taking in terms of that, the longevity of the shut of the lockdown versus the upside. So again your probability distribution has gone wider and fatter tails. But there are these big dislocations.

[00:21:12] Graeme Forster: So we were just going through business by business, underwriting the existing businesses. We held rapidly going through a lot of other stuff. That was down a lot. Mostly we’re looking for aerospace stuff. We were looking in the energy space. Oil went negative, like an incredible period. The likes of Glencore, which is a big commodity trading business, was falling.

[00:21:33] Graeme Forster: And that was interesting because we thought they were primed to make a lot of money out of the volatility of commodities around the world. There were a few, one of the few companies that could store the oil on the ships that were being sort of pushed out of. Of Texas and there was nowhere for it to go, which is why it went negative.

[00:21:50] Graeme Forster: And so Glenco could just buy that or even get paid for it, to take it, store it on these big ships that they’d hired, which so you had, which was actually getting expensive, renting these ships and the share price was down. So it was actually it seemed like a very positive development in certain companies when and the share price prices weren’t reflecting that. And there were a lot of instances of that ilk during that period. 

[00:22:14] Trey Lockerbie: That’s fascinating. You mentioned Allan Gray earlier, the founder of both Orbis and sister company Allan Gray. He is a billionaire, and I’m curious about what it’s like to work under someone like Alan. What have you come to learn about him and what has made him successful in building multiple businesses with offices all over the world?

[00:22:38] Graeme Forster: Yeah, I mean, Alan was extraordinary. So he started out his career in the US Fidelity, I think he was at Harvard Business School before that. He’s from South Africa. So he came kind of over in the, in this kind of rich period of stock picking, especially at Fidelity right through the sixties and the seventies.

[00:22:55] Graeme Forster: That was the place to be working with some of the well-known names coming out of that era. But once he had. Developed his skillset, his style if you like, as an intrinsic value focused investor. His mission really was to take that back to South Africa, where the investment landscape, as you can imagine, was incredibly inefficient, massive opportunities for a value investor in a market like that at that time.

[00:23:25] Graeme Forster: But also not just from the stock picking perspective, but from the perspective of building a business. Where most of the asset managers, well, there were no asset managers at that time. Your assets were managed by insurance companies and those products were sold. Going back to that notion of, investment products should be bought and not sold, they should be bought on their merits since their his theory, once he could start investing with a few of his friends, some money, there’s money and build a track record in a market that was very inefficient and incidentally, starting in 1973.

[00:23:59] Graeme Forster: Which, if you recall, was the peak of the nifty 50 level in the us. Of course, markets weren’t quite as global then as they are now. Today we see very similar dynamics across all markets. Back then it wasn’t quite like that. But again and if a big inefficient market than the US led to even bigger inefficiencies in South Africa.

[00:24:16] Graeme Forster: A great period to start as a bottom. Intrinsic value focus investor and they over 50 years, which took Alan running that firm up until 1990 when he left to found all this, which is basically the global equivalent doing exactly the same thing, same philosophy, same process.

[00:24:36] Graeme Forster: Since 1973 to today, so it’s the 50th anniversary, Alan Greeno. Not many investment firms last that long. Over multiple generations of stock pickers and chief investment officers, they’ve delivered around six, I think six or 7% gross alpha in US dollars. I think around 16% a year, over 50 years. So $10,000 invested would.

[00:25:02] Graeme Forster: I think calculating it around 16 million or something today. Just absurd wealth creation. And the two things. Number one edge to deliver the great returns. Number two, you need longevity because time is the other secret. I’m not talking about Warren Buffet. I think the statistic is that 90% of his wealth came after his retirement, his official retirement age of 60.

[00:25:25] Graeme Forster: It’s longevity and it’s key and it’s, and if you can deliver excess returns over very long periods of time, you get these extraordinary results and so hugely inspiring in the way he went about things in terms of his, as him as an investor that worked with him in Bermuda here. For a good few years.

[00:25:45] Graeme Forster: And you know what mostly stood out was the flexibility he had. He could look at a lot of different businesses, a lot of different industries. You couldn’t really pin him down. Was he a value investor? Not really. Was he a growth investor? Not really. Was he kind of event driven? Not really. Did he put a lot of weight on this factor or that factor management or not really.

[00:26:06] Graeme Forster: Right. He was very flexible in the way he thought. And I think that’s absolutely critical and it’s just lost. Especially when you go through these periods like the last 10 years where everything’s been about compounding. Finding the next great compounder, finding the next Amazon is pretty difficult to do, but if you have that mindset of how you invest, you need a great management team, you need to be able to invest at a high rate of return.

[00:26:30] Graeme Forster: Right? But if that’s your narrative, that’s fine, but you cut off a lot of potential ideas in the world, because there’s only a subset of companies that. Narrative. If you just go for companies that have great management teams, it’s only a subset. If you just go for companies that have a net balance sheet versus a price you pay, you basically find nothing.

[00:26:50] Graeme Forster: Maybe a few things in Japan and Korea. So if you only have tho those specific things that you look for you cut down your opportunities set massively and inefficiencies generally are coin hard to find. Therefore, you need a big, wide opportunity sense. It’s much better to be flexible. It’s much better to have a very open line, an open mindset.

[00:27:07] Graeme Forster: I care about intrinsic value. I will buy the highest growth stock in the world if it’s price is below intrinsic value and vice versa. And that’s what Alan was like. He was all over the shop. And so he is creating the flexibility he had and I learned, and also a lot from. 

[00:27:22] Trey Lockerbie: That’s really interesting because I think where people run into trouble is when they take these methods or strategies or philosophies and turn them into their religion, right?

[00:27:31] Trey Lockerbie: I mean, buffet himself, as you kind of highlighted there, who unbelievably, by the way, I think it’s more like 99% after his retirement age of his well which is just hard to wrap your head. But I remember he said he’s not a value investor, he’s just an investor. Right. He didn’t want to put a label on it because it’s just about laying out capital today to get more in the future.

[00:27:52] Trey Lockerbie: And so I find that really interesting and, and it makes me kind of curious about you as well, given your background and being, having that flexibility. Because  when I looked you up, what came to my mind was someone more like Jim Simons, who. It takes his mathematical background and turns it into probably the most successful hedge fund ever in terms of performance, but again, is not so much the value investor type who lets things compound.

[00:28:13] Trey Lockerbie: It’s more quant driven in and out and actually keeps the fund size quite small intentionally. I’m curious what your thoughts are about that style of investing versus value investing in kind of how you found your path . 

[00:28:27] Graeme Forster: It’s a good question, but you know, early on I would’ve said maybe a more quantitative approach was right, given my background.

[00:28:36] Graeme Forster: And I looked into that and I looked into Jim Simons and I was at there was a book written about it recently, wasn’t it? It was quite a. Well-written book and fascinating his path through that fund and founding renaissance. And interesting that he was quite a fundamental investor himself.

[00:28:56] Graeme Forster: as well, on and off, despite his background. What put me off from a more, a pure quantitative. Endeavor was two things. Number one, I actually think, and this has been very, this has hit home over the last few years, especially that you need, it’s societal, To have active, intrinsic value focused investors.

[00:29:17] Graeme Forster: Very active in markets. It’s a societal good, and it’s almost like it’s almost a really sort of negative thing to say because of the negative press that finance has had over the last two decades or more. But I think it is critical and because if prices get out of line with the underlying.

[00:29:37] Graeme Forster: And underlying dynamics of businesses or commodities, then you get huge misallocation of capital because decisions are made on prices. Prices are the key signal of the economy. And so I think there’s a, again, it’s going to sound ridiculous. There’s an altruistic element to investing, and I think we’ve lost that.

[00:29:52] Graeme Forster: Right? And when I joined Orbis 2006 ish, there was a very active management scene, and it was coming out of that 2000 to 2006 period. A lot of active managers did very well because there was a big dislocation in the market that closed. But then over the last 15 years, that’s kind of gone away.

[00:30:10] Graeme Forster: Passives have come up. There’s fewer analysts on company calls. I think there’s fewer people doing what we do. And so that was, that entered into my mind. If you’re a quant investor there’s an argument that you’re improving efficiency, but you’re not really un, you’re not investing like you’re buying a portion of a business.

[00:30:26] Graeme Forster: You’re not really understanding the fundamentals of that business. It’s signal driven. So I don’t think it quite lines up with that as an objective. The second thing is I was always paranoid about what happens if you signal disappears your back tests to the moon. Get all these nice little signals.

[00:30:42] Graeme Forster: You can use linear and non linear techniques. You can bring AI into it. It could just evaporate. If you don’t have a fundamental basis for why something works, I think it’s really hard to put a lot of money behind it, in my view. And if you look at all the thrones across the space, I don’t think they’ve been wildly good.

[00:30:59] Graeme Forster: Really a mixed bag in terms of the alpha generation and the accessor return generation. Renaissance themselves would. They have a range of performance profiles within their funds and there’s one particular fund that’s shot the lights out, seems to do it every year, and it’s capped, as you say.

[00:31:15] Graeme Forster: That’s incredible. I don’t know how they do it, whether it’s known, the technology they have, the data they have or the information flow, maybe how quickly information’s flow. I dunno how they do it, but across the quantitative space. It didn’t look to me like there was any particular edge of going in that direction versus the fundamental direction and the advantage of going the fundamental direction.

[00:31:35] Graeme Forster: I could come into Orbis and I could look at a track wreck board of 8% gross alpha since inception, and I could look at a track wreck board of 8% gross alpha since inception in the sister company, Allan Gray Limits in South Africa, and I could analyze. What decisions had we made on what basis? How had we delivered such ridiculously high excess returns over such a long period of time?

[00:31:57] Graeme Forster: And if I could learn that right then I’ve got  something that’s sustained that should sustain why we should it because it’s sustained for 50 years and it’s based on the fear and greed of human beings and the accountability of. The markets are not efficiently priced. We’ve seen that very clearly over the last four or five years.

[00:32:14] Graeme Forster: All the mean stocks and everything else that’s gone on. And that’s why it’s interesting. That’s why it keeps you, I also find it more interesting, right, because you’re looking at things more fundamentally, really trying to understand things from the axioms rather than data mining, and then let the portfolio run and then tweak.

[00:32:32] Graeme Forster: That’s a little bit less interesting to me. 

[00:32:35] Trey Lockerbie: Now, you threw out this allocation there a minute ago. I was reminded of your essay called the “Greatness Allocation”. And I would like for you to share with us the cycle that you define or describe in that article, because I think it’s a great framework for more of a macro view, even though we’re talking about value investing in micro things. But just having, reminding ourselves that we do need an idea of the bigger picture to some degree and why things are happening the way they’re happening. And you’ve kind of developed this framework. Can you talk to us about the cycle that you’ve described here?

[00:33:19] Graeme Forster: Yeah. I mean, as you say, Trey, we’re bottom up, so we look for Mispricings from company to company, but it’s interesting. When you go through certain periods when we start seeing opportunities in similar businesses, certain similar stocks, and over the last sort of four or five years, maybe a bit longer, we were seeing much more opportunities in what we would describe as short duration businesses rather than the long duration businesses.

[00:33:44] Graeme Forster: Short duration businesses being ones that generate a lot of free cash flow and paying it out. You’re getting high dividend yields, high free cash flow yields, but they’re not necessarily reinvesting those and growing very quickly. But you know, if you look, if you put an IRR. On that investment versus the intrinsic value of what we think the intrinsic value of that business.

[00:33:59] Graeme Forster:  It was much higher than what we were seeing on the other side in those long duration businesses where there was an expectation for high free cash flow at some point in the future for trading very high, multiple. So the portfolio was skewing over to the short duration end and essentially thinking, why is that the case?

[00:34:13] Graeme Forster: Because we’ve seen it before. We saw it in the late nineties. We saw it in the Orbis portfolios in the late nineties. If you go back to 1973, if Alan had launched, not in South Africa, but in the. I strongly suspect he would’ve been nowhere near that nifty 50 area, and he would’ve been in exactly the opposite and done wonderfully well for the next sort of decade as that unwired.

[00:34:35] Graeme Forster: So we’ve seen it three times and each of those periods there was a commonality, and that was the term premium term. Premium is not a commonly understood sort of thing. When I say term premium, it applies to the bond world, like a 10 year treasury. People think of the yield curve and they say, well, term is time premium.

[00:34:53] Graeme Forster: Is the premium you get on the long yield versus a short yield. It’s actually not, that’s not the typical definition  or at least it’s not the academic definition that comes from the central banks and whatnot who calculate. Central banks are actually one of the core institutions that actually calculate this number, but I think it’s a really interesting variable.

[00:35:10] Graeme Forster: What is the price of time? I call it the price of time, and now there’s a book that’s just come out. Edward Chancellor, who I think has been on your show as well. Very smart chap and I need to read this book. I’m waiting for the hardback to arrive in Bermuda. It’s been very slow. It’s all sold out, so it’s obviously doing very well, but he terms the interest rate as a price of time and there’s a I think there’s a good rationale for that, but I think of the price of time as more the term premium.

[00:35:35] Graeme Forster: Why is it the price of time? So, . If you get a 10 year yield on a bond, you can break that out into, let’s say three bits. It should embed expectations for the path of the real interest rate over time, right? Because if the real interest rate is expected to go up, you should have a higher, long yield, because the expectation for that should be embedded in that yield.

[00:35:55] Graeme Forster: It should also embed the expected inflation rate because this is a nominal. So you don’t want to be eaten up by inflation. So if it was being priced correctly, it should price in that inflation rate expectation as well. So really other expectations and an inflation rate expectation. But there should be an extra bit.

[00:36:12] Graeme Forster: You get on top of that, an upgrade is called the term premium. And the reason you should get that bit is because you are willing to hold the 10 year bond and not just sort of buy, because you could buy one year bond and roll it every year and you get the real rate. and you’ll get the inflation expectation move.

[00:36:29] Graeme Forster: So if you’re willing to hold the 10 year, you should get something a bit extra, right? You should get compensated for taking on time risk. That’s real time risk. And the reason why you should get that is because the expected path of real rates isn’t a path. Going back to this TIB idea, many more things can happen.

[00:36:45] Graeme Forster: This will happen. It’s a distribution, right? Real rates could go through. They could go negative, inflation could go to 20%, they could go to minus five. Unlikely. There’s a distribution around these things. And so if there’s uncertainty and that’s basically taking time risk. Stuff happens in time, you should get compensated.

[00:37:04] Graeme Forster: So that term premium should definitely be positive. In my opinion, and it’s been positive for the whole of history, but it’s been negative for the last five years, which is absolutely crazy in my view, right? So you can point to that as a real inefficiency. Real inefficiency in markets has gone negative.

[00:37:19] Graeme Forster: So the price of time has been negative. That’s capitalism turned on its head. Now if you go back to the late sixties, it was very low as well. Because she had financial repression after the Second World War and that lasted for a long period of time as they were trying to bring down the debt in real. And so I think that low term premium in the sixties contributed to this massive misallocation of capital in the late sixties, which drove all the money into the new economy stocks.

[00:37:44] Graeme Forster: Why does it drive the money into the new economy stocks? Cause if you’re not pricing time or time is priced negatively, then a dollar in 10 years is actually maybe worth more than a dollar today, right? In this bizarre world of a negative term. So in that world, It’s almost [00:38:00] rational that you price these growth on new economy stocks and the new economy stocks in the sixties and the seventies were like the Xeroxes of the world, right?

[00:38:07] Graeme Forster: They were inventing the personal computer at the forefront of all of these different innovations. They traded it 70, 80 times earnings. Now they were earning, so it wasn’t crazy, but I mean, it was. Very punchy multiples. So that low term premium drove a big gap between the new economy, the old economy, the term premium was very low in the late nineties as well.

[00:38:25] Graeme Forster: After the Asian financial crisis, Greenspan cut rates aggressively and the term premium went very low. And I think that drove the tech bubble. And again, you see this big. Divergence, and we saw that obviously recently. Negative term premium qe, massive qe all around the world, every central bank can think of huge QE and negative term premium, not even low negative.

[00:38:44] Graeme Forster: Phenomenal. And you get an even bigger district dissertation in the market between the new economy and old economy. So the way I think that, and what does that do? If the share prices are mispriced, then the management teams do all sorts of one key things. Do they not? Because they act on the basis of their share.

[00:38:59] Graeme Forster: If your share price is in the sky, that’s the market telling you to go out and grow. Just go and throw money at stuff. Like if you’re Netflix, just grow your subs. It doesn’t really matter what you earn. If you grow your subs, you eventually dominate the whole world and charge what the hell you want, right?

[00:39:14] Graeme Forster: There’s the narrative, and that has a massive distortionary effect on what management teams are doing because that management team decides. Build their own content and just throw so much money at that. So, because it’s all, they can lose as much money as they want, they stop putting films through theatrical release.

[00:39:29] Graeme Forster: They’re just sort of straight to their platform. Cause any incremental sub. It doesn’t matter if they’re giving up hundreds of millions of dollars at the box office. Any incremental sub was worth more than that. Disney did the same. So you get, you see all these sort of I think perverse kind of capital allocation decisions through periods where the term premium goes negative.

[00:39:45] Graeme Forster: And that is bad for the economy, isn’t it? Where we’re seeing it, right. I mean there are shortages Sure. Through covid shortages in raw materials. On the energy side, on the metal side we’ve seen it to a fairly extreme degree. And that was happening.Ukraine kicked off and I think we’ll continue over the next sort of five to 10 years.

[00:40:05] Graeme Forster: because the CapEx levels in primary energy are as low as we’ve ever seen. And so that leads to kind of a more inflationary dynamic, which is what we saw in the seventies. It’s what we saw in the two thousands. We don’t think of the two thousands as inflationary, but we just had that big outsourcing of labor in China at the same time, which kind of balanced off, but you know, in terms of.

[00:40:26] Graeme Forster: Commodity push through. There’s quite an inflationary period. Inflation expectations were sort of above two and a half, 3% over that period. So it leads to, it’s like a, it’s a cycle because once it busts, once it breaks, we’re in a, we’re in a sort of process of it breaking the, it becomes self-sustaining.

[00:40:42] Graeme Forster: It’s a function of not having enough of what we need that drives inflation, that drives the term premium up, that drives rates up, and that drives the dislocation to close. We saw that through the seventies from 73 to 19. , big dislocations closed through the two thousands, these big dis And that was the birth of the hedge  fund.

[00:41:00] Graeme Forster: Right? The birth of the hedge fund was 2000 to 2008 because they had so many inefficiencies to play with that that industry boomed and they could charge whatever the hell they wanted. And then of course, once all the inefficiencies are closed they were in a bit of trouble and so they’ve kind of waned up the last 10 minutes.

[00:41:16] Graeme Forster: That’s the natural cycle we’re in. I think we’re quite early in the cycle of that unwinding. It just takes time . 

[00:41:23] Trey Lockerbie: And it’s interesting to hear you say it’s bad for the economy, right? Because it seems like it’s so great for the economy in the short term, but you see all these side effects. So we’ve referenced the 1950s a couple times.

[00:41:33] Trey Lockerbie: It’s reminding me of Morgan Howell who wrote the book, the Psychology of Money, one of his great insights in my opinion. Is that he says why do we reflect on the 1950s as this sort of golden era? And not only are we reflecting back then they knew it was sort of a golden era. There are these articles written about this might be the best time in history.

[00:41:50] Trey Lockerbie: Everything was kind of going great after this war, and the economy was growing. But his insight is that due to the highest tax rate being 91% and a few other things, there was actually not much of a wealth disparity like there is today. And so people. Circumstance versus their expectations were more in line.

[00:42:09] Trey Lockerbie: And so since then, the income per household, per capita in the US has gone up three times, but people are still feeling poorer than the 1950s because there is the asset inflation, I think you’re talking about that’s been a result of these policies. It separates the circumstance from the expectation.

[00:42:29] Trey Lockerbie: So people have better circumstances, but the expectation is so much greater given these wealth disparities very interesting. 

[00:42:35] Graeme Forster: And I think what we’ll start to see and what we’ve seen in these previous cycles is you start to see more of a labor, a push to from ca you know, the capital being the main driver and everyone focusing on that to more focus on labor policies.

[00:42:50] Graeme Forster: And I’m surprised it hasn’t happened sooner because your average boater should be really angry. Their real wages have been diminished for so long and it has been,  especially over the last decade. And I think it’s been covered up a little bit in the sense that you’ve had a kind of deflationary wave, partly as a result of money, free money getting thrown at businesses that are giving you free stuff, free delivery of food and all the rest of it.

[00:43:14] Graeme Forster: And so you feel like you’ve been, even though your wages haven’t been going up, you’ve had a little bit of a free lunch. But that’s sort of come to an end. And now we’re kind of going into the period where I think you are going to start to see more union action and people can start demanding.

[00:43:28] Graeme Forster: In terms of raw wage, keeping up with inflation, and I don’t think the central banks are sort of in tune with this. There was the leader of the E ecb the English central. Came out and said, don’t ask for a pay rise. You know what? There’s all these bizarre dynamics going on, but I think we’ll look back in five years.

[00:43:46] Graeme Forster: Look, this is more of a turning point in terms of real wages starting to rise in a more concerted way, which should be good. That’s a positive. It’s really positive for society. Central banks worry about it as they think it might become unhinged, but if you run real wages negative, that’s really corrosive for society as well.

[00:44:03] Graeme Forster: So you need to return to the power of labor versus. I think we’ll be a big theme going forward. 

[00:44:11] Trey Lockerbie: And because all of these countries are operating off the same currency type policies it’s a global phenomenon. We’re seeing and you mentioned there’s different dynamics playing out. We’re currently seeing China actually easing, for example and opening up more as the US is actively tightening.

[00:44:26] Trey Lockerbie: And so I’m kind of curious because I’m so. Myopic on the US as I live here and I just focus on this market. But I know at Orbis, really where you guys have really shine are these international, global, and emerging strategies. So you’re looking all over the world and I’m kind of curious how you see someone like the US Fed’s policies affecting the rest of the world and how it derives your strategies when you look at places outside the US .

[00:44:50] Graeme Forster: As we just talked very broadly about these macro variables and the great misallocation of capital, we do try to be very bottom-up and that’s critical. We launched Saudi Japan’s strategy in 1998 and the TOPIX has done 3% a year in yen. So, in dollars, it’ll be even lower since that point.

[00:45:11] Graeme Forster: It’s been awful, right? As an index investor outside of the US where these big caps drove the indexes high, but as a stock picker, Alan used to love Japan because it just had so many niche opportunities of very discounted securities. Where we could go and meet with management teams and help them to understand the capital allocation framework a little bit better and work with them to maybe improve some of the decision making, especially on the capital allocation side.

[00:45:40] Graeme Forster: And then you start to release some of this excess capital that is sitting on their balance sheet or improve some of their dividend policies or investment policies. And it’s been fabulously successful over long periods of time. And so you look at some of these indices and you think, well is there any return outside of the.

[00:45:57] Graeme Forster: There is a return. In return, the individual security is massive inefficiencies. Now, does the interest rate environment affect everything because it’s the price of money that’s so dominant as a variable in determining asset pricings. And that’s where we just have to weather those swings and we just sort of say, okay we are owning this business with a sufficient margin of safety.

[00:46:19] Graeme Forster: And sufficient discount, what we consider to be intrinsic value, that actually through an interest rate cycle, whether interest rates go up next week or down next week, we feel fairly confident, right? And within a framework that we are going to generate excess returns in this business over time. And that’s the best we can do, right?

[00:46:35] Graeme Forster: Because these big macro variables are very difficult to predict. Everyone’s looking at them, what edge could you possibly have unless you’re sitting there with Jay Powells and having a cup of coffee . 

[00:46:46] Trey Lockerbie: That price of money you highlighted is, according to data you were writing about in a different article, a different article, but you were saying that the data shows the entire 2022  decline can be explained simply by higher bond yields. I’m generalizing to a degree, but compared to a few other factors. Could you talk about what you were seeing in that and how you’re deriving what we saw in 2022 and how you’re rising?

[00:47:17] Graeme Forster: I mean, it is hard to disaggregate, but there’s two, I mean, very simplistically, there’s two ways you generate investment returns.

[00:47:24] Graeme Forster: One is earnings growth, and the other is the change in the multiple on those earnings and a change in the price. Cost of money should necessarily impact the multiple you pay for an earning stream or a cash flow stream. So when the rate went. , you’d expect to have a fall in the multiple logical especially given markets sort of price.

[00:47:48] Graeme Forster: Spot rates, and nobody’s really thinking in terms of, well, the term premium is running negative 1%. You’re probably going to go back to normal at some point, which means you’ve gotta put another 2% on the long yield. Nobody’s really thinking like that. So you get this change in the multiple, on the basis of the change in the yield on bonds and on that, on the interest rate.

[00:48:07] Graeme Forster: And I think, I do think a large portion of them. The fall in inequities in 2022, it’d probably be attributed to that. There, there should be and that’s rational. Then it’s, now it’s a question of, well, what next? Do we see earnings reset at some lower level? I don’t necessarily, we don’t necessarily worry about the ins and outs of the next quarter.

[00:48:28] Graeme Forster: Next year we are going to see a recession or things going to get worse from here in terms of economic growth. What I would worry about more is structural change. If you look at the US for example, margins are very high and that’s a function. Lower labor cost, lower tax rates, lower interest cost, things that could change structurally.

[00:48:45] Graeme Forster: If some of those things start to change, then margins will start to compress. And actually you’ll see a longer term, a more impactful margin reset in the US and earnings dropping. And I mean again, this is a very broad argument and we do look at things from business to business. So we don’t worry too much about these big picture dynamics.

[00:49:05] Trey Lockerbie: Talk to us a little bit about how 2022, although it was a very uglier in the markets, was simply kind of wiping out some of the canes just from the year before. So what about the decade before, just given the move in 2022, was it enough to determine a correction to, historically speaking, for comparing to other eras?

[00:49:24] Trey Lockerbie: Is there further to go if you had to guess? 

[00:49:27] Graeme Forster: Yeah. Well, I think markets are still quite expensive and. Again, the if you have this dynamic of the low term premium, it just it leaves a shadow of fraught, I would say, and it takes time for mindsets to kind of reset to a, actually, what is a more normal world when you go back to the seventies, multiples are much, much lower than they are today.

[00:49:47] Graeme Forster: Much, much lower and. That was normal then. And then when the inflation started to recede in the eighties, it took a long time for investors to kind of get over that shadow of the previous decade. And I feel like, you know, we’re going to be in this phase where we’ve had free money for a long period of time and that casts a shadow.

[00:50:05] Graeme Forster: people anchor to valuations they’ve seen over the last decade. Those aren’t necessarily real. They might be an aberration. And actually you should be anchoring on that one of the other previous decades where you know, you’re in a more normal monetary environment, for example, in a more normal labor environment as well, maybe a more normal tax environment.

[00:50:22] Graeme Forster: All these things you gotta think about. So you could see I do think the last decade is not a good template for the next, but again, all these things depend on expectations. If everyone in the market believes. , then the prices would reflect and then actually you might get a repeat of the last decade, I think it’s not very likely.

[00:50:40] Trey Lockerbie: Yeah, there was some recent data actually showing that. . Even though the last quarter in the US the inflation was a little bit hotter, the consumer consensus was projecting the inflation to go down to like 2.7. I want to say if I’m going off memory boost, even though the number came out a little higher than expected, the con, there’s a disconnect between the consumers and the C P I and some, which is kind of interesting and I don’t find people discussing very often, but when we were talking about the price of money, when bond yields go up, growth stocks usually the first or the, I’d say the most, From something like that for the reasons you’ve kind of described and you’ve put out some, also some cool research around good and cheap companies and how they can still perform during bear markets.

[00:51:24] Trey Lockerbie: What have you seen in the data just a, as a, I guess, as a general overview of how good and cheap are still persevered through times where markets can get ugly? 

[00:51:36] Graeme Forster: I mean, you can, the classic example, this is the early seventies. You just wanted to be in reasonable cheap businesses just away from the pizazz, as Alan used to call it.

[00:51:47] Graeme Forster: Just get away from the areas that were, everyone is pouring over. We like apathy. Yeah. We like areas that just they’re not in the spotlight because they are falling like a knife. They’re not in the spotlight because they’re. The next big thing, they’re just not in the spotlight.

[00:52:04] Graeme Forster: Nobody’s talking about them. Nobody’s thinking about them. And that’s where you start to see really interesting opportunities. And in bull markets and bear markets alike. The bear market of the seventies, it was boring. Real economy businesses with high free cash yields, it really excelled. If you didn’t own those businesses, you did very poorly in real terms, in the 2000 to 2007 period.

[00:52:24] Graeme Forster: Very similar. That very wide dislocation just on a tedious retailer on 10 times earnings. You’ve done exceptionally well. From 2000 to 2006, and again, this looks very similar today. We are finding businesses in a range of different sectors where you have good valuation underpin, which could be the yield, right?

[00:52:43] Graeme Forster: You would get repeated, maybe you’re getting five, six, 7% dividend yield, so not a free cash flow yield, dividend yield, so they have more cash that they could pay. They wanted to. That’s the margin of safety, but that dividend yield is growing in inflation like rates. So if you’ve got like a 5% dividend yield,  And a 4% inflation like growth, you’ve got 9% off the bat and is 9% that bad.

[00:53:05] Graeme Forster: In this market, it’s probably quite good, especially a good sort of solid 9% like that where your growth rate is pretty predictable and your dividend yield is high. And then if you can pick those up with massive optionality on top where you know there’s two or three things that could happen. That lead to not your 9%, but more like 40, 50% upside, then you know, you have a very asymmetric situation where your downside’s very low upside especially if you can get a lot of these different options in your portfolio, and that comes back to the Kelly criterion little, tiny little edges left, right, and center in the portfolio.

[00:53:38] Graeme Forster: Then that, I think that’s kind of where we’re positioned today in that, in those types of opportunities, 

[00:53:44] Trey Lockerbie: And you are physically positioned in Bermuda, you were referring to Alan describing pizazz, right. With these markets, I’m reminded of Buffett moving back to Omaha to kind of get away from the noise.

[00:53:55] Trey Lockerbie: Do you find that being physically in Bermuda similarly helps you keep distance? I mean, even though you’re so close to New York and some other obvious markets, does it help you kind of keep a clear mind looking out at the stars as we described? 

[00:54:09] Graeme Forster: It’s fabulous. Really is. There’s very few places like it because you almost want to be in a library-like atmosphere.

[00:54:17] Graeme Forster: So you can just think and develop an independent view. You can read your not option of being surrounded by different opinions being sort of thrown at you. You left, right and center. . But if you are in those types of environments, it’s almost like you’re out in the country or something. No, it’s, no, it’s easier in the modern world of remote working to sort of, so Bermuda isn’t so unique anymore.

[00:54:39] Graeme Forster: But in terms of having a good solid financial center in a very small place that’s hugely efficient and convenient. So if I want to get to work, I can walk five minutes pop and see my kids at school during their sports day. Everything is so efficient and. No time is wasted. No, it’s not a minute.

[00:54:59] Graeme Forster:  I do, every minute I spend, I’m either doing something productive, rather I’m enjoying my family. If you’re living in a big city with all the noise, it’s hard. It is harder to focus also, it’s inefficient, right? You’ve got a lot of commute getting from place to place.

[00:55:12] Graeme Forster: It’s really difficult. I do love London. Love New York. It’s cities. They’ve got a buzz about them, but I don’t love living there . 

[00:55:20] Trey Lockerbie: Graeme, this was so much fun. I really appreciate you coming on the show and sharing a bit more about your philosophies and strategies here. I really hope we can do this. Again, thank you for the book references as well.

[00:55:30] Trey Lockerbie: We’ll provide them in the show note. Before I let you go, are there any other resources where people can go to, to find more about you or Orbis or Allan Gray or any other resources you want to share before we go? 

[00:55:41] Graeme Forster: Thanks, it was a lovely discussion. In terms of resources, as I said earlier, we have very little social media presence. We are reclusive, I would say. But if you go to the Orbis website, www.orbis.com, you can choose any region you want on that website and get all of their information on the funds. One thing I should have mentioned was that one thing Allan Gray was passionate about was democratizing investment. Because if you are an ordinary person working in some field, you need advice and handholding when it comes to your finances. And one of the issues with the industry, in my opinion, is the layers of fees you pay to get that advice. You’ve got the advice and then you’ve got the actual fees.

[00:56:32] Graeme Forster: So, Alan was a big believer in going direct to a firm. You go to the website, and you can invest directly. Now, you can’t do that in all regions based on what we have at the moment, but it is our plan over the long term to develop that ability with new clients to have a much more frictionless way to invest in excess return strategies. So if you go to the website, there’s a lot of information around Orbis on both the institutional and retail side. 

[00:57:07] Trey Lockerbie: Graeme, I really appreciate the time. Thanks again. 

[00:57:11] Graeme Forster: Thanks Trey. Thank you. 

[00:57:13] Trey Lockerbie: All right, everybody, that’s all we had for you this week. If you’re loving the show, don’t forget to follow us on your favorite podcast app. And if you’d be so kind, please leave us a review. It really helps the show. If you want to reach out directly, you can find me on Twitter @TreyLockerbie. And don’t forget to check out all of the amazing resources we’ve built for you at theinvestorspodcast.com. You can also simply Google TIP Finance, and it should pop right up. And with that, we’ll see you again next time. 

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