[restrict]

Hari Ramachandra  12:32  

Actually, that’s a very good point, Calin. The way I see Apple is that it’s like a fashion company, like Disney theme park, as popular as long as Disney can keep producing great movies or can keep creating new characters. As soon as that stops, the danger is it’ll even affect the theme park because people will lose interest and they will move on to the next trend.

Apple faces that danger and the maybe the market is pricing in that risk in the current price. So they always have to be this cool company. Without Steve Jobs, it will be hard to say whether Apple can continue to be cool because he personified Apple and he personified coolness. So, in fact, Professor Bruce Greenwald at Columbia University, he doesn’t agree that Apple will be what it is today, 10 years from now.

Preston Pysh  13:32  

So, Tim Cook, if you’re listening, that was Hari’s way of saying, “Hey, man, you’re not that cool.” Go ahead, Toby. 

Tobias Carlisle  13:42  

So I have an Apple laptop and the router is an apple router. All of the other things that I use are just different means of accessing content, right? So the Amazon Fire is just a way of accessing content. I have a Kindle. But all of those things pull from Amazon, Google handles the email, various other things. I don’t think that five years ago, you would have predicted that Amazon would have been a direct competitor to Apple, and maybe not Google either. I just think it’s interesting. They’ve all come from pretty different industries to sort of come in and compete. I still think Apple’s a very good stock and I do think it’s very cheap at the moment. So I think it probably outperformed the market, but not as not as well as it has done in the past.

Preston Pysh  14:22  

Yeah, I like how you phrase that, Toby, that it will outperform the S&P 500 or the Dow. I agree with you on that moving forward. I think if you took a five to 10 year snapshot, and you had to buy one versus the other, I think Apple is going to outperform them over that period of time, but I definitely don’t see it. I’m not buying it, like going back to our original conversatio,  I think that I value my liquidity more than I would value ownership of Apple at this point in time. 

So one of the things that I want to talk about real fast, because this was a really interesting thing that happened at the Berkshire meeting, and Stig and I didn’t talk about this when we did our podcast when we covered it. Buffett’s the discussion of Amazon, for me, and Jeff Bezos in particular was really an interesting thing that happened at the last shareholders meeting. 

Those guys gave huge props. I mean, huge props to Jeff Bezos, and kind of looked at him like, these guys are a force to be reckoned with, because they’ve basically taken business and flipped it upside down with the fact that they don’t need to have a bottom line. They’re just basically like cannibalizing everything and anything. They basically said, “Whenever we look at a business, we pretty much try to factor in the Amazon factor of are we going to get crushed? Is this guy going to take us to the cleaners?” 

And boy, that was an interesting discussion. So when you think about that, and you’re looking at these two guys, Charlie Munger and Warren Buffett,and how much they’re looking at Jeff Bezos, like this guy is something else. And this is a force to be reckoned with. I guess you take a different approach than a value investing look when you’re considering it.

Tobias Carlisle  15:58  

Jesse Felder… I know you guys have recorded a call with him and he’ll be coming out at some stage before this comes out. He made a very good point on his Twitter stream the other day that it is no reason why a stream of cash flows should be worth any more now than they were worth in the past.

So I don’t think that the laws of valuation changed that… The laws of valuation have always been the same. It might be that these companies are able to grow more quickly because they’re more asset light and so they don’t need to reinvest, which means they can throw off more cash. But that also means that the competition doesn’t need as much capital to get in the game. They can compete for much less. So those forces should still drive down. Ultimately, the cash flows and the valuations we should find equilibrium at a lower sort of profit margin. 

Preston Pysh  16:47  

I agree with that, Toby. But what I also know about Jeff Bezos from the book that we read, “The Everything Store,” he has an entire arm of his business, that is doing nothing but trying to go out there and find competitors in the space. It’s like, I forget what they call this department within his business, but it’s like their competitive advantage annihilation department is what I would probably call it, where they go out and they try to find businesses that are competing with them. 

They do one of two things, they go to them and they say, a.) we want to buy you. And if you don’t let us by you, we’re going to make your lives absolutely miserable. And here’s how we’re going to do it. Whatever line like, I think the example they used in the book was about a diaper company or something like that. Stig, was that right? So they go to this diaper company, they’re like, “We’re gonna sell this at a loss. We’re going to continue to sell this at a loss until you come back to us and you say you’re ready to sell us your company. And oh, by the way, when you do that, we’re going to be paying you at a lower multiple, because your numbers are going to be horrible by that point.”

That’s how these dudes play. And so how do you compete with somebody like that? So I think here’s something that we got to get into when we’re talking about value. You’ve got to value the intelligence of the company itself, you’ve got to value the size of the company and their ability to basically create havoc in certain markets. Then you’ve got to really kind of value their ability to just have this unprecedented amount of growth in their revenue stream. I think maybe it’s something that you just watch it so closely, and maybe you don’t take a big position, but maybe it’s something that you just hop on for a little bit. I don’t know what the right answer is. But I know it has my mind like going wild of am I missing a big opportunity here because I’m not valuing things appropriately? And I’m so stuck in this Warren Buffett value discount the cash flow kind of mindset. And I’m not thinking outside the box. I guess that’s my concern.

Stig Brodersen  18:46  

I think when Warren Buffett talks about the Amazon factor, it’s kind of like when he bought Dexter Shoes, and he figured out that he was losing to the outsourcing power of China. Now basically, that’s a threat to the current business. Amazon might be a threat if he was was to buy retailer, but it doesn’t change the way that we should value Amazon as a company, in my opinion. Before they have proven that they can actually make money, and especially with the decline, you also see in the revenue right now in the growth rates, I don’t necessarily see that it’s a good investment at the price level we’re seeing right now.

Tobias Carlisle  19:19  

I would say that if you’re going to invest in something, so there are a lot of retailers that are cheap at the moment. And the reason that they’re cheap is because Amazon’s cannibalizing their business or Amazon’s eating that business. 

But you can go back and read Buffett’s letters from 30 years ago, and he would say that retailing has always been a really tough business. There’s always some other big guy who’s doing it better coming along behind you. Amazon may be the apotheosis of that kind of process and there might be nobody who ever comes along who’s bigger than Amazon. Yhey might just lock the market. But then again, it might be Alibaba, or it might be some other company from outside the States. 

The point that I would say about value investing is you don’t necessarily have to have an opinion on Amazon as an investment. They say you don’t have to kiss all the gold. Amazon is an incredible business and I love shopping at Amazon because it’s really fun. But that doesn’t necessarily mean I have to go and buy the stock.

Hari Ramachandra  20:11  

I agree with Toby. I think you don’t have to kiss every gold. 

Tobias Carlisle  20:17  

Well, it’s fun to try.

Hari Ramachandra  20:20  

Buffett, in fact, mentioned this in one of his interviews, he said, “Amazon is doing to Walmart what Walmart did to Macy’s and other folks.” So to answer your question, maybe it would be worth looking at Walmart’s valuation history, how things went along. And maybe Amazon will see what Walmart is seeing now, a decade later.

Preston Pysh  20:43  

I love that, Hari, and I think you’re exactly right. I think if you’re gonna model this or at least attempt to try to build some type of model, I think that you hit the nail on the head as far as where this is going. 

Now, I think we’re maybe a slightly different direction on where this one goes. Their technology side and some of the other things that they’re in. I mean, the space side, even with being a competitor to SpaceX. I mean, there’s just so many different sides to this, but I really agree with you. I think that their bread and butter is really their retail side. That’s the thing that’s really just showing so much growth and given them the legs to do the things that they’ve done. So, really interesting point. 

So, do we have anyone that wants to kind of throw things in a different direction than what we’re the one we’ve been in?

Stig Brodersen  21:29  

So, the thing that I would like to bring to the MasterMind group today is talking about Mohnish Pabrai’s new ETF. This is something that we really been looking forward to for a long time. For those of you that don’t know who Mohnish Pabrai is, he has been called the new Warren Buffett. I know that a lot of people has been called the new Warren Buffett. In my opinion, he might just be the one. He is super, super smart. He has a significant track record. 

But Mohnish Pabrai has launched a new ETF. He did that back in April. And he has three different strategies and the way that he came up with those three strategies was actually through a dinner he had with Charlie Munger. 

During that dinner, Charlie Munger mentioned that if an investor did just three things, he would be able to outperform the market significantly. The first thing he said was, he was looking at *cannibals. And what he meant by *cannibals was he was looking at companies buying back stock really aggressively. The second thing Munger told Pabrai was that he was looking at what other great investors were doing. So basically, this is the *13 Fs, right? And the third thing Charlie Munger told Pabrai was that he should carefully study spin offs. 

According to Pabrai, this is what he did. He composed a ETF with hundred securities, and he was using each of these three strategies to merge into one ETF that should hopefully outperform the market.Wwhat I would like to bring to the MasterMind Group today is to go through these three strategies one by one. Then after I presented one strategy, and my thoughts on that, I would like to hear your thoughts on that, and whether or not you would agree with the thesis. 

So the first strategy there was buying back shares. That is how Mohnish Pabrai wants to allocate 75% of the funds. What he wants to do is to study the companies that had bought back between one and 26% of the shares in the previous 12 months, and he will only be looking at companies for the market cap higher than 1 billion and he would invest in the 33 with the highest conviction. 

So why would that make sense? Well, if you read “What Works on Wall Street,” and what you can also do is listen to episode 57. There was an episode that Toby actually co-hosted with us where we interviewed Jim O’Shaughnessy. We talked about Jim actually following the same strategy these days. he is looking at companies or these cannibals as Munger is calling them. 

What Jim  O’Shaughnessy found out, and I think this was a time series from 1964 to 2009, so a long period, was that the decile of that bought back stocks most aggressively outperform the market by 3.8%. On the other hand, if you look at the companies that were issuing shares, and the *inaudible do that for acquisition purposes or to come to management… They wre actually underperforming the market by 4.1%. So there’s a vast difference here of those that are most aggressive and those that issue shares by almost *8%. 

So, again, yeah, why would this work? Well, some might argue that it’s because the management feel that the stock is undervalued. I don’t know necessarily, if I think that’s a good point, because there are so many companies out there that would just buy back shares every quarter had done that for decades. So that might not be the reason why. 

But companies that are buying back shares significantly, they have strong cash flows, their surprise support element before rebalancing… Clearly, the more undervalued stocks are the more stocks that can buy and they would be ranked higher in Pabrai’s algorithm. So I just want to throw that strategy out to the MasterMind Group before we go on to the to next. Do you think this is a good strategy to follow?

Tobias Carlisle  25:14  

Yeah, I think it’s an excellent strategy to follow buybacks. I would be leaning on O’Shaughnessy’s research in saying that buybacks have been predictive. I think that he’s got some more granular research where he says that you need to find the ones that are maximizing the amount that they can buy back. I think it does indicate cheapness of the stock because you’re looking at a fundamental measure, like basically it’s negative investing cash flow, which you need to have some cash flow. There are some cash on the balance sheet, relative to the price of the stock that you’re buying back in the market capitalization. So I think it is kind of a derivative of value. 

One of the things that O’Shaughnessy says that’s interesting, though, is that he favors rather than just simple buybacks, he favours a metric called shareholder yield, which includes dividends and capital returns as well. There’s an ETF that deals with that directly and it’s Meb Faber’s Cambria Shareholder Yield, and the ticker for that is SHLV. I don’t know how that’s performed. It’s only a fairly recent launch. But I think if you’re looking for a pure shareholder yield approach, probably Cambria is the better one. But O’Shaughnessyuses that strategy. It’s central to his his flagship fund. So it’s a very good metric.

Preston Pysh  26:32  

I’ve got a quick comment and it kind of relates to a book that I’m reading right now called “Shoe Dog.” It’s all about Phil Knight. He’s a fantastic writer and kind of his rise to Nike and building Nike. The one thing that was kind of amazing about that story is just how cash-strapped he was for years and I mean years upon years of building Nike and how he was growing like a rapid pace, but he never had enough cash on hand. And so when you’re talking about share buybacks, you’re talking about a company that’s buying back their own stock versus not buying back their own stock. 

When I look at like Phil Knight in the early days of Nike, he could have never bought back any shares, literally. I mean, he was just constantly talking about how can I raise more cash, so I can buy more tennis shoes for the next quarter so I can continue to grow the demand that’s out there. When you look at a company like Berkshire Hathaway, they are just flush with cash and that’s a company that if their price did go down to appropriate levels, they would buy it back. 

Now, let’s talk about IBM. How long have they been doing their buybacks? And I mean, aggressive buybacks. Then you look at their stock price, it’s gotten punished. So I guess my point is this. I guess I have not been able to look at things from the vantage point where I can say this is a situation where a share buyback is good, ashare buyback is bad. IBM example, or here’s a company that can’t even do a share buyback like Nike. But if you would have bought there, if you would have been able to buy their stock way back when they were cash-strapped, and having difficult times, you would have done insanely well. 

So I guess my answer is, I don’t know, I’d have to dig into it more. I think maybe when you look at things, not from the micro level of just three companies and three examples, but maybe if you’re looking at it from a macro perspective, and you’re looking at a basket of 100 different picks, and you’re looking at buybacks versus not buybacks, maybe you get better results. I think it’s important for people to understand that there are caveats to this. It’s not something that you can just go out and buy an individual stock pick because they’re doing buybacks and expect that phenomenal results.

Tobias Carlisle  28:44  

Buybacks tend to track along with the market. So when the market is up, they are in an absolute sense, there are lots and lots of buybacks. And when the market is down, the buybacks disappear, and ideally, you would like your management to be doing the opposite, right? You don’t want them buying back stock when it’s expensive. And you want them buying back as much as possible when it’s cheap. 

The reason that they they do that is because they’re like everybody else. They are sort of procyclical. It’s only a handful of people who can sort of operate in a contrarian way. The nice thing about I think about a buyback type index or buyback type ETF is it is kind of operating in a contrarian way in the market as it exists because it is trying to maximize. It’s finding the companies that are maximizing the amount that they’re buying back, which means that the underlying business, the fundamentals are sufficiently big, relative to the market capitalization that they can have a material impact on the market capitalization when they’re buying it back. 

But I think if you add in other factors in there, if you’re looking for… You want it to be undervalued, so you can use it as an indicator of it being undervalued, or you can go and look at other things. Is it cheap on an enterprise multiple basis? Is it cheap on a PE basis? Is it cheaper on a price to book basis? If you do those things, you get better performance again.

Preston Pysh  30:00  

I’m glad you brought that up because when you go back and you look at the middle of 2015 to the end of 2015, that period of time was… I mean, there were so many buybacks happening on the market. It was totally insane and when you looked at the PE ratios across the board, we’re at the highest market valuation that you could have. So that was literally the worst time that businesses could be buying back their own stock because of the multiples.

Stig Brodersen  30:26  

Yeah, guys, after being at Berkshire, I have a new idol and that’s Charlie Munger, because he’s just the best person that’s sitting back and just grunting something negative, at some point in time. It’s really hilarious. 

So my Charlie Munger comment to this would be that I was browsing through the previous quarter results from Exxon and I could see that they were buying back quite a few shares, which surprised me because they actually told the public that they’re not going to do it. Then I dipped into the numbers and it turned out that they’re only buying back stocks that they had been issuing to the management and key employees. So there are hundreds of millions of dollars. I can’t remember the exact amount, but it’s a significant amount of stocks for a company that size. So I wasn’t too happy about that. It was just really to give Preston some points for being negative. And then I came on being, I guess, even more negative. 

Hari, I saw you had a point as well.

Hari Ramachandra  31:22  

No. The point I had was my concern about buybacks is most CEOs are not capital allocators. They haven’t risen to the position because of their skills and capital allocation. Rather, it might be in other functions. And number two is I rarely see a company specifying its plan to buyback shares based on a ratio metric. As Toby mentioned, Berkshire is probably the only company I know which packs it buyback to a particular book to price ratio. Do you guys know any other company which does this?

Tobias Carlisle  32:01  

I’ve never heard of it being done explicitly. I think that the better ones try to buy it back when it’s at a discount of value. I know Buffett would never use book value as a valuation metric. But it’s kind of interesting that he’s… And he would say that the intrinsic value of Berkshire has far outstripped its book value growth. So I guess he’s saying… And I think he’s prepared to do it at a premium to book. It’s like 1.2 times.

Hari Ramachandra  32:23  

That’s correct.

Preston Pysh  32:25  

Stig, I know you want to keep going with our second point with Mohnish, but I got a quick point that I want to make when this whole 1.2 times book value price premium that Buffett would buy back shares for his company. I really think that during the next downturn, whenever that is, we have no idea when it’s gonna happen. But when the next downturn does happen, I think Berkshire is going to go below that 1.2. I really think on this next one, I think Berkshire is going to be buying back their own stock at a record pace more than they’ve ever done in the history of that company because he knows what he’s buying. He knows what he’s… He’s buying his own cooking. I think at this point, both of those two are in a position where they don’t necessarily trust every other company out there and the books of all these other companies and the dependencies of these other companies. But they do know their own business and I really kind of see them go into their Berkshire stock in the next contraction. 

It was interesting during the meeting, Buffett had made the comment because this 1.2 premium share buyback thing kind of came up briefly. And Buffett goes, “And if it does go down, we will be extremely aggressive.” And then he like kind of corrected himself and he says, “We will buy back whenever it’s at one point.” 

So that’s that was me reading the tea leaves on this one of I think that that’s going to be Berkshires play, but I could be 100% wrong. That’s just kind of how I anticipated those. 

So Stig, let’s go to the next point with the money discussion.

Stig Brodersen  33:51  

Yes, so the next strategy is called select value investing manager holdings and that accounts for 20% of the funds. So 75% for share buyback and then 20% for select value investing manager holdings. And the introduction to this is really easy. So it’s 22 managers that Pabrai has selected and he really trusts from other managers *inaudible files, 13Fs. He would be looking at the holdings, how much they have been, how much the weight is in those respective portfolio and then he will put that into a given weight in his portfolio, which would be 34 stocks. 

If you think that my presentation is messy or whatnot, or if you would like to know the specific rules, we will link to the prospectus where you can read more about this. 

Would it make sense doing this? Well, Pabrai has always said that his stock screener is really the 13Fs of other value investing manuals that he trust and respect. So without paying for it, you can actually go in and find perhaps the best stock picks. At least, that is what the greatest minds in the world are missing in right now, and here, Pabrai is using the same strategy. And what is interesting is that he’s removing himself from the equation. So it’s not like, well, Warren Buffett just bought Phillips 66. Do I think it’s within my circle of competence? Do I like the price? 

He’s basically saying, “Well, if Warren Buffett, and clearly other people as well, like that pick, then I would need to do the same thing.” This is people like Warren Buffett, Carl Icahn is also included and Tom Gayner who Hari mentioned before, *inaudible is also included among those 22 people. So I’m curious to hear your thoughts on whether or not you think this is a good strategy to replicate? 

Toby, I sees you have a point.

Tobias Carlisle  35:40  

I’m going to refer to Meb Faber again. He’s recently released a book called “Hack the Market,” something like that, where he looks at precisely this… He set up a cloning tool, maybe 10 years ago that looked at 13Fs and I think it’s called alpha climb. You can go in and you can select the managers who you like. 

There’s a lot of research that says asset managers who have performed well in the past do tend to continue to perform well in the future. The only caveat, and I read through the book when it first came out, but my main takeaway from it was if you’re going to do the 13F investing, you need to be aware that the position in a 13F managers holding that its size, the largest, tends to underperform. The reason is, that’s a position that they’ve put on. It’s already had its growth, and they’re about to chop that on *inaudible. 

So you can do this by itself. You can set up 13F screeners and just find a concentration of… Rhere are lots of sites that do it. I think that the list I had a quick look through for price lists, I think it’s a good list, and I think it’ll probably outperform. I’d be interested to know how he’s gonna deal with that.

But the largest holding is if you aggregate 22 managers, and you’re looking at proportionate to their portfolios, which is the largest holding, you need to be able to have some way of dealing with with that particular issue. But aside from that, I think it should do very well.

Preston Pysh  37:00  

Yeah, I was just gonna throw out Meb Faber as well. He has the “Ivy Portfolio” as well, that as a book that kind of hits on this. I know he has an ETF that is already doing this stuff. That’s another one that we’ll have to do a little research on and add into the show notes. But my understanding, and I might be wrong here, but off the top of my head, I don’t think that it’s done so well, in the last three years, this ETF. I think it’s underperformed the market, but do not quote me on that. I could be 100% wrong, but we’ll go ahead and find it.

Toby, do you know?

Tobias Carlisle  37:31  

I don’t know if he’s got that precise when I was just gonna say in relation to underperforming the market and I meant to inject this before when Hari was talking about price returns. So there are two sort of aspects to the business that are run but one of them is quantitative analysis of value strategies. 

And so, value has actually been in a bear market since for about a year. It topped up about a year ago. And so when I when I say value, I just take a simple average of a whole lot of different value investing metrics like price to earnings and price to book. What would a portfolio, if you had just bought cheap companies a year ago, look like?

So in February at the bottom, it was down more than 20%, which is the definition of a bear market. It’s now recovered, but it’s still down almost 14%. You can look at any individual manages returns and look at how they’ve done. So Buffett was down last year, David Einhorn was down. Last year Bill Ackman was down significantly last year. 

For each one of them, you can identify the particular stock or several that they bought the kind of impacted them. And so it always feels and I know, as a value manager, it always feels very personal when yours are underperforming the market. But basically, it’s something that it’s systematic, and it’s impacted every kind of value manager out there simply because a blend of value stocks is down. So I’d be guessing that part of Pabrai’s most recent troubles. They do tend to outperform over the long term. So that’s the other corollary.

Stig Brodersen  38:59  

And then the last one that *spin-offs is only 5%. But I think the strategy is really interesting to discuss. Just the example of a spin-off that comes to mind is when Conocophillips was spinning off Phillips 66. So in this example, you have vertical integrated on the gas company that is spinning off at downstream division, where it’s mainly it’s in refining. So why would a company do that first of all?

Well, it’s actually to unlock shareholder value. Think of this as you would now have called Phillips 66, that can now focus on the core competence resists refining, and they also have a big division chemicals, but basically, they can be more focused, or at least that’s the intuition, or one of the intuitions behind why the strategy would work. 

So Pabrai’s ETF would look at issues that have been spun off in a 12 to 84 month timeframe, and he would be ranking those again to those that are most recent, and this would be in my cap in excess of $500 million. So I think it’s really interesting that he is not looking at companies that are spinning off within the trailing 12 month. I know Greenblatt is looking at this.

There you go. Toby’s holding off, you can be a stock buy genius where he actually talks about the strategy. And he’s actually looking at the previous as far as I remember, he’s looking at the previous 36 months. So he’s not looking up to 84 months, but he doesn’t have the 12 month penalty that Pabrai has. 

And why not? Well, to me, it’s probably because Pabrai knows that there is a tendency to overselling right after the spin off. The reason why that might be is that funds might not want to own it because it’s too small and they need to sell it. It could also be because the new spin off company doesn’t pay a dividend, which a lot of people don’t like. So that’s another reason why you might want to avoid that the first 12 months. 

But basically spin off is an idea of buying something cheap, something that might be on *inaudible or something, that is really focused on the core competences and where there is a lot of drive to perform in the years to come. So my question to the MasterMind group would be: do you think the spin off strategy is a good strategy to include for Pabrai and his ETF?

Tobias Carlisle  41:17  

I think it’s a very good strategy. In my own business, I think about… There’s kind of two aspects of the business. We buy things that are quantitatively cheap and that performs sort of in line with value. And then we look at things that you can’t screen for. So that in that sense, we’re trying to avoid competing with the bigger one funds that we don’t have any particular skill in. But we are able to beat them by digging up these little positions, one because they’re smaller, and two, because they don’t screen very well. So that’s one of the things that we do look at spin offs. 

The only problem is I think that the returns to it have diminished a little bit in recent times. The reason is that it’s so well known that you don’t want to own the main, the continuing company. You want to own the spin company that I think that the margin has diminished a little bit. So that it’s it’s a less good strategy than it used to be, but it still should perform. And it provides that little bit of performance that’s not necessarily tied to the market. It’s kind of its own idiosyncratic returns, which is the attraction of special situations.

Hari Ramachandra  42:18  

So overall, Stig, the way I look at Junoon, that is Pabrai’s ETF that you’re talking about, that’s a ticker symbol as well, is that in investing is the process that is more important than the outcome because the outcome has a lot of other factors. So at least he’s laying out his process and the process is sound, as Toby just mentioned. However, for the outcome, we will have to wait and watch.

Stig Brodersen  42:46  

Yeah, so my own take, and I gotta be honest with you guys. I have been so excited about this ETF. I can’t remember the last time I’ve been so excited about the lauch, except for Toby’s, by the way and we’re going to talk about that in a little bit here. But I’ve been super excited about it. 

The one thing I don’t like about it because I’m, as you can probably hear, I’m quite excited about this. I think the empirical evidence speaks for itself. To me it is quite expensive and the management fee is 75 basis points, which is not unusual for a fund like this. So it’s not vastly above market rates. I can definitely understand why *inaudible wants to make money of whatever product they come up with. 

One thing is that I don’t think Pabrai has that many expenses to cover with this ETF. There are some very strict rules and he hired to managers actions to implement them, but it’s not like he has hired like 100 analysts screen for the best stocks, meeting with the management and so on. This is not what he’s doing. This is a very mechanical system. So for me to charge 75 basis point for that, I don’t know. I still like ETF but it might be a bit pricey, claiming that if you outperform the market by quarter 6% or whatnot, but it is pricey to me.

Preston Pysh  43:56  

Yeah, I guess for me, I would probably and maybe this is the business side of me coming out on how I would price it. I’d probably priced the fee a lot lower initially to get some investors into the fund. And then if it’s performing well and you have a great track record, then I guess you could ratchet it up so that you know you got a premium that’s worth the…

Stig Brodersen  44:16  

Yeah, this is not fair at all, Preston, because we actually haven’t heard about Toby’s. No matter what you say, you’ll be like, “Oh, guys, this is the worst hand off ever.”

Preston Pysh  44:25  

Let’s be quiet and let’s listen to Toby.

Tobias Carlisle  44:28  

So I’m in the process of launching one. I can tell you that is 75 basis points, he’s not taking home a lot of money. It does depend on how how much capital you raise. So at sort of below $20 million, they don’t break even for the manager. There are very substantial costs that go into setting them up. And then in operating, I think they cost sort of in the vicinity of $150,000 a year to operate. So you’re not really breaking even until you’re above that level. 

My favorite strategy is the Acquirers’ Multiple, not necessarily just that strategy by itself, but just a deep value strategy that looks for companies that are going to be taken over. So I had the trim tabs ETF to hand because I think that it’s interesting that buyback yield is so predictive of takeovers. I don’t think that they’re necessarily good in and of themselves, just that they generate catalytic returns in the sense that they generate returns that aren’t necessarily tied to the performance of the market. So that’s the challenge, what I have designed something that sort of operates a little bit like a special situations fund, but it’s a deep value fund. So it’s going to be called something like the Acquirers’ fund. And it’s going to find in about the largest thousand or so companies. The 30 best ideas at any point in time. And those ideas are going to be the ones that are the most undervalued and they have.According to the research that I have done, they have the best chance of sort of attracting some sort of takeover offer from a buyer fund, or an activist or something like that. 

So what I really wanted to do was to produce something that is a little bit unusual. And hopefully, I’m going to attach a survey that your listeners can click into and tell me if this is a good idea or not a good idea, but I would produce this as a hedge fund. So it’s a fund that will actually hedge on a tactical basis. So it will seek to avoid the big draw downs. It’s going to be unhedged through good periods of time, it’s going to be hedged when the market draws down. That’s usually a good thing because the underlying strategy should outperform the hedge. So even if it is hedged to generate positive returns, but you don’t want to hedge all the time because there are periods when the market is cheap. It’s not a good idea to be hedged. 

So basically, concentrated deep value, which is my specialty, with near term catalysts to sort of generate returns that aren’t necessarily tied to the market and a hedge so you, hopefully, avoid the really big drawdowns. I don’t think anything like that exists, which is why I’m interested in doing it. And you know, you don’t pay 2and 20 type fees for this you pay, there’s no carry, of course. I mean, there’s no performance fee, of course, and then the fees can be considerably lower than that. I’m interested to know what everybody thinks. I’d love to hear from your listeners too. So let me throw it to you guys first.

Preston Pysh  47:17  

So Toby, first of all, is it an ETF? Or is it a hedge fund? 

Tobias Carlisle  47:22  

It’s an ETF. 

Preston Pysh  47:23  

It’s an ETF. All right. That’s the main thing.

Tobias Carlisle  47:25  

So it’s a hedge fund strategy in an ETF wrapper.

Preston Pysh  47:29  

I gotcha. So this is, I mean, this is my personal opinion. Some people listening to this might think that you know, I’m obviously catering to Toby just because he’s here on on the show. But to be quite honest with you, his deep value strategy makes more sense to me than Pabrai’s strategy. That’s me though. For me, I don’t buy into the whole and maybe it’s because I don’t have the stats. Maybe if I talked with Patrick or James O’Shaughnessy, and they showed me a bunch of these charts with the share buyback thing, maybe I’d buy into it more. But right now I don’t have that in front of me. I’m not an expert in that. And to be quite honest with you, when a company’s doing massive buybacks, I actually maybe get a little turned off by it a little bit, especially when you’re kind of at the top of a credit cycle. I just don’t understand that at all. Makes no sense to me. 

Whereas a deep value strategy at the top of a credit cycle still makes sense to me, because let’s say a company’s beat down and, you know, they’re trading in a very low multiple, and the markets screaming high, you know, the overall S&P 500 is very high. I think that yeah, if the stock could get punished a little bit more, but relative to the market as a whole, I think you’re gonna outperform it. I’m gonna stop talking. I want to hear what other people have to say. I’m really curious to hear what our community has to say because Toby, we are definitely going to put that link up on the show notes for people to participate in that questionnaire because I want to hear what they have to say as well because I think that that’s really going to give us some good information to help you develop a great product for people, that I’ll probably personally use myself. So what do you guys got? 

Hari Ramachandra  49:06  

Toby, when are you launching your ETF? Is it already available? 

Tobias Carlisle  49:10  

It’s not. The strategy that I want to put into it has been set for a long time. But there are lots of different ways that I can implement it. I can buy 100 stocks in a sort of bigger universe or I can buy a concentrated portfolio. I can hedge or not hedge. So those are things that if I if you asked me what I want to do, what I want to do is buy the 30 most concentrated stocks. Sorry, 30 stocks or concentrated portfolio, you know, pretty big liquid market where there’s a good chance of catalysts coming along with a hedge because I just can’t stand 50% or 60% drawdowns. They sicken me. 

And I think that, you know, in the testing that I have seen when you hedge you get so far ahead in the big drawdown that it sort of locks in a lot of performance for when you recover, provided you’re fully invested in the right part of the market. So it’s just sort of it’s questions like that around the edge that I’m interested in hearing. But if everybody else says, I don’t want to hedge portfolio, then I’m not going to release a hedge portfolio.

Preston Pysh  50:14  

So Toby, a lot of people in the audience might not even know what you mean by having a hedge portfolio. So describe that to people so that they really kind of understand it.

Tobias Carlisle  50:22  

So what we would do is we would use a moving average, like the 200 day moving average. Basically all that looks at is the closing price for the last 200 days of the market. And when the market trends below that price, you put a hedge and the way that you do that is by either selling futures on the market or basically selling the index. 

So what you’re saying in that is two things. One, we’re going to get protection as the market goes down, the short on the index will go up. But you’re also saying the portfolio that we’re holding will outperform the index and so we should generate positive returns for periods like that. It’s idiosyncratic. It doesn’t generate positive returns all the time, it can be up and down. So periods like we’ve just gone through, it would have been down because values itself as a strategy has been down. But in a big drawdown where the market goes down, the short protects the portfolio, and it offers the opportunity to make positive returns

Calin Yablonski  51:20  

Toby, how do you intend to rebalance your portfolio at the end of the 12 month period?

Tobias Carlisle  51:24  

So that’s a great question. It rebalances on a quarterly basis. And the screen is run on the end of a quarter. Then the companies are bought and rebalanced back to equal weight. So it holds 30 stocks at about 3.33% of the portfolio. Then over the course of the quarter, some will go up and they may remain in the screen and so there’ll be trimmed back to 3.4%. Some will go down and they may even fall out of the screen and so they’ll be eliminated and there’ll be others that will be substituted. The substitutions are done on the same basis that they’ve been In the initial, that when the portfolio is first first formed, which is to say, things that are deeply, deeply undervalued, where there’s a very good chance of some sort of catalytic event emerging to create returns that aren’t necessarily attached to the market.

Preston Pysh  52:17  

So, Toby, I know from reading your book, when you’re talking about mean reversion, and we had this conversation, I think when we originally had you on the show. I don’t even know how long ago, a year, year and a half or whenever that was? But the conversation really kind of revolved around how long does it typically take for a company to mean revert? And I kind of remember the conversation saying around a year. So if you’re rebalancing this every quarter, talk to us about that if we’re really kind of waiting a full year for things to mean revert.

Tobias Carlisle  52:46  

I think in terms of a business turning around, it’s true. It can take even longer than that, you know, I would, I would say three to five years really. But what this thing is doing is it’s saying, you know the rate of change of the mean reversion is greatest when it’s coming out of the bottom. That’s the bit that you really want to capture. So you can grab that part. Then you have some sort of possibility of an event. 

The attractive things to me about event driven investing is it’s not tied to what the market does. An event can cause a company to go up a great deal where the market is falling. That’s the real challenge of creating these things is to create something that doesn’t behave like the market does. So these things, it shouldn’t behave like the market does. It should be heavily weighted to sort of going up regardless of what the market does.

Stig Brodersen  53:36  

So to answer your question about hedging, I think for me personally, I don’t think I like that idea too much. But it really depends on which type of strategy you’re using. I mean, if I was only going to buy into one ETF, I could see why it would make a lot of sense. Say that I would buy into your ETF, Toby, say it would be 10%. Well, for me I would just really look for the performance here and I would probably allocate something else to do my personal hedge that that I know how to control. I think that would be my concern, because there’s a lot of focus on the expense ratios on ETFs. For instance, for Pabrai’s fund, there were 75 basis points, but there was a lot of hidden fees and a lot of hidden costs within an ETF just as any other investment vehicle. 

If you need to buy or sell for that matter, futures, money can only come from one place, and that is me as an investor. So I think that would be a concern I have. I don’t know the specific number. So I wouldn’t say if it’s a very expensive strategy, but I think that would be my concern. So I’m sorry, if that was something that you were going to launch.

Preston Pysh  54:44  

I like Stig’s point because what he’s kind of getting into is, as an investor, if you’re already trying to hedge or trying to look at things from where are we at in the credit cycle, well, I’m not going to do a deep value strategy at the top of a credit cycle. I’ll just kind of wait until this thing matures a little bit and then maybe dive into a fund like that. 

But if it’s already doing it, it almost be like double hedging because you’re already kind of taking care of some of it. I think that’s a really interesting discussion and I think it’s something that from us to be looking at it from a product that you’re obviously wanting more participants in. 

Are most people and most investors gonna understand what a hedge strategy even is? And if they don’t, is it something that you’re too concerned with because are you just kind of looking at what is the best product I can build that will give me the biggest fattest return over whatever period of time possible? I think you’re kind of leaning towards the latter. I’m curious to hear your response.

Tobias Carlisle  55:40  

I’m probably a little bit more bearish than a lot of people… I think that the market is very expensive. I think that if we can look forward implied returns for the market, and we can see that they’re low, unusually low, to sort of negative over the next period of time, and there’s no way that any sort of on value strategy escapes the gravity of the market when something like that happens because they talk about, say correlations go to one. What that means is that everything behaves the same way because people become panicked. It’s this sort of selling, anything that can be sold is sold. So it doesn’t really matter if your company’s already undervalued as something that is already undervalued as sort of irrationally priced, then here’s no reason why it can’t become more irrationally priced. 

I never know how big the next drawdown is going to be. We’ve had two absolute blockbusters since 2000, that have been down sort of 50% plus each. I think that the conditions are there for another drawdown, another decline in the same sort of magnitude. 

The reason that I haven’t launched it sooner is because I’ve been concerned about the big drawdown and I think I would much rather just be the farmer who sort of sits on his his property and doesn’t do anything, until there’s sort of blood in the streets and then he gets in his car and he drives into town to see his broker. And when everybody’s in panic, then he buys something. It fills his portfolio up and then it goes back to the farm and he doesn’t emerge for seven more years to do it again. 

Preston Pysh  57:13  

p{lus, you’ve been preoccupied writing another book we might mention.

Tobias Carlisle  57:20  

Well, you know, I’ve got lots of time, I can launch it now. If the market was cheap, I’d be working really hard to get it out right now. But the only opportunity that you get to be that farmer who goes and puts all of his chips on the table is that that time starting. So I’ve been waiting and I’m sort of inclined to do it as a hedge strategy because then it takes that timing issue away. And it’s something that I would put all of my own personal capital into, all my family capital into, and just be comfortable holding for here until kingdom come.

Preston Pysh  57:55  

I think your last point for me is so important and when Stig was talking about Mohnish, that was what I was thinking in my head is how much of his own personal net worth is going to go into this ETF that he’s standing up? Because that’s huge. That is absolutely huge. It speaks more volumes than anything else is the same reason why pretty much all of Warren Buffett’s net worth is in Berkshire Hathaway, because he stands by his product. 

Stig Brodersen  58:25  

Toby, I’m curious to hear about the your thoughts about the timing, because I was thinking, yeah, it would have been nice to start the track record when the market is cheap. Relative performances is one thing, but you can eat it. As value investors, we’re looking at the absolute returns, but I’m just thinking, have you thought about and to just be brutally honest here, have you thought about launching it now where it might be easier to attract capital because everyone’s looking for a place to put their capital and would somewhat easier to raise capital. But at the same time, if we see the recession, people will just storm out and you have all those say $150,000 in fixed cost and you might not only be losing, cal it 50%, when the market dropsm or if it drops 50%. But also, people would just withdraw the money at that point in time anyway. So what are your thoughts about the timing of launching it now or in a year or a year ago?

Tobias Carlisle  59:18  

Those are exactly the considerations that you need to make as a manager, I think I don’t want to be responsible for the wholesale destruction of somebody else’s capital. That’s the thing that keeps me awake at night. So that’s one of the reasons why I haven’t launched it because I think that the returns, I can look at the returns to the value portfolio, prospective returns based on what historically the market has looked like. And they’re not particularly appetizing at a level like this. 

Having said that, I would have said exactly the same thing in 2012. And it’s been very good since then, over that period of time, but I think that that’s sort of largely been a what had historically been a very expensive multiple pay for undervalued stocks has become an even more expensive multiples of pay for undervalued stocks. So I keep on waiting on Jesse Felder. But one of the charts that he put up was this price to sales ratio of the market is higher now than it has ever been before. It’s higher than it was in 2000, higher than it was in 2007. That’s just one metric, gamed by lots of different things. So I always use multiple metrics when I’m trying to make these sort of decisions. 

But the market is extraordinarily expensive. Deeply undervalued stocks are also expensive, although now that there’s been some sort of, they call it dispersion. There is some sort of carnage in a few sectors. So I think that the time to launch is rapidly approaching. But I can’t get away from the fact that I’m concerned about the level of the market. 

Preston Pysh  1:00:43  

We just want to thank the members of our mastermind group, Toby Carlisle, Hari Ramachandra, and Calin Yablonski for coming on the show. We just love talking to you guys and I know that our audience, having met a lot of them out in Omaha this a couple weeks ago, they thoroughly enjoy these episodes where we get together and just kind of shoot from the hip and really don’t have an agenda, but just kind of chat and just talk about each other’s business and kind of what we’re up to. 

All the stuff that we talked about, make sure you guys go into the show notes and check it out, especially the the questionnaire for Toby. Let’s help Toby out to design a product so that we can all help each other. Maybe have something that’s really worthwhile here in the long run. 

So that’s all we have for you guys this week. One of the things that I want to throw out there, Stig and I are trying to do live events all over the world in Seoul, South Korea. We’re doing live events in Baltimore, Huntsville. I would really, really like to do one out in California, particularly in Santa Monica, where Toby Carlisle lives, because I love Santa Monica. It’s like the nicest place in the world. So Toby, I need to chat with you about maybe putting something on the calendar for people out in the California area. And I know Hari would probably buzz down from Silicon Valley to kind of hang out and maybe some others, I don’t know, but we need to get something like that on the calendar. 

And if you’re in any of these spots, and you want to come out for dinner, have a nice social hour or three or four afterwards and just kind of sit down face to face and hang out for an entire Saturday evening. That’s what we’re really getting at with our community. It works out as a fantastic networking opportunity for folks that participate. 

If you want to learn more about this, go to our top level page at The Investor’s Podcast, where we have our mission statement, 123. Number three says, “Look for live events in your hometown.” And if you click on that, you’ll see where we’re going and where we might be linking up with people. So be sure to check that out, if you want to see about meeting up with us for any kind of live event. But other than that, that’s all we have. So we’ll see you guys next week.

Outro  1:02:42  

Thanks for listening to The Investor’s Podcast. To listen to more shows or access to the tools discussed on the show, be sure to visit stage.theinvestorspodcast.com. Submit your questions or request a guest appearance to The Investor’s Podcast by going to www.asktheinvestors.com. If your question is answered during the show, you will receive a free autographed copy of The Warren Buffett Accounting Book. This podcast is for entertainment purposes only. This material is copyrighted by the TIP Network and must have written approval before commercial application.

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