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Algy's Investment Podcast
Anne‑Christine Farstad: How to Find Stocks Pricing in “Armageddon” (Before They Rebound) | #26
01:01:25
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- [00:00]
A
I had really experienced the most violent, aggressive and difficult end of the job market. Given how difficult the job is emotionally, you do need to be surrounded by nice people. Human beings are extremely emotional. They tend to react with kind of fear and greed at the extremes. That's something you can exploit. It's pretty wild out there these days. The strongest period of performance has always been coming out of a crisis. When there's blood on the streets, that's when you find the best opportunities. So blind panic is a very good time to be a contrarian investor. Today's outstanding fund manager is tomorrow's laughing stock. Taylor Swift recently wrote in her album that you're only as hot as your last hit. I feel that very acutely. Would you buy more if the stock fell?
- [00:50]
B
Welcome to this episode of Algiers investment podcast. And today my guest is AC Fastad, who is someone I've known for quite a long time. She has been one of the cornerstone investment managers in the Jupiter Merlin portfolios in recent years. And it's as a result of that that I've managed to persuade her to come and join us today. So welcome. Thank you very much for coming.
- [01:13]
A
Thank you for having me.
- [01:15]
B
So first question I've got to ask you is can you give me an insight into what the culture is like at MFS and then what it was that tempted you to join them in 2005?
- [01:28]
A
Well, back in 2005, I had spent a few years working for an extremely difficult hedge fund called Bailey Coates, which some listeners may remember. And so I had really experienced the most violent, aggressive and difficult end of the job market. And I think when I decided to leave Baby Coats, I just wanted something that was very, very different. So I actually applied for a few hedge funds and mfs. And in MFS I found this incredibly collegiate, warm, kind, long term environment. And, you know, I thought I would be happy there. Whereas some of the hedge funds actually reminded me of the hedge fund I'd just left. And so that was over 20 years ago. So I'm very happy I did join it. And it turns out that my early impressions about the culture were right. And given how difficult the job is emotionally, you do need to be surrounded by nice people.
- [02:34]
B
And so what's the genesis behind your investment philosophy?
- [02:39]
A
So when I started out, I started out at UBS on the trading floor in 2002 as a graduate. And the first thing I really witnessed was the demise of the Internet bubble. And so I think that was a very formative experience for me because I realized quite quickly that avoiding investment Bubbles was critical to the job. And you don't actually get money, massive bubbles bursting all that often. You know, we had the Internet bubble and we had the global financial crisis. But it's perfectly possible to have young people in the job today who've experienced neither. So I'm very grateful in terms of my starting point. The second thing is, I think from a kind of market history perspective, I started at an interesting point because I saw the beginning, the birth of hedge funds, I saw the beginning of quant funds, CTAs, and of course the huge success of passive. That has been probably the single biggest thing to happen to the industry. And the momentum that those sorts of funds created, the momentum markets that those funds create. And that really informed, I think, the beginning of contrarianism in my mind at least.
- [04:02]
B
And before we started our conversation or started recording it, we had a laugh because we were talking about having an elevator pitch. And what on earth is an elevator pitch?
- [04:14]
A
Well, I think it's quite an American term, so I think I've learned it from my Boston colleagues. But I think the basic idea is we get into the lift together and by the time we arrive at the first or the second floor, I've been able to explain to you what it is we do.
- [04:29]
B
Oh my goodness. Well, go on then, why don't you give me your elevator pitch? Now,
- [04:34]
A
I think broadly the elevator pitch, and that's not my phrase by the way, but the pitch is really that we believe that markets overreact to short term news and that human beings are extremely emotional and they tend to react with kind of fear and greed at the extremes. And that's something you can exploit as an investor if you have a good long term home that you, that you sit within. And ultimately the way in which I think about doing that is really through valuation because I believe that valuation drives probabilities and that the cheaper the stock you buy, the less you have to believe about the future ultimately. And I'm in the business of probabilities, not certainties. I'm not a superforecaster. I don't have, you know, I can't tell you what's going to happen to geopolitics and macro over the next 10 years. I don't have a crystal ball. So really it's about investing with a margin of safety and buying stocks that are already discounting Armageddon and that are therefore very asymmetric and crucially with strong balance sheets. Because we found time and time again that debt is the enemy of the contrarian investor. Because you don't want to add and you don't have duration.
- [05:52]
B
So I think the old strategy is absolutely fascinating and my next question therefore is, what's the story behind yourself and Zahid Qassam getting together to manage the money that you want now?
- [06:09]
A
So as I said, I started running contrarian value in 2016 and Zahi joined the strategy in 2021. And actually that's a very classic MFS process. There are always two PMs on every strategy for succession reasons. But the interesting thing about choosing a CO PM for contrarian values, you can imagine in a room of 100 people there aren't very many contrarians. Zahid was a very obvious contrarian from the get go and I had the opportunity to work with him for many years as an analyst and I suppose in Covid when he was covering some of the North American Airlines, I really got to experience that firsthand. So actually when it came to adding a CO pm, you know, I had a short list of one and that was Zahid. And of course part of that is temperamental. I think he's a natural born contrarian. But part of that is also values based and human connection based. Zahid has a super interesting background, very different to me.
- [07:11]
B
What is his background?
- [07:12]
A
He's from the Ishmaeli community, which is already quite a small and unique Muslim community. And his family had to leave Eastern Africa in the early 70s and he grew up balancing the books in his family's dry cleaning business in Vancouver as a young child and had a lot of responsibility very early. And one of the many things I love about Zahid is he doesn't take this job for granted. I think he feels very lucky to be in the seat that he's in. He, he's very hardworking, he's very creative and he's not at all complacent. So he's someone I admire personally in as well as an investor.
- [07:51]
B
You've nailed it there. It is so important to admire the people, have respect for the people you work for, isn't it?
- [07:57]
A
Especially through periods of underperformance.
- [07:59]
B
Yes, you get through difficult times.
- [08:02]
A
Yes you do. And the personal difficult times. I mean, you know, it's a stressful job and both Zahid and I have gone through things personally that have meant we've had to support one another, we through those things. And I think you would never make it without that values based piece.
- [08:19]
B
Thank you for sharing that with me. Can I just touch on why you are different from a traditional value fund? How do you define contrarianism well, contrarianism
- [08:34]
A
at its very basic level is a very hated stock that is discounting an awful lot. And what we find is very often when stocks are discounting a worst case, it doesn't take very much to make those things work. Now, where I think we're different from a traditional value, and I sort of touched on this in the genesis piece, is I think there are a number of deep value investors who run screens on a universe and they say, here are the thousand cheapest companies in the world and I'm going to choose 100 of those. What I felt very strongly when designing the product is that sometimes those cheapest hundred companies in the world are not cheap relative. And so you would find yourself at a conference with these very talented deep value investors who I respect a great deal. And they knew that they were going to underperform because they knew that their pool looked expensive. I can't bear that. I don't ever want to know that I'm going to underperform. I also think there are probably now cheaper ways to get access to deep value factor and price to book and all sorts of other things, which was less of a consideration 10 years ago than it is today. So really it's the idea that sometimes value is cheap relative and sometimes it's cheap absolute. And the kind of very naive example I give clients in meetings is to say, look, if a capital intensive cyclical value stock was trading on 10 times and a brilliant business was trading on 12 times, it may not make sense to just lean into valuation. You also have to think about quality and return on invested capital. And all of those things where things become radically different is in periods of big valuation dispersion. So when value's trading at eight times and quality is trading at 30 times, then it's a very different conversation. It makes sense to lead into valuation. And we've seen a number of periods of kind of valuation dispersion and then much narrower valuation dispersion. So I think that's how I think about it.
- [10:45]
B
So in the way which you think value isn't always cheap to have a
- [10:52]
A
portfolio, value is not always cheap. Low multiple stocks are not always the best place to put client money. I believe that fervently.
- [11:00]
B
And I think that's probably kept you over the years in a much better place than deep value funds that have just got valuation behind them and maybe balance sheet strength. But they are traditional value funds.
- [11:18]
A
I think that's right, yeah.
- [11:20]
B
Is market volatility your friend or your foe?
- [11:25]
A
It's absolutely our friend. I mean without, you know, if we're hoping for the biggest overreaction possible at all times to be able to accumulate the ideas that we think are the most asymmetric on behalf of clients. So the more dislocation there is, the better it is for us.
- [11:48]
B
So I remember Rahm Emanuel, who was the chief of staff in the White House in 2008, being attributed to having said, never let a good crisis go to waste. So my question for you is, what's been your best crisis so far?
- [12:10]
A
If I was firstly going to generalize about, you know, our franchises as a whole, the strongest period of performance has always been coming out of a crisis. And I think that makes sense because when there's blood on the streets, that's when you find the best opportunities. So blind panic is a very good time to be a contrarian investor. So that's the first thing I would say probably. Covid is probably the most obvious example over the last few years, but we could also use the, the post Russia Ukraine power crisis in Europe. I mean, it's amazing how many crises we get. Of course we're living through war in the Middle east. As this is recorded, there seems to be at least one disaster per year. But Covid is probably the most obvious example of a crisis where we were able to rotate the portfolio into some of the areas of the market that were most affected by the COVID crisis.
- [13:16]
B
And was it the vaccine that gave you the confidence to rotate the portfolio or was it just on price? When you saw the damage that was done to the market by the fear
- [13:33]
A
of COVID it definitely wasn't the vaccine because we were six months ahead of the vaccine at at least. I think the way we think about things is really very, very price sensitive because we think about the asymmetry of the risk reward. So if you take the COVID example, you had very high quality cyclical businesses like richemont, like booking.com, like, well, Ryanair. We can argue about, about the quality of Ryanair because it's an airline, but it's a very high return airline and a very well run airline. For us, it's really about price and we use dislocations in the market and we just slowly size into the dislocation because I think this is another way in which we are different from other fund managers. We don't do macro top down forecasts. So we didn't sit there listening to endless podcasts about vaccines and how they were being designed. We don't try and think, you know, that far forward. We Just tried to think of great businesses that would be able to survive because they had strong balance sheets, a lockdown of one year, two year, three year, ideally facing weaker competitors who wouldn't be able to survive. So there was an element of kind of last man standing in some of the investments that we made. Ryanair being a good example of that, if what was bad for Ryanair was catastrophic for other airlines. And so really that we always start with the risk reward. And what that allows us to do is, rather than thinking, I'm really frightened right now, I think I should get more defensive. We put the fear to one side and we really lean into the numbers and the risk reward and what those are telling us. And we look for strong franchises with great balance sheets that we think are going to come out stronger from the crisis. And I think that's really fundamental to who we are.
- [15:32]
B
And so that asymmetry tells me that your strategy is almost. I don't want to give you a plug here, but the strategy is a style for all seasons, because the style. When does the style struggle to perform? Because I don't think it probably does.
- [15:50]
A
Well, that's very kind, but it does. In a very narrow thematic momentum market, price and valuation cease to have any meaning because risk rewards are, of course, grounded in valuation and there's an element to which we buy early. So we are kind of often negative earnings momentum and price momentum and all of those things. So I think history would suggest that we've managed to kind of keep up in some of the really tricky growth markets, but certainly that's not when we would expect to outperform.
- [16:25]
B
Okay. No, I completely understand that. And actually, I wouldn't want you to, because that would mean that you were actually not implementing the strategy which you said you were doing.
- [16:34]
A
I think that's right.
- [16:37]
B
How has the behavior of markets changed over the last decade?
- [16:42]
A
I mean, it's changed so much. I mean, we talked about the emergence of passive, and passive is the ultimate momentum investor. They behave like momentum investors and they create momentum markets simultaneously, which has been really interesting to watch. I think. Also, obviously, the emergence of the hedge funds and the pods and the CTAs has all increased volatility, which is really interesting because now, now when we look at kind of quarterly numbers, it's not unusual to see a stock give slightly weak guidance and be down 15% on something that 10 years ago would have been plus or minus 1 or 2%. So it's created enormous volatility because there's just so little of the market that's dedicated to active and to true price discovery.
- [17:44]
B
Yes.
- [17:46]
A
So it's pretty wild out there these days.
- [17:50]
B
And what about liquidity in markets for your strategy? Do you find that the strategy has any liquidity constraints or is it quite easy to get in and out of stocks when you want to do that?
- [18:02]
A
Well, it's certainly easier getting in and out of stocks when everybody else is doing the opposite.
- [18:06]
B
Yes, good answer. We're going to now move on to your investment process.
- [18:12]
A
Yes.
- [18:12]
B
And I'd like to ask you a very simple question, is just how do you and Zahid work together?
- [18:20]
A
Well, he is based in Toronto, which is great because it gives us just that little bit more time across the globe to think about things in terms of how we work together. You know, in terms of idea generation, I would say the number one generator of ideas for a strategy like ours is actually Mr. Market. You know, you should expect that if there is a sector or a stock that is down 50, 70% over three years, sometimes over three, three days these days, but that we will be looking at it and investigating it. We also use a number of quant screens that are kind of too numerous to go through over this podcasts that we use to keep us honest because obviously we're trying to be less human than others, but we are still human. So we use these sort of heat maps that allow us to think, where's the consensus? Where's the contrarianism? And to challenge ourselves. We're constantly trying to challenge our own biases, our own behavioral biases, but also the biases that we all develop over time as investors. And then we work with our amazing group of global analysts. And it's such a privilege when you're trying to make decisions, often quite quickly, to have this group of specialists who really, really, really know the businesses that they're talking about. So, you know, we talked about the COVID crisis earlier and, you know, within a few days of the COVID crisis, you know, I was able to get on a call with our global airlines analysts and our fixed income airlines analysts and talk about the capital cycle by route and the balance sheets and the revolving credit facilities and pick from a global set of stocks. Which ones would you want to own? All else being equal, which ones were already facing competition that was extremely challenged financially going into this and is therefore now, because I think Norwegian had already gone under and Thomas Cook and various other players pre Covid were already in big, big trouble. So this was a massive accelerator for a capital cycle that was already underway. And that is really helpful.
- [20:34]
B
And then. So what kind of investments tend to get into the portfolio?
- [20:40]
A
That's an interesting question. I think one of the things that we talk about a great deal is, and if you were fly on the wall listening to Zahid and I's conversation day to day, you'd hear this a lot, which is if we buy that company and we come into the office tomorrow and the stock has opened down 20%, would we want to add? And the reason that's really important is because we have to really feel we understand the business and the thesis and be able to track it in a meaningful way in order to be able to add on weakness. So over time, simplicity and transparency has become a more and more important part of our process. So I'll start by saying that secondly, I would say that there's probably three different types of contrarian stock that typically make it into the portfolio. One is the kind of value stock with a capital cycle. These are capital intensive stocks that have been through a difficult cycle and where capacity is starting to come out. But you have found the last man standing. And there are a number of examples of that over time. The second would be the distrusted growth quality stock, the fallen angel. So if we give the example of COVID again, that would be the booking.com, which was a duopoly, had 35% EBITDA margins, had been growing very nicely and was trading on 10 times trailing earnings by the time we looked at it in Covid because we were never going to travel again. And I think where we find probably the best ideas often is when the market has seen a long cycle and has started to say that the cycle is actually structural. And that is a very typical kind of life cycle of a contrarian stock, I would say, because as human beings we're constantly trying to explain moves in stocks to ourselves. So after a sector hasn't worked for years and years and years, it must be structural, mustn't it? So I think that's what happens naturally. The final thing I would say is that we have a number of restructurings because when companies are having a hard time, either in a capital cycle sense or, or in a kind of fallen angel sense, very often there's a restructuring. And so that's a fairly permanent feature of the kind of businesses we look at.
- [23:15]
B
And so therefore, what's your definition of risk and how important is downside management to you?
- [23:25]
A
Downside management, Risk first and foremost starts at the stock level, I think. And so downside management is, is a huge part of that. One of our Analysts in London coined our downside as the global financial on crack analysis, which has kind of stuck, but looking for. It's really a kind of everything that could possibly go wrong for the company goes wrong. And we are quite creative with what that can be. And I would say there are very few stocks in the world that can't fall more than 50%. And so our downside cases really do reflect that. And what we find is that there are stocks that often come quite close to trading near that downside Armageddon case. And so on a stock by stock basis, that is one way of controlling risk. Now of course, also on the stock by stock basis, you've got operating leverage, financial leverage. A combination of those, of those two features can be absolutely lethal. So you probably want one or the other. And so I think there's a lot of, you know, and then as I said, simplicity. Do we really know what we're buying? Because very often there are stocks that are very contrarian but where we honestly aren't sure. And we can construct a terminal value question, but. And that makes it very hard to add when the stock is down, which as I said, is, is our obsession. So I'd say that's, you know, and then obviously there's portfolio risk. And portfolio risk is an art and not a science. But I would say that it's really about testing, you know, what is the combination of the names that we own going to produce for clients at the end of it and trying to think about that a number of different ways. What are unexpected affected problems that the portfolio might face. And that's quite interesting because I think we don't have to look very far back in history to realize that AI has turned out to be something that is a correlated risk across a number of sectors in ways that I think the investment community hadn't necessarily anticipated. Now, we're not big in AI stocks as you would imagine as a contrarian, but it's, it can be very hard to miss correlations. And then of course we have the MFS risk reviews that take us through factor risk and interest rates and oil and FX and all of those things. And really it's about making sure that the portfolio is what we think it is and that we haven't missed anything that is going to blindside us and that's going to hurt clients. The one thing I would say is, you know, we are risk seeking. So I think if you'd looked at the portfolio, for example, in at the lows of COVID you would have seen a very pro Inflationary, pro, cyclical, constructed entirely bottom up. By the way, as I said, we didn't have a view on the, on vaccines and we could see that the market was discounting a very low probability of inflation. But that's again, that's not what we're trying to do here. We're trying to pick the best bottom up stock stocks for clients like yourself. But I think you would see big risks across the portfolio, but they are deliberate.
- [26:47]
B
And so if you had a. For example, at the moment, I think that a lot of the software stocks have been hit very hard by the threats of AI. Is it possible that you both could be attracted to stocks within that sector if they carry on being hit by the market?
- [27:10]
A
It's jolly hard. The software question, what I would say is this. We've looked deep and hard at the AI loser bucket and my first observation around software would be that it still isn't all that cheap just on kind of near term numbers and therefore the asymmetry is not so dramatic. So if you take certain well known European large software players and you assume a 2% terminal growth rate, you get kind of 50% upside and if you assume a kind of 2% terminal decline, you get 40% downside or something. I mean, I'm slightly characterizing it and that seems like an awful lot of forecasting you have to do past 2030 to believe in that 50%.
- [28:03]
B
I think that's a really good answer.
- [28:04]
A
I can find some very much simpler businesses with 100% upside where I don't have to forecast what's going on 10 years from now. And so I'm minded to lean into those.
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B
And in terms of valuation guardrails to stop you buying stocks at the wrong price, do you have any?
- [28:29]
A
Well, I think one of the valuation guardrails is of course thinking about market regime and valuation dispersion and making sure that you're thinking about value versus ROIC and quality and other factors. So that informs the shape of the portfolio and the kind of ideas you're hunting for. I mean, the great Mike Goldstein, who's someone I admire so much, always talks about it's best to know which game you're playing in markets. And this is really around his quant framework for valuation dispersion. So I think that's one way of thinking about risk and I think that's one area that it's easy to get wrong. I think in terms of valuation. I would also talk about that simplicity point again. I know I keep coming back to it, but sometimes it's not really price volatility or the price of an asset going down that hurts you. It's the fact that you don't want to buy it when it goes down. Because in a way, if you really love the idea and you really think it's a great business and that's trading well beneath its intrinsic value, you might be quite pleased if Mr. Market gives you an opportunity to buy more of it. Where it's far less pleasing is when you've got it wrong, which of course happens to Zaheed and Uzhai and everybody else. But also when you don't want to add because you realise you're out of your depth because the balance sheet was wrong, or you can't explain the business you thought it was in the numbers. That's really awful.
- [30:06]
B
And do benchmarks impact you at all? Do you pay any attention to benchmarks?
- [30:16]
A
I mean, as little as possible is my answer. The problem with benchmarks is an obvious one, which is that when do you want to be big in financials? When they're 40% of the benchmark or when they're 5% of the benchmark? Ditto oil choice. Choose your poison. They are big insectors just as they peak and small insectors just as they trough. So that is inherently an anathema to what Zahid and I are trying to do here. That said, of course, we sit in client meetings and clients look at us relative to a benchmark and we sit in risk reviews where we're also looked at relative to a benchmark. So it is something we think about, but it doesn't guide the decision making.
- [31:04]
B
And then how do you avoid getting sucked into those very cheap stocks that never regain the market's confidence?
- [31:14]
A
Well, there's lots of things we don't do. We don't do anything where we think there's a question around the terminal value. We don't do anything where we think it's a business that's, that's losing share. So we don't do anything in the kind of melting ice cube type of type of area. Because I think there are some value managers who make money by buying very high free cash flow yield stocks where they're buying back tons of share and that's how they do things. We don't do that. And I'm sure sometimes that costs us money and I'm sure that sometimes it prevents some of the value trap stuff that you're talking about. I would say our bread and butter is actually buying distrusted, quite high ROIC businesses where the baby gets thrown in with the bathwater.
- [32:06]
B
ROIC obviously stands for return on Invested Capital. Invested capital. What about quantitative analysis? What sort of screens do you use?
- [32:19]
A
We use a lot of different screens and I would say that most of them are designed to get a handle on sentiment. And so, you know, as I referenced earlier, we have a number of screens that essentially create some kind of heat map from green to red of where the market is most complacent and where the market is most worried. And those are enormously helpful because if you still, if you still own something that is starting to become more consensual, what is it that you're doing there? And you need to challenge yourself. Similarly, if there are sectors that are consistently in the green where you don't have any exposure, is that based on a stale bare thesis? And so I think they're really designed to challenge our assumptions in the portfolio and in the market as a whole. We then also have some much more obvious screens which are, you know, global's a big universe. And we have a lot of screens that simply tell us where the large pockets of underperformance have been, where Mr. Market is throwing up ideas. And we slice and dice that a million different ways, as you can imagine. And then we have a lot of screens around kind of valuation dispersion, which again, we slice and dice a million different ways.
- [33:37]
B
And how often do you run those screens?
- [33:41]
A
Some of them are run weekly, some of them are run monthly. It's a real mix.
- [33:44]
B
Okay, and then how many stocks do you analyze? And of the stocks that get into your sort of hopper analysis, how many stocks then get into the portfolio?
- [33:59]
A
I honestly don't think I know the answer to that question. The answer is we look as many at as many stocks as humanly possible because we have found that the more stones you turn over, the more likely you are to find a gem. Also, when you find something else outside the portfolio, you look at the risk reward compared to what you have in the portfolio. And that's really helpful because sometimes you might look at it and think, oh, actually I prefer what we own, but that's also helpful. So it's a constant assessment of risk rewards across the market.
- [34:37]
B
You've already spoken about there being maybe one opportunity a year when there's been some sort of systemic shock to the system which has enabled you to change the portfolio a bit. But how high can your turnover be?
- [34:56]
A
The turnover is an output, not an input, and so it's much higher in periods of volatility. Those seem pretty continuous. I think at the name Level, it's probably average at around 50%. But at a total level, because we're topping and tailing, it would be higher than that.
- [35:17]
B
So it could be as high as 100% historically.
- [35:21]
A
It's an output.
- [35:21]
B
It's an output.
- [35:22]
A
It's an output. We don't worry about that.
- [35:24]
B
So it's a very active strategy, isn't it?
- [35:26]
A
It's a very active strategy.
- [35:28]
B
So what's the longest you ever owned a stock for?
- [35:33]
A
I think probably around six or seven years. Yeah, I think that's about right.
- [35:39]
B
Okay, so you'll be. If the valuation's right, you'll be patient.
- [35:43]
A
Yes.
- [35:48]
B
How sensitive are you to the price that you paid when you bought a stock? Stock? Do you watch it closely?
- [35:55]
A
Well, I think because we're so rooted in the risk reward, which is relative to the price that we pay on behalf of clients, I think we are very aware of it. I think we have quite an absolute mindset in some ways. So the price paid is important in absolute to us. That said, you know, I think it's, you know, risk rewards do change over time as well, so. So that's different as well. And so our attitude to risk reward will really depend on. On the type of asset that we've been buying for clients. So quality compounders, you can't treat quite the same way. And so the answer is it depends.
- [36:50]
B
It's a very clear answer.
- [36:52]
A
The answer is it depends.
- [36:54]
B
And then it's very interesting you mentioned about having an absolute mindset, because I think that's incredibly important for I look back over the last 25 years, fund managers who had an absolute return mindset running long, only money have they often been the ones that I favored? Could you give me three adjectives that best describe the psychology of yourself and Zahid behind the process? Tough question.
- [37:22]
A
Yeah.
- [37:25]
B
What would you say? What would you say you are?
- [37:28]
A
I think I'm going to go with pragmatic because I think we really try not to be too wedded to anything. And that's what I mean by pragmatism. Curious. Because we're constantly trying to figure out where we might be wrong and to evolve as markets evolve and patient. Because I think if there's one problem Zahid and I don't have, it is getting spooked out of things.
- [38:00]
B
That's actually a really good answer. What I'd like to do now is just to move on to portfolio construction. We've touched on it. But just for those people that aren't so well versed in financial jargon, can you describe to me what asymmetric risk at stock level really is.
- [38:22]
A
Asymmetric risk is gloriously simple as a concept. So in a perfect world, you'd buy stocks that had 0% downside and 100% upside. Now, that is a difficult thing to do in reality, but asymmetry is really throwing everything at a company to see what the downside might be. So this usually involves an economic cycle plus some own goals, and then putting that kind of trough on trough, because that is actually where things trade, even if you think they shouldn't. And then the upside is a kind of dare to dream where everything that could go right for the company does. That's actually the bit that requires the most creativity because most investors are very anchored to the recent past. And so it's quite hard to imagine a company that hasn't been firing on all cylinders. Firing on all cylinders. So that's the really fun bit of the job, I think.
- [39:35]
B
And then how important is the chief executive of a company when it comes to dare to dream?
- [39:45]
A
I think it depends. Again, I think there are some businesses where it's much more important than others. In truth, because we have to act so quickly on a big dislocation, it does happen that we start positions in companies before we've had a chance to meet the chief executive. And I think that's an interesting part of the due diligence process is because usually the big question mark is capital allocation, of course. And that's also where we're very grateful to have the investment team who probably met with the company four times in the last 12 months or whatever between portfolio managers and analysts and everything else. So I think. But capital deployment is far more important for some businesses than others.
- [40:43]
B
And so just moving on to the stock set sector and country level risk management, could you give me a bit of color as to what investors are getting in terms of diversity at the three different levels?
- [41:03]
A
So we've said that we don't really look very much at the benchmark. And I think you would certainly see that if you looked at our geographic exposure, which is very, very different to the market. We're very underweight. The US and at the sector exposure as well, you would see that.
- [41:26]
B
So the U.S. i think the world index. The U.S. is nearly 70% of the world index now. Is it? Yeah, something like that. What would you have in the. What would you have had in the US last year?
- [41:44]
A
Probably 10% or something.
- [41:46]
B
Okay. And so quite a lot of. Quite a lot of exposure to the uk.
- [41:52]
A
Quite a lot of exposure to The UK and quite a lot of exposure to Europe and a bit to Japan as well.
- [41:57]
B
So your benchmark, aware, but pretty agnostic to it. It's all about stock price and you go where the best opportunities are to be found.
- [42:10]
A
Geographically, yes.
- [42:11]
B
At sector level, will you limit the amount you'll have in any one particular sector just because you and Zahid feel that from a risk reward perspective you don't want to have too many eggs in that sector basket?
- [42:26]
A
That's an interesting question. Yes, I think we would limit it to some degree because if you have exposure to beauty or spirits or whatever, you don't want your client's entire return to be governed by what is essentially one bet. So of course there are some things I think where we're different, however, is if you think of the COVID crisis, we started by using cash and then we used defensives and really by the end of the two months of market turmoil that we had, from whatever it was, February to April, I can't remember it's feeling, feels like long time ago now, you would have seen a massive rotation into cyclicals. So those cyclicals, there was some diversification. So it wasn't that we were just betting on luxury or travel or industrials or retail or whatever. There was a mix of things. But certainly you would have seen a very dramatic rotation.
- [43:35]
B
And is there a price for everything or are there any sectors you would never invest in?
- [43:43]
A
Well, I think if one of the parameters is that you need to understand it, there are probably some sectors that are difficult. I've already referenced the fact that we don't do anything that we don't think has kind of terminal value. So that's one thing. We also don't do businesses where the, where the product is the stock. So there are some brilliant people doing biotech or whatever where one molecule is going to govern the outcome for the company. We don't think we are best placed to do that. But then there are just some businesses that are very opaque where there might be players outside of the business who have an awful lot of power. You know, we don't do much, we don't really do emerging market. But you know, one thing that we did look at was the Chinese Internet stocks when they were very dislocated and we did a lot of work on them and they didn't meet the parameters for us of would you want to buy this if it was down 20%? Because we just didn't feel we knew what was going on in that market. So I think it really comes back to Simplicity, I think that's a great example.
- [44:54]
B
So which, reversing the optic for a second, which sectors have been your most fertile?
- [45:03]
A
Well, the big controversy is usually the economy. So I will start there by saying the thing that human beings in markets worry about most often is the economy. So we've probably spent more more of our life digging through cyclicals than most. I would say that cap goods has probably been the sector that's added the most value to our strategies over the last 10 years. And I think it's just because these are businesses that are reasonably easy to understand. There are so many different little subsectors. There's always something going on in certain part of the market. So you get lots of different little cycles going on within them. A lot of them are actually very high quality, high margin, high ROIC businesses, but that trade very cheaply when people are worried about them. So that's probably a sector where we spent a lot of time.
- [46:07]
B
And have you ever invested in the technology sector?
- [46:10]
A
Yes, we have, yeah. I think in 2016, 2017 was probably around 20% of the portfolio. And this is one of the things I love about contrarian investing is that today's mag7 is yesterday's contrarian stock. So you know, we owned Apple when it was on a low multiple of free cash flow with a gigantic net cash balance sheet, I think was on three and a half times free cash flow or something when we owned it and look at it now.
- [46:42]
B
So never say never is part of
- [46:44]
A
your philosophy then never say NEFMA is part of the philosophy. But I suppose with a lot of technology the difficulty will be the simplicity element and the regulatory element.
- [46:55]
B
So many investors who'll be listening to our conversation today are already invested in passive index trackers and one of them is the World Index. What is the active share of your strategy versus the World Index?
- [47:10]
A
We're very different to the World Index, as you would expect, and our active shares generally been in the high 90s.
- [47:16]
B
Gosh. So it really does stand well apart from that index. I'm going to move on to another question now, which is a set of questions which is really about patience, risk and timing. So the cheeky one start off with is what is your investment mantra?
- [47:39]
A
Well, I think if you haven't picked it up by now, I don't know what to say. Would you buy more if the stock fell? I mean, if you were a fly on the wall, you would hear, you know, and it's super helpful because in real time you can phone one another and say, well, the stock is down today. Do you want to add. It's such a helpful litmus test.
- [48:02]
B
And then how do you both agree when to buy or sell a stock?
- [48:07]
A
Well, I think because we're so grounded in, we agree on the risk reward and then the risk reward informs the decision. So I think that's quite simple. And if we don't both agree on it, then it doesn't go in the fun.
- [48:19]
B
Yeah. So the strategy is robust enough to be able to, for you to make those decisions quite easily between the two of you.
- [48:26]
A
Yeah, there's certainly never been a bottleneck of that kind.
- [48:29]
B
But then how do you avoid selling too early?
- [48:31]
A
We don't. We always sell too early. I think it's part and parcel of being what we are really. We're constantly trying to high grade the risk rewards within the portfolio. And that means that sometimes you're selling something that's working that now, you know, looks less asymmetric than it did to buy something that's really not working, that's had two profit warnings that goes on to have a third profit warning. So I think it's, that's just part of, that's part and parcel of the, of the beast.
- [49:05]
B
So your ability to cope with sellers remorse is just part of the job, isn't it?
- [49:10]
A
Yes, it's sometimes very upsetting, but.
- [49:12]
B
Yes, but you just gotta do it. Yes, stick to the process.
- [49:16]
A
And it's hard as well because it's usually quite hard to disaggregate at the end of the year. What you, you know what. Yes. You can see that you sold it and it continued to go up 30%. But you can't always remember what, how you, how you allocated that capital. So we try not to torture ourselves. One thing we do do very rigorously is follow up on all the stocks we passed on to see what worked and what didn't and why and what we missed. And that's a very helpful process as well.
- [49:47]
B
And then how much pain can you take on the, on the downside when that, when that stock's fallen 20% and you've had a, you've had, you've had a conversation, but it's in the portfolio.
- [49:56]
A
Yeah.
- [49:56]
B
How much pain, absolute pain can you take before you sell?
- [50:02]
A
There is no absolute pain threshold. The real pain comes from not being sure of what's going on and not wanting to add. And that is the most painful thing, a dislocation in a company that we really feel, we understand where we really feel that it's super asymmetric and that we understand the true downside, if it trades down towards our, you know, our most dramatic Armageddon downside case, that can be quite exciting rather than painful.
- [50:40]
B
Moving to today, the current situation in markets, which regions offer you the best opportunities in the strategy?
- [50:52]
A
Well, I mean you can see very clearly from our positioning that we think that is the UK and Europe relative
- [51:00]
B
to the US and is the UK equity market ripe for takeover activity?
- [51:07]
A
Well, we're certainly seeing a lot of it and I think part of it is kind of UK small and mid cap where the buyer of last resort turns out to be a competitor or a private equity company or whatever else. I think it is and I think there are a lot of very, very world class businesses in the UK that sadly that will be how it ends up.
- [51:33]
B
What is it that's made the UK so much more attractive from a valuation perspective? Was it the pension fund setting down at UK equities the last 30 years? It just seems like the UK lost its vigor of for international investors, but now it's coming back.
- [51:52]
A
Well, I hope you're right. I hope you're right. I think it's a lot of different factors, isn't it? You know, it's partly the UK and the pension fund and Brexit and a combination of, you know, Liz Truss, Boris Keir, Starmer, pick your poison. But I think it's also just how strong the US has been in terms of attracting flows and this very strange situation we have that retail investors across the world own the S and P
- [52:26]
B
regardless of where they are and regardless of the valuation.
- [52:30]
A
And regardless of the valuation, so is the AI and the more those stocks go up, the more they'll all own
- [52:37]
B
of it, of course, which is, you know, self fulfilling.
- [52:40]
A
Yes. We've come a long way from, you know, buy low, sell high, haven't we?
- [52:45]
B
We certainly have, yeah. So I interrupted you. Is, is the AI boom that we're going through now creating opportunities for you to look at in any high quality businesses?
- [53:00]
A
Well, we've touched on some of the software stocks where I, I think there is a terminal value question that is that it's difficult for me to know the kind of work I could do on behalf of clients that would give me conviction one way or the other. I think where we will start to see it in a way that is more investable for people like us is going to be on the labor side. So if you start to have businesses that are not necessarily directly impacted by AI, but where the market starts to think, well, there's just going to be far Fewer people. Some of those things might become investable.
- [53:40]
B
Yes. Which sectors are the two of you looking at today which you thought you never would be expecting to look at?
- [53:54]
A
Well, we always think we'll look at anything. So in a way it's not at all unexpected when it does happen. I think if you think back to the days where bond proxies and kind of quality were very expensive, I think it's interesting, for example, that we now own consumer staples and healthcare. And I think that's more or less the first time in the fund's history
- [54:24]
B
that is absolutely fascinating because there's no doubt about it, there are quite a number of quality investors that have really struggled the last two or three years. And maybe some of those stocks. Fascinating that some of those stocks might be creeping into or have crept into your portfolio.
- [54:44]
A
Yes. I think the CEOs are less pleased than when they meet the contrarian franchise meetings.
- [54:50]
B
Oh, yeah. But they can't have everything. So does your strategy, does it feel fresh today?
- [54:58]
A
Well, as I said, you know, you should expect more turnover in periods of volatility. And the war has meant that there has been volatility. And in periods of volatility, it's always easier to deploy capital because you suddenly see, you know, real opportunity. And what becomes more difficult in those periods is finding things you want to sell in order to allocate that capital. So I think we always feel that the strategy is ultimately designed to be fresh all the time. But after a dislocation like the one we've had, we probably find that there are more opportunities through those periods.
- [55:42]
B
And then looking at your portfolio relative to history, is there any sort of valuation guideline you can give me today that gives me a feel for whether it's extremely good value or pretty good value relative to history?
- [56:02]
A
I don't really think about it in those terms for the reasons that we outlined before. I'm going to answer it slightly differently. I think the US is expensive and over earning and we don't own very much of it. So I definitely think that we are far less expensive and have far less over earnings risk.
- [56:26]
B
I think there's a very, very clear answer to that question. What do you think is the price you pay as an individual for being an outstanding fund manager?
- [56:41]
A
That question amuses me because you've just said that, you know, there's a number of kind of very high profile quality fund managers who've, you know, effectively been taken out and shot over the last few years. So today's outstanding fund manager is tomorrow's laughingstock so, you know, I think it's Taylor Swift recently wrote in her album that, you know, you're only as hot as your last hit baby, and I feel that very acutely. So please don't say the words outstanding fund manager ever again because I feel very, very nervous about it.
- [57:19]
B
What would you deem to be a great success in say, 10 years time for your strategy?
- [57:31]
A
Well, I think one of the unappreciated elements of the fund management job is what a brilliant job it is for working mothers. And so one of the things I've really appreciated is that I've been paid to think rather than for FaceTime. You know, I don't have billable hours, so I've had time to do a job that I really, really enjoy, but also to be a mother. And so part of my kind of 10 year success will obviously would be incomplete without feeling like my children and my family are happy overall, you know, where at the kind of less human level and the more job level in a sense, you know, I hope that I'm able to stay curious and agile and to continue to change as markets change. I hope I'm able to continue to work with people that I really like because I think that makes the whole process so much more enjoyable. And you trust and that you like and you trust? Yeah.
- [58:37]
B
And have you got any advice for young people who may be struggling, leaving university right now, but looking at going into the fund management world as to how they should go about researching and learning and getting a feel for our industry?
- [59:05]
A
That's a good question. I think the young people I've met who, you know, who come up through the ranks and who we meet either as kind of research associates or through our MBA programs who have something special are invariably those who go back and look at the history of markets and investing and that start, whether it's conscious or not, that start to think about patterns and playbooks and the way in things. I think there's a huge element of pattern recognition. So I'm always interested when I meet young people who think about, who read about kind of financial bubbles and all their different forms and what are the characteristics you need for a financial bubble. Because history does rhyme. Even in a market that's changing, where the participants are changing and the structure is changing all the time, there are certain elements that do rhyme. So I think educating yourself on the history of the industry and the markets is a really good place to start.
- [60:22]
B
Well, Izzy, I'm going to thank you profusely for despite suffering from jet lag flying over from la, making this podcast episode so special by giving us so many insights as to how you and Zahid think and talk and communicate and manage the money, and I think that those investors who are already with you are in very safe hands. Thank you very much. Thank you all. Content on the Algies Investment Podcast is for your general information and use only and is not intended to address your particular requirements. In particular, the content does not constitute any form of advice, recommendation, representation, endorsement, or arrangement, and is not intended to be relied upon by users in making or refraining from making any specific investment or other decisions. Guests and presenters may have positions in any of the investments discussed.