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- [00:00]
A
Foreign Neal Grant's interest rate observer of the air. I'm Jim Grant, and with me, as always, is the great deputy editor of Grants, Evan Lorenz. Henry French is at the control panel. And with us today is a guest named Dev Katasaria. And by the time we are finished, you will be as amazed as we at Dev. Singular career path. Now, Evan, if you were the recipient of a B.S. degree from the Massachusetts Institute of Technology, went on to the Harvard Medical School, what do you think you'd be doing for a living long about now?
- [00:42]
B
I'd probably rest my laurels and stu. Be a doctor.
- [00:44]
A
Yeah. But that is not the route that Dev Kata Saria has chosen. He's in the buy low and sell high field, Evan. Although I don't see much, so actually, Dev is. We'll find out more, but I think he's a bundle of paradoxes. For instance, he runs a hedge fund, as it says on the label, which apparently is unhedged. He has a business that is named Valley Forge, but which nonetheless is based in Florida. I suppose, though, if George Washington had the same tax structure we had, he would had his army based in Florida. Right.
- [01:19]
B
Better weather, too.
- [01:19]
A
Yeah. And so hedge funds, proverbially, are pretty busy enterprises. You know, they buy, sell, they hedge. They have derivatives. Dev has eight. Or is it one position? I think is right. It's eight or 10 or 12, no more than 20. And what his firm does for hockey tickets from the brokers, I don't know, because he sits with them. And Evan, get this. They go up and up and up. And the. Dev got his start in the unprosperous year of 1907, soon become much more unprosperous. But with that far too brief introduction. Welcome to our house.
- [02:00]
C
Well, thank you so much for having me. My mom still wishes she could go to parties and say, you know, her son's a cardiothoracic surgeon, so. Yeah, it's a.
- [02:08]
A
Why doesn't she say it?
- [02:11]
C
Well, what I got.
- [02:13]
A
I got a suggestion for your mother. Tell him that he compounds at 15% a year.
- [02:19]
C
She still doesn't exactly know what I do in my day job, but.
- [02:22]
A
Well, actually, that is a very good question. If you don't move your positions like respectable hedge funds do, which is kind of manically, what do you do all day long?
- [02:32]
C
We spend most of our day reading and preparing.
- [02:35]
A
So you never left academia? Really?
- [02:38]
C
No, no. We are students of business of all types. I love thinking about ice cream shops and restaurants and car washes. It's not only focusing on what we invest in. But I'm a lover of all business models and what we do because opportunities that we like. You know, I think about it as Buffett's punch card. You have to make 20 decisions in a lifetime. If you find the right opportunity, make sure it counts. And so we make few decisions, but when we make them, they're big. And these aren't static positions, something that we bought 17 years ago, we might buy another 13, 14, 15 times along the way when the market is not properly assessing intrinsic value.
- [03:26]
A
Dev, what do you think of the strong form efficient markets hypothesis?
- [03:32]
C
Generally it is true. Our job is to find a few instances every year, every few years where there is a disconnect. And our job is to predict the future. If you use simply current data, current PE ratios, current information. Today information is widely available to everyone. We have to assume that everyone has the same information that we do, but we need to interpret that better than others. There was a time back in the 1950s or 1960s, you'd have to drive to Hartford, Connecticut to the committee commissioner's office to learn about insurance companies. That's no longer the case. And so what we need to do is to assimilate a large set of future risk factors to determine the proper risk reward decision for an investment that we're making. And a lot of that skill for me comes from my venture capital days. We were working with very small companies pre revenue and we had all sorts of risk factors, management team, competition, regulatory issues, legal issues, financing concerns. But we needed to boil all of that down into a single decision. And I think as I look at my peers and many individual investors, they get confused by the large amount of information that's out there on any given situation or any given company. When I read a 10 page report on a business or an industry, the points that I walk away with are often different than what most people are concerned about or talk about. So we need to get to the essence of the business. What will matter for earnings power 10 + years out from now. And that long term time horizon allows us to focus on what really matters and not things in the short term. But there are situations where we are buying into something because a Stock is down 40%, 50% because of some regulatory legal issue or some competitive threat, a bad earnings release. But I would say two thirds of the time we're buying into these great businesses because of what I call market neglect. It's sitting out there right in front of you and we see something that most others don't.
- [05:46]
B
So you have eight Positions you trade infrequently at best. And you spend most of your time turning over stones, looking for the next great business to invest in. What does the pipeline look like today and how does it compare to the times in the past? Because from our perspective, the market seems not cheap.
- [06:00]
C
There's tens of thousands of publicly traded companies. The number of publicly listed companies continues to shrink. I was very happy to have the IPO SPAC craze over the last few years, add some more new names to the marketplace.
- [06:13]
B
Did you find any good companies from the SPAC craze?
- [06:15]
C
No, but. But I'm holding out hope that more.
- [06:18]
A
More reading? Yes.
- [06:20]
C
I'm holding out hope that some of them develop into quality businesses someday. As we look at, you know, we're trying to find eight to 12 of the best business models in the world. An ideal portfolio for us is if I could find 12 equally good companies and equal weight them in a portfolio, that would be my ideal. But that's not life, that's not reality. You are, even when you're talking about some of the best business models in the world, you're going to concentrate on ones that are far stronger than others. But our fishing pond is about 40 to 50 companies. So of the tens of thousands of companies out there, our first screen is business quality. And we define business quality simply as finding the perfect intersection between growth and predictability. You can have companies that are growing at a high rate, but maybe they're young, they're not predictable. Or you have companies that are very predictable that have been around a long time, like Colgate, very predictable company, but has low organic growth. We're trying to find companies where they're high growth but also very predictable.
- [07:17]
B
Can I ask a question about one of the companies you own and one of the companies you don't? So you own asml, which makes the semiconductor equipment that allows TSMC and other companies to make microchips that go into everything. You do not own tsmc, which kind of has a monopoly on making high end chips right now and it's had tremendous earnings growth. I'd love to maybe understand why did you buy one and not the other? And kind of what turned you off in TSMC and what turned you on for asml?
- [07:42]
C
We generally like to buy into very dominant businesses where industry dynamics are stable. ASML is a Monopol monopoly. It makes machines about the size of a school bus. Arguably they're 10 to 15 years ahead of anybody else in making these machines. These machines make the leading, you know, the leading edge chips that go into the servers that are needed to power AI. And so there's a, there's a vast need for new ASML machines, their newest generation machines. TSMC is one of the, the major customers of ASML, very capital intensive. TSMC's advantage today comes from really scale. And that is not a advantage that we prefer. We would much rather have that advantage in the form of industry dynamics that have been stable for many decades or a technology advantage in the case of asml, which really makes it the, you know, the only, all of the growth in AI. You know, we wanted a predictable way to participate in AI. We could have bought Nvidia, we could have bought Microsoft, Google or even tsmc. But we wanted the most predictable way to participate in AI and we felt that was asml. Because at the end of the day, the chip demand that will be needed to power the service for AI, all of that has to flow through asml.
- [09:07]
A
There's so much of the world seems to be migrating to the private more market, whether it's credit to equity, what have you. You spend a long time in venture capital. Why have you chosen to make your career in public equity markets rather than venture?
- [09:20]
C
I was in venture capital for almost 18 years. I had a successful career there. I could have continued in taking the path of least resistance. For me, I did not find the private markets to be a reliable way to make money. We were fortunate in our last fund to be founding investors of a company that later sold, I think for about 2.7 billion. But in private markets or venture capital specifically, you might invest in a portfolio of 12 companies. Using the baseball analogy, you're hoping for one or two home runs, maybe some singles and doubles, and then you have a bunch of losers. For me, that didn't resonate as a way in which I wanted to grow wealth for myself and for others in public equities. What I love about the public markets is the meritocracy of it. You know, you wake up every morning and the opportunity set that I have, that you have, that Warren Buffett has every day, it's the same for everybody. I love the fairness of that, of that game. And there's a more direct correlation between making good decisions, being smart, having the right temperament and outcomes. And so it's a game that I believe is a lot easier to play. And if you do it right, you can have the returns of a private fund, but with all the advantages of, you know, transparency and reporting, you can exit positions that you're ultimately unhappy with. You have, you have, you know, daily Liquidity. So I, you know, for me, when I look at the risk rewards of the different asset classes, I prefer public equities over any other asset class. And, you know, there's a reason that Warren Buffett isn't a mezzanine debt investor. You know, he also sees the straightest path to making money.
- [11:03]
A
What do you think about the preponderance? I'm not sure. Preponderance, the heavy exposure of the very best universities to which you attended. Exposure to, like private equity. Illiquid, heavily leveraged, very popular. Do you worry about your alma maters given their exposure to these asset classes?
- [11:23]
C
I think allocators gravitate towards private equity, private credit, because there's not a mark, mark to market for these funds.
- [11:31]
A
You use the word allocator. Now that is a, that's an interesting word, isn't it?
- [11:36]
C
It is, you know, there's, it comes in all, all, all sizes. An individual should be an allocator as well as an endowment. But, you know, endowments I have, they're, they're a unique animal. And I think what they want to do with their, their reporting is to avoid volatility. And Munger, in an interview said that you have to be prepared in public equities a few times every hundred years for the market to fall 50%. And if you don't have that disposition, you don't deserve the great rewards that public equities offer. But what private funds and private investments do for endowments is that many of the problems in those areas can be hidden for long periods of time because they're, you know, you don't have these daily write downs. There's no daily pricing, there's no monthly pricing. You could have two different investors in the same private credit fund have vastly different holding values on their books. And so it's unfortunate that there's a preference for these asset classes. But I believe that any great portfolio's foundation has to start with a public equity, you know, a public equity foundation. And it can't be simply a throwaway decision. You can't simply, you know, index it or give it to someone in an sma. You need to actively find managers that can outperform in public equities and use it as your foundation. And then the other stuff should be the window dressing around it.
- [13:08]
B
You mentioned Munger and Buffett. If I look at what Berkshire Hathaway has done this year is it sold a lot of its stocks, a lot of its compounders, it's unloaded a tremendous amount of Apple, which has been a Great trade for it. And it's now sitting on its largest cash position in its history. Do you hold cash? And if so, how does that cash holding compare relative to your history?
- [13:27]
C
We've held cash as high as 20% in our past. I think one of the learning lessons for me was that if you own great businesses, compounding machines, over the long term, holding cash is, is a drag on returns. Our returns would be far better if we held zero cash along the way. So today, you know, cash sits around 1% for our fund. It'll probably sit around 0 to 5%, you know, in the future. But, you know, if you own a great business, you should be fully invested. I'm very curious about what Buffett's motivations are. Is it around a worry about future tax rates? Was it that Apple was caught flat footed on AI? Is he raising cash for a big acquisition? My worry is that if something happened to Buffett, who is going to put that $325 billion to work? Although there's some quality people at Berkshire Hathaway, no one is an allocator like Warren Buffett. And so the risk that I would see is not that he has the cash, but, but you know, if something were to suddenly happen to him, you're leaving the company with a very big problem.
- [14:41]
A
You know, we live in kind of a charmed world in that up and to the right is the perceived default experience of investing. If you had been born a few generations earlier, you would have assumed that downward and to the right was the default investment position. Are you not projecting an unusual, if not unique period of history into the future?
- [15:04]
C
You know, for us as very long term investors, we think about the earnings power of our companies over 10, 20 year time frames. There is a lot of noise, geopolitical noise, macroeconomic noise. I view our job as a relative game. It's possible that the S and p might be 4% annually for the next decade, far below what we've had over the last couple of decades. It's our job to outperform whatever the s and P500 is going to do by a meaningful amount. So it's not necessarily what you earn on an absolute basis, but you have to earn more than your neighbors to maintain your buying power. So I view our mission at the end of the day to significantly grow the relative buying power of our investors. And we will be thrown all sorts of curveballs, interest rates, there may be crises along the way of different types. You know, AI will certainly lead to massive unemployment, which will completely change how we think about the economic landscape. But at the end of the day, our job is to continue to outperform on a relative basis.
- [16:13]
A
Are you that sure about AI?
- [16:15]
C
I am sure.
- [16:17]
A
About the capital investment side of it or about the out, about the, the asset earning side of it?
- [16:22]
C
Well, we have a view that AI technology will be quickly commoditized. You know, in a few years an off the Shelf AI program will, will be able to handle 95% of the human tasks that we have today. And so AI will be widely available, it will be cheap. You may need advanced AI for military applications, scientific applications. It's very tough for us to figure out who the winners are in AI. Who's going to be able to monetize AI? There's massive investments being made by the leaders today. But you take something like Google search. ChatGPT just came out with their plan for ChatGPT search. Other companies are working on search. I think search looks very different 10 years from now than it does today. And what does that mean for a company like Google? The implications as a society from AI? I'm more clear on. I think there's nothing in human history that, that we've experienced like AI. It will put significant numbers of people out of work. I think a child that's born today, it's very clear what their profession will be 20 years from now when they're, when they're coming out of college. And there are massive implications for society for companies.
- [17:36]
B
Two of your biggest position or two of you, all your positions are big because, because you only have eight of them. But two of your positions are MasterCard and Visa. And if you're expecting unemployment to pick up dramatically because of AI, which would also imply that incomes for consumers are going to go down dramatically. Is owning the two payment rails that most people make, you know, purchases on a good decision in light of your.
- [17:57]
C
View on AI, you know, you're absolutely correct. If there's a recession, if there's unemployment, anything that affects spending can affect volumes. At Visa and MasterCard, one of the hallmarks of the businesses that we own is pricing power. And our companies exert pricing power at different levels. We think the best way as an equity investor to protect against risks like inflation or even deflation is to own companies with pricing power. If inflation is 10%, we want companies that can raise their prices 13 or 14%. Visa has a number of different business lines, but it has tremendous pricing power. And so we don't know exactly how it works would play out. But we have some confidence that the transition from cash to electronic payments will continue. We think there's a great growth opportunity in business to business payments. We think the companies have a lot of latent pricing power. They have services businesses that are growing nicely. So we don't know how all of those factors will exactly settle out. But yes, a weaker consumer certainly is a net negative for those businesses. But we believe that the positive aspects of the, of the businesses could compensate for that concern.
- [19:01]
A
Dev the Valley Forge Capital Fund charges 1% management fee and 2% incentive fee. After AI finds its running room, what will those charges look like? And what will the value add of a human being in the search for good investment ideas? How will that compare to what AI will generate for the same search?
- [19:25]
C
Well, I'm very skeptical of my peers. I think there's only a handful of individuals in the country that can meaningfully outperform the S&P 500 over a long period of time.
- [19:37]
A
Is one of them in this room?
- [19:39]
C
Well, I can't. I'll leave that for others to say. Besides Evan, we have a 17 year, not me, we have a 17 year track record. We have a lot more to prove. But most of what exists today in public markets is, is random noise. And so will AI outperform or, or at least equal the P the vast majority of public equity manager managers today? Absolutely.
- [20:04]
A
Going back, going back, we're not talking about them. We're talking about. Well, we're talking about the cream of the crop. And what you add is judgment. Right? Information is generic and ubiquitous. Judgment is scarce, precious and highly compensated. But if AI is in fact transformative, who's to say that its judgment might not supersede that of the average bull?
- [20:28]
C
It's hard to say. I continue to be amazed by AI and how quickly it's developing. The only thing I do have confidence in is that we'll be one of.
- [20:37]
B
The last to fall going back to great businesses and the potentially transformative effect of AI. So another two of your positions are Moody's and S and P Global, which with Fitch as a distant third are the three companies that dominate bond ratings. They do a great job. If you want to have your bond bought by anybody, you want their imprimatur on it. AI seems like a short term benefit for them because what might take like 100 analysts, you can maybe cut down to 50 with AI because AI can do a lot of tasks and as AI gets better, maybe you cut it down to 10. But if off the shelf, AI can replace the vast majority of bonds or bond ratings and you could eventually get A program that does it. Couldn't that just erode the value of the franchise of these three companies? Because you can have a generic program just rate the bonds for you.
- [21:21]
C
Sure. So on the first point, we think that companies where human capital is their largest expense, and that describes most of our companies, there will be a period here over the next five years where margins that we had modeled will be far greater than we could ever imagine. So it will be a net benefit for companies like ours in the near term as it relates to displacement of things like fico, Consumer credit scores, Moody's ratings, S and P ratings, they're toll collectors in these industries and people do not use them. Obviously there is a level of predictability that goes with their ratings, but there's a networking effect that is associated with these ratings that simply isn't, you know, two, two kids in an MIT dorm room who come up with a better mathematical model for FICO scores, you know, displacing fico because in both instances, the ratings are cheap relative to the overall issuance of debt. They're cheap relative to the credit decisions that banks have to make. You know, whether it's a $50,000 car loan or a million dollar mortgage and their stamps of approval. And for a bank that wants to follow credit evolution of its credit quality and its loan portfolio over time, a bank is buying, another bank wants to assess the credit quality of the portfolio that it's buying, whether they want to securitize that debt for the public markets they use, they look to FICO scores in the same way when people want to assess credit quality for, for companies, they look the, for the debt debt ratings, they look to an S and P and Moody's rating. If we created our own ratings agency today and went to IBM and said, hey, listen, we'll offer our ratings to you for free. We still could not undercut Moody's and S and P because when someone chooses to use another company like Fitch, Kroll, Morningstar, it's viewed as a lower quality offering. And IBM is forced to pay 30 to 50 basis points more in interest annually on the $5 billion, for example, that it's issuing. So there is no way to undercut S and P and Moody's even, even if you're offering a competitive rating for free. So I don't see any displacement of things like FICO scores Moody's ratings simply because there's an AI model that says that it can calculate the credit decision 5 percentage points better. It's not simply about the predictions that those ratings are Making, but there's a networking effect. There's a value to those ratings that goes far beyond that.
- [23:51]
A
Well, they survived 2004, 5, 6, 7. And the. Look back at those decisions that Moody's and S and P made during that period, which means they can survive just about anything.
- [24:01]
C
Well, you know, as an investor, you remember certain things as, as defining moments of your life. I. I remember sitting in the lobby. I. I just. Just got married. I was on my honeymoon. I was sitting in the lobby of a. Congratulations.
- [24:16]
A
That's a while ago, right?
- [24:18]
B
Belated congratulations.
- [24:19]
C
I got a woman to marry me. Yes. Yes. I was able to convince a wonderful woman to marry me. So we were on our honeymoon in Mexico. I was sitting in a hotel lobby, you know, just outside of Cancun in Puerto Morelos, and another. Another miserable day in the market. This was early 2009, and futures were down, and I was able to buy S and p global for $17.50. I remember what exactly.
- [24:47]
A
So that made the honeymoon. That's right.
- [24:50]
C
At the time, it was. It was a scary decision, or felt. I mean, I, I was confident in the decision, but it was scary for anyone else at that, at that time. I remember exactly the moment. I was sitting at my mother's desk at my. My childhood home in Connecticut, Windsor, Connecticut, when I bought Moody's at $16.50. Both of those stocks today are around 500. And that is what we do at Valley Forge is the risks that others saw in those businesses, we thought certainly were overblown, misunderstood. We realized that there was no way to displace Moody's and S and P from, you know, we call them a natural duopoly in this. In the debt rating business, there was no way, legislatively, from a regulatory perspective, from a lawsuit perspective, perspective, to alter these core industry dynamics. And so it gave us a wonderful opportunity to buy into these phenomenal businesses.
- [25:44]
B
The market is not as cheap as it was in 2009, but we're seeing a lot of volatility. Trump just got elected. We've seen some stocks shoot up in price. We've seen bonds fall in price. Are you seeing any new opportunity sets given the volatility and kind of your expectations for what the world's going to do in the next four or six years?
- [26:01]
C
I would, I would. I caution people to be careful on forward PE multiples. You know, as a general S and P matter, the market generally trades in a range of reasonableness. There are extremes like 1999, 2000, the.com bubble, where certainly, you know, Coca Cola was a PE of 60 or something like that, where things were extreme. But generally speaking, equities trade in a range of reasonableness. If you look at some of our companies and you look at their forward multiples, they seem expensive, but those multiples are, in my view, inaccurate. And that's really where I go back to that idea that everyone has the same information today, but you have to be able to think about this information differently. And so if you look at the Ford multiple of Fair Isaac, it doesn't incorporate the special price increases that the company has. The company recently raised prices of its mortgage score is 100%. In my investment career, I've never seen a company raise the price of its product or service by 100% in a single year. So as mortgage volumes come back, as interest rates stabilize, go down from here, hopefully there's going to be a lot more mortgage activity that's going to be a tremendous benefit to fico. And that's not factored into their forward multiples. So if you're simply, you know, if you simply open up your Bloomberg machine and start going and looking at ford multiples for 2025 and 202026 and from there deciding what you want to buy and sell, you're really making a lot of mistakes because those forward multiples don't often represent reality. Sorry, there was a second part to your question.
- [27:35]
B
No, I'm just saying given the volatility you see today, you've pointed out that at different times, when the market dislocates, you see opportunities and you execute on them. But given the volatility you're seeing today and kind of your expectations for the world going forward, are you seeing any new opportunities crop up? And if so, would you share any?
- [27:50]
C
When you're looking at some of the best business models in the world, they're not created every day. Talking about the 2,000 or so companies that came out in the IPO SPAC market, none of them hold a candle to a model like FICO Consumer credit scores. The business models that we like have been around for decades. So it's tough to displace these business models that are so entrenched. We continue to look. If you look at our short list of 50 or so companies, we add a couple names to our short list every few years. So there's very low turnover to, you know, to what we consider some of the highest quality businesses for scalability, there's.
- [28:29]
A
Hardly anything that touches meta. No. Is that not on your list of admirable businesses?
- [28:35]
C
You know, we have avoided big technology over our 17 years in, you know, running the fund, we owned a little bit of Amazon along the way. I was never happy with the capital allocation of these big tech businesses. You know, these businesses have dual class structures. A lot of times there are pet projects of the founders. You know, there was, I think the learning lesson there is that, you know, these business models were so powerful that they overcame, you know, some of the sins of these businesses. But when Google announces a stock buyback today, or actually announces something rational about how it's going to use its free cash flow, the stock goes up 10% in aftermarket. And so these businesses have generated amazing amounts of free cash flow. There's always been concerns about the companies using that money rationally in a predictable, prudent way. You know, that's still our concern on a going forward basis. Now with, with AI, companies are investing tens of billions of dollars. They've become very capital intensive. Their R and D costs are really, you know, continue to, to surprise us, you know, and, and so what's the return on, on investment for all of those, all of those, you know, all those expenses? And if, if you believe, like us, that AI will be largely commoditized, you know, who's the winner? Who's monetizing, you know, all of those AI investments? It's, it doesn't have the predictability that we like to see.
- [30:09]
A
If, if AI is going to result in mass unemployment and also in the commoditization of the very product itself. It sounds rather dystopian and it sounds as if we were looking at a very unhappy society. How will that affect capitalism as we know it? The tax structure as we know it? And what is to happen of that irrepressible human feeling called envy?
- [30:36]
C
Sure. You know, if you take it to, you know, if you take, you know, you say, you know, listen, we're going to have 20% unemployment and then you sort of take each step down. You know, the implications of that for society. Yeah, it's, it's, it's pretty scary. I, I don't, I don't really know how society will react when you have tens of millions of people sitting at home with nothing to do. Can, can the government provide the support? Can we keep them occupied?
- [31:06]
A
Well, let's have another subject, I guess. Well, you can take up short selling. That might be. Well, Deb, thank you for being with us. It's been, I know you got to go back to Pennsylvania, to Valley Forge. Oh, wait, Florida. Valley Forge. It's been nice having you with us. Thank you.
- [31:21]
C
Thank you for having me.
- [31:22]
A
Okay. Until next time, ladies and gentlemen, this is current Eel Grant's interest rate, observer of the air.