B (3:01)

Mark Holoesco, welcome to Hidden Forces.

C (3:04)

Thanks very much. Nice to be here.

B (3:05)

I'm excited to have you on, Mark. This is part of a series of episodes that I'm doing on value investing, informed by a macro framework that sees the future that we're embarking on as being one that may be more favorable to that investment style. And so I think I want to expose our audience to it and explore some of the work that folks like you are doing in this area. Before we start, I'd love to talk a little bit about your career because you seem like someone whose career progressed very quickly, and I'm curious to learn a little bit more about you and how you got your start in this business.

C (3:39)

I guess I started very young. I guess when you say it progressed very quickly. I started working for a trust company while I was in college and high school here in the Bahamas. I grew up in the Bahamas, and when I came back from getting a master's degree, started working for the trust company and basically decided I didn't want to be a. A trust employee. So reached out to Sir John Templeton, who was on the island, famous global international investor, and he turned me down initially for a job. And then I decided I would get him to sponsor me for the CFA exam, charter financial analysis exam, because there were only two CFAs on the island. He was one. You needed to get a CFA to sponsor you. So I wrote him back and said, geez, you know, thanks very much for turning me down, but would you sponsor me for a cfa? And he agreed. Then a year later, when I passed the first level of the cfai, wrote him back, thanked him for sponsoring me, told him I'd passed the first level, and he invited me in. And after a conversation on a Saturday morning in his office, which used to be in the attic of a shopping center, he offered me a job. And so that certainly changed my professional life and my life in many respects. I guess my career developed rapidly because at the time it was just Sir John and I in the office. On the investment side, he had two accountants, two secretaries and receptionists, and we had an office in Fort Lauderdale with more analysts. But Sir John and I, we were it in terms of the investment staff in the Bahamas. So I got to work next to him, and he became comfortable with me and gave me more and more responsibilities. I started off researching companies for him. He would come in, lay a piece of Paper on my desk. Normally it was hotel stationery because that was the cheapest way of getting stationary, was to take some from a hotel you stayed in. And he'd write me a little note saying, do this or do that, and I would do it, put it on his desk. And. Yeah. So he just kept giving me more and more responsibilities. Became a research analyst for the group, took over the management of some of the portfolios that he ran for private individuals. And then in May of 87, so I started working for him in 85. In May of 87, he came in and put all of his mutual funds on his desk and said, from now on, you figure out what should go in these portfolios and leave the trade tickets on my desk. And that was 11 o' clock in May of 1987. And I left the office and I went for a long run to try to calm down. Then that was sort of the beginning of my management of mutual funds. So, yeah, very quick progression with him from 85 to 87, and then did other things after that.

B (6:27)

Yeah. And so it was your time at Templeton Global Advisors and how you went from a research analyst in 85 to managing all of the portfolios that were previously managed by Sir John Templeton himself that I identified as the sort of reason why I said that you progressed very quickly. I have a number of questions that I wasn't prepared to ask because I didn't know some of those details. I didn't know that you got turned down on your first pitch. So I'm curious, what did you say to him that you can tell us that didn't work? And then I'm just curious to understand.

A (6:55)

How you actually, before I even ask.

B (6:56)

You that, I didn't know that you grew up in the Bahamas either.

A (7:00)

What was that experience like? And also, did you have some sort.

B (7:02)

Of template in your father that got you interested in finance, or what was the source of your early fascination with this business?

C (7:10)

I really couldn't figure it out. I grew up in the Bahamas. My mother's family's been here since the 1700s. So long history in the Bahamas. I did all the typical things you do when you grow up. In the Bahamas, I worked on a dock, pumping gas. You know, I. I worked for a mechanic on boats. And I decided that working outside in the blazing heat in the summer really wasn't for me. My mother knew somebody at a trust company and got me a job there. And quite honestly, I was in the file room when I first started. But I was just always fascinated by the Idea that somebody could give you their money and you could grow it over time. And quite honestly, at the time, the trust company that's no longer in existence really didn't do that. Well, both of my parents were lawyers. I decided I didn't want to be a lawyer, so I was just fascinated by it. And I was also fascinated by the fact that every day you woke up, you know, if you're an architect and you're designing a building, you can put those plans down, you can walk away and the design is exactly where it was when you left it two weeks ago. If you're a portfolio manager or a research analyst and you put your portfolio down, you go away for two weeks, you're two weeks behind. I enjoyed the fact that it was. I'm a very competitive person, so I enjoyed the fact that you could quantify what you do and you can compare it to other people. I was also fascinated by the fact that it changed every day. It was very fast paced, in my opinion, at the time. So I didn't really have an aha moment in terms of getting in the finance business. What did I say to Sir John? You know, it was interesting. When I first wrote to Sir John, he turned me down. So he'd never met me. When I wrote him back a year later and thanked him for sponsoring me, you know, I think part of asking me in was he wanted to see if I could pass the first level of the cfa, even though I had a master's degree. I also caught him at the right time. He really needed help, needed staff, although he could have hired anybody anywhere in the world. But it was interesting when I sat down with Sir John on that Saturday morning and he interviewed me in an office with butterflies all over the wall, which was sort of fascinating. He had a pink jacket on, yellow pants, suspenders and butterflies all over the wall. He didn't ask me any investment questions. I'd prep for a week to answer all sorts of investment questions. And I guess he felt that because I passed the first level of CFA and I got a master's degree with a concentration of finance, technically, I should know what I'm doing. His first question was, where did I go to church? So it was really, hopefully an interview of character, of work ethic, talked to me about team sports that I did in school and extracurricular activities, my family, things of that nature. And, you know, I was so excited when he offered me a job on the spot and he didn't tell me what the salary would be. And I went home and I Very excitedly told my dad I got a job with the great Sir John Templeton. The first thing out of his mouth was, what's he going to pay you? And I said, I don't know. My father thought I was an idiot because I didn't know what I was going to get paid. But actually it was paid by the hour too. My first raise was $1.50 an hour. I joined him in the early summer. In the late summer I came to work and there was an envelope on my desk and I thought, well, it's not working out too well. And I opened up the envelope and it said, due to your hard work and diligence, I'm happy to raise your salary by $1.50 an hour, effective September 1st. So I was paid by the hour. I got my first raise, it was $1.50 and it sort of went off from there.

B (10:43)

I love that you didn't ask him how much money you made. I wonder if that also was an important indication not only of your character and motivations in seeking employment with him, but also an indication of maybe what he saw in you or what he was looking for in someone to mentor, which was someone that was passionate about the work and not necessarily motivated by making money, which is a common motivation in Finance.

C (11:06)

At 25, fresh out of school, trying to start a family, you obviously worry about money, but quite honestly, I had struggled trying to find a good job coming out of college. When I finished college in 82, US was in a recession and I didn't really know anybody in Boston and New York and thought that was the route to go if you wanted to get into the financial service sector. So I went straight to business school, to a school that would take you without any full time work experience. And so I was just happy when I got the job that I was going to actually learn that obviously Sir John had such a great reputation. And to me, if anybody worked for Sir John Templeton, whether it was for a month or six months or six years, it's sort of like going back to school and the reputation that he had would be so valuable. So I wanted to be able to eventually buy a car. I was sort of going to work on a motorcycle, which was difficult in the rainy season, but at the time money really wasn't that important.

B (12:06)

Yeah, you had a long term perspective. You said that you got a master's and then you said business school. I'm assuming the master's is a master's in business. What did you study in college?

C (12:15)

Economics. I went to Holy Cross College studied economics, but really what I really studied was crew. I was on the crew team. And although I majored in economics, I learned so much in athletics and rowing crew and the camaraderie, the teamwork, the joy of working hard, accomplishing goals, things of that nature. I got as much out of rowing crew in college than I did out of classroom. My parents hate to hear that after spending all the money to send me to college. But I started economics in college.

B (12:48)

If you had to identify the most valuable lesson from your time in athletics, could you pick one specific thing? Was it overcoming challenges? Was it the teamwork? What was it?

C (12:58)

For me, it was learning the joy of hard work. You know, a lot of people shy away from hard work. And, you know, when I consider how hard we had to work and prepare to row, I still sort of get tingles. You know, it was just such a. You know, we had an amazing coach who basically taught us the value and the beauty of hard work. And so for me, I always like to tell people I'm not really smarter than most people. I'm just willing to go the extra distance. I'm willing to work harder than most people. If you take four steps, I'm willing to take five. That sort of thing.

B (13:34)

Well, if anyone's inspired by that, I recommend they go back and listen to our conversation with Tim Grover, who was Michael Jordan's strength coach, for a conversation about what it takes to be a winner. One of my favorite episodes ever. So, last background question mark. Which is what led you to start your own fund in 2000? What was your vision then, and what were you hoping to accomplish with that?

C (13:53)

Well, I started off with Templeton, and it grew very rapidly. And it turns out in 1992, Sir John sold the business. I became a director of the firm, the head of global equities. But my main job was running the global equity division and managing the mutual funds that was assigned to me. And then in 92, Sir John sold the business to Franklin, became Franklin Templeton. And they were fantastic, and they grew the firm rapidly. So the funds that I was managing grew extremely rapidly. We had about 19 billion of assets when we sold to Franklin. And as my funds grew, I gave them up to other people to manage. And by 2000, I was running the templeton foreign fund, which is about 15 billion in Templeton growth fund, which is about the same size. And the group that I was managing, we had about another 40 or 50 billion. So it seemed like I was becoming a manager of people as opposed to a manager of assets. And I was in a unique position where I had a great relationship with the Johnson family, who owned majority stake at Franklin. And I told them that, look, we had grown rapidly, we'd had great success, but I wanted to concentrate on picking stocks and doing it with a few people for a few clients. And that's what I truly love. I truly love coming to work and turning on the computer and seeing what's going around the world. And I didn't enjoy the 70 people that reported to me from nine different locations around the world. They were fantastic people. But it involved an enormous amount of travel and administrative work. And I found my time on research was shrinking and my time on administration was growing. And I just love investing. So I had an agreement with them that I would start a new subsidiary. I would get 60% of the profits, they would get 40, and we would concentrate on running a global equity long short fund. But that was also at a time in 2000 when the markets were. We had the bubble and there was a great opportunity to start that fund. We eventually started a long only fund and then eventually I bought the majority of the business off of them. So really it was. I decided to start my own business because of the love of investing and the lack of love of managing large groups of people. And you also remember when I started working for Sir John, it was just Sir John and I and five other people in the office. And the decision making was so quick and my boss was just next door. And then when you get into a larger organization with people all over the world and committees and it was just phenomenal people, but just a different environment. So I wanted to go back to the environment that I found myself in when I first joined John Templeton.

B (16:38)

So what an interesting conversation that would be. We're not going to have that because we're here to talk about investing. But what an interesting conversation that would be to discuss the difference between running a large and small organization, especially in the investment world.

A (16:50)

I'm glad that you said that you.

B (16:51)

Love investing because that's what we're here to talk about. Let's start with frameworks, which is something I always try to pull out of people to get to first principles in terms of how they see the world, how they see investing. You invest with a value oriented framework and you also have a macro overlay that you bring to you're investing. How would you describe each of those? Let's begin first with your value framework.

C (17:13)

People describe value investing different ways. And I guess I would describe it is that we try to compare a company's price to its intrinsic value. And intrinsic is an important part of the phrase. And so what's the company worth? And an intrinsic value can encompass growth, encompass breakup value. So to us, it's not just investing based on momentum or growth per se. It's what is this company worth, and where's the stock price now? Very simplistic description, but very complicated process. When we do that, we try to come up with a price target. If I'm right, I think the stock can go to this level, but more importantly, we come up with a risk target. If I'm wrong, how much money am I going to lose? And in the investment business, it's really that component that I think distinguishes us from other people we spend an enormous amount of time on. What if I'm wrong, how much money am I going to lose? And if you have a collection of stocks and your upside is 50% and your downside is 10, you don't have to be right more than half the time to make good money. If your upside is 25%, your downside is 25%. Well, you got to be right the vast majority of the time to make money. So the framework is that let's try to find things that are intrinsically cheap, where our upside to downside ratio is skewed to the upside. And that gives me a sense of how much risk I'm taking to the portfolio. I remember coming out of the bubble in 2000, and at one point, stock markets had dropped, I think, 15% one year and 20% the next year. And we got to the point where in a hedge fund, we were 90% net long. Which hedge funds don't get 90% net long? And somebody says, well, that's an enormous amount of risk you're taking in the portfolio. I thought to myself, wow, it's the least amount of risk, I think, I've ever taken a portfolio, because my downside on the collection of 40 or 45 names that I have in my portfolio was single digits, and my upside was more than 50%. So from my perspective, it was the least amount of risk I'd ever taken in the portfolio. Although when you look at the net exposure I had in the fund, people say, well, you're taking a lot of risk. So there's a couple of points there, I guess. One is that we look at risk. It's the possibility of losing money. That's the risk. And when an analyst recommends a name, I talk about what is the catalyst for this name in terms of how will we achieve the upside and what will convince you if you're wrong and what do you think can go wrong? And so for a bank, it may be that the analyst is using a downside that reflects a recessionary environment. Then it's my job as the portfolio manager to decide when that may occur and when that risk in that stock may occur. Or if you're the energy analyst, you might be using $80 upside for oil and $40 downside. Then it's my job, more the analyst, to think about under what scenario could oil prices get down to $40, which would make that a poor investment? I guess that's where some of the top down work comes into play. It's intrinsic value as opposed to value. And sometimes that incorporates growth, sometimes it doesn't.

B (20:38)

So if I'm listening to you correctly, it sounds like in addition to the importance of how you define value, it's also important how you define risk. Do you believe you can do more to limit the downside than you can to control the upside?

C (20:56)

I would say we're more aware of the downside and I don't know if we have control over it because a lot of times we have no control over markets. But I have more control on how I put my portfolio together. I can manage the risk in my portfolio by limiting the amount of names that I have. They have lots of downside and you're going to be in this business, as you know, if you're right 2/3 of the time, that's a phenomenal batting average. But you don't have to be right 2/3 of the time if you limit your downside. Once again, if you really do your work and you're going to be wrong on the downside two thirds of the time when you pick an upside, you're going to make mistakes or something's going to happen that you don't anticipate. Same thing on the downside. We're constantly trying to adjust our upside and downside. But to me it gives a framework for how much potential reward and risk I'm taking and how aggressive I need to be. If I've got tons of names all over the world and I can put together a portfolio with 50% upside and 10% downside, that's a great ratio. If you get to a point in the United States where you have very frothy markets and it's difficult to find a portfolio that has that type of ratio, most of the names in the US are more up 50, down 50, unfortunately that tends to move you and push you to other markets around the world. A lot of times your framework decides how you allocate assets, both in terms of types of names and the geographic places that you might look.

B (22:27)

I poorly framed that question about relative measures of control and managing upside down versus downside risk. Let me see if I can ask it again. Does your focus on mitigating risk to the downside reflect a broader recognition that over many cycles the benefits of being invested outweigh those of being in cash, and so focusing more of your attention on what can go wrong so you can remain in the game, so to speak, makes sense?

C (23:01)

You know, I think my history has given me a better appreciation for downside. I mean, when I took over the funds from Sir John Templeton, I took them over in May of 87. I don't know if you remember what happened in October of 87.

B (23:16)

That was 6. But yes, I've read about it.

C (23:18)

Yeah. So I always joke with people that Sir John Templeton was a better market timer than people think he was. You know, he gave up all of his funds in May of 87. And in October we had the great crash. And we ran both global money and international money. The Templeton Foreign Fund was a non US equity mutual fund. And so we were investing outside of the United States during the Asian crisis, the Latin American crisis. And if you grew up in the 1980s and early 1990s, you saw an enormous amount of damage in equity markets outside of the United States. So I guess I was somewhat conditioned by the environment that I grew up in professionally, where I'm perhaps too concerned about the downside. And I would say that's probably. If you say, what's one of the faults of your approach? Or what's one of the downsides to your approach? I would say that we're too much of a nervous Nelly sometimes.

B (24:15)

You started the fund in 2000, which was a great year to begin a fund, a value investment fund. It sounds to me like if I were to put some dates together, it seems that 2000, 2007 or so was a good period for value. What explains why value investing has underperformed and lost so much favor with investors, especially over the last five to 10 years, in your view?

C (24:42)

Well, it's underperformed dramatically over the last five or 10 years. And that's because we've just been an unusual interest rate environment more than anything, and an unusual liquidity environment. And when you have massive liquidity and when you have interest rates to the extent they are historically, you've always unfortunately had these periods like this. If you're a company and your cost of capital is 2%, you only need to make 3% to borrow capital. And you get all of these inefficient companies that are out there that compete effectively with more efficient companies, more profitable companies. But really we just had unusual amounts of liquidity in the system. Liquidity leads to speculation. You've also had a real lack of growth in. Look at last year, I think the Mag 7 in the United States, the earnings grew 36%, something along those lines. The other 493 companies in the S&P 500 grew their earnings low single digits. There's really been a lack of growth not only outside of certain stocks in the US but outside of the US As a result of that, people have overpaid for growth. But if you look at a graph of value versus growth investing over time, and start in the 1970s, there were periods of underperformance for value, but nothing as prolonged as what happened after the financial crisis when they just brought rates down to unusually low levels and flooded the system with money. And after Covid and I would say those are two extremely unique events and that we're slowly trying to figure out how to move away from that period and with a higher cost of capital, I think you're going to see a major change in that environment. Dream value and growth. But so liquidity and rates really have driven this fascination with growth versus value investing.

B (26:38)

So I've heard you say that 2002 marked a turning point for value. Why do you feel that way and what would you point to specifically to support that argument?

C (26:50)

Well, I think rates pretty much bottomed back then. And I think that as rates normalize and as liquidity starts coming out of the system, the two of those events, which I think have already started, you can say, okay, well, rates have gone up or down. But I would say that that marked a low point in terms of rates and a high point in terms of liquidity. And there's such a disparity now between value and growth all over the world. And there's so much concentration of people's portfolios on growth versus value that to me, it's cost of capital and liquidity. The things that have caused this disparity in performance have changed. In terms of liquidity. There's different ways of looking at liquidity. If you take the U.S. the Federal Reserve balance sheet that's rolled over, okay, it's still massive, but it's moving. Whether it's on an absolute basis or a percentage of gdp, it's shrinking. You look at government spending, it's completely out of control. We've never had government spending. These budget deficits, 6% of GDP. When you have basically a good economy and low unemployment, obviously there's a new administration trying to get that under control. There's absolutely no way you can continue with 6% budget deficits as a percentage of GDP. So you've got the Federal Reserve balance sheets are starting to turn. Government spending is going to turn. The treasury with the way they've been issuing government securities on the short end versus the long end, provided massive liquidity. The other area would be bank credit. And bank credit is also changing. So I just feel that liquidity is all the things that provided excess liquidity in the system are beginning to change. The other thing too is that government debt is so high in the United States, it's high everywhere in the world. It's the same level as it was coming out of World War II. Back then, the government basically inflated their way out of the debt problem. There are very few ways of solving the debt problem other than growing the economy and trying to inflate your way out of the problem. To me, that argues for sustainably higher rates than people anticipate as the world also struggles with lower liquidity levels.

B (29:02)

Is that another way of saying that the reason why you think we're in a period of structurally higher rates is because of the refinancing costs reflected in part in government deficit spending and the size of national debts?

C (29:17)

That's a part of it. But I think people's view on rates is conditioned by what's happened over the last 10 or 15 years. What has happened over the last 10 or 15 years is completely abnormal. People haven't been in business in the financial sector, haven't been alive for more than 50 or 60 years. Just think that the post financial crisis era was normal. It's not. I just think that we're going back to a more normal level of rates prior to the 2008 period. And part of that is, yes, sustainably higher inflation. That doesn't mean inflation's going to be 6, 7, 8%. But if you have 3 to 4% inflation or even 2 to 4% inflation, you add some risk premium on top of that. Rates today are much more normal than people realize. This idea that rates need to continue to come down. I don't think we're going to go back to 2% on the US Treasury.

B (30:14)

The inflation in your view would be driven by monetization government spending.

C (30:20)

Well, government spending has certainly provided massive amounts of impetus to Inflation. We've had too much money in the system and a lot of that money has been provided by the US Government. And unfortunately a lot of the employment is provided by the US Government as well. If you look at the employment statistics in the United States and look at changes in employment and how much that's been created by the government, tariffs cause slightly higher inflation, although the administration will tell you it won't. There's so many different elements out there that are adding to inflation. The government's got a real tricky job in the United States now to try to grow the economy without letting inflation rise too much. But at the same time, the only way you're going to get out of this debt problem is to let inflation help and inflate your way out of the debt problem.

B (31:05)

So this is a problem, obviously that's not unique to the U.S. no. However, there is an outstanding concern about the value of the dollar. You've written about this as well. How does this factor into the value of the dollar? Because the dollar has been very strong in recent years.

C (31:20)

Yeah. So as a global investor, obviously if you invest outside the United States, you have to take currency into consideration. The great thing about investing outside the United States today is that you can hedge away most of that risk and it, it doesn't cost you anything. So when you hedge and if you use the forward markets, basically the cost of hedging is normally the differential in interest rates. And because of where US Rates are today versus most countries around the world, you don't really have to take much currency risk. So that's interesting and helpful. However, currency does a lot of different things to different companies in different parts of the world. We had a morning meeting today. We were discussing how a change in yen value impacts the book value of Japanese companies. And you have to be aware that currencies have a major impact on how companies report. It's a global economy. BMW In Germany does 40% of its business in China, has a large business in the United States. Although you're investing in a euro based company, its actual business exposure to the euro is very low relative to its dollars and Chinese currency. You have to take all that into consideration, figure out whether or not the companies hedge themselves, and then whether or not you want to overlay a hedge on top of that. Currency is something you take into consideration when you're evaluating a company. The risk to that company in terms of where it's doing business. It gets very complicated, particularly when companies themselves are hedging. And then you have to decide whether or not I want to hedge again, but it's just one of those macro factors that you need to take consideration. I just believe that purchasing power parity, which a lot of people look at, doesn't really tell you where the currency is going to go. It tells you what the environment is in a particular country at any point in time. There's the famous Big Mac index. What would a Big Mac cost in the US versus Japan? And if it's cheaper or more expensive in Japan, maybe it tells you something about the purchasing power of the currency over there. But really differences in interest rates and what business people decide to do is what drives the currency in the short run in the medium term. Right now I think that it's difficult to say with tariffs being imposed that the dollar is going to weaken substantially because normally the dollar, if you put a tariff on a foreign country, their currency tends to adjust somewhat to take into consideration that tariff. But over the long run, it seems as if to me that the dollar is one of the most consensus trades in the world. Our funds are based in dollars, so we have to take that into consideration when we invest overseas. But if you look at the dxy, the trade weighted basket of currencies, generally these levels. Sir John has an interesting graph he gave me a long time ago. It basically showed the trade weighted dollar going up and on one side he wrote time to invest in US names. It showed the trade weighted dollar going down and he wrote on the side time to invest in foreign companies. And in 1990 when he gave me the graph, it was at a low and he wrote on the side time to invest in U.S. companies again. Well, we're at a point in time where the currency buys you a lot overseas and the dollar is very sort of crowded. So I'm happy to slowly be looking to increase non dollar weightings in our funds.

B (34:45)

I'm actually interested to ask you about this because I think I've heard you say that you own a small percentage of U.S. based companies or you aim to own a small percentage.

A (34:54)

Do I have that right?

C (34:55)

No, we don't aim to own any percentage in any country. We just try to look around the world and see what's cheap. 20% of the names around the world are in the US but the US is 70% of the index. We were 20% in a long only fund. We're roughly 20% in the US in our hedge fund because we can also short securities on a net basis. We're single digit and that's pretty unusual. However, when I joined Sir John in the late 1980s, I ran the Templeton Foreign Fund. It was a fund that invested outside the U.S. at one point in time, the IFA index, which is the index of non U.S. stocks, was 70% Japan. I went to zero. And people thought, wow, that's incredibly risky. You're being compared to an index that's 70% Japan, year zero. My response was, wow, you're taking an enormous amount of risk. You're investing half of your portfolio in a country that you know is substantially overvalued just because it represents 70% of an index. How could you do that? I looked like an idiot for a year or two in the Templeton Foreign Fund when I was so underweight. Japan. But quite honestly, for Most of the 1990s, it didn't matter what I did. I outperformed the index because Japan peaked out and started to drop. The same thing today in the United States. People say, geez, you're taking an enormous amount of risk. You only have 20% of a long portfolio in the United states. That represents 70% of an index that you're compared to. Isn't that risky? Once again, I define risk as the potential to lose money. And from my perspective, when I look around the world, the downside in the US is much greater than the downside in a lot of the companies that I'm investing in, Japan and uk, Et cetera. So in the short term, maybe it's risky. In the long run, it helps your career.

B (36:52)

I have a few more questions I want to ask about rates and tariffs, but this benchmarking has come up a number of times on this conversation. It sounds to me like something that's been very important in your career is not just what you've benchmarked to, but not being wedded to benchmarks that everyone else is focused on. Which is also another way of saying being a contrarian, being willing to go your own way.

A (37:14)

Would you agree with that?

B (37:15)

And how important has that been in terms of your success as an investor?

C (37:20)

I was thinking about this the other day because they asked me what characteristic makes you a good investor? And I say, well, you have to be rational versus emotional. And to a certain extent, you have to sort of enjoy being off on your own. If you're comfortable in a crowd, if you enjoy waking up on a Saturday and going playing golf with everybody on the golf course and dressing like they all dress and playing with all the rules and sitting around the golf shop afterwards with everybody, I find that incredibly uncomfortable. Quite honestly, I'd rather be out sailing on a windsurfer by myself or at the same time, you have to have the ability to work with other people. Go back to the crew analogy. You have to have this love of working with people but being uncomfortable being with the crowd. I heard someone describe that if you're in the jungle and a tiger approaches you, you want to run away with everybody, away from the tiger, but at the same time you don't want to be running over the cliff when everyone's running over the cliff. So I think you have to have this comfort level about doing things by yourself and an uncomfort being in the crowd. So I think that's a characteristic that's really helpful as a global money manager. And it goes to the index. I want to be in business, I want to make money and I don't want to lose money and I want to be. When I started my business, somebody says, why are you starting it now? I said, look, I don't want to be a long only money manager and be down 20% when the market's down 50 and say, wow, what a great job I did. I want to make money. And so for me, I think over the long they're going to be periods sometimes, you know, long periods where you underperform the index. But over the long run, if you can stick to what you're doing regardless of what the index said you should be doing, and if you're not worried about that index and the composition that index, you know, you can only get different results from other people by doing things that are different from other people. And it's easier, it's easier doing that when you're not following the index.

B (39:32)

Is it also fair to say that you're less concerned about career risk than most people?

C (39:37)

You're always worried about your clients and you don't want to disappoint your clients. One of the things you have to be careful of as you get older and more established and more comfortable that you actually take risk in this business, you're not avoiding risk, you're just managing risk. You're understanding risk. Sometimes as you get older and you're more comfortable financially, you're not willing to take risk, but you have to take risk and you have to manage that risk. It's easier to do that if you're financially comfortable and if your clients have been with you for a long time. 80% of our clients have been with us since the first year we started our hedge fund. And that's helpful.

B (40:17)

I mentioned that. Well, hopefully we'll have a chance in the second hour to talk More about your process and philosophy. But I mentioned that I had a couple more questions about rates and tariffs. So you mentioned earlier in our conversation that it's likely that we're moving into a higher, structurally higher inflationary environment and an environment of higher rates. The question I have for you is what do you see for real rates? Does that still mean a positive rate environment or is the inflation indicative of structurally negative real rates? I'm just curious how you see that.

C (40:49)

Well, it would be better for the government if we had negative real rates.

B (40:55)

And you think that speaks to the discussion we had earlier about the debt and deficits and government spending and some of the outstanding liabilities that need to be financed.

C (41:04)

Look, the new Treasury Secretary who's I think an incredibly capable guy, smart as a whip, probably one of the better treasury secretaries the US has had for a long time, he's got this three, three, three approach. And one of his three's approach is that he wants to get the budget deficit down to 3% minus 3%. That's still a budget deficit. So he's still talking about adding to the debt. So for me, the only way they're going to get debt under control is to inflate their way out of the problem. So I'm not a rate expert, but to me it means negative real rates.

B (41:46)

So tariffs. I'm confused. I mean, I do feel like there is some obvious way in which tariffs are used in this administration for political or geopolitical purposes. I don't necessarily see the larger strategic game plan for revitalizing the American economy and how tariffs are being used in that context. They still seem to be more of a tactic than a strategy, a tactical deployment than a strategic use. How do you view tariffs being used in this administration? Is there some way in which you expect them to be used? Do you have some confidence around how they'll be deployed and what impact they're going to have going forward?

C (42:25)

Well, I agree with you. I think they are tactical and I also agree that they don't really improve the competitive structure of the companies they're trying to protect longer term. Why are they tactical? I think these numbers aren't exactly right, but they're close. I think something like 80% of all exports from Mexico go to the United States and it represents something like 25% of GDP. Mexico is very, very vulnerable to rates. If you want to negotiate with Mexico and you threaten to slap tariffs on Mexico, that's huge. Same thing for Canada. I think something like 70% of all exports from Canada go to the United States. And it's also a very large percentage of your gdp. However, you've got to be very careful because if you look at the percentage of cars being produced by US manufacturers in Mexico, it's a very large percentage. For General Motors, I think it's like 35 or 40% of the cars sold in America come from Mexico. You're also damaging US Companies to a certain extent. It's interesting, we have an investment in BMW and BMW is actually quite good in terms of its domestic production versus its Mexican and Canadian production versus the US manufacturers. I would say BMW is in a better situation to not get hurt by these tariffs than the US Companies that you're trying to protect. The other thing it does is that as I mentioned, higher tariffs also impact the currency. The currencies tend to adjust a little bit, not by the same extent as the tariff, but to some extent depending on the country. So if you put a 10% tariff on certain goods coming out of a country, it tends to weaken that currency to offset the cost of the tariff. But that makes the dollar stronger, which makes your goods in the United States less competitive overseas. Yes, I think it is a negotiating tactic. And I believe that a better scenario for the United States in terms of its competitive industrial base is to remove regulations, which they're doing quite rapidly, keep the tax rate low, which they're trying to implement, but also not keep the dollar so strong. I mean, obviously if the dollar weakens, that's to your benefit as an exporter around the world. So I think the tariffs are creating a lot of confusion. I think they are a tactical negotiating tool. However, there are some countries that dump things into the United States. Sometimes they don't dump them directly into the United States. And tariffs on certain goods from certain countries, even when they come indirectly, some goods come from China to Canada and then from Canada to the U.S. and so it might appear as if you're putting tariffs on Canadian companies, but it's actually goods coming from China. It's very complicated, but I would say it's a tactical tool. It's going to create confusion. Confusion is good if you're a long term investor because it creates abnormal price movements. And if you can take advantage of that from a longer term perspective, then that's okay.

B (45:31)

I've heard what feels like mixed messages coming out of this administration on the dollar. It sounds like there is both a desire for a strong dollar, maybe because it sounds good, and then also some policies to weaken the dollar. I'm curious if you have a sense of any Kind of clear direction in this area.

C (45:49)

Look, I think that nobody in the administration is going to come out and say they want a weak dollar. Just like the current Treasury Secretary has come out and said he's not going to change the allocation of government debt when it rolls over more to the long end. Although when he wasn't the Treasury Secretary, he was criticizing the then Treasury Secretary because they didn't roll a lot of the debt into the long end to take advantage of low rates. So no one's going to come out and say, I think they want a weak dollar. I don't think that politically is acceptable. But I think it would be to their benefit to have a weak dollar and it would be much better longer term than tariffs. Just as if they could get long end rates down. Yes, they would love to roll this enormous amount of debt coming due this year into the long end of the treasury, but they're not going to tell you that upfront.

B (46:36)

So let's go back to this question of valuations. The valuation of US companies versus companies in the rest of the world or Japanese companies, companies in Europe. You've written quite a bit about how there are a lot of opportunities in the uk we touched on this a little bit. But what explains, if you had to be specific and summarize this, what explains the overvaluations in the US in your view?

C (46:57)

The overvaluations in the US is just liquidity and low rates and the concentration around the world and the fact that the United States has been a place dominated by companies that are growing. And so to a certain extent the success has caused the overvaluation. Some of the valuation is justified, but not the extent companies selling at 20 and 25 times revenues. We have companies out there that are 250 billion in size, that are generating a billion dollars in cash flow. At some point valuations became stretched in the United States. But the success and the differentiation between growth in the US And a lot of countries around the world has caused this over concentration on US Assets and the overpricing of US Assets.

B (47:46)

There's a sort of momentum trade associated.

C (47:49)

With this very much.

B (47:50)

So how much do you factor in systematic passive flows into this equation? Do you have any concern that value will continue to struggle as those flows continue to dominate the pricing relative to discretionary allocation decisions of active managers like you?

C (48:06)

Yeah, it's interesting because it works both ways, right? It works on the way up and then when you get some of these companies reporting poor earnings and the Mag 7 starts to struggle, it's going to Work on the way down too.

B (48:17)

So you think that cost of capital that we talked about earlier, some of the underlying structural economic effects are going to ultimately be the spark that serves as a catalyst and then that momentum will go into reverse.

C (48:28)

Look, you never know what the catalyst is going to be for the system. You might be identifying it for companies generally. But look, look at AI. Look at all of a sudden the information that's come out on Chinese development of AI totally unexpected and what that did for those companies. And if those companies, there's such an over concentration and if people start pulling that and they start shrinking as a percentage of the index, then it's sort of self fulfilling, right? The index starts to shrink in that area. So it's difficult to say what's going to cause it. We're even having companies that are reporting great numbers and beating and they're dropping once again, I think it's just an over concentration in people's portfolios. They've gotten too big and they need to rebalance. But generally I would say higher cost of capital. The percentage of companies in America that don't make money is at an all time high while the market is at an all time high valuation. That's interesting.

B (49:27)

I love that you brought up Deepseek because I also had that reaction. The market got so spooked. Besides the fact that it didn't entirely make sense why it was selling off, given the fact that the software innovations made by Deep Seq weren't necessarily bearish, you could argue they were bullish for the need for further compute. It just shows you how fragile this bull market is, I think. And it also reveals something else. I'm curious if you agree with this. I think it reveals an underlying anxiety about America's place in the world. Our geostrategic positioning, our national security state, our geopolitical power. That brings me to another question, which is how do you factor these things in? Politics, national security? How do you factor these things in when you consider where to invest? Understanding that government regulations may change in line with the needs of the national security state and that could impact the value of your investments?

C (50:24)

Well, I guess the greatest example of that today is China and Taiwan. A lot of people say China is investable. There are other people out there that say because investors say China is uninvestable, it's actually a great investment. The risk to your Chinese investments is that a situation happens like Russian investments. I'm on the board of a company in Europe that manages funds for individuals and they had some exposure to Russia Invading Ukraine, you couldn't trade those assets. You had to price them at zero. So that's the geopolitical risk. Obviously, the biggest geopolitical risk today is China, Taiwan. And the impact that would have, obviously on the semiconductor sector is massive, given the strength of Taiwan semi manufacturing. So it goes back to that upside downside. I mean, when you get to the point where companies get close to net cash and in the course of a year or two or three, you feel you can get that investment back in terms of cash return from a company, your job as a portfolio manager is to decide, well, is that geopolitical risk reflected in that? And okay, I'm not certain about what China will do with Taiwan. So how much do I want to have in China? Do I want to take that risk? And will it be 5% of my portfolio, 15% of my portfolio? So I'm willing to take some risk with Chinese investments, but it's not 10% of my portfolio. But what most people don't realize is we mentioned BMW earlier. 40% of their business is Chinese. Most people's investments in China are much greater than they realize. Even if their portfolio manager says, oh, we don't invest in China. Heck, you do invest in China. You go down your portfolio and you look at all the investments that these companies have and all the revenue and income that's generated in China, most people would be shocked. So my direct investment in China is about 4.5%, but my indirect investment in China is probably closer to 15%.

B (52:35)

I love that you brought that up. First of all, how confident are you in that 15% number? Because as we saw, even the US government, even the military, didn't understand how vulnerable its supply chains were. They had to cancel or halt production of the F35 fighter at some point because they discovered that a critical magnet was being produced in China. How confident are you about the vulnerabilities of the companies that you invest in, given how interconnected this world has been and how globalized it's been?

C (53:06)

Well, I hate being compared to the US Military because I believe they've never been able to complete an audit. So I don't know that. I don't know that they're the best comparison. So look, let's look at some of our investments in China. Outside of the political risk in China, there are industry risks in China, like real estate. The real estate industry is a mess. The banking industry is a mess. So one of our largest investments here is Yum. China. They have the Kentucky Fried Chicken and the Pizza Hut franchise in China net cash balance sheet. This time last year, it was like 25% of its balance sheet. Now it's a little bit smaller because they've just raised their dividend 50%. They're opening new stores. The population continues to become wealthier and able to afford eating out more. It's a company that basically you can look at the growth of its store base and the amount of cash it generates and the amount of cash you're getting back. What's the geopolitical risk of Kentucky Fried Chicken and Pizza Hut as opposed to real estate or finance, et cetera. But you can be pretty comfortable. It takes a lot of legwork. You know, I've been to China, visited the management of Yum China in China. You know, I remember the first time I ever went to Hong Kong. I went with a gentleman by the name of Mark Mobius around our emerging markets group. And we were chatting with an analyst in Hong Kong and they had invited some companies there. And one manufacturer of a company was talking about his watch facility and it was pretty close to the border, so we decided we'd go check it out. Turns out it wasn't there. Didn't have a watch manufacturing facility where he said he had it. A lot of information is available if you were just willing to read through annual reports and go visit companies. So we're pretty comfortable with what our indirect exposure is to China. That's our job. Our job is to figure out where these companies make or where they generate revenue, how they generate profits, what competitive advantages they have, what are the risks to that business, both politically, technology or corporate wise, and then adjust accordingly.

B (55:12)

It also sounds like you might be more willing to invest in a Chinese company if its operations are primarily overseas or its factories are located outside of China or it's listed outside of China. Those are all nuanced ways of assessing the risk of the particular company.

C (55:30)

Somewhat correct. Yeah.

B (55:31)

So I'm going to move us to the second hour mark. I want to talk a little bit about opportunities outside the United States. I asked you, for example, what accounts for the overvaluations in the U.S. i'm curious to ask you the opposite question of what accounts for some of the undervaluations, especially in places like the UK I also would like to discuss more about your investment process and your investment philosophy, as well as some of the unique opportunities that are in the U.S. i think you've written quite a bit about the energy sector.

A (55:57)

For anyone who is new to the.

B (55:58)

Program, Hidden Forces is listener supported. We don't accept advertisers or commercial sponsors. The entire show is funded from top to bottom by listeners like you. If you want Access to the second hour of today's conversation with Mark, head over to HiddenForces IO Subscribe and sign up to one of our three content tiers. All subscribers gain access to our Premium feed, which you can use to listen to the rest of today's conversation on your mobile device using your favorite podcast app. Just like you're listening to this episode right now. Mark, stick around. We're going to move the rest of our conversation onto the Premium Feed.

A (56:34)

If you want to listen in on the rest of today's conversation, head over to HiddenForces IO subscribe and join our Premium feed. If you want to join in on the conversation and become a member of the Hidden Forces Genius community, you can also do that through our subscriber page. Today's episode was produced by me and edited by Stylianos Nicolaou. For more episodes, you can check out our website @HiddenForces IO, you can follow me on Twitter Cofinas, and you can email me @InfoiddenForces IO. As always, thanks for listening.

B (57:10)

We'll see you next time.