Podcast Announcer (2:45)

Since 2014 and through more than 190 million downloads, we break down the principles of value investing and sit down with some of the world's best asset managers. We uncover potential opportunities in the market and explore the intersection between money, happiness, and the art of living a good life. This show is not investment advice. It's intended for informational and entertainment purposes only. All opinions expressed by hosts and guests are solely their own, and they may have investments in the securities discussed. Now for your host, Kyle Grieve.

Kyle Grieve (3:27)

Welcome to the Investors Podcast. I'm your host Kyle Grieve, and today we're going to examine lessons from an economist that basically all investors can learn from. Sounds kind of strange, doesn't it? Most of the time, most investors, including me, rightfully show just outright disdain for economists simply because they confidently attempt to kind of paint these accurate pictures of what's happening in the economy, only to be correct at pretty much the same rate as a coin flip. But today's economist John Maynard Keynes is a member of the eminent dead who is definitely worth learning from. I won't be going over his economic theories at all in this episode, as they aren't nearly as interesting to me as what we can learn from his very, very successful investing career and money management adventures. Now, the biggest misconception about Keynes is that he was simply just an economist, and while he's obviously best known for his contribution to economics, which still reverberate today, he was actually an exceptional investor as well. So what most people don't know about Keynes is that he managed the King's College chess front from 1931 until 1945, and he also managed separate accounts starting somewhere in the early 1920s. Now, it's pretty hard to get a complete picture of his results from both of these times, but some others have tried to collect them. So in the great book called Concentrated Investing, they cite research showing that From August of 1922 to August of about 1946, Keynes annual returns were about 16% per annum, beating the UK index by nearly 6% per annum. Another fascinating aspect of Keynes was that he evolved very significantly as an investor as he gained more and more experience. While he always had some sort of an ego, he kind of shifted away from relying on his economic insights for trading to a much better approach. And that was to become an investor who had concentrated his bets in a few great businesses that he could hold for multiple years. Keynes wrote, as time goes on, I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. Now you may be asking, why should I bother listening to an investor who was born in the 19th century and whose career ended shortly after World War II? But I think any modern investor can learn from Keynes mistakes and from the strategies that he eventually came to see as powerful at generating exceptional returns. And the interesting thing about a strategy that I'll be diving much more into here briefly was that it's a strategy that many great investors already have employed in the decades since Keynes passed away. And I think it will be used by many great investors and investing legends that are being made today. Now, Keynes early career helps us understand why he began primarily as a speculator and later transitioned to a more long term base investor. So one of Keynes earlier bets was made in 1919, right after World War I. Keynes had been in the middle of editing his book the Economic Consequences of Peace, so he felt that he had a very good grasp of the economic impacts of World War I. After spending time studying currency markets, he formed a view that he was bullish on US Dollars and bearish on most European currencies. So he placed his bets and he was actually quite successful in this one, earning about £6,000 in profits. Now the initial success here led him to team up with a former colleague to form a syndicate predicated on speculating specifically on currency fluctuations. They raised about £30,000 from family and friends. He quickly made a 30% return during just the first three months of operations. But just a few months later, the fund was actually completely crushed. Keynes ultimately had to actually take out a loan and liquidate portions of his personal portfolio just to clear his debts to the syndicate. But he did so. So while Keynes was able to make trades based on his valuable insights, he was also often wrong about the timing and the scale of his decisions. He was very focused at this time on being kind of this top down, macro heavy focus investor. And he believed that was his edge in the market. The problem with this is that as Keynes famously said, markets can remain irrational longer than you can stay solvent. And at the time he didn't have a framework for how much investor behavior affected markets. But he later remedied that. Now I like to think of myself as a fundamentals based investor. But I have to admit that I picked businesses for their macro tailwinds before. And once those macro tailwinds end, things get pretty ugly. One choice I made was on a tiny micro cap that manufactures a variety of trusses and engineered wood products. I bought this business back in 2023. From 2021 to 2023, Canada, where this business is domiciled, saw a surge in new builds, mainly because we had a large influx of new immigrants increasing our population numbers, but also because interest rates were just very, very low. So builders could borrow cheaply which increased their returns. And buyers could also borrow cheaply, allowing them to bid up the prices of homes. It was a win for the business. The problem was that I assumed that this level of new builds was maybe a little bit more sustainable into the future. And unfortunately I was wrong. It wasn't. I still hold this business because I realized that the cycle will eventually turn upwards again at some point. And even bottom cycle, they are still generating profits, albeit at a much lower rate than what I originally hypothesized. So while this wasn't a macroeconomic play, it was an error on my end not to better understand the industry's natural cyclicality so I could make better decisions about the business's medium term outlook. Now back to Keynes. Lucky for him, he came across a book that completely changed his investing strategy. The book was titled Common Stocks as Long Term Investments by Edgar Lawrence Smith. It was one of the earliest books to measure the quantitative performance of stocks versus bonds in the US from around 1866 until 1922. And the hypothesis was simple. Equities outperformed bonds during periods of inflation due to the corporation's pricing power. During periods of inflation, bonds had no such advantage because their coupon payments were completely fixed. Keynes could see this hypothesis working in practice. So in Germany, for instance, where hyperinflation was completely rampant, shoppers were actually entering grocery stores with a trolley full of nearly worthless cash, only to leave with a handful of tiny items. So clearly the value of bonds and cash during that time in Germany was not a wise place to have money. Smith later updated his work and actually discovered that stocks also outperformed bonds, even during deflationary times. But the big finding that Smith really imparted to Keynes was in the compounding nature of stocks that were not offered by bonds. Companies could reinvest profits, creating an environment for compounding to take place. And if prices dropped, companies could theoretically invest in things like manufacturing equipment at really low prices, which would eventually pay off very handsomely. Once prices normalized. So not only did equities provide a stable cash flow stream similar to bonds, but they could also increase capital gains, a feature that was obviously completely not available to bondholders. So what this shift meant was Keynes was now relying on a much different process. Instead of focusing on macro and then finding bets that fit his narrative, he was actually looking more for businesses that could just compound in value. Now, I'm sure he probably considered some macroeconomic forecasts in his analysis, but he focused much more on other factors, which we'll get to here shortly. So when you make this shift, you change your process, which is hopefully going to impact your outcomes. So for any investor that's stuck on, you know, making macroeconomic predictions and asking whether the market will go up or down, I think Keynes would tell you to focus on your process and what you prioritize. A really good business can do well in all sorts of market environments. And this is despite what happens with index funds. Just because an index is expensive doesn't mean there aren't cheap, exceptional businesses out there that can make great investments. You just have to be willing to go out there and find them. Now, another crucial problem that Keynes overcame that many investors seem to struggle with, is this problem of market timing. When Keynes first approached investing, he did so from an ego driven perspective. He once said that his superior knowledge of economic cycles gave him the means of forecasting the future superior to the ordinary. But boy, was he wrong. Before the Great Depression, Keynes traded commodities futures, including rubber, wheat, cotton and tin. But as the Depression began, these trades turned against him. And very quickly, due to his superior knowledge, he believed that these lower prices were simply a feature of a regular business cycle. But where he erred was in believing that the Great Depression was just another part of a cycle and it wasn't. Making things even worse. Keynes set up his positions across different industries, believing that diversification would balance things out as a position in one commodity decreased. He believed he was hedged because other positions would rise. Because of this strategy, he stayed in his positions well into the Depression and the results were ugly. He'd already gone broke in the 1920s, and this time he lost nearly 80% of his capital on these more speculative bets, as he once again believed that he could accurately predict the market. But by 1936, when another one of his books, the General Theory of Employment, Interest and Money, was published, it's clear that he had had a light bulb moment. He writes, if I may be allowed to appropriate the term speculation for the activity of forecasts in the psychology of markets and the term enterprise for the activity of forecasting the prospective yield of assets over their entire life. It is by no means always the case that speculation predominates over enterprise in one of the greatest investment markets in the world, namely New York, the influence of speculation in the above sense is enormous. Even outside the field of finance, Americans are apt to be unduly interested in discovering what average opinions believes average opinion to be. And this national weakness finds its nemesis in the stock market. It is rare, one is told, for an American to invest, as many Englishmen do, for income, and he will not readily purchase an investment except in the hope of capital appreciation. This is only another way of saying that when he purchases an investment, the American is attaching his hopes not so much on its prospective yield as to a favorable change in the conventional basis of valuation, that is that he is, in the above sense, a speculator. Now this is a great quote worth unpacking because it contains a ton of wisdom. So the first interesting point concerns his distinction here between a speculator and an enterprising investor. As Benjamin Graham later concluded, there are two types of investors, those who speculate or those who attempt to figure out what others think about a stock and its price, then profit. Once there's someone else to sell it to at a higher price. Then there's the enterprising investor who focuses more on intrinsic value. Keynes use prospective asset yield. There's still nothing wrong with this, although I believe the markets have evolved significantly since Keynes day. For instance, he seems to discourage profiting from stocks based on capital gains. I personally prefer to make nearly 100% of my returns from capital gains. And there are very good reasons for this. So the first one here is capital allocation. A business can do things like pay down debt, make distributions to shareholders in the forms of dividends or share repurchases, or my personal favorite, just reinvest into the business. In Keynes days, most businesses were very asset heavy manufacturing businesses. And since many investors had to deal with scams, they treated dividends as part of their due diligence. If a business paid a dividend, chances are that its books weren't cooked and they were paying shareholders with real money. But today, in many markets around the world, especially in North America, where I'm largely concentrated, the risk of scams is very low. Are they still out there? Yes, but the regulatory bodies that we have out there to protect us tend to be very good at filtering them out. And I don't think many western investors into public equities are really that worried about this potential problem when they invest. So let's look at a business that I own and one that my co host stig pitched on tip 557. The business is Technion. Now, I have a very good idea of when I started buying this because it was before my wife went into labor. And one thing that I admired about this company, which is a serial acquirer of niche industrial businesses, is that it made a very good capital allocation decision early on. So they had actually been paying a dividend, but since they were able to find some just very good acquisition candidates with high returns, it actually made no sense to pay a dividend. So they actually just cancelled the dividend and decided to allocate all profits back into the business. To me, this shows management is thinking like an owner. As a shareholder, I'd rather have a business like Technion, which has a track record of great acquisitions, keeps acquiring businesses rather than giving me cash. In my view, the act of paying cash to shareholders is a signal that the management has nowhere else to invest its profits. And in many businesses, paying a dividend is actually the best possible capital allocation decision. So if we looked at a business such as Costco, I think we all know that it's a very, very good business. And there's no argument there. Costco boasts a 22% return on invested capital, which is a very good number. But they would not be able to sustain this number if they put 100% of the profits back into the business. In the last 12 months, they've reinvested about $1.2 billion. But during the exact same time, they've actually distributed $3.7 billion to shareholders in the form of dividends and buybacks. Now, since Costco can only develop so many stores at a time, they simply would not be able to reinvest all of their excess profits at that 22% return if they tried. Their returns would likely fall below their cost of capital, which, as we know, destroys shareholder value. So instead of trying to do that, they have made the intelligent capital allocation decision to distribute a portion of their profits back to shareholders. Now, while I love Costco, the business, I'm not as crazy about it as an owner of the stock, simply because I prefer businesses like Technion, which can earn a similar return on invested capital to Costco, but reinvest 100% of its profits back into the business. This means, provided that I'm correct on my assumptions, that Technow will be able to increase its intrinsic value at a rate that's much faster than Costco, and that's simply because it can compound all of its profits at a very high rate of return, rather than just compound a fraction of profits at a high rate of return. Now, I would here disagree with Keynes when he said that if you don't invest for income, you are speculating. You can even take Keynes approach of using earning yields as an abstraction of sorts. If a company has a high prospective earnings yield, then theoretically, if it decided to stop investing in the business and distribute that cash to shareholders, you would actually be looking at a business where cash is paid out from the business to shareholders. That's one way of doing it. And many investors look at evaluation and yields that way. But where Keynes was completely correct and where I completely agree with him, is that speculators at their core do not care much for intrinsic value. They're simply buying a stock because they think someone else will pay them more for it. And I think most speculators don't even have a view of what the intrinsic value of a business actually is. This is an egregious error that I think all investors should attempt to avoid at all costs. And Keynes showed exactly why this is such a bad error. So I mentioned earlier that Keynes was attempting to profit from investing through his superior knowledge. And while he probably did have superior knowledge compared to the majority of the market, he was using it not as an enterprising investor, but as a speculator. He may have been right at times about his currency or commodity type bets. But even the most intelligent speculator cannot successfully predict how the market will actually interpret that information once it becomes widely known. Now, from his experience, he gained a key insight. In the short term, the market is not about the truth. It's about expectations. Most investors spend their time trying to figure out what other investors will think about specific stocks. As a result, they spend little to no time trying to figure out what something is really worth. So in the short term, prices don't track intrinsic value. They track beliefs about change. Let's take a quick break and hear from today's sponsors.

Oslo Freedom Forum Sponsor (19:02)

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Masterworks and Other Sponsors (20:41)

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Kyle Grieve (23:06)

all right, back to the show. Keynes realized that when you play this game, you aren't even really playing an investing game. Instead, you're playing a guessing game of predicting mass psychology. And given that Keynes went broke twice in his investing career using this strategy, he knew it was a game that very few people could win consistently. Keynes writes about this game using a brilliant analogy. Professional investment may be likened to those of newspaper competitions in which the competitors have to pick out the six prettiest faces from 100 photographs, the prize being awarded to the competitor whose choice most nearly corresponds to the average preferences of the competitors as a whole. So that each competitor has to pick not the faces which he himself finds prettiest, but those which he thinks are likeliest to catch the fancy of other competitors, all of whom are looking at the problem from the same point of view. We have reached the third degree where we devote our intelligence to anticipating what average opinion expects the average opinion to be. But whether you're guessing on stocks or pretty faces, the chances of you winning that game reliably is just a very unlikely outcome. As I alluded to earlier, Keynes decided that he would evolve from playing this guessing game, which he knew he couldn't win, into a game where he felt he actually did have an advantage. And that was to try to find businesses where he felt he could understand what they would earn at a given point in the future. Remember I mentioned his point on understanding earnings yields? This is where understanding a business in depth comes into play and can offer great results. The first mindset shift that Keynes had was to focus on the business and not the ticker. Instead of guessing what would happen to the ticker, he focused on what was happening inside of the business to help generate returns. Instead of focusing on macro narratives, which he had very unsuccessfully tried to do. He focused on the micro realities of the business. And the micro realities of a business include things like business models, balance sheets, earnings, power, and management quality. So if you're listening to this and want to understand how to better understand a business, you should be able to answer the following questions about each business inside of your portfolio. How do they make money? How will the business's intrinsic value rise, stagnate or decrease? And why would you own this business for the next five years if the stock market closed? If you can't answer these questions, I think there's a very good chance that you're speculating. But if you can answer them, you're on the right track. Another area where investors get confused about a business is in the information available to them with understanding. If you want to learn about a business, there's no shortage of information to help you get there. But everyone has access to the same information. The edge comes in how well you internalize the information, how well you generate differentiated opinions, and whether those opinions are actually correct or not. Do not make the mistake of blindly following someone else's thought process on a business. One exercise that I like is to try and find areas of good analysis that I actually disagree with. The reason I like this exercise is that it forces me to think critically and not rely on another writer's opinions. Now, I will admit most of the time when I disagree with an author or an analyst, I find out later that I actually do agree with them. But. But the point of this exercise is that it really helps me investigate things on my own, using source material rather than just relying on secondhand information which isn't always accurate and doesn't always align with my view. For instance, I was recently researching a payments company that I'll be pitching to the Tip Mastermind community. So one of our members sent me a video featuring a fund manager discussing the business, and in it he described how the business could be destroyed. When I heard what he said, that it could be destroyed if certain financial institutions decided to lower their FX rates, it really got me thinking. And while I ended up agreeing with what he said, I found myself thinking more deeply about the subject and even added additional reasons that would make his event even less probable. I think approaching questions about a business in a distinctive way is a very good way to develop your own conclusions and opinions, which is very essential if you hope to achieve differentiated returns compared to the average investor. Another problem with investing today is the sheer volume of information that we're just constantly bombarded with. And I think this information really just gives us a false sense of security. If I compared my ability to access information versus Kane's, I have a massive edge where he had to get financials, you know, mailed to him. I had them at my fingertips. I can get them in five seconds if I wanted to. I can also look at all their competitors and their industry. I can get insights from other analysts and I can watch interviews on things like YouTube or on podcasts. There's so much information that I have access to, but the best investors today are skilled at filtering out what is not useful, which is often a lot of the information that's out there. Now, one example of using deeper knowledge to ignore the noise was the tariff tantrum that the market had in April of 2025. Now, during this time, one of my largest holdings, Aritzia, was hit very hard, drawing down by about 43%. Now, was I one of the masses that was selling my shares to avoid short term losses? No, I felt my knowledge of the business was sufficient to understand that it would be able to weather the storm. They had multiple suppliers and they could reduce the reliance on China to a single digit percentage in the next few quarters, which would significantly reduce the pain of additional tariffs. And since April 8th of 2025, at the bottom of the drawdown, the shares were up nearly 200% as of February 2nd of 2026. If you have the right insight on a business and can withstand volatility, there's a lot of upside to be had. Now, as we've seen, Keynes had a great evolution in his investing, but it wasn't just a strategic evolution. He also improved his temperament and observed what character traits helped him succeed and which ones made him fail. And his conclusion was very similar to the great Warren Buffett quote about intelligence. Investing is not a game where the guy with a 160 IQ beats the guy with 130 IQ. Once you have ordinary intelligence, what you need is temperament to control the urges that get other people into trouble in investing. The emotional flaws that Keynes showed early in his investing career are not novel. I think there's the same problems that all investors face today. Keynes had two traits about 100 years ago that I think everyone will be completely familiar with, and those are overconfidence and impatience. Keynes thought process was that he just knew he was right and because of that, he couldn't tolerate that. He was often early in his predictions. This forced them to do things like doubling down, not in terms of adding capital to a position, but in terms of emotionally speaking. Keynes was the type of person who had a high degree of intelligence first that had to learn temperament as he gained more and more experience and lived through more and more pain. Does that sound familiar? We all learn from making mistakes. I spend all day looking at other legendary investors, their wins, their losses, and even I continue to make mistakes. And my most vivid mistakes are not the ones that I've learned vicariously through others. They were from losing my own cash, from my own decisions. Sometimes it's stupidity, sometimes it's bad luck, but those lessons are always the ones that sting the worst. What Keynes did, that many investors are unable or unwilling to do, is to make temperament into an edge rather than being a victim of intelligence. Keynes had two near death financial events that I've already alluded to. And this forced him to accept that while he was intelligent, he couldn't rely on that to make good investments. Instead, he began focusing more and more on slowing down and avoiding overactivity. What his experience and observations of the market taught him was how important the right behavior was. The problem with temperament is that it's simply just not easy to change. If you've been the type of person who's just gambled their entire life, chances are you're going to gamble on stocks as well. And if you treat investing as just another form of gambling, there's a very, very good chance that you'll just lose money to the house, just as you would lose to the house in a casino. And a really interesting angle to consider when investing is that two investors with two different temperaments can treat the same stock completely differently. Let's go through a hypothetical case study of two investors. Their analysis of a business might be the exact same. They see the same competitive advantages, the same levels of talent and management and capital allocation, and they know the potential market is just large for that business. They can both see that the business's value is completely disconnected from its price and that it's trading at a discount to its intrinsic value. But then something happens. The market becomes volatile and the stock, which they both looked at and analyzed and thought was cheap, becomes even cheaper due to this market sell off. This is part of investing where being a genius does absolutely nothing to help you. These are the times when temperament is going to benefit you or harm you. These two investors can be classified by temperament. One has a temperament of early canes. They are intelligent and believe their intelligence will give them an advantage over other investors. They know that the business we just discussed will benefit from very specific macro tailwinds. But when they're wrong and they See, the market is punishing their stock. They become perplexed, angry even, that the market is just too stupid to understand what they see. After a few months of losses, they just end up selling out because they get annoyed, the market doesn't agree with them and they can't stand the pain of losing any more money. The second investor has a better temperament for investing. They realize that the market will often disagree with them on a stock. But they did their work and even though the stock price has dropped, nothing has changed fundamentally with the business. They see this market wide drop as an opportunity to just actually buy more. The lower price gives them a larger margin of safety and increases their prospective returns. As a result, they actually decide to add to their position. They already have about 5% of their capital in the position by costs, but they really like the business and are fine with adding to their current position. So they decide to back up the truck and get their cost basis to around 10% of their assets. So what happens next will be familiar to many investors. The market emerges from the doldrums and the capital that exited equities returns to equities. The businesses that are most clearly continuing to get better are the ones that tend to be bought up first and price and value begin to converge. The investor with poor temperament lost part of his capital simply because he had a short term mindset and an ego that interfered with his decision making. The second investor with a better temperament for long term investing doubled down, lowered his cost basis, which increased his returns even more once the price began to rise. Any investor who has been in the market for a few years will run into this exact scenario. You spend 40 hours researching a business, its competitors and its industry. You conclude that you like the business and then it's trading below intrinsic value. Then you buy it and the price inevitably goes down. We've all been through this, and one mindset shift that I focus on that really helps me deal with these kind of common problems is to improve my position. Sizing going in so when I first started investing, markets were quite euphoric and it wasn't unusual for a business that I would buy to go up 50% or more shortly after I bought it. So I was actually coming from a place of fear that if I didn't weigh a position high enough in the beginning, I would never be able to add to the position. So at this point, I decided to get as much money into a position at cost as soon as I could. But over the years, I've learned this was a mistake. For the following reasons. So the first one here is that there's been exactly zero times that I haven't learned significantly more about a business after I started owning it. For this reason, I think drawing out the accumulation phase of a business is very intelligent. The next one is sometimes I realize that I either don't want to keep owning a business, don't understand certain things that I realize are key to my thesis, or I might realize that I simply want a lot more of the business. But that comes after I first start buying it. So by taking smaller stabs at a position, I feel like I'm reducing the risk of costly analytical errors that I may have overlooked earlier in the analytical process. The primary risk of investing this way is that I may end up liking a position and only have, you know, maybe a 1 to 5% of my assets in it, only to see the price skyrocket. This has happened with nearly all of my big winners, and it's even more prevalent in micro caps where the disconnection between price and value can be even larger, leading businesses to go, you know, 5x in a year. Yes, this has happened to me, but to me, investing is a long term game. And if I own truly exceptional businesses, then it should remain exceptional for, you know, two, five or ten years from now. And that means I have multiple years to add to my position if it takes off in price. One great example is Terravest Industries. This is a serial acquirer of a variety of steel related businesses in H vac, containment vessels, water treatment and oil and gas services. I first started buying shares in April 2024 at about $70. I already felt like I was kind of late to the party, to be honest, as it had already doubled over the past year. But I realized this was a serial acquirer with a long road ahead run by very, very talented capital allocators who were very well aligned with shareholders. So, you know, I pulled the trigger. After buying, I was hoping that the business would go through a down cycle and maybe lose a few investors, causing the price to drop, but that just didn't happen. Instead, it went nearly parabolic, rising to about $170 in just a year. But good news, it dipped twice in 2025. The first time during the tariff tantrums in April and again by the end of the year due to a quarter with results that weren't quite in line with market expectations. Now, both of those times were times where I got to add to my position since I realized I probably wouldn't get into opportunities like that again. My first few buys only represented about 3 1/2% of my portfolio. This is relatively small for me. For a compounder, I'm usually fine getting the position to about 8 to 10% by cost basis. But with the ads from those drops, I've increased my position size to about 5% by cost basis. I'd still like to add more, and we'll be waiting for more weakness in the coming years to bring it closer to that 8 to 10% range. Now, I've discussed here how key temperament is to good investing, and I even hinted that I use temperament to help me position my portfolio accordingly. One key tenet that Keynes imparted to us was the importance of concentration and why it's vital to outperformance. Now, based on the limited amount of data that I can find in Walsh's book Keynes in the Markets and Concentrated Investing, it appears that Keynes tended to be more diversified much earlier in his career than later in his career. But later on, when he saw the benefits of long term investing, he became more concentrated. So in the book Concentrated Investing by Bonello, Biema and Carlisle, they mentioned that he had about 40 to 50% of King's College funds and just a few stocks with single positions well in excess of 10%. This level of concentration came after he learned the importance of understanding individual businesses was more important than understanding the macro. And it came from understanding himself better after the errors that he had made early in his career as well as the great insights that he had into mass market psychology. Another reason the concentrated approach worked well for Keynes was his ability to actually take part in it. Most financial institutions simply do not allow for a concentrated approach as they aim to reduce tracking error. So tracking error is the extent to which a fund's performance deviates from the performance of the market's results. For a concentrated investor like Keynes, the tracking error was nearly 14%. So when it's positive, that means a manager is beating the market, and when it's negative, it means that they are losing. Concentrated portfolios will have large swings in tracking error. So that means you need shareholders or counsels in Keynes situations who are okay with these heavy swings. Unfortunately, many people are simply just not okay with it. They want managers with low tracking error. Why? I guess it's because whether you perform well or badly like everyone else, there's kind of a comfort to be found regarding this. Keynes wrote, if he is successful, that will only confirm the general belief in his rashness. And if in the short run he is unsuccessful, which is very likely, he will not receive much mercy. Worldly wisdom teaches us that it's better for reputation to fail conventionally than to succeed unconventionally. Keynes had several experiences with institutions. At King's College, he was able to run a concentrated portfolio and weighed out volatility and underperformance. For instance, in 1938 the fund dropped 23% versus only a 9% drop for the market. But Keynes also had experience as the investment manager of Natural Mutual Life Assurance Society, an insurer. He was appointed to that position way back in 1919 and that portfolio lost £641,000 in 1937, prompting a letter from the chairman of the insurer which mentioned that Keynes inactivity of his pet stocks was resulting in losses. In a response, Keynes replied with three primary points. One, he didn't believe that he should sell these stocks now that they had dropped because their intrinsic value hadn't changed. He also felt that the long term probabilities of their success still made them good bets. Number two, he had zero shame about holding a stock when the market bottomed. He was aiming for long term results and the short term fluctuations are not what he felt he should be assessed on. And thirdly, he just didn't feel like he had done a bad job. As an owner of public equities, there will inevitably be negative price fluctuations. Keynes eventually resigned as a chairman of the insurer. The board could tell that there was another war brewing and they wanted him to reallocate assets to safer assets like gold or bonds, which Keynes obviously resisted. Keynes said many things that Buffett would later echo regarding diversification. Keynes wrote in his letter to King's. My theory of risk is that it is better to take a substantial holding of what one believes in than scatter holdings in fields where he has not the same assurance. But perhaps that is based on the delusion of possessing a worthwhile opinion on the matter. He then added the theory of scattering one's investments over as many fields as possible might be the wisest plan on the assumption of comprehensive ignorance. Very likely that would be the safer assumption to make. Keynes actual portfolio management was a little bit harder to find. There was a great chart in concentrated investing showing his real value add wasn't necessarily in making larger positions out of his highest conviction bets. His big value add was in making sure that he was underweight in his bottom five positions. That is a very interesting data point. For instance, was this underweighting a result of the stocks decreasing in price or were these just smaller kind of tracking positions that he just never attitude because he never saw what he wanted to justify making them larger positions. I think this is a very neglected part of portfolio management. I've already discussed how I like to manage buying businesses that I want to add to, but sometimes it's just not so obvious whether a position should be added to, left alone, trimmed, or completely sold out of Keynes improved his abilities of keeping his losses small as he gained experience. During the 1921 and 1946 period, his bottom five positions accounted for 11.7% of his portfolio, but from 1940 to 1946 this dropped just 6%. Good value investors are masters at avoiding losses, so if you have positions that you like that offer good upside but also carry higher downsides than other positions, you may consider minimizing risk by just underweighting them. You can make the argument, well, why own them then? And I think the answer to that only comes over time. If you have a business in your portfolio, let's say that you can lose 50% on on a 5% probability, but make 200% on with a 95% probability. That's an expected value of 2.8 and you want to make that bet. But you have to also focus on the downside here. So in this case you might make it a smaller position. And as the narrative unfolds and more data becomes available, you can add to it. If you feel like it's becoming de risked, let's take a quick break and hear from today's sponsors.

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Kyle Grieve (45:13)

All right, back to the show. The next lesson from Keynes regards markets as social systems. So I mentioned earlier that Keynes discussed this kind of beauty contest analogy and how that's basically just a guessing game. Now. It's an alluring game to play because, you know, it's really easy to talk ourselves into thinking that we have insights that allow us to win that game. Keynes once believed that, and it took over a decade to change his mind. But he eventually did. And when he decided to reflect on what he learned, he understood that Markets don't rely on the truth over the short term. Over the short term, they rely on expectations. The price of a stock isn't a consensus view of its value, it's a consensus view of belief. And the market's beliefs can rapidly disconnect from the truth over short periods of time. While they may look stupid to some observers, the market at its heart is a social animal. That's why Keynes was able to maintain his composure and his strategy through tough times. He knew that in the short term, the market will become disconnected from reality simply because of investor psychology. But over the long term, the truth is what drove value. The market only stays irrational for short periods of time. And once it becomes obvious to even the most skeptical investor that they were wrong, the market will correct itself. So let's rewind back to November of 2021. I felt on top of the world because my investment in Inmode had just turned into a seven bagger after I'd only held the business for just a year and a half. Inmode, for those who don't know, is a business that specializes in the manufacturing and distribution of minimally invasive aesthetic devices. But what happened fundamentally to the business at this time? Did its intrinsic value also go 7x or were there other forces at play? So EPS had gone up pretty substantially from about $0.80 to $1.80. So there was a great tailwind from that. But that alone doesn't justify that large of a rise in price. The other part of it was the PE ratio and PE expansion. So the PE ratio at the same time went from about 22 times to 50 times. The market clearly was voting that it liked the business. But that elevated PE ratio simply just wasn't warranted. As this was not a recurring revenue machine, it just caught the attention of momentum focused investors who bid up the price in expectations of continued growth. I think if Keynes had been observing this investment, he would have told me to sell it once it was clear that the price was approaching this insanely high PE ratio. I unfortunately held on to my shares, not because I thought the business was inexpensive, but because I believed it still had a lot of room to continue to get better. Unfortunately, that never really materialized, but still exited with multibaga returns. Now, in concentrated investing, one key theme for a concentrated investor is that risk can be viewed through a different lens. Depending on the type of access that you have to capital, you can either have permanent or non permanent capital. If you're a fund, you have non permanent capital, you run the risk of being forced to sell Positions if they aren't doing well, simply because you might get redemptions. But on the other hand is access to permanent capital. People who invest their own money, you could say, have access to this permanent capital, provided they're not using margin. Or you could also take the Warren Buffett approach of just owning a series of private and public businesses inside of a publicly held corporation. In that sense, you don't have to worry about being forced to sell positions. Managers of non permanent capital are often required to respond to market beliefs rather than reality if they're getting redemptions. This often happens when they aren't performing well, meaning they will often be forced to sell positions that have decreased in price, but not necessarily decrease in value. Managers of permanent capital do not suffer from the same systemic problems. If a stock goes down in price and they view that simply as a mistake that the market is making, then they can just hold the position or even add to it. This strategy is completely different between these two archetypes because of the constraints that they have. The other point about the market's expectations is that expectations are often based on narratives and they completely ignore fundamentals. You see this all the time in story stocks. So there was recently a commodity play that I was recently pitched that had a very exciting narrative. The business is called Liberty Stream, and I do not hold any position in it. Essentially, it was a business that treated water, which was a byproduct of oil drilling. The business discovered some IP to treat this water and as a result extract lithium, which is a very hot commodity these days due to its use for batteries and the onshoring of natural resources. While I thought the story was very interesting, the market clearly has too. So the stock price has gone up over 400% over the last year. My problem with it was that the business just isn't generating any profits and to make it even worse, isn't even generating any revenue. So it appears that revenue will come online soon, but I simply just can't justify investing in a narrative with no numbers to back it up. Could it work? Yeah, of course. But there's a literal graveyard full of great stories that never worked. So I'm okay waiting for validation on a business like this before I decide to invest. If I wait, chances are I'll pay more, but I'll also have validation that the business can actually generate revenue and profits. So let's go over how Keynes battled his emotions. He came up with this notion that he called a sense of proportion. And this is a kind of confidence that value would assert itself over time. Even though prices would often try to fool you into thinking that you're wrong. The next is that he reduced diversification. Keynes realized that being overly diversified didn't necessarily reduce returns, but increased psychological noise. Holding fewer positions reduced this noise, which made him less prone to errors. Next is lengthening holding periods. If you set up your investing strategy as Keynes did, to find a few good key businesses to hold long term, you don't have to worry too much about short term fluctuations because you simply understand your businesses well enough to withstand volatility. And lastly here, he just owned businesses that didn't require market validation. Keynes improved his immunity to animal spirits by owning businesses where value could be more easily assessed independently of price. Now, these are key points I think all investors should take note of because it's very easy to lose our emotions. So constantly monitor things such as how you feel about your positions and act only on data points that reveal the truth, not ones that trigger emotions. And you should also avoid acting on data points that are purely based on narrative. Next, I want to focus on making investing more systematic rather than reactive. So Keynes early investing was based more on a reactive approach. Find macroeconomic tailwinds in the world, then find investments that would move along this hypothesized narrative. As we now know, the strategy failed Keynes twice. As a result, his strategy evolved. As he learned and improved from his experiences, he became much more systematic. He invested in fewer positions, held them longer, developed a clear criterion for what define an enterprise, and avoided short term forecasting whenever possible. His system wasn't based on hard science like mathematics. It was designed to take advantage of his behavioral edges while reducing opportunities for him to be clever at the wrong time. This reduction in opportunities to be clever was a complete game changer. It's precisely what Buffett and Munger later adopted as key to their success. In Berkshire Hathaway's 1989 annual letter to shareholders, Buffett wrote, After 25 years of buying and supervising a great variety of businesses, Charlie and I have not learned how to solve difficult business problems. What we have learned is to avoid them. To the extent we have been successful, it is because we concentrated on identifying one foot hurdles that we could step over, rather than because we acquired any ability to clear seven footers. Keynes knew that he was susceptible to trying to profit from being clever. He was a highly intelligent person who wrote entire books on economics and was correct about some incredibly large events, such as how German reparations were likely to cause heavy destabilizing effects and increase the likelihood of another armed conflict. In Europe or around the world. So he designed his process simply to try to sidestep his tendency to self sabotage. Another part of his process that worked wonders related to how he treated his ideas. In his early days he would trade positions based on his macro insights, but he developed into a much more investor focused person who wanted long term exposure to great businesses that could compound. This was an important mindset shift. When you shift away from always, you know, trying to find your next trade to being content with what you own and closely monitoring it's your investing life becomes much simpler. This has been my experience as well. As I've grown as an investor, I have my pet stocks or businesses that I intend on holding into the future. Instead of searching for my next big idea, I may deepen my knowledge on what I already know or try to reduce my gray spots. Here are more areas of my process that have helped me remain inactive and avoid being clever. 1. I focus on businesses rather than industries or themes. Instead of trying to find an attractive industry which I once did, I just focused on finding great businesses. So I remember going back to 2020, I was looking at 3D printer businesses simply because they were being bid up like crazy. Now lucky for me, I never actually found anything that made sense for me valuation wise, so I never actually bought anything there. But now I just focus more on finding great businesses. After I can tell it's good, I broaden my research to better understand its competitors and its industry. The second is that I focus on look through metrics. When I conduct my quarterly portfolio reviews for the TIP Mastermind Community, I don't discuss which of my positions has declined the most in price. I instead look at the fundamentals. Which of my businesses appears to be decreasing in growth? Those are the positions that I should be most fearful of, not the positions that have the largest unrealized losses. Buffett conducted a thorough experiment. If the market closed for five years, how would you assess the performance of your businesses? And its conclusion was simple. Look at the operating profits. I choose to look at things like revenue growth, owner's earnings growth, and returns on invested capital. As long as those numbers remain above my hurdle rates, I know I've done my job as a capital allocator. Speaking of the TIP Mastermind Community, we're getting close to May, which means the community will be very well represented in Omaha for the Berkshire Hathaway Annual Meeting. TIP will be hosting a few dinners and socials in Omaha for our TIP Mastermind Community. These events will be great opportunities to meet kindred spirits in the value investing space, build meaningful relationships, and discuss stock ideas and investing strategies. We'll be closing the group to new applicants at the end of March, so if you'd like to join us in Omaha, you can apply to the community by visiting theinvestorspodcast.com mastermind or by sending me a note on LinkedIn. The third one here is to treat your businesses like artwork. So I sold this mental model from Mohnish Pabrai and I think it's a great one to keep very top of mind. Long term, investors should view their portfolio as a museum. There will be a few featured works of art that should never be touched. They will be very rare, but will also be the most valuable pieces of art that you own. The rest will be decent pieces, but you know you may want to sell them if they become too expensive. Then you'll invest in a few pieces of art that turn out to be mistakes, and those you can just try to sell and recycle that capital back into, you know, even more art pieces that can become featured in your museum. The point here is to treat your winners well and remove your losers. And when I'm discussing winners and losers here, I'm not talking about price. I'm talking about intrinsic value. Price will follow intrinsic value over the long term. I'd rather have a business that doubles its intrinsic value over a business that had a zero change in its intrinsic value but doubled in its price based purely off of multiple expansion. Those are the three areas of my investing process that have helped me immensely. Keynes is very well known for the quote, when the facts change, I change my mind. What do you do, sir? But some context about why he said that is very helpful. To understand it better, we have to rewind all the way back to 1921. John Maynard Keynes was already a very formidable economist and his opinions carried considerable weight. So when he found himself being grilled by officials during a government hearing, the detractor claimed that Keynes tended to change his mind on important topics over the years. And this is where Keynes came back at him with that quote above. So we can see here that Keynes was already a deep thinker in his early years, and he was willing to not only make subtle changes, but also abandon his entire belief systems if the information that he had access to updated his beliefs. Some of his earlier beliefs included that he could beat the market with macroeconomic insights, that economic cycles were completely forecastable, and that diversifying with opposing risks would reduce risk. But over time and through experience, he observed his own experience in each of these concepts, and all of them failed catastrophically. The final straw after the 1929 crash cemented that he needed to make some very large scale adjustments to his beliefs. Otherwise he was likely to keep making mistakes and one could only go broke so many times. As a result, his thinking evolved. He shifted from being a macro focused investor to looking at individual businesses. He went from having a trader's mindset to focusing more on owning great businesses that he could stick with through economic cycles. Instead of diversifying, believing he could avoid risk that way, he concentrated because he knew that he could understand a few key businesses better than spreading himself across multiple companies and concepts. And then he just moved away from trying to benefit from his forecasting and relied more on his judgment about a good business. To an outside observer, Keynes may have appeared inconsistent, but I believe the answer is different from a government official's perspective. Relying on the expertise of someone like Keynes, I can see why they might have been upset with Keynes for changing his mind. But since Keynes was focused on the truth, he had to up to his beliefs as new information became accessible to him. And whether those changes in his beliefs bothered others didn't matter as long as he felt he was getting closer to the truth. This is such a powerful concept because it's easy to see how it plays out in real life, especially in investing. Investors will have their belief systems and some will ride those beliefs to the grave, even in the face of overwhelming evidence to the contrary. When you hear about investors sticking with a business while it's being liquidated, you can tell exactly what I'm saying. I'm lucky. Or maybe it's just that I haven't been investing long enough. None of my businesses that I've ever owned has gone to zero. I've had some massive losses, but no zeros yet. Part of the reason for this is that most of the businesses that I own are relatively conservatively financed and generate a lot of cash. Businesses with these two attributes are a lot less likely to file for bankruptcy. And conservatively financed businesses often mean they don't have assets that would go to their debtors over holders of their equity. But where belief updating has come in handy for me is in analyzing when I'm wrong on an investment. One big insight I had about belief updating is how I update my thinking when I'm looking at forward returns in kind of that one to three year range. So when I was a newer investor, I was far too optimistic. I'd have my bear base and bull case, but I think I attributed far too high of a probability to the base in bull case and I'd give too low of a probability to the bear scenario. So back when I started I might have given maybe a 20% probability of the bear scenario, but given that I only tend to be right about 50% of the time, I realized I should probably shift that bear scenario upward and probably more significantly even than I ended up doing. So today I generally start with about 33% bear case scenario for my compounders. And for my inflection point businesses I'm even more pessimistic and I give them about a 40% bearing bear scenario. But probabilities are also a very dynamic thing. They aren't a static data point. As I've owned businesses for an increased length of time, I can continue to update the probabilities. On a great business like Teravest, the bear case becomes less and less likely, which improves my return and reduces risk. When I see a business that I own going through this process, I tend to prioritize making it into a larger position. Where this is most valuable is in businesses where things aren't going the way that you want. They may have a bad quarter and I have to figure out whether it's a one time thing, whether management's execution is slipping, or whether it's a long term issue that I should be very concerned about. If a business isn't executing, then my bear probability usually increases and if it becomes obvious that my returns drop below my hurdle rate because of this belief updating, then I know I might have a candidate to sell in my portfolio. This helps me avoid becoming calcified in my beliefs and it also helps me get rid of positions that are becoming riskier. Now. As Keynes displayed, the flexibility of his thinking was one of his greatest assets. If it wasn't, there's probably zero chance that I'd be talking about him today and that he would be considered an investing great. The hard part about flexible thinking is admitting that you were wrong. Or even more difficult, is letting go of an identity that was once tied to what made you who you are. This makes me think a lot about Twitter. So on Twitter you get people who have a good idea, they share their thoughts, and then they become known as, you know, the Nvidia guy or the Meta guy. But once they change their mind and decide to sell the business, they get a lot of people that start to attack them. While it would be easier for them to not change their mind as it would appease the random followers of their ideas, this completely ignores the fact that belief updating is very key to successful investing. I've gotten this to some degree, so I've discussed businesses like Evolution Gaming and when people realize that I no longer own it, even you know, over the last few months, I tend to get barded with questions about why I ended up selling it. Now I have no problem explaining the reasons. I've explained them on the podcast before and on Twitter. But you know, the important part of investing is that investing is done for your wealth and not to appease others. So while you may have to back away from an idea that you were once known for, in the long run it's the right thing to do if you observe new data that negates your initial thesis, Taking a bird's eye view of what Keynes live through really helps us understand how important adaptable thinking was for long term survival. Keynes lived through two world wars, currency regime collapses, the Great Depression, and structural market changes. There is no fixed strategy that would have survived so much disruption. What actually survived was John's ability to revise his thinking and improve upon older ideas. He also developed a capacity for patience, but to take advantage of this personality trait, he had to shift his investing strategy so that patience would reward him rather than keeping him tied to a sinking ship. And then he realized he needed to focus on things that just changed slowly. Things like business quality and management and the cash flows that it produced. Even looking back since COVID it's obvious that some strategies are very short lived. Yes, you could have just done well during COVID by simply owning a bunch of technology stocks that were trading at high multiples and continued to be bid up. But that exact strategy was completely killed during the 2022 bear market, resulting in major losses as investors just were exiting these overpriced businesses. If you decide to take a thematic approach to investing, you must have an exit strategy. I think Keynes eventually settled on a universal truth and that was that investing should be long term oriented and focused on buying businesses below their intrinsic value. Basically, it's the same value investing tenants that Benjamin Graham would cover after Keynes had already figured it out. I'd like to wrap up today's episode about Keynes by mentioning that Keynes investing success didn't come from being right, it came from being different. His worst investing results came during periods when he trusted his intelligence and macroeconomic insights the most. He won after abandoning the ideas that the market rewards, things like brilliance, speed and prediction. His six teachings that I think apply today are 1. Markets or social systems don't make the mistake of thinking they are rational in the short term. 2. Process matters more than intelligence. Abandoning the requirement for high intelligence for success will be more powerful than trying to look smart. 3. Speculation and investing are two different things. Reflect on your investments and observe where you may be speculating, then adjust accordingly if necessary. 4. Temperament is the real edge. If you don't have the ability to endure volatility and temporarily look wrong, you won't succeed in investing. Remove the ego. 5. Concentration is earned, not assumed. Most investors should probably start in a diversified manner. Once you gain experience and have some good ideas that you can tell are outperforming, then begin concentrating into the best ones. And lastly here, number six Adaptability is a competitive advantage. Don't fear changing your beliefs. Allow them to develop and improve. It's part of gaining wisdom. That's all I have for you today. Want to keep the conversation going? Then follow me on Twitter at irrational mrkts or connect with me on LinkedIn. Just search for Kyle Grief. I'm always open to feedback, so please feel free to share how I can make this podcast even better for you. Thanks for listening and I'll see you next time.

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