Dispelling Big Investing Myths | Dan Rasmussen

[00:00:00] Investing is not a game of analysis. It's a game of meta-analysis. It doesn't matter what you think. It's matter what you think relative to what everyone else or really the market consensus thinks. It's just like your buddy comes over and he says, hey, I don't want to take out another loan from the bank. Can you lend to me at 12%? You say, well, why isn't the bank lending to you, right? Shouldn't you be able to borrow at six?

[00:00:21] You can learn almost nothing about the future growth of a company by looking at its historic financial statements. If we don't start by incorporating the idea that we're going to make mistakes, that our forecasts are going to be imperfect, and then try to say, well, gee, what can we learn from that? How can we first stop acting on things where we're more likely to make a mistake, where we're being too hubristic?

[00:00:46] Welcome to Excess Returns, where we focus on what works over the long-term in the markets. Join us as we talk about the strategies and tactics that can help you become a better long-term investor.

[00:00:55] Jack Forehand is a principal at Validia Capital Management. The opinions expressed in this podcast do not necessarily reflect the opinions of Validia Capital. No information on this podcast should be construed as investment advice. Securities discussed in the podcast may be holdings of clients of Validia Capital.

[00:01:08] Hey, guys. This is Justin. In this episode of Excess Returns, Jack and I chat with Dan Rasmussen at Validia Capital about their top five research notes from the past year.

[00:01:15] We explore why corporate bond yields don't always match actual returns and dive into the U.S. market's post-financial crisis outperformance and the possible opportunity in less expensive international stocks.

[00:01:24] Dan also sheds light on the variability of private equity returns among top managers and the persistence of outperformance.

[00:01:30] Dan's thoughtful approach uncovers contrarian opportunities that challenge prevailing market sentiment.

[00:01:34] As always, thank you for listening. Please enjoy this conversation with Verdad's Dan Rasmussen.

[00:01:39] Dan, thank you very much for joining us today.

[00:01:42] My pleasure. Nice to be back with you all.

[00:01:44] Jack and I are excited to have this conversation with you. We've been following your research and the research at your firm for a number of years now.

[00:01:53] And what I would say is it's always super well-written, evidence-based.

[00:02:02] There's good long-term, I think, investing lessons that all investors can learn from in there.

[00:02:09] And, you know, there's usually a value or like a contrarian type theme throughout.

[00:02:16] Maybe not in every single one, but, you know, that's your style of investing.

[00:02:20] And what I would also say is that, you know, a lot of times you guys are writing about, you know, where you're putting capital to work.

[00:02:28] And that's something that I appreciate.

[00:02:30] So you're publicly out there sort of articulating your stance on different areas of the market and where you're finding opportunity.

[00:02:36] So for people that want to access that research, that don't follow Dan and his team's writing, they can go to verdadcap.com, very easily sign up for his weekly research note.

[00:02:48] And that comes every Monday.

[00:02:50] So, Dan, thank you very much for joining us.

[00:02:52] Yeah, my pleasure. It's great to be here.

[00:02:55] One of the things we wanted to do was you recently sent out an email that was highlighting the top five pieces of research throughout the year.

[00:03:04] So this conversation, we're going to kind of work through as much of those slides as we can and just get your thoughts.

[00:03:10] There's going to be some visuals in there.

[00:03:12] So anybody listening on audio, please go over to YouTube if you can so you can see those visuals.

[00:03:17] But maybe, Dan, let's just start with writing in general.

[00:03:20] It seems like you have been writing since you started the firm.

[00:03:26] And I was just wondering if you could maybe take a minute and just explain sort of how you view writing and the importance of these types of pieces.

[00:03:35] Yeah, absolutely.

[00:03:36] Well, you know, Justin, you mentioned that we often have a contrarian or a value theme.

[00:03:42] You know, one of my core ideas about investing is that investing is not a game of analysis.

[00:03:48] It's a game of meta-analysis.

[00:03:49] It doesn't matter what you think.

[00:03:51] It's a matter of what you think relative to what everyone else or really the market consensus thinks.

[00:03:56] And so I think the most important challenge in investing is to identify not just your ideas, but how your ideas conflict with, ideally, contemporary or popular opinion.

[00:04:06] Right.

[00:04:06] What is everyone else thinking that's wrong?

[00:04:08] And if I had to say that there's one sort of prompt for every piece of research that we do, it's what is everyone else thinking that's wrong?

[00:04:15] You know, what is something unique that we have to add?

[00:04:17] And, you know, I love writing because it forces you to put your thoughts, really get your thoughts distilled into something that's sort of concise and weaponized as an idea.

[00:04:28] And so it's always been a great discipline.

[00:04:30] And the way I've thought about it is that this is the research we're doing for investing to make good investment decisions.

[00:04:36] You know, I initially thought, you know, I do all this research.

[00:04:39] You know, before I started publishing what I wrote, I thought, you know, gee, I do all this research and I don't get any credit for it.

[00:04:43] You know, nobody knows that I spent 12 hours studying some random esoteric topic.

[00:04:49] But if I write about it, then people know.

[00:04:51] And so I started writing down, you know, all the research that I did that justified sort of our investment strategy or investment decisions and started sharing it.

[00:05:00] And people would say, well, gee, aren't people going to steal your ideas?

[00:05:03] And I said, you know, that's the greatest flattery that you could get if someone steal.

[00:05:07] You want people to steal your ideas.

[00:05:09] You want people to adopt your ideas.

[00:05:11] That's what winning looks like, right?

[00:05:13] Say, well, gee, X, Y and Z is crazily undervalued.

[00:05:17] And then people steal your idea and it becomes not undervalued.

[00:05:19] Well, you just made a lot of money.

[00:05:21] So in my view, it's a win-win, right?

[00:05:23] You distill your ideas.

[00:05:25] You get them more concise, more sharp.

[00:05:27] And then if you persuade other people, it only benefits you and your investors.

[00:05:31] And that's been a core idea behind my writing.

[00:05:35] Speaking of writing, you announced just this morning.

[00:05:37] And by the way, this announcement came after we asked you to come on the podcast.

[00:05:41] So we were happy to hear about this.

[00:05:44] But you announced the pre-release of a new book that will be available soon.

[00:05:49] What's the book about?

[00:05:51] The book is called The Humble Investor.

[00:05:53] And it's now available for pre-order.

[00:05:56] So shameless plug.

[00:05:57] If you are an Amazon Prime subscriber, go on Amazon.

[00:06:01] Or if you're a Barnes & Noble devotee, go to their website and buy the book.

[00:06:06] And the book is about this idea of humility.

[00:06:09] There's so much that's written about investing and investing analysis that a new amount of knowledge is going to give you a new amount of edge.

[00:06:16] Or a new amount of analysis is going to give you a new amount of edge, an incremental edge.

[00:06:19] And the idea here is that we have to acknowledge the limits of our understanding.

[00:06:24] And investing, this is very important.

[00:06:26] And I think there are two, I think, very simple ideas that sort of act as a preface for this book.

[00:06:34] You know, the first idea is that investing is betting on the future.

[00:06:38] So investing is betting on predictions.

[00:06:40] And so it's very important to know a lot about our ability to make predictions and whether we can make good predictions and how our predictions are.

[00:06:47] And then the second idea, and one of my favorite economists, this guy Woody Brock, wrote this.

[00:06:54] And he said you won't find the word mistake in the index of any contemporary book about economics.

[00:07:00] But everyone who's an investor knows that mistakes are so common, right?

[00:07:04] I mean, who among us has not made terrible investment mistakes?

[00:07:07] Many terrible investment mistakes, right?

[00:07:10] Especially if you buy single-name equities, right?

[00:07:12] Making mistakes is part of investing.

[00:07:15] And so if we don't start by incorporating the idea that we're going to make mistakes, that our forecasts are going to be imperfect,

[00:07:23] and then try to say, well, gee, what can we learn from that?

[00:07:27] How can we first stop acting on things where we're more likely to make a mistake, where we're being too hubristic?

[00:07:35] And then second, can we go further and say, what do other people, and this comes back to my idea about writing,

[00:07:40] what do other people think they know that might not turn out to be true that I could profit from?

[00:07:45] How can I take the other side of the bet?

[00:07:47] And I think the easiest way to do that is to look for hubris, because hubris is obviously very amply represented on Wall Street.

[00:07:55] And if we can think of ourselves as taking the other side of the bet, that's what we want to do.

[00:08:00] We want to consistently look for places where consensus optimism or consensus pessimism is so strongly felt that the market is either wildly overvaluing or wildly undervaluing a potential future that could occur.

[00:08:13] And in keeping with that, I think there are a bunch of core pieces of research, which I highlight in this book.

[00:08:20] And one of them is about forecasting growth rates, which is obviously the core to every investment model.

[00:08:28] And what I show is that growth rates don't persist.

[00:08:33] So a company that has been growing very fast for the last few years that investors say is growing very fast actually has no higher probability of growing fast in future years.

[00:08:43] Then does a company that has had very bad growth rates over the previous years.

[00:08:47] And that's just one example of starting to reframe and use this book and the empirical evidence I present herein to start to reframe our thinking away from analyzing individual investments with a confidence that we have a crystal ball that will allow us to understand, say, the discounted cash flow model for a given stock.

[00:09:08] And reframe it by thinking more about this meta-analytic question about what does everyone else think they know that they're too confident about?

[00:09:17] How can I gain edge on betting on uncertainty, betting on unpredictability, and use that wisdom about our inability as humans to understand the future to make better investment decisions?

[00:09:30] I'm just curious. Was that growth rate study a Malvisan study or was that something else?

[00:09:34] It was not a Malvisan study.

[00:09:36] Okay.

[00:09:37] It was originally, there were some academics that did the original study in the early 2000s and then I replicated it with another 15 years of data and also took it internationally to Europe and Japan.

[00:09:50] Oh, nice.

[00:09:50] So it's a really cool, a really cool study.

[00:09:54] On this idea of, well, things people, a lot of people believe that aren't necessarily true, this kind of leads into the title of your most read piece of the year, which is yield is not return.

[00:10:02] And high yield debt can be so enticing for people.

[00:10:05] You see those huge numbers in terms of the yield and people think they're going to get that yield.

[00:10:10] And this piece sort of outlines why that might not be true.

[00:10:12] So can you talk about what you did in this research?

[00:10:14] Yeah, absolutely.

[00:10:15] This is by my colleague, Greg Obenshain, who is our director of credit here at Verdad.

[00:10:19] And it's a wonderful, simple piece.

[00:10:22] I think that everyone intuitively thinks that yield equals return.

[00:10:26] It's one of the obvious things that one would assume about the bond market.

[00:10:29] If I buy a 5% yielding bond, I'm going to get 5%.

[00:10:33] If I buy a 7% yielding bond, I'm going to earn 7%.

[00:10:36] And yet efficient markets theory is equally present in fixed income as it is in equities.

[00:10:42] Which means if the efficient markets are right, there's actually no reason to think that a 7% yielding bond should earn more than a 5% yielding bond, which is a totally mind-boggling conclusion.

[00:10:53] But in reality, it's a very simple efficient markets argument, right?

[00:10:57] Everything should have the same expected return.

[00:10:59] Risk should be perfectly priced in.

[00:11:00] The reason a bond yields 8% and another bond yields 5% is that the default rate of the bond, the likelihood of a default on the 8% bond is high enough to justify that incremental yield.

[00:11:13] That's why I often joke about private credit in particular, which is offering 8% to 12% yields.

[00:11:20] And they always say, well, we're lending to good companies.

[00:11:23] And I said, well, the intersection of good companies and companies that borrow at 12% is very minimal, right?

[00:11:28] It's just like your buddy comes over and he says, hey, I don't want to take out another loan from the bank.

[00:11:33] Can you lend to me at 12%?

[00:11:35] You say, well, why isn't the bank lending to you, right?

[00:11:37] Shouldn't you be able to borrow at 6%, right?

[00:11:40] And why are you borrowing from me at 12%?

[00:11:43] And then even more foolishly, if I just think, well, wow, what a great opportunity, a 12% yield.

[00:11:48] I'm going to earn 12% instead of 6%, right?

[00:11:51] Or 15% instead of 6%.

[00:11:52] And instead, you have to start thinking, well, there's no more obvious meta and analytic argument than looking at fixed income and saying yield doesn't return.

[00:12:02] And in fact, because of defaults, because of downgrades, what ends up being true is a phenomenon we call fool's yield, which is that yields and total return actually do go up incrementally, right?

[00:12:14] So if you start with a AAA yielding government bond, that is absolutely no risk.

[00:12:18] And then you go to, say, an investment grade corporate bond, you're actually going to earn an incremental return because you are taking, in fact, taking more risk.

[00:12:24] If you then go up to double B corporate bonds and even high single B corporate bonds just below investment grade, right?

[00:12:31] These are companies like Ford or something, right?

[00:12:33] You're actually going to earn a little bit of incremental return even above the investment grade index.

[00:12:38] But you start to go higher, right, into bonds that yield, you know, these days, 7, 8, 9, 10.

[00:12:43] And what you actually find is you earn lower returns than you would have earned in the 5% or 6% yielding bonds.

[00:12:49] And the reason for that is that people are reaching for yield, they're being fooled by the yield, and they're getting drawn into underpricing the default risk.

[00:12:57] And so we see that very clearly looking across different segments of the bond market, where what you see and what ends up happening is that you have to look at performance relative to yield.

[00:13:10] And what you see is that investment grade bonds, you know, triple A, double A, single A, triple B even, basically earn their yield, right?

[00:13:19] Yield does equal return for the most part when it comes to investment grade bonds.

[00:13:23] When you go down to double B bonds, you maybe lose 50 basis points relative to your yield.

[00:13:28] But you go to single B or triple C, you're losing 2.5%, 3.3% relative to your yield.

[00:13:36] So you're actually losing a huge amount.

[00:13:37] And what we then show is if you take really high-yielding bonds that are trading below their, you know, let's say 50 cents on the dollar or 60 cents or 70 cents on the dollar, you know, once you go below about 80 cents on the dollar, your returns are materially lower than stuff that trades at above 90 cents on the dollar.

[00:13:59] And if you go below 60 cents on the dollar, you tend to actually lose money.

[00:14:02] So there's this idea that risk should be priced into the market, that in some sense everything should be efficiently priced.

[00:14:12] But what you actually see is this fool's yield phenomenon where the higher-yielding stuff ends up returning actually worse than lower-yielding stuff once you pass this fulcrum point.

[00:14:22] You mentioned this is a short piece.

[00:14:24] And I think that's one of the best things about what you guys do is there's so many Wall Street research pieces that could be two pages that are like 20.

[00:14:31] And you guys, everything you guys do and everything probably we'll talk about today could be described as a short piece.

[00:14:35] Like you guys get to the point, you have charts, you make it really, you don't put any more words in there that need to be there.

[00:14:40] We try, Jack.

[00:14:41] We try to cut it down to the bare bones.

[00:14:44] That's part of, I think, good writing, right?

[00:14:46] I mean, what was it, Mark Twain?

[00:14:47] Yeah, you know, if I'd had more time, I would have written you a shorter letter or something along those lines.

[00:14:52] A little bit before this, before we go on to the next piece is private credit.

[00:14:55] Because I actually became familiar with you because of private equity.

[00:14:59] Because you've talked a lot about how maybe the returns in private equity, you know, we shouldn't expect the returns going forward that we've seen in the past.

[00:15:06] And I'd assume that's probably worse now.

[00:15:07] What are your views in general on private credit?

[00:15:09] Yeah, I'm very skeptical because of this idea of efficient markets, right?

[00:15:14] And this idea that, you know, higher yields shouldn't necessarily translate into higher return.

[00:15:19] I think people are being seduced by high yields into putting money into things that they perceive to be higher returning.

[00:15:26] And within the world of private credit, you know, unlike the world of corporate bonds, there's a lot of renegotiation, right?

[00:15:36] It's a negotiated asset class.

[00:15:38] So you don't necessarily get good default statistics.

[00:15:41] But I would say, you know, I joke that lending is the second oldest profession.

[00:15:45] Lenders have been around for a while.

[00:15:47] Banks have been around the block.

[00:15:50] And, you know, if you're not able to borrow from a bank, right, if the rate you have to pay is so high that you can't get access to corporate bond markets and can't get a loan from the bank, you have to turn to private lenders.

[00:16:01] You know, what does that mean about your risk and your quality as a company, right?

[00:16:05] Clearly, either you're borrowing too much, right, which is the case of most private equity deals.

[00:16:09] They're borrowing too much, unsafe levels of debt, unhealthy levels of debt, or the company just isn't that good.

[00:16:15] And I don't think that investors should spend a lot of time or a lot of their investment allocation putting money into really risky borrowers.

[00:16:24] The long-term base rates of doing that by looking at, say, triple C-rated debt or single B-rated debt just suggests that the returns don't outweigh the risk.

[00:16:34] And when you add on private market fees, it's probable that it's even worse than that.

[00:16:42] So the second most red piece of the year was the great rotation.

[00:16:44] And this gets into something we've talked about a ton on this podcast, which is this idea that the U.S. has just outperformed everything else forever.

[00:16:51] And you've had people like me every year, you know, showing our evaluation charts and saying, this can't continue anymore.

[00:16:56] And then it continues more beyond that.

[00:16:58] So how do you look at that?

[00:16:59] Like, what's happened in the past?

[00:17:01] Before we get into the future, like, what's happened in the past?

[00:17:03] Is it justified by fundamentals?

[00:17:04] Is the U.S. just getting more expensive?

[00:17:06] Like, how do you look at that?

[00:17:07] Yeah.

[00:17:08] Well, you know, even before this piece a few years back, I wrote one of our best-read pieces of a few years back was called Investing in a Bubble.

[00:17:16] And one of the points I made is I went back and I read all the great investors, people we think of as great investors today.

[00:17:22] And I read their old investor letters.

[00:17:24] And I asked, when did they first know that the technology stock bubble of the late 90s was, in fact, a bubble?

[00:17:32] Right?

[00:17:33] When did they identify it?

[00:17:34] Did they identify it?

[00:17:36] Right?

[00:17:36] Because, you know, if you're living through a bubble, can you identify it?

[00:17:38] Do people know?

[00:17:39] And what I found is that I think it was Ray Dalio called the tech bubble in 1995, I think.

[00:17:47] And I'm going to misquote the years, but you're going to get it roughly right.

[00:17:50] I think, you know, Howard Marks called the tech bubble in 96, Seth Klarman in 97.

[00:17:55] Okay.

[00:17:56] So, you know, everybody knew it was a bubble.

[00:17:59] The problem was they figured it out that it was a bubble too early.

[00:18:03] And so if you come out in 95 or 96 or 97 and you say the U.S. equity market's a bubble, the technology stock market is a bubble.

[00:18:12] And then the market goes up 25% in 95 or 96 and it goes another 25% in 97.

[00:18:18] So the bubble just keeps inflating and then it goes up another 25% in 98.

[00:18:22] And you say, well, it's a crazy bubble.

[00:18:24] You know, we've got to keep our money out of this.

[00:18:26] You know, don't do it.

[00:18:27] And then it goes up another 20.

[00:18:28] You know, the Nasdaq is up another 25%.

[00:18:30] Well, what you've done is you've lost all credibility, right?

[00:18:33] You were the boy who cried wolf.

[00:18:34] You said it was too risky and look at how much people made, right?

[00:18:38] You told them don't invest in fart coin and look at how much money they made.

[00:18:42] You're just a Cassandra.

[00:18:43] You don't understand the new economy.

[00:18:45] And in fact, the stuff that you're telling me to invest in, you know, you want me to invest in French equities.

[00:18:51] You want me to invest in oil companies, you know, whatever boring, you know, value investor idea people are coming up with.

[00:18:58] When it just doesn't do as well, people said, well, I wasn't going to do well.

[00:19:02] If I wanted to make money, I would have put it in tech stocks.

[00:19:04] The only reason I put it in this is maybe it's diversification that didn't work.

[00:19:07] But the interesting thing is that by 2003 or 2004, actually, if you bought the value index, you came out way ahead of if you bought the Nasdaq because the up was so high.

[00:19:20] Yes.

[00:19:21] And by 99, you looked like a complete idiot for not buying the Nasdaq, for owning anything else, for owning international stocks, for owning value stocks.

[00:19:28] You were the worst investor in the world by 1999 or 2000.

[00:19:31] But the bubble deflated so quickly and so dramatically.

[00:19:37] And then the market, the money flowed into these other sectors so rapidly that you came out ahead only two or three years later.

[00:19:44] And that's what sort of made the record of some of these people we think of as great investors today.

[00:19:48] They endured a period of underperformance where what they were doing was wildly out of favor.

[00:19:52] They were patient.

[00:19:53] And then it worked and they were vindicated.

[00:19:55] And now I would argue that we're in a similar phase here where U.S. equities are reaching valuation levels that we haven't seen since the 90s.

[00:20:03] It feels like most recently it feels like 2021 in terms of mania around memes.

[00:20:11] And conversely, you go internationally.

[00:20:15] And the minute you step outside the U.S. border, the minute you step off a U.S. listed exchange, valuations plummet about 50 percent.

[00:20:23] And actually, some of the quality of these companies is very high.

[00:20:26] Now, they don't have tech stocks, OK?

[00:20:27] So we're at least not as many or not as good, OK?

[00:20:30] So set that aside.

[00:20:32] Everyone's going to say, well, Dan, you're not sector adjusting.

[00:20:33] Well, sector adjust all you want.

[00:20:35] Every sector international is cheaper.

[00:20:37] And it's not just, you know, yes, there's other than health care, OK?

[00:20:42] Yeah, Europe has some good health care stocks, Nova Nordisk, et cetera.

[00:20:46] So that's fine.

[00:20:47] But every sector is cheaper.

[00:20:49] Every market is cheaper.

[00:20:50] If you control for all of these factors, it's still dramatically cheaper.

[00:20:54] And what you're left with is this flow dynamic where people just keep dumping money into U.S. equities.

[00:20:59] It keeps working.

[00:21:01] People that advocate international equities keep losing.

[00:21:04] And so what I argue is that at some point, the divergence with the fundamentals, between the fundamentals and where the flows are driving valuations, becomes so fast.

[00:21:12] And I think we're clearly there today that the great rotation is coming.

[00:21:18] It almost has to be.

[00:21:21] And when you look at the challenge with this thesis, the fundamental challenge with this thesis is that the people that have been saying it today, me, for example, have been wrong on this point.

[00:21:33] I was wrong last year.

[00:21:35] I was wrong the year before.

[00:21:36] I was wrong the year before that.

[00:21:38] In fact, I've been wrong about international equities basically as long as I can remember.

[00:21:43] And that's the challenge.

[00:21:44] So you're going to believe me or believe that those arguing in favor of international equities, you're believing someone who's been routinely wrong, whose logic has led to losing money relative to owning the U.S. index.

[00:21:57] And that's the challenge, right?

[00:21:59] Do you believe that I should buy something that yields, you know, basically the universe of things that are yielding dividend yields of 4% or 5% or 1% or 2%?

[00:22:06] Things that trade at 25 times P or 15 times P, you know, which all, by the way, have roughly equivalent forecast growth rates going forward.

[00:22:14] And I think that these price dynamics competing with the valuation or quantitative metrics is the sort of fundamental dilemma that investors face today.

[00:22:26] I'm just curious, since you mentioned the late 90s, how do you compare and contrast now to then?

[00:22:30] Like there's some people I know who think we're in a bubble just like then.

[00:22:33] And then there's other people, you know, you'll see charts put up of like NVIDIA or as any examples, free cash flow against their stock price.

[00:22:39] And they'll say, you know, these MAG 7 stocks, like the fundamentals are tracking the price a lot better than you saw with like a Cisco back then.

[00:22:45] So how do you compare and contrast the two periods?

[00:22:48] Yeah.

[00:22:48] Yeah, I think that's right.

[00:22:49] I mean, I think the first thing that let's compare is that both were born out of massive technological innovation waves, right?

[00:22:57] The first, the development of the Internet.

[00:22:58] And then in the 2010s, it was the cloud, mobile, and now maybe AI.

[00:23:06] Well, clearly AI is driving stock prices.

[00:23:07] Is AI going to drive growth?

[00:23:09] We don't know.

[00:23:09] But certainly the cloud and mobile.

[00:23:12] And those allowed these big tech companies to scale their profits to the moon at very, very high margins.

[00:23:19] And so you saw very high growth rates and very high margins and very high free cash flow generation, which is certainly totally different than the 1990s.

[00:23:26] Yet at the same time, you know, we see some similar phenomenon, right?

[00:23:31] In the 90s, we had the IPO boom.

[00:23:35] In 2021, we saw the SPAC craze.

[00:23:38] And now we have, you know, the meme coin and cryptocurrency, you know, I would argue bubble, right?

[00:23:48] Where we're seeing massive amounts of money poured into things like, you know, fart coin and whatever, right?

[00:23:54] They clearly have no business model, right?

[00:23:55] They're obviously no business model.

[00:23:57] There's not, they're not even businesses at all.

[00:24:01] And so I think there is obviously speculative mania going on, right?

[00:24:05] You look at the PE multiples, right?

[00:24:06] Yes, NVIDIA is a great company.

[00:24:08] Yes, they're generating a lot of free cash flow.

[00:24:10] Yes, the margins are great.

[00:24:12] But still, the valuation is insane.

[00:24:14] And I think basically you go down the stack and you look at almost any one of these companies, you know, Spotify or Palantir or, you know, Snowflake or whatever.

[00:24:23] And they're great companies.

[00:24:24] I'm not arguing they're not great companies, but the valuations are clearly insane.

[00:24:28] Or at least they're clearly not value investments.

[00:24:30] And I think you have to, you know, wrestle with that.

[00:24:37] How do you think about timing with this?

[00:24:38] I mean, obviously we know it's impossible time, but obviously valuations look really good on the international side.

[00:24:44] And one of the challenges investors face is, you know, people like me and you, we say every year, you know, this is going to be the year or not.

[00:24:50] This is going to be the year, but things are getting worse and worse and worse and worse.

[00:24:53] And then it's gone on for decades.

[00:24:54] I mean, is it possible it goes on for another decade?

[00:24:57] Like, how do you think about timing with something like this that's valuation based?

[00:25:00] Yeah.

[00:25:01] You know, I think that I think there's a challenge in that, you know, momentum predicts short term results a lot better than valuations do.

[00:25:12] And so, you know, in the short term, we want to be chasing momentum.

[00:25:15] That's the sort of right answer.

[00:25:17] But in the long term, it's valuations that win.

[00:25:20] Right.

[00:25:20] If you look at these charts of 10 year returns versus CAPE across countries, you see a very strong relationship where they'll lower the CAPE multiple, the better the forward returns.

[00:25:29] Every quant model, anyone who's looked at this data is going to come to the same conclusion because it's so obvious.

[00:25:35] And yet that doesn't really tell you anything about next year or even the next two years.

[00:25:40] But it seems to have in the past told you a lot about 10 year forward returns or seven year returns or five year, four year returns.

[00:25:46] And so I think the best that you can say is is patiently doing the right thing over and over again is the right answer.

[00:25:52] As long as you have a long time horizon.

[00:25:54] And by the way, the right answer isn't to be 100 percent international.

[00:25:59] Right.

[00:26:00] All we're saying is that, gee, you know, the what if you're in developed markets, the U.S. is 70 percent of the developed market benchmark or something like that.

[00:26:08] And maybe maybe you say, well, gee, you know, I don't know.

[00:26:11] Maybe we should revenue weight it.

[00:26:12] Right.

[00:26:12] Maybe we should put it at 50 percent or something or 60 percent.

[00:26:15] Maybe we should profit weight it or whatever the number you're going to come to.

[00:26:18] You're not saying I put nothing in the U.S.

[00:26:20] Right.

[00:26:20] So you're still going to be doing quite well with the U.S. portion of your portfolio.

[00:26:24] And you just keep adding and adding and adding.

[00:26:26] And over time, when that that the international markets catch up, you'll be very happy that you continue to diversify that.

[00:26:36] And in the short term, you won't feel as pain because you still have some money in the U.S.

[00:26:39] And I think that's roughly the right answer.

[00:26:41] It's enduring some amount of pain and underperforming a benchmark because you're diversifying and you're consciously saying, gee, this seems too extreme.

[00:26:51] And I think one interesting counterargument to that is people saying, well, international markets have become so much more correlated.

[00:26:56] Am I actually getting any diversification benefits?

[00:26:59] And to which I respond, you wouldn't be asking that question if it wasn't diversifying, because the reason you're asking for it is because international markets have done so much worse than the U.S.

[00:27:09] And at some point, they'll do so much better.

[00:27:12] And it'll be over a long enough time horizon.

[00:27:14] You don't really care about the day-to-day fluctuations.

[00:27:16] What you care about is what happens over a three- or five-year horizon.

[00:27:19] And it's obvious that there are big divergences and can be big divergences and have been and are right now big divergences between U.S. and international equity performance.

[00:27:28] Yeah, I think the idea you talk about with incremental changes, like that's the key to this whole thing.

[00:27:32] And the same thing with value underperforming in the U.S.

[00:27:34] It's like when people want to go all in on the underperformance, like that's when they run into trouble.

[00:27:38] But sometimes just simple changes.

[00:27:39] Like, for instance, if you have a certain allocation to value or international your portfolio, well, you're probably below it because the other stuff has been outperforming.

[00:27:46] Maybe just getting back to where you want to be in the first place is a good starting point.

[00:27:49] Like, I think looking at it in that way is probably better than, you know, trying to make these massive changes.

[00:27:53] Yeah, I think that's right.

[00:27:54] And you start from the market way.

[00:27:56] So what's the market benchmark?

[00:27:57] You know, here's where the market is.

[00:28:01] You know, how far divergent do I want to be relative to that?

[00:28:04] And, you know, I think, you know, you can come to your own conclusions based on your own conviction.

[00:28:10] And maybe the max you go is earnings weight or revenue weight or something like that.

[00:28:15] And somewhere in between is the answer that's right.

[00:28:18] But I think today with the extreme, the extremes we're in, I mean, this really does feel like 2021 all over again.

[00:28:26] I think it's so prudent to diversify into things that make a little bit more sense from a valuation perspective.

[00:28:33] I've said two quick peripheral questions around this.

[00:28:35] Do you how do you view market concentration?

[00:28:38] You know, there's some people who will say, like, when the market gets really concentrated like this, it's a big risk to the market overall.

[00:28:42] Like when you look at history, how do you view market concentration and whether it's a risk to the market?

[00:28:47] Yeah, well, if you look at the 2000, you know, the 1990s, 2000 example, it was the exact same phenomenon where you had very concentrated outperformance that then unwound.

[00:28:56] And so at the same time as you were seeing growth outperform value, you were seeing large outperform small, you were seeing U.S. outperform international.

[00:29:03] It's the exact same dynamics playing out then that are playing out now.

[00:29:07] I mean, I think they're also quite correlated.

[00:29:09] And I think that it's, you know, it's just another sign that we're seeing the exact same type of phenomenon we've seen before.

[00:29:20] And I think a study of history will suggest that, yes, history doesn't repeat itself, but it does rhyme.

[00:29:26] The other question we talk about a lot on the podcast is the idea of the impact of passive investing.

[00:29:29] We've had Mike Green on and talked about his arguments.

[00:29:31] This idea that as money keeps going into passive and as the default option of 401ks becomes these passive funds, it's driving up the biggest companies relative to everything else.

[00:29:40] I mean, do you think there's merit to that?

[00:29:42] So I think there is merit to it.

[00:29:46] And I think there is merit in the following way.

[00:29:50] I think in that there's been a shift towards passive.

[00:29:54] When people say, I'm going to put my money, I'm going to go passive, they don't come back and say, gee, I've put my money in the MSCI XUS mid-cap index.

[00:30:04] That might be a low-fee index that they can access, but that's not what they're putting their money into.

[00:30:09] When they say they're going passive, what they actually mean is that they're by either the total stock market index or the S&P 500.

[00:30:18] And if you look at Vanguard's market cap, they're sort of AUM by fund.

[00:30:25] That's basically true.

[00:30:27] You know, 80% or so the last time I checked of Vanguard's assets, equity assets, were tracked to those two indices.

[00:30:34] And so what you see is basically this sort of mix shift or allocation mix of where investors are putting their incremental dollars.

[00:30:42] And I think Mike has done a lot of work on saying, by the way, if the S&P 500 index fund notices that a company that sort of is, let's say it's a U.S.

[00:30:52] It's 60% of their revenue comes from the U.S., but it happens to be headquartered in Ireland and listed on the London Stock Exchange.

[00:31:01] The S&P 500 index committee isn't going to say, well, let's add it to the index because it's so much cheaper than anything here in the U.S.

[00:31:08] And it's so attractive and it's basically a U.S. company anyway.

[00:31:11] It's just in Ireland for tax reasons.

[00:31:12] And they just happen to list on the London exchange, right?

[00:31:15] They don't do that.

[00:31:16] And an active manager might have.

[00:31:17] And so the sort of barriers between these different regions and these different indexes become so big, right?

[00:31:25] The gap between them is a chasm because it can't be bridged by the manager because the manager is constrained by the rules.

[00:31:32] And so I think what you do see is this driving a few different things that are very clearly correlated with the rise to pass.

[00:31:42] And is it causal?

[00:31:43] I don't know.

[00:31:44] I think partially.

[00:31:45] But you're seeing very clearly U.S. outperformance because passive means U.S.

[00:31:50] Passive means, right?

[00:31:51] You're clearly seeing large cap outperformance because, by the way, passive generally means the S&P, not the Russell 2000.

[00:31:58] And in addition, you know, I think you're seeing generally diversions from fundamentals, right?

[00:32:05] You're seeing just people buying the market rather than people buying individual securities en masse.

[00:32:11] And I think it's hard not to come to the conclusion that that's behind.

[00:32:15] It's accelerating.

[00:32:16] Is it the sole driver of these trends?

[00:32:18] No.

[00:32:18] But is it part of it?

[00:32:19] Yes.

[00:32:21] So your third most read piece of the year is the dispersion delusion.

[00:32:24] And I really like this one because I probably think these types of things that you address in the paper, this idea that in private equity, there's this elite group of managers that outperforms everything else.

[00:32:34] There's big dispersion, you know, from the averages and that those managers' performance persists over time.

[00:32:39] So is that true?

[00:32:41] You know, it's funny, Jack.

[00:32:44] So, you know, I've done a lot of criticism of private equity.

[00:32:48] And I love, you know, one of my investors is this really brilliant guy who does a lot of his own quantitative research himself.

[00:32:55] And he said, you know, I've been getting so many of these marketing pitches about private equity that all advertise dispersion.

[00:33:01] And I said, but logically, you know, I know it's micro cap exposure.

[00:33:04] I know it's concentrated micro cap exposure.

[00:33:05] And it's got to be true that this dispersion is not driven by some brilliance of the managers.

[00:33:12] It's got to be driven by just the nature of the portfolios.

[00:33:14] Can you go to a simulation and show me if this is true?

[00:33:17] And sure enough, his logic was exactly right.

[00:33:19] So if you go and take, you know, private, average private equity fund.

[00:33:24] And so if you think about the average private equity fund, there are a few sort of stylized facts.

[00:33:29] Stylized fact, number one, all the things that are in that fund are tiny.

[00:33:34] Generally about 150, 200 million of market cap.

[00:33:37] Stylized fact, number two, the portfolio is really small.

[00:33:40] We're talking 10, 20 holdings maybe, right?

[00:33:43] And probably some concentration in there.

[00:33:45] So very, very small number of names.

[00:33:47] Very small number of very small size names.

[00:33:52] The third, which is sort of a funny one, is it tends to be deployed over two or three years, right?

[00:33:57] So, or maybe longer, right?

[00:33:59] So a 2020 vintage fund might be partially deployed in 20, partially deployed in 21, partially in 22 or something like that, right?

[00:34:06] There's a spread in the years it's deployed.

[00:34:08] You then take all those things and you say, well, let's take a thousand private equity managers that are each forming concentrated portfolios of microcaps that are also spread across two or three years at relatively random increments.

[00:34:22] And then you look at the dispersion of outcomes among those managers.

[00:34:25] Well, it turns out if you did the exact same thing in U.S. microcaps, you just took random portfolios of 10 or 20 microcaps.

[00:34:31] You bought them over two or three years, held them for four or five years and then sold them.

[00:34:36] You'd see exactly the same dispersion that you see from private equity.

[00:34:39] In other words, private equity's dispersion has nothing to do with what the investment consultants are saying, which is, you know, Jack is a really brilliant private equity investor and Dan is a really terrible private equity investor.

[00:34:52] And so every year Jack's going to be top quartile and Dan's going to be bottom quartile.

[00:34:57] And here at, you know, Boston Associates, we know how to pick the Jacks and screen out the Dans.

[00:35:03] And so you're going to get top quartile private equity returns, not median private equity returns as a result of our superior due diligence process.

[00:35:12] Or if you are, you know, you know, Hudson Bank stone partners and you've had one top quartile fund and you say, therefore, we're the dispersion of managers suggests that yet again, we're going to be, you know, repetitiously producing top quartile returns every time.

[00:35:28] In fact, this is just people being fooled by randomness.

[00:35:30] I think you'd have to invert that, by the way.

[00:35:31] I think Dan would probably be the top quartile and Jack is probably the bottom quartile.

[00:35:34] I think after having talked so much shit about private equity over the years, I think, you know, I think I'd clearly be cursed, Jack.

[00:35:42] You know, the private equity gods would act against me to make sure that if I ever did private equity, it'd be a horrible outcome.

[00:35:48] It's funny, like this reminded me so much of your leveraged small value paper from back in the day because you did the same exact thing.

[00:35:54] Like you look at the returns of private equity and then you were able to replicate them by looking at common characteristics in the public markets.

[00:36:00] And you're doing the same exact thing with dispersion here.

[00:36:01] Yes, yes, that's exactly right.

[00:36:03] Right. And I think it's demystifying private equity as part of the goal.

[00:36:06] Right. And I think part of that is this idea of coming back to my book about humility.

[00:36:11] Right. And I think part of humility is saying, you know, gee, is it really likely that there's some really smart group of people out there that just systematically is better at everything?

[00:36:22] And that when you look at an extremely efficient market, that there's some huge edge that's being driven by by that.

[00:36:28] Yeah. And if you look at the mutual fund research, which I think we're all familiar with, it suggests that there really isn't.

[00:36:35] Right. It just doesn't seem like there's some group of managers that's just reliably outperforming year after year that you can find and bet on.

[00:36:41] And if that's true, then, you know, why would magically private market people be so much smarter than public market people?

[00:36:48] Right. Or the top quartile of private people be so much smarter than the rest?

[00:36:52] Or is there something they know? Right. Or something they're doing?

[00:36:55] And I always try to find the systematic explanation. You're like, well, what if what if you assume that there's no skill or that everyone's equally skilled?

[00:37:04] Because it seems really hard. Like everyone I know that works in private equity is basically the same resume.

[00:37:09] So, you know, they learn the exact same things, the exact same business school.

[00:37:13] So I just don't understand, you know, how some group of them could be magically so much better.

[00:37:19] It just makes more sense to me. They're all pretty good. They're all but they must systematically be doing something.

[00:37:24] And my idea about what private equity is, is it's system. It was systematic exposure to microcap deep value with leverage.

[00:37:32] And in terms of explaining dispersion, it's systematic exposure to concentrated portfolios of microcaps that are invested in over a random two or three year period and held for a random three to seven year period.

[00:37:43] And that creates the dispersion.

[00:37:45] And I think that that sort of explanation by randomness as a competitive thesis to the marketing driven thesis about, you know, excellence among a certain group of investors feels more right to me.

[00:37:59] I'm just curious, going back to the way I came across in the first place, the idea that private equity has gotten very expensive.

[00:38:04] Like, has that gotten worse in the past few years?

[00:38:06] And then I would assume the multiples they're paying are even higher now than they were a few years ago.

[00:38:09] Yeah. And 2021 was a step change.

[00:38:12] OK, so 2020, 2021 was peak private equity, peak valuations, peak deal activity.

[00:38:18] And so if my thesis about private equity is to be correct in any realm of being correct, it will be correct about the 2021 vintage or it will be completely wrong.

[00:38:29] And I think that that's what we're waiting to see.

[00:38:32] The 2021 vintage was done, you know, 20 or 30 percent premium to any other vintage or previous vintage and with about 50 percent higher deal activity.

[00:38:41] And since 2021, valuations have come down, deal activity has come down, but it's still even higher than it was pre-2021.

[00:38:49] And I think if you look at what PE has been investing in, interestingly enough, if you go, it's been kind of 50 percent or so technology and health care technology.

[00:38:59] Those have been the big bubble boom areas.

[00:39:03] And I think the question is, does concentration in very expensive technology companies, in this case, micro cap technology companies, how does that end up playing out?

[00:39:12] And so you're seeing some of the same themes from the public market play out here.

[00:39:16] Right. And again, when people are talking about private equity, they're generally talking about U.S. buyouts.

[00:39:21] You know, it's probably very true that European buyouts or Japanese buyouts are being done at very reasonable multiples.

[00:39:27] And I have nothing against that. If you're buying deep value micro caps with debt, I think that's a great strategy.

[00:39:33] And I'm sure there are people doing that in Europe and Japan at very good prices, et cetera.

[00:39:37] But in the U.S., it's really a very concentrated, highly levered bet on micro cap technology and health care companies, which seems like, again, part of the same dangerous set of overvalued themes we've seen in public markets.

[00:39:51] Just one more for you before I hand it back to Justin.

[00:39:53] And I think I can put this in the category of things I know your answer before I ask you.

[00:39:56] But I do want to ask it because I've been seeing in the news a lot recently is it seems like they're going to attempt to put private equity inside of an ETF.

[00:40:03] And I don't even know how they're going to do that. I don't know how you could possibly value it throughout the day.

[00:40:07] But I'm wondering what your thoughts are on those types of things like coming into the ETF space.

[00:40:11] Yeah. You know, I think I think the sort of fun question about it is and there's been some recent work on this done in secondary markets.

[00:40:19] So there are these secondary funds which will go out and buy stakes, you know, LP stakes and private equity funds.

[00:40:29] And one of the interesting phenomenon is that accounting rules allow them to mark those stakes at NAV.

[00:40:35] Okay. So let's say the stake is trading at that.

[00:40:41] The NAV is 150 million and they go and buy it from somebody at 100 million dollars.

[00:40:48] So they bought it at a big discount to now the next day.

[00:40:51] They can market on their books at 150.

[00:40:53] And so what you see in the secondary funds and there's been some egregious examples of that.

[00:40:58] Well, they'll buy like some venture capital stake at 10 cents on the dollar and literally the next day, literally the next day market at 100 cents on the dollar.

[00:41:06] Right. That's what's happening in the secondaries world.

[00:41:09] But it's not big step to go from that secondary world to an ETF.

[00:41:13] Right. If you're just having stakes in private equity funds, you know, why couldn't you list those stakes and own in an ETF a diversified set of LP interests in a variety of private equity funds that would then trade like a closed end fund at a premium or discount to NAV.

[00:41:29] But I think what you'd get into is these layers of subjective valuation where the private equity firm is creating the NAV.

[00:41:38] You're then judging whether the NAV, you know, accords with actual fundamentals.

[00:41:43] And then maybe the ETF buyers or sellers are judging whether your NAV is right.

[00:41:47] Right. And I think what all this would expose is somewhat of the difficulties and maybe selling points.

[00:41:54] But but certainly one of the big themes of what goes on in private equity is the idea of volatility laundering because they can make up their own marks because they mark only quarterly.

[00:42:03] It doesn't appear to be as volatile. And so I'm delighted to see a private equity ETF.

[00:42:06] I hope it happens sooner rather than later so that people can start to see that these things are actually quite volatile, that the marks are an illusion,

[00:42:14] that they're dependent on a whole set of multiple subjective assumptions that when market participants actually come in and look at, they say not sure this is true.

[00:42:25] The last two pieces, Dan, are country specific related pieces.

[00:42:29] And this first one, which was titled Activism at Scale in Japan, talked about the changes that are taking place in Japan from a capital allocation standpoint.

[00:42:42] So maybe just to sort of set the stage, can you just set up sort of what Japanese companies and their stocks were sort of looking at and why the government and, I guess, exchanges started to pursue this?

[00:42:57] So in Japan, it's prestigious to be listed.

[00:43:01] So everybody, every company, they want to be public, which means that there is about 3000 or more publicly listed Japanese companies, which is about the same as the U.S.

[00:43:11] in a market that's maybe a tenth of the size.

[00:43:14] So a huge number of public companies relative to the size of the market.

[00:43:18] And most of those companies are very small.

[00:43:21] Now, in addition to being very small, they're also trade very cheaply with a very large percentage, maybe almost half trading below book value.

[00:43:33] And when you think of book value in Japan, it's not a lot of intangibles.

[00:43:37] It's not a lot of goodwill.

[00:43:39] It's a lot of real estate.

[00:43:41] It's a lot of shares and other companies, these cross shareholding.

[00:43:44] So it's long-term investments in property plus cash and then, you know, your sort of networking capital.

[00:43:51] So the tangible book value is very close to the actual book value.

[00:43:56] And half the companies are trading below tangible book value, which is just crazy.

[00:44:02] And the Japanese government is looking at this and saying, you know, nobody – we're having trouble attracting capital to Japan, right?

[00:44:09] The market has gone sideways for decades.

[00:44:11] And when we look at the market, one of the problems we see is this kind of wasteland of microcap stocks that trade below their liquidation value.

[00:44:20] And that to us feels wrong.

[00:44:22] So we're going to introduce some corporate governance reforms.

[00:44:24] And the sort of signature one is we're going to have every company that trades below book issue a plan for how they're going to get to book value.

[00:44:33] And that's a, you know, a very simple, very clear direction, right?

[00:44:39] Just try to get to book value.

[00:44:41] All this half of companies in the sort of wasteland of Japanese microcap say to get to book value.

[00:44:45] And so now you might as a Western investor say, well, wait a second.

[00:44:50] That's a little crazy, right?

[00:44:51] How can you just tell a company to change their valuation, right?

[00:44:53] Let's like, you know, yelling at the ocean or something.

[00:44:57] It's crazy.

[00:44:57] But in fact, it's not crazy in Japan.

[00:45:00] It's actually totally achievable because when you're trading below tangible book, it's very easy to trade above book, right?

[00:45:08] You just sell some of your assets or liquidate some of your assets and buy back shares or increase dividends.

[00:45:13] You just mechanically can do it, right?

[00:45:15] You know, if you have $100 million of market cap and, you know, you have $100 million of cash and you trade at half book, we'll just take the $100 million of cash and buy $100 million of shares.

[00:45:28] Your shares will now be worth $200 million, right?

[00:45:30] Like you can just mechanically solve this book value problem.

[00:45:33] And that's the Japanese government is doing.

[00:45:35] So they're pushing through this price to book reform.

[00:45:37] They're basically pushing balance sheet efficiency out to these Japanese companies.

[00:45:41] And what we're seeing is actually a very positive reaction.

[00:45:47] So what we did is we used ChatGPT to go and analyze all the plans on the TSE website and score each plan by what actions, tangible actions are actually taken.

[00:46:00] And we found that about 58% of companies are increasing their dividends, 23% are buying back shares, and 13% are selling their cross shares, their long-term strategic holdings.

[00:46:12] So vast corporate change happening in Japan.

[00:46:16] And what we're seeing is that that's leading to divergent performance among Japanese stocks so that over the past year, and this was through the summer, companies that had agreed to sell cross share holdings were up 56% over the past year.

[00:46:32] Companies that said they were a repurchased stock were up 46%.

[00:46:35] Companies that were going to increase dividends were up 41%.

[00:46:40] Companies that didn't issue plans were up only 21%.

[00:46:43] Companies that were considering only 28%.

[00:46:46] And companies that had committed to some vague action like improving growth rates or improving investor relations up only 31%.

[00:46:52] So basically just this linear relationship between companies taking tangible action, which again is the majority of companies taking tangible action, but those companies that have taken material action, had had divergently positive stock price performance.

[00:47:06] And so what I think is that this is a self-reinforcing thing.

[00:47:09] And when I was last in Tokyo, I met with a very smart investor who'd been doing this for years.

[00:47:14] And he said, what people get wrong about Japan is they know that corporate Japan is very slow to move.

[00:47:22] And it's like turning a cruise ship, right?

[00:47:25] It takes forever to have some big change in strategy or culture.

[00:47:29] But what they're missing is that once that change becomes the approved answer, once it's the thing that you're supposed to do, everybody accelerates.

[00:47:39] So because they all want to abide by the rules.

[00:47:43] They all want to fit into what the Tokyo Stock Exchange wants them to do.

[00:47:46] Hard to change their minds.

[00:47:47] But once their mind are changed, the actions accelerate.

[00:47:49] And I think that's what you're seeing.

[00:47:51] What we're seeing in Japan is that each quarter and each quarterly report, each biannual report, you're seeing incremental actions by these companies to follow the TSE directives, do more getting rid of cash, more selling cross share holdings, more share buybacks, more dividends.

[00:48:07] And so I think that when you see an opportunity as big as this to buy stuff that trades at below tangible book value, where there's an activist in the form of the Japanese government that is pushing these companies to act, I think it creates this really unique opportunity globally.

[00:48:21] Where, you know, you can't find companies trading below tangible book in the United States, at least not ones that you'd want to touch the 10-foot pole.

[00:48:28] But it's half the Japanese market.

[00:48:30] I think it's a good point.

[00:48:31] It's not just like a one-time bump.

[00:48:33] You know, there's in all likelihood a long-term compounding effect as more and more companies embrace it, as those companies that are embracing it start to see the benefits of it.

[00:48:42] But then you get the whole capital allocation efficiency sort of flywheel going.

[00:48:49] And with things being so cheap over there, it looks like a good opportunity, I think.

[00:48:56] And by the way, Buffett, not that those big conglomerate companies were, I mean, maybe that was part of his thesis.

[00:49:02] I don't know.

[00:49:03] He's been, you know, he started buying a couple of those Japanese companies a few years ago, and I think he's done quite well with that.

[00:49:08] Very well.

[00:49:11] Okay, the last one is around Britain.

[00:49:16] And I think this was sort of more of a valuation play.

[00:49:22] Brian, one of your partners, wrote this piece.

[00:49:24] And this was really just talking about sort of looking at Britain before Brexit from a valuation standpoint and then sort of after Brexit happened and the discount of Britain relative to other markets.

[00:49:43] So I'll just let you kind of speak to that.

[00:49:45] Yeah.

[00:49:45] So I'd say first, Brexit has been bad for corporate Britain.

[00:49:51] Okay.

[00:49:51] It's been bad for corporate Britain in large part because of a change in valuation.

[00:49:56] There's been a valuation shock where post-Brexit, UK companies are trading at significantly cheaper valuations relative to mainland Europe than they were prior to Brexit.

[00:50:07] There's been some also margin impacts where it appears that there's been some margin compression in the UK.

[00:50:15] And so all of this means that UK stocks are significantly cheaper relative to mainland Europe than they were, and their margins appear to be slightly more compressed.

[00:50:26] And I think the narrative that we see about Brexit is that Brexit has been bad.

[00:50:30] I think it's hard not to read the Financial Times, the Wall Street Journal, and think, well, gee, you know, Brexit was a mistake or a failure.

[00:50:35] It hasn't lived up to its promise.

[00:50:37] And I was talking with a very smart friend of mine who supported Brexit.

[00:50:43] And I said, you know, gee, you know, as an American, you know, I read the newspapers.

[00:50:47] It sounds like it's been terrible.

[00:50:48] You know, what am I missing?

[00:50:50] And he said, all right, two things.

[00:50:51] So, Dan, go and look up the UK's GDP growth since Brexit.

[00:50:55] And then go look up the Eurozone's GDP growth since Brexit and tell me which is higher.

[00:50:59] So, you know, chat GPT, go type it in.

[00:51:02] Chat GPT comes back and shows that actually the United Kingdom has grown GDP faster than the Eurozone since Brexit.

[00:51:07] And he said, well, look, you know, why would we why would Britain tie itself with an anchor to the Eurozone when the Eurozone is growing slower?

[00:51:17] And he said, then everybody, everybody, you know, tricks you by comparing the UK's GDP growth to the US or something.

[00:51:22] Right. And of course, it's been terrible.

[00:51:24] But that's not because of Brexit.

[00:51:25] Right. In fact, they've done better than they would have had they been attached to the Eurozone.

[00:51:29] And then he said, you know, point two, he said, you know, what do you think is the big when you talk to investors?

[00:51:34] You know, what is the big theme about why Europe is so unattractive or, you know, why it's so cheap?

[00:51:39] And I said, well, you know, excessive regulatory burden.

[00:51:42] And he said, yes, that's exactly right.

[00:51:43] And he said, and that's what Brexit was about in part was getting rid of the excessive regulatory burden.

[00:51:48] He said, no, it hasn't happened. Right. The UK has not deregulated substantially since Brexit.

[00:51:52] He said, what they've created is the optionality to deregulate.

[00:51:56] If at some point Doge comes to Great Britain and they bring in Elon and Vivek to fix their regulatory problems and make their government efficient.

[00:52:06] Right. You're going to see a massive reduction in regulation and a freeing of corporate UK that could allow corporate UK to have higher margins and higher growth rates than what you're seeing in the Eurozone, even more so than they do now.

[00:52:23] So on the one hand, you've got faster GDP growth already, but you've also got a substantial optionality for improvement.

[00:52:30] And I thought that was a great point.

[00:52:31] And I think what you're seeing in Europe today, by the way, Europe is extraordinarily cheap.

[00:52:37] I think it's one of the greatest opportunities for value investors out there.

[00:52:40] And I think within Europe, the UK is obviously a huge component of the cheap of the cheapness of that market.

[00:52:47] And I think that Brexit has, I think, wrongly driven a lot of negative sentiment towards the UK.

[00:52:54] And is that mostly like a flows sort of issue?

[00:52:58] Like the markets, the investors have just been kind of fleeting, you know, out of UK stocks and that's the driving force of that for the most part?

[00:53:05] Fundamentals have kind of maintained.

[00:53:07] Yeah.

[00:53:08] OK.

[00:53:09] For long term, I mean, could be a good opportunity then.

[00:53:12] Yes.

[00:53:15] We have two standard closing questions we like to ask all of our guests.

[00:53:21] And the first is what is and there's probably a lot of things, a lot of ways you could go here.

[00:53:27] What is one thing in investing that most of your peers would disagree with you on?

[00:53:34] Yeah, I think it comes back to something I talked about at the very beginning, which is sort of core to my worldview, which is the predictability of growth.

[00:53:39] And I think that most investors implicitly or explicitly believe that historic revenue or EBITDA growth is predictive of future revenue or profit growth.

[00:53:50] And I do not think it is.

[00:53:52] And I think the empirical evidence supports the idea that you can learn almost nothing about the future growth of a company by looking at its historic financial statements.

[00:54:01] And I think that is the most controversial thing.

[00:54:04] And I think the implications of it are so massive that I'd say that that's my greatest point.

[00:54:13] And last one here.

[00:54:15] What's based on your experience in the markets, what's the one lesson you would teach the average investor?

[00:54:21] I think the average investor should look at humility, right?

[00:54:26] I mean, should say, let's take the set of things I think I can do and try to figure out which of those are actually impossible.

[00:54:33] And that once I have a better sense of self-knowledge, I'll be better able to focus in on this sort of universe of things where they are both things I can figure out and things that are possible to know,

[00:54:45] rather than focusing on things which I think, like future growth rates, are clearly impossible.

[00:54:51] Good stuff, Dan.

[00:54:52] Thank you very much.

[00:54:52] We are big fans.

[00:54:53] We wish you all the best with the book.

[00:54:56] And happy holidays.

[00:54:57] Appreciate it.

[00:54:57] Thank you.

[00:54:58] This is Justin again.

[00:54:59] Thanks so much for tuning into this episode of Excess Returns.

[00:55:02] You can follow Jack on Twitter at Practical Quant and follow me on Twitter at JJ Carboneau.

[00:55:08] If you found this discussion interesting and valuable, please subscribe in either iTunes or on YouTube

[00:55:13] or leave a review or a comment.

[00:55:16] We appreciate it.