Expert Investor: Andrew Oskoui – Concentrated Value Investing

HOSTS Alec Renehan & Bryce Leske|4 June, 2020

Meet your hosts

  • Alec Renehan

    Alec developed an interest in investing after realising he was spending all that he was earning. Investing became his form of 'forced saving'. While his first investment, Slater and Gordon (SGH), was a resounding failure, he learnt a lot from that experience. He hopes to share those lessons amongst others through the podcast and help people realise that if he can make money investing, anyone can.
  • Bryce Leske

    Bryce has had an interest in the stock market since his parents encouraged him to save 50c a fortnight from the age of 5. Once he had saved $500 he bought his first stock - BKI - a Listed Investment Company (LIC), and since then hasn't stopped. He hopes that Equity Mates can help make investing understandable and accessible. He loves the Essendon Football Club, and lives in Sydney.

In this expert investor interview, we are joined by the value investor Andrew Oskoui. Andrew is the portfolio manager and principal at Blue Tower Asset Management based in Austin, Texas. Blue Tower combines quantitative analysis with the principles of classic value investing to find interesting opportunities in public markets.

In this interview we explore Andrew’s investment strategy and unpack what combining quantitative analysis and classic value investing means in practice. We then get into some of the opportunities Andrew is seeing in market’s today. In particular we unpack the work Andrew is doing in the Japanese market finding truly undervalued companies. We also touch on some of Andrew’s thoughts on Private Equity and the reasons he sees trouble ahead for this part of the market.


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Bryce: [00:00:57] Hello, Equity Mates, just a quick intro here to let you know that we recorded this interview with Andrew back on the 3rd of April. We thought we should let you know and put some context to when this was recorded, given how much has happened in the markets since. So keep that in mind when listening. And we very much hope you enjoy this interview. Welcome to another episode of Equity Mates, a podcast where we help you learn to invest in 45 minutes or less. We break down the world of investing from beginning to dividend so that you can hopefully make some returns. My name is Bryce and as always, I'm joined by my equity buddy Ren. How's it going, bro? [00:01:30][33.7]

Alec: [00:01:31] I'm very good. Bryce very excited to do this episode because we may be locked down, but we're keeping our interviews going. And this is the first one we've done where we're all in separate rooms. [00:01:43][12.1]

Bryce: [00:01:44] Yes, the show must go on Ren. We are now unfortunately not in our studio beloved studio. However, to your point, technology allows us to continue. So we are going to be doing another expert investor interview today. And we're very excited to welcome Andrew Oskoui to the show. Andrew, welcome. [00:02:04][20.5]

Andrew: [00:02:05] Oh, it's great to be on your show. Thanks for inviting me. [00:02:08][3.3]

Bryce: [00:02:09] So I assume you're also looked down over there in the States? Our audience would know by now, based on your your accent, that you are overseas. How are you going at the moment? [00:02:18][8.7]

Andrew: [00:02:19] Oh, things are going pretty well, about a month's worth of, you know, food and supplies. So it wasn't getting in the panic buying. When everything was going to the grocery stores there, [00:02:30][11.1]

Bryce: [00:02:30] you'd be out of a doomsday prepa. [00:02:31][1.0]

Speaker 4: [00:02:34] Well, six weeks preparation. [00:02:35][1.0]

Bryce: [00:02:37] So Andrew is a portfolio manager at Blue Tower Asset Management. It's a fund that combines quantitative analytical technology with the best practises of classic value investing. So we're very much looking forward to really unpacking what that means. But before we do, Andrew, we always like to start with a bit of a game. So try to Ren who will kick us off? [00:03:00][23.1]

Alec: [00:03:00] Yes, sir. Andrew, the game is called overrated or underrated, but as some guests have previously called out, it probably should be called overvalued or undervalued. But the game is we throw out some investing ideas or themes or indexes and we ask your thoughts on if they're overrated or underrated, just to get a sense of who you are as an investor and what you're thinking about at the moment. So are you up for playing? That sounds great. Okay, so you're based in America, but a Bryce and I are Australian, so we're going to have a bit of home country bias to start things off. Overrated or underrated. The ASX 200 index [00:03:38][37.5]

Andrew: [00:03:39] I would go with overrated and looking at country indexes isn't something I typically do because with my firm we're doing analysis from a bottom up company perspective and you can find great companies anywhere. But if I were to be looking at one country versus another, I would look at it through the sectors that make up that index and then also look at the cyclically adjusted PE ratio of that index relative to its average historically. And with Australia financials and materials, resource stocks are oversized sectors relative to other countries. And I think materials and resources are going to be hurt a lot by the current recession that we're going into. And globally, we're in the low interest rate environment, which also hurts financials by putting their net interest margins. And also, yeah, things are moving very fast with the crisis. It seems like every day in the markets is almost like a month of regular time. But at the end of 2019, the cap ratio of Australia relative to its past was fairly high so, yeah, all of those things together I'd go with over it. [00:04:53][74.5]

Bryce: [00:04:53] And so how do you feel about the S&P 500, overrated or underrated? [00:04:58][5.0]

Andrew: [00:04:59] I would go with it also being overrated. The S&P 500, [00:05:03][3.8]

Andrew: [00:05:04] it's mostly large cap growth stocks [00:05:05][1.7]

Andrew: [00:05:06] right now. The tech companies [00:05:08][1.7]

Andrew: [00:05:09] are a huge part of the index relative to history. And these are [00:05:12][3.3]

Andrew: [00:05:12] really excellent companies and excellent businesses. [00:05:15][3.0]

Andrew: [00:05:16] But they're really priced for perfection right now. [00:05:19][3.0]

Andrew: [00:05:19] People are pricing them to continue [00:05:22][2.9]

Andrew: [00:05:23] executing great into the [00:05:24][1.5]

Andrew: [00:05:25] future. And even if you're investing in a great [00:05:28][3.2]

Andrew: [00:05:28] business, if you're overpaying for it, it can lead [00:05:30][2.0]

Andrew: [00:05:30] to painful [00:05:31][0.3]

Andrew: [00:05:31] stretches of multiple compression. U.S. stocks are trading at a very high premium relative to international. [00:05:38][6.6]

Andrew: [00:05:38] And historically, that hasn't been a case. I mean, it's all of this multiple expansion has happened since the 2008 crisis. [00:05:46][7.1]

Alec: [00:05:47] So, Andrew, moving to the biggest topic that seems to be on everyone's mind at the moment, overrated or underrated, the coronaviruses impact on the economy? [00:05:57][9.9]

Andrew: [00:05:58] Yeah, that's a that's a tough one, because I think the impact of the virus itself, like the primary impact, is overrated. But with a lot of these processes, you can have second order impacts, which can oftentimes be bigger [00:06:13][14.9]

Andrew: [00:06:13] than the primary thing. [00:06:14][1.0]

Andrew: [00:06:14] So it. Could be that the second order [00:06:16][1.7]

Andrew: [00:06:16] impacts is underrated, so [00:06:18][1.8]

Andrew: [00:06:19] whenever I see events like this, I try to look at historical events, things that kind of [00:06:24][5.2]

Andrew: [00:06:24] rhyme with what we're going through right [00:06:26][1.7]

Andrew: [00:06:26] now. And so when I saw this virus in the horizon, I wanted to see how other pandemics in the 20th century had affected financial markets. So I wanted to see what Warren Buffett mentioned in his letters about the 1957 pandemic or the 1968 flu pandemic. Both of these had very high death tolls. The estimates for the 1957 pandemic is that there's one to four million dead and for 1968, around a million dead. And it was kind of surprising to me that, you know, Warren Buffett never even mentioned that in his letters. It didn't have enough of an impact to really even be notable at the time. So it didn't really have that big of a direct economic impact. [00:07:11][45.2]

Andrew: [00:07:12] But with the coronavirus, the [00:07:14][2.2]

Andrew: [00:07:14] world is kind of a different place today than the 50s. [00:07:17][3.1]

Andrew: [00:07:18] 60S were a lot more globalised and interconnected. [00:07:20][2.4]

Andrew: [00:07:21] Also, we have social media and 24 hour news, which means that these viral pandemics can affect the mood of the population a lot more and can affect consumer confidence, business investing to much greater extent than it could in the past. The reaction that the governments are having to this pandemic could be [00:07:42][21.4]

Andrew: [00:07:43] far greater [00:07:43][0.7]

Andrew: [00:07:44] in some cases than the actual [00:07:46][2.0]

Andrew: [00:07:46] virus. But there's a lot [00:07:47][1.0]

Andrew: [00:07:48] that we don't know about [00:07:49][1.2]

Andrew: [00:07:49] the coronavirus. [00:07:50][0.4]

Andrew: [00:07:50] Still, we don't know what the long term effects. I mean, people focus on the fatality rate, but you could have non-fatal morbidities, organ damage that you might not know about years later. And I think looking at it optimistically, people are innovative and creative. The entire world has been galvanised to find solutions to [00:08:10][19.7]

Andrew: [00:08:10] the coronavirus crisis. [00:08:11][1.1]

Andrew: [00:08:12] And we're going into this pandemic with better [00:08:15][3.2]

Andrew: [00:08:16] biotechnology sources than we've ever had before. This set a world record for the [00:08:21][5.7]

Andrew: [00:08:22] fastest time between having a novel pathogen identified and having its genome sequenced. And already there's many vaccine candidates. So, yeah, I would say [00:08:31][8.9]

Andrew: [00:08:31] overrated for the virus itself. [00:08:34][2.8]

Andrew: [00:08:35] I think we're going to be able to confront it with innovation, but people aren't really taking into account how great a lot of the effect of these shutdowns, how big of an effect that's going to have on the economy. It could be that we reach unemployment levels higher than what we saw during the height of the Great Depression. [00:08:52][17.5]

Bryce: [00:08:53] Yeah, very much an unknown. And time will only tell. So, Andrew, we are fascinated with the story of people's first investment. Just to get an idea of where your journey started and any major lessons that have come from that. So are you able to tell us what was your first investment and are there any sort of major things that you learnt from that that still sort of guide you today? [00:09:15][22.3]

Andrew: [00:09:16] Well, to get to my first investment, I'm going to have to go back quite a bit to when I was eight years old. I had always just naturally had an instinct for saving. And I had collected a lot of money from, you know, Christmas gifts and birthdays and doing work around the neighbourhood, doing gardening. [00:09:35][18.8]

Andrew: [00:09:36] And my mother, who is a certified [00:09:37][1.5]

Andrew: [00:09:38] financial planner, she had told me instead of just having it all in, you know, a shoe box, I could invest it in mutual funds. So it was putting in new opportunities fund that I invested and most of my money in through my childhood. And yeah, it had a long time horizon. It was aggressive investments that they were making. It was mostly large cap technology growth stocks. And I believe that if you're not able to dedicate yourself full time to investing, [00:10:05][27.2]

Andrew: [00:10:06] it's usually better to hire skilled manager to do it or index your assets if it's just a very small [00:10:13][7.2]

Andrew: [00:10:14] amount and you don't want to go through the manager selection. [00:10:16][2.3]

Alec: [00:10:17] So, Andrew, from that first investment, you were actually a scientist by trade and now work at Belltower Asset Management. I was Bryce mentioned in the intro. So to start our conversation around Blue Tao, can you tell us what your investing philosophy is? [00:10:32][15.3]

Andrew: [00:10:32] That when I started the firm, I wanted to take the best practises of quantitative rules based investment and combine it with best practises [00:10:42][9.7]

Andrew: [00:10:43] of traditional value investor [00:10:45][2.0]

Andrew: [00:10:46] diligence. So essentially what that means is all [00:10:48][2.1]

Andrew: [00:10:48] of our ideas come from, well, almost all of our ideas come from algorithmic stock screening and a very flexible strategy across all geographies and sectors. [00:10:59][10.5]

Andrew: [00:11:00] Oftentimes, things that become cheap only do so once in a while. And investing is a [00:11:05][5.4]

Andrew: [00:11:05] cafeteria where [00:11:06][0.8]

Andrew: [00:11:06] not everything is always on the menu and there's diversification, benefits, investing globally. And, you know, with having a. Quantitative rules based strategy has hurt a lot of people in the past because oftentimes when stocks become cheap, they're becoming cheap for [00:11:24][17.9]

Andrew: [00:11:25] a good reason. For example, [00:11:26][1.2]

Andrew: [00:11:27] if I were to look at, you know, a stock screen of the cheapest value stocks right now, most of the ones they would be showing up would be airlines and oil exploration companies. And we have you're using a stock screener. It's going to be looking at historical financials. And, you know, the algorithm doesn't know that we have a global pandemic and oil supply glut. So you need to have that human [00:11:53][26.3]

Andrew: [00:11:54] there to override [00:11:54][0.7]

Andrew: [00:11:55] the process. And sometimes stocks that are [00:11:58][3.4]

Andrew: [00:11:59] cheap or cheap for a very good reason. Sometimes there's fraud [00:12:02][3.7]

Andrew: [00:12:03] and purely quantitative strategies have been really burned [00:12:07][3.6]

Andrew: [00:12:07] by [00:12:07][0.0]

Andrew: [00:12:08] frauds in the past. [00:12:09][1.0]

Andrew: [00:12:09] They were in the [00:12:10][1.0]

Andrew: [00:12:11] early 2010s some quantitative mutual funds that invested in a lot of the [00:12:18][6.7]

Andrew: [00:12:18] Chinese reverse merger [00:12:19][1.2]

Andrew: [00:12:20] scandal. Stocks in Canada, such as Sino-Forest, because know, looking at these companies, the balance sheet seemed great. They were generating excellent earnings. But the problem is that the holdings on the balance sheet didn't exist. The earnings didn't either. And so, yeah, these funds got burned pretty badly by that. So I think you do need a human decision maker and you from walking off a cliff because of a quantitative strategy. [00:12:47][26.3]

Alec: [00:12:48] People are interested in the Chinese reverse merger wave. There's a great doco on that called The China Hustle that people can check out. So, Andrew, just to clarify, so I guess you use the quantitative strategy as a tool of investment options. That's when you apply traditional value investment techniques. Is that sort of the philosophy of the fund? [00:13:09][21.1]

Andrew: [00:13:10] Sometimes opportunities that are arbitragers that can show up like Adlard [00:13:15][5.3]

Andrew: [00:13:16] tender offer arbitrage where you're not [00:13:18][2.5]

Andrew: [00:13:18] really investing in a specific company, but it's something that [00:13:22][4.2]

Andrew: [00:13:23] a keyword search [00:13:23][0.7]

Andrew: [00:13:24] financial filings might highlight that there's this opportunity. And so most of the portfolio, though, is made up of these high quality companies that [00:13:34][9.5]

Andrew: [00:13:34] are trading at bargain prices [00:13:35][1.1]

Andrew: [00:13:35] that we find through narrowing down the universe of stocks. [00:13:39][4.0]

Bryce: [00:15:01] So I guess the question that comes out of that is you based in America and by a lot of traditional value investing metrics, America has been extremely expensive of light, at least until sort of twenty twenty here. So how did that strategy go of trying to filter onto the cheapest stocks and then apply value investing techniques in such a frothy market environment [00:15:26][24.6]

Andrew: [00:15:27] with value investing? This has been one of the longest winter of value investing. There hasn't been a period of underperformance this long and some of it comes into how you define value price to book. That was the most commonly used value metric in academic [00:15:47][19.6]

Andrew: [00:15:47] research of [00:15:48][0.6]

Andrew: [00:15:49] studying the value factor. But it might not be as valid anymore in today's market because starting in the 1980s, U.S. stocks began doing a lot more buybacks, which affected their book value. And tangible assets are becoming increasingly important. And another thing to think about with value investing is that value tends to make [00:16:11][22.5]

Andrew: [00:16:12] a lot of their gains through multiple [00:16:14][2.0]

Andrew: [00:16:14] expansions. Essentially, US company gets beaten down very badly, it's [00:16:19][4.8]

Andrew: [00:16:20] trading at a very low multiple. [00:16:21][1.1]

Andrew: [00:16:22] There's a lot of negative emotion around the company and then turns out that the pessimists have gotten overly pessimistic and things aren't as bad as the market thought, or sometimes it's just that a company was very small and it got ignored by the market. And as people start to see the opportunity that's there, it gets a lot more attention and the multiples expand. So it was really this multiple expansion historically that gave a lot of the gains to value investing. [00:16:50][28.6]

Alec: [00:16:52] And I'm just going to jump in there just for people that are unsure with the terminology, multiple expansion. If you want to just define that term really quickly. [00:16:58][6.9]

Andrew: [00:16:59] Sure. So if a company is trading at, let's say, five times earnings, in addition to [00:17:05][6.0]

Andrew: [00:17:06] the return [00:17:06][0.8]

Andrew: [00:17:07] that you get from the dividends at the sockless being, you can also get a return from the multiples expanding. So it goes from five times earnings to 10 times earnings. [00:17:15][7.7]

Andrew: [00:17:15] You doubled the value of your investment. [00:17:17][1.6]

Alec: [00:17:18] Yeah, nice one. And for people that are unfamiliar, that's the price to earnings ratio is the number that he's talking about. [00:17:23][5.4]

Andrew: [00:17:23] The in value historically has outperformed the high [00:17:28][4.2]

Andrew: [00:17:28] price to book growth stocks, [00:17:29][1.2]

Andrew: [00:17:30] and that was because the expensive growth stocks ended up not achieving the growth that people were expecting. And then these stocks got revalued down to lower multiples. But over the past 10 years, that hasn't been what's been occurring. Value multiples keep getting cheaper and growth multiples keep on expanding. Historically, the performance of values has been cyclical. And, you know, you can go look at the headlines of the 90s. [00:17:54][24.4]

Andrew: [00:17:55] People were talking about [00:17:56][0.9]

Andrew: [00:17:56] values, death back then as well. And people wondered if Warren Buffett had lost his touch because he wasn't investing in these dotcom named bubble. If 98 and 99. [00:18:06][10.0]

Andrew: [00:18:07] Whenever you start hearing people [00:18:08][1.5]

Andrew: [00:18:09] say that value investing is dead and after a long period of underperformance, that tends to be when the cycle [00:18:15][6.3]

Andrew: [00:18:16] reverts [00:18:16][0.0]

Andrew: [00:18:17] and then value has a [00:18:18][1.5]

Andrew: [00:18:18] great period of [00:18:19][0.6]

Andrew: [00:18:19] excellent outperformance. And yeah, the relative multiples between value and growth right now or I mean, the spread is truly one of the biggest in market history. So optimistic that that's going to reverse itself. [00:18:33][13.6]

Bryce: [00:18:34] So, Andrew, you mentioned that investing is like a cafeteria where not everything's always on the menu, which is a great way to put it. And we always like understanding what is on the menu, given what has occurred over the last sort of eight weeks or so in the markets. I'm imagining that your screeners would probably be lighting up a bit more than they were towards the end of last year. Is there anything that is sort of on your watch list that you're finding very interesting at the moment? Or are you still seeing a lot of companies overvalued? And and this is just a little blip. How are you seeing your watchlist at the moment? [00:19:10][36.6]

Andrew: [00:19:11] You're seeing some really great opportunities. I mean, this is more of a target rich environment than I've ever seen in my investing career. The biggest thing with this kind of market that we're in right now of [00:19:24][12.6]

Andrew: [00:19:24] the coronavirus crisis is [00:19:26][1.9]

Andrew: [00:19:26] all of financial crises. They are kind of similar in that there's a massive range of possible outcomes. No one can really disprove the most negative outcomes [00:19:35][9.0]

Andrew: [00:19:36] or disprove the [00:19:36][0.7]

Andrew: [00:19:36] most optimistic outcomes. And dispersion of potential [00:19:40][3.2]

Andrew: [00:19:40] features makes a lot of people [00:19:42][1.5]

Andrew: [00:19:42] unsure of what to do when they sit on their hands and wait [00:19:46][3.3]

Andrew: [00:19:46] for clarity of the [00:19:47][1.3]

Andrew: [00:19:47] situation. [00:19:47][0.0]

Andrew: [00:19:48] Of course, once [00:19:49][1.0]

Andrew: [00:19:49] there's a happy consensus, then [00:19:51][1.6]

Andrew: [00:19:51] the prices are going to [00:19:53][1.3]

Andrew: [00:19:53] be much higher [00:19:54][0.5]

Andrew: [00:19:54] in [00:19:54][0.0]

Andrew: [00:19:54] whatever direction the consensus is to go into. So, yeah, in this current environment, one of the most salient features is that there's been a massive liquidity crunch for the U.S. dollar, and that's caused some of the days of the past month. We've seen big declines in not just stocks, but bonds. In the same day, there have been days where stocks, bonds and gold all had a [00:20:19][24.6]

Andrew: [00:20:19] very [00:20:19][0.0]

Andrew: [00:20:19] large negative moves in the same day. And what's that showing is that people with [00:20:23][3.9]

Andrew: [00:20:24] diversified portfolios, either they're having [00:20:25][2.0]

Andrew: [00:20:26] margin calls you to leverage that they had and they have to raise cash. And so they're just selling everything or they are having redemptions. And so it's really a forced selling behaviour. And when you see this forced selling, combined [00:20:38][12.4]

Andrew: [00:20:39] with very few buyers, [00:20:40][0.8]

Andrew: [00:20:41] what happens is that a lot of the least liquid positions sell off more then more liquid positions. So and by liquid, I mean just how much volume that security has. So if we look in the U.S. market, large caps as of right now are down about 24 percent. But small cap stocks are [00:21:03][22.1]

Andrew: [00:21:04] down around 35 percent. So it's really [00:21:06][2.7]

Andrew: [00:21:07] that the low volume stocks have fallen more. So when people see these steep declines, they sometimes see it as a buying. No opportunity to just buy anything and see people wanting to buy airlines or invest in stocks just because they've gone down, but a lot of these companies are going to end up going bankrupt. I mean, stock that fell 90 percent could have just been a stock that fell 80 percent and then fell another 50 percent. So just because a stock is falling a lot doesn't mean it's not going to keep on falling. So I would tell people to try to avoid bankruptcy risk and focus more on high quality companies that may have fallen a lot just because they're not very liquid, especially in some markets. You know, Japanese microcaps [00:21:54][47.0]

Andrew: [00:21:55] have very low [00:21:56][0.9]

Andrew: [00:21:57] liquidity. And it's really amazing some of the bargains that you can find in the Japanese small cap and micro-cap stocks. [00:22:04][7.3]

Andrew: [00:22:05] There's free [00:22:05][0.5]

Andrew: [00:22:05] cash flow, positive dividend paying companies there that have negative enterprise value, which means that market cap of the business is lower than the net cash position of the business, which is kind of difficult [00:22:21][15.7]

Andrew: [00:22:21] to wrap your head around [00:22:23][1.4]

Andrew: [00:22:23] how things could possibly be that cheap. But, yeah, people are just forced to sell. And so things can decline a lot when there isn't any buying volume. There wouldn't have been these kinds of negative enterprise stocks, you know, two years ago when there wasn't this kind of crisis environment. [00:22:40][16.5]

Alec: [00:22:41] That's fascinating. I think a lot of people are probably Googling Japanese small caps at the moment to try to find some of those bargains. [00:22:49][8.1]

Bryce: [00:22:50] Andrea, just just write out 10 of the stocks on your list. That would be really helpful. [00:22:54][3.7]

Alec: [00:22:54] So I guess I wonder, even before this crisis, you were interested in Japan. I read in your Q4 Blue towelled that you had some exposure to Japan. And I think for a lot of people, Japan is a really confusing market. You know, the Bank of Japan owns over 70 percent of the Japanese ETF market. They've done quantitative easing to a massive extent over there. How do you think about Japan and investing in Japan when there's, you know, so much central bank activity and so much government involvement? [00:23:26][32.0]

Andrew: [00:23:27] You yeah. With the Japanese market, it's important to keep in mind that historically [00:23:32][4.8]

Andrew: [00:23:33] stock returns [00:23:33][0.4]

Andrew: [00:23:34] and GDP growth have not been very [00:23:37][2.6]

Andrew: [00:23:37] well correlated. [00:23:38][0.5]

Andrew: [00:23:38] In fact, little correlation that does exist is actually slightly negative. So if you could [00:23:44][5.3]

Andrew: [00:23:44] see with perfect foresight [00:23:45][1.2]

Andrew: [00:23:46] which countries were going to have high versus low GDP growth, you would have actually got in better returns [00:23:51][5.5]

Andrew: [00:23:52] being in the lower GDP growth countries. [00:23:54][2.3]

Andrew: [00:23:55] And so with Japan, a lot of the reason why they're having such a high intervention of the Bank of Japan into the ETF market there and buying the government debt. At the moment, most of the government debt of Japan is owned by the central bank. They own most of the ETF market and about eight percent of the equity market as a whole. And the reason they are making such aggressive interventions is to try to get positive inflation. They're trying to avoid this [00:24:27][32.0]

Andrew: [00:24:27] deflationary [00:24:27][0.0]

Andrew: [00:24:28] spiral, and it's deflation is coming in Japan just due to the saving nature of the population there and also the demographics that they're having right now of such [00:24:39][11.3]

Andrew: [00:24:39] a large retired population relative to the overall [00:24:43][4.1]

Andrew: [00:24:44] population of Japan. And so [00:24:45][1.4]

Andrew: [00:24:46] and these are deflationary pressures [00:24:47][1.5]

Andrew: [00:24:48] and that's why they're having this large intervention. [00:24:50][2.5]

Alec: [00:24:51] And that as a value investor, do you think about that or are you just looking at individual companies, regardless if the Bank of Japan or another central bank has to be sort of buying them to support the broader economy? [00:25:04][12.9]

Andrew: [00:25:05] Yeah, I think you should look at these companies on a standalone basis, but it's one of the effects of this equity buying by the Bank of Japan because they're going and purchasing these ETFs, which tend to be [00:25:17][12.3]

Andrew: [00:25:18] the larger stocks in the [00:25:19][1.4]

Andrew: [00:25:19] market, the small caps in Japan, they've kind of become orphan securities with no investor constituency that's following them. Large institutions don't want to research them because even if they did find a good opportunity there due to the low volume issues, they can't really invest a large [00:25:37][18.4]

Andrew: [00:25:38] amount of their portfolio [00:25:39][1.0]

Andrew: [00:25:40] into these stocks. And a lot of these really small Japanese companies, they don't publish any of their financials in English, which really [00:25:47][7.4]

Andrew: [00:25:47] puts off foreign investors. So, yeah, it's very few [00:25:50][3.1]

Andrew: [00:25:51] people following them. None of the Japanese securities in our portfolio have any sell side analyst coverage. And so, yeah, when you have no one that's really following these kinds of companies, they can become inefficiently priced. And that creates opportunities for people who are [00:26:09][18.1]

Andrew: [00:26:09] willing to do the research and [00:26:10][1.2]

Andrew: [00:26:10] have low capital base so they can actually take meaningful. And some of these companies, but, yeah, I would warn people when negative aspect of that, especially in the current environment, is that because there's been this global liquidity crunch, that's doubly the case with these Japanese stocks. And so, I mean, March was such a crazy month. There's such amazing volatility. We saw one of the best single daily increases in the S&P 500 in March and second worst percentage drop in March. But one of the crazy things I was seeing in Japan was that the bid ask spread of some of these stocks that got into such a broad range that the bid ask spread was 20 percent of the closing price of some of these Japanese stocks in our portfolio. So the bid price is what people are willing to buy a stock at. And the ask is what they're willing to sell it at. And so you had distance between that is 20 percent of the stock price means that you're trying to buy and sell these very quickly. You're going to be losing a lot crossing that spread each time. So these kinds of companies, [00:27:21][70.4]

Andrew: [00:27:21] you have to really do your due [00:27:23][1.6]

Andrew: [00:27:23] diligence and be willing to hold it [00:27:25][1.6]

Andrew: [00:27:25] for multiyear holding periods to [00:27:27][2.0]

Andrew: [00:27:27] get the benefits of their cheap valuation. [00:27:29][1.4]

Alec: [00:27:30] It's a fascinating market and it's definitely something that if there are negative enterprise value companies, I'm sure a lot of people will be looking more closely at. Sounds like some people might have to learn Japanese to really do the research, though. And one other topic that you wrote about in your Q4 letter that I'm interested in getting your thoughts on was private equity. And for people who are unfamiliar, private equity has been an unbelievable performer since the GFC. It's essentially, you know, investors give an investor or a company a big pool of money to then go and buy assets, buy companies, a lot of distressed companies normally. And yeah, it's been a it's been a big, big winner since the global financial crisis. So you wrote about private equity in your letter. And if we start quite broadly, can you just explain what you wrote about and what your thesis was in your letter? [00:28:22][52.0]

Andrew: [00:28:23] Oh, certainly private equity, which can cover, you know, huge range of different strategies, including venture and infrastructure projects. And but in my letter, I was focussing on the buyout funds of private equity, which is what most people think of as the typical private equity fund. And this used to be a really great investment strategy. But like any great strategy, if it gets overly crowded, it's going to [00:28:50][26.8]

Andrew: [00:28:50] cause the returns to deteriorate [00:28:52][1.6]

Andrew: [00:28:53] because no strategy has an infinite capacity for capital to really look at private equity. I mean, it used to be one of the really best returning strategies of the 20th century, especially in the 1980s and 1990s. And we don't have that great of data [00:29:09][16.2]

Andrew: [00:29:09] for the returns that [00:29:11][1.5]

Andrew: [00:29:11] people got in those periods because things weren't systematised with databases like we have today. But just to give an example, in January 1982, [00:29:19][7.6]

Andrew: [00:29:20] the former U.S. secretary of the Treasury, William [00:29:23][2.9]

Andrew: [00:29:23] Simon, he got together, a group of investors, and they acquired Gibson [00:29:27][3.8]

Andrew: [00:29:28] Greetings, which was pretty short of greeting cards in the U.S. and they purchased the company for 80 million dollars with the rumour was that [00:29:36][7.7]

Andrew: [00:29:36] one million of that 80 million was their own capital and the other 79 was debt. And then by midnight 1983, just six months after the original deal, they ended up doing an IPO of the company and they sold it [00:29:51][15.3]

Andrew: [00:29:51] for 290 [00:29:52][0.8]

Andrew: [00:29:53] million. And Simon himself, the portfolio manager, his cut of that was he made a six million dollar profit, which, yeah, those kinds of returns in [00:30:02][9.4]

Andrew: [00:30:03] just two years show you. [00:30:04][1.1]

Andrew: [00:30:04] I mean, this is just an anecdote, but, yeah, you could make really great returns. Essentially, what was happening is they were buying these illiquid private companies at low multiples. So it was, you know, kind of like buying small value equities. They would use primarily debt to make the purchase and then they would IPO the stocks at a higher multiple. So they're getting the advantage of leverage and then they're also taking advantage [00:30:31][26.2]

Andrew: [00:30:31] of their arbitraging [00:30:32][0.9]

Andrew: [00:30:33] the [00:30:33][0.0]

Andrew: [00:30:33] multiple difference [00:30:34][0.5]

Andrew: [00:30:35] because private companies could buy them at a much lower multiple than equivalent publicly traded companies for trade at sea, buy them, lever them up, and then IPO [00:30:44][9.4]

Andrew: [00:30:45] them or sell them. And a really excellent strategy when it worked. [00:30:48][3.5]

Andrew: [00:30:49] But since 2014, the buyout multiples that private equity has been paying have just been getting at extremely high levels because of all the competition for these deals. So in the 90s, a typical multiple they would pay would be six to eight times enterprise value to EBITA. And in 2019 the median multiple was 11 times enterprise value to even a. And compounding it is in the U.S. now, they're making changes to corporate tax law that the tax shield of interest payments is going to be reduced in 2022. So it's not going to be as advantageous to put a lot of debt onto a company because your interest that you're paying on your debt, if it's sufficiently high [00:31:35][45.6]

Andrew: [00:31:35] relative to your earnings, [00:31:37][1.5]

Andrew: [00:31:37] you're not going to be able to get the full deduction of that on your taxes. [00:31:41][4.0]

Andrew: [00:31:42] So there's more and more [00:31:43][1.2]

Andrew: [00:31:44] money moving into private equity. They're having [00:31:46][2.7]

Andrew: [00:31:47] to overpay or move into more risky [00:31:50][3.2]

Andrew: [00:31:51] investments, and that's going to [00:31:53][2.7]

Andrew: [00:31:53] cause their returns to deteriorate. [00:31:55][1.4]

Andrew: [00:31:56] There might even be negative real returns at these kinds of multiples that they're paying. And they're definitely, at this point, paying more than the equivalent public stocks. And for the most part, they're not really making these amazing operational improvements that they're claiming to be making. You're seeing business investments cut at a lot of these acquired targets as Gené is being cut. But, you know, we're not going to know how bad the returns of the deals being made in 2019 will be until, you know, a decade from now. [00:32:28][32.1]

Bryce: [00:32:28] It's hard to know, I guess, what is going to happen. I think one of Alec's bold predictions at the start of the year, we will do an episode where we try and make some bold predictions for what we think might happen. And from memory, one of Alex was private equity will stumble in 2020. Was that true, Alex? [00:32:45][17.0]

Alec: [00:32:46] Yeah, that was my predictions are my fingers crossed. I mean, not everyone that works in private equity or invests in it, but yeah, I think and what you write in your letter really resonated with me that there is so much money in the space and that as more money goes in, they're chasing less attractive and less attractive opportunities and they're willing to accept worse and worse returns on the capital that they're investing or having having to take high risks to maintain a good return. It just seems like at some point something's going to have to change. [00:33:17][31.1]

Andrew: [00:33:18] And also something to think about with the people investing in private equity right now is essentially the principal agent problem that we're seeing from institutional investors, that when you have these big pension funds managing the retirements of a million public employees, they the managers of this fund, it's, you know, a very great position. It's really kind of a terminal career position. It's hard to move up from that kind of job. And so people want to keep their job when they're in these pension funds and they have this Trade-Off where if they allocate to a public equities manager and the public equity manager, you know, someone who's trading publicly traded stocks, if they have a bad [00:34:01][43.6]

Andrew: [00:34:02] year stocks or mark to [00:34:03][1.5]

Andrew: [00:34:03] market on an ongoing basis every single day. And so be very obvious if the managers lost money. And so the allocator of the pension fund runs the risk of being fired. But if a private equity firm makes a bad investment, it's going to take years to find out maybe, you know, five to 10 years. And by then perhaps the allocators moved on to a different institution or has retired. And because private equity holdings aren't mark to market, instead, they use these accounting estimates of value with the estimate being made by the private equity firm itself. And so it's not until they do the winding down of the fund vintage of that year and sell off the holdings that you really see. What was the true return from beginning to end for those investors? Yeah, so it's kind of strange to think of it that way. We tend to think of liquidity as being something people want to pay a premium for. [00:35:02][59.2]

Andrew: [00:35:03] But at least [00:35:03][0.4]

Andrew: [00:35:03] with private equity, it seems that the illiquid assets are now trading at a premium to things that are very transparent and public. And this really amazing broadcast that one of the pension funds did, that they have their meeting open to the public on YouTube. And so they had the board asking the allocators, questions about the different investments. And one of the allocators of this fund was actually saying that having their investments, being not transparent and using these estimates of value as opposed to being mark to market makes their investments less risky, because if they don't see the price move a lot, there is only [00:35:48][44.5]

Andrew: [00:35:49] value maybe four times a year or 12 times a year, whereas [00:35:52][3.5]

Andrew: [00:35:53] stocks are being constantly valued and their price is jumping around a lot. It means that the private equity investments are less volatile and they're price at lower. Volatility means that they're less risky. And so he actually called it time diversification, which is a term I never heard before, that having something that is illiquid. Opaque in what it's really worth and, you know, valued [00:36:18][24.5]

Andrew: [00:36:18] by private equity firm itself as opposed to the market pricing [00:36:22][3.6]

Andrew: [00:36:22] it, they're saying that makes it inherently less risky, which I found amusing. I think that some motivated thinking. [00:36:29][6.8]

Alec: [00:36:30] Yeah, yeah. For Australians trying to think about the the risks of illiquid assets that are priced by the company where the alternative asset manager, Blue Sky, who was in the headlines with some of the valuations that they'd put on the what their holdings, and then a big U.S. short seller came in and sort of blasted them and they're now out of business. So there's definitely some risk if if the market's not pricing your assets, but rather the companies is so an interesting one to think about. But, Andrew, we quickly running out of time. So we want to get to sort of what's going on in markets now and I guess your outlook moving forward. Bryce mentioned that way. You do I bold predictions episode every year. And so I guess now we're not going to hold you to this. And if you don't have any predictions, that's OK. But do you have any predictions or any thoughts on what we're going to say in markets for the remainder of 2020? [00:37:23][53.3]

Andrew: [00:37:24] Yeah, with 2020, the thing that's going to really be driving the returns for the whole year is the coronaviruses crisis. [00:37:31][7.5]

Andrew: [00:37:32] Whether you believe [00:37:33][0.9]

Andrew: [00:37:34] the optimistic or pessimistic outcomes of treating the disease and also what the government reaction is going to be in the US. They just approved two weeks ago this two point two trillion dollar stimulus, the biggest in history. And there's already talk of doing further stimulus, of doing another [00:37:54][20.3]

Andrew: [00:37:54] infrastructure [00:37:54][0.0]

Andrew: [00:37:55] stimulus bill to do government funded construction projects. And the US is taking a lesson from Japan and the Treasury [00:38:04][8.2]

Andrew: [00:38:04] is going to start [00:38:05][0.4]

Andrew: [00:38:05] buying ETFs in the U.S. stock market. So, yeah, it's a lot of uncertainty. I think that the coronavirus is not going to have as much of a disruption on the U.S. economy as some people are thinking. SARS, some [00:38:21][16.0]

Andrew: [00:38:21] Federal Reserve chairs. [00:38:22][1.0]

Andrew: [00:38:23] We're seeing GDP declines of thirty six percent quarter from twenty nineteen. And I think that's possible. But I'm going to predict that it's not going to be that bad. And the massive injection of liquidity into the U.S., if we do do another infrastructure bill and this two point two trillion dollar stimulus and the other central bank bond buying programmes, if it ends up being the case that the virus wasn't that bad, we could see the beginnings of inflation in the US dollar. And so, yeah, I think from where we are right now at the beginning of April, I think indexes are going to likely end the year higher than they are right now. I think we're at the maximum of uncertainty, which tends to depress valuations. [00:39:14][51.3]

Bryce: [00:39:15] So interesting where we have that in right now. And on audio side, we would check in with you at the end of the year. Andrew, we've reached our time to to wrap up, unfortunately. But, you know, it's been a fascinating conversation. Before we get to our final three questions that we always finish with, Alec has mentioned a few times throughout the episode about your investor letters and particularly your Q4 one that you've sort of recently sent out. If our listeners want to read a bit more about what you're doing and some of your thesis is where could they go to find more information? [00:39:52][36.7]

Andrew: [00:39:53] Oh, you could go to our website, Blue Tower, ASOT dot com. We have all of the letters we've ever published on the website. And you can also see past factsheets of [00:40:04][11.4]

Andrew: [00:40:04] what our [00:40:05][0.2]

Andrew: [00:40:05] top 10 portfolio holdings of past [00:40:07][2.1]

Andrew: [00:40:07] quarters. [00:40:07][0.0]

Andrew: [00:40:08] And if people are interested in learning more about our strategy, you can apply for [00:40:14][5.3]

Andrew: [00:40:14] an account from our website. We use interactive brokers as a [00:40:17][3.4]

Andrew: [00:40:17] custodian, which I think is one of the best platforms out there for international investing. And it's open to Australian investors, not one. [00:40:26][8.8]

Alec: [00:40:26] Willandra, as Bryce said, we always finish the interview with the same final three questions, so we'll jump into those. Now, the first one is do you have any must read books? And these can be investing or otherwise? [00:40:39][12.6]

Andrew: [00:40:40] I would say I've been a fan of Joel Greenblatt and he has a book called You Can Be a Stock Market Genius, which was published a while ago at this point. But the general idea of his book is that markets are not efficient and securities can become mispriced. And the book goes over some common situations that often lead to mispricing. And another I'd recommend is when Genius failed the rise and fall of Long Term Capital Management by Roger Lowenstein. You know, these days of leveraged strategies getting blown up by the volatility, I think it. A good idea to look at this long term Capital Management, a hedge fund that had multiple Nobel laureates of economics in their management, huge portfolio and a lot of institutional backers, and they had such a massive blow up that the [00:41:31][50.7]

Andrew: [00:41:31] Federal Reserve had [00:41:32][0.9]

Andrew: [00:41:32] to step in to stabilise it. And it's a great lesson about the perils of using too much leverage for that type of strategy that you're in. [00:41:41][8.6]

Alec: [00:41:41] Yeah, the long term capital management story is a crazy finance story definitely worth learning more about. So, Andrew, the second question is, what is your go to source for investing information? [00:41:53][11.0]

Andrew: [00:41:54] I'm not a fan of Garou focus or downloading financial data. There's a lot of different platforms out there. Bloomberg seen as icons. People, if they just want to have financial data on equities, should look into what fits their needs the best. I always like to look at the actual filings of companies to double check that data and all of these platforms. You know, in Japan, they have the idea that the US has the [00:42:22][28.8]

Andrew: [00:42:23] Edgars for the [00:42:24][0.9]

Andrew: [00:42:24] raw filings because even the best of these databases, they can oftentimes have very mistaken data, [00:42:31][7.2]

Andrew: [00:42:32] especially for these [00:42:33][0.9]

Andrew: [00:42:33] smaller companies and with companies. If you want to catch up on what other people are saying about it, you can speed up your research by looking at a lot of the value investing forums like Value Investors Club, [00:42:45][12.4]

Andrew: [00:42:46] Sub-Zero or corner of Berkshire and Fairfax. [00:42:49][3.2]

Andrew: [00:42:50] And yeah, someone has already written up a two page thesis on your company and it can save you a lot of time. [00:42:55][5.1]

Alec: [00:42:56] Yeah, I definitely think they're good suggestions and it's a good call out around trusting the data on some of those screener's. I've I've used good focus before and have had that issue, especially when looking at Australian stocks. I guess they don't get as much attention as some of the U.S. ones on the platform. This leads us to our third and final question. If you think about, you know, your younger self when you're just starting out making your first investment. What advice would you have for your younger self? [00:43:22][25.7]

Andrew: [00:43:22] I would say don't get too focussed [00:43:24][1.8]

Andrew: [00:43:25] or have [00:43:26][0.7]

Andrew: [00:43:27] tunnel vision on achieving [00:43:28][1.6]

Andrew: [00:43:29] your short term goals. [00:43:30][1.3]

Andrew: [00:43:31] People should be open [00:43:32][0.7]

Andrew: [00:43:32] to whatever opportunities [00:43:33][1.1]

Andrew: [00:43:34] might come by. It's an unpredictable world and you don't know what the future holds and who might be a person to teach you something new that's important or who's going to start the next Google. So whenever you find people in your life that are, you know, genuine quality, people maintain friendships with them, make it a priority. Even if they move to a different city, it's not too hard to do occasional email, see how they're doing and phone calls, especially now with all of us in seclusion. I think it's a great opportunity to catch up on old friends that fallen out of touch with. [00:44:07][33.1]

Bryce: [00:44:08] That's why I've been hanging around Alec for the last few years, because I'm hoping he's going to start the next Google yet to play out the way. Andrew Massive, thank you for joining us this morning. As we're all in isolation, I'm sure our audience will get a lot out of that interview as we have. So a big thank you and very much. Looking forward to continuing to to read your letters and seeing how a blue time progresses over this year. And perhaps we'll check in later in the year to see how your bold predictions pan out. So from Alec and I thank you very much for joining us. [00:44:42][33.9]

Andrew: [00:44:42] Thank you for having me. [00:44:43][0.7]

Speaker 5: [00:44:44] Thanks for listening to Equity Mates investing podcast production of Equity Mates Media. Please remember that everything you hear in Equity Mates investment podcast is general advice on link. The content has been prepared without knowing the personal objectives, specific financial circumstances or goals. The host of Equity Mates investment podcast may maintain positions in the companies discussed before considering any investment. Please read the product disclosure statement and consider speaking to a licenced financial professional. [00:44:44][0.0]


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