WEBVTT - Hotchkis’ Green on High Quality at Low Valuations 0:00:11.720 --> 0:00:14.880 Welcome to Inside Active, a podcast about active managers that 0:00:14.920 --> 0:00:18.000 goes beyond sound bites and headlines and looks deeper into 0:00:18.040 --> 0:00:22.840 their processes, challenges, and philosophies and security selection. I'm David 0:00:22.920 --> 0:00:26.240 cone I, lead mutual fund and active research at Bloomberg Intelligence. 0:00:26.600 --> 0:00:29.840 Today my co host is Michael Casper, sector and small 0:00:29.880 --> 0:00:33.560 cap strategist at Bloomberg Intelligence. Mike, thanks for joining me today. 0:00:34.040 --> 0:00:34.600 Thanks dude. 0:00:35.720 --> 0:00:38.839 So you wrote a note last week talking about small 0:00:38.880 --> 0:00:42.360 caps in the election, and so you know, I think 0:00:42.360 --> 0:00:44.479 our audience would probably love to hear or how the 0:00:44.520 --> 0:00:46.920 election has affected small cap stocks. 0:00:47.240 --> 0:00:51.120 Yeah. So from a technical standpoint, I'll go over that first. 0:00:52.200 --> 0:00:55.200 The Russell two thousand has broken out of pretty much 0:00:55.200 --> 0:00:59.080 it's twenty twenty four range and is approaching all time 0:00:59.160 --> 0:01:03.160 highs pretty much. That's the only resistance that we're seeing 0:01:03.160 --> 0:01:06.160 in the chart for the Russell two thousands to the upside. 0:01:06.319 --> 0:01:08.399 RSI is still a little bit shy of where it 0:01:08.440 --> 0:01:12.279 tops out, typically above a seventy handle. We're currently sitting 0:01:12.280 --> 0:01:15.759 at about a sixty seven handle on RSI, and mac 0:01:15.800 --> 0:01:20.160 D has crusted over the signal line and positive. So everything, 0:01:20.160 --> 0:01:23.320 at least from a technical standpoint looking pretty good. We 0:01:23.360 --> 0:01:26.479 did a little bit of analysis though on Trump's first 0:01:26.560 --> 0:01:29.640 term and how small caps did. Of course, his initial 0:01:29.720 --> 0:01:34.960 election back in twenty sixteen caused some hope for the 0:01:35.040 --> 0:01:38.440 Rust of two thousand going into his first term about 0:01:38.440 --> 0:01:42.240 tax reform and maybe some protectionist policies that could help 0:01:42.600 --> 0:01:46.080 a reshoring effort towards small caps. We really saw that 0:01:46.120 --> 0:01:52.720 play out from twenty sixteen into early twenty eighteen, where 0:01:52.760 --> 0:01:57.080 small caps had a big cycle of outperformance, but from 0:01:57.080 --> 0:02:00.320 then on it was a bit more rocky for the 0:02:00.400 --> 0:02:04.720 Russell two thousand. Fundamentally, this definitely did show up in 0:02:04.800 --> 0:02:07.240 revenue growth numbers. They exceeded the S and P five 0:02:07.320 --> 0:02:11.680 hundreds revenue growth for a pretty good stretch from twenty 0:02:11.720 --> 0:02:17.320 seventeen to twenty eighteen. So kind of hoping that some 0:02:17.360 --> 0:02:21.040 of that comes back, But again a bit of a 0:02:21.040 --> 0:02:25.880 bumpy ride at least from when Terra started getting announced onwards, 0:02:26.000 --> 0:02:28.160 and of course there was a lot of monetary policy 0:02:28.440 --> 0:02:30.880 and other stuff going on at the same time, so 0:02:31.600 --> 0:02:36.760 it can't be all attributed to Trump's trade and fiscal policies. 0:02:37.720 --> 0:02:40.520 It'll be interesting to watch, but I think we'll talk 0:02:40.560 --> 0:02:43.280 a little bit more about small caps with our guest today, 0:02:43.919 --> 0:02:46.840 and with that, I'd like to welcome David Green. David 0:02:46.960 --> 0:02:50.200 is a principle of Hotchison Wiley and a portfolio manager 0:02:50.560 --> 0:02:55.720 on the small cap value, value Opportunities and international value portfolios. David, 0:02:55.760 --> 0:02:56.919 thanks for joining us today. 0:02:57.840 --> 0:02:59.280 It's my pleasure great to be here. 0:03:00.000 --> 0:03:02.280 I'm sure our listeners would love to hear how you 0:03:02.320 --> 0:03:05.880 got your start in the investment business. 0:03:06.480 --> 0:03:09.080 Well, I got my start at a very young age. 0:03:09.120 --> 0:03:12.880 My dad was a physicist by trade, but he loved 0:03:12.840 --> 0:03:15.320 to invest in the stock market. And I grew up 0:03:15.360 --> 0:03:18.320 here in Los Angeles, and the market opens about six thirty. 0:03:18.400 --> 0:03:21.079 It opens at six thirty in the morning here, and 0:03:21.320 --> 0:03:23.080 he would have me sit in front of the TV. 0:03:23.240 --> 0:03:25.800 It wasn't there was no CNBC, there was no Internet. 0:03:26.240 --> 0:03:28.160 But when he was getting ready for work and before 0:03:28.200 --> 0:03:29.960 I went to school, he would say, can you just 0:03:30.000 --> 0:03:33.160 watch these tickers and tell me you know what g 0:03:33.480 --> 0:03:35.440 is when it comes by, or what Coca cola is 0:03:35.480 --> 0:03:36.200 when it comes by. 0:03:36.920 --> 0:03:37.800 And so before I. 0:03:37.840 --> 0:03:41.320 Knew it, I went from not only following the box 0:03:41.360 --> 0:03:43.720 scores of all my Major League of the Major League 0:03:43.720 --> 0:03:46.880 Baseball teams, but the stock quotes and the newspapers the 0:03:46.920 --> 0:03:50.120 next morning, and I got very interested. I then went 0:03:50.160 --> 0:03:54.000 on to college at Berkeley and I studied economics, and 0:03:54.040 --> 0:03:57.640 then I went first to Potential Investment Corp, then to 0:03:57.760 --> 0:04:00.280 Goldman Sachs, and then to Hotchkison Wiley, were I've been 0:04:00.320 --> 0:04:03.680 for twenty seven years now, and all but one year 0:04:03.720 --> 0:04:05.840 of that time I've been on the public market side. 0:04:05.880 --> 0:04:09.440 So I was able to turn what cultures started as 0:04:09.480 --> 0:04:12.600 a as a spark from a hobby that my dad 0:04:12.640 --> 0:04:14.720 had into my own passion and make. 0:04:14.560 --> 0:04:15.400 A career out of it. 0:04:16.120 --> 0:04:18.520 Great. Well, you know you mentioned Hodgkisson Wiley, and you 0:04:18.600 --> 0:04:20.520 know that's what we're going to be talking about today. 0:04:20.800 --> 0:04:23.080 Could you kind of give us a brief overview of 0:04:23.120 --> 0:04:25.560 the equity investment philosophy of the firm? 0:04:26.800 --> 0:04:27.120 Sure? 0:04:27.279 --> 0:04:27.359 So. 0:04:27.480 --> 0:04:31.320 Hotkinson Wiley was founded by John Hotchkinson George Wiley in 0:04:31.440 --> 0:04:35.839 nineteen eighty and they founded on it on a value philosophy. 0:04:36.440 --> 0:04:39.400 And if you go back, you know, well before Hotchkinson 0:04:39.440 --> 0:04:42.599 Wiley's founding, we have data that goes back actually to 0:04:42.720 --> 0:04:46.080 nineteen twenty six, almost one hundred years now. Value has 0:04:46.120 --> 0:04:48.680 been a very powerful force of outperformance in the market. 0:04:48.800 --> 0:04:51.760 Notwithstanding sort of the recent past but even if you 0:04:51.800 --> 0:04:53.840 include that recent past and you still go back, it's 0:04:53.839 --> 0:04:57.440 still significantly outperforms. And the idea is that if you 0:04:57.520 --> 0:05:00.479 buy a stock with a at a low price, you've 0:05:00.480 --> 0:05:04.000 got a built in margin of safety and it's very 0:05:04.040 --> 0:05:08.240 hard to predict the long term future. But when investors 0:05:08.240 --> 0:05:12.040 are paying very high prices for growth, oftentimes that growth 0:05:12.080 --> 0:05:15.359 does not materialize. And if you're buying something at a 0:05:15.360 --> 0:05:18.119 low valuation, you have you know, you have better chance 0:05:18.200 --> 0:05:20.920 that your downside is supported. And so that was the 0:05:20.960 --> 0:05:23.320 philosophy that originally started with the firm, and it's the 0:05:23.400 --> 0:05:26.200 DNA which continues to the firm. In the firm to 0:05:26.240 --> 0:05:31.320 this day, forty four years later. I would also say, 0:05:31.520 --> 0:05:35.839 as the firm has matured, we have spent an inordan 0:05:35.880 --> 0:05:40.440 amount of resources and investment on the research process. Today 0:05:40.560 --> 0:05:43.920 I I I. If you think about Hotchkisson, while I 0:05:43.960 --> 0:05:46.760 always say there's three things to think about. The first 0:05:46.800 --> 0:05:49.520 is value, the second is research, and the third is culture. 0:05:50.360 --> 0:05:53.359 And each one of those is integral and important to 0:05:53.640 --> 0:05:55.960 sort of who we are as a firm. But the 0:05:55.960 --> 0:05:59.040 research on the research side, we have twenty three people 0:05:59.120 --> 0:06:01.760 focused exclude on research, and this is a firm with 0:06:02.360 --> 0:06:05.080 under seventy people in the total firm, and in addition 0:06:05.120 --> 0:06:09.080 to those twenty three people, we also have six research associates, 0:06:09.440 --> 0:06:12.279 so we've got twenty nine people. Were almost half the 0:06:12.320 --> 0:06:15.760 firm focused exclusively on research, and it's really how we 0:06:15.920 --> 0:06:20.800 define ourselves. And when you think about a value stock, 0:06:21.080 --> 0:06:23.760 you always want to be careful that just because something 0:06:23.880 --> 0:06:26.720 is a low price doesn't necessarily make it a value. 0:06:27.080 --> 0:06:29.680 You don't want to end up with newspaper stocks that 0:06:30.080 --> 0:06:32.880 have a very bleak future. You don't want to end 0:06:32.960 --> 0:06:36.839 up with retail stocks that Walmart could be coming into 0:06:36.880 --> 0:06:41.120 their neighborhood. So the research side is very important because 0:06:41.120 --> 0:06:43.760 it says just because something is trading at a low 0:06:43.760 --> 0:06:46.279 price doesn't necessarily make it a value. So we spend 0:06:46.320 --> 0:06:48.599 a lot of time thinking about quality. And then the 0:06:48.640 --> 0:06:51.599 third thing is culture, and culture is very important and 0:06:51.680 --> 0:06:55.720 culture at our firm, and we have a very collegial firm. 0:06:55.920 --> 0:06:57.919 As I said, I've been there twenty seven years and 0:06:57.960 --> 0:07:01.400 the average employee ten year is very very long. People 0:07:01.680 --> 0:07:05.559 rarely leave Hotchkisson whilely. In fact, when we interview new people, 0:07:05.600 --> 0:07:07.479 one of the things they always ask is what do 0:07:07.520 --> 0:07:10.320 you do that you keep your people so long, and 0:07:10.360 --> 0:07:12.080 I think there's a couple of things. First of all, 0:07:12.160 --> 0:07:13.600 we spend a lot of time on the front end 0:07:13.640 --> 0:07:16.120 making sure we get the right person. But who is 0:07:16.200 --> 0:07:20.760 the right person? It's somebody who is very intellectually curious, 0:07:21.720 --> 0:07:23.760 wants to spend a lot of time doing research and 0:07:23.840 --> 0:07:27.240 thinking about things, but also is willing to work in 0:07:27.280 --> 0:07:32.160 a collegial team environment and understanding that if you have 0:07:32.240 --> 0:07:35.600 a long term view and you can keep your emotions 0:07:35.640 --> 0:07:38.920 at bay and always be respectful, that will lead to 0:07:39.040 --> 0:07:41.440 very good investment decisions over long periods of time. 0:07:42.160 --> 0:07:42.679 That's great. 0:07:42.720 --> 0:07:44.840 So I like to dig a little deeper. I know 0:07:44.880 --> 0:07:47.560 you're manager on three funds, but I think for the 0:07:48.200 --> 0:07:50.640 purpose of this discussion, we'd kind of want to focus 0:07:50.680 --> 0:07:53.360 in on more than domestic strategies. So if you could 0:07:53.400 --> 0:07:55.680 kind of give us kind of an idea of what 0:07:55.720 --> 0:07:59.000 the investment process is for the value opportunities and small 0:07:59.040 --> 0:07:59.960 cap value funds. 0:08:01.120 --> 0:08:01.600 Sure. 0:08:02.160 --> 0:08:04.880 So it's interesting, especially when you include small cap, because 0:08:04.920 --> 0:08:07.920 there's literally thousands of stocks out there to choose from, 0:08:08.960 --> 0:08:12.200 and so oftentimes when we're trying to find a stock, 0:08:12.240 --> 0:08:15.120 it will start with screens and we'll be screening on 0:08:15.240 --> 0:08:17.520 valuation things like priced to earnings, price to book. I 0:08:17.520 --> 0:08:20.000 would say the most important screen in my mind is 0:08:20.040 --> 0:08:23.840 something called enterprise value to operating income. Enterprise value being 0:08:23.840 --> 0:08:26.800 the market cap plus the debt minus the cash, because 0:08:26.800 --> 0:08:29.600 that will take into account sort of the entire balance sheet, 0:08:30.800 --> 0:08:33.280 and so we look at screens. In addition, we have 0:08:33.360 --> 0:08:38.760 these analysts who are so well versed in their individual 0:08:38.840 --> 0:08:42.440 coverage universe that they're constantly meeting with management teams, they're 0:08:42.440 --> 0:08:45.719 talking to suppliers, they're talking to competitors. So there's oftentimes 0:08:45.720 --> 0:08:48.480 stocks that will come that for some reason, it falls 0:08:48.480 --> 0:08:50.920 through the screens at bad data or whatever, and it 0:08:50.920 --> 0:08:53.160 will come in through the analysts will say, this is 0:08:53.200 --> 0:08:55.600 actually something that I discovered on my own, and so 0:08:55.640 --> 0:08:58.480 that will augment stocks that we add to the process. 0:08:59.120 --> 0:09:02.240 Once we've identify certain candidates that we think are interesting, 0:09:02.840 --> 0:09:06.200 the analyst will be tasked with putting In the short term, 0:09:06.440 --> 0:09:10.240 maybe it's under earning because the cycle is against it, 0:09:10.280 --> 0:09:12.200 and we expect that cycle to normalize. 0:09:13.120 --> 0:09:14.280 But over five years. 0:09:14.080 --> 0:09:17.360 Time, we think that we can normalize the earning's power. 0:09:17.400 --> 0:09:19.760 And also by looking out five years, it's long enough 0:09:19.840 --> 0:09:22.400 that we can normalize the cycle, but short enough that 0:09:22.440 --> 0:09:24.760 we have pretty good visibility. After five years, it gets 0:09:24.800 --> 0:09:27.760 tougher and tougher to project out, so the analysts will 0:09:27.760 --> 0:09:31.000 project that earnings for five years. In addition, we have 0:09:31.040 --> 0:09:35.120 built a proprietary scoring system called our Fundamental Risk rating system, 0:09:35.520 --> 0:09:37.680 and we look at three different things. In our fundamental 0:09:37.760 --> 0:09:40.120 risk rating system, we look at the quality of the business, 0:09:40.520 --> 0:09:42.200 we look at the balance sheet, and we look at 0:09:42.240 --> 0:09:45.520 the governments. And so the analysts will also be tasked 0:09:45.559 --> 0:09:48.440 with scoring according to this fundamental risk grading system. And 0:09:48.440 --> 0:09:52.280 there's a huge matrix that goes with each one of 0:09:52.280 --> 0:09:56.520 those individual components, and they will bring in that sort 0:09:56.559 --> 0:09:59.600 of deliverable to one of our six sector teams depending 0:09:59.600 --> 0:10:02.000 on where I it's in. And the six sector teams 0:10:02.040 --> 0:10:06.520 we have are capital, goods, consumer, healthcare, Energy, financials, and tech. 0:10:07.040 --> 0:10:09.200 So wherever it fits in, they'll bring it in and 0:10:09.240 --> 0:10:13.800 that sector team will then review peer review the financial 0:10:13.840 --> 0:10:16.640 model and the fundamental risk ratings. And I think what's 0:10:17.160 --> 0:10:19.400 unique here is the ANALYSI is not coming in with 0:10:19.440 --> 0:10:22.560 the recommendation. They're not saying you should buy X Y 0:10:22.640 --> 0:10:24.840 and Z stock. They're coming in they're saying, I think 0:10:25.040 --> 0:10:27.520 X Y and Z stock is going to earn you 0:10:27.679 --> 0:10:29.959 three dollars a share, and my margine assumption is they're 0:10:29.960 --> 0:10:32.480 going to do a ten percent ten percent operating margin 0:10:32.840 --> 0:10:35.360 and that will be what the debate is around. And 0:10:35.440 --> 0:10:37.560 because of the debate is all around sort of the 0:10:37.559 --> 0:10:42.040 financial projections and the matrix according to for the fundamental 0:10:42.120 --> 0:10:45.520 risk ratings, it doesn't end up being an emotional you 0:10:45.559 --> 0:10:47.680 should buy you should not buy. It ends up being 0:10:47.800 --> 0:10:51.280 a very almost like intellectual exercise, if you will, with 0:10:51.320 --> 0:10:54.280 some very healthy debate. And so once that is done, 0:10:54.520 --> 0:10:58.000 and once the earnings power is established by the sector 0:10:58.080 --> 0:11:01.680 team and the fundamental risk ratings have been established, it 0:11:01.720 --> 0:11:04.359 will then be up to the portfolio manager to decide 0:11:04.600 --> 0:11:07.199 where and how much that stock fits into the portfolio. 0:11:07.600 --> 0:11:10.200 So lots of people right now are worried about multiples, 0:11:10.280 --> 0:11:12.440 especially in the S and P five hundred. Do you 0:11:12.480 --> 0:11:14.520 share that concern or are you more in the camp 0:11:14.600 --> 0:11:17.280 that you know maybe the max seven gets add some 0:11:17.320 --> 0:11:20.760 productivity gains to lower that multiple. And kind of a 0:11:20.800 --> 0:11:23.319 second part of that is how do you think about valuations? 0:11:23.360 --> 0:11:25.320 Are there any specific metrics you like to use? I 0:11:25.320 --> 0:11:28.200 know you mentioned pees and price to books, but like 0:11:28.240 --> 0:11:29.320 to pick your brain on that one. 0:11:30.480 --> 0:11:34.200 Yeah, So when you look at the Magnificent seven, and 0:11:34.280 --> 0:11:36.480 first of all, we group and men I think there 0:11:36.480 --> 0:11:40.040 each one has its own individual story on individual. 0:11:39.679 --> 0:11:41.560 You know, opportunities and risk. 0:11:42.040 --> 0:11:46.240 But as a group, they clearly are well above the 0:11:46.320 --> 0:11:48.600 valuation both of the rest of the market and well 0:11:48.640 --> 0:11:53.040 above the valuation that they have been historically. And I 0:11:53.040 --> 0:11:56.000 think the biggest risk to that part of the market. 0:11:56.520 --> 0:12:00.320 They're clearly excellent companies. But the biggest risk is part 0:12:00.320 --> 0:12:03.760 of the market is you are pricing in a lot 0:12:03.800 --> 0:12:06.400 of growth for many, many years to come in order 0:12:06.440 --> 0:12:10.840 to justify that valuation, which means essentially that that's a 0:12:11.040 --> 0:12:14.360 very very long duration asset. And there's two things that 0:12:14.400 --> 0:12:18.400 could significantly upend the prospects for the for the valuation. 0:12:18.520 --> 0:12:18.760 There. 0:12:19.240 --> 0:12:22.920 Number one, the growth may not come come to fruition 0:12:23.040 --> 0:12:25.320 as people expect. And it's very hard to project out 0:12:25.400 --> 0:12:28.720 very long periods of time. I mean, it's hard to imagine. 0:12:28.720 --> 0:12:32.160 But in nineteen ninety nine, General Electric was the largest 0:12:32.160 --> 0:12:36.240 market cap, and you know, obviously there's you know, Cisco 0:12:36.400 --> 0:12:39.840 was one of the largest market caps. So things change, 0:12:40.360 --> 0:12:42.880 so trying to project out for long periods of time 0:12:42.960 --> 0:12:46.720 is difficult. In addition, if we do get a rise 0:12:46.760 --> 0:12:49.280 in interest rates when you have an asset that is 0:12:49.320 --> 0:12:52.640 that long duration, arise in interest rates will have a 0:12:52.679 --> 0:12:56.120 severe impact on the present value of that earning string. 0:12:56.559 --> 0:13:00.559 And so they'reible, They're susceptible from sort of two elements. 0:13:01.240 --> 0:13:03.560 And so I think that as a group, and again 0:13:03.600 --> 0:13:05.719 I'm speaking as a group, because each individual stock will 0:13:05.760 --> 0:13:08.960 have its own risks and merits. But as a group, 0:13:08.960 --> 0:13:10.880 I think I would say there is a lot of 0:13:11.000 --> 0:13:14.720 risk that in that part of the market. With regard 0:13:14.760 --> 0:13:17.520 to the rest of the market, the rest of the 0:13:17.559 --> 0:13:20.640 market in general looks like it's trading at about in 0:13:20.679 --> 0:13:26.800 line with its historical averages. So it's not which is 0:13:26.880 --> 0:13:31.360 very reasonable. And what is notable is not what the 0:13:31.400 --> 0:13:33.319 rest of the market is trading it relative to its 0:13:33.320 --> 0:13:35.440 own history. It's what the rest of the market is 0:13:35.480 --> 0:13:37.839 trading relative to the Magnificent seven. 0:13:40.480 --> 0:13:44.040 And do you think the election results changed the calculus 0:13:44.040 --> 0:13:45.920 at all for for small versus large? I kind of 0:13:45.960 --> 0:13:49.120 went to my shpiel before about the whole Trump first term, 0:13:49.160 --> 0:13:51.359 but interested to get your thoughts. 0:13:51.960 --> 0:13:54.200 Yeah, you know where I really think it's it's going 0:13:54.280 --> 0:13:58.920 to make a difference, is I think with regard to 0:13:59.200 --> 0:14:04.120 mergers and actuitions, and what you saw recently under the 0:14:04.120 --> 0:14:11.200 current administration was a really strict regulatory environment. Companies were 0:14:11.720 --> 0:14:14.800 either not allowed to merge or they saw what was 0:14:14.880 --> 0:14:16.960 going on and they chose not even to pursue an 0:14:16.960 --> 0:14:19.400 acquisition because they think they didn't think it would get 0:14:19.680 --> 0:14:23.440 through the regulatory agencies. So I think the fundamental difference 0:14:23.440 --> 0:14:25.440 be with the Trump administration is you're going to have 0:14:25.680 --> 0:14:30.800 much less regulation or much less onerous regulation with regard 0:14:31.080 --> 0:14:35.320 to companies merging. And for small caps that's important because 0:14:35.320 --> 0:14:37.760 when you think about how you can get your performance 0:14:37.760 --> 0:14:40.560 from small caps, one of the ways is if you 0:14:40.640 --> 0:14:44.200 have a stock that has a low valuation, there's always 0:14:44.200 --> 0:14:46.720 the opportunity that it can get bought and that a 0:14:46.800 --> 0:14:48.480 larger company can come by and say, you know, this 0:14:48.520 --> 0:14:51.240 doesn't make any sense. You know, I'm trading at a 0:14:51.240 --> 0:14:54.120 fifteen pe and this small cap stocks at an ape. 0:14:54.600 --> 0:14:57.480 I could buy it at a twelve pee and give 0:14:57.520 --> 0:15:00.720 fifty percent return to the small cap sharehold, and yet 0:15:00.960 --> 0:15:04.160 I can still buy something at a discount to my 0:15:04.160 --> 0:15:07.320 own stock price. So I think that's where will be 0:15:07.320 --> 0:15:11.240 one of the fundamental sort of opportunities for small caps 0:15:11.240 --> 0:15:15.880 that they really have not enjoyed in the recent last 0:15:15.920 --> 0:15:16.480 four years. 0:15:17.560 --> 0:15:20.040 I kind of want to go back to your process, 0:15:20.160 --> 0:15:22.200 and you know, kind of what you were talking about 0:15:22.280 --> 0:15:24.640 kind of sounds bottom up to me, and so I 0:15:24.640 --> 0:15:26.880 was kind of wondering, if you know, if you do 0:15:27.000 --> 0:15:31.880 consider macro themes as part of your evaluation or portfolio management. 0:15:33.440 --> 0:15:34.280 Yeah, it's interesting. 0:15:34.440 --> 0:15:39.080 So we don't start with the macro, but a lot 0:15:39.120 --> 0:15:43.080 of times the macro will drive certain themes within the portfolio. 0:15:43.120 --> 0:15:44.960 There was a time I remember when in the top 0:15:44.960 --> 0:15:48.000 ten we had three trucking stocks. Again, we weren't trying 0:15:48.040 --> 0:15:51.600 to buy trucking stocks, but that was what the macro 0:15:51.920 --> 0:15:54.760 was causing that part of the market to be out 0:15:54.800 --> 0:15:56.800 of favor. You might have a situation where let's say, 0:15:56.800 --> 0:16:00.880 like oil, is oil price as well normal. Let's say 0:16:00.880 --> 0:16:02.680 it's a forty or fifty dollars a barrel. It's not 0:16:02.680 --> 0:16:06.360 there today, but if it were, and people were investors 0:16:06.440 --> 0:16:09.720 were pricing oil as if it was going to stay there, 0:16:10.320 --> 0:16:12.960 when we would do our normal, which would be our 0:16:13.000 --> 0:16:15.600 normal right now assumption for oil as seventy five dollars 0:16:15.640 --> 0:16:18.720 a barrel, so at forty we would expect the price 0:16:18.760 --> 0:16:22.200 to come up because at forty people wouldn't invest. Likewise, 0:16:22.200 --> 0:16:24.000 if oil was one hundred and twenty dollars, we would 0:16:24.000 --> 0:16:26.120 expect it to revert down because people would invest and 0:16:26.160 --> 0:16:28.880 bring a lot of supply in. So when it's when 0:16:28.880 --> 0:16:32.960 the market is somehow divorced from its normal kind of 0:16:33.400 --> 0:16:39.320 where equilibrium, that will lead to situations where multiple stocks 0:16:39.600 --> 0:16:43.080 can get interesting. And so you might have if everybody 0:16:43.160 --> 0:16:45.320 was pricing in energy stocks at forty for a long 0:16:45.360 --> 0:16:48.120 period of time, you might have a situation where that 0:16:48.160 --> 0:16:50.680 part of the market would be. Energy stocks in general 0:16:50.680 --> 0:16:52.880 will be interesting to us. And it's not again that 0:16:52.920 --> 0:16:54.680 we would start with the macro, but it's that we 0:16:54.720 --> 0:16:57.600 would be led there by what the market is giving us. 0:16:58.880 --> 0:17:01.920 Are there any sectors right now that you find particularly compelling? 0:17:03.880 --> 0:17:05.440 Yeah, there's a couple. It's interesting. 0:17:05.520 --> 0:17:08.000 So, you know, when I talked about the research team 0:17:08.080 --> 0:17:12.200 and what we look for, we're looking for as high 0:17:12.280 --> 0:17:15.359 quality of business, we're looking for new things. We're looking 0:17:15.359 --> 0:17:19.560 for low valuation and high quality business. And it won't 0:17:19.600 --> 0:17:23.680 surprise anyone probably that the highest amongst the highest quality 0:17:23.720 --> 0:17:27.600 businesses we found are software businesses. Once you have a client, 0:17:28.320 --> 0:17:31.160 if it's if it's the right, software which is hard 0:17:31.200 --> 0:17:33.600 to get off of you tend to have very low 0:17:33.720 --> 0:17:38.120 schurn and very high gross margins. And interestingly enough, there 0:17:38.160 --> 0:17:41.480 are a couple of software companies that we own, Workday 0:17:41.520 --> 0:17:46.160 and F five, which we think are really interesting because 0:17:47.800 --> 0:17:50.840 people are not appreciating the fact that even though they 0:17:50.840 --> 0:17:54.640 have very high gross margins, they're operating margins are understating 0:17:55.000 --> 0:17:57.119 where they will be in normal and why is that. 0:17:57.119 --> 0:17:59.320 That's because they're spending a lot of money on marketing, 0:17:59.680 --> 0:18:02.000 so they're selling their product and they're spending a lot 0:18:02.040 --> 0:18:04.800 of money on sales, and they're also spending a lot 0:18:04.800 --> 0:18:07.800 of money on research and development. Both of those costs 0:18:07.920 --> 0:18:11.040 are going through the income statement. They're not being capitalized. 0:18:11.080 --> 0:18:13.359 If it was a chemical plant, you'd put it, it 0:18:13.400 --> 0:18:15.600 would be capex and it would be capitalized and it 0:18:15.600 --> 0:18:17.520 wouldn't go through the income statement until the plant was 0:18:17.600 --> 0:18:18.080 up and running. 0:18:18.080 --> 0:18:20.680 It was being depreciated over time. 0:18:20.840 --> 0:18:23.600 So this sort of quirk of accounting, if you will, 0:18:24.119 --> 0:18:26.760 has led us to an interesting part of the market, 0:18:27.240 --> 0:18:31.600 and I think that that is not totally understood. And 0:18:31.640 --> 0:18:34.080 then I would say the other area that is also 0:18:34.160 --> 0:18:37.960 interesting to us is there are certain energy stocks which 0:18:38.320 --> 0:18:42.359 right now, given how weak oil has been and how 0:18:42.440 --> 0:18:43.879 much the rest of the market has gone up, that 0:18:43.960 --> 0:18:45.520 are also interesting to us right now. 0:18:46.160 --> 0:18:48.080 And are there any signposts that you're looking for to 0:18:48.119 --> 0:18:52.360 signals shift from tech leadership to broaden to the rest 0:18:52.400 --> 0:18:53.840 of the stocks. 0:18:54.520 --> 0:19:00.879 So I think if the economy stays strong general economy, 0:19:00.960 --> 0:19:07.199 because tech has the leadership in tech has been a 0:19:07.200 --> 0:19:09.760 little bit of its own sort of sub sector, driven 0:19:10.240 --> 0:19:13.600 in many cases by AI. But if it brought if 0:19:13.600 --> 0:19:17.960 the economy stays strong in general, that will allow sort 0:19:17.960 --> 0:19:20.480 of the rest of the market to do well. And 0:19:20.520 --> 0:19:22.760 then the other thing I would say is if you 0:19:22.760 --> 0:19:25.000 want to look at where it could cause the multiples 0:19:25.040 --> 0:19:27.600 to compress relative to each other. Again, if you have 0:19:28.560 --> 0:19:31.439 interest rates increase, I think that will put pressure on 0:19:31.480 --> 0:19:33.840 the Magnificent seven relative to the rest of the market. 0:19:35.040 --> 0:19:38.159 I think I saw in the perspectives for their funds 0:19:38.160 --> 0:19:41.879 it did mention ESG, and so I was curious, you know, 0:19:41.960 --> 0:19:46.080 if ESG factors into the research at all. 0:19:46.240 --> 0:19:49.000 Yeah, So, you know, when you think about all of 0:19:49.040 --> 0:19:52.199 the risks that we're trying to compile, and we have 0:19:52.240 --> 0:19:55.720 our fundamental risk rating system, ESG is embedded in our 0:19:55.760 --> 0:19:59.000 fundamental risk rating system in the sense that if you 0:19:59.040 --> 0:20:01.760 have environmental consc NS. If a company is polluting, that 0:20:01.880 --> 0:20:05.200 is a true cost to the business and a true 0:20:05.320 --> 0:20:08.760 risk of the business. If a company in social is 0:20:08.800 --> 0:20:13.000 not treating its employees properly, that's true that business will 0:20:13.000 --> 0:20:15.840 have a difficult time sustaining itself if a company has 0:20:15.920 --> 0:20:19.040 bad governance. In fact, interestingly enough, in our fundamental risk 0:20:19.080 --> 0:20:23.399 rating system, governance is one of the three pillars that 0:20:23.440 --> 0:20:28.240 we actually it has its own pillar, and that's especially 0:20:28.240 --> 0:20:31.960 true when you talk about small caps, because governance is 0:20:32.040 --> 0:20:32.760 so varied. 0:20:32.800 --> 0:20:33.560 In small caps. 0:20:33.600 --> 0:20:36.400 You have the founder who started the company and took 0:20:36.440 --> 0:20:39.520 it public and he's still working, you know, twelve or 0:20:39.560 --> 0:20:42.560 fourteen hour days. He's taking a small salary, and he 0:20:42.640 --> 0:20:44.520 owns a lot of stock, and he's doing all the 0:20:44.600 --> 0:20:48.840 right things. To the founder who's cashed out, he's at 0:20:48.840 --> 0:20:51.800 the golf course, his children are running it and he 0:20:51.880 --> 0:20:55.600 may they may or may not be competent. But the 0:20:55.640 --> 0:20:58.480 point is you've got and he yet he still controls 0:20:58.520 --> 0:21:01.560 the board. And you have to do your due diligence 0:21:01.640 --> 0:21:04.600 and find out where each company fits in along that 0:21:04.680 --> 0:21:05.679 governance spectrum. 0:21:05.920 --> 0:21:07.600 And so we spend a lot of time doing. 0:21:07.440 --> 0:21:10.600 That, I also do want to ask about another type 0:21:10.640 --> 0:21:13.600 of risk. You know, the portfolios don't have you know, 0:21:13.640 --> 0:21:16.760 a huge amount of stocks in them, so I guess 0:21:16.760 --> 0:21:19.160 I was just wondering how you handle concentration risk. 0:21:20.800 --> 0:21:22.080