Speaker 1: Welcome to Inside Active, a podcast about active managers that
Speaker 1: goes beyond sound bites and headlines and looks deeper into
Speaker 1: their processes, challenges and philosophies and security selection. I'm David Cohne,
Speaker 1: I lead mutual fund and active research at Bloomberg Intelligence.
Speaker 1: Today my co host is Gina Martin Adams, chief equity
Speaker 1: strategist at Bloomberg Intelligence. Gina, thank you for joining me today.
Speaker 2: Thank you for having me, David. I'm delighted to be here.
Speaker 1: So I first wanted to ask you about a note
Speaker 1: you wrote recently regarding valuations masking slowest EPs recovery. Since
Speaker 1: I believe it was twenty eighteen, can you give the
Speaker 1: audience kind of an overview of what was happening?
Speaker 2: Yeah, I think a couple of things really come to mind.
Speaker 2: The first is that valuations have really done the heavy
Speaker 2: lifting in the S and P five hundred bull market
Speaker 2: since twenty twenty two. If you go back to that
Speaker 2: bullmarket low or the big bear market low from twenty
Speaker 2: twenty two and classify this recent three year run as
Speaker 2: a big ballmarket rally, we've had trailing twelve month earnings
Speaker 2: that have grown just fourteen percent this is the slowest
Speaker 2: pace of non recessionary growth in the index for a
Speaker 2: rolling thirty some odd month windows since at least early
Speaker 2: twenty eighteen. Despite that really slow earnings growth, almost painfully
Speaker 2: slow earnings growth, we've had more than seventy percent price
Speaker 2: appreciation in the S and P five hundred, and this
Speaker 2: year in particular has been really interesting because it's sort
Speaker 2: of turned that relationship on its head for the first
Speaker 2: time in a long time. Earnings may actually grow faster
Speaker 2: than valuations. This may be one of those rare years
Speaker 2: in the S and P five hundred where we get
Speaker 2: some earnings growth allowing companies to grow into valuation multiples
Speaker 2: that have expanded so very quickly over the last three years.
Speaker 1: Great, well, I'd love to hear our guest thoughts on this,
Speaker 1: so I think it's a great time to introduce David
Speaker 1: Jaru to the podcast. David is a chief investment officer
Speaker 1: of US Equity at TROW Price and a portfolio manager
Speaker 1: for the Capital Appreciation strategy, including the Capital Appreciation Mutual
Speaker 1: fund ticker p RWCX and the Capital Appreciation Equity etf
Speaker 1: ticker TCAF. David, thank you for joining us.
Speaker 3: H it's a pleasure. Thank you for having me on.
Speaker 1: So let's start with your thoughts on the market dynamic
Speaker 1: that Gina has observed on with rising valuations and a
Speaker 1: slow EPs recovery.
Speaker 3: No, I think it's I read the artic thought that
Speaker 3: was a very thoughtful analysis, and then you don't see
Speaker 3: most people addressing. But as Gina said, if you kind
Speaker 3: of go from the market trough in twenty twenty two,
Speaker 3: the market with basically trot about you know, fifteen or
Speaker 3: sixteen times forward earnings, today we're kind of, you know,
Speaker 3: twenty two or twenty three. So we've had basically the
Speaker 3: market and Multiple go up by about fifty percent off
Speaker 3: the trough, sort of trough to peak, and Ernie's growth,
Speaker 3: which again and as Gena says, is starting to get
Speaker 3: a little bit better. This year, we'll probably end up
Speaker 3: doing double digitaries growth or let's least at least high
Speaker 3: school digitaries growth this year after a couple of years
Speaker 3: of what I call kind of somewhat sub parties growth
Speaker 3: in both twenty three twenty four. Great.
Speaker 1: Great, So let's switch over to your funds. So let's
Speaker 1: let's talk specifically about the capital appreciation strategy. What is
Speaker 1: the investment process. You know, how how do securities make
Speaker 1: their way to the portfolio?
Speaker 3: Sure, you know, you know there's we think about the
Speaker 3: sp FI FI. Let's just we'll take it through equities.
Speaker 3: We'll talk a little bit about fixed income, and we'll
Speaker 3: talk about kind of process. What I would tell you is,
Speaker 3: you know, there aren't five hundred great companies in the
Speaker 3: sp five hundred, right, you know, we believe there's only
Speaker 3: about one hundred and twenty five stocks that we call investable.
Speaker 3: And when I need investable, what does that mean? It
Speaker 3: really means, you know, when we look back and what
Speaker 3: are the five or six characteristics that kind of cosset
Speaker 3: stocks in to perform? And we want to avoid those
Speaker 3: five six characteristics. What are the five six characteristics? You know,
Speaker 3: bad management teams, secular risk, you know, extreme valuation and
Speaker 3: inability to do a high school digit kind of total return,
Speaker 3: poor cap allocation. Those are the kind of things if
Speaker 3: we basically get the whole last P. Five hundred and
Speaker 3: we may say, if we can avoid companies that have
Speaker 3: one or two, one or two or more of those
Speaker 3: fatal flaws, their odds about performing are really really low.
Speaker 3: So we want to we want to basically remove basically
Speaker 3: three hundred and seventy five companies that we invest in,
Speaker 3: So we invest the one hundred twenty five hundred companies
Speaker 3: that have none of those fatal flaws where we think
Speaker 3: the odds about performance over any kind of three five
Speaker 3: ten year basis are quite hot. So that's kind of
Speaker 3: our equity selection basis. The other thing about our equity
Speaker 3: selection basis is we tend to have in our north
Speaker 3: stars at five year i r R, what is the
Speaker 3: expected earnings five years out, what is the expected multiple
Speaker 3: we're going to get, and what is the kind of
Speaker 3: embedded i rr we're going to try to invest obfuly
Speaker 3: in the highest risk just at irs we can, and
Speaker 3: the equity sleeve, in the fixed income sleeve, we you know,
Speaker 3: we compete against kind of a Bloomberg ag However, we
Speaker 3: tend to think the Bloomberg gaging is actually not the
Speaker 3: best universe. That's a universe built based on the size
Speaker 3: of different markets. Are supposed to attractives of different markets.
Speaker 3: So you would see us investing much heavily you know
Speaker 3: what we call high quality leveraged loans, high quality high
Speaker 3: yield bonds with very very low risk of default. And
Speaker 3: then selectively by treasuries when the treasuries are attractive as
Speaker 3: they are now. So again we're focused on not the
Speaker 3: largest markets, but we're the best risks returns over time.
Speaker 3: And if you look at over time, the best risk
Speaker 3: of rewards and fixed income are not mortgages, not triple
Speaker 3: A securities, but double B credits, leverage loans. That's where
Speaker 3: the risk of reward is the highest. The last thing
Speaker 3: I would say is that we tend to be kind
Speaker 3: of countercyclical. In twenty twenty two, when the market was
Speaker 3: facing difficulties, we were adding to lot of equities. We
Speaker 3: were adding to semiconductor companies, we were adding to pyxicality.
Speaker 3: During this Trump tariff noise that drive the market down
Speaker 3: to four to nine hundred, we put four billion dollars
Speaker 3: to work in three day period of time. During COVID,
Speaker 3: we put nine billion dollars to work in less than
Speaker 3: a month. So you will almost always see us acting
Speaker 3: counterintuitively to the market. Marketing going lower, we're adding to
Speaker 3: risk assets. Market goes higher, we're reducing risk assets. And
Speaker 3: that process, over the last nineteen years since I've been
Speaker 3: managing these strategies has added a lot of alpha to
Speaker 3: the strategy being a little bit countercyclical when because we
Speaker 3: know when markets go lower, the odds of losing money
Speaker 3: actually go lower, the odds actually generate above average returns
Speaker 3: go higher. And again, you know, we know we are
Speaker 3: willing to invest into uncertainty in those kind of periods
Speaker 3: of time in the mark, whether that be in fixed
Speaker 3: income or whether that be in inequities.
Speaker 1: So before we dig a little bit deeper into that,
Speaker 1: I just wanted to ask a little bit about the
Speaker 1: two different fun types. I know, we you know, the
Speaker 1: big difference is obviously the ETF doesn't hold fixed income
Speaker 1: whereas the mutual fund does. But are there any differences
Speaker 1: between the equity portfolios of the you know, between the
Speaker 1: mutual fund and the ETF.
Speaker 3: The ETF would have will have more names, you don't
Speaker 3: have a little bit lower track year. The ETF has
Speaker 3: a slightly different objective. The e TF wants down from
Speaker 3: the market over time. It wants to do with always
Speaker 3: having a risk profile that's less in the market, and
Speaker 3: it also wants to have a a taxial income that
Speaker 3: is basically zero and has a you will always have
Speaker 3: a dividend below that of the market. So we say
Speaker 3: we can outform the market with less risk and more
Speaker 3: tax efficiency over over a long period of time.
Speaker 2: David, you mentioned all the factors that you do to
Speaker 2: use to avoid stocks, sort of avoiding the fatal flaws?
Speaker 2: Is the language that I loved you used? What do
Speaker 2: you what are you most attracted to? So how do
Speaker 2: you define capital appreciation potential? I know you mentioned I
Speaker 2: is a really critical component of your process, But are
Speaker 2: there other factors that you use? How do you identify
Speaker 2: those high RRR companies?
Speaker 3: Well, if you think about again, we think about the
Speaker 3: five hundred companies and the SPIF hundred, maybe a couple
Speaker 3: of companies outside the SPF hundred. We reduce that three
Speaker 3: hundred and seventy five companies that don't have one or
Speaker 3: more of those fatal flaws GITA, and then we'll basically
Speaker 3: myself and my team, we will basically actively model those
Speaker 3: one hundred and twenty five companies. We will look at
Speaker 3: their earnings power today. We'll look at their earnings power
Speaker 3: where what we think is going to be twenty thirty
Speaker 3: twenty thirty one. We'll look at what the dividends that
Speaker 3: are likely to pay over that period of time. We'll
Speaker 3: look at what the right multiple for that company is
Speaker 3: and then that will basically spit out an internal rate
Speaker 3: to return, and then we're trying to find companies that
Speaker 3: have an attractive risk to just return, but also with
Speaker 3: a as narrow of a range of outcomes as possible
Speaker 3: is really key to our process, right, So if you
Speaker 3: look at our portfolio today, we would have an IRR
Speaker 3: in the portfolio in the low teams. In the equity
Speaker 3: market that was as hot is during COVID in the
Speaker 3: mid twenties, during twenty twenty two, was in the mid teens.
Speaker 3: During the Trump tariff tantrument, if you will, it was
Speaker 3: also in the mid teens. But we compare that relative
Speaker 3: to what we perceive as a market i AR that's
Speaker 3: kind of in the mid seele digits and the potential
Speaker 3: to hopefully generate kind of mid you know, five hundred
Speaker 3: BIPs or more alpha versus the market over that period
Speaker 3: of time. So we're literally looking at one hundred and
Speaker 3: five companies that meet our criteria where we think there's
Speaker 3: a high odds of outperformance and the you know, we're
Speaker 3: trying to find that you're roughly the highest sixty on
Speaker 3: a risk us basis within the equity, sleep of the
Speaker 3: balance strategy, cap appreciation, and maybe we're like the top
Speaker 3: ninety stocks within the cappreciation ETF.
Speaker 2: You mentioned the SMP five hundred a few times, but
Speaker 2: it sounds like you're amenable to ideas outside of the
Speaker 2: SMP five hundred when and if it's appropriate, can you
Speaker 2: talk to us about you know what you know many
Speaker 2: people would suggest are really clearly very high valuations for
Speaker 2: certain select groups in the s and P five hundred.
Speaker 2: How are you navigating that right now? And is that
Speaker 2: pushing you into ideas outside the United States or even
Speaker 2: ideas in private markets not necessary?
Speaker 3: Maybe yes and no, Maybe yes and no to that
Speaker 3: to that point, you know, there are great companies outside
Speaker 3: the US, I would say coming great companies outside of
Speaker 3: the US are rare. So one example of a great
Speaker 3: company outside the US is Kadie National C and Q.
Speaker 3: It is an oil sands oil producer. The average major
Speaker 3: in the United States has a reserve life of like
Speaker 3: nine years. That means Exxon or Chevron has to go
Speaker 3: out every couple of years and spend it Shad's capital
Speaker 3: to buy Hess or buy Pioneer, whereas C and Q
Speaker 3: does have to do any acquisitions at all, they have
Speaker 3: twenty nine years reserve life, they can continue producing, and
Speaker 3: their continued to extend that reserve life. They traded a
Speaker 3: discount to C and Q or to Exon, and yet
Speaker 3: they grow production faster like four percent versus three percent.
Speaker 3: They have a higher dividend yield UH, and they have
Speaker 3: better cap allocation UH and so and again a very
Speaker 3: very strong tremendous on a free cash to that allows
Speaker 3: them to buy back stock, pay a dividend. It's almost
Speaker 3: five percent. So we do see opportunities out there. However,
Speaker 3: I would say is when when we do the micro analysis,
Speaker 3: when we go through look at all the companies in Europe,
Speaker 3: look at all the companies in Japan, like all the
Speaker 3: things in Australiak at all the other companies in develop
Speaker 3: market economies, we don't find a lot of great companies.
Speaker 3: We think, you know, the US has more than its
Speaker 3: fair share of great companies. And while the European and
Speaker 3: Japanese and Australian indexes are trading at lower valuations, in
Speaker 3: the US index is there's a there's a reason for that.
Speaker 3: And what what is in Europe is mostly you know,
Speaker 3: low quality banks, low quality materials, companies, energy companies that
Speaker 3: don't want to be energy companies, utilities that don't have
Speaker 3: the same characteristics as US utility. There's no mag six,
Speaker 3: there's there's very little, you know, attractive kind of businesses
Speaker 3: and kind of garpie companies. So if you do it
Speaker 3: an apples apples basis, we don't think the US is
Speaker 3: expensive relative to what you can get in Europe or
Speaker 3: Japan or Australia. Now your question on private markets, I
Speaker 3: do see opportunity in private markets. Again, we own four
Speaker 3: companies that are that are not public companies today. That's
Speaker 3: about you know, maybe let's call it four percent of
Speaker 3: our equities are in privates. We tend to own more
Speaker 3: what we call it kind of more stable private equity
Speaker 3: type businesses. So we would own a company like broad
Speaker 3: Street or Hub, which are both insurance brokerage companies. They're
Speaker 3: a little smaller than the Marsh mcclennan's or Aon's of
Speaker 3: the world, but they trade for lower valuations. They are
Speaker 3: able to do more acquisitions at low multiples, and they've
Speaker 3: been in creating value at it let's call it a
Speaker 3: mid to high teenh pace versus the public guys who
Speaker 3: kind of are growing, let's call it a ten percent
Speaker 3: pace with great management teams at evaluation that is below
Speaker 3: marsh or on. So we've chosen to take advantage of
Speaker 3: that kind of that private versus public market arbitrage and
Speaker 3: own some of those companies in size. We also own Weimo.
Speaker 3: Weymo is a private company. Obviously, they are the leader
Speaker 3: in autonomous driving. The last mark there I think publicly
Speaker 3: was in the you know, the forty to forty five
Speaker 3: billion dollar range. We're a big believer that when Weimo
Speaker 3: goes public, given the giant tam It has, that that
Speaker 3: will be a company that will probably have a market
Speaker 3: value of somewhere rotween two to three hundred billion dollars.
Speaker 3: I think Tesla has proved that, you know, autonomous driving
Speaker 3: is really really hard, Tesla's not ready for prime time,
Speaker 3: and that Weimo is by far the market leader and
Speaker 3: autonomous driving today.
Speaker 1: But I did want to ask, you know, in the
Speaker 1: perspectives it does talk about opportunity, opportunit hunistic investments in
Speaker 1: the portfolio. Is there a percentage that you limit these
Speaker 1: two No.
Speaker 3: Actually, it's it's an interesting question, David. What I would
Speaker 3: say is, I think everything we're trying to do is
Speaker 3: a little bit opportunistic, right, We're trying to take advantage
Speaker 3: of marketing efficiencies. We're trying to take a longer term
Speaker 3: horizon than other market participants. Some you know, some some
Speaker 3: situations like we, you know, we've bought hole Logic. Hole
Speaker 3: Logic is a company that we haven't really owned in
Speaker 3: the past. The company's trading at sixty four sixty three
Speaker 3: dollars a share. There's you know, there's been a you know,
Speaker 3: a I think a Financial Times reported that multiple private
Speaker 3: equity firms were looking to take hole Logic private at
Speaker 3: seventy two dollars. I think it would make sense that,
Speaker 3: you know, that would they would be able to generate
Speaker 3: a very high return if they were to do that.
Speaker 3: Given how attractively valued Hole Logic is. We believe that,
Speaker 3: you know, that that company could still go private, probably
Speaker 3: at a higher valuation, so that I would describe that
Speaker 3: as an opportunistic investment. You know. Another opportunitist investment is
Speaker 3: kind of Beckton Dickinson. Beckton Dickinson's has some challenges around tariffs,
Speaker 3: some challenges around weakness in China, but this is a
Speaker 3: company that has a massive some of the part's discount,
Speaker 3: they started going down the path of rectifying that supply.
Speaker 3: Some of the parts discount they're selling off in an
Speaker 3: arm T transaction some of their dignostics and life science
Speaker 3: tool businesses to Waters. We think that'll be a value
Speaker 3: creating endeavor. We think they'll end up spinning off their
Speaker 3: pharmaceutical systems business as well, maybe do another rm T
Speaker 3: with that transaction. And once you keep doing you know,
Speaker 3: once you do that arm T with the pharma systems business,
Speaker 3: once you get Waters transaction done. This is a company.
Speaker 3: It's basically traded for eight times earnings, which has the
Speaker 3: potential especially they continue to buy that stock to grow
Speaker 3: earnings in the you know, the low teens. Most companies
Speaker 3: that have low teens earnings growth don't trade for eight
Speaker 3: times earnings. They trade for more than like key to
Speaker 3: twenty times earnings. So we think Beck then this is
Speaker 3: also kind of an opportunistic investment. We've also had Catalyst
Speaker 3: in place with a starboard who's probably one of the
Speaker 3: better activists in the marketplace actively involved in the stock
Speaker 3: as well. So we will own a number of names
Speaker 3: where we think there is some kind of hidden optionality
Speaker 3: ow producing investment where we think we can make a
Speaker 3: lot of money in the near term.
Speaker 2: David, could I ask a little bit about kind of
Speaker 2: how you navigate some of the key risk factors that
Speaker 2: we think about as equity strategists. So one of the
Speaker 2: things we're thinking about a lot this year is concentration risk.
Speaker 2: In the fact that you know, effectively only ten percent
Speaker 2: of the S and P five hundred is now actually
Speaker 2: driving gains in the market. We think about the MAG
Speaker 2: seven as a specific risk within that concentration risk. I
Speaker 2: noticed in your portfolio that you have pretty heavyweights in
Speaker 2: Microsoft in the video. At the same time, you know,
Speaker 2: navigating a big difference in positioning in Amazon and Apple.
Speaker 2: Maybe talk to us broadly about how you're thinking about
Speaker 2: the biggest stocks in the S and P five hundred,
Speaker 2: how to navigate the risks as well as the benefits
Speaker 2: that they provide to your portfolio.
Speaker 3: You know, that's it's it's a great question. I would
Speaker 3: just I don't think we should really talk about the
Speaker 3: MAG seven anymore. There's really no reason for Tesla to
Speaker 3: be included in the MAG seven. Tesla is losing share
Speaker 3: in all of its end markets. It's autonomous driving efforts
Speaker 3: are are flailing. This is this. If we're gonna put
Speaker 3: Tesla in the in the Mag seven, we should put
Speaker 3: GM and Fords and every other you know, Toyota in
Speaker 3: the Mag seven as well, because it doesn't Tesla's not
Speaker 3: a stock anymore. Tesla is a cryptocurrency. Tesla is a
Speaker 3: It is a it is a purely speculative vehicle, so
Speaker 3: it doesn't has no characteristics like the other companies in
Speaker 3: the Mag seven. But if you you know, think about
Speaker 3: the Mag seven, So we to your point, we have
Speaker 3: a large overweight in the Mag seven. In Microsoft, we
Speaker 3: think you know, it trades at a very reasonable valuation
Speaker 3: even after a big move in the stock. This is
Speaker 3: a company that is you know, clearly a winner a market,
Speaker 3: probably the fastest growing company in kind of cloud computing.
Speaker 3: We think that growth rate has been accelerating and potentially
Speaker 3: could accelerate off a very very large base. You know,
Speaker 3: just a great company, great management team. And actually, if
Speaker 3: you think about AI, focusing on inference not on training,
Speaker 3: inference is more durable than training. In addition, you know,
Speaker 3: I think they've actually said no to open AI in
Speaker 3: some cases, which I think will end up proving to
Speaker 3: be a very wise capitallication. Decision that hurts the growth
Speaker 3: and the short term. So we love that. We love
Speaker 3: We love Amazon for a lot of the same reasons.
Speaker 3: You know, cost Go trades for fifty times earnings. Walmart
Speaker 3: trades for thirty five times earnings. You know, Amazon, even
Speaker 3: with a great cloud computing, a retail business that grows
Speaker 3: faster than both of those companies I mentioned, is still
Speaker 3: trading in the low thirties. It doesn't make any sense
Speaker 3: from my perspective. Again, not as fast is growing as
Speaker 3: amaz as your division, but still very very fast growing.
Speaker 3: And again we think Aws, which is kind of growing
Speaker 3: in the mid ties, can accelerate over time. I already
Speaker 3: mentioned no no position in Tesla. Tesla could fall ninety
Speaker 3: percent and we wouldn't buy one share of that. We
Speaker 3: had an underweight to Apple, Apple has You know, Apple
Speaker 3: is a great company. I do wonder in five or
Speaker 3: ten years, well, we'll still be using Apple devices and
Speaker 3: the same we were using today. You know, Apple will
Speaker 3: generate somewhere between twenty twenty five billion dollars a year
Speaker 3: from Google for its its tax, if you will, there's
Speaker 3: a very high probability that Google's ability to pay Apple
Speaker 3: that that very large, high margin revenue stream will go away,
Speaker 3: maybe as early as AUGUSTA this year, depending on a
Speaker 3: court decision. So again, you know, Apple and Google or names.
Speaker 3: We have a little bit of an underweight on were
Speaker 3: underweight in video as well. It's not that in video
Speaker 3: is not a great company. We just think there's a
Speaker 3: better rist reward if you want to play aig PUS
Speaker 3: in am D. You know, today in video it's basically
Speaker 3: one hundred percent you know, let's called ninety five percent
Speaker 3: market share of all GPUs acceleraties in the marketplace. We think,
Speaker 3: in talking with all of our doing all of our
Speaker 3: channel checks and research says in five years that share
Speaker 3: is going to go from ninety five percent to seventy percent.
Speaker 3: A m D today has let's call it a three
Speaker 3: percent market share of GPUs on the on the A
Speaker 3: I side, new products get very you know them four
Speaker 3: hundred class gets really good feedback from channel partners, and
Speaker 3: we think a MD can clearly be a fifty percent
Speaker 3: market share over time next in the next five years.
Speaker 3: In that case, AMD's that's probably going to triple, whereas
Speaker 3: in video can still go up, but probably not nearly
Speaker 3: as much as as a m D. Another company we
Speaker 3: liked a lot that helps offset the underweight to in
Speaker 3: video is Amfanol. Anthonol makes a lot of the connectors
Speaker 3: and switches that basically go between GPUs that basically allow
Speaker 3: GPUs to work, makes allows large clusters of GPUs to work,
Speaker 3: and honestly, for ANFLOL, it doesn't real matter if in
Speaker 3: video works or a MD works or custom silicon works,
Speaker 3: Anthonol's connectors are needing all those situations. So again underweight
Speaker 3: in the video, but still a overweight to what it
Speaker 3: called AI GPUs.
Speaker 2: I'm glad you brought up this Tesla conundrum because it's
Speaker 2: been one of my frustrations of kind of this MAG
Speaker 2: seven construct as well. And as a result, I just
Speaker 2: really quickly looked up on the terminal here as to
Speaker 2: who are the seven biggest stocks, because I think that
Speaker 2: was the original kind of construct is the biggest and
Speaker 2: Broadcom is actually in there now. I know that Berkshire
Speaker 2: has occasionally jumped in in the place of Tesla, So
Speaker 2: to your point, Tesla's been in and out of even
Speaker 2: the top seven if you use top seven as your
Speaker 2: construct of of MAG seven, but that's maybe here nor there.
Speaker 2: I just found it very interesting and we won't tell
Speaker 2: Elon Musk that.
Speaker 3: You know, you can tell you mustag you want, you
Speaker 3: can tell that he doesn't deserve it anymore. You have
Speaker 3: to grow. You have to grow to be in the
Speaker 3: max seven.
Speaker 2: You cans fighting words. Okay, hold it, hold him to that.
Speaker 2: I will hold him to that.
Speaker 3: Okay. Good.
Speaker 1: So I wanted to ask does bond analysis affect your
Speaker 1: equity decisions at all?
Speaker 3: It does?
Speaker 2: It?
Speaker 3: Does it? Does? I mean? We we are we have
Speaker 3: the ability to go where we see value in the marketplace. Right,
Speaker 3: So I always think about, you know, having a double
Speaker 3: b rated Hilton bond, right that's earning six percent, that
Speaker 3: has a beta of point two? What is the risk
Speaker 3: reward of that that Hilton bond relative to a low
Speaker 3: risk equity that you know, like a utility that might
Speaker 3: have a beta point five? Right, So, we we have
Speaker 3: the ability to go where we see value in the marketplace.
Speaker 3: And some of the way that manifests itself is, you know,
Speaker 3: during the COVID downturn, you know, we were selling bonds
Speaker 3: and buying equities. During the Trump tariff tantrum, we were
Speaker 3: selling bonds and buying equity. Today with the market being very,
Speaker 3: very richly valued as you know, again Gina's thoughtful analysis highlighted,
Speaker 3: you know, our fixing can exposure, you know, has gone
Speaker 3: from back in twenty twenty two kind of high teens
Speaker 3: percentage of the portfolio today in the low thirties. So
Speaker 3: we have the ability to go where we see the value,
Speaker 3: and we can change that bond allocation as well. Back
Speaker 3: in twenty twenty two, we were mostly in leveraged loans
Speaker 3: because we thought you had free optionality if rates ever
Speaker 3: went up, and they did, and today we have a
Speaker 3: little more balance because rates are higher. You'll see us
Speaker 3: having the almost fifty percent of our portfolio and kind
Speaker 3: of five year treasuries and you know, a low teens
Speaker 3: kind of exposure to leverage the loans and a high
Speaker 3: stealage exposure to high quality, high yield. So we can
Speaker 3: change the mix of equities versus debt, but also the
Speaker 3: mix of debt and actually the mix of equities too.
Speaker 3: In twenty twenty two, when the market is really cheap,
Speaker 3: we owned a higher beta mix of equities. Actually started
Speaker 3: buying a video. We bought somemic connectric companies, We bought
Speaker 3: in industrials because everybody believed that there was one hundred
Speaker 3: percent chance we're going to recession. We said, even if
Speaker 3: there is, even if we do go into recession, all
Speaker 3: those cylical companies already pricing it in. So just because
Speaker 3: Jamie Diamond was saying we're going into recession, the market believed,
Speaker 3: it believed that was happening, and but it was already
Speaker 3: fully priced in. So it created a really attractive restueward.
Speaker 3: If we went to a recession, there were that we
Speaker 3: had limited downside. If we didn't go into recession, all
Speaker 3: those cyclicals would pop in, which they did. Today is
Speaker 3: the inverse. Everybody is very, very bullish on the economy.
Speaker 3: Everybody's bullish on a cyclicality, everybody's bullish on beta, and
Speaker 3: we're taking the other side of that. So we're adding
Speaker 3: to utilities, we're adding to lower beta stocks, we're adding
Speaker 3: to healthcare. We're kind of doing you know, because not
Speaker 3: because you know, we're betting the time is going to
Speaker 3: fall off the cliff. We just think over a five
Speaker 3: year basis, you know, buying Goldman Sachs at two times
Speaker 3: tangible book value, you're not going to make a lot
Speaker 3: of money. Buying JP Morgan at fifteen times, you're not
Speaker 3: going to make a lot of money buying select industrials
Speaker 3: at twenty five times earns. You're not going to make
Speaker 3: a lot of money, but buying really great utilities at
Speaker 3: a discount of the market where their business is inflecting
Speaker 3: positive on an organic growth basis. Healthcare comes is a
Speaker 3: little bit out of favor today, but where the long
Speaker 3: term sol looks really good. But there's all these idiosymocratic
Speaker 3: ideas that we like. That's we're always kind of going
Speaker 3: where weceive value, not what the market is telling us
Speaker 3: we should like. I think that's that that that ability
Speaker 3: to think independently the market is really important to our
Speaker 3: strategy and important to our success over time.
Speaker 2: Well, I think we're all in trouble then, because our
Speaker 2: sector scorecard right now is telling us also move into
Speaker 2: defensive ideas. So watch yourself. We all have the same idea.
Speaker 2: We could be in trouble. But I would agree with you.
Speaker 2: In general, the market seems to be a little bit optimistic,
Speaker 2: which is crazy to think about three months ago. You know,
Speaker 2: for a hot minute, we were pricing kind of really
Speaker 2: devastating conditions emerging, and then we pivoted so quickly and
Speaker 2: we roared back, And I think that's been a really
Speaker 2: big challenge for investors. But if you think the dynamics
Speaker 2: of trade as one of the big policy issues that
Speaker 2: has emerged this year, are there any nuanced changes that
Speaker 2: you're making in your portfolio specific to trade policy risk
Speaker 2: and the evolution of tariffs and the changing global trade
Speaker 2: relationships that have really kind of hit us this year
Speaker 2: as a major risk to stocks.
Speaker 3: You know, not really, I would say a couple of things.
Speaker 3: One I would say in the market was very very
Speaker 3: to your point, the mark was very, very concerned about
Speaker 3: tariffs early April, early in mid April, right and the
Speaker 3: market fell off again. We use it as an opportunity
Speaker 3: to buy directions. But today the market is just you know,
Speaker 3: I think they believes is the Taco situation and it
Speaker 3: won't manifest itself. I would say, as someone who is,
Speaker 3: you know, again a chief hit investment officer, one of
Speaker 3: the things in addition to managing money for my clients
Speaker 3: is trying to be a trying to think about bigger
Speaker 3: picture issues for the market. I think when that one
Speaker 3: of the reasons that we had so much conviction to
Speaker 3: put four billion dollars to work in three days at
Speaker 3: the market's bottom was a some of the work we
Speaker 3: did to the that came up to the you know,
Speaker 3: talking with you know, law school professors, talking to constitutional scholars,
Speaker 3: and we believe very strongly, uh, you already saw it
Speaker 3: kind of it C decision on this. I think by
Speaker 3: the you know, let's call it early next year, the
Speaker 3: vast majority of tariffs that this president's put in place
Speaker 3: will be ruled on constitutional. Maybe not all of them,
Speaker 3: but the vast majority of those tariffs will be ruled
Speaker 3: on county that you could actually argue that's a little
Speaker 3: bit of a bullish sign for the market that again,
Speaker 3: the Supreme Court, I would bet in the seven to
Speaker 3: one or seven two or eight one decision will strike
Speaker 3: down the vast majority of the tariffs. The ITC already
Speaker 3: came back three zero. That was a Obama, a Bush,
Speaker 3: and a Trump supporter who probably don't agree on anything,
Speaker 3: could agree that the tariffs were unconstitutional. And I think
Speaker 3: we'll see that at the Supreme Court. And so I
Speaker 3: think the vast majority of the terrafs, maybe maybe the
Speaker 3: Chinese terraffs, maybe the Illudin was still terraf, might stay
Speaker 3: in place, but the vast majority of the other terrafs
Speaker 3: will be ruled unconstitutional.
Speaker 1: I also want to ask about management teams. So you know,
Speaker 1: we talked about what you look for in companies and
Speaker 1: you know what you're avoiding when it comes to looking
Speaker 1: at management teams. Do you have any set of process
Speaker 1: where you're you know, is there like a way you're
Speaker 1: evaluating them or certain things that you look for.
Speaker 3: Well, there's a couple of hats we really want to
Speaker 3: invest alongside management teams where the cap allocation is excellent.
Speaker 3: I think if you look at a lot of the
Speaker 3: giant winners for our strategy over the last decade or more,
Speaker 3: whether that you know, AutoZone, O'Reilly, five, Serve, Texas Instruments,
Speaker 3: Dan or her Roper, those were all companies that had
Speaker 3: excellent cap allocation that really we're able to generate very
Speaker 3: attractive returns with an efficient capital structure almost all of
Speaker 3: those cases. So capital location. We also want management teams
Speaker 3: that are operationally sound, where they you know, again they
Speaker 3: generate nicety in creminal margins on incremental sales. They don't
Speaker 3: they don't have big operational hiccups all the time. They
Speaker 3: they what they promise they're going to do, they actually
Speaker 3: deliver upon to the best extent they can. I think
Speaker 3: those are the you know, good operational prowess, good capitallarcation,
Speaker 3: and you know companies that that that that that run
Speaker 3: their business as well well.
Speaker 1: This is a great discussion, David. We really appreciate your
Speaker 1: time and thank you again for joining us.
Speaker 3: No, thank you for having me great questions as always,
Speaker 3: Thank you and.
Speaker 1: Gina, thank you for being my co host today.
Speaker 2: Oh my absolute pleasure. Thank you David, and nice to
Speaker 2: meet you. David. Thanks for thanks for joining us.
Speaker 1: My pleasure and I want to thank our listeners. If
Speaker 1: you liked the episode, please subscribe and leave a review. Also,
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Speaker 1: on the Terminal Until our next episode. This is David
Speaker 1: Cone with the Inside Out.