#26 – The Pragmatist
Alec Cutler is a value investor who manages a highly successful low risk balanced fund, based in Bermuda. He has forthright views on markets.
Alec Cutler runs one of the best performing low risk global funds and has a pragmatic investing approach. In this interview, we discuss inflation and markets and what this means for stock selection. Alec explains his views on what makes for a successful investment team. And he explains the principles of investing he learned as a child from his grandmother, which still guide his investing framework today.
Getting into Investing
Alec wanted to be an investor since the age of 8. He was introduced to investing by his grandmother (similar to Beth Lilly in Ep 24). His grandfather had a seat on the New York Stock Exchange. HIOs wife inherited the seat when he dies and refused to sell it to her husband’s partners. She leased the seat as women in those days were not allowed to have seats on the NYSE but she didn’t like the offered price.
She learned about investing at cocktail parties in spite of an education well below her intelligence and became a highly successful investor. She would meet public company executives at these parties and learned about their stocks. She was a much better investor than her late husband and taught Alec some of the basic principles of investing:
- the importance of cash earnings
- good steward managements
- the importance of investing in products that matter and have staying power
- and the gains that come from paying less than something is worth.
Alec’s World View
Alec has a very strong and extremely interesting view of the world. He highlights that institutional memory and anchoring are significant in investing. The first blip in a regime change is often ignored or is overcome by “buy the dip” which admittedly has worked pretty effectively to date.
Underlying this, however, is a tremendous amount of liquidity and stimulus which Alec believes has become an addiction. He believes that when we look back, the Fed encouraging the Government to spend money in the Covid pandemic was equivalent to going off the gold standard in 1971. Liquidity of $7tn was injected in just a few months and the Inflation Reduction Act will deliver another $2-3tn of liquidity. Alec says the economy is addicted to money and the market is addicted to money.
The last bubble created a massive misallocation of capital and the result is inflation. Alec thinks the biggest risk is if the Fed believes they can really get to 2% inflation, as he thinks the natural rate of inflation for the next few years could be 5%.
He believes the market is telling him to own TIPs and high free cash flow quality stocks. And as long as he is clipping good dividends, Alec feels he is being paid to wait.
Alec’s Investment Approach
Alec believes in having a diverse team. 40% are women, a deliberate strategy. (This must be harder to achieve than it sounds – we have been trying to boost the number of women listening to this podcast which is far lower than we would like – suggestions welcome).
Not everyone thinks the same and he classifies team members as storytellers or numbers people. Typically one of each group will review a potential investment. The team travels a lot and Bermuda is very accessible. Interestingly, in contrast to say Chris Pavese who sees his remote base in the Blue Mountains, away from the noise of New York, as a big advantage, Alec didn’t stress that as an attraction of Bermuda which was a personal choice for him.
Having a diverse team has enhanced their process significantly.
The Successful Investor
We joked about the CFA – you can be a highly ethical person but still fail their ethics exam. The qualification tells you where everyone’s baseline is. It weeds out a few, but it’s more knowing what everyone else knows.
There are three levels of investor in Alec’s judgment.
At the bottom level, having a passion, the maths, the spreadsheet ability and the accounting knowledge are all taken for granted.
At the next level, can you learn from your mistakes?
At the top level are the few special people with an innate ability to recognise patterns, no fear of being wrong and an uncanny ability to overweight their future winners. And it takes a long time to prove that you are any good.
ABOUT Alec Cutler
Following a spell in the Navy, Alec joined Brandywine, now a $66bn firm, working directly with founder Tony Hitschler, then one of the top value investors. One piece of advice he gave was after periods of acute success, he would come into Alec’s office and say “Great job! This too shall pass”.
Alec stayed with Brandywine until Tony retired then moved to Orbis in Bermuda. In 2012, he started a moderate risk global fund. He was attracted to balanced funds and there was a gap in the Orbis portfolio and the fund has performed extremely well.
Alec recommended two books. He likes Stocks for the Long Run by Jeremy Siegel as a primer on the history of markets and believes that you need to be a historian as an investor. His other choice is a biography of Leonardo DaVinci which focuses on how peculiar he as and how he thought out of the box.by
How to Think like Da Vinci by Michael Gelb
HOW STEVE KNOWS THE GUEST
Steve met Dan Brocklebank of Orbis at a conference and Dan introduced them. Steve and Alec share very similar views on the long term outlook so immediately got on, and Alec kindly agreed to come on the podcast on his next London visit.
Full disclosure: Orbis is a client of Behind the Balance Sheet.
00:02 – Investment advice and mistakes
08:30 – Learning from top investors
22:53 – Liquidity, stimulus, and confusion
32:10 – Inflation and central banks
58:57 – Diversity and skills in investing
01:14:02 – Nerves and recommended resources
Added post publication using AI
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STEPHEN CLAPHAM: ALEC Cutler is a value investor who manages a balanced fund based in Bermuda. That fund has been one of the best performing low risk global funds. And ALEC has an interesting and pragmatic investing approach. In this interview, we discuss inflation and markets and what this means for stock selection. ALEC explains some of his holdings.
STEPHEN CLAPHAM: I groaned when I learned a stock I picked and gave up on years ago has been an eight bagger since why do I keep making these mistakes? ALEC explains the principles of investing. He learned as a child from his grandmother which still guide his investing framework today. He explains why diverse teams work better and how he matches numbers people with storytellers when they review a stock and why the C FA is simply table stakes. I really enjoyed this discussion. Well, apart from that stock mistake and particularly our exploration of why the 2020 Will likely be very different from the 2010 S, a number of tailwinds that have been propelling markets in the last 20 plus years and it’s not just interest rates, they’re all now becoming headwinds.
STEPHEN CLAPHAM: I’ve been presenting in this for the last 12 to 18 months at various investment conferences. And I’m thinking perhaps I should do a webinar for podcast listeners. If you’re interested, let me know, email me at info at behind balance sheet dot com. I’m sure you’re gonna enjoy this episode. And just to emphasize, we recorded it in the summer and Alex discussion of stocks is not investment advice. Do your own research.
STEPHEN CLAPHAM: ALEC Welcome to the show. I’m so pleased that we finally get to meet in person and I always ask the same opening question. Did you always want to be an investor?
ALEC CUTLER: At least since age seven or eight when my grandmother started teaching me everything there was to know about investing.
STEPHEN CLAPHAM: So, yes, I love the grandmother’s stories. We had the very first episode of this podcast we had on Brent Hoberman and John Armitage. Brent’s the a leading light in UK tech and venture capital and John manages a $28 billion hedge fund. He’s got one of the best track records in the world. But there’s this like bizarre connection because Brent’s grandmother was one of the early investors in, in John’s Fund.
STEPHEN CLAPHAM: And John started talking about this grandmother and the grandmother was obviously a formidable character and the sound of it, your grandmother was as well. But you told me this story about, she said, don’t buy sugar because you can get the sugar packets for free in, in restaurants. She must have been a wealthy woman.
STEPHEN CLAPHAM: Why did she have this frugality? And have you inherited that?
ALEC CUTLER: I have. But my wife hasn’t.
ALEC CUTLER: So, yeah, I guess, yeah, she was, she was quite frugal and she, she understood value for money. My grandfather had a seat on the New York Stock Exchange and when he died in the late sixties, when I was three, his partners at Rothschild said, well, you Will sell this back to us. And she said, I don’t like the price. And they said, but you’re a woman.
ALEC CUTLER: And she said, I don’t like the price. So she kept it for another 20 years, leasing it out. So she was a, she was another tough customer, another tough grandmother.
STEPHEN CLAPHAM: Well, you weren’t allowed as a woman to, to own the seat.
ALEC CUTLER: Not according to our family lore.
STEPHEN CLAPHAM: No, it’s quite, quite amazing in the sixties. I mean, it’s not that, I mean, it’s that long ago, but it’s only 50 years ago.
ALEC CUTLER: I think Muriel Seabert was, was shortly after that. So they did break down eventually.
STEPHEN CLAPHAM: And you told me this story about the Charlie’s Folly file dedicated to hot stock losses. Tell us about that.
ALEC CUTLER: Yeah. Well, she, she, I think she was a better investor than my grandfather who was the professional investor. He bought his seat March of 29. So not exactly the best timing. I think he probably bought pretty high. And and she was offered a low price and said no way.
ALEC CUTLER: It was clear, I didn’t know what a value investor was back then. But if you add the frugality with the sense of value for money and the importance of dividends, the importance of a of a good management team, the importance of buying things for less than they are worth based on cash earnings.
ALEC CUTLER: These are all things that she was teaching us at 78 years old. She was clearly a, a value investor and, and clearly was not afraid to be alone and wrong.
STEPHEN CLAPHAM: And how, how did she learn all this? I mean, the importance of cash earning, I mean, how would she have known?
ALEC CUTLER: She learned it at cocktail parties? Classic, right.
ALEC CUTLER: So what did you do as a stockbroker back in the, back in the sixties, fifties and sixties, you had cocktail parties and you talked about stocks and she listened and she is one of those classic women of the fifties and sixties and forties that wasn’t allowed to go to school, education way below her intelligence and, you know, to make money was a model back in the fifties and forties when you weren’t supposed to be a model.
ALEC CUTLER: And she picked up from just the listening to what was going on became a fantastic investor.
STEPHEN CLAPHAM: And you, you mentioned the, the importance of good stewards management. What did she teach you about that was she, did she have any sort of lessons to learn?
ALEC CUTLER: I mean, they, she, they lived in New York City, so she frequented a lot of the management teams back then. If you were a decent size company, you were headquartered in New York.
ALEC CUTLER: So she knew them personally and she knew the good ones and the bad ones and she knew the ones that wore Fancy watches and had slicked back hair and suspenders and, you know, all the classic sort of Wall Street. No, nos for, someone who promoted themselves more than their, more than their company and their shareholders.
STEPHEN CLAPHAM: So you did a spell in the Navy and then you joined Brandy Wine, you didn’t immediately set out to become an investor. So tell us about Brandy Wine was that you were working directly with the founder and that’s not like a 60 $70 billion firm. It was like.
ALEC CUTLER: So what was that like? That was an opportunity to work with Tony Hitler was fantastic. You know, anyone who gave me a device in business school said work for somebody who is great. If you can find a visionary, make them your mentor. It doesn’t matter how much money you make, work with that person for free and visit them on weekends, do whatever you can to soak up what they have.
ALEC CUTLER: Tony Hitler at that time was one of the top us value investors. Deep value. He had nerves of steel and yet he was a quite emotional person and friendly person. So it really interesting mix for for a for a value and deep value investor.
ALEC CUTLER: So I had a I had a wonderful experience with Tony and stayed at Brandy Wine until he left, which was hard because I chafed at the the discipline particularly you had to sell, you were allowed to buy anything in the bottom quartile a price to earnings cash flow or book. But you had to sell when it reached median.
ALEC CUTLER: And yeah, and that made zero sense to me from day one that you would do all that work on a contrarian idea like Adobe at $8 with $10 in cash in 1998 and then sell it when it was up 50 60% and hand it off to a growth investor who rise it for 4000%. So I didn’t like that. I chafed at that. I tried to create ways around it, but it was a, it was a hard and fast discipline there.
STEPHEN CLAPHAM: Why do you think they impose such a rigorous discipline because that, I mean, that one of the cardinal rules in investing equity investing is you’ve got to be flexible, right? I mean, why have that straitjacket?
ALEC CUTLER: But it worked really well for decades if you had done that over decades and, and brand new one was a very quant front end shop.
ALEC CUTLER: And we did studies and had studies published and in fact, I, I did a, a tax adjusted version of one of the basic value studies at, at Wharton with Jeremy Siegel. And it works extremely well and actually had pretty low val so high sharp ratio.
ALEC CUTLER: And they, they run a quant fund on the side. It still does quite well, but it’s a lot of turnover.
STEPHEN CLAPHAM: Yes. And I, I hadn’t realized you were at Wharton with Jeremy Siegel. Who, what was he like?
ALEC CUTLER: He was fantastic. Yeah, he is. He’s exactly what he’s like on TV.
STEPHEN CLAPHAM: I’ve never seen him on TV.
ALEC CUTLER: I, I, I’m, no, he’s on, he’s on American TV all the time. He’s a big commentator now, but we were, we didn’t know it at the time, but I suspect that we, as grad students were helping him write chapters in his book Stocks for the long run, which is really the, the Bible now, I think for anyone getting into investing. Yeah. Well, it’s been.
STEPHEN CLAPHAM: Pretty popular but I feel a bit, I feel a bit sort of parochial sitting in London without having an opportunity to watch Jeremy Segel on the television.
ALEC CUTLER: But I’m sure you can find him on YouTube and I’m sure you can, I’m sure you can anticipate what he’d say.
STEPHEN CLAPHAM: Oh, yeah, I know. I, I’m sure I love that line. You told me about that. Tony Hiler used to come into your office and say great job this too shall pass. He was obviously, quite good at understanding the emotional context.
ALEC CUTLER: Yeah. And, and as a, as a contrarian investor for sure, you know, once you think you’re God’s gift to investing, you better watch out because it’s about to come down on you. And that’s just the nature of the beast.
STEPHEN CLAPHAM: And I mean, you, you, you previously had a spell in the Navy. I mean, quite a lot of military ex-military people seem to do quite well in finance. Why do you think that is? I mean, is it just a discipline thing?
ALEC CUTLER: I think there’s a discipline aspect to it. I think there’s an understanding risk inherently. I used to tell people that, you know, they say, why are you so calm, dealing with billions of dollars?
ALEC CUTLER: I said, well, I’ve, I’ve, I’ve piloted a ship through the straits of Wanda Fuca with fishing boats all around at night like this is nothing compared to that. And I think about my daughter flying jets in the Navy, you know, that that’s real life and death risk.
ALEC CUTLER: This, this is embarrassment risk. Yeah, we do take our, we take our job very seriously. We provide a service. We try and enhance people’s savings and wealth. But if we have a bad month or a bad year because the market disagrees with us, it’s not the end of the world.
STEPHEN CLAPHAM: That’s quite good. That’s quite good philosophy. So you, you told me that at Brandy Wine, you resisted Warren Buffett’s bid for Clayton Holmes. What was that like? Did you get to meet Buffett or did you encounter him? What was he, what was he like being on that? I imagine it’s quite formidable being on the other side of the fence.
ALEC CUTLER: It is. I never, I never got to meet him. He didn’t show up at the, at the meetings where the votes were counted. But it was an incredibly valuable experience mostly because I got to know Will and Alan Gray from Orbis where I am now and learned how such high integrity that, that, that firm had and how focused it was on protecting its clients.
ALEC CUTLER: I mean, it’s a vicious defense of clients rights and you’re not gonna take this company from us type attitude. And the fight was, you know, it was a six month long fight.
ALEC CUTLER: The vote was delayed at one point because they didn’t have the votes and something magically happened where they were able to get someone to cross the line and, and vote. Yes. And the, the merger was, was completed and I think it’s been highlighted in, in several of Buffett’s reports as having been one of his best investments.
ALEC CUTLER: But the real value for, for me was meeting, Will and Allen and getting to know the Orbis team.
STEPHEN CLAPHAM: And you lost Holmes at what, an eight times pe something like that.
ALEC CUTLER: Yeah, we were buying, we held it for a couple of years at 68 times earnings and Buffett paid nine or 10 and I think it’s just been a massive win for him and we knew it was going to be a massive win.
ALEC CUTLER: But it’s, it, it’s one of the tough things about deep value investing in particular is some deep pockets can come along and take you out and that can be for the amount of time and effort you put into it. You know, the 30% pop on that day doesn’t feel very good.
STEPHEN CLAPHAM: It was funny. It was David Einhorn said exactly the same thing. He bought a stock and it got taken over and he felt that it got taken, it should have been 40% higher. And he said, well, you know, I made 70% or 90%. He said, I just, you know, I didn’t have, he didn’t have the ability to resist, but it was, it, it’s really, really frustrating, you know, how good a deal with the other person’s getting and they aren’t being forced to pay up, but it must be frustrating.
ALEC CUTLER: Well, the thing that frustrates us most is when we lose permanently, lose capital on something. So, and, and that’s, that is, that is an investor behavior that can be quite negative. Right? I refuse to sell because I’m down.
ALEC CUTLER: But if we’ve done the work and we know the company’s gonna recover and we bought it at 100 it’s sitting at 50. It doesn’t deserve to be at 50. It deserves to be at 100 and 20 someone buys it at 70. You’ve now permanently impaired capital and that from a, the way we keep score, that’s a loss.
STEPHEN CLAPHAM: No. Sure. Well, what you can score, that’s a loss. But yeah, that’s just the, I think that’s a reflection of current market.
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STEPHEN CLAPHAM: So you, you started with Orbis, you moved to Bermuda, which is obviously a more pleasant environment than New York. We’ve had a number of people on the show who work live in environments which are away from the noise and we’ve had sort of slight debates, discussions. So Chris of asset management lives and works in.
STEPHEN CLAPHAM: So he works for the hill family are based there. It’s the Blue Ridge Mountains in North Carolina. You know, he said, oh, Steve, you must come and visit. It’s beautiful and I I kind of get all that, that it’s quiet, it’s nice.
STEPHEN CLAPHAM: And, but I pointed out to him that, you know, I live in London and as a global investor, every large company is going to come through London, you know, if they want, if they want international investors. So there’s loads of conferences, these things are optional. You don’t have to go, you don’t have to get sucked into the noise. You don’t have to, to do it, but you have the opportunity to do it.
STEPHEN CLAPHAM: Well, how do you feel? I mean, you were, we’re in London now. So you obviously you have to travel from Bermuda. I mean, what’s the advantage and disadvantage of living in, in Bermuda, living away from the noise? I mean, Bermuda is obviously a big financial syndrome.
ALEC CUTLER: Well, was it Tony Hitler actually believed that it was important to be away from the noise. So, so we were in Wilmington, Delaware at Brandy Wine and and I found it to be quite valuable. We’re on the train line so people could come visit.
ALEC CUTLER: Bermuda is a wonderful place. People come to visit there too. So we do have management teams come through and when they do come through, it’s special for them and it’s special for us. So it, it means something. It’s quality time, it’s dinner, it’s taking them out on a boat or taking them golfing or finding them a tennis partner to play with.
ALEC CUTLER: It’s a much higher quality experience and when they’re doing a road show and they’re doing the road thing and, you know, we never ask questions anyway. We prefer to, to do things one on one and, and off the, off the beaten roadshow path.
ALEC CUTLER: But beyond that, to, to be a contrarian, it seems to help to be removed. You know, we’re expected to try and analyze what’s in the box anticipate where the box is going and it’s really hard to do that when you’re in it.
ALEC CUTLER: Yeah, I, I get that. Yeah. And we do have a team in London team in San Francisco team in Hong Kong. We have Cape Town.
ALEC CUTLER: We have a lot so you got people, analysts on the ground so they can keep, keep an eye on what you on what you’re on and give you some warning signals and with technology we can join any of those meetings from, from Bermuda.
STEPHEN CLAPHAM: Yeah, I mean, I I, obviously we’ve had a massive change since COVID and you are able to do to join all the conferences, et cetera remotely. But I find it slightly this, I don’t know, it’s just slightly unsatisfactory. So we, we could have had our, this conversation over Zoom but it’s not, it’s not bad, but the quality of our, of our conversation is better if we’re in person, it’s two D versus 3D.
ALEC CUTLER: Yeah.
STEPHEN CLAPHAM: But when you’re, when you’re talking to a management team and you want to understand, not necessarily that you’re expecting them to be lying to you.
STEPHEN CLAPHAM: But there are areas of, of where they’re comfortable and obviously there’s not an issue and there’s areas where they’re uncomfortable and it’s just that sense of, oh, obviously, when I start asking about this division, he doesn’t, he’s worried about this division and being aware of that, I think is huge, huge part of having the 1 to 1 meeting. And I find that just much less satisfactory.
ALEC CUTLER: And yeah, and we’d rather just skip straight to going to visit the company because the, the, you know, when you go to a presentation, they practiced that it’s been vetted through the lawyers.
ALEC CUTLER: There’s no body language because they practiced it 50 times and they’ve been told body, body language expert not to do this and this when you go to visit them at their company headquarters, which I’m doing on Monday and Tuesday out in Birmingham, you know, those are valuable experiences we find and you can get the, you can get the entire management team, especially if they’re down.
ALEC CUTLER: I mean, I had the opportunity as a young analyst to go meet Adobe. And they were so pummeled that the two founders showed up to the meeting. It was a one hour meeting.
ALEC CUTLER: I spent three hours with them, they told me everything there was to know about acrobat, which they were just, just putting out and the FDA had just signed a release saying that any drug submissions had to be done over acrobat. And at that time, Adobe was thought to be a dead company that Apple was gonna kill them.
ALEC CUTLER: Yeah. How funny Apple and Microsoft were gonna kill them. And there’s Adobe signing a massive contract with the government in those days. Of course, they could tell you that they wouldn’t, it was a public release release that no one cared about. Oh, really?
STEPHEN CLAPHAM: That’s amazing, isn’t it? That’s astonishing. And presumably when you go and see companies, they’re like, oh man, we’ve got an investor coming to see us because you’re buying all the stuff that nobody else wants.
ALEC CUTLER: Right? So we’re the friendly face usually, usually.
STEPHEN CLAPHAM: So listen, we’ve been talking about the, the sort of, we’re at an inflection point. We share this sort of perspective that we’ve had 40 years of falling rates and I’ve, I’ve been doing a presentation. I, I’ve done it twice in the last month. To private investors conferences just, and I, I can’t remember what the title of it is. It’s something like why you need to look back 100 years to look forward. 10. Not very catchy, but.
ALEC CUTLER: I can save you a lot of money because it can save you a lot of money.
STEPHEN CLAPHAM: Well, I mean, what I’ve just said is, look, it’s not just 40 years of falling rates. You’ve had cheap, plentiful labor, you’ve had globalization, China, you’ve had cheap energy, you’ve had technological, you’ve had demographics, you’ve had the Berlin Wall, you know, you could go on and on and on. And what I do actually, I’ve got this slide which is, let’s, let’s go back 100 years.
STEPHEN CLAPHAM: And so I got a picture of a Tesla and a picture of a, a center door, a model T Ford and say, let’s pretend we’re in 1923 and the, the data point is actually 1921. But, you know, I, I’m still using the same slide and, if you were in 1921 and you look back 50 years, do you know what I mean? Can you guess how many months were bear markets?
STEPHEN CLAPHAM: How many months were, were bull markets? I mean, the, the number is astonishing. So there were 412 months of bear market and 180 months of bull markets and people seem to be conditioned this idea that the stock market goes up at 8% forever. I mean, I just read a book by Nick Mali, which, I mean, it’s not a bad book, but this seems to be like a given.
STEPHEN CLAPHAM: So the stock market is going to go up at 8%. So you need to get your money in now. And Buffett in a way has been encouraging this perspective. And I’ve been saying, well, it’s possible that that’s not going to happen for the next 10, 2030. I don’t know how many years, I mean, what, what did you, what’s your take on that?
ALEC CUTLER: We think you’re spot on and, you know, we study human nature a lot in this, in this business, either formally or informally and the institutional memory has a lot to do with an anchoring theory, right? So whatever has been is what you expect and the, the first blip in a regime change is ignored completely or is by the, by the dip, by the dip by the dip, which has been working great.
ALEC CUTLER: But if you look at the, at what’s stacked up against us after 40 years of what’s been a tailwind, it’s pretty ominous and, and impressive. And when I speak to that, I get a lot of nods and then I suspect people go back to, they see C NBC or something and they get pulled up again.
ALEC CUTLER: But what’s really underlying it, it appears is just a tremendous amount of liquidity in the market. And stimulus and that also appears to be something that people are getting used to. Yeah. So there’s an addiction to stimulus and money being pushed into financial assets and the economy, you know, we talk about how it used to be called helicopter money.
ALEC CUTLER: And, and now it’s just, it’s actually really happening. And I think if the, if the Fed, you know, look back in the, in the seventies and, everyone gave Arthur Burns credit for being an idiot and creating the disaster. That was the seventies.
ALEC CUTLER: But if you look back to the seventies, you would say that the, the thing that threw everything off was, was going off the gold standard in 1971 that threw Arthur Burns for a loop because there go your guard rails. I suspect if we look back in 10 or 15 years and the decade, this decade is winds up being awful over the next decade, winds up being awful.
ALEC CUTLER: I think we’ll look back and see during COVID, the Fed, the Federal Reserve Bank pleading with the government to stimulate and spend money and give money away Will be that 1971 gold standard moment in that they, the government has never been told by the Fed to spend money. The Fed was the, was the adult in the room, right? And then they said, spend money.
ALEC CUTLER: And how long did it take the government to spend $7 billion? Seven sorry trillion dollars and chump change billions $7 trillion in a few months. And then we had the inflation reduction act that quickly followed thereafter, which was another two or three trillion when, when all of a sudden and done the, the economy is addicted to money, the markets addicted to money.
ALEC CUTLER: It’s gonna be interesting to see to what degree the Fed can follow through on quantitative tightening because every time they seem to tighten something blows up. Yeah, like the regional banks.
ALEC CUTLER: And we have a big debate in our shop and we are not economists or strategists, we kind of assume that, that pursuit we are stock pickers and, and bond pickers, but we do have to go to 50,000 ft every once in a while and say what the heck’s going on.
ALEC CUTLER: And when we do that, we look at the cycle of, you know, the, the Republicans just approving another $4 trillion in, in deficit spending and looking at the Federal Reserve saying, well, you’ll buy that right? You’ll buy those bonds, right? And then how does that not inflate the Federal Reserve balance sheet? So we just don’t see how we’re gonna get out of the cycle.
ALEC CUTLER: And then the question is, well, maybe we can go to infinity on the cycle of, of, of liquidity. And the only thing we keep coming up with is inflation. Yeah, the bond vigilantes can’t compete with the Fed, you know, no one has no one with a 50 leverage, can do, can do something about $4 trillion in bond buying from the Fed. So it has to come out in inflation somehow.
STEPHEN CLAPHAM: No, I think that, I think that’s right. But I’m curious, do you say you as the pursuit of, looking at the economic strategy? Because, I mean, you’re running a balanced fund. So you’re doing, you know, I mean, how can you not spend a lot of your time if you’re investing in bonds?
STEPHEN CLAPHAM: I mean, I I I’m not familiar with, with, you know, people that invest in government bonds really. I mean, you know, I’ve worked with people that did 60 40 always thought it was pointless. But if you’re, if you are going to look at government bonds, then surely you need to be a bit of an economist, don’t you?
ALEC CUTLER: I mean, we have a currency team and if you think about what a currency team is, they’re really government economists. Sure.
ALEC CUTLER: They advise us on currencies and if you want to place a bet on a currency, you buy the government bond. We also have two very experienced fixed income portfolio managers on our directly on our nine person team where we make our asset allocation, however, is bottom up.
ALEC CUTLER: So we force our fixed income ideas to compete against equity ideas, we force them to compete against gold or commodity, we compete all of those to compete against hedged equity. So higher risk equity with with the market hedged and then we can do currency overlays on top of that. So it looks like a very confusing bowl of spaghetti.
ALEC CUTLER: And you know, there were people that said you can’t really do acid allocation that way, but we have now for 11 years and it’s worked just fine when you give you an example. Why in the world would you buy a US tenure at, at 3.74%?
ALEC CUTLER: No inflation protection with a at seven years of duration risk when you can buy a Kinder Morgan and get a 7% dividend, that’s inflation protected. All the contracts are inflation linked. All their counter parties are a rated, 90% are a rated and they have a 12% free cash flow yield. So dividend well covered run by Rich Kinder, one of the visionary legends in energy investing.
ALEC CUTLER: They rent out natural gas pipelines. The business for national pipe natural gas pipelines looks pretty darn good kinder. I’m not gonna buy a A US 10 year when I can buy Kinder Morgan. So just an example of how an equity can compete against.
STEPHEN CLAPHAM: But I mean presumably you got to have some 10 year us. Treasuries are some duration of us treasuries just to give you a balance in the in the overall portfolio or can you go 100% equity?
ALEC CUTLER: No, we can, we can go up to 75% net equity. Yeah, we’ve averaged around 63. Ok. So not far off a 60 40. And we’ve made up that what we’re dedicated to is making a moderate risk portfolio. As we saw in 2022 having 40% of your portfolio in 10 year bonds wasn’t a moderate risk portfolio.
ALEC CUTLER: And we were screaming about that for years. We’ve been calling fixed income reward free risk. And in 2020 you had 20% of the bonds in the world had negative yields. Like how is that protecting you to the downside in your equities?
ALEC CUTLER: So we put a ton of flexibility in our, in our mandate such that at that time, we could be, you know, a slug of gross equities, 20% hedged 10% in gold in gold miners and 10 15% in short dated bonds and tips.
STEPHEN CLAPHAM: So you just go very short dated in the government securities and, and inflation.
ALEC CUTLER: Protected and we weren’t giving up much in the way of yield going short dated. You know, you’re, you’re getting 50 basis points instead of 100. Yeah, so 100 basis points for seven years of duration risk that it was insane.
STEPHEN CLAPHAM: Yeah. No, although I mean, presumably now the balance is better.
ALEC CUTLER: Yes, it is. And we’re moving it up a bit. Most of it’s in tips though because if you look at where the inefficiency is in the market and I know you don’t want to get Too Short term. But I think this is actually a long term statement. Inflation expectations are way too low. And I don’t understand. Well, I do understand the psychology behind hope.
ALEC CUTLER: But you’ve had a, you’ve had a Federal Reserve Bank and I won’t comment on the Bank Of England or the ECB, I know the Federal Reserve better, but they haven’t been right on anything for years and yet they have everyone convinced that we’re going back to 2% inflation. So inflation expectations out 10 years or as far as we look is for us to go back to 2% inflation on average over the next 10 years.
ALEC CUTLER: That’s starting now. It’s starting a year ago. It’s starting a year before that. We’re well into the point in time where the Fed said we’d be back at 2% and they just keep moving the line and moving the line and people keep believing and believing it don’t know when they’re gonna stop believing that.
ALEC CUTLER: But if you own tips, you don’t really care. So we’re getting one point between 1.6 and 2% nominal on the tips plus inflation. So the bond is paying us on a, on a quarterly basis at 1.6 to 2%. Plus we get all the accumulated inflation between now and maturity. We’re betting that that’s gonna, that inflation is gonna be more than 2%.
STEPHEN CLAPHAM: I think that’s a pretty reasonable. I mean, it’s quite, it’s quite funny, isn’t it? Because, I mean, you can, you can see some of the data points do indicate that underlying inflation is coming down in the, in the United States.
STEPHEN CLAPHAM: But common sense tells you that we can’t go back to the period that we’ve just come through because it’s inflation seems to be pretty endemic. I mean, I, I know so particularly here in London and food costs. So I think we’ve got something like 19% inflation in, in food here.
STEPHEN CLAPHAM: I should add for the benefit of the listeners that were recording this at the last week, in or second, last week of June just to, just to time stamp that because obviously these things are, are moving around quite a lot. I mean, if you sort of looked at five years, where do you think inflation might be?
ALEC CUTLER: I don’t know, but I think the odds are, it’s gonna be higher than 2%. Yeah. So we can, you know, if you’re the biggest worry about the future has to be inflation. Sure, you can throw a global conflict in there because that looks pretty scary too. And especially when you have a daughter in the military.
ALEC CUTLER: But which is also inflationary, but inflation is a killer and everyone knows that it comes from different places at different times. So we have all of these central bankers trained doing their doctoral thesis is on the, on the 19 seventies but inflation is not gonna pop up in the same way every time.
ALEC CUTLER: And if you look at that layer cake that you went through of inflationary impulses of tail winds that have become headwinds and then you add on green inflation. So Jeremy Grantham came out and put a price tag on green inflation at $100 trillion.
ALEC CUTLER: We need to spend to get to net zero and he’s a fan of getting to net zero. $100 trillion. The US GDP is 30 trillion. I think this is a massive number. People, people lose a con lose the concept of what a trillion is. And I at conferences, I asked people if you go back in time, a trillion seconds, what year are you in?
ALEC CUTLER: And I get some, I get some answers that aren’t even close but it’s 30,000 BC A trillion is a big, is a big number.
ALEC CUTLER: And that that inflationary impulse alone that’s gonna come from electrifying everything is just immense and we’re starting to see some balking at that. So it may be fast. It may be slow. But that layer cake of inflationary impulse is just too big to ignore.
STEPHEN CLAPHAM: And the, the $100 trillion just to be clear is inflationary because it’s not creating any incremental output. It’s simply to replace assets that we’ve already got. And if we didn’t have a problem with, with the climate, then we wouldn’t necessarily need to replace.
ALEC CUTLER: Those assets it’s reducing output. So if you are, the example I like to give is your, you’re gonna, you’re gonna force the cement factory to replace the heating part of cement, which is how you make turn limestone into cement. You get it really hot.
ALEC CUTLER: You have to replace, oil, coal or natural gas with electricity. That’s being mandated. If it was more efficient to heat that up with electricity, we would have done it to begin with. Yes, of course. So we’re shifting from a, from a more efficient, cheaper way to make cement to a more expensive way that doesn’t reduce prices that increases prices.
ALEC CUTLER: Plus you have to amortize the billion dollars that it takes to change over from natural gas to electricity. I don’t know what we’re going to make our roads from. But if tarmac which is made from oil is the, is the cheapest way to make a road, I, I’m pretty certain that it’s gonna be more expensive to maintain our roads unless we’re gonna just drive on, go back to gravel and dirt or we might be doing less driving maybe.
STEPHEN CLAPHAM: And it Will be, my theory is we’ll all be in the autonomous cars. So, or maybe we have flying cars and we’ll have, of course, we have the flying cars, I’m sure. Well, I mean, they were all the rage in just a couple of years ago. I haven’t heard, I haven’t seen any flying cars.
ALEC CUTLER: All the spanks. Right. You have to burn a lot of coal to charge them up.
STEPHEN CLAPHAM: That’s, this whole green inflation thing though, I think is, is really a fascinating subject. I mean, now, you know, I’m, I’m with Jeremy Grantham. You know, we need to, we need to do this because our children need to have a planet to, to, to live on. But the, the, the whole ESG thing has been hijacked by people in finance in order to make money is a big marketing game.
ALEC CUTLER: Now, it’s.
STEPHEN CLAPHAM: Just extraordinary and, and this, this idea that yeah, of course, you can invest in things that Will benefit from the $100 trillion of spend. But the underlying picture Will be one of a more inflationary environment. And why do you think people don’t understand that equities don’t necessarily protect you against inflation?
STEPHEN CLAPHAM: Because I mean, if we go back to the seventies, equities were rubbish, I mean, except for really cheap ones, except for small cap and did quite well, small cap and value did well, I mean, what do you think Will do well this time? I mean, it won’t, Will it necessarily be the same, same thing?
ALEC CUTLER: It feels like it’s going to be I I call them advantaged industrials. So A I the, the other A I, but if you think about where we’re headed, we need to completely rebuild the grid. The European and North American grids are on average 40 years old. The design life is 20 to 25 years for high voltage cabling.
ALEC CUTLER: And if we’re going and we’re completely reorienting it when you put ev charging points everywhere and you put windmills, windmill fields and solar fields, solar farms 500 miles away from the coal pain. You’re gonna close down.
ALEC CUTLER: You need to completely reorient the grid or the wires melt and that’s what’s happening. So you need to completely rewire everything that is trillions. California alone just to, just to harden, just to replace their high voltage lines and move them down into underground is one or $2 trillion. California alone.
ALEC CUTLER: And that’s where you, they’re the case point. California and Texas are the places where the fires are starting because the, the lines are overheating and sagging and they sag down into a tree and they are uncovered so they start a fire.
ALEC CUTLER: But the, the shot is across the bow that the, the net, the grid networks, the electricity that we’re banking, all of our greening lawn are decrepit and need to get replaced. So you can make, we have a, we have a significant investment in the companies that facilitate that change that has to happen. So there’s, there’s one odd thing that’s happening right now.
ALEC CUTLER: People are worried about a recession. We’ve been baking in a recession now for over a year and cycles have kind of been treading water because they’re waiting for the recession to be called so that people can buy them because that’s the way it works.
ALEC CUTLER: And construction is, is typically a high beta economic cyclical, right? But we have to spend so much money on, on greening everything on electrifying every process. Add to that the ons shoring that’s happening onshore is already happening. No one waited for the IRA to get subsidies.
ALEC CUTLER: People have been pulling out of China for quite a while and moving things back to the US and, and and Canada and Mexico and the UK that money’s being spent and that is you can’t just plop a factory down somewhere that has a road that has a port extension that has in addition to the airport that has a rail service.
ALEC CUTLER: All that, all the infrastructure has to happen and if it’s not done by commercial means, it’s gonna be done by the government via subsidy, be a cash.
STEPHEN CLAPHAM: Well, I mean, the construction numbers are off the charts in the U Si mean, I’ve forgotten what the number is but I, I, I’ve got the picture of the chart in my mind. I mean, I I was a, a standard, I mean, there, there’s no, not even a sign of a recession. I mean, I don’t know.
ALEC CUTLER: Not in construction.
STEPHEN CLAPHAM: I mean, obviously the US is a consumer, 70% consumer so we can have a recession and construction going up.
ALEC CUTLER: But the UK has cranes all over it as well. Belfer Beatty has the biggest bookings they’ve ever had. It’s, well.
STEPHEN CLAPHAM: Most of its competitors have gone bust. I mean, that, that when you’re the one well managed one that helps the capital cycle, which we always always like the infrastructure, the, the grid plays. I mean, what, what was the company that you’re referring to? It? Always used to be?
STEPHEN CLAPHAM: A BB was the one that people always cited and, you know, it was, it was never a very good stock. I never really, I mean, we, we I have been played around in it and made, made some money in it, but it should have been like, you know, one of these long term quality compounders and it just never kind of fulfilled that promise. Are there others that you that you like? Yeah.
ALEC CUTLER: So I, I think maybe I’ll be one of your, one of your only guests to mention a European success story.
STEPHEN CLAPHAM: Go on like the.
ALEC CUTLER: Electric cable was a terrible business for a long time. You built, you built out the US, you built out Europe and then what do you do?
ALEC CUTLER: So that that business went into negative growth for decades. The Europeans bought all the American high voltage medium voltage cable companies, cable manufacturers. So all of the western world, if you Will is being supplied by three European companies, the old Pirelli, which is now called Prism, NKT in the Netherlands and Nexon in France.
ALEC CUTLER: They are, they’re virtually 100% of the high voltage cable that now is in extremely high demand. Zeman’s energy makes the transformers and switches and they make the, that by the way, when they did, when Siemans spun out Zeman’s energy because they want to get out of this dirty energy business, industrial stuff. They didn’t even feature their grid equipment division in the, in the roadshow materials.
ALEC CUTLER: They talked about gas turbines which was thought to be in permanent decline. Now, the EU has decided that that’s the transition fuel and we’re moving to hydrogen. So gas turbines are going to be around forever. Taking the taking the excess energy from the, from the windmills and solar plants converting into hydrogen and burning the hydrogen when they’ve, when it’s dark and cold and no wind.
ALEC CUTLER: In the US Maz Tech, we know I followed, I followed a company called Quanta Forever and they become the, the darling of transmission line development.
ALEC CUTLER: But Mastec is a much cheaper version of that. They are about a third transmission line engineering construction and a third windmills and solar and a third natural gas pipelines, which we have a contrarian view on Quanto was another.
STEPHEN CLAPHAM: Disappointing stalk that I played around with is that it, it was the one that does the the poles, wasn’t it? And part of the, I remember part of the part of the business was erecting new new transmission poles and, and that construction part of the business was never a, never a particularly high quality business.
ALEC CUTLER: It’s extremely high quality. Now, is it a 40 multiple, very depressed to know that it’s up about 500% in the last three years? Oh, really?
STEPHEN CLAPHAM: Because I, you know, I did a spell helping, a wealth manager in London with their international equity portfolio and then they ended up asking me to run some money for some of their other clients.
STEPHEN CLAPHAM: I, this is a part time thing which I’m not keen on the idea of, of doing equities part time because I think it’s 100% full time or nothing job. But, but the, the Quanta was, you know, exactly the, the play on this opportunity. And, I got, I got that one wrong because, you know, it had some problem with the contract and of course, it, you got it early that is early or late or wrong. They’re usually the same thing. Right.
ALEC CUTLER: I mean, we’ve been looking at this problem, I’ve been looking at this problem for 15 years. We’ve been past the design life on these lines for 15 years and every year it gets a year worse. Quanta was, it was an obvious play on it and, you know, we can’t control when the market recognizes value.
STEPHEN CLAPHAM: No, but you, you don’t get paid to wait around for 15 years. I mean, that’s the, I mean, at the end of the day you can be early and, you know, if you’re running a very big fund, then you kind of got to be early because if you’re late, you, you, you, you end up pushing against you and, and it’s very difficult to, to, to make money, but you can’t be too early.
STEPHEN CLAPHAM: And I think a lot of people, a lot of analysts in particular, you know, say, well, I’m right. You know, I’m going to be proved right. But I don’t think that’s the right philosophy. You need to buy the stock at the right time. I’m not saying that you need to time it to the minute, but you can’t, you can’t be a year or two early because especially if you, if you run into trouble along the way as I did with, as I did with.
ALEC CUTLER: That, yeah, the market can stay crazy longer than you can stay liquid.
STEPHEN CLAPHAM: Well, you know, i it’s just, you know, 11 more of the to add to the long list of my investing mistakes, but it, it’s, it’s not really any comfort at all to know that it’s gone off.
ALEC CUTLER: You know, the older, the older we get as value investors, the more we focus on catalysts for that reason. And now you can see, you can see the age of the network and you can see the catalyst we’re gonna elect electricity is the, is the solution to all our problems. Oh, of course, of course.
STEPHEN CLAPHAM: Now I was reading, a AAA transcript of something that Stanley Dren said and I thought it was really brilliant and I’m gonna read it to you. So this was on June the seventh.
STEPHEN CLAPHAM: So two weeks ago and he said there’s a 500 year history of asset bubbles well documented in the price of time, which Edward Chancellor’s book, which I haven’t yet read. But, basically it documents and I really know about this one about the last 100 years, but going out 500 years, every time you had a significant asset bubble, economic trouble lay ahead when you had 11 years of free money.
STEPHEN CLAPHAM: People do stupid things. All you have to do is look at how someone paid $80 billion for dodgy coin. I don’t know how to pronounce it, which was invented as a joke that can only happen in the world of free money. It also suppressed people worrying about the kind of stuff I just talked about. But you keep rates at zero.
STEPHEN CLAPHAM: But the fact that this was arguably the most disruptive economic period we’ve had since the late 18 hundreds and there were no bankruptcies tells me there’s a lot of stuff under the hood. Now, I’ve been writing about the problems stored up in private credit and in private equity. Do you? I know that you agree with that bubble stuff. Talk about what the consequences of, of the free money and the daft valuations have been.
ALEC CUTLER: Or Will be. Yeah. So, I mean, free money and debt valuations. We could also term misallocation of capital and a misallocation of capital does bad things to the economy. Has you, it has you investing in things that you want but don’t need it. Has you not investing in things you need but don’t give a crap about like where copper comes from and then they, the result of that invariably is inflation.
ALEC CUTLER: You have more money chasing less, less inputs. And we’ve seen that and people have blown it off as it’s a COVID effects and supply chain disruption and things like that. And maybe there’s maybe there’s some of that but there’s just been a lot of wasted money around and then that creates inflation and then the, the central banks freak out and they clamp down the biggest worry I have.
ALEC CUTLER: So inflation is a worry. The biggest worry is a portfolio manager I have with the portfolio that I that I’m in charge of and my team runs and has created that we consider to be moderate risk is that the Fed actually really does believe that 2% is the right number and that they have to get there or they Will be pilloried and they won’t be able to go to the country club when they retire and they can do it eventually.
ALEC CUTLER: If you push hard enough, if you crush the economy enough, you can get there, that Will be robbing from the poor to preserve the rich for one. But it would be disa, it would be disastrous.
ALEC CUTLER: And what I’m worried about is that lay all those layer cakes of, of inflationary impulses. These 700 economists sitting in the Federal Reserve Building that have Fancy degrees either don’t see or don’t believe or whatever. I have no confidence in them now that they, that they just keep raising rates in order to crush down to 2%.
ALEC CUTLER: If the natural rate of inflation for the next 15 years is five and you’re crushing to two, you have to completely destroy the economy and then you destroy the economy. You get what you, you get what you finally were looking for, you get deflation, you get a depression and then you shove a bunch of bunch more money back in.
ALEC CUTLER: I think that would be awful for the world, awful for the economy, awful for, for social conflict. We could be in an awful state created by the world’s central banks who somehow agreed in Vienna or something at some random time years ago that 2% was the right number.
STEPHEN CLAPHAM: But they were, I mean, they, they’re not wedded, handcuffed to the 2%. I, I mean, I, I think they, you know, the, well, the, the, the risk of error obviously lies on them giving too much money away because, you know, that’s politically palatable. So I, I don’t share your concern. I think though, you know, if we’re, if four or 5% inflation, I mean, 4% sounds better than 5 4% inflation.
STEPHEN CLAPHAM: I think it would be quite manageable. And historically, and it’s been, you know, things have been fine and you just make sure that you get paid 4% more every year and, and, and, and that, that’s ok. And I think if they start putting people out of work in order to get inflation below 4% I mean, there’s no, they’re not gonna, that’s not a vote winner. So I don’t, I, I’m, I’m more relaxed about that.
STEPHEN CLAPHAM: I’m just trying to think through what happens if it’s not, I mean, four or five is fine. But how do you get to four or five? And what happens if it’s eight and it isn’t that great and could be, could be very, very painful. I mean, do you, do you have a sort of scenario that says, you know, I think there’s a 10% probability of two and a 30% probability of four or no?
ALEC CUTLER: We, we just go where the market leads us. So what is the, what is the market giving us? The market is giving away high free cash flow, high dividend yielding really good companies that have bright futures regardless of what variant of economic activity we have. The market just doesn’t care about those names.
ALEC CUTLER: Those are short duration and there and tips are being given away those are relatively short duration, relative to nominal bonds. And that’s what the market is telling us to own. We can create all kinds of economic scenarios where that winds up being OK. Even in economic scenario where we go, we we gracefully go down to 2% or zero and back to two.
ALEC CUTLER: And we have quantitative tightening, those names Will do just fine.
STEPHEN CLAPHAM: So why, why are these good companies being overlooked? What, what, what’s the issue? Is it just, there’s no value investor around? I mean, the, the, well David Einhorn is very eloquent about this.
STEPHEN CLAPHAM: And he, and you know, my, my philosophy when I was at the hedge funds was to do special situations and you know, to buy stocks where for whatever reason, the market got their earnings wrong that when the earnings come through, they’re much higher than people thought the stock, not only gets a lift from the earnings, it gets re rated and those sorts of things you can make 50 60 70% earn says, well, you can’t do that anymore because there’s nobody left to buy them.
STEPHEN CLAPHAM: That’s right.
ALEC CUTLER: So do you share that increasingly? I do? And it’s it can be depressing, but we can react to that. So, you know, I’m visiting these companies on Monday and Tuesday and I’m going to talk to them about dividends so we can get paid if I’m getting paid in dividends, I’m ok to wait and be patient and, and wait around for what I hope doesn’t happen.
ALEC CUTLER: And that is we resort to venture capital showing up and buying up these, all these lovely smaller British companies that have great free cash flow and they’re really well well run. So that may wind up being a catalyst that you know, it’s not gonna work with a, with a Dupont or a Westlake chemical, but it can work with a Headlam or a Victoria PLC here in the, in the UK.
ALEC CUTLER: And then we can do a better job, I think as value investors in getting the word out.
STEPHEN CLAPHAM: And how do you do that? I mean, other than going into the.
ALEC CUTLER: Podcast, that’s it. I mean, going out and just telling people, doesn’t this look crazy? Yes, it does. Why don’t you buy it? I don’t like.
STEPHEN CLAPHAM: The idea of talking about stocks in the podcast because then it then makes the podcast have a very much shorter shelf life as, you know, ideally I want to have longer, but it is, it is interesting to talk about stocks, but Einhorn is buying stocks where they’re buying the shares back.
STEPHEN CLAPHAM: And he says, well, you know, I’ll be the last man, the whole thing, right? Which, which is fine because if they’ve got, you know, enough cash flow and sensible balance you, that’s fine. But I suppose he has to do that because he’s more us oriented and us don’t like dividends really, I mean.
ALEC CUTLER: 30% withholding tax. Yeah. Well, we’ve got.
STEPHEN CLAPHAM: Withholding tax as well. I mean, but people, I don’t know, our, our whole equity, investing space is dominated by, by dividends. UK equity income funds. I mean, there’s 100 different UK equity income funds and basically they all own Shell and Rio and they, they’ve been doing quite well recently.
STEPHEN CLAPHAM: But I mean, you think dividends are an important part of your investing philosophy and I’m interested to talk about that with you because I’ve never really worried about dividends. I mean, you know, people talk about dividend yield and I actually what the dividend yield is, I mean, the dividends are completely discretionary number and as you saw with Shell, it can be unchanged from 1945 for 75 years and then it’s gone.
STEPHEN CLAPHAM: Yeah. And so I don’t really like investing on the basis of dividend yield. I teach in my courses. You know, I do these online courses. I say, well, look, the dividend yield is not a valuation measure, right? You don’t, you don’t want to factor that in the dividend.
STEPHEN CLAPHAM: I mean, it’s quite nice to get some dividends, but it doesn’t really matter because you can always sell a portion of your holding. It doesn’t matter. So don’t worry about the dividend, but you like dividends. And one of the things I’ve been, I’ve been thinking about in an inflationary environment is that dividends actually might become more important, I think they do.
ALEC CUTLER: Yeah. Well, when my grandmother told me they were important. Oh, well, so just go with it seriously. It, it, it forces discipline on management. It reminds them that they have owners and as an owner, I mean, if, if I were to buy any company outright, I’d want to get some cash flow from it as the owner from what’s in excess of their needs to, to grow healthily.
ALEC CUTLER: So if a, if a company of ours has has growth prospects that are fantastic, good for the good for you, cut the dividends and, and, and do as I would do, do as I would do if I were, if you were to ask me and you said you had this great opportunity, then yeah, go for it.
ALEC CUTLER: But we’re in a much more mature world where that’s not the case for a lot of companies. So they can either build up cash, they can buy shares back. But remember a lot of these companies are now small cap. So I think Einhorn is really referring to companies that have significant market values. But if he was to go out and start buying back their shares aggressively, what are they gonna be?
ALEC CUTLER: It may literally be one share left that’s worth £250 million. But that’s, that is a, to me, that’s an endgame. That’s a take private effectively. And I’d rather see an equity culture returned to the UK and have, have the stock double or triple because the UK now has a decent equity culture.
ALEC CUTLER: And you know, the other thing that we can do as an investment firm is lobby the government to try and recreate the equity culture. And you know, in that respect, the government, I think it was in 2001 in sending all the pension plans to go to LD. I was not great for the UK equity market. They own 50% of every company now. They own two. Awful.
STEPHEN CLAPHAM: Well, I mean, the government’s, I mean, we had this amazing position and the government’s completely screwed it up. I mean, I, I was talking to a friend of mine who’s IR for one of the big F 100 companies and he said, you know, they’ve got hardly any analysts following them because my too has meant that nobody’s got money to pay for research and guess what?
STEPHEN CLAPHAM: People don’t provide research for free. So the, I had a friend who, who was head of research at one of the bracket firms and he said, you know, when one of my really good analysts comes in and says I’ve got an offer from a hedge fund, don’t even, you know, there’s no debate I’m going, he would go, oh, no.
STEPHEN CLAPHAM: So that’s, you know, that’s another notch down in the I I survey. And then he would look and he say, but, you know, I can put that junior in, in that, in that seat. And, oh, man, I’m gonna save this in my budget because his budget was shrinking every year.
STEPHEN CLAPHAM: And it was, I mean, he’s not, he said it was, it was like an awful job, but the whole method has completely undermined our whole stock market and, and, you know, I don’t know, I don’t know what the, I don’t know what the end game is, whether everybody just goes and decamps to America because they got higher multiple or.
ALEC CUTLER: I mean, that could happen that could the V CS could bring them there. But the, the you know, when my came in, we saw that as a, as a wonderful thing for us because we have our own analyst teams. We do our own work.
ALEC CUTLER: We don’t read much Wall Street work, but it’s also, it’s come back to hit us. It’s boomeranged back in lower and lower volumes and no one caring. So we can scream about AAA neglected small cap all we want. But we’re just shouting into the, into the ether. But I mean.
STEPHEN CLAPHAM: Presumably these prices Will rectify themselves over time is enough. You know, if they get cheap enough enough people Will just put their own money to work enough, people Will go out and train themselves, go to a well known online school and learn how to learn how well I’ve been saying, so I’ve been saying this to people, you know, I say saying, look there’s no more.
STEPHEN CLAPHAM: There’s no point in buying an ETF now because you’re buying all the rubbish of not all the rubbish, but you’re buying all the most highly valued stocks everybody knows about. And you’re not buying any of the really lowly valued cheap stocks that are going to make you the money. So you’ve kind of, if you want to protect your wealth in an inflationary environment, what you need to do is you need to learn how to invest.
ALEC CUTLER: It’s fun and it’s fun and you live there. So I, I went to a wedding in, in Hull and I talked to a guy and he happened to be a rug distributor, a rug layer and I asked him about Headlam and he said, fantastic company. Really like those guys. Did you invest in? Do you own their stock? No, never thought of that. I don’t do that kind of thing. This is, this is like pure Peter Lynch invest in what you know.
STEPHEN CLAPHAM: But no, well, I think we don’t have the same culture of investing as in this country as you, as you do in the United States. And that there’s a, there’s definitely a massive difference. I mean, I mean, we obviously we don’t have a Berkshire Hathaway, but even if we did, I doubt that we would have the, the following.
STEPHEN CLAPHAM: And it was, it was really, I mean, I, you know, I went to Omaha in May for the first time and I had a brilliant time, but I was really struck by the, the volume of people and the number of people and I went to dinner.
ALEC CUTLER: And that’s with value out of favor and it’s a real zoo and value has been in favor for four or five years.
STEPHEN CLAPHAM: Well, I suppose it’s just become a more popular thing and there’s a lot of events around it, but I went to a value investing dinner in Native Columbia University. So Mario Gabele sponsors that provides the food and there were 300 or something people in the room.
STEPHEN CLAPHAM: And I was, I was really surprised at the number of young people, students and number of women because, you know, one of the, one of the issues that we have with the podcast is not, we don’t have enough women listeners. And, you know, investing is, it’s a brilliant job if you’re a woman, but not that many women do it. Do you have any women in your team?
ALEC CUTLER: 40%? 40 percent.
STEPHEN CLAPHAM: So you got nine people, four women.
ALEC CUTLER: Yes. Oh, Crikey. Yeah, we’re doing well. And why is that?
ALEC CUTLER: And we made it a effort and it’s not so that we can pat ourselves on the back. It’s because that diversity is critical, not everyone thinks the same and clearly not every woman thinks the same either but or man, it’s just been, it’s been a wonderful thing. It enhances the conversation and and arguments.
STEPHEN CLAPHAM: So, how do you, how do you engineer a diverse team? What your, what your secret.
ALEC CUTLER: We make a big effort to go find the people that we want.
STEPHEN CLAPHAM: But you’re in Bermuda. I mean, it’s quite a small gym pool.
ALEC CUTLER: We, we go very far a field, so, three out of nine people on the team are South African for instance. Oh, really?
STEPHEN CLAPHAM: So, you’ve recruited from the parent?
ALEC CUTLER: Yes. Ellen Gray in in South Africa.
STEPHEN CLAPHAM: That’s quite, that’s quite interesting. And, and how do people find it moving from South Africa to Bermuda? I can’t imagine a bigger contrast.
ALEC CUTLER: I’ll just say they love it. Yeah, I’m sorry about that.
ALEC CUTLER: But I mean, it is a, it is a, you know, every place has its things and but we haven’t, people seem to want to stay. So, but you also.
STEPHEN CLAPHAM: Talk about personality types and you talk about what was you said, you talked about numbers focused or storyteller investors. How do you, how do you know when you interview somebody what they are?
ALEC CUTLER: No idea. It doesn’t come out for a little while, but some people, what you’re referring to is what we and, and this isn’t when we set out to create a truly diverse team, we didn’t really know what the benefits would be because I haven’t seen a truly diverse investment team before.
ALEC CUTLER: So I don’t really know. But one of the, one of the first benefits we found were some people are much more dialed into the numbers and some people are dialed into the story. They want to tell the narrative. That’s how they think. That’s how they’re imagination works.
ALEC CUTLER: And we work on stocks together as a team quite often in, in part, to bring those two different diverse ways of looking at the same problem to bear on the same problem. And it’s, it’s produced some, I think, I think it’s enhanced our process considerably.
STEPHEN CLAPHAM: So, so let’s say that we decide that we’re going, in spite of the fact, it’s going up 54, we’re going to look at Kwanzaa. What, how does the process work? Do you give it to two people or one person?
ALEC CUTLER: It may be one person and a mentor and the, the two of them may be on different sides of that story in numbers or if we’re moving really quickly, I might take the story. I might take the narrative and say, you know, this is the theme and this is how it plays into the theme and this is their place in the, in, in the world.
ALEC CUTLER: And Mark might focus on the, on the cash flow.
ALEC CUTLER: And someone else might focus on management just to get it done quickly.
STEPHEN CLAPHAM: And how do you coordinate if it’s three of you looking at the same stall?
ALEC CUTLER: We’re all in the same place, we’re all in Bermuda. So it’s quite easy.
STEPHEN CLAPHAM: And then you would have a meeting, say over zoom with the company just to save time with the three of.
ALEC CUTLER: You your visit. Yeah, our visit ideally visit where Bermuda is a, is a very, is a wonderful airport. You can get anywhere from Bermuda. You can get to five gateway cities in the US from which you can fly just about anywhere because you’re flying into JFK and Logan and you fly into Heathrow so we can and the flight to Heathrow is six hours. Oh, that’s not too bad. New York’s an hour and a half.
STEPHEN CLAPHAM: So, you, the team does a lot of travel.
ALEC CUTLER: We’re recovering, you know, we’re still, it’s taken a while to get out of the COVID mode. Hey, it’s, you not only have to be willing to travel but you have to be willing, the companies have to be willing to talk to you and it’s actually gotten them, a little, taken them a little while to get to that. Now, I’d say we’re full bore. All right.
STEPHEN CLAPHAM: So, what, what does that mean? I mean, how many weeks a year would somebody be on the road?
ALEC CUTLER: The more, the better?
ALEC CUTLER: Yeah. Yeah. 68 maybe.
STEPHEN CLAPHAM: And how do you manage that with their traveling and them being part of the team and keeping on top of things? I mean, nine people is quite a big team.
ALEC CUTLER: Right. So, yeah, that’s where technology is wonderful. Yeah, I mean, I’m, I started out as a tech analyst and a utility analyst at the same time. But I looking at the advances in tech and how they have helped us be efficient, how they’ve helped us not be efficient, social media, you know, the communication side of things has been fantastic and.
STEPHEN CLAPHAM: You know, what does it take to become a successful contrarian? Pm? So you talk about the, you know, having good foundations and you, you like your people to have the C FA. I mean, I don’t really understand why because the C FA seems to me just like an exercise in box ticking. So, you know, yeah, I can endure this punishment, but it’s not very good for learning about analysis.
ALEC CUTLER: Who remembers the terms in the ethics section. A year later, you can be highly ethical and fail the ethics section of the C FA. It’s kind of ridiculous. But it’s more a matter of this is a competitive endeavor that we do. So the C FA or the NBA to my mind tells you as a young competitor in this business, what everyone knows what everyone’s baseline training is.
ALEC CUTLER: That’s really it, you do learn, you pick up some techniques, you do weed some people out quite frankly who really, they might say they’re passionate about the business. But if it, you know, you’re on to year five and they haven’t quite managed to sign up for the last section of the C FA. It’s a bit of a tell Hey. So, but it’s really more knowing what everyone else knows. I mean, I, I mean.
STEPHEN CLAPHAM: Not funny enough. I’ve got one of the students in my analyst academy course, wrote to me and said, I don’t know why I bothered with the C FA because I just needed to do this and, you know, it, I’ve trained people that have got the C FA and they, you know, they don’t know the balance sheet cash flow, you know how they fit together.
STEPHEN CLAPHAM: I mean, it’s just, I, I think it’s really not serving our industry as well as it should because, you know, you’re getting the charter financial analyst after your name, but you don’t actually know how to do analysis. I think it’s a bit of a travesty, but let’s assume that everybody’s got the, the, the basic skills, what then takes them that next stage up.
ALEC CUTLER: So to me that I like to think about it in terms of a pyramid and the bottom of the pyramid are the things that one needs to have and you can’t have the next layer of the pyramid without the bottom of it. So you do need to start from the bottom. And I, and, and quite frankly, I have met some analysts that early on have struck me as being, having some of the elements at the top of the pyramid.
ALEC CUTLER: It’s highly unusual, right? And then you have to build everything under them. But that next level up. So bottom, bottom level are the nuts and bolts. The math comfortable with spreadsheets and working your butt off, and having a passion for it without that, you know, why bother?
ALEC CUTLER: No. Sure. And you need to be able to read a balance sheet and all that. Yeah. And, next level up is by way of filter is, can they learn from their mistakes? And it sounds like such a simple thing and it gets to sport. There are some incredible athletes who never get past little league, much less high school or college using American terms because they won’t learn, they know they’re great.
ALEC CUTLER: And when they make a mistake, it’s someone else’s fault or in this business, the market, the market got it wrong and it’s absolutely critical if you’re gonna be a good long term investor to know that you’re gonna be wrong and what to do about it and how to learn from it.
ALEC CUTLER: If you get that right, you can be, I think you can beat the market. You can be a good investor, the top of the pyramid, the special people I believe have an innate ability to recognize patterns. They have no fear of being alone and wrong of going a different direction. And this is the contrarian pyramid, right?
ALEC CUTLER: And and then have a an uncanny ability as well to no one to overweight their future winners, you’re going to have a portfolio, you know, Alan Gray who is, no one would remember the name unless you’re South African. But he had had an incredible batting average in an incredible sort of 10 alpha career first at Fidelity, then building his own firm in, in, Cape Town and then Orbis refused all publicity.
ALEC CUTLER: So no one knows who he is. But, yeah, his batting average was 57 58% on getting his stock right or wrong. But adding, you know, where, where were the waiting, his winners were bigger weights than his losers.
ALEC CUTLER: And that is a, that’s a skill that’s, I, I would guess nearly impossible to teach. That’s real gut discipline, nerve, the ability to be dispassionate. And then the, the last element is so the top of the pyramid just solely because it’s about, numbers is time. It takes a long time to prove that you’re any good at this.
ALEC CUTLER: And if this was, it’s where the sports analogy breaks down, unless you want to say that, you know, half time in the investing sport is 15 years. So you, you learn a lot over time, you gain more patterns that you can put into mosaic. And, and understand the complexity around an issue by knowing what you’ve known before.
STEPHEN CLAPHAM: Why do you think then the average hedge fund manager is 42. Why? I mean, it seems to be considered a young man’s field of endeavor and I, I find this bizarre, right, because I agree with you. I mean, I’m old so I, you know, I’ve got a vested interest in this but I, I.
ALEC CUTLER: Mean, I think hedge funds, you do lose your nerve. So I, they’d say that about traders too, you know, Wall Street traders are pretty famous for being athletes who burn out or retire rich after they’re 35.
ALEC CUTLER: I think, we’re not hedge fund managers so it’s not really our, our game.
ALEC CUTLER: So I, you know, maybe mutual fund managers or strategy managers are much older, even, even the mutual fund managers, I don’t think the average age is much, much higher than that. Well, that’s a, that’s a pyramid effect too. Right. The very best are, are going to be older, I think. Yeah. No, I think that’s fair and, and you can’t buy statistically.
ALEC CUTLER: That has to be true because you can’t tell whether you’re any good in this business or not, until you’re been in it for 30 years. So there, I think there are a lot of, I mean, I was considered to be one of the, one of the top us value investors when I was 40 but three years later I was an idiot. I was considered an idiot.
ALEC CUTLER: I mean, so you can look at a 40 year old and say that guy’s great. But two years later, you never heard of him and then he might pop up a little while later in a, in a, in another role or might be at the same fund in, in back in cycle and you have to go through 12, 15 cycles before, you know, whether you’re wiggling ahead or not. No, that’s interesting.
STEPHEN CLAPHAM: And it’s been really fascinating talking to you. I’m so pleased I’ve been looking forward to this. I always ask people the same closing question. Can you recommend a book or a practice or both to somebody that’s thinking of becoming a, a, an investor?
ALEC CUTLER: I mentioned stocks for the long run from Jeremy Siegel. I think that is a, it’s a great starter for anyone who says. What’s this all about? I think this is fascinating. It just gives you such a good primer on the history of markets.
ALEC CUTLER: You know, it’s the, it’s the one book you can buy in a library or buy in a bookstore that has the critical charts in them that show you if you want to be a historian and you need to be a historian in this business. What the history looks like the other is completely different.
ALEC CUTLER: And I’ve given both of these to my 26 year old daughter, by the way, who, who’s passionate about investing is how to think like Da Vinci by Michael Gelb.
ALEC CUTLER: And it is, it’s, if you want to be a really good investor, it teaches you, it’s, it’s a biography of Da Vinci and along the way, it’s focused on how peculiar he was and how different he was and what his different disciplines were and what his different behaviors were and how far this dude thought outside the box and how healthy that is and how our education system over the last 50 years has tried to beat that out of people.
ALEC CUTLER: And one of the so I can summarize the entire book by saying by one simple sentence, if Da Vinci was alive today, he’d be medicated.
ALEC CUTLER: And in a special school, we don’t tolerate the Da Vinci’s of the day of today. And that is to me, if you want to be a great investor, read that book and explore your creative, innovative nutty side that people look at you and say that’s the dumbest thing I’ve ever heard.
STEPHEN CLAPHAM: That’s very funny because last month with William Green, actually recorded the podcast with William six months ago. And he was saying that, you know, in order to be successful, you’re just going to be a little bit weird. And that’s exactly it. Very interesting. I’ve not, I’ve not read that book, so I’m going, I’m going to read it with your son.
ALEC CUTLER: I think you will enjoy it.
STEPHEN CLAPHAM: Yeah, I, I, well, I, I usually steal his books because he, I mean, he’s got a, he’s a voracious reader. I mean, he’s just been finishing Kissinger’s book and this is why he’s doing his G CS ES. That was his way of unwinding was to, to read these, these poems were quite quite impressive. Listen, thank you so much. I really enjoyed it.
ALEC CUTLER: I really appreciate your time. Thank you very much. Been great.
STEPHEN CLAPHAM: Well, I could have chatted for longer with ALEC. I really enjoyed our discussion particularly given our views on how markets may unfold in the next decade are really quite similar. It’s always dangerous to have that confirmation bias.
STEPHEN CLAPHAM: But the facts in this case, I think are un refutable a whole layer cake as ALEC puts it of tailwinds becoming headwinds whether inflation pans out at 5% or whether we could even slip back into deflation. The view of one commentator I enormously respect is of course unknowable.
STEPHEN CLAPHAM: But the odds are that investing Will become even tougher. This may not be what listeners want to hear, but it’s almost inevitable that investors Will have to work harder and look more closely at balance sheets. We can help.
STEPHEN CLAPHAM: Thanks as ever for listening and please share with all your friends and please follow us and leave a five star rating in Spotify or on Apple podcasts. And if you’re that way inclined, the podcast is now also available on our YouTube channel. See you next time.