HOW STEVE KNOWS THE GUEST

Phoenix Asset Management holds an AGM and Steve went along to listen to Gary as he was interested in the detail of his research process. After a few months they managed to have a call and Gary was delighted to come on the podcast, as he liked to be in the company of some of the great guests on the show. Steve is hoping to do another session with Gary where he walks through one of his investments.

Our new Podcast Venue

Many thanks to Rose, our wonderful sound engineer who has made many of our guests feel at home in the podcast studio in the office. Rose now has significant other duties and Steve decided that he wasn’t competent to be a sound engineer and to use a different venue. This session was recorded in a canal boat in Little Venice, which Steve passes on his walk between his home there and the office in Paddington.

Contents

00:00 – Introduction to investing insights
07:17 – Journey to fund management
16:03 – Valuation and investment process
24:28 – Research and decision-making framework
36:02 – Primary research and continuous learning
48:47 – Understanding market dynamics
57:38 – Assessing management and psychology
01:05:04 – Overcoming bias in investments
01:13:38 – Analyzing sector changes
01:22:25 – Reflections and future outlook

Transcript

STEPHEN CLAPHAM: Hi, welcome to the Behind the Balance Sheet podcast, where we meet leading investors and commentators and educate ourselves about the world of investing and the world. Our mission is to remove some of the mystique around investing and improve our understanding of what makes a successful investment or indeed an unsuccessful one. Our goal is to inform, educate and entertain. We hope you enjoy this and every episode.

Behind the balance sheet and affiliates and podcast guests may own shares or have an economic interest in securities discussed in this podcast, which is aired for your education and entertainment only. Nothing in this podcast should be construed as investment advice or relied upon for investment decisions. Always do your own research.

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STEPHEN CLAPHAM: My guest this month may be more familiar to listeners in the UK than those in America or further afield. Gary Channon runs a value fund, a closed-end fund, and a private equity vehicle here. But I asked him on the podcast mainly because he’s really thoughtful about his investment process. He runs a highly concentrated fund. The top five positions are over 50%, and he holds no more than 15 stocks. And he has this very rigid process where he won’t buy a stock unless it’s trading at half what he thinks is intrinsic value.

STEPHEN CLAPHAM: He’ll then hold his stocks for extended periods, often for many, many years. And he’s quite happy not doing anything to the portfolio in a 12-month period. I wanted to pick his brains on his investment process because he only buys stocks where he can monitor the business performance independently. That’s a really unusual characteristic.

STEPHEN CLAPHAM: Also, his framework for evaluating stocks includes parameters like the depth of work completed and the analyst’s confidence levels. Again, something quite differentiated. He has instructed his entire research team to become AI experts, and he’s already seen significant benefits. And on AI, he thinks that means that sell-side analysts will be more or less gone in just two years.

STEPHEN CLAPHAM: And we talked about his techniques for interviewing management, which includes spending an astonishing four to six hours preparing for a one hour meeting. It took me a while to tease out some of Gary’s secrets, but I ended up learning a lot, especially about those management meetings. I’d also love to get your feedback.

STEPHEN CLAPHAM: I normally record in my office, but I’ve lost the services of my wonderful sound engineer, Rose. And rather than do the sound myself, I’m using a nearby facility in a canal boat. Check out the show notes on the website for some photos. Let me know if you can hear the difference. Thanks as ever for listening. Enjoy my conversation with Gary Channon of Phoenix Partners.

STEPHEN CLAPHAM: Gary Channon, welcome to the podcast. Did you always want to be an investor?

GARY CHANNON: I sort of got into it by accident. I was at boarding school and in the library, the FT was there and nobody read it, probably because it was pink and it was an all boys school. And I was sort of fat.

STEPHEN CLAPHAM: What school?

GARY CHANNON: It’s called the Royal Hospital School. It’s for the sons of people in the Navy. My parents were in the Navy, so they’re all children of seafarers.

GARY CHANNON: And, yeah, so I was fascinated. It was full of numbers. And it might have been the 11 when I first went there, 11, 12. So that’s how I got into it.

GARY CHANNON: Had a very lucky start. First investment ended up making a lot of money. Well, actually, second investment made a lot of money.

STEPHEN CLAPHAM: What was it?

GARY CHANNON: Polypec, which turned out to be a fraud. My first investment, I just wrote to the bank, and I said, can you buy? I’d read it in the Sunday Times. It said this stock was going to go up. That was Johnson & Firth Brown. It was sort of 17p. And I said, can you buy me 10 shares? £1.70. I had like £8 in my account when I was 12.

GARY CHANNON: And the bank should have probably just thrown that away. But they actually did it and sent me actually the certificate and a very nice letter saying, you can’t sell these shares until you’re 18. We’ve bought them. And normally our minimum commission is £5, which will slightly wipe you out. So you might want to sort of get some more money, you know, before.

GARY CHANNON: And also maybe some reading. And he sort of recommended a book. Unfortunately, I wasn’t an intelligent investor. And so I borrowed £50 for my dad. And there was a book in the library about how the stock exchange works, one of those terrible books. But it did say try to find things that are in your domain. And my family owned post office stores.

GARY CHANNON: In Devon and I would read everything so reading the convenience news and Polypec had bought Del Monte and so I thought I had a bit of specialist knowledge and I bought Polypec and £50 actually turned into nearly £2,000 and I tried to sell it when it was like £900 because I did it by post by writing a letter by time it doubled again by time they got the letter and done the trade so it turned out later while I was working at Goldman to be a fraud and delisted but That got me.

GARY CHANNON: And so throughout my teenage years, I was one stock at a time. But this was Thatcher’s privatization era. So I would just stag every privatization, put all my money into each one and just compound it away. And my best track record ever is those teenage years, because by the time I stopped, it was about £50,000, that £50. And I’d never had any diversification.

GARY CHANNON: And the 15-year-old Gary is probably the most confident person he’s ever been. The rest of my life has been sort of a rollback of that confidence. But anyway, so that’s how I got into it, into investing.

STEPHEN CLAPHAM: And what did you do with the 50 grand?

GARY CHANNON: Life got a bit complicated for me. I got expelled and that was the end of my education. I went home to help my mother.

GARY CHANNON: My parents separated just after that, and so essentially supporting my family.

GARY CHANNON: I did something else that I thought was clever. I put some into a gold fund. I’d read something and thought I knew what I was doing. That was a mistake because when I wanted the money out, I had to pay all sorts of costs to get it back out.

GARY CHANNON: But, yeah, so that was my glory years, 11 to 15.

STEPHEN CLAPHAM: How funny. And how did you end up in the city? You started as a derivatives guy, right?

GARY CHANNON: I didn’t start as a derivatives guy. I became a derivatives guy. And it’s probably quite important. I hadn’t realised. I was a chess person as a child. I played a lot of chess and I’d have had a chess brain. But I, so I wanted to work in the city. I mean, this is, this is going to sound.

GARY CHANNON: Awful but I wanted to be a lorry driver my granddad was a lorry driver my uncle’s a lorry driver and I thought that’s the best job in the world just driving I didn’t actually drive but it looked like the best job in the world why is it the best job in the world if you like cars all right and also it’s sort of no people if you knew me better just kind of you know on your own on the road anyway my mum said you know be a bit more ambitious and And I went away and I thought, oh, what’s the best job in the world?

GARY CHANNON: Oh, being in charge. So I said, I want to be prime minister. So, okay. I mean, she treated me seriously. I imagine she was probably laughing on the inside. But I thought I needed to be, and she would say about politicians being corrupted and all that. And so I decided I needed to be a millionaire first.

GARY CHANNON: So in my sort of roadmap, I was going to go to Oxford, study PPE. Go into the city, become a millionaire, and then go into politics. That was the model. So expelled at 15, I was slightly off track, but I hadn’t given up. So my thought was I’d go into the city. So where I worked as an agricultural merchant, I got them into doing some grain hedging.

GARY CHANNON: But I kept applying for jobs. So I applied 1987. So it was a bubble time. There was a real shortage of people there hiring anybody. I had no CB. I wrote a single letter, said, here’s my IQ, and this is something about me, but I have no qualifications.

GARY CHANNON: And Nico saw me. And, and some of the people that later told me that they recommended not hiring me, but the Japanese liked me. And I got hired to as a Japanese government bond trader, which in those days in London was a market-making role, but all in Japanese.

GARY CHANNON: So, that’s how I started. But then the, the way the Japanese government worked is it didn’t allow derivative trading in Japan, but as a, as a way to prepare the Japanese to take on the Americans, they allowed them to start doing it in London. So we issued bond warrants. And they allowed the big four.

GARY CHANNON: And I got that task. So I learned derivatives the hard way by building a model. And then I went to Goldman to do equity derivatives and do it properly. Fisher Black was in our team. But yeah, that’s how I got into derivatives. And it’s a completely different mindset. It’s a probabilistic mindset.

STEPHEN CLAPHAM: And were you still investing at this time? Were you still investing in your own account?

GARY CHANNON: I do probably the occasional PA trade every two or three years. And it would be some extreme event. Like in those days, BP cutting their dividend. And I just read Mugliana Miller and like dividend policy doesn’t relate to value. And I didn’t know Buffett at that stage. But no, I didn’t do any PA trading.

STEPHEN CLAPHAM: And so how did you end up running money?

GARY CHANNON: So when I went from Goldman to Nomura to run equity derivatives. And a big part of that, what we were doing, is arbitrage and program trading. And the way that we would provide liquidity to customers was that we’d fold it into a pot of stocks around the world, and then we would hedge with futures, and then we would deal with tracking error.

GARY CHANNON: So I built all these models for these to deal with that tracking error so we could run that business. But we were in the UK systematically underperforming. We were getting picked off. People would say it’s a passive portfolio, but they would stick their dogs in there and my traders would end up losing money. So I went looking for a stock picking module. Really to improve our models.

GARY CHANNON: And I vaguely heard of Buffett and I read the Loewenstein book. So 1995 had an absolute epiphany. That just, it just made so much sense to me. I just absolutely loved it. Not only that, just the way that Buffett goes about life and business. And I suppose I was searching for my thing. The reason I moved to the Muroff and Gordon was to accumulate my own capital I’ll go and work for myself.

GARY CHANNON: But I wasn’t quite sure what that was going to be. Then I knew what it was. And so I spent a couple of years using Nomura’s money to teach myself. I’d do like a value book and started with ratios and bought textile businesses on low P’s and low price to book and things like that. And when I thought I’d got it, which will sound incredibly hubristic and arrogant, but in 1997 then I resigned and started Phoenix.

STEPHEN CLAPHAM: And you did that just with your own money or people actually gave you money?

GARY CHANNON: Well, they did give me money, but I left it on the basis that I’d do it with my own money.

GARY CHANNON: Bonuses I’d accumulated and I was a good leaver. I had some bonuses to come. I hadn’t thought about the raising money a lot. I thought I’d be from home. I’d be a one man band.

GARY CHANNON: And while I was setting up, Chris, who was the head of Chris Borthas, who was the head of sales. Nomura came and said, do you want any help raising money? I said, I haven’t really thought about raising money because I only want to raise 100 million and do that. So at the beginning, it was people who knew me and were willing to put some of their own money in. And some of those investors, I still have them.

GARY CHANNON: But it was a lot harder than the business plan we built. I wanted to launch it with performance fees only. And the regulator said, well, where’s your revenue? I said, well, we’re going to perform. Well, what if you don’t perform? So we had to have a management fee.

GARY CHANNON: But The plan didn’t go anything like the business plan. But after two years, we were closed. We got the $100 million. We had a stroke of luck. A lot of value investors were getting fired, and we picked up an institutional account and then a bunch more because of that in what had been sort of 2000, year 2000.

STEPHEN CLAPHAM: And so we’re now, what, 26 years later, and you’ve got how much under management?

GARY CHANNON: $1.6 billion.

GARY CHANNON: For almost 10 years, we didn’t need to go and raise money. But the person I’d closed out to, who took 80% of the capacity, it was a slightly foolish thing because they were all mature pension schemes. So if we outperformed, we got trimmed.

GARY CHANNON: And through time, we got trimmed anyway because they were being turned into bonds because they were closed schemes. So it’s not the place where you should close your capital, where it doesn’t compound. But they were a certain type of advisor. Stanford Associates, Nathan Gilbert, absolutely brilliant man.

GARY CHANNON: But his way of selecting managers who are country focused. Went out of fashion for pensions and he was losing clients and so we were. And then so I went out in 2009 and reopened and went to look for capital again. Had one year and raised nothing. Was about to give up and then things started to unfold. But yeah, that’s the, we don’t really like raising capital. We want to just compound the capital we’ve got.

STEPHEN CLAPHAM: And you’ve developed this very distinctive process with three components, business, management and price. So I think price is very straightforward because you want to double your money. We’ll come back to valuation later. But the management and business, first on the management, I mean, what do you look for when you look for in the management team?

GARY CHANNON: I suppose one of our thinking frameworks for businesses is it’s a pot of capital with a strategy and that makes returns.

GARY CHANNON: And what sits between you and those returns is management. So the first thing we look for is integrity. I mean, absolutely. So we don’t go beyond that.

GARY CHANNON: And not because we think people are stealing money. It’s just how they report to you. If you’re not getting honesty, then how are you making any of your judgments?

GARY CHANNON: Then we look for alignment. So we want to understand what makes someone tick. Are they motivated? And are they motivated in a way consistent with shareholder return? And then the final bit is competence. Now, this is the piece I underplayed.

GARY CHANNON: I thought, and I took sort of Buffett literally, if the business is good enough, so it takes care of itself. But actually, exceptional management makes a difference. But our base was, are they competent? Do they know what they’re doing? And that’s the three ingredients.

STEPHEN CLAPHAM: And what about the business? I mean, what makes a quality business for you?

GARY CHANNON: I mean…

GARY CHANNON: All value investors are trying to do the same sort of thing, is make their judgments based upon value rather than what the stock market’s doing. And for me, I had a penny drop when I properly studied Buffett.

GARY CHANNON: So when I really got into what he was saying, because we know, and we’re a kind of investor that wants to buy something as if we’re going to own it forever. So we’re not trying to anticipate how it might be valued in the future. Was saying, if I own this forever…

GARY CHANNON: What’s it worth to me so that’s a look into the future based upon the information you had today and Ben Graham grounded that a lot in the balance sheet and the things that were in the financials and Buffett kind of updated that and said a lot of the good stuff’s not in the financials and it’s so we it’s the return on capital if you’re going to own the business for a long period of time If it doesn’t have a high return on capital, you’re not going to have a successful investment.

GARY CHANNON: Return on capital, marginal return on capital, enduring. Businesses don’t decide to have low returns on capital. It happens to them. So if someone’s doing it enduringly, then they probably got something at Buffett called a moat. So is it, do they have a moat and do we understand it?

GARY CHANNON: And so we’re looking for a certain type of business, which we think lends itself to having a stab at. What the future looks like. So where we can extrapolate some of the past and build a horizon of future value and then handicap that and pay a discount to it. So our business process does that. So, yeah, that’s it. I’ll say a bit more about the process.

STEPHEN CLAPHAM: Oh, you go first. Well, I…

STEPHEN CLAPHAM: I mean, you’ve talked about intrinsic value being like your North Star. And, you know, what I think is quite interesting is when you’re, when you’ve got a very long term time horizon.

STEPHEN CLAPHAM: You’re buying businesses when the share prices are depressed. So you’re trying to buy good businesses. So by definition, you’re buying them when something’s gone wrong. And you need to normalize the earnings in that case, because you’re saying we’ve got a temporary.

STEPHEN CLAPHAM: So how did you do that? Because you’ve got quite a range of different businesses in your portfolio, right? So I mean, what’s the process? How do you think about this?

GARY CHANNON: Yeah, okay.

STEPHEN CLAPHAM: What’s it going to be? It’s got a temporary problem. It’s made these returns in the past. We think it’s going to get back to that in the future. How do you think about it?

GARY CHANNON: So you’re right. To get opportunity, the value needs to be obscured. And we need to have some, I mean, we have something that anybody could have, which is a very long-term perspective. And most people can’t operate like that. And even if they can, they can’t attract capital that will have that patience.

GARY CHANNON: But the other thing is, how do we build those models of the future, that intrinsic value?

GARY CHANNON: I hope so. Something like a logic cascade. There are certain things you can extrapolate into the future with some confidence. So we talk a lot about the sort of the Buffett inspiration and all of that. But a big part of what goes on at Phoenix is the psychology side. So Kahneman and all of his, you know, as my wife’s a psychologist, so trying to figure out the future. So we start with this.

GARY CHANNON: And people do this without even realising it. They are assuming that capitalism prevails or the rule of law. But really, how do people live and how do they transact? So household formation, population, demographics, something like that. You could have a reasonable stab at what happens. And you look at the way… So we were doing a house builder.

GARY CHANNON: You’d start with what’s the population, and then it’s actually households and household formation. And then how do people buy houses? And if they can’t buy, they can rent. And you build this logic cascade. And then you get down to the competitive landscape. So how does it work? And then how does the business model work? So we look for things where we can have a stab at having a reasonable chance of projecting that future.

GARY CHANNON: So you need pricing power. Businesses need to be in control of their economics. So, and that really improves the probability of you getting the future right, we think. So we’ve narrowed it down into a very, you know, a very specific type of business. So, but the type of pricing powers that we tend to find are the ones that aren’t obvious to people.

GARY CHANNON: It’s not like Coke. It’s not a brand. You know, house building doesn’t obviously look like it’s got pricing power, but ultimately that’s what we look for. And then you’re trying to look into the future based upon what you’ve got. And then we’ll build those valuation horizons. And one of the things we really care about is worst case. So we want to test the downside because we have very concentrated positions.

GARY CHANNON: And then you have horizons of outcomes. But very few businesses that we look at, we can do that with. It also takes us a really long time to do it. So a big important part of our process is we separate out doing the research. And doing the investing. We collect things that we’d like to own. And so we’re ready when they become at the right price.

STEPHEN CLAPHAM: But I mean, pricing power. When I look at your portfolio, I’m struggling to see pricing power. You know, does Michael O’Leary have pricing power? I mean, he’s got low cost, but he doesn’t have pricing power.

GARY CHANNON: So I suppose the way we define it, so at the heart of things, there’s something called DREAM, which turned out to be… Probably one of the most brilliant things we did, but like a lot of the brilliant things at Phoenix, it was an accident. It wasn’t a thought through a piece of genius.

GARY CHANNON: It was for some other purpose and then it worked out. So it’s control your economics. Low-cost producer is one of those. It’s the weakest. It’s not like being a monopoly. An unregulated monopoly is the best or a patent or a brand, but being the low-cost producer allows you to control your economy.

GARY CHANNON: So down to a level so so so that’s a different type of that’s a form of pricing power well well DREAM does it stand for something yeah i mean it was actually called halicarnasis because i did it the first one in in bodrum and that’s bodrum’s old name but it means a dynamic relative evaluation and assessment model so my first hire i planned to be a one-man band and i got these segregated accounts for managing out 100 million pounds but it’s just me and Chris and I spent until early hours doing the admin in the evening and the auditor was incredibly efficient so I hired Charlotte who’s still my number two and but the admin for her took an hour and so I had somebody who knew accounting and was very capable and smart so we started working together Now, she’s a glass half empty person.

GARY CHANNON: So we would say what I would say is good and what she would say is good. And so DREAM was a way of us agreeing on assessments. And so we took all of the components of our evaluation process and we separate them. And the manual tells you how to score them. And it tells you how to score them as a rating.

GARY CHANNON: And then you do depth and confidence. Because I found that the rating would be lower because of a lack of depth or lack of confidence. These are separate assessments. So I thought if I actually draw, you know, we’d say this is what is a 10. She said, I’ll never give anything a 10.

GARY CHANNON: It says it’s a 10. So that’s what DREAM was. But it turned out to be something very brilliant because it forces us to do the same assessment with every company rather than just assess the available information.

STEPHEN CLAPHAM: And you come up with a score at the end.

GARY CHANNON: Yes. And they’re all weighted. And so a triple A is something that scores a weighted 7. So most of the factors are where 5 is the average business and one standard deviation is 3 to 7. And a weighted seven is what’s an A. So we try to, we say collect double A’s, businesses that are an A, management’s that are an A, and then we’re waiting for the price event to happen.

GARY CHANNON: But we look at ones and say it’s a single A. We like the business, not this management team. We’re waiting for the management to potentially change. But that’s what it is, yeah. And then you, it’s Socratic. Two people need to do it. So the idea is you talk about it.

GARY CHANNON: You know we’ve been doing one recently where the market definition is really hard and you’ve got to do this market share market potential and it forces you to have the discussion what information have we got how do we define it and then you put down your rating and you put down and it allows us to continuously improve because then we go back because when we make mistakes i find you go back and say what have i got i’ve got some notes i’ve got what i Think I thought, where a stream means you’ve got…

GARY CHANNON: Quite good information about where you got wrong, where your assessment’s going wrong.

STEPHEN CLAPHAM: So you’re documenting your thoughts at the time. Yes. And you can then, and presumably you’ve got quite a few companies that you’ve done this for.

GARY CHANNON: Yes, and there’s different levels. So to do a full DREAM process, so if it’s me and an analyst doing, because it’s a series of, we’ll have an hour on a factor. So it might take four or five months to do.

GARY CHANNON: Do one and you can only go into these factors if you’ve already built the expertise so the idea is and there might be three people in the discussion so it might have taken you a year or so to get into the position to be able to have the discussion to be useful to be able to rate something but but when you’re in the early days you have low confidence and debt you still got to have that so we don’t make any investment that hasn’t been through a DREAM assessment but the full longly documented one you know can still happen after we’ve made the initial investment so you might do an initial assessment think this looks good the share price is right so we’ll go in now and we’ll do more well what i’m going to say is we we would have we’ll have made the assessment but we don’t know if we don’t own the investment you know Burberry which we bought last year which we talked about so for 10 years it’s in the process it’s in the system it’s gone in and we’ve thought about it in a DREAM way.

GARY CHANNON: We’ve got our assessment. So when it goes in, it’s like, well, what is it? It’s a potential double A, potential triple A. So it’s a potential double A. We’re verifying, we’re verifying, we’re verifying. And you can always produce that what we call a snap DREAM of what that scoring is. Once you own it, then a proper formal DREAM needs to be done.

GARY CHANNON: And what’s called a rating square, the nine numbers that you get from, you know, the rating, confidence and depth for those three factors, business management and price. That’s done and then updated and maintained every time there’s a new piece of news or change. So those only happen once you have the investment.

GARY CHANNON: Otherwise, we’d be doing it on the whole candidate universe of 100 stocks.

STEPHEN CLAPHAM: So you only learn from your mistakes on the ones that you actually make investments in?

GARY CHANNON: Well, I mean…

GARY CHANNON: I mean, in those ones, they’re very well documented. I mean, yes, the other learning of the thing, if we discard something, we write discard notes. We’re writing to a future analyst, picking it up and saying, why did we discard it? If you discard something that’s a winner, then there’s some information in those discard notes.

STEPHEN CLAPHAM: And how would you…

STEPHEN CLAPHAM: Arrive at that learning only if you were thinking of buying it again? Or do you sort of periodically go through and say, here’s the best performing of the ones we’ve discarded. What did we miss?

GARY CHANNON: There’s something very interesting at Phoenix, which is strange for people coming into it. Everybody’s an island. And so I can write a DREAM, you could write a DREAM, and they could be different.

GARY CHANNON: You’re writing a note, I think, to your future self and encourage people to go back and read what they thought because all that you keep seeing is your own naivety. You see how much you changed from a year ago or five years ago and how much you thought you knew and you didn’t know. So that’s what it is.

GARY CHANNON: We try to get the learnings of… So, you know, you’ll have seen a number of people have talked about how the aviation industry is very good at learning from its mistakes versus healthcare, which is less good. And part of that is the way they investigate accidents.

GARY CHANNON: So we’ve done a few of these where we’ve got somebody from outside the team with somebody in the team who wasn’t involved in the investment to do a proper post-crash, post-mortem on an investment.

GARY CHANNON: That’s gone wrong to try to get access to all the emails and all the information we’ve had to see what lessons we can have. So, yeah, we do it in that sense. You learn quite slowly. But just dynamically going back, no investment unfolds how you expect it. There’s information. Of course, yeah.

STEPHEN CLAPHAM: I mean, you get things wrong a lot. You can’t afford to with such a concentrated portfolio, surely.

GARY CHANNON: We get, I mean, there’s two types of, broadly, two types of errors. There’s the errors we made. In our assessment or judgment. And then there’s the world unfolding differently to what you’ve modelled.

GARY CHANNON: So we’re constantly updating our view. How I think about it, we’re trying to figure out the world and every day new information comes in. So it’s like a Bayesian process. You update it, either how the world works or your assessments. So we build roadmaps for our companies out for 10 years because although you tend to model lines, you expect ranges.

GARY CHANNON: So we try to do that for all aspects of the business and the management. And then we test the news every day against, is it on or off roadmap? Are we bumping at the curb? So to tell you the world’s not unfolding the way you thought. But the true overall error, our starting point is, do we lose money?

GARY CHANNON: So I think we have a low error rate and it’s declined through time. So we’ve been measuring from the beginning our strike ratio. So how many times we lose money versus make money. So by number, it’s just under 80%.

GARY CHANNON: Now, that doesn’t mean that if you make 1% a year over five years, it’s not a success. It’s a failure of sorts, but you’ve still got your money. But by value, it’s 95.5%. So 5%. So I think that’s a really unusual error rate. And that’s because of the quality of the work, the investment team.

GARY CHANNON: And that should be more alpha. If we’ve averaged six or seven points of pre-fee alpha, that’s because of my… Poor portfolio construction. I think the error rate, the quality of the judgment, you know, should result in 10 points of alpha. And that’s me just learning to, well, the weaknesses in my own efforts.

STEPHEN CLAPHAM: So you think your portfolio management, your position sizing has improved over time.

GARY CHANNON: My biggest weakness is selling.

GARY CHANNON: So I think I’m sort of personally wired to be contrarian. I would like, you know, we like to say we’re independent minded. And I think that’s true.

GARY CHANNON: But I also don’t like being in crowds. And so I think that’s good for buying.

GARY CHANNON: And I think the buying’s got better. I mean, I think in the last 10 years, I’ve only made one investment, but I don’t think we’ve made money. So I think I got better at buying.

STEPHEN CLAPHAM: One investment, you won’t make money. How many?

GARY CHANNON: Out of 11.

STEPHEN CLAPHAM: Out of 11, okay.

GARY CHANNON: Yeah, we’re not very active.

GARY CHANNON: But the, and that’s an improvement on the past, and it will be more by value. But the…

GARY CHANNON: My weakness is selling. So if you are going to buy an outstanding investment at some point, and for a long part of it, people are going to agree with you. And that’s a problem for a contrarian. So our track record would have been better over the last 25 years if we’d never sold anything. And that’s true of every year’s portfolio, and I’ve improved it. The first 10 years was appalling.

GARY CHANNON: But In the next 10 years, I’d improved it so it was neutral. But our biggest mistakes are those things. You know, we own 20% of Games Workshop. If we still held the 20% of Games Workshop, it would be over a billion pound of value and stuff. And really, there was nothing in what happened at Games Workshop that forced us to sell.

STEPHEN CLAPHAM: So what made you sell?

GARY CHANNON: There was a change of leadership from Tom to Kevin.

GARY CHANNON: No, there was a, I was concerned because it was Mark Wells and then, so the way the leadership change happened slightly. I interpreted Kevin wrongly.

GARY CHANNON: When I was reading, he was using the word I, and some things which actually, if I’d gone and looked, it turned out that he wasn’t writing his own reports as much. And at the time, he turned out to be absolutely brilliant. But the thing was, he was handing back all the money. They changed the rule book.

GARY CHANNON: They upset all of the existing diehard fans by completely simplifying the rules. Very bold thing to do. The thing is, I didn’t need to act on that. In fact, when I saw Tom, not long after we’d been selling, and also the price had gone up. So there you are, everybody agrees with you. It’s a great investment, and it’s gone up a lot. And incredibly high marginal return on capital, just a wonderful business.

GARY CHANNON: But at that time, they’d been going sideways for quite a long time, and I worried that he was messing it up.

GARY CHANNON: And what happens is the high price seduces you.

GARY CHANNON: If he was messing it up and it was trading at half where he’d bought it, you’d probably persist and you’d do more work and you’d figure it out. Anyway, I learned from that. We don’t sell so easily now, but that’s by far the worst thing I’ve ever done in 26 years.

STEPHEN CLAPHAM: Well, you made good money out of the position.

GARY CHANNON: I think you only get handed in, your track record will be at the end of, 50 years or 60 whatever it’s going to be i’m going to live to 100 well i’m going to probably take it easy in the final 10 so i’m 57 at the moment so it’ll be dominated by three to five one of those that you held on to i i think when i look at the great records but you only find because you’re in the game because you’re there looking for them and and that was when i i missed

STEPHEN CLAPHAM: You can always buy it back.

GARY CHANNON: I can’t undo the error.

STEPHEN CLAPHAM: No.

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STEPHEN CLAPHAM: So I mean, that’s quite unusual for a fund manager. Talk to us about that.

STEPHEN CLAPHAM: And you use your relatives.

GARY CHANNON: We use everybody. Again, this is one of the things that we do, which is, I think, gives us an edge, that happened by accident. Again, it wasn’t a stroke of brilliant. So we’re very Phil Fisher inspired. So scuttlebutt, that’s always been the case. Go out and get information, get firsthand information.

GARY CHANNON: We don’t use anybody else’s research. Everything we do is primary. We’re trying to figure out how the world works. Why does somebody go in that shop and not that shop? Or why do they buy this and not that? And when I closed the fund, Chris launched a…

GARY CHANNON: He had no job. We hadn’t really thought the business through. What would happen if we didn’t need a salesman? And I had a salesman. There was only three people in the company and one was a salesman and we were closed. So he launched a fund. He hired a couple of graduates. And then at some point we closed the fund and he left after a couple of years.

GARY CHANNON: And I said, graduates, what am I going to do with these? I said, okay, you can go out and shop, go mystery shop. And then we made a virtue of that. And so we… We do make these like very long-term predictions of cash flows, but then we check in real time.

GARY CHANNON: So we only invest in businesses that have the transparency that allow us to see it separately to what management’s telling us. And that rules out lots of businesses where we just can’t do that. So the mystery shopping is about that competitive. If you saw the rise of Sports Direct against JJB, if you look at our notes.

GARY CHANNON: We were going into stores on the same street and JJB didn’t have the stock and the Sports Direct was full and they were selling the same product at a lower price. And you could see the battleground. And I suppose that’s what we’re trying to see, trying to see a business in real time, in action, looking for signs that our hypotheses are wrong or confirming our idols.

STEPHEN CLAPHAM: And I mean, any examples other than, I mean, that’s an interesting example. Any other examples where You’ve done mystery shopping, for example, when you’re looking at an investment and you said, oh, no, we don’t want that. I mean, anything where you’ve challenged a sort of conventional thesis through the mystery shopping?

GARY CHANNON: Yeah, that’s good. I mean, that’s what that’s what happened. So we would we would go out and talk to builders about.

GARY CHANNON: About Travis Perkins. So we were working on Travis Perkins for a long time. It was in our process. And all the time we would hear that they were not the cheapest. And it would bother us. So what’s the edge? They’re expensive. That’s a vulnerable position to be in. Yes, they’re in the middle of town and all these things, but… So we didn’t invest.

GARY CHANNON: And then, and they would say, look, the builder’s not paying the price. It’s the passing on to the customer. That’s not what the franchise is. It’s the advice. It’s all of these other… Things, availability of stock, and we give them credit terms. We fund their business. And then along came the financial crisis.

GARY CHANNON: And then when we went out and tested it, people were still saying Travis was expensive, but they were still using it. And it sort of proved it. And it doesn’t quite answer for rejecting, but we rejected. But then we saw that and actually they gained share in 2008 and 2009. So if you gain share when the world’s ending and people care about price. Then actually we’ve got it wrong and we changed.

STEPHEN CLAPHAM: And, I mean, you do this incredibly detailed work. I was quite impressed when I first saw you speak at one of the conferences, you were talking about EasyJet and how you went through the timetables. And with Barrett, you used to scrape their website and visit lots of sites.

STEPHEN CLAPHAM: And, I mean, you still own Barrett, but you’re now using AI to help. So can you talk a bit about how you do that? I don’t know if you’re willing to.

GARY CHANNON: So, yeah, I mean, there’s a lot to figure out in house building. Then you’re figuring out what do we monitor.

GARY CHANNON: So we would monitor enough sites. I mean, at one point we’d done it to extremists. I mean, we’ve been doing it since 2008, tracking Barrett. And then Barrett used to joke that if their accounting system went down, they’d call us to find out how they were doing. So we get sales rates.

GARY CHANNON: We get a lot of other local color. So we put ourselves in a position when we go to see managements, we know a lot about their business. So and the right kind of management is like that. They respond well, but some don’t. But it unhurs a lot of information. So by having enough of them, we can estimate sales rate.

GARY CHANNON: We can see what’s happening with price. But also we can get some local color of problems like now. We might pick up Barrett and Red Row integration issues that are going on at a site level. So we still do a number of sites, but what we’ve been able to do is build a tool that just scrapes all of the sites. And so now we have an almost very real-time idea of what their sales rate is.

GARY CHANNON: And most of the time that doesn’t matter, but it can matter in extremis. So again, financial crisis is a good example. Everybody thought the world was ending. And our work would say around London, that’s what had happened. The activity on the visits on site just stopped. If you went to Fulham Reach, there was like nothing going on. People weren’t visiting.

GARY CHANNON: But as we got out of London, people were unaffected by it. By the time you get to Yorkshire or something, there was just no effect. The effect was the World Cup. It wasn’t the financial crisis. So that’s really useful if you’re being… You’re acting in the cheapness that’s in the market. The market’s assuming the world’s ended and you can see that it hasn’t. Nothing’s changed.

STEPHEN CLAPHAM: So when you’re doing this data scraping, does that tempt you into making short-term trading decisions? Because you kind of know that the results are going to be better or worse than the stock market is anticipating.

GARY CHANNON: No, and I suppose in the first five to seven years, I would have this, oh, this set of results is going to be a catalyst. I’ll increase the holding just beforehand because I can see it better than everybody. And I would generally say, especially Barrett, I will read a set of results of seven, say, oh, they’re decent and the shares are more likely to be down.

GARY CHANNON: So people would always ask at the beginning, well, what’s your catalyst and stuff? I have no idea. Usually if we buy something, it tends to go down. We got a little bit better recently on that, but it doesn’t matter to us. But no, we haven’t.

GARY CHANNON: I’ve never done anything short term, other than change my mind. So at the beginning of financial crisis, we were making investments. So actually, at some point, unearth something and change your mind. Well, then we’re out quickly if we’ve made a mistake. But no, never try to anticipate price change. I think we’d be very poor there.

STEPHEN CLAPHAM: But you’ve got the information.

GARY CHANNON: Yes, but whatever game you’re in, in this investment thing, I think you’ve got to know what your edge is. And then you’re on this long journey of continuous improvement.

GARY CHANNON: So part of it’s your process, as you talked about. So our process has got a built-in feedback loop, so we get better through time. The checklist, the filter gets thicker as we learn, and so we keep playing that game again and again. I’m very influenced by Kahneman, but Kahneman had this debate about expertise, and he didn’t believe in financial services, there was such a thing as expertise.

GARY CHANNON: The debate was so big that actually you couldn’t build up expertise. And Gary Klein is another psychologist who’s a real expert in studying expertise. And he’d studied chess players, he’d studied paramedics and firemen, and they actually had a bit of an academic debate, and then they came together and figured it out.

GARY CHANNON: And I was quite influenced by that. They agreed that in financial services, in anything, if the domain is specific enough, there’s a robust feedback loop. So that’s what we try to do. If we do the same thing again and again, we might get better at it.

GARY CHANNON: If we start drifting off into other stuff, then we’re at risk. So that’s what I think. So if you’re in the game of anticipating share price, then that’s your thing. And there’ll be people who are good at that and they forget it out and they’ll spend their life doing that and they’ll have their edge. But I know what our edge is and it’s not that.

STEPHEN CLAPHAM: And one of your edges is going to be AI, right?

GARY CHANNON: I think AI is going to be amazing for us.

GARY CHANNON: We’ve we’ve been using it, it augments us in a really incredible way. If you think what we try to do, we go out there looking for certain types of kind of building deep expertise enough to be able to make good judgments. We’ve already got at the center a way of putting all that information in a way that it can be utilized to make decisions. So we will be way more productive.

GARY CHANNON: With it and then the monitoring tools like you said instead of sending someone out there’s a lot of stuff we we will be able to automate so our error rate should go down our candidate universe should grow we should get more alpha is what I think from AI. But it also means it’s very complicated looking at companies because they’re going to get disrupted in ways that we probably haven’t even thought about yet.

STEPHEN CLAPHAM: And I mean, you’ve had the team spent, all the team working on AI.

GARY CHANNON: Yes. I mean, one of the things I did was I…

GARY CHANNON: I gave them all a little envelope and in it was a name, a Phoenician name based upon a famous Phoenician and an agent that they needed to build. And the agents are either searching for ideas or they’re part of our DDE process or they’re part of monitoring. So in order to be able to upskill themselves to do that, they’ve had to learn all the available tools and build these agents.

GARY CHANNON: That will then feed into our process. So by doing that, it also makes them very aware of how much that feels changing, because in that, where we do that work, there’s new stuff coming every couple of days. There’s things that we were having to do manually three months ago that are now in the latest versions of the tools and stuff.

GARY CHANNON: But yes, so everybody is AI. I say proficient. That’s a bit…

GARY CHANNON: It’s too early to say that, but it’s a very important part of our process.

STEPHEN CLAPHAM: And you’ve been doing this yourself?

GARY CHANNON: Yeah.

GARY CHANNON: I mean, I’m very curious about anything new. So I’ve been on it for a while. I had a year last year where I was with my mother, who unfortunately died at the end of the year. But I was using it for all sorts of things to give myself expertise, initially to optimize soups.

GARY CHANNON: But by the end of it, something very profound happened for me, which was I built a…

GARY CHANNON: Model of her and all her data and applied all the research and stuff in the world and it came up with some suggested treatments and this is after her treatment had failed, worked and then failed and she’d been on immunotherapy and developed resistance and she didn’t have long to live but actually it surprised and we were dealing with you know top oncologists and One of the recommendations, I told the other two, the drugs are not allowed to do that, they’re not licensed, but one of them, it was a good recommendation and they recommended it for her.

GARY CHANNON: And the only reason we didn’t go down that route was because she may have then died in hospital and she wanted to die at home. So she didn’t have the treatment, but it blew my mind away. It blew, the professor, it blew his mind away that here I was having a top level, you know, oncology conversation.

GARY CHANNON: And so… I really realized that, you know, the, the, the, be able to, it just changes the way we’re all going to work. And if you’re, if the real benefit, I think we have as investors, most, most people have a job, they have to do something. So their learning is like, you know, at the end of the day or, you know, the real expand, knowledge expanding.

GARY CHANNON: We just sit there and do that all day, figure the world out, learn and learn. Now in your hand, you’ve got an expert in most fields. Yeah. So you’ve got to learn how to think properly. But you can get up to speed very quickly. We spend a lot of time in the round things, learning and then doing the thinking.

GARY CHANNON: So it might take you months to go and do all that stuff and then you can do the thinking. Well, now you’re straight away. So that airports thing you were talking about, EasyJet. So I could see EasyJet earning high returns on capital. I couldn’t figure out why. So airports commissions, it’s perfect. They’re studying and studying about whether I have another runway.

GARY CHANNON: So in there, a bit like the CMA, if you look at that, they commission all sorts of research. So in there, I came across this thing, which was a topography for anybody in London, how far they were to an airport and how much they would pay. And you saw the basically the price premium for not being able to move and therefore the value of slots.

GARY CHANNON: And somebody I think called Frontier Economics has only done this work for the part of the process. And there was my penny drop moment. Slot constrained airports. That’s why they earn high return on capital. They’re not competing. But that was I’ve been on that for months and months and months. One now. I might get there in a week.

GARY CHANNON: And that’s quite profound for us.

STEPHEN CLAPHAM: I didn’t think that was that difficult to work out, right?

GARY CHANNON: People would say at the time, EasyJet and Ryanair are competing. And so, and it’s not the case. Ryanair is not in any slot-constrained airports. So we did the test. You may have seen that on that presentation. So we did 2,500 airport pairs. And So those are all the European cities where there’s flights between. We did it for EasyJet and we did it for Ryanair. And at the time, the overlap was 4%.

GARY CHANNON: And yet between them, they did 40% of the traffic. So people keep talking about EasyJet’s more expensive than Ryanair, so they can’t compete. But they’re not competing. They’re in a different game. Operating out of Gatwick against British Airways is not competing against Ryanair. So that was a variant perception, as people call it. Yeah. But it came down to, that’s where the penny dropped for me, yes.

STEPHEN CLAPHAM: But if you asked Michael O’Leary, he would have told you that he was competing against EasyJet.

GARY CHANNON: He’s not at Gatwick and doesn’t have any slots at Gatwick and can’t get into Gatwick. And he, you know, so… And if they fly London to Paris by Ryanair, then, you know, you go to Stansted and you arrive 100 miles north of Paris and you’ve got to get into Paris. And so are they in the same, if you want to go, versus Gatwick to Charles de Gaulle? And to me, those two are not competing.

STEPHEN CLAPHAM: Would they?

STEPHEN CLAPHAM: They are competing because it is a competition on price and convenience. But no, I completely get it.

GARY CHANNON: And the return on capital for EasyJet, just to show you, it was Carolyn McCall and Andrew Finlay just basically set a return on capital hurdle. And so they ended up in slot-constrained airports.

GARY CHANNON: I’m not sure they had that insight, but she applied a capital discipline and undid all the flag-planting that had gone beforehand and ended up. In the places where you can earn high returns on capital. And that is not head-to-head against Ryanair and Stansted.

STEPHEN CLAPHAM: And you don’t own EasyJet now, you own Ryanair.

GARY CHANNON: We own Ryanair and we do own some EasyJet.

GARY CHANNON: Our problem with EasyJet was the people we backed changed and it was a mistake we made. And we’re in the process, there will be a time and the right value where… Where we would reduce that. It’s incredibly undivided.

GARY CHANNON: We understand the thing we’re afraid of isn’t about to happen the next time they come to be able to do a capital raise or place a big play in order where we would worry about capital allocation skills. So, yeah, that’s what happened. The CEO changed, then the CFO changed, and then they did one rights issue in COVID, and then they did a really dumb rights issue on the way out.

STEPHEN CLAPHAM: So just going back to AI, how much time are they spending? And are you getting any benefits yet? I mean, are the benefits down the road? I mean, just talk a little bit about how you think about that sort of investment benefit trade-off.

GARY CHANNON: There’s no management at Phoenix. We sort of hire a certain type of person who sort of doesn’t or probably doesn’t even want to be managed. So I don’t know what they do on a day-to-day basis. I meet them once a week. I mean, We’re all in the same office, but we come together on a Friday afternoon and talk.

GARY CHANNON: But we already have the effects, yes. I mean, those monitoring programs, those scraping tools.

GARY CHANNON: We’ve been analyzing businesses where we can now, we can kind of check the geometric competitive landscape. We can look at where theirs are. We can see where the competitors are, the populations are. These are tools that have been built. We’re also applying them in our own businesses.

GARY CHANNON: So in Dignity, we can figure out, you know, where would you put a crematorium or what would be the predicted number of funerals in these areas and stuff? Because these are all tools that the team have built. So, yeah, they’re not just sandboxing. We’re already using it.

STEPHEN CLAPHAM: So you’re already getting a net benefit.

GARY CHANNON: Yeah.

STEPHEN CLAPHAM: That’s interesting. And this idea of running a… A fund which is investing in public companies and running a fund which invests in private companies. Can you talk a little bit about the difference from your perspective as a portfolio manager and why you wanted to go down that route?

GARY CHANNON: Actually, I think Buffett summed it up quite well. It’s even in his last annual report.

GARY CHANNON: As I said earlier, the disconnect between the thing you modeled and what you get. Is usually for us is management. Now, the world can unfold in a way you didn’t predict, so that accounts for part of it. But more often than not, our problem would be management, what they did with the money, how they allocated it.

GARY CHANNON: And when you own 5% or 10%, and I went down the route of, well, let’s try and get other shareholders and do things. That’s a thankless task. Get four other fund managers. They might agree on a day. By the time you’ve got to the EGN, they’ve changed their minds.

GARY CHANNON: And then we will put someone on the board. And I thought it’s been good for the team to put them on boards to try to influence. But I can’t really point to any impact we’ve ever had for all the work that’s gone into using those. We’ve learned a lot, but we haven’t. So we just don’t do that anymore. But if you have control.

GARY CHANNON: If you own the thing, then you get to choose who runs it. So you protect yourself from all of those things. So then you’ll get the underlying returns of the business. If you have a problem with management, you can change management. If they’re going to do something dumb with the council, you can say no. And that’s the benefit we get.

GARY CHANNON: So there’s maybe a wonderful business, but not the right management. And we couldn’t make the investment. And sometimes you can buy whole businesses inexpensively. But that same domain knowledge, sometimes there are wonderful businesses trading cheaply. If we try to buy all of Burberry, we want to buy it for $2 billion.

GARY CHANNON: We’d have to pay $5 billion. So that same expertise can be applied in a way where you can have a little bit of a wonderful business when they occasionally trade cheaply and you wouldn’t be able to pay that price. You bought all of it and every so often you can buy a business. And you want to buy a business you can own forever.

GARY CHANNON: And it is. It is different and we’ve had a lot of learning from doing it. It’s much more difficult in practice, but again, we apply the same continuous improvement, but I think it’s, it’s wonderful to be able to do both and they’re very complimentary.

STEPHEN CLAPHAM: And I mean, do you see that as one of your core skills assessing people?

GARY CHANNON: It is something we take very seriously.

GARY CHANNON: I mean, I’m married to a psychologist, so I’ve been sort of under assessment for 35 years.

GARY CHANNON: And so at the beginning, what I did is I’d use body language to try to assess people or their words. And then we’d spend a long time constructing our meetings with management to try, because people don’t volunteer the difficult information. So there are different ways of asking things.

GARY CHANNON: And we spend a lot of time trying to think about how do we get managers to talk about something. But, yeah, it’s so important. Judging people, judging customers, consumers, how they’re changing. So the psychology of human beings and human motivation is a really important part of what we do.

STEPHEN CLAPHAM: So how do you get a management to talk about the things you don’t want to talk about?

GARY CHANNON: I get to share my techniques and stuff. Because we recently did something and the analyst, knowing what the technique was, nearly burst out laughing in the middle of the meeting.

STEPHEN CLAPHAM: I don’t want you to share any secrets. I just think it’s quite an interesting area because investors generally aren’t very good at running management meetings, I would say. Yes. And some of them are getting a bit of experience. There are companies that train people to do better meetings. I mean, I do a sort of simplified version of this, but it is just about, well, how’d you get the answer you want?

STEPHEN CLAPHAM: And, you know, I just do, I mean, I’m not sophisticated about this and I don’t think it’s a particular skill, but one of the things that I see people do a lot is they ask very long, complicated, rambling questions. And if you ask a three-part question, you’ll never get the answers to the three parts.

GARY CHANNON: So I’ll give you, okay. So firstly, we don’t have a meeting with management until the end. So be an expert when you arrive. Don’t be educated by management because you won’t know what you don’t know. We would rather see a competitor first.

GARY CHANNON: So before we met the Hargreaves management, we would meet AJ Bell. And so if you really want to learn about a management’s weaknesses, hear it from their competitors. People are very happy to hear. So go in with, and then also try to have something useful.

GARY CHANNON: That you know in detail but i would say my tactic is be friendly we always go in in multiples so never go on your own you know writing down trying to do the questions and stuff and then trying to remember afterwards my memory is not what it was but i used to have a complete recall i could play the meeting back oh really yeah so i could go back to it and do but still you discuss it and say yeah did you notice he looked across at him did you notice they looked at each other when you said that.

GARY CHANNON: You could miss that so having multiple people in the room so so we would plan for one hour meeting might spend four or six hours thinking it through really of what we’re trying to get out of it and this is when i teach it if i’m teaching saying what actually are we trying to learn and let’s hypothesize that this is the case how will we get that out how will we get to this point of view and how or how we get some to share something not price sensitive but just maybe commercially sensitive.

GARY CHANNON: And there are various techniques. You can put words in people’s mouths, you put numbers and people correct you, or their face will tell you something. So there are ways to get things that you think are important. So I’m not trying to be clever.

GARY CHANNON: So integrity, I’m really trying to get something where people need to contradict themselves. So I keep a piece of information that I know. I take them down a path where they might agree and later on produce a piece of information. Today.

GARY CHANNON: Contradict themselves because they care about being correct and truthful or is the appearance more important and do they therefore like sort of they would you know not not dishonest but slightly untrue and you just learn something about them we’re trying to make those assessments about what type of management because when we we judge integrity we have it on a range. So you have it, you don’t have it, you have it, are you…

GARY CHANNON: Are you very open and tell me all the negatives that’s nice they’re very rare you just don’t lie and the very the weakest one is i just won’t lie you’ll have to ask me the right question i won’t tell you an untruth and unfortunately the disclosure rules and stuff are made management’s more closed up than they used to be and and people i mean they they’re sales people these days i mean you’re dealing with UK management so it’s not as bad as it is in the united states where And I would say if a management’s in the public domain, don’t have the meeting.

GARY CHANNON: I do think, like you said, so we have a charisma red flag. So if you’re going to see Mike Ashley, Mike’s highly charismatic. You’ll come out wanting to buy the shares. So we like have a charisma down, so it’s a red flag to begin with. And we say, have a calling off period.

GARY CHANNON: So we’re aware, but being with a charismatic is terrible. It will, you better not see management at all. I like it if someone else is, so I’ll send the team out to do management meetings. Most of the time it removes me. It makes it easier for me to be objective about them.

GARY CHANNON: But if someone’s doing a recorded Q&A and stuff, they’re in the public domain. You’ve probably got all the information. You need, especially from a larger company, to make the assessment without getting all the biases that happen as soon as you sit in front of someone.

STEPHEN CLAPHAM: And how do you stay detached when you’re owning a stock for a long time and you become friendly with the management? Because you must do. I mean, you’ve owned Barrett’s for how many years?

GARY CHANNON: Yes, but I’ve not owned it for four times during that 26 years.

GARY CHANNON: And the same with Fraser’s, we almost went down to nothing.

GARY CHANNON: So first is have the kind of relationship where that’s not a, not a baggage between you. So I think Mike would say he knows when he’s doing well, if we’re selling that.

GARY CHANNON: So that means there’s not like a, I owe you, I’ll go, you know, have the stock. So I scenario is that get comfortable with it, make sure there’s no quid pro quo. It’s not supported, not supported. We’re rational investors.

GARY CHANNON: We say, you know, you’ve got to, and, and if. The shares are trading well where you’re taking money off the table. The management are perfectly happy. They’re already getting rewarded for that. So a nuisance value coming off the register is not an issue for them.

GARY CHANNON: So we have been willing to sell things. It doesn’t seem to be. Endowment bias is something we worry about a lot, the bias that you have from holding something. And a lot of errors we’ve had have been endowment bias, and a lot of corrections to our process came out of that. But But we’ve been quite willing to not have a holding or to reduce the holding, put it back on, try to do the rational thing.

GARY CHANNON: What I have learned through time is the probability of being correct. So a stock that you’ve owned for a long period of time and had lots of access to. The value of that is very high in terms of how like you are to be right or wrong about the future versus something new.

GARY CHANNON: And in my early days, I dumped that into the next thing to pick up another 10% and off I was gone. So we don’t do that so lightly anymore. Put a high value on the expertise that’s been accumulated.

STEPHEN CLAPHAM: But you’re still happy to sell?

GARY CHANNON: Because it’s a valuation thing in the end. So there has to be a price level. Now you’ve got different, there’s not one value. No, no, sure. But ultimately, if we buy a pound for 50p and it’s selling for a pound and I’ve got other pounds for 50p, I ought to be making the switch.

STEPHEN CLAPHAM: But you, I don’t know, what’s your turnover been like? I mean, it’s been pretty low, hasn’t it?

GARY CHANNON: I think it’s pretty low. If you take out dealing with money coming in and out, in some years it’s single digits. The highest it’s ever been was in 2000.

GARY CHANNON: Eight where i think it was a close to 100 percent so when there’s a lot going on there’s a lot of opportunity it’d be high so probably average out in the teens i i think you most of the capital is already allocated it’s how i feel you found the business you’ve made the investment you’re monitoring the management we’re happy with it there it’s in the right hands job done so i’m really allocating capital at the margin the dividend money that comes in and the things that you trim and stuff.

GARY CHANNON: So, you know, that’s a 10 to 20% job of allocation, not the 80% if you’ve got those right.

STEPHEN CLAPHAM: You’ve got it right, but the stock hasn’t performed. What do you do? I mean, so you’ve got the fundamentals right, but not… Because I was interested, you said you don’t take any sell-side research. And I always wonder about that because I always think if you… Thank you. If you don’t take any sales address, how do you know what’s in the price? How do you know what the stock market is thinking?

GARY CHANNON: I mean, I do sometimes go and look at what that thinking is. If we’ve built an expertise. So I think it’s terrible to go into a field via someone else’s opinion. So primary, first principles, research, thinking, because it’s about a business.

GARY CHANNON: So go and see people. Don’t read people’s opinions. Because you don’t, unless you know the person, you don’t know how to interpret. You don’t know what they’ve left out. You don’t know what their baggage is.

GARY CHANNON: But if someone’s offering you a pound, I always have this, if we put a desk outside of Phoenix and we were selling pounds for 50p, do you think people would come and buy them? People say, it must be a catch. I haven’t actually done the experiment, just in case it catches on and people figure out what you’re doing.

GARY CHANNON: But you want to know why. So you’re right about that. So what is it? Not necessarily read the research, but try to understand how the world looks at things.

GARY CHANNON: Or I’ll go and look at the forward earnings estimates. One of the problems we have is we model cash, not earnings. And some of our best opportunities are where cash and earnings look different. They just don’t come through in the same way, like in, say, house building. So I’ll have a look. And so I had to rebuild our models as like an earnings model.

GARY CHANNON: So to say, well, do I disagree with what the analysts are saying? They’re modeling something else called income or counting income or something. So what does our model look like that? And then I can see the difference. And then I can see when their numbers will change and things.

GARY CHANNON: So I’ve done exercises like that. I’ve been through stages where I’ve tried to get analysts to come and… I’ve given up this a long time ago, but I… I remember in 2010, 11, and Barrett shares were a pound, and we were trying to get the company to buy them back. And I’d have people giving me all sorts of pessimism.

GARY CHANNON: And I’d say, come to our office. Honestly, write on the board your scenario. Let’s count the cash. Let’s just see if you can. And nobody ever took me up on those things. I’d given up on ever trying to get analysts to change views. So I think they were in a difficult game. And I don’t think there’ll be many of them in two years.

STEPHEN CLAPHAM: In two years?

GARY CHANNON: I can produce some of the stuff we’ve done recently where we’ve asked certain types of questions and put it together into one deep-search report. That’s better than any work I’ve seen analysts do. So they’re going to become prompt engineers.

GARY CHANNON: So maybe you need one to do the job of 10, and there’ll be a few of them. But the fund manager could do that themselves. So what’s the role of the analyst? I just don’t see that that’s got any value anymore. I can definitely see AI can do a better job.

STEPHEN CLAPHAM: That’s very interesting because, you know, normally when you talk to most people, they’re worried about hallucination and those sorts of issues.

GARY CHANNON: I just run the same prompt on at least two. I’ve got four that I use all the time, ChatGPT and Gemini and Claude and DeepSeek, and I just copy the prompt and run it in all four. If it’s a report two or three, you can see the hallucination straight away. The probability that they both hallucinate in the same way is very, very low.

GARY CHANNON: It’s coming down a lot. And I If you are being hallucinated to, if you’re in a field where you don’t, then that’s a bit dangerous. But we’re using stuff where you’ve already got some domain knowledge, so you should spot the hallucinations. So it’s more that those hallucinations are a much more milder weakness than the quality of the research we see.

GARY CHANNON: I think analysts are in a…

GARY CHANNON: In a really difficult job. I mean, we are very comfortable with the idea that there’s no relationship between fundamentals and share prices under three years. And I think plenty of academic studies have done this and proved this. And yet analysts have been judged off a shorter timeframe. So in a shorter timeframe, it’s a random walk.

GARY CHANNON: Now, if analysts really were in the business of say, predicting lottery numbers, because that’s their job. Now you write an incredible report and then… You know, it comes out 22 and you said the number would be 23 and you say you almost got it right. And then you explain why you’ve got it slightly low and you estimate the lottery numbers for next Saturday. And then you get them wrong.

GARY CHANNON: And then you say, well, that’s because this and this happened. Trump said this, Trump said that. So they are trying to intelligently interpret a random walk. I think it’s a thankless task. The quality research, the good analysts, the thing that actually they may be able to bring is if you’ve been in a sector for 20 years, you know.

GARY CHANNON: Your way around you know who’s good you know about management and that is a useful piece of information those people could probably work on the corporate advisory side and breach but i just i think the producing a piece of research about what’s going on at lloyds or something i think the fund manager could do that for themselves by just typing in a prompt that’s.

STEPHEN CLAPHAM: Interesting I mean, obviously, the sell side has been reduced in quality and reduced in cost because there isn’t the revenues available, particularly in the UK. Or in Europe, less so in the US.

GARY CHANNON: I mean, I’ll give you an example. So Glaxo, we’ve owned Glaxo before. We have a top level understanding, an insight about pharmaceuticals that actually the value is not in drug discovery. It is in being able to take an idea and distribute it. And that’s why the Big Pharma companies are the same people as they were. 100 years ago or 50 years ago, same leadership, even though what they’re selling has completely changed.

GARY CHANNON: But the world has been changing. So we wanted to understand how the regulations have changed to allow companies to go longer before they sold out to pharma. So we did a deep research report on that. It did all the case studies, showed all the regulations, how they changed, and how COVID had changed them some more to show how people could go all the way through towards.

GARY CHANNON: Before they had to sell out to Big Pharma in the past. That would have been Big Pharma. So it lowered the cost of getting a usable drug. And then we were on patent cliffs. So we wanted to simulate. So we’ve got 40 years of patent. Now we knew the issue of patent cliffs. So 40 years of simulation of patent cliffs.

GARY CHANNON: Put those two models together and asked them to build a 10-year view of what might happen and stuff. So this is incredibly good work. That was the report that was published. And it was enough for us just not to make the investment, just like the world’s changed the way we thought. And I spent probably 15, 20 years on that sector. I probably read 30 books.

GARY CHANNON: And we studied like 40 years of pharma annual reports when the analysts went through. It took nearly a year to do all that work, to basically we put all the, as if Black’s had always been together. And we showed that the market shares were very stable, incredibly stable, if you took out the M&A.

GARY CHANNON: And we managed to, me and the analysts working on this, we did this in a week and it would have been five or six months work to reject that investment. So that, you know, that opened me up to, you know, so some smart analysts are going to start producing some very interesting piece of work, very different from what they’ve done before. And maybe there’s a role there, but they’ve got to change the nature of the job. Wow.

STEPHEN CLAPHAM: It’s very interesting you say that because I really shy away from using AI to produce anything. So I’ll do some, you know, so I’m writing my sub stack this morning before we met and I was doing some work on this particular commodity market.

STEPHEN CLAPHAM: And it’s a lot easier to do the work using AI because you don’t, it just shortens the research process. But the idea of having it right. What I’m going to write scares me. Yes. And so I like to do all that myself. And maybe it’s…

GARY CHANNON: I think the final bit’s got to be you and you’d feel the difference. My wife’s writing a book at the moment and she’s always wanted to write a book, but she also think it would take her too long to research. And I said, you’ve got now an expert.

GARY CHANNON: She’s doing her research. It’s Ottoman history and stuff like that, but she can do it all in a way that she’d previously have gone off to a library in Istanbul and all this stuff. And now it’s accelerating.

GARY CHANNON: Talking to me at four in the morning about how it’s how it’s all coming together but the actual end piece i still think there’s a lot of stuff that needs to be authentically human it’s the same with the oncology you you don’t want a tool to tell you you’ve got cancer and how you’re going to deal with it that’s a human thing the human gets all bented so when when when kasparov lost to deep blue in chess he went off and did a whole i had a team of doing AI working with Oxford and he started a tournament called Centaur.

GARY CHANNON: Centaur chess so man and machine and what was interesting in that it wasn’t the best chess player and the best software the bet it was the best combination yeah the people who understood what this software could do were were the best performance i think it’s the same with AI and you’ve got to you’ve got to sort of augment yourself and do the best bits that are human because i i did ask myself does value investing have a thing but actually the essence of what what our edge is.

GARY CHANNON: Doesn’t go away because of AI we get we get augmented by providing we do embrace it but if but if you were starting as a value investor today you know will you ever need a a team will you you’ll have an agent to do the you know fund reporting you’d have an agent to do this you’d have an agent to do that and so you do need someone so you don’t go mad but but otherwise yeah you you you can do a lot just just with tools so you need less people You do, the route to go down that route, we’ve made a virtue of the way we do it.

GARY CHANNON: It’s a team-based approach.

GARY CHANNON: So our team are not building their future replacements, but they are very augmented. So the amount of productivity I expect out of them is much higher. Our reach, we’ve always operated in our circle of competence. Our ability to increase the circle of competence has been really scaled up. We’ll take it cautiously, but that’s what I see.

STEPHEN CLAPHAM: Really fascinating talking to you. I always finish by asking people to recommend a book. And I know you’ve got a library on your website. No, you’ve got a library in the office. I’m not visiting your office.

GARY CHANNON: Yeah.

GARY CHANNON: Yeah, we have a lot of books and that’s just a selection because I think one of my ways I used to pitch people coming to us, you know, I’ll save you reading lots of rubbish business books because most of them are not great. So I try to find the one or two or three books in a field that you should read.

GARY CHANNON: If I meet somebody in a field, say, what’s the best book in your field? And then just read that and not read all the less good ones. So to me, the… The part that still is underestimated and understood is psychology. So I would say Daniel Kahneman’s Thinking Fast and Slow.

GARY CHANNON: And it’s a book to read slowly. You know, if you read that in a weekend, there’s something wrong with it. It’s like each page has to be lovingly, it’s like a Bible. And think about what it’s teaching you. So it’s a thing to take six months reading and going back to.

GARY CHANNON: And if you don’t have the time to read all the book, if you’ve read the first hundred pages, I think you’ve got 80% of it.

GARY CHANNON: But I think that’s…

GARY CHANNON: That’s profound. So I’ve got two twin pillars. It’s Buffett and Kahneman. And I think the psychology side is still underestimated.

SPEAKER 7: And would you recommend any books on Buffett?

GARY CHANNON: I think people are affected in different ways. I mean, the Roger Lowenstein book is written so well, it inspired me in all sorts of ways, but it doesn’t tell you how to invest. Robert Haslom has written better books about.

GARY CHANNON: What it is and his process snowball’s really fascinating because you get inside of his character he may not have liked it have you read Alex Morris’s book he’s he’s gone through all the agms oh yes so you know all the transcripts are available so i built all these sort of individual gpt so i built something called ask Warren and i’ve even given it Warren’s voice And so I’ve loaded every transcript and every chairman’s letter.

GARY CHANNON: So because what happens is I do recommend people go and read the letters. There’s a lot of them. And there’s a lot of AGM transcripts and questions. So if you ask it, what does Warren say about software? Or what does he say about integrity? Then Ask Warren gives you quite a good summary.

GARY CHANNON: So I would say for things like that now, where there’s a lot of information, dump it in one GPT and then query it. And then, or you could say, build me a 10-page summary of things or, you know, the thing you wanted to learn. But yeah, there’s nothing like reading the real thing and travelling his journey from the original partnership letters all the way through.

STEPHEN CLAPHAM: No, absolutely.

GARY CHANNON: That’s not for everybody, is it?

STEPHEN CLAPHAM: Well, you’ve got to be a bit of a geek, I suppose, to do that.

GARY CHANNON: And then it’s diminishing returns. There’s always something new. But if you’ve read the last 50 years, then this year’s will have, you know, 5% of it will be something new and the rest is stuff you’ve already heard.

STEPHEN CLAPHAM: But it’s good stuff. So I don’t mind, I don’t mind rereading it. We’re recording this at the end of April and recording on a Tuesday. I’m flying to Omaha on Thursday. And I, funny, the, the, the actual meeting itself is, I mean, it’s fun to do, but it’s more the whole atmosphere around it rather than.

GARY CHANNON: It has become a whole ecosystem and I used to go every year, but it’s the same time as my wedding anniversary. So once they started Yahoo streaming it, I no longer went. And we have sort of hosted, you know, in our boardroom, if anyone wants to spend Saturday night in our boardroom, watching it or somewhere else.

GARY CHANNON: But you’re right, there’s always one of our team, one of our team’s going this year. Karthik is going to be there. And yeah, I think you’ve… I always say that if you’re a Christian and you’re around in the time of Jesus, you want to go and see him at least once. And so I do think there’s a lot you’ll get out of it.

STEPHEN CLAPHAM: Gary, thanks a lot.

STEPHEN CLAPHAM: I wish I’d started on the management meetings, as I was really interested in Gary’s approach. I was a bit worried when he thought that analysis would be basically an AI task in two years. I think he may be being a bit overambitious. But there’s no question that Gary’s an incredibly thoughtful investor, and he’s developed an approach which we can learn from.

STEPHEN CLAPHAM: He was understandably reluctant to share too many trade secrets, but I learned a lot, and hopefully you got something out of it also. Thank you for listening. Remember, the best way you can support this podcast is to share it with your friends. You can also leave a five-star rating on Apple Podcasts or Spotify, or even leave a review. I really appreciate your support.