#12 – The Value Architect

Chris Pavese - BTBS

SUMMARY

Chris Pavese, President and CIO of Broyhill Asset Management, is a seriously thoughtful investor. We talk about how investing straddles left and right brain thinking, about whether the advantage of being located outside the bustling environment of a New York or London will continue to confer the same benefit in the days of Zoom, and about the benefits and joy of reading widely. Chris explains his investment philosophy, why he has fewer than 20 stocks in the portfolio, why the only research he buys is from a short seller, even though he doesn’t short, and we discuss the north-south divide in Europe and the US.

INTRODUCTION

Chris Pavese is the President and CIO of Broyhill Asset Management. In this podcast we explore what makes it distinctive, talk about Chris’ views on fashionable tech stocks (spoiler – they may have fallen a long way but Google and Facebook could easily see advertising revenues fall, as advertising is a cyclical business), and what lessons he learned from selling Microsoft and Apple too soon.

Broyhill logo - Behind The Balance Sheet

GETTING INTO INVESTING

Chris started to train as an architect but investing turned out to be a more attractive and quicker option as he explains in the podcast. And he joined Broyhill at quite an early age, but he certainly seems to be enjoying it.

FINDING VALUE

Chris runs a highly concentrated portfolio – less than 10 stocks is too concentrated; while more than 20 is too diversified. This is unusual for a professional investor but he feels that knowing what he owns is critical and he has the advantage of having family office quasi permanent capital. Because of the long term nature of his strategy, he will run heavy cash positions, as high as 40%,  at times, if he cannot find enough stocks to meet his value criteria.

BROYHILL APPROACH

Chris discusses the idea that unanimity in the team is not necessarily the best route to performance. In one team he knows with four portfolio managers, they all discussed every idea, with one person leading. The decision was not however a team decision and they found that the most successful ideas were those where there was the most dissent. It was the controversy that created the opportunity. Accordingly, he is the ultimate decision maker at Broyhill. 

ABOUT Chris

Chris Pavese is the President and CIO of Broyhill Asset Management, a boutique investment firm established as a family office in 1980. Chris trained as an architect and then switched to finance and had two jobs before Broyhill. He first was an associate, then joined JP Morgan Asset Management where he spent five years as a PM, before being recruited by the Broyhill family to manage their family office at quite a young age.

The firm was established as a family office and is guided by a value orientation. Chris believes the detachment of being located in the Blue Ridge Mountains confers an advantage. 

 

2020.10-Chris_updated

Source: Broyhill Asset Management

BOOK RECOMMENDATIONS

Although he never used to be much of a reader, and really only started when he was in the middle of his career, Chris set up the Broyhill Book Club  and is making up for lost time. He gave an extensive list of recommendations.

For an example of creative thinking coupled with scientific process, he enjoyed Leonardo da Vinci by Walter Isaacson.

He recommends anything by Richard Feynman for his knowledge and humour. Surely you’re Joking Mr Feynman is one of Steve’s favourites. He puts E.O. Wilson in the same category.

He likes Daniel Kahneman’s Thinking Fast and Slow, Superforecasting by Stephen Tetlock and Thinking in Bets by Annie Duke, again all favourites of Steve’s.

Seeking Wisdom by Peter Bevelin and his A Few Lessons from Sherlock Holmes as well as the Sherlock Holmes books are all recommended.

On financial history, Chris recommends Extraordinary Popular Delusions and the Madness of Crowds by Charles Mackay and Manias, Panics, and Crashes: A History of Financial Crises by Charles P. Kindleberger. 

In that genre he also likes Edward Chancellor’s Devil Take the Hindmost.

By the same author, he thinks Capital Account and Capital Returns are great analogues for the related periods of the 1990s and early 2000s. These are two of Steve’s favourites also.

Manias, Panics, and Crashes: A History of Financial Crises
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HOW STEVE KNOWS THE GUESTS

Steve first became aware of Broyhill through the book club and then through various research notes. Chris is the first American  investor on the show, and Steve had been looking to broaden the list beyond UK shores. He reached out to Chris and they managed to get a date together. It’s one of the most fun elements of doing the podcast – you can contact someone you don’t know and spend an hour learnings from them and then share that with the audience.

 

CHAPTERS

00:02 – From Architect to Investor
10:59 – The North-South Divide
26:53 – Short-Term Thinking vs Long-Term View
44:14 – Recession and Valuations
57:11 – Uncertainty and Risks Ahead
01:07:45 – The Broyhill Book Club
01:15:06 – Forecasting Supply and Demand

 

TRANSCRIPT

STEPHEN CLAPHAM: In this episode, I’m joined by Chris Pavese, the president and CEO of BroyHill Asset Management. He’s a seriously thoughtful investor.

STEPHEN CLAPHAM: He trained as an architect and we talk about how investing straddles both left and right brain thinking Roy Hill is based in the South of the US, in the Blue Ridge Mountains. A beautiful part of the country. We talk about the north South divide in Europe and the US. A warning: if you’re English, you might not like some of my comments from the perspective of a scot.

STEPHEN CLAPHAM: But we had a really interesting discussion about whether the advantages of being located outside the bustling environment of a New York or London will continue to confer the same benefits in the days of Zoom or whether there might be an even bigger advantage. Roy Hill is a book club and we talk about the benefits and indeed the joy of reading widely.

STEPHEN CLAPHAM: Chris explains his investment philosophy and why he has fewer than 20 stocks in his portfolio.

STEPHEN CLAPHAM: He explains why the only research he buys is from a short seller even though he doesn’t share for me. This is a really enjoyable discussion. I hope you enjoy it as much as I did.

STEPHEN CLAPHAM: Chris. Hi, welcome to the show. Thanks so much for coming on. I really appreciate it.

STEPHEN CLAPHAM: Thanks for having me, Steve. Oh, no, not at all. So look, at one point you had planned to be an architect and you even did some time in a Frank Lloyd Wright building. So how come you ended up as an investor?

CHRIS PAVESE: Yeah, it’s it’s a good question. And what I’ve talked about a bit more recently. And I think several years ago had actually written a piece comparing you know, the architectural process with the investment process obviously very different roles. But I think there’s a lot of similarities.

CHRIS PAVESE: You know, the, the, the short version is you know, I was two years into a five year architecture program, undergraduate program at Penn State was loving it. Although, you know, it was, I mean, that program, I don’t know if you remember any architecture students in an undergrad or graduate program, but we basically lived at the studio.

CHRIS PAVESE: I mean, I remember spending, you know, one stretch 36 to 48 hours or more straight in the studio, you know, during finals, you know, ordering food, sleeping under the desk, et cetera.

CHRIS PAVESE: So like investing, it’s, it’s a business and and a career that I think you have to actually, you know, deeply, deeply love and be passionate about to succeed and, and I did but like I said, two years in, I came to the realization that I could graduate with an undergrad in architecture, go back to school for another two years for a master’s and then seven years you know, have both an undergraduate and graduate degree in architecture or I could switch over do four years in business slash finance, develop somewhat of a business understanding.

CHRIS PAVESE: And then go back for three years for a master’s in architecture and have two degrees in that same seven years. You know, life just kind of gets in the way of plans occasionally and it was, you know, this was the late nineties markets were booming.

CHRIS PAVESE: You know, I’ve, I’ve always kind of straddled. I, I guess both what you’d call like left brain and right brain thinking. Right. There’s, there’s a, a good piece of me that enjoys the sort of creative element of design, both architectural and, and investing design and process as well as sort of the more scientific and mathematical process. And I just decided to to, to make the jump over what seemed like a more academic and financial and mathematical career. But I think it, I think investing recruit requires just as much creativity as any architectural career would require, it’s just applied maybe slightly differently. Yeah.

STEPHEN CLAPHAM: It, it’s funny you should say that because I’ve always described myself as creative and my wife kind of laughs. But I, I think investment analysis is a creative endeavor.

STEPHEN CLAPHAM: I mean, I don’t know that it’s as creative as architecture because I remember I did a project, a loft department in, in, in London on the river with a, a very famous London based architect. He might not be fas amous in the United States, but a guy called Seth Stein. And I remember when he came up with the drawings. It was like, how could he visualize this from an empty box? And I, I remember asking him, what would this look like from when I’m sitting here, how will that? And he drew all these little drawings.

STEPHEN CLAPHAM: And when I actually moved in, I looked at the drawings and it was exactly the way he had envisaged it. So I think, you know, architecture is, I mean, I think in investing is creative, but architecture, I think is a creative at the next level.

STEPHEN CLAPHAM: But you moved to Broyhill and you went there as CIO after five years as a PM at JP Morgan and one year as an associate before that, so you must have joined there when you were quite young and I was wondering what was it that they saw in you that enabled them to trust you when you were relatively young with relatively limited experience is that that’s family wealth, right?

STEPHEN CLAPHAM: It’s quite a brave and, and I mean, for you quite a heavy burden, I would imagine.

CHRIS PAVESE: Yeah. And not to mention a little bit of a culture shock moving from you know, midtown Manhattan to, to what I lovingly refer to as a Maybury North Carolina. That, that reference may, may not carry a whole lot of weight in, in across the pond.

CHRIS PAVESE: But you know, just, just to think of a sleepy, what people would call AAA one stop light type of town in, in, the middle of the, or at the base of the foothills of the mountain Appalachian Mountains in North Carolina.

CHRIS PAVESE: So it’s a bit of a transition. I’ve asked myself, that’s the, a number of questions why a, you know, conservative long, you know, family with this rich Southern history would, would be comfortable with, you know, Italian, a, a young Italian kid that grew up in New Jersey and, and worked in New York.

CHRIS PAVESE: And, you know, I’m still reminded that I’m, I’m the damn Yankee in the office which again may not translate across the pond. But for clarification, right? At a, a Yankee is a, is a northerner that moves into the South. The damn Yankee is one that doesn’t move back. And so, I’m, I’m reminded that on a regular basis.

CHRIS PAVESE: Yeah, it was just, you know, I, I think we just, we just hit it off. You know, like I was, I started, started my career at J PM in 98 left in oh five. So I guess that’s about seven years at J PM. You know, at the time Morgan was this boutique investment Bank with a storied history.

CHRIS PAVESE: At the time I joined, I think J PM had maybe 10, 12,000 employees and maybe a dozen portfolio managers at the Bank. You know, shortly after I joined there was the merger with Chase. Shortly after that, there was a merger with Bank One that of course, brought Jamie Diamond into the fold.

CHRIS PAVESE: And so the organization changed dramatically. I’m not sure what the employee count is today, but it’s somewhere in the hundreds of thousands, not, not anywhere near 10,000 Morgan at the time, had a, had a phenomenal investment management training program learned a ton those first few years And this was, you know, as, you know, a, a much different world than it is today.

CHRIS PAVESE: I think, you know, late nineties, early 2000, you know, most of the learning at any organization you were at, you know, came from internal, you know, came internally, you know, we had no blogs, we had no substack. You read other research publications, right? But the, the amount of knowledge distributed today and that we’re back today is just really unparalleled.

CHRIS PAVESE: So back then I was fortunate to learn from a, from a strong organization. But felt like, you know, I’d soaked up everything I could possibly soak up at the Bank and was, was ready to, to try something new and expand my horizons.

CHRIS PAVESE: And there was an opportunity, there was opportunity to do so with the Broyhill family. And, you know, we’re, we’re almost 20 years later today and I’m, I’m still here and I’m still enjoying the ride just as much as I did day one. Well, that’s, that’s fantastic.

STEPHEN CLAPHAM: You’ll be amused to hear that. Jamie Morgan bought Chase shortly after Chase bought a small Scottish Merchant Bank, originally Scottish, but then based in London, Robert Fleming. And I was at Robert Fleming and, you know, Chase took us over and it was, it was really good fun. I mean, I was in the Chase offices in New York the day the deal actually closed. And when JP Morgan took over, there was all this, you know, maneuvering because of course, JP Morgan had a research department. This is a sellside Bank. I was in Robert Fleming. We had a sellside Bank. Chase had a couple of analysts.

STEPHEN CLAPHAM: So there was all this jockeying as there is when you’re putting two businesses together and, originally seemed that I was going to be binned and I managed to get myself in a position where they decided not to bind me. And, then the week before they decided to fire, not just me, but every director of Chase Stroke, Robert Fleming. And, it was very funny. I mean, the whole experience was very funny, but the funniest thing was that there was one guy that they didn’t fire and he was based in Edinburgh because what they’d done was they decided who they were going to fire by looking at the floor plan.

STEPHEN CLAPHAM: And he, he didn’t have a desk in London and he didn’t realize that he worked from the Edinburgh office, they didn’t even realize that any, there were any others in, in Edinburgh office so that, you know, the well executed plans of a smooth machine like JP Morgan, I’m sure it’d be much better under Jamie Diamond. But, don’t hold your breath. The, the, and I should say, you know, oh, I’m based in, in London and the people that listen to this podcast, they’re astonishingly. I mean, much to my amazement, the podcast has been downloaded in over 100 countries.

STEPHEN CLAPHAM: So, but the explanation about the north and South of the United States is always helpful because the north and South of every country are remarkably different, particularly in Europe and particularly in the UK, because I’m from Scotland, which is a superior country.

STEPHEN CLAPHAM: But I live in England with the English is, you know, but I mean, the, the thing about the America is it’s kind of the other way around, isn’t it? Because the people in the South are nicer than the people in the north. Whereas in, in the UK, the people in Scotland are nicer than the people in England. Is that? That’s right. Yeah.

CHRIS PAVESE: I’m gonna, I’m gonna bite my tongue there and I’Ll, I’Ll, I’m going to plead the fifth of, of my comments to you.

STEPHEN CLAPHAM: But, you know, I mean, all this sort of marketing type blurb that you produce, you know, Royal is always talking about the Blue Ridge Mountains. I mean, I I, I’ve actually been, I’ve, I’m well traveled in the United States funnily enough. So I’ve actually been to the Blue Ridge Mountains.

STEPHEN CLAPHAM: I spent a very happy weekend in Gatlinburg, Tennessee, which I guess isn’t far from you. But I mean, why, why is it good to be an investor in that sort of environment? Is it just because you’re far away from the noise of New York and the bustle and the, and the short termism and the hustle?

CHRIS PAVESE: Yeah, I think that’s a, I think that’s a great question.

CHRIS PAVESE: And one that I’ve thought about a lot since, since joining Roy Hill.

CHRIS PAVESE: And more as I’ve matured, as you, as you said, when I was late twenties, when I moved, when I was in my late twenties, when I made the move down here, you know, looking back, I don’t know that I could do my job as well as, as well as we do.

CHRIS PAVESE: If I was in New York 24 7, I love going back, you know, I, I, I, I, I plug in to New York and other large cities and, and, you know, financial centers regularly throughout the year, but it’s just, it’s just so nice and, and so valuable to be able to unplug as well decompress and really just kind of truly, you know, think independently about sort of what you took in what you learned or what you thought you might have learned.

CHRIS PAVESE: And process that information. I feel like, you know, in New York and probably many other cities, it’s just, you know, the focus is on the next week, the next quarter, the next month and you know what the noise is, the noise is deafening and it’s repetitive and it’s hard to run into people that don’t have the same view or, or, you know, aren’t, aren’t sort of beating the same drums all the time.

CHRIS PAVESE: And so I, you know, I think, I think being away from that, being removed from that intentionally, for us anyway. Right. I mean, every, every investor is different. Every investor, there’s a lot of ways to make money in the market.

CHRIS PAVESE: I, I think a lot of this business is finding out what works for you and what works for your investors and sticking with it and this works for us, right? For other firms to, you know, being close to that information and being that tuned in on a daily basis or even minute to minute is important for us as a, as a distraction.

STEPHEN CLAPHAM: Do you think that, I think, sorry, I was just gonna ask you, do you think that’s changed post COVID? Do you think your relative advantage is eroded a bit as more people work from home and there’s more distance or do you think it, it would still be?

CHRIS PAVESE: Yeah, that’s a good question. I think a lot of it is just, it, it’s, it’s also So, it’s, it’s distance geographically. Right. But it’s also a distance mentally and, and it’s just sort of a, a different psychological and analytical framework and behavioral framework.

CHRIS PAVESE: And, you know, some people are, you know, people are just programmed different than others and we just tend to, you know, we just tend to do better, sort of out here on our own.

CHRIS PAVESE: We’ll see how the whole COVID, you know, work from home thing plays out over time. I wouldn’t be surprised. It’s been a few years, right. And particularly as the, as the economy changes and, and potentially employers gain more, you know, get some leverage back over employees, we start seeing people coming back into the cities and coming back into the office and, and really from demanding people back in the office.

STEPHEN CLAPHAM: But we’ll see, I mean, it’s interesting we get that here, you know, if you speak to investors in Scotland, not that there’s that many of them left, but they feel, you know, when I was on the South side, when I started in the industry, there was a, you know, there was a different environment when you went to Edinburgh and there was, you know, in, in London.

STEPHEN CLAPHAM: So, and I think there is a distance, although honestly, I wonder why, because if you’re in London or if you’re in New York, you got the advantage that they’ve got all these companies coming through, for example, whereas if you’re in North Carolina. You know, I don’t know, you know, companies coming through New York aren’t necessarily going to come and come and see you now.

STEPHEN CLAPHAM: That may be there in a, in a Zoom based world. That’s less of a disadvantage, I imagine. But there, there’s also the, the, you know, why would that not be an advantage? You know, if you’re in New York and you can see that company next week and you don’t have to make the effort of phoning them. You can actually be in the room with them. That’s a lot better than not having that opportunity.

STEPHEN CLAPHAM: And I, but I know what you mean because people do get caught up in the short term and there, and there’s a, there’s an awful lot of mingling and you think, do you think part of it is the fact that investors are talking to each other more and they’re in the same room and they get caught up in the same things? You think it’s easier to distance yourself if you’re physically distant?

CHRIS PAVESE: I, I think, I think. Absolutely. But I also think the point you made in terms of access is an important one, right? And that’s clearly a tradeoff we’re consciously making and comfortable making. But it, it’s also, I feel like you can still get that by plugging in when you need to.

CHRIS PAVESE: Right. You, you may miss like there’s no shortage of ideas, right? We don’t have a problem coming up with ideas to, to track down and hunt down. Right. It, it’s really the, the bigger problem is, is creating the right filter.

CHRIS PAVESE: And so, right, you don’t have to meet with or necessarily should meet with everyone coming through all the time because it’s, it’s, you know, I kind of look at that. It’s almost like email. Right. If you’re, if you’re spending all day in your inbox, right.

CHRIS PAVESE: You’re managing other people’s priorities rather than your own. And I guess I could see the same thing as if you’re in New York, right. If your inbox is constantly filled up, you know, it, it literally and figuratively with people wanting to come and meetings and people coming in to see you.

CHRIS PAVESE: You know, that’s different than being selective and hand picking. Ok, like I need to spend time here. Let’s go out and spend a week visiting these companies visiting, right? Or head out to this conference or, you know, this or that and spend a day talking to these businesses, these companies, these investors and sort of doing it on our, on our schedule as opposed to theirs.

STEPHEN CLAPHAM: Yeah, I mean, I suppose, you know, I, my background is I was a global investor. So, you know, sitting in London when you had a, you know, a lot of companies from Overseas coming through, it was quite helpful because it meant you didn’t need to travel as much going up and you just get a flavor of what was going on in different parts of the world.

STEPHEN CLAPHAM: And of course, there’s no pressure on you to take a meeting. You know, you, you know, that companies in town, if you want to see them, you can see them. If you don’t want to see them, you can’t. But it is an interesting, issue about, you know, that distance and that separation and, you know, the extent to which it does enable you to take a more balanced, longer term, easier view.

STEPHEN CLAPHAM: I don’t, I mean, I don’t have a strong feeling about it and I suspect that the fact that you can now Zoom have a Zoom call with a company makes it a lot, it makes everything a lot easier. We don’t need to go to New York or London or Hong Kong or wherever we’re not Hong Kong.

STEPHEN CLAPHAM: Of course. Now, now I was reading your 2021 letter and you write really, really well. And I thought it was very funny because you were talking about monkeys throwing darts and you wrote a dart throwing. Chimp will occasionally hit a bull’s eye. But as much as you might like to think so, that doesn’t make him the next Warren Buffett of dart throwing whoever that is.

STEPHEN CLAPHAM: Now, I should interject you. I know you’re American. So you may not be aware that there is a World Darts Championship which is held like half an hour away from me, Peter Wright is the current champion.

STEPHEN CLAPHAM: I had to look that up but you, you say you go on to say we see a lot of dart throwing chimps in this market as the majority of investors managing capital today have yet to experience a protracted downturn. So what I want to ask you is, did the men stocks the bull market geniuses, the, the Twitter talking about Zoom being a great company. Did that get to you a little bit?

STEPHEN CLAPHAM: Because it, it kind of got to me a little bit because I was thinking, man, these people do not know what they’re doing and they’re, they’re, you know, people think they’re geniuses and when’s it all when I know I can, you know, obviously nobody likes a bear market. I’m kind of pleased that the bubble has been burst. But I mean, how do you, how do you feel about this?

CHRIS PAVESE: Yeah, I mean, I’d be lying if I said it didn’t get to us, right? I mean, I mean, and it wasn’t, I mean, the last few years, well, at least up until 2021 were kind of a frenzy accelerated version of what we had been experiencing for the last several years, right? I mean, value investing, conservative investing is underperformed growth or more, right?

CHRIS PAVESE: Or more aggressive style of investing for the better part or more of the last decade. So it’s been a, it’s been a long slug for investors like us, you know, like I was gonna say, like many investors today, but the reality is there, there aren’t, I would say the majority of investors, they probably haven’t lived through a number, you know, a variety of different cycles, let’s say.

CHRIS PAVESE: And you know what we saw today was very similar to what we saw in the late nineties, in our opinion. And I think, I think the folks that got caught up in this or probably the folks that didn’t live through that, it’s one thing to read about history. It’s another to actually experience it, right? Like you can, you can spend as much time as you want in school, learning about finance and learning about how to value a security.

CHRIS PAVESE: But until you actually buy those shares and live through, you know, those shares being cut in half, you know, the behavioral aspect of investing is just a, it’s a completely different game and it’s something that just, you know, you learn over time, you know, there’s so many great quotes from the late nineties.

CHRIS PAVESE: You know, I I I I would say and to put this in perspective, I think it was like in our 17 or 18 letter, we had a long excerpt where we were quoting Julian Robertson’s final letter to investors while he was shutting down Tiger Global, right?

CHRIS PAVESE: So, like we were making these comparisons to the nineties for the last several years, which also is not unusual, right? I I think it was, what was it? Was it 96 when Greenspan came out and coined the term irrational exuberance, right? So that was, I mean, he was four or five years ahead of the top.

CHRIS PAVESE: He had another bread and really the last two were the most spectacular in terms of games for the NASDAQ internet, which is exactly what we saw here. The last one or two were the most spectacular for the meme stocks and for the Twitter audio, that’s a great term, by the way, Steve.

CHRIS PAVESE: So it was frustrating. You know, it was a little bit easier for us to stomach as you know, we were still able to make money during those markets.

CHRIS PAVESE: There was a lot of you know, what we call a statistical value investors that are just sort of stuck to buying low pe low priced book stocks that, you know, some of which lost a lot of assets, both in terms of performance and clients over those years leading up to the market top, you know, but we want to be in a position to, you know, in an ideal scenario to make a little bit of money in many market environments, right?

CHRIS PAVESE: Whether we’re in a complete, you know, risk on, you know, throw the baby out with the bath or the water or just kind of throw darts at the board and anything works, we want to be able to make a little bit money in those types of markets and we want to be able to make money in markets like we’ve seen over the last six months and it, it’s a little bit easier to, to sort of stick with it if you’re making money.

CHRIS PAVESE: Although it, like you said, it’s still, it’s never fun making less when, you know, than everybody else around you, especially when you feel and are confident that everyone else around you or a good portion of the folks around you getting rich are doing so for the wrong reasons.

STEPHEN CLAPHAM: Yeah, I think that, I think there, there’s an intellectual dishonest, see sometimes through about people in these markets. And I, I don’t know, I mean, I think every serious investor wonders.

STEPHEN CLAPHAM: Yeah, I, I, I had a conversation by email with somebody. I know that I’m actually invested in his fund through a structure. And they, he, he was writing about his terrible relative performance last year and this is a brilliant investor and he was kind of beating himself up because he, you know, he hadn’t beaten the market and I said, if you’d beaten the market, I’d be wanting to take my money out.

STEPHEN CLAPHAM: And, you know, and of course, now, you know, that these people are all recovering relative, although obviously when the stock market goes on, it’s more painful. I mean, I love it in the letter you, you mentioned that Cathy Wood still manages more money than David Einhorn.

STEPHEN CLAPHAM: I mean, how long will that carry on is David Einhorn? And it seems to me. So these, these are the, I mean, you picked exactly the right example. David was in London about a month ago and I went along most somebody kindly invited me the presentation he was doing, I went along and, you know, chatted to him. He was incredibly smart, incredibly thoughtful investor.

STEPHEN CLAPHAM: And it’s kind of bizarre to me that, you know, he has to fly to London to look for, you know, investors and Cathy Wood just has to tweet and people give her money.

CHRIS PAVESE: I mean, I, I, I it’s unjust, right?

CHRIS PAVESE: Yeah, I mean, we just, I just sent something around to the team yesterday.

CHRIS PAVESE: I mean, the Arc Innovation ETF which is sort of their flagship product, which is still, you know, north of nine billion in assets today. They’ve seen inflows for eight straight days today. So like, and you know, and so I, I wanna say it’s, you know, it was north of 600 million in inflows in the last week or two.

CHRIS PAVESE: So the fact that like, despite being down, I’m not even sure how much at this point, investors are still plowing money into that fund. And really, that’s just a proxy, right? For just the entire speculative corner of the market I I think is a big, it’s a big warning sign, right? That we’re nowhere near to the wash out we need.

CHRIS PAVESE: Right. Like, even, even 2008. Well, of course, you know, 2020 COVID bear market lasted all the few weeks. I mean, it was one of the, the most severe declines that, that certainly, that we’ve ever seen or experienced.

CHRIS PAVESE: But even in history, right, it was, I mean, just the, the, the, how quickly the markets dropped, I mean, it was just relentless day after day after day and they were big declines, but the trip back was just as fast, if not faster. So you really didn’t wash, wash out any of the sort of speculative excesses that we had in the market up to this point. And in fact, we just amplified them over the next 12 to 18 months.

CHRIS PAVESE: Oh eight was, you know, was it took a little bit longer, right? But it was still, you know, it was still a very sharp rebound and really it was a very sharp downfall. I mean, we were kind of, you know, treading water up to the Lehman event, right?

CHRIS PAVESE: But beyond that, and, you know, and then after that, it was straight down from end of September through March, which is, you know, not in hindsight, a great length of time for, for sentiment to really shift and for, for that new generation of investors to kind of step in contrast that to, you know, what, what the markets went through in the seventies or even in the early two thousands. Right.

CHRIS PAVESE: I mean, it was, it was a grueling bear market. It was death by 1000 cuts from 2000 to 2002. And so by the time, you know, the day traders back in 98 99 you know, maybe after a year after the first six months, 1st 12 months, like they were probably still doing what investors are doing today.

CHRIS PAVESE: And that looking at every down, you know, every down day as a as an opportunity to step in and throw more money at it. And every time the market started rallying, they were worrying about missing it and plow back in, you know, and that happened for three years until investors said, ok, this isn’t working anymore.

CHRIS PAVESE: I give up, I want nothing to do with the market and that sets the set the stage, right? For, for one of the greatest bull markets in history over the next really 20 years, it was briefly interrupted in oh eight. But outside of that, like that, that 20 year stretch was one of the best in terms of the, you know, annual Caker over the long term for the market.

CHRIS PAVESE: I think you need to see that type of wash out to set a to set a foundation for, for growth going forward. And I think that’s just gonna take time.

CHRIS PAVESE: I mean, you mentioned, you mentioned the Twitter crowd, you can see it right in the commentary on Twitter and the fact that folks are just, they, they’ve not changed their tune, they’ve not given up, you know, the, the stocks that we’re trading, you know, stocks are at 10 times sales.

CHRIS PAVESE: But that’s because they traded at 50 to 80 times sales 6 to 12 months ago, you know, 10 times sales historically has not been a, you know, it’s probably been more of a top and a bottom.

CHRIS PAVESE: You know, and, and the fact that we’re looking at it today as a, as a potential, you know, indicator that that stocks are getting cheap.

CHRIS PAVESE: You know, and, and every company different, you know, using a multiple sales isn’t the best. I don’t think is the best metric.

STEPHEN CLAPHAM: It’s a shortcut in a lot of ways, but, you know, different businesses deserve, you know, there may be some that, that deserve to trade at 10 times sales but not the quantity they’re trading there today or were trading there six months ago, you know, I can remember being asked to be the corner stone investor in a new IP O very interesting company went out to the hedge funds and I, I asked them, well, and I mean, this isn’t recently, you know, this is a long time ago and they, they told me the, the valuation and I said, well, that would be 10 times sales and they said, yeah, I said, I, I mean, you know, if you’re thinking about five times sales, I might look at it but at 10 times sales, forget it.

STEPHEN CLAPHAM: And of course, it came to the stock market went up and then, you know, fell by 80%. The, the, it’s interesting that you, you make this point because this, the calibration people are still sort of anchored on that high and they haven’t yet, sort of really sort of re examined what the valuation should be.

STEPHEN CLAPHAM: So they’re not, you know, they’re, they’re not looking back over a long enough horizon, they’re just looking back over a very short term and not really thinking about what valuation might be in the longer term.

STEPHEN CLAPHAM: And obviously we’re at a, we’re at a juncture where we don’t know where interest rates are going to top up. So, you know, the, you know, there’s a certain, I had a certain amount of sympathy when interest rates were zero as the people paying up a lot for assets. Because what, you know, how else, where else do you, you know, do you invest?

STEPHEN CLAPHAM: And I guess we get to that point again, but I wonder if we have to find, you know, some, you know, more real levels when you, I, I don’t like to talk too much about current prices and current market levels because I think that makes the, the podcast very, have a very short time value.

STEPHEN CLAPHAM: And I kind of like to do sort of more longer term thinking. But I just was curious because back in August of 2020 you were quotes saying markets could be trading at half these levels in a year or two. And S and P then was about where it is. Now.

CHRIS PAVESE: I mean, if you were interviewed, now, would you still say that if, if you looked at, well, let, let me preface this saying, Steve, you know, the the stock market is one thing, right? A market of stocks is another, right?

CHRIS PAVESE: And so, and so we’ll have, we, we may or may not have views which may or may not be accurate on where the overall market should trade regardless of where the overall market should trade, right? Our job is to find good investments and, and mispriced mispriced assets.

CHRIS PAVESE: But could we see the market trade down materially from here even after the decline we’ve seen? I mean, the reality is we have, the overall market hasn’t seen much of a decline.

CHRIS PAVESE: The, the the, you know, the biggest names in the market have just started to crack, right? Like the like Q one of this year, well, really the most egregious, egregious pockets of the market really peaked, you know, early to midway through last year, right? So they’ve really been declining for 12 months now.

CHRIS PAVESE: But the overall market was held up by the largest names in the market which accounted for you know, nearly 30% of the S and P at the peak, which is also a record high and also what you see near cyclical full market peaks, right?

CHRIS PAVESE: You see an increased concentration driven by increased flows to passive, which drive more concentration, which drive more flows, et cetera that works on the way down as well, right? When those flows start reversing those. So same names that drove, that drove markets higher can drive the markets lower. You know, you think about names like Google, Facebook, Amazon.

CHRIS PAVESE: You know, we’ll take Amazon out for, for, for a second. But, you know, historically, well, historically, at least as long as they’ve been around, you know, people haven’t really even been able to imagine those advertising business slowing, let alone actually declining year over year. But I mean, if you think about both Google and Facebook, right?

CHRIS PAVESE: They, they make up one the majority, the the large majority of the online advertising market, two, right? That market has grown significantly as a share of the overall advertising market. And guess what? Advertising is a cyclical business? When companies go through tough times, they cut advertising and, and, and past cycles, right?

CHRIS PAVESE: Like those that secular driver moving from offline to online was enough to sort of keep those companies continuing to grow. At some point, they become a large enough piece of pie, a piece of the pie when the pie shrinks, they shrink. And so you know, could you see a shift in sentiment where the multiples on those business go from, you know, where they are today to something substantially lower.

CHRIS PAVESE: You know, I, I was going over some, some, some material earlier this week and, you know, it’s hard to believe but it wasn’t too long ago where like stocks, like Microsoft, well, Microsoft and Apple, right, were trading at single digit multiples of earnings.

CHRIS PAVESE: You know, they were trading north of 30 times. Right. Both companies, up until a few months ago, I’m not sure exactly where they stand today.

CHRIS PAVESE: I would argue those businesses haven’t changed much. Right. It’s just kind of what people have been willing to pay for those businesses have changed. And so could we get back to a situation where the sentiment shifts again? You know, Apple takes a wrong step somewhere.

CHRIS PAVESE: They have a bust of a product and all of a sudden people assume that, you know, they’ve lost its mojo and, you know, they’re never gonna create another iphone and the game’s over. And, you know, it, it, it’s tough to sort of, again, step out of, sort of consensus and kind of look at, you know, contrary or contrary factuals, right?

STEPHEN CLAPHAM: Like what, what could possibly happen, example, actually because you, you know, you think about, I mean, you know, my perception is that we’re going to much more difficult economic times and if we’re going to much more difficult economic times. Well, you know, luxury products. Yeah.

STEPHEN CLAPHAM: Luxury, luxury and luxury for you and me. I mean, are we going to be rushing out to buy the newest iphone or? I wonder, seems slightly bizarre to me. Nobody’s ever said that, you know, Tim Cook’s not Steve Jobs.

STEPHEN CLAPHAM: And, you know, I mean, I know, I mean, he’s done, you know, a brilliant job but it seems that nobody can say anything bad about any of these companies. And there’s a very unbalanced debate I think is the, my observation, but let’s not, let’s look a bit longer term.

STEPHEN CLAPHAM: I’ve been doing a few podcasts this year just talking to a lot of macro type commentators and talking about, ok, so we’ve had 40 years of falling interest rates and we know that that’s not going to happen for the next 40 years, obviously, from our starting point, it can be, can do, obviously, we’ve got all the issues of inflation and everything else.

STEPHEN CLAPHAM: So I was saying, well, you know, what’s worked in the last 40 years probably isn’t going to work any longer. And so you need to think a bit differently and I’d, I’d like to get your perspective on that partly as a stock picker and partly because you also do things beyond stocks, right?

STEPHEN CLAPHAM: So, can I just, I’ve got three sort of issues about this? Let me, the first one is about, you’ve talked about value beating growth by 16% percent per annum. I think it was for five years after the tech boom. Is this, you know what we should expect over the next few years?

STEPHEN CLAPHAM: And you also talked in your letter about your portfolio having a bit more rotation of late. One of the things I wonder is, are we going to be, have to be a bit more nimble in the next few years? So say the market is the same level in 10 years time, which I think is, you know, wouldn’t be an unreasonable assumption.

STEPHEN CLAPHAM: Does that mean that we’re gonna have to, you know, find this special situation, watch it go up then find something else and I mean, are we gonna have to play through a different playbook?

CHRIS PAVESE: So that’s the interesting question.

CHRIS PAVESE: So a couple things there, Steve, and one I, I think, let me back up to your, last question too. I mean, that’s a good differentiator, right? So, like if you look at something like the schiller pe right earnings on 10 year trailing basis, I mean, we’ve come down from nose bleed levels to, I mean, I think we’re still near 30 times trailing 10 year earnings, right?

CHRIS PAVESE: Versus, you know, long term average, I don’t know, call it 16, 17, 18 if you want to give, you know, market credit for a rising trend.

CHRIS PAVESE: So, you know, and as you know, right, like markets are like rubber bands and this and this works for markets overall, but also a also individual stocks where, you know, you move from one extreme to another, you rarely go from one extreme back to average average is created by periods above average and periods of below average.

CHRIS PAVESE: And so if you’re trading, you know, at a, at a record extreme above average, yeah, you’re probably not gonna stop it at trend or, or long term average. But that doesn’t necessarily mean.

CHRIS PAVESE: And this just quick circling back to your last question before moving on to this one, that markets need to be cut in half today or over the next year, like you said, they could be flat, you know, we could just go nowhere for a while with a lot of volatility. And that’s another way where you get back to average.

CHRIS PAVESE: That also to your point, right?

CHRIS PAVESE: It is a much different environment that most investors have seen over the last 10 years and for most of the last 20 years, you know, one of the questions we’ve asked ourselves numerous times over that period was, you know, and you’ve seen a generation of investors grow up under the under the understanding that if you buy a good company, you don’t have to worry about ever selling it, you can own it forever because good companies only go up in prices, right?

CHRIS PAVESE: And it doesn’t and there’s no too high a price, right? For a great business that was really just more a relic of the market we were in, right? Like, and people have learned that lesson over and over again through history.

CHRIS PAVESE: And we’ve forgotten it over and over again through history and to your point. Yeah, I, I think, I think understanding them market regime and the market environment that we’re in should inform how you shape and construct portfolios. You know, we were slow to learn.

CHRIS PAVESE: You know, an important lesson over the years and still, you know, still learning an important lesson where like I think you need to differentiate upfront when you own an asset.

CHRIS PAVESE: What type of asset it is, right? So we own a I I, I’Ll give you an example of a couple of mistakes we’ve made in the past to, to illustrate this. But, you know, we owned both Microsoft and Apple at single digit multiples of earnings and sold both for phenomenal games a year or two later and gave up multiples of those phenomenal games over the next several years, right?

CHRIS PAVESE: That was a probably one of the most costly mistakes we’ve made and that mistake was simply just as opposed to saying, ok, this business is starting to get expensive, it was dirt cheap.

CHRIS PAVESE: Now it’s probably fairly priced. We’re gonna punt this and buy something else that’s cheap, that’s not as great of a business, you know, in hindsight, right? The, the the lesson to learn. There was, you want to give those businesses more room to run, you can’t own them at any price, right?

CHRIS PAVESE: But, but you want to give them more room to run as opposed to other businesses that are just, you know, wildly underpriced, but perhaps lesser quality businesses right there, there, you probably need to sell those businesses as they approach fair value as opposed to holding on and let that fair value compound for you over time.

CHRIS PAVESE: And so obviously, it depends on, you know, how you think about and, and how you construct the portfolio as to, you know what that means for what the portfolio looks like and, and what would, you know, might be a sideways market, right?

CHRIS PAVESE: If you’ve got if you’re, if you’re true to your stripes, and you’re buying businesses below fair value and trimming or selling them as they approach fair value or get into, you know, get more and more expensive.

CHRIS PAVESE: Right, in theory, as markets like even in a sideways market, you can, yes, let’s say we go through a period of a year or two where markets are rallying and getting more expensive and most of the underlying stocks in those markets are rallying and getting more expensive, then we should be selling those as they get more expensive, which in theory, right, will be increasing our cash position and lowering our equity exposure and it works on the flip side too, right then as markets fall back to normal or cheap levels, we should see more opportunities to buy even cheaper stocks and we should be putting some of that cash to work.

CHRIS PAVESE: You know, over the last 10 years, holding cash has, you know, we’ve been screamed at, yelled at frowned upon for holding cash. But I think like cash in this type of environment proves it’s worth very quickly, both in terms of right cushioning some of the volatility that we’ve seen this year and are likely to continue to see in the future.

CHRIS PAVESE: But it also just provides you with that element, you know, in a market that’s not trending one way or another, you know, being able to sell something without having a mandate that forces you to put that cash right back to work just because, you know, you sold something. I, I think there’s a lot of value in that type of approach and that’s, that’s frankly how we’ve, how we’ve always approached the market.

STEPHEN CLAPHAM: Well, what would be the maximum of cash you would hold or does it depend on the market?

CHRIS PAVESE: You know, it depends on the market and the mandate. But I mean, we’ve run, we’ve run as high as 40% over the last 10 years.

CHRIS PAVESE: We’re not, we’re not that high today, but it’s also, you know, that’s a function of both top down and bottom up opportunity set. So today, for example, I would say risks are higher than they’ve been in a very long time, but there’s also enough interesting, potentially uncorrelated opportunities in the market or less correlated market opportunities in the market where we, we would rather hold things like that than hold cash.

STEPHEN CLAPHAM: I mean, there, there are a lot of optically cheap stocks around. The one thing that slightly puzzles me at this juncture is we’ve got over half of economists now forecasting a recession. I don’t know what planet the other half are on, but economists are always slightly bizarre but the analysts don’t seem to have bothered cutting their numbers.

STEPHEN CLAPHAM: I mean, I haven’t looked this week. But last time I looked, I, I couldn’t see any, you know, the S and P 500 estimate just carried on going up. And I was thinking, you know, there’s some disconnect here. Can you make sense of that?

CHRIS PAVESE: No, although, right.

CHRIS PAVESE: I would say economists may be ahead of the game this cycle and analysts are probably where about where they usually are, right.

CHRIS PAVESE: I’d say the economists are the exception. Not necessarily the analysts e earnings estimates are normally the last to kind of revise down after the companies tell them the needs have come down or after they start missing.

STEPHEN CLAPHAM: I mean, it’s pretty unusual for economists to, to be so, you know, for over half of them to be forecasting a rec, I mean, recession, I mean, the, you know, recessions aren’t usually as well telegraphed you know, it’s not usually as obvious as it is now. I mean, maybe, maybe I’Ll be wrong.

STEPHEN CLAPHAM: I mean, I hope, I hope I’Ll be wrong but it seems to me, you know, they’re all indicators, all signposts are pointing to a very tough environment and I mean, what the economists who aren’t forget in a recession, I don’t quite know what their assumptions would be.

STEPHEN CLAPHAM: But, you know, if analysts you would imagine would be looking at this and saying, well, things are not going to be as easy as they have been. And of course, we’re coming from historically, very high margins and returns in capital. So you imagine that the, there’s quite a significant amount of downside in earnings and of course, particularly in S and P 500 there’s quite a lot of leverage.

STEPHEN CLAPHAM: So, you know, there’s a kind of a very unpleasant cocktail, around, I mean, I think there’s still some good cheap stocks but I, I, I, it just puzzles me slightly that, the overall appearance of the market is cheaper than it actually is.

CHRIS PAVESE: Yeah, I think we would agree.

CHRIS PAVESE: That earnings are probably the next shoe to drop, right. And, and so investors looking at the market now and saying, you know, and, and sort of quoting it on current earnings or either trailing or forward earnings, you know, it, it’s, you know, the P is corrected, the E hasn’t yet.

CHRIS PAVESE: I mean, the other thing that’s interesting. And again, it, it seems to us that we’re headed towards recession, there’s enough unknowns and uncertainty and risks on the horizon and risks we’re currently dealing with that.

CHRIS PAVESE: It’s, it’s hard to imagine that we don’t get there and we can debate whether it’s a, you know, just a, a slowdown or, or, you know, the, the depth of the reception or, or how big of an issue it is, You know, normally, you know, one of the things that’s interesting is, you know, so at least in the US, you look at like the Atlanta Fed has the GDP now forecast, which right now is sort of bordering on zero for the current quarter and is sort of fluctuating negative to positive.

CHRIS PAVESE: And so, you know, folks are looking at that, I mean, normally by the time everyone agrees that we’re heading for a recession, we’ve, we’ve already been in one for several months and, you know, I mean, it doesn’t feel like that in the US. You know, consumers are still spending money that we gave out, you know, for the last year or two.

CHRIS PAVESE: But, you know, with housing prices where they are with what it’s cost, filling up gas tanks and, and put food on the table, it’s just, it’s just hard to see how the average average consumer really, anywhere in the world can continue spending like they’ve been spending.

STEPHEN CLAPHAM: No, I, I mean, for the average person, it must be getting increasingly tough and, you know, this is a terrible thing about inflation because it’s a tax on the poor, you know, you and I can manage and cope with the, you know, the additional cost of filling up our cars.

STEPHEN CLAPHAM: But it’s the average person who probably needs to drive, have to work and who will find it much, much tougher, which I think is, is, is the sort of terrible, sad thing. And of course, many people just don’t really understand what inflation is.

STEPHEN CLAPHAM: I mean, I’ve always felt, I mean, although I, I know we’ve been in a disinflationary environment, I’ve always felt that my personal basket of consumption was subject to quite significant inflation and that’s before any of this started.

STEPHEN CLAPHAM: So, I mean, I think, you know, my personal consumption is over 10% inflation right now and I don’t see any prospect of it, of it tailing off and we’re beginning to see this being reflected in labor demands in the UK, although I think that’s not quite as strong in the United States, but maybe we’ll just be worse hit.

STEPHEN CLAPHAM: Do you talk a bit about international beating the U Si mean, I wonder so how, I mean, how does your allocation look now, how many stocks would you normally hold in your portfolio? And how many would be us? How many would be international? And are you being pushed Overseas?

CHRIS PAVESE: I think that was as usual, more a function of the opportunities that we’ve been seeing and, and where we’re seeing value in markets.

CHRIS PAVESE: You know, historically, we’ve run with 10 to 20 names in the portfolio. We’re at the, the high end of that today. And again, that’s just, you know, that’s more personal preference than, than any scientific calculation.

CHRIS PAVESE: I’ve learned over the years that, you know, when we, when I start approaching that 10 line item, I lose sleep because I feel like we’re, we’re over concentrated when I start getting north of 20 or too far north of 20 I start losing sleep because I feel like I don’t have my arms around the proportio as tight as I should be.

CHRIS PAVESE: And so that’s kind of been the sweet spot for us, for us and that ranges to, with the types of names that we own, right? So we try to leverage the work we’re doing to get the most bang of it. We’re a small team that’s by design. You know, I don’t, I don’t want to manage a large team or a large organization.

CHRIS PAVESE: I like we, we like being involved in the weaves on every position, but that means, right? We’re, we’re limited in, in what we can look at. So we need to, you know, we need to make sure that filter is, is working robustly, but that means we’ll, we’ll own names. So we’ve got you know, we have $2 stores in the industry, we have two tobacco indus, we have two tobacco companies.

CHRIS PAVESE: We’ve got three airports. You know, you can think of those each as one position because they’re, they’re very, obviously very closely related. And it’s, you know, the work is the work is the same across the businesses international today, probably represents roughly 40% of the portfolio of, of our equity portfolio.

CHRIS PAVESE: And, you know, really, that’s, again, that’s see, that’s more a function of mispricing than any top down view of the world. You know, I can tell you, you know, a lot of those names ha happen to be in Latin America. I can tell you that we didn’t sit down and, and come up with a, you know, wildly bullish economic scenario for, for Argentina, Mexico, Brazil or just in general.

CHRIS PAVESE: But we were finding, you know, a, a very high number of very cheap, very good businesses in those markets. And that’s perhaps because nobody else could come up with a good reason, a wildly bullish economic scenario for those markets. But that doesn’t mean that there’s not good businesses that could continue to perform well, even in those geographies, I’m sure that’s right.

STEPHEN CLAPHAM: I mean, the, the Argentina is a, an interesting country, not a huge amount of opportunity to invest though, it’s just difficult to find, I always find it difficult to place to calibrate. I mean, obviously more stuff in Brazil but more problems.

STEPHEN CLAPHAM: Mexico I think is very interesting. I just, I was just at, at lunchtime I went to a presentation of a new most startup investment. I do a little bit of startup investing and it’s a manufactured product and they’re looking to penetrate the US market and they’re, you know, I said, so where are you going to make this?

STEPHEN CLAPHAM: And they said, Mexico and, you know, it’s kind of an obvious thing, especially when the dollar is so strong that it gives a massive, massive tailwind for that, that sort of economy. You’ve written quite a bit about how you operate as a team and that’s quite unusual because most teams think they’ve got some sort of secret sauce and they kind of want to keep it secret.

STEPHEN CLAPHAM: I’ve never met anybody who had any secret sauce. I mean, I always ask people about how they do things and I’ve never, you know, nobody ever told me, I mean, maybe they have secret sauce and they don’t tell you. But, but, you know, now I’ve a training business and I go into clients and, you know, you do get a sense, particularly if you’re doing a big program, you do get a sense of how they operate.

STEPHEN CLAPHAM: And, you know, most firms have, you know, they’ve got different ideas about, they do, but they basically do the same thing, but they don’t like to talk about it. But one of the things you talk about is, you know, having bear and central cases and multiple scenarios for every investment and, and each team member having their own ideas about the value.

STEPHEN CLAPHAM: How does that? I mean, what, what do you do? You all come in and you say, I think it’s worth three and I think it’s worth four and I think it’s worth five. Oh, let’s, let’s just take four. I mean, how do you, how do you discuss it? And how do you, how do you form the team? Opinion?

CHRIS PAVESE: Yeah, I mean, like you said, Steve, there’s certainly no secret sauce and it’s something that we’re, we’re constantly refining and, and trying to improve and, and trying to learn from, you know, as many sources and resources as we can, you know, anecdotally and go off on a slight tangent here. I had a really interesting conversation.

CHRIS PAVESE: I guess this was pre COVID was sitting down with a firm that made all of their decisions there, you know, everyone at the firm, there were, there were four investors at the team at the firm and they were all invest, they were all portfolio managers, there were no analysts, they all had the same type and anyone’s idea, they all discussed every idea together as a team.

CHRIS PAVESE: But normally there was one person leading the effort on each name, but the discussion was a team, but the decision was never made as a team. Right. So, and I thought this was really interesting in that it, it was not a decision by a committee.

CHRIS PAVESE: So if you presented something and everyone on the team disagreed with you, it still went in the portfolio. If you felt strongly about it, it was sized differently, right? If you’re the only one, a supporting the, the name, but it’s one portfolio and you know, there’s, there’s, you know, 334 in invest investment members on there and they debate and they talk through it.

CHRIS PAVESE: Also no presentations, which I thought was very interesting because they didn’t do formal pitches because they felt that in that, you know, by doing that, the best pitch or the best presenter made it into the portfolio and not necessarily the best idea. And I think that’s so, I mean, that there’s so much value in, in recognizing that, right?

CHRIS PAVESE: I mean, it’s just you go to an investment conference and, you know, I’m going to one in a, in a few weeks and you know, you hear, you know, some phenomenal presentations of horrible ideas and you hear, you know, awful presentations of phenomenal ideas. And it’s very hard to separate the two when you’re sitting there.

CHRIS PAVESE: But what I thought was most interesting from this firm in particular was that when they looked at the performance of the, you know, when they ran an attribution on the fund over time, the best performers over time, where those names where they had most disagreement and still put the name in the book. Right.

CHRIS PAVESE: And if you think about it, that makes sense. Right. If you all agree that it’s a great investment, everyone probably else does as well outside of the firm and it’s probably priced as such. But if it’s an investment that is, you know, drenched in controversy, it’s got a higher likelihood of being mispriced.

CHRIS PAVESE: And so, you know, I, I think, I think it was very smart to have to make sure that those names made it into the portfolio. So even if everyone disagreed, I wouldn’t say that we, we go that far. Right. So I, I mean, I take input from as many sources as possible, both internal and outside firm, but ultimately, right, the decision in terms of when, where and how much we invest rest on my shoulders.

CHRIS PAVESE: So, you know. Right. Right or wrong. I, I take the credit on both sides of those trades, but I, I do think it’s important to, to think through, you know, various potential outcomes and not just this is what we think the stock is worth, right? Because it’s there, there’s just too many variables.

CHRIS PAVESE: You know, we try hard to isolate, you know, what are the three or four things that really matter here and that are going to drive value because there’s hundreds of things and hundreds of questions that you need to ask, but really there’s only three or four that matter and looking at the 100 can take your eye off of the three or four that, you know, if you missed one of those can be very costly.

CHRIS PAVESE: And so, but just tackling that as a team talking through it, making sure that we flush out any disagreement so that we at least understand where everyone’s coming from and understand the counter point of view, I think is tremendously important.

CHRIS PAVESE: You know, we talk to while we, you know, we enjoy being kind of apart from consensus and, and outside of major financial centers, I enjoy talking to other investors and both to kind of poke holes in our ideas and to generate new ideas, we pay for one piece of external research.

CHRIS PAVESE: And even though we don’t short stocks, the only research we pay for is a firm that provides short recommendations. Because I just think there’s, there’s tremendous value in understanding kind of that perspective, you know, on, on different industries, whether or not we’re involved.

CHRIS PAVESE: It, it may be something we’re looking at or maybe something related to a portfolio company or best case scenario, they issue a short recommendation on something that we own. And so we can sort of have an active dialogue and understand and you know, where those differences of opinion lie and what I found over time is more often.

CHRIS PAVESE: Well, assuming we’re just not outright wrong or they’re not outright wrong more often than not, it’s just a difference in time horizon there, right.

CHRIS PAVESE: If you’re shorting stocks, your time horizon is by definition, I think, much shorter than, you know, someone that’s with the longer term horizon that’s owning, owning companies that want to compound over value because time works in your favor. Whereas if you’re short a stock, you’re, you’re, you’re on the clock.

STEPHEN CLAPHAM: Yeah, I mean, the, the, the, it’s interesting, the last, podcast we did was with Dan mccrum who was F G journalist who exposed the war card fraud in Germany.

STEPHEN CLAPHAM: And I interviewed, Southside research boutique who’d issued 40 something research reports on card every one, a cell over a period of six or seven years. And of course, when you’re a South side boutique and people are paying you to give them short input, you just have to keep, you know, and you, and you believe something’s a fraud, you have to keep up the program of cell notes.

STEPHEN CLAPHAM: But when you’re actually sure it’s impossible. And I used to, you know, when I was, when I was at hedge funds, forensic accounting shorts was something that I approached with great trepidation. And, you know, I’ve even not sorted things that I knew were fraudulent or likely to go bust, but simply because they were so shorter.

STEPHEN CLAPHAM: And if you think something’s slightly fraudulent, the chance of it coming up with good results is actually exceptionally high, you know, perversely. And so, and then you get the short squeeze and you get, and it’s just too, it’s just too painful, you know, I just, I just got beaten up too many times.

CHRIS PAVESE: And maybe the best example that, that I can remember, Steve is that you mentioned David Einhorn earlier at the start of our show and his book, Be Fooling some of the people all the time on his battles with allied capital, right? That began, I think in the late nineties and maybe early two thousands, right, an ally didn’t ultimately file for bankruptcy until the financial crisis.

CHRIS PAVESE: And, you know, after oh eight, and David was short that entire time, I mean, that, that’s just a that, that was a phenomenal book. Just kind of to get your arms around the extent of what it takes to kind of do that level of diligence and stick with the position and how difficult it is. You know, it, when every bone in your body tells you you’re right and the market’s just telling you you’re wrong for 10 years.

STEPHEN CLAPHAM: What, what I found remarkable about that book was that none of the outside listened to him. How can you imagine, you know, being you’re a South side analyst and David Einhorn says he’s short of this thought. I mean, I, you know, I would say, I wonder if I could, you know, come around and talk to one of your analysts for half an hour, would, would they spare the time?

STEPHEN CLAPHAM: I mean, they, they just didn’t listen, I mean, I asked them about it. They, oh, they just didn’t listen. People are not interested in the numbers, people like stories. And this is, you know, I think this is very, very true.

STEPHEN CLAPHAM: One of the things in our forensic accounting course, we look at how many people read the financial statements and you’d be amazed, I mean, the evidence is that just reading the financial statements will give you an information advantage. Now, you know, that sounds, it’s like ridiculous.

STEPHEN CLAPHAM: But of course, every investor, every professional investor reads a 10-K, but I can guarantee you that they don’t, it, it, it is the most amazing thing, but talking about reading. So you started the Bro Hill Book Club, which is how I first found you. I think, why did you do that?

STEPHEN CLAPHAM: Tell us about your, you know, what was the motivation and what’s it been like having a book club as a professional investor?

CHRIS PAVESE: Yeah.

CHRIS PAVESE: So let me, let me give you a bit of context first there. I was never a big reader. I don’t think I picked up my, well, let me clarify. I don’t think I voluntarily picked up my first book to read until long after I was already in the, you know, in the middle of my career, post undergraduate studies. It just was not something that not something I ever really enjoyed.

CHRIS PAVESE: You know, we talked a bit starting off Steve about what it was like leaving J PM and, and, and moving South working for a small family office, you know, that was the most exciting thing about that journey for me starting out, you know, while I was still in my twenties was having to kind of create and find my mentors. And all of those came in books, right? Like a mentorship doesn’t have to necessarily be in person.

CHRIS PAVESE: And it’s a little bit difficult to be in person when you’re in Leno, North Carolina, finding a mentor in the industry. And so I, you know, I began reading everything and anything I could get my hands on and, and started discovering, you know, the world of investing outside of JP Morgan, which formed a lot of my thinking to this day, it wasn’t until several years after that.

CHRIS PAVESE: I mean, this is a, well, I guess the book club we started doing about five years ago. So it was 10 or so years after first joining, I’m not sure what the catalyst was, but I remember one December just to that I was going to read a book a week the following year and that’s really how it started.

CHRIS PAVESE: And then at the end of the year, I thought to myself, you know what I should, maybe I should kind of do something to kind of put this list together and, and share it and that was how it started. And then once you did it one year, I couldn’t necessarily stop doing it. And, it, it, it just brings me a lot of joy, the whole, the, the process process. And I normally do it, you know, we, we changed it a few years ago.

CHRIS PAVESE: We used to do it at the beginning of the year as an annual book club for, you know, selfish reasons. Just given everything else that’s going on at the beginning of the year between, you know, earnings reports and, and holidays and, putting together an annual letter that was probably not the best time to try to put together a, I try to put together a AAA list of books, comprehensives that we did.

CHRIS PAVESE: So we moved it a few years ago to a summer reading list, which works great because I, I, I get to spend, you know, if, if we’ve got a summer vacation somewhere along the, somewhere in June or July, I spend that week, mornings before the family gets up, just kind of reflecting and looking back on everything I’ve read and sort of put notes together and then just hand it off to the team to actually get it out the door.

CHRIS PAVESE: But it’s, it’s a phenomenal experience. If nothing else, it’s been a, it’s been a great way to meet new people. I’m not sure that I knew that Steve that that’s how you came across us, but I, maybe you wouldn’t be surprised but, you know, we’ve met a lot of folks that, have reached out to us, you know, in some form or fashion after reading one of those book clubs.

STEPHEN CLAPHAM: All right. It’s interesting. So you take notes and you do it like a, like a, a job, like you do write a review and, and take it quite seriously.

CHRIS PAVESE: It depends on the book. Right. You know, I, I think there’s different types of reading for different types of book, depending upon what you want to get out of it. You know, there was a year where I focused on speed reading and sort of, you know, it was 100% focused on how fast I could get through things and was timing myself and sort of measuring productivity and it just wasn’t enjoyable, right?

CHRIS PAVESE: And it’s, it’s nice to be able to speed read an earnings transcript rather than listening to it hour, two hour call, you know, being able to li literally 5, 10 minutes glance through and take away the main points, but there’s books that are just enjoyable that you wanna, you wanna read over time and just kind of soak up and sit with and there’s others that are not.

CHRIS PAVESE: And then there’s books where there are just filled with lessons that either I want to share with the team, either about investing or kind of team performance culture, et cetera that I’m I’m taking notes in the margin more diligently and sort of categorizing and sharing my thinking, you know, as I’m doing it and then, you know, I’ve got those to go back to when we publish the, the full list at the end of the year and you’re reading physical books and not kind of, it’s a variety, right?

CHRIS PAVESE: So, so my strong preference, all else being equal is I love a hard cover in my hands. I like being able to scribble on the margins. I like to be able to end underline. I like to be able to sort of create a index on the back cover or inside cover of the book that said Kindle for note taking can’t be beat.

CHRIS PAVESE: So I’ve got that we can keep out on this forever, Steve and maybe this will be another call in the future. But like I’ve got all of my Kindle highlights, export to a database where I keep all of my notes on books and reading as well as all the search we’re doing on the team, et cetera. And so all that is sort of automatically exported and categorized and indexed.

CHRIS PAVESE: And so Kindle’s really nice for that, but if it’s a book, I really enjoy, I’Ll still, I’Ll buy a hard copy as well. And then audible is just I can’t listen to books or podcasts for that matter unless I’m traveling for some reason. And so books on audible and podcasts are relegated to the things I’m listening to in the car.

STEPHEN CLAPHAM: Oh, yeah, I I mean, I found that I, I haven’t, I don’t really like the idea of listening to a book and I prefer to listen to podcasts. So I’ve not tried, an audible, although funnily enough when I, I was asked, would I record the audible version of my own book? And I thought, oh, don’t be, it would just take forever just get somebody to do it.

STEPHEN CLAPHAM: And that I hadn’t realized the process is that they get people to audition by reading the preface. And I mean, they, they were god awful though. I, I had to listen, I had to choose and they were all, except one person was actually quite cheerful. And so I said, well, let’s just have the cheerful person.

STEPHEN CLAPHAM: They’ve got an American accent. I, I thought if I read it then nobody’s gonna understand it. So I thought, well, let’s get these, this part. And of course, when they actually did the recording, they weren’t quite as cheerful, I think as, you know, obviously I’m more palatable one page than 200.

STEPHEN CLAPHAM: But which I is perfectly understandable. Oh, tell me one thing that I always ask people to recommend is a book that they love or a book that he would give to somebody who is wanting to become an investor. I mean, you’ve probably got a few recommendations but give us a couple that you really liked.

CHRIS PAVESE: Yeah. So that’s a tough one. Right. Because I, I, well, one I’d love, I’m an over gift or when it comes to book, I mean, I would say just about every other thing I read, somebody comes to mind and I send them a copy of that book.

CHRIS PAVESE: It’s just it’s another thing that brings me joy. So it’s tough to make, it’s tough for me to make a blanket recommendation without knowing who that, you know, personally who that recommendation is for the young, young young.

STEPHEN CLAPHAM: Are you going to North Carolina? What would you pick up in the airport?

CHRIS PAVESE: So younger me, let me, let me give you a couple, let me, let me give you a couple, one of my favorites of all time. And it, and it’s a, I think the best historic example of blending creative thinking with scientific processes and design would be Walter Isaacson’s Leonardo Da Vinci biography.

CHRIS PAVESE: And I would also say I would read anything Isaacson has ever written is phenomenal and would be near the top of my list. But his account of sort of Da Vinci’s life and accomplishments and, and sort of tying that together with the value of having what, you know, what we would call a childlike curiosity or, or a beginner’s mind is just a phenomenal. I I that just brought me so much joy.

CHRIS PAVESE: I would probably have start reading a lot, those lines more, a little bit more science for perspective as well then. So I would read anything by or or about Richard Feynman for both the knowledge base and humor that comes with that category. And I would put E O Wilson in, in that bucket as well. He’s written some phenomenal stuff younger me probably needed to learn a little bit more about decision making and human psychology.

CHRIS PAVESE: So some recent favorites there, obvious one, Daniel Kahneman, anything he’s written, Thinking Fast and Slow, kind of being the primary source there. The book Super Fast Forecasting, Phil Tet Lock and, and company was phenomenal. And then you, you could pair that with Annie Duke’s thinking and bets and then maybe slightly more off the run.

CHRIS PAVESE: Not sure if you’re familiar with the work of Peter Belin Steve, but seeking wisdom I think was the first when he wrote a few lessons from Sherlock Holmes is another. And I would also add any Sherlock Holmes related or, or original stories are some of my favorites too.

CHRIS PAVESE: And there’s phenomenal linkages there to let’s see, sort of investigative work to the type of investigative work required for investors. And then the other one that Belen did was a few lessons for investors and managers from buffet. And then maybe, well, particularly today, I’d say, you know how we started this conversation. I’d say history is more important.

CHRIS PAVESE: And understanding history is probably more important than it’s ever been. So some of my favorites there, kinder begs manus panics and crashes. Charli Mckay’s extraordinary popular delusions, the madness of crowds. And I’ve got to mention since we just chatted last week, Ed Chancellor is Devil. Take the behind most.

CHRIS PAVESE: I don’t know if you know Ed, but he, he’s another he, I, I guess somewhere in your backyard, see if he may be, he may be a good addition for for the show at some point. That’s, I think one of the sharpest financial historians in the business and well, also wrote in addition to his work in financial history, what I would call two of the most underappreciated books on investing that I would put on my top 10 for any investor.

CHRIS PAVESE: And this, I guess these are the only actual finance books, dedicated financial books. I’m I’m mentioning here, the first was Capital Account. Which probably, well, I think you had, I think you had one of the guys from marathon on or one or, or, or more guys from marathon on, on, on the show, haven’t you? Yeah.

STEPHEN CLAPHAM: So, Edward Chancellor is a friend of Russell Napier, who’s a friend of mine and Russell.

STEPHEN CLAPHAM: I did a podcast with Russell and Jeremy Hoskin, who was one of the marathon partners when he split up and he set up in his own Hosking Company.

STEPHEN CLAPHAM: So I did the podcast two or three podcasts ago with Russell and Jeremy because they are all friends and we, we’re trying to do the Capital Account, the capital cycle in an age of financial repression because obviously, you know, the, in an inflationary environment, it’s going to become much more important.

STEPHEN CLAPHAM: And Russell was sick of the sight of me because that we, we did the, we recorded the podcast on the Thursday, we had a drink on the Friday and on the Saturday, I went to the lecture that Edward gives on Russell’s course. Russell does a course called The History Of Financial Markets.

STEPHEN CLAPHAM: And he’s now it’s now an online version, but he does it in person. So I’m going for the full course in October. But he said, oh, you should come and listen to Edward explain the Capital cycle because obviously we just done the podcast. And then on the Monday, I took him to see David Einhorn.

STEPHEN CLAPHAM: So we had, we had quite AAA few days together. But yeah, those books were magnificent and I, I mean, funnily enough, I know the, the people that are still at marathon. I also, I I also know them. And you know, they’re very, very smart and investors.

CHRIS PAVESE: And I mean, I think those books today are just, you know, not have, you know, you cannot pick a better time to read those books just given the slam similarities, like the first book which Ed reminded me that he had sent me a copy of Capital Account, which I think now sells for like 1000 books because it’s out of print.

CHRIS PAVESE: Maybe like a decade ago. So he was quick to remind me of that and and, and point out that if he was smart, he would have been dripping out those into the market, right, over, over, over, you know, talking about Capital Account and, and managing supply side, but, you know, Capital Account as you know, covers the period, right?

CHRIS PAVESE: Marathons, letters from the late nineties to the early two thousands, which I think are a phenomenal analog for what we’re seeing right now. And so, you know, if you could get your hands on a copy of that, I would highly recommend it. The next best thing would be capital returns.

CHRIS PAVESE: I think it’s called, which is the, the second version of that book which covers, you know, the period from, you know, leading up to and after the housing crisis. So you’ve got like two financial bubbles building and bursting, right? Like you, you’ve got data and anecdotes on them in real time in both those books that are just, I, I think they’re phenomenal.

STEPHEN CLAPHAM: Yeah, it, it, it’s an interesting thing that people haven’t paid more attention to. I mean, I, I thought that it was really widely known and understood and I’ve written about it a couple of times and people said, oh man, that’s fascinating. I said, well, I, I just assumed that everybody had read that stuff and then realized it’s a lot easier to forecast supply than demand.

STEPHEN CLAPHAM: So, you know, everybody spends all their time thinking and I mean, I guess this comes more naturally to me because my background, when I started, I was a transport analyst on the South side. So in the transport sector, it’s all about how much supply is coming and all you need.

STEPHEN CLAPHAM: You know, that’s what you watch when, you know, there’s too much supply, but obviously it’s very, applicable to lots and lots of industries. And it’s strange that people don’t pay more attention to it because there’s, you know, there’s no question that it’s a, you know, a very, very effective approach.

STEPHEN CLAPHAM: Listen, thank you for that. I don’t think we’ve had as many book recommendations as, as that I’m looking forward to the web developer managing to fit them all on the page because we’ve got a new website and, the technology of doing the pages is, is much more difficult as it used to be. So, she’s going to be thanking you.

STEPHEN CLAPHAM: You’re lucky that you’re in, that little town in North Carolina. I read about it. I thought it was a very cruel comment on Google somebody, somebody who lived there. I looked it up, it said, 18,000 people, low cost of living is great, mostly friendly people.

STEPHEN CLAPHAM: I thought everybody in the site was friendly, mostly friendly people and good opportunities for work. There isn’t much going on after nine PM or on Sunday because it’s obviously good for, if you want to read. Right. Listen, I, I’m looking forward to my next visit to the Blue Ridge Mountains. We had a very good time.

STEPHEN CLAPHAM: Last time I’ve got, I’ve been making all these new, wonderful friends in the United States and, and lots of people in your neck of the woods, so I’m not going to make it this summer because we’ve got a trip in the west of the country.

STEPHEN CLAPHAM: But hopefully another time I really, really appreciate you taking the time and, you know, sharing your experience and, and, you know, you’ve got a very, very unusual role because there aren’t many people that think 20 stocks is too many.

STEPHEN CLAPHAM: And, and, you know, I’m completely with you because I think, you know, people overvalue having diversification and once you get 15 stocks, you’ve got all the diversification you need really. And, thank you so much for your time and I look forward, hopefully we’ll manage to get a drink in person. You should come to the UK because there’s loads of cheap stocks here.

CHRIS PAVESE: Well, I may take you up on that, Steve and we, we’d love to host you, whenever you get back out to the east coast here in the States. So please let me know. Thank you so much.

STEPHEN CLAPHAM: All right, thank you.

STEPHEN CLAPHAM: Well, that really got me thinking about whether it’s better to be based at the heart of the action in London or New York or whether distance gives you a better perspective. Obviously, there are lots of advantages of being in the countryside and Zoom is now a great leveler. You can easily attend conferences and many company meetings take place over Zoom.

STEPHEN CLAPHAM: For me, London is still the greatest city in the world and I can see myself moving. And after listening to Chris’s extensive book suggestions that also got me thinking about whether I’m reading widely enough. I hope you enjoyed this episode as much as I did. Please let me know your feedback.