The transcript from this week’s, MiB: Adam Karr, Orbis Investments, is below.
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VOICEOVER: This is Masters in Business with Barry Ritholtz on Bloomberg Radio.
RITHOLTZ: This week on the podcast, I have an extra special guest, his name is Adam Karr and he is head of Orbis US and portfolio manager at the company’ global equity strategy. The firm manages over $37 billion in assets. Orbis has just an absolutely fascinating history. Their founder was a portfolio manager at Fidelity for a while, his name is Allan Gray and he went out and launched Allan Gray limited in 1973, eventually becoming South Africa’s biggest private investment manager. They expanded in 1989 to be more international and that’s when Orbis was created.
The firm is really quite fascinating for so many reasons. Their track record has been outstanding. Their fee structure is fairly unique in the industry, very much aligning clients’ interests with the firm and the employees of the firm’s interest.
I know everybody sort of pays lip service to that. These guys really do that, you pay for alpha and nothing else, and if the firm underperforms its benchmark, you get refunds on your fees and then some. It’s really very, very unique and very interesting.
In addition, their structure have — what Allan Gray did with his original shares is quite fascinating. All told, this is really quite an intriguing conversation. I think you are going to find it quite interesting and unique in the world of investing.
So with no further ado, my conversation with Adam Karr of Orbis Investments.
VOICEOVER: This is Masters in Business with Barry Ritholtz on Bloomberg Radio.
RITHOLTZ: My special guest this week is Adam Karr, he is the head of Orbis US and portfolio manager for Orbis Investments, a firm, which runs about $32 billion in assets, the firm’s flagship global equity strategy has outperformed its benchmark, MSCI world index since its 1990 inception. Orbis brings a unique fee structure to clients who only pay when the firm outperforms.
Adam Karr, welcome to Bloomberg.
ADAM KARR, HEAD, ORBIS US: Barry, thank you. Thank you for having me, I’m looking forward to it.
RITHOLTZ: Same here. So let’s start with your background before we work our way to Orbis. How did you first get interested in investing, I read something that you used to help you grandfather clean up banks at night and you started reading docs that were lying around that led to an interest in finance? Give us a little background on that.
KARR: I wish I was that precocious. So taking it back, I first became captivated with investing in middle school, I guess it was the late 70s early 80s I grew up in Illinois, the south suburbs of Chicago. And I just spent a lot of time with my grandfather, he was a janitor, a caretaker for a local Savings and Loan and I used to go with them every night to help clean the bank.
And I would mop floor and dump out wastepaper basket and there was his really interesting newspaper in the garbage that looked different than anything that we had at home or school or anywhere else and had these odd-looking dot-matrix photos on the cover.
And of course, that was the Wall Street Journal and I just was fascinated by looking at the paper trying to follow the story. I can’t say that I really understood it, I certainly wasn’t reading bank documents.
But it was that that really started me in the journey of getting really interested in the market, and on Friday nights, we didn’t have to go to the bank because we could go on Saturday and we used to watch Louis Rukeyser’s Wall Street Week every Friday night in the beginning…
KARR: You know, I would just I did it because it was a way to spend time with my grandfather, but over time I really came to enjoy it and I think that was really just the genesis for me getting quite interested in markets and companies.
RITHOLTZ: The fascinating thing about that period is the pace of Wall Street Week and the pace of Rukeyser was so different than what we experience today. Do you look back at that period as sort of a kinder, gentler era or was that just part of the inevitable evolution of finance?
KARR: I mean, to be honest, Barry, I was nine or 10 years old so I can’t say that I could do it in (ph) context and full construct, but it was just — for whatever reason, it was just fascinating to do and really planted the seeds early.
RITHOLTZ: So let’s fast-forward little bit to your current philosophy not that when you were nine years old, you talk about having four core pillars of your beliefs thinking like a business owner, contrarian thinking, long-term perspective, and being unconstrained.
Tell us about those four and how that belief system developed?
KARR: Yes, so it’s probably helpful and I will dive in on the pillars just to give a little bit of context from Orbis. So Orbis is in its 30th year founded 1989 by a gentleman by the name of Allan Gray, South African. So what is Orbis? We’re a global equity specialist, today, we manage about 37 billion in AUM across the globe doing info and long only absolute return and multi-asset strategies.
Orbis global equity is our flagship strategy and it represents 67 percent of our total AUM. We are mostly institutional with the exception of some retail in Australia and the UK.
Our investment approach is pretty simple at the end of the day. We strive to buy assets at a meaningful discount to intrinsic value. I think the key term there is intrinsic value, we’ll not devalue managers, we simply buy didactically based on low price to book. We try to think much more holistically about the true value of each business as an owner, and we try to go after it when there’s some kind of dislocation.
We got a deep team of analysts about 35 all around the world in local markets, and we are really of the mind that if you want to generate an alpha, you got to go against the crowd, think and act differently.
Our strategy — our equity strategies are all unconstrained, so we’re going to look very different to the benchmark, and we tend to run pretty concentrated, our global strategy’s got about 60 positions with our active share running over 90 percent.
Now, there’s a couple of aspects about Orbis that are pretty unique are one of which used how we think about fees. All of our fee structures are performance based, we can dive into that more deeply, but in a nutshell we’re contrarian intrinsic value equity managers.
Now in terms of the pillars and how they interact, I think it’s worthwhile to say, you know, sort of our DNA of who we are is deeply rooted in our founder. In his view, this is going all the way back to South Africa when he first launched our sister firm is that if you want to generate an alpha, you have to go against the crowd. And I can still hear Allan to this day say, you know, if you want to be good, work hard, but if you want to be exceptional, you have to come at the problem completely differently, you got to turn it on its head.
And so this really kind of then forms the pillars and I think of it kind of the way that Jim Collins talks about flywheel, like there’s no one silver bullet, it’s the way that they interact together. And so the first is this concept of independent thinking. You have to attract and retain highly independent minded people, people that love and relish having a view that’s different to others, that is the heart and soul I think of how we try to construct our model.
And then two, you have to structure the firm in the values and the culture that rewards independent minded people, like I can do things that are different just to create a structure that allows them to do that. And one of things that we do, all of our analyst manage their own paper portfolios, and so that — it’s quite different than a lot of shops and I’m not picking on any shop but many places the analysts will in air quotes “pitch” names to PMs.
For us, the analysts are putting forward what they would buy themselves and be accountable for objectively. And it’s interesting because when I talk about this in recruiting to perspective analysts, you can see some analysts are really drawn to that, you can see them lean in, they are excited about it, and some lean back and like “oooh.”
KARR: And you can tell that it kind of intimidates them. And the point there is that it’s self reinforcing system that attracts people to us and helps us retain the individual that are most aligned with that.
And then the third pillar.
RITHOLTZ: Let me jump in right over here before we get to the other pillars. I recall reading an article about you and the firm some time ago, maybe it was 2015 in Barons where one of the analysts was pitching Nike which was rolling out this newfangled direct to consumer Nike.com idea and pitched to everybody in the firm all called in from around the world and was fairly savaged in various critiques and counter arguments and push back. But ultimately the firm ends up buying half a billion worth of Nike which has been a giant homerun ever since.
Is that typical for the processes, is that how that usually runs?
KARR: Yes, so that is a – I mean it’s a great example, Barry, in the sense that many firms, and again, not to critique, but many firms will manage their portfolios on a committee basis. And our belief is that the best decision, particularly contrarian decisions are not made by committees, they are made by individuals who have done the work and have a conviction and are willing to be accountable for those decisions.
Now we obviously don’t put people in positions to move capital for clients right away based on demonstrated track record, but our capital allocators have demonstrated those rack records and it’s not a committee decision. And so the Nike situation was a very contentious investment committee on and in fact, myself and the analysts, I would say were on one side relative to the rest of the investment team.
And the core issue there, I mean nobody would dispute that Nike is a great company and has great content and very creative, and great athletes, but they were making a big pivot to go online and go direct. And the key question — the burning question was will that be better and more profitable for Nike going forward.
And our thesis was that in cutting out wholesale, you eliminate that margin and they will be able to retain and there’s a lot of other reasons why we think it’s going to be better, we thought it was going to be better but it was a very contentious issue.
We had the investment committee, great discussion and debate, there were points raised that we step back and spent time on but at the end of the day, as a portfolio manager that I made a decision to take a position. And that’s the core premise of how we invest of allowing individuals to express themselves where they have conviction.
RITHOLTZ: So that raises a second somewhat related issue as to the difference between traditional value, you very distantly mentioned price-to-book which has done quite poorly the past, I don’t know, 20 years and certainly the past decade but you keep bringing up intrinsic value and I’m wondering how much of that intrinsic value allows — that definition allows you to embrace more of a posture that includes some out-of-favor growth stocks?
KARR: For sure.
So I think we got a 30 year track record if you look across those 30 years, it’s across many different cycles and market environments, growth value and we — by far, we tend to do best in you know, classic value markets.
I think where we differ from our peers, however, is that the we do okay in growth markets and why is that? We’re not didactic, first of all, what is value, we are not didactic around what value is in the sense that it’s a hard parameter around price-to-book or a specific PE metric above which we won’t buy.
What we really think about holistically is the business, the quality of the business, the durability of the cash flow, the ability of those cash flows to go over time, the moat, and then we look at the price, and we go after situations when we see a meaningful gap — excuse me, between those two, that’s what we are as a manager and I think, you know, everybody likes to put you in a box — MorningStar, others, and what we would like to say is our dot moves around, you know, don’t put us in any one box.
The dot moves around and I think it is because the areas of the market that are offering the most value move around over time and that’s something that we’ve always lived to and hopefully has been beneficial for our clients over time.
RITHOLTZ: So you get to run the US segment of what is a global portfolio, obviously the US market has been pretty dramatically outperforming the rest of the world not just in 2020 but pretty much since the end of the financial crisis and in ’09, how long do you think this relative outperformance of US versus overseas is going to last? Are we ever going to see any form of mean reversion or have things aligned in such a way that, hey this could go on for who knows how long?
KARR: Yes, the $64,000 question. If you point there, I think, you know, the returns in the US which is what I live and breathe has been sensational relative and historic context to beat the S&P since 2009 is compounded at 15 percent, the NASDAQ compounded at 20 percent two to three x the long-term, seven percent to eight percent average.
In some ways, it is surprising, in some ways not, I mean I’m not — studied it empirically so take it with a grain of salt. But you know, in speculating some of the drivers, I mean the most dominant force in the market globally and in the US over the past decade has been monetary intervention which has truly been unprecedented.
And by and large, and I’m sure others would disagree but I would say leadership, Bernanke, Yellen, and now Powell, has been pretty constructive so I think that’s been the context within which this has been enabled.
But there’s really been an insatiable appetite from growth, non cyclical growth, secular growth, and if you look at the market structure today, what do you see? I mean the top five companies, now six if you include Tesla in there, the S&P are 25 percent of the — of the S&P which by historical standards is now quite concentrated, is now over 50 stocks that traded more than 10 times revenues, and that is just in the S&P.
And there is all kind of stocks outside of it like Snowflake and Doordash and Zoom, and traded pretty heady multiples. And so it’s been underpinned by exceptional revenue and earnings growth and exceptional multiple expansion.
And it’s been that mix that has created this cocktail combined with lower taxes and lower regulation falling wage burden, that’s created a pretty awful cocktail. So the most important question is where to from there, where to from here?
And you know, by historical construct, spreads are quite wide — quite wide and you know, we don’t make forecast and there is not a prediction as to when it will turn or why it will turn. But we are of the belief that that really should normalize in time.
And I think simplistically, that’s around the fact that it’s unsustainable for the market to compound at that rate. And when you look back – you look at Orbis’ history, you go all the way back to 1990, I think Japan was something like 45 percent of the world index and we had zero exposure to Japan on the view that that was extreme and grossly overvalued.
We go to 99, 2000, you know, there was an area of the market, technology and we were on the other side of that and tobaccos and what not. And you look at today and those spreads are just as wide if not wider, and we do as we should today, we have a pretty meaningful underweight to the US. I think the US is now 65 percent 66 percent of the world index and we are about half that in our global strategy.
So we’re on the other side of that. And it’s interesting because you know, when you look at it, when you look at the data, and you think about it. It seems like, you know, it’s clear what one should think about doing.
But when you’re in the moment and it’s been painful in getting, it’s hard to do. And I think that really speaks to the behavioral side of investing which is one of the aspects of the lesson that it’s always attracted me the most is it’s most difficult when you are in those moments, and I think now is one of those times.
RITHOLTZ: Quite intriguing. Last question about these topics.
So you on the US segment of what is a global investment company, what is your day-to-day job like, what is your actual title? What are you responsible for?
Are you running the team? Are you running the portfolio? Tell us exactly what your job entails.
So, I’ve been investing for about 25 years both public and private markets, the last 18 years at Orbis, I joined Orbis in 2002 and so today, I’m responsible for the US efforts of the firm, and our US team is based in San Francisco.
I’m one of the five capital allocators or PMs for the flagship global strategy, so I’m the PM for the US strategy, that’s my day-to-day which is a lot of reading and a lot of interacting with my investment team in terms of sourcing and thinking about ideas.
I also sit on our on global management committee which I’ve done for — it’s about 15 years, but I think at the core, you know, I started as an analyst, and a generalist in Bermuda which is where the firm’s headquartered. And today, I do the same thing, I picked up a lot of other responsibilities along the way but first and foremost, you know, we’re bottoms up fundamental stock pickers, as analysts understand different issues (ph) and that’s what I spend the majority of my time doing.
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You only take a fee when your funds outperform your benchmark and not only that, you return the fees when you underperform, explain the genesis of this and how it works in the real world.
KARR: So, genesis, and to do them, I’m just going to pivot back quickly, Barry, to the kind of the four pillars to round that out. So pillar one, people, independent-minded. Two, structure, give them a space to be independent-minded and express themselves. And the third pillar is around alignment, is to seek, align clients in a way that our incentives are truly aligned. And then the fourth pillar is to structure the firm’s ownership to promote putting us in a position to take a long-term view and differentiated actions.
And just on that last point, the firm is privately held, our founder vested his interest into a charitable trust, so that charitable trust uniquely will own Orbis in perpetuity. And the significance of that is it allows us to take actions that are longer-term and that are differentiated and that relates to the fees and I will tell you. So specifically on the fees, the Genesis goes all the way back to the beginning of the core value around alignment. We’ve only had performance fees in the history of the firm, our original fee if you go back to 1990 was a base fee of 150 basis points with 100 basis points fulcrum fee up-and-down fully symmetrical.
Then our structures evolved as the markets evolved and I think improved. So let me touch on the principles of it and then I will talk specifically. So, in a perfect world, the client wouldn’t pay any fees until they redeemed at which time they would just pay based on the value that you added.
Obviously that is impractical because managers need to pay bills but the principle of alignment around that is the key to our approach. And so we try to do that in two ways, the first is just management and staff co-invest in the same vehicle with the same fees, we’re the largest investor, and the second is that all of our fees are performance based, fully symmetrical and we refund the fees when we underperform.
So they only pay a fee if we are adding value. And so the best example is what we call a zero-based fee option which is for institutional clients and size, and so that pay no base fee, and they only pay a performance fee if we deliver alpha and on that alpha, the sharing ratio is two thirds for the client and one third to us as the manager.
If we subsequently underperform then those fees are refunded and they go into a trust account which sits there for the client in the future.
It’s important to think about the incentive there because we – you know, our incentives are not to grow AUM, we don’t survive unless we generate alpha and add value which isn’t to say that we can guarantee that we would do such but we can’t say that we will fully align and we feel the pain when we don’t deliver.
What is interesting about this is we first introduced this refundable fee structure in 2004 and I think it’s fair to say that clients were pretty skeptical of the structure, I think there was a lot of questions around, you know, why would you do this, there must be some kind of gotcha in here…
KARR: This has to be better for you and — but I think now we have well over a decade of history with the structure and we’d be able to speak to clients, it’s been a wonderful alignment vehicle. And what we have seen in practice is that when we go through periods of underperformance which we inevitably do, clients are reluctant to redeem because they’ve got fees sitting in that reserve account, and number one, it dampens that relative underperformance because you have those fees being credited back, and two, you see an asset there and you are reluctant to crystallize it because you know it’s there.
Now for us as a manager, that is ideal because it means that we don’t have lockups or any restriction that the clients are sticking with us is exactly the time when it’s most critical for us as a manager, such that we’re not fighting redemptions at that time when we have a drawdown and allows us to lean in to those positions where potentially it’s most attractive to do so.
And so that’s – it’s been a very powerful alignment between us and our clients, and one of the things that we measure ourselves on which I think doesn’t get talked about enough in the industry is the behavioral penalty.
And you can look at a manager with a phenomenal track record, but what did the clients actually realize? And oftentimes that gap is quite wide. We obsess over fees and the lowest cost fees, but if you look at the actual data, the behavioral penalty blows away many cases the relative difference that you see in terms of where manager strike fees.
And what we have seen in practice over the past decade plus is that that behavioral gap has come down considerably which is directly tied to what we’re trying to do in terms of our products.
So it’s something that we’ve been very pleased with. Now, I guess other side of it is why don’t more people do it ….
RITHOLTZ: But before we get to why more people don’t do that, I want to make sure I fully get the details of the fulcrum fee.
So institutional account, I’m going to assume 100 million and up, no base fee meaning no annual fee, so you outperform in a given year and you take some of your fee which is based on 33 percent of the alpha that’s generated and that goes into a trust that sits and waits for the eventual underperformance and is then used to reimburse some of client losses or at least client underperformance. Am I getting that more or less right?
KARR: Yes, directionally. So two fees, so our zero base which is for institutional accounts above 100 million, no base fee are two thirds one third sharing ratio, and then we have a core which is for clients less than that, institutional clients, 45 base fee, management fee with a 25 percent sharing ratio.
And I will use that as an example going forward. So we generate alpha, it goes into what we call a reserve account. From that reserve account, it doesn’t flow out to us as a manager until we accrue more than 3 percent of NAV in the reserve account.
RITHOLTZ: Got it.
KARR: And once it goes above that threshold, it can flow out to us at a ratio — at a rate of one percent per annum. So we’re building up the reserve account before anything goes to us as the manager. That reserve account is actually invested — reinvested in the fund and so that’s what it sits in, in the reserve account.
And then in periods of underperformance, that underperformance at the same sharing ratio, in this case 25 percent is credited back to the NAV of the client.
The other thing that is important to mention here is that the client fee is — sorry, the fee is bespoke to the individual client and their experience from inception. So they are not taking on the characteristics of the pool, it’s specific to their individual experience.
RITHOLTZ: Makes sense, it is set up as an SMA, not as a fund, is that what you are saying?
KARR: It’s a pool vehicle but the fee is…
RITHOLTZ: Got it.
KARR: Individual to them.
RITHOLTZ: I got it, it’s very specific.
So my firm, we bill quarterly and it is like a big deal, we’re recording this the first week of the New Year, sometime this week, we’re running different billings at Fidelity, at Schwab, at TD on clients and it’s a whole process to do.
You guys assess performance fees twice a month. How complicated is that and what’s the thinking behind that sort of performance fee assessment? What are the advantages and disadvantages of that.
KARR: So we strike twice a month or when the client transacts, so it’s an either-or and the reasoning and benefit is the fee is individual and bespoke to the client, that’s what it brings them.
And you can imagine from the client perspective, there is a lot of value in that.
I think the disadvantage from a firm perspective is I think what you are alluding to is there’s a there’s an operational burden and complexity behind that and when we launch this going back to 2004, you know, it was a meaningful investment, operationally and capital to build out the infrastructure to be able to support it.
RITHOLTZ: Quite interesting.
So I first learned of you guys and you in particular via a Wall Street Journal article written by Jason Zweig that was one of the first mainstream pieces really delving into the details of the fulcrum fee. And we’re an RIA so we can’t really do the same sort of symmetrical fee sharing that you guys do, the complications make it all but impossible, but we were very much inspired by what you did and created what we call Milestone Rewards which is simply if you’re an individual investor and you exhibit good behavior, meaning you complete your financial planning, you do an annual update and you don’t dabble with “I don’t like emerging markets so I’m going to jettison that from my portfolio” unbeknownst to us on a random sort of thing, we will end up dropping people’s fees after three years of good behavior.
Hey, you’ve learned — we’ve helped to teach you the right way to do this and now you’re exhibiting better behavior and besides most of the heavy lifting is really in the first couple years so we will reduce your fees.
So that was our response to your media coverage, what sort response did you get to that media coverage? What did clients say and what did prospective clients have to say?
KARR: It’s interesting from a client perspective because it’s complex so I think if you are an agent and you have to go and represent it to the board, it is viewed as complex and different on you know, we know the appetite for those.
The clients that have been with us and have experience that I think tend to be our greatest advocates. And in a way, this speaks a little bit to one of the points I mentioned earlier around the pillars is that it creates a bit of a self reinforcing mechanism. What I mean by that is that clients that sort of intuitively understand this and can appreciate the benefits are drawn to us where as others aren’t.
And so we’re not being shopped for the lowest fee but for the best alignment and that works for us, we’re not trying to be everything to everybody and that sort of self-selection aspect I think is something that we’ve seen play out in practice.
And then if you just look at the numbers in terms of the behavioral penalty over time, I think you know, that is speaking to it objectively.
You got to be curious, Barry, since you mentioned your own actions, what have you seen from your clients and what kind of — have you seen a difference, you look at the behavioral penalty side, what has it done in your business?
RITHOLTZ: So it’s a couple of things. One is, hey the whole industry is under fee pressure on and like you, I’m a student of behavioral finance, and so rather than merely lower fees and get no behavioral result out of it, we try to craft a fee reduction program that you know we make a big deal about telling prospective clients about it and reminding clients regularly, hey you have to — you have to do your annual review, you after you know do your financial plan, we want to cut your fees 15 percent but you got to check these boxes.
And so it’s more than just competing on price because you know I don’t want to compete with Vanguard – whose going to, or Blackrock, who’s going to compete with their four BP funds, h we use both of their funds because they’re so inexpensive but instead, we want to do we can to create I mean — I’m not a fan of all the cutesy versions of alpha — tax alpha, advisor alpha, behavioral alpha, but there is something to the concept that if you can get people to think about their investments in a way that helps lead to better behavior, ultimately that’s going to have as big an impact as anything else you can possibly do.
So net, net, it’s been a giant positive even though it’s definitely like you wait it’s an administrative project, there’s a whole lot of organizational alpha that goes behind this. There’s just a lot of moving parts and it took us a couple of years to really polish that up and get it well.
We’ve only been doing it for I don’t know, once say four or five years, you guys are a decade and half into it, so I have to think that you have pretty much worked all the bugs out that might’ve appeared in the early days. What sort of issues arose when you first rolled this out?
KARR: I mean, it’s, when we first rolled it out, you know sort of I’m exaggerating a little bit but it was kind of crickets.
KARR: What’s interesting as you said is, you know, the industry has evolved quite a bit and it’s going to need to continue to evolve and so I think the appetite for this kind of discussion has changed pretty meaningfully and you know, we feel good about it because it is something we have done for a decade plus, and we have done all the operational stuff, but there is another side of this too which is think about it from the firm’s perspective and from the partnership in that, you know, it makes for a much more volatile earning stream.
And we had to go through, you know, a multi-year period where we were reserving on our own balance sheet by distributing less than we would otherwise do so that we could build up reserves to manage the volatility that will come to the firm because of this fee structure and many years to do that. Another form of investment outside of just the operational side.
We have that in place now but you know that’s not for every firm is going to want to do that. And so it will be interesting to see how the industry evolves over time because even if you want to do it as a firm, I have been doing it in practice is a nontrivial initiative.
RITHOLTZ: To say the very least.
So you describe yourself as a contrarian value investment manager. 2020 was certainly an outlier of the year in so many ways. How do you describe where we are in the market cycle, what do you think is going on in that battle between value and growth?
KARR: So I’m reminded of the Jesse Livermore quotes in “Reminiscences of a Stock Operator” where these customers asked you know “what should I do?” and he looks at him, and he says “Well, you know it’s a bull market” and I feel like you know, kind of like the music is playing for sure, it’s been quite robust surprisingly so. I mean I think also of the Templeton line where “Bull markets are grown on pessimism, grown on skepticism, ,mature on optimism and die on euphoria.”
I wouldn’t say that we’re at euphoria right now, but we’re approaching on and there’s definitely some speculative signs. I think if you look at what’s happening in the SPAC market, you look at the IPO market, because the cover story in Barron’s a couple of weeks ago around the IPO frenzy, if you look at the level of retail engagements, margin debt levels, the Robin Hood tribe, I mentioned earlier the number of stocks that are trading in the S&P above ten times revenue, and then you look at some of the companies recently Snowflake and Zoom and Telecon (ph), there’s definitely some speculative elements today that I see relative to my time as an investor.
While it being said, I think now is an incredibly exciting time to be a fundamental active investor. You know, we, as an active investor, you live for dispersion and the dispersion in the market is pretty wide by all accounts.
I hate getting drawn into the value versus growth because I think it oversimplifies a lot but kind of anywhere you go at it, the gap between kind of one side of the market that the growth — the secular growth winners, the defensive growth names, the story stocks like Tesla and then everything else on the other side, any company that got some perceived degree of uncertainty or cyclicality, there hasn’t been a real better appetite for until recently.
And if you look at the gap between those two sides of the market, you know, it’s as wide as it has been sometimes – perhaps ever.
And you know, that creates interesting opportunities. It’s not a call, you know, valuations are horrible timing mechanisms but they are very telling with regard to future returns and I think the side of the market, the winners that had really been bit up, I think the expectations in those stocks are pretty full and I think there’s an opportunity for them to disappoint.
And when they turn, if you look back historically, when it turns it tends to be reasonably sharp.
And I mentioned, you know, going back to 30 year track record of Orbis, Japan in the 90s, early 2000 and now is another of those times, the opportunity to lean in on the other side looks pretty compelling. Now it’s difficult to do because you — you’re underperforming and you’re lagging and anyone can tell you that you’ve missed the boat and you are crazy and the world has changed, but that’s exactly why those opportunities exist over time.
And I think they are starting to see, there are some interesting signs recently if you look at FANG relative to the S&P, it’s not rolled over but it started to plateau, it’s not leading, you know, our founder used to always say look at the leads to the market bulls, the bulls are losing steam, they are not demonstrating the leadership they have in the past. You look at the Russell 2000 a broader base index relative to the S&P, you are seeing the same thing on a relative basis, so there’s some interesting signs recently, all that – it’s not a forecast that we’re going to rollover, but these things don’t go forever. I’m of the belief that there are cycles to markets, all the things that you’re seeing now like value is dead, these are the characteristics and elements that you see at these late stages in the cycle.
And I think, Barry, on the other side, the most crowded trade the last 10 to 20 years has been the move to the passive investing indexation, these indices that got very concentrated. There’s – you know, there is risk embedded in them, if you look at the concentration in those stocks, look at the cross holdings with individual stocks across those indices and ETFs, you have a turn there that could be quite powerful.
And so as an investor, we look forward most importantly is looking forward, I think having some exposure on the other side is warranted.
RITHOLTZ: Makes a lot of sense.
You mentioned the Russell 2000 which for, I don’t know, the first three quarters of 2020 dramatically underperformed all of the momentum and big cap growth but the last couple of months of 2020 saw a pretty robust catch up especially for small cap value. What does that tell you?
KARR: I think it’s a bit to the point – I mean, just – let’s go back, let’s backtrack for 2000, I mean coming into the year January early February, you know, there was a view of accelerating growth. And you were seeing that in the small caps and then Covid hit, and we had a very meaningful drawdown.
And then more recently the last three months and certainly most recently with news of the vaccine, you start to see that recovery and I think it’s there’s an expectation looking forward of you know cyclical recovery, in particular, those names that were disproportionately hit, just the smaller companies through the Covid drawdown.
So I think you’re seeing that manifestation. If look at you know the existing positioning, you know it’s so lopsided that could have- we will see where things go from here, obviously the election news more recently has not been that encouraging but we try to take a longer-term view.
We will see where it goes from here but it could have a decent way to go, I mean that’s certainly what the data would tell you.
RITHOLTZ: Quite interesting.
So let’s talk about the Orbis Global Equity Fund. Since 1990, that has crushed its benchmark. How have you guys managed to accomplish this in an era of relative underperformance by value and what is your role at Orbis Global Equity funds?
So going back to inception in 1990, it’s been across many cycles and we are proud of that track record. But it’s been – I mean let’s be clear, Barry, it’s been a difficult decade the last 10 years for us and we haven’t performed the level of expectation that we that we hold out for ourselves.
I think if you look back in history and that’s across you know, a number of different market environments, you know, we tend to do best in what would be air quotes “value market” and we kind of hang in there in the growth markets and that’s exactly what you see kind of this last three, five, seven years certainly relative to our value peers, I mean our value peers — pure value peers have gotten really punished during this.
And I think the difference there for us is that I – and I touched on this a little bit earlier is we’re intrinsic value, so we’re not didactically going after just below price-to-book, we have a more – much more holistic view of what we think value is and we go after those gaps. And that can be you know, a dirty industrial company or it can be — could be a technology or Internet-based company.
And that’s allowed us to be more flexible over time, but there also tend to be bigger periods and I mention this if we go back to 1990, Japan 45 percent of the index, it’s just important is what you don’t own, we didn’t own anything in Japan and then in 2000 and I think today would be similar in that, you know, it’s been painful getting here where you have a pretty meaningful underweight to the US as we sit today, and we’ll see where it goes from here but no one knows when those pockets turn, when they get to those extremities like we see now, they tend to be pretty fruitful and that is one of the reasons that I’m pretty constructive as we look forward.
Again, not calling the timing, you know, because it’s not what we do but you know, based on where we’re at now and how we are positioned, I think you know, could be meaningful.
RITHOLTZ: So you hit upon something that I want to address because I’m intrigued by the concept. You mentioned as a contrarian, you’re constantly looking for things the crowd has overlooked. But one of the things we tend to notice over longer market cycles is that the crowd tends to be right much of the time. It is at those major turning points where the crowd completely loses their minds and gets a totally wrong.
But what are the challenges of being a contrarian when you’re leaning into the wins and you know it’s an uphill battle most of the time, how do you manage around that.
KARR: Yes, so I think you are exactly right and I would just observe that now is one of those times that all of those behavioral characteristics are in play, you know, the chorus is calling for it’s dead, it’s over, I still believe in cycles, the pricing valuations don’t matter, I still believe in price evaluations, not as a timing mechanism but fundamentally. I believe it is unlikely and unsustainable that returns will continue to compound at 15 percent to 20 percent. I don’t see any reason why structurally it should change or shift from kind of the long term cross cycle returns of seven percent to eight percent, yet the popular chorus is on the other side of that.
It’s all of the behavioral elements are in play today, in terms of how you manage it, I think it starts with yourself as an individual, as a decision-maker. I think one of the most difficult things in this business is knowing yourself and managing himself particularly in those situations when you are underperforming in a position or in a portfolio and you look long and other people are telling you you’re wrong, clients might be heckling you and telling you are wrong. And how do you make decisions in that situation is one of the most important characteristics of what we do.
And then the other side of it is you want to try to put in place things that allow you to stay true to your process, and that gets to the elements that I was such a little bit in terms of the kind of people you put in your team, the kind of culture that you create, how you manage your day to day, what do you look at, and importantly the kind of clients that you have, what expectations do they have for you.
And then lastly, your own ownership structure and I touched on that a little bit, those are all things that you can try to put in place structurally to allow you to be in a position to make the best decisions when behaviorally it’s most difficult.
RITHOLTZ: And to clarify, are you guys long only or long short?
KARR: Our main strategy or flagship is long only.
RITHOLTZ: Because it’s one thing to be long and wrong as the market goes up or to be long and underperform but I can’t imagine what sort of agony it would be to be short Tesla as it goes up 640 percent, there is contrarianism and then there’s just — that’s a type of pain that is hard to imagine.
But let’s stick with the bottoms up stockpicking because a lot of what we’re discussing is very much the macro environment. You mentioned of monetary policy, we talked about Covid, there are so many broad macro issues, how do you guys think about the macro situation and it seems unavoidable at least in 2020, is macro part of your process if you are a bottoms up stock picker or do you have to try not to think about what’s going on in the broader sense?
KARR: Yes, I think the short answer is you have to, right? We’re not — we are a bottoms-up fundamental stock pickers, we are owning businesses and their cash flows. That being said, you have to have an eye to the context that you are in, I think one of the things very clear going back to 2007-2008, the value tribe got crushed by financials at increasingly lower price-to-book multiples into a macro environment that is not conducive.
And I think if you were only looking at the company and didn’t have construct for the context, you got punished and we were not immune to that to be clear.
But there’s an important lesson in there and that you have an eye to the context, you know, we don’t have strategists in house, we don’t have economists, we are not making forecasts on GDP, anything of that nature which we don’t believe in but you do have to have a construct of the environment in which you are in.
What I say to the team is you can have a great house in a bad neighborhood and it doesn’t matter how good that house is if you are in a bad neighborhood, and so you have to understand what neighborhood you’re in.
And a specific example for me where I’ve gotten really penalized is I had a very stock specific thesis in an oil and gas company, US oil and gas company called Apache, it was stock specific and idiosyncratic that I really believe them and a number of those elements have played out but it’s in the context of an energy space and the WTI is at 90 versus 30, it doesn’t matter what the company specific idiosyncratic factors are, you have to have a view to the context, that’s a very specific example but I think it covers across the board and I think that’s how we as teams how we interrogate and think to make sure that we have an eye to the context.
RITHOLTZ: We were just discussing the exact same thing with despite for the past four years having the most pro-coal president in history, it didn’t matter which coal company you owned, the question was — was it ugly or uglier?
So I totally get the even a good house in a bad neighborhood isn’t going to help you, but sticking with the macro issue, you mentioned monetary policy and you also mentioned valuation, let’s tie all three of those together how responsible is today’s effectively zero interest rate lower for longer policy affecting today’s relatively high historical valuations.
KARR: I mean it’s you can’t – I can’t quantify it empirically, Barry, that you — when you — when your risk-free rate of zero and arguably your real rate is negative that will influence on the nontrivial way how you price cash flow streams, and we have seen that.
And to the point on context I think one of the more critical of myself not being more fully cognizant of that as the environment to my analogy before, the neighborhood over the past decade.
And so it’s been a meaningful driver.
The more interesting question as investors is where are we today and what does the future look like from where we sit today? And I try to spend more time thinking about that.
RITHOLTZ: Quite interesting.
And we talked about ownership and thinking like an owner. I want to have you clarify something about Allan Gray. So when he launched Allan Gray Limited in 1973, he was a former Fidelity manager and Allan Gray became South Africa’s biggest private investment manager.
You mentioned he put his equity stake in Orbis in a trust and that’s now perpetual, what is the — is that the entire ownership structure or are employees also owners of the firm?
KARR: Employees are owners of the firm, and so Allan put it — and his family, put his entire interest into charitable trust which will be held as the controlling shareholder in perpetuity. I think there are a couple of elements to this. One is just — I mean it’s a phenomenal thing what he’s done and I think it gives a degree of purpose to what I do in my own work knowing that there’s a set of beneficiaries behind that in terms of what we do.
But from a business standpoint, I think it’s interesting a couple of levels. First is the issue of succession investment firms is a pretty storied track record if you look at how investment firms manage continuity over time and he did it in a way that was really very thoughtful but quite seamless to manage long-term continuity of the firm and the leadership.
Employees are owners of the firm and have a meaningful stake in the combination the family and executive and staff are the largest investors in the fund which gets back to the thinking investing like an owner.
But it also allows us to make decisions that are driven by what we believe and for the long-term and I couldn’t imagine running an investment firm that was publicly traded that had quarterly reduced objectives.
And so you take something like our fee structure, refundable fee reserve, that is a difficult decision, it is not without consequence for the firm or partnership but having a structure like ours allows you to take those kind of long-term decisions which allows you and reinforces you to take those decisions that are contrarian to what most other people might be doing, in the times that are the most difficult.
And so it’s a powerful reinforcing mechanism if that makes sense.
RITHOLTZ: It totally does. Quite interesting. I know I only have you for a finite amount of time so let me jump to our five favorite questions that we ask all of our guests starting with what are you streaming these days? Give us your favorite Netflix or Amazon Prime shows or podcast, what is keeping you entertained during lockdown?
KARR: You surely have more time during Covid time. So I want to mention — Netflix is “Unorthodox,” a story of a young girl with the civic groups in Brooklyn, it’s just — I just really love the story about the lead characters, just terrifically well portrayed.
“Guilty Pleasure” “The Jinx, the Life and Death of David Durst (sic)” just the one who loves to study human behavior, what motivates people just a fascinating character study and I’m not giving anything away but the last kind of 20, 30 seconds of the series is just priceless, just wait for it, it’s really good.
RITHOLTZ: “The Jinx.” Okay.
KARR: I love documentaries. “American Factory” I will mention which won the Oscar, story of a Chinese billionaire open factory, an abandoned GM factory in Ohio, pretty thought-provoking. “13th” a documentary by Ava DuVernay, I think, you know, really zeroing in on the history of racial inequity in the US and specific on the nation’s prison system, I think, you know, in our times and what’s been going on in this country is a real message there.
And then from podcast, present company included or excluded Barry, I enjoy Shane Parrish and “The Knowledge Project” quite a bit.
RITHOLTZ: Yes, that’s a great pod, I’m a fan.
Tell us about some of your early mentors, who helped guide your career and bring you to where you are today?
KARR: So I have to start with my grandfather, he is really my hero, he just — the value of hard work and generosity and talked about growing up under his wing and a lot of who I am today is cultivated by him.
I will also mention two other individuals, there’s a program called Sponsors For Educational Opportunity which focuses on first-generation low-income kids of color and gets them to Wall Street. And so when I was 19, when I was in college, I got an opportunity to work at DLJ, Donaldson, Lufkin and Jenrette, and it was because of program Sponsors for Educational Opportunity.
And one individual there is a Gentleman named Stephen Streeter (ph) who ran their venture capital group called Sprout. And at the time, SEO was just starting to build out with kids outside of the Ivy League and Stephen came to Chicago and he met me and not only did he get me into the program, but he said, you know, I want you to work at my firm at DLJ.
And just — he was just a great mentor to me then, a big believer in me, when I would question myself, just a phenomenal individual, he’s s an adjunct Professor at Columbia and not just me but so many people he has influenced, he has been a phenomenal inspiration for me.
RITHOLTZ: Quite interesting. Let’s talk about everybody’s favorite question, books, what are you reading now or tell us about some of your favorites?
KARR: So one thing I’ll mention before going specifically to books just on the question of mentors. In this (inaudible) something that I believe that maybe a lot of other people don’t is that I feel like I have a lot of mentors who are individuals that I’ve never met. What I mean by that is books, like books have always been mentors to me, I think you can read about somebody and really come to understand them and actually never have met them. And you understand how they think and you — when you understand how they think, you can ask yourself in the same way that you will go see a mentor and say – you know I’m having a challenge with this or how would you think about this, but just ask yourself what would they say?
And oftentimes you can answer the question for yourself. And so there’s been so many individuals that I consider mentors who I have never met but have been cultivated through books. And so I said this is in the universe of potential mentors I think so much bigger than a lot of people acknowledge I want to get credit to.
Now to the concept of books, the actual physical book that I have probably gifted more than any other is “The Art of Learning” by Josh Waitzkin, he — Josh is a chess prodigy, he is the character for “Searching for Bobby Fischer” and the thing that really strikes me and I love about it just Josh is all about pursuing excellence and he has done it in chess, and push hand and foiling, which is he obsesses on the craft and process of becoming world-class at something.
And I personally really geek out on process and trying to just push and be on your craft and Josh articulates that, he is so thoughtful in how you think about that and break it down and just many, many lessons in there.
The other book I would mention that I really enjoy, I read this summer on the Maria Konnikova, “The Biggest Bluff, How I Learned to Pay Attention and Master Myself.”
So Maria is very interesting, true story, she got her PhD in behavioral psychology at Columbia studying under Walter Mischel, famous for the Marshmallow Test, and she never played poker before and the book is about her learning to play poker and actually doing it quite well and there is the aspect of playing the cards, the probabilities, which I think is a lot like investing, it is just playing the probabilities and then it’s playing the players playing the cards which is also like investing, the behavioral side.
And there’s just a lot of takeaways in her book which just focus on poker but for me around investing and managing yourself and the power of paying attention.
RITHOLTZ: Quite intriguing. What sort of advice would you give to a recent college grad who was interested in a career in finance as a portfolio manager or an analyst?
KARR: There is a book I read a couple years ago called “Excellent Sheep: The Miseducation of American Elite” by William Deresiewicz, a professor at Yale, and what he really draws on as you just glide a little bit of the title is like as a professor at Yale, seeing these incredible young people, the brightest minds, but they just fit on this treadmill, that perfect test scores and great grades and just on this treadmill of continuing to in air quotes “demonstrate excellence” but maybe lost a little bit in terms of how to think creatively and critically and the real purpose behind what they’re doing.
And in a way that resonates with me in terms of what you’re seeing in young people, just phenomenal people but haven’t had a ton of adversity and really thinking deeply about what it is they want to do and why they want to do it and less about the treadmill and the brand and that external affirmation but for what they want to do.
And so my advice to a young person would be around that and specifically if they’re looking to go to investment management, would be pretty similar to the same thing that I would say to somebody you know, in college or high school, and say, don’t go for what you want to go for is the best professor, it doesn’t matter what the name of the course is, but you know, find an exceptional professor, there’s magic in that.
And the same thing when thinking about you know, taking your first step is find a phenomenal individual that you connect with and work for them, it doesn’t matter what the brand is, everybody’s drawn to the best brand or what they think is most coveted but find a phenomenal individual, forget about the brand and all the accoutrements around it, work for that individual and I think what you will take away from that will be so much deeper than just going for that external validation.
RITHOLTZ: Good advice. And our final question, what you know about the world of investing today you wish you knew 25, 30 years ago when you were first ramping up?
KARR: So you know,, I started my investment career in the private side doing distressed turnaround investing, and when I started my public market investing career, I was all about that, you know, hard assets, downside cash flow and I think what I learned over time and you have seen this evolution in other investors is really the importance of human capital and culture and people.
And I think the phenomenal companies that really compound over time have something about their human capital and their culture that is unique, distinctive, enduring, not always but enduring and allows them to compound it in a way that is much more meaningful than buying that cigar butt.
And so what I wish I would’ve focused on earlier was that element rather than just looking for the 50 cent cigar butts.
RITHOLTZ: Quite interesting.
Thanks, Adam, for being so generous with your time. We have been speaking with Adam Karr, he is the head of Orbis US and portfolio manager at the $37 billion Orbis Investment International Firm.
If you enjoy this conversation, well, be sure and check out any of our previous 390 or so such interviews that we’ve had over the past — is it six years? Oh my goodness, that’s a long time.
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I’m Barry Ritholtz, you’ve been listening to business on Bloomberg Radio.