My interview with Harvest and its community
I am very happy to be a part of the Harvest investment community and a Verified Professional here.
Thank you to all the Harvest members who submitted questions.
I hope you enjoy the interview and full transcript below. Please contact me on 646 535 8629 or toby@eyquem.net if you'd like to discuss the strategy, or any other aspect of the conversation.
-Tobias
Professional investors, funds and allocators contact
Khai@hvst.com
to be part of our Harvest Interview Series
T
Harvest Interview Series: Deep Value Investor
TOBIAS
CARLISLE
Founder & Managing Director
Eyquem Investment Management LLC
{ INTERVIEW BY KHAI NGUYEN }
Tobias Carlisle is the founder and managing director
of Eyquem Investment Management LLC, and serves
as portfolio manager of the Eyquem Fund LP and the
separately managed accounts.
He is best known as the author of the well regarded
website Greenbackd, the book Deep Value: Why
Activists Investors and Other Contrarians Battle for
Control of Losing Corporations (2014, Wiley
Finance), and Quantitative Value: A Practitioner’s
Guide to Automating Intelligent Investment and
Eliminating Behavioral Errors (2012, Wiley Finance).
He has extensive experience in investment
management, business valuation, public company
corporate governance, and corporate law.
Prior to founding Eyquem in 2010, Tobias was an
analyst at an activist hedge fund, general counsel of a
company listed on the Australian Stock Exchange,
and a corporate advisory lawyer. As a lawyer
specializing in mergers and acquisitions he has
advised on transactions across a variety of industries
in the United States, the United Kingdom, China,
Australia, Singapore, Bermuda, Papua New Guinea,
New Zealand, and Guam. He is a graduate of the
University of Queensland in Australia with degrees in
Law (2001) and Business (Management) (1999).
Khai Nguyen:
Tobias, welcome and thank you for joining us.
Tobias Carlisle
: Khai, thank you very much.
KN: You started Eyquem Investment Management in 2011, a
fund rooted in deep value investing. Why did you decide to
launch your own fund and why deep value?
TC
: I started Eyquem in Australia basically sitting at the desk
that I had sat at previously at an activist hedge fund. The initial
version of it was an Australian legal structure and it operated for
20 months until the end of 2011. I then moved to the U.S.
because I had met my wife in San Francisco while working as an
attorney. I decided to set up in California and the reason for
setting up was to work for myself and establish my own track
record so it's been operating continuously since then.
My background was in corporate advisory law and in mergers and
acquisitions. This was at a time when the market was right for
that sort of transaction work and capital raising was also kind of
bread and butter stuff. There were some more unusual things
that occurred like activists harassing companies and I’d never
encountered that before. I didn’t really know what it was before I
started working as a lawyer but I had read Security Analysis and
The Intelligent Investor when I was in college and law school. I
would see these guys approaching these companies trying to
extract some value and it was difficult to understand what value
proposition they could see in the companies because they were all
struggling and not particularly attractive looking businesses. I
went back to Security Analysis and reread the chapters on
liquidation value investing and net-nets. I then realized that what
PRO
Professional investors, funds and allocators contact
Khai@hvst.com
to be part of our Harvest Interview Series
All value investing strategies will
underperform for periods of
time. In order to beat the market
you have to be prepared to
depart from it.
they were trying to do was more of a balance sheet approach and
I just found it fascinating. The research that I did showed that the
returns to it were very good possibly because it's such an unusual
style of investment. Through a lot of work and given the
opportunity to employ legal skills and the transaction work that I
had done, it just seemed like a better fit for me than the franchise
style investing that a lot of other value investors try to employ.
KN: What’s been the most difficult part of being a deep value
investor?
TC:
All value investing strategies will underperform for periods
of time. In order to beat the market you have to be prepared to
depart from it. I like to think of it as counting cards at the
Blackjack table and trying to bet heavily when the odds are in
your favor. Even when the odds are in your favor there's no
guarantee that you'll outperform. So you can bet heavily when the
odds are in your favor and still underperform.
KN: In the value investing world you’re best known as the
author of the popular website Greenbackd.com. What is the
story behind the blog?
TC:
I started Greenbackd in late 2008 because I had been
fascinated by net-net, liquidation value investing, and activism
for a very long time. There really hadn't been a large number of
them around. I used to read a blog called Cheap Stocks written by
Jon Heller and he had this 7 or 8 year track record of picking
these net-net stocks that generated extraordinary performance.
When the market got very cheap in late 2008 it seemed like a
good opportunity to start writing about them because they were
out in number. I was buying them personally and I thought it was
an interesting idea that you don't see a lot of at that stage. I
started writing it because I wanted a very long term public track
record of picking these sort of positions like Jon had achieved
with his site. Blogging and writing is an excellent way to hold
yourself accountable for decisions that you make. If you write it
down and you revisit it 12 months later, you can actually see your
reasoning and learn where you made your mistakes. I think for
me that was really the beginning of a rapid evolution as an
investor.
KN: How does running a well-regarded value investing blog
play into your investment process?
TC:
In its initial incarnation it was just stock picks as regularly as
I can put them out. As it's evolved it's become more focused on
strategy. Where it was initially wholly focused on net-nets, I
realized that there needed to be some sort of evolution to deal
with markets where net-nets weren't available. I had some
research that I had kept from when I was a legal research clerk
way back in the early 2000s in the dot-com bust that talked about
all these small companies that were struggling to find attention.
That research contained this metric called the enterprise multiple
which a journalist described as the "acquirer's multiple". He
called it that to make it understandable so I always thought of it
as the acquirer's multiple. It works in a very similar way to the
net current asset value rule in that it looks for a cash rich balance
sheet. It penalizes companies for holding debt, having large
minority interests and preferred stock that need to be funded,
and underfunded pensions and off balance sheet liabilities. It
rewards them for having cash on the balance and strong
operating earnings. It's the same metric that activists, private
equity firms and leveraged buyout firms use to target companies.
It has this dual effect where it finds these very undervalued
companies and allows you to also look at the same opportunities
that are targeted by these other firms. Those firms create
catalysts and I think that's part of the reason that the returns to it
have been so strong.
KN: You’ve been on the record as saying: “A wonderful
company will earn a market rate of return if the stock price
fairly reflects its intrinsic value. You don’t get paid for picking
winners; you get paid for identifying mispricings.” How then,
do you find mispriced opportunities?
TC:
That's a good question. I use the acquirer's multiple
exclusively to screen for them. It's a truth that is sometimes
ignored by investors—even value investors. There's a fairly well
known behavioral error where you like a product or admire a
company and you have good feelings about the stock so you buy
the stock on that basis, regardless of its valuation. That leads to
underperformance. The opposite of that approach would be to
find things that are obscenely undervalued on a simple metric
and then to buy a basket of them. This is something that anybody
can do really. You find in that basket that it's filled with stocks
you really don't want to buy. Right now it might be filled with
iron ore miners, gold miners, or energy companies. It's whatever
is the most frightening industry or sector at the time. It forces
you to buy these out of favor, frightening industries and that's
where you find the mispricings. It's the shunned, the feared, the
disgusting because you look silly when you buy them and you
look particularly silly if they go down afterwards. That often
happens even among value investors. If all those things line up
then there's a good chance that what you're finding is mispriced.
Professional investors, funds and allocators contact
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Buffett and Munger have both said
that they'd rather have a lumpy 15%
than a smooth 12%. I think that's
why they’ve also said that you
shouldn't be in the market if you
can't stand a 50% drawdown
KN: While we’re on the subject of opportunities. Can you go over
two companies that you’ve identified as undervalued and
qualify as deep value stocks?
TC:
I have two in my Harvest portfolio. The first one that has
really underperformed is AGCO Corporation (AGCO). It makes
agriculture equipment, heavy machinery, and stuff like tractors
and combine harvesters. It's been beaten up. In 2013 it got into
the mid $60s and now it’s in the mid $40s. On an acquirer's
multiple basis it's trading a little bit north of 7 which ordinarily I
would say is fairly expensive. But in this market there's just not a
great deal around so it's relatively inexpensive compared to other
things that are around. It’s got a market capitalization of a little
bit over $4 billion and it's carrying a little bit of debt but it’s got
very strong operating earnings of around $1 billion. Its gross
profits on total assets, which is another ratio I look at in deep
value, runs around 30%. It's probably worth 50% more than
where it's trading at the moment. It pays a little dividend and it's
in competition with Deer, Caterpillar and companies like that.
The thing that makes it most interesting is that it has a holding in
an Indian company that's not being accounted for in that
acquirer's multiple.
The other position in my Harvest portfolio is Argan (AGX). It's
one I've held for a while. It's in my portfolios currently. It traded
as high as $40 earlier this year but it’s off to the low $30s now.
On an acquirer's multiple basis it's currently a little over 2 so it's
very cheap. But it's a smaller company with a market
capitalization of only about $500 million. It's a power
construction and engineering type business. It does a number of
things like telecommunications infrastructure services and
project management, largely to telecommunications and electric
utilities. It's the sort of business that should be a little bit cyclical.
It's so cheap that even if the earnings and operating earnings do
come off a bit there's a possibility of a 50% plus return from here.
Those are the two positions that I favor, AGCO and AGX. They're
both in my Harvest screen and they're both off from where I
picked them up.
KN: In your experience what characteristics or attributes are
advantageous for a value investor to have?
TC:
You need to be willing to stand apart from the crowd. I think
a naturally contrarian instinct is a good one. It's a double-edged
sword. My wife would say that I'm contrarian about everything all
the time. So that might not seem like a good attribute but in an
investment sense it is. It's not being contrarian for the sake of
being contrarian. Seth Klarman describes it as a contrarian with a
calculator attached. You need to be willing to ignore popular
stocks and look at things that are very unpopular. You need to
run the analysis to see if they are in fact cheap and then act on it,
which often the most difficult part. To buy them and to hold them
in size and if it goes down be prepared to buy more and if it goes
to zero to be prepared to look silly. Those are the things that are
rare qualities and probably the most important.
KN: And with that, I want to open it up and ask you questions
submitted by the Harvest investment community.
Which individual served as your biggest influence as an investor
and why?
TC:
It's got to be Benjamin Graham because his writings are so
lucid. Anytime I thought that I found something original I've
gone back to Security Analysis or The Intelligent Investor and
found that Graham got there first. In the process writing Deep
Value, my most recent book, I had an opportunity to go through
that to see if I could find some pertinent quotes or ideas that he
had. In the course of looking at the Magic Formula and Buffett's
investment methodology, I went back and looked at some of the
things Graham had said and he'd already said that it's incredibly
difficult to separate out the performance of a business due to the
underlying business conditions to the industry and the quality of
the management. This is one thing that I had always struggled
with. How do you examine a management and determine
whether they're good or bad simply on the performance of the
business? Buffett himself has said that good jockeys will go well
on good horses but they'll struggle on broken down nags. So how
do you know that you've got a good manager when they might
just be the benefit of a particular good business condition? So for
me it's Benjamin Graham but I got to Graham through Buffett so
Buffett's had a huge influence too.
KN: There have been several discussions on Harvest lately from
funds talking about diversification is de-worsefication. Is there
an ideal number of stocks to have in a value portfolio?
TC:
I'm currently working on a new book that will be released in
late 2016 or early 2017 that looks precisely at that question and
right now I'm deep in the theory of it. Munger would say that any
more than 3 stocks is a crazy merry-go-round, but Greenblatt
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might say that the ideal number is somewhere between 20 and
30. I'm a little bit in the Greenblatt camp. I think the theory
depends a bit on you as an investor. If you're a Kelly betting type
investor and you can identify those opportunities that are
substantially better than the others then you're well paid to
investor more heavily in those positions. I think that Kelly, in
isolation, will make you over bet. Kelly betting in a value
investing format means you're going to have a number of positive
expectation bets so you can't just bet like you're at a Blackjack
table where you can put 40% of your stake into a single very good
position. You have to put them over a number of other positive
expectation bets. That Kelly betting investor can go very well but
you also have to remember that there's a lot of randomness in any
given position. A very good undervalued position can still go
down a great deal and other positions that are less good can
outperform. So diversification can capture to your own benefit
some of that randomness. If you tested it empirically, I think the
number falls out to somewhere between 20 and 30 positions. 30
might be too many for the average investor but I think 20 is fairly
manageable. That might be 2 positions a month or if you're
holding for longer periods of time that could be a single position a
month which should be manageable.
KN: As a value investor, how do you decide what allocation of
the portfolio to keep in cash? Cash as dry powder for
with the market. So that means that in 2007-2009, if you're in
the cheapest acquirer's multiple decile, you were down along with
the market which was 60% in the 20 months or so from July
2007 through March 2009. The good news is that by June 6,
2009, which is a little under 3 months from the bottom, you
would have recaptured everything that you'd lost and made
enormous gains thereafter. Buffett and Munger have both said
that they'd rather have a lumpy 15% than a smooth 12%. I think
that's why they’ve also said that you shouldn't be in the market if
you can't stand a 50% drawdown. What they’re saying is that if
you're fully invested you're going to have a lot of volatility and big
drawdowns like that. You can lessen those drawdowns by
carrying cash but it hurts returns. Of course, if you can't find a
position to invest in then it makes sense to hold cash instead but I
don't think you should set a fixed proportion of the portfolio to
hold in cash waiting for some better opportunity.
KN: Given your style of investing, as well as stylistic biases,
what is the ideal size for your strategy across investment
vehicles? At what point would you feel concerned about your
ability to execute on the strategy?
TC:
It's a question I've examined and discussed with a lot of
other people. It depends on how the strategy is executed. If your
strategy is to hold all the positions for a year like in a Magic
Formula type sense, and rebalance once a year, I think that at the
moment the capacity is somewhere between $500 to $1 billion.
Some people are surprised that the number's so low. Even
limiting yourself to the S&P 500 universe there's much less
liquidity there than most people realize. Having said that, there
are a number of different ways that the strategy can be
implemented so it could be just investing a small part every week
so that you're averaged over the entire year. That is a much larger
number. It could be as much as $10 billion. The other possibility
is that you're looking for individual positions to move in and out
of a model and that number will depend on the size of the
positions. Again, that's somewhere between $1 and $2.5 billion. I
think they're extraordinarily large sums to generate good returns
that reliably exceeds the return on the market.
KN: Which market environments are most challenging for a
value investor?
TC:
Very expensive markets that are continuing to strike ahead.
The current market is incredibly challenging because there are
few positions that pass my absolute screens and staying out of the
market means that you're underperforming by a wide margin.
One of the ways of implementing this strategy is to remain fully
invested in the cheapest relative portion of the market and that
strategy performed very well in 2013. It doubled the return on the
market and this year it's pacing the return on the market still. If
you're implementing it like a traditional value investment
strategy where you're looking for the absolute positions and there
are very few that meet the absolute screens then it's always going
That research contained this
metric called the enterprise
multiple which a journalist
described as the "acquirer's
multiple". It works in a very
similar way to the net current
asset value rule in that it looks for
a cash rich balance sheet.
TC:
That's another question I've tested empirically. Market
timing is impossible to do. What you're saying when you're
holding cash is that you're waiting for a time where you're going
to be able to find another position that you can put into the
portfolio. Every single backtest that I have done has shown that
simply being fully invested all the time leads to the best
outperformance and it leads to the best risk-adjusted
outperformance. So I don't advocate carrying cash in a portfolio
but you have to realize that the corollary to doing that is huge
volatility in your performance. You'll be in a 2000-2002 type
scenario or a 2007-2009 type scenario where you draw down
Professional investors, funds and allocators contact
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to be this type of market—very expensive and still moving up.
That means the opposite kind of market is best for deep value
guys where the markets are crashing, cheap and continuing to
fall. It's ideal because you can get set in lots of great positions.
KN: Have you ever had to override your approach because of
changing security or market dynamics?
TC:
No, I'm very careful not to do that because that's a key error
that a lot of investors make. There's good research out there that
says that experts underperform their statistical prediction models
and rules. They continue to underperform when they're given the
benefit of the statistical prediction rule. What that means is that
when you cherry pick from your model you invariably pick things
that will underperform the model and you miss the things that
outperform. The reason is that things that outperform are often
the most frightening looking securities. This is known in
literature as the “Broken Leg” problem. Suppose you have an
algorithm that predicts whether John will attend the theatre on
Friday. If we know that he has a broken leg, so the argument
goes, surely we should be able to override the model to account
for it. The answer is no and the reason is that we identify more
broken legs than there really are. There is going be an error rate
in the model but the model's error rate is known and likely better
than the error rate flowing from your own ad hoc decision
making. So I'm very careful to follow the stock screen religiously.
KN: What are your thoughts on the concept of a “value trap”?
How long will you hold onto a non-performing position?
TC:
I have some unconventional thoughts on value traps.
Investors think that they can identify these things prospectively
but I don't think you can. If you're applying a systematic process
that's based on research and statistical analysis of past positions
and it doesn't perform, it doesn't necessary mean that you've
made a mistake or that you've invested in a value trap. Any
decision that you're making has to be repeatable over lots of other
positions. Some positions work and some don't. It's very difficult
to identify beyond what you've put into the screen what makes
those positions perform and what doesn't. I do think that you
need a good buy and sell rule. My rule for selling is if it's a fixed
period of time after I've bought it, no less than 12 months, and I
find that it's no longer in my model then I sell it and I don't worry
about it at all.
KN: I read your blog post last year on value investing in Japan's
bear market. Do you still see the same opportunities and what is
your outlook on the country given its recent economic setback?
TC:
That's a really good question. Japan is one of those great
tests of this type of investing. It has worked. Since the 1990s
when the Japanese market was trading at 100 times cyclically
adjusted earnings, the U.S. traded at 44 times cyclically adjusted
earnings in 2000 to put that in comparison. So Japan was more
than twice as expensive as the U.S. It's basically fallen since 1990.
If you'd invested in very simple value strategies in Japan like
buying the cheapest 10% of the market based on price to sales,
price to book or price to earnings, it returned something like 20%
a year which is phenomenal. On top of that the currency was
generally strengthening against the U.S. dollar over that time so
you had a slight tailwind in addition to that 20% return. That
research was done by a Japanese university. The currency has
been a tailwind to U.S. investors although that's not been the case
more recently. The question is what happens if Japan goes into
this so called Keynesian end times where they're printing so
much money the government can't fund its own debt and they
enter into hyperinflation or high inflation? I think if that happens
then those business will certainly be hurt but you'd be better
served as an investor holding a business than you would be
simply holding the currency. Potentially the stock market could
perform very well under those conditions. Whether you'll do as
well in dollar denominated terms is yet to be determined. It's a
very interesting opportunity. I still think Japan's very cheap. If I
run my global models I could buy almost 100% of the stocks
globally that are cheapest are in Japan so I have some limits. I
limit my portfolios to 40% Japan simply because I don't know
what's going to happen there but I still think that's a very big
allocation to Japan. So that's a very good question. I don't really
know the answer but it'll be interesting to see.
Tobias Carlisle
2800 Neilson Way, Suite 1411
Santa Monica, CA 90405
(646) 535 8629
info@eyquem.net
If you are a professional investor, fund, or alloca
-
tor and would like to be part of our Harvest Inter
-
view Series, contact
Khai@hvst.com
You need to be willing to
stand apart from the crowd. I
think a naturally contrarian
instinct is a good one. It's a
double-edged sword.
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