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Terry Smith은 자산운용에서 좋은 기업의 조건으로 높은 투하자본이익률(ROIC), 성장 원천, 경쟁 방어막(해자)을 꼽고, 재무제표 숫자와 '왜 이 사업이 좋은가'를 함께 봐야 한다고 강조한다. 무형자산의 중요성 증가와 장기 관점, 단기 소음 무시를 조언한다. 특정 자산에 대한 단기 가격 예측은 없다.
다듬은 글
Our guest today is known as the English Warren Buffett due to his style and success in investing . His 1992 book Accounting for Growth and the controversy surrounding it helped him reach the top of the bestseller list, knocking Steven Hawking's A Brief History of Time out of the top spot . I asked if a book with accounting in the title had ever been a bestseller.
he was a head of research, a CEO of a public company, a former top bank analyst who doesn't want to own a bank in his fund, and a respected, successful founder and chief investment officer of global equity fund manager Fundsmith. So Terry Smith, welcome to the Money Maze Simon podcast today , thank you.
Looking back, Tery, you graduated in history from University College, Cardiff in 1974, and finance was different, more boring, in the 1970s. Some might say that's all the better. What attracted you to it? I actually graduated with honors in history and my professor Stanley Crimes, SB Crimes called me in one of those classic meetings that were held in his office in those days over a glass of Sherry one afternoon and told me that he thought I quote, I would do very well in my final exams.
So I said, "Well, you should know, Professor. After all, you're going to be grading them." There was a lot of room for joking, and he said, "I think you will." Because he was about to retire and he said, I think you'll be my last honors student, which was nice. And he said, I'd like to offer you a position, because basically, to do a doctorate, you know, take a research fellowship or something like that, which was at that school, and I think you could have a career in teaching history, in research, in writing about history.
And I said, well, that's very flattering. Can I ask how much it costs? And he on that, please? I asked Ra, how much do you get paid? He said, "Well, I don't really know. I'll have to find out why." And I said, "Well, I don't really have any money." He says, "Oh." Anyway, when I finally found out how much it paid and decided to go into banking, which I did, instead, he admitted in a very, let 's say light-hearted but fatherly way that I had turned down a career as a historian because of, quote, vulgar commercial considerations.
Well, that's not possible. That answered the question of why I had chosen this path and not that. Nothing beats academia. So I want to fast forward a few years , because before long you became the highest-ranking banking analyst in London, and I'm curious to know what you were doing at that time that got you to that top position.
I think I was literally the only banking analyst ever working in a bank at that time. The other banking analysts were people who had gone into stockbroking and they did various things in brokerage firms, whether in sales or elsewhere, and they were selected from a group for analysis. They could become analysts for the mining industry, or for retail chains, or for banking.
I was the first of a generation, I remember a few who followed me, who left banking and became banking analysts. I was the very first. So when we had, for example, what was then called the LDC crisis , uh, the LDC crisis in the 1980s, when we had a big problem, basically with the bankruptcy of South America, because developing countries were not able to pay their debts, and it hit the banks very hard.
And I knew that if you look at the numbers in Taleb's Black Swan, he says that the banking sector at that time had wiped out all the profits that it had ever made in history because of the losses. So it was quite serious, and it affected the banks significantly. They had to do a massive rights issue to recapitalize themselves.
I could do things, let's say, because there wasn't that much transparency back then. Accounting wasn't nearly as it is today. I was able to find ways to allow us brokers and our clients, the investors, to get very good estimates of the bank's exposures at the time. For example, I knew that we had applied to issue bonds in the United States, that we had to meet the disclosure requirements, and they were much stricter than the British regime for public companies and all these limited liability companies.
And so you could go and look at those bond records and see what the concentration of risk was. So I was able to do those things because I worked in a bank. I worked in the finance department of the bank for about half of my time. So I kind of knew, I had a pretty good idea of how it all worked. So in 1990 you're the head of corporate research at Philips and Drew.
As I mentioned, in the late 1980s I was a client of Philips and Drew and in 1992 you're publishing a book called Accounting for Growth, about I spoke to and you were fired after a heated argument with UBS. And there was irony in that title, of course. And you wrote and I'll quote you because we're going to come to this.
Well, whatever rules you put in place, smart people will find a way to paint a distorted or embellished picture of their performance. And I think we can only conclude that this trend has worsened. But how did you come to be so focused on this? Yes, it was basically a combination of factors. I joined UBS in 1990 as head of research because they were in trouble and the trouble was that they were involved in a deal for Blue Arrow, which was run by Tony Berry.
I think he had controlled Tottenham Hotspur for a while and they had bought Manpower in America and they had done a big convertible bond issue with Nat West as co-manager to finance that. So remember, we were in 1990 or when it actually started. It was a £750 million issue. That's still quite a lot today.
It was huge at the time and it was a complete flop because it was bought by a shell company. A complete flop. But instead of admitting that it was a flop and that they were left with most of the issue, they hid it in the books of the market makers, which were not subject to disclosure and pretended.
They even paid for full-page advertisements in the newspapers about how successful it was. And of course, when it came out that they had lied outright about it, a number of things happened. One was that four members of the senior management, including the head of research, were arrested. And then the next thing was that the institutions, which were rightly outraged by this action , went on strike and, so to speak, stopped trading with them.
So I got a call from a headhunter. Please don't laugh at this point, because I'm very sensitive, who said he wanted to hire you as head of research. And I said, okay, because I wanted to move up and to do other things in your career and not be a bank analyst forever. And he said, they want you to regain the moral high ground for them.
They think you have a reputation with the institutions as an honest person and that you're going to come in and help them with that. And as I always tell people, to explain the incident, the accounting, the overgrowth and the aftermath, I think I regained that moral high ground a notch or two higher than they wanted, you know.
So I came in during that, that was the background to my coming in, and then when I came in, there was a recession. Obviously, we had just had Iraq invade Kuwait and the price of oil had gone up very significantly. And as a result of that, we had a recession here, so we had a war in the Middle East, a big increase in prices, oil, and a recession, and a couple of companies, big companies that were in the TC index or had just been in the TC index, went bankrupt and went bankrupt right after they reported record profits, which is quite interesting.
In one case it was Polypec, in another it was British and Commonwealth. And I was quite interested in my late father-in-law, who was a school principal and so on. An intelligent man, certainly, but not a man who had anything to do with finance. But I remember him talking to me about it because he had such a general interest in it and he knew what I did for a living.
So he would talk to me about these things and say, "That's not possible, how can you go bankrupt after reporting record profits." And I said, "Well, you only go bankrupt when you don't have enough cash, but profits and cash aren't the same thing ." I said, well, no, they're not. And I gradually got the impression that first of all, it was necessary to do a bit of education, if you will.
And secondly, that companies with capital were clearly playing a very dangerous game. However, basically the losses went to the balance sheet and all income to the profit and loss statement. And those two things were so different in what they were telling you. And so I sat down and wrote this book, and I thought it would be useful to do this regaining of the moral high ground that UBS claimed to want.
But like I said, I think I may have overestimated the desire a little bit afterwards, but I suppose the seeds of your later investment philosophy were sown in that incident. Yes, it was. Hey, I was probably born that way given what I did as a banking analyst. But as you say during this episode more specifically and then again a little later when I came to Collins Stewart and then a little later when I got to Collin Stewart, I started to feel that the numbers are basically the most important thing you can get from companies and that, you know, an awful lot of people are focused on the talk, you know, the story that they're telling us, how they're presenting it.
So I said, well, we shouldn't look at the numbers. Why? Because that's not why we have accounting. I think I read somewhere that that's why we have accounting. And so I started to focus on that as something that should be, it's not always, but it should be the primary source of information. That's interesting because obviously there was a bit of a shift in your skills because you went to Colin Steart as a management buyout and ended up as a CEO of a public company and I wonder what other skills you had to acquire as a CEO of a company.
Being an analyst and being a CEO are actually quite different things, in my opinion. And clearly, you know, the point of analysis is to be able to find out what's going on within companies, whether they're creating or destroying value, and to try to assess their own thinking and then communicate that effectively to investors.
So that's basically what you do. When you get into companies, you have to deal with other things, like people, which is quite interesting. So you really have, you know, you have somewhere between hundreds and thousands of people depending on which business I run. And it becomes a bit like boxing, but with six-bars on your hands, because you essentially have to delegate and accept that there are other people doing things and you have to learn to let them do it to some extent, provided they operate within the framework that you want them to.
So you know, I don't think that very many people have ever made this transition, that it's not obvious or easy in my opinion. I'll tell you a short story if you can bear with it for a moment. I once had a client in the Bahamas who was a research manager for Templeton. His name was Michael Holovesco.
I flew to Lifeford K and presented my analyses and such to him. He always seemed cool to me, but he was a bit of a grumpy guy to deal with. And then he left Templeton and started his own business called Holovesco. They sponsored a cycling team. Maybe they still do it today, for all I know. But the next time I visited him in Holoveso, everything went wrong.
We were in the Bahamas and the power went out. He said, "Don't worry about it, come to my house, plug in your computer there. My son will show you how to connect." And it was very nice to have a cup of coffee and I said to him, "Don't be mad at me for saying this, but you seem a lot more relaxed than you did before." he said yes, when I was at Templeton I wanted to analyze things and make investment decisions, but in the end I had to deal with clogged toilets.
I don't want to do this. The reality of being a CEO or manager versus an analyst is that you are often dealing with clogged toilets. Yes, I never got high enough to have this opportunity. I actually literally had to deal with toilet issues. That's why I used that example. When I was doing research at Colin Stewart CFR, cash flow and return on investment became the main pillar of what you did.
This brings us to Funmith, which we will be talking about. In short, founded in 2010, you achieved an annual return of about 16%, which are very impressive numbers. you manage, correct me if I'm wrong, approximately $40 billion on behalf of families, foundations and banks. Just fill me in on the details.
Number of people, number of offices. 59 people, three offices. One in London, one in Connecticut, one in Mauritius. We keep the numbers low, intentionally. Later, we may touch on military history, as you mentioned, and I always remember Colonel David Stirling's saying about small groups of like-minded individuals.
And so we do it, and also because we think there are few things we can have an edge over. We believe and hope that we have the upper hand in money management and we believe that we can have a little bit of a lead over others in the way we communicate and deal with clients. But that's about all . As for the call center, I don't think we have any advantage in running it.
So once it goes outside of these core competencies, so to speak, we're very happy to try to find other people to do it for us. I understand. So let's start with what your goal was when you founded Fundmith and whether it has changed in any way. The goal was to run the best fund there was. And you might say, that's a bit of an immodest statement, and it is.
But I'm a big believer that if you don't set a high goal, you know, if you don't aim for the moon, I don't see a way you're going to hit the roof of the house. So that's basically what we were trying to do . And we felt it needed to be done in a way that was different from the vast majority in the industry.
Because if we looked at most of the industry, we tried to use the late Sir John Templeton's adage, which is, "If you want a different result, you have to do something different." You won't achieve a better result by copying what others are doing. There is a quote by Henry Ford. Success does not come through imitation.
However, I think it's true. So we decided we wanted to do things differently than the rest of the industry was doing. We wanted to do things differently in how we invest, in the concentration of our investments, in the way we communicate directly and clearly with clients, but to do it all differently and create the best fund as a result.
Define the best fund, the one with the best long-term risk-adjusted return. Not the best yield. It may or may not be the best yield. The fact is that someone can achieve a better return. But look at the risks they take and you'll think, wow, that 's interesting. Our goal was to deliver the best long-term risk-adjusted return .
You clearly stated that the only way to succeed in investing is to stand out from the crowd. For those who don't know Smith, if you go to your site, which I did, and read your messages, listen to the comments, I have to say it's absolutely clear and accessible. Completely clear and accessible. And you have something called an owner's manual, which is very helpful since I recently needed to fix a tire.
I was in the garage and looked at the owner's manual. It's a German car. The correct tire pressure was difficult to find. It was on the inside door pillar next to the driver. The owner's manual is great. And you're starting to talk about the things we want to address right now. And that a quality business is one that can maintain a high return on invested capital.
A lot of people talk about buying great companies, which is such a simple slogan in this industry. Let's take a closer look at what defines a good company through your lens. Yes. Okay. What defines a good company? It's a company that has three or four things. High return on invested capital, which is often overlooked.
Buffett said in his 1979 annual letter that it is the most important measure of a company's performance. It has been almost overlooked since then. Look at a survey of companies to see how many of them report return on capital. Isn't that still the main measure? Why? Because it's kind of in everything else we look at.
If you invest in my fund, you are interested in the yield, but you just mentioned yields. You are investing in your bank account, you are interested in the interest rate. What is yield? You buy some bonds, you want to know what the yield is, the return. Why ignore it when it comes to businesses? Because ultimately what we do when we invest is we buy a portion of their capital.
We want to know what the return on it is . And if the return is too low, it won't create any value for us over time . You know, whatever the cost of capital is. And as a broker, I was taught well that if you don't know the answer to a question, it's 10%. So let's assume it's 10%, which is probably pretty close to 10% by the way, and I'm kidding, but I think it's pretty close to 10%.
So if a company can't earn 10%, it takes capital at a cost of 10% and earns nothing. Whereas, if you can earn 30%, which is the average of the companies in our portfolio, roughly speaking over time, it is clear that it borrows money from the market at 10% and earns 30%. It creates great value. So that's the first point.
Point one must achieve a high return on capital. Point two must have a source of growth. It's no good having a great return if you have nothing to invest in. I think the most under appreciated and little discussed aspect of stocks is that they have a unique characteristic that no other asset you can invest in has.
They can appreciate in a compounded way, like if your company has a return on capital of 30%, or in this case, 20%, and you retain about half of that capital, which is what companies do on average. They have a dividend that is covered twice on average and can reinvest the half they keep with a profit every year at 20 or 30%.
it will be valued in a compound way much more effectively than you could with any other method. Whereas, if you own the building you are in today, or I own this building, we will receive rent. Yes, from renting to people, but the rent is not reinvested in the building, right? You might say, well, I could go do it myself.
Well, you could, but there are quite high transaction costs involved and you may not necessarily get the same return as on the original investment. If you add bonds, well, look, I don't know if you have an investment in US Treasuries, you get a 4% or 5% return, but they just send you a check, they don't send you any more bonds.
And if rates go down, that's a pretty big problem for you , because when you withdraw money, you have reinvestment risk. they have to have a source of growth in which they can invest the time of those fantastic returns and it's usually a combination of the consumerization of the developing world, where people consume more than the rich, and the premiumization of the developed world, those of us who don't drink more, but drink better quality alcohol or whatever.
secular trends like aging and healthcare and so on and so forth. So they have to have a source of growth and then they have to have a means of fending off competition. what Buffet calls a moat, essentially a protection around your castle. I do n't particularly like that term, but I couldn't think of a better one , so we'll stick with his expression.
If you have a company that has a 30% return on capital and is able to grow at 8% per year, let's take a company like coloplast or something like that, where your investment has that, capitalism should mean that others will want to take it from you . Others should look at it and say, oh, I want to do that too.
And so you should find that new players are coming into your industry or that your competitors are investing more capital to try to get your market share or that private equity is getting involved to try to fund things like that and so on and so forth. So there has to be a way to protect those revenues and that usually comes down to brands, strong brands, control of distribution, an installed base of devices or software that gives you a stable market.
Sometimes patents in patented developments, such as drugs and the like. So those are the things I look for in companies. While I'm a person who says numbers are paramount, it's not enough to just find someone with high returns and growth. You have to be able to ask yourself and at least think you can answer this question.
Why is this business so good? Given the nature of capitalism, we would expect people to move from high returns to average returns over time. So why is Coca-Cola able to sustain itself for over 100 years and still have high returns? What gives her this ability? And you have to be able to answer this question not only does it have good numbers, but why does it have good numbers?
Why were they able to persevere? One of the things that changed over our careers was the growth of intangible assets as business became less asset-intensive. And I just want to understand how you've had to, you know, adjust your thinking, as the old price-to- book ratio is perhaps a less relevant metric in today's world.
Yes, I mean you have to adapt to that because one of the things we're starting to realize is that the most valuable assets are the intangible assets, and the things that are hard to imitate are things like brands, distribution, network effects, patents and so on. Whereas physical assets, things like factories and offices and ships and vehicles and equipment, if you have enough money, you can go and replicate most of these things.
And honestly, it's a little easier because usually these people we call banks will lend you money if you have physical assets because I think they think it's safer to lend versus oh, I have this asset. So the thing with intangible assets is that they are harder to create because you can't borrow money for them as easily.
If you go to the bank and say, I want to buy this building and the rental yield is this much and I'll put in this much equity, eventually you'll agree on some numbers. If you come in there and say, I have this idea, I'm going to create this brand, they'll say, "Well, let us know when you do it." So you need real equity for that .
And that's one of the things that makes intangible assets very valuable is that they're hard to replicate with borrowed money. It is also very difficult to get around them. the intangible, which means we are more likely to drink Coke or Pepsi, that as a doctor I am more likely to use Beckton Dickinson needles and and I am more likely to use the Striker Mao surgical robot in a pediatric procedure.
These are things that are very difficult to replicate, and many of them are companies that you own in your fund. But one of the, I suppose, dilemmas we've all had as investors is that a great company doesn't always equal a great investment. So can we talk a little bit about how you, you know, try to solve this equation?
Yes, what I mean by that is that the obvious fact is that a good company may not become a good investment for several reasons. The most obvious is the price. You know, my God, it's terribly overpriced. However, this is essentially a matter of time and patience. There's a great quote from Charlie Munger where he says, over the long term, the return you get from a stock will equal the return the company gets on its capital.
And he has a great point about it. No matter what price you pay and the company has very low returns, it will be a bad investment in the long run no matter how cheap you buy. However, people are often confused by this. They think that high-priced means expensive and low-priced means cheap. Well, inevitably.
You know, the funny thing is, if you go buy a car for a Ferrari, they ask more than for a Ford. It's just a fact. And the same applies here. Then you find shocking results throughout history if you look back at how much you could have paid for very high-quality companies and still achieved an above-average return.
We got data going back to 1973 and looked at the full range of companies in terms of what PE you could pay and still beat the index by about 1%, which of course most people can't do. And the answer was something like , for L'Oreal you could pay 278 times earnings, for Pepsi 100 times. We humans are very bad at determining what premium we might pay for things .
The problem with paying 278 times, besides being very scary, is that there will probably come a time in that 50 year period when you will lose money because of it. We've been through one in the last 18 months, where interest rates are rising and those inside are suffering. And the problem with turning a quality business into an investment is that you shouldn't ignore valuation, but you certainly shouldn't let it dominate your thinking, because you wouldn't have what is more of a Charlie Manger approach.
The problem is the emotional stress you can experience with it . That is truly the biggest enemy of investment performance is ourselves. In this regard, we are our own worst enemies. Of course, another reason why a great company sometimes fails to become a great investment is management failure. So the reality of investing is that if you invest with us at Funmith, you have contractually entrusted us with a portion of your assets, your capital, to manage.
Thank you. We then contractually entrust this to the management of the companies when we buy their shares and hope that each year that company with its great returns will take a portion of those returns, in most cases about half, and reinvest them to achieve great returns on that extra portion of incremental capital.
We think that if it's a company with a 30% return, it would be great if they achieved something similar with incremental investments, which can be in business expansion, acquisitions, new product development, anything they can invest in. Occasionally you will encounter management that will do the exact opposite and destroy value.
This is why a great company sometimes doesn't become a great investment, because you evaluate it in retrospect. You need to look through the windshield to drive properly. The problem is that sometimes it's unclear, cloudy, foggy outside, and the wipers and lights don't always work well. All those things, whatever analogy you want, that's what you have to do.
It's not just about a great company looking in this direction. You have to have a reason to believe that it's a good company looking in that direction, that the manager you're talking to and who's doing the job will do sensible things, and that's not always the rule. And have you improved in assessing whether management is providing good governance?
Yes, I think so. A big part of getting back to my topic is in the numbers. If the numbers say this, then we do n't really need to discuss it that much. But telling funny stories about how good they are won't change that. But yes, we have improved and there are very simple things that, besides numbers, will tell you how people are doing.
The way they present things and talk about them often tells you a lot about this. So, I can give you two recent examples of people who completely overlooked what was happening to the detriment of business, and it was evident from the way they presented it. when PayPal was getting into trouble. And I can describe this difficulty as, during the pandemic, they were obviously doing well in online payments and they set a goal to grow from 450 million users to 750.
But after a year, they dropped it after just one year. Over the course of the year, the engagement of their 450 million users they had did not grow. So they weren't gaining new users, at least not as quickly as they expected. As a result, they didn't sell more even to existing customers. They didn't click on PayPal that much anymore.
Expenses grew much faster than revenues and as a result, performance was poor and the share price fell by, I do n't remember exactly, about 60%, 70% or something like that . And the then CEO Dan Schulman stood up at the results meeting and said, that was the background, he said he was horrified, that he was horrified by the events in Ukraine.
I thought there was enough to be horrifying. even in PayPal's own performance, and I'm not quite sure why we wanted to hear his views on Ukraine. So he has the right to his opinion on Ukraine, of course, like everyone else. But what does this have to do with PayPal? And recently we had another exactly the same case here.
The ST Lauder firm has not been doing well recently. It had three warnings of a decline in profit and a €500 million write-down of inventories. Because they misjudged the Chinese market after the borders opened. The CEO said during the presentation of the results that he was very horrified by the events in the Middle East.
When I was running companies or when I am running companies, I always tell people, sometimes it was quite difficult, even when I focused on the right things. You know, it's not like you flip a green switch and all those important things you're supposed to be focusing on get fixed. But if you don't even focus on the right things, how it's supposed to work, and we literally find that if people are talking nonsense, if they're dropping whole sentences that we don't understand what they mean, that's not a good sign that they're really able to tell you what's going on.
So there are a lot of things like that in this regard. So the most obvious one is if they invest outside their core competence. Most of us are not poly historians. Few of us will be like Leonardo da Vinci, for example. However, we may be good at one or two things, and companies are the same way. They may be good in snacks and drinks, but they will also be really good in drinks, which is the case with Pepsio, for example.
By the way, the answer is no. They won't be very good at it. They can be very good at, you know, in the case of, if you take Google or Alphabet, they've clearly had tremendous success with online search and advertising. Why do we think they will be good at autonomous cars? Why should they get a return on their investment there ?
After all, even Ford and Volkswagen are running away from it as a project and running away from it as a project. And once they start to deviate from their main strength, you usually feel that you have a problem. As I was thinking about our conversation today, I was going through some of your older work, and one of those that was very prescient and not without controversy at the time was OSku.
And of course under Terry Lighiy's leadership, you write that RE's return on invested capital fell from 19 to 10. And you say that the market ignored the fact that more capital was being spent to generate these profits . I think they took on a lot of debt back then. Tell us briefly why there were warning signs flashing around Tesco when the Market was, frankly, deeply in love with it.
If you go back to Buffett's 1979 quote in the annual letter that I mentioned, he says that the main test of management performance is return on capital, not earnings per share growth. And the market is completely fascinated by earnings per share. And it goes back to something you mentioned right at the beginning of this interview.
And whatever you establish as the way of looking at things, people will find a way around it. So once you have management that realizes that all people care about is earnings per share growth, guess what they deliver. They will deliver exactly that profit growth, at the expense of capital. People are often confused by this.
How is that even possible? Think about it this way. You have 100 in your bank account and you get five percent interest on it. Okay? And then you deposit another 100 into your account and get 10% interest. Well, that's great. It doesn't sound particularly good to me, but even worse. This is closer to the Tesko example.
You have 100 in your account , you get five. Then you put another 100 in there and get a total of 7.5. That sounds pretty bad to me because it means the other 100 were earning 2.5. And that was exactly Tesco, that major strong British chain, which produced 18 or 19%. She was still there . But those other investments like Fresh and Easy in California and Texas actually produced negative returns, but of course earnings per share grew.
People were completely blown away by it. Oh, yes, the earnings per share are amazing and then of course suddenly they aren't . And the whole thing collapsed and basically never really recovered from it. Will Baron, so I have to ask you, since you've been successful with banks, is this something you don't invest in?
One could argue that there is a concentration of power at UBS. They got CS at an extremely low price and so on. Is this an insurmountable limit? Will you never own a bank? Look, I would never say never. There is never a very long time in business, so one has to be a little careful. There are many good reasons not to own banks including, I would say, UBS regardless of that cheap CS deal.
And by the way, it has nothing to do with my past, with them. That's ancient history and I don't think anyone, anyone, who was involved in that. I have been in contact with people involved, both on the other side of the dispute, in recent years or some major upheaval. I mean, the reality is, it was liberating for me because I became an entrepreneur after that, so I didn't feel any great animosity, and I hope they don't either.
But you know, even the Credit Swis purchase is kind of in style, you're sure it's a really good thing for UBS , because the whole point of Credit Swiz is that it was problematic, you know, and um and unless they're really going to eliminate the problematic part, I don't see the point in it. They are about to leave investment banking.
which does not work. Well, yes. And so there are many reasons not to own banks. They need leverage to achieve a reasonable return, which is always a warning sign, dangerous. they are subject to regulation that significantly impacts their ability to achieve this, their revenues. The regulator's attitude towards every banking crisis is more, more, more capital regulation, which puts them at a disadvantage in this regard and subjects them to systemic risk.
You can run a bank, you can run your bank perfectly, but what someone else does in the bank next door can cause a run on deposits. And the result is, boom. You know, the Silicon Valley Bank case clearly led to a chain reaction in other American regional banks, which may not have done anything outright wrong in their business , but the level of unrest caused by the attack on Silicon Valley Bank caused a lot of it.
It 's not impossible that they will never be a bank again. I wouldn't go that far. Some would object. We have returned to the past we knew with higher costs of capital and more realistic monetary policy, but there are consequences when we see how businesses respond to these higher rates. And I think the question that caught my attention when I was talking to Chris Dale, who runs Kindberry Capital, which is a European long short fund, I'm an investor in him.
We talked about the decline in standards in the field of exploration. We are in an era where technology has never been more accessible at our fingertips. And yet , as I listened to him, it seemed ironic that no one wanted to dig into the notes to the financial statements. I want to tell you what's going on.
If you go back to the topic of accounting for growth, part of the consequences of accounting for growth, and I don't want to put too much emphasis on this, but I knew David Twidy quite well, and it was the accounting standards board that was improving things. The standard of accounting has undoubtedly improved in the years since accounting for growth.
Not because of me, but because it was necessary. and other people like Sir David Tweedy have done a good deal of work to improve it. The problem was that no one read the accounts anymore , but as you say, people did n't bother to dig into it. We were going through IBM's accounting when we opened the funds in 2010 and we never invested in them.
Fortunately, I have to say, but as we went through it, I can give other examples. We found an error of $1.8 billion in cash flows. We called IBM's investor relations department and they said, hello, you don't know us, we're fund managers who just started. We look at your business and we are on the side of whatever your statements were and we have this problem here.
We don't have cash flow and they don't care, that 's normal, we'll get back to you. And then they called us a day later and said, you're absolutely right, it's bad. We said, "Well, that's pretty interesting. Has anyone else noticed that?" And they said no, they definitely didn't call us and ask, and it was one of those things, such a big mistake that you think to yourself, I'm probably crazy, I'd better call the company and ask them about it.
And I can give you as many examples as you can eh process and listen to where it's clear that others are n't reading it because what they're reading now eh is a leadership presentation. Oh, those nice slides they publish, which since I've run a few public companies, I can tell you a few things about.
Secrets and tricks from practice. You always try to show the strange in the best light. And when you look at those numbers that are there, where it says, you know, Ebitda achieved this and there's usually an asterisk next to them that you can find there and it says adjusted at the bottom. The strange thing is that the things it regulates are all bad things.
You know things like, um, litigation, restructuring costs, acquisition costs, and acquisition write-offs. Oh, okay. So if we leave that out, it all looks much better. I suppose. People do n't really bother to read the reports, which are probably pretty good now. Again. You asked me before what to look for and warning signs in companies and the like when companies publish results, not their report, but the presentations themselves and so on.
If the edit pages are larger than the reports themselves, you clearly have a problem. And you get to a point where a strange thing happens. People will start believing their own stories. Management will start making decisions based on those adjusted numbers. they convinced everyone, finally convinced themselves, that this was the right thing to do.
So there are things like this happening out there that I think are quite harmful. I mean, another thing I would criticize the analytics community for is outlook. When I was an analyst, there was no such thing as an outlook . My job was to try to predict what would happen. I had to say what would happen to Barkle's profits, to the revenues and everything else.
And now they're getting views directly from companies, and they believe it. And of course in many cases it is correct to believe this. Sometimes companies don't have a fortune teller. So the company we're following is called Adien, a Dutch payment processing company, if you're not familiar with it, it's had a pretty bad time this year.
The stock price fell by half because it essentially failed to meet its outlook. It grew by, I don't know, 30%. It 's not like it's headed for disaster, but it's gone from 30% growth to 20% or something like that. The problem with the stock price, of course, was that the analytical community had knocked it down based on that outlook.
And then a few days ago, she suddenly gained a third of her weight. It literally rose by a third in one day because they released an outlook for next year, which was higher. I said to myself, haven't we been here before ? So it would be fair to say that you have all the skills that would potentially make you a good short seller, but you have only used them to avoid the dips in your long portfolio.
But in this higher rate environment, don't you sometimes find yourself thinking, oh, of course, not in our main fund because that's a fund focused only on long positions, but it's tempting. Yes, I worked with some of the best and most well-known short sellers in the world that you've heard of during my time as an analyst.
And you know, it's a skill that I really admire and so on, but it's a whole different methodology of investing. You know, the risk-reward ratio is completely different. That 's one thing. However, it is the diametric opposite of what we do, as you are surely aware. But you know, there's limited downside risk.
It cannot be more than 100%. and unlimited downside risk. Stock prices can go up, you know, indefinitely. It 's also very active. You know, if I sell something short today and it drops to zero tomorrow, I need a new sale. So, even if it doesn't go down to zero, if it just works significantly, it happens that the more successful it is, the less significant it becomes for my portfolio.
It's very active. It must also be active in terms of risk management. I remember having a client when I was still a broker who I gave a quick tip about online directories. It was called the people, the yellow pages. Yes. And she sold it short from about nine pounds to 90 pence and remade it. And she said, "You know, it kept happening that there were takeovers because it's such a strange thing.
And my main broker kept calling me and saying, 'This is a margin call.'" You either have to close it or send me more money." So I closed it. Then the stock crashed again. It's quite, it 's not as easy as it sounds. No, absolutely. And I've tried it a little bit in my career and I can attest to that.
The other thing that you don't do, I think it's a conscience thing, but I just want to understand if it ever seeps into your investment process and that's thinking about macro. We think about macro, but it doesn't really have much or any impact on the investment process. Ultimately, we invest in companies.
Whenever people talk about macro, I quote a quote from when I was a broker and Mercury Asset Management, which became Mary Lynch and so on, had this triumphant cadre that ran it. Stephen Zimmerman, Carol Gall and Leonard Licht had a trading room there, and I was told that in those days, the trading data was a big thing.
The whole market would shut down on the third Thursday of the month or the second Tuesday of the month to get the data on trade for the past month. I don't remember what day it was. The market stopped around 11:30 until we got the trade data and then people started trading. They might still have some data.
People say it doesn't matter anymore. I'm not convinced. But anyway, that's how it used to be, and this young man who had just started working and was told, you know, to be on his toes. And that was back when everybody didn't have Bloomberg or Reuters or anything like that, he saw those things flash somewhere and he immediately got up from his desk and yelled, "Bad trade data." And Leonard Licht is said to have yelled back, "Sell mine for me.
Great, Sin, but what do I do with it?" So we end up investing in companies and look, while we think about macro, you know, we absorb a huge amount of information from companies over time . This and that affects us. For example, when we talk about inflation, which is the topic of the day now, so to speak, or about recession, which will probably be the topic of tomorrow, I assume, because it could be.
However, we always say that it's interesting how people follow statistics like CPI and look at GDP and the like. How about looking at some company statistics? What I mean is that payment processes can tell you a lot about the economy. What do VISA and Mastercard do? What are they telling you about what's happening?
Are payment processes growing or declining? How much do they grow? Do people use debit or credit cards? Because he often tells you this, it tells you a lot about when I remember when one of the many controversies about the extent of immigration was being addressed in Britain in recent years. Not whether it should be allowed or what, but just how many there were.
If you recall, the government was talking about tens of thousands. It turned out to be hundreds of thousands. Someone did a good survey that looked at footfall data at food retail stores, i.e. Tesco, Sainsburys, AZDa, Lidl, Aldi, Morrison and so on. So what was the traffic there and what was the number of active SIM cards in mobile phones.
They looked at it and said, the population is growing by half a million a year. And it was true. There is a lot of good data from companies that can inform you about macros that we think is often ignored, and we are actually quite interested in it. But it doesn't actually determine investment decisions.
I don't sit there thinking I know what's going to happen in the macroeconomics and that I'm going to do this or that based on that, because first of all, I don't know what's going to happen and second of all, that's not why I'm investing in it. I understand you. Tell me about Fmith, where would you like to see this company in five years?
He 'll probably do exactly the same thing as anything else now. Hopefully, it will deliver good risk-adjusted performance for our investors. I don't care if it gets bigger, doesn't get bigger, or gets a little smaller. So I don't have any specific goal that I want it to be this much or that much money.
It's perfectly fine the way it is. The further, the more. And I have to be careful. Because someone says, "I'm about to retire," I have no desire to retire, nor do I plan to, but you never know. I want to continue what we started, which is to involve people in the company and in the ownership of the company so that it has a long-term future.
So when I'm no longer here or I'm not able to be here or whatever, to have other people sitting here doing the work after me and taking over, I think that's how I would like it to progress. That's basically it . We currently have no idea about a new fund. If we have an idea for a new fund, we'll try it with our own money first, before bothering anyone else and so on, but we don't have one and we may never have one.
I don't know, you know, it doesn't really matter. We are fine the way we are. Yes. Well, you were, as we mentioned, part of a very unusual group that outperformed the world indices. I think the data speaks to about 90% of active global equity funds, especially in the US, underperforming their benchmarks.
Worldwide it's 98%, which is really a lot. 98% of global equity funds have underperformed the index since we opened over the past decade, and something is wrong. So let's stop there, because we all know what happened to passive investing and that extrapolation can be lazy. What do you think we will see in a higher rate environment where the Magnificent Seven perhaps has some of the characteristics of the Niftyfty?
Yes, I think passive investing is a really good choice for most people. Since 98 or 90% is lagging, this is obviously a very good option. Achieving better results in the long term is not easy. Finding something that outperforms the market is not easy. So it is a very good choice for people. But I think if we have rates that stay where they are or somewhere around that level for an extended period of time, then I'm not worried about our investment methodology at all.
It clearly suffers in periods of rising rates because markets are not perfect. So I can provide as much evidence about this as anyone wants. They're not completely imperfect, are they? They are somewhere in between and it changes a little from time to time. But it does mean that if we own quality companies, and that's the thing I would stake my reputation on, that we have quality companies, they will be worth a little bit more on average .
On average, however, not always, not all the time. I hope that from time to time I will find a Microsoft or a Novo Nordisk or a Domino's Pizza where the market has overlooked them, but I won't find them every day, or even every year, but on average they will be slightly more highly valued, which means that when rates rise, they will perform slightly worse than lower-valued stocks.
Value will have its moment in the spotlight. It has to be that way. If alternative strategies never had their moment, everyone would be doing them and it would be over. So it will definitely happen. But if rates don't rise, I don't think it hurts what we do as investors. And if it stays roughly where it is, if inflation stays roughly the same and rates stay roughly the same, I think we're doing pretty well, because if inflation is 5 or 6%, it's better to have a company that's making 30% on capital than mine that's making 10.
You know? Sure. And so it doesn't bother me. And another thing that doesn't worry me too much, even though it's going to be uncomfortable, when it happens, it happens, and you can call me and ask, Tery, how are you feeling right now during the recession? I mean, I've experienced a lot of them. I started working during one in the 1970s.
I experienced one from '79 to '81. I experienced another in '92. I saw one in '00 and '01. Honestly, I'm not easily overwhelmed by anything, and I think the things we own as trustees will do relatively well during this time. So none of those things you described in terms of the ongoing high rate environment bother me.
The only thing that I think will happen, what we're already seeing and I think we'll continue to see , is if we assume that rates stay where they are, where the United States government itself will give you 5%. That's quite tempting for many people. So I don't think we will see big flows into the equity sector.
I think if that happens, we'll see more of a continued outflow from the equity sector because people will think they can have 5% risk-free, so they'll go for it. Well, they're probably making a mistake. In the long run, you will earn about 9% on stocks over time as a passive investor. Over very long periods of time, it can be measured and it is quite consistent.
But of course you can't guarantee that you'll get it this year, so a lot of people say, I'd rather have that 5% and wait until I'm sure. Of course, if they wait until they're sure, they've missed it. But the fact remains that if rates stay where they are, then first of all, passive investing is better than active for most people, to sum it up.
Secondly, if rates stay where they are, I'm not concerned from the perspective of us as an active manager and the type of company we own. I'm not worried about a recession given the type of companies we own, but competition from bonds will remain strong for most investors under these circumstances because I think most people are more worried about losing money than making it.
And so they say, look, Tery, you're absolutely right. You have all those statistics. You seem to be proving that passively investing in stocks will earn me 9% over time. I'd rather have 5% than lose 9. Can you guarantee that I won't lose 9% this year? No, I can't. That's great. And that's a great place to end it.
I have a few general questions. We started by talking about your passion for military history, which I happen to share. Like I said, I'll show her. Tomorrow. A great book by General Peter Eus and Andrew Roberts about the changing conflict is coming out. That's my current reading. This is the second volume of Sugden's biography of Nelson, which I am currently reading.
This is the other one known as the Sword of Albion. How interesting. Well I eh read that you did important work to get eh a New Zealand gentleman named Keith Park, later Sir Keit Park, recognized for his work during the Battle of Britain. Tell us why you did it. Why did I do that? It was, again, it was actually a combination of things.
My father was a scoundrel, so I probably had a slight emotional attachment to it. I was an enthusiastic pilot myself. I flew gliders, then airplanes and helicopters. I was wondering how right you are to point it out. I'm very interested in military history, and then I read a book by Steven Bangya, who has written some very good works on military history and is a very unusual military historian in that he is not a trained historian.
In fact, he ran the Ashbridge Management Center. I think he worked in the insurance industry at a high management level at one time, but he wrote exceptionally well, in my opinion . I considered his book. The Most Dangerous Enemy for the definitive work on the Battle of Britain. But as I read it, it basically points out that Park was the only man that Dauding trusted to execute his strategy and that he was the only man who could lose the entire battle in a single day.
and yet he demonstrated great judgment and character in executing that strategy despite all the temptations to do other things and having his decisions scrutinized by people who simulated his decisions over time and it was essentially impossible. No one has been able to significantly improve his actual deployment decisions.
And then finally he said two things that really got to me. he said he was like a magician in Arthurian legend. He literally travelled halfway around the world because he was a New Zealander to defend a country that was not his own. And then, when he was done, he just disappeared. A very humble personality.
And he ended up with no monument to him anywhere in the world . Except for one alley in Bigin Hill near the old fighter base. In K, it's called Kapelle Ferne, there is no memorial anywhere else. Anyway, when I finally managed to get his memorial installed at Water Place right next to Pal Mal, I invited Bangajo to dinner because he was very supportive of the campaign.
I think he inspired me to finally get going on it. I told him I wanted a reprint. Well, friends who are still in the military tell me that the new movie coming out next year, Lords of the Skies, which is about the American Bomber Command during World War II, is going to be absolutely brilliant. So two final questions.
We ask our guests after the book, if you could give us just one thing as advice for listeners, what would it be? Don't keep looking at things. Okay. Think carefully about what you actually want to do. And when you do, go do something else for a while. I always tell investors because they call me and ask what this, what that I say.
You should only look at the fund once a year, only one day a year when you look at it, because all the noise is happening in between. Regarding the quarterly stock price reports, in our daily notes that we write within the company, we pointed out that after all the commotion that year, the index is the same as it was six months ago.
So ignore the noise. Try to ignore the noise. I think it's very important. And we have a good group of young people here at universities. We are sponsoring eight now on the Money Ma podcast. These are financial and business associations, young people thinking about finances and investing. Any advice?
Get some education. Lucy Kellawe, who wrote for the Financial Times about work, wrote a very good column some time ago when she was still working there, saying that the internet age has done a disservice to many young people because they come in thinking they're going to start a business and they don't have the skills to do it.
So even if they could be successful over time, they will write themselves off. And what they should do is find a job and get trained, which is what I did in banking. I went into banking after rejecting history for purely commercial reasons. And every time someone showed up and asked, would you like to take a law course?
Yes. Service. Yes. Everything. Absorb knowledge. And while you're doing all this, try doing one more thing. Try to find a mentor. Try to find a mentor. Someone who knows how it works and is willing to put in the time and effort to share it with you. usually and this has happened to me in my career as well in the form of an exchange and that exchange usually consists of you ultimately doing their work for them and they take all the credit, which is fine.
It's what people would call an apprenticeship. Who was your mentor? A guy named John Spencer, who was the head of crowdfunding at Barklist when I started there and really loved Yachting and ended up going to sea for six weeks in the summer and let me run the crowdfunding department. I always tell the story that in those days, as I say, I was an angry young man.
I mean, I'm an angry old man. I, uh, almost every other day, had an opinion about something that we were doing wrong. You know, the bond issue in America. We're doing it wrong. We shouldn't do it like this. We should do it like this. I've always said, you know, non-compliance by commitment, we do it.
I would always barge into his office and tell him we were doing something wrong. And he had a methodology that worked in those days. He said come back at 5pm at the end of work hours. Let's talk about it. And he had a bar cabinet. He had a bar cabinet, so he pulled a bottle of something out of the bar and poured it for me.
And when I woke up the next morning, I was dizzy and couldn't remember what was bothering me so much. It worked, it worked like a dream. Until one day. I don't know how, but I somehow built up an immunity to drinking with him or something. Um, I finally showed up the next day and brought up the same topic and he was sitting there saying, "Tery, you seem confused." And I said, what am I confused about?
He said, you work for me, not the other way around. We are still in contact and continue to work together to this day. It was, uh, it was in 1979, I think. Oh yes, wonderful. Well, look, I have to mention our mutual friend Tyrel Young, who was with me at Morgan Stanley. He really wanted to make sure we had this conversation .
So thank you. Tyrel Tyrel was with me at UBS of course? Of course he was. Yes, yes, yes. Three conclusions back then. The first is that when you look at companies, remember that return on invested capital is absolutely at the top of the list. Number two. As an investor, ask yourself why this business is so good.
And number three, that intangible assets are actually much harder to create than we might think. And so their rarity and their appeal within the valuation you apply to them simply makes them different and more valuable than previous investing generations might have thought. Right? I think so. I think that's a good summary.
Okay. It was a pleasure to meet you after years of reading and hearing about you .
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