Transcript: Dennis Lynch
The transcript from this week’s, MiB: Dennis Lynch, Counterpoint Global, is below.
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This is Masters in Business with Barry Ritholtz on Bloomberg Radio.
BARRY RITHOLTZ, HOST, MASTERS IN BUSINESS: This week on the podcast, I have an extra special guest. You may not know his name but you probably should given the stellar track record he’s managed to put together over the past 20 or so years.
Dennis Lynch is Head of Counterpoint Global that is sort of a group, a firm within a firm at Morgan Stanley Investment Management. They run a ton of money about $130 billion and their track record, especially this year, has been pretty banoodles.
The growth fund is up 85 percent, discovery is up about 100 percent. There was performers advantage, it’s only up 50 percent. They run very interesting concentrated portfolios. Their entire approach is somewhat unique.
They’re not like very many people. Maybe Will Danoff or Bill Miller run a similar style of investment management. To give you an idea of how outside of the box this group thinks, they recently, by recently a year ago, they hired Michael Mauboussin to be the head of their research just for the group. Mike has been on the show a couple of times and I just love the way he thinks. And any group that brings someone like him in, obviously, is not your traditional Wall Street stock picking fund managers.
I found this conversation to be absolutely fascinating. If you’re at all interested in how to build a portfolio, how to select stocks bottom up, why the buckets we use and phrases like small cap or value or growth can be so constraining and really harmful to performance, I believe you’re going to find this conversation to be absolutely fascinating.
So, with no further ado, my conversation with Counterpoint Global at Morgan Stanley’s Dennis Lynch.
VOICEOVER: This is Masters in Business with Barry Ritholtz on Bloomberg Radio.
RITHOLTZ: My special guest this week is Dennis Lynch. He is the Head of Counterpoint Global at Morgan Stanley Investing Management running about $44 billion. He has five separate funds his group is responsible for, Advantage, Growth, Insight, Discovery and Inception. The largest of which is about $15 billion and year-to-date is up about 85 percent. Dennis Lynch, welcome to Bloomberg.
DENNIS LYNCH, HEAD, COUNTERPOINT GLOBAL, MORGAN STANLEY INVESTING MANAGEMENT: Barry, thanks for having me.
RITHOLTZ: So, let’s talk a little bit about Counterpoint Global. Everybody knows the name Morgan Stanley but not everybody knows the name Counterpoint Global. What is the thinking behind a company within a company?
LYNCH: I’ve been at Morgan Stanley, I think, over 20 years and ever since I have it within the investment management, they’ve followed the philosophy of trying to make sure they have a diverse group of thinkers and small decision-making teams and I think that’s a really healthy environment for trying to do the hard — one of the hardest things out there which is beat the market.
So, it’s been a great environment for that and in that context, we’ve been able to build Counterpoint Global, our group, over the course, really in a strong manner, over the last 16 years with the great resources we also get from Morgan Stanley generally. So, I think it’s been a good combination of a good — big term philosophy from Morgan Stanley and then allowing Counterpoint Global and the key members of the team to be very entrepreneurial in that context.
RITHOLTZ: So, not to read too much into what you’re saying but you’re giving me the impression that this is a model within Morgan Stanley and there are number of small entrepreneurial teams within investment management, is that right?
LYNCH: Yes. That’s been the model and I think it’s really heathy. I think there’s been some good research that shows that strong decision-making, particularly in the investment committee side of things, tends to occur when you’re dealing with small groups of — and teams as opposed to kind of large bureaucracy.
RITHOLTZ: So, I count five different funds that Counterpoint Global is running, Advantage, Growth, Insight, Discovery and Inception. Are these all run as a group or are there different managers for each? How do you guys structure this amongst yourselves?
LYNCH: So, believe it or not, actually, Counterpoint Global in its totality is about 19 products globally, which include the portfolio management team in New York that I had as well as the portfolio management team in Asia, which my partner and co-CIO, Kristian Heugh, runs.
And so, in total, we have 19 products, currently 130 billion in assets and we probably own about 200 companies though globally. So, despite the fact that sounds like a large number of products, we’re very concentrated in each product and we’re very picky about what we invest in.
So, it is a pretty small group of companies when you think globally. We basically — we run — we have two lead managers in two different locations and the portfolios are kind of informed by the insights of the entire team and we go through the process kind of at the end of the process to figure out what you go where based on how big a company is, where it’s domiciled, et cetera.
RITHOLTZ: On other words, you identify a company you want to own and then figure out afterwards which fund, which product is the right fit for it?
RITHOLTZ: That’s very different than the typical mutual fund.
LYNCH: Yes. And I think it’s a big different. When I think about Counterpoint Global and how we’re different, it is one of our big differences. The people on our team aren’t what we call investors. They show up or wake up each day looking for the best ideas in their areas of expertise but they’re not trying to find the best large-cap growth healthcare companies.
So, if you’re Jason Young, a world-class health investor on the team, that’s not how you’re approaching your time spent your day to da. You’re looking for great ideas within healthcare. And it just so happens, given though we have U.S. products, international, global products and ones that focus on the market caps on different parts of the overall product set, we have a home for your idea. And so, I think it is one of the things that differentiate the team.
RITHOLTZ: So, you went from being an analyst to being a portfolio manager. How challenging is it should go from analyzing a business to building an investment portfolio? What was that transition like?
LYNCH: Well, I think there are a lot of different personalities out there and I think it really depends on the person. Actually, one thing we try to do from time to time every few years is do personality assessments for people on the team just to promote a little bit of self-awareness. So, it’s good to get another view kind of how your hardwired especially in times like this where we’re having extreme volatility.
It’s kind of nice to remember that sometimes you’re hardwired to react to certain way under duress and maybe that self-awareness helps you make more high-quality decisions. But I guess in our case or in my case, I’ve always — while I love details and certainly can be very detail oriented at times, I also love learning about a lot of things.
I went to liberal arts college and so, I have — I really do enjoy the extra perspective of learning about a lot of different industries and sectors. So, going from an expert or analyst in one area to being an investor more broadly I think kind of fit my personality specifically.
But what we try to do on the team is attract really unique people and then based on their personalities and their passion sort of enable them to do what they do well. And so, we’ve got all sorts of different types of people doing — playing different roles. And in my case, I think, given my love for learning about a lot of things, the transition probably made more sense and was easier than for someone else.
RITHOLTZ: So, I have read a lot about personality testing.
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RITHOLTZ: And there seems to be two groups of thoughts on it. One is there’s a lot of down and dirty kind of oversimplified tests and they’re of no value whatsoever and there’s another group of thinking that says, hey, if you ask the right questions and you really dive deep enough, you can find things out about how people think, how they behave and what type they fall into.
So, I’m going to assume you guys aren’t doing anything down and dirty, you’re really doing a serious dive into that sort of profiling of various researchers and managers in the group.
LYNCH: We are but here’s the thing about anything like this personality test, this sort of topic and we have got a great diversity of thinking on the team here. Some people think it isn’t very useful and some people find it extraordinarily useful.
I look at it as a low-cost way of getting the team together in one place and spending time as a larger unit where we can hopefully bond and share a day where we’re where — sometimes we were making fun of each other for our differences. But I think that — so, worst case from my vantage point, it helps the team culture.
But we have some people think this is very useful and some people think it’s useful and I get both sides of that. I actually used to think it was useless earlier in my life and as I start to explore, I found there to be some utility.
So, it really depends on the person. It’s why we do it every few years. The worst case, it’s like — it’s a cultural bonding thing and best case maybe people gain (inaudible) self-awareness.
RITHOLTZ: Quite interesting. I find myself about halfway in the process that you already went through going from pooing it to, all right, maybe it’s worth exploring and who knows what will come out of it.
LYNCH: I was very disappointed when I initially took the Myers-Briggs a long time ago to find that I wasn’t so unique after all. It was a lot more accurate than I expected it to be. So, that’s worked on me kind of moving in that direction.
RITHOLTZ: Reminds me of my favorite scene in Monty Python’s “Life of Brian” where all individuals, everybody chants together, we’re all different. It’s pretty hilarious.
LYNCH: It’s awesome.
RITHOLTZ: So, let’s talk a little bit about growth investing in 2020. Obviously, the stay-at-home trade has been enormously profitable. One of your biggest funds has — is up almost a hundred percent year to date.
Some of these stay-at-home names like Shopify and Zoom and Twilio, were these in your portfolio pre-COVID or did you guys recognize, hey, this is going to be a long working remote scenario and we want to load up on the names that would benefit from that?
LYNCH: These — for the very most part, these are all holding going into 2020 and they — usually, our performance to any given period of time is more function of this is what we made a year or several years prior than it is kind of the moment — sort of the in-the-moment reaction to what’s happening and, obviously, 2020 being an exceptional time.
So, we did all these stocks that you’re mentioning prior to 2020. That was actually the transition we made maybe a few years back. If you look maybe eight or 10 years ago, you might have seen in our portfolio the large stakes and companies like Amazon and Apple and Google and Facebook.
And a few years back, we’re looking at the opportunity set and I think all good investing opportunity set driven, we thought there were some really interesting young companies in some of the areas that have benefited more recently not just from COVID from secular growth.
And so, what I would say is we added things like some software as service and e-commerce companies two to three years ago, all of which fortunately benefited this year. And what I’d say there is I think many of these companies offer time and cost efficiencies to their customers or their clients.
And in a time of general — generally, in a the time of crisis, you’re going to see a more likelihood of faster adaption or people sort of looking more at the world from a blank sheet of paper standpoint and more likely to do things that are different and change their behavior.
In addition — so, I think that’s generally true but from a luck standpoint, in addition, I think we were relatively fortunate and a tough time for everybody that some of the specific needs that a pandemic required, like delivery and staying at home and working and streaming from home, certainly were extra benefits and much more luck driven that it was, I think, and us reacting quickly to that environment or anything like that.
RITHOLTZ: So, that raises an interesting question, how much of these spectacular gains in 2020 for this group of companies is future growth being pulled forward to 2020 and how much is a permanent shift in the dynamic?
LYNCH: Well, I think there’s definitely some evidence of few things. There’s some evidence you’ve seen some of the fundamentals pulled forward for some of those companies, i.e., growth — faster growth than expected coming into this period.
But as you’re alluding to, you’ve also seen pretty dramatic outperformance of the companies in relation to the rest of the market. So, I think it’s a combination of both forward — fundamentals being pulled forward as well as potentially to a degree future returns also being pulled forward.
And so, yes, it’s not as — we still really like the portfolios today from a fundamental standpoint, but when you think about perspective returns from here, we’re not as — we’re not expecting the high returns we’ve seen over last 10, 20 years at Counterpoint Global.
But I think that’s really true of all asset classes with interest rates, where they are and especially real interest rates were possibly negative. It doesn’t — there are no — there doesn’t seem to be a whole lot of great places to find new incremental investments.
So, we’re mostly happy staying in the course but we recognize that by pulling some of those fundamentals and valuation expanding in the near term, you’re not likely to see the return profiles we’ve been able to achieve historically.
RITHOLTZ: We’re recording this the day after the big Pfizer vaccine news came out, 90 percent effectiveness in a large study and the market action was value stocks, I think, had their best day in at least five years. Tech didn’t do nearly as well. Do we think this trade is going to be changing on a permanent basis or is this just a little bit of digestion as to what everybody thought was eventually going to come, namely, some sort of vaccine, some sort of return to normalcy?
LYNCH: Yes. I think — if you’re a trader and you’re really focused on the next few months or the next few weeks or shorter time horizons, then I think you’re very interested in this kind of question and you might be looking at market activity as a barometer for whether or not there’s been a really dramatic — what has surely been a very dramatic short-term impact to that news.
Whether or not that would sustain itself, it’s very hard to predict and certainly, we don’t have a strong view as to whether that will continue or not in the very short term. I think it’s great news in general. I think the economy is going to be a lot bigger five to seven years from now, the sooner we get out of this.
And it’s hard to sustain an economy through fiscal stimulus and other means and that’s not good for anybody, including the companies that have done — the small group of companies that have done really well this year. So, I look at it as a positive development and having said that, it’s also — there’s also a lot of unknowns and uncertainty.
I think how fast we can get any sort of functional vaccine distributed and implemented, there are other things that can also still go wrong in terms of mutations of the virus, et cetera. So, this is still a time of uncertainty. Usually, when you see this sort of dramatic change in things, it just — what it does tell you is how people might have positioned in the short term that are trying to make short-term profits.
And so, obviously, this suggests that some people were — there’s — these stocks would become popular in the short term and that the people that need to protect their short-term gain or think in terms of those smaller increments of time are going to have a problem.
I think even within the last year, for example, our stocks weren’t doing — some of the stocks that done so well this year were doing terribly in relation to the market in the fourth quarter. And when we didn’t do as badly in the initial drawdown post-COVID occurring, let’s say in March-April, I think part of that had to do with some of the people that are shorter more and didn’t know (ph) our stock at that point because their relative momentum was pretty terrible at the end of last year.
So, this is not the fun part of being a long-term investor because we’re all human and you’re going to experience these kinds of times. But how we think about the decision-making and how we’re kind of making our choices, it’s more of a three to five-year thing and it requires being able to zoom out from time to time and recognize that the rest of the market is going to focus on short-term reactions sometimes more than you’d like.
RITHOLTZ: So, let’s briefly discuss that short-term reaction back in February and March. In a very short period of time, I want to say five or six weeks, the S&P 500 was down 34 percent. You’re running some pretty high beta names and a lot of volatility. How do you manage around a drawdown like that? Is it merely the cost of admission if you’re going to own some of these high-flying names?
LYNCH: Well, it’s pretty interesting, right, because as you — you used the word beta which is obviously the modern portfolio proxy for risk and one would have guessed that if you’re — you had a higher than average beta profile in your portfolio that if the market was going to have the drawdown at that earlier in the year that these stocks or those stocks would do worse and it actually wind up being the opposite which is pretty amazing.
But I think what it shows you is the limitations of quantifying risk in that way or really — we love quantifying things, right, but sometimes, it really only tells us so much and we can kind of overly — that oversimplification can lead to over confidence.
So, meanwhile, now you have the opposite happening where you have good news and these companies going in that direction at least temporarily. So, I guess how we think about drawdowns are — they are part of investing in general.
No matter what you do, you’re going to have — any successful investment over time that’s publicly traded usually has some drawdown period and we’ve lived through so many of them over the last few decades. I mean, I can remember vividly having a large position in Facebook after they’ come public and having the stock go down 60 percent at a time when I believe market was up pretty significantly and that was a very challenging time.
And the way we think about risk generally is not really beta, it’s more about company specific fundamentals and exposures and we’re trying to make sure we build a portfolio that has exposure to all parts of the economy. So, it’s not one take that.
But from time to time, on a company specific basis and even sometimes kind of short-term correlated basis with a group of companies, you can have these drawdowns and they’re painful. And I think it’s why Warren Buffett says, it’s not really about how smart you are investing, it’s more about your temperament.
These are the timeframes where you kind of learn a lot about a team and whether they can handle that and off to your clients and there has to be a nice, hopefully, symbiotic relationship whether your clients understand that that’s the part of the equation that you’re going to experience from time to time.
So, while we would love to avoid them, at the same time, I think it is a part of any successful investment in a public market that you’re going to have this kind of really dramatic swings. And the way we think about it is not really trying to figure out things like beta or whether some companies are currently correlating that that maybe don’t have real fundamental correlation long term.
We think about it more on a company specific level and making sure we believe in those companies, the people running them, the skin in the game of the people running them hopefully. There’s a lot of – often mostly in our case, a lot of equity ownership of the management teams.
And then just thinking first principles, are we betting on one big thing or not. And sometimes, everyone else thinks you’re betting on one thing but my guess is when we look back in five years, many of the companies that are being grouped in some of these artificial classifications like work from home or FAANG or the Four Horsemen, these types of things that are used from time to time to discuss markets.
If you look later on, five — three, five, 10 years later, often the outcomes are very different on a company specific level and part of our job is to be able to communicate that with our clients when we live through periods like this.
RITHOLTZ: So, last question in this area, you mentioned not everything can be quantified, ow much of the success of these portfolios of the past few years is driven by quantitative analytics and how much of it is more qualitative insights into the potential of the underlying business?
LYNCH: Definitely I’d put most of it in that second category, which is certainly so much of our time is spent on numbers in the industry when we do our research. But at the end the day, I think that this is more of an insight business and a creative business and looking at the world differently or looking at an idea differently than the rest of the world and trying to understand what that is as part of the process.
So, I think we’re much more qualitatively driven. But it doesn’t mean we’re anti-quant. I think a good investment culture is constantly thinking about alternatives and not being close minded but being open.
I do think generally the problem with quantitative or algorithmic or kind of very specific rule-of-thumb-based investing is that markets are complex adaptive systems that change over time. So, the idea that — while it’s appealing human on emotional level that there might be some secret formula that always works or works for both extended period of time, I generally think that’s a bad thought given that like the markets today are so different even than they were three to five years ago in terms of the level of passive investing or the number of hedge funds or the types of companies in the markets that comprise the markets.
So, it’s very hard to think in those terms. It doesn’t mean quantitative can’t be a useful tool in some ways maybe in helping us conduct our research. But generally, we’re set up more in the judgment business, in the qualitative assessment business. And I think that that — given the nature of markets that you have to have that as part of your DNA.
RITHOLTZ: So, Dennis, let’s talk a little bit about being an active manager and being a manager that’s running a concentrated portfolio. It’s been pretty tough for active managers the past decade. How have you been able to stand out from the move towards passive?
LYNCH: I think — if you think about the investment industry, it’s become, over time, maybe as a mature industry, very compartmentalized. And so, most people have a very specific area that they’re focused. Maybe it’s small-cap growth or international large-cap value.
So, I think to some degree, that’s a bit of a trap and people get — lose perspective in being so compartmentalized in their knowledge. So, I think one thing we’ve done, and we talked about this upfront, is as a team, we’re structured in a way that the investors spend their time looking for great ideas regardless of those — the end objective of those kinds of compartments.
And I think that that additional perspective is valuable and useful when we look at the opportunity set. It gives us a different perspective. The fact that (inaudible), who’s the world-class Internet investor, can look at small-cap companies that could disrupt large-cap companies or large-cap or non-U.S. companies that can hurt the small-cap companies I think is something that not all teams share and I think it’s a huge competitive advantage from a structural standpoint.
I think also — we look at great — I think really good investing over a long period of time is opportunity set driven and that’s how we kind of define ourselves. We don’t think in terms of the — sort of the value growth and some of the — sort of the standard nomenclature because as we said before, the markets continue to evolve, it’s a complex adaptive system.
So, the behaviors and ideas you had 20 years ago might no longer be going to — leading to success today. When I think about my own career, I went to Columbia Business School and I was — I got the chance to learn a lot about things like return on invested capital and free cash flow and yields. This was back in — early 1990s.
And when I got into the investment industry, I was surprised how little people were focused on those metrics. This is probably around the time when Joel Greenblatt wrote a book like “The Little Book That Beats the Market” about those kind of variables, ROIC and free cash flow.
And I think for quite some time, being more focused on that and sort of the earnings and P multiples were sort of an interesting way of looking at the opportunities in the market differently than other people. When I think about our experience halfway through the 20 years and having some successful companies like Amazon and Facebook before they had reported earnings, it let us to continue to be open in the idea that investing through the income statement can be a good idea.
And more recently, I think there’s a little more recognition that investing today on the corporate level is happening more from a — into things like intangible assets relative to tangible assets. And so, back in leads of things like lack of earnings but not necessarily a bad decision-making at the corporate level or something bad about the business.
So, that openness and willingness to look at the different opportunities out there also has led (ph) us more recently as some of the companies that have succeeded more recently. So, I think, overall, the team has an open mindset but also, we’re constantly trying to understand where the best ideas are there in the markets given the fact we have a global mandate. And I think it’s the perspective plus that openness that hopefully beats to environment where we can succeed.
RITHOLTZ: So, you’re echoing some of the thoughts I’ve heard from people like Will Danoff at Fidelity or Bill Miller formally of Legg Mason now with his own shop as well as Joel Greenblatt who have said, if you’re just looking at P/E ratios, you’re missing a lot of the pictures.
Is that something that has evolved over the past 20 years? Have there been a group of people who recognize that and basically profited from it while a lot of people were stuck in the old dynamic or am I overstating that?
LYNCH: Well, I definitely think to an extent that is true that if you define yourself so narrowly in any business but particularly in these businesses, low P/E investor or high P/E investor or a low price (inaudible), if you sort of identify too much of one variable and you’re not open to thinking about how the actual economic circumstances in reality might affect those variables, i.e., intangible capital being more valuable in those investments than they have been historically and more important and more necessary, then I think it’s just important not to anchor on I can’t buy something because they’re one variable.
I mean, the reality is real life is more complex than that and looking at a lot of different vantage points, I think it help you understand the situation more fully. And in this case, I think what you’re saying has some validity because sometimes people just to keep — it’s easy — we all got to get through our days and it’s a lot easier to live with rules of thumb or either you identify with the tribe or you identify with an approach and just stick to that and to kind of think — try to think beyond some of those things and explore the ideas that might be the drivers behind them.
RITHOLTZ: So, we’ve mostly been discussing the factors in decision-making behind selecting a stock. But a number of studies have discovered that the bigger challenge is identifying when to sell a stock. That seems to be where all the profits are made and it also seems to be where all the mistakes are made. How do you determine when to sell something that’s been in your portfolio either for a short time and it looks like you’re wrong for a longer time and it’s gone as far as you might think it might go?
LYNCH: Well, yes, there’s several reasons we’ll sell. I mean, the first that comes to mind is diversification. Sometimes, company, as part of the portfolio, just gets too big and we need to think about that to some degree on an — now I’m talking primarily on an individual company specific name basis that we don’t want to have too much exposure to one idea at some point no matter how strong it’s been.
Then we also might sell because we think the risk reward is no longer as compelling as other ideas that we’re looking at that would be under devaluation bucket of selling. There, I think, it’s important to — it’s important distinction like you mentioned earlier around P/Es and such.
What we’re really looking at when I said valuation is what’s the market cap today. And based on our analysis over the next five and 10 years, where can the market cap be, not necessarily a multiple because I think people sort of conflate that. When you hear the word valuation, it usually means — what it really means is a short-term multiple and, again, after simplification, it’s not really giving you a full picture of the potential of a company in my mind.
And then finally, we’ll sell because the pieces changes, right? So, we’re constantly focused on competitive — the competitive landscape that our companies are operating in and monitoring that every second of the day. And from time to time, threats will merge for our companies that are competitive and might be from a company that’s disruptive, young and most people aren’t following it or two different existing company trying to follow some sort of bumbling type of approach.
But we will closely watch how that’s changing and that might be a variable that hasn’t shown up yet in the companies’ results, but that we’re starting to anticipate that the uniqueness of the company and their competitive advantages and what we thought otherwise.
RITHOLTZ: Let’s talk a little bit about how you construct portfolios and what they look like. And one of the first questions I have to ask is you have fairly concentrated portfolios, how do you know what’s too concentrated, how do you figure out how to size various positions?
LYNCH: Sure. I will — look, I think there are only so many great ideas globally, right? And so, I think — and as I’ve mentioned, we’re opportunity set driven. So, you’re right, today, we’re fairly concentrated in relation to what you might expect generally within the mutual fund industry.
But right now or at least in the last two years, we thought there were just a unique group of companies that warranted taking a larger position and maybe slightly more concentration given our conviction in their competitive advantage and the opportunity that they have in front of them.
I also think though it’s bad to be dogmatic and that you can have another environment or an opportunity set where you want to own some more names. More names make the cut and that might affect the weightings that you are going to allocate too all the names that you currently already own or want to continue to own.
So, we generally, though, are going to be more active and different than the market by our DNA and I think a big part of our culture is our willingness to be different. You don’t want to just be a contrarian in life. I think Jeff Bezos has said that being a contrarian is usually wrong but when — but the big ideas and the big kind of gains in life occur when you are willing to be a little bit outside or away from the crowd or against the crowd and you have to have that in your DNA.
But in terms of our general thought around sizing, generally, when we have a core position that we think really fits all of our criteria, it’s usually going to be 2.5 or .5 percent of the portfolio type of allocation cost initially.
Occasionally, we’ll have ideas that are a little more speculative but have maybe some binary components to them, things like biotech might fit there or there’s some limitation but the upside is significant enough for us to want to make a small allocation. In that case, we’re on things even in the small like a 50 basis-point increment because I would call that as betting small to win big where you’re not risking much but it’s still — it’s kind of worked in the context of the overall portfolio because the upside is so great.
And I think more broadly away from even the funds that we manage like somebody might put bitcoin into that category as a personal investment. Amount that you’d willing to sort of take a risk that this is going to zero but you’re opening up your overall portfolio. There’s some big upside potential and maybe even potential that can help at a time of crisis, something that’s anti-fragile or that can benefit from a disorder while the rest of your portfolio is going down as always appealing (ph).
So, the bottom line is we have our core position size as I mentioned. We think a little bit about speculative value and speculation and binary outcomes and manage that risk by resizing the — those ideas properly.
I think there really aren’t any bad ideas in life. I mean, obviously, you could probably come up with a really bad idea. But just — it’s really about sizing.
LYNCH: If you bet one penny out of a dollar, you really haven’t lost much if you lose. So, it’s really about sizing that and sizing is a function of our conviction and the quality of the idea.
RITHOLTZ: Right. And obviously, anytime you have an opportunity for really asymmetrical risk reward bet, you can do that with one percent.
RITHOLTZ: So, you mentioned …
LYNCH: And it really depends on you and personality, right? Some people might think one percent is too much or not enough and for us, at least for our funds, that’s usually more of 50 cents out of a dollar, 50 basis points.
RITHOLTZ: Got you. So, you mentioned Jeff Bezos and Amazon.com. But I’m curious about your process, what brings you the names like Amazon and Shopify and Slack and Zoom and Moderna, not specifically the work-from-home theme but what was the pre-2020 approach that led you to these companies? Is it growth? Is it growth at a reasonable price? Is it the unique winner-take-all companies with a moat around their business? What’s the thinking that leads you here?
LYNCH: I mean, those are some actually good stabs at it. I think our ideas tend to emerge from all the activities of the people on the team. We’ve been lucky to have people on the team for, I think — I think we had very low turnover over the last 16 years. So, we’re proud of that.
And part of the benefit of them being in one place for a long period of time is they get to develop really stable contact networks with an industry, companies, corporate world, the investor world, et cetera. So, we always have ideas that tend to emerge from our research and our daily activities.
But you’re right, we’re — there are certain things we’re looking for apart (ph) from screening for high growth rates or something of that nature. It’s more certain characteristics jump out at us. Like inside ownership. Like a lot of these cases that you just mentioned or at least many of them, you have the founder or the person in charge has a large equity stake, a lot of skin in the game.
So, that’s always really interesting to us. When you have somebody who’s not just the CEO and managing a business but really someone who acts like an owner. Similarly, for us, our team has a lot of ownership of our products. I mentioned, we have a large number of products across the platform.
I personally have money in every one of them. I don’t think you should start a product unless you think it could succeed and that you’re willing to put direct investment in. In addition, I think what’s great with Morgan Stanley through its deferred compensation program forces you whether you like it or not or to put at least 25 percent of your preferred pay into the products you manage. Our team tends to put over 90 percent.
So, for me, we’re putting our skin in the game every day in the products we’re managing for our clients like at Counterpoint Global and we’re looking for companies that do the same thing that are owner operators not just people that are caretakers of something that’s already been built.
And not to disparage some of those situations but I think the more interesting component is trying to find that — identify cultures that act like owners like we do and I think that that’s really appealing. And when you can combine that with high growth potential and big addressable market, obviously, that’s even more appealing.
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RITHOLTZ: So, much of your process sounds very much bottoms-up stock picking fundamental analysis of different companies’ businesses. How much do you pay attention to what’s going on in the world top-down?
I don’t get the sense that you’re hanging on every Fed release or every macroeconomic release like ISM or international deficit. Do you guys factor top-down into your process very much?
LYNCH: So, yes, we’re mostly focused — I want people to call it bottom-up. So, making company specific investments. Like a few things that come to mind when you asked that question.
I mean, one is I think I’d be remiss and anybody would be just in for all-asset classes in general but the fact that we had a tailwind behind the — a lot of — pretty much every asset class over the last 30 years with interest rates kind of going from where they had been to where they are today and that’s part of — this is something that sort of lifts all asset classes to some degree and probably does help companies on the margin more.
Intellectually, you can understand that that have high growth in the future where the values undercome as opposed to something that’s like right today currently there, something that might be more of a hard asset.
So, I think interest rates obviously matter. The problem is we don’t know what they’re going to do. And so, are they going to go up, are they going to go down, and if they do, why? We don’t know what circumstances may lead to those things happening or why the Fed might do what it does.
So, I think given that we — our mindset is that some of that is so unknowable that it’s better to focus on specifics that you can control. And in the process, when we look at our companies and play around the sensitivities and what they could be worth, we obviously need a cost of capital. We need an alternative to look at and that includes other companies and asset classes, including the retreat (ph) rate.
We tried over time to not give a whole lot of benefit to the fact that interest rates are as low as they are today and generally, we don’t. But when I play around the sensitivities to buy (ph) the companies, it is a consideration because it’s also possible to stay where they are.
So, it’s probably along with a way of saying we’re not that focused on the macro. It does matter in the sense that things like interest rates represent fundamental alternatives and cost of capital and the consideration in how you think about company valuation whether you like it or not.
Having a strong view about what’s going to happen in those — to those variables though, I think it’s — some people might do that well. It’s not a part of our DNA and I think that the only problem with that thought process is that if you think interest rates are going up and you’re going to build a portfolio around that thought, if you’re wrong, you got to change your whole portfolio.
And what we try to do is buy unique companies that have exposure to many different end markets ultimately that can be, hopefully, a lot bigger than the market caps are today in excess of hopefully their alternatives and let some of the rest of that all play out. And really, it’s control what you can control and it just fits the way we think about the world, which is more individual judgments as opposed to kind of larger takes on asset classes and things of that nature, which I think part that — to us, they’re not that useful.
If you tell me the market’s overvalued in aggregate, it doesn’t help me make a decision about the one company I’m looking at. It might be really undervalued, right? It actually might hurt you think the market is overvalued 10 years ago.
And so, I think the market is overvalued right now so I’m not going to buy Amazon even though I’m interested. So, if anything, sometimes, I think, the discourse in the industry around these aggregate notions of high-cost mutual funds are bad or the markets overvalued or like in hindsight, those things are always obvious but it almost hurts your ability to make individual decisions. So, again, we’re really focused on individual company decisions.
RITHOLTZ: Quite interesting. So, as long as we’re discussing decision-making and the thought process behind the selection, let’s talk about someone you brought in recently to be the Head of Consilient Research at Counterpoint Global, Michael Mauboussin. How significant is that role and how closely do you work with him?
LYNCH: Look, we’ve known Michael for a long time. He’s — in fact, when I was at business school, I was exposed to some of his great content and great thinking at Columbia.
And we’ve always respected a lot of what he has to offer and in fact, when he was on the sell side, he was kind of the guest star in our team meetings at least a few times a year. So, we wanted to know what was kind of going on in his mind.
And I think reading Michael’s research and being a part of it now is kind of like (inaudible). It really helps. You prepare for making good decisions and thinking about thinking and I think that that’s — there’s a lot of utility there. When I think back over time as an example actually, I think when Michael was at Legg Mason with Bill Miller, they had — Bill had — particularly it was — had pieces about Amazon which wind up being one of the only things that matter over the last 20 years in equity markets.
And they had this whole concept around how Amazon was being looked at as or kind of misclassified. People were looking at it as a retailer and it was really logistics company. And Michael, I think, we should talk about that as misclassification or looking at circumstances versus attributes.
So, sort of the mistakes we make as decision-makers, we got to put something into a bucket in order to compare to things. But sometimes, that initial decision is wrong and when it is, that can lead to this pretty big misperception.
So, this is the kind of stuff that Michael is about. It really fits the intellectual curiosity, which is a big part of the team, and a lot of people talk about intellectual curiosity and talent development. I think bringing Michael in just — is the real natural thing for us to do given what we’re about.
And already a year into it, we’re seeing great benefits. Michael is also a great coach for people earlier in their careers to just become not just good analyst but good thinkers and decision-makers. And he’s rebooted our book club, we had some great authors in.
So, knowing the team’s DNA and what Michael does is a very — it was a very natural thing. We were happy to have the opportunity to do it. And Consilient Research is basically the idea that — exploring ideas not just in day-to-day financial world but in other domains can lead you to may be coming up with good decision models or rules of thumb or help you think differently about some of the things that are occurring in the financial world and Michael had a long history doing that for his boss then (ph).
And so — and he call this piece the Consilient observer. So, we just said, well, why don’t we just reboot that because it was so great. So, we hope to continue to benefit from his insights and share them with people in the community as well.
RITHOLTZ: Yes. That was definitely a good hire. And I see him as a very good fit into what you guys do. You mentioned Bill Miller. Bill Miller has brought up what he sees as a problem in part of the active world of investing and it’s what he describes his closet indexers and low active share. I think his active share is pretty much in the 90s.
I’m getting guess your active share across the big funds are going to be pretty close, right? You don’t really seem to look very much like any of the indexes out there.
LYNCH: Yes. We have a wide range of products but we’re in the 80s and some in the 90s. So, it just depends on Page 1. And then part of that really is about the benchmarks. Some of them are super concentrated. So, that can affect those metrics. But, yes, we’re at the extreme similarly to what you just characterized.
RITHOLTZ: Yes. And we really haven’t spent much time delving into valuations and I want to ask you a very big picture question. We’ve seen valuations creep up not just over the past 30 years of falling interest rate but over the past — go back to World War II, valuations have continued to rise since then. How much of this has been a significant undervaluation of the economies of scale of technology and how digital can grow with far less needed capital and labor?
LYNCH: Yes. I think it’s a good point. We talked earlier about how markets can change over time and that’s why rules of thumb are sometimes useful for periods of time but have a — often can become — actually, they can become a problem, right? They can become — just like expertise, it’s useful when the world is not changing too quickly.
But if there is a change over time, expertise can become a real — a problem. You suddenly — you have to jettison your way of thinking and learn new things that most people are often hesitant to do that. I think the constituencies in the market today, meaning the earnings or the cash flow that sort of backs up ultimately the valuation of let’s call it the market even though I don’t love talking in aggregate frankly.
But, yes, there’s no question that it’s driven more from more of a capital light vantage point than maybe when you look back over time in the history markets and their times and railroads are 50 percent. So, certainly, today’s market is very different and the earnings of it, maybe the quality of those earnings might be different.
And there are puts and takes to be fair. I don’t want – it could be a very long discussion. But the – I think that is a very — I think this whole concept that — of tangible versus intangible and Michael’s actually written about that a bit and looks really focused on as we speak, Michael Maubossin, is it’s something that most people haven’t appreciated enough probably that earnings and the way companies make investments, has have changed and that has — that definitely affect some of these rules of thumb that maybe people have thought about for many years.
So, again, the last thing I’ll say here, though, some — reacting to the question which is really kind of about the market and I think you always have to be a little careful about market aggregate discussion because again, our DNA and what we’re focused on is company investing and finding those unique situations.
And if you get too — if you spent too much of your time on the aggregation of trends or the aggregate trend and predicting them and discussing them, I think, it’s a little bit, gets you off track, at least, from — it does for us from what our — what our core mission is.
RITHOLTZ: Quite interesting. So, you mentioned the aggregate. Let’s get a little more granular and drill down into at least those five funds. I love the names of these. Advantage, Growth, Insight, Discovery, and Inception. I mean, kudos to whoever was putting — putting those titles together.
They range — the smallest one is about half a billion, the biggest one is almost 15 billion and they’ve all done super well this year. Advantage, up more than 50 percent, Growth up over 85 percent. Insight is almost 88 percent, Discovery is 99 percent, Inception is 72 percent. What are the differences of these five funds? Is it U.S. versus overseas? Is it small versus large or are those buckets just not relevant?
LYNCH: No. So, ultimately, it’s a great question because I talked about the team — I think the differentiator for us is that we’re investors first and the sort of category stuff happened at the end of the process. And I think most of the industry is — start off with a product or a category and build a team around it.
And obviously, their strength and — could be strength and weaknesses to both of those strategies. I think in a world where most people are compartmentalized, it’s better to have some perspective because you’re kind of going against the grain and maybe picking up things that they can’t.
In terms of these individual products, Inception is our small-cap product. And so, ultimately, when we find companies that have market caps in the range of general to Russell 1000 growth small cap arena, that’s the home for which we can take — with which we can take advantage and hopefully, those insights or ideas.
Discovery, a really more of a mid-cap growth strategy in the sense of the market cap range. And by the way, both are U.S. and the ones we’re discussing here are all U.S. as well, it’s centric.
And then where large cap is or Growth — sorry, excuse me — growth is a large-cap growth strategy by market cap. And so is advantage but the only difference there is that we do two — we have two different constraints. Growth can own whatever it wants in terms of opportunity set whereas Advantage, from a competitive advantage standpoint, when we look at why a company is unique, like is it network effect or scale or switching cost or brand or these — the designation that we look at there, we stay away from intellectual property driven, technology driven, competitive advantages in Advantage and we tend to own companies a little bit later in their life, not in the early part of their lifecycle.
So, it’s a different variation for that product of our large-cap growth thinking. But at the end of the day — and as you said with the names, I mean the names were really what we want to do is not be the large-cap growth fund or small-cap growth fund. I think great investing is you have to define yourself to a degree, but if you limit yourself to the designation, you’re doing a disservice to the people who have allocated your money.
Because if I take a real big step back at the industry, the real goal is to be an alternative. And the alternative is really, probably, the S&P 500. And if you’re really good at doing this part of that world that still doesn’t beat the S&P 500, and you haven’t given yourself enough flexibility to do that, then at some point, your asset class is not that useful or might considered null and void or not worth pursuing.
So, what we try to do is name the fund in in ways that are indicative of the pain (ph) culture but also are — and have tendencies, like I said, these buckets at the end of the process, the conventional consultant thinking, but we’re — there’s still more flexibility in running inception than there is as I call it — we call it small-cap growth because there are more constraints with that naming from a 40 Act legal standpoint.
And so, leave yourself — be who — you have to know who you are in this business but you go to leave enough flexibility to evolve. And I think that’s, hopefully, something culture we’ve been able to achieve but part of that is even what — the name of your funds or even the name of your team.
So, Counterpoint Global, the idea behind counterpoint, simply, there’s two — actually two meanings. One is Counterpoint is often used, thought of it the other side of the argument. And so, it connotes that willingness to be different, not always contrarian because that, I think, is generally wrong, but you have to be willing to stick your neck out in order to succeed from time to time.
So, that’s — that the symbolism there. But the other meaning in music is counterpoint in music is when you take unique melodies or voices and you — when you — that sound great on their own. But when you layer them together to get — in a situation where the outcome — the output’s better than the sum of the parts.
So, like in a musical, usually each character has its own theme and at some point, at the end of the first act or the final act, those themes kind of intermingle musically at some point and your kind of like, wow, you’re like, wow, that’s amazing. Or like, “She’s Leaving Home” by the Beatles or “I’ve Got a Feeling” by The Beatles. These are cases where there are multiple melodies happening that stand alone.
But so, hopefully, from a theme standpoint, that whether it’s our ideas that we can put in the different products where they fit or whether it’s the people or the way we can combine our products, hopefully, there’s the benefit of counterpoint which is creating something that exceeds the sum of the parts.
RITHOLTZ: Quite fascinating. I know I only have you for a certain limited amount of time. So, I want to jump to my favorite questions that I ask all of our guests and see what — see what’s going on in your life these days.
Let’s start out with streaming. Tell us what you’re watching either on Netflix or Amazon or anything you happen to be listening to on podcast, what’s keeping you entertained during this period of work from home?
LYNCH: The series I just finished and I blew right through it, I thought it was — and not super well-known, I think, but might’ve flown under the radar, it’s called “Halt and Catch Fire” and it’s available on Netflix and it’s kind of like a Madman version of the gaming world, the video gaming world in ’80s and how that environment went from the ’80s and what was happening with the Ataris of the world and all the early PCs and then and then the evolution of that up until sort of the — of the the Internet.
And you follow these characters through that journey. So, it’s really interesting to watch, the progression, to — I think it’s really well known from an entertainment standpoint but it also happens to fit, things we’re interested in in terms of how technology’s evolved over time.
My wife and I are also enjoying Ted Lasso on Apple Plus or Apple …
RITHOLTZ: So good.
RITHOLTZ: I just — I just read it was renewed for a second season so I’m thrilled about.
RITHOLTZ: It’s awesome. It’s funny you mentioned “Madmen.” I missed that when the first time it went around and my wife and I has just started streaming it a few weeks ago and I had to find someone who lived through that year to say, hey, how hyperbolic and exaggerated is this? And the consensus seems to be, no, that’s pretty much how it was like which is kind of shocking.
LYNCH: It’s literally a different universe than where we are today. But, no, we — I enjoyed “Madmen,” too. It’s a — there’s some really great stuff in there.
RITHOLTZ: Tell us about some of your early mentors, who helped to shape your career.
LYNCH: Well, I would — I mean, very lucky, my dad has always been a great influence. He was an investor as well. He is — he had his own firm for many years. But just — and what we do is very different than what he did back then and partly that is opportunity-set driven.
But really, my dad, which has always been a really great role model in terms of how he handles himself and how he — he’s very thoughtful and he finds — he’s really able to find the positives in other people which has really been valuable for me, in my life.
In terms of specifically in investing as well, certainly he helped me there as well. But that — when I think more specifically in my career, I took a classic combi (ph) business with a guy named John Griffin to used to be the President of Tiger, the hedge fund, and had his own hedge fund, Blue Ridge Capital for a long time.
And if you take — and that happened to me as first class which is very lucky that he taught, first class that he taught. And he — if he leaves his class and you haven’t gotten passionate about investing afterward, then you probably shouldn’t be in the field.
So, John had a great way of communication passion and sort of establishing what it takes to make it in the business, I think. So, that was a really — he’s been a really valuable person for me.
And then there are a lot of people in the industry I admire. We talked about Bill Miller and his willingness to be different and you talked about Will Danoff who I’m friendly with. And I really think he’s been unbelievable over the course of his career, to touch base with him on things.
Other people like Ron Baron, I admire mostly from far. I think he’s been really good at what he does and Henry Ellenbogen. He used to be at T. Rowe, now who runs Durable. There’s another person, Baillie Gifford (inaudible) organization, James Anderson have also been great.
So, sometimes the mentorship happens just by sometimes being friendly with but also in addition, just kind of learning from people from afar and some of those people had been influential for me.
RITHOLTZ: Quite interesting. Tell us what you’re reading, what are some of your all-time favorite books and what are you reading currently?
LYNCH: Sure. So, my favorite all-time book, probably, might — it’s probably “The Art of Learning” which is by Josh Waitzkin who was the subject of the movie “Searching for Bobby Fischer” which is about the young chest prodigy who might be the next great chest player for the United States.
And the book’s about what it was like to be him during that timeframe and his journey as a chess player and eventually went on to be, I think, the Tai Chi Push Hands Champion of the World which is a whole different domain where he excelled in division (ph) of the chess.
And really, I’d say the heart of the book is about the side B of having a growth mindset versus the fixed mindset and the idea that be willing to fail and try new things and learn from it as opposed to getting too wrapped up in your current identity and having that and limit your ability to learn as a person.
And I certainly know what that’s like. I think, probably, most people as they think about themselves, will -can find themselves doing a lot of fixed mindset things.
So, just a concept of trying to be somewhat open to new things and (inaudible) learning stuff for me, it’s actually, really helped to me in my life and I probably read that about 15 years back but I highly recommend it.
What I’m currently reading, frankly, I don’t read a lot of books as much as I used to because there’s so much material investment related that I like to read. But we do have a Book Club that Michael rebooted at the — for our team, Michael Mauboussin.
This year, we just had two people and the first one was a guy named Michael Kearns who is the — actually, he’s a consultant or adviser from Morgan Stanley but he wrote a book called “The Ethical Algorithm.” And it’s really about the pluses and minuses of algorithms and where they can be strong and benefit us in society and how they can be harmful. And I thought that’s a really — that was great framing and good — a good topic for the team.
But then we also had David Epstein (inaudible) wrote “Range” and “Range” is kind of the other side of the Malcolm Gladwell argument about 10,000 hours equals expertise or mastery. It’s more about cases where people don’t declare what they’re going to do until a little bit later in life, like Roger Federer in tennis as an example instead of like the Tiger Woods model of — playing, literally playing, golf right out of the crib.
And really interesting thinking there around the benefit of having broader perspective before you get too narrow and that resonates us without team, too, based on some of the things we talked about today just having that, being able to cultivate perspective in a world where there’s a lot of expertise.
Our whole industry is based around expertise. So, I think, often what’s missing is being able to connect things between areas of expertise and hopefully that foreign place were set up to do that as a team.
RITHOLTZ: Really interesting. What sort of advice would you give to a recent college grad who was interested in a career in asset management?
LYNCH: Most — well, actually, very similar to what we just talked about previous — and the previous question that you most job start off in that sort of expert. You’re given a very specific task and I think that’s just the nature of how the system is set up and you follow a sector or an industry.
I mean, when I was at JPMorgan on the sell side, just got to follow EMP companies, companies that, explore (ph), produce for energy and, well, yes, excuse me. And so, it’s great to dive in and become an expert and there’s a lot of value, like, in that learning process.
But to the degree you can complement that with broadening your learning and not just be so narrow, I think there can be benefits to kind of pursuing that.
And today, in today’s world, there are so many sources for doing that. You can — you use stuff like Twitter to you advantage or there’s ways if you want to be a learning machine, you can — you can find Internet resources that are really — really throw a lot of interesting stuff at you and hopefully round out your perspective if you’re really been put into a narrow position. So, that will be my first instinct.
RITHOLTZ: Quite interesting. And our final question, what do about the world of investing today that you wish you knew 30 years ago when you were first starting out?
LYNCH: Probably everybody learns in math class or at some point in their like, compound annual growth and you can see when you’re doing it that it’s a powerful thing. But I think as I’ve gotten further on in my life, and I think we tried to certainly professionally but in many ways, in my life, you try to take advantage of those — the developing habits that will lead to good things down the road and making investments today that will benefit you later.
Like — but I would say I wish I’d had an even greater appreciation of that earlier my life. I mean, somebody like Warren Buffett, the real great investors, I would say probably really get that very early in life and he’s somebody who just started young and that time is such an advantage.
So, just a — a really great, even better awareness of those — that concept in hindsight is something that I always try to highlight the younger people because while I knew that a little bit mathematically, I probably didn’t focus on how that can really benefit you whether it’s financially or whether it’s even habit formation and what it leads to down the road that might be your health or some skill you want to develop.
So, I’d say compound (ph) annual growth and really taking that to heart and making it a part of your DNA.
RITHOLTZ: Thank you, Dennis, for being so generous with your time. We have been speaking with Dennis Lynch, head of Morgan Stanley’s Counterpoint Global.
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