Transcript: Simon Hallett
The transcript from this week’s, MiB: Simon Hallett, of Harding Loevner, is below.
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ANNOUNCER:: This is my Masters in Business with Barry Ritholtz on Bloomberg Radio.
RITHOLTZ: This week on the podcast, I have an extra special guest. His name is Simon Hallett and he is the co-chief investment officer at Harding Lovener which is a firm that’s been around for about 40 years and manages about $73 billion. He also is the majority owner of Plymouth Argyle, a football club in the U.K.
He has a fascinating background and has been running money on an international basis for many decades. He is uniquely insightful to discuss how to pick stocks, what the different between growth and value is and how to use both in order to identify companies most likely to outperform the market.
The track record of Harding Loevner international funds has just trounced the MSCI benchmark by 250 basis points annually over decades. So, this isn’t somebody speaking theoretically. They have actually put processes to work that have allowed them to dramatically outperform.
With no further ado, my conversation with Simon Hallett.
ANNOUNCER:: This is Masters in Business with Barry Ritholtz on Bloomberg Radio.
My special guest this week is Simon Hallett. He is the co-chief investment officer at Harding Loevner, a firm that manages about $73 billion in assets the is also the majority owner of Plymouth Argyle, a football club located in the U.K. Simon Hallett, welcome to Masters in Business.
HALLETT: Thank you for having me, Barry.
RITHOLTZ: So, let’s talk a little bit about your background. You earn you BA at Oxford and then you begin working in the financial services industry in London in the early 1980s. Tell us about that era.
HALLETT: It’s actually the late ’70s. I graduated in 1977 and went to work for the Midland Bank which was then one of the big four clearing banks in England.
In the early ’80s, I moved to investment management investing, let’s say, in Hong Kong. In London, that was an era of high interest rates. We were just coming off the financial crisis into mid-’70s. When I moved to Hong Kong, we were just beginning in a property collapse. So, I moved there in 1981 and the property market collapsed in 19 — in summer that year.
The oil price was 32. It was about to go, fallen half as well. So, it was an ear, really, of continuous crisis as far as I was concerned.
RITHOLTZ: Hong Kong in the 1980s, that had to be a of fire, though, because Hong Kong was really ramping up. They were the gateway to Asia, not just Japan, but China and a lot of the rest of Asia. What was your experiences like in Hong Kong?
HALLETT: Well, it was the first time I traveled anywhere other than — to France. So, everything about it was tremendously exciting. As you say, it was a great time to be in Hong Kong. It was a few years before the rest of Asia began to open up.
But Hong Kong itself just had a massive expansion in population as a result of immigration from China. After the misery of England in the 1970s, it was just amazing to be surrounded by people who also lived in great poverty, having just arrived from China but being left to their own devices to better their lives, almost always successfully.
So, all the cliché’s about Hong Kong about its — that it’s a culture of independent, it’s the culture of trying hard to personal success were true. And I just found it tremendously exciting.
RITHOLTZ: So, what do you make of what’s been going on with Hong Kong the past few years, not only since the handover from U.K. but increasingly aggressive Beijing policy towards Hong Kong?
HALLETT: I find it horrifying. Hong Kong was very much left to its devises. I thought that the China-British during declaration in the mid-1980s was going to be tricky that guaranteed the independence of Hong Kong. Clearly, that’s been overcome. And I think it’s not going to be good for Hong Kong as a place and I — I worry about the future of the people that I know who is still there and the rest of the population. I don’t think it’s going to be healthy for Hong Kong.
RITHOLTZ: Quite interesting. So, let’s talk a little bit about your investing style. You’re essentially a bottoms up fundamental stock picker. Since, we’re …
RITHOLTZ: … talking about the macro landscape, do you ignore what’s going on in the background? Does it not enter the calculus or does that force you to modify the sectors and companies you’re considering?
HALLETT: No. very hard to ignore it. We’re investment people, we’re kind of curious about the world and we’re opinionated. So, we have opinions about the macroeconomic environment but we tried very hard not to let it influence our portfolios.
I actually like to quote something that you wrote four or five years ago when you’re asked about the economy and what you think.
I think your basic answer is why would you ask me? Why do you think that my forecast have any value and why do you think forecasts themselves have any value? And that’s pretty much the view that we take. The academic study suggest that sorry (ph) little correlation between, let’s say, GDP and stock market returns.
HALLETT: I think it’s interesting to discuss why there’s little covariance between GDP growth and stock market returns. But the fact is that there’s not.
Secondly, you can’t forecast GDP. So, it distresses me that the financial services industry devotes so many resources to try to make forecast that are inaccurate and have no bearing upon over — across customers’ returns. So, I look upon macroeconomic forecasting as damaging to good investment returns.
So, no. We don’t — we don’t follow with them at all. Having said that, we do think about them a little bit and thinking about expectations, so how we should expect portfolios to perform. So, a good example was — would be after the financial crisis where our expectations to the economy such as they were, were the — was based upon Reinhart and Rogoff. We thought it would be a long hard slog to recover fully from the financial crisis.
We thought that knowing a bit of that people psychology that they’d start the year optimistic, they’d end the year pessimistic. And that would lead to more market volatility. But we thought it would be a good environment for our kind of kind of investing in high-quality long-duration growth companies.
And we were — we were right about that. Interestingly, we were completely wrong without full cost of stock market volatility and we are actually right with relying on the Reinhart and Rogoff forecast of the macro economy. So, it’s quite ironic that the things that we think we can’t forecast at all was the one we actually got right.
RITHOLTZ: I recall — I want to say it was December of ’07 that Reinhart and Rogoff came out with a short whitepaper that looked at five previous financial crises. Now, remember, the market peaked in 07 to come out with something like that in 2007 was way, way ahead of its time and that whitepaper not only was prescient, it became the basis of 800 years of this time it’s different.
They really had a handle on what financial crises due to stocks and economies. Did their research really influenced how you looked at the recovery from a financial crisis like ’08-’09?
HALLETT: Absolutely. I mean, that view that it would be a long hard slog was entirely based upon their work. And I have to say that this is something that I looked upon us typical of my entire career. I’ve been very open about things.
We have relied very heavily on other people’s work, on other people’s academic work and forming our own views. I always say that I haven’t had an original thought in my entire career. But I’ve been very, very good at identifying useful thoughts from other people and implementing them and investing.
Reinhart-Rogoff was a classic case. We read the book, book became popular. It was available 15 bucks on Amazon, and it helped us with our expectations and our client communications for a decade. People underestimate the power of the written word, I think.
RITHOLTZ: The pen is mightier than the swords and it’s certainly true in the world of finance.
HALLETT: And I think there’s this really relentless pursuit of originality. We all feel the present to be original, to be original thinkers and I don’t think it’s necessary. I think there’s so much good advice about how to behave, how to invest out there, and what’s the key to success in investing and taking that advice and using it to the benefit of your clients?
RITHOLTZ: I couldn’t possibly agree more.
Let’s talk a little bit about the track record that Harding Loevner has put together. The global equity portfolio since inception has outperformed MSCI by 250 basis points annually. That’s pretty interesting. Is this still the same methodology or philosophy that was used when you joined the firm back in, what was it, 1991?
HALLETT: The philosophy has not changed but the methods, the investment process has a lot. Our investment process today is much more structured. It’s much more disciplined. We’re much more objective about how we define the characteristics of the companies we follow. And the result has been a gradual shrinking of the freedom that our portfolio manager has.
I think that’s one of the interesting things about the lessons from behavioral finance. What we’ve learned is that people need to control their behavior but they find it difficult to do so. So, one of my roles as co-chief investment officer and previously chief equity officer has been that I’ve had to set out the rules and then make sure we stick to them.
And of course, that’s going against the financial services culture that our portfolio manager is the top dog in an investment process and people don’t like having the freedom restricted.
So, the methodology has changed and it’s been a methodology that has been disciplined, has been objective, and it’s been reducing the autonomy of individuals. But the philosophy has been constant that we will focus exclusively on long-duration growth companies pay attention to the price of which their stocks trade.
So, let’s talk a little bit about the methodology. Your firm references four qualities for a company to be a potential portfolio holding. Competitive advantage, quality management, financial strength, and sustainable growth. How do you quantify these?
Some of them are kind of squishy, like, quality management. How do you determine who is a quality manager or not and is that a subjective squishy rating or do you come up with a way to make it much more quantifiable?
HALLETT: Yes. They — the squishiest of these four criteria is undoubtedly one that assess management. And again, thinking about how the process has changed over the last 30 years, we used to think we knew quality management when we saw it. And often, that’s simply met — meant that we met them and we like them.
And there’s very little correlation between we like people or whether they could manage corporations and balance (ph) of their shareholders. So, we are, today, much more objective in how we assess management. And just to give a little bit of detail on that particular one, we quite early on, started using cash flow return on investment based on the work of people like Michael Mauboussin, not just to value companies but to assess the abilities of management, not just to generate free cash flow about how they allocate it.
We actually used Holt valuation system with some adjustments for our own beliefs. But we can use that to look at, for example, how management allocates capital.
And for us, that’s a very, very important way of looking objectively at their track record. I think when you’re investing for the long-term in quality growth companies, obviously, a lot of the value is — in the future cash flows.
But the past has to be some guide — you have to believe that the past is some guide to the future. So, a good track record is something that we like to see and we will use that to assess management.
The other aspect of high-quality management for us is corporate governance which is essentially how those high returns on capital end up with shareholders.
Are they retained in the company, are they paid out in dividends, are they distributed via buybacks or are they used to further the interest of other stakeholders, most noticeably, of course, the executives of the company?
So, corporate governance for us, again, is more than just a matter of sticking a finger in the air, making a judgement. It’s — we have a series of checklists which will identify the practice that we think that are important in assessing overall levels of corporate governance. So, I’m not going to pretend that all the companies in which we invest are perfect.
One of the checklist, for example, ask questions about record of integrity and they will be exclusionary. So, these companies don’t meet minimum standards. We won’t — we won’t follow them.
So, we have, though, more discipline. We have more structures. And I think when it comes to allocate new capital, we’ve got much more objective. But I will say that when it comes to assessing management, we also have an element of assessing their strategic vision. And that, really, will be from analysts making judgments from reading transcripts, from interviewing managers and so on and so on.
So, the arc that Harding Loevner really has been from qualitative judgment tools, objective judgment, and that’s ties (ph) to the full criteria that we use as well.
RITHOLTZ: So, I can certainly see financial strength being totally quantifiable and even sustainable growth, you can track that overtime. What about competitive advantage? That’s one of those sort of Warren Buffett moat-type things that also sounds a little subjective. How do you make that less squishy?
HALLETT: We make it less squishy. But again, being structured and disciplined. So, we rely very heavily, not just on analysis of competitive advantage which is really answer to the question, what is it that this company does well that gives it an advantage in the industry in which which it competes.
But we also look at the micro quarter (ph) forces structure of an industry to make sure that the company is operating in an industry where high margins can be protected. So, it’s not always objective and quantitative but it is structured and consistent across the various sectors and geographies in which we invest.
And ultimately, competitive advantages seen in high margins and strong cash flow return on the investment which are sustainable in the long periods of time. So, and again, it’s a mixture of trying to be disciplined and structured about where you’re making judgments and trying to be objective about where you don’t make judgments.
And I think in some ways, this is a feature of all research. We are not ashamed that a lot of the inputs we use are backward looking. But backward-looking inputs are the ones that are facts. Subjects goes to an opinion about the value of accounting rules, I think, that the people have described him as opinion (inaudible) expert.
But at least they’re more objective than the forecast which has caused subject to bias (ph). So, they’re doing research, trying to value companies for us to make sure looking backwards for objective fact and looking forward, making forecast but recognizing that those forecasts are subject very heavily to biases (ph).
RITHOLTZ: Quite interesting. So, Simon, you’re the majority owner of the Plymouth Argyle Football Club. This raises a question, why buy a soccer team? Is this an investment or a labor of love?
HALLETT: It’s certainly not an investment, or if it is, it’s the worse one I’ve ever made. It’s a labor of love.
It’s not just any football club. This is the football club that I supported as a kid. I first did on the Terraces (ph) in 1966 when I — when my family moved to Plymouth.
So, this is the team that I’ve been a fan of for most of my life in the 54 years. So, it’s a labor of love. And it’s really a little bit of giving back to the community in return.
The role of the football club in local communities is probably greater than sports teams in America. They’re deeply embedded, they have a long history, we have a community trust which is very active, doing good works. And it’s important to me that Plymouth Argyle be a vehicle for me to get back to the community in which I was raised.
And, frankly, the community that paid for my education. I’ve turned my education into successful business that I’ve reaped the rewards of and the great fans (ph) of Plymouth paid for my high school education and for my university education. So, it’s a way of giving back.
And I should say that — I don’t like the idea that a successful entrepreneurs who make a fortune should give back. They’ve usually done it by selling business services of prices that people want to pay. It seems crazy to me that people say that Bill Gates should give back when you think of all the good that his product has done in the world.
So, it should be a voluntary act. But for me, I generated a return on the investment that great payers, the taxpayers of Plymouth pay me (ph) and I think some payback is appropriate. But it’s also — so, it’s a happy coincidence but it’s also my boyhood club. So, it’s been great fun.
RITHOLTZ: So, I understand — I’m a World Cup fan. I understand, generally, how U.K. soccer clubs move up and down the different leagues. But for us ugly Americans who may not really understand, first tier, second tier, third tier, can you give a little explanation?
In the U.S., we have professional football teams and we have college teams. We have Major League Baseball Teams and there are Minor League teams and nary the twain shall meet. But U.K. soccer clubs, they can move up and down from league to league? Could — can you give that a little explanation?
HALLETT: Sure. So, leagues here are closed systems. The divisions without a league are mostly closed system. It’s very unusual for teams to move from the American League East to the American League West. So, obviously, that has happened in the past. But so, they’re closed systems.
Leagues in professional sports throughout the world, not just in soccer and not just in England are much more open. So, let’s say — let talk about the four divisions of English football. They’re actually about 100 divisions but let’s just talk about the top four divisions.
If you think about divisions in the league being horizontal with no movements between Central and Western, in English football, the leagues are hierarchal. So, there’s a progression from, let’s say, fourth tier up to the first tier which is the English Premier League that people have probably heard of.
So, the end of every season, teams in the division are ranked by their results and the best two would go up to the next division and the bottom two goes down. So, it’s terrifying. So, the fight in football is not just about winning the division, it’s about being in the top.
Top two, so you get promoted and avoiding being in the bottom two. So, you get relegated and getting relegated has a massive emotional impact as well as a financial impact. And as we know, losses count more than gain. So, in some ways, the theory of relegation is greater than the glory associated with getting promoted. But it — it’s a terrifying system. But the impact is that it makes almost every game meaningful.
RITHOLTZ: Loss aversion applies not just to investors but to football clubs. That’s quite fascinating. So, in the U.S., there were complaints that the perennial favorites for long time, the Dallas Cowboys in football, the New York Yankees in baseball, it was the team that spent the most money.
And even with the salary cap, the big market teams had an advantage because they could attract players that potentially would earn all these marketing and advertising endorsements, you’re more likely to get that in New York or L.A. then you are in, let’s say, Cleveland.
How important is finances to the success of a team and is there any limitation on what the teams can spend other than how much their owners are willing to write checks for?
There are limitations but they can be got around by owners willing to write checks. So, we have financial fair play rules but they’re not terribly effectively enforced. And financial fragility of clubs in the low division is quite a feature of the last 20 years. Many have gone bankrupt including my own, 11 years ago, almost went out of business.
So, it’s a very interesting question about the role of money in success, though. And here is where — it’s like investing. I mentioned that there’s a lot of behavioral finances relevant to managing a football club. In particular, when it comes to getting players, so what clear and this sounds obvious, but it’s not immediately obvious because football is a game like investing where short-term outcomes of results of combination of luck and skill.
But it’s pretty clear that over long, long period, skill dominates luck and the most skillful players generate the best results. Also, it’s a reasonably efficient market and the most skillful players tend to cost the most.
But it’s not at the edge. It’s a completely inefficient market and there are all sorts of things that you’d recognize from the field of behavioral finance where people make errors in overpaying for players.
So, people associate good players. There’s recollection of — people associate good players with good clubs. They assume that these good players need (ph) to plays for a successful team and they assume that he’s bad player if he’s played for an unsuccessful team.
So, a player of equal ability who played for a top team will be more expensive than one who pays — plays for a bottom team. So, similarly people will extrapolate, it’s astonishing how often a guy would come out and score an unusual number of goals for his long-term record and then will get traded following which he may revert (ph) and the price that was paid looks to be irrelevant.
So, when we’re thinking about managing Plymouth Argyle, we’re thinking very, very hard about these inefficiencies in the market and how we can best use — use our resources. So, I think that there is a role for thinking about market inefficiencies, thinking about how those inefficiencies are created by human behavior and then exploiting them so that you can outperform essentially your financial resources.
RITHOLTZ: So, is there any sort of Moneyball for football yet? For soccer? Have people come up with different ways to quantify the performance of players that perhaps are nonstandard and provide an edge until everyone else figures it out?
HALLETT: To me, the Moneyball for soccer is Moneyball. The lessons in Moneyball are applicable not just to investing. It was a book that we sent to our clients. But also in football. And there’s been a progression in the use of data analytics from baseball to basketball where they said it could never happen.
It’s now kind of beginning to creep into hockey and American football, the NFL. So, it’s at the very beginning stages of being used in soccer. It’s very, very interesting to me that the two clubs that are most associated in England, anyway, with the use of data analytics are one very small low budget club called Brentford which, actually, in a couple of hours, we’ll know whether it’s been promoted from the second tier to the premier league which is owned by a hedge fund manager who made his money out of sports betting.
And he, basically, gathered data on soccer matches throughout the world and was able to assess the odds of Team A beating Team B and bet on it accordingly.
So, he bought Brentford and has used data analytics essentially for recruiting the way that I was describing previously, very, very effectively.
The other end of the scale, Liverpool Football Club who, at the moment are, as they like to say Champions of Everything, are owned by John Henry from New England Sports Group who’s also the owner of the Boston Red Sox.
RITHOLTZ: Boston Red Sox. Yes.
HALLETT: And but there’s the link straight back t Moneyball with Theo Epstein, note being Billy Beane’s number two the Oakland A’s. So, the Moneyball effect on — and people refer to the Moneyball effect on football. But again, what’s fascinating is that it’s just like as described in Moneyball and just as I described in the changes in our investment process at Harding Loevner.
The use of data analytics is a way of becoming more objective in assessing players and overcoming biases in the same way that the use of objective data is the way of assessing, let’s say, corporate management and overcoming your biases.
But the people, the practitioners resisted. And just as Billy Beane described with the scouts, I’ve experienced with my colleagues at Harding Loevner. And I’m now experiencing with football people at Plymouth Argyle.
We don’t know about these things but actually turning them into a process and applying them. Richard Thaler — Michael Mauboussin was telling me that Richard Thaler was observing at a sports analytic conference recently that everybody knew that three points is more than two points in basketball and however (ph) we can calculate your success rate, yet it took the Golden State Warriors, I believe, to start shooting three points.
Larry Bird would concentrate on two points whereas he could have increase the results further — of Boston Celtics if he’d taken more three-point shots.
So, turning what we know into practice is your key competitive advantage in my view, not the knowledge itself. And again, in Argyle, as I’d like to say, one of the things that I think will help us is that we have a football management team that’s young, it’s fairly inexperience, very, very willing to learn. So, they are fully prepared to embrace data analytics in helping them recruit players.
RITHOLTZ: I have one last soccer question for you and it’s about Theatre of the Greens, the park where the Argyles play. Destroyed in World War II by German bombers during the Blitz. How closely located is the current Stadium to where the original — I think it was late 19th Century Stadium was erected.
HALLETT: It’s on the same site. We’re — we’ve been at home park since 1901. Actually, Plymouth is a naval port and Plymouth and Portsmouth is the two big naval ports on the South Coast of Britain.
So, Plymouth was completely destroyed during the war. It’s very heavily bombed. And the Argyle stadium is only a couple of miles from city center. In fact, it’s on a hill and a park and if you look at, you can see the — what’s called Plymouth Sound which is where the ships leave.
So, actually, it’s quite funny in a not a particularly funny way. We’ve just completely refurbished our very historic grandstand which dated from the early ’50s and was getting very dilapidated.
And when we were doing that, one of our worries was that we unearth unexploded bombs. Luckily, we didn’t.
RITHOLTZ: Well, that’s quite amazing.
Let’s talk a little bit about your process. I read in an interview, you did some years ago, I think it was with Kate Welling that you were, quote, “relentlessly bottoms up.” What does that mean, relentless bottom up? And is that a way for investors to get better than market returns?
HALLETT: Well, we think so. By relentlessly bottoms up, I mean that we’re — we don’t allow believes (ph) in our forecast or other people’s forecast about the macroeconomic environment to effect, stop selection or portfolio construction.
Though, as I’ve said before, we do let it — we do think about the macroeconomic environment and how we should expect our portfolios to behave in certain regimes.
But our core belief is that by focusing on high-quality companies that grow their own in over (ph) long periods of time paying attention to the prices you pay to them.
You’re going to generate reasonable returns that have a good probability of being (inaudible) with the market if you can control for investing behavior. We believe that there’s difference between price and value and that price converge its own value overtime, but that convergence is an unpredictable pace.
We also believe that it’s important to assess value but that it’s very, very difficult. We all know that the value of security is the discounting present value of the cash flow that’s associated where the appropriate rate for discounting at some combination of risk of rerate and equity risk premium.
But we don’t really know what the proper risk rerate is what the proper equity risk premium is. Let alone can we accurately forecast cashflows. So, assessing value is very, very difficult. But we think we have to do it. It always reminds me of that line for Ken Arrow about his weather forecast during World War II and he told the general who’s weather forecast were useless and he should ignore them and the general staff told Ken Arrow that the general knew that his forecast were useless but he needed them for planning purposes.
So, we recognized that our valuations are in accurate but we need them. And our essential belief is that if you get the valuation wrong and therefore the price you pay for a company is too high, the growth will bail you out and gives you a return over a long holding period.
So, that — that’s why we want growth. That’s why — that’s how we think about value. But quality, for us, is partly a function of our personalities. We tend to be rather conservative, risk averse people and we recognize that if a return is minus 100 percent in any series (ph), then your long-term return is going to be zero.
So, for us, high quality means something about high margins. It also means of our ability to send those margins. It means something about management and corporate governance since we’ve discussed.
But essentially, it means that the riskiness in a company is relatively low. We’re not going to get scared out of selling it at the wrong time. What we didn’t recognize 30 years ago when the firm started was that quality was a factor that was going to be recognized by the academics that’s permanent for allegedly permanent source of return.
We just thought it was something that appeal to us and would help us generate the returns that we needed for our clients.
RITHOLTZ: So, you guys were Fama French before Fama French discovered quality. That’s kind of interesting.
Let’s stick with the topic of growth. How do you define sustainable growth and how can you identify that in advance? It’s easy to say look at how much Amazon and Google have grown their earnings for the past 20 years, but how do you do that in 2002 or 2010 looking out a couple of decades?
HALLETT: Well, we didn’t. Now, we invest on the kind of spectrum from value to growth. And at one end of the spectrum, deep value is buying companies, the kind of Ben Graham security analysis way where you’re getting — you’re paying pennies in the pound or cents in a dollar for assets. And at the other end, high growth is where company goes public were just a bright idea.
For us, the growth is — the mixture of quality and growth is neither at the extreme of one end nor the extreme of the growth end. So, we do own companies such as Amazon which don’t have earnings but they have massive cash flows but we haven’t owned it for 20 years. I think we’ve owned it for several years but not — not several decades.
So, if companies just have a bright idea, we’re not going to be able to forecast and we’re going to say they’re not going to meet our financial strength criteria where financial strength doesn’t just mean leverage but it means having access to capital in a way that’s sustained and we’d look upon bank capital being rather volatile, let’s say, there’s the old story about a bank — bank is something who lends you money — lends you an umbrella when the sun shine and takes it away when it starts to rain.
I think there’s an element of truth in there. So, we like companies that are relatively that have financial strength to -generating their own cash flow or at least have sufficient reserves to hide them overtime (ph) when they’re going to be generating cash flows.
But look, there’s — this is — so, we tend not to try to identify the massively fast-growing companies. But to generate high returns and to generate the type (ph) of returns, we generated over three decades. You don’t need to have portfolios that are exclusively in those kind of companies that they — they’re very fashionable over the last two years and particularly over the last three or four months.
But the classic company for us is, I always say, Nestle. We’ve owned Nestle for 30 years. It never grow — or very rarely grows earnings in more than 15 or 20 percent. It usually grows earnings at seven or eight percent. It reinvested cash flows in the 30-year annual — over (ph) 30 years annualized returns on Nestle are about 12 percent.
Massively more than our portfolios, by the way. And much more than the market. So, it’s that ability to compound reasonable growth over long period of time that never gets dramatically overpriced in the market and is really where the core of our return should be.
And again, it comes back to behavioral — behavioral issues. One of our clients asked one of my colleagues once why we — he should pay us an investment fee for 30 years to adjust — sit on (ph) Nestle. My colleague’s answer was, well, you wouldn’t have done it.
And I think that restraint in behavior whenever he’s yelling at you to trade, trade, trade, has been a key to our success. Our holding period is over five years and that’s consistent across all our strategies. So, for us, successful investing is Charlie Munger said, it’s a matter of finding a bunch of good companies and sitting on your behind.
The trouble is, most people can’t sit on their behind for so long.
RITHOLTZ: Yes. To say the very least. So, let’s talk a little bit about the current macroenvironment which is somewhat unique in at least the past centuries investing history. I guess you have to go back to 1918 to find something similar. How do you look at the pandemic, the lockdown? How well certain countries like South Korea or Japan or Germany have managed it and how poorly certain countries like the U.S. or Brazil have been managing it? Does that impact where you think about putting capital or the type of companies you might want to invest in?
HALLETT: In the short term, when the pandemic hit and it looked like we were possibly going to be a facing a depression, we did do a kind of relook at all the companies in our portfolio to make sure that they had the financial strength just to double check the bad (ph) — the financial strength to withstand a period of, let’s say, two years of zero-positive cash flows.
So, that — that was one immediate impact. In the longer term, I guess for us, the issue is about valuation and how we should think about interest rates that are approaching the zero bound. As I mentioned, we do care about price. We do calculate value and interest rates that are close to zero do very strange things for value.
Particularly, do strange things to the value of growth — of growth stocks. And I think that part of the justification for what we’ve seen happened in markets since the pandemic really took hold has been about the revaluation of cash flows that many, many years into future. But that’s (inaudible) will your listeners will understand the basic arithmetic that when interest rate is zero, you’re different between a cash flow now and a cash flow in the future.
The difference, of course, is in riskiness but the actual value if you can — if you can forecast it will be — will be the same. So, we’ve seen this massive revaluation of growth stocks. Though, I have to say, I think that to some extent, that’s a (inaudible) narrative that’s woven around what, in many ways, weighs as randomness. We’re extraordinarily good producing stories to explain something that’s already happened.
Yet, those same stories tend to have no predictive value. So, I thought it was interesting that as we think about the value of growth stocks and the relationship between price and value, a paper that I think AQR came out with a month or so ago looking at the influence of interest rates on the whole value growth dichotomy and they found that value stocks did not respond to higher interest rates as we all feared.
So, we are thinking about the current economic environment. We’re thinking about impact of the pandemic but we are, apart from just checking up (inaudible), we haven’t taken any action.
RITHOLTZ: Quite fascinating. So, looking at value, looking at international, over the past decade, this is both before the pandemic and in the recovery since the markets bottomed in — at the end of the first quarter, value has been getting trounced by growth. Growth is the big winner. And the U.S. has more or less been beating not only emerging markets but developed ex-U.S., do you see that continuing?
What is more likely to reverse the past decade? Growth beating value or U.S. beating international?
HALLETT: Well, we’re — we’re global investors and we’re global growth investors. So, I want growth to outperform and I want the world to do, at least well, relative to the U.S. So, I’m hopelessly biased.
And I must say that over my, now, 40-year career, my biggest flaw that I recognize quite early but didn’t understand what the reasons — my biggest flaw is that, yes, I’m very optimistic about the future. But I’m very pessimistic about the current. And we know — we now know from the kind of behavioral illusionist why that is, that all of us are risk averse about the present and risk taken about the future.
So, again, I find the ability to time these things zero. So, my guts tell me, and I have very little confidence in my guts so be warned, is that the rest of the world will turn around relative to the U.S. before growth turns around relative to the value.
And the reason is that I do think that the value growth thing is at least something to do where the economic cycle and interest rates and I think that the economic cycle is poor. I think that, for obvious reasons, and I think that interest rate’s going to stay lower for longer which is, by the way, something that we believed without too much conviction since the financial crisis.
So, once again, the pandemic has revealed this continuing or accelerating trends that we’re already in place which is an interesting issue. When it comes to the rest of the world as is the U.S., I think one of the issues that the U.S. has had or the U.S. stock market or publicly-traded stock market has had is that many of the world’s great growth companies are American.
And increasingly, they once driven overall market aggregates that is important to note that things like American small caps have also done pretty well over the last few years.
So, I think what we’re going to see that the broad market in the U.S. will underperform the broad market outside the U.S. but that we may well continue to see the dominance in some of these big market cap names. But I have said, at some point, it’s just a gut feel that it’s been down so long, it feels like up to me.
RITHOLTZ: So, let me ask you a quick question about emerging market. When you first started, EM was a lot of materials and energy. Today, that’s transition to consumer brands and big Chinese technology companies, talk about this transition a little bit and tell us what it might mean for investors going forward.
HALLETT: I think it’s — for investors, it’s a little bit dangerous and it’s something that we’re worrying about at the moment and trying to formulate policy.
The — if you want a diversified global emerging market portfolio, you have to be careful at this stage because Chinese stocks dominate the market benchmarks and the direction is that they’re going to come to dominate that even more.
So, we’re already at over 40% and it looks like we’re headed towards in the 60, 65, maybe even 70 percent. So, Chinese markets that is available to foreigners invest in the benchmarks continues to broaden and deepen.
So, I think that for investors, you have to be very careful about how you consider a diversified emerging market exposure. We’re very much at the stage that we were at in Japan in the late ’80s where Japan dominated the non-U.S. benchmarks at one point, the Japanese market was six — over 65 percent, I think, of the non-U.S. equity index.
HALLETT: And also, Japanese market, about a quarter was Japanese banks which were poorly managed and trading at 15 times book value.
So, a diversified exposure to non-U.S. markets was a very risky one. I think that there are parallels with the dominance of China in the emerging market benchmarks. But they’re not — history rhymes. It doesn’t — it doesn’t repeat itself.
One difference is that Chinese stocks are not dramatically overpriced as they were in Japan in the late 1980s. So, a lot of what’s happened in China, the China to become such a large part in the benchmark hasn’t been through price rising, price is rising. It’s been through more opportunities for investors and that’s actually something that we try to take advantage of at Harding Loevner over the last two years.
So, I think that transition is important for investors when they’re thinking about the riskiness of global emerging market. What that transition actually means for emerging markets is a much more difficult question, I think. And I’ve just note that back in the early ’80s when I started investing in emerging markets before they’re actually called emerging markets, you’re looking at companies like Malaysia, the Philippines by the late ’80s, Indonesia.
But outside of Southeast Asia, it was South Africa and you were just beginning to invest in a couple of latin American countries. And we al thought of emerging markets as being warrants (ph) on the west. If your sgdp grew a little bit more than expect, emerging markets would soar.
And obviously, it was resources and resource consumption that was the common thread that tied the two together. We hoped in the 2000s that the rise of the emerging market middle class would mean that emerging markets would be less volatile, that they’d be less financially leveraged and that the rise of spending of the expensive consumption would be helpful in broadening exposure to noncommodities.
But that was all turned over with a rise of China in the massively rapid industrialization of China. And instead of the west being common thread to commodities that drove the emerging market was China. So, we haven’t really seen the broadening of emerging markets that we’d hoped to see. I think the — we are beginning to see it. I think it will — it is something that still going (ph) come but and that the rise of China has, in some extent, mask what’s happening elsewhere.
But at the moment, with the pandemic coming on, I think that it’s going to be a while before we see the good values that are apparent in some of the consumption stocks in emerging markets being turned into stock market returns.
RITHOLTZ: So, I have to get to my speed round questions. But before I do, a quick question. Outside of China, you mentioned Malaysia, what other countries are intriguing? India, Vietnam, Turkey? Does any specific country call out as well? This could be — if China is the new U.S., what’s the new China?
HALLETT: I’ve always thought that it would be Vietnam. I first went to Vietnam to do investment work over 20 years ago and I followed it. It’s got a large population. It’s got a lot of the characteristics that’s underlying dynamism with a large or largish internal market.
But governance has been an issue. Politics has been an issue. It’s very unusual that you get this mixture that you get in China, top-down government that where you may hate the politics, you may hate the lack of individual freedom, but where at the local level, the ability to be an entrepreneur generate profit to yourself is really quite intense.
I don’t think there’s anywhere else in the world like it, but also has the ability to put the infrastructure that enables the economic growth and wealth creation at the same pace (ph). I obviously can’t think of another parallel.
RITHOLTZ: Quite fascinating. All right. So, let’s jump to our favorite questions, our speed round. These are what we ask all our guests and hopefully it provides a little insight into the man behind the portfolio.
Tell us what your streaming these days? What are you watching on Netflix or Amazon or whatever podcast you might be listening to. What — what’s keeping you entertained during lockdown?
HALLETT: Well, funny, that’s the same things that keep me entertained not during lockdown. I mean, it’s a terrible thing to say. But I live in the countryside in Bucks County, Pennsylvania, and I’ve got a large house (inaudible) to me and my wife and we miss our grandkids but our life is mostly unchanged.
Our idea of an exciting time to sit on our arm chairs with our Kindles. So, but I do miss podcasts and actually, in the last couple of weeks, I used to listen in the car in the way to at work, so in the last couple of weeks, I’ve started going for an hour’s walk every day. And my favorite of the new ones is the second series by Michael Lewis where he’s talking about …
RITHOLTZ: On coaching. Yes.
HALLETT: His theories (ph) on refereeing.
But apart from that, I listen to — I listen to this podcast. I listen to Ted Seides, I listen to Patrick O’Shaughnessy. I listen to the standard behavioral finance-oriented type financial ones. I also listen to ones about sport. And I’m particularly interested in data analytics football.
So, that overlap between sports and investment that I find so fascinating. I don’t watch very much Netflix. I don’t watch very much TV and it’s not because I don’t like it. I actually love it. I haven’t got the self-discipline. My attention wanders and my kids used to get — driven mad when I’d say who’s that guy? And they’ll have to explain.
I also …
RITHOLTZ: That’s very funny.
HALLETT: … against Netflix for behavioral reasons. So, it’s an interesting thing. I used to love the idea of Netflix when we use to get posted (ph) DVDs and I was one of these people who’d order my DVDs on a Sunday and I’d order 1960 strange movies with subtitles or Japanese directors, again, with subtitles.
But on Friday night, when it came to watching a movie, I wanted to watch, “Love, Actually” or some romantic comedy. And again, I think you tend to see everything through behavioral eyes once you know about this. This is the classic. In the short — in the short term, we want fats and sugars, but our long-term self wants fruits and vegetables.
So, again, in the short term, you want to watch a romantic comedy. Your long-term selves says watch something intellectual.
So, I don’t watch much Netflix. The only show I’ve watched in the last month has been something called “The Great” which is a kind of rather surreal mixture between — kind of dark comedy about Catherine The Great. So, I thin — I forget. I think it’s on Netflix.
RITHOLTZ: I’ll definitely check that out.
Tell us about us about your …
HALLETT: Yes, worth it.
RITHOLTZ: … early mentors. Who influenced the way your career developed, who helped shaped your investing philosophy?
HALLETT: Well, I don’t — I don’t mean to be — I don’t mean to be dismissive but the people that I’ve worked with and for in the early stage of my career was during that time when investment management was about individual genius. It was about people being smart, smarter than other people, not being — you have to know more. You had to speak — be smarter, you had to — it wasn’t about structure and discipline.
So, the people that I worked with really were examples and I — they were great people and I enjoyed them very much and they treated me very well. But everything I learned from them, we’ve overturned at Harding Loevner. I often say that if you look at anything about what are those firms that I work at which were successful firms, we do it the opposite at Harding Loevner. So, they were kind of negative mentors and I don’t mean that to be rude about them.
So, I very heavily relied book learning and what we’ve learned at Harding Loevner and my longest standing relationship is with David Loevner who’s been a friend of mine since the mid-’80s and a business partner and close collaborator now for 30 years. So, David would deny it but I’ve learned a lot from David over the years.
RITHOLTZ: You mentioned you enjoy sitting in your EZ chairs with a Kindle in your hand.
RITHOLTZ: What are some books you’re reading now and what are some of your favorite books?
HALLETT: Well, I — a lot of my favorite books would have mentioned on your podcast before. I do need to mention that we owe a great debt to Michael Mauboussin. I often said it is remarkable that you can get his complete works for less than 50 bucks and you can learn everything that I’ve learned in 40 years about decision making and investment.
I’ve give a shoutout to Russo and Schoemaker, that book 2002, I think winning decisions which I think is one of the best books about decision making and doing research. It doesn’t get a lot of attention.
I read a lot of novels which is very personal. The best book I’ve read in the last few years and probably the best book I’ve read in my life was last yar when I read Robert Caro’s four-volume biography of LBJ which sounds daunting. I don’t — it must 3,000 or 4,000 pages in length. I read it on a Kindle, so I can’t tell you exactly what it weighed (ph).
But it’s a superbly written book with — which with often novelistic like descriptions of, for example, life in the Texas Hill Country in the early part of the 20th century. But it’s much more social and political history of the U.S. in the first half of the 20th century.
It’s brilliant on politics. It’s brilliant on the political process, it’s brilliant on corruption, and the corruption of power. But above all, the third volume, “Master of the Senate” is brilliant on race (ph) on the length that 12 senators from the south went to keep institutionalized racism the norm.
So, one book that I’m reading at the moment is actually I’m started again and I just finished the first volume, “The Passage to Power.” But I think it’s topical now and I thoroughly recommend everybody read it and you can only bring yourself to read one, read “Master of the Senate.”
And on the subject of institutionalized racism, I think everybody should read Dan Bauer’s (ph) book called “American Prison” which is — so, Dan Bauer’s (ph) a journalist who has a political point of view. I think he writes for Mother Jones but he experience incarceration in Iran for four years and then put himself as a prison guard in the American penitentiary system and the book has this very interesting structure of observations of a prison guard in the American penitentiary system today that was appalling as you can imagine.
But every other chapter is a history of the penitentiary system and I think, that in itself, is fascinating and gives a lot of explanatory powers (ph) where we are today with mass incarceration in the United States with incarceration — incarceration being dominated by African Americans and I find that appalling and I think that Caro goes a long way to describing why racism is so institutionalized in this country and Dan Bauer (ph) goes to explaining how it’s reflected in our prison system.
RITHOLTZ: Quite fascinating. What — what sort of advice would you give to a recent college graduate who is interested in a career in investment management?
HALLETT: Well, firstly, I’d say don’t think that you know what career you are going to be best at or have the most fun at when you’re a recent college graduate. Give it a try but be prepared to give it up.
I think (inaudible), in range, talks a lot about this. It’s a very good book on career planning. But if you are determined to be an investment management, I think you have to recognize that it’s industry that is both blessed and coursed. It’s blessed by the fact that everything’s relevant.
So, to your great intellectual curiosity which I think is necessary but not sufficient for being a good investor, everything’s relevant. So, you have a license to go and find out anything — anything you like and I think that’s a wonderful thing.
But it’s also a course and that you’d don’t know where to stop and that’s actually one of the lessons of Russo and Schoemaker book. Just finding out more, just for the sake of finding out more. Makes you feel better about individual decisions. It gives you more confidence but it doesn’t help the accuracy or the validity of that decision. So, be careful.
But the most advice that I can give you — that I would give anybody is just stay on it, don’t let anyone compromise your integrity. This is a fabulous industry to be in. I’ve been very, very lucky that it’s — my career in time has been one where the investment industry was tiny to where it is today, where it’s huge.
So, basically, all you needed to do is to be sensible and stay on it and I don’t know that the industry is going to grow as much as it’s grown over the last 14 years but I do think it’s going to be absolutely critical (ph) just to stay honest and you, at least, get yourself a good chance of capitalizing on any success you may have.
RITHOLTZ: Quite fascinating. And our final question, what do you know about the world of international investing today that you wish you knew when you were first starting out over three decades ago?
HALLETT: The importance of — to me, the behavioral finance findings and more generated decision-making findings. It’s a very, very different world of investing today. When I started, I’ve had a good education. I was widely read. I was kind of curious as a young guy.
And I didn’t know anything about stocks. Nothing. Nobody in my family had ever mentioned a stock. Nobody ever owned one. I barely knew how a bank worked.
Today, finances is — finance is pervasive throughout the media and throughout, to some extent, anyway, the education system. So, the world of investing is very, very different but the world as human beings is very much the same and I wish I’d known earlier on, just how important it was, not to be smarter and no more than everybody but to be able to control your own behavior.
But partly, I found it fascinating. But also, I think it’s at the core of why we’ve gone from being smart people who knew a lot to being intelligent investors.
RITHOLTZ: Makes a lot of sense. Thank you, Simon, for being so generous with your time. We have been speaking with Simon Hallett of Harding Loevner which manages about $73 billion.
If you enjoyed this conversation, well, be sure to go to Apple iTunes, or Spotify, Overcast, Stitcher, wherever finer podcasts are sold and you can find any of the previous 350 such conversations we’ve had over the past six years. It’s actually — this week is our sixth year anniversary.
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I’m Barry Ritholtz. You’ve been listening to Masters in Business on Bloomberg Radio.