Market Commentary – May 2019
Managing the Managers
This May, I was invited out to Manhattan, NY for a due diligence trip with First Eagle Investment Management. First Eagle has been the only money manager that I have used throughout my 17 year career in this business and one of their funds was the first fund I ever sold a client. They have always taken a thoughtful approach to portfolio construction and follow the mantra of being patient and investing in businesses rather than trading in and out of pieces of paper. Being that I have been invested with them for so long, one might ask – well why the trip to the mother ship for a due diligence trip? Don’t you know everything there is to know about the money manager… their buy/sell discipline, portfolio construction, etc.? Yes, I do – however just because you hire a manager to run money for a part of your overall strategy doesn’t mean that you “Set it and forget it”… you still have to “Manage the Managers”.
During my visit I was able to meet/listen to their CEO Medhi Mahmud, their head Portfolio Manager Mat McLennan, their Director of Research Matt Lamphier and the Head of Value Investing at Columbia – Bruce Greenwald. Although I don’t like taking time away from the office especially during the work week, I thought it was important to spend the time re-reviewing why I had hired this money manager to be a steward for my client’s capital. Here were some of the interesting tid-bits that I took away from the sessions.
Matt McLennan had many great lines during his presentations, but I have included those here that stood out most to me – they are as follows:
- Very few assets can withstand long term impairment of capital – the survivability factor of a business is important
- Interest rates are being kept below the growth of money supply – that’s why T-Bills are no longer “Risk Free”
- As companies reinvest each year they generate the equivalent of economic tree rings
- You have to be careful owning passive equity exposure after periods of margin expansion, P/E expansion & debt accumulation – cheap beta may not be a panacea
- Unusual Fiscal Policy has artificially kept markets buoyant – what will this do to affect of the next economic downturn?
- China has been the epicenter of global debt creation/accumulation over the last decade – Chinese M2 has greatly overtaken US M2 even though it’s a smaller economy — too much debt leads to low interest rates
- Corporate Boom/Bust in the 90s, Household Boom/Bust 2000’s, Govt. Debt Accumulation Next??? (Difference is Govts can print money!)
- Political Populism, Rise of Autocracy, China #2 spender on military globally (In excess of Japan, EU, Russia)
- We view ourselves as business gardeners – planting seeds, letting trees grow/pruning weeds
- We are great believers in “Selectivity” – Start with the balance sheet, debt is the greatest killer of companies/equity
- High growth money supply with repressed interest rates – need to own scarce assets… scarce tangible vs. scarce intangible – looking for unlevered free cash flow yields of 5%+ – more of our investment is focused around scarce intangible assets over commodities
- Gold is unique in that it’s not industrially useful – growth of supply is predictable, unlike fiat currency – it has preserved it’s purchasing power over time – we use gold as a hedge instead of purchasing derivatives (No counter party risk) as it tends to move inversely to equity markets – the more stocks tend to drop the more negative the correlation becomes
- The US Dollar is being held up by interest rate differentials around the world
- High debt levels tend to be deflationary – so is technology/automation/low cost of labor from globalization – central banks are coming up with creative ways to prevent deflation
Bruce Greenwald who’s quite the character had a few choice contributions:
- I don’t think interest rates are necessarily driving equity valuations – in 1990 US moved from manufacturing led economy to services – “Enemy of profitability is competition” – you have to dominate the local economy with scale, access and distribution
- Manufacturing is more centralized vs. services which can be more locally delivered – rise of the service economy has also led to greater inequality of income
My greatest take away from spending time with First Eagle was the clear focus and intention on being stewards of their investor’s capital. This was the reason they were the first financial product that I ever convinced a client to purchase and also why I still continue to use that same product to this very day. I did however realize a few things during my trip 1) It’s possible that the fund does at times hold too much cash… we hire managers to invest 2) The PMs may not be owning enough of their favorite ideas… if you love an investment and have the rationale to back it up, shouldn’t you hold more than 2% in it? 3) The statement that they don’t rely on catalysts for their companies when they make investments because the future is too uncertain… agree that no one has a crystal ball, BUT unless there’s change moving forward where will the creation of value come from to move the value of the asset higher? Although I have full faith in their investment process, my take away from my Due Diligence trip is that I have to “Manage the Manager”. I’m the final allocator of capital for my clients there are times when I need to give more of my client’s capital to an investment manager and times that I may take capital away. The investments in our client portfolios are like the instruments in an orchestra…as the maestro it’s our job to determine which instruments should be played and when to make that beautiful music! As in all things in life – The only constant is change… our investment process will continue to evolve over time. I thank First Eagle for their hospitality, their stewardship and the opportunity to sit with some of the sharpest investment minds in the world.
Securities offered through M.S. Howells & Co. Member FINRA/SIPC. Advisory services offered through Koa Wealth Management. M.S. Howells & Co. is not affiliated with Koa Wealth Management.
Koa Wealth Management
11260 El Camino Real, Unit 220, San Diego, CA 92130