In this episode of The Acquirer’s Podcast Tobias chats with Lawrence Hamtil. Lawrence is a Principal and author at Fortune Financial Advisors which offers independent financial planning and wealth management services. During the interview Lawrence provided some great insights into:
- Why Investors Will Achieve Better Results By Focusing On Sectors, Rather That Value Or Growth
- The US Stock Market Provides Greater Diversification Than The Rest Of The World
- The Sin Premium – Sin Stocks Can Be Very Profitable
- While US Markets Might Be More Expensive That Doesn’t Mean You Should Sell Apple To Buy A Bunch Of Cheap Mining Stocks
- Mid-Cap Stocks Are Better Performers And Rebound More Quickly Than Other Sectors
- The Low Volatility Anomaly – Low-Volatility Stocks Have Higher Returns Than High-Volatility Stocks
- It’s Not Small-Cap Versus Large-Cap, Its Getting Exposure To The Right Sectors
- Too Much Time Is Spent On The Question Of Whether We’re Growth Or Value Investors
- What Brand Of Tube Socks Do You Recommend?
You can find out more about Tobias’ podcast here – The Acquirers Podcast. You can also listen to the podcast on your favorite podcast platforms here:
Tobias Carlisle: When you’re ready, sir.
Lawrence Hamtil: Let’s go!
Speaker 3: (singing)
Tobias Carlisle: Hi, I’m Tobias Carlisle. This is The Acquirers Podcast. My special guest today is Lawrence Hamtil of Fortune Financial Advisors. We’re going to talk about sin stocks, we’re going to talk about sectors, and how that impacts value and growth, international and domestic, and lots of other interesting stuff. We’ll be talking to Lawrence right after this.
Speaker 3: (singing)
Speaker 4: Tobias Carlisle is the founder and principal of Acquirers Funds. For regulatory reasons, he will not discuss any of the acquirers funds on this podcast.
Speaker 4: All opinions expressed by podcast participants are solely their own and do not reflect the opinions of Acquirers Funds or affiliates.
Speaker 4: For more information, visit AcquirersFunds.com.
Tobias Carlisle: Hi, Lawrence! How are you?
Lawrence Hamtil: I’m doing well, Toby. How are you doing?
Tobias Carlisle: I’m very well, thanks. Let’s dive into it. I’ve been following you for a while on Twitter, and the thing that you speak about most is the impact of sector weightings on various different analyses of the market, and how some of the things that we think about, value versus growth, we think about large versus small, or US versus international, you say that there’s this undiscovered or undiagnosed sector bit that’s driving a lot of those returns.
Tobias Carlisle: So, let’s talk about that in the value versus growth context first.
Lawrence Hamtil: Sure.
Tobias Carlisle: You say that there’s… no value premium in large cap, there’s a value premium in small and mid. But you say that a lot of the returns over the last few decades have been driven by sectors more than by value or growth.
Tobias Carlisle: Can you explain what that means?
Lawrence Hamtil: Yeah. Well, I think, first off, when I talk about the lack of a value premium and large caps, it’s classically defined as price-to-book. I think other metrics might show some better results.
Lawrence Hamtil: But if you look at sort of the past 20 to 30 years of, let’s say, the Russell 1000 growth versus value indices, you typically have in the growth portfolio a lot of technology and healthcare, and the value portfolio, a lot of banks and energy. There have been a couple of different cycles; the late nineties, where healthcare and tech did really well; banks and energy didn’t do so well, so it kind of gave this image that growth was killing value.
Lawrence Hamtil: And then, that reversed in the 2000’s when oil prices took off, and there was kind of a global financial bubble, so to speak. Conversely, tech stocks cratered after the tech bust, and so value kind of reclaimed the lead.
Lawrence Hamtil: And then, of course, we have the financial crisis, and energy prices have plummeted, and now growth is kind of retaking the lead. There’s this cyclical nature to this, but in my mind, it’s not so much growth versus value; it’s these huge weightings of certain sectors in one index, and under-weightings in the other.
Lawrence Hamtil: And some different analyses I’ve looked at, for example in technology, where so-called value technology stocks have actually outperformed the overall growth index. So, it seems to me the conclusion should be that technology, no matter how it’s defined, has done really well, and energy and banks, no matter how they’re classified as growth or value, haven’t done as well.
Lawrence Hamtil: That’s kind of how I understand these things, and how I’ve come to look at it, and I think it’s helpful to unwrap these indices sometimes and kind of look under the hood and see what’s really driving one thing or another. Is it the valuation, or is it the sector weightings that are, of course, effected by what’s going on in the global economy? And so forth.
Tobias Carlisle: Is it a definitional problem of value? Is it using price-to-book to classify these things? Do you improve your results by using the flow metrics, like cashflow or earnings?
Lawrence Hamtil: I think looking at a lot of different metrics, a lot of research has shown that having kind of a combination of things does improve your results, and the other thing that allows you to do is it allows you to stay away from absolutes.
Lawrence Hamtil: So, if you have a lot of different metrics, you can kind of create a more sector-neutral approach so you’re not making implicit sector bets, and I think that overall reduces the tracking there. Of course, certain industries like technology, they might be cheap on a PE basis but expensive on a price-to-book basis. So, if you just use price-to-book, you would not have much exposure there, but if you used a kind of multi-tool approach, you would have a lot more balance, I think.
Tobias Carlisle: Let’s just go back to one of the first things you said. When we look back over the last 30 years, for example, that’s three pretty clear cycles in my mind. There’s the 1990’s, which ends with the dot-com bubble kind of bursting.
Tobias Carlisle: But in that run-up, that’s tech massively outperforming, and healthcare massively outperforming, and those were classified by price-to-book as growth stocks. Because they were expensive through that period.
Lawrence Hamtil: Sure.
Tobias Carlisle: And then, following, the next decade, there’s a tech wreck and there’s this energy and financial super-cycle, and price-to-book for whatever reason classifies energy, or tends to classify energy and financials as value, and tech continues to be classified as growth, and so value gets this really nice tailwind through that period.
Tobias Carlisle: And then, in the last 10 years, that’s reversed again, where we’ve had the credit crisis, so financials have been hurt really badly. The energy, oil prices have dropped, so energy stocks have been hurt really bad. Then we’ve had that second coming of the dot-com, and so, it’s looked like a growth decade again.
Tobias Carlisle: But what you’re saying is that if, instead, you remained sector-neutral through that period, rather than dividing those sectors on the basis of value, that you could have done better, and the example you give of that is that tech value names have done better than the tech index or other tech names.
Lawrence Hamtil: Yeah, yeah. I mean, to clarify, I looked at, say, for example, the Russell 1000 sub-indices, and they have the sub indexes for value and growth, and so, the Russell value technology stocks outperformed the Russell 1000 growth index, I believe, over the last decade.
Lawrence Hamtil: So, it’s hard for these companies, no matter how cheap they are, to overcome certain macro headwinds. And I’ll throw another variable, which is inflation in the currency. From 2000 to 2008 or so, the US dollar lost something like 40% of its value versus other currencies; well, of course a weak dollar is good for energy prices, and so, that’s going to be a big tailwind for these value portfolios.
Lawrence Hamtil: And that has reversed since the financial crisis with the dollar having appreciated fairly substantially, especially over the last five years. So, these stocks, they might be cheap, but they’re probably going to continue to stay cheap until some of these external factors alleviate a little bit.
Tobias Carlisle: If you, on an unconstrained basis, do you think that this is… Which sectors do you think are more likely to outperform at this stage of the cycle?
Lawrence Hamtil: It’s hard to say. I mean, there’s definitely going to be a little bit of mean reversion over the long-term. Personally, I try to stay somewhat sector-neutral in the portfolios that I manage. Most of my clients, they’re not really interested in having a lot of tracking error. So, we try to stay pretty close to the overall weights in the index.
Lawrence Hamtil: But I will say that we tend to have a little bit of overweights in technology, healthcare, and consumer staples. But that’s also where we happen to like most of our individual names. We would be less likely to take big, concentrated bets on what we think are more cyclical sectors; financials, energy, materials. Even though that might be where some of the cheaper names are.
Tobias Carlisle: The sector analysis extends beyond just value and growth. One of the interesting blog posts that you have on your site, you talk about… and this is a discussion that’s ongoing on Twitter at the moment, that the US on, say, a [inaudible 00:09:51] basis seems to be extremely expensive, and the rest of the world seems to be cheaper.
Tobias Carlisle: But you say that that’s largely, that’s the composition of the rest of the world versus the composition of the US, and if you make adjustments, that sector composition, if you adjust for that sector composition, the rest of the world starts looking much more expensive and the US looks a little bit cheaper.
Tobias Carlisle: And that’s because the US has a lot of consumer staples that the rest of the world just doesn’t have, and the rest of the world tends to be more financials and materials.
Lawrence Hamtil: Right. No, I think that that’s fair. And I think if you look at, for example, Europe, it’s been pretty much kind of a quote-unquote “lost decade” for European stocks. If you look at the, let’s say, MSCI Europe. But if you look at some of the European sectors individually, healthcare and staples have done reasonably well. They just happen to be relatively small weights in the index.
Lawrence Hamtil: But that also sort of obscures what you’re talking about with the overall valuation, and so, in a globalized marketplace… For example, let’s look at a company in the Europe market, Nestle. It’s a global, multinational; Switzerland alone doesn’t have enough people to support other products that Nestle wants to sell. So, they have to go abroad to sell their products.
Lawrence Hamtil: Well, of course, in this atmosphere of multinationals and globalization, a lot of these similar companies are going to be priced fairly similarly. And that’s true when you look at, let’s say, European consumer staples versus US consumer staples and so forth, where you tend to get the bigger divergences in valuation or in what you might call the static industries like utilities and financials.
Lawrence Hamtil: But again, they’re fairly cheap for a reason. They tend to have a revenue base that’s purely domestic; they might be more highly regulated. So, you kind of have to do a little bit more digging to see what the truth is there. What are you really buying if you’re buying these cheap foreign markets?
Lawrence Hamtil: And to your point, they simply aren’t as diverse as the US market. There’s, I think, some cultural aspect to this, as well. In the Anglo-Saxon countries, you’re familiar with Australia, the US certainly, Canada; there’s a lot more equity reliance, and some of the European markets, Germany, France and so forth, they might be more reliant on the banking system for financing. So, the equity universe is relatively limited.
Lawrence Hamtil: And I think that that’s a under-discussed factor in this conversation, as well.
Tobias Carlisle: That’s not something that I’ve encountered before. Are you saying that this is in a startup-type context, that the Europeans tend to rely on debt rather than equity?
Lawrence Hamtil: I think that that’s true. There have been some studies that I’ve read in the past where a lot of… For example, in Germany, a country I’m somewhat familiar with, a lot of the businesses tend to be family-owned and somewhat closely held. And so, in the bigger stock market in Germany, you tend to have a lot of big blue-chip companies that are pretty much the same as they’ve been for decades: Siemen’s, BASF, Deutsche Bank, BMW and so forth.
Lawrence Hamtil: They don’t have the kind of creative destruction that you might see in the US, where every five or 10 years, the major leaders are changing. It’s a little bit different when you’re looking at historical valuations and so forth. In Europe, you tend to be betting on the same horses year after year. In the US, there’s a lot more… not necessarily turnover, but there’s a changing of the guards, so to speak.
Tobias Carlisle: Being Australian, I’m very familiar with the Australian index, and so, in trying to construct a sector, or try to construct a more balanced portfolio in Australia return money, that was one of the issues that I encountered, that the Australian index is a lot like the Canadian index. And for folks who don’t know what it means, it’s about half financials. Which is a huge bit, which sounds unusual.
Tobias Carlisle: And then, I think it’s about a third basic materials, which might be what you’d expect, which is mining and so forth. But then, if you try to find… if you use a research affiliate’s fundamental index, which tries to get to the underlying revenues and profitability and so forth, rather than just market capitalization, where it doesn’t actually help much at all because that’s just the size of those industries in the countries.
Lawrence Hamtil: Sure.
Tobias Carlisle: And that’s one of the great things about the States, is it does have a very, very substantial technology sector. Very substantial consumer staples and so on, that do seem to be pretty good industries for the most part. And I think I saw something, that the [inaudible 00:15:17] stocks, or the technology stocks, at least, are the reason why the US has outperformed over the last decade, whereas the rest of the world has basically stagnated.
Lawrence Hamtil: Yeah, I think that that’s probably true, and for whatever reason, if you look at it from even an immigration standpoint… I don’t know the exact numbers, but a lot of companies here in the US are founded by immigrants, and people tend to come here and…
Lawrence Hamtil: Look at Google, for example. They emigrate to the US and they start these huge companies that are successful, and that just doesn’t seem to be the case in a lot of foreign markets. Whether it’s regulatory, cultural, I don’t know, but the phenomenon is there. And it does make…
Lawrence Hamtil: I made the comment before, when you talk about home bias, that we’re often told as American investors to diversify abroad, but the reality seems to be that the US market diversifies the rest of the world for foreigners. Just because it’s so deep and there’s a lot of very diverse industries from which to choose, it would be very difficult to build a very diversified domestic-only portfolio in most other countries, except maybe Japan.
Tobias Carlisle: And one of the things that you’ve suggested to correct for that as a US investor looking to go abroad, is to look in each sector and just find the better companies in each sector, and then buy them regardless of where they are. So, that’ll still mean that you have a very large US weighting, but you may end up with some more international exposure.
Lawrence Hamtil: Yeah, I think that that’s true. If you look at the global equity portfolio, it’s something like 55% US, 45% rest of the world. But if you look at it from a sector standpoint, which I believe has kind of started to dominate the discussion versus regional or country factors, you probably will end up with a lot more US companies, and I’m just guessing here, but it might be something like 80% US, 20% foreign.
Lawrence Hamtil: But that’s not just looking back over the past decade of US dominance. It’s just looking where the opportunities are, where the best-run companies are, how they treat their shareholders, returning cash, et cetera. That’s just happened to be what I think is fundamentally true regardless of relative valuations and so forth.
Tobias Carlisle: One of the interesting things that I saw in that US first, it’s the international blog post, is when you talk about materials as a sector. And then you break down the materials sector even further to illustrate something interesting about the US versus the rest of the world.
Tobias Carlisle: So, materials in the US tends to be dominated by industrial chemicals, which you say is a much better business than materials in the rest of the world, which tends to be metals and mining.
Lawrence Hamtil: Yeah, I think if you look at it, mining’s kind of a tough industry, right? It’s very capital-intensive; the end product is basically fungible whether it’s mined in Arizona or Indonesia; there’s not much of a competitive advantage except for maybe the assets that you own and your cost of extraction and so forth.
Lawrence Hamtil: But it’s not like, for example, Apple competing with Samsung, iPhone being different from an Android phone. I mean, copper and gold are pretty much the same, no matter where they’re extracted from the earth. And of course, it’s very cyclical.
Lawrence Hamtil: That industry’s tough, and it probably deserves to be trading at a lower multiple than, say, industrial chemicals, which are also cyclical but slightly less so. And of course, you have the ability to differentiate your products and so forth.
Lawrence Hamtil: When we look at these relative valuations by sector, that’s very helpful, but you also have to go through and look at the sub-industries, too, and really kind of take a scalpel to these indices to see exactly what you’re buying, because you are making a bet on those underlying industries.
Lawrence Hamtil: So, I think that’s what… and it makes sense, too, that these foreign material sectors would be dominated by mining, because kind of like utilities and banks, you can’t move the mine to another location. It’s static, right? So, it’s going to be purely domestic or wherever those assets are owned.
Lawrence Hamtil: Chemicals, you can kind of make those just about anywhere, as long as the facilities are in place. It’s a lot of variables going on there, for sure.
Tobias Carlisle: And one of the, just to illustrate the point that you make in the blog post, you say… telling people to lighten up on their US exposure is something like telling them to lighten up on apple to increase their exposure to BHB [inaudible 00:20:33], NHSBC.
Lawrence Hamtil: Right. Yeah, I mean, that’s basically, it’s a little bit of a bitter pill to swallow, so to speak. Well, let me reverse what I said and say, it’s an easier sales pitch to your client to say, “The US is expensive, the rest of the world is cheaper.” I don’t know that many clients would respond, if you actually said, “We’re going to sell your Apple and buy a bunch of mining stocks.”
Lawrence Hamtil: They might think, “Okay, hold on a second. That doesn’t sound so appealing,” right? But that’s basically what you’re doing by making that trade, and I think we haven’t even discussed the currency impact, which I believe is kind of the main driver of excess returns, one way or another, the US versus the rest of the world.
Tobias Carlisle: Well, let’s talk about the currency.
Lawrence Hamtil: Sure! Well, I just posted to Twitter a couple of graphs, just looking at the impact of, say, Switzerland, which is a country that has a history of a strong currency. And I think it’s appreciated something like one percent per annum, versus the US dollar over the last century, something like that. So, it’s not a country with a history of high inflation, where currency’s going to be a real big issue.
Lawrence Hamtil: But looking at relative valuations, there doesn’t seem to be much of a pattern over the past 40 or so years where Swiss stocks were cheaper, and so they did better than the US over the subsequent decade. It really has more to do with the US dollar being weak or strong.
Lawrence Hamtil: And so, most of my work has shown that any time the US under-performs, it’s usually because the dollar’s been weak. And when the rest of the world under-performs, it’s because the dollar’s been strong.
Lawrence Hamtil: It’s a hell of a headwind to have to overcome the currency translation, and I think that that’s something that a lot of people don’t take into account. Now, personally, I think when you own foreign stocks, the main benefit is for currency diversification; I mean, the dollar’s not going to be strong forever. We just talked about the period from 2000, 2008 when the dollar declined substantially.
Lawrence Hamtil: So, I don’t want to be perceived as saying, don’t own any foreign; I just want to understand that it plays a certain role in your portfolio, and I think the currency aspect is the bigger aspect, versus just trying to outperform on a valuation basis or something like that.
Tobias Carlisle: That’s interesting. One of the other places where you say that sector has a great deal more influence than the traditional classification is large cap versus small cap. And you say that it’s defensive sectors that tend to be… defensive tends to turn up more in large cap, and there are more cyclicals in the small cap.
Tobias Carlisle: Am I mangling what you’re saying there?
Lawrence Hamtil: Well, I think to some extent, it’s true, but the, for example… And small value tends to have a lot of regional banks.
Lawrence Hamtil: The large cap pool, of course, is going to be dominated by big multinationals that derive something like 30 to 40% of their revenues from overseas. Small caps are probably going to be more domestically oriented, so I think they’re probably more tied into the cyclical nature of the US economy alone.
Lawrence Hamtil: But broadly speaking, I think, looking at the numbers, a lot of the… depending on how you’re defining it, and looking at each sector, consumer staples for example, tend to exhibit the same characteristics whether they’re large, medium or small cap companies.
Lawrence Hamtil: Obviously, energy companies; small, medium, or large are to a great extent going to be subject to whatever happens in the energy markets and the price of oil, for example. So, when we look at a small cap premium, I think it’s very…
Lawrence Hamtil: Well, in a few sectors, maybe, that small caps have actually delivered a higher risk-adjusted return than large caps, but broadly speaking, just as we talked about with the foreign versus US, large versus small, these companies aren’t operating in a vacuum. And they’re going to be subject to the same macro factors, and they all tend to exhibit the same characteristics in an upturn or downturn, despite what size they are.
Lawrence Hamtil: Of course, small caps are probably going to be more volatile as a class, just because they’re less diversified, maybe have lower credit ratings and so forth, but yeah, broadly speaking, I think the sector and industry factors dominate this discussion.
Tobias Carlisle: One of the analyses that you do in this blog post is you talk about sectors like consumer staples, utilities, and healthcare, which are traditionally defensive sectors, and then you do several different analyses of them. You say that they have better return relative to the risk where we’re defining risk as volatility, here. They tend to have shallower and shorter draw-downs, and on a rolling 60-month basis, which is a rolling five-year basis, they tend to have better maximum draw-downs so that…
Tobias Carlisle: The worst performance is better over those periods of time.
Lawrence Hamtil: Yeah, and I think that that’s just more evidence to show that utilities are utilities, whether they’re large, medium or small. They have relatively stable cash flows, they’re not cyclical; even in a downturn, people have to pay their electric bill and so forth.
Lawrence Hamtil: Consumer staples, you look at the S&P 600, and those are the small cap consumer staples sector; it’s going to be companies like WD-40, Cal-Maine Foods. I mean, these are basic things that people have in their house all the time pretty much regardless… It’s not to say that they’re great investments all the time, but they just tend to have more predictable cash flows.
Lawrence Hamtil: Healthcare’s a little different. Small cap healthcare tends to be a lot of biotech and things like that, which are not exactly known for their stability and share returns. But yeah, I think if you look at it from those different risk metrics, whether it’s draw-downs or worst returns over any five-year period, they’re all going to be fairly similar because they’re all interacting with, like I said, those same macro factors.
Lawrence Hamtil: I think one analysis I did was showing the relative performance of consumer discretionary versus consumer staple stocks, relative to the change in jobless claims. And I think it was something like maybe a third or so of the relative returns of consumer staples versus discretionary could be explained by the jump in jobless claims, of course, during recessionary periods.
Lawrence Hamtil: And that was true for the small cap sectors as well as large cap, which kind of gives a little bit more evidence that these things are not acting in a vacuum, as I’ve said.
Tobias Carlisle: One of the interesting things for me that came out of that post of yours, and this is something that an earlier guest, Ben Clamen, a point that he made, too; he said that mid-cap has tended to be the better market capitalization region to be in, and it’s delivered returns that are something like the returns to small cap, which have tended to be a little bit better, but it’s done that on a risk basis that looks more like large cap, so you get a little bit of the best of both worlds.
Lawrence Hamtil: Yes, and I think that that’s something that I’ve looked at, as well, and my theory behind that is that the mid-cap companies tend to be better, more higher quality, shall we say, than small-cap companies, but they tend to be less picked-over than the large-cap. I think that they’re, probably have as a whole fewer analysts digesting their performance all the time. And so, they have this perhaps kind of an ability to be under the radar and still be worthwhile investments, that not everybody is looking at the so-called celebrity stocks and the large-cap sphere.
Lawrence Hamtil: So, yeah, I think whether you look at it from a risk-adjusted standpoint or even just an absolute return standpoint, they have been better performers. And when I do this kind of analysis, I always try to look at duration of draw-downs and the depth of it, and over the past several decades, mid-caps have tended not just to be the best performers but also, they’ve rebounded more quickly in general than other sectors of the market. And they’ve tend to had a little bit shallower draw-downs certainly than small caps.
Lawrence Hamtil: So, I think that’s kind of the sweet spot, if you will, of the market. It has been historically, anyway; whether or not that it continues is, of course, anybody’s guess, but history would say that that’s where you would probably want to be.
Tobias Carlisle: Yeah, I tend to agree with you. I think that there are a few factors at play. One of them is that by the time they get to that size, they tend to have professional management, and they’re sufficiently well capitalized that they can survive some of the little bumps in the business cycle.
Tobias Carlisle: And then, in addition to that, there’s an enormous amount of professional private equity and professional activism that hunts in that region from sort of one billion to 10 billion, or two billion to 10 billion dollars. So, if they get out of line a little bit, there are…
Lawrence Hamtil: Right.
Tobias Carlisle: There are professional investors in there who are trying to push them back. And then, the other reasons you identified, too; they’re just not as picked over, so they tend to be a little bit cheaper. I don’t know if that’s always the case. It might not be the case. Remember, they have tended to be a little bit cheaper. Mid-cap is my favorite area.
Lawrence Hamtil: Yeah, and I think those are all very good points. I haven’t done this analysis, but I suspect it’s true in many foreign markets, as well. Just speaking from some rough analysis I did a while ago, I know in Germany, too, for example, that tends to be where the real dynamism is in their economy, is in the middle-sized companies.
Lawrence Hamtil: I don’t know how diverse it is on a public market basis, but I think that there’s a little bit of a under-discussed aspect of dynamism here, like what you’re saying, that if they get out of line, maybe outside investors will pressure them to make changes, something like that.
Lawrence Hamtil: It might be a little bit easier to accomplish that in a smaller company than a larger one. I’m not sure.
Tobias Carlisle: The ideas that you’re proposing are… radical’s probably the wrong word, but they are quite different to the way that we traditionally think about asset allocation. So, you’re saying that it’s not a value versus growth, it’s not US versus international, it’s not small-cap versus large-cap; it’s getting exposure to the right sectors.
Tobias Carlisle: How do you implement that for clients? What does your portfolio or your model portfolio, how does that end up being constructed?
Lawrence Hamtil: What I try to do, and of course it varies from client to client, but we look at, first of all, the global equity portfolio which includes emerging market countries. And we want to say, “Okay, well, what type of exposures do we want for each client?”
Lawrence Hamtil: Some investors might be on the more conservative, lower-risk side of the spectrum, and so they’ll probably have a little bit more exposure than others to classically defined, low-volatility sectors whether it’s staples and healthcare… not as many utilities, to be honest, especially where they are in this cycle. They tend to be a little bit driven by interest rates more so than other factors, so I am not as well-versed in that part of the market.
Lawrence Hamtil: But broadly speaking, looking at the average client, the sector exposures are benchmarked to the S&P 500, and we look at those weights and we try to be not necessarily too different from that benchmark, but it’s going to stray a couple percentage points here and there.
Lawrence Hamtil: And of course, the way I define things might be a little different from how the index providers define it. For example, in financials, I don’t have a lot of bank exposure, but I think of my financials exposure as maybe service companies, like a Visa or MasterCard, which I’m not mistaken might be classified as technology. I’m not 100% sure.
Lawrence Hamtil: So, the way I approach it is slightly different, where the sectors overall, in my mind, are not too different, but the sub-industries might be a little different from the benchmark. Again, kind of to sum that up, we try to be sector-neutral but with an element of customization, and that’s not just on the US-versus-rest-of-the-world allocation; it’s also with the industries within each sector.
Tobias Carlisle: And one of the things that I’ve seen you speak about or tweet about is some of the tobacco stocks. You like tobacco as an industry?
Lawrence Hamtil: I do. Personally, it’s one of my largest holdings as far as an industry goes. I think you have a lot of positive things going for it, which is you have a huge barrier to entry because of the regulations. Kind of the ban on advertising makes it difficult for new players to compete. It also allows the companies to return a lot of cash to shareholders.
Lawrence Hamtil: I think if you look at the products, even though the absolute or the percentage of people smoking in the US has been declining steadily, the absolute number has more or less stayed the same. Of course, the population has grown, changing the percentage, but what you see there is the ability of these companies to raise prices again and again, and so, their profit margins have been high. And they’ve continued to make money even as their product sales have declined on a somewhat continuous basis.
Lawrence Hamtil: Globally speaking, out of seven billion people, I think the number’s a billion who still smoke. And so, there’s still a demand for these things, for better or worse, and I think in an industry that is dominated by a few companies around the world that are relatively insulated against competition, there’s a lot to be said for it.
Lawrence Hamtil: Of course, you can look back historically and see that there’s a lot of potential there. Currently, the industry is out of favor, but there’s a element of cyclicality to it. People tend to not want to own these companies because their products are harmful to people, and that tends to push the valuations lower. But that also tends to be a boon for the people who are willing to own then, because as you know, lower valuations tend to work themselves out to higher forward returns.
Lawrence Hamtil: That’s the so-called sin premium, if you will. Yeah, I think that there’s a lot to be said for it. Past results of course don’t indicate anything as far as what the future may hold, but I do think the fundamentals of the industry are still relatively strong, especially on a global basis.
Lawrence Hamtil: And for people who are interested in owning the shares, I think personally, like myself, you just have to understand that there are going to be periods when regulation and so forth are unfavorable. Investors are going to shy away from the stocks, multiples will compress, and it’s not necessarily always going to be a smooth ride.
Lawrence Hamtil: And of course, I think one thing that attracts me to consumer staples in general is there tends to be a little bit of a lack of outside disruption. If you look at the best-performing industries over time, tobacco, alcohol and so forth, they’re asset-light companies, relatively stable cash flows in terms of the economic cycle, and they’re not necessarily going to be disrupted.
Lawrence Hamtil: If you look at Apple, for example, before the iPhone, Nokia was the major cellphone maker in the world. And of course, Apple came along and upset that, and it seems to me, with technology and so forth, there’s always something new and better that’s coming along. In the staple sector as a whole, that seems to be less the case, because those products are going to be in demand, generally speaking, without much interruption.
Lawrence Hamtil: So, I think, I’ve written a lot about that sector. I tend to favor boring industries and companies, myself. I’m a suffering tobacco investor at the moment, but I’m not giving up on it.
Tobias Carlisle: You’re sounding a little bit like another reasonably well-known Midwestern investor. Buffett, of course.
Lawrence Hamtil: I wish I had his success…
Tobias Carlisle: It’s early days. When you see that valuation compression in tobacco, is it because of something like vaping? Are you concerned that that potentially steals some of the returns to tobacco, or do you think that that is something that just helps the industry?
Lawrence Hamtil: Well, it’s an interesting question, and I’m not sure that I have all the data yet to answer it, and I’m not sure anybody else does, either. But some analysis that I’ve seen has indicated maybe it’s a little too hopeful. I don’t know.
Lawrence Hamtil: But the vaping is not necessarily just a cannibalization of current smokers, but might also be attracting people who never consume nicotine in the first place. So, you go maybe from a so-called melting ice cube to something that sort of expands the potential profit pool.
Lawrence Hamtil: And I think that there is that potential. That remains to be seen; it’s early on. But then, you look at the global marketplace for tobacco, each country I think is going to have different results. So, it’s looking at the US and extrapolating to the rest of the world might be misguided.
Lawrence Hamtil: But I think, one way or another, combustibles are going to be a big part of the global tobacco portfolio for a time to come, and vaping will probably take some share away from that. But I’m not convinced that it will be kind of a cannibalization, if you will. I think that there’s some upside potential there, as well.
Lawrence Hamtil: But it’s still early on, and there needs to be a little bit more results to be studied, to see exactly what effect it will have.
Tobias Carlisle: Do you like the vice or sin industries as a whole? I mean, we’ve talked about alcohol. I think aerospace and defense falls into vice or sin, and maybe marijuana stocks are kind of in that category now, as well.
Tobias Carlisle: I don’t know what else you’d expand it to include, but it’s traditionally also included casinos and gambling.
Lawrence Hamtil: Yeah. I think historically, these industries in the so-called vice portfolio have outperformed, and Pem Van Fleet, who is a friend of mine, he’s kind of the expert on low-volatility stocks, and he and his colleagues at Rubiko… Rubeko, if I pronounced that correctly, wrote a paper about the so-called sin anomaly, and they basically broke it down into I think value, low volatility, and quality.
Lawrence Hamtil: And I wrote a blog post about casino stocks which, for whatever reason, have tended not to follow the path as the other so-called sin industries. You mentioned that alcohol, tobacco, aerospace, and defense, all of those have done very well, but they also screen pretty well as far as the factors of quality, low volatility, and value.
Lawrence Hamtil: Casinos do not, or have not, and I think that’s, for example, one reason why I say not all sin stocks are created equal. You have to be aware, too, that there might be a high degree of leverage, or cyclical earnings, whatever the case might be, that makes those industries a little bit subpar compared to their peers in the so-called vice portfolio.
Tobias Carlisle: It’s something that I find interesting, and it’s not something I fully understand, but I don’t know why casino stocks tend to be so bad. But they seem to be very boom/bust. Their busts are terrible! And I don’t know if it’s because they’ve got… because it is all that leverage they tend to have to build the casino, and I guess the revenue side, that must be cyclical. It’s that when times are tough, people don’t go to Vegas.
Lawrence Hamtil: I’m sure that has something to do with it, too, and I think one, and I’m no expert by any means, but I think one other element that the other sin industries have is what we call wide moats or high barriers to entry. It’s difficult, for example, as we discussed in the tobacco industry for new players to come in. In the aerospace and defense industry, it’s a difficult marketplace to disrupt incumbents and so forth.
Lawrence Hamtil: Casinos don’t seem to have that added element of insulation against other competitors. For example, you can go to Vegas, you can go somewhere else around the world to gamble; I don’t know if that has any impact whatsoever that… Just seems like the fundamentals of that industry are worse compared to the others in that category.
Lawrence Hamtil: But you’re right. I mean, the booms and busts are pretty epic in the casino industry. It’s not for the faint of heart to hold those shares.
Tobias Carlisle: You only hunt in them when they’re in a bust. And when you see the boom coming, you sell them.
Lawrence Hamtil: That seems like a fair assessment, but it would require a braver person than I am.
Tobias Carlisle: You raised it as another one of the topics that I associated with you, is the low volatility anomaly. Can you describe what that is, and tell us how we can take advantage of it?
Lawrence Hamtil: Well, I think that there are a few different variations of it, but I guess simply put, over time, stocks with a lower degree of volatility than others have-
Tobias Carlisle: This is price volatility?
Lawrence Hamtil: Yes. Yeah, have tended to do better than others. That could be due to different reasons. It could be, for example, in the S&P 500 low volatility index, which is widely quoted, it tends to be a lot of… I don’t believe it’s sector-neutral, so you have these kind of big sector overweights, usually real estate, utilities and consumer staples; well, we know why those are low volatility. It’s because they’re classically defensive sectors.
Lawrence Hamtil: If you look at a minimum-volatility portfolio, which is another variation, it’s really kind of a minimum variance, so it’s more sector-neutral, but you’re looking at it from a slightly different angle. But broadly speaking, the effect is very similar.
Lawrence Hamtil: But in my mind, the way I understand it is these stocks tend to do better because, as we said, there’s less volatility, which means there’s less severe draw-downs, and I think of it in a baseball analogy; it’s kind of like doubles and singles add up over time to much more than home runs and strikeouts. And so, Pem Van Fleet again, he talks about the associated pain with low-volatility investing is that it’s almost sometimes unbearably boring. Because people look at their contemporaries with these high beta stocks, and they have big swings on the upside and big down drafts on the downside, while you’re there kind of being the tortoise versus the hare.
Lawrence Hamtil: And I think that in the long run, all of that takes effect and it compounds itself to a better overall return, but there are a lot of different ways to take advantage of it. There’s certainly a lot of ETF’s and mutual funds that are low-cost and effective for what you want to accomplish.
Lawrence Hamtil: Currently, there’s a lot of discussion because these stocks have done so well relative to the market over the past 12 months, that a lot of them are expensive. So, investors should be aware of that, but I would point out that there’s a high degree of turnover in these indices. You’re not necessarily going to be betting on the same stocks that are currently in it, because of the periodic rebalancing.
Lawrence Hamtil: And the other thing is, unlike other factors such as value, there’s not a lot of evidence to suggest that valuation has a big impact on subsequent low- or minimum-volatility returns. So, of course, look into that, and see if it’s appropriate for you. But it’s certainly something that’s gaining a lot more exposure in the press because of the recent success.
Tobias Carlisle: I think one of the things you said in there is that the sectors that tend to be low volatilities are sectors that you like, is that sectors that tend to be low volatility… I like the way that you can… everything is a sector bit!
Lawrence Hamtil: Well, to be honest with you, I guess I’m not coming from a real great academic background. I sort of stumbled upon this in my earlier days when I was kind of more like a stockbroker and looking at companies from more of a fundamental standpoint, and I tended to overweight a lot of consumer staples. And then, when I started to explore the phenomenon a little bit more, I realized it was actually a fairly well documented factor, that companies with less degree of variability and so forth tended to do better.
Lawrence Hamtil: Whether or not that… you know, some people disagree and think that low volatility’s a function of value and quality and so forth. I don’t know; that’s for other people who are smarter than I am to decide.
Lawrence Hamtil: But I think, broadly speaking, it’s true that companies that… exhibit less dramatic swings, are going to do better in the long run. And that’s I think been proven true not just in the US, but in most markets around the world. So, it’s sort of a misunderstood phenomenon, I think. A lot of people are finding it difficult to kind of admit that everything they’ve been told about more risk equaling more reward is probably not true.
Lawrence Hamtil: So, that’s sort of a bitter pill to swallow for a lot of people who are trained in that idea.
Tobias Carlisle: It does seem to break EMH. It seems to be the exact opposite of what EMH teaches us.
Lawrence Hamtil: Yeah, exactly! Yeah. And I think that’s a whole other interesting conversation to have, about these so-called factors. And I discuss, or I think I have, low volatility as more behavioral factors. There’s the whole theory of leverage aversion, and so, the idea is low volatility stocks tend to do better because investors tend to favor higher beta stocks, because they give them sort of de facto exposure to leverage.
Lawrence Hamtil: I don’t know those-
Tobias Carlisle: Or it’s a lottery ticket type bit.
Lawrence Hamtil: Exactly! Yeah, I find that theory compelling. Personally, I think it makes sense, and I think that as we look forward, as these factors become more discussed, more widely documented and actually investible through different products, I feel like these factors, like momentum and low volatility, are going to persist because they’re based on human nature.
Lawrence Hamtil: At least, that’s my understanding. And I don’t think human nature is going to change very much. So, I feel like they’re very durable as far as their potential going forward.
Lawrence Hamtil: I think a lot of the success in any portfolio, and this is something that we don’t talk about enough, but you have to have the right shareholder base, right? My clients being a large pool of retirees for the most part, with a few exceptions, they’re not going to tolerate a lot of differentiation. But if you’re like Buffett and you can tolerate periods of tracking error and so forth…
Lawrence Hamtil: It just kind of depends on having the right partners who are in the portfolio with you, and that’s a critical thing, I think. And every industry has its day in the sun. It’s just a question of when, and of course, a test of somebody’s conviction to hold in the down periods like with tobacco now, for example.
Tobias Carlisle: I saw somebody on Twitter today had a line like, “I’m going to buy the yacht when my particular industry gets its high beta moment.”
Lawrence Hamtil: Yeah, it sounds like something to shoot for. But yeah, I don’t know. I think the other trick in this industry is just trying to survive. A lot of people try to focus on finding the biggest winners and so forth, but for me, just staying in the game is winning in itself.
Tobias Carlisle: Do you regard yourself as a value investor? You sort of, you’ve got a lot of Buffett-type lines in there.
Lawrence Hamtil: Yeah. I think that I agree with Howard Marks, that the best company can be a bad investment if the price is wrong. On the other hand, looking at value and growth are not naturally… are not enemies, so to speak.
Tobias Carlisle: Right.
Lawrence Hamtil: There are a lot of companies that look like value that are not good investments because they’re not growing their earnings, for example, and vice versa.
Lawrence Hamtil: I consider myself a little bit of a skeptic, and I think that you just sort of have to be aware that not all industries are created equal. It kind of really struck me when somebody talked about the oil industry, and how you’ve got BP and Exxon and Chevron, and their final product is not much different, one from another.
Tobias Carlisle: Right.
Lawrence Hamtil: So, what’s the competitive advantage? And of course, you introduce the foreign competition and so forth, and I think, “Okay, well, what impact does that have?” Then when you look at individual companies, if you’re going to take a bet on those, what’s their advantage that warrants taking a little bit more concentrated bet?
Lawrence Hamtil: And I tend not to have… the people that I work with, they tend to have a little bit more creativity, in my mind. I look at, for example, one of my ideas that’s not quite fully developed is industry moats. And so, I look at railroads, airports, tobacco. Sometimes it matters more the field in which you play than how well-run the company is, or any other thing.
Lawrence Hamtil: And I think that is something that is misunderstood, too, when people look at these value versus growth. I mean, maybe sometimes it’s just better to go back to basics, if you will.
Tobias Carlisle: Right.
Lawrence Hamtil: Yeah.
Tobias Carlisle: That’s very interesting.
Lawrence Hamtil: Yeah. I don’t know! I think you have to ask yourself, too, if people were having this discussion in 1979 or 1980, before our big bull market took off, how they would classify their investments. And of course, people don’t remember that technology stocks, for example, were terrible investments until just about the middle 1990’s.
Lawrence Hamtil: Energy would have been a growth play, for example. So, these things aren’t static. They change a lot over time, too.
Tobias Carlisle: Yeah. It just made me think of We Work, for some reason there. I look at We Work and I think, “There’s no reason why this is a high-growth stock, other than the fact that it’s raised an enormous amount of money and invested an enormous amount of money.” That’s the only thing that makes it high-growth.
Lawrence Hamtil: Yeah! Exactly. And I think that that, again, it kind of goes back to the behavioral aspect of innovation which is, you could spend a whole nother hour talking about that, and while these companies and their so-called innovations benefit humanity in general, most of them turn out to be terrible investments.
Lawrence Hamtil: People overestimate their ability to change things, and they overpay for it, and whether, I don’t know, I mean, the jury’s still out on Uber and Lyft and all of these… I don’t know if We Work is classified. Were they a unicorn at some point?
Tobias Carlisle: Well, they’re like, a 48 billion dollar valuation, or they’re talking about going public, [inaudible 00:56:48] so they must be multiple-
Lawrence Hamtil: Yeah, okay. So, they are. I’m not as familiar with that. But I mean, what are you really buying other than… I don’t think anybody really knows what the hell they’re buying, to be honest with you.
Lawrence Hamtil: I’m a little bit more familiar with Uber and Lyft. Is it a service company? Is it a tech company? I don’t know.
Lawrence Hamtil: Those are, they fall into my, as Ben Carlson said-
Tobias Carlisle: Too hard?
Lawrence Hamtil: Too Hard Pile-
Tobias Carlisle: Yeah.
Lawrence Hamtil: And I’ll just stay in my lane, so to speak, and look at my 19th Century portfolio of oil, railroads, and cigarettes.
Tobias Carlisle: I like that portfolio!
Lawrence Hamtil: I have a feeling they’ll be with us for a long time still.
Tobias Carlisle: Yeah, I agree.
Tobias Carlisle: And I think as we’re… we’re sort of coming up on time, but I think I’d be remiss if I don’t ask you a little bit about the squatting and the deadlifting. So, what brand of tube socks do you recommend?
Lawrence Hamtil: Well, anything that protects your shins from the deadlift bar! So, in my mind, I’ve had pretty good luck with anything that gets up to my kneecap, and of course, I look like everybody’s grandfather at the gym, but being somebody who has always deadlifted barefoot, I’ve always used high-pull socks, and some people like shin guards. I think you want to keep the bar as close to your shins as possible, so I prefer the socks.
Lawrence Hamtil: But that’s just how I have coped with the pain associated with deadlifting, with the barbell.
Tobias Carlisle: What about with the Zercher squats? Are you allowed to wrap the bar or anything, or you got to take that raw, you got to take that commando?
Lawrence Hamtil: Well, yeah… I don’t know, it probably sounds a little bit masochistic, but I feel like the bar, it’s going to kill you one way or another, so the least amount of friction when it kind of rolls around in the crooks of your arms…
Lawrence Hamtil: For anybody unfamiliar with the Zercher squat, that’s something that you pin against your belly with the crooks of your arms. It’s going to be painful; there’s different ways, whether you use a thicker barbell or whatever. I tend to just have the best results when I take the pain and just keep it tight. And I figure, you have…
Lawrence Hamtil: Somebody said, and I forget the gentleman’s name, but I associate it with weightlifting and also with investing. He said, you have the… the only choice in life is between the pain of discipline and the pain of regret. So, I figure I’ll take the pain of discipline, and if that means Zercher squatting without any supports or whatever, then that’s what it has to be.
Tobias Carlisle: And if folks want to get in contact with you, your Twitter handle and so on…
Lawrence Hamtil: And I’m always have my email there, if you need to get in contact or have any questions about anything. And always happy to respond to any comments and so forth.
Tobias Carlisle: I will put those three blog posts and your Twitter handle, and I’ll link to your Fortune Financial in the show notes for this. And so, folks’ll be able to get in contact with you, and find the correct form for front squatting and back squatting and deadlifting.
Lawrence Hamtil: Yeah, hopefully if they end up following on Twitter, my Twitter portfolio is basically sin stocks, squats, and home and auto repair. That’s basically my three basic areas I cover.
Tobias Carlisle: That’s fantastic. Lawrence Hamtil, thank you very much for giving us the time.
Lawrence Hamtil: Thank you very much! It was a pleasure.
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