During their latest episode of the VALUE: After Hours Podcast, Trainer, Taylor, and Carlisle discussed Investors Have Too Much Focus On The ‘r’ In (1+ r)^n. Here’s an excerpt from the episode:
Jake: So, that’s what we’re going to get into now, more specifically, is this tuatara. They’re endemic to New Zealand, and they’re roughly similar to lizards, but it’s actually an entirely distinct order of lizard, of reptile, I mean. They originated 250 million years ago, but their order broke off, it branched off, and that split actually happened before lizards and snakes even diverge from each other, and it was basically geographically isolated.
So, a typical lizard, like, a normal lizard that we think of will live for five years in its natural habitat. Yet somehow, this animal lives for 100 years. There was Rory Sutherland, who’s one of my favorites, he was talking recently about some of the most interesting information lies in the outlier, not in looking at averages. The world always looks at averages, but when you notice something odd, it can really help you to understand even more if you can figure out what’s going on with that outlier.
He actually tells this funny story about, in Pfizer, when they were testing Viagra– So, they get to the end of the study. And of course, they were trying to test it for blood pressure or hypertension or something. The subjects were like, “I’m not giving these pills back.”
Tobias: [laughs]
Jake: They wanted to keep them. No one had ever really been asking, “I want to keep this little blue pill that you gave me and I’m not giving it back to you.” And so, they’re like, “Well, what’s going on here? They’ve never asked us before to keep the pill.” And obviously, it turns out it was helping in other ways. Anyway, this tuatara actually reproduces very slowly. It takes 10 years to 20 years to reach sexual maturity. And the females mate and lay eggs only every four years, and it takes then 12 months to 15 months from copulation to hatching, which is a really long time. In the wild, they’re known to still be reproducing at age 60. And in fact, there was one male in captivity, he became a father at 111 with an 80-year-old female.
Tobias: [laughs]
Jake: They have one of the slowest growth rates of any reptile. They continue growing larger for the first 35 years of their life. So, in the business context, investing context, I think everyone is looking for these hyperscale companies with these rapid growth prospects, get big fast, which in my mind represents having a very large R in that 1+R equation. But something that grows slow and steady, slow to reproduce like the tuatara might be providing a bigger N on that exponent of your equation, and actually might be the true driver of a very long-term return. So, there’s a little lizard and returns, hopefully weave together for you.
David: We got to open the tuataras fund.
Jake: 100%.
Tobias: The focus is on survival rather than high rates of growth.
David: At some point, we got to be countercyclical, do something a little different, because there definitely are tons of funds that focus on the R.
Tobias: Yeah, that’s true.
David: That is everything is about the R. I think a lot of people pay lip service to N and very few people actually build their strategy around it.
Tobias: Do you think Seth Klarman is an example of that focus on the N more than the R? I think that every time his letters come out, people are– shocked is probably too strong a word, but surprised that his returns tend to be so low.
Jake: Absolutely. Great example. I put Berkshire in the same category.
Tobias: The thing for Berkshire though is the returns are quite high. The R is quite high there. The skill of it has been to generate a very high R in a context of a very high N of a big N.
Jake: It was early. But I would that R has definitely come down over the years as any– You get so big. Of course, it’s going to be its own anchor.
Tobias: What is it now? 10%, do you think?
Jake: That’s probably the high end is what I would underwrite.
David: There are a lot of other things in the Berkshire business that have been able to help goose returns, for sure, especially– [crosstalk]
Jake: Yeah, leverage.
David: Leverage, and the deals they were able to do with Goldman and others during the– those great deals, right? Convertible debt at 8% or 9% and converting at a super low price. That’s the benefit of being Berkshire that you’re in a position to get that call and then to be able to answer it.
Jake: Yeah. Those bathtub Sunday night deals are usually pretty lucrative, if you can get them.
David: [laughs]
Tobias: Did he negotiate it from his bathtub? Is that the–?
David: I think Warren is drinking a Coke in his bathtub, hanging out.
Jake: That was the joke.
David: [crosstalk]
Jake: Yeah. “Mr. Moynihan, I have some money for you.”
David: If you don’t take my money, I guess you’re going to get to talk to– Who was the head of the Treasury at the time that blew up Lehman?
Tobias: Was it Paulson? Hank Paulson?
David: Paulson. Yes. Yeah, I got him on the other line. You want to talk Tim or me? [laughs]
Jake: Paulson’s money was probably cheaper.
Tobias: Yeah.
Jake: It tends to be cheaper.
Tobias: Who else is in that category of like an N type investor, very long-term? It’s hard to think of too many. Maybe Fairfax. Although Fairfax tend to hedge the book a little bit, so they’re always–
Jake: Yeah, that’s somewhat of an operational thing for them too. They’re taking pretty big liabilities often on the insurance side. So, you really need to keep a strong balance sheet. But yeah, I would say they’re pretty good N.
David: My experience is that there are really very, very few N investors out there, very fewer than even pay lip service to it. When I first launched New Constructs, before we had our own fund, I spent a great deal of time marketing to institutional investors.
Jake: So, that’s what we’re going to get into now, more specifically, is this tuatara. They’re endemic to New Zealand, and they’re roughly similar to lizards, but it’s actually an entirely distinct order of lizard, of reptile, I mean. They originated 250 million years ago, but their order broke off, it branched off, and that split actually happened before lizards and snakes even diverge from each other, and it was basically geographically isolated.
So, a typical lizard, like, a normal lizard that we think of will live for five years in its natural habitat. Yet somehow, this animal lives for 100 years. There was Rory Sutherland, who’s one of my favorites, he was talking recently about some of the most interesting information lies in the outlier, not in looking at averages. The world always looks at averages, but when you notice something odd, it can really help you to understand even more if you can figure out what’s going on with that outlier.
He actually tells this funny story about, in Pfizer, when they were testing Viagra– So, they get to the end of the study. And of course, they were trying to test it for blood pressure or hypertension or something. The subjects were like, “I’m not giving these pills back.”
Tobias: [laughs]
Jake: They wanted to keep them. No one had ever really been asking, “I want to keep this little blue pill that you gave me and I’m not giving it back to you.” And so, they’re like, “Well, what’s going on here? They’ve never asked us before to keep the pill.” And obviously, it turns out it was helping in other ways. Anyway, this tuatara actually reproduces very slowly. It takes 10 years to 20 years to reach sexual maturity. And the females mate and lay eggs only every four years, and it takes then 12 months to 15 months from copulation to hatching, which is a really long time. In the wild, they’re known to still be reproducing at age 60. And in fact, there was one male in captivity, he became a father at 111 with an 80-year-old female.
Tobias: [laughs]
Jake: They have one of the slowest growth rates of any reptile. They continue growing larger for the first 35 years of their life. So, in the business context, investing context, I think everyone is looking for these hyperscale companies with these rapid growth prospects, get big fast, which in my mind represents having a very large R in that 1+R equation. But something that grows slow and steady, slow to reproduce like the tuatara might be providing a bigger N on that exponent of your equation, and actually might be the true driver of a very long-term return. So, there’s a little lizard and returns, hopefully weave together for you.
David: We got to open the tuataras fund.
Jake: 100%.
Tobias: The focus is on survival rather than high rates of growth.
David: At some point, we got to be countercyclical, do something a little different, because there definitely are tons of funds that focus on the R.
Tobias: Yeah, that’s true.
David: That is everything is about the R. I think a lot of people pay lip service to N and very few people actually build their strategy around it.
Tobias: Do you think Seth Klarman is an example of that focus on the N more than the R? I think that every time his letters come out, people are– shocked is probably too strong a word, but surprised that his returns tend to be so low.
Jake: Absolutely. Great example. I put Berkshire in the same category.
Tobias: The thing for Berkshire though is the returns are quite high. The R is quite high there. The skill of it has been to generate a very high R in a context of a very high N of a big N.
Jake: It was early. But I would that R has definitely come down over the years as any– You get so big. Of course, it’s going to be its own anchor.
Tobias: What is it now? 10%, do you think?
Jake: That’s probably the high end is what I would underwrite.
David: There are a lot of other things in the Berkshire business that have been able to help goose returns, for sure, especially– [crosstalk]
Jake: Yeah, leverage.
David: Leverage, and the deals they were able to do with Goldman and others during the– those great deals, right? Convertible debt at 8% or 9% and converting at a super low price. That’s the benefit of being Berkshire that you’re in a position to get that call and then to be able to answer it.
Jake: Yeah. Those bathtub Sunday night deals are usually pretty lucrative, if you can get them.
David: [laughs]
Tobias: Did he negotiate it from his bathtub? Is that the–?
David: I think Warren is drinking a Coke in his bathtub, hanging out.
Jake: That was the joke.
David: [crosstalk]
Jake: Yeah. “Mr. Moynihan, I have some money for you.”
David: If you don’t take my money, I guess you’re going to get to talk to– Who was the head of the Treasury at the time that blew up Lehman?
Tobias: Was it Paulson? Hank Paulson?
David: Paulson. Yes. Yeah, I got him on the other line. You want to talk Tim or me? [laughs]
Jake: Paulson’s money was probably cheaper.
Tobias: Yeah.
Jake: It tends to be cheaper.
Tobias: Who else is in that category of like an N type investor, very long-term? It’s hard to think of too many. Maybe Fairfax. Although Fairfax tend to hedge the book a little bit, so they’re always–
Jake: Yeah, that’s somewhat of an operational thing for them too. They’re taking pretty big liabilities often on the insurance side. So, you really need to keep a strong balance sheet. But yeah, I would say they’re pretty good N.
David: My experience is that there are really very, very few N investors out there, very fewer than even pay lip service to it. When I first launched New Constructs, before we had our own fund, I spent a great deal of time marketing to institutional investors.
You can find out more about the VALUE: After Hours Podcast here – VALUE: After Hours Podcast. You can also listen to the podcast on your favorite podcast platforms here:
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