TAM Stock Screener – Stocks Appearing in Dalio, Burry, Greenblatt Portfolios

Johnny HopkinsStock ScreenerLeave a Comment

Part of the weekly research here at The Acquirer’s Multiple features some of the top picks from our Stock Screeners and some top investors who are holding these same picks in their portfolios. Investors such as Warren Buffett, Joel Greenblatt, Carl Icahn, Jim Simons, Prem Watsa, Jeremy Grantham, Seth Klarman, Ray Dalio, and Howard Marks. The top investor data is provided from their latest 13F’s. This week we’ll take a look at:

GameStop Corp (NYSE: GME)

GameStop is a U.S. multichannel video game, consumer electronics, and services retailer. The company operates across Europe, Canada, Australia, and the United States. GameStop sells new and second-hand video game hardware, physical and digital video game software, and video game accessories, mainly through GameStop, EB Games, and Micromania stores and international e-commerce sites, including www.gamestop.com, www.ebgames.com.au, and www.micromania.fr. The company has two main business segments: Video game brands and Technology brands. The technology brands segment sells wireless products and services and operates Spring Mobile managed AT&T and Cricket Wireless branded stores, along with the Simply Mac business.

A quick look at the price chart below for GameStop shows us that the stock is down 27% in the past twelve months. We currently have the stock trading on an Acquirer’s Multiple of 3.08 which means that it remains undervalued.

(Source: Morningstar)

Superinvestors who currently hold positions in GameStop include:

Ray Dalio – 1,362,110 total shares

Ken Griffin – 785,857 total shares

Michael Burry – 536,862 total shares

Joel Greenblatt – 145,107 total shares

Cliff Asness – 123,765 total shares

Steve Cohen – 34,776 total shares

Investors Can Use Consumer Satisfaction Surveys To Capture Alpha

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During his recent interview with Tobias. Phil Bak of Exponential ETFs discusses how investors can use consumer satisfaction surveys to capture alpha. Here’s an excerpt from the interview:

Tobias Carlisle: So just to go back to the ACSI, the consumer sentiment … Is it consumer sentiment?

Phil Bak: Satisfaction.

Tobias Carlisle: Satisfaction. Pardon me. So they look at the conducting surveys, how are they actually gathering that data?

Phil Bak: So they are conducting surveys. They do over 300,000 surveys a year and all the data is normalized by seven different factors. We have a patented econometric model that we use to eliminate outliers and various things. So it’s a very quantitative dataset, which is ironic because a lot of people view it as more of a quanl… It is measuring something more qualitative, but the data gathering process is very differentiated from the others in that space of market research because their approach is extremely quantitative.

Then ultimately, we use that as a signal. All the data is published publicly and is published historically also from in sample returns on theacsi.org. And you can see, and historically it’s a tremendous driver of Alpha both in a hedge fund and just looking at the pure data.

Phil Bak: So the fund launched in November of 2016, and we don’t use any company in the fund that we don’t have a statistically significant sample on. So for example, everyone wants to know what we think about Tesla. And I personally, I think Tesla’s a cool out. I know you know, reading a lot of the debate on it is very interesting.

But in terms of the data and it’s purely rules based fund, so our own opinions have no bearing on the allocations. We can’t get normalized statistically significant sample in order to be able to test of Tesla owners because there just aren’t enough of them. So we’ve really good data on Ford and Honda and Toyota and all the others.

But until we have that data set, we can’t use Tesla. So it’s an interesting product because there are certain areas where we have better data and worse and there are certain sectors that are more elastic to the data than others.

Phil Bak: If you think about it, like if 20 people get food poisoning at Chipotle, in Massachusetts, you’re going to have a 15% reduction and people walking through the doors in Texas across the country the next day. Immediately, there’s high, high elasticity there.

Whereas Wells Fargo could have another banking scandal and you’re not going to move your mortgage. You’re probably not gonna move your wealth management account the next day. It’s a much longer cycle. So because of that, we look at the data sector by sector in order to capture the different elasticities, all the allocations are relative to its own sector of all the different stocks.

Tobias Carlisle: You’re taking the satisfaction surveys and then you’re mapping them to other product or a ticker.

Phil Bak: That’s right.

Tobias Carlisle: … and you aggregate that up and then you look at it on a sector by sector basis to create the portfolio?

Phil Bak: Exactly. Yeah. So, we’re not measuring sentiment or satisfaction on stocks. We’re looking at the products and services and then we roll them up. So yum brands will have many scores and will have a proprietary model to estimate revenue contribution and to put that into the overall score. Because again, we’re not looking at sentiment and whether people are going to buy or sell the stock.

We’re trying to understand, “Are there going to be repeat buyers? Does the company have pricing power? How is Apple able to charge three times the amount of some of the Chinese phone manufacturers in China, three times the amount for phones with identical specs?” That’s because they have the pricing power through the brand, through the customer satisfaction. Maybe it’s through the ecosystem that people are locked into, but those are the things that we can capture that we feel are not necessarily priced in.

Tobias Carlisle: So it’s very much a leading indicator in it. It shows up in earnings quarters or maybe even a year or so later?

Phil Bak: Yeah. Our research shows three to 11 months is the timeline that from when we start to see changes until we see it. Typically, we’ll see it hit in the form of a big earning surprise. So you get a big hit or miss and it says, “Oh wow, I can’t believe I used Kmart before as an example. I can’t believe Sears. I can’t believe Sears missed.” Well, can you? I mean, think about it. Would you want to be stuck having to go shopping at Sears? Probably not. It’s always intuitive after the fact. You never see a company or very rarely see a company go out of business or face troubles where it’s like, “Oh wow that’s so surprising because I loved that product or I loved shopping there.” Very rare. Very rare.

16 Of The Best Books On The History of Finance & Investing

Johnny HopkinsInvesting BooksLeave a Comment

Some time ago we started a series called – Superinvestors: Books That Every Investor Should Read. So far we’ve provided the book recommendations from:

Together with our own 2018 recommended reading list of:

This week we’re going to take a look at sixteen of the best books on the history of finance and investing. Here’s the list:

1. The Great Crash of 1929 (John Kenneth Galbraith)

2. Manias, Panics, and Crashes: A History of Financial Crises (Charles Kindleberger)

3. Too Big to Fail: The Inside Story of How Wall Street and Washington Fought to Save the Financial System from Crisis — and Themselves (Andrew Ross Sorkin)

4. Devil Take the Hindmost: A History of Financial Speculation (Edward Chancellor)

5. The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron (Bethany McLean)

6. The Greatest Trade Ever: The Behind-the-Scenes Story of How John Paulson Defied Wall Street and Made Financial History (Gregory Zuckerman)

7. When Genius Failed: The Rise and Fall of Long-Term Capital Management (Roger Lowenstein)

8. The Big Short: Inside the Doomsday Machine (Michael Lewis)

9. Lords of Finance: The Bankers Who Broke the World (Liaquat Ahamed)

10. Against the Gods: The Remarkable Story of Risk (Peter Bernstein)

11. Barbarians at the Gate: The Fall of RJR Nabisco (Bryan Burrough)

12. The Ascent of Money: A Financial History of the World (Niall Ferguson)

13. The Quants: How a New Breed of Math Whizzes Conquered Wall Street and Nearly Destroyed It (Scott Patterson)

14. This Time Is Different: Eight Centuries of Financial Folly (Carmen Reinhart, Kenneth Rogoff)

15. The House of Morgan: An American Banking Dynasty and the Rise of Modern Finance (Ron Chernow)

16. Liars Poker (Michael Lewis)

Investors Can Extrapolate The Premium Provided By An Equal Weight Portfolio Versus Market Cap

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During his recent interview with Tobias. Phil Bak of Exponential ETFs discusses how investors can extrapolate the premium which is provided by equal weight portfolio versus market cap, saying:

Well, I think it really started and like you said, with equal weights. My background, I was at Ridex Investments, which is now part of Guggenheim, and the ETF is actually now part of Invesco, but one of the products that I was the product manager on at the time, was RSP, was the equal weight S&P 500. And we’re doing a lot of research and we’re trying to explain why is it that equal weight outperforms large cap. And mostly it’s a size tilt but it’s also the rebalance mechanism. We did a lot of empirical studies on those two and how they impact and market cap weight. And what I was trying to do is say, “Well, how do we take that premium of equal over market cap and how do we extrapolate that? How do we either isolate that or provide more of that?”

If you think about it, one of the analogies that we use a lot is tea. So nobody likes the room temperature tea. People like hot tea or they like ice tea, right? One of the other, nobody says, “Oh I want to get a cup of room temperature tea.” Well, the way we see it equal weight as a half measure. Equal weight is room temperature tea. If you want that tilt, if you believe that the smaller companies in the S&P 500 have more growth potential and that’s a better way to invest, then you should invest that way. And if you believe that the market cap weighting and momentum is a better way to invest, then you should invest that way. So really, it’s kind of the counterpoint or the other balance to market cap weighting.

The Acquirers Podcast

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How Can Investors Use ‘Reverse Market Cap’ To Generate Excess Returns

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During his recent interview with Tobias, Phil Bak of Exponential ETFs explains how investors can use ‘Reverse Market Cap’ to generate excess returns, saying:

So reverse cap is very simple. We take the … In this case it’s on the S&P 500, and we take the index constituents of the S&P 500. Now whereas typically the S&P 500 of course is weighted biggest to smallest. So it’s weighted by market cap. We take the reciprocal of the market cap, so one over the market cap and then re-weight the weights based on that.

So what you get is a portfolio where rather than being tilted towards the bigger companies, you are tilted towards the smaller companies. You still have full representation over all 500 companies. It’s still a large cap fund, a weighted average market cap of our fund is 18 billion. But what you get is really two things.

One is you get a size tilt, so a small money speed factor exposure within large cap, but the other thing is that if you think about how an index re-balances, certainly a market cap weighted index, every quarter you have a rebalance semiannually. You have a reconstitution and every time you rebalance you re-up all the different stocks to their market cap. So you’re selling the losers. You’re selling the stocks that have gone down and you’re taking that excess capital, you’re putting it into the winners. You’re always by rule buying high and you’re selling low.

What we’re doing is the opposite. We’re buying low, we’re selling high. Every time the company runs up, when we hit rebalance, we take money off the table, we profit take and we put it back into the companies at the bottom of the S&P 500 that we feel and historically have had more room to run. That rebalance mechanism is actually a larger driver of historical alpha in the fund than the size tilt.

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(Ep.5) The Acquirers Podcast: Phil Bak of Exponential ETFs – How Reverse Cap Beats The Market (Cap)

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In Episode 5 of the The Acquirers Podcast, Tobias chats with Phil Bak of Exponential ETFs. During the interview Phil, who is an expert in ETF’s, provides some great insights into:

  • How Investors Can Use ‘Reverse Market Cap’ To Generate Excess Returns
  • The Market Doesn’t Care Where You Live – Home Country Bias Could Be Hurting Your Returns
  • How Can Investors Extrapolate The Premium Provided By Equal Weight Versus Market Cap
  • How To Create An ETF
  • The ETF Rule

The Acquirers Podcast

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:

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Full Transcript

Tobias Carlisle: All right. You’re good to go?

Phil Bak: Yeah, I’ll start.

Tobias Carlisle: Yeah, let’s do it. Hi, I’m Tobias Carlisle, this is The Acquirer’s podcast. My special guest today is Phil Bak. He’s the CEO of Exponential ETFs. He’s got a really interesting background and he’s got some really interesting ETF, so we’re going to ask him about that right after this.

Speaker 3: Tobias Carlisle is the founder and principal of Acquirer’s Funds. For regulatory reasons, he will not discuss any as the Acquirer’s Funds on this podcast. All opinions expressed by podcast participants are solely their own and do not reflect the opinions of Acquirer’s Funds or affiliate. For more information, visit acquirer’sfunds.com.

Tobias Carlisle: Hi Phil, how are you doing?

Phil Bak: Hi, how are you? Thank you for having me on.

Tobias Carlisle: My absolute pleasure. What is a reverse market cap?

Phil Bak: So reverse cap is very simple. We take the … In this case it’s on the S&P 500, and we take the UNIX constituents S&P 500. Now we’re at typically the S&P 500 of course is weighted biggest to smallest. So it’s weighted by market cap. We take the reciprocal of the market cap, so one over the market cap and then we weigh the weight based on that. So what you get is a portfolio where rather than being tilted towards the bigger companies, you are tilted towards the smaller companies. You still have full representation over all 500 companies. It’s still a large cap fund, a weighted average market cap of our fund is 18 billion. But what you get is really two things.

Phil Bak: One is you get a size tilt, so a small money speed factor exposure within large cap, but the other thing is that if you think about how an index re-balances, certainly a market cap weighted index, every quarter you have a rebalance semiannually, you have a reconstitution and every time you rebalance you re-up all the different stocks to their market cap. So you’re selling to the losers, you selling the stocks that have gone down and you’re taking that excess capital, you’re putting it into the winners. You’re always by rule buying high and you’re selling low.

Phil Bak: And what we’re doing is the opposite. We’re buying low, we’re selling high. Every time the company runs up, when we hit rebalance, we take money off the table, we profit take and we put it back into the companies at the bottom of the S&P 500 that we feel and historically have had more room to run. And that rebalance mechanism is actually a larger driver of historical alpha in the fund than the size tilt.

Tobias Carlisle: So the rebalance is the thing that drives your returns because in some ways it’s a little bit, it’s like quasi value investing or pseudo value investing. Is that what you see?

Phil Bak: That’s right. Yeah. The factor loads currently, and it’s cyclical, but the factor loads right now are stronger towards value than they are towards size, which is very counterintuitive. Now in an environment that’s a value environment that can shift back the other way. Not always, it’s always going to be value bias because you’re always buying low, you’re buying low, and you’re always putting money in market cap weight. By definition, you’re going to put money in the most overvalued companies, you’re going to have the higher allocation.

Phil Bak: But there are times where we hit a value cycle, we hit an anti-momentum cycle, which is very different than the one we’re coming out of. But in those environments we’re going to have less of a value bias than we would in an environment like we do today.

Tobias Carlisle: That’s interesting. In an environment like this one, which is more biased towards momentum and large cap type stocks, you find that the portfolio looks more like a value portfolio, but that can change in a different environment.

Phil Bak: That’s right. And it’s the same thing on a sector level too. So if you look at it today, you’ll say, “Oh, this is like an anti-fang, anti-technology portfolio.” But if you look at it before the global financial crisis, it looked like an anti-financials portfolio because every time there’s a sector that gets out of whack in the S&P, we’re on the other side of it. So it’s a very interesting strategy. If you could distill it down, some people distill it down and say, “Well, it’s like a size play within large cap,” which it is, but I think a more accurate definition of what it is, is mean reversion as a factor.

Tobias Carlisle: I was just going to say it is mean reversion, which is one of my pet subjects. Mean reversion is what’s driving the returns there.

Phil Bak: Yes.

Tobias Carlisle: I funded it. It’s a fascinating idea because it’s one that if anybody who follows the equal weight S&P 500 versus the regular S&P 500 which is market capitalization weighted can’t help but fail to … I mean, you can’t help but notice the fact that over time the equal weight has that perform pretty materially a year on year. Not that it happens every single year, but there is this gradual advantage to being an equal weight. So I imagined that that is then magnified again when you look at the reverse market cap weight.

Phil Bak: Yeah. So it’s not exactly a mirror image because in terms of the alpha between cap weight unequal and the alpha between equal and reverse cap is very close. The reason why it’s not an exact mirror is because the smaller companies, the deviation to the mean is a lot smaller than on the large side. So for example, in the S&P 500, the weighted average market cap, the mean market cap of all the companies is about 200 billion right now. But Apple is, I think it’s still over a trillion, right? So it’s five times bigger.

Phil Bak: There’s no company in the S&P that’s one fifth the size. So you have much more of a dispersion. What that also means for reverse cap is that you get a far more diversified basket in reverse cap than you do in market cap weight. So people talk a lot now about the concentration in market cap weighting, the top holdings are for a little over 4% now in market cap weighting, the top weighting, sort of reverse cap. We have now one that ran up to about 120 basis points, which is very unusual app rebalance, historically. Typically, our top holdings have been 80 to 90 basis points and it’s just a much more diversified allocation across the 500 stocks.

Tobias Carlisle: That’s very interesting. That’s not intuitive. That’s not something that you would expect thinking through it, but that’s an interesting outcome.

Phil Bak: That’s right. Yeah. The allocation of the 500, the skew from the biggest, the largest is very different. It’s a lot flatter in reverse cap weight and that’s why we think it also has a lot of utility to be used alongside of cap weighted fund. If you say, “You know what, if this is the bridge to follow, I believe in, Google never invested reverse cap, I’m just going with cap.” Fine. Okay, that’s fine. You can do that, but then you can use reverse cap alongside market cap weight to further diversify.

Phil Bak: It’s the same 500 stocks, so if you add it as a 10, 20, 30, 50% allocation alongside market cap weight, all of a sudden your overall allocation to the 500 stocks is much more diversified. If you look at it by HHI, Herfindahl-Hirschman, which is the sum of the squares of all the different weights of the 500 companies, you can bring down that HHI from 89 in a market cap weighted 100% to 33 in a 50-50. So it’s a drastic improvement over diversification.

Phil Bak: A lot of people will say, “Well, yeah, the S&P is concentrated, its always been concentrated. That hasn’t really hurt me.” It’s true. But one thing that people really are overlooking is the fact that historically, while there has been a lot of concentration in the S&P 500, what we’re seeing today is not all that unusual relative to historically. What is unusual is that the top five companies now are all in the same sector and they have a lot of the same risks that are forward looking, not backwards looking like antitrust risks, risks of being able to penetrate the emergent markets. These are risks that Apple, Microsoft, Amazon, that they share in common. Whereas historically, you’d see, well yeah, the top five companies in the S&P are always a high weight, but you’ll have a utility, you’ll have a telecom, you’ll have a more diversified group of stocks.

Tobias Carlisle: So your portfolio at the moment, you’re underweight technology, is that fair?

Phil Bak: Well, relative to cap weight, relative to market cap weight. Yup.

Tobias Carlisle: And what are you overweight in that portfolio?

Phil Bak: Right now we’ve got, like you said, it’s a little bit of a value bias now. So we have utilities are a little bit overweight. I think financials, I’d have to take a look, but certainly utilities are and we’re seeing a real value bias right now.

Tobias Carlisle: It’s a fascinating idea. Where did it come from?

Phil Bak: Well, I think it really started and like you said, with equal weights. And my background, I was at a Ridex Investments, which is now part of Guggenheim, and the ETF is actually now part of Invesco, but one of the products that I was the product manager on at the time, was RSP, was the equal weight S&P 500. And we’re doing a lot of research and we’re trying to explain why is it that equal weight outperforms large cap. And mostly it’s a size tilt but it’s also the rebounds mechanism. And we did a lot of empirical studies on those two and had the impact and market cap weight. And what I was trying to do is say, “Well, how do we take that premium of equal over market cap and how do we extrapolate that? How do we either isolate that or provide more of that?”

Phil Bak: And if you think about it, one of the analogies that we use a lot is tea. So nobody likes the room temperature tea. People like hot tea or they like ice tea, right? One of the other, nobody says, “Oh I want to get a cup of room temperature tea.” Well, the way we see it equal weight as a half measure, equal weight is room temperature tea. If you want that tilt, if you believe that the smaller companies in the S&P 500 have more growth potential and that’s a better way to invest, then you should invest that way. And if you believe that the market cap weighting and momentum is a better way to invest, then you should invest that way. So really, it’s kind of the counterpoint or the other balance to market cap weighting.

Tobias Carlisle: That’s a great analogy. So your background before you launched your own firm, Exponential, you were with the NYSE?

Phil Bak: Yes.

Tobias Carlisle: What were you doing there?

Phil Bak: So I was managing the ETF listings business by the end. I was there for six years and most of the time I was managing ETF issuer, relationships and launches and market maker payment programs. So it’s a lot of very geeky nuance market structure type stuff. I worked a lot on our actively managed generic listing standards, which nobody except for a few lawyers even knows what that is. But the rules that govern a lot of the ETF listings now, everyone knows that when you launch an ETF, you have to go to the SEC to the Division of Investment Management to get approval. Of what people aren’t as familiar with is that you also have to go to the Division of Trading and Markets because not only does the issuer need permission from the SEC to launch, the exchange needs permission to be able to list it.

Phil Bak: And for whatever reason, the Division of Trading and markets is the place where the SEC decided to hold up a lot of innovation that have been going on in the ETF space over the last few years. So it was a lot of market structure stuff. Right after I started, we had the flash crash and spent a long time working on that and different rules to help govern that. A lot of stuff working with the market makers and a lot of legal stuff. Primarily really consulting with ETF issuers and helping them get products out.

Tobias Carlisle: You must’ve seen some explosive growth in ETFs over that period. Is that the tipping point from when they sort of went from being a little bit less well known to being kind of right in the middle, right mainstream investment products?

Phil Bak: The growth has actually been a little more steady than people think. We’ve had about like low 20s to 30% year over year growth in AUM in ETFs going back about 15 years now. When you talk about percentage growth, the numbers get bigger and bigger. So you see that tipping point. But it’s been fairly steady. And what started out as a product primarily geared towards fee-based advisors. I’d say about 15 years ago maybe, or really where it started to pick up steam, only in the last probably five to 10 years, people started to realize, “Hey, I can use the advantages and the benefits of an ETF in my buy and hold allocation strategies. So ETFs were natural for broad benchmarks, for hedging, for overnight cash equitization, all that.

Phil Bak: Then people started to build allocation models of the ETF, and then we started to see more trading products. So leveraging inverse funds and fixed based funds in different commodities, gold because ETF has such a great access tool and a way to really have price discovery not in the home market but in the ETF. It’s just a natural. But what we’re starting to see now that I think is unique is funds like ours, like you know what, my actively managed or my rules based process driven buy and hold product that’s not going to have a super high trading volume. But that makes sense for allocators to hold over the long term. This is the vehicle that’s more efficient for that as well.

Tobias Carlisle: Before the NYSE, you were at Ridex, so you’ve had a really long history in ETFs. How did you get started in investing and why were you attracted to ETFs?

Phil Bak: So I started my career as a trader and I got one of those jobs back 2000, 2001 or so where it was, “Hey, show up. Do you have a pulse? We’re gonna to give you an account to trade.” It was Detroit, one of these Nasdaq momentum traders. I showed up for the interview, they checked my pulse, it said I’m alive. Okay, they’re going to register me for the series seven a month later. And if I pass the seven, I should come in. And if I don’t pass it, don’t come back. That was it. And so I show up and I passed my seven, I show up, I’m all ready to go and I’m ready for my training or whatever it is. And head trader sits down with me. He says, “Okay, if you’re gonna buy any offer, it’s control P, to post a bid …” He showed me all the keystrokes, and then he leaves. I was like, “Wait, wait, when do I buy, when do I sell?”

Phil Bak: He’s like, “Ah, I just told you, control+P, control+S.” I said, “None of them. When do I buy it?” He was like, “Oh, okay, if you’re good, you’ll figure it out.” And that was it. He walked away. And that was the extent of the training. Now, as you might imagine, those times, I mean that was really right when electronic training started to take hold and nobody can compete with an algorithm. But at the time we were coming off of an environment where people could, and there were people, there were 200 traders on the desk in downtown New York, one of them I remember was an MD that left his practice because I mean it was fun. It was like playing a video game all day and people were making money for a short time, but not forever.

Phil Bak: And when I started, there were 200 traders on the desk. And then six months, there were 20, and another six months after that, that firm and many like it had shut down. And a lot of those day-trading firms kind of converted into different shops or they’re trying to get people to put money in and all sorts of a nefarious activities started to go on. So I became an FX trader and I was trading the graveyard shift and was not seeing a lot of daylight. And it was rough and I’m at a social function, and I’m standing in a circle, it’s a business, “Oh, you’re a trader? What should I invest in?” “I’m doing short term momentum trading on currencies, is there still a little bit of analysis sending out to clients?”

Phil Bak: So I just said, I’m like, “Just buy a low cost portfolio of ETFs. Don’t try to buy anything too crazy.” And one of the people that I hadn’t even been introduced to yet was in the circle that I was standing. He said, “I can’t believe you just said that. I’m about to start a company on that exact thesis.” And it was a guy named Sandra Gerber who had a hedge fund and he was just starting a company called XTF Asset Management, some of the data company XTF is a derivative of that and it’s the same company is still around. Most of the companies are long gone. We were basically an ETF strategist before it existed. But that was all the way back in, I don’t know about ’05, ’04. And I worked there as kind of a the Jack of all trades analyst type.

Phil Bak: And from there I went to a company called [inaudible 00:15:13] and we were a startup ETF issuer. I built a carbon credit ETF, which is long gone, long forgotten. We did a target date ETF for TD Ameritrade. We had these health shares that were pretty much hated, mocked across the industry. But we had some stuff that was pretty interesting and ultimately the company did not make it and that’s when I went over to Ridex. At Ridex, we did the currency shares, we did the equal weights, we did the pure styles, and then I did some alternative mutual funds for which I got my career then went over to NYSE.

Tobias Carlisle: So you’ve had this very long career really in ETFs, which is a little bit unusual given that they are reasonably new. At what stage do you think I need to launch my own ETF, I need to get out there and show the world what reverse market cap weight can do?

Phil Bak: Well, that’s hard to say. I mean, there’s two parts of it. One is what is the validity of the idea that I’m trying to come out with and what’s the market appetite, am I solving a problem? And the other is my personal ambitions, “Do I want to start my own company?” And it was really the latter that drove a lot of it, unfortunately. I had some personal and some health issues, I had some other personal issues and I had a point of crisis in my life and I came out of it and with a very different attitude, I had been very happy at the exchange and I was very comfortable and it was a good job and I was lucky to have it and I hopefully did a good job. But when I came out of that personal crisis, I’d a very different attitude where life is short and life can change and be taken very quickly and I really wanted to maximize the time I had and really eliminated a lot of the fear from my thinking and from my process.

Phil Bak: And I think what had held me back from doing something like this earlier was that fear. So what really started was not reverse cap was our flagship product, the ACSI, the customer satisfaction ETF. And that started because at NYSE of windows, the Nasdaq indexes, nobody really knows the NYSE indexes. We did have an index business, but we’re trying to build it out and we’re working on different ideas and different ways to do things. And I had a regular shopping experience. There was a Kmart near my house. And if you have Kmart by you, but it’s horrendous now. Good. It’s a good postscript to the story that, that Kmart is closed. But I had to buy a bunch of stuff from my kids for camp, like bathing suits and bug spray and things like that.

Phil Bak: And the target was a bit of a drive. There’s like maybe 15 minutes away and the Kmart was right there. Well, how bad could it be? How bad could it possibly be? I’m just going to go to Kmart. It’s right here. And it was hard. It was that bad. There’s no prices, there’s no anything. I’m waiting on line. There’s like nine ladies each one of them like slowly rest there. Their purse on the counter. It’s like they’re writing a check, and I’m like looking around, I’m like, “This is horrible. I’m never coming back here.” Then I start thinking, “Well, okay, I’m never coming back here.” Let’s take me on a more statistically significant sample. Let’s say everyone who goes to Kmart today across the country has a miserable experience and none of them are repeat buyers.

Phil Bak: Well, how do you capture that in the data? That’s a leading index. That’ll show up in the balance sheet, but it will show up after the fact, after next quarter when people stop coming back. So how do you capture that ahead of time and get ahead of that? And I get back to my desk, I don’t know. I was looking for consumer data, sentiment data. Wasn’t sure exactly what I’m looking for, but I start googling and searching around. It turns out the world’s expert in quantifying customer satisfaction is a professor, there was a few businesses based on that, right near me in Ann Arbor, Michigan, half hour away.

Phil Bak: So, I called him, I said, “Well, my name is Phil and I’m interested in seeing your data. I have a thesis and if you give me your data, I’ll back test it and create a financial instrument on it.” And had lunch with him and it made the pitch. And I said, “Look, I think if the thesis holds and we see a signal in the data, we can maybe license an index to like a wisdom tree or Vanek and make as much as eight basis points, it’d would be like four basis points for you and four for the Exchange.” He said, “Four basis points?” I said, “Yeah.” He was like, “Great.” He says, “Do you know that I’ve a hedge fund that charges 220 using the data?”

Phil Bak: I had no idea. So obviously that project didn’t go anywhere, but we stayed in touch for a couple of years and in that time that we stayed in touch, we’re seeing flows move out of hedge funds, especially for domestic equity, moved out of hedge funds into the ETF and decided that this was a better structure for the investment. Once we built the team and once we had the company operationally up and running, I said, “Well, now I’ve got a team, we have all these ideas, I have all these other funds I want to do.” So we said, “All right, well, let’s start with one, pick your best idea. We’ll start there and start building out.” And that was worse cap.

Tobias Carlisle: So just to go back to the ACSI, the consumer sentiment … Is it consumer sentiment?

Phil Bak: Satisfaction.

Tobias Carlisle: Satisfaction. Pardon me. So they look at the conducting surveys, how are they actually gathering that data?

Phil Bak: So they are conducting surveys. They do over 300,000 surveys a year and all the data is normalized by seven different factors. We have a patented econometric model that we use to eliminate outliers and various things. So it’s a very quantitative dataset, which is ironic because a lot of people view it as more of a quantity. It is measuring something more qualitative, but the data gathering process is very differentiated from the others in that space of market research because their approach is extremely quantitative. And then ultimately, we use that as a signal. All the data is published publicly and is published historically also from in sample returns on the acsi.org. And you can see, and historically it’s a tremendous driver of Alpha both in a hedge fund and just looking at the pure data.

Phil Bak: So the fund launched in November of 2016, and we don’t use any company in the fund that we don’t have a statistically significant sample on. So for example, everyone wants to know what we think about Tesla. And I personally, I think Tesla’s a cool out. I know you know, reading a lot of the debate on it is very interesting. But in terms of the data and it’s purely rules based fund, so our own opinions have no bearing on the allocations. We can’t get normalized statistically significant sample in order to be able to test of Tesla owners because there just aren’t enough of them. So we’ve really good data on Ford and Honda and Toyota and all the others. But until we have that data set, we can’t use Tesla. So it’s an interesting product because there are certain areas where we have better data and worse and there are certain sectors that are more elastic to the data than others.

Phil Bak: If you think about it, like if 20 people get food poisoning at Chipola, in Massachusetts, you’re going to have a 15% reduction and people walking through the doors in Texas across the country the next day. Immediately, there’s high, high elasticity there. Whereas Wells Fargo could have another banking scandal and you’re not going to move your mortgage. You’re probably not gonna move your wealth management account the next day. It’s a much longer cycle. So because of that, we look at the data sector by sector in order to capture the different elasticities, all the allocations are relative to its own sector of all the different stocks.

Tobias Carlisle: You’re taking the satisfaction surveys and then you’re mapping them to other product or a ticker-

Phil Bak: That’s right.

Tobias Carlisle: … and you aggregate that up and then you look at it on a sector by sector basis to create the portfolio?

Phil Bak: Exactly. Yeah. So, we’re not measuring sentiment or satisfaction on stocks. We’re looking at the products and services and then we roll them up. So yum brands will have many scores and will have a proprietary model to estimate revenue contribution and to put that into the overall score. Because again, we’re not looking at sentiment and whether people are going to buy or sell the stock. We’re trying to understand, “Are there going to be repeat buyers? Does the company have pricing power? How is Apple able to charge three times the amount of some of the Chinese phone manufacturers in China, three times the amount for phones with identical specs?” That’s because they have the pricing power through the brand, through the customer satisfaction. Maybe it’s through the ecosystem that people are locked into, but those are the things that we can capture that we feel are not necessarily priced in.

Tobias Carlisle: So it’s very much a leading indicator in it. It shows up in earnings quarters or maybe even a year or so later?

Phil Bak: Yeah. Our research shows three to 11 months is the timeline that from when we start to see changes until we see it. Typically, we’ll see it hit in the form of a big earning surprise. So you get a big hit or miss and it says, “Oh wow, I can’t believe I used Kmart before as an example. I can’t believe Sears. I can’t believe Sears missed.” Well, can you? I mean, think about it. Would you want to be stuck having to go shopping at Sears? Probably not. It’s always intuitive after the fact. You never see a company or very rarely see a company go out of business or face troubles where it’s like, “Oh wow that’s so surprising because I loved that product or I loved shopping there.” Very rare. Very rare.

Tobias Carlisle: What’s the unifying theme between your ETFs? How are you selecting ideas and moving them towards a fund or electing not to proceed with them?

Phil Bak: What we think is going to happen long term in the industry is there’s going to be a convergence between active and passive, where active management is going to be transparent, rules-based systematic processes and all of our funds have that in them. So everything we do as an index fund and of course an index fund in the parlance of we’re creating an index that fall as a rule set. The rule set is all transparent and public so everyone could see exactly what we’re doing, and then when we manage the fund as portfolio managers, we’re managing to the tracking error of the index.

Phil Bak: So we can’t say, “Oh, we’ve underperformed for a little bit. We’re going to try to catch up and make a bet.” That’s taken out at the table, which I think is a big benefit for investors. But we wouldn’t do anything that we don’t think has longterm viability where the investment thesis should in our view be as valid 10 years, 20 years, a hundred years from now to the extent that we can see as much as it is today. We don’t do a lot of the, kind of fast money products that we think are hot right now but may not be hot 10 years from now.

Tobias Carlisle: So just for people who don’t know, can you go through the process of how does somebody set up an ETF? From having an idea to getting it listed on an exchange?

Phil Bak: There are different ways that you could structure it and depending on how you do it, it could be a difficult process. It could be a pretty easy process if you use a lot of service providers, is not an insurmountably difficult process. So it can be done and lean on your service providers if you’re thinking about doing it because they can be of a lot of help. The key player that a lot of people don’t know, the kind of the unsung hero in a lot of cases is the fund administrator. And the fund administrator does a lot. They calculate the NAV on a daily basis, but they also interface with the authorized participants who create or redeem. And all this is kind of behind the scenes. The ETFs are so elegant and simple on the front end, you buy it, you get the exposure. It’s really easy to do. On the backend there’s a lot of moving parts.

Phil Bak: So ETFs are created or redeemed in blocks of shares through authorized participants. I’m not going to bother explaining all that, but if you think about it in terms of when you buy a pair of shoes, you go to footlocker and buy a pair of Nike’s. Nike doesn’t make any money. They make money when they drop off a truck load of shoes at footlocker and then you go and you buy a parent draw down the inventory. So the APS, they’re the ones who were sending those truckloads of shares of the ETF to the market and then the market makers are selling them one pair of shoes at a time. This is kind of one way to think about it. The administrators also handle all the catch and when you talk about taking the fees out of the fund, that’s all handled automatically by the fund administrator.

Phil Bak: A lot of the compliance functions are handled there. So the key things to think about are, you have a trust, you have an advisor, and then in some cases you have a sub advisor. We act as sub advisor for a lot of funds and all those three levels really manage what we’d say is like the primary market of the ETF. So what happens between the authorized participant and the fund itself and what the fund is holding and trading. And then you have the whole secondary market, which is the capital markets function and that’s the market maker, the lead market maker, the exchange where it’s listed, the tracking error of the fund. So what’s the difference between where the bid ask is in any given moment and where the fair value is. And that needs to be managed as well.

Tobias Carlisle: So your own personal investments, how is that philosophy sort of manifest in the firm?

Phil Bak: You don’t want to invest the way I personally invest. So I have over 100% probably of my personal in exponential at the company. So we’re just hitting our third year. We’re still early stage and we’re at the point where to the extent that I had additional discretionary income, I’d be putting an investment into the company to help build out. The way I would invest for my grandmother or would [inaudible 00:27:54] I believe in our funds 100% to the extent that I believe in equity investing, I think that personally, there is a very high likelihood that markets could be choppy going forward. I think that a home country bias is very pronounced and the valuations in the U.S. are very pronounced. So I think our funds are the best if possible. I don’t know what I’m allowed to say in compliance, but I believe in our funds in terms of domestic equity exposure. If I was designing an allocation model for myself or for a client, it would be more diversified than that.

Tobias Carlisle: Right. That home country bias is very pronounced in lots of different portfolios just for the simple reason, it’s so hard to invest in foreign markets because you get the techs complication and withholding and all of those sort of issues. Are there any funds that you don’t manage who deal with that well, do you think? Is that something that you would examine?

Phil Bak: I think there are some interesting funds. Yeah. So, there is no equal weight. Of course, along with reverse cap, I believe very much in equal if it reverses more of equal than equal, but there’s a real lack of options in international and emerging markets outside of market cap weight when it comes to ETFs, if that’s the way that you can access it. I think that when you look at a lot of the foreign markets and you look at market cap weighting, the biases or the bias, but the concentration is even more pronounced. When you look at Taiwan, it’s like over half Taiwan semiconductors that’s unmanaged, and unconstrained. if you look at the broad MSCI global, I think right now U.S. is over 50%, which is very risky.

Phil Bak: So, look, I believe in diversifying my bets and I would most likely, and I’m kind of throwing us off the cuff, but I most likely take more of an equal weight approach to the different markets, even if they’re smaller. To me, that doesn’t necessarily need to be reflected in my bets. I think that a lot of the emerging market funds that I believe there’s one that equally weights China, Russia, India, and I think there’s one the allocates evenly among those. And that would be something that I would find more appealing. There’s also a very strong thesis I think about the consumers in emerging markets, there’s a couple of funds that address that, and I think there is a very good reason to be more bullish in those.

Phil Bak: There’s also an upcoming fund that allocates based on freedom, which I think is really a fascinating concept. I’m very interested to see how that does for international exposure. I think that will probably be a little more underweight China than I personally would want to be. But within a lot of the allocations, I think it makes a lot of sensors, a direct correlation cannot deny there’s a direct correlation between economic freedom and prosperity that follows.

Tobias Carlisle: The exposure to foreign markets is a very tough one. It’s one I think about a lot because I was born in Australia, raised in Australia, so I look at the Australian index and the Australian index is half financials and I think it’s 15 to 30% basic materials that you might expect because it’s a mining country and Australians are overweight.

Tobias Carlisle: The Australian index, Canadians are the same. It’s a heavily financial, lots of basic materials and Canadians are overweight, so it becomes hard to kind of get out of your own stock market, home country bias. It’s real for everybody else in the world. The thing that makes it pressing for U.S investors I think, is that the U.S. is overvalued relative to the size of its GDP in a global sense, which is something that happened in the ’80s to Japan.

Tobias Carlisle: It was a massive stock market relative to its GDP, which was no doubt, very big. That’s a theme that I think is probably that the U.S. goes back to sort of the stock market goes back to its sort of a GDP weighting globally. Are there any broad themes that you look at and maybe move an ETF in that direction or just for your own personal investing?

Phil Bak: Well, I would say that the market doesn’t care where you live. So the whole thing about the home country bias, if anything, you would want to be underway your home country, because you already have enough exposure to that economy. The economy goes to hell where you live, you’re going to feel it. You want to be diversified outside of it more so than anything else. But I mean, look, I’m bullishing merging markets. I think we’re hitting a global world, more and more opportunities and technologies are being as readily available across the world as they are in the countries where they’re developed, be it here, be it in Europe, be it anywhere else. So I think we’re going to continue to see emerging markets and even frontier markets to a degree catch up in those markets where there is the right environment, where you do have that economic freedom, where you do have the right infrastructure, where you do have a trusted government. I think when you have the right infrastructure in place that can happen, it can happen quick.

Tobias Carlisle: What about other broader themes besides sort of geography? Is there any consumer products or developmental technologies that lead you to thinking?

Phil Bak: I like alternatives. So specifically market neutral alternatives, especially given where like into here where I think we might be in a cycle, so funds like MNA theme funds or funds like that, different spreads, commodities are interesting. I mean, it’s impossible at the time. Commodities, we’re looking at some signals and commodities that nobody’s ever looked at before and we’ll see what the results are. We’re close to getting results on a thesis there that may or may not lead to something. You never know. You run these as you know, you spend a lot of time at data. Sometimes you have something amazing, sometimes you don’t, the data tells a tale. But I think in general when you look at alternatives, people think, well alternatives are hedge funds or alternatives are PE and you can have a broad equity value product of a strategy that’s delivered in hedge fund PE.

Phil Bak: I think there’s some research now that says, “Look, if you take leverage microcaps you’re going to get the same thing as a PE, manage the smoothing effect. So you get more liquidity that way. So when people talk about alternatives, I think they’re kind of missing the point. You want something that has no correlation to stocks or bonds where you’re already have too much exposure not you personally but most people and a lot of those old strategies like convertible bond arbitrage is one that I like a lot. Other long short strategies, I think there’s more opportunity to do funds there and I think those are places where I personally love to invest.

Tobias Carlisle: That private equity model is a good one where you only have to report on an irregular basis or quarterly basis and so you can’t see the movements in between. It does give that impression of having very smooth returns.

Phil Bak: Yeah, it’s great if you can do it. And then also you can write down stuff that you can keep evaluation where you want it to be with certain tricks of the trade for a long time. So people look at private equity returns and you have to normalize it for the smoothing. You have to normalize it for what you’re actually getting into market and then you add in the liquidity, the opposite of the liquidity premium and the fact that you have no liquidity for long periods of time. And I think private equity is a lot riskier than people think about, especially now, especially coming off a period where we’ve had, “Look, these guys can access free capital with interest rates being so low and we’ve had an economy that’s expanding, that’s a great market, so you can’t make money in PE, buy something. Yeah, yeah, you add a little bit of management juju, you kind of play around with it and then you package it up and you make a nice return on it.”

Phil Bak: But no matter how bad you are, it’s like flipping a house in the middle of a housing boom, no matter how bad. All right, so I thought I can spend $20,000 on granite and then $30,000, it doesn’t matter because the market saved you anyway. The market went up by so much that you can’t lose money. And I think we see that now with PE, not to say that there aren’t great private equity companies and investors there are, but the idea that any private equity company is just a better bet than the public markets doesn’t seem like something that could hold on an indefinite time horizon.

Tobias Carlisle: That was Dan Rasmus, and I think he did that research advert where he said, if you looked at the factors driving the returns of private equity tends to be, it’s a leverage small cap bet that he can capture. I don’t think he has an ETF, but he captures it in an LP anyway, just investing in public markets. While we’ve got the expert on ETFs, the question that I’m very interested in, there’s a talk of that the ETF rule, when that is implemented, can you just explain what the ETF rule is and what you think the prospects are for that being implemented in the sort of short to medium term?

Phil Bak: If you look at the ETF, the SEC rules that govern the ETFs, like I said, there’s a few. You have the exchange rules, you have the 40 Act rules, you have the registered investment company. I mean, there’s a whole bunch of different rules. But the main rule that covers ETFs is called the 40 Act rules. The 40 Act stands for the 1940 Act. In other words, 80 years ago, literally ETFs are being governed off rule that’s 80 years old. I mean, how crazy is that? 80 years ago there were no ETFs. There were certainly no vix futures. I mean, these funds are being governed. So in order to be able to listen to ETF, you have to abide by the 40 Acts. So you have to exempt herself from, which is a mutual fund rule, so you have to exempt yourself from those requirements that are like a fund and not an ETF.

Phil Bak: It’s a little bit confusing, but basically in those ways that the ETF differs from the mutual fund, you need this thing called exemptive relief that says that you’re allowed to be an ETF who knows ways that are different from what’s laid out in the 40 Act rules. And that makes no sense to have a rule like that and to have an exemption like that from an 80-year-old rule. But now all of a sudden, ETFs are the investment vehicle of choice for the modern investor.

Phil Bak: So the SEC has been working on a new rule called the ETF rule and more directly and instead of managing by exemption is going to manage more proactively say. These are the rules that level playing field, you don’t have two companies that could do leverage and nobody else can, two companies that can do custom creation redemption that nobody else can. It’s gonna be a level playing field. Here’s the line in the sand of what will allow and won’t allow and everyone can go ahead and launch their fund knowing what the schedule or what the requirements are.

Phil Bak: So net is a good thing. It’s going to take a long time to come out. People think it’s ready to go. These things always take longer. The SEC hasn’t published it yet in what’s called the Federal Register, which is really the first step of the process. Then it goes through a lengthy comment period, assuming there’s going to be a lot of comments, which there are. It could go for a process as long as 280 days. Every lawyer is going to want to weigh in. Every capital markets desk is going to want to weigh in. There’s little issues around the edges that are kind of up for debate. I think the core rules are pretty much consensus. We’ll agree to them. I think they’re pretty straightforward.

Phil Bak: Now it was very kind of the SEC to wait for every company that wants to just to kind of have exemptive relief before they announce that they’re working on this rural because you’re solving a problem for companies that are coming in to get exemptive relief that most companies or most large asset management companies already have. So it would have been very helpful 10 years ago. Today, there’s now a trickle of new exemptive relief that are coming out. That exemptive relief process, if you’re not doing anything too funky, if it’s a vanilla strategy, you can get that exemptive relief in a few months and it’s not that challenging.

Phil Bak: There was a time where there was a year or two years and rumors that lawyers would charge way above million, $2 million in some cases to get it. At that time back then it would’ve been very helpful. Now it can make things a little more efficient. It’s not going to have the biggest difference in the world. Companies can still, now they can get their own exemption in between until the ETF rule is out there and it’s not prohibitively expensive or timely anymore.

Tobias Carlisle: I think it was proposed something like 10 years ago. Initially it wasn’t, just they’ll pick a fish to fry at the time because the global economy was tanking, but it sounded like it was going to come back on the books last year, but still not yet.

Phil Bak: Well, the SEC did publish kind of their working document and what they’re thinking in terms of the rules and they opened it up for comment periods and a lot of the industry commented. There are things around the edges that will cause some debates. So for example, the IOPV is the entire day, the every 15 second value of the fund that gets published in real time. And some people think it’s very helpful. I think it’s very helpful if you’re trading a fund and there’s a wide badass spread, you can reference it and see what the fair value is in real time. A lot of people think it’s harmful because there’s nobody really vetting out if the index provider’s right and is that truly fair value and they have a whole host of ETFs that are open either from a foreign market while the foreign market’s closed or in fixed income.

Phil Bak: You don’t have real time transactional price to price it off. So in some cases it can be harmful, you can get bad data. So there’s a lot of debate in the industry, whether that should be killed or kept and is there value there? A few things like that that are kind of around the edges that people are going to argue about but I think what will happen is just the SEC timeline is always longer. Always bet the over on an SEC approval, always.

Tobias Carlisle: One of the interesting things that might happen is that at the moment the index funds get a special capital gains, tax treatment that’s not available to active funds. Do you think that that gets implemented and what do you think the impact of that is?

Phil Bak: I don’t know. I don’t know much about that and I’m not sure if that will come to pass.

Tobias Carlisle: I think it’s kind of interesting because there are funds that are for the capital gains tax treatment that you get in an index fund, is so helpful. It makes that index ETF, it’s better than running it as a managed account because you don’t get the flow through for the tax purposes better than a mutual fund, better than lots of other structures. But when the active investors are able to take advantage of that, that means that you can just put any hedge fund, mutual fund, into an ETF wrapper and trade it as an active product the way that-

Phil Bak: Yeah, I wonder if that’s right. Yeah. And it’s a huge advantage. I mean, that’s probably more than half of the ETF advantage right there. And that’s why you see ETFs so popular in the U.S. and popular but less so outside the U.S. because you don’t have the same tax benefit. I think what that might be is nontransparent active ETFs. So when you’re looking at an active ETF, I think the easiest way to think about it right now we have active ETFs on the market, but there are daily transparency, meaning that they disclose on a daily basis of what they hold with the T plus one leg, so we really see two days ago what they held. But you can see on a daily basis of what they held.

Phil Bak: So if you think about an index fund and you think about the way an index fund re-balances, let’s say an index would rebalance every single day. It’s the same operational process that would be what we call active transparent. You publish basket, the portfolio manager trades the next day. Everyone sees and prices off the new basket. What a lot of people are working on now are nontransparent active where there’s total discretion and the ETF manager would show their holdings on a quarterly basis.

Phil Bak: There’s a couple of different ways that people are addressing it. Some are using proxy portfolios, [inaudible 00:43:12] because the market makers still needs to price in real time off the portfolio. Now they don’t know what the portfolio is, how are they going to make a market? They can say, “Oh well, it’s domestic equity. So it could be, “We started the day at $25 and the market’s flat, so I’m going to price it at 1495 by 2505. I’m probably right, but maybe I had a 5% allocation to that stock that’s on the news today for a big scandal. How do you price that in if you don’t know what’s in there?”

Phil Bak: So one methodology is to use what’s called a proxy portfolio where either you run a risk factor optimization or you do some other representative basket. You say, “This is similar enough to what the actual is,” and you price off of that. Another one is to use a blind trust where you have only the market maker knows what’s in it and nobody else. I think all of those have some issues. They solve some problems and kind of remains to be seen whether the SEC will approve those or not. If they did, I think a lot of those structures could lose those tax benefits because if you can’t create or redeem in real time, which you can’t do if you don’t know what stocks to deliver, then there is no income transaction, and that’s where ETFs get that tax efficiency.

Tobias Carlisle: That’s a great answer. Phil Bak, thank you very much for your time today. If folks want to get in contact with you, what’s the best way to track you down and see what you’re doing?

Phil Bak: exponentialetfs.com is where we are. I’m on Twitter a lot too much on philbak1. And, yeah, thank you, Toby. Thanks for having me on.

Tobias Carlisle: My pleasure.

James Montier: Why Does Everyone Hate MMT?

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James Montier recently released a great paper titled – Why Does Everyone Hate MMT?, Groupthink in Economics. In the paper he argues that MMT is misunderstood by the ‘great and the good’ such as Rogoff, Krugman, and Summers, saying:

Modern Monetary Theory (MMT) seems to provoke a visceral reaction amongst the ‘great and the good’ such as Rogoff, Krugman, and Summers. However, when reading their criticism I am often left with the impression that they haven’t actually bothered reading anything on the subject of their critique.

Rather, they seem to prefer to knock down straw men based on massively caricatured paraphrasing, and by using name-calling and scary (but empty) stories to make their case. These are not the actions of people interested in open and honest debate, but are more reminiscent of the actions of ‘mind guards’ in defense of groupthink. In my experience, MMT provides a much more accurate and insightful framework for understanding the economy than the precepts of neoclassical economics.

Montier concludes the paper with his nine characteristics of the Groupthink mentality, saying:

Sadly, the behaviour of the great and the good is far from exemplary in terms of economic debate. Terms like mess, foolish, fringe, nonsense, and voodoo alongside fear-mongering mentions of hyperinflations may make for an exciting story but they do little to advance the debate. In fact, the use of these words and the generally dismissive (but thoroughly unsubstantiated) nature of these articles appear to be typical of the output of those suffering from groupthink.

The term ‘groupthink’ was coined by Irving Janis in 1972. In his original work, Janis cited the Vietnam War and the Bay of Pigs invasion as prime examples of the groupthink mentality. However, modern examples are all too prevalent. Groupthink is often characterised by:

  1. A tendency to examine too few alternatives;
  2. A lack of critical assessment of each other’s ideas;
  3. A high degree of selectivity in information gathering;
  4. A lack of contingency planning;
  5. Poor decisions are often rationalised;
  6. The group has an illusion of invulnerability and shared morality;
  7. True feelings and beliefs are suppressed;
  8. An illusion of unanimity is maintained;
  9. Mind guards (essentially information sentinels) may be appointed to protect the group from negative information.

The failure in some cases to even bother to read – let alone understand – the elements of MMT coupled with name-calling suggests that the great and the good are acting more like mind guards (defending a broken orthodoxy) rather than academics evaluating an idea on its merits. A truly sad state of affairs.

You can read the entire paper here – James Montier, Why Does Everyone Hate MMT?

TAM Stock Screener – Stocks Appearing in Soros, Dalio, Simons Portfolios

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Part of the weekly research here at The Acquirer’s Multiple features some of the top picks from our Stock Screeners and some top investors who are holding these same picks in their portfolios. Investors such as Warren Buffett, Joel Greenblatt, Carl Icahn, Jim Simons, Prem Watsa, Jeremy Grantham, Seth Klarman, Ray Dalio, and Howard Marks. The top investor data is provided from their latest 13F’s. This week we’ll take a look at:

Encana Corp (NYSE: ECA)

Encana is an independent oil and gas producer with key assets in the Permian, Eagle Ford, Montney, and Duvernay areas. At the end of 2017, the company reported net proven reserves of 790 million barrels of oil equivalent. Net production averaged 361 thousand barrels of oil equivalent per day in 2018, at a ratio of 43% oil and natural gas liquids and 57% natural gas.

A quick look at the price chart below for Encana shows us that the stock is down 35% in the past twelve months. We currently have the stock trading on an Acquirer’s Multiple of 6.04 which means that it remains undervalued.

(Source: Morningstar)

Superinvestors who currently hold positions in Encana include:

Steve Cohen – 42,878,499 total shares

Chris Davis – 41,529,994 total shares

Ken Griffin – 20,605,997 total shares

Jim Simons – 8,904,300 total shares

Paul Singer – 3,050,000 total shares

George Soros – 2,000,000 total shares

Lee Ainslie – 823,060 total shares

Bill Miller – 574,170 total shares

Ray Dalio – 401,415 total shares

Cliff Asness – 123,449 total shares

This Week’s Best Investing Reads 4/5/2019

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Here’s a list of this week’s best investing reads:

Howard Marks Memo – Growing The Pie (Oaktree)

Ray Dalio – Why and How Capitalism Needs to Be Reformed (Part 1) (LinkedIn)

How is the Market Doing? (The Irrelevant Investor)

Stock Investors: You Have Nothing to Fear but Fear Itself (Vitaliy Katsenelson)

Real Estate vs. The Stock Market (A Wealth of Common Sense)

Bill Ackman Trounces S&P 500 in 1st Quarter (GuruFocus)

What We Are Witnessing Today Is A Different Kind Of Stock Market Euphoria (The Felder Report)

The First Line of Investing Defense? You (Jason Zweig)

Top Stockpicker Steps Off Hedge Fund Stage (Validea)

What Sports Teaches Us About Investing (MicroCapClub)

A man and his signals (The Reformed Broker)

Andreessen Horowitz Is Blowing Up The Venture Capital Model (Again) (Forbes)

The Miracle Years Are Over. Get Used To It (NY Times)

Warren Buffett: Banks will be worth more money 10 years from now (Yahoo Finance)

The Index Bogeyman (Independence Advisors)

The ETF Tax Dodge Is Wall Street’s ‘Dirty Little Secret’ (Bloomberg)

Are Large Passive Funds Discouraging Competition (Morningstar)

Sam Zell – A Guide to the Risky Art of Ressurecting Dead Properties (samzell.com)

March – The big rotation from stocks to bonds (Mark Rzepczynski)

Brace yourself – the global economy might be healthier than it looks (MoneyWeek)

Fees vs. Fines (Collaborative Fund)

Momentum for Asset Allocation (Morningstar)

The Forecasting Business Shouldn’t Be This Bad (Bloomberg)

Just One More (Of Dollars and Data)

Hedge Funds Are ‘Impotent’ As Activists (Institutional Investor)

Not all measures of value stocks are created equal (FT)

Guide to the market 2Q19 (JP Morgan)

First World Problems in Fund Management (Epsilon Theory)

LYFT-Off? | No Mercy / No Malice (profgalloway)

Investments That Ride a Generational Wave (CFA Institute)

The myth of average returns (Evidence Based Investor)


This week’s best investing research reads:

Introducing the Newfound Research U.S. Trend Equity Index (Flirting with Models)

Positive & Negative Of Corporate Earnings Trends (UPFINA)

Major Asset Classes | March 2019 | Performance Review (The Capital Spectator)

Short Selling + Insider Selling = Bad News (Alpha Architect)

An End of Quarter Edge (Quantifiable Edges)

Machine learning, now 100%, continues to perform (The Hedge Fund Journal)

Market Risk Premium and Risk-Free Rate used for 59 Countries in 2018: A Survey (papers.ssrn)

High Accuracy Predictions Are Not Always Profitable (Price Action Lab)

Illusionary Investing (Advisor Perspectives)


This week’s best investing podcasts:

(Ep.4) Mark Jones of Pragmatic Capital – How To Find Contrarian Stocks (The Acquirers Podcast)

Dan Ariely – Investing in Irrationality (EP.93) (Capital Allocators)

Becoming a Model Thinker – Scott Page (The Knowledge Project)

TIP236: Momentum Indicators for the 2nd Quarter 2019 w/ Dr. Richard Smith (The Investors Podcast)

Brian Singerman – Investing in the Best Founders (Ep.127) (Invest Like the Best)

i3 Podcast Ep 22: Rich Pzena (Market Fox)

Bill Miller: Stocks More Attractive Than Alternatives (Bloomberg)

Episode #149: Phil Haslett, “Lyft’s Doing $2 Billion Dollars A Year In Revenue, And It’s Growing That Revenue 105% A Year. There Are Only 8 Companies Listed On The Stock Exchange In The U.S. With That Kind Of Profile” (Meb Faber)

Ep 80. Avoiding Confirmation Bias, Doing Research, Changes to Investing Style, and Much More (Focused Compounding)

Animal Spirits Episode 75: The Netflix of Financial Advice (Animal Spirits)


This week’s best investing chart:

Annual Returns and Intra-Year Declines 1980 – 2019 (JP Morgan)

(Source: JP Morgan)

Warren Buffett – Top 10 Holdings Q42018

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One of the best resources for investors are the publicly available 13F-HR documents that each fund is required to submit to the SEC. These documents allow investors to track their favorite superinvestors, their fund’s current holdings, plus their new buys and sold out positions. We spend a lot of time here at The Acquirer’s Multiple digging through these 13F-HR documents to find out which superinvestors hold positions in the stocks listed in our Stock Screeners.

As a new weekly feature, we’re now providing the top 10 holdings from some of our favorite superinvestors based on their latest 13F-HR documents.

This week we’ll take a look at Warren Buffett (12-31-2018):

The current market value of his portfolio is $183,066,067,000

Top 10 Holdings

Stock Shares Held Market Value
AAPL / Apple, Inc. 249,589,329 $39,370,221,000
BAC / Bank of America Corp. 896,167,600 $22,081,569,000
WFC / Wells Fargo & Co. 426,768,902 $19,665,511,000
KO / Coca Cola Co. 400,000,000 $18,939,999,000
AXP / American Express Co. 151,610,700 $14,451,533,000
KHC / Kraft Heinz Company 325,634,818 $14,015,323,000
USB / U.S. Bancorp 129,308,831 $5,909,415,000
JPM / JPMorgan Chase & Co. 50,116,394 $4,892,364,000
BK / Bank of New York Mellon Corp. (The) 80,937,250 $3,809,716,000
MCO / Moody’s Corp. 24,669,778 $3,454,756,000

Herding In Investing Significantly Impairs An Investor’s Ability To Generate Market Beating Returns

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During his recent interview with Tobias, Mark Jones of Pragmatic Capital provided some great insights into why ‘herding’ in investing significantly impairs an investor’s ability to generate market-beating returns, saying:

Mark Jones: I think there’s a lot of herding in investing and I think that that significantly impairs an investor’s ability to generate market-beating returns. It’s difficult to beat the market if you’re investing with the market. I think that the underlying driver of that is this psychology whereas, I think most investors focus on what they see as valuable and what they see as a valuation metric versus well, the market is your customer if you will. One period, you’re their customer, the next period, it’s your customer. You have to know your customer.

I think that instead of focusing on if you like this business or don’t like the business, let’s just focus on the numbers and say, “Well, what is the market expecting and what will the market pay if this happens? If that happens?” Kind of base it on that. I’m looking forward to kind of starting a new narrative on investing and helping people to find their unique approach to really shine as investors.

The Acquirers Podcast

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Smart Investors Use Put and Call Options To Hedge Stock Positions Before An Earnings Call

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During his recent interview with Tobias, Mark Jones of Pragmatic Capital discusses how investors can use put and call options to hedge their stock positions prior to an earnings call, saying:

Mark Jones: Right, so when I’m looking at these derivatives, I’m using them primarily for two reasons. One is to accelerate the returns if there’s some material price movement within a certain period of time. A small period of time like an owners call, but also as insurance. I’m either using it to ensure the downside if the call goes against me or the call goes great but the stock still responds poorly. I want a cushion for that but also to lock in gains. Insurance from losses and insurance to lock in gains ahead of some material price movement for a really nominal price if you will.

They’re more short-term in nature and typically, I’m looking at, it’s all based on expectations so I have models and things like that where I model okay, under these scenarios if the price moves this much, here are all of the option chains. How much are they going to move based on this assumption in a price movement.

I’m really familiar with the Greeks and things like that so I typically on average, I’m going to get something that’s about 5 to 10% out of the money both ways so that I can have that momentum on both sides depending on what happens. Then after the call, once kind of like that wave hits and things fizzle out, you sell the positions and then you reevaluate.

I’m typically not in call options for the long-term. If I have an option that is kind of more longer term, it’s going to be a put option as a form of insurance primarily to lock in gains that I have, and while I’m in the early stages of the fund that I’m launching, I’m likely going to have some puts there just as an additional margin of safety while the firm is starting to accumulating profits so we could start playing with the house’s money.

The Acquirers Podcast

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Michael Mauboussin – You’ve Bought A Stock, It Goes Down – Are You Still Right Or Are You Wrong?

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We’ve just been listening to Michael Mauboussin’s interview with Patrick O’Shaughnessy on his podcast, Invest Like The Best. During the interview Mauboussin provides some great insights into what investors can do if they’ve added a stock to their portfolio, and it goes down. Are they still right or are they wrong? Here’s an excerpt from that interview:

Mauboussin: The other thing I’ve been super excited about over the years. If I endeavour to be a long term oriented investor. I’ll just make this up. I’m looking at two or three year time horizons. It really is difficult if you’re descretionary because you put the stock in your portfolio. You’re long and it goes down. Am I right or am I wrong? That’s an interesting question. Part of that is to say, are there mechanisms to give us intermediate feedback that’s useful and timely. That’s why the work by Phil Tetlock and others on things like Brier Scores.

O’Shaughnessy: What’s a Brier Score?

Mauboussin: A Brier Score is a measure of the quality of your probabilistic forecast. Glen Brier who is a meteorologist. So it’s basically judging like you woke up in the morning and said there’s x percent chance of snow, or whatever is was. How accurate are those forecasts. So the way a Brier Score works is basically zero means youve nailed it. Everyday its sunny, you say sunny, everday its rainy, you say rainy.

A Brier Score scale can go to one or two. Lets say you score a two, that means you’re wrong about everything. Its a way of keeping track of probabilistic forecasts.

A couple of things that are really important about this. One is, whenever Brier Scores are kept and feedback is given back to decision makers. Meteorologists, people in the medical field. They get better at this. They get better calibrated. So the feedback makes people better. So you say, what does that have to do with investing?

Well you think about it. You have a thesis on a stock. What I should be able to do. Is layout the path, the thesis that I expect. Again its deviating from what the market believes. That’s a really crucial thing. And then I should be able to assign probabilistic forecasts to certain sign-posts. So I believe sales are going to be higher than the market believes. There’s x probability that sales will exceed this amount in this quarter. And I can give a probability to it. So now I’ve set myself up for a Briers Score.

Its a probabilistic forecast. It’s within a specified time period. We can agree on the outcome. And its important to our thesis. And now all of a sudden I’m giving you all of this intermediate feedback. And by the way we talked about Baysean updating before. It opens up your mind to say, “Hmmm, I thought this was going to happen. It didn’t. Let’s talk about whether we’re in the same place and the thesis is still unfolding correctly.”

That’s a technique that’s super-cool.

It’s this idea of intermediate feedback in a field where the feedback is really messy and noisy. Again, if you’re using two to three year horizons. This is a way to give you weigh-points along the way to make sure you’re doing things right.

How To Find Contrarian Stocks That Generate Outsized Returns

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During his recent interview with Tobias, Mark Jones of Pragmatic Capital describes his approach to finding contrarian stocks that provide outsized returns, saying:

Mark Jones: Right, so I have a four-step research process and this is how I vet or I audit the market’s point of view. I find that there are a lot of situations where a stock will come up and the level one of my process, which is more screening. So I have an algorithm that basically does financial statement analysis that I would conduct myself and it returns indicators for all of the stocks in the universe that I’m looking at, that look attractive or just not attractive here.

What that screener is really looking for, is a divergence between fundamentals. We’re talking about revenue trends, revenue trajectory and a profitability, and profit trends, and profit trajectory, and what the stock is doing. If we can start there, then we can say, “Okay, well clearly, if the company is doing well based on the numbers and the stock is not doing well, then that means that the market is predicting that the company will not do well going forward.”

That’s an easy step to kind of interpret the market’s predictions. You have to use inference there but beyond that, there are a lot of situations where I could say that I could see where the market is coming from. Where a stock is down 60-70% and a company’s revenues or EPS, they’re growing right now but if you do a little digging, you can see, “Okay, I can see where the market is coming from here. There’s no story here.”

But if I get through level one and I’m looking at the financial statements and I’m looking at the headlines and I see, “No, I don’t see where the market is coming from here beyond just speculation,” then I move it through the process, two through four, and what that process is centered on is basically getting an understanding of that company’s, I call it the economic ecosystem, to understand what’s really going on. Aside from the stock market, what’s happening on a fundamental, micro-economic level? You can get really deep there. That’s where you can get in the weeds and get lost but that whole process is to kind of come to a point of view on if the market is right or wrong.

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(Ep.4) The Acquirers Podcast: Mark Jones of Pragmatic Capital – How To Find Contrarian Stocks

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In Episode 4 of the The Acquirers Podcast, Tobias chats with Mark Jones of Pragmatic Capital. Mark has an unusual approach to picking stocks and it works. It’s made him the top-ranked analyst in SumZero on a last 12 months basis. During the interview Mark discusses:

  • How To Find Contrarian Stocks That Generate Outsized Returns
  • How Many Uncorrelated Stocks Should An Investor Hold In Their Portfolio
  • How Smart Investors Use Put and Call Options To Hedge Stock Positions Before An Earnings Call
  • How ‘Herding’ Significantly Impairs An Investor’s Ability To Generate Market Beating Returns

He also discusses how his strategy has performed with stock holdings such as:

  • Weight Watchers
  • AMC
  • Pandora
  • Pure Storage

The Acquirers Podcast

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Full Transcript

Tobias Carlisle: You ready, mate?

Mark Jones: I’m ready, yeah.

Tobias Carlisle: All right. Let’s do it.

Mark Jones: All right.

Tobias Carlisle: Hi, I’m Tobias Carlisle and this is The Acquirer’s Podcast. My guest today is Mark Jones of Pragmatic Capital. Mark and I met last year, have had a series of fascinating conversations because Mark has an unusual approach to picking stocks and it works. It’s made him the top-ranked analyst in SumZero on a last 12 months basis. We’re going to hear from him right after this.

Speaker 3: 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. All opinions expressed by podcast participants are solely their own and do not reflect the opinions of Acquirers Funds or affiliates. For more information, visit AcquirersFunds.com.

Tobias Carlisle: Mark, welcome to the podcast.

Mark Jones: It’s great to be here, Toby. Thanks for having me, I’m looking forward to a great conversation.

Tobias Carlisle: You and I met, when we first met, you described yourself as a contrarian and I was, I got to say I was skeptical because I hear that a lot, everybody is a contrarian including me but as we talked, it became clear that you really are doing something unusual so can you just give us a little, a flavor of how you approach an investment?

Mark Jones: Right, okay. Yeah, so I definitely know that everyone says they’re contrarian. That’s kind of like the rule of thumb, that every investor should say, right, but I think that I am truly contrarian in that any investment that I’m looking at, I am directly going against the herd as measured or assessed by how the stock has behaved in the last 12 months or so. If the stock is going really well, I’m not going to go along that stock. If I’m in it then that means that I’m short and if the stock is doing terribly, they’re down 60-70%, well I’m going to go along.

Mark Jones: That way, we can just clearly say, “Okay, well that’s contrarian because you’re objectively against the herd.” That’s how I like to invest because I believe that you get the biggest bang for your buck that way. Whereas if you’re putting in the deep research and you’re right about the company’s economic trajectory, well, you get the biggest reward once you’re proven right because if you’re going against the herd, then that means that the current price is a reflection of current expectations but if their expectations are completely wrong, well, then that means that the stock’s price is going to go in a completely opposite direction.

Tobias Carlisle: You’re looking at a stock is down a lot, then how are you kind of making it the assessment that the market has it wrong? What’s your insight?

Mark Jones: Right, so I have a four-step research process and this is I would see how I vet or I audit the market’s point of view. I find that there are a lot of situations where a stock will come up and the level one of my process, which is more screening, so I have an algorithm that basically does financial statement analysis that I will conduct myself and it returns indicators for all of the stocks in the universe that I’m looking at, that look attractive or just not attractive here.

Mark Jones: What that screener is really looking for, is a divergence between fundamentals. We’re talking about revenue trends, revenue trajectory and a profitability, and profit trends, and profit trajectory, and what the stock is doing. If we can start there, then we can say, “Okay, well clearly, if the company is doing well based on the numbers and the stock is not doing well, then that means that the market is predicting that the company will not do well going forward.” That’s an easy step to kind of interpret the market’s predictions. You have to use inference there but beyond that, there are a lot of situations where I could say that I could see the where the market is coming from, where a stock is down 60-70% and a company’s revenues or EPS, they’re growing right now but if you do a little digging, you can see, “Okay, I can see where the market is coming from here. There’s no story here.”

Mark Jones: If I get through level one and I’m looking at the financial statements and I’m looking at the headlines and I see, “No, I don’t see where the market is coming from here beyond just speculation,” then I move it through the process, two through four, and what that process is centered on is basically getting an understanding of that company’s, I call it the economic ecosystem to understand what’s really going on. Aside from the stock market, what’s happening on a fundamental, micro-economic level. You can get really deep there. That’s where you can get in the weeds and get lost but that whole process is to kind of come to a point of view on if the market is right or wrong.

Tobias Carlisle: Why don’t you give us an example? We’ve discussed several of your positions. Give us an example of a stock and then walk us through the process.

Mark Jones: Okay, so let’s see, what’s the most exciting?

Tobias Carlisle: Weight Watchers was one we discussed.

Mark Jones: Yeah. We could think about Weight Watchers. Okay, so Weight Watchers, this is an example of more of a turnaround story whereas the stock responded in a more delayed fashion through the turnaround. For a while-

Tobias Carlisle: When did you find it? When are you sort of looking at it?

Mark Jones: I found Weight Watchers around February 2017, so right before their Q4 earnings call. That’s where they were flagged in the algorithm and what really stood out about Weight Watchers was yes, for a certain period of time, they were just in a free fall. Revenue, earnings per share, was just falling at a constant rate of about 25% quarter after quarter.

Mark Jones: Then all of a sudden, that shifted and the negative growth decelerated and then you saw on the last two quarters I believe, that it actually accelerated, and that growth accelerated and it wasn’t a lot but it was still, okay, there’s something here. These numbers don’t just come out of the blue, there’s some economic substance for why a company was in free fall and then things were turning around.

Mark Jones: You couple that with the fact that the company had about a short interest that was about 80 or 85% free float. That really stands out to me and so with that, I said, “Okay, I’ve heard of Weight Watchers before.” I thought they had a broken business model from just my recollection of the company but again, I have to put my point of view aside and say, “Okay, well let’s go look at the data,” because I hadn’t looked at the data at the time. Once I started doing research, I saw that the company had completely changed their business model. They had aligned it more with the times, with what the consumers wanted, which was more of an integrated approach to weight management.

Mark Jones: The content was stale. They had the same content, same approach from 10-15 years ago. Things are changing now. You have a lot more connected devices, you have a lot more technology. There’s a lot more motivational content in weight management activities, so basically, they realigned their got-to market strategy for the times, got Oprah front and center. A lot of people knew she was affiliated with the company but she started to be in the commercials talking about her experiences and how it’s not just about weight loss, it’s a lifestyle change and it’s about wholeness and wellness. That’s really key right now in the environment.

Mark Jones: In doing the research and actually seeing Google trends, impressions on social media, and then looking at the actual underlying operational data of the subscriber growth, they also changed the business model to have more of a subscription-based model, which really helped and you look at the trends between operational data and financial data, and you do a lot of quantitative analysis, regressions and things like that to see what’s the relationship here? Because of the operational data is positive, well, that’s a great indication of future financial data.

Mark Jones: Once I finished the research, I saw, “Hey listen, the company lost 70-80% of its value over a period of years,” one can say that was just or not just. The specific amount is not as important as the sentiment and I can understand that sentiment, but once I did the research and I say, “Listen, this is a new company and the market is just reluctant to accept that,” but the last step of the entire process is looking at what Wall Street’s numbers are, because a company that beats earnings estimates, that’s going to go well for them and sure enough, I found that estimates were very conservative if you will, and that’s what happened.

Mark Jones: They beat estimates. That week, they went up about 50% and ever since then, they’ve been on [inaudible 00:09:02] of early this week but that’s you know.

Tobias Carlisle: It’s had a big tumble. Does that sort of peak your interest again? Is it something that you want to go back and look at in some depth?

Mark Jones: Well, you know, this was an interesting case study for me because it’s one thing to do all the research on the front end and say, “Listen, this stock is mis-priced, expectations are wrong. There’s going to be some correction.” Okay, well, what magnitude of correction? When are you going to walk away from this and say, “Okay, the story is over here,” because Weight Watchers ended up going up about 700% from the time that I got in and since then, it’s gone up a little more, gone down a little more and then last week, they had a major fall and I thought to myself, “Well, how would I have stayed in after the initial year,” because in the year I got in, it was up 700%. That’s great.

Mark Jones: I think that it’s all based on sentiment and if you look at sentiment, it’s positive. Okay, well, that makes me kind of, because I’m not contrarian anymore, right, so it’s okay, but I can still ride this wave. If earnings estimates, it all comes down through earnings estimates. If you find that earnings estimates were conservative based on your financial forecast then go ahead but you find that the estimates are starting to be more aligned with yours, maybe the stock can still go up, maybe not but I’m not really into that game because it’s hard to predict that but definitely if you find that earnings estimates are starting to get ahead of the company like a pendulum, then I would get out. It’s really always going to be based on sentiment, and expectations.

Tobias Carlisle: You’re looking for a stock that’s sort of down a great deal and the underlying earnings story has changed a little bit and then you’ll go in and do this really deep research, which looks at their entire ecosystem. I think the way that I sort of really understood what you were doing, I think you were talking about one of the cinema-

Mark Jones: AMC.

Tobias Carlisle: AMC, so AMC was one that I really kind of, for me, that was the thing that helped me understand what you were doing. Can you walk us through the AMC investment?

Mark Jones: Right. That was really interesting because AMC stock went down about 60%. That seems to be the sweet number for companies that actually move forward. Not the 40%, 30% but 60-70, that means that this is a live one.

Tobias Carlisle: That’s panic.

Mark Jones: Right, exactly. I love to be on the other side of that so long as the data is there, right? When I look at AMC and I’ll be honest again, just as a consumer, my opinion of AMC is that hey listen, streaming is presenting an existential threat. Netflix is huge. Netflix is getting even bigger. Movies don’t seem to be that great these days, but this is all just consumer perspective, right? I didn’t do any real research, this was just as a consumer but I thought to myself, “Hey listen, based on the algorithm, there looks like there’s a divergence here. Put your own personal views aside and go and do the research,” just like I did for Weight Watchers and what I found was really interesting, something I did not know, is that of course AMC’s performance is, AMC is a derivative on the box office, right?

Mark Jones: Yes, they have other lines of business but it’s related to attendance, right, like food and beverage. If you really want a handle on AMC’s operational trajectory, you have to have a handle on the box office. While you read the headlines, you read what the “experts” are saying, no one can predict the box office so on and so forth but actually, there’s an organization by the name of Box Office Mojo and they aggregate all the of the data from movies back to I think 1999, based on studio release date, all of that.

Mark Jones: I love data analysis. I went to Carnegie Mellon and the focus at Carnegie Mellon is quantitative analysis, extracting meaning from numbers. I looked at that as a gold mine. What I found was that the box office was actually cyclical. The box office, you could see, if you chart it out, you could see two years up, one year down, two years up, one year down. Then you start to look at the earnings calls of Disney, which is the largest studio to see well, what are they saying? This is that economic ecosystem analysis.

Mark Jones: I think it’s really important to get outside of the company you’re looking at and look at the companies that they’re interacting with because no company exists just in isolation, right? With that, you found that Disney was saying the same exact thing, that Disney actually planned for 2017 so I found AMC in 2018 so this is after the 2017 year, which was down. Disney actually expected 2017 to be down because they were planning for a blockbuster 2018 and ’19 and they have their own production schedule so on and so forth.

Mark Jones: Once I actually looked at the underlying data for the studios, what the studios were expecting, how many movies came out? How many movies were franchise movies? What’s the average revenue for the franchise system? What’s the standard deviation of revenues because if their standard deviation is relatively small, then I can forecast future films based on historic franchise films and that’s what I did and I found that everyone was expecting the box office to be down about 2 or 3% in 2018. My forecast had the box office up about I think 8% or so, and the box office ended 2018 up about 9% I believe.

Tobias Carlisle: Basically, you’re saying that when the big studios release their sort of marquee names, that’s the driver so it’s not really necessarily a secular kind of drift down in cinema attendance, it’s sort of driven more by what movies are coming out, what big movies are coming out, and that insight led you to get long AMC at just the right time.

Mark Jones: Exactly, right. I think that if you just [inaudible 00:14:57] and look at the data and while you know streaming is big, they can coexist and you find that if the content is there, because there were some studios that didn’t do well, because their movies just were not good. Whereas most studios actually have a clear production schedule and they’re doing well.

Mark Jones: Everyone thinks that, “Oh, well, you know cinema is going down because attendance is falling every year.” You find that, no, that’s not the case. When you have these blockbuster years, attendance increases and average ticket price increases and that helps everyone in the industry. That’s just another example of looking outside of the company at the ecosystem, which directly affects the company and that’s something that the market completely missed.

Tobias Carlisle: What were the big marquee releases in 2018?

Mark Jones: Actually, Disney is the largest and the most impactful studio of all. Of all the studios, I know the movie industry can seem like it’s really chaotic and there are [inaudible 00:15:56] studios, there are independent studios but about 90-plus percent of the box office revenues are derived from only seven studios. If you analyze those seven, you could get a good feel for where they’re at health-wise via acceleration or deceleration of growth and you find that Disney, their market share is about 20-plus percent of the over all box office.

Mark Jones: There has not been one year where Disney had a down year and the market was up. There has not been one year where Disney had an up year and the market was down. Basically, if you really want a hand on where the box office is going, you should look at Disney. To answer your question, Disney had several major films in 2018. Black Panther was a huge breakout hit, over a billion in sales. Of course, the Avengers movie was a major hit. Then they had other franchises that really augmented that Marvel franchise system and that really made Disney’s revenue increase significantly in 2018, which directly helped the movie theaters.

Tobias Carlisle: You don’t really describe yourself as a value investee. You sort of think about value as a component in what you’re doing but that’s why you’re a contrarian because you’re really looking for that wide divergence between a sort of trend in the stock price and the underlying trend in the fundamental to the company, plus some sort of insight into where it’s going to be in a future state.

Mark Jones: Right. Yeah, so I actually get this a lot. I would say I’m more aligned with value investing principles than other flavors of investing. However, I do have clear divergence points with value investing. I’ll be careful what I say because I have a lot of friends who are value investors. I know you’re a value investor, right?

Tobias Carlisle: Including me.

Mark Jones: I’ll be careful with that. I know that Warren Buffet is a value guy. I understand that, but I believe that our purpose as investors is to generate the highest returns and if we look at, “Okay, well, how do we generate the highest returns?” We have to look at, well, what drives stock price movement like Stanley Druckenmiller focuses on? What drives stock price movement, would be expectations, performance relative to expectations, which that’s obvious but also, I’ve done quantitative analysis studies that have proven that the companies that significantly outperform and the companies that significantly underperform, they had a major divergence between expected performance and actual performance.

Mark Jones: What I find is that places us, and of course, when we talk about performance, we’re talking about fundamentals. That’s value, right? You’re looking at the actual fundamentals of the company. However, I think that the other side of the equation, expectations, looking at what does the market expect and taking both of those into consideration when you invest, that to me is the holy grail of investing and that to me, is called contrarian.

Tobias Carlisle: Basically, it is sort of value-related but maybe using the, you’re kind of trying to use the turn in the fortunes of the company as your catalyst, like that’s the time that you want to put the investment on.

Mark Jones: Right, or even situations where there have been companies such as Pure Storage, which was one of my first picks actually that the company was doing really well. A tech company, they provide flash storage to enterprises, who are now transitioning from magnetic disks, floppy disk, you know, would you believe that most data that companies have are stored on a hard drive, magnetic disk?

Tobias Carlisle: I would not believe that.

Mark Jones: Right, exactly and that’s only because it was so expensive. It was so easy for us to get these flash drives because the unit cost on a consumer level went down a lot but for corporations, it did not. Well, Pure Storage is a start up, they’re not a start up anymore, they were a start up a few years ago that developed the flash technology for the enterprise level. They were a true disrupter. When they had their IPO in the fall of 2015, stock did well and then it did horribly.

Mark Jones: I found them in about March of 2016 I believe because revenue was growing immensely. Profitability was improving significantly so EPS was improving significantly. I found that that was contrarian even through the company wasn’t having poor fortunes, it was just that the market had some view that was a divergence from what I believe the underlying economic story was, which proved to be true.

Tobias Carlisle: You do deep research on a company by company but a lot of this, your method is based on some other research that you’ve done more broadly. You went to Carnegie Mellon, what did you study there?

Mark Jones: Right. I did an MBA at Carnegie Mellon.

Tobias Carlisle: You did an MBA, and you did this research at Carnegie Mellon?

Mark Jones: Right, so prior to Carnegie Mellon, I was in accounting so I studied accounting undergrad and grad, CPA, all of that. That has helped tremendously in ways that I probably can’t fully appreciate because when I see financially statements, I speak that language, right? That’s the only training that I had academically. When I went to business school, I wanted to augment that accounting perspective with a quantitative analysis skillset and also, economic analysis.

Mark Jones: While I was at Carnegie Mellon, I really wanted to join a hedge fund and I thought, “Hey, if you want to join a hedge fund, you have to have to be a great stock picker. You have to have your own value proposition.” With that, while I was spending an hour in class on school work, I was spending an hour stock picking and researching stocks to practice and get my skills up.

Mark Jones: I eventually got to a point where I said, “Well, is there some type of pattern between the stocks that do really well, and the stocks that do really horribly?” Because up to that point, it all seemed random and you on CNBC and there are a lot of people talking but there’s really no circling back to see, “Hey, were you right, were you wrong?” There was no post-mortem analysis. Hindsight is 20/20 but who’s looking back?

Mark Jones: While I was developing this skill set at Carnegie Mellon to do quantitative analysis, run regressions, gather large quantities of data, and extracting meaning, I said, “You know what? Why don’t I create a project for myself?” I went to the Bloomberg Terminal and I ran a query for a stock screener. Basically, it consisted of each year for a 15-year period. What I did was I gathered all of the stocks that had a market cap in between, above 500 million, anything below that, I just thought that they were too, there wasn’t a lot of liquidity there so there could be other factors there. At the time, this was my thinking.

Mark Jones: I left out commodities, biotech, bio-pharma, these really niche industries. What I did was I looked at okay, what was the, I wanted to see how did the company perform as far as revenue growth, profitability growth, and then what were the expectations for these companies? Then I would have a call on for the stock price return.

Mark Jones: Basically, I had all of the data points I wanted to observe. There were about 40 of them and there are thousands of companies obviously in the market each year, so I ran this regression for each individual year to see is there a pattern between the top 5 percentile and the bottom 5 percentile. What I found with a high degree of statistical certainty was that companies that did really well, they had performance that significantly deviated from expectations, coupled with their stock performance prior to that deviation was the opposite.

Mark Jones: If a company had a positive deviation the stock was negative going into, well that was very likely in predicting that the stock would do really well, and vice versa for the shorts. After I found that, I never have deviated from that approach of okay, well that’s contrarian. I looked at that and said, “Okay, well you’re going against the herd.” If you look at it logically, it makes complete sense. If you’re going along with a company everyone is short and you were right, it’s going to pay off big and vice versa but you need to be right. That’s the big thing, right, and that’s where the deep research comes in.

Tobias Carlisle: It makes a lot of sense. When you say expectations, what is that? What is the data line or what are you looking at when you’re saying expectations?

Mark Jones: I quantify expectations using Wall Street’s estimates and of course, that’s nor the qualitative expectation. The more, if you want a number for expectations, I really look at the stock price. If the stock price is going down significantly, that means that there’s negative sentiment, right, and vice versa for positive. However, what this quantitative analysis had it shown and what logic would show is that even though investors may not be following Wall Street’s recommendations to buy or sell a company well, if this company beats Wall Street’s estimates or misses Wall Street’s estimates, the stock price moves.

Mark Jones: That shows that investors do care about those baseline numbers that Wall Street has so I quantify the consensus view as Wall Street’s estimates, and sometimes you have companies that beat estimates and the stock doesn’t go up or it actually goes down but that’s more of an anomaly than a principle.

Tobias Carlisle: You said, before you were talking about Druckenmiller but Druckenmiller is not your guy, David Tepper is.

Mark Jones: Right. I’m probably biased, right, because I went to the Tepper School of Business. I had the fortunate opportunity to meet David Tepper, to interview with his firm for an internship. I received very positive feedback from people at his firm, from him directly, just telling me that the stock I pitched, everyone liked it and they really appreciated my logic there and actually that they had selected me for the internship but they had canceled the program so that didn’t work but that was enough to me, for me to see that I had something that was unique and that was different.

Mark Jones: Interestingly enough, the stock I pitched was a contrarian stock, it was a short on GameStop and that was a first flavor of contrarian. Once I saw, it just makes sense to me being contrarian but do your research. Do your research and be right because if you’re right, then the reward is big and also, if you’re contrarian, you can just bet that there aren’t a lot of people who see the world the way you see it, which helps you in the event that you’re right.

Mark Jones: Yes, David Tepper is my man. He’s contrarian. Any time that he makes a move, in the earlier years it was directly contrarian, it was explicitly contrarian where it was the market thought things were going to go one way, he thought the opposite. Now, his firm is so large that I would say he’s contrarian in that the market may have a positive view on a company but his view is more positive or vice versa so I would say it had to augment because of the size of his firm.

Tobias Carlisle: GameStop is a really interesting name because it’s one of those ones that it screened really cheaply for years, and years, and years and it’s had this terrifying downward run the entire way through and nobody looks at the stock and thinks, “Well, that’s a really good long, other than the fact that it’s kind of quantitatively cheap.” I mean a short is an interesting position to put on, so walk us through the GameStop short.

Mark Jones: Right, so the GameStop short was rally interesting in that and again, I was in business school during this time so I’m still learning as I go and I’m still learning as I go, right? There is so much more to learn. However, with GameStop again, I’m coming from the background of accounting so I’m looking at, “Okay, what are the numbers?” I know that these numbers tell a story. I’m really interested in a company’s story. Every company has a story.

Mark Jones: I found that GameStop was a situation in which I saw that I thought differently because people who are more oriented towards finance looked at financial metrics and things like that but I’m not a finance guy. I’m passionate about economics, micro economics. With GameStop, what I did was I focused on, well, what’s the underlying micro economic story, because if I can get a handle on that and see what’s the growth trajectory of this company, well eventually, that will bleed into the stock.

Mark Jones: Finance is all based on how do you value a business based on certain assumptions. Well, I focus on those assumptions, right? If your assumptions are wrong, it doesn’t matter if you have a perfect DCF, your assumptions are wrong. Garbage in, garbage out, right?

Mark Jones: What I found was that of course, anyone can look and see, “Okay, GameStop’s business model was facing an existential threat in that game manufacturers and the studios were starting to develop digital downloads for the hardware.” I don’t know if people know this or don’t, but while GameStop most of their revenue comes from new games, 50% of their profits came from the selling of used games because if anyone has had a game before, you buy the game for $50, you go trade it in when you’re done with it and they give you $10 for it but then they go and they sell it for $20-25. The mark up is huge.

Mark Jones: That’s a great business model. Great job GameStop, right? However, if people are starting to download the games digitally, well in T0, which is right now, instead of buying a physical game, you buy the digital game. Well, on T1 when you would normally go back in and trade it in and GameStop would have that inventory for used game sales, well they don’t have that anymore because you can’t go and trade in a digital game.

Mark Jones: While that was the short thesis for years, the problem with the shorts before I found GameStop was that they didn’t have a handle on the catalyst, when, when is this going to happen? When is this going to happen really to me means, when is this going to start to show up in the financial statements? Again, you do the deep research and you see the data that is being provided not by GameStop because they were being very secretive, okay, let’s say conservative with information on digital downloads and things like that. That’s a red flag to me.

Mark Jones: One book that I read called “The Art of the Short Sale”, the best investing book I’ve ever read, of course I have “Margin of Safety” and it’s a great book but I like “The Art of a Short Sale”. It talks about when you found that management isn’t being as open, you know? If there’s great news, companies are going to shout it from the rooftop but if they’re being more conservative, there’s something there.

Mark Jones: With that, okay, that’s fine. The company doesn’t have to give me this information. I can go other places to get this information because a company doesn’t exist in isolation. There are other businesses out here. Once you go to the earnings calls of the manufacturers and you see what they’re saying and you go to the industry experts, you start to interview people who are involved in the industry, you could see that the suppliers of the games were really making a move to get GameStop out of the supply chain.

Mark Jones: Primarily, because they receive more profits from digital downloads than the physical games and also, years before they had taken GameStop to the court because GameStop wasn’t sharing any of the profits with them from those used games. I think they had a sour taste in their mouth because GameStop said, “Listen, our agreement was that we would buy new games from you and what we do with the used games, that’s what we do in the secondary market.”

Mark Jones: Well, now that the tables have turned, these suppliers, they were in no hurry to negotiate with GameStop because GameStop was just a retailer. When you’re getting into a digital space, well the physical retailer doesn’t have as much value. That’s what I saw was the issue with GameStop as far as the timing, the rate of digital downloads was increasing significantly primarily for two reasons, one, technology. As technology advanced, bandwidth levels increased, you could start to actually download games onto your console. The memory increased in the console, the technology enabled the transition. Before, the technology just wasn’t there to download these huge games.

Mark Jones: Additionally, the suppliers with that technology now being enabled, they started to incentivize customers to download digitally. They would give 20% discounts if you downloaded digitally. They would pre-release if you downloaded digitally. Gamers love games so if they can get it a week before, a day before, that’s a big thing for them so those two forces really caused the rate of digital downloads to increase and since that has an inverse relationship with the rate of physical purchases, it started to hurt GameStop.

Mark Jones: While it took about a year for that to fully show up because again, T0 you don’t really see an impact because while the top line has had ones there, you’re really going to see the impact on the bottom line and sure enough after a year of this transition, GameStop’s stock just started to descend materially and last I checked, it’s still doing that. They actually tried to reposition the company and when you see these types of shenanigans that you know something’s up, and they start to say that they were not a video gaming company, they were a refurbisher of consumer electronics. They started this business to buy used phones and tablets and things like that and refurbish them in their center in Dallas that they did for the games and sell them.

Mark Jones: That’s not their bread and butter, that’s not their core [inaudible 00:33:59]. They made billions selling video games. They were not going to replace the lost billions that were going to come with selling used cell phones and sure enough, last time I checked, they ditched that business and it’s just in free fall. It gets to the point where you can’t pay enough in dividends to make investors overlook just a deteriorating business.

Tobias Carlisle: You’re doing enormous amounts of research for each of these positions that you put on. How do you think about sizing positions when you first put them on? How do you think about managing a portfolio?

Mark Jones: Right, so the way that I approach portfolio management, which includes sizing correlation and things like that is that I believe in having a concentrated portfolio of about 12 to 15 holdings. I believe that and just even based on just statistical principles. Once you have about 15 unique observations if you will, you’ve got most of the benefits of diversification. Once again, it’s a 20, 25, 30, 35, 50, there’s something more there. You’re starting to diversify your time and you only have so much time.

Mark Jones: What I find is that, and I have views on that approach of having 50 positions in your portfolio, I believe that 12 to 15 is enough so long as these stocks are truly uncorrelated with each other and given that I focus on idiosyncratic situations that by definition means that they’re not correlated with each other because AMC is trading based on what’s happening in the box office. Pure Storage is trading on what’s happening in the flash storage industry. Weight Watchers is weight management so Pandora is streaming, so these are all completely different stories.

Mark Jones: These stocks weren’t related when they had their major sell offs or like Overstock had a major ride up and so with that at that point, we can already see that these stocks have broken out of the orbit of being related to the overall market because while the market is up 20%, these stocks are down 60-65% so that’s how I approach.

Mark Jones: As far as position sizing, I believe in equal waiting. If I find that I have more, if I want to go overweight a certain position and underweight a certain position, to me that means that I probably have more conviction in one and less conviction in the other and if that’s the case, then I need to revisit what I’m doing because I believe in kind of the six sigma approach of quality, quality, quality.

Mark Jones: Like Warren Buffet said, “You stay in your area of core competency and you focus on the balls that you can hit.” You don’t have to swing at all of the pitches that are being thrown. If I have a basket of 12 to 15, I want all of these to be my high conviction plays, if I have a portfolio of 50, these five are my high conviction, well then it’s like what are those other ones? That’s the way I approach it.

Tobias Carlisle: If you have a position like Weight Watchers, which is up enormously as you hold it, do you trim it back or do you hold it until you sort of decide to get out? How do you manage them?

Mark Jones: I do like to use derivatives to augment trades. Ahead of an earnings call, I definitely believe that it’s prudent to purchase some calls [inaudible 00:37:21] because again, these are contrarian stocks so one thing you’re going to get from contrarian stocks is volatility and especially if you believe that there’s material price movement coming in the future. You definitely kind of want to augment that trade with some options on the upside and the downside. With that, I view that as kind of accelerating.

Mark Jones: That’s not something that is a constant in the portfolio, so I definitely I guess just trade around a position depending on what’s going on with the actual stock but when we start out at T0, everything is equal weighted and then as time goes on, if I find that I’m going to start to pair down the size of position, then that means that my conviction of the price improvement from now until next year, I don’t have as much conviction in that and I need to revisit the entire trade because I don’t believe that again, the purpose of an investor is to generate the most significant returns that you can for yourself and your investors.

Mark Jones: You can have a stock that like Weight Watchers, it goes up 700%, I wouldn’t hold after that because it’s not after you have your returns, it’s always about what’s the marginal benefit of holding this? It’s not about how much have you made on it in the last year, that’s great but that’s done. As you invest, you’re investing for the future so there’s always another contrarian stock out there.

Mark Jones: I look at them like waves. If you find that this wave is starting to crest, well, get off and go find another wave with that money and that’s how you really get that compounding effect.

Tobias Carlisle: Do you have like an average holding period? Are they too different to have that determination?

Mark Jones: Yeah, so I have an investment horizon of 12 to 18 months. Sometimes it plays out much sooner than I expected but and when I say plays out okay, well you have the catalyst and there’s a shock to the stock. Then it starts to trend upwards. That’s what I love but if you have a situation where there’s a catalyst, it goes up materially, it trends upwards but then you find that on a technical basis, the stock is kind of waned and it’s not trending upward anymore, it’s just kind of staying where it’s at, then you look at what are the estimates from Wall Street? If the estimates look reasonable, well, it’s over. Get off and move on.

Mark Jones: However, if you find that it’s trending positively and that marginal gain is still there to be had and estimates continue to look conservative, then the underlying merits of the position are the same as they were before the stock had gone up. That’s how I look at when specifically am I going to get out but I want to give it 12 to 18 months to correct itself and take on a life of its own. Also, when you’re contrarian, you can have a stock that’s up 70% and if there’s anything that is less than stellar or something that kind of echoes an unsubstantiated fear, you can have a sell off. Primarily, because people are looking to lock in some gains that they had.

Mark Jones: For instance, iRobot it a great one. Even though the story was solid and it remains solid through the story I’m about to tell you, what happened with the stock was it went up about 70% and proved all of the critics wrong and then they had a Q3 earnings call, they did wonderfully. However, they source some of their manufacturing from China and this was when the initial talks of tariffs were happening and the stock had lost about 20% just based on them saying that there would be a 5% hit from tariffs, even though the company had beat and raised their guidance to be significantly above what the [inaudible 00:41:09] was expecting.

Mark Jones: I thought, “Okay, well one, the stock was up a lot in a small period of time.” I’m always leery about that because easy come easy go, right? There’s not much support for those price levels. I really appreciate technicals. I’m not a technical guy but you can extract meaning from the technicals so once the stock had taken that laws, it trended downward.

Mark Jones: Then going into the Q4 call, it lost all of the gains. It stayed that way until we’re getting towards the most recent call in January and from December to January, it improved about 40% and then the call in January went exceptionally well and now the stock is up a total of 90%. That’s a really volatile story where it’s up 70, even, and now it’s up 90 but overall, the underlying economic story has been the same. When you’re contrarian, expect volatility so you have to give it time to, you have to give the market time to accept that it was wrong.

Tobias Carlisle: Earlier you were talking about when you put a position on, you have core equity holding and then you have some puts and calls around these. Can you just talk a little bit about how you structure the positions when you put them on?

Mark Jones: Right, so when I’m looking at these derivatives, I’m using them primarily for two reasons. One is to accelerate the returns if there’s some material price movement within a certain period of time. A small period of time like an owners call, but also as insurance. I’m either using it to ensure the downside if the call goes against me or the call goes great but the stock still responds poorly. I want a cushion for that but also to lock in gains. Insurance from losses and insurance to lock in gains ahead of some material price movement for a really nominal price if you will.

Mark Jones: They’re more short-term in nature and typically, I’m looking at, it’s all based on expectations so I have models and things like that where I model okay, under these scenarios if the price moves this much, here are all of the option chains. How much are they going to move based on this assumption in a price movement.

Mark Jones: I’m really familiar with the Greeks and things like that so I typically on average, I’m going to get something that’s about 5 to 10% out of the money both ways so that I can have that momentum on both sides depending on what happens. Then after the call, once kind of like that wave hits and things fizzle out, you sell the positions and then you reevaluate.

Mark Jones: I’m typically not in call options for the long-term. If I have an option that is kind of more longer term, it’s going to be a put option as a form of insurance primarily to lock in gains that I have, and while I’m in the early stages of the fund that I’m launching, I’m likely going to have some puts there just as an additional margin of safety while the firm is starting to accumulating profits so we could start playing with the house’s money.

Tobias Carlisle: Right, so Pragmatic has been a research shop up to this point and so you’re launching a new fund, talk a little about that.

Mark Jones: Right, exactly. Yeah, so actually, Pragmatic is now taking on its I guess its third life because initially, it started as a hedge fund. I was in business school and again, I was focused on joining a hedge fund and I found that by the time i was about to graduate, I had a really unique way of looking at the world and it had proven to be effective. Logically, you could see that okay, well if you could be more accurate than Wall Street, then you’re going to do well.

Mark Jones: However, it’s great when you can see that actually start to happen and I was actually able to see first-hand while I was in school just how much information does not go into a lot of trading decisions that the market makes on a name by name basis. I don’t look at the market as this big machine. I look at the market as well, there’s a market for AMC stock, there’s a market for Weight Watchers stock, and there’s a market for all of these stocks. It’s an auction.

Mark Jones: It’s like while the overall stock market is an auction house, this auction house has a bunch of rooms, and I want to go in the rooms where I can gain an information advantage on. With that I found, you know what, it’s in my best interest to, I developed a reputation within my local city, Pittsburgh, for being a great contrarian stock picker and I was coming out of a great institution, especially in Pittsburgh so with that, I was able to raise of capital from my local network to start a fund as kind of a proof of concept, beta if you will.

Mark Jones: With that, I was able to successfully prove that I could pick contrarian stocks. The average stock that I selected with the fund had an improvement of 85% in one year. I had about a 93% accuracy rate and actually you know, picking these stocks. It wasn’t a situation where you had kind of two home runs and they covered the losses of 13 things that went completely wrong, right?

Mark Jones: I found that if I wanted to really grow the firm, I needed to extend beyond Pittsburgh and I needed to get my name out there and while I did really well with the fund, my asset base was too low to really be sustainable, so I took a step back and I said, “Hey listen, I’ve been selling my research on the side to hedge funds that I’ve been in touch with while I was in business school for recruiting purposes.” Because they saw the value of my research and they saw it as a way to augment their underlying portfolio management process.

Mark Jones: What I did was I put the fund in hibernation if you will and I launched Pragmatic Conclusions. Pragmatic Conclusions was a research business, a specialized research business and it consisted of providing three deep research reports to hedge fund subscribers each month for a subscription fee and the way I positioned this was this is a fraction of the cost of hiring a new analyst and you’re getting differentiated research. If you bring on an analyst, they’re going to follow orders that you give them but if you take my research, this is unique, and it’s fresh, and it’s novel.

Mark Jones: That helped a lot and then I joined SumZero to really get the name out there more and things like that. I was able to get a lot of subscribers from people, from funds on SumZero, seeing how well research my names were. It’s not just that I was right, I was right for the right reasons. That’s really important. My research reports are extensive and I want you to finish reading my research reports and feel like you have an understanding of the company and the stock versus having more questions than answers.

Mark Jones: With that, as my rankings improve material in SumZero, my number of subscribers materially improved as well. I got to a point last August where I said, “Okay, well of course I love doing research.” Running a research business is a business in and of itself and my core passion is investing. It’s research for the purposes of investing. That’s when I said, “Okay, I’ve got a name now. I’ve got more of a reputation now. 2018 is going phenomenally well for me, even though the market isn’t doing too well, it’s time to pivot and get back to raising capital so I can get back to raising the fund so I can get to where I’m going”, which I want to be one of my generation’s most successful investors and I believe that I have a unique approach to do this and it’s an approach that is evergreen.

Mark Jones: Basically, meaning it doesn’t matter what the market conditions are, because my approach is idiosyncratic, it’s not systematic. If it’s systematic then you have to focus on macro and that’s a lot more difficult to understand but if it’s idiosyncratic, you’re looking at micro economics, well basic micro economic principles will always exist. If you focus on that, that’s going to be evergreen.

Mark Jones: That’s what I’m focused on now, is getting the firm back to being active and just showing the world what we can do at Pragmatic.

Tobias Carlisle: One of the last names that you mentioned that I just want to follow up on because it’s a, Pandora is a streaming service that I use. I love the service. I don’t know the stock that well so maybe just give us a little flavor of Pandora.

Mark Jones: Right, and you know, funny thing about Pandora, I love the service as well. However, when I found the stock, I was primarily listening to Spotify because the last I remembered, Pandora was just internet radio. They didn’t have on-demand music. I found Pandora from the screen. I saw that okay, well the screen saw that revenues were increasing. It looked like a healthy business and the stock had gone down about 60-65%. This is like the sweet spot that I found. It wasn’t planned, it just happens that the average stock that I move forward with, they lost about 60-65% within one year.

Mark Jones: That to me is kind of like a major signal, “Hey, look at this. The market may be right in selling off but let’s look at this.” Again, as a consumer I thought, “Oh, you know Spotify is doing great. That can’t be good for Pandora. See the stock has gone down 60-65% maybe for a reason,” but when I looked I found that well, yes there was a reason. The company started to get more focused on building their on-demand platform and they started to let their underlying ad tech capabilities fall behind and they were missing out on a lot of ad revenues that were out there because Pandora is actually an advertising business, that’s really what they are.

Mark Jones: They are the largest holder of digital advertising industry in the world, audio. What I found was that this is the bread and butter for them. Not on-demand music and subscriptions and things like that and by the time I found the company, they had already recognized that, “Hey listen, we made a mistake by letting our bread and butter get a little stale while focusing on this,” because that’s the talk of the town is Spotify, and they wanted to compete there. Once I started to do the research, I found that they brought in a great, new CEO from Sling TV who was really keen on getting the ad technologies back up to par and specifically, there’s an area of ad technology by the name of Programmatic and historically, advertisers would manually purchase advertising slots via TV, radio, internet, whereas as Programmatic was a way for them to automatically purchase advertising slots and it accelerated the amount of purchases that were happening in the ad industry.

Mark Jones: This market had grown to be about a billion dollar market, specifically in the digital space and Pandora had no exposure to it because they didn’t develop the technology to be able to support this. There’s just so much revenue that they were just missing out on because they weren’t supplying what their market needed. Well, they got that under control, they made an acquisition to really help get the tech up and sure enough, once the average user base number started to stabilize and they started to have other incentives for people to interact with the app so if you don’t want to pay a monthly subscription fee, if you watch a video ad, you could have the premium features for an hour.

Mark Jones: Pandora would get money from that so they were accelerating the advertising revenue and sure enough what happened was the market saw that they were wrong and that Pandora started to materially beat earnings estimates because everyone was projecting that. Pandora was in a slow decline and they had an existential threat so once the company started to materially beat revenue and earnings projections, the stock went from about 450 when I found it, to a height of about 920-930.

Mark Jones: Unfortunately, Sirius came in and put a bid in to buy the company, which great for them because it’s a great company and this is a great time to have Pandora. However, at that point, the stock was no longer trading based on Pandora’s underlying fundamentals and what the market expected for Pandora, it was now trading on the market’s view on Sirius, which I wasn’t interested in Sirius at all. They’re two completely different stories.

Mark Jones: What happened was, you saw a cap on how much the stock would go up and even after that, Pandora still had earnings cost that blew estimates out of the water and while the stock had gone up from 450 to over 9, that’s over 100%, I think Pandora had so much more room to run if not for that Sirius, I call it interference but I get it. This is a valuable company and they wanted it, but what happened was once they were finally taken out, it was for about $8.10 and something like that so it’s still a major gain. I found Pandora at about I think April or May of 2018 so a great run but I’m an investor and I look and I say, “That was a great run but it could’ve been so much better.”

Mark Jones: The underlying micro economic story was solid. You have a company that people don’t really understand the company, they don’t really understand how they make their money. They don’t really understand what are the differences, what’s their value proposition in their market? Once this company gets a handle on their value proposition and they start focusing on it, it’ll show up in the numbers and once it shows up in the numbers, the market has no choice but to correct itself, and that’s what happened with Pandora.

Tobias Carlisle: That’s getting close to the time that we’ve got. I really appreciate you spending some time discussing, I think you got a fascinating approach based on some deep research in individual positions and some sort of overarching research, which is equally fascinating and the results are born out in those SumZero performance that you’re like 75% average performance of the stocks you picked in there. On a rolling last 12-month basis, you’ve been topping those rankings so congratulations on that.

Mark Jones: Thank you.

Tobias Carlisle: Welcome to Los Angeles, man. I’m very happy to have somebody else out here who I can chat with about this stuff.

Mark Jones: Thank you.

Tobias Carlisle: If people want to get in touch with you, what’s the best way to do that?

Mark Jones: You can of course get in touch with me. I’m on LinkedIn, I’m on SumZero, also through the website, PragmaticCap.com. If you want to have a conversation with me, my contact information is on there. It’s definitely the best way to get in touch with me but I definitely recommend for people to get onto SumZero and see the research for themselves. I’ve got a lot of the research on the website as well but I think that the research itself, it speaks for itself. I hope that going forward what we both can do is continue to offer a unique perspective on investing.

Mark Jones: I think there’s a lot of herding in investing and I think that that significantly impairs an investor’s ability to generate market-beating returns. It’s difficult to beat the market if you’re investing with the market. I think that the underlying driver of that is this psychology whereas, I think most investors focus on what they see as valuable and what they see as a valuation metric versus well, the market is your customer if you will. One period, you’re their customer, the next period, it’s your customer. You have to know your customer.

Mark Jones: I think that instead of focusing on if you like this business or don’t like the business, let’s just focus on the numbers and say, “Well, what is the market expecting and what will the market pay if this happens? If that happens?” Kind of base it on that. I’m looking forward to kind of starting a new narrative on investing and helping people to find their unique approach to really shine as investors.

Tobias Carlisle: Yeah, I couldn’t agree more and I can’t wait to see what you do. Mark Jones of Pragmatic Capital, thank you very much.

Mark Jones: Thank you for having me. Take care.

George Soros – Top 10 Holdings Q42018

Johnny HopkinsGeorge Soros, PortfoliosLeave a Comment

One of the best resources for investors are the publicly available 13F-HR documents that each fund is required to submit to the SEC. These documents allow investors to track their favorite superinvestors, their fund’s current holdings, plus their new buys and sold out positions. We spend a lot of time here at The Acquirer’s Multiple digging through these 13F-HR documents to find out which superinvestors hold positions in the stocks listed in our Stock Screeners.

As a new weekly feature, we’re now providing the top 10 holdings from some of our favorite superinvestors based on their latest 13F-HR documents.

This week we’ll take a look at George Soros (12-31-2018):

The current market value of his portfolio is $3,300,433,000.

Top 10 Holdings

Stock Shares Held Market Value
LBRDK / Liberty Broadband Corporation, Class C 7,290,838 $525,159,000
VICI / Vici Properties Inc 20,898,926 $392,482,000
CZR / Caesars Entertainment Corporation 33,160,623 $225,161,000
YHOO / Yahoo! Inc. 2,556,619 $148,131,000
MDLZ / Mondelez International, Inc. 1,303,800 $52,191,000
XLF / SPDR Financial Select Sector ETF 2,025,759 $48,254,000
IWB / iShares Russell 1000 ETF 285,531 $39,600,000
PM / Philip Morris International, Inc. 590,000 $39,388,000
COUP / Coupa Software Incorporated 610,000 $38,345,000
GLIBA / GCI Liberty, Inc. Class A 910,000 $37,456,000

This Week’s Best Investing Reads 3/29/2019

Johnny HopkinsValue Investing NewsLeave a Comment

Here’s a list of this week’s best investing reads:

In the face of adversity, are you a Guernsey or a Brahman? (Farnam Street)

ROCE-Growth Matrix, and Few Potential Wealth Creators (Safal Niveshak)

One more elephant for Berkshire? (The Reformed Broker)

Spotting Investment Opportunities In Out Of Favor Industries (Forbes)

2019 Ivey Value Investing Classes Guest Speaker: Guy Gottfried (YouTube)

The Perfect Track Record (The Irrelevant Investor)

When Everything Declines at Once (Morningstar)

151 Trading Strategies (papers.ssrn)

The Big Short’s Steve Eisman raises bets against Canadian banks (FT)

Never Confuse Luck With Smart Investing (Bloomberg)

In Defense of Complexity (bps and pieces)

Jamie Dimon: CEOs optimistic about business outlook (CNBC)

No Laws, Only Tendencies (Of Dollars and Data)

The Dilemma Facing a $358 Billion Investing Giant (Jason Zweig)

Majority of highest-earning hedge fund managers and traders are at quant firms (Mathinvestor)

Pershing Square 2018 Annual Report (Pershing Square)

Cost of Smart Beta Leads to Distorted Investor Expectations (Validea)

Want to Be a Better Investor? Stop Staring at Your Portfolio (Vitaliy Katsenelson)

The Value of “Overvalued” Stocks (MOI Global)

How Often Is It a Stock-Picker’s Market? (A Wealth of Common Sense)

Time Dilation (Flirting With Models)

We Are All Active Managers (Above The Market)

Different Kinds of Information (Collaborative Fund)

Thinking about trade BAIT – Where is your advantage? (Mark Rzepczynski)


This week’s best investing research reads:

Industry Insiders Can Outperform the Market (Alpha Architect)

The Yield Curve Fully Inverts: Average Stock Market Returns, Recession Risk & Rate Cut Probabilities (UPFINA)

The Currency Market Is Positioned For A Minsky Moment (Speculators Anonymous)

How to Increase Yield Using Covered Calls (Sure Dividend)

Dealing with Conflicting Market Signals (Price Action Lab)

Danielle DiMartino Booth: Now is a Pivotal Time for Gold Investors (Palisade Research)

Yield Curve Inversion: Evaluating the Risk (Advisor Perspectives)

The Discovering Markets Hypothesis (DMH) (CFA Institute)


This week’s best investing podcasts:

Aswath Damodaran Part 1 & 2 (Futurebuilders Podcast)

Animal Spirits Episode 74: Footing the Bill (Animal Spirits)

TIP235: Gold Miners and Other Commodity Companies w/ Marin Katusa (The Investors Podcast)

Jordi Visser – Next Generation of Manager Allocation (EP.92) (Ted Seides)

Michael Mauboussin – The Four Sources of Alpha (Invest Like The Best)

Emily Wilson on Translations and Language (Coversations With Tyler)

Episode #148: Paul Lountzis, “The Qualitative Characteristics Are Becoming Significantly More Meaningful And More Important In Company Analysis” (Meb Faber)


This week’s best investing chart:

What Style Are Investors Chasing Today? Growth!

(Source: Research Affiliates)

TAM Stock Screener – Stocks Appearing in Greenblatt, Dalio, Griffin Portfolios

Johnny HopkinsStock ScreenerLeave a Comment

Part of the weekly research here at The Acquirer’s Multiple features some of the top picks from our Stock Screeners and some top investors who are holding these same picks in their portfolios. Investors such as Warren Buffett, Joel Greenblatt, Carl Icahn, Jim Simons, Prem Watsa, Jeremy Grantham, Seth Klarman, Ray Dalio, and Howard Marks. The top investor data is provided from their latest 13F’s. This week we’ll take a look at:

Biogen IDEC Inc (NASDAQ: BIIB)

Biogen and Idec merged in 2003, combining forces to market Biogen’s multiple sclerosis drug Avonex and Idec’s cancer drug Rituxan. Today, Rituxan and next-generation antibody Gazyva are marketed via a collaboration with Roche. Biogen also markets novel MS drugs Tysabri and Tecfidera. In Japan, Biogen’s MS portfolio is co-promoted by Eisai. Hemophilia therapies Eloctate and Alprolix (partnered with SOBI) were spun off as part of Bioverativ in 2017. Biogen has several drug candidates in phase 3 trials in neurology and neurodegenerative diseases and has launched Spinraza with partner Ionis.

A quick look at the price chart below for Biogen shows us that the stock is down 19% in the past twelve months. We currently have the stock trading on an Acquirer’s Multiple of 7.07 which means that it remains undervalued.

(Source: Morningstar)

Superinvestors who currently hold positions in Biogen include:

Cliff Asness – 3,156,081 total shares

Jim Simons – 1,014,714 total shares

Ken Fisher – 137,952 total shares

Ken Griffin – 136,179 total shares

Joel Greenblatt – 106,435 total shares

Ray Dalio – 45,895 total shares

Steve Cohen – 35,000 total shares

Paul Tudor Jones – 24,710 total shares

In Investing The Counter To Fooled By Randomness Is Fooled By Narrative

Johnny HopkinsPodcastsLeave a Comment

During his recent interview with Tobias, Corey Hoffsten provides some great insights into how investors can be fooling themselves by coming up with a narrative and then data-mining the facts to fit that narrative, saying:

Corey: Yeah, I think it sounds wonderful and flowery and intuitive to say, “Hey, I want the economic rationale, why would I invest in something without the economic rationale?” But I think the counter to fooled by randomness is fooled by narrative, right?

If I discover an anomaly and then come up with a rationale as to why that anomaly works, am I just fooling myself into believing that narrative? If I come up with narrative and then data-mine the facts to fit that narrative, am I any better off necessarily?

So I think it is one of these things, as a quant we always try to say, “Hey we’re evidence-based.” The real truth is, the amount of evidence we have at our hands is very, very limited. Financial markets, there’s really just a few driving forces, we’ve only seen a few big regime shifts over the last 50 years, and arguably some of those regime shifts make prior data totally worthless.

I mean, is anything prior to World War Two really relevant? The advancements we’ve seen in technology and access to information and our education about financial markets really raises the question of, is some data and some anomaly that works back in 1910, is that relevant?

We tell ourselves, yes and we’re looking for this robustness across countries and geographies and asset classes and history, and I do think that is a good start, but I think it’s always good to keep in the back of our mind, everyone’s looking at the same data, everyone’s looking at the same anomalies, yeah that does help with the robustness conclusion, and hopefully there is some economic or behavioral risk-based intuition to whatever we’re trying to harvest. But at the end of the day, it is a limited data set that we keep going back to and trying to mine, and we do run the risk of at a certain point, just data-mining it to death.

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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:

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Seth Klarman – Unsuccessful Investors Are Dominated By Emotion

Johnny HopkinsInvesting Strategy, Seth KlarmanLeave a Comment

One of the best books ever written on investing is Margin of Safety, by Seth Klarman. There’s one passage in particular in which Klarman discusses behaviors to avoid in order to achieve success in investing, saying:

Unsuccessful investors are dominated by emotion. Rather than responding coolly and rationally to market fluctuations, they respond emotionally with greed and fear. We all know people who act responsibly and deliberately most of the time but go berserk when investing money. It may take them many months, even years, of hard work and disciplined saving to accumulate the money but only a few minutes to invest it.

The same people would read several consumer publications and visit numerous stores before purchasing a stereo or camera yet spend little or no time investigating the stock they just heard about from a friend. Rationality that is applied to the purchase of electronic or photographic equipment is absent when it comes to investing.

Many unsuccessful investors regard the stock market as a way to make money without working rather than as a way to invest capital in order to earn a decent return. Anyone would enjoy a quick and easy profit, and the prospect of an effortless gain incites greed in investors. Greed leads many investors to seek shortcuts to investment success. Rather than allowing returns to compound over time, they attempt to turn quick profits by acting on hot tips.

They do not stop to consider how the tipster could possibly be in possession of valuable information that is not illegally obtained or why, if it is so valuable, it is being made available to them. Greed also manifests itself as undue optimism or, more subtly, as complacency in the face of bad news. Finally greed can cause investors to shift their focus away from the achievement of long-term investment goals in favor of short-term speculation.

High levels of greed sometimes cause new-era thinking to be introduced by market participants to justify buying or holding overvalued securities. Reasons are given as to why this time is different from anything that came before. As the truth is stretched, investor behavior is carried to an extreme. Conservative assumptions are revisited and revised in order to justify ever higher prices, and a mania can ensue.

In the short run resisting the mania is not only psychologically but also financially difficult as the participants make a lot of money, at least on paper. Then, predictably, the mania reaches a peak, is recognized for what it is, reverses course, and turns into a selling panic. Greed gives way to fear, and investor losses can be enormous.