Jonathan Wellum on Mastering Value Investing and Navigating the Complexities of ESG and Economic Challenges

Unlock the secrets to investment success with Jonathan Wellum, a titan in the realm of value investing, who grew a mutual fund company to an impressive $15 billion in assets. In our latest episode, you're invited to sit at the roundtable with Michael Michael Gayed and Jonathan as we dissect the disciplined evaluation of companies, emphasizing the significance of free cash flow and present value analysis. Find out why adjusting your investment models to fit seductively low interest rates can be a perilous game, and learn how Jonathan keeps a realistic view on investment risks.

The financial tides are turning, and with Jonathan's seasoned perspective, we navigate the complex relationship between rising interest rates, global debt, and their effects on the corporate world. Discover why gold and Bitcoin might be the life rafts you need for hedging against counterparty risks, and get Jonathan's exclusive take on the safety net of royalty companies in the gold sector. Through our conversation, arm yourself with the strategies to maintain profitability in your investments despite economic stagnation plaguing countries like Canada and Europe.

Finally, we tackle the thorny thicket of Environmental, Social, and Governance issues in investing. Feel the pulse of the investment community's recent pushback against ESG strategies and understand how ideological extremism may be distorting the energy markets. We also shine a light on the importance of cash reserves in uncertain economic times and share insights into crafting a portfolio that not only withstands volatility but also sets you up for long-term wealth creation. Join us for an episode that promises not only to enrich your understanding of value investing but also to equip you with the knowledge to thrive in a fluctuating economy.

Nothing on this channel should be considered as personalized financial advice or a solicitation to buy or sell any securities. 

The content in this program is for informational purposes only. You should not construe any information or other material as investment, financial, tax, or other advice. The views expressed by the participants are solely their own. A participant may have taken or recommended any investment position discussed, but may close such position or alter its recommendation at any time without notice. Nothing contained in this program constitutes a solicitation, recommendation, endorsement, or offer to buy or sell any securities or other financial instruments in any jurisdiction. Please consult your own investment or financial advisor for advice related to all investment decisions.

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Transcript

Speaker 1: 0:08

My name is Michael Guy. I'm a publisher of the Lead Lag Report. Join me for the rough hour is Jonathan Wellum. Jonathan, you've just up the audience and to me a bit more formally who are you, what's your background, what have you done throughout your career and what are you doing currently?

Speaker 2: 0:20

Yeah, it's a pleasure to be on the program with you. Thank you very much for the invitation, michael. Yeah, so I got involved in the mutual fund industry back in 1990. So about 34 years ago and I got involved with another very entrepreneurial gentleman called Michael Lee Chin and he was this is up in Canada and we just had two little funds about $12 million in assets and we had this crazy idea that money should be run from a long-term compounding discipline perspective, like the way business people would run their money. So we ran that mutual fund company up to about $15 billion and then sold that to Manulife in 2009, right just during the financial crisis, he took some money off the table and reinvested it.

Speaker 2: 1:06

Then I started up my own company called Rock Link Investment Partners, which I now run in 2010, right after we sold to Manulife, and then we just look after private wealth families, my own money and things like that. The last few years we've actually started to expand and grow the business. I brought in some young guys, some CFA's, and we're looking at expanding and providing opportunities for our investors, but we're basically been in the industry for 34 years. I consider myself more of a value investor sort of try to look at the market three to five years, discipline, long-term compounding and really more fundamental in terms of my analysis, but obviously looking at the bigger picture because you have to always contextualize your investments. So that's just a quick overview on myself and that's sort of my background.

Speaker 1: 1:53

There's a value investor you must love in video, if that's your case. But this point of being a value investor. I think is important. First of all, let's define for the audience what a value investor actually is, because I think a lot of people use terms like ah, this stock's undervalued based on this chart, but I would think Right.

Speaker 2: 2:10

So what we attempt to do. As best as possible and, michael, you know this because you're in the industry and it's difficult, it's not easy we try to evaluate and look at the company as if we are going to buy the whole thing. And so we look at a company, we look at the. Typically, I think the measure that we will use predominantly not always because it'll depend on the industry will be the free cash flow of the business. So we will try to look at the free cash flow and then do a present value analysis of that. So we're going to try to look at the future cash flow of that business and then try to discount it back at a reasonable cost of capital and then try to buy the businesses below the current valuation that the market seems to be putting on it. The exception to that would be hard asset businesses, real estate businesses, some of the mining companies, royalty companies. Then we would look at net asset value. But what we're trying to do is look at what would a rational person who was going to take a five to 10 year position in the company actually pay and expect above your cost of capital rates of return. And so it's not short term at all we're trying to look at things from a secular perspective. We're some of the growth opportunities. So if you take an avidia good case in point, yeah, we don't own it.

Speaker 2: 3:22

Great business growing quickly, but for us the world has to really come together in a perfect way for many years to justify the valuation today and that makes us nervous.

Speaker 2: 3:33

It's also it is a commodity business also to a certain degree. I mean, I know it's specialized, but there's other competitors can eventually come into that space also. So we want to be very careful in terms of businesses like that. And do we leave money on the table sometime? Sure, but we often will avoid the pitfalls of losing a lot of money also, which I've been through in 2009, not 2009, 1999, 2000 through the tech bubble. I mean, we up in Canada we had a company called Nortel, and Nortel was this business that everybody wanted to buy. It was going straight up. But if you did a 10 year cumulative free cash flow analysis on their business, that never generated a cumulative 10 year free cash flow at all in the business and yet it was the highest value stock on the down the Toronto stock market at one point and then went virtually almost to zero. And so again we go back to the fundamentals and we want to be careful and protect our investors capital.

Speaker 1: 4:30

All right. So that term you use, reasonable costs of capital. I want to push on five to 10 year outlook reasonable costs of capital. I don't think in 2018, most people would have thought that rate could be where they are today or 2019. I think even deterring what's in quotes reasonable. And how do you do that in the context of very long timeframe when you've got so much debt, got so many dynamics that grow off of what the real interest rate should be?

Speaker 2: 4:53

It's a great question and one of the biggest challenges the last number of years has been what I would refer to as the insanity of the central banks and the zero interest rate policies, or near zero interest rate policies, and even the negative interest rates in the United States, and not in the United States, in Europe, where you had almost 15 trillion in sovereign debt trading and negative yields and that's nominal negative yields, not even factoring any inflation. So, yeah, so that's really changed in certain way the cost of money. But from our perspective, we would never adjust our models down to those kind of low numbers. So we've never taken numbers down below.

Speaker 2: 5:30

Even in a really high quality company with a long term, a long standing franchise, great mode around the business, predictable business, we would never take the cost of capital down below 8%, even at the low, and we typically are 8% to 9%, and then companies that are higher risk. We're going to run 10%, 11% depending on the business. So we really haven't moved our cost of money around as much as, say, the market is pricing money, because we think that is just ridiculous and it's going to get you into trouble and it's too generous in terms of valuing companies on the long term. They just can't stay at these kinds of levels without doing severe damage to our economy which, as you know, we have done certain amount of damage in keeping companies afloat that probably shouldn't have been afloat. In the cost of money it does need to be higher if we're going to really run a productive, growing economy.

Speaker 1: 6:18

She is just finding real, legitimate, undervalued opportunities that is easier in Canada versus the US or that there's more of an opportunity set outside of America's market.

Speaker 2: 6:30

Yeah, we probably have 60% of our assets would be in US-based businesses, because the US market, being right next to us, is just so large and so deep and so wide compared to the Canadian market that we spend a great deal of our time in the US companies and many of, as you know, the top companies in the US are also global companies.

Speaker 2: 6:54

So US is very important to us.

Speaker 2: 6:57

And then in Canada, yeah, we have a handful of companies that we like in Canada, but they generally are fairly well global businesses also and they tend to get priced fairly efficiently along with their American counterparts, and many of them trade on the New York Stock Exchange anyway, whether they're ADRs or other securities, and so I would suggest that the pricing is pretty tight between the countries and I don't think there's that much differential when you're looking at companies and certain valuations. I mean we're a bit more commodity based, and so when you look at the commodity space, some of the valuations there certainly appear to be a much more attractive than, say, the technology industry, and so in Canada we will have more as a percentage of our businesses in the commodity space and therefore you could argue that there's some better value there currently and in terms of globally for us, because we're a relatively small team and we stay focused, we will invest and do have some holdings that would be European-based and but we really don't get into the two far-flung corners of the world.

Speaker 2: 8:01

Because if we can't get their travel there, understand those businesses, understand the culture, the people running it, the counting conventions, then we leave that space up to other people. We only need to have 25 to 30 great businesses and we should be able to find those within North America and also in the European context. That's good enough for us All right.

Speaker 1: 8:23

So let's go back to the cost of capital. I was under the impression and I say this or ghastly that when the cost of capital rises immediately, things are supposed to get harder for companies, and that means low in growth, lower margins, layoffs and widening credit spreads. I don't think anybody had on their bingo cards that you go through the fastest rate hike cycle in history and you'd actually be at cycle lows in terms of credit spreads, at least in the US and in New York different. But what happened in the last two, three years in terms of that dynamic? Why is it that default risk hasn't really increased when you look at the bond market itself, whereas if you look, at least in the US, all-cap companies, zombie companies they haven't done all that much because they're worried about an higher rate. Why isn't the market not more concerned about refinancing our risk?

Speaker 2: 9:10

It's a great question and I'm not sure I can give you a very good answer to that, other than a certain degree of liquidity in the marketplace. When rates started to go up in 2022, with the back half of 2022 and then into all of 23, yeah, we really tried to batten down the hatches, thinking that, look, you have a situation where the global debt is just off the charts. It's just done nothing but go up. So the debt crisis they saw the debt crisis, the more debt, as you know, and so forth and corporations are carrying a lot of debt and personal debt is off the charts. In my own country, canada, our personal debt is one of the worst in the world as a percentage of income. So it's about 175, 180% that the income, which is, I think, in the US, maybe 120, 130.

Speaker 2: 9:55

So when you're thinking about that, yeah, you'd think that we should see all of the things that you talked about. We should see corporate debt costs go up, we should see high yield spreads increase and so forth, and I would suggest that we want to be prepared for that and we want to be in companies that can weather increasing challenges, because I just don't think the current situation is sustainable and some of the global trends are not healthy. I think that will put more stress on the bond market and on companies, and we're already seeing that, with the exception of the US, I mean Canada is basically going sideways. No growth up here, it's not shrinking a little bit, and Europe is going sideways also. I mean there's some countries that are recession is certainly not growing, and so I think that we will see we've got to see some impact on businesses and profitability to a greater extent going forward in our view, but why it hasn't happened as fast, and I'm also very surprised in terms of what's happened last year.

Speaker 1: 10:51

Yeah, I think it's that. Further, I think that really very much to demand for gold, maybe demand Bitcoin to some extent, although the ETF dynamics throw it off. Yeah, when I think about debt, my mind immediately goes to counterparty risk. The more the debt is, the more likely that you're not going to get paid fully on what you've lent to that debt holder. So counterparty risk goes up and I think that's really ultimately kind of the argument for owning gold. And, as I mentioned, owning Bitcoin, let's talk about gold. We've got quite a bit of experience there. First of all, is my understanding of the thinking correct on gold? Because a lot of people say it's an inflation edged or value? I really viewed very much on that counterparty risk side of things.

Speaker 2: 11:28

Yes, I agree, I try not to get involved in making predictions. I mean, I don't know exactly where the price is going to go, but it does hold value, and when we talk to our investors, what we're concerned about is purchasing power in a hedge that will be there, that will maintain its value over time if things are not holding their value in other areas. And is it that insurance? Now, I think the price again is denominated in US dollars, so whatever you're going to denominate it in, then it's the dollars. We can go up a great deal, and certainly versus other currencies other than US dollar.

Speaker 2: 12:00

So we view it also as a hedge and we try to build in 15, 18% of one's portfolio into a range of different companies that have exposure to the precious metals, and we've done that for some time simply because of the debt levels, and I don't know when the thing is going to pop or when there's going to be a major issue in the marketplace, but we know that it will come, and so, in my view and for our clients, we want to be there ahead of the game. Plus, we want to buy great companies that are still growing. Even with the price of gold going sideways. There's still good cash flow businesses. They're making good money and doing well. But that's our view also. On the gold, again, it's a percentage, it's an allocation, it's there to offset other things that could go down a little bit in a market volatility.

Speaker 1: 12:49

And as I understand it, what you said, you get that exposure primarily through the royalty side, the royalty players.

Speaker 2: 13:29

We have done that. Yeah, that's. I mean back in 1990s. Through the 1990s, when I was with the fund company, we became the largest institutional shareholders of Franco Nevada and so I got to know Seymour Shulik and Pierre LaSondt who are the co-founders Pierre a little bit less Seymour quite well and we love those businesses because, again, as a value investor, what we're trying to do is find cash flow businesses and so if you can be an investment banker to the gold sector or silver sector in the case of Franco, they also have some royal royalties, some copper royalties and so on. But to us that made a lot of sense because if you can do great deals and they can get a royalty and have a perpetual right to a great mine, then to us that's a cash flow opportunity, good cash flow growing vehicle, and they don't have all of the drilling risk and a lot of the same level of political risk and managing the mines and so forth.

Speaker 2: 14:22

So that's what I got into, that and we did very well in the 1990s through Franco and then when I started up Rocklink, we then went to some of the royalties.

Speaker 2: 14:32

Again we said, okay, our first place to go would be the royalty companies because of safety, diversity. You've got in some cases several hundred royalties, so you don't get massive exposure, just one spot, one location, one mine, one problem and so forth and last, and so that's what we've done. So we have positions in Franco weed and precious metals, some in royal gold, a little bit of Cisco and more recently we've been picking up a smaller company that we think is incredibly undervalued and run by some good people that will start to produce cash flow this year and quite a bit in the years ahead, and that would be gold royalty GROY. That trades in the US, and that's our primary way. We do have a little bit in Egnico Eagle. We think that to Sean Boyd, and the is a great manager and the assets that Nico has are largely in Canada, Australia, united States, and so from a political risk perspective, good locations and the mines are some of the best in the world, and so that's the way we played it.

Speaker 1: 15:29

Speaking about free cash flow. Of all the sectors to focus in on, I'm going to imagine oil and gas is key to that. Free cash flow tends to be very high there, With the hell of a sector in 2022, not so much in 2023, what are your thoughts on oil and gas here? Separating out of the two separately? Because, again I go back to, I felt the cost of capital meant free cash flow mattered more, and that's the case. Why is it that energy stocks are just not really having that persistence?

Speaker 2: 15:56

Yeah, it's a great question. Our view is that valuation will be recognized over time. It's the old expression I'm sure you've heard many times where Ben Graham says the market is a voting machine in the short term and a weighing machine in the long term. So we constantly try to just try to get the right weights and then be patient, get the right companies, get the right valuation. So, in our view, the oil and gas sector is an interesting one. Yeah, we've built probably about 10%, 10%, 11% of our portfolio would be exposed to that area, and we buy the companies that have the long term reserves, so they don't even have to do a lot of exploration to prove up any more reserves Not that they aren't, but they've got long reserves. Their cost structure is fairly fixed. If anything, they can continue to be more and more efficient, and so we get a good sense of the free cash flow.

Speaker 2: 16:46

And at $70, $75 WTI, these are companies that are generating, in some cases, free cash flow yields any worse, from 8% to 12% to 13%, which is amazing, and all of the pressure that's out there ceilings, especially in Canada, in terms of the whole green agenda and so forth.

Speaker 2: 17:04

Our view is that, if anything, that's just going to keep the prices of oil in particular, probably biased a little bit more. On the upsides it's more difficult more regulations, harder to drill, harder to do, more exploration and so forth, but that just gives the companies more free cash flow. And so what are they doing? They're buying back stocks, so they're shrinking the float. The companies that we own, most of them, are buying back a share of it of stock, paying down debt. In many cases the debt is going to be almost gone A lot of these companies in the next couple of years, and they're increasing dividends. So in our view, that's not a bad combination when you're in a market that tends to be a little expensive. And so that's what we do. We own some MEG, meg Energy in Canada, a little bit of Suncore, also some Canadian natural resources, a couple of the companies that we own in that space and, again, long tail reserves, well run companies and companies that are in great financial position, also Since you mentioned ESG.

Speaker 1: 18:00

I think we should hit on that. We have a funny way of thinking about it, or be drew to the acronym. This is the, at least in the state. I mean, I deal with a lot of ETS issues, right, and ESG, with a lot of the wholesalers, are trying to push out to FAs. The last several years I think a lot of that has largely gone away and some of these funds, that ESG in their name, which were really just tech plays, they just don't take advantage of the momentum on the marketing side. Yeah, they're now starting to show us some redemptions, so probably for the audience. How we got to this point where ESG got so extreme, at the point where a fund company is giving a URI on that side of the business, really kind of pushed it and now out that pendulum swinging back.

Speaker 2: 18:40

Yeah, and I'll give you again my view on it, and I'm coming at it from a perspective of being very concerned about environment and stewardship of resources. I'm actually pretty strong practicing Christian Protestant, so I believe in hard work and good ethical approach to business and so on, and so they come with all of these interesting terms. I mean, who doesn't like environmental, social and governance? Right, these are, of course, everyone wants good governance, everyone wants good social schemes and we want to be concerned about the environment. But I think that in my view, it's really become an ideology and it's become almost a religion, almost a cultist religion. On the climate, and everybody's concerned about the climate, but some people just seem to have gone way overboard in making just incredibly outlandish claims in terms of what's going on with the environment and the effect of CO2 in the air and the fossil fuels and all of that which you're well aware of, and so it's almost like this has become a religious model for people and as it started to break out the last couple of years, and so to me, when they talked about you know we joke we call environmental, social and governance. We refer to it as extortion, shakedown and grift. I think those are the best words to use it. And what it does to me is it starts to overlay a whole different regulatory regime on the marketplace. So if you look at the environmental, what it really has become is no oil. How do we get rid of all fossil fuels? How do we get rid of this? You know this oil and gas industry which is incredibly important to our whole industrial revolution and to our economies today and it will be for deputies to come. So just thinking that you can get rid of this and you can score companies on how much they can minimize CO2, I think is incredibly naive and dangerous if it's pushed too fast on the marketplace and then, of course, with that environment also, it means how do we substitute other energy? So then you get into solar and wind and all of these other energies which can have their place, but they're very inefficient In most cases you can't use them as base load and so forth, and so you end up with this whole forced agenda which is increasing our cost structure of businesses and generating energy and it's curtailing in many cases, the development of oil and gas so that the prices are a little higher than they should be. It's giving power to OPEC other countries to set the price, all of this, which then runs through our economy and there's a real cost to that.

Speaker 2: 21:06

But when they get into the social side also you've seen this the social side starts to emphasize things like critical race theory. It gets into a whole bunch of things like abortion and you're saying, well, what's that got to do with business? And it's exactly. They're pushing a whole issue. The transgender, the LGBT that all becomes part of the social agenda is like what people's sexual proclivities are should be the concern of corporations, and how you're building products and so forth, and it just, this whole thing just spins out of control. And then when you get into the governance side of it as we've seen in there's been high profile cases now it gets into race quotas. You're now hiring people based upon their race, their gender, their sexual proclivities and so forth, not on merit and not on meritocracy, not on the best people, not trying to have equality of opportunities, but then forcing this kind of equality of outcome. And so what you have, michael, is you just have this massive interference in the capital markets. It's just massive. If you let this thing run, and it's dangerous and it's going to lead to lower rates of returns. It's going to lead to less efficiency, less productivity, hiring substandard people in many cases, and so forth, and that's going to be really detrimental to the capital markets. So that's what we've kind of seen, and so you're right.

Speaker 2: 22:22

There's been pushback because a lot of this stuff is insane, it's unjust, it's showing partiality where you shouldn't show partiality. It's laying businesses aren't hiring the best people, they're not holding people to the highest standards, and so forth. There's pushing agendas that business has no right to be pushing social, moral, ethical agendas that are further and further detached from the running of a company and proper corporate governance and seduciery responsibilities. What happened to all of that? So that's why we get really frustrated within.

Speaker 2: 22:53

We go back and we look at companies. We say no, we want the best boards, we want the best people, we want the best capital allocation. Lay out your program. We're not interested in virtue signaling and some employees running around dressed up like who knows what. We want them in the factory doing their work and producing the best products.

Speaker 2: 23:12

And we've seen whether it's Silicon Valley Bank and some of the issues there, the wokeness, or whether you've seen it more recently, even on the suppliers to Boeing. I mean, there's a whole list of things that you can point to where this is seeping into. Disney also has gotten way off track, and we think that we need to go back to our baseline again and back to businesses running for their constituency, remembering who their customers are, serving their customers properly, hiring the very best people, regardless of their gender, their color and so forth, and putting the best people in the right seats. That's the way we want to see it, and I think that's starting to come back, because if you don't do that, michael, returns go down. People start to get impacted.

Speaker 2: 23:51

If you're running pension funds, you're running institutional money and your returns are dropping and you're not operating in a seduciary way, and the pressure is going to be all over you, and I think that's what we've seen is pushback against the Black Rocks, the Vanguard's, sedalities and so forth that are pushing a lot of that agenda on companies. The last thing I'd say is that this ESG it's almost like a social credit score. You either follow this or you're going to be punished by institutional investment services type of thing. I think that's just wrong. We need to push back against that. We need to have again companies run honestly, ethically, to the highest standards, best people and making sure they're serving their customers and clients so that they can sell the products and services that the clients are demanding, not what they think the HR department thinks should be shut down people's throats.

Speaker 1: 25:07

You get a sense that the ESG set of things is really understood by those that are not paid attention to financial markets. Again, I talked to a lot of advisors and I would ask them your own clients ask about ESG and almost all of them say no. It seems like there's a lot of hype around it in certain circles, but for the vast majority of people you don't have a clue. I agree.

Speaker 2: 25:28

I agree, and most people when they see ESG, they're just thinking, okay, they're trying to protect our forests and clean air, clean water and things like that. They don't see all of the other stuff below the surface hiring people based off an intersectionality chart and what oppressed groups are in, and so forth. They don't see that side of it and that's because they haven't. Really in many cases, most investors haven't been through the university systems and taken all the latest gender studies and all of the other nonsense that goes on which is being pushed into the corporations we saw. I mean, look at Anheuser-Busch and the Bud Light situation where all of a sudden, you use someone to sell your product. That is the antithesis of your market. What's that all about? How does that happen? And where's the CEO? Where's the direction of the companies? And that's just a completely crazy thing to do, and yet that's what we see coming back Now. We're seeing that pushback now because all of a sudden, I think CEOs are asking more questions what's happening? And the agenda?

Speaker 1: 26:27

we need to pull it back into the center again, for the extremes Got a question from somebody in the audience asking about how do you see ESG acceptance differing across different regions or states or different parts of the world. It's probably no different than looking at in the US at least, sort of a look at red versus blue. It's probably the easiest way to do that. But are you seeing more dispersion in opinions around ESG and are there any sort of commonalities in those that are very in favor of it?

Speaker 2: 26:54

I think this is the case and I haven't done a great look at it. So I want to be. You know, that's a caution I put out front.

Speaker 2: 27:01

I think the countries that have adopted the ESG in a way that I'd see maybe be more dangerous than others would be the traditional Western Anglesphere countries, right?

Speaker 2: 27:13

So I'd say that you know, the UK, australia, canada, united States and some of the other European countries, I suppose the ones that were traditionally the strongest economic countries and, I think, the strongest Judeo-Christian based countries and rejecting their core faith, which we've seen across all of these countries, I think they replaced the ideology of a whole ESG movement. I think they become more vulnerable to this religious kind of push of this new system, the woke-ism, if he will. But if you go in the Far East, are you going to Africa or are you going to parts of South America which we don't do a lot of investing there? They're not in by being of this at all, I mean, and you're not seeing it in Japan or China. So I think you know it's, I think it is definitely regional and it's probably more hyper concentrated in the countries that have been the strongest Western countries, which are under a lot of pressure and we're seeing really the whole deterioration of our moral base in our countries.

Speaker 1: 28:09

Yeah, well, I think the point is that having an ESG focus is almost a luxury right, Because if you are poor and don't have much food and much up to and you're in India, you don't really care about CO2 emissions. You care about using coal.

Speaker 2: 28:24

Right, and I would argue, though, that I'm not sure that the whole environmental you know whole ESG agendas it does anything for the environment. Anyway, I think it's. My own view is that it's really a power grab and it's moving capital into different industries like the you know, the solar wind. I mean nuclear would be certainly. I'd be positive on nuclear and I think that would be a great way to generate energy. But the whole evening thing, for example, I mean, are we really less creating less pollution by going to electric vehicles? I don't think so. I don't think anyone's ever proven that, and so I think, yeah, we're going to go to hydrogen and you're going to go to nuclear, things like that. I'd be really pro that. And so I think the agenda doesn't really even solve the problems that they're trying to address, but it does line the pockets of a lot of different industries and businesses, and I'm a little bit cynical when it comes to that side of it. I always look at follow the money, and that tends to, you know, tell you a little bit more.

Speaker 1: 29:20

Speaking about following the money, you sent me a note saying that you actually got a decent cash allocation and you're expecting a large pullback. I think in Marcus, let's broaden out to where we are in the cycle. What are your thoughts on the way things, the way things have acted so far this year? I have been very loud and arguably wrong in a lot of ways, the right and some others around this being one of the more bizarre and close bull market in history, given that it looks like you've got a content tracing AI bubble that's driving the large cap averages but, at the same time, most stocks are still below their Russell 30221 peak. Respectably, where are we Talk about the macro side and how you're thinking about markets here?

Speaker 2: 29:58

Yeah, I mean I probably wouldn't be too much different than yourself. I mean, we've seen, yeah, the market indexes and averages with the exception of the Russell, which I think is more indicative of really what's happening across the broader markets being weaker but heavily concentrated in the typical companies which everybody knows already, and a handful of others, and so we are concerned about that and we are concerned about the fact that we're a little long in the tooth in terms of this cycle. We've seen the cycle propelled, in our view, by massive deficit spending. So you look at your own country, I mean, you guys are just spending money like absolutely drunken sailors down there, and we're doing the same thing in Canada. So if you're running a $2 trillion deficit and that becomes natural and normal, that's a normalized deficit. That's just not sustainable.

Speaker 2: 30:46

In our own country, in Canada, we've doubled our national debt in the last sort of three, four years, with a prime minister who's completely and totally inept financially in terms of numbers and spending money. And so, yeah, so we're concerned with that that, with increasing interest rates and this money having, you know, the US has to again float, it has to, you know, roll over its debt. I mean significant amount of debt. As you know, the US debt is very short-term, so they basically it's an adjustable rate of mortgage. Basically there's so much money that's rolling over that's got to put some pressure. And we've also seen in Canada the biggest thing up here with some of these mortgages. So, you know, the mortgage debt has gone from 2% maybe on your mortgage to 2.25%, now up to 5%, 6%, and people were fully stretched.

Speaker 2: 31:29

So, yes, we think that it has to at some point be an economic turn down that will affect profitability and earnings of companies, and so, therefore, we want to have some cash on the sidelines.

Speaker 2: 31:42

The good thing is that cash now, even short-term cash, can make it 5% with virtually no risk. So, in our view, we talk to our clients that they're quite happy to have 20, 30% in cash as long as they're making 5% without any risk, and so that's what we're doing. But, yeah, we think we're a little long on the cycle and we just want to be very careful, and you know we're value investors. So if a unique positions emerge, so all of a sudden, three or four companies emerged and we thought we're trading at 20, 30% Discounts in terms of value, you know, the present value of the future cash flow and so forth, then we would invest in those and we would use a little bit of our cash if we can find great ideas. But yeah, we are a little bit concerned and we think that the deficits and the aggressive spending, you know, just can't continue without some kind of reset or penalty or some kind of pain marketplace.

Speaker 1: 32:31

You say I mean, you're not doing that based on technicals or anything, You're just looking at this from a time and sort of logical perspective.

Speaker 2: 32:37

Exactly. And that's yeah, because, again, we're looking three to five years and so we just want to be careful. And a lot of our investors you know they're wealthy people and they're not trying to necessarily track the index perfectly, that's not their preoccupation. Their preoccupation is don't lose my money, keep it compounding for me at a reasonable basis and we'll be very happy. And I mean I look at it again. I mean I've fallen war on Buffett.

Speaker 2: 33:00

One of the first investors that I got to really follow back in 1990 was Buffett. I've been down to, I think, about 14 or 15 of his annual meetings over the years and we used to go down with a whole team of people and you know, and you look at Buffett too carrying around a little bit more cash. I think anybody who's just disciplined looks at this saying you know what I get? 5% Market's done really well. We've got a lot of geopolitical issues, we've got absolutely inept political leadership in so many countries around the world and you've got deficits running at record levels. The global debt to GDP is way over 300% debt to GDP. This you know. There has to be a break in here somewhere, and so be prepared, and our investors are quite happy to be prepared. They don't need to be getting leaking out return every single week, every single month. You have the same rate the market's doing If we can protect them on the downside and then grab a whole bunch of upside and bounce back.

Speaker 1: 33:58

And I'm very proud of you to have that type of a client base. I think you and I would probably both agree that stickiness is not as sticky as it used to be when it comes to investor money. Increasingly, people are short-term turnovers higher. You know, the long-term of both people is more like two months that's supposed to two years. That's a dynamic which, you can argue, makes it in some ways easier to be a value investor because you know you can identify and stick to that approach If you really believe it a while fewer people are sticking to it but at the same time it makes it hard to really build a business.

Speaker 2: 34:27

Right, yeah, that's the way we've marketed and talked to our clients, and our client I mean we have virtually almost all the financial assets of our clients, generally speaking. So it's not like we're just running a fund and they put a certain allocation into it. We run segregated accounts along with some funds and so they are expecting us to protect the capital. And that's the way we prepare it. And over time you generally will outperform, keep with the market or outperform it anyway. Because, again, if you can keep from the drawdowns as you again you've been in the business you know, if you can avoid the torpedoes and you can avoid the drawdowns and then capture a good portion of the upside, you will do better over time. And the other factor that comes into it similar to you guys in the US, but certainly in Canada, where we're heavily more heavily taxed overall is capital gains taxation. So if you can, as you know, you can compound and avoid paying tax by compounding and keeping your money in an unrealized growth of capital, then you're going to have much better returns over time. And we again sit down with clients and try to work on your after tax rates in return. So if you can stick to an event with an investment that can compound for five or six or seven years, rather than buying and selling every six months or every year and generating capital gain, your returns will be higher and you don't have to generate your you know pre-tax rate of return doesn't have to be as high. I mean, as you know, as you work through those numbers. So that's what we try to do.

Speaker 2: 35:50

It makes it easier, I think, to focus on the businesses, understand the CEOs, the strategy of the companies, treat them like your own, because in the companies that we own we really get to know them well and they're almost come like your children. And it's sometimes tough to do a switch, which I mean every year. We probably do two, three switches out of a company into another one Because of opportunities of you know, we think maybe just aren't the same in that business, or we made a mistake or the valuation is high, so there's constant turnover. But it's very methodical, very careful, very strategic. And then the cash holding is there just to, in this kind of environment, just to be, you know, keep powder dry so that we can pounce, if you will. We've got a list of companies we'd love to own, but they're just a little bit too expensive, and then we just wait and see if there's a price break.

Speaker 1: 36:36

So about the sell discipline? I think it's. You know, it's very easy to identify an undervalued company that you don't own than to identify an overvalued company that you own, because the moment you own it you don't think you're overvalued. Right, let's talk about that, because I think that's an important point. It's always easier to buy than to sell.

Speaker 2: 36:51

Absolutely, and it's easier to buy when everyone else is buying. It's just amazing how you just are itching to buy when the price is moving up right and everyone else is buying, and so even as a professional after 34 years, it is so difficult not to move with the masses, and the sell discipline is tricky. So what we've done is we just spend a lot of time on valuing the business. We run models. We will run, you know, a new model. Well, I say it will update the model at least quarterly as earnings come in, and then we will track that daily. We have a printout of you know what the companies are trading at the price, you know the discount and so forth, and so if they get above a certain level, then we are becoming more and more historical just in just sell or reduce the position, and you're quite right, you fall in love with your companies and it's a dangerous thing to do. The company does not know that you own it, the company doesn't care about you, and you have to get over that sometimes. And so the best way to, I think, do that is to stick to price disciplines and discounts, to intrinsic value and then surpluses. You know it was trading at a premium and then lightened up when you get to certain premiums and certainly stopped buying.

Speaker 2: 37:57

The other thing that we do is we try to again every year. We try to have, as I say, two three would be probably on the high end but one or two of these substitutions. So we'll go for a company that we think is a good company, maybe it's trading an okay price, but its future isn't going to be as high growth as another one. And then we make sure we're constantly trying to prune. We call that pruning our portfolio and then putting better companies in and it's like largely keeps us out of trouble. But yeah, we don't execute perfectly. As you know, no one does, and that's one of the toughest things is the cell discipline, because you do get to know the companies and sometimes you don't really want to pay the tax either if you're going to generate a capital gain, and so you have to just stick to the numbers and try to take the emotion out of it as best as possible.

Speaker 1: 38:39

I know you're more on the equity side, but I am curious, speaking about undervalued, at what point are bonds undervalued enough to be a viable alternative to equities?

Speaker 2: 38:49

Yeah, good question. Good question. You're right, I'm much more on the equity side. Yeah, we would. I mean we, yeah, we generally on the fixed income side have kept ourselves average duration of our portfolios. Just since you know, since I've been running the segregated accounts for private clients for the last 14 years, our average duration we've kept it probably about two to three years. So we have just basically been picking the coupons and not playing the yield curve moves.

Speaker 2: 39:18

We are watching it now as the long end moves up and if we do go into recession, we're looking at ways to then step into the long end of the market and take a little bit of you know, hopefully capital gains on the way down. But I haven't been comfortable with that yet. Even though we peaked in the land was at the end of October, the rates really ran up high. I just I'm still not convinced that we've got all this inflation out of the system. I mean, I'm hoping that we have, but there's so many policy decisions that are out of our control so that we just try to be careful with investors' money.

Speaker 2: 39:49

So our average duration on the fixed income side, we're keeping it relatively, I'd say, two to three years. We're grabbing the interest rate. At that point we don't have a lot of downside and we can quickly sell and redeploy as we have to. But we'd want to see rates of return over a couple of year period that we're going to be, you know, 15 to 20% rates of return. You know comfortable that the economy was weakening quite a bit, so they'd have to haul down interest rates.

Speaker 2: 40:16

I'm still not sure I'm still sitting on the fence in terms of what the next little while looks like. Do rates actually, on the long end, go a bit higher? I mean, there's good argument that could happen despite all this debt, just because of de-globalization and some of the longer-term trends that are taking place, and so what we do is we're just hedging ourselves and being very careful, not trying to go out on a limb to make some money. Where we can lose, it's just the returns aren't large enough in many cases, unless you really put on a lot of risk, and so to me it's a little bit asymmetric, and so that's why we would prefer making most of our money in the equity markets and protecting it in the debt markets.

Speaker 1: 40:52

Is it fair to say that if you're going to be a true value investor, you have to, by nature, have a concentrated portfolio, that it's not sort of a style that you can apply across hundreds of different thoughts?

Speaker 2: 41:04

I think so. Now, it would depend on the number of people you have to do the research, but I think the optimal way to run money I'm biased, is my opinion. I know other people are going to disagree with me but that is to run a focused portfolio. So when I say focused, I mean our top 10 holdings would be probably 60% of the portfolio, 60% or 60%, 65% of the equity portfolio, and then the other 10 to 15 would be the remainder. And I think that for a couple of reasons. First of all, it's really hard to find great opportunities and so when you do, you want to latch on to it. Second, it's very hard to follow these companies and really know them well and to really understand the business, competitors, the industry, all of the different challenges, most of the challenges that you need to know if you're going to be an investor, and so, in terms of attention and detail, it's better if you have a smaller number of companies and then you have less companies canceling out and make good returns with companies that may be under reform.

Speaker 2: 42:00

I think if you one of my mentors early on he said, jonathan, if you want to look at the wealthiest people in the world, go to the Forbes 500 list right, go to the Forbes 500 list. You're going to look at the wealthiest people in the world. He'll say how many businesses do those people own? Do they own 500 businesses like you would own in a couple of fidelity mutual funds? No, they own usually a handful of companies and they've owned them for extended periods of time. And so I do think and this is my bias that the best way to create wealth is focus, knowledge and patience, and so I think that's. I think you're exactly right. Most value investors are focused because they really take larger positions and they research them in more detail than you would if you were just finding ways to place secular trends or, yeah, short-term opportunities.

Speaker 1: 42:50

And Jonathan, as we wrap up here, for those who want to track more of your thoughts, more of your work, or you can learn more about your way of looking at the world where would you point them to?

Speaker 2: 42:56

Probably our website would be the. My website would be the best, which is just wwwrocklink and that's link with a C, so R-O-C-K-L-I-N-C. So the link at the end is a C, not a K, and there we have, under newsletters and so forth, you'll see videos, all of our quarterly reports. We usually post anything on there, even this conversation. Having with you, we would push, we would put a link on presentations that I do out at conferences and so forth. So that's probably the best way to track me down in terms of following us. I'm on. I mean, I'm on Twitter and different things. I don't necessarily use that extensively, but I use it to follow people like yourself and others, but that's probably the best way to get me just a website.

Speaker 1: 43:40

Appreciate it by joining. Hopefully you'll enjoy it and hopefully I'll see you all in the next space. We thank you, jonathan. Appreciate it Great. Thank you very much, michael. All the best Cheers everybody.