[REPLAY] Paul Black - Gratitude, Fun, and Growth Stocks (Capital Allocators, EP.51)

26:11And that works for a retailer. But do you really need happy employees to run a railroad? Probably not, right? You're probably not all about, hey, I want a bunch of yahoos running around throwing parties. You want people that are highly accountable, probably think a certain way, more linear, because it's all about delivering an on-time product in an efficient, cost-effective manner. So in Canadian National or Canadian Pacific Railroads, you're going to pay people more than you would in a retailer. But high levels of accountability, there's a high cost of failure there. So probably a lot more in different stresses.

26:48Very different corporate culture you need for that than you need for a retailer. We found there are different cultures for different businesses that are effective. So let's turn both of those to that point on WCM. How do you think about your moat and your culture and how that impacts your business? It's a great question, and it's something we've thought a lot about. Can I go back in time a little bit? Sure. Let me tell you, our firm was actually founded in 1976. and I kind of see the founder's still alive. He controlled everything in the firm. You know, 1976, that was two years after ERISA. That was when it was a brilliant time to start a money management firm.

27:30You know, you should be able to build a multi-billion dollar money management firm just by showing up every day. But he was tough. He controlled 100 % of the equity. He made most of the money. Most importantly, he made all the decisions in the business and on the portfolio. And I think, as you'd guess, what happens, a lot of talented people in this business, and you can attract them to a money management firm because it's stimulating and usually it's fiscally rewarding, but there was this constant revolving door of talent that would come in, realize very quickly there was no place for it to go, and leave.

28:02So for 20 years, actually 22 years from 76 to 1998, the firm never grew over$200 million. Never. In the perfect time to launch a money management firm. We'd argue right now that that's because it was an extremely unhealthy culture. I've got some great stories. Let me tell you one that sticks out in my mind, and I think it just completely illustrates kind of the unhealthiness of the culture. So I was hired to kind of help raise assets, sales, marketing, and I was fortunate because I didn't really know what I was doing because I had come from portfolio management. about six months into it to uh the job the founder came to me and he said hey paul why don't we um go to one of the local beaneries break bread and let's talk about the firm and where we're going i said hey that's great i said yeah i'd love that i'm getting attention from the the founder i'd love it so the next day we walk out of the building he's got a brand new nissan nsx the fastest production sports car in the world at the time 90 000 car we get in that car we drive around the block and down the block and pull into a taco bell no kidding i'm not kidding we get out of this 90 000 production sports car and we go and we get in line founder goes first buys his tacos pays for him i go next i buy my own tacos and i pay for him We then walk out, and in Taco Bell, the seats are small, and you're literally about a foot away from the person that you're sitting across from.

29:41And the founder asked me, he said, So, Paul, what is it that you need to really grow this firm, to really make it go? And I said, You know what would be great? It would be great if we had some investment performance. Because we were in the bottom decile for every time period. I said, It would be great if we had some investment performance. Well, you know, you probably don't want to say that to the lead portfolio manager and founder of a company. That meeting was over. And as we walked out the door, he said, as he's getting into his$90 ,000 sports car, Hey, Paul, you don't mind walking back to the office, do you?

30:19I said, probably not. Walked back to the office in 95-degree weather wearing a suit. He took off in his sports car. And that was completely emblematic. of some of the issues in the organization. I'm not saying he was a bad guy. I'm just saying he was a little bit out of touch. Were you surprised that the door wasn't locked on you when you made it back to the office? Yeah, I really was. So it was just a classic example. Every day, the founder would come in, say hello, go back to their office, close the door, and never to be seen again. And the only way you could communicate with the founder, he had a mail slot in his door.

30:59He literally had to take a piece of paper and write a note on it and put it in the mail slot. So, you know, not conducive to, that's why we're so, our offices are wide open. There's no hierarchy. Fun is a huge value because that wasn't fun. And you know what? You didn't get the best out of people because they were not having fun. There were four of us that bought out the original founder in 1998. And I'm not kidding, not even tongue in cheek. What we decided was, hey, what did the founder do? Let's go 180 degrees the other way. And we'll probably build a doggone good culture, right? So what does that mean?

31:34That means, you know what? First of all, we're going to share the wealth. And secondly, we're going to be transparent about pay. It's not going to be opaque. And third, we're going to hire this young talent. And when we figure out that that talent's really adding excess returns to the portfolio, they're going to own equity. And they're going to own a decent amount of it. As a result, we've grown from$200 million to$26 billion in assets under management. Great products. I think we do something very different in terms of how we approach competitive advantages and the work we do on culture. But to me, it's the core set of values in our firm that were born out of a tough experience that come down to two things.

32:15What are most people's core values? Oh, integrity, dependability. We're not going to steal from our clients. And that's kind of like that's permission to play. You've got to have those, right? That's obvious. We have two core values. One is gratitude and the other is fun. And those two core values really do reflect who we are. And I'm convinced that those core values and living those core values has led to our ability to make mistakes and be free to analyze those mistakes, not so that somebody can be punished, but so that we can learn and get better. Gratitude, again, stealing from Buffett, you're born in America, you won the lottery.

32:59I mean, come on, you've got to be grateful for that. And I've had clients ask me, well, how's gratitude help us as your clients? And I think what it does is hopefully with gratitude, there's a level of humility to know how fortunate you've been. You're, again, allocating capital in this day and age, and you get paid handsomely to do it. Not so maybe 100 years ago. If there's a level of humility, hopefully there's also a recognition that, hey, we may not be the smartest guys out there. We may not work the hardest because everybody on Wall Street works hard and smart. But you know what we can do?

33:31We can care more about our people. And to me, that's an enormous competitive advantage because the evidence is overwhelming again that small teams perform better. And I think if those small teams are healthy and they're grateful and they're having fun, you're going to have a better chance of getting great results out of that. When you look at this landscape for active management, touched on it a little bit earlier, you said there's evidence that active management works. I've been the poster child that that's not the case. So why don't you talk a little bit about what you've done and what you see?

34:06One basic premise I have is that when you start in this business has everything to do with what you ultimately believe about markets. If you started, let's say, in 1972 and you ran portfolios from 72 to 74, it's highly likely that you come out of there writing a book about how you can't beat the market. If you started in 1983 like I did, even though we had a little blip in 1987, you probably, since you've had a pretty robust market in the U.S. and even globally for a lot of years, you probably have a sense that active management can outperform. I went out recently and went through a database and said, you know, what's the reality here about how many people, how many active managers beat the market?

34:52So we looked at all active managers in the database. There were 2 ,000 that had at least a 10-year track record. And of those 2 ,000, 50 % of them beat their respective markets, whether it's EM, small cap, bonds. What was that time period? That was 10 years. Which 10 years? 10 years ending December of 2017. Oh, okay. Yeah. Tough 10 years. Yeah, tough 10 years. and fully 50 % now. Now, okay, people are going to argue out there. There's a survivorship bias. Absolutely. But let's tone it down, make it call it 25%. Do you think that most people that are allocating capital should be able to find one out of four managers that has a good shot at beating the market?

35:32I think so. And here's the reality. The reality is, on one hand, I get people going passive because for the most part, managers don't do anything different to justify an active management fee. Most managers are all about protecting their assets. So they're going to run a 100-stock portfolio. They're going to buy the high-quality, wide-mode business selling at a discount. And you know what? And then they're going to wonder why they don't outperform. And frankly, there is a big, I know it's hard for the Northeast to see, but there's a lot of groupthink in the Northeast. And there is beauty to being removed from that.

36:10So if you set the premise right from the beginning, which is, hey, let's run a more focused portfolio of 30 names, that gives us the best chance of outperforming. We're going to take a quick break in the action to tell you about SRS Aquium. Want to make sure your M &A processes aren't stuck in the past? Partner with a company that's been defining the future of dealmaking for nearly two decades instead. When it comes to M &A innovation, SRS Aquium has reshaped the way that deals get done, streamlining processes for maximum efficiency and minimum headaches. Professional shareholder representation, online M &A payments, digital stockholder solicitation, SRS Aquium pioneered each and continues to set the bar for game-changing innovation.

37:02So leave the days of disjointed deal management behind and define your future with SRSAquium, the smartest way to run a deal. Learn more at SRSAquium.com. That's S-R-S-A-C-Q-U-I-O-M.com. And now, back to the show. You'd mentioned that firm over time has gone through some tough periods and a lot of introspection and learned from them. Why don't you tell a few stories about those periods? Yeah, one of them, you know, firm founded in 76 in 1994. The firm was still a couple hundred million dollars. And there was a transition between the founder and the son, who's my partner now, where the founder of the firm just decided one day that he's done managing money and kind of told the son, Kurt, that he had to take over the portfolio the next day.

37:56Well, having never run money before and all of a sudden having to run$200 million of it, didn't really quite have a solid repeatable process in place. Firm performed very badly for a year, lost a lot of money, probably went down to about$150 million. If you ask Kurt now, he'd tell you that he was getting his resume out. Here's a business owner, right? And you know what's hard about that? He's the son of the founder and he feels like he's driving it into the ground. It was a huge learning experience in terms of, you know, one, Kurt came from an engineering background, so he was trying to quantify a subjective process.

38:33And he saw everything through numbers. And if you ask Kurt now, he'd say, even though I'm an engineer and I get numbers and it's not about that, the competitive advantages is all, in our case, is on the qualitative side. That was a big lesson. And then we were running in 2000 to 2007 a large-cap growth strategy, U.S., and good, solid companies. We did a couple things wrong. One, we really believed in this wide moat stuff. So we were buying these wide moat businesses. And we really believed in valuation. You've got to get them cheap. So we were buying Yahoo instead of Google. And this is in a 20-stock portfolio, right?

39:09Yahoo instead of Google, eBay instead of Amazon, and Dell instead of Apple. Why? Because they were wider moats, and they were cheap. And we thought, how can we not lose? Well, we got murdered. Those three stocks murdered the performance of the portfolio. A very hard time. We ultimately got fired from$4 billion of money that we had raised because people trusted we could do well for them. And, you know, it's interesting. What I find is that people don't want to believe that money managers make mistakes. And they certainly don't want you to learn. They don't want to believe that you didn't know before, but now you know.

39:49We're supposed to be omniscient, right? And what we have found is that over time, there are a few people that actually look, they don't look at those periods of time where we almost bury the firm as failures. They look at them as sources of strength. And that's how we see the world too. Some people might feel shame in them. We feel like, man, how about that for an education? How about that for learning a very different way of approaching the markets? So again, good humility, which makes you grateful that you survived and showed up to live another day. And those periods of time have been huge for what we're doing now on the global equity side.

40:33Yeah, so you spend a lot of time now in international markets. What are the differences in how you think about culture in other countries? That's a good question because it is different. What we do think in part, we have a hard time being a growth manager, finding a lot of great companies in Japan, in part because of the cultural issues. I think it's changing a lot, but historically it's been hard for us to find names there where we think the cultures are healthy. There's a lot of, you still have the cross ownership of shares. You still have a very paternalistic society and paternalistic companies.

41:06They're not very transparent. So it's very difficult for us to find names for that reason in Japan. We do have a number of them, but in general, it's difficult. In other parts of the world, interestingly, what I have found is when you look at compensation structures, which is another way of looking at culture, how do they pay people? I think it's great that outside the US, you don't see guys making$30 or$40 million while their CFO makes$500 ,000. You just don't see that. You see a lot more reasonable equity payouts and or salary payouts in those companies, which I like. I like a lot because I think ultimately that benefits everybody.

41:44It benefits shareholders. But you're right. In emerging market, you know, people were, you know, we own Walmart in Mexico about five or six years ago. I think it was. There was a big New York Times piece on kind of the bribery or the so-called bribery that Walmart was engaging in to get space, right? Now, interestingly, what most people haven't heard is the end of that story, which is it was just big, you know, it just blew up and Walmart was in flames. Nothing came out of it. Nothing was proved. Emerging economies, they operate a little differently than a lot of European and North American countries.

42:20And things that we would see as being kind of under the table are just normal. So there is this part where you've got to understand that and just make sure that it's reasonable. You know, if you could turn back to growth stock investing as a concept, in the ETF world and all the factor, the blowing out of sort of factor products, you hear about value products, you don't hear about growth products. So the notion is supposed to be that value stocks work because they're boring and nobody pays attention to them. And growth stocks, you do get the Google or the Amazon every now and then, but on average, the growth stocks underperform because people are optimistic and they price them too high.

43:02Where does that break down? Or is it more that there's a subset of that gross stock universe that you've been able to identify? Because it's clearly worked for you guys. Yeah, I think there's a subset. We're not buying fad names or real high-priced names. We're not buying momentum. It's funny because how many years ago, 15, 20 years ago, there were a bunch of multibillion-dollar momentum shops. and I can't really think of one right now that is still in existence. So when you think of growth in terms of momentum, I completely agree. They were all down here. It was all San Diego. No, they were. It was all Nicholas Applegate.

43:40That's right, Nicholas Applegate, Turner Investment Partners. There was a great firm called Duncan Hurst that came out of the Security Pacific Bank. Yeah, they're gone. They're gone. And I'll never forget actually one year when I met with a gentleman at Duncan Hurst and he was telling, he was a marketer and he said, hey, you know, I'm so good at closing business now. He said, I win all these deals. And I said, does it have anything to do with the fact that in 1991 you're up 90 percent? Maybe. But he thought it was about him. And that gets to my point about humility. He thought it was about him.

44:15Like, let's make no, let's not confuse the issues. So a lot of times in the growth stock universe and the way you approach investing, you're looking for certain tailwinds in trends and sectors. What are the things today that you're excited about? It's hard to bet against China. It really is. Now, we're not loaded up in China. We've got a couple of names in the portfolio. One of them is Tencent. It's really, really hard to bet against China. I know people don't always believe the numbers that come out of China. I was there in 1981 as a student. And in 1981, there wasn't a car on the street. There wasn't one building.

44:56There weren't any hotels. There weren't any restaurants. People were driving black bikes everywhere. You come back today, they buy more cars per year than the U.S. does. There are beautiful buildings across Shanghai and Beijing and other major cities. So I don't know what the growth rate is, but it's extremely high. It's extremely high. And a quick little story about one of our ideas around investing kind of globally is we really like to own businesses in countries that are optimistic. And it goes back to my earlier comment, the optimist win. I was in China four years ago, and we met with a group of doctor students, medical students.

45:38And I asked the question, what motivates you? What gets you up in the morning? And they said, you know what motivates me? These are 20-year-old students. What motivates us is to be like America, to be as successful financially as America is. And I thought, what a contrast to, you know, I thought about 20-year-old kids in the States, and what do they want to do? They want to figure out the next video game that they can beat or win. And I thought four or five years ago, I said, that's a very powerful, optimistic, doesn't mean they're going to, but I sure do like that energy. And you go over, there's a lot of energy, a lot of positive energy in China.

46:12On the other hand, you go down to Latin America, you go to Brazil, you go to Argentina, not as optimistic because they've had years of corruption. They've had years of volatility and interest rates and currencies. And interestingly, a couple of years ago, we were down there. We met with 12 companies. Ten of those companies complained about the macro. It's really hard for us to operate. You've got this corruption. You've got the real getting clobbered. you know interest rates are rising inflation's out of control we can't really we just can't make it happen a lot of excuses there are two companies that never mentioned the macro what we do we came back we bought those two companies you know they knew that they had a significant edge in spite of what was going on around them and those are the kinds of companies that you want to own so so in general we are looking for those those businesses where there's a obviously a growing competitive advantage, but also a belief within the organization that it doesn't matter what the external situation is like, we're going to run right through this.

47:16And then when you get down to either the sector level or the subsector level, are there particular tailwinds that you have as kind of themes through what you're looking for? Yeah, I think you're always looking for that. You certainly want to have tailwinds. It's just an acknowledgement that that's how life works. I think anyone that doesn't acknowledge that is just not being honest, right? It's like, you know, J. Paul Getty, you know, someone asked me, how do you make a billion dollars in oil? So it's really easy. You know, you get up really early, you work really hard, and you strike oil. And there's this notion that he was fortunate.

47:45You know, he drilled the well in the right places, and he was fortunate. So I think having tailwinds is essential to success. Obviously, there are demographic tailwinds. I think a big advantage we have is that we tend to own businesses in the growthier sectors like technology, healthcare, and consumer. And if you think about the emerging middle class throughout the globe, this is just one aspect of it. But as people get wealthier in Brazil and Indonesia and India and China, of course, what are they going to do with their money? They're going to buy products from the companies we own. So if you think about a beautiful big picture tailwind, you can do what Jimmy Rogers did, which is said, hey, you know, he drove around China and Asia on his motorcycle.

48:24And he came back and said, oh, yeah, you got to buy emerging economies. And you do that by buying commodities. We'd argue it's a way better idea to buy companies that sell products as these people get richer. That's a beautiful tale, and that's not going away for 15 or 20 years. That's just something you can really take advantage of. How do you think about downside protection in the portfolio? That's a really interesting question because I've said a couple of things today. We're growth investors. We run 33 stock portfolio. First thing everyone's thinking is volatility, right? Wow, you guys must, you probably capture 140 % of the market when it's going up, but you get 110 when it's going down.

49:06And interestingly, that's not the case. Everything we do in this portfolio is to manage on the downside for all the reasons we know about. How do we do that? I think one way we do that that's real important is being right more times than not on the direction of the competitive advantage. Because in difficult periods of time, if you can own the company that isn't constrained by the financial markets and can allocate their capital into the spaces where their weaker competitors cannot, what you find is that really those companies hold up really well. Of course we do the basic portfolio construction of diversifying among sectors and industries and making sure we never have more than 4 % or 5 % in any one name.

49:49Those are obvious. But at the end of the day, everything we manage is to do well in tough markets. I'm surprised, frankly, how well we've done in the rising markets. Where we really expect to do well is in tough markets. Very, very counterintuitive. But to me, it goes right to the heart of what we're doing differently around the issues we've raised. So in the evolution of the business, you mentioned going through a tough period of time and having$4 billion of money come out. And as an allocator looking at something like that from the outside, you say, well, yeah. But at that point in time, as you said, you guys were doing some things wrong.

50:25Yes. What's been the patterns that you've seen of what you would consider more positive allocator behavior and less positive allocator behavior? You know, unfortunately, even the so-called sophisticated capital allocators tend to do what everybody else does, which is when they do a search for a manager, they tend to find the guys that have done the best, you know, most recently, with the argument being because they've done well for 10 years, they're going to keep doing well. Well, you know, lots of things can change. To me, a better way to look at it, and I know you've done this yourself, is to really figure out the people in the organization and whether they're the right people to continue to generate the kinds of returns.

51:10And then, of course, you need a process. But the allocation behavior still, you know what? Most individuals still chase money. They still chase performance. We tell them all the time, look, if we've done particularly well, we completely understand you taking money away from us. And why don't you put it into a strategy, like maybe a value strategy that hasn't done well. But you believe in the people in the process. That's brilliant. It's so simple. But nobody does it. And even today, nobody does it. So what's going to happen now? What are the public funds? A lot of public funds now are moving to passive.

51:39Right at the bottom of the cycle. And, you know, it's just like seven years ago. Everybody had to be in hedge funds and long shorts with a little leverage. And now what's happening today? You know, they're getting fired time and time again. It's probably a great time to build a long short hedge fund. And so after a 10-year period of time, a great performance in long only, people load up on long only. So their behaviors really, I don't think in general, have changed and I don't think they will. So I imagine one of the questions you must get a lot now is you're at$26 billion not too long ago and years ago, but you were a lot smaller.

52:17How have you managed the change within the portfolio at$26 billion compared to when you were a few billion? Interestingly, and we keep track of this, our average market capitalization today versus 13 years ago is about the same. It's$76 billion. Our median market cap's about$35 billion. 13 years ago, it was about$35 billion. So we never generated returns by kind of creeping down. So it was large cap stocks, even when you were a lot smaller. Yeah. And you know, the beauty of kind of owning your own firm and being a part of it and having a group of people, there's 40 of us here, is you don't have to run all the money in the world.

52:56I mean, if we found out all of a sudden that we were sacrificing returns, we'd close the product immediately. Yeah, this is our goal. We love taking on the big guys. Like you said, who is this firm in California that's adding 500 basis points per year over any time period versus all the big guys we know about? It is fun to do that. So that's more fun than raising more assets. And we want to make sure we keep ourselves in a position to continue to do that. Paul, it's great. I think we need to turn to some closing questions. Oh, boy. What was your favorite sports moment? I'm a Pat fan. So there's been a lot of them.

53:35But my favorite was with my son, who's now 13, so he was probably 11, being with my son, who kept asking me during the Atlanta game recently, two years ago, hey, Dad, can they win? I'm like, no, I don't think so. Actually, what I said to him, I said, you know what? Yeah, I kept telling him, yeah, Jake, they can win. They can win. Hey, Dad, third quarter, it's 28-3. Dad, can they win? Like, yeah, Jake, they can still win. And then they came back, and they won. I mean, one of the most extraordinary, and my son takes it so seriously. I mean, he was literally, you know, weeping at that last part of the game.

54:21And then, you know, they won, embraced. Really one of the great moments. Of course, being a Boston fan, I mean, 2004, when they won the World Series for this time, phenomenal. But sharing it with my son, highlight. What teaching from your parents has most stayed with you? Showing up. Never, ever give up. You know, I've thought about that a lot. There's a lot of times when I would have wanted to quit, you know, especially when we tried to bury the firm. But you know what? If we would have quit, we would never be here for this period, for this ride right now. What is it? Woody Allen said 95 % of life is showing up.

54:59I think it's 99. just keep showing up, keep doing what you're doing. And you know what? You'll be there when good things happen. It's huge. It's a huge, huge lesson. What information do you read that you get a lot out of that other people might not know about? I'll tell you a great one. I just opened it this morning. There's a gentleman named Nick Murray, and he's actually kind of an advisor to financial advisors. He writes a monthly newsletter. But what I love about it is he always, his basic thesis is how negative the press is, how pessimistic the press is, and how really, you know, again, he's a big fan of the optimist wins over time, but we don't see that out in the world.

55:40We see only the problems. So he keeps you focused on what's actually working. And then he always has great resources, great books that he's read, a couple of blogs. I just went to a, there's a, there's an, it's funny as I'm talking about optimism again, but there's a, there's an optimist blog I just went to today that was kind of talking about the short-term negative perspectives versus long-term kind of wealth creation. Those are two that are real, real valuable to me. And of course, I read the Wall Street Journal, but those are two. And then we have a lot of guys that have various podcasts that I listen to.

56:12Of course, I listen to Capital Allocators. Of course. I do my work and get a lot of good information. Yeah. What life lesson have you learned that you wish you knew a lot earlier in your life? I think that notion of keep showing up, I wish I would have got that earlier because I think it would have been easier to endure through some very difficult periods of time I wish I would have learned that early in my business career Because you know again, I didn't pull the trigger on moving or leaving the bank, but I really wanted to And i'm glad I didn't because I wouldn't be where I am now if I had pulled the trigger on any of those things So so I would have I would have liked to had somebody tell me paul keep showing up That's why I kind of preach that all the time in this firm.

57:00How do you advise that to your kids when, you know, when we were growing up, it feels like there was a lot more stability in people's career paths. And now there seems like there's a lot more mobility. So does showing up mean the same thing that it might have, you know, 20 years ago? That's a really good question. That's a great question. I think it does because when I say keep showing up, I could have left the business. I was thinking, oh, I love camping. I'll be a camp counselor or something. I actually was talking. I could have left the business. But you know what? I always loved the business.

57:37I just didn't love the vehicle in the form of a bank that I was doing it in. So keep showing up. Keep pursuing what you're passionate about. And that's how I found WCM Investment Management. Yeah. All right. Last one. You know, it's your waning days. You are, at this point, probably a camp counselor. Who knows? Exactly. Maybe the camp counselor at WCM. What advice would you give yourself today? I'd probably argue that as much as you love the business, remember there are other parts to life. And make sure, you know, whether that's being healthier or whether that's spending more time with my family, my wife, my kids.

58:19The problem for me is I just love this business so much. I'm not trying to run away from anything. I love it. And I love the people in this business. So I probably would say get a little bit more balance there, Paul. A little bit more balance. Because I think in 20 years, I'm going to say, okay, I don't have to do all that. I can get other people to do that. And just kind of slow it down a little bit. Because we're running pretty hard right now. Great stuff. Thanks, Paul. Thank you, Ted. Hey, before you take off, I've started sending out a monthly email that shares a small selection of what caught my eye over the month.

58:55I get a lot of emails like this, and I'm sure you do too, so I'm only going to send no more than a handful of the very best things that caught my eye. If you'd like to receive that email, hop on my website at capitalallocatorspodcast.com and join the mailing list.