#70 - David Powers: Wasatch Culture, Market Cycles, Long-Term

0:05Welcome to the Insightful Investor Podcast, a weekly series that seeks to share industry, investment, investment, and market insights. We define insights as concepts that are counterintuitive, widely misunderstood, or underappreciated. In other words, unique ideas that you probably won't hear elsewhere. I'm Alex Shahidi, the host of the podcast and co-CIO of Evoke Advisors, a leading investment advisory firm. Learn more about our show at insightfulinvestor.org.

0:38Joining me today on the podcast is David Powers. Dave is a senior portfolio manager and team leader of global value at Wasatch Global Investors, which is a$25 billion equity manager based in Salt Lake City that just hit its 50-year anniversary. And Dave has been at Wasatch for about a dozen years, but he's been managing value equities since 1997. Welcome, Dave. Thank you. Let's go back to the early years. What originally attracted you to investing? I've actually thought about this many times over the years. I think it all sort of went back years and years ago. Growing up, I had a very close family and we played a lot of card games, board games, sports.

1:25And I kind of believe that those experiences in some way laid a groundwork for the interest in investing. Every Sunday, my dad would go through the business section of the newspaper, record prices of stocks that your mom owned, and he would teach my brother and I a little bit about investing. I'm not sure I got it all at that point or it all registered, but I think it started to grow a bit when we bought our first Commodore 64, to date myself a bit here, computer game, which was essentially called the stock market game, or I think something close to that. I played the game for hours and tried to amass as much of a fortune as I could.

2:08And frankly, I got a bit hooked. And so that's kind of, I think, how I got going. Well, were you good at that game? I learned how to manipulate it. So I would say that versus skill. Got it. It was fun. Interesting. Now, you were a college pitcher. And how would you say that experience helped shape your approach to investing, especially regarding mental preparation and maybe even contrarian thinking? I loved sports as a kid and baseball and pitching in particular. When you're young, you can kind of get by with maybe some raw skill and throw a fastball by someone or a curveball, especially kids that are sort of not into the sport as much as maybe you are.

2:58But as you get older and players get bigger and stronger and you need to kind of develop a strategy. and my towel was pretty good but it wasn't enough I had to start to think like a contrarian had to throw pitches where the batters weren't expecting them you know either off speed outside inside fastball curveball just something they weren't expecting so so the mental preparation of the strategy particularly kind of as a contrarian became a bigger part of the game my career in summer leagues in college was good but it didn't last too long but I did develop skills that I think I use in investing today, including the willingness to take a chance and to be a contrarian.

3:45And I sort of think of sports as a whole taught me a lot about how to win and lose and how to bounce back the next day. And in investing, you have down days. It's a very humbling business, but you have to bounce back and say tomorrow's a new day and forget yesterday and sort of unemotionally, what is the rational thing to do from here? And I think a lot of that kind of started from baseball and pitching. That's interesting. And I guess part of sports and investing is you live through this learning curve. and is your sense that the learning curve in investing is always steep or does it flatten over time?

4:32I don't think it ever flattens and I hope it never does because I really love this business and part of that is just learning every day. However, I think I would take a little bit different tilt on this in the context of I think learning comes in these step changes. So sometimes like there's big changes in learning. You learn a lot. And that is sort of like you tackle a new company, you tackle a new industry, you put together a new portfolio. And those big aha moments are great, but they're usually followed by sort of a gradual learning. I think in the beginning of my career, I would say that a lot of it, you start out with the science, the math, what you kind of learned in school, and then it later becomes the art.

5:18and that becomes more important and that is what sort of continually involves. Being open-minded is the only way to succeed. I'm often telling this to young people. They just learn, listen, learn and be open-minded to changes. I mean, through almost 30 years of investing, I've had my shares of ups and downs and it's a humbling business. And a lot of what you learn and you grow from is your mistakes. Recognizing the blind spots, understanding what you know and maybe what you don't know becomes more important. But I think also you have to learn how to curb your ego. That's not always easy because that's why we kind of like what we do.

5:58But you also have to surround yourself with really good people and that helps maintain and be very adaptable. So one thing that I've learned is through time, you invest for decades, there's certain principles that are timeless. And then there are other aspects of investing that change with time. So how do you balance being dogmatic with those principles you feel are timeless and being adaptable with areas that may change with time? I think being dogmatic and adhering to the big objectives is really important. For instance, we are large cap value managers. We deliver large cap value portfolios and we never drift ever.

6:45And so that's one thing I think dogmatic is important. Another example might be that you have to develop and have a disciplined process and sort of consistently apply that. How we find ideas, how we perform the work, build our portfolios and retaining the structure, a structured framework increases performance repeatability. However, the business is constantly evolving and as such, we have to remain adaptable. The world is getting more competitive and so sort of the day-to-day adaptability of pushing us to high grade and improve our process is also a place where you have to be adaptable and maybe not so much dogmatic and flexible.

7:36You're flexible in your day-to-day kind of activities and how you do research, what technology you use, how you communicate with the team. I think those things are sort of more the day-to-day flexibility and where you don't want to be as dogmatic. But the big pieces, I think you do. I've noticed there aren't a lot of firms that have been around 50 plus years, as Wasatch has. And a lot of those come and go because they have a certain belief and that belief becomes dated and they fall out of favor and eventually they go out of business. It's really interesting how that has happened over time. I think you just have to be mature enough to sort of say, where are we going?

8:18What's been working for us? How do we understand a changing environment and really make sure that you're willing to be open-minded and persistent in learning and adapt with the times. You don't know it all. You want to get better. You want to do what you have to do. And you have to be organized and understanding that the world is changing, and you have to change a bit with it. So it's a bit of a blend. But that's kind of what makes it fun. That's right. Well, Wasatch has a very interesting culture. I'd like to ask you a few questions about your organization. You've been around for 50 years, just celebrating its anniversary.

8:58But what do you believe is the secret to the firm's longevity and success beyond being adaptable? Well, I think a big piece of it is the firm is independent. It's 100 % employee-owned, and I think this allows management and research to invest long-term. So Wasatch is a very good place to be a portfolio manager. I get management support. I get resources. I, too, have a long-term investment horizon, and this is very consistent, and I can consistently apply the philosophy and the process. And that is, I think, a real differentiator. It's very nice. You come in every day and you're sort of in line with how the firm sort of operates and it gives you the best chance to do well for your clients.

9:55As an advisor, one of the key questions I often seek to answer when evaluating investor managers is, it's a very basic one, is what business are they in? Everyone says they're in the business of generating returns for their clients, but their actions often suggest that they're actually in the business of gathering assets. How does Wasatch and you think about this seemingly inherent conflict? Wasatch never emphasizes asset gathering. Matter of fact, for some of the funds we close because that's the right thing to do for the clients. It helps performance. It's the right thing to do. from that context.

10:38And performance always comes first. There's no pressure to raise assets. And I think it goes back to Wasatch being 100 % employee-owned, which is sort of the emphasis is on focusing on performance and doing the best that we can for clients. And so there's no pressure to just go out and gather assets. And that's related to being long-term, I suppose, because if you're, perhaps if you're owned by a public company or you're more short-term focused on the revenues per quarter or per year, obviously gathering assets is the quickest way to increase revenues. But long-term, it's probably not the best for performance.

11:21I think the view is that if we can perform, it'll all come together. And not to sort of cloud the issue. And so there isn't any forcing on how there's no pressure to meet something quarterly. There's no pressure from management to say, hey, you need to improve your returns today. There's a belief and a support that with a long-term investing profile, and if we consistently apply our process, good returns will happen, investors will be happy, and the assets will grow naturally over time. And so it really goes back to a core belief of the long-term investments, staying independent, and good things will happen long-term.

12:05Would you describe the culture there, particularly the ethos that I've read about disagreeing without being disagreeable, and this approach you call multiple eyes, and how all of this fosters better investment outcomes over time? I'll put this sort of in short, broad terms. I think there's a belief that if we bring bright people together, we're going to have better decision making through a more thorough vetting process. So we believe in discussing the issues, the stocks, the facts, whatever the case may be, the interest in very professional manner. And we really try to encourage input from all others.

12:52You get great ideas that way. So sort of, I guess, directly answering the question, we emphasize team over any single individual. and this really isn't the place for a superstar. We don't really believe in the superstar PM model. So it's really all about team and trying to get different inputs with people with different experiences and skill sets in trying to get to the best answer, but do it in a way that's professional and enjoyable. And I suppose ultimately what you're seeking is whatever the truth is. And that, I think you can reach easier if you approach it from multiple perspectives rather than one angle at the problem.

13:37And you do that by having collaboration and learning from one another. Well said. You're 100 % correct and well said. Thank you. So given that, is there a risk that if you have too many inputs or a process that's more consensus-driven that you can dilute the alpha and dilute the unique insights? Well, Wasatch is known for small cap growth, but it's actually a great place to be a value investor where the patience and the discipline is rewarded. I've been doing this for more than 10 years at Wasatch and I've been able to apply the process consistently the whole time. So the inputs, we're able to manage that quite well.

14:25I have a really good team that I work with. And there isn't a lot of bureaucracy here as a whole. So almost all the time, I am able to focus on the research and portfolio performance. I'm not distracted. So I'm not sure you can say that everywhere. So there's a lot of other stakeholders and bureaucracy in places. We're fortunate enough that we're just generally straightforward and almost all the time. just sitting there working on the portfolios and really trying to get the best performance. There's not a lot of undue distractions. So we're able to consistently apply the philosophy and the process.

15:10It's great. Starting at a very high level, is your sense that public equity markets are relatively efficient or do you feel like there are corners of the market that are less efficient? Yeah. Yeah, so there are definitely corners of the market that are less efficient. I think over the long term, very long term, large cap equities can be somewhat efficient as there's an awful lot of research coverage. There's a lot of eyes looking and a lot of information and it's regurgitated. And so there's a lot of efficiency long, long term. However, the nice thing is that human behavior can be very emotional and drive stock price movements with a tendency to overact, providing great opportunities.

16:03And what I've also noticed over time is that the holding periods among investors, on average, have shortened. This is good for us. we truly are long-term where there is less efficiency. So essentially, we are looking for undiscovered long-term value. Said another way, as a traditional value manager, we seek mispriced opportunities due to excessive pessimism and low expectations. And these opportunities are usually found in parts of the market or corners of the market that are less efficient. So for us, we embrace the inefficiency of the market. So we think they're particularly thinking long-term, we can find stocks that aren't fully priced, which is great.

16:54It sounds a little counterintuitive what you said. So I'd like to ask it in a different way. The part about the inefficiency lies in being a long-term investor. And the reason I say it sounds counterintuitive is because we're all taught to be a long-term investor. That's the way people have been investing for a long time. And I agree that the time horizon for most people has gotten shorter. And it's really interesting. Maybe it's not counterintuitive, but it's, I think, interesting that being a long-term investor is where the inefficiency lies because so much focus is on short-term results. Would you elaborate on that?

17:29Yeah, great question. Great pickup too. So what I think happens is there's always sort of concerns that sort of get extrapolated into the short term. Investors kind of walk away, they leave it, they kind of oversell it. Our advantage is to sort of look out, okay, what's going on today, but what kind of effect does that have on the stock idea long-term? And it's usually sort of looking out long-term is where we can find that value that's being mispriced because of issues today. I sort of think about the short-term oversell, overreaction, ignored, we're not looking here, we're looking somewhere else, and sort of looking and saying, okay, that's what's being discounted today.

18:16But there is value in sort of a turn or those issues going away that the long-term is really where sort of looking past that is where the opportunity is. So when I talk and thinking long term, that's kind of the philosophy of the mindset of being able to take advantage of some short term over corrections. It seems like if you're investing in large cap value, that's a reasonable approach because large cap tends to be more efficient than small cap. You have more people following the companies. And then as a value oriented investor, you're focused on buying something at a discount, which oftentimes comes when there's an overreaction to some negative news.

18:56Yes, that's correct. That's exactly it. We sit and patiently sort of wait for those opportunities, which is sometimes out of favor, sometimes unsexy, but is actually where we can find a lot of good value. And that's where we go to work. Would you also talk about how you combine, you can talk about at a high level, how you combine both bottom up and top down analysis in your investment process? So my philosophy has been formed by almost 30 years of experience. And I started out as an analyst and then as a portfolio manager running several different value strategies and even as a director of research one year.

19:38And from all of those experiences, my investment philosophy, I would say, has generally remained consistent. But the investment process has evolved and grown. Now, philosophically, I'm a fundamentally driven traditional value manager. I seek opportunities where future inflection, improvement, and or risk reduction are not discounted in the current price. So essentially, what I'm looking for is what can go right that isn't discounted in the current price. So the stock picking is a big piece of the backbone of the process. But the macro awareness is also important and I think adds to success. Let me explain here.

20:29So cyclicals are heavily macro influenced and are big parts of the opportunity set and big parts of value indexes. So we have to have a bit of a top-down view, and it's important. We're not forecasters. We do not believe that we're very good at getting that exactly correct, but we do believe in sort of combining the bottoms up and the tops down. And that sort of leads me into sort of the investment cycle as a whole and understanding styles and regimes. And we try to understand where we are and where we're going, which helps us position for potential opportunities. So essentially, we're trying to anticipate where the puck is going and get into the right stocks ahead of time.

21:22So it's a combination of both the bottoms up and the top down. And we think that combination kind of helps us in performance and portfolio construction. And are there times or environments where the macro perspective and the determining what regime you're in takes precedence over the bottom up analysis and vice versa? They typically work in tandem. We don't really walk in and say today we're going to focus on bottoms up or top down, but it's a continual process. So how you sort of find ideas can be through the stock ideas or they can be through as we're sort of noticing what's going on in the macro world, the top down.

22:16We have a lot of experience of sort of looking at cycles. And so we really try to leverage the combination of the cycle and then also where we are from the stocks. That being said, there are days where we're sort of saying, hey, we think we're kind of going in this direction. Let's get ahead and let's start looking for stocks there. And there's times when we'll start to look at stocks and say, hey, this is a good idea. We can find something better than what we already own within a space. But generally, we're doing this in tandem. And we're talking about this in tandem as a team. And we're thinking about portfolio construction.

22:53And we're thinking about where we want to invest geographically in our size position. And the combination of this is sort of spewing ideas from sometimes on the bottom up and sometimes from the top down. But it's kind of in the conversations that brings it all together. When you're doing the bottom up analysis, it's obviously informed by your top down views as well, because you're thinking about where earnings may be in the future. You're thinking about how the company may be changing its vision or maybe changing a strategy. So it's all, I guess, all encompassing. Yeah, I mean, all the stocks generally have that you're searching when you kind of get into a stock, you're looking for those idiosocratic opportunities that maybe aren't well understood in the rest of the market.

23:37But we have to combine sort of the external environment. And is it a cyclical stock? Where are we in the cycle? Is it just this sort of a steady Eddie growth stock? What's going on, but it's cheaply priced. So we have to combine the two and understand. So a lot of the work is on the company individually, but it's also trying to combine and understand how the external market affects that company and then how that company fits into the overall portfolio. So, again, it's kind of a back and forth. We don't really believe you can sort of do one without the other. And we find value in being able to do both.

24:14We generally had success in sort of thinking more broadly in sort of the top down and the bottom up and sort of position better within portfolios. One thing interesting that I've observed the last couple of decades as an allocator is there are certain investment managers who only focus on bottom up and they might do well for a time and then the environment completely shifts and it's a new regime. And then they have a hard time understanding why they're not doing as well as they were for a decade or longer. And so you can see that blind spot that comes from not even looking at the macro at all, particularly when you go through those major inflection points.

24:53Exactly. And so I think you have to be aware of both of those. And you really can reward your client by making those turns well. So strictly looking at either one or the other, you could look at top down, but then you've got to find the really good ideas that aren't priced or discounted correctly. You could look at just the bottom up, but those turns are fairly sizable. And so the inflections, as the way we sort of talk about it, can be very meaningful. And if you're sort of not aware that you might be moving in that direction, you could miss quite a lot. So we would totally agree with that. It's sort of believed that a combination of the two is really what helps long term, particularly in portfolio construction.

25:40Is there anything specific that you look for in, I think the way you term it is low expectation, excessively discounted stocks, anything that maybe others tend to miss? Yeah, I mean, I guess, succinctly, again, we kind of look for what can go right. So we're sort of looking at a stock that's kind of down out of favor and sort of maybe ignored. And I was trained as an accountant, I build big, deep models, including detailed segment analysis, I don't think I or we are any better at forecasting anybody else. But the exercise helps us get insights into the company's growth and profitability drivers.

26:23We also get a view into intrinsic value. It's usually a range where we kind of think this is what the stock is worth. We get a view into discounted expectations and where we're different. And what we're trying to do is identify stocks where the market is underappreciating long-term growth, profitability, risk reduction, or maybe some combination of the three. An example, so AT &T back in 2023, mid-2023, the stock had a big pullback. The market was concerned about industry competition, their ability to generate free cash flow, and lead sheet cable liabilities. Well, we viewed all those concerns were fully priced into the stock.

27:14And we also believed that the industry was fundamentally better and stronger than what was estimated. and that the company's strategic vision or execution, I should say, would be better than the market expected. Well, we ended up being correct. The company continued to surprise the market with better fundamentals and increased cash flows, which led to better margins and better growth. And that excess free cash flow was also used to pay down debt, which we sort of view as reducing risk. So that example has just sort of hit everything, but that's kind of what we're looking for. We're looking for something that will go right, that's sort of better than expected, it's not priced in, and there's the opportunity.

28:05One concept that you've described a few times is being a long-term holder of equities. But how do you navigate the challenges of maintaining a long-term investment perspective in a world that's, as you mentioned earlier, is increasingly focused on short-term results, especially when dealing with investors? Wasatch as a firm may give you a long leash, but many investors may have less patience or operate under shorter time horizons. So how do you deal with that disparity? First of all, the long-term oriented, again, that's kind of where our edge lies. We have that long-term mindset. Even though I think a lot of people talk about it, I do really believe it's increasingly rare and gives us a bit of a competitive advantage.

28:50We are comfortable in only businesses that appear unattractive in the short term. Do this usually matters that don't, things that don't matter long-term. So the emotion kind of gives a shot at some stocks that we wouldn't normally be able to get a look at. So in some ways we're sort of attracted by, as I like to sort of say, the ugly or the uncool at times. The second part of that, though, ties into the first, is what we do is we spend time communicating to our clients exactly who we are, our philosophy, our process, our hope that we are aligned with that mandate so that we're all coming together and understanding what we do, what we think we do well, and then we do it, and then we don't drift.

29:41So I think part of that is applying your process and philosophy, communicating to clients, this is what we do and how we do it. And then hope that you're on the same page and that there's an understanding with that and that we attempt to earn that and we never style drift. We stay with it. This is what we tell clients. This is what we do. So when you meet with company management, are there any types of questions that you ask to uncover what the market misunderstands about their business? Because you're trying to find things that are not properly discounted. Yes. So I consistently try to focus on capital allocation, particularly where is management investing?