The hidden opportunities in a slowing economy. December 8, 2023

24:38In fact, than I did in recent times to get the same amount of stuff. In fact, over the last 13 to 15 years, I've gone nowhere. And you would imagine with all the increase in technology, potentially with what productivity that should bring about, you know, we're saving less, we're earning less, we're making less per person as a country. Like all of these things are going absolutely in the wrong direction. So I'll actually say here, despite my criticisms of the central bank, that they were probably right to pause. And in fact, mate, I think you and I – I'm going to do a victory lap here. I reckon you and I called this right at the start of the year because we both said that inflation – remember, like, again, it feels like ancient history.

25:31Inflation was diabolical, right? And so, yeah, they're going to do what all of the central banks around the world have to do to sort of fight it. And again, that's a whole other topic. That's what they think they have to do and that's what they do. But they will hit a point where even if inflation is still around, and let's not forget here, I want to make this point as well. Yes, inflation has come down, but what that says is the rate of increase in prices is slowing, but prices are still going up. They're still going up close enough to 5 % per annum, right? which compounds really aggressively against you.

26:05And that's why real per capita household income has been going down. But do you see what I'm saying here? It's like this is not a good set of numbers. I don't know. The RBA gets to a point where it's kind of like we can't increase interest rates. There's not so much more we can do. What about inflation? Well, okay, here's your choice. We'll put up interest rates even more. We'll crush inflation. But in winning that battle, we've decimated the economy. We've collapsed the Australian property market, which again is, I know, it's the big 2 ,000-pound gorilla in the room. And we said they will hit a point where they will have to roll because it is a lesser of two evils outcome.

26:59and I think we're there. And we're already seeing the bond market reflect this. We're seeing a lot of the boffins say this is that this is it. Maybe another rise, maybe one more quarter of a percent rise, but that's it. And I think I still stand by that. And I think that's a very safe bet, even if inflation runs hotter for longer. In fact, I probably wouldn't mind if inflation runs hotter for longer if I'm in power because it helps sort of reduce some of these debt burdens. Or am I being too cynical?

27:33I don't think you're being too cynical at all. I think the RBA, I don't want to repeat myself, but I will very briefly, which is to say, firstly, the RBA is doing what it feels like it has to do because the government is not doing anything. And that is the fundamental starting point of why rates are where they are right now. Rates would have to go up because it's an important part of the policy toolkit and foreign exchange rates matter. And if we had rates of 0.1 % still, now we shouldn't have got that low in the first place, so the starting point is also challenging. If we had 0.1 % rates right now and a much better fiscal policy, we'd have other problems.

28:05A combination of good fiscal policy and good monetary policy would mean rates would be lower and we'd have the same impact on aggregate demand, probably a fairer way, by the way, and so you'd be in a better position. I will say, and I have said before, I am not – we shouldn't – I don't think we should believe you. I think you might disagree with this. I don't think we should believe the RBA will save the economy from recession at the expense of inflation. I actually think it's far more likely to reverse. We saw during, this is not saying it will happen again, we saw during the early 80s, I mentioned this before, Paul Volcker, the then US Fed chair, put up rates, caused a recession, and then put up rates during that recession because he believed, I think correctly actually, that inflation is a far bigger scourge than our interest rates.

28:48And so he said, okay, I need to kill inflation. We just talked about the graph from Ben Phillips, the 15 years of effectively nothing while we got smashed by inflation. so I'm not convinced the RBA will actually will try to avoid a recession if the cost is higher inflation now the pollies may prefer that higher inflation frankly which may actually be as you said why they maybe haven't acted so quickly but to the extent the RBA is independent and I actually believe it is maybe I'm being too Pollyanna but I think Michelle Bullock's shown herself already to be pretty much an independent thinker given Jim Chalmers' dissatisfaction with what she said I think I'm not as cynical as you I don't think in that sense but I do think they will risk a recession to kill inflation that being said they will also realise that there's a recession and then there is smashing businesses and households unreasonably to a too significant extent and they I'm not saying they will the board has said they will do what's necessary to return inflation they've been very very very clear the board is resolute I think is the way that sentence starts the end of every RBA statement for months and months and years I think that's true and they believe it.

29:53I do think at some point where they say, all right, now we've got a balancing act like they did this week. Hey, how much is too much? Where do we draw the line? I would also think they will err on the side of hoping they've done enough rather than making sure they've done enough. And I think I would say that sentence is probably exactly why they didn't raise rates earlier this week. Isn't it true too that they don't have financial stability as part of their core mandate anymore? This is – let me rant further. They don't because APRA is now responsible for that bit. Okay. Australian Prudential Regulatory Authority.

30:24I would smash the two back together. God love bureaucrats and to your point and politicians. APRA, the banking regulator, effectively the financial stability regulator, was spun out of the RBA as its own agency. I don't know how many years ago, but enough years ago that it was long enough ago. There was a huge, huge, huge mistake. And we've seen that. We saw APRA lower the lending buffer during, you know, when rates were already tiny. Talk about a known goal. Right? And by the way, allegedly, I believe that they were instructed to do so or encouraged to do so by the then Treasurer Josh Frydenberg.

30:55Now, that may not be true. If it's not true, I apologise to Josh in advance. Well, here's the thing, right? So once you say, hey, the RBA is independent, but APRA is not. APRA does what the Treasurer tells them to do. And once you say, well, okay, now if you're Treasurer, what rules do you play by? You avoid cooperising the RBA because that's political suicide. But if you lend on APRA, you might just do that. So you're right. The RBA doesn't have financial stability as a key metric. I would put the two back together. I think it was madness to separate it. The Reserve Bank, literally, you've said many, many times the way the bank works in terms of, you know, it's literally taking deposits from and charging interest to those banks to say, well, let the prudential regulation sit off to the side.

31:33I think it's madness, frankly. Yeah. So if that's not – so I've got mandates that I have to sort of try and achieve and stability is not one of them anymore. Correct, correct. Inflation is absolutely one of them. Yes. And the key one. Yeah. So maybe I am more inclined to really cause havoc out there than I otherwise would have. Because when I'm worried about inflation but also stability, I'd imagine that might stay in my hand. I think the other thing that's a little bit different, I was going to make a comment on what you said about Volcker, who absolutely did the right thing, I think. But he was in a world where there wasn't much.

32:15I think debt to GDP was 30 % or something. Yeah, right. It's 120, 130 % or something at the moment. So that's also very – my thinking, and this is subject to change because it's a very difficult subject, but is that they just can't because by increasing interest rates, the debt servicing costs for the US government, the largest economy in the world, is untenable. It just compounds – we talk about compounding a lot here. It's just sort of like it is the classic credit card debt spiral where I can't meet my interest payments, so I borrow to pay my interest payments. And that compounds – by the way, that is happening now, right?

32:58So it's sort of – particularly because we live in an interconnected world and the RBA cannot ignore what is happening in the world's largest economy. you have a scenario where, again, my view is we will see interest rates roll because mathematically it has to because it's going to bankrupt the US government, which is already living well, not a little bit beyond its means, well beyond its means and is now getting involved in multiple wars, even this week, you know. Who was it? It might have been Bernie Sanders or someone came in. We can't fund this. How are we funding buying more weapons for Ukraine?

33:39Like this is expensive, expensive stuff. And so they, again, my view remains and has been for a while, they will roll and that we will cop the, not necessarily, I think we are past the peak of inflation. Let me say that clearly. Yeah, yeah. But that it'll take, here's two possibilities. It'll either take a while for inflation to come under control because they can't put rates to where they potentially need to be. Or inflation is resolved, but by virtue of a crippling and what you hear termed as a hard landing. So not just a little bit of a slowdown, but I don't want to use the word crash, but we're talking unemployment going up significantly.

34:30And that is something that I think everyone is very worried about rightly, because the contagion that happens in those scenarios, because when people lose an income, then it's not a question of how much can I shoulder in terms of paying the mortgage. We've seen household saving ratio is non-existent. Household savings, period, have been falling. We built up a lot in COVID, and that's been falling precipitously too. We have been living on borrowed time. And now I am a forced seller, which pushes prices down a little bit, which forces other people. So things can run away very quickly. So you are having to navigate a very difficult path here and walk an extremely fine line.

35:17So I actually think, despite all my reservations about the way the system kind of works, Baloch was right to not increase interest rates. As much as I personally, I'm looking to buy a house, right? But me and the wife are like, please go up, please go up, please go up. Even though that would mean, well, doesn't that mean that you're going to be paying higher? Yeah, but on aggregate, I think it might be actually, I'd rather pay a higher interest rate on a lower loan. And the rate will come back down again. And that's the other thing about why interest rates are more probably better to favor increasing rates over letting inflation continue is because you bring the rates back down at some point.

35:57As you've said many times, inflation never comes back down. The rate might fall, but the prices stay high. So you literally ratchet up. You don't ratchet up rates, but you do ratchet up prices. That's why inflation is so insidious because there is no – the inflation rate might be cyclical. As the interest rate is cyclical, the problem is that the interest rate doesn't rely on a ratcheted base, whereas pricing just goes up and up and up and never comes back down. And the other potential issue to worry about is negative real rates. That is interest rates below the rate of – sorry, the inflation rate greater than the interest rates kind of thing.

36:35So it's sort of like that is a situation which can be very – again, cynically, you might say it is desirable from a certain standpoint. Yeah. I don't even know. I'm trying to think where to go with this because it's a deep rabbit hole and maybe it's best not to set foot down that path. But negative rates, negative real rates can be their own kind of problem. Do you have any thoughts on that or is that best left aside for another episode? No, I think, well, I think almost by definition, when rates were low, it's a bit like it's a share process. If you have a growth rate that's greater than the discount rate and you do a discounted cash flow, you can literally pay an infinite price for shares or you get an infinite valuation for shares because the growth is always going to outpace the discount rate and if that's the case, then there's no price too high to pay and there's no valuation.

37:32And the same is true when, as you say, when you end up with a situation where inflation is higher than rates, it just creates that problem of you can effectively borrow in real terms and pay back in nominal terms, which means you're always here. You're kind of getting paid to borrow money, right? As long as you can deliver those same gains in your own business at a profit line, which is not always that easy. And this is where the whole thing is not as easy as saying, well, one is higher, the other, therefore it's always good. Marginal lending is the same thing, right? If I could borrow at 6 % and get 10%, would I be okay?

38:01Sure. But what if you don't? Well, then the whole thing breaks down. So you're right. It's its own issue. I will move us on, Matt, though, if it's okay, because we've spent a bit of time on this one and we're meaningfully through the pod. I do want to talk about the other bit of news which broke after we recorded last week's episode. That was the death of Charlie Munger, which we hadn't had a chance to comment on at the time. Charlie, of course, Warren Buffett's right-hand man, died at 99.8, I think, or something like that. He was about five weeks short of his 100th birthday, which knowing Charlie would not have cared about at all because he's not the sort of guy.

38:34But a really, really, really significant loss, mate, I think, for the investment community. The great thing about Charlie is that, like Warren, he spent a lot of time writing, talking, thinking, expressing himself. So we have plenty of great Charlie Munger anecdotes and quotes to kind of go from and to keep us post his departure from this mortal coil. For those who don't know, so Warren Buffett run Berkshire Hathaway for getting close to 60 years now. Charlie Munger I think was with him for almost all of that time. He's been Berkshire Hathaway's vice chairman for almost all of that time. The two spoke apparently almost daily and were not two sides are the same coin in some senses, very different characters.

39:18Charlie, a Republican, Warren, a Democrat. Warren, the more genial, folksy guy, Munger, the more acerbic, cut straight to the point, take no prisoners kind of guy. Incredibly smart, polymath, trained lawyer, made his fortune in real estate investing, then joined Berkshire, a multi-billionaire in his own right, much less wealthy than Buffett because he gave a lot of it away a lot earlier. Didn't compound it the same way Warren did. But a remarkable, remarkable man. I'm going to share a couple of quotes, mate. We might do a little bit more on Charlie, but I'll share a couple of quotes. Can I start with one?

39:53Oh, please, go on. I hadn't heard this. I thought I'd heard them all. I hadn't heard this one. Okay. And it relates to what you're saying with him being a Republican versus Buffett being a Democrat. He was asked about politics and he said, I don't like left-wing woke and I don't like right-wing nutcase either. I'm an equal opportunity hater of political orthodoxy. And I love that. Isn't that great? There's Republican, Democrat, there's a lot of heavy lifting those labels kind of do. But I think that belies Charlie's more pragmatic, practical kind of way of thinking, which is like, if you're going to put a label, yes, it's probably a Republican, but I'm not a right-wing nutcase either here.

40:35And he was very critical of a lot of the things that, you know, of Trump and, you know, so he was very much a free thinker. And I thought that's a good quote to start. And one of those people like Buffett who, despite their fortunes made as capitalists, also very clear about the excesses of business and some of the ridiculous behaviours that happened in corporate boardrooms, in investment areas, in business itself. Just that kind of idea that there's more, you know, the quote you gave is a perfect one, which is basically that extreme idea of you don't have to be all in on this or a thoughtless defender of a particular ideology.

41:19Just because you consider yourself a capitalist doesn't mean everything capitalism stands for is right or everything that a capitalist does is right. Yes. And similarly, on the other side, depending on where you're saying, there's much more value in recognising the positives and negatives of any particular political stance. But, yeah, I think that's absolutely the case. Interestingly enough too, mate, we might do a separate episode on Charlie, some of his thoughts. But one of the things I did like about Charlie, I've always stuck in my mind, is they talked about fossil fuel extraction. And Warren's spoken much more strongly about climate change action.

41:55I think Charlie was kind of a bit of a we'll find a way to fix it kind of guy rather than a let's stop doing it kind of guy, and that's their own views. What was fascinating about Charlie Munger though, he had a very specific view about not mining but not drilling for too much oil in the US. And this is just worth thinking this through, right? So I'm a big fan of increased resource royalties, so you might think I'd agree with Charlie here, and I do. Munger's point was we shouldn't drill all this oil because at some point in the future, it's going to be much more expensive, much more valuable. And it was just literally a case of if we keep the thing, if we don't need the thing right now, and you can keep it until it becomes scarcer and more valuable, then it'd be in your best interest to do so.

42:34Interesting. And I just thought, you know, if you think about a country or a company where it's the short term, let's just get it out of the ground now, sell it now, make a couple of dollars now and let the future look after itself. Munger and Literature has done mentally the kind of discounted cash flow, the net present value and said, so hang on, we don't need this yet. And at some point when someone else wants it from us, we can charge a higher price. Once the middle of this is out of oil, once whatever's out of oil, once the cost of drilling it's more expensive, we're going to have all this stuff and we can sell it to them then.

42:59And just think through that idea. It's not, some people will be like, obviously, Other people are like, that sounds weird. But if you really think that through, just that idea of could we exploit it now? Yeah. It's why I'm a fan of higher resource rents for exactly the same reason. Someone will say, yeah, but when the price drops, we're not unprofitable to mine it, won't it? It's like, yeah. Yeah, exactly. Because then when it's more profitable, I'll mine it again. The Australian taxpayer gets more per ounce, per ton, per barrel, per whatever. That's exactly what you want, right? It's like insurance companies.

43:29Writing policies just because you're supposed to write them when the pricing's bad, when it's unprofitable to do so, So the insurance company should stop dead. I'm not going to write that policy. I can't make any money. But no one does because they all feel like they should keep doing it because that's what they're supposed to keep doing. So they were digging and drilling. Which mining company says, yeah, we're going to shut that operation for a couple of years. We'll wait until the iron oil price goes back up. People would lose their collective. That's exactly what you should do. You wait for the better pricing.

43:52You say, I'm going to absolutely go nuts when the pricing is higher. My shareholders, if this was a private company, if you and I owned all the oil in Australia, would you drill it at$40 a barrel? No, of course you wouldn't. You wait until it was$80 a barrel and then do it then. But I just liked, again, I don't want to kind of, it's about fossil fuels and climate change and it gets a bit of motive at some point. I just liked that concept of Munger saying, don't do it, not necessarily because, well, not at all, because it could have been for the environment, but we'll get more for it later. And if you owned it and you cared about the present value of that, you'd say, no, it's worth me waiting.

44:21Yep. The one wrinkle in that is there is the threat of disruption in the sense that we have the renewables come down the cost curve we crack fusion, fission becomes more acceptable. So it becomes a stranded resource. So it's like we're waiting, we're waiting, we're waiting, we're waiting. Ah, now let's use it like, well, no one wants it anymore. We don't need it. The world's moved on, which, you know, maybe, and I think that's a long way off. So it's probably, it's a safe bet, but. No, it's a fair, it's the right kind of point of that. Motley Fool Money. For more, subscribe to the free newsletter at fool.com.au forward slash listener.

45:05Hey, speaking of Charlie Munger and rants, we are well and truly slap bang in the middle of prediction season. Oh, prediction season. And I had a big rant on this for the listeners who get our mailing list or have seen the website or follow me on Facebook, you'll have seen this article. And it wasn't to take any particular predictor or pundit to task. We've talked a lot about predictions before, mate, but I just thought it was worth raising because I'm already now seeing the next year. What's going to happen next year? I do a radio spot on 2GB and I think it's 4BC and maybe in Melbourne too, the Monday News show with the Nine Radio Network.

45:41And as I tweeted about this, the producer tweeted back said, guess what we're going to ask you about on Thursday. So it'll be an interesting conversation. We're recording this on Thursday morning. So he at least knows what I'm going to say, which is I don't know. You're very unsatisfying, right? Isn't it? Very unsatisfying. And I'm sure he's laughing about it. He's also thinking, dude, I've got to fill some airtime here and can you just have a go? Let's do something so our listeners got something to kind of grab. Well, fortunately, if you say that, there's 100 people he can ring up. He'll say, this is what's – that'll give you a definite, right?

46:11And so people like us, you know, are not particularly, you know, valuable contributors in that context. And that's why other people will be called on instead of us because I don't know it's not very satisfying or, you know, would you like this company? I don't know. What's it worth? I don't know. Where's SharePoint's going to be in 12 months? I don't know. Why are you here for? You know, I want certainty. Correct. And that was my point of this rant that I had on all those platforms, on email and the website and Facebook, was exactly that, that that sense of we desperately want certainty and we want to believe.

46:44It's not even that people necessarily think they want certainty. You don't necessarily say, I'm going to ask Andrew because I know he'll know and therefore when he tells me I'll know the answer and then I can go and do it. There's not that sense, but there is that sense of, I'm interested in Andrew's view and if he's got a thought, then that might help me and so maybe I could either agree with it or disagree with that or I could use this confirmation bias or at least I had something, our stupid desperation to, I say stupid, I don't mean it in a personal level because it's a human trait. It's built in a revolution.

47:11No one's failing necessarily other than you have to work really hard to try and avoid it because that idea of a number in a box. It's why valuation models work beautifully because you can say, this company's worth$5.63. Okay, good, now I know what the value is as opposed to, well, it's roughly in this sort of range. Well, what good's that to me? I can't use that. It is the folly of prediction. It gives you a chance to reuse one of my top five favourite quotes, which is the John Kenneth Galbraith one, pundits forecast not because they know but because they're asked, which I just love and it's so a million percent true.

47:42I'll give you one. I'll give you one. Speaking of Buffett and Munger, I'm going to paraphrase because I forget the exact wording, but it's sort of like forecast tell you more about the forecaster than what's going to happen. My favourite example, actually shout out to Shane who tweeted this in the week, it was like the Property Tribune website, had a prediction from a housing industry body about what's going to happen to prices next year. Have a wild guess what their forecast was. Do you think it was bullish or bearish? It was bullish. Oh, prices are going to rip next year. And it just reminded me exactly of that quote.

48:18It tells you more about the post. Never ask the barber if you need a haircut, right? Never ask the housing industry body what house prices are going to do. They're going to go up. That's what they're going to do. But what about they're going to go up? And it is so transparent and yet, you know, it seems to resonate. So I guess we all are trying to take from the buffet those things that will reinforce our biases. And, you know, there's a wide array of opinions to choose. If you want to believe X, Y, and Z, you'll find quote unquote evidence for that in terms of at least the other people's views and forecasts.

48:58And they'll say, see, I knew it. because that person said the same kind of thing. Correct. And that's the – so I just want to share that. I know we've said it before. We'll say it again. But just this time of year, the newspapers get thinner and we turn a page in the calendar and all of a sudden it's like 2024. Oh, I know what we'll do. We'll ask all these experts what's going to happen. I feel a little – a tiny bit sorry. They get plenty of money. I do feel a little bit sorry for other people in other organizations, mate. I said again in that piece that as the chief investment officer of a financial services company, it's entirely reasonable that my employer would say to me, you need to put together a forecast pack for next year for when our clients ask.

49:35Now, I'm really, really lucky. The monthly field have asked me to do that. I also would refuse to do it, so I'm also very lucky for me that I don't get fired for doing so. But I'm in a good place. But if you're a chief economist of any bank, if you're this sort of person, you're paid, as you said, mate, for certainty or at least to have an opinion, if you say, I don't know, it's like, well, yeah, what do you think? That temptation to kind of go, well, I guess you are. so I think maybe probably this. Yes. And it's not to say I don't have a hunch about what's going to happen. I've just talked about what might happen with inflation and interest rates and that sort of stuff.

50:04It's not that we don't have those. It's the idea of a prediction versus a sense of a range of possible outcomes. And that's where it gets insidious because once you have a number, once you have a forecast, you then do things subconsciously or consciously because of that. I think this will happen. Okay, well, then I should do that. As opposed to, well, I don't know, this could happen but it might not. Well, okay, I can't use that then. Ironically, the best response from any forecaster is when you go away going, well, I can't use that. It's like, great. That is excellent. Because if you start to think, Mike's going to go 20%, housing is going to go up, well, I should buy an investment property then.

50:37Or Mike's going to crash, well, I should sell everything then. When you start to think that as opposed to, the forecast is probably wrong. So start there, you know. But you can't do it. You can't. There's a great piece of work I've heard about. I've never actually read the source documents. I assure I'm not parroting an urban myth, but I could be. that there was a piece of research done where participants in a study were told something and they're told it wasn't true. And they were asked later and some disturbing number of people, a large minority of people, were asked that it was true. Yes. Not because they hadn't heard that it wasn't true, just because they'd heard the statement and that statement had embedded itself in their head.

51:12The sky is red. That's not true. And then someone asked later, was the sky red? No, it wasn't. Obviously, that's a silly example. But that idea of like, so is the sky red? Well, yeah, a decent number of people said they thought it was because they'd heard that statement said. Now, that's why this is so insidious. And by the way, again, a shout out to people who think they have absolute control over their brains and subconscious. Can I tell you, you really, really don't. And if you think you do, you need to get the hubris checked. And I mean that in the most loving possible way. Well, that belief is itself a behavioural bias.

51:40Yes, exactly. But it's hard, right? It's hard to get rid of. It's like once you think that, how do you, you know, it's a horribly difficult position to get yourself out of because it's just not true. And if you can't believe it's not true because you don't believe it's true, then you can't open yourself up to the rest of them and you are going to get taken to the cleaners in all probability. I have to put this one forward from a Charlie Munger quote, which I love, I love, I love, I love. I mean, it's so core to everything I do. I started a business based on this, Frank. He says, we're always learning, modifying, or destroying ideas all the time.

52:15Rapid destruction of your ideas when the time is right is one of the most valuable qualities you can acquire. You must force yourself to consider arguments on the other side, which is just great. I am not entitled to have an opinion on this subject, Charlie says, unless I can state the arguments against my position better than the people do who are supporting it. Only then am I qualified to speak. Isn't that – Love it. Oh, I just love – I raise it in response to what you're talking about because that's the salve, right? That's not, I wouldn't say the cure, but it is a mitigating kind of thing, which is because you are going to want to sort of think in that way.

52:57But whenever you're trying to sort of invert things, think things through from the other angle seriously, not just pay it lip service. Okay, there's a whole bunch of people who feel the exact opposite way. I'm going to think through their arguments seriously and in good faith. And then I can, there's one or two possibilities, right? I'm either going to destroy my idea, which is good because my idea was probably wrong if I've on balance considered both sides and come away with a different view. Or equally valid is I've built stronger conviction. So when the volatility comes, when the uncertainty comes, like, no, I've really thought this through and I'm not going to sell.

53:35I've got the diamond hands, right? Not the paper. I'm going to hold on. I'm going to buy more, which you're not going to do if you don't have the conviction. So it is super potent, super powerful. Great one, mate. Okay, let's keep pushing through. We had a couple of big business stories this week and it's worth one of my own shares in, but I guess maybe interested in it for that reason instinctively, though you brought it up before I did this morning. So let's blame you and suggest I wasn't going to do it. I probably was. Sol Pats, a business we've talked about ad nauseum, almost rivaling Kogan for the drinking game.

54:11But really, I find this, in fact, I asked the Motley Fool investment team this morning on spec, just, hey, guys, what do you reckon about this? And so I want to get your thoughts, Ram, and I'll give some of mine, but this is a diversified investment house. They've had investments in everything from property. They've got a cross-sharing in Brickworks. They've got shares in TPG Telecom. They've got tech start-ups in there as well. Yeah, copper miners and God knows what else. Yeah. They have gone in a big, big, big way into funds management. They are, and I don't mean big ways in, it's not meaningfully large for them at the moment, But it was something they weren't in at all effectively.

54:50They've done some, they bought, they've emerged or acquired Milton recently, an early investment company. They lobbed a$3 billion bid this week for Perpetual, the fund manager, who recently took over Pendle Group. They have a majority shareholding or a large minority shareholding. I think it's Pengana, is that right? I can't remember now. I should know. Something like that, yep. But it's a really interesting, big change for them as a business. And they've always been diversified. There was bits everywhere. So no surprise they're doing something new all of a sudden or just every now and again because that's just what you do.

55:25But it is interesting that they've gone effectively, you know, neck deep or trying to go neck deep in this thing. $3 billion is, I don't need to tell anyone, a very, very significant chunk of change. It's a very new business for them or relatively new business for them. Not so they don't have the capacity. it's about a quarter of their market cap. I mean, this is not small, right? And by the way, that's$3 billion currently. If there's a bidding war, they'll have to up their stake. It might be$3.5 billion if they get it at all. I find this fascinating, mate, and I have some thoughts, but I'm not going to share them yet.

55:59I'm just going to ask you, why would a company like Solpats, do you reckon, want to be buying or investing or getting into the funds management game? And separately, it's a bit like the RBA, what will they do, what should they do? So why would they want to? Secondly, do you think it's a good idea? Would you be counselling SOPAT to continue on this path or would you say, guys, that feels like a lot of money and I'm not sure this industry is the right thing for you? I mean, funds management is an insanely profitable business if you get it right. We talk a bit about operational leverage and scale advantages.

56:33So, you know, you've got your stock picking gurus, you've got your admin, you've got the office and this and that. But whether you're managing$2 billion or$10 billion, the work is kind of the same, right? Like the fixed cost burden there. And you're charging a percentage of funds under management. Well, over time, like we have bear markets, obviously. We have tough patches. But as you're fond of pointing out with a Vanguard chart, right? Markets tend to rise over time. Assets tend to rise over time. So as I get bigger and bigger and bigger, and it's largely a distribution game, by the way. It's like if you want to have one skill as a fund manager, it's not really stock picking sort of like the least important skill.

57:14It's just distribution, getting more people to tip money. That is so true. Do you know what I mean? It's all the matters. Yep. And it's kind of interesting when you, again, you point out the fact that most fund managers most of the time underperform the indices when fees are included. Yep. But, you know, because it's a sticky business too. I make a decision, someone throws me some money, it's there forever. It's there forever. Well, we've seen Magellan and others lose a fortune in mandates. You can lose some money if you get it wrong, but the attractiveness is exactly that. A &P is another sort of example there potentially as well.

57:48Yes. And so I think when you understand the business and you look at that, you go, this is the rivers of gold here. Now, that being said, this probably points to the fact of how poorly managed, in my humble opinion, allegedly, whatever words I need to say to not get in legal trouble. I think you can use that as a defence. I said whatever words I needed to say to not get legal trouble, Your Honour. How could I possibly still be in trouble? Let's go with allegedly. I'm having an opinion, right? And I assume I've got an opinion. Page P-A-T. This has been a disaster, a train wreck. Ever since the GFC, shares have been heading down, right?

58:27This is like 16 years or something now, more or less, up and down, up and down. But generally down. They've never got back to those highs. That isn't a consequence of the market being irrational. Their per share earnings have been falling away as well. Last year they reported a 6 % return on their equity. Like what do you – here I am saying it's a wonderful business, right? And it's just like what have you guys done? What have you done? It is absolutely diabolical that you have done that bad with a brand that is so well sort of recognized because generally speaking, People look at things like, well, I've never heard of Phillips Funds Management.

59:08I've definitely heard of Perpetual. I'm going to go with Perpetual. Like, you know, it counts for a lot. So I assume, I have no idea, but I assume the team at Solpats have gone, these guys are in trouble. You know, they're relatively cheap because of a consequence of what's happening in the market. Maybe they've had some poor fund flows, et cetera, but they've got a good brand. I reckon we could do a better job of that and then we could enjoy some of these economics when they go well. But as you've said, I mean, it's not a slam dunk, right? Because Magellan and others have, you know, when that operating leverage cuts both ways, when the fund flows go out and when the assets under management fall just by market prices falling and the rest of it, things compress in the other direction.

59:57So it's not an easy thing necessarily, but these are also very prudent operators. And I would say just by virtue of the way that they've run their business, their conglomerate would probably suggest they're reasonable capital allocators as well. So I get, I get, I get the thinking. And I guess they've just done the sums and thought, what, what was it? $3 billion bid? Yeah. Shares are trading at$2.5 billion. The market cap are perpetual. This, this, this seems like a, we can offer a premium and still get a bargain and this, this will pay for itself very quickly if we get it right. I don't know.

1:00:31I think that's it, mate. I am only mindful that for everything you've said about the – I'm a – what worries me about funds management is it's one of those businesses where the business model should stack up, the results often don't. It's one of those when theory and practice, what's Yogi Berra's thing? In theory, there's nothing different between theory and practice, but in practice there is. There is, yeah. It's a lovely quote. I should write some of those down. They're such great quotes. only in the sense that we've seen platinum lose money, Magellan lose money, lose funds under management. If you're Salt Pats and you're buying a business like this, you're kind of betting on the future of the FUM, right?

1:01:11And to some degree, it's the value of the brand and the people who you've got working for you and your ability to compensate them and have – your right distribution is the only thing that matters except it's the only thing that matters in both directions and Magellan has found out to its absolute chagrin. I did I did I was speaking of Victor Labs I will say I don't think I don't know if I said publicly I hope I said on Twitter at some point but basically I said you know Michelle sponsored the Ashes at one point the Cricket Ashes and I remember making the point that Michelle's got no business sponsoring the Ashes right this was this was one of those top of the market top of the whatever's type things this was a $65 a share business it's now$7.83 it's fallen by the best part of 90 % maybe it's 80 % whatever the number is no more than that the The fall from grace has been astonishing over the past three years.

1:01:58And so I don't know. Part of me thinks softpats can see the benefit of this. If Perpetual has a Magellan moment, you're paying$3 billion for a business that might be worth conceivably a billion dollars, half a billion dollars in the next number of years' time. I don't know. It's a risky bet for me given you can't – the brand value is only short-term compared to Vegemite or some other brand. Even TPG that it owns a very large chunk of, the brand's worth something that's very hard to wreck and customers will walk away very slowly. You're right the economics is beautiful if you keep the business coming or you keep the funds on hand.

1:02:33If you don't though, if it goes the wrong way, I like soft hats, I own soft hats. I'm not going to tell Rob Miller what to do. He's a very smart cookie. He can make his own calls, right? Todd Barlow, the CEO there, is also a super smart, capable guy. So I'm not saying they shouldn't do it, but it is something where I kind of go, this is not a heads-eye wind-tiles I don't lose much. This is one where heads I win a lot, tails I lose quite a bit. And that's just a wider range of outcomes. Now, maybe SOPATs with a$12 billion market cap should take these risks. Maybe it's exactly what they should do because they've got the business to withstand it, they can absorb volatility, all that kind of thing, as long as that any value destruction that may come at some point isn't permanent.

1:03:09That would be the real concern for me. Yeah, I mean, absolutely. That is the biggest risk. I'm just looking here. I dug up their presentation. So they have, yeah, fund flows have definitely resulted in their net pat dropping 42 % in FY23. Oof. Oof. That was after revenue rising 32%. Oof. No, thanks. But, I mean, that's the time to strike, right? Well, that's the other, exactly. If you think it's going to bounce back, that's exactly what you want. If it doesn't bounce back, of course, you're in a very different position. Yep, yep. So, I mean, I will watch with great interest, but it's potentially risky, but potentially with big reward.

1:03:53I mean, Perpetual's knocked it back anyway. Yes, for now. Isn't it funny? Who knows what's going to happen? Well, isn't it interesting though? Because it materially undervalues the business. And so I was like, well, it's still like a lot more than what the market valued the business at as well. That's right. So, and what are we looking at here? We're on something like a yield of about 5 % or so. It feels about right to me, to be honest. By the way, the company wasn't buying back its own shares yesterday either before the big came in. Oh, isn't that interesting? Not they always have the money, but yeah, that kind of difference.

1:04:27The market's wrong and undervalues us. Well, if it undervalues you by, I don't know what's the premium they're bidding, whatever it is. If you think it's worth even more than that, then the chance for you to buy back shares at a meaningful discount. By the way, they bought Pendle Group to take over there. They could have used that money to buy back their own shares. if the value, now maybe Pendle was cheaper than Perpetual, maybe it was still a good deal. It doesn't mean you can't do either, but they chose some capital allocation decisions not that long ago. Yes. That if the shares were that cheap, could have well and truly gone to buying back Perpetual shares instead.

1:04:56You just nailed it, sir. That is the question to ask at the AGM. If shares are so materially undervalued, why were you not buying them back? I would love to hear the answer. Like, what's the answer? Now, by the way, it's also possible they're right and the shares are undervalued and just because they weren't buying them back doesn't mean they're right to sell at a cheap price necessarily. No, but they are clearly poorly allocating capital. It's that much undervalued. You can't have it by its ways. Well, you're right to reject the offer, but you're still completely – In which case, you were – What are you being paid these incredible board fees for if not to ensure the prosperity of shareholders?

1:05:33And here you've got an opportunity to pick up shares and do the opposite of dilution at a bargain. It's going to create incredible value. It's very interesting, isn't it? The cynic in me often thinks to, and again, I say this mostly tongue in cheek, not entirely, but a little bit. I was going to say not much. But, you know, boards don't like to vote themselves out of a job. Yeah. You know, and so the board there going, yes, we should totally take this. It's like, well, wait a sec. Does that mean that? Yeah, we don't need you after this deal is done. Like, oh, so I don't get to, you know. Now, you know, I'm sure they're very noble characters that put the interests of their representatives ahead of themselves in a lot of cases.

1:06:14But it's got to be a factor, right? Yeah. The last thing I will say in this one too, mate, is for all of that we just said, there was also a dance to be danced. Yes. Which is no takeover target accepts the first offer because why would you? Yes, done, sold. Exactly, exactly. Whoa. I wouldn't have offered you more if you'd hung around. You were very quick to say yes. Now, sometimes I don't come back, right? So it's always a dance. but in the front page of Director 101, they always look back the first offer. I hope they come back with a bigger one. It's just rule number one. That's true. There's always a bit of a dance here too.

1:06:46Maybe they are prepared to sell out. They're just desperately trying to get an extra 5 % or 6%. Here's the only thing. They get to say they did their job right. So when they do lose their jobs, they say, well, I managed Perpetual. Look what I got for shareholders. So I might be doing the same for you. Let's talk. It's a funny old game. Yeah. Hey, mate, will you come back on Sunday? Yeah, I'd love to. I think I already have, haven't I? I was going to say the best thing is I know you go too because before you record it, heads up for our listeners, I'm going away next week in the US for a week for work.

1:07:12So we've got a couple of pre-recorded episodes coming up and we did. We changed the order of recording this week a little bit. So we will be back next week. Guaranteed to be there. But in the meantime, well, let's assume I don't screw up giving the files to the good people at Listener. That's possible. They don't screw up getting them on the pod machine. So let's assume, good Lord willing, the creaks don't rise. We'll both be here on Sunday. Until then, enjoy the first half of your weekend and full on. Cheers. The Motley Fool and people appearing in this program may have positions in the companies mentioned.

1:07:39General advice only. Please speak to your financial professional to understand how it may pertain to your situation. Subscribe to the free newsletter at fool.com.au forward slash listener. The Motley Fool operates under Financial Services Licence 400691.