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Embrace Big, “Inevitable” Trends

September 16, 2017 in Commentary, Letters

This post by John Huber is excerpted from a letter of Saber Capital Management. John writes about his investment approach at Base Hit Investing.

“The outside world can push you into Day 2 if you won’t or can’t embrace powerful trends quickly. If you fight them, you’re probably fighting the future. Embrace them and you have a tailwind.” –Jeff Bezos, 2016 Amazon Letter to Shareholders

Jeff Bezos wrote about four things that an industry-leading company must do to stay on top (or in what he calls “Day 1” – the healthy growth phase of a company’s life cycle, as opposed to “Day 2”, which is the beginning of a company’s demise). One of the keys to staying hungry, according to Bezos, is to embrace these big, sweeping, fundamental trends.

One of these big trends is the Chinese ecommerce market, which has recently passed the US as the largest in the world, and yet is still growing at around 20% annually.

Buffett once talked about companies he considered to be what he called “the inevitables” – durable businesses that he felt were sure to do well over time due to structural competitive advantages. The Chinese ecommerce market could be described as one of these “inevitables”.

Studying the online shopping market in China led me to learn about other industries benefiting from the same general tailwind – mobile advertising, video consumption, mobile payments, cloud computing, and many other related industries are certain to grow significantly over time as tens of millions of people in China enter the middle class each year and allocate higher percentages of their growing purchasing power toward these areas.

And unlike burgeoning industries of yesteryear such as automobiles or airlines that produced rapid growth in volumes but created little to no lasting value for owners, the Chinese ecommerce and digital advertising market are dominated by a select few companies that are highly profitable, well-managed, and are well-positioned to create enormous value from these industry tailwinds over time.

As Bezos said in his letter, “these big trends are not that hard to spot” – and the growth in China’s online shopping industry is certainly not hard to spot. But just as large-cap stocks can occasionally become sizably mispriced despite their wide following, the usefulness of an insight does not necessarily correlate to how original it is. In other words, it is widely known that China’s ecommerce market is huge and rapidly expanding, but there are still plenty of opportunities to capitalize on that obvious trend as investors.

While there will be many bumps in the road, productivity and consumer spending will continue to rise in China over time, and some of the best companies in the world will come from business models that capitalize on this extremely powerful fundamental trend.

One of our investments that will benefit immensely from this tailwind is Tencent Holdings.

Tencent (TCEHY)

In June, I did a presentation for MOI Global (the value investing community) on Tencent Holdings, a company we invested in late last year.

Tencent is a Chinese internet holding company with one of the most powerful network effects in the world. The company operates in numerous businesses that generate significant free cash flow, take very little capital to grow, and have huge runways for growth in China and around the world. These businesses and investments consist of video game publishing, music and video subscriptions, ecommerce, mobile payments, and online advertising among other assets.

But the company’s crown jewel is WeChat, which is a mobile app that is unlike any application that exists in the West. WeChat dominates China, and its 963 million users spend more time on WeChat than US users spend on Facebook and Instagram combined. And it’s far from just a messaging and social media application. WeChat is used for just about everything in China including messaging, work communication, calls, social networking, online shopping, paying bills, transferring money, and much more. Incredibly, one-third of WeChat users spend more than 4 hours a day inside the WeChat universe.

This is a clip from an Economist article that outlines a sampling of what WeChat is used for in China:

“Like most professionals on the mainland, her mother uses WeChat rather than e-mail to conduct much of her business. The app offers everything from free video calls and instant group chats to news updates and easy sharing of large multimedia files…

“Yu Hui’s mother also uses her smartphone camera to scan the WeChat QR (quick response) codes of people she meets far more often these days than she exchanges business cards. Yu Hui’s father uses the app to shop online, to pay for goods at physical stores, settle utility bills and split dinner tabs with friends, just with a few taps. He can easily book and pay for taxis, dumpling deliveries, theatre tickets, hospital appointments and foreign holidays, all without ever leaving the WeChat universe.”

WeChat is an asset that has barely been monetized yet, but is in prime position to capitalize on numerous fast-growing industries like mobile advertising, online shopping, and mobile payments.

Tencent has a truly exceptional collection of businesses. Despite a vast untapped potential in some of those markets referenced above, the company is already highly profitable. Revenue is growing at close to 50% annually. Thanks to 30% net profit margins, Tencent turns a good chunk of that revenue into free cash flow for the company to reinvest. I estimate that the company is producing about 35% returns on incremental capital investments, and is growing its already sizable $8 billion of free cash flow at 40% per year.

Growth obviously will slow down at some point (40-50% growth rates only last so long), but given its unique competitive position and the huge size of the markets it operates in, there is likely a very long runway ahead for the company, despite already being one of the most valuable companies in China.

To summarize, there are four things I like about Tencent: the huge network effect of WeChat, the massive runway for growth, the high returns on capital and significant free cash flow (despite barely scratching the surface of WeChat’s potential), and the fact that the company is run by its driven, long-term focused founder who remains one of the major shareholders.

We bought shares of TCEHY in late 2016 for an average price of $25.

The stock has risen significantly (it has gained around 80% year-to-date), and I have no idea where the stock goes in the next year or so (as is the case with any stock), but I think over a long period of time Tencent shares will likely compound at a rate that roughly mirrors the growth of the company’s intrinsic value – and I think this rate of compounding will be quite high (15-20% annually) for a number of years to come.

The slide presentation further details my thoughts on Tencent, and also outlines how I think about the valuation of Tencent, which I view as a long-term compounder.

Large Caps

The tailwind of these big, external trends is an insight (albeit not a particularly unique one) that I’ve been thinking about this year. Another insight that I feel is much less commonly held is that large-cap, well-followed stocks can be excellent investments at times. As I’ve mentioned before, I don’t intend to be investing in large-caps exclusively. On the contrary, I am always hunting for off-the-radar ideas that might be undervalued. But sometimes large-caps can offer significant value, and my objective is to find value, not to win style points by locating the most unique investment idea.

As a quick summary, here is a chart that I put up in last year’s mid-year letter, demonstrating how much large cap stocks bounce around:

Large Cap Stocks vs. Small Cap Stocks

Top 10 Largest Companies in S&P 500 (as of 6/24/16)

Here is the same basic chart updated for 2017:

Top 10 Largest Companies in S&P 500 (as of 8/15/17)


What’s remarkable is that even with volatility being at all-time lows for much of the past year, mega-cap stocks – ten of the largest, most well-followed companies on the planet – still saw an average of a 40% gap between their 52-week high and low prices.

Despite the army of analysts poring over unlimited bits of information that supposedly increases market efficiency, Apple is currently valued at a whopping $300 billion more (or nearly 60%) than it was just one year ago.

There are many others in that list that have seen similar fluctuations. In fact, our three largest investments in the last 18 months have come from capitalizing on significant downward fluctuations in the stock prices of very durable, very large, and very well-positioned companies with predictable earning power and good balance sheets. All three of these investments were shunned by many would-be value seekers who felt like they had no “edge”. While they most likely lacked an informational edge, they didn’t realize that a time-horizon edge is often more significant, and this type of edge can be used to invest in stocks of all sizes.

Along those lines, Apple remains our largest position, although it obviously doesn’t offer the same value as it did a year and a half ago when we first started investing in it. For new investors who want to read what I thought about Apple, I summarized my views here, and also in the 2016 letter.

Apple falls into what I refer to as “Category 2” investments – stocks of durable, mature companies that occasionally get mispriced by Mr. Market. These are stocks that might offer 30-50%, or even 100% on rare occasions, but typically will be sold as they approach a more reasonable value.

The ideal investments are the “Category 1” investments, or the compounders – businesses that produce high returns on capital and have long runways for potential growth.

The nature of the market is that most investment opportunities will be of the Category 2 type, while the biggest winners will be from Category 1.

I continue to seek out investment opportunities in both categories, and as category 2 investments become more fairly valued, I will look to reinvest capital into more undervalued ideas.

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Returns are based on the “Saber Capital Portfolio”—a real money account that is managed alongside all other accounts. I also refer to this as Saber’s model portfolio. Performance data of this account is produced directly from Interactive Brokers. Returns are not audited. It is important to note that each client may experience slightly different results from the model depending on the timing of deposits, withdrawals, the opening/closing of the account, the fee structure specific to each account, and other timing issues. The valuations of your investments at the time of purchase may be significantly different than the valuations at the time of purchase in the model because of these timing issues. I expect the net results of the model account to roughly equal the results of client accounts over time, although there can be no guarantee because of the timing issues referenced above. The gross returns of the Saber Capital Portfolio are taken directly from Interactive Brokers. The net returns are estimated using a 1% management fee and 15% performance fee. Your net returns could vary from the model depending on the fee structure of your account. Your personal account statements with your account specific performance net of all fees will be coming in the mail each quarter, and can also be accessed anytime online. Please note that any performance fees earned during this year will show up in the following year’s 1st quarter statement. Also note that the time weighted return (TWR) on your account specific performance summary is net of all fees.

The Magic of Insurance

September 16, 2017 in Asia, Asian Investing Summit, Equities, Financials, Industry Primers

This article is authored by Roshan Padamadan, MOI instructor and COO of Sixteenth Street Capital. The article was originally published in April 2017 in conjunction with Roshan’s session at Asian Investing Summit 2017.

With its funny accounting, I have seen even veteran investors shy away from insurance.

I was assessing my relative strengths recently, and I realized that being comfortable with insurance accounting was one. An industry veteran asked me to look at the Indian life insurance companies, and thanks to him, I found a couple of gold nuggets.

ICICI Prudential has finished six months on the stock market. HDFC Life is in the process of merging with a listed company, Max Financial Services, over the course of 2017, and the combined entity will be India’s largest life insurer. These are unique, high-quality franchises.

Despite their large sizes (~11.3% market share for ICICI Prudential; and 12.4% pro forma for the merged HDFC Max entity), these two giants do not face off in the market directly. Bancassurance is the dominant (~70% share) distribution channel for these players, and they both use their respective parent’s bank branch network (~4,500 each) to reach customers. Max uses Axis Bank and a few other banks in addition. Excessive competition is the enemy of high capital returns, and where competition can be avoided legally, it is good for the capital provider.

Axis Bank has a special place in my heart, as it is my first 100-bagger. Holding it ever since its IPO in 1998, I have seen it through falls of 30% thrice, 50% once and even 70% once. I was very keen to see if ICICI Pru and HDFC Max would turn out to be 100-baggers. I came to the conclusion that I am looking at stocks that may turn out to be at least 20-baggers, over 20 years. Getting to 100x is possible, but not easy, as the starting point is different.

I realize that the market is more mature now than in 1998. No chance of getting a bargain price of a forward P/E of 9x (UTI Bank’s number in 1998; UTI Bank eventually was renamed Axis Bank). These insurance stocks trade at high P/E multiples prima facie — they are not the relevant metric, as the business is still not mature, so the numbers are high (P/E of 100-300x), as these companies just got out of the J-curve (companies going through a period of losses are in the cup of the “J”), and profitability is still nascent. Insurance is a long gestation business, and it takes time to prime the pump. About 15 years. The leading private sector players in India have recently passed this mark. As they keep growing their customer base, their cost ratios and expense ratios may trend to the incumbent’s level, a 20% improvement. And possibly beyond.

Price to book is useful for financial entities, and is a good measure for a bank, combined with return on assets, return on equity, and rest of CAMELS ratios to build a picture of a bank in the analyst’s head. For insurance companies, analysts use Embedded Value (EV). This is an addition of “book” (net asset value), plus an expected value of future profits. In most businesses, companies are discouraged or prohibited from counting future profits on the conservatism principle. In insurance, it is ok, because of the contracts (the policies).

Insurance accounting is primarily different because the costs are not all expensed in year one, and it is not certain that future premiums will come in. (If the premium doesn’t come in, the contract is broken. A broken contract may be profitable, and is not always loss-inducing). A new policy can cause a loss in year one, but it may well have a positive net present value (NPV), based on future premiums, and expectations of future costs. Costs are both tangible costs such as commission expenses, overheads such as travel and rent, as well as financial costs reserved for the risk, such as mortality risk, or other risk allowances.

Just like a bank, insurance companies have their own money too. A bank may easily have 10 dollars for each dollar of shareholders’ equity, from deposits, and interbank borrowing, aside from corporate borrowing. ICICI Pru has about 20x in liabilities compared to its equity base. But an insurer is safer than a bank due to contractual restrictions on liquidity of its liabilities. Banks have to be protected by use of a Deposit Insurance scheme to avoid a bank run, as they not designed to function if a substantial part of their liabilities are taken out. Insurance policyholders know, or ought to know, that the Insurance company payouts on a cancelled policy can be substantially lower (could even be zero) than premia paid in, and these are usually clearly laid out in policy documents. Insurance companies have built-in protection on the liabilities.

It will be sad if many policyholders cancel their policies, but an insurance company doesn’t collapse like a bank would. Indian insurers saw lapse ratios of as high as 80% (5-year), and they still survived. They shrank their agent base, adjusted their commission structure (stern guidance from the regulator helped), and evolved their product pitch and distribution methods.

Insurance companies have handcuffs on them on the other side: they are severely constrained on what they can invest in. They have restrictions on investing outside their home country (Indian insurers: 0% allowed outside India). They have limits on how much can be held in non-investment grade debt. A severe restriction on matching asset-liability tenures makes them the buyer of negative-yielding or zero yielding debt, such as we now see in Europe, and in Japan. No private bank would usually be able to sell such debt to an individual client.

There is a breakeven point for new policies, and insurance companies can lose money on new policies if cancelled too soon, given that agent commissions, and overhead costs cannot be clawed back. However this is not true for all types of policies, and long-lived plans can have substantially higher premia in earlier years than the real risk cost, and a lapse in such plans do not hurt the insurer, and they can book a profit on the lapse.

At present, Indian insurers see a high lapse rate of as much as 50% of policies lost in the first five years. This may be from relative lack of maturity of two groups: insurance agents, and customers. The industry has responded by cutting first-year commissions to a very modest 5.6% average for private sector players. Life Insurance Corporation (LIC), the incumbent, pays 7% on average. These commissions were as high as 50% of first-year premia in the run-up to 2008.

LIC had a 50+-year headstart, and its assets under management is about 20x the two private sector leaders, who manage about INR 1trillion each (~USD 15bn). In incremental market share, the private sector as a whole is capturing more than half the annual sales. The newcomers were allowed in 2000. They have shown a better understanding of efficiency, information technology investments, direct sales, and as a result, they have evolved to using bancassurance as one of the most efficient forms of distribution.

India’s GDP growth is expected to be around 6-7%, on average, for the next decade, or two, arising from a young population, and a country playing catch-up on infrastructure and productivity growth. India’s insurance growth rate may sustain at over 12% CAGR over the next 2 decades. Growth in Embedded Value will be at least in line with premia growth, aided by cost efficiencies getting better.

High rate of capital compounding, and a long, long runway, gives a pair of great compounders. The businesses could grow steadily, organically, without infusion of equity capital. Insurers will likely use their 25% sub debt, preference share and debenture allowance.

The implied excess return (based on recent share prices), of return on capital over the cost of capital, is only 1-2%. I expect these stocks to earn well over a 4% spread over time, and possibly upto 8% spread over cost of capital, giving a discount to fair value of 33-66% . The key assumption is that growth rates in insurance premia will stay over 12% on average over the next 20 years (2x GDP growth). Further upside will come from cost efficiency improvements to incumbent levels, and possibly beyond. Market maturity – and agent maturity – will help improve persistency over time. (Persistency is a measure of how long the policies sold stay active. The lower the lapse rate, the higher the persistency.)

Growth acceleration can come from unlocking of future profit pools (more pure protection; higher adoption of health insurance, critical illness cover).

Inorganic acquisitions by these leading private sector insurers to kill off competition, or tuck-in acquisitions to expand product range/geographic coverage, could be additive.

Stock could stagnate during periods of weak consumer confidence, as India’s policy environment on direct and indirect taxes is always evolving. These stocks are only suitable for consideration by investors with horizons of greater than 3 years, giving the companies time to adjust their tactics and strategy, and recover from any economic, regulatory or social shocks.

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Disclosure: No positions held in the stocks mentioned, except a personal long position is held in Axis Bank since 1998.

How to Translate into English Filings not Available in English

September 16, 2017 in Equities, Micro Cap, Tools

You are looking for companies in which to invest and you find one that meets your core criteria. You are ready to research your candidate and then you realize that the company did not issue their filings in English. A big problem that many microcap investors have. What can you do then?

Download the filing that you want: I recommend download it directly from Morningstar. For example, search on Google “(Company name) filings morningstar” and the result that begins with “quicktake.morningstar.com …” is the one you are looking for.

You want the PDF version: Once you have entered to the filings list of the company you chose on Morningstar, look for the PDF version; Click on it and in a new window will open the file. Once opened, you will need to download the file to your computer.

Unlock the filing: Once the filing is downloaded to your computer, just right click on your file, choose “properties” and select “unlock”; Then you click on “apply” and “Ok”.

Unlock the file (again): Now that your PDF filing is unlocked, you will need to unlock it again online with some PDF’s unlockers (search for them on Google). Once unlocked, download and forget about the previous one you uploaded to unlock.

Time to translate: Go to Google Translator and click on “translate a document”. Upload your newly unlocked PDF and select “detect language”; On the other side select “English” and click on “Translate” (the blue botton).

Check if it was translated properly: Once you see that your filing is translated into English, I recommend that you need to scroll down the entire file as there will be parts that are not translated, and reviewing the whole file will be translated into English.

Download it! Once the previous point is done, you must print the translation (Ctrl + P on Windows or Command + P on Mac). But be careful, you will not print. What you will do is save the translation as PDF on your computer. You will click on the “change” box that appears in the “destination” section and select “Save as PDF”. Once done, you will return to the previous menu and just click on “Save” and there you go! You already have your filing translated into English and in your computer!

You must know that sometimes the translation that Google does eat parts of the text (you will notice that some words appear stacked on top of others); Or that the order of sentences is inconsistent. Therefore, you must read carefully and try to decipher the message of the translation. Good luck!

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Thoughts on Intelligent Cloning

September 16, 2017 in Commentary, Skills

This article is authored by Peter Coenen, a value investor based in the Netherlands.

“Santa knocks on all our doors not once, but four times a year.” –Mohnish Pabrai

The idea of “intelligent cloning” is all about combining Ben Graham thinking on risk aversion with the Munger “rule number one” on how to become a successful investor. Munger’s first rule is to carefully look at what the other great investors have done. The second rule is to pay close attention to cannibal companies (companies buying back huge amounts of stock) and the third rule is to focus on spinoffs.

If there is one investor out there that takes these simple Munger ideas very seriously it has to be Mohnish Pabrai. Recently he wrote an article in Forbes entitled “Beyond Buffett: How To Build Wealth Copying 9 Other Value Stock Pickers”, where he talks about “Shameless Cloning”. Actually he wrote it together with Fei Li and you can find the article on his wonderful website Chai with Pabrai.

Shameless Cloning. Isn’t that great. You know that there are some great investment minds out here. Don’t try to compete against these guys. Instead copy their best ideas and profit from them. I love it! Mohnish Pabrai is not just a great investor, he is a great communicator as well. I like the way he puts forward his ideas. Let me just quote from his article. Here it is:

“Santa knocks on all our doors not once, but four times a year. During his off­season, he reliably shows up bearing profitable gifts on February 14, May 15, August 14 and November 14. These are the deadlines for 13­F filings”.

Think about that. Four times a year you get probably the greatest stock picks on the planet on your doormat. For free! Mohnish describes a method to pick 5 stocks and rebalance the portfolio once every year. So, how did this 5­stock portfolio perform over the last 17+ years? It beats the S&P 500 by 10.7% annualized! That’s amazing!

A slightly different road

I toke a slightly different road. Not necessarily better, but different. First of all I am a long term investor and hold stocks as long as the company remains a good company. So I will avoid annual rebalancing. And secondly I make an extra effort and try to avoid the investing mistakes of these great value investors. Does anybody know how many mistakes great value investors make? It has been said that George Soros made money on fewer than 30% of his trades.

Now think about this for a moment. Suppose you run a concentrated portfolio of 10 stocks. And you joined the merry band of shameless cloners. So you picked for instance Valeant (Bill Ackman/Sequoia), SunEdison (David Einhorn), Horsehead Holdings (Mohnish Pabrai) and Royal Imtech (for many years the stock market darling of the Dutch stock exchange). These are all companies that went bankrupt or had to raise from the ashes. I mean, the result would have been devastating.

In comes Ben Graham. When investors make mistakes it is usually because they forget the inherent simplicity of the Ben Graham value investing system. I truly believe an investor can make better decisions by keeping things simple. So why not apply the Graham criteria for the defensive and enterprising investor to avoid mistakes? Now you might argue that these criteria are outdated and rightfully so. When Graham wrote them down he didn’t had access for instance to cashflow statements. Well. Then let’s rewrite them with the knowledge and insights we have right now.

What you want to do is to avoid the “too risky” investments. And to identify these I use 5 criteria. Very straight forward:

  • A “balanced” balance sheet. So you try to avoid too much debt, too much leverage and too much goodwill/intangibles.
  • Consistency in the per-share figures. I just don’t like companies that show a consistently growing earnings-per-share (which is good) in combination with a highly fluctuating operational cashflow per share.
  • Substantial free cash flow. As a company, if you don’t have free cash flow, you don’t have anything. Management could choose to reinvest in the business, buy other businesses, reduce debt loads, buy back stock, or pay out dividends.
  • Consistently high return on capital. You probably all know Joel Greenblatts Magic Formula. There are many ways to calculate ROC, so you have to figure out what suits you best and why.
  • Margin of safety. There is no such thing as a company that’s worth an infinite price. So you want a price that makes sense. I believe it was Chuck Akre who once said that he is willing to pay up to 20 times free cash flow for a high quality company. You might want to figure out what Warren Buffett paid for Precision Castparts.

By using this simple set of criteria you would have avoided Valeant, SunEdison, Horsehead Holdings and Royal Imtech. Instead you would have probably invested in John Deere (Team Berkshire) and Allison Transmission (Lou Simpson). As of recently team Berkshire sold John Deere. Probably not because it is a bad investment, but just to free up money to invest elsewhere. I will keep John Deere in my portfolio as long as the company remains a good company.

You might argue that team Buffett found better opportunities, so why not follow them for example into airlines. Well. That’s not who I am. If I find a low-risk solid-return opportunity I buy it and forget it. The same for Heineken. It’s not trading at an attractive price right now, but if the markets would go way down and I could buy Heineken below 55 euro, I buy it and forget it. And it makes life a lot easier, you know. If you continually keep hunting for “the best opportunity”, eventually that will drive you mad. In Value Investing your worst enemy is probably your own brain.

One final twist. Dependent on how many great value investors you want to follow you very well might end up with more than one investment opportunity. So which one to choose? You might want to use a simple Joel Greenblatt ranking system. So you rank e.g. 10 candidates by ROC. The highest gets 1 point and the lowest 10 points. And then you rank them by margin of safety. The highest gets 1 point and the lowest 10. You add the numbers and choose the lowest number.

Now let’s go back to Mohnish. He beats the the S&P 500 with 10.7% annualized over the last 17+ years. That’s like indexing on steroids and you can probably boost returns even further by using the above set of criteria. But you have to be very rational and unemotional to successfully implement a long-term cloning strategy. And most people unfortunately are impulsive and irrational. The average investor is probably too restless and the smart investor too smart to just follow a simple strategy. For most of us investing periodically in a low cost index fund probably remains the best low-risk solid-return proposition on the planet.

Mohnish and Fei end the article with the hope we will join the merry band of shameless cloners. Well. Just count me in.

Happy Santa Claus!

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Disclosure: This article and the information contained herein are for educational and informational purposes only and do not constitute, and should not be construed as, an offer to sell, or a solicitation of an offer to buy, any securities or related financial instruments. Further, The Value Firm® makes no representation, and it should not be assumed, that past investment performance is an indication of future results. Moreover, wherever there is the potential for profit there is also the possibility of loss. Positions held by The Value Firm BV may be inconsistent with views mentioned herein. The Value Firm BV accepts no liability for any errors or omissions in the given content.

The Role of Active Management in the Modern World

September 16, 2017 in Audio, Equities, Featured, Financials, Interviews, Latticework, Latticework New York, North America, Transcripts

A trio of thought-leaders explored The Role of Active Management in the Modern World with the MOI Global community at the Latticework 2017 summit, held at the Yale Club of New York City in September.

The expert panel featured: Robert Robotti, president of Robotti & Company, Michael van Biema, founder of van Biema Value Partners, and Andrew Burns, associate at Global Endowment Management.

Jim Basili, managing partner of Blacktree Capital Management, moderated the conversation.

The following transcript has been edited for space and clarity.

Shai Dardashti, MOI Global: I am honored to have Jim Basili hosting our next panel conversation. Jim is a longtime friend; we met a decade ago, if I recall correctly. He is the managing partner of Blacktree Capital Management, a family office he established in November 2007. I am also very excited to announce that, in January 2018, Jim will launch a new fund called Lightsail Capital, making long-term investments in a group of small growing public companies. We could talk more privately, but Jim has a history of investing in smaller companies in various contexts and what he’s doing now is very interesting.

Jim Basili, Blacktree Capital Management: It is my pleasure to be with such a distinguished panel here, and I am going to introduce them to you guys, and then we will launch into a conversation, which we are all going to enjoy.

Andrew Burns works at Global Endowment Management. Global Endowment Management is a multi-endowment, multi-institution firm, managing about seven billion dollars as an outsourced chief investment office for its clients, letting them aggregate their capital so they can benefit from the scale that some of their larger peers have. Andrew focuses on public markets for Global Endowment Management. He joined the firm in 2008, so he got there just in time to have a full market cycle of education in about two years. We will talk a lot about the changes that he has seen at Global Endowment Management since.

Bob Robotti is the president of Robotti & Company. He got his start in public accounting before coming to Wall Street, and that start was an incredibly auspicious one because he audited Tweedy Browne, the legendary value firm. If that is not pedigree enough — I’ve heard you tell, Bob, that the first stock you ever bought was a recommendation from Walter Schloss’s son, Edwin. On top of that, he also audited Gabelli & Company’s books, and then went on to work for Mario Gabelli before starting Robotti & Company. Robotti & Company have now been around for over thirty-five years, which is a very long time to have a market-beating track record, and their track record has beaten the market by a wide margin in that period.

Also here is Michael van Biema of van Biema Value Partners, a multi-strategy allocator, and Michael, before forming the firm, was a professor at Columbia Business School for about a dozen years beginning in 1992. In that time he taught at the vaunted value investing program for both M.B.A.’s and executive M.B.A.’s and he also managed to find time to co-write a book which many of you are probably familiar with and have enjoyed, ‘Value Investing: from Graham to Buffett and Beyond.’ Despite his finance and value pedigree, Michael’s own education was not in finance or value. He was an electrical engineer as an undergrad and got a Ph.D. in computer science. His first jobs after graduation were in the IT field, not in the investing field; perhaps, we will get to talk a little bit about the way those two fields are converging.

I would like to start by interrogating the title of this panel, which is, “The Role of Active Management in the Modern World”. We are going to break down that title a little bit and ask some questions about what that title means. The first thing that we are going to do is talk about that word ‘active’ — because there was a time when there was no other kind of management than active management. It is a sign of where we are today that we have to make a distinction between active management and something else. That something else, obviously, is indexation or passive investing. By some accounts, that now equals about a third of investor capital the United States, up from roughly nothing in the 1960s; it has been a very dramatic change.

I would like to ask each of you guys as panelists, “How do you feel about the ways passive indexation can be done right, and maybe more interestingly, the ways it can be done wrong?” Before we got on stage I spoke to each of you, individually, and you all said you felt there was a place for passive investing — and you all had some interesting comments on what that might mean in terms of the way it is done right and done wrong. Talk about what is good and bad, what is right and wrong about passive in the way it is done today.

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