Murray Stahl’s comments from the 2015 FRMO Corp annual shareholder meeting.
Murray Stahl: Thank you, Therese, and thanks to everybody for coming today. Before I start, when Therese read the results that we won by 99%, I couldn’t help reflecting that it had the aura of a Joseph Stalin kind of election. [laughter] It wasn’t done intentionally. Of course, we want to win, but we do invite shareholder input. We don’t have all the ideas; we don’t have all the wisdom; we have made mistakes, and we are not immune to making them in the future. We are duly humble.
There's a gold rush coming as electric vehicle manufacturers fight for market share, proclaimed David Einhorn at this year's 2021 Sohn Investment Conference. Check out our coverage of the 2021 Sohn Investment Conference here. Q1 2021 hedge fund letters, conferences and more SORRY! This content is exclusively for paying members. SIGN UP HERE If you Read More
That’s why this year’s shareholder letter was designed to do two things. First of all, it’s more sober. Normally, we’re very lighthearted in the shareholder letter, but the tone of this year’s letter is more sober because, as a company, we’re growing up. The purpose of the letter was to show the range of activities that we’re involved in now, which is much greater than ever before in FRMO’s history.
I should say something about our history. When we started 14 years ago, we only had $10,000. As we accumulated capital, from the start to about 2008, if you look at our various reports, our assets were largely invested in cash. In 2008 and the first few months of 2009, you’ll see a change. We were actually very aggressive during that time period. It was a time of planting. And now, to some degree, it’s a time of harvesting, at least as to conventional equity investments. It’s also a time of seeding new activities. We have more liquidity than we ever had in the history of the company. We’re not expending it at the moment; we’re waiting for opportunities.
Our philosophy of life has not changed from what it was historically. When we see opportunities, we’re prepared to be very aggressive. When we don’t see opportunities, we’re prepared to hold cash. I think that’s nothing other than prudent. And, hopefully, we’ll always act in that manner.
Murray Stahl: Bermuda Stock Exchange investments
When you look at some of the seedlings sprout—the seedlings of the past that we intend to hold—we’re very pleased with their development. For example, when you look at our investment in the Bermuda Stock Exchange—and I encourage you to study that investment—we’re now exposed to an asset class, a real asset class, that we ordinarily wouldn’t get exposure to in the conventional asset management business. What’s that asset class? It is insurance-linked securities.
What’s an insurance-linked security? It turns out that the greatest insurance companies in the world actually issue four-year bonds with coupons ranging from 7.5% to 8%. Hence, they’re A-rated paper, with four years to go. How wonderful is that in the current interest rate environment? Of course, there’s a price to be paid, which is that there’s roughly a 3% chance that the bonds, which are tied to an insurance pool, might actually be subject to an adverse insurance event. Your bond might be wiped out. Over time, you’re going to lose 3% of your capital. You earn 7.5% to 8% minus 3%, making it very competitive with a high-yield bond.
That’s a small but very rapidly growing asset class. Its size approaches $25 billion, and the Bermuda Stock Exchange has about a 67% market share in that class. This data is available on the Bermuda Stock Exchange’s website.
So, we’re growing up as a company. That’s not something we could accomplish through the conventional asset management business. One day, we hope—we do not know, but we hope—that the insurance-linked securities business is going to be orders of magnitude larger. We don’t know that; we can’t predict it, but insurance companies like to lay off their risk, and Bermuda is the home of that kind of investment.
Similarly, let’s look at our investment in the Minneapolis Grain Exchange, or MGEX. As the name suggests, it primarily trades grain, but it recently launched another contract that I’ll talk about later. Commodities are all in a bear market, yet MGEX has had record volume for its 2015 fiscal year, which ends August 31.
MGEX also has a carbon credits business, announced some months ago. The State of California is now regulating carbon emissions, and permits are required for companies that emit CO2. Those permits are transferable, and the transfers have to be tracked. A good place to track them is an exchange, and the Minneapolis Grain Exchange is doing such tracking. That’s an interesting kind of investment.
We made an investment in an entity called OneChicago, an exchange for trading single-stock futures. Single stock futures are a way of getting leverage, essentially, apart from getting it from a prime broker. Prime brokers, because they are banks, are regulated, and are having difficulty extending the kind of credit to funds that they did historically. It can be done with a single-stock future, and it can be done a lot more safely, because the transactions clear through a clearinghouse. There shouldn’t be loan defaults.
In the history of commodity trading contracts, I believe there hasn’t been a default since 1854, because there is daily mark-to-market and daily margin variation, and one has to carry proper collateral at all times. You usually have a half-hour to get the collateral. If you can’t get it, the positions are liquidated. Consequently, we’re involved in something safer for the world, and I think we’re doing a good thing.
Our partners, by the way, at least the large ones, are Chicago Board Options Exchange, the CBOE; the CME, Chicago Mercantile Exchange; and Interactive Brokers. Those are three pretty big outfits, and then there’s us.
We’re looking for more such investments. If we can find them—I don’t guarantee we’re going to find them—but, if we can find them, we’re going to make those investments. We have lots of cash available to do it. As of quarter-end, our year-end, we had over $44 million of cash on the balance sheet, and had $102 million of shareholders’ equity. I think, as a balance sheet, we’re more conservatively positioned than at any time in our history.
Murray Stahl: Investments in Winland Electronics
Another interesting investment that we made during the year was in a small company called Winland Electronics (“Winland”). That puts us in the electronics business. Winland makes wireless transmitters that capture data pertaining to moisture, temperature, air pressure, and similar conditions. You might think that it’s just a trivial activity, and, from the point of view of the great electronics companies of the world, it is trivial. I’m sure many companies can do it, but they don’t. Thus, Winland, small though it is, has a fairly high return on capital. It generates reasonable quantities of cash. We bought it when it was quite undervalued. Companies that are not in the indices and that no one knows about, are still out there and, every now and then, you can find them.
We’re not giving up on equities, by any stretch of the imagination. We’re just going into areas where we haven’t been before. We’re doing it, I hope you agree, in a fairly conservative way. We make a very small investment—we’re not risking a lot of capital—we do our homework, and we learn more about the business. When we feel we’ve learned a lot about it, we expand, if it’s still a suitable investment.
One of Winland’s activities—and I won’t go into great detail on this, but, to show you how we’re expanding—is an investment in a company called Exhibits Development Group. What do they do? They create exhibits to be shown in museums. Winland didn’t actually invest in the company; it invested in an exhibit called “The Beatles: Magical History Tour.” As the name suggests, it’s comprised of Beatles memorabilia that’s going to be shown in various museums. The Exhibits Development Group’s website has information on where the tour will be shown. It’s going to last for a long time, and I hope you can go.
The important point is not that we’re investing in another business, it is how we’re getting into another business. Winland has excess cash—more than it can reasonably deploy in the electronics business. As are most small businesses, Exhibits Development Group has been starved of capital for years because the trend of modern investing is to invest with liquidity, meaning the biggest companies get loans, the biggest companies have their stock traded, and the very small companies are, to some degree, excluded from that process.
Essentially, Winland made an investment in this exhibit. From a look-through point of view, from an FRMO point of view, when you look at the money that was invested in Winland and our share ownership of Winland, we’re indirectly at risk for $30,000. If the investment goes to zero, on a look-through basis, if somehow the 15% we own in Winland were consolidated, we’d be $30,000 the poorer. Actually, not even $30,000 the poorer; because we’d get a tax credit from it. We might be $20,000 the poorer.
I hope we’ll be able to do more of those sorts of transactions. The message is: the company is growing up. Now you might ask the question, so I’ll ask it for you: why does it have to grow up? Why can’t we just confine our activities to what we did historically, which is largely equity management in the context of Horizon Kinetics, and keep raising money there? There are many reasons. I’ll just name a few and I’ll invite my colleagues to opine if they care to.
First, speaking for Steve and myself, something could happen to us. If we’re just a money management company, we’re the asset. If something happens to us, it’s not going to be a good result for shareholders. Second, we could make a mistake. We would prefer to be infallible, to not make mistakes but, unfortunately, since we have to be honest, we must admit that we do. From time to time, and maybe even more frequently than that, we make mistakes. Third, as an asset class, equities are a great place to be, and we want to be there. The opportunity set waxes and wanes, though. Sometimes there are more opportunities, and sometimes there are fewer. At the moment, we see fewer opportunities. That doesn’t mean there aren’t opportunities; it may just be that we overlooked them, or we’re not smart enough to find them. But we don’t force ourselves to make investments when we don’t see investment opportunities to exploit.
At the moment, we’re fairly well positioned, I think, to make use of any opportunities that should come our way. We’ll see if they come our way or not. We’re still committed to the business of conventional equities. We’re there. We’re not leaving it. We’re going to do everything we can to make it a success. But, don’t forget, that it’s been a 35-year period, or maybe a 33-year period, with some interruptions, of a vast bull market, now characterized by indexation. Therefore, when I say there are valuation issues, almost all of it really comes from indexation, a topic I write about all the time. Accordingly, I’ll go into a little detail.
Most of you are familiar with the idea of indexation. Essentially, you buy a basket of securities. Nothing wrong with that, as long as the valuations of the companies are set by people who pay attention to valuations. If they do, and the index business is a sufficiently small part of the whole, you’ll usually be buying your index at a fair price, and you’ll usually have a good result. But today, the index business is the biggest thing in asset management. This is my opinion, so don’t take it as gospel or fact, but I believe that it affects valuations. You probably are all aware of companies that you think trade at ridiculous valuations. I think it comes from that source: indexation.
We are in the research business, and we believe you should do serious research before you undertake an investment. Think about the last time we had a mortgage business—this was 2006-2007—when there was no income verification on loans. How did that work out? I think less than satisfactorily. Now people are buying baskets of securities without research, which is the equivalent, in a mortgage, of buying properties without income verification. We just don’t want to participate in practices like that.
Murray Stahl: Indexation activities
We have engaged in some activities in indexation, but you can take a good thing too far. We don’t want to take it too far. So, even in that field, we’ve been fairly conservative and fairly cautious.
I don’t want to give you the idea that some imminent horrible thing is going to happen. At least, I don’t want to give you the idea that I know that some imminent horrible thing is going to happen, because I don’t know that. We’re value-based investors, and it’s all a question of valuation. I’m not predicting the course of the economy, because I don’t know what it will be.
I can just tell you that indexation as a business was successful for the following two reasons: one, when indexation started in the early 1970s, interest rates, with some interruptions, had been coming down for many decades. Now we’re at close to zero. That rate decline impacted the valuations of large baskets of securities. I don’t know what will happen with rates, if they will stay the same or go up. But I do know one thing: they’re not going down. Therefore, when you buy an index, you have to be mindful of that situation, because you won’t get the valuation increase that people have achieved historically when they bought indices.
Second, the early 1970s saw the inception of more aggressive fiscal stimulus, in the deficit sense of the word. There were deficits before the 1970s, but nothing on the order of what’s happening right now. Again, I don’t predict problems; I just say: Be mindful of the following observations.
Let’s say there were a recession. Let’s just say there were. I don’t know that there is going to be one. We have a $640-odd billion deficit. What would happen to the deficit if there were a recession? There would be less tax revenue; the deficit might be $1 trillion. It might be more than $1 trillion. The government would be left without the customary means of spending more money and stimulating the economy. That stimulus is what led to the success of indexation historically, because we live in democracies. Governments are mindful of spreading the benefits to many different areas of the country, which affects many different companies. You could buy a basket of 500,000 companies, and many of them would benefit from fiscal stimulus.
The next time we have a recession, whenever that happens, we might be bereft of that approach. We need to be mindful of that. All equities are influenced by indices. All indices are influenced by valuation. Valuation is influenced by interest rates. And earnings, at least historically, have been influenced by deficit spending. So, I merely say: be mindful of those observations.
We position FRMO to be ready, but there’s a cost associated with it, and it’s called opportunity cost. If the money were invested, we would, in principle, have a higher return on equity. Currently, we’ve got not quite, but more or less, half our shareholders’ equity invested in cash or cash-like instrumentalities, and we managed to have an 8% return on equity. We could have had a much higher return on equity had we invested the whole balance. But, hopefully, there will be opportunities and we look forward to finding them. Maybe we’ll find them tomorrow but, at the moment, we’re still searching.
See full PDF below.