Notes from UTIMCO Board of Directors 20th Anniversary Event. Created in March 1996, UTIMCO is the first external investment corporation formed by a public university system and oversees investments for The University of Texas and Texas A&M Systems. You can find the UTIMCO meeting audio stream here.
UTIMCO 20th Anniversary Meeting Notes – Ray Dalio
Also see Dalio Watching End Of Debt Supercycle Play Out In Real Time
Talk of inflation has been swirling for some time amid all the stimulus that's been pouring into the market and the soaring debt levels in the U.S. The Federal Reserve has said that any inflation that does occur will be temporary, but one hedge fund macro trader says there are plenty of reasons not to Read More
- People are drawn together by common values. Meaningful work and meaningful relationships through radical truth and transparency. Bring uncomfortable things to the surface. Meritocracy – find the best answer. Thoughtful disagreement. It takes deviating from the crowd. “We’re misunderstood because it’s a distinctive culture.”
- A beautiful deleveraging – if growth is higher than interest rates, we pay off debt with the least amount of dislocation. Productivity determines how we live, how fast it grows is most important. Short-term debt cycle is the business cycle, 5-8 years. Long-term cycle – lowering of interest rates: causes asset prices to rise, makes items cheaper to buy on credit, and reduces debt service payments. That ends at zero interest rates – monetary policy 2: CB makes bond purchases and buys another financial assets, going up in price, lowers future expected returns - wealth effect. Becomes decreasingly effective. Greater currency vol. This all happened in the 30s.
- Japan hit zero interest rates 20yr ago, shooting for 2% inflation and can’t. In Europe, zero interest rates and economies are depressed. US is less-far along. Economic restructuring and a balance of payments challenge. Requires a debt restructuring. It’s a heart transplant. Pushing on a string – not as easy to stimulate. Tools? Range between coordination between monetary and fiscal policy – run a deficit – to helicopter money – CBs put money directly into hands of spenders. In 1930s it was veterans. Depends on political environment. Emotional people choosing emotional leaders is natural – happening elsewhere too. China is the least risky politically.
- Everyone is long, everyone is leveraged. You need balance in asset classes. “All-weather” / risk parity, etc. Tell me what econ environment we’ll be in, I’ll tell you what assets to be in. Balance – knowing what we don’t know, is a good thing. Alpha is a zero sum game. A lot of people think they can do it, but a game very few people can play. The ones that can play are probably closed to new investment.
- We can hold illiquidity risk in an endowment model. Advantages? Look at premiums. Avg return of private equity manager = to public manager but top quartile much better. Risk premiums have moved around a lot, pay attention to where they’re moving. We’re not in PE / illiquid assets because the ability to change our mind has been more valuable than those risk premiums. They’re often not as good as thought to be.
- Inflation / Deflation: put $$ under your pillow, so start looking for alternatives. Other currencies aren’t popular, gold isn’t popular. With negative interest rates I think you get Japan type situation – stagnancy. Won’t see inflation near term. This isn’t 2008; it’s containable.
- Extended period of an experiment. Unprecedented environment, no one was around 70 years ago. We are 6-7 years into in expansion. Uncomfortable situation – if things get weak, what are the tools? Not an easy adjustment process. Business cycle point to late cycle – credit markets, M&A, flows into liquid large cap. Yet housing performing well; difficult for investors to read. Macro driven markets – tough time for fundamental stock pickers. Long-term viewpoint, stable capital, ability to go long and short is essential.
- On coming to activism late-cycle: one should be willing to own a biz all through the cycle.
- My top mistakes – not making tough decisions quickly. Allowing mediocrity to exist in a high-performance organization, selling / not selling. You learn the benefits as you reflect. Force yourself to do things you’re naturally uncomfortable with. Build a portfolio that suits your temperament.
- People in our seats think they get to be an asshole, but the cost of that is high – employee turnover, not being a team, self-focused, all high. Need respect, a healthy debate. Comp system based on a piece of the pie. Critical for us to get through tough times together.
- Growth of ETFs, quants, etc. that is less micro in nature. You need people willing to understand where perception is, willing to have a unique perspective about that. No longer good enough to have a quality business and a great stock and just think it’s worth more. Biggest skill-sets: desire to win above a desire to be right. Dangerous investors are those who want to be right more.
- People are missing that the world isn’t ending, particularly in the US. Companies in general are termed out, even leveraged one. You have record high margins, people are concerned because of cyclicality. In free-fall, there’s no elasticity to demand – can’t raise revenues by raising prices. We’re looking for industries w/ consolidation where there is elasticity. Most of expected return is in the risk-premium now. With lower rates, duration has extended - % move in a stock for a change in assumption is much higher now. 20% isn’t that much of a move in context of long-duration asset. Some of 20-30yr bonds are down 50% with credit quality not changing much. We have to get used to that; tweak strategies to capture vol rather than being impacted by it.
- After the stocks you have invested in your fund, the next most important thing is who is invested in your fund. We’re funding our investments with our assets. We insisted on lockups. Can’t take advantage of opportunities without it.
- Collegial atmosphere. Performance in interviewing, not just stock picking. Dinner at the end of the interview – group setting, get to know them. Ask questions that don’t come out in the normal interview.
- Hardest things to find in people – look past the quarter, see around the corner. Takes up to a year to break some of the habits from people being told to dump a position because of a bad Q. If someone gets a stock right for the wrong reasons, not a good thing; can’t count on that luck continuing. Develop deep industry knowledge and see where things will end up. If you’re right and got in too soon, build a bigger position rather than getting out.
- We look for riskier things – harder for smart people to become comfortable with. In commodity industries, we look when there’s blood on the streets and look for the survivors – those who won’t come to the capital markets. We look to rule out certain possibilities. The other guys go out of business first, the industry consolidates and the survivors are stronger.
Also see ValueAct Bullish On Valeant – 2015 Letter
- Trend of more activism good or bad? It was needed. In 2000, great age of passivity. 2 proxy contests a year from 1996-2001; everyone was asleep. Enron & Sarbanes-Oxley helped. Now with any new innovation “everyone’s doing it” but it’s cyclical. Companies have become their own activists; GE for example. Dangerous for late-comers; the easy stuff isn’t there. So they go to weak companies and then in a downturn they blow up.
- Most of our board work is defense – how do we turn a lagging asset into a high-return asset. We don’t look for projects. If a good company could be made better, we ask for a board seat. People look for the house on fire, call up the CEO and make them fly down; that’s the bad stuff.
- On mistakes: Keep it simple. Quality business: low part of cost structure, critical path, high-retention with customers. Not active in the consumer world because it’s the hot thing. Dogmatic valuation discipline – we want half the return up front and half via growth – 10%. Biggest mistakes when we can’t find quality businesses at our price and we buy the project. Complexity complicates. One company embodies all of these – 2004, Axiom in Little Rock. Ran Citi’s credit card biz. Profitable data selling biz, but not profitable outsourcing biz – I said just separate them and give the other biz away. Frustrated with CEO and did a proxy contest. The biz was much more complicated than I thought. Got my 2 board seats, but everything I thought about the biz was wrong. Data biz being subsidized by outsourcing biz. Went negative, took my 4 years to get the CEO replaced. Said this was terrible way to do biz.
- Succession planning: generalist approach, focused on business models. Distributed equity in VAC broadly. Good to eliminate drama within the firm – if I could ID successor 10y in advance, I’d publicly announce and put on management committee. Locked in the 10y plan in 2008. Made it clear who would run the biz after I’m gone – make it comfortable for him.
- I’ll get on a plane with an associate and try to figure out PPG’s business model. Build lore. Train your own people, don’t plug holes with outsiders, and have commitment.
- Looking for: an inner calm, find humor in disaster. As a board member, seeing the sausage made isn’t pretty. So much noise coming at you, have to back up and absorb not overreact.
Also see Letter - After Strong 2015, Maverick Capital Prepares For A Volatile 2016
- 120 long, 80 short, 40 net typically. 26 net right now. Don’t feel the need to take as much beta risk – if the market rallies 10% and I’m 26 vs 40, only miss out on 140bps; don’t really care.
- Share a lot of concerns with Burbank. Carnage on the multi-platform hedge funds. Leveraged strategy was good in a low-vol environment. January was their worst month every, February is worse. 19.1% vol now vs 18.8% long-run; this is normal but we’re not used to it. High-correlation between stock dispersion and volatility; this is a more exciting chance to deliver alpha via L/S.
- 108 longs & shorts total, 38 people on the team, ~3 names per person. We haven’t come across any magic bullet, just try to think about things more intelligently, be competitive, do our work and stick to the process.
- 6 sector teams, most ideas at that level. Sector head can initiate a new position. We meet weekly for several hours to debate merits of individual positions. I look at exposures, factor biases, portfolio management, etc.
- Why shorting is important: if you want to believe in any market – that price reflects sentiment, by adding short-selling, you add to that. You want to believe that price is based on what people believe. Without shorting, we would lose the opinion of people who don’t want to be long.
- In 2008, people lost faith in prices and the crisis got worse because of the ban. Recently, Chinese did the same thing. My first pitch at Tiger was a short. Pitched at $20, went to $50. Right only because of Tiananmen Square.
- I have my worries, but I get the most worried when other people have no worries. Disaster porn is everywhere. I’ll take the opposite side of that. There are companies trading at reasonable valuations that will do well 3 years out.
- At 40% net now, right at our long-run average. It worries me when you see L/S funds try to be the snake (do macro and quant).
- I’m bullish on the need to have liquidity.
- Markets are way overrated about discounting the future if the future is different from the past.
- We look at things via: Macro / Bottom-up / Risk-quant view. Crude quant strategy: mean reversion.
- Smart-beta has been legitimized but people don’t really know the fundamentals.
- Earnings estimates / ratings on commodities are stale but still used in quant strategies – not reflective of reality.
- The future 3-5 years from now will be unrecognizable from today. 1994->1999->2004->2009 as examples. We’re going into a world with unanticipated consequences. Focus now is lack of liquidity. Liquidity sets the multiples.
- My belief is the dollar will keep going whether fed tightens or not. Happened in the 1990s and broke EM then. Only differentiator now is human capital – clusters in cities. The only thing you want to be long is the formation and scaling of human capital. Too much debt, too old, policy isn’t in place for growth. Obvious solution is fiscal stimulus but that won’t happen until 2017 at least.
- Most equity people aren’t trained in risk / quant; speaking a different language. Systems show us what we’re exposed to. 80% of trading is HFT. Move to passive / ETFs is staggering; the market is getting stupider. Sell-side getting less interested. Traders don’t know what’s going on and aren’t doing work. Fundamental guys are being tossed around by “the snake” of HFT / quants etc.
- 2013 was the best year – most liquidity. Mean reversion trade into liquidation is happening now. Markets are rallying now into ECB, China, etc. That’s all they’ve got for ideas.
- US needs tremendous infrastructure, but that’s 2017. We’re going up and down hoping for liquidity, but my fear is we’re pricing at the end of this year.
- Machine learning is different than HFT – HFT removes liquidity.
- China macro situation: transition from fixed asset formation economy to consumer & service economy. Great leadership is determined to make that transition. Refrained from pure stimulus and focus on reforms. Everyone’s calling me for opinions on short RMB positions – everyone’s on the same trade.
- Opportunity set and challenges are different; a lot of companies were high-growth, but now you need to focus on capital allocators. Today the businesses are trading at higher discounts.
- All we do is quality. Spend quality time with quality people building quality businesses. Nature of quality is defensive: they behave well in downturns. Air conditioners – industry suffered but they took more market share, input prices (commodities) decreased so much that margins expanded. When they come back, they’re stronger. They had 7% market share and now have 45% through 2 cycles. 23 bagger. We can buy them at 5x PE and in the US this biz is 15-20x PE.
- Use shifting sentiment / pessimism to your advantage.
- Build network, like-minded people in China. It’s large enough that we can build those long-term sustainable businesses. Hillhouse isn’t about quick flips. If you’re building a business, Hillhouse is someone you could talk to.
- Believer in Taoism – you believe in the simplicity of business. People are focused solely on analyzing business models. We believe in a positive sum game – we try to help our businesses. I don’t believe in the information game – trying to figure out next Q, etc. Computers might be able to do a better job too, but not a lot focus on what a biz looks like in 5-10 years, is this org built to last, what sort of people are behind this business, etc.
- Idea generation – we believe that mobile will be way more important to EM than to developed markets – leapfrogging, WeChat for mobile pay. Will make a huge difference in peoples’ lives. China: younger, more tech, less educated, want things for free, etc. so WhatsApp and WeChat are relevant. Be meaningful, relevant, engaging to your markets and consumers. Closing millennial gap and EM gap. In China, we’re bigger than Unilever & P&G combined, built a $1bln brand in 7 years by being close to consumers and relevant. Invested in a Korean cosmetics company. Global conglomerates are retreating because of activists – lever up, cut costs, buybacks, etc. – allowed regional conglomerates to take their place.
- Millennials important in China and globally. They drink coffee, have pets, and won’t work long hours. We own China’s largest pet food company. Behavior is focused on experience-based consumption. Dish on top of your roof isn’t a status anymore; experiences are status. When we develop proprietary insights and look for ways to invest. We found the best way to play aging population wasn’t healthcare, but pet food. In China, we’re at the starting point of Unilever or P&G. Understand entrepreneurship, leverage technology to build brands, add value. These businesses compound – work while I’m sleeping. As long-term investors we like to build culture, ecosystem with the businesses.
- Comp: we won’t charge any fee on cash we hold in the portfolio.
- JD – “the Amazon of China.” We believed in the business model, it was already tested. E-commerce should value quality, authentic products relevant to consumer needs. That’s the differentiator. We saw the delivery density start to work, economics turn. It’s Amazon + UPS; no UPS in China. It’s fully integrated. 99% of Amazon’s fulfillment isn’t last mile delivery, just warehousing. We’re confident that JD builds their system for the long-term. Now doing 450bln RMB. Offline retailers never had a chance to develop supply-chain advantage – leapfrogging – no Wal-Mart with the supply chain incumbent advantage. 1tln RMB in the next 3 years. We encouraged them: don’t look at short-term operating cash flow via working capital, invest in consumer education. Refocus on core competitive advantages.
- How has TMT changed? Looking now to pace of innovation, building scale. More and more marginal innovation now, we’re not involved there. Public was actually cheaper – I wanted to do VC but found Tencent was only $500mln and publicly traded. Saw valuation discrepancy across public and private markets.
- Last few years big influx of capital to TMT in China.
- Don’t get too busy as an analyst – when opportunity knocks you better be home. Don’t get stuck on the marginal ideas. Losing your money is a small thing. Losing time and perspective is much worse. Don’t compromise on quality, don’t work on marginal ideas. Building your network will pay off – people will know what you stand for.
- Education has changed my life. Look at engineers produced by China because gov’t focused on education. I benefited from learning both in US and China. Over 1k students in last 7 years at Hillhouse Academy. One student came back and donated 20mln RMB. Not only help people change perspective, but build an ecosystem of your own. There are small things we can change ourselves – if we change 1k people, they can go change more people. Women leadership – a lot of capable women we have to help stand up. Maybe in 10-20 years they create great businesses and we’re investors, but they’ll create value.
- We’re not focused on macro, but we know how our businesses will behave. Hedging isn’t big part of what we do.