What It Means To Be a Relative Value Investor

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Transcript:

Bob Huebscher:

Hi. It’s Bob Huebscher and this is the Gaining Perspective podcast where we bring you insightful conversations with some of the top thought leaders in the investment advisor profession and investment management industry. I am the founder and CEO of Advisor Perspectives.

Colorado-based Cambiar Investors is known for its ability to adapt to evolving markets and industries. It has weathered numerous market cycles and knows how to position portfolios with the goal of delivering longterm performance to its investors. It makes decisions that are aligned with positive outcomes for its clients. Brian Barish is the president and chief investment officer at Cambiar and is responsible for the oversight of all investment functions at the firm. Prior to joining Cambiar in 1997, Brian served as director of emerging markets research for Lazard, a New York-based investment bank. He also worked as a securities analyst with Bear Stearns and Arnhold and S. Bleichroeder, a New York-based research firm. Brian, for our listeners who may not be familiar with Cambiar, tell me about the firm’s history and what led you to join the company.

Brian Barish:

Cambiar, the name is a Spanish verb to change. The idea is that change is constant and that we really never have the same set of financial conditions twice. The firm happened to be founded by my father. His name is Mike Barish. He reasoned, at the time, which was in 1973, that the name Barish Asset Management was probably not the most marketable name for an asset management company, so he’d better pick something else. So he went with Cambiar. I’m not of Hispanic or Latin American descent. It’s really an Eastern European name, but that’s where the name came from. It kind of flows off the tongue and works pretty well.

As a philosophy, the idea was to find quality businesses that are trading at discounts to what we think they ought to be worth. That’s really always been the approach, that it leads to a valuation sensitivity to stocks and stock prices and market opportunities, but not necessarily a deep value or classic value type of mindset.

Bob Huebscher:

So let’s distinguish then what the difference is between that classic value approach and what you’re known for, which being a relative value investor. How do you define relative value?

Brian Barish:

It’s probably best to define what it is versus classic value. So with classic value, you want to appraise the value of a business, and you’re probably going to use a DCF type of analysis to do that and buy the stock when it reaches some certain discount relative to that appraisal, so say 30% or 35% discount to what you think is the fair value of the company and you try to use that to, to block out a lot of the noise that exists in the market.

Relative value is a little more flexible. We tend to look at cheap relative to, so relative to a company’s own history, cheap relative to a company’s peers. It might be cheap relative to a market opportunity that we judged to be particularly large. So it’s a little more flexible. I think one of the embedded assumptions in relative value is that although in theory, it’d be great if we could appraise the value of businesses using a DCF approach. DCFs have a lot of subjectivity to them in terms of what the estimates for earnings and cash flows are and what the right discount rate is going to be. So we want to use more current market-based pricing signals to determine what constitutes a value or not.

Bob Huebscher:

All right. Well, let’s talk about some of those market-based signals. So the valuation spreads between traditional value and growth investments are now at historic levels. What is driving that, and how do you think investors should respond to that gap?

Brian Barish:

It’s a very good question, and the valuation gap is truly extraordinary. So in the second quarter of 2020 when obviously, the COVID a pandemic was raging and you had lockdowns all over the globe, the spread between growth stocks and value stocks reached the 100th percentile in terms of historical observations. They’ve literally never been cheaper. There’s a long, short value-oriented hedge fund called AQR that’s pretty well known, and they put out some numbers suggesting that this was a 4.3 to 4.6 standard deviation event, which means something like one out of once in 5000 years type of event from a numbers point of view. So when you get numbers that are that far out there, it suggests there’s something going on that’s not just a statistical anomaly. Maybe there’s something more foundationally going on, and we’ve done a lot of work on this.

We’re actually getting ready to put out a podcast in the next little bit on it. Basically, when you look at value and you look at how value indices are put together, the number one determinant is low price to book value, so low price to replacement costs of physical assets essentially, is how that index is determined. There’s a bit of a measurement error embedded in that definition of value. We know for a fact that in the 21st century, intangible assets are becoming increasingly more important to business success. So back in the 20th century, you’d call intangible assets things like patents, manufacturing, know-how and brands. Whether it’s patents or manufacturing, know-how, or brands, these are forms of intellectual property that are very valuable, but they do fade over time. In the 21st century, those remain of significant value and perhaps certain kinds of know-how and certain kinds of patents are more difficult to come by, but there’s an added component, which is that we have a de-physicalization of the economy in general.

We have the digital economy, whether that’s Amazon or video games, or other ways in which we have more of a digital manifestation of physical things that’s devaluing the physical assets that are out there in some way in favor of non-physical assets. So we have a problem of measurement, to put it in simple terms.  In terms of value indices and I think that’s driving a lot of things. There’s a lot of business disruption that’s caused by new business models. I think the important upshot is that value investing was always about two things. It was about having a margin of safety in terms of where you commit capital and what your expectations are, and also that you let price be a very important determinant of your actions and you don’t just chase interesting concepts at essentially, any price. That’s the way we’ve always operated. I think what you want to do to operate intelligently but still use a value framework to divorce yourself to the extent that it makes sense from looking just at price to physical assets. It’s an increasingly, a relic of the past.

Bob Huebscher:

So what I hear you saying is the de-physicalization of intellectual assets has distorted price to book ratios as a relevant metric for measuring the spread between value and growth. Could it also be that we’ve seen a number of businesses emerge like Amazon and Apple and Netflix that have that de-physicalization of their intellectual property, but have also just become monopolies and that have led to them to high levels of profitability for them? Is that contributing to the spread?

Brian Barish:

That is as well. One other area that it’s worth exploring is the concept of market structure. So in the, let’s say the 20th century, there were a lot of market structures where you had kind of natural duopolies, think of Coke and Pepsi or Nike and Adidas, in terms of branded product duopolies. When you have digital marketplaces for things like app stores or e-commerce or cloud computing, you have what would be called a liquidity-driven marketplace structure. When you have a liquidity-driven marketplace structure, those tend towards monopolies. So think about the Chicago Merc for a commodities trading or the New York Stock Exchange for equities trading. Those are very old-world versions of liquidity-driven market structures, but they’re happening more and more off.

If you think about it again, using price to book as a determinant of value, it’s a terrible way of thinking about what constitutes value and what doesn’t constitute value when you have one of these liquidity-driven effects. It’s a long conversation that could go on for a while, but in the digital world that we live in now, you’re seeing these liquidity-driven marketplaces erupt more and more frequently. Uber would be another example of a digital liquidity-driven marketplace structure, just to name something else that’s new and indifferent that affects transportation, obviously. But it does again, point to the de-physicalization of the economy and what constitutes value and it’s just a very different world than the one that a lot of people grew up with from an investing perspective.

Bob Huebscher:

I want to come back to another point you made that we’re in the hundredth percentile of spreads between value and growth. Is it inevitable that there will be a reversion to the mean, and then that will see strong performance from value stocks? Or can this have performance persist, the performance of growth persist for significantly longer?

Brian Barish:

Is it inevitable? The inevitable is a strong word, but I would say there’s some inevitability to it. I read an analysis recently, and this was of Tesla stock, which was not a stock that we own, but it’s obviously a name has captured a lot of imagination, that they’ve opened a wormhole into the year 2030 and the stocks being valued on what their business might be looking like ten years from now. Obviously, a lot of things can happen in this space of 10 years. There is a lot of projecting of future success going on in the marketplace. It’s not dissimilar to the late 1990s in that respect. Value ultimately took over from growth in the year 2000. One of the observations I recall from that time period and I was managing our funds at that time, a lot of the projections for growth, for specific companies and specific sectors, they were just wrong. Things did not happen as people anticipated with growth in revenue and profitability for data and data common, data related telecommunications being probably the worst, the most off-base in terms of what people’s expectations were.

I do think there’s more quality and durability to the business models of Apple, Google, Amazon, Microsoft, and some of the other big ones, but things happen fast in technology. What you might think is a business that has an unbelievably defensive moat, that can go away fairly quickly. So I think there’s some inevitability to it, but what we are also seeing is that there’s a lot of industries that are on what appears to be the wrong end of societal and technological trends. The automotive business jumps out immediately. Commercial real estate and office towers with the advent of work from home and the maturation of a lot of that technology, those seem to be on the wrong end of history to some extent. It’s hard to project what those statements that I just made truly are going to mean, and that’s why we have markets and relative prices. We let the markets help us sort these things out. Net, I see having price sensitivity and not projecting with wild aggression, new and cool sounding business models into the future. I think there’s some merit in that and having a little more conservative approach here.

Bob Huebscher:

I think that article that you mentioned about Tesla and the wormhole was written by Vitale Katsenelson.

Brian Barish:

That’s correct. Yes. I know of Vitale pretty well. He’s a very area dyed writer.

Bob Huebscher:

As do I. So if we don’t have that article on our site yet, we’ll have it up there soon and we’ll include a link to it in the notes that accompany this podcast. So I want to ask one more question about growth versus value. Does there need to be a catalyst to revive the performance of value stocks?

Brian Barish:

Maybe. Maybe. If you go way back to the year 2000, we had a lot of liquidity, excess liquidity in the market in 1999 because you had the longterm capital tobacco in 1998 and then Alan Greenspan got very worried about Y2K in 1999. That proved to be a whole lot of nothing. Then as we rolled into early 2000, the fed began removing the excess liquidity they had put in the market and that basically was the straw that broke the camel’s back in terms of the speculative thrust that we had. I would think that there would probably be two forms of market developments that might shift the debate. One would be indeed, how do some of these businesses perform? There’s a lot of expectations baked into growth stocks right now and inevitably, some of them are not going to be realized.

It’s possible. I wouldn’t count on it, but you may see some greater degree of regulation to some of these liquidity-driven monopoly marketplaces that we just talked about earlier. That’s a possibility that could happen more under a democratic regime potential if we got that in the election this fall. The other is the dollar. We haven’t really talked about that yet, but we’ve been in a strong dollar marketplace that tends to favor American champion type of businesses as preferred destinations for global capital, and that’s exactly what’s happened. You’ve just seen the best American technology franchises and other growth franchises just utterly predominate in the market.

It’s possible we’re starting to see a bit of a regime change in the dollar towards a weaker dollar. I wouldn’t get too carried away with it just yet, but we appear like we’re going to have zero or near-zero interest rates in the U.S. for the visible future and that compares to us having a positive interest rate and being really the only serious reserve currency in the world that had a positive interest rate for the last several years. That little change in variables can have big implications. That doesn’t mean that the Euro is suddenly a really good currency. They still have their problems. It doesn’t mean the Yen is really a good currency. They still have their kind of chronic deflationary problems, but a lot of things in business and the financial markets, they happen at the margin. The margin looks like you’re not going to get much yield in the U.S. dollar either.

Bob Huebscher:

So we could see a weakening of the dollar or a breakup of some of these monopolistic businesses. Inevitable maybe a strong word, but at some point, we’re going to see a reversion to the mean.

Brian Barish:

I’d go back to the name of our company. Change is inevitable at some level. Predicting what it’s going to be, that’s tougher, but it would seem to me that the dollar weakening is a bit of a tipping point of some form and we’ll see where this all goes.

Bob Huebscher:

All right. So I want to turn to the funds that you offer through Cambiar. Looking at the performance for various Cambiar strategies, you have a number of products that span international, small-cap, SMID, other asset classes. How have you managed through the covert crisis? Where have you found opportunities and what areas have you been avoiding?

Brian Barish:

Sure. We’ve managed, I would say pretty well, if I can give us a compliment through this. Our domestic strategies are all well ahead of their benchmarks. Our large cap domestic strategy’s practically flat. Year to date, which is a good deal better than the market and especially, the value end of the swimming pool. International markets have been weaker than the U.S. year to date, but they’re kind of starting to catch up. I can tell you that in, in late March, I was kind of wondering if we were going to have some sort of modern depression as a result of the virus, but have been pleasantly surprised that monetary authorities have acted as forcefully and as powerfully as they have. It’s kind of worth noting just for general thought that when you compare the current crisis to what happened in 2008, even though the GDP impact is worse, the financial impact has been nothing like that and that’s because we had fairly successful reforms of the financial system following the 2008 crisis.

Basically, the monetary policy transmission mechanism is working. So we’re getting money out into the economy and it’s leading to there being less damage to the economy and the financial system than you might have otherwise thought. So what we’ve done that I think has been helpful has been to put together a framework for how to think about individual stocks and upside opportunities in the context of what is a very acute short to medium term business disruption. We have five buckets; so low, medium, high, kind of extra-large business disruption, and then sort of a last category of needs reassessing, maybe not likely to have a good recovery coming out of this. So what we’ve tried to do is pace our investments where we’re looking for moderate discounts to fair value if they’re in the low disruption bucket, medium to medium-large sized discounts to fair value if they’re in the medium bucket and on down the line with the idea that it would be prudent to allocate capital to the first three buckets where you could expect eventual full recoveries to the business.

When you get into extra-large levels of disruption, that’s things like airlines and hotel and leisure and businesses where they’re just going to lose immense amounts of money until the economy can be fully reopened, in those cases, we see capital structure damage. So you’re going to get diluted a lot as a shareholder by either equity issuances or a lot more debt. We don’t feel that that’s worth pursuing. The last category needs reassessing, this is happening at the end of a long and fairly prosperous business cycle. What happens when that’s the case is you have certain sectors of the economy that they need to shrink. They’ve been kind of carried up by the fact that the economy has been as good as it’s been and ultimately, when the recession comes, you need to force capacity out of the system. That can be a very ugly process that leads to bankruptcy. So we’ve tried to avoid making investments there.

It has been surprising how well the markets have come back. I’m mildly surprised, but it does show you that there’s a tremendous amount of power to aggressive monetary policy. And secondly, that markets do indeed, look ahead. They’re not looking at how bad the numbers are going to be in the second quarter of 2020 or the third quarter of 2020. They’re looking to make informed conclusions about what kind of earning power you’re going to have in 2021 with the idea that earnings in 2020, as long as you’re not damaging the capital structure of a company, they’re kind of a write-off. They don’t really reflect the merit of that company’s business and business strategy. It’s just a very unfortunate year in the history of the world and we’ll move on from this. So just having that framework, that’s been very helpful to making capital commitments intelligently.

Bob Huebscher:

You mentioned the weakness in the international markets. I’m going to come back to that in a second, but I know from looking at your site and looking at the research you’ve been doing, you’ve been closely monitoring the biotech implications of the pandemic. Is there anything there that you’ve learned that you’ve been able to apply to your investment approach?

Brian Barish:

I would say not a huge amount. I think we’ve all become closet virologists as a result of the pandemic and looking at vaccines and the potential for vaccines, and when those might come to the market. When this first broke out, our healthcare analyst indicated that she thought we would not see a vaccine in 2020. It just takes a while to develop these things, but that early 2021 was a reasonable timeframe. Since that was back in March, so we’re doing this in July, and in the ensuing four months, we still think that’s about the correct timeframe. Maybe the tails have come in a little bit. So it’s definitely not likely we’re going to get one before October. There are enough candidates that look to be efficacious and that looked like they’ll probably be safe that we don’t think it’s going to be much later than the second quarter of 2020.

Brian Barish:

Ironically, there have been some stocks that are vaccine stocks. We own a couple of them. We own Gilead and Pfizer, and that’s just more of a curious luck category in terms of our net exposure to it. But vaccines are not really very profitable business for pharmaceutical companies. You don’t get paid a lot. You’re taking a lot of risk in terms of what, if for some reason, there’s a safety problem. So they’re not really very big catalysts from a pharmaceutical perspective, but they’re obviously the timing of a vaccine is a very big catalyst in terms of the overall market and businesses from banks, to hotels, to aircraft manufacturers. You would want to know with some precision when a vaccine is finally going to happen.

Bob Huebscher:

All right. So let’s talk about international markets. I know you invest both domestically and in the international markets. With the U.S. markets outperforming international now for nearly a decade, that’s a trend that continued through this year’s pandemic volatility. Some investors still remain underway to international. What’s your assessment of valuation opportunities abroad relative to those in the US?

Brian Barish:

My views are complicated on this. I would tell you right now, the international markets are a lot cheaper than the U.S. and the currencies are also cheap relative to the dollar. So there’s a potential for a tailwind from both valuation uplift and currency uplift, and that would be at a high-level way of characterizing the opportunity international. You’ve been able to say that what I just said for about the last five years though, so it hasn’t really worked for a while. What the international markets lack are champions in some of these technology and marketplace type of businesses. So we have Apple and Google and Facebook and Amazon and Microsoft. In Europe, they don’t really have anything that resembles that. maybe SAP is a big business software company.

In China, you have two very big internet giants in Tencent and Alibaba. We own both of those effectively in our international strategy. You haven’t had the same kind of leadership in these growth categories, and that’s been very challenging for the international markets in general. They are cheap, they are unloved, expectations aren’t very high. It wouldn’t take a lot to see stocks perform better and conversely, valuations and expectations to some extent are very high in the US and that can be a formula for disappointments. I think it would be some combination of that. Bob, I started being in this business at the very end of the Cold War, at the end of the 1980s, and it’s been very interesting to see some of the geopolitical that have happened in 2020 and in late 2019, in particular, in Hong Kong where China is essentially moving in.

They’re basically saying, “You don’t have the liberties you thought you had any more. You’re part of China now and you must kowtow to Beijing.” Back when I started, the Cold War was ending and the U.S. won, right? The US market based economic system with little government involvement in setting the pace and direction of the economy was the winner. Whether it was communism or socialism or other state-led forms of economic development, those lost. And from Latin America, to Eastern Europe, to East Asia, it was expected that these economic regimes, they were going to need to align with a more American version of things and that over time, their economies would converge towards an American model. That all sounded great at the time, but we can see fairly clearly, that’s not what’s happening.

You’re seeing more state led types of structures dominate with China being a very powerful example of that. It doesn’t mean that they’re going to perform well, economically. It just means that that’s just what they’re doing. Where we’re going with this, I’m not exactly sure. I think a lot of people have speculated that the neoliberal orthodoxy of free trade and free movement of labor and capital, that we’re moving to something a little different than that where a lot of that movement will be more constrained. I’m not quite sure you can reverse the globalization that’s happened, but it really does change investment priorities. I’m not exactly sure how that’s all going to evolve in the next decade, but it will certainly have bearing on the performance of international stocks.

Bob Huebscher:

So looking at what we’ve covered here, it seems like we’re faced with two significant divergences in the market; one between value and growth, the other between U.S. and non-U.S. stocks. It will be interesting over the next year or more to see how long it takes for those divergences to correct if they do. Brian, my final question is this, if there’s one thing you’d like our audience of advisors to take away when it comes to relative value investing and how you practice that discipline at Cambiar, what would that be?

Brian Barish:

Real simple, buy good businesses. The direction China takes, I don’t know. The direction the dollar takes, I don’t know. The direction of the growth versus value trade, I think that you can recover some certainly, but the magnitude of that, again, I don’t know. But what we’re trying to do is buy good businesses and not overpay for them. It’s as simple as that. Good businesses, they have differentiation, they have pricing power, they tend to be innovative and it’s good businesses that tend to prevail. They exist outside the United States, whether or not European GDP growth is ever very good, maybe irrelevant to businesses that are of good quality and that are thoughtful about how they grow and develop. So that’s the approach that we take and it’s tended to be a solid all weather approach to investing. There can be very acute market environments where other things are just going to work better, but those have tended to ween and our approach has tended to endure.

Bob Huebscher:

Well, thank you. And we’ll include a link to the Cambiar Investors website in the notes that accompany this podcast. I’ll also include a link to the article that Brian mentioned by Vitale on Tesla. Brian, is there anything else you’d like to add?

Brian Barish:

No, not really. Thanks a lot for having me on your program. I really appreciate the opportunity to talk about what we’re doing.

Bob Huebscher:

Well, thank you for listening to the Gaining Perspective podcasts with Bob Huebscher and today, featuring Brian Barish of Cambiar Investors. To support our podcast, please share, subscribe or leave a review to help make our podcast more findable for your friends and colleagues. You can subscribe to Gaining Perspective on iTunes, Spotify, and Stitcher.