Podcast Summary
Evolving Investment Strategies: Stay competitive by adapting investment strategies to changing market conditions and competitive pressures, with a focus on fundamental principles.
Learning from this podcast episode is the importance of evolving investment strategies to keep up with changing market conditions and competitive pressures. The conversation between Patrick O'Shaughnessy and Jason Karp covered various aspects of investing, including the role of quants, passive indexes, value versus deep value investing, and the opportunities in private markets, particularly in the health and wellness sector and the cannabis industry. Karp highlighted the growing dislocations between fundamental values of companies and their prices due to the rise of quantitative and passive investors. He also shared his experiences with starting a food business, Hugh Products, and his evolving views on cannabis as an investment opportunity. Overall, this conversation emphasizes the need for investment strategies that rest on solid fundamental principles but continuously adapt to remain competitive.
Shift in Trading Dynamics: From Fundamental to Non-Fundamental: Investor behavior has changed significantly, with passive, quant, CTA, and risk premia-focused investors dominating public markets, leaving less room for traditional stock pickers. Private markets have seen a surge in growth, offering investors unique features like reduced volatility, less frequent mark-to-market, and the ability to avoid market downturns.
The dynamics of trading in public markets have shifted dramatically in the last decade, with a decline in fundamental discretionary trading and an increase in non-fundamental sources. Today, over 90% of trading activity comes from passive, quant, CTA, and risk premia-focused investors, leaving less room for traditional stock pickers. This trend has significant implications for public investors, as the time it takes for a business's cash flows and fundamentals to converge with stock price can range from 3 to 5 years. Meanwhile, the private markets have experienced a surge in growth, driven by an influx of private capital and the increasing popularity of staying private longer. Companies like Uber have shown that they can achieve significant scale without going public, providing investors with unique features such as reduced volatility, less frequent mark-to-market, and the ability to avoid panicking during market downturns. These factors have contributed to the massive influx of capital into private equity, making it an attractive alternative for investors seeking low volatility and stable returns. While private equity may not be inherently better than public stocks, its features make it more appealing for certain investors, particularly those with fiduciary responsibilities and budget constraints.
Private Equity's Enduring Potential for Alpha: Despite competition and higher valuations, private equity offers alpha through value investing by focusing on cash flow growth and longer time horizons.
The private equity market still holds potential for generating significant alpha, particularly in areas outside of tech, despite increased competition and higher valuations. Value investing, specifically, can be effective by focusing on the growth of cash flows, rather than deep value opportunities which have become increasingly rare due to market efficiency. The speaker emphasizes the importance of understanding the relationship between effort and outcome, with longer time horizons leading to more linear results in private equity. Additionally, the speaker's perspective on deep value investing being less effective today is based on the increased competition and market efficiency, making it harder to find undervalued companies with certainty.
Focus on earnings growth for value investments: Identify assets with strong earnings growth for confidence in cash flows and potential profit, despite market conditions or multiple changes. Consider industry cyclicality to forecast future cash flows accurately.
Instead of focusing on deep value investments with low price-to-earnings ratios, it's more beneficial to look for value investments with earnings growth. By identifying assets with strong earnings growth, an investor can be confident in their cash flows and potential for profit, even if the multiple decreases or market conditions change. The underlying cyclicality of businesses is important to consider when forecasting future cash flows, as some industries are more stable and predictable than others. For example, fashion trends can be unpredictable and make it difficult to extrapolate future cash flows, while industries that are dependent on GDP, such as construction and manufacturing, are more cyclical and follow economic trends. By understanding the nature of the business and its growth potential, an investor can make more informed decisions and increase their chances of success.
Businesses deeply entrenched in consumers' lives are more resilient during economic downturns: FANG stocks, integral to daily habits, are surprisingly cheap despite strong cash flow and growth potential. Understanding growth trends and avoiding mispricings is key.
Certain businesses, particularly those with subscription models and daily use habits, are more resilient during economic downturns due to their deep entrenchment in consumers' lives. The FANG stocks (Facebook, Netflix, Amazon, and Google) are prime examples, as they have become integral to daily habits and are surprisingly cheap compared to their cash flow profiles and growth potential. Additionally, historical data shows that there have been periods where these companies were undervalued based on current earnings, highlighting the importance of understanding growth trends and avoiding mispricings at both ends of the spectrum. Furthermore, the dominance of tech companies may continue for an extended period, as studies suggest a long deployment age after technological busts. However, it's important to remember that even large and well-established companies can be disrupted. Overall, understanding the underlying business and its growth potential is crucial when evaluating investments.
Evolution of Financial Markets and Gaining an Edge: Despite increased regulation and competition, structural edges like long-term holding, patient LPs, and unique fund structures remain valuable in evolving financial markets.
The financial markets have evolved significantly over the past few decades, with increased regulation, competition, and access to information. When the speaker began in the markets in 1998, having a Bloomberg terminal was a unique advantage, and information was scarce. However, with the advent of Reg FD and the proliferation of hedge funds and individual traders, the playing field has become more leveled. Research-based edges have largely disappeared, but analytical and structural edges still exist. Structural edge refers to having the ability to hold investments for a long time, having a patient LP base, or having a fund structure that allows for playing offense when others are playing defense. As the markets continue to evolve, it's essential for investors to adapt and find new ways to gain an edge.
Navigating the Shifting Market Landscape: Identify undervalued businesses that don't screen well for quants or passive strategies and hold them for the long term. Be aware of overcrowded sectors and trends to separate stocks from businesses.
The market landscape has shifted dramatically in recent years, with fewer public companies, increased competition from quant and passive strategies, and a strong correlation between growth and momentum. This creates opportunities for long-term investors who can identify undervalued businesses that don't screen well for quants or passive strategies, but it requires holding those investments for the long term. On the other hand, there are also risks in overcrowded sectors like growth tech, where momentum has become highly correlated with growth and passive strategies tend to dominate. It's important for investors to separate stocks from businesses and to be aware of these trends in order to navigate the market effectively.
Identifying a gap in the market for a high-end, unprocessed food restaurant: During the late 2000s, Jason Goldberg saw an opportunity to create a restaurant offering delicious, unprocessed food between expensive fine dining and raw food hippie restaurants, recognizing the challenges of running a restaurant and the need for expertise in sourcing organic ingredients and finding trained chefs.
Jason Goldberg identified a gap in the market for a high-end, unprocessed food restaurant in New York City during the late 2000s. He was inspired by his own health struggles and his brother-in-law's interest in health and wellness. They saw an opportunity to create a restaurant that offered delicious, unprocessed food between the expensive, slow fine dining and the raw food hippie restaurants. Goldberg, who was a public markets investor at the time, recognized the challenges of running a restaurant and the need for expertise in sourcing organic ingredients and finding chefs trained in cooking dairy-free, gluten-free, and refined sugar-free meals. The result was Hugh Kitchen, which now serves over 1,000 people a day and prioritizes deliciousness and the "kid test" (food that is healthy but also tastes good to children).
Building a business that's good for consumers and the world: Successful health and wellness businesses prioritize taste and adherence to strict guardrails, using high-quality ingredients to create delicious, healthy meals. Founders' commitment to their principles, even when it goes against profit motive, leads to a successful and sustainable business.
Successful businesses in the health and wellness sector, particularly in food, must prioritize both taste and adherence to strict guardrails. As the Collaborative Fund's investment thesis suggests, these businesses should be good for consumers and the world. Hue Kitchen, for instance, built its business on this principle, using high-quality, vetted ingredients to create delicious, healthy meals. The founders' commitment to their principles, even when it went against their profit motive, helped them create a successful and sustainable business. The health and wellness sector is an increasingly compelling area for investment due to the profound changes in consumer attitudes towards food and the potential for reversing many health issues through diet and lifestyle.
A new generation prioritizes transparency and real food: Consumers are moving towards real, whole foods and prioritize transparency, forcing traditional food companies to adapt or face declining sales and potential acquisitions.
There's a significant shift happening in the health and wellness industry, particularly in food, driven by a newer generation that is more digitally aware and less trusting of brands. Consumers now prioritize transparency and want to know the mission behind the companies they support. This trend is not a fad, as once people learn about the potential health risks of preservatives and chemicals, they don't go back. The food industry, one of the oldest industries, is facing challenges as customers move towards real, whole foods. In the public markets, many big food companies are struggling to innovate and keep up with consumer demands. In the private markets, there's been a trend of big companies buying smaller ones for their revenue, with the added benefit of distribution and supply chain synergies. The RXBAR acquisition by Kellogg's is an example of this trend. While the exact financials may not be disclosed, the distribution and supply chain benefits can make the deal worthwhile. Overall, this shift towards transparency and real food is a major trend that is here to stay, and its impact on the food industry and investing opportunities is significant.
Focusing on self-sustaining businesses for long-term growth: Invest in businesses that don't rely on external funding and have long-term growth potential, such as the cannabis industry, which is poised for significant growth in the next 5-10 years.
In the current market, particularly in the CPG space, there's a trend of companies aiming for rapid revenue growth to attract big buyers, leading to potentially overvalued businesses. However, it's crucial to ensure these companies have solid economic models that can sustain themselves, especially during market downturns. The investor in the discussion emphasizes the importance of focusing on businesses that work independently of external funding and have long-term growth potential. He sees great potential in the cannabis industry, which he believes will be one of the biggest industries in the next 5-10 years due to its growth potential and his personal connection to it through his insomnia issues. He encourages investors to educate themselves about the cannabis industry as it's essential to have a strong understanding of it, possibly even more so than crypto.
Cannabis: From Propaganda to Fact: Despite historical misconceptions, cannabis is safer than alcohol and has medicinal benefits, debunking decades of propaganda and misinformation.
Our perception of cannabis has been shaped by historical propaganda and misconceptions, and the reality is that it is far safer than alcohol and has well-established medicinal benefits. The history of cannabis being classified as a Schedule 1 drug in the 1970s, alongside drugs like heroin and LSD, has led to decades of misinformation. Contrary to popular belief, cannabis was actually known to be safer than alcohol in the 1930s. The mafia, who controlled the alcohol trade during prohibition, played a role in keeping cannabis in the shadows and demonizing it. The more recent research shows that cannabis is not toxic and has medicinal benefits for various conditions, including epilepsy, inflammation, and insomnia. It is important to approach cannabis with an open mind and do thorough research to separate fact from fiction.
Cannabis Industry's Legalization Wave and Investment Opportunities: The $50B cannabis industry, with Canada's legalization of recreational use, offers investment opportunities in both medical and recreational sectors. Key growth levers for hue products include optimizing supply chains, expanding offerings, and capitalizing on demand.
The cannabis industry, estimated to be worth $50 billion, is experiencing a wave of legalization and presents significant investment opportunities. With Canada fully legalizing recreational use in 2018, the tipping point has been reached, and both medical and recreational sectors offer potential for growth. Understanding the industry, its players, and subsectors is crucial, as there will be winners and losers. Unlike crypto, cannabis businesses generate cash flows, making them a more stable investment option. For hue products, a business that makes and sells cannabis edibles, key growth levers include optimizing supply chain and distribution networks, expanding product offerings, and capitalizing on increasing consumer demand.
Focus on high-quality, healthy products and educating customers: Company differentiates with unrefined organic ingredients, avoids harmful additives, and educates customers and employees.
The company's success lies in its focus on producing high-quality, healthy products, such as their 70% dark chocolate with no refined sugar, and their clean, lab-tested coffee. They differentiate themselves from competitors by educating customers and employees about the benefits of their unrefined organic ingredients and the importance of avoiding dairy, gluten, preservatives, and other harmful additives. The company's key business levers include maintaining good gross margins, expanding distribution channels, and increasing customer loyalty through effective communication and education. A crucial aspect of their mission is investing in their employees and creating a strong internal culture, as they believe that passionate, knowledgeable staff will become successful ambassadors for the brand. Overall, the company's success can be attributed to their commitment to producing and promoting healthy, delicious products, and their dedication to educating their customers and employees about the benefits of their ingredients.
The Importance of Emotional Intelligence in Hiring: Emotional intelligence, including self-control, conflict resolution, empathy, intellectual honesty, and resilience, is vital for success in various industries, especially the investment industry. Consider hiring individuals with athletic backgrounds, military experience, or parental experience for demonstrated emotional intelligence.
While intelligence and passion are important qualities in potential hires, emotional intelligence is even more crucial. Emotional intelligence encompasses self-control, conflict resolution, empathy, intellectual honesty, and resilience. These skills are essential in various industries, especially in the investment industry where one is constantly presented with conflicting information and challenges. The speaker suggests hiring individuals with athletic backgrounds, military experience, or parental experience, as they have demonstrated the ability to handle conflicts and remain resilient. Additionally, keeping a consumer perspective and trusting one's gut instinct about a product or experience can lead to successful investments. Ultimately, the hiring process should focus on understanding a candidate's experiences and abilities rather than relying solely on resume criteria.
Trusting instincts and understanding personal motivations: Recognizing personal needs and why we're drawn to certain things can help identify trends and market successes earlier. The power of kindness and mentorship can lead to personal growth and success.
Understanding our personal motivations and connections to products or services can help us identify trends and potential market successes earlier than others. The speaker shares his personal experience of recognizing his daily need for a sweet indulgence and how it mirrors consumer behavior towards businesses like Netflix. By trusting our instincts and understanding why we're drawn to certain things, we can make informed decisions and potentially stay ahead of the curve in recognizing trends. Another important takeaway is the power of kindness and mentorship. The speaker shares a story of a coach who believed in him and encouraged him to stick with squash, ultimately leading him to success and personal growth. This illustrates the impact that positive influences and support can have on our lives and achievements.
The power of kindness and belief: Kindness and belief from a mentor can lead to significant personal growth and transform someone's life
Kindness and belief in others can lead to significant personal growth. The speaker shared a story about a mentor who, despite the speaker being the worst player on the college football team, took the time to encourage him and believe in his potential. This mentor's kindness and belief led the speaker to persevere and ultimately become one of the top players on the team and an academic All-American. This experience was a turning point in the speaker's life and made him who he is today. It's a reminder that small acts of kindness can have a profound impact on someone's life. Additionally, the speaker highlighted the importance of mentors and the role they play in shaping our lives. The conversation covered a wide range of topics, and it was fascinating to hear the speaker's insights and experiences.
