20: Global Investing Strategies for Uncertain times with Matthew McLennan

Transcript

Templeton & Phillips Capital Management Podcast featuring Matt McLennan

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Hi, my name is Lauren Templeton and you are listening to investing the Templeton Way.

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This podcast is for anyone interested in learning more about investing.

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In this podcast I will be interviewing some of the greatest minds from the investment community

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and exploring topics ranging from international markets to behavioral finance.

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To learn more, please visit us at investingtheTempletonWay.com.

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Any information presented in this podcast or available on the website is not intended

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ads and shall not be construed as financial advice.

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This podcast is produced for entertainment value.

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Investing is inherently risky.

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And I encourage you to seek financial advice from a professional who is aware of the facts

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and circumstances of your individual situation.

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Thanks for listening.

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Welcome to the Investing the Templeton Way podcast.

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I'm your host Lauren Templeton.

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And I'm your co-host Scott Phillips.

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And this podcast we bring you thought provoking conversations with experts and leaders across

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the investment industry.

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And today we're thrilled to have Matt McLennan as our guest who is portfolio manager

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and head of global value at First Eagle investment management.

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I personally have been an investor in First Eagle for many years.[EC1]

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With over three decades of experience in the finance industry, Matt has been recognized as one

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of the top investment managers in the world[NM2] .[EC3]

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He has been with First Eagle since 2008 and has been responsible for managing the firm's global

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value strategies overseeing over 80 billion in assets and management.[EC4]

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First Eagle itself manages a hundred and twenty-four billion.[EC5]

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Throughout his career, Matt has been a vocal advocate for value investing, a philosophy that

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seeks to identify undervalued stocks that have the potential to outperform the broader market

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over the long term.

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He's a sought-after speaker and has been featured in numerous publications including the Wall Street

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Journal, CNBC and Barron's.

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In today's episode, we'll dive deep into Matt's investment philosophy, his approach to managing

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risk and volatile market and his outlook for the global economy.

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So without further ado, let's welcome Matt to the show.

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Welcome Matt.

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Thank you so much, Lauren.

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Thank you, Scott.

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Yeah, so I would like to start these shows just getting to know you a little bit better.

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It sounds like you had an interesting childhood and you grew up in Australia.

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Is that correct?

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That's correct.

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I was actually born in Rabaul, New Guinea.

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The first six years were there and then in Queensland Australia thereafter.

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Wonderful.

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So how in the world did you become an investor interested in investing and pursuing this career?

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Well, sometimes in life you have to make all the right mistakes before you chart

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a more recent course.

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If I'm honest with myself, and I think back to when I was a teenager in the 1980s, I was kind

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of enticed by what was going on with the corporate readers at the time.

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They appeared to have discovered this magical elixir to create wealth.

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And the stock market, as a teenager, seemed like some stacked game of monopoly to me.

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Of course, we all know later that leverage and the overvaluation of these writers paid and

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their behavioral hubris, all led to some spectacular implosions in later years.

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At the time, it seemed like they were onto something.

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And at the same time, I had a high school math teacher who figured that he had discovered the

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hidden patent in charting the Dow Jones[NM6] .

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And unfortunately, for him, he put his discovery to work and tried to trade futures around

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this discovery and lost it all.

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I sort of reflect back on that period.

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I think to myself, why did I get attracted to get rich quick-type speculation early on in life

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as opposed to what I now think of as investing?

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As we discussed, I was fortunate enough to grow an up in Australia in an incredibly happy house

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in the woods and surrounded by books and a supportive family.

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But it was also a childhood that was very simple.

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And of modest means, we didn't have electricity or running water in our house in the woods.

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And I guess I had some youthfully naive fire in the belly at that stage and that had sort

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of exceeded my wisdom.

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And with the benefit of high tide, I'd say, though, that I was better to have been attracted

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for the wrong reasons early on when I had very little capital to deploy.

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And out of, I guess, the ashes of that period of not so great market history, I took the opportunity

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to devote myself to learning, studying finance, accounting, law, economics, academic literature.

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I basically devoured at all.

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And I was fortunate enough to be hired by my thesis supervisor at the time into an investment

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job in Brisbane, Australia.

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And there I got to meet a range of third party managers and I came to the opportunity to distill

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the threads of continuity amongst their approach.

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And I ultimately joined Goldman (Sachs) in the early 1990s.

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And I was well-mentored there by folks who work for people like Lewis Simpson at Geico

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or Lew Sanders at Bernstein and continued reading and learning.

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I really just settled on a value approach to investing, really looking for businesses that

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were entrenched and cheap.

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What I took time to learn was that investing done properly is all about compounding out

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at any satisfactory rate of return and avoiding the permanent payment of capital rather than

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swinging for the fences.

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If I look back on my childhood, my mother's approach to gardening was probably a much better metaphor

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for investing than the actions of corporate writers or stock charts speculators.

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That was really what got me involved in investing.

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Yeah, it's so interesting.

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Everybody finds their way to investing, value investing on a different path.

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So it's interesting to learn yours.

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You have been at First Eagle now for over a decade.

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Can you talk about the investing landscape and how it's changed over the years?

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And how you've adapted your approach to stay ahead of the curve?

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So yeah, it's coming up on 15 years at First Eagle.

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And it's been a wonderful experience.

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And I think the beauty of the job of being an investor is that the learning curve never stops.

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It's a field that really has sort of knowledge conciliates if you will.

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You're blending science and humanities looking for some sort of asymmetry between price and prospects.

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It's endlessly interesting.

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And I think as I reflect on the last 15 years, I mean, part of the journey for us as a team at First

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Eagle has been really sort of focusing on how to think about the evolving mix of the underlying

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investment opportunities set to businesses that are characterized by more intangible assets as opposed

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to tangible assets.

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And that requires somewhat of an evolution of thinking.

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And that's been an area that we spend a lot of time thinking about in addition to reflecting

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with where we are on some of the imperfections that we see in the financial architecture globally.

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And thinking about how we should navigate potentially troubled waters in the years ahead.

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Mm-hmm.

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We've had a similar thing going on in our firm with a focus on those intangibles.

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Yeah, I mean, I think just from a value investing standpoint generally, it was kind of an evolutionary

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process, maybe you share that view, Matt. I'm not sure, but when you're kind of focused on the

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balance sheet and assets, you're dealing with historically, accounting conventions that were made

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close to 100 years ago and have no perception of what we're looking at today.

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And so it creates these kind of interesting perspectives.

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What do you do with capitalized cost?

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You know, are there's intangible assets actually where something should you be valuing

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them? And so I think value investors generally have had to come to grips with that.

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What has been your experience?

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Well, I think you're 100% right. I think when you look at a traditional capital-intensive

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business, a lot of the investment in that business is really only captured in the cash flow

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statement. If you're expanding the railroad network or your steel plant, so you're building

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your buildings, all of that goes through the cash flow statement. And if you're a company

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that's built upon intangible assets, whether it's research and development or advertising or having

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a unique sales network, whatever it might be, if you try to expand that business, you're going

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to be investing through the profit and loss statement. And so one really has to sort of adjust

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for those kinds of differences. And I think just from a balance sheet standpoint, often the

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two most valuable assets don't show up on the asset side of the balance sheet. And by that,

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I mean, for a business, the most valuable assets often a high level of market share that's being

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stable generationally. That kind of entrenchment is a very valuable intangible asset.

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Incumbency, is a very valuable and intangible asset. But it doesn't show up on the balance sheet

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per se, like why the extent to which there's management acumen in allocating capital over time,

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that doesn't show up on the balance sheet. Yes, there's trace elements of it. You might have

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a balance sheet that's not that level or getting high returns on capital. But there's no discrete accounting

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for those assets that are incredibly valuable. And so we spent a lot of time thinking about that.

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And at the end of the day, growth is only valuable if it's profitable. And the precondition for

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profitable growth is really some form of advantaged incumbency and a management team that focuses

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on that core advantage and focuses on efficiency and deploy measured behavior. And so we spent a lot of

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time thinking about those variables that are kind of hard to capture in just financial statement analysis.

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Well, now that we're talking about growth, I mean, we have been through just the most incredible

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period with low interest rates and a misallocation of capital, of course, the extreme valuations

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of growth stocks, which have somewhat corrected. I mean, Scott and I were counting over 700 stocks in the

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US at the beginning of 2021 trading at a price sales multiple of over 20 times, just some really

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extraordinary valuations. How have you experienced sort of the rationalization of the market and

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this higher interest rate environment? Have you done anything in your portfolio to reposition or how do you

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think about that? Well, you're right, 2021 was a pretty extreme year in markets and I think it'll

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probably go down as a generational low in the cost of capital, you know, sovereign interest rates were

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low, below 2% credits credits were low you know, high yield credit spreads were only for 250-260

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basis points. And as you point out, earnings multiples will high, revenue multiples will high price per

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human was high, you know, and the capital markets will wide open, you had spacs, you have all of these

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high growth ideas and in fact, I hadn't seen anything really like it since 1999. And obviously

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that generational low in the cost of capital, when combined with exceptionally accommodated fiscal policy,

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produced inflation. And what we saw over 2022 was somewhat of a normalization of the cost of

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capital, interest rates went up to levels more consistent with the historical averages,

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high yield credits blew out to a little bit in excess of the historical averages and earnings

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multiples on the market came down to levels more consistent with the last couple of decades averages. Albeit

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not cheap. And you know, we fortunately weathered that storm reasonably well in the sense that we

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hadn't really participated in those pockets of the market that were pricing excessive optionality. We

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would sort of stuck to our knitting, stuck to situations where the investing arithmetic

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made sense between the free cash flow yield today and the measured pace of growth and intrinsic value[NM7] .

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And you know, people would often ask, how do you know how a time value of growth, I say you don't

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know, but I do know that arithmetic ultimately works. And so there wasn't a lot that we had to do

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differently. We had during the proceeding years been positioning the portfolio for more resilience,

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so leaning into the wind a little bit. And I think that that position does to sort of endure

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last year and to be able to put a little bit of capital to work in the summer. But I think that

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place that we're at now is a little tricky. I know markets have recovered some and perhaps looking

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forward to lower inflation and interest rates. But as I reflect on the current environment,

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I feel that the increase in the cost of capital that we've seen,

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has not fully flowed through to the economic reality. And I think the bond market is flashing

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some warning signals here. Whether it's the yield curve inversion, whether it's the Fed

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fund rate[NM8] itself bursting out on the upside of a 40 year downtrend, whether it's how your credit

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spreads been wider. And I think we're also starting to see some signs of slowing economic momentum

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in some of the expectation surveys, now orders by an ISM services and manufacturing orders or

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the conference board consumer expectations. There's signs of a labor market

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softening at the margin. And so, unfortunately, when the momentum shifts negatively,

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it tends to run for some time. And so I think this is a moment in time where we might have seen

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the early stage of the adjustment of repricing, but there may be more challenges that lie ahead.

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The tell me why you're portfolio at First Eagle is well positioned to weather that market[NM9] ,

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if we have a hard landing recession, etc. Let me say up front, but we have enough humility to

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recognize that if we have a hard landing, no one's going to be immune from that in totality.

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You know, we are a long-owned, we manage our own, and we have about 70% of the portfolio invested in

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equities. But I hope we would be to avoid the worst of potential permanent negative impairments

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of capital during a downdraft. And we have an a ballast in the portfolio between our cash and our

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gold holdings to not only be able to sort of weather a storm, but to be a selective purchaser of securities

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that offer a deeper margin of safety[NM10] in a more distressed environment. And the one thing that

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is kind of weighing on me here is I sort of think about markets and the issues that we went through

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with the recent sort-of banking crises. What we might be seeing here is the opening stages of a

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more of a sovereign credibility crisis in the United States. If you think about the last few

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cycles that we've been through in the late 90s that we talked about before, the credit problems

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emerged in the corporate sector. You'll remember the Enron's, the World Coms,

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those situations. And then in the mid 2000s people had moved credit-wise into housing credit,

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more than just low risk credit, house prices never go down. And I think where is the

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where is the excess stack of debt today? It's in the sovereign sector. Especially following the

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large fiscal stimulus with COVID, there was a huge amount of sovereign debt issuance. And

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one of the things that strikes me is a very meaningful difference between what we saw in the most recent

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year and what we saw in 1999 is that you'll call back in 1999, the last time we had about

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below 4% of unemployment, that there was a budget surplus in the United States. In the last year

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with 3.5% unemployment, we had close to a 6% deficit. And so we're not on a

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fiscally sustainable course. And if you think about where the problem surfaced in the banking sector,

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it was losses on sovereign securities, whether they long-dated treasuries or whether they were

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mortgage-backed securities[NM11] with the implicit backing of the state. And I think one of the ironies

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of our financial architecture is that for banks, sovereign assets have close either zero or low

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risk waiting depending on the nature of them. Yet we know that sovereign debt is not risk-free. If you have

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unsustainable fiscal policy or you have sort of inappropriate monetary policy, you can suffer meaningful

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capital losses. And so I think we're maybe at a moment where the confidence in the sustainability

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of our fiscal picture could come into question. And I think that presents a whole host of

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different challenges for investors. And shared eyes, it's very interesting time to be an investor and

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to think about positioning the portfolio for that. So First Eagle has a great history of preserving

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capital on the downside. That's what we like about First Eagle. When we're looking at putting

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First Eagle in our personal portfolio or talking to clients about First Eagle, we like the history

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of preserving capital on the downside. How as a company do you have the culture? How do you keep your

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wits about you? And these crazy irrational markets, like the one we've had over the past 10 years.

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How is that so preserved into the culture at First Eagle? It's very challenging psychologically

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because in an environment like 2021 or 1999, you have to be willing to be short social acceptance.

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Ultimately, people will view what you're doing as sort of static and not keeping up with the times in

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a moment of inexuberance like we saw in 2021. And part of what we do is spend a lot of time

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being frank with our clients about who we are and who we're not. Setting realistic

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expectations. And I think that's important because if you promise to be all things to all people,

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then you're almost forced to change with the times rather than the charter city course. The second thing is that

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we have, I guess, the benefit of an approach that's been time-tested, the global strategy

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traces it's roots back to 1979. And so I think the fact that you're acting as custodians

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of an approach that's been time-tested gives you some staying power, then if you're experimenting

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with a new approach, then it comes down to the simple fact that when we look at the portfolios bottom-up,

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we invest in what makes sense. If we're worried about fiscal issues and monetary policy,

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then it makes sense that we hold some goal as a potential hedge. In fact, when I look at the last

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century of investing history, when equities have had their lost decades of often being when

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gold is had its best decades. And so having some anchor in a potential hedge like gold gives us the patience

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to endure extremes in markets. And I think just seeing opportunity bottom-up even though the market

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itself got pretty expensive, the international stock universe was at a 50-year-low relative to the

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US. If you just looked at the ratio of the MSGIE[NM12] for the compared to the S&P 500, it was at a 50-year-low

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and so for a long-term investor for whom the arithmetic matters, the combination of cheap currencies and

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higher-free cash flow yields gives you the conviction if you will to stay the course. And then

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when we look at what we own bottom-up, we'd see that we weren't just like

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skewed towards things that were statistically cheap, but we're trying to focus on businesses

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that have scarcity value and that have innate persistence whether if we're in the world of

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newer companies we have in trend software, but more mature companies that aren't excessively valued

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locally advantaged scarce real assets or companies that have local market services density,

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50 or 60% market sharing local markets or companies that have generational brand equity or

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heritage as like honing precision products. When you look at the nature of the businesses we own,

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you just start to get more comfortable at these businesses that should grow in a measured pace over time

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and if they offer a attractive free cash flow yields give you the ability[NM13] to generate sound

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real returns. And so it's keeping centered and it's these crazy times is really a function of

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having a clear philosophy, a clear sense of true north, but also feeling comfortable with what you

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own bottom-up and it's a combination of those two variables. You know, one of the things that I think

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is a little bit unusual about First Eagle is your gold position. I mean that's what I always think of when

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I think of First Eagle. I think about you know there's going to be some exposure to gold and

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gold mining stocks. The other thing I think about when I think about First Eagle as a manager

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and please correct me if I'm wrong about any of this because I certainly could be. But I think that

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compared to most managers in the industry you will sometimes have at First Eagle,

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larger cash balances in the portfolio than that average manager. Maybe as much as 30% in the past you

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want to comment on the use of gold and the use of cash in the portfolio is in the strategy behind that.

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Sure, so I think that our philosophy is one where we're almost better thought of as business gardeners

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or business collectors then we are stock traders and that means that when we approach the task of

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investing we tend to have a more absolute mindset and the reason I mention that is that we only put cash

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to work if we find a business we like at a price we like and there are some environments where it's

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harder to do that and we might be trimming names that become more fully valued and so the cash

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will build as a residual of that discipline approach to investing and then in windows of distress

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all of a sudden there's fewer stocks that we want to sell because they're trading with a wider

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margin of safety and price and there are businesses that may have been on our wishlist that are all of

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sudden attractive to us and so we put that cash to work and if you look over the last 15 years our

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largest cash drawdowns were in Q1 2019 and the way could global financial crisis and in Q1 2020

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joining the COVID-19. The cash is really thought of as a sort of deferred purchasing power.

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We want to be primarily owners of business but we only want to do so on sensible terms and so the cash

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will ebb and flow throughout the business cycle. The gold is in some ways a longer term

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a form of deferred purchasing power. The problem with cash is that over the last fifty years the

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yield on cash has been less than the rate of money supply growth and the economy and so while it

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provides for a nominal stability in the short term it's a different form of wealth destruction over the

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long term because you're not keeping pace with the rate of monetary creation. Now gold is a little

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different from cash because it offers no yield but it's constrained supply and in a way it's

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perhaps not surprising that because we broke the link between our currency and gold in the early 1970s

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because we didn't want the discipline of gold is perhaps not a surprise that gold has outperformed

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our money over time and so you know over the last 50 years money supplies compounded out at 6

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or 7% cash has been closer to 5% and gold has been north of 8% and gold ironically is

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interesting for us as a potential hedge and people say why would you hold this useless lump of

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yellow metal and I like the little paradox is that its utility as a potential hedge is its

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uselessness as a commodity anything that's useful has its price being very sensitive to the business

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and so on. You know land prices whatever it may be gold is chemically a note which means that

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it tends to be more inversely related to the business cycle in fact it's a note that means

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that it lasts indefinitely and it means that it has a more steady supply because the gold

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mine in a year is only one and a half percent of the total amount of gold outstanding and so

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it's very predictable supply and it means that gold's price tends to to be inversely correlated with real

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interest rates and over time because of its scarcity it tends to go up in line with money supply

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and nominal activity and so you know as far as hedge assets go with we found it more attractive than

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say buying put options because they cost a lot to buy and put options you have to be right on the

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timing and we're humble enough to know that we can't time markets and it's had a better risk-reward

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than owning sovereign paper you know given the sovereign challenges that we've outlined earlier in

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the discussion so we've settled on goal as a sort of long-term potential hedge or longer term form

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of deferred purchasing power if we were to go through a lost decade in stocks or something worse like

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the 1930s or the 1970s then I would imagine that you'd see us progressively start first to deploy the

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cash and then ultimately to deploy some of the gold in the ownership of business and I'm much more

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advantageous terms than today. Yeah you bring up some really interesting topics

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there Matt in relation to gold and in particular you know this this idea that gold can offset

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geopolitical events but really it's utility comes in the negative real interest rates and some wondering

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you know what the Fed funds futures almost unanimously saying that the Fed is going to be cutting

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rates soon this is set up for one of those dynamics where the Fed, as you pointed out in your annual

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letter missed an opportunity in 2021 maybe they make another mistake and inflation and wage rates are just

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too sticky. Yeah no it's it's such a great question you know I think we've seen a number of policy

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mistakes unfortunately over the last few years I mean I think the biggest of which was the second

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fiscal package because if you think back to the beginning of 2021 we'd already started rolling out the

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vaccine you know we had business confidence at or you recovered that's the time where you

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start to dial back the stimulus typically but we had a kind of trillion dollar type stimulus program

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and now we're in a fiscalian sustainable situation and then the Fed also changed its approach

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to say you know what we're not going to target inflation we're going to do average inflation rate

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timing so we're going to wait till we see inflation and what that meant is by the time inflation was upon us

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the genie was out of the bottle and they could no longer tap the brake it had to pull you know it had to pull

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the hand brake and so the Fed you know may now be just as a sort of missed inflation risk maybe missing

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financial stability risk the fact that we had a 40 year downtrend in policy rates and we've just

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broken out on the upside means that we're going to test the vulnerable points of the debt stack in the

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economy you know in the coming quarters of economic activity softens and so you know when you

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own something like gold which is a perpetual asset what matters is not just what's happening now but

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what happens on the next roll and it's interesting to me that you know gold had had some of a peak back

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in 2020 and it started to soften ahead of two year rates and Fed policy rates moving up so it's almost

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a gold market anticipated the need for a tightening and more recently the gold markets had a pretty

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fun bit to it and I think probably because of what you're saying that the Fed is going to force

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themselves into a tricky situation where we have a financial stability issue that means they have

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to ease policy ahead of solving the inflation problem or that we end up in a recession and there are pockets

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of debt vulnerability and they have to ease policy to address that and so I think gold might be sniffing out

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the prospect of lower real interest rates in the fact that even though the nominal level of interest

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rates went up this cycle quite a lot it's still below the year of the year rate of inflation

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and so if we get into worse state of the world from here rates could move into more deeply

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negative territory particularly if the sovereign debt dynamics are not that attractive you know it tends to

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be an element of financial repression used to solve sovereign debt problems and so I think the gold

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markets might be smelling something and you know if we look at the last couple of cycles gold typically

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hasn't peaked out until the forward curve for interest rates has troughed and I think we're probably

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some ways away from that we don't try to predict where it's going to go we're not smart enough to

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do that but I do think that the behavior of gold is telling us something about vulnerable is in the system

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and the final thing I'll mention is that and this is a hard thing to gauge but the dollar is let's say

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60% of world currency reserves there's a game changer when Russia made a Ukraine we sanction the

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ability of the Russians to access their dollar reserves and you have to think if you're a China or

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a Saudi Arabia or someone else who is a reserve accumulator are you less incentivized to acquire dollars

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as reserves now than you work before and so that's just a provocative question that's out there and

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we know from the world gold council that there's been more foreign central bank buying of gold in the

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last year than that has been for quite some time. These are great comments. There's one other

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question that I've always been curious about and I think this is really neat that you all do this.

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You own bullion but then you'll go and look at the miners as well and so there's a value

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investing play within that now I'm wondering just how you kind of go through that decision making process

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like what's more attractive than the others just valuation. You know it's a big question we and we we

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don't try too much but I guess how feeling is if we were going to hold gold in a

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vault we should be willing to hold it in the dirt via the miners if there's a margin of safety and price and

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and so our approach when we look at the gold miners is that we we look at the existing mine plans

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for those miners and we look at their cost structure and what the runoff value of those

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producing reserves would be a current spot prices and if we can get a meaningful discount in the public

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markets we'll take that and then we get the opportunity of their resource optionality at a very low price

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you know if prices go up resources that they have can be converted to producing reserves and so

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there's some incremental optionality that we hopefully get at low price through some of the miners and

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one of the things I would say is that there've been environments in the past where the miners were

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at a hedge on the potential hedge of gold such as the 1930s where Roosevelt compulsorily acquired gold

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and one way you could own it was through the miners and so there've been states of the world where

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the miners have ironically been a safe way to access gold. Yeah it's so interesting. Well first

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you go you're ahead of globe the global portfolio at first you go tell me your thoughts on the different

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regions of the world I think I read that currently you have about 50% in the United States but what

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do your thoughts on China and Europe and different areas of the world right now? Where are you seeing

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opportunities? Yes so we're right believe us in diversification. If you accept uncertainty

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as a fact of life it means that the tales of reality are going to be far better than what you would

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predict with a statistical distribution and that leads us to be open minded to diversify

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across industries and across the globe and so our portfolio has been quite balanced you know roughly

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half of our equity to being in the US as you point out and the other half have been outside the United

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States and the United States obviously have been a very strong equity market but the United States

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does not have a monopoly on good businesses and so it pays to be open minded to opportunities that you

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see outside the United States and so you know in Europe you know what's been appealing to us has been

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some of the consumer branded goods companies that really have very strong brands that have been around

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for a long time in many cases have strong emerging market footprints and that offer free cash flow

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yields that are closer to 6% than you know the 4% you get on similar companies in the United States

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you know what the other things that's interesting in Europe is there's a range of investment

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holding companies where again these are often stewed by families or founders where you know you

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can essentially get exposure to the stops that they own at a meaningful discount to the sum of the

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parts and so you can get a double discount through some of these holding companies and again it's harder to find

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these situations in the United States throughout Asia we see some interesting situations in Japan

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one of the areas that we've focused on over the years has been the factory automation space there've been

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some you know Japan has the world leaders in CNCs robotics, pneumatics, electrical sensors

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all the things that are needed to automate the factory of tomorrow and if we ever see a de-globalization

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of factory supply chains we're sure going to need the technology that resides in those Japanese companies

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you know in places like Latin America where valuations got quite depressed during COVID

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there's even though those economies can be wildly cyclical there are some very cash flow generative

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businesses that are quite stable, think of the brewing and beverages industry in Latin America and some

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of these companies have 60-70% market share positions where you know we were able to build positions

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of single-digit cash flow multiples and you know these are just very attractive businesses and the

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last thing I sort of mentioned in Europe is some of the luxury products companies over the years again

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Tiffany doesn't exist anymore it was acquired so my point being that one of the motivations for us to

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go overseas is not that we're making a tactical call on valuations albeit multiples are about a third

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lower overseas and currencies have been depressed versus the dollar but it's for the simple reason that

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as business collectors there are some great businesses outside the United States and yeah I guess we have

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a lot of institutional memory having been invested globally since the late 70s is an organization.

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It brings up a really interesting question to me at least Matt. I completely understand what you're

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saying with the bottom-up analysis and but at the same time I also thinking that you guys are

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also finally tuned into risk and I would assume that includes geopolitical of course.

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Where do you kind of draw the line in terms of well that's more institutional risk and I want to take in

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terms of things like property rights and some of these other factors that are more difficult for

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an analyst or bottom-up analyst to see where do they filter into your picture? I like just for

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instance like China and some of the... It is a great question. We had no direct

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investments in Russia for example you know in in the strategies that we've discussed today

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and I think that's a reflection of some concerns around things like property rights and China's been

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a little more complex and nuanced because it is so much larger than Russia and I think one of the

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things that's been interesting about China is that because of the geopolitics it's been marching

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to a very different business cycle than the United States. The Chinese market was going down and

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we were having the bubble that we were talking about and so you know we have seen you know one or two

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opportunities over the years in like for example a Hong Kong property holding list of property

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holding companies where the holding companies trade at very large discounts to the private market

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valuations of the underlying real estate and typically hold much less leverage than say a REIT[NM14] in the

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United States you know we've also seen some opportunities for there's one holding company we own

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in Europe that owns a stake in a Chinese company that is a very strong underlying business and

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the valuation margin of safety is wide and the European company is doing a stock repurchase and so

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you know you have these situations where you feel there's enough of a margin of safety and price

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to make an investment you know we've had some investments in Taiwan over the years and so you know

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I think the reality is that you cannot avoid all geopolitical risk in that as we sort of started

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this conversation earlier on unfortunately there's sovereign and geopolitical risk in the United

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States as well and so part of our solution is just to be diversified[NM15] there are some markets we haven't

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gone into as discussed otherwise it's to be diversified to have a margin of safety and price and to look at

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the underlying business character and the history of management doing rational things with the cash flow

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yeah well it is you have so many similarities to first of all has so many similarities to John

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Templeton's philosophy on investing which is global in nature and I've heard you talk a lot about

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the mistakes of temperament and how important it is to exercise patience, humility and flexibility

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I see that so much and then investment philosophy at First Eagle you can see the patience,

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the humility, the flexibility built into the strategy do you have any tips or comments for investors

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and cultivating that right temperament? Well I think you know I would just make the point that when it

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comes to investing I think to be a whole investor there's an analytical toolkit you need but the

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temperament needs to be weighed against that I remember when I went to Egypt at the end of 2019

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and I took the family through some some pyramids and some tombs and things like this and

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there was interesting hieroglyphics where they weigh the heart against a feather to determine the

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soul. Humility stems from just recognition of uncertainty and I think in some ways you know

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people come to investors they're like well we want you to have the crystal ball we want you to tell

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exact what's going to happen in the world but it's it's far more powerful to accept that you don't know

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for sure because you end up investing in each situation with more of a margin of safety you expose yourself

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to a wider sea of opportunities and the consequences of making a mistake are more absorbable

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if you have an error tolerance approach and so just accepting it is really important and I

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take the same thing on patience you know I think back to the gardening discussion we were having it earlier today

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that you know there were many things that my mother planted that took many years to come to fruition

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but it was worth the weight and a lot of good things in life take time I mean you know great artists

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is only often recognized a generation or two after they painted their work and it survived the test of time

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and in investing to us the most predictable sources of outperformance in a world that's largely unpredictable

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and things to take time to play out like for valuation discounts to correct it's a passage of

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years if you've got a really strong business that can generate more free cash flow that accretes slowly

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to your benefit over years if management are doing sensible things with that cash flow the benefits of

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that tend to accretes slowly over time and ironically when people look for rapid growth or they're often

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in industries that are characterized by rapid change and your ability to be certain of what a company

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will be worth in five or seven years time is often lower in those industries with rapid change and so

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you know we think temperament is incredibly important we want to surround ourselves at First Eagle

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even with people with smart and nice and willing to sort of think long term yeah I've heard

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you come in a lot about that long term focus and avoiding short-term thinking and that has been

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a bit unusual in this past market over the past decade I feel like investors are getting more short

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term in their thinking and that benefits will accrue to having a long-term

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investing time horizon. What is your investment time horizon? Well if you look at our portfolio's turnover it's just a

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little bit above 10% so if you invert that it implies that we have about a decade horizon which is

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longer than most private equity investing there are a number of investments we've held for a decade so

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it's it's truly long term in nature and I think that's a distinguishing feature of the way we invest and I

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think it it's clarifying for people to know that if they're going to invest they're going to own something

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for the long term and it makes you think twice about the kind of business you want to put money into

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and the price point which you want to do that and and I'm a great believer that there should be

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aggressive reflection but only selective action in portfolio management and I think what I see a lot

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out in the marketplace is aggressive action and selective reflection and so that's the the paradox of the

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investing world and so what are you how does that work in at First Eagle as a portfolio manager are

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you making investment decisions or you sitting down with a committee or talking about different stocks you have

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about a hundred stocks in the portfolio and global universe so probably the MSCI[NM16] equity would be your

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universe yes so if you if you think about First Eagle, one of the secrets of First Eagle is

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there's really a team of teams as opposed to you know being about anyone individual and if you look at

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each of our strategies there tends to be you know two to four portfolio managers sometimes they're a little

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bit more on the strategy and and we don't divide up the portfolios between the portfolio managers

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but what we've done is with intentionality we've we've typically had thought of the job of managing

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portfolios as kind of a partnership exercise where you acknowledge as a portfolio manager that no one

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on the team has them are not fully on the truth and and you know it encourages a very sort of open

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discussion of ideas before we we make them and to be extent that one person on the team is not comfortable

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with an investment we tend to be to that more conservative perspective so it's a high hurdle for an

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idea to come into the portfolios and if we've owned something for five or ten years and one of the

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portfolio managers starts to be wary again we tend to sort of be to that perspective so it tends to be a

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lower hurdle to exit the purpose of having teams of the portfolio managers is to make sure that we're

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allocating capital prudently and to make sure that we're really stewarding a philosophy and an approach

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as opposed to relying on the pressience of any single individual to pick stocks. What are the other aspects

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of your sell discipline? I mean you just commented on it a little bit that if somebody is weary but

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I'll almost find that it's more worrisome if no one has any concerns about any of the

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positions how do you make that sell decision? It's a great question in fact one of the things

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that always provides me with discomfort is when someone says what are your favorite ideas and I say well I

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am just every idea has its imperfections and I think it's important to understand that when you invest

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that every idea has ways that it can go wrong and so just thinking through the ways in which things

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could go wrong is a good place to start. In terms of the sell discipline one of the paradox of our

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business as well and it's often hardest to sell something when it's most expensive because in the revision mirror

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the business is likely performed very well. Revenue is might have exceeded expectations,

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margins might have gone up, management might have done a few smart things and people feel good

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about the business but as an objective check will sometimes stand back and we'll say look at the

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20 year cumulative log returns of a star pool. We'll look at where the enterprise value of that business has

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been relative to revenues over the last couple of decades and if we're really at a high point

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it's a good point to reassess have we lost our valuation margin of safety should be at least shrinking

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this position and then the other kind of difficult thing about selling is that if something hasn't

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worked out usually the market has derated the security so you're in this sort of angst quadrant where

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the business is not as good as you thought it was but the price is lower so what do you do and

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one of the problems in more concentrated portfolios is people tend to sort of double down because they

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have behavioral commitment to their concentrated portfolio it's one of the things we're very conscious

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of not doing it First Eagle is not just reflexively doubling down and it's stopped it's down

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we really like to sort of ask ourselves is there something about the market position that's subject to

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fade at the moment or is there something about management's behavior that's highly likely to

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guide with us? One question I just to follow up on that Matt is how do you determine like let's just say

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3% position from a 1% do they start at the same size or do you have more conviction and some versus others?

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You know it's position sizing is a really important discussion here at First Eagle we you know

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in fact I had a meeting with the other portfolio manager over the last week where we sort of talked about

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Let's continue to think through our philosophy of position sizing and if I could sort of summarize it

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you know it's a combination of the investing arithmetic you know the margin of safety and price but also

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the degree to which we are comfortable that we fully understand the business's prospects

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and so it's not just alpha[NM17] it's it's a certainty equivalent that that matters and so one of the

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mistakes that investors often make is that they'll have huge ratings and stocks they think

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are a big discount or have large growth prospects but they may not have paid as much attention to

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the stability of the business and and so for for us for a position to be a decent size a tends to need

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both a valuation of safety and a degree of entrenchment that we feel comfortable with or a

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competency that gives us the sense that the business is going to have a clear terminal value in five or

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00:51:13,080 --> 00:51:22,040

ten years time that makes a lot of sense yeah well I guess my last question for you would just be

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what's keeping you up at night right now, what are what should investors be

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most worried about right now I would ask about the opportunities but I think you're going to say that

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international markets present opportunities we've already commented on that a little bit

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00:51:40,040 --> 00:51:47,480

what's keeping you up at night Matt? What's keeping me up at night is some of the fiscal and sovereign

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debt issues that it costs you know earlier in the podcast the fact that we're you know we're running

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the sort of deficits we are at the peak of the economic cycle you know worries me because if there's

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00:52:01,240 --> 00:52:08,920

not a credible fiscal outlook then that internal affects inflation expectations long term and it

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increases the risk of us entering into a window that's that's more stagnationary in nature and

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the 1970s was not a pretty period for investing and so you know and we've we've there's not a lot of

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political will on either side of the spectrum here to address fiscal challenges and and

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that's the case sometimes markets force the issue and and so that's just one thing that's

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back in my reflections right now you know we try to invest in a way such that those sorts of worries

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don't keep us up at night but at the end of the day you know if the asset that's seen as

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00:52:59,480 --> 00:53:08,360

risk free is all of a sudden not seen as risk free that upends a lot of things in markets and and so

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let's hope it doesn't come to pass but you ask me the questions I'm answering on this

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thank you I really appreciate your time today and where can investors who have an interest in

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00:53:22,760 --> 00:53:29,320

First Eagle go to learn more about your company your strategies or read your annual letter

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00:53:29,320 --> 00:53:37,560

I think it's pretty much all available on the website for the website and you know obviously

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00:53:37,560 --> 00:53:43,960

you know if investors are dealing with their own wealth advisors there wealth advisors probably

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have access to a range of different resources as I would relate to First Eagle but you know I will say

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that if I look at the team members of First Eagle one thing that characterised the team members is they'd

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largely bought into our investment philosophy before even joining and and I noticed at about

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00:54:02,520 --> 00:54:11,720

our clients too that you know it's always a source source of joy for me in some ways when I get to meet

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with clients and many of whom have been invested with us for decades and they've really sort of

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internalized the mindset and and I think if you if you have that amongst your employees and your customers

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you know hopefully you create a business that has sustainability as well yeah well we've enjoyed being

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00:54:32,360 --> 00:54:38,280

at First Eagle investor and big believer and everything you do and really appreciate the time you've

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spent with us today and I know our listeners will enjoy learning more about your strategy in your

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thoughts on global markets so thank you Matt thank you so much for giving me the opportunity.

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00:54:48,120 --> 00:54:54,120

to have the discussion I've enjoyed the two and fro and look forward to seeing you both soon.

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00:54:54,120 --> 00:55:02,680

Thank you for listening to investing the Templeton Way please be sure to subscribe on your favorite podcast

534

00:55:02,680 --> 00:55:10,520

player to view the show notes and resources mentioned in today's show head to

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00:55:10,520 --> 00:55:20,920

InvestingtheTempletonWay.com

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20: Global Investing Strategies for Uncertain times with Matthew McLennan

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