Turning Over 70,000 Rocks

Hey folks, just a reminder that I continue to remove shows from the public podcast feed and I am putting those episodes behind the paywall on Substack. So if you have been binging the archive and it seems like stuff is missing, the way to get those older episodes is to become a premium subscriber. Then if you just search the word archive in the risk of ruin Substack feed, you'll be able to find the rest of the back catalog. Anyway, just wanted to mention that and I hope you enjoyed this episode. Yeah, but I think there are some investors and I think maybe it's just a bias in all of us that sometimes you start to research a stock and you almost get comfortable with it and you learn more and more about it and you start to become more comfortable and expert in it. And you do want to have a high level of knowledge and expertise and a very large deep dive into the next that you hold. But then it becomes hard to sell a stock that you've sunk all that time and cost into. So you may have spent months researching a stock, something happens and some reason we have to sell it. But you feel reluctant because you just spent so much time looking at a stock, you're very familiar with it, you may have talked to the management, talked to other people on social media about it and they kind of, you're known as the person either found it or talks a lot about this stock, that's a dangerous place to be and I think because then you're that guy that owns that stock. And then what happens the next day when you want to sell it, then you have to change that as quickly as you can. You're listening to Risk of Ruin. I'm John Reader. This is episode 49. Turning over rocks. So a little bit of a disclaimer or perhaps a warning as we start this episode. Okay, the mission of this podcast is to find interesting people who are doing off consensus things with regards to risk and then talk to them. See how they think, see why they decided to pursue their own path. As it relates to financial markets, I will stipulate that the widely accepted thing to do would be to, as they say, index and chill, find a low fee instrument that does a good job of tracking market returns, then set it and forget it. And then you can trick yourself into thinking you can pick stocks slash beat the market, then just end up underperforming due to trading costs, dumb tax mistakes and the other byproducts of overconfidence. I think this idea to just index is terrific advice that will help almost everyone that comes into contact with it. And also there will never be an episode of this podcast with the title index and chill. Again, this show is explicitly about the off consensus, which means we are going to talk to people whose views are at least in some small way dangerous. If you hear from an investment manager whose job is to beat the index, they don't have much hope to do that if they just mirror the thing they're trying to beat. That is axiomatic. So that is the first bit of business. The second thing is about a relationship to the guests. All right, my intent with the show is not to have any kind of quasi-taught service, which is selling either individual stocks or investment managers. That individual stock thing is usually pretty easy since I asked guests about trades that are historical. There's not even really a chance for listeners to follow the idea. I think on the rare occasion where a guest has mentioned an active holding, I try to say, "Hey, by the time this episode comes out, you will have no idea whether this guy still owns this stock." But for the managers, it is a little more complicated. We're kind of making a bargain, right? The managers usually are interested in increasing their profile because one way they make money is by managing more total money. These are busy people who have better things to do than answer my meandering questions, but they come on the podcast because they think it probably can't hurt their business. That's just a realistic and fair thing to admit. But I don't have any money with any manager that has appeared on the show. And the reason is that my outlook is the same one that underpins the strategy behind the show. I want to hear how these people think about what they're doing. But I want to adopt the stuff that I find useful and try my hand at implementing the ideas on my own. Now that might have been a lot of throat clearing to get to the real point, which is this. The guest for this episode has put up some chunky returns, like in the ballpark of 40% annually since 2019. I think that could end up sounding very attractive. But none of this is investment advice to either put money with his fund or buy any individual stock he talks about. You should do your own research and take responsibility for your own financial future. Consult a professional or read a book. Okay, this is Andrew Martin, a fair light capital. He has a PhD in astrophysics, which you could hear that and think, okay, this episode is going to be about some finance thing, right? Except no, he is a small cap value investor. Again, it's one of those specialism things that by the time you get to an end of the PhD you're supposed to know something, it's novel that nobody else is thought of. So again, maybe there's that kind of spark that kind of helps with investing as well that you have that confidence by the end of your PhD or the only person that has come up with XYZ ID and it might be a big or a small idea. But there's nobody else in the world who's kind of dead out exactly the way you've done it. It has to be like a novel idea, same with investment, I guess, that by the time you've finished all your analysis, you may be one other handful of people who truly are really understanding this idea as much as you do. Sometimes you know, they're more people, but yeah, and then you've got to have the confidence to talk about it and invest in that. Below you were saying, knowing that other people have reject to the idea, the stock is cheap. So why is it cheap? You need to understand why and you kind of do that analysis. I think, yeah, the kind of PhD I did is what was very kind of technical. So that kind of helps with any aspects in any financial analysis you have to do. There's some coding sometimes, you know, to keep it like AI at the moment. This stuff you have to do around that. So it's kind of helps with all those kind of skills as well. I think of the idea of value investing as being like you can see the market and you can admit that in the vast, vast majority of the instances, prices are probably pretty close to fair or at least the prices are off. It's debatable or marginal. But then you keep noticing rare anomalies or things that shouldn't exist if prices are correct. So I think, yeah, one of the first ideas that families of Bank of America in 2011, that stock everybody had heard of, that kind of stumbled across a writer by Bruce Birkowitz, who was doing this big presentation about, you know, this is a crazily cheap large bank in the US and it was post credit crunch, posted to global financial crisis, you know, 2011, so that started to be resolved. But Bank of America still had a lot of problems. So they were being sued by the US government. They still had a lot of residential losses coming through. But when you went through their financials, and this is something anybody could do, you could see that they're essentially five businesses that they ran, like cards, retail banking, investment banking, those are very profitable businesses. And so if you kind of looked through eventually the legal case was going to get settled, I didn't think the US government was going to bankrupt a company called Bank of America. And eventually the residential mortgage losses would kind of tail away and you'd actually have a very profitable business. At that point, you could buy Bank of America from between three and four times earnings, kind of crazily cheap. It was just because other time people thought it was going to be essentially run out of business over the next two years, kind of an incredible thing. But that didn't happen. And the stock re-rated multiple times. And then I guess saying I started to look before and after that, just smaller stocks as well, just to see if there are other ideas out there of things that are even more obscure. If a bank of America idea can be that cheap, then there's even smaller cap stocks would be even cheaper, better investments. When Andrew says that the idea was to look for companies smaller than Bank of America, he means it as in he regularly invests in stuff with market caps of $50 million. At the top of the show, I said that the dominant financial advice is to get exposure to the market through a low-cost index fund. If you do that, you'll be pretty heavily weighted to the largest companies in the world, which have market caps of $1 trillion. So these mega caps are each about 20,000 times the size of the company's Andrew buys. So just a completely different world. Actually, lots of funds can't even buy the companies that Andrew owns because of various rules on size or whether the stock trades on the right exchange. Okay, but Fairlight can buy them because Fairlight is also small. Yeah, we started off super tiny. So we're just a little bit under $8 million AUM of the money, but yeah, we'll grind pretty quickly. I have to continue that. At the outset, Andrew's firm wasn't so much a fund as they were an idea to prove that the small cap, deep value ideas could work. There's less than that. It was a few hundred thousand dollars. So yeah, we were just crazy small. Just started off with the process that we developed just to see how that went for the first few years. Obviously, the returns were pretty good. They've kind of stayed good as we've grown. A lot of people say as you grow, the returns will change, but we're still small enough that I think they can still put out really good returns. Hopefully that will continue until, you know, hopefully beyond a hundred million AUM, you know, up to a billion or something like that. The way that I found Andrew is that I check the subreddit for security analysis because each quarter they have a thread that catalogs hedge fund investor letters. I like to read these things because they're going to be very, very, very, very, very, very, give some sense as to market mood. They also might have long or short cases for individual stocks. I mean, you might get something like one manager promoting micro strategy in the same quarter that another manager details their short case. And I like to compare those to see which I find more credible. Also, sometimes they might discuss stocks I'm already in, including information I missed. Okay, well, and going through the letters, I noticed a couple things about Fairlight Capital. One was that I had never heard of a single stock mentioned in any of their letters. The other was that they kept talking about their method for finding these stocks, which they referred to as A to Z as in literally just go through the stocks one by one. The universe of stocks, I guess we can look at is in the region of probably 70,000 different companies, which is obviously a huge number to try and go through. So we kind of break it down into different countries and different exchanges. So I might look at saying the Singapore exchange over a period of a couple of weeks. And then I might get back to look at say the OTC markets in the US, sort of like the European exchange. So I kind of go A to Z or it isn't actually A to Z. It's kind of a random order. Usually that comes out of whichever database you're pulling the the ticker's and the business names out of. Yeah, and just literally look at through them one by one. And as you're saying, particularly in foreign jurisdictions, foreign exchanges, there'll be some filings are in English, some aren't. So it's got a lot easier with AI and those kinds of tools that you can do that a lot more easily. But it was very difficult. So three or four years even ago that you couldn't just put it into an LLM or some kind of translation piece of software. But now you can put in a whole 10k and then a few seconds or a minute or two, you can get a really good translation or translate the tables, data tables used to be difficult, the text of what's being said in there. I think it does, you know, as far as you, you know, what could tell it does a really good translation. So that's a very kind of easy process compared to how it used to be. And then looking at the actual figures themselves you write, we have to kind of standardize those. The main thing you have to be careful about is just in terms of the financial reporting versus the currency of the exchange itself. So you might have, I was saying mining company or oil company, so probably a better example where they're actually reporting in dollars, but they're actually in a foreign currency, you know, maybe in euros again or where it is. So you have to do those, you know, obviously have to do those translations, just make sure everything marries up. So there's a few extra steps, but yeah, really it's just going through, you know, pick an exchange, you know, it might be hundreds of names or thousands of names. You have to kind of just, you know, brute force go through it, you know, and I've tried using filters and screeners and things like that. And I think that can help accelerate the process sometimes. But I think the heavier the screeners and filters, the put on the, the more that you are, can actually kind of filter out real stuff and good stuff. So at the most, you know, I might filter on size, but if you start filtering on things like PEs or net income or whatever it is, you're going to filter out something that might actually be a good idea that a rough P calculation for a database is kind of mangled the numbers and see not seeing what the true pictures of a business. So if kind of I think go to the raw data itself and get through one by one. When you find what you think is an idea and this could be anything like stocks or sports or whatever, but an idea that you're excited about, one of the first things you have to do is understand how this thing could still exist. Why hasn't someone else come along and bid all of the value out of it? The best ideas we find don't have any analyst coverage or maybe one or two occasionally if they're a bit bigger. But I think that problem was probably, maybe I'm kind of misrememberable, but worse a few years ago than it is now there's it seems like there's kind of an army of investors out there, smaller investors and people post on things like sub stack and on X and other different social media platforms about the ideas that are finding. So there's other people kind of how they're trying to find stuff. And I think it's almost the opposite that when you find an obscure idea, I think there's probably maybe 50/50 you have a look through social media and you find somebody else has also found it and then you'll see other people's objections to it and what they don't like about it and that kind of fills in those gaps. So that's maybe not as difficult as it was, but there are 50% where there'll be nobody looking at it, which then is good in another way because you know there is nobody else looking at it and it could be misfounded just because people haven't found it. And we find things like that kind of all the time just still it's kind of incredible really with the data availability and MLMs and all the tools right there to search for things that they're still stocks out there where people just haven't looked at them or haven't talked about them and maybe they have looked at them and they've discounted them. And I think yeah, to kind of get around all of that, you've got to make sure you know as much about the business as possible so you know about the management, their history, how they've come to fraud, have they done anything that's you know, again shareholders interests so if they issued lots of stock or you know they've indebted the company or all those kind of bad things you don't want. So you look at kind of the management behavior and get over those elements to the investment idea and then the business that's up, fun to stand up to businesses, what it does and usually as you kind of go through all of that analysis it becomes more obvious I think why it's cheap and I think yeah, before you invest you probably need to have a really good idea why it's cheap. You know and maybe it is like you're saying there's like some new patent or a piece of IP or something or a contract that's been awarded that hasn't kind of become widely known or there's some kind of negative sentiment around the stock like a legal challenge or something that's going to maybe go away or maybe not go away but you kind of need to understand where the company sits and why it's cheap. Yeah and there's always kind of reasons around that and then that has to kind of become part of your thesis I think of why you do all your dent belief, what other people are saying about the stock you say they're wrong for X, what we said recently you have to kind of go through that whole process of yeah understanding why and I think it isn't always that simple most of the time it seems like it's quite complex to go through that process and understand why other people are liking the stock that you've found. I always think it helps to be specific so if you want an example of the kinds of companies Andrew is buying here's one. Sraabi Gold is a junior gold miner with production in Brazil who stock trades in London you probably know that the price of gold has more than doubled since the start of 2024 okay well in addition to that Sraabi has increased their production from 33,000 ounces to 44,000 ounces over roughly the same time so better unit prices and more of it. Also Fairlight had bought Sraabi so cheaply that even after the stock had run up by a lot it still had a very high free cash flow yield. Yeah the junior gold miners worked out very well for us because again I was turning over rocks looking at lots of different stocks and again like you're saying a macro theme came out but again and again junior gold miners kept popping out of me of being really cheap. Kareem Kareem quickly some of them and the gold price was just seem to be going in one direction. Yeah and then looking at that from our perspective you know what I was able to kind of look at it and say well even if the gold price right now and if it fell 10 to 100% this would still be very cheap stock. You know you found a couple like that where outside of the gold thesis price part of it that they were growing anyway they were growing their production and the amount of answers of gold that they produce it. So that was still seeking to do wealth them over the next couple years and those yeah I think one of those investments went up six times for us which is no incredible return for us and so yeah that really helped last year for example. So I think that's one where you know I've not a series sold at exactly in right time or selling them down but it was one of those ideas I think when you get in at the right time you have a good idea of the thesis it's almost impossible to sell incorrectly because you've made no good amount of money even if you don't sell at the exact top. My perception of small cats was that they would kind of fit into a number of different buckets all of which would make them hard to invest in like I assume that you'd have a lot of just essentially stock promotion schemes right a huxer somehow gets control of a small public company. Hires an army of internet touts to pump the stock and then the real business is just dumping on over-gradulous retail investors and maybe there is some of that out there but not enough to keep Andrew from finding good companies and then the other kind of business that I assumed would make up a large portion of what's left would be just boring stuff that doesn't have any kind of special anything and doesn't grow or you know once large companies that are now just a husk but Andrew says that's not right there are lots of businesses that might have something compelling once you start to dig like a food process company that had a method for turning essentially excess waste produce into snacks or a company that might have a small slice of the AI boom. Yeah I think some market caps are boring businesses that I think all of them are and it's there are some yeah companies are the one you mentioned that maybe stand out a little bit because they're doing something that's very unique unique and you think is going to work really well so that's obviously good things fine but we found other ideas where there'll be a tech stock there's doing something kind of extraordinary and there was one earlier in the year and it just happened to be in this subsector of the technical world but it had been doing that business for decades and it just so happens that it was cooling chips so GPU cooling is obviously very important now so it does it in the same way as some patents and IP that it protects and it just so happens now it's in the exact sweet spot for this type of technology and it seems to be growing really quickly so you get lots of different odd little businesses that sometimes have been there for years sometimes they made a pivot or an inflection which is kind of what we're looking for in a lot of the time a lot of the businesses might be only a few years old they've just set up. and for whatever reasons, they haven't got much VC money or the founders put money in and is setting up that way. Yeah, so I think there's all kinds of different businesses. Maybe we've gone through a period of investment or a lot of boring, sanding businesses, but yeah, you do get a lot of interesting stuff out there as well. Even though Andrew goes through stocks one by one, some of them can be rolled out quickly. Others take more time to roll out and then what's left are probably the good ones. Some stocks you look at, maybe it's a biotech that has no revenue and has loads of debt, or it's burning through its cash pile or something like that. You can roll that out straight away. We don't invest in those kind of things. I don't have much of an expertise or no expertise in biotechs or pharmaceuticals. So you can roll those out quite quickly. There's a lot of ideas that you can roll out quite quickly. But then there'll be somewhere they do look more interesting and they're profitable, maybe growing. Then you have to do more work. So it's kind of a process of elimination, really rolling out ideas, doing more work until you can roll them out. So it's almost like I'm looking at everything and trying to roll it out rather than trying to find that long great investment. So I kind of think of it that that. Got to try and roll out every idea and eventually get to the point where I can't roll this out idea out. It's actually a good idea. And by that time, you need to have done the full analysis and built. You know, there are simple, complex multi-dependent on the type of businesses. One of the things that's kind of funny to think about is that when you find a deep value name, you're going to be super stoked about it, right? Like, look at this thing I found that is selling for a fraction of what it's worth. But now think about that same thing from the perspective of the company. They're not going to be so enthused about being a deep value name. In fact, if that happens, it means something has gone terribly wrong because the story they've been telling hasn't created many converts to their cause. So you get these situations where executives are almost exasperated that no one has noticed, that things are going well. Maybe they throw their hands up and say, fine, if no one wants to buy our shares, I guess we'll just have to buy a bunch of them. Sometimes not always, but sometimes that can be a signal for Andrew. It's almost like, given this hypothesis, what would we expect the evidence to look like? I usually find them through my own research, but then once you start reading the filings, hopefully, hopefully you see those kinds of signs. I actually think I found on today, but let's buy the buy. What you expect to see if the company is doing really well and the filings, let's say, are nonsense. They are usually buying backstock, sometimes through the company itself or even personally as well. So sometimes you'll see where both of those things are happening, and the management is repeatedly putting out by the press releases or they put it in their filings, or they call to filings and the management discussions that we are undervalued, we are buying backstock. Here's a new buyback regime. We're going to be trying to buy back as much stock as we possibly can. When you see all those things, those are obviously very good indicators that the numbers you are seeing are very likely to be real because the management is also putting their own money behind it, unless they're behaving in a very, very irrational way. That's usually a very good sign. So those are all the kinds of things that you see when that's happening. Sometimes you find a stock that is very cheap and certain jurisdictions where the manager won't be buying it back, and it's not necessarily a negative signal, it's just that for whatever reasons, maybe the already own a good chunk of the company, either the company's out there, inside his own like 50-60% they're actually selling down to, as they put it, liguity and stock. But there's obviously they've got so much invested in the business already that they don't want to put even more money of their own into its unsustainable. But yeah, those are the kinds of signs that you're looking for. There's a lot of buybacks and places, usually a good sign. I asked Andrew, between having an ability to reason through every company's business prospects, sort of from the ground up, or just seeing a lot of company situations play out, i.e. getting in a lot of reps, which is more important. He said basically, reps are so important that he thinks young investors should maybe start off over-diversifying just so they get the experience of looking at what of situations. Yeah, I think the reasoning bar is important, like you need to have a good level of ability just to be able to do that from scratch. But I think experience is incredibly important. Like, yeah, the more I do this, the more I realize how important that is, that it's almost like your brain is now LLM and you're training it by just doing this process. I think if you're never together, like you say that you're looking at financials and filings and you're seeing the outcomes, and that's the thing, I think that's very important as well, but I'm trying to focus a lot on the outcomes. So I know a lot of some investors have heard, or are used to do it also myself, will look at investment, and maybe you do invest in it, you don't invest in it, but maybe it's one that you sell for various reasons. I think it's good to keep tracking that just to see that kind of data point. I sold this year ago, what's happened since it got up, it's gone down, it's gone sideways, was I right to sell it? I think that's very important, to feed that into your training of yourself. Because obviously you're going to be tracking everything, you do end, so you're going to know whether those go up and down, but things that you've rejected or close near misses, that looks good to look at those as well. Yeah, and I kind of helps to learn the patterns and learn what it is you're looking for, and you've obviously got some kind of overarching guidance of what it is you're looking for, whether it's cheapness or growth, or your own kind of flavor investment, but feeding the results into the end point of your methodology and your process, and it's really important to just kind of keep doing that, it's relatively over and over again, and you just can't do too much, really, just do that as much as you possibly can. To the point where I think I don't know, maybe for younger investors or people are just starting out, trying to invest a lot, so maybe even have much lower concentrations to start off with, because then you're looking at a lot of different stuff, if you can, because there's just volume brute force, could pay that too, I think. One of our previous guests, John Hempton, said that if all you do is listen to the things that companies say about themselves, then every stock is along. So how do you tease out which companies are actually good investments, and which ones are BS? One thing that we do try to do as much as you can is once I've gone through all my research, I try and speak to the companies, I speak to the, ideally the CEO or somebody in the senior management, and if not that, then you end up talking to the investor relations person, but hopefully you're talking to senior management, and then you start to get a good feel of how they behave, are they overly promotional? Sometimes that's kind of obvious when you speak to them. Are they just being very measured about their business? I mean, the thing that kind of always strikes me as, aside from the level of intelligence, or that somebody has, it's the level of experience, I'm always kind of struck, that we're looking at lots of different types of businesses, whether it's technology, cement, whatever it is, you learn a huge amount from somebody, and usually just like a half hour call about their business, there's usually several facts that they'll kind of throw at you that just come and knowledge to them because they've been more keen at business for decades, and you may have been looking over mud and seeing not aware of those particular drivers to the business or things that are involved in their business. So I think those things are kind of struck me, and you kind of get a feeling I think that, yeah, if there's a CEO who's very promotional, he's kind of almost trying to sell the business to you too much, then that throws up some amber flags, perhaps. But if you've got a kind of more, not relaxed, but more kind of measured CEOs, just talking to you about the business, giving you use information, and answering your questions in the careful way, then that's obviously a very good sign. But you know, you obviously can't tell every single time whether somebody's going to be good as a manager for you as a shareholder, but again, then you have to look to the history. So what have they done in the recent past and they've been buying batches or as she shares or how have they managed the business? Often it's on the capital allocation side, you can kind of see their behaviors. And how they talk to share owners as well. I mean, you get some management I've heard on earnings calls where they're just very openly outright rude to some of the people asking very reasonable questions, and that's usually a very, very strong rent flag. You know, you see that in big and small companies. So yeah, you can never be 100% sure, maybe you get a cent clue, Zach, as you talk to them. Now, maybe either the golden era of investing in a universe of 70,000 small caps or the beginning of the end, you know, sort of depending how things go with AI. For now, the AI tools are helping Andrew a lot. Fairlight is a tiny firm, but they can build the tools to cover things as if they have a much larger staff. Yeah, we've built a few things, actually. Yeah, some of them are more, the most useful ones are just pull out information. Yeah, they're really kind of quick and easy way. That's kind of the most helpful thing. Then on the flip side, yeah, the AI, LLN world with agents, that's, you know, three of some interesting ways you can look at investments. So we started to do some, you know, bidding experimentation with that a lot over the last 12 months or so. So yeah, there's been sort of, say coding or vibe coding around that. Yeah, it kind of comes back to the kind of manual brute force versus the filters that I think AI is probably better than filters in a lot of ways, but you still have to be careful that an AI is going to look at the world in a certain way and you kind of train it to look at the world the way you do. But that's always, yeah, it can be one removed from yourself. Yeah, trying to build quite a few different tools that kind of speed up the process because yeah, with 70,000 stocks, you've got a lot to look at. So anything we can use to kind of help that along. If you ask Claude, you know, here's an iron or mining company had quartered in Singapore, is this a good investment, making no mistakes? So one of the problems with that is going to be that large language models are models, right? Their objective is to get to the most likely answer based on their training data. And yet, a truism about markets is that in order to generate access returns, you need ideas that aren't obvious. Asking about that was trained to generate almost the middle of the distribution. to find you something that can be extraordinary is maybe not very realistic. But obviously AI tools have been rapidly adopted by market participants, and that's probably accelerated a lot just in the last three months. Yeah, you can't just write out there and say, "Find me a portfolio of really great stocks that fit our criteria because it'll come back with lots of things that kind of middle of the road and it doesn't quite address what it is you're looking for. But it can kind of be used in a cumulative ways, I think that you can kind of use it to filter things out. So in a way, you can kind of use it as a screener. So you're looking for something that's cheap, growing, just give me a whole bunch of these and give it very light criteria. So it's not kind of filtering things out. I'm not really asking it to do all the analysis and give me the fully fledged idea because it will struggle that. But you can kind of to some extent by saying, giving it very stringent criteria. So it's not just a few cents and two products. You can give it quite detailed prompt instructions for a specific. There's some metrics we use that you can feed into it. And then it's probably quite good at, you know, it is quite good at doing those kinds of things. These are the metrics. We look at fine things that are broadly within this sphere of behavior of a kind of stock and give me all the ideas and maybe write a couple of cents as some why you think it fits within our criteria. And it's quite good in terms of also pulling out a lot of information as well. I'll pull out a lot of recent use filings. And so it's quite good at then kind of building that on top of the numerical side of it as well. But yeah, really it's the best I think is kind of for us the way we work. A kind of glorified screen or a filter those around a bunch of ideas. You still have to go through manually. It's not going to give you the kind of finished product. But it might occasionally throw at something interesting. This all sounds terrific. But at risk of being a Debbie Downer, I can also see the inverse problem, which is, what if your original edge was being willing to go through tens of thousands of stocks when no one else had the patience for it? Then aren't LLMs going to make it possible for more people to endure the brain damage involved? It might help people do all that analysis. But I think it's that thing of the final step of the LLMs giving you maybe a different kind of filter. Oh, but it's still a kind of average. It doesn't look at the world in the way that we do. It won't give us those ideas. And I think one of the things I have to be careful of is being biased by that as well. That an LLM will give you an opinion, which is something sometimes I haven't won from it. And I have to try and ignore that opinion that I may disagree with what it's saying because of other experience I've got. Or a different way of looking at the world, like you say, that you have to kind of ignore. But I'm hopeful, and I think what will end up happening is that it's just an additional tool that helps you turn over rocks. But it's ultimately the final analysis thesis, the kind of patterns you're looking for, but will differentiate people. And I think that'll still continue to happen. I asked Andrew what things he sees other investors doing that he finds challenging. And he says that he has no real talent for being able to make macro forecasts. He's just too focused on these individual companies. Although he is able to pick out some macro trends because he's in the weeds with all these companies. One of the things he noticed was what he called the hidden recession. The managers of lots of diverse companies were reporting headwinds, even while the AI boom was in full effect. And it just struck me there was a pattern over lots and lots of different companies in different sectors and different countries that they weren't doing as well as they were a year or two ago. But then you turn on CNBC or some other news channel and everybody's talking about how the economy's booming, GDP was growing. And there's an AI tech boom, love it. Money flowing into that sector just struck me as very different to what I was seeing. In the case you see that in a company that there was a company doing really well. But it was almost like you could look at the revenue picture and you'd know whether it was tech stock or not. And it was very striking that all these more boring companies, whether they were the banks or real estate or whatever it is or healthcare in some cases, they just weren't doing as well. So the money it seemed like was flowing out of that into the tech world. So I think in that still the case now I think that there's this kind of two-speed world living in the moment. Which makes it difficult. Because I'm working from the bottom up to try and find these ideas that there's this bias against the non-tech world at the moment. I think one reason I find this stuff to be so fun is that it really is like a wide open choose your own adventure. Even after you come up with a strategy like small-cap value stocks, there's still a lot of decisions to be made in terms of managing to a target return and a desired volatility. So yeah, we typically have around about 2018-20 kind of names in total. Usually a larger majority of the portfolios in maybe ten names are the rest of the kind of exiting a position or entry positions building up in my head a kind of benchmark. This is a good position we want to have on the portfolios about 8%. You know, it might go a little bit higher than that if you have a lot of conviction. But I think my preference is to try and find as many ideas as I can type of kind of your level around 8%. That you know, if it does well, it'll make a meaningful difference. But if something really bad happens, it's not going to cause you a huge problem in terms of unit returns across the whole portfolio. So that's the kind of range I look at. Like I was talking before about the kind of 8% is kind of in my head. Often the ideal kind of sizing maybe a little bit bigger. I think yeah, you do hear or so investors are now other people sort of treat this very differently, where they're going into much more concentrated positions. So above 20, 30% which we don't do any more anyway. And I think that's going to help with those kinds of volatilities. I think in our portfolio over time that last year was very good for us. We did well across a whole bunch of different names. And so we still have that kind of a good spread of different names in portfolio. And so I don't think it was any particularly larger amount of risk last year versus the year before the year before. It was just kind of all the styles seen to align last year for us with lots of different names. Do well at the same time for us. And I think I hope that's going to kind of be the pattern go forwards that will spread amongst as many ideas possibly confined. And some years will do really well. Some years will do pretty well. And we've had positive returns every year. I'm hoping that we can continue to do that as well. But really that's kind of the main change I think is that we didn't think about risk in terms of far or anything like that. It's really about concentrations and the risk to capital. Constrations in ideas, sectors or in a particular thesis. So yeah, that's kind of how we think about that. If you're turning over 70,000 rocks, looking at companies based all around the world that still trade for less than $100 million. There's going to be at least some garbage in there, right? So I asked Andrew if they ever short stocks. I haven't done that a lot, but we did do one last year, where it was just, it seemed to me so obvious. Then it was a fraud that I did a very small short and it just to, yeah, obviously make a bit of extra return. So yeah, occasionally we'll do that. But I think it's in my experience so far, it's been rare that it's that obvious that it's kind of just shouting at you that it's fraud. But maybe that'll happen again as I don't need that kind of over the years. But yeah, there are definitely times when you look at, it's kind of the flip side when you look at something that's very expensive or has an unusual financial characteristics. You kind of pick out that there are fraudulent elements to it. Things that just don't make sense. Then yeah, in those cases, we'll do small short just to see, kind of take it self-y, don't they? Yeah, we have done sort of short in the past. And on bigger stocks that were kind of more story names, then you have to be very careful that you can lose money even if you are correct. It's just based on timing. So yeah, it's more of a timing issue that I think particularly the thing is that once you find a fraud, it's knowing when you think it's going to blow up. And I think in this particular case last year, it's gotten so large that it just couldn't continue all the year, 18 months. If you come out short again, something, you know, you can be right or wrong, but it's kind of very high stakes when you're short company because you're, you're maybe accusing a company of fraud, which carries legal risks for you to send you restrictions as well. So you have to be very careful with that. And I think all the long investors are then going to obviously focus their wrath on you at that point. So there's kind of no upside to ever telling you, kind of hit your short, I'd rather just go short. And if you're going to make money anyway, you don't need to advertise it. Yeah, I'm coming not a big fan of, you know, some investors in the past who kind of put out these big kind of hit pieces or pieces of research that say something is a bad company for actualized reason and the stock falls just because they're not going to be able to advertise it. The stock falls just because of the right up. I think it's, yeah, I'm not a big fan of that. So yeah, I'd rather just go short when you think something is in a good position. And then yeah, we'll just see what happens. Here is something that is not fun, but that happens sometimes when you're holding stocks that you have picked you wake up in the morning and the stock is down 10% and you have no idea why you look at the various news services. You search on Twitter or stock tweets maybe and the only mentions you can find are people asking, why is the stock down 10%? Okay, I asked Andrew, you were in thinly traded stocks. I mean, the daily volume on some of the stuff has to be tiny. I bet you have days where some stock is down 20% and it's unclear why. So what do you do? You know, you may have built up a position over a long period of time, so a few weeks or months, a couple of months. And yeah, it can then be the negative sentiment of the market. Well, yeah, just you're not even short the news is. So you haven't found it yet, perhaps. But it's down 20%. Then yeah, you really have to try and then trying to turn it if something real has happened to the business as there's been some news somewhere. So you need to try and find it as quickly as you can. [BLANK_AUDIO] and then decide what you want to do. If it's a piece of news that you don't think affects the business, then you should be holding that. If it's a surprise, then you have to have a rethink. You have to get through your alt-teaches again. Yeah, there've been cases. So the management in one business we owned, did something that wasn't entirely happy with and I don't think all the other investors were happy with either so the stock fell a little bit and actually extended the position. And I think we were down on that position by about 20%. But other things, we do well in the portfolio. So I thought, well, I'll just get out of this because this is kind of the thesis that I had was that, the manager was going to behave better in the future and then it turned out that it wasn't there as well as I'd hoped. So by that point, then you have to actually then say, "Is my thesis broken or not?" Is kind of the essential aim of what you're trying to figure out? Yeah, that's stock moves. If it's just volatility because of overall market, then you should really be holding it. It's really about the thesis of, why are you invested in the first place, whether you want to keep holding it? And then the flip side of that is that, whereas for a large cap stock, a 10% update would be pretty good. Andrew is dealing with stocks that can move even more than that. A stock had a really good piece of news part of the thesis that we're hoping would come true. Did come true? Yeah, and I don't think we're out 50% straight away, but in a few days it went up 50%. And it was one of those, what you really think forward the dreams and our areas that the business has done something or formed really well, that even with 50% up, it's either asked cheap or cheaper than when you first bought it because revenue is great, that businesses get great. Yeah, and that's really what you're kind of looking for hard to find. But yeah, if you can find something like that where it re-rates, then yeah, that's a good, good problem to have. Well, you have the flip side problem, then a concentration that your 8% might become 12, 13, 14%, if to come and manage that. But yeah, that's, yeah, hopefully what we can find more of. I think it's very easy to hear talk about the emotion of doing this stuff and almost dismiss it, right? Like just make good decisions. Why is that so hard? And probably for some people, it really isn't hard. Some folks might have a naturally more suited ability to look at things in a robotic way. But if you go through a downswing or even just a lack of an upswing, and you can feel how different your brain chemistry is, I would just say that when I personally feel that, I don't know any other way to describe my reaction except this feels dangerous. Because of course, there's the decision making part. You don't want to let emotion leak into the decisions. But then there's also the wellbeing part and the fact that doing these things that result in positive and negative emotion, that's just supposed to be part of your life. And you definitely don't want to let it control your entire life. To take it a step further, there's probably also the risk of becoming dopamine seeking. As in when I am looking for these good bats, I feel good and when I stop, I get bummed out. So I will just spend all of my time looking for this stuff. That is what I mean by a little scary. - I think one of the things for where I can't invest in a great certain biases that those kinds of emotions and chemical reactions in your brain can make you hold onto losers because you don't admit that you have lost money and crystallize that or it might make you sell again because you're thinking I made this great return. I'm gonna sell it and get that, get that, crystallized and get that getting in there. Poor failure. But I think what I want to try and do, and it's very difficult for everybody, is just to not be like that, try and take out as much of the emotion as possible and those kind of chemical effects. And I heard one trader who was talking about the reason he knew he'd started to become a better investor when he would go home to his wife or talk to her at the weekend and check no clue whether he was up or down or how have I been doing that month. And then he realized I'm actually getting a little bit better at this because I can filter out all of that emotion a bit better than they could do before. So yeah, I think that's what I'm trying to do. It's very difficult, obviously when the market's up down, yeah, you feel those emotions, but almost again, trying to forget about that as much as you possibly can and come straight on your process, although it is virtually impossible to do, but as much as you can. When you have a variant opinion about some idea, there are two types of feedback that you might get. One is informed feedback, which tends to be helpful. You know, what do other people know about this thing that I am missing? Then there is another form of feedback, which is uninformed, sort of hot take or knee jerk feedback. That is the kind that is more likely to be infected by the status quo and by a complacent thought. Andrew says one reason he doesn't really seek input from his investors about any of the holdings is that their thoughts are less likely to be of the informed variety. You know, he is the one who has done all of the work. And so he is interested in hearing from other people who have done lots of work and he is less interested in hearing from people offering the fruit of convention. I think it used to be the case they'd ask more than they do now. And I think maybe by virtue of the responses I give them, they don't ask as much because I dislike trying to explain any of that stuff to them. For reasons of bias that it's going to change, perhaps the way you think about things because I've had lots of conversations in the past where you'll explain a particular idea and they give you feedback on that idea. And it's kind of I don't want that feedback because I don't want any biases to come in from the way you view the world because no offense to other people, but if you ask a lot of people, you can then be pulled towards that average kind of idea like the other lens that they think about the world in a different way. And wouldn't necessarily invest in things I wouldn't invest in. So I'm kind of selfish in that way. I don't want to talk to them about that kind of stuff. And I'll talk to them about returns and fridge and all kind of stuff about what's happening in the world. But it's very kind of esoteric and nothing to do with specific ideas. Yeah, I dislike kind of talking to our investors about that. It's kind of useful sometimes when you get a specific feedback from other investors, when you've done a write-up, they might put down some factual things to you. But yeah, in terms of their sentiment and what they think about the way you're investing and trying to avoid that. I think one problem fund managers can run into is that they get investors because the returns are good. Maybe they can even explain the process to the investor and it all makes sense kind of. But then if the returns don't stay good, the investor doesn't really know enough to stick with it. Right, all of the talk about process was sort of window dressing to pretend that the capital was committed for reasons beyond simpler returns. Okay, in the case of Fairlight, they've had positive returns each year. But they also had two years where they underperformed the market. You know, in 2023 and 2024, the market was up 25% each year. And that's a decent pace to have to keep. Well, in that case, they're going to be investors that think, you know what, maybe I should try something else. Maybe whatever this guy was doing before was perfect for that regime. And we're in a new market now. Yeah, and obviously when you do, well, yeah, you get, you know, congrats and what have you been. Yeah, when you're under the forming, yeah, some people will just redeem their capital, which is fair enough they can, you know, it can choose to invest in other things. But I think you kind of hope people have a longer term view that, you know, I invest my end money in the fund. Yeah, I'm invested for many, many years. So I just want to do well over a long period of time. And hopefully over time will beat, you know, the market beat, you know, whichever measure you want to use, as it be 500 or the, you know, very segmented indices. But yeah, I think people can just take their own view of whether they want to stay in the fund and take a longer term perspective of things. And there'd be some years where we do under preform, I'm sure, another years where we over preform by hope. And yeah, we're just going to keep trying to do our process over and over again and refine it and improve. So hopefully, you know, that happens less. And the metrics I kind of look at are kind of cumulative, you know, annual turns over time, you know, which is a little bit below, you know, 40%. But I'm just kind of trying to keep that average as high as possible and do well over a longer period of time. That's really what I'm aiming at. I don't really try and worry too much about it, particularly a quarter or a year we've done well or badly. Because there's all sorts of stuff happening in the world out there having, you know, like hours. This year is a good example. And there are certain things that are outside of your control. So really just worrying more about the process and trying to find new good ideas. That's what really I've worried about. There's almost an unbelievable feeling of freedom when you realize that for anything you own in a highly liquid market, you can change your mind at any time. And yes, you probably have to pay some transaction costs for the privilege to sell. Although this is something that very public fund managers really seem to have less of an ability to do. I mean, you can see this where some manager has a very strong thesis and then things don't go their way. But they double and triple down rhetorically. Then eventually the goal posts have moved and the new thesis is we might get our money back. I mean, if you were a public bull, that would actually be a hard situation to avoid. And so some of the freedom to sell might actually be related to the amount you can divorce that stock from your ego. In my head, when I'm talking about names in the letters, I'm almost thinking I want to talk about something new each time. So then that weight kind of disappears that I'm not talking about. Surabia would have reduced every single time. Because yeah, what if I do all the sudden, Surabia down a little bit or do something else? Yeah. And like you say, you then become the person who always talks and knows the most about this position. And then one day you've sold it and you still get people asking you questions about it. Yeah, I kind of want to be talking about new things in the letters each time. And that's, I don't know if to me, that's kind of more interesting. Anyway, like here's this new thing we found that we've been recently invested in, you know, not talking about something that's two years old. She may still hold, but you kind of don't want to be, yeah, the guy that owned that stock and you might want to sell it tomorrow. I think some investors seem to get very wedded to a particular stock, you know, goes back to the idea of not talking about certain ideas too much. And there are certain investors who sometimes reach out to us, perhaps, sicker ideas we put out there and they'll keep asking us questions about it. And sometimes after, you know, tell them, "You know, this is something we sold a few quarters ago. We don't look at that anymore." Or maybe tracking it just to see how it did have to be sold. But yeah, I think it's some investment, I think, just get very weirded and fall in love with the stock in any way that I try not to, I try it with very kind of, yeah, just looking at the numbers being very kind of mathematical about it as much as possible. So I find that a bit easier, I think, than some investors. Despite their good returns, Fairlight is still managing a very small amount of capital. So I ask Andrew, "Surely you get interest from investors." So when they don't invest, what do they say? Sometimes we've had a few institutional calls and it's partly because of our size, sorry, a bit of the small funds still at the moment. And often, what often happens is it's not what we get ghosted, but they just don't invest and that's it. They don't say no, and they say, "Can we have, you know, your, you know, your quarterly letters be put on your mailing list?" And I think really the return just kind of rules out one way for people to say no. And so a lot of people just kind of want to keep tracking us and see what happens. And yeah, maybe for some other institutional investors, as we vary, then we'll kind of go into that window of moving the needle for them. But that's kind of typically what happens. I think this has been a super interesting episode precisely because it's such a fun thing to think about. If you could pick the kind of socks to get up into the 40% in your return range, there's another series of issues just waiting for you when you get there. Like, what's the total capacity for the strategy? I mean, that's always the question, right? When you have something that's working, what's the limit to scale? So we're done some bad testing on that just to kind of see given what we've been invested in, what we could have done. And yeah, and a larger amount of capital wouldn't have impacted us that much so far. But there is a kind of, it's been fairly, even though we've grown a lot in size, it's kind of been fairly gradual over time, that we've moved up in market cap and the rest of the stocks now that I can't look at that I probably could have looked at a couple of years ago. And there was an example earlier in the year of a really good stock, but we just couldn't buy enough of it quickly enough. They did very well, which is so, you know, then frustrating. But yeah, it's going to generally lower the returns over time, but it's just that unknown of how quickly that happens. And I think there's an element of you may not have been able to invest in stock game, but maybe you'd have found stock B that was a bit bigger and you'd have just had to hunt in a slime and you have a market cap grand. So I think yeah, over time, the returns will probably go down on, but it's just a question of how quickly that happens. Risk of ruin is written and produced by me. Special thanks to Andrew Martin, a fair like capital. I'll put a link in the show notes so you can find Andrew's investor letters. If you want to get in touch with the show, you can email me [email protected]. You can also follow me on Twitter @halfkelly. [Music]