Welcome to Inside Active, a podcast about active managers that goes beyond sound bites and headlines and looks deeper into their processes, challenges, and philosophies and security selection. I'm David cone, I, lead mutual fund and active research at Bloomberg Intelligence. So active equity funds can take many forms, some concentrated, some highly diversed, some momentum, and some with a contrarian strategy. In today's episode, we'll be speaking with a portfolio manager
whose strategy adheres to the latter. I'd like to welcome Murray Style to the podcast. Murray is chief executive officer, chief investment officer, and co founder of Horizon Kinetics and a portfolio manager for the Paradigm fund ticker WWNPX, which we will discuss in a little bit. Murray, thanks for joining me today.
Thanks for having me.
So let's start with your investment philosophy. Your long term contraying value philosophy is central to Horizon Kinetics. Can you describe how this philosophy originated and how it's evolved over your career.
Well, the firm is called Horizon for a simple reason that it was my observation that people in the professional cadre of investors are really intent on finding investment opportunities within a less than a one year time horison. But a simple reason that the year or the calendar year
if you like, is the grading period. So the utility of some return beyond the momentary grading period is much less than the utility return within the grading period, So things get overvalued in the short run and there are limited utility therefore undervalued in the long run.
The equity yield curve is mentioned as part of your firm's investment philosophy, is a way of understanding return expectations over time and why certain opportunities are overlooked. Can you walk us through how you think about the equity yield curve and practice and how it influences your investment decisions.
Sure? Well, the equa yell curve, if you could draw it, would look no different than the bond yield curve, with the salient exception that the equityal curve is very very steeped unlike the bond yield curve, and the reason that relates to long term horizon investing. So let's say you're not a professional investor, you had your own company. It's a private company, and let's make believe it was in the field of biotechnology and you made some incredible discovery.
It's going to benefit greatly mankind. And for a variety of reasons, you can't make the announcement of your discovery on December sixteenth, because if you had planned a vacation with your family, so you decide you're going to make the great announcement on January sixth. Well, if you own a company and it's a private company and you happen to profit immenseally on January sixth, it's a little concern
to you. However, if you're in the world of public equity, there's a very big difference between any event that happens on December sixteenth, one year and January sixth of the following year, because not only your bonus is paid and the evaluations are made on the one year grading period is also a very small matter of the performance fees
that people get. So of course, if you don't achieve it in the calendar year, you may or may not achieve it in the following year, and that, I would argue strongly motivates people's behavior.
Interesting. Now, you also emphasize fundamental research on can we say like less trafficked opportunities. What criteria makes a company compelling to you even when it's misunderstood or always say out of favor.
Well, it's I wouldn't say necessarily that they're always misunderstood. It's that people don't take the time to understand them. So let's say it's under scrutinized. And you could see why if you just think about the world of liquidity. So the idea is people want to manage huge amounts of money because they charge a fiant So in order to manage huge amounts of money, you have to have securities, to have a liquidity characteristic that would accommodate that kind
of management. If you have less sums of money, or you're longer term oriented and you don't trade a lot, you can accommodate the company that's underscrutinized that might have a lot of liquidity attached to it. In other words, you can wait and be patient. So it's a question of what you'd like to do as an investor. I would like to be more patient and traffic in the world less scrutinized. So that's how it characterize it.
Okay, And if we kind of zero in on the Paradigm Fund, which kind of looks at these type of companies, you know, long product cycles, high barriers to entry. How does that play out in day to day portfolio construction with the fund.
Well, it's very hard to find companies that have a long product life cycle. So I'll just mentioned text specific since you would have mentioned it anyway. It has the virtue that it's the Texas specific land company. There's only so much land on this planet, and the character land is not changing. You're not going to make land technologically
obsolete by whatever scientific developments you have. Matter of fact. Conversely, you can make the land much more valuable, but not less valuable, by scientific bands and those are things that are happening to that company right now. So land under the American Accounting Convention is not marked to market anywhere else in the world. IFRS accounting, it is marked to market. So something that's not marked to market, it's not going to be well understood. Each portion of land, whatever is
located in the United States, is unique. So land is that type of asset class where the individual the individual plot matters a lot, and it's not studied as an asset class. Even though there's a lot of wealth globally tied up in land, and you won't find an ETF or a fund dedicated to land because generally speaking, it's not marked to market and it's not traded heavily. It's a perfect investment for the fund.
So if we kind of dig a little deeper and just talk about positioning, has the funds positioning sizing kind of or your philosophy about it changed over time, or you know, do you increase position as conviction grows or kind of try to spread it more broadly?
No, I, when I start, I take a relatively small position, meaning in my parlance, less than five percent. Of course you'll observe VI positions greater than five percent. So what happens. Let's create a hypothetical portfolio. I will buy twenty names and let's make believe purchase this discussion that they were twenty names equally weighed or twenty five percent positions. What's going to happen over time if you're long term investor is, even if they're all successful, the returns are going to
be normally distributed to Galssian log normal. Something is going to be your best investment, even th they're all wonderful investment, somethings to be your highest rate of return. What you'd like to have happened is you would like your highest turn to be your biggest position. The only way to achieve it is to leave it alone. If you leave it alone, because you can't know perspectively what is going to be your most successful investment. You can only know
that retrospectively. So if you wish your best investment to be your biggest investment, need to leave it alone. And leaving it alone, it will become, in the fluence of time, a disportionately large position your portfolio. And that's how it happens.
So if we kind of even go a little deeper, and so if you have a one position or even two positions that are very heavy concentrated in the portfolio, how do you wait, I guess concentration risk in terms of you know, versus diversification. Is that something that clients ask you about.
Oh, they're asking me about all the time. And the conventional of you, of course is you shouldn't let anything be concentrated. And the reason is because if it becomes a disproportioned large position, what if it has to draw down and if it has a draw down, it will have, of course, a disproportionate impact on the portfolio. That's the conmensial logic, and it's very hard to argue with the logic except for one small item, which I'll bring to
your attention at the moment. The funds are designed for taxable people. So in preventing a company or a position becoming disproportionate in size because there might be a draw down, you need to sell down some or maybe all of it, and when you do, you expose your client base to taxation.
So in the effort to protect the portfolio against the draw down, you exchange that circumstance for the certainty of having a large draw down with regard to taxes, because if you live in the state of New York, as I do, you're going to pay the federal rate and New York rate, and that's going to be a prop roximately in round numbers, one third of your profits. And of course we'll leave aside whatever it taxes the City of New York might impose upon one.
Okay, And if you get to a situation where you do want to sell, I mean your portfolio is very or I should say even ultra low turnover ratios in comparison to a lot of other funds I look at. So when it's how do you decide when it's time to sell the specific catalysts you look for.
Well, there are two circumstances for selling. One circumstances just found something better to invest in it, which case will sell some of the security which is inferior and perspective return, and buy some security which is presumably superior. That's an obvious circumstance. Another circumstance, which is equally obvious, is sometimes your big position it just doesn't have the appreciation potential in once heead it's not the same thing negative about
the company. But no company is an extraordinary company forever, and you may wish to gradually sell some and fund some other investments. Of course, you don't wish to sell the investment until you found something new. Or in our horizon parlance, we don't through out dirty water until we have clean water.
That makes sense, good analogy. Another thing I wanted to ask you about the portfolio, because this is something I'm seeing starting to pop up quite a bit in equity mutual funds, is your exposure to bitcoin via ETFs, and you know it's a meaningful exposure. What was the original rationale for adding bitcoin to the fund and has that rationale kind of changed?
Okay, so first tell you before I answer that question, is we only put a twenty five basis point position in bitcoin because at the time, this was more than a decade ago. Its prospects were, let us say, not as certain as at traditional equity would be because it's not traditional equity. However, the upside potential was enormous, so that was the rationale. We can go into what the
upside potential is. It's still fairly large, so I felt the portfolio should have some Bitcoin, and there was the possibility that it would have returned that's outlandish relative to anything else in portfolio, which proved be true, and therefore
it provides covariance to portfolio. The worst thing that possibly happened is it becomes bankrupt or worthless or nearly worthless, and it becomes worthless or nearly worthless, and only starting at twenty five basis points, so the damage to the portfolio would be rather limited.
How do you communicate that to some of your investors that might be skeptical or you know, kind of only want to look at fundamentals.
Well, bitcoin, believe it or not, has fundamentals, so everyone thinks it has no fundamentals. So this could be I'm going to cut it short because inches of time, but if you want to explore this, I'll explore it as long as you want. So Bitcoin is created by a process unfortunately known as mining. The reason I say unfortunately known as mining is it's really a bad term. We're stuck with it. Mining is just a process of validating
the transactions on the blockchain. That's good. Mining is so in exchange for millions of servers, literally millions of servers validating the transactions, and if you post it on the blockchain, you get every ten minutes something called the block reward, and that block reward is issued in the chords to protocol that in theory, will give a reward every ten minutes, meaning a block should be written to the blockchain every
ten minutes. Doesn't happen exactly every ten minutes, but a protocol is designed to equilibrate the process, so on average it happens every ten minutes. Okay, So the protocol is designed to raise, in the fullest of time, the cost of validating a transaction, so the cost of creating a bitcoin, if you like, because that's the process by which you
create a bitcoin, you validate transactions. The cost is rising now if you consider a bitcoin to be a commodity and the protocol determines that the cost of creating the commodity. In other words, bitcoin is going to rise every four years. I'll explain why it rises in a minute, but for a moment, it's going to rise every four years. You
can now forecast an extraordinarily robust return. Why is going to rise every four years because the block reward is reduced by half every four years, in an event called a having. They called it a having because the luck of ward's been cut in half, and every four years. This happens. Next having occurs on or about April eighteenth, twenty twenty eight. So if you want to be if you're doing the same amount of work and you want the same number of bitcoin to be issued, it's not
going to happen. So if you want the same number of bitcoin to be issued, you have to do twice as much work, meaning you have to have twice as many servers baldaying transactions, thereby drawing more electric power. So it costs more So now if there were a protocol that said, every four years, the cost of creating an ounce of gold is going to double, what would happen
to gold prices? If there were a protocol it's said every four years, the cost of creating a barrel of oil or a million bitter to you of natural gas, or a bushel of wheat or what have you, we're going to double every four years, what would happen to that commodity? That was the logic a bitcoin. So when I read the protocol, and once I understood that, I realized it was well worth doing that. Now, in point of fact, the return was even higher than which could
happen and did happen in accordance with the protocol. It was even higher than that. So it was an extraordinary investment. But I had a logic to it, and that was the logic. It was based on mathematics.
Okay, so obviously different than what a lot of folks on Twitter that I think everything belongs in bitcoin. So I'm definitely here, you know, happy to hear the logic behind it. So if we move in a slightly different direction, you know, I read your Q four commentary and it kind of it drew a contrast between strategic resource owners and shall we say, traditional IT companies. How do you think mainstream investors are kind of misgauging the long term potential for these different groups.
Oh, that's easy to answer. So historically, as long as we had investments through the bulk of recorded economic history, hard assets were the bulk of people's wealth. Last quarter century, and I personally we dated not the quarter century. I personally we dated from June of two thousand and seven, So it's not quite a quarter century. Why June of two thousand and seven, Because June of two thousand and seven was creation of the iPhone, Although we might not
have realized it at the time. Now there are clearly well in excess of five billion users of smartphones, all having access to the Internet and all that goes with that. That was enormous investment opportunity, And unlike what we all believed in two thousand and seven, even prior to two thousand and seven, with the advent of the Internet, we didn't nobody realized that the business was being custraed in a handful of companies, and those companies had extraordinary cash
flow characteristics. Why extraordinary because the Internet runs essentially on the landline telephone system. So what people refer to as the magnetics in seven, or sometimes they refer to it at some other number of magnifs in eight. But those companies were using the existing telecommunications infrastructure, and therefore they
had unbelievably great cash flow characteristics. In other words, for me to do one incremental search on Google and me to click on the right thing, and Google gets paid based on my response to an ad, there's no incremental capital spend or maybe even no incremental actual SGNA spend for me to do that. It had just enormous positive cash flow characteristics, enormous operating leverage, positive operating leverage characteristics. Nothing like that had ever been seen. However, it just
can't continue forever. So now we're moving into the world of as most people say, artificial intelligence, which I say, it's high performance computing. Why is it high performance computing because the amount of data that's needed to be manipulated in order to serve the modern function. As a trivial example, that you and I could be watching the same YouTube video, but our interests are different and databases nowhere. Interests are different,
and we will see different advertising. Can you imagine multiplied by now it's almost six billion people on Internet, how much data you really need? Well, that involves enormous capital expenditure. As you you can see from the most recent earnings releases and capital spending forecasts of Amazon, Alphabet, Meta platforms and all. You've seen the earnings, you've seen what the
capital spending forecasts are. They're unbelievable, and they should be believable because when you think about if you were looking at a company like Nvidia and more power to them, have nothing against them, so you can calculate how many servers they're going to sell, multiplied by how much power is drawn by each server. It's enormous man electric power. We're going to have those a nation engaged in capital spending and build the electric generation infrastructure in order for
that to happen. So we enjoyed almost unique in history, but not entirely unique, a period of time when a handful of companies had enormous cash flow positive cash flow characteristics that simply can can't continue because capital expenditures are going to be required, and it's there for everyone to see.
It's not a secret. That's the change that we have to accommody ourselves to So, to make a long story short, we're returning, as we inevitably were going to, to the world of hard or tangible if you like assets.
So do you think that will change you know, the you know, one of the things I look at is, you know, you've got as you mentioned, the mag seven, maggate or whatever. You know, they're calling these these companies these days. Do you think they're going to be less dominant in market indexes, you know, giving active managers more of a you know, chance to compete.
Well, they're going to have to be for a simple reason that you work for Bloomberg and you know you're coming out shortly with the Bloomberg five hundred index, and so the the inclusion criteria for s TOB five hundred is different than the Bloomberg Index. So let's take an example. Let's say open ai to people borrows chat GPT. Let's
say they were going to the IPO. Well, in the case of Bloomberg, open ai is probably going to be in the top five hundred mare capitalizations on day one, and therefore it will very quickly find its way into Bloomberg Index. There may be a day or two of transition, but it's going to be not immediately but almost immediately go into the Bloomberg five hundred index. The S and P five hundred index has different criteria the SID. First of all, there's trading criteria, which it might not meet
in the beginning. But secondly, there's a seasoning requirement, so that has to be publicly traded for a certain period of time. So if SpaceX and open Ai, an Anthropic and other companies that were all familiar with, if they were to come public in a given period of time, which would happen because says an appetite for one, there'll be an appetite for others. You're going to have two
large capitalization indexes. You're going to have a Bloomberg five hundred index, you have an S and P five hundred index, and they're going to look very very different in the largest capitalization portion of the index. And also interestingly, in a fundamental sense, Anthropic, open Ai and others are going to compete without that. So now outbed is going to go from a circumstance where it is a quasi monopoly to being challenged. Doesn't mean it's going to be defeated
by the challengers. Of course, but it's going to be challenged, and it's going to be challenged. Usually when a company is challenged and has a lot of capitalist spending requirement to maintain its dominance, which means your free cash flow, not necessarily your cash flow, but your free cash flow
is going to diminish. Generally speaking, the market would award it, we would reward it, so to speak, or price earning is multiple because there's higher risk because you may not be where this company may not be the dominant company.
So it actually brings me to a different topic. You know, I'm glad you mentioned open Ai and you know some of these other private companies that we're looking at. Private companies is kind of like it's a thing we're really focusing on our team, and so, you know, you had also mentioned in your recent Founder's letter in January, you know, you defended private investments as kind of a natural extension
of your investment philosophy. How do you think privates are private companies complement or contrast with, you know, more of the public stocks that are in the paradigm.
Fund Well, for us, it's a natural extension for a simple reason that the the growth and eventually the dominance of indexation basically meant that for the last quarter century, the IPO market has been so to speak, there's been historical standards, not a lot of activity. And for private equity funds and for private companies in general, it's been
very hard to attract equity capital. And for owners of private equity funds who require liquidity, there are a lot of people who can get liquidity and must have it, and therefore opportunities for people who wish to offer liquidity. There are opportunities that wouldn't otherwise exist. So in the historical context would never have seen this. Now we're able to buy pieces of private companies for valuations that would never have been possible historically, and it's only thanks I
would argue to the dominance of indexation. Of course, the index fund could not have a private company and involved in it. So if you're going to be the non index and the index won't do private companies and they meet your criterion valuation hurdles, makes sense to buy some private companies. And we bought some private companies.
Does your evaluation models Is it similar when you have the privates in the publics?
It's not always similar, And the reason is always sober, because sometimes you can buy a private with failure orbus cash flow. Sometimes you'll buy a private it has no cash flow, so you're buying an emerging company and justification camp in cash flow justification has to be they either have an opportunity with no competition or a very limited competition,
and that's one possibility. Or they may really have developed something proprietary and they have a long lead time on a potential competition, and you have an opportunity to actually buy something that you wouldn't encounter in the public markets. Those are a rationale. So we don't buy very many private companies because not in their many companies will fill those characteristics. Occasionally you find a few, Yeah, and we found a few.
Makes sense, you know, if we take just a little bit of a step back. I didn't want to ask again. You know, with you mentioned country and value investing, you know you're holding it a long term, so you may see periods of underperformance for certain companies. How do you keep that conviction during those phases when the markets aren't rewarding those type of companies.
Well, if the company continues to do what they're supposed to do, meaning they have a business plan they're executing. The fact that the market has moved on to something else is not something that concerns me very much, just makes it a better opportunity. So there are periods of time when marketing one move on, or put more quantitatively, you're never going to find the stock that's on a new high list every day. It's just not going to happen.
So people decide what they're going to do is if it's going to fall off new high list or it's in danger of falling off new highlist, they can change it for another company. And the math, this is math, is against that. So prim mid me, I'll give you very simplified math that everybody can understand. You have a security that we're going to call security A, and you'd like to change it for something it's better for security B.
So it's two transactions. You're selling security A because you need the money to buy security B on the assumption you're fully invested. So now no one in the world of equities is going to say they're right one hundred percent of the time. So let's say that this not I, but this high pathetical the portfolio manager is right seventy percent at a time, I don't know if you would even find anyone that would be boastful enough to say they're right seventy percent of time. But let's say they are.
So you sell security A, you have a seventy percent chance of being right, use the money and buy security B, for which you have a seventy percent probably of being right, but you're probably a successful investment. Is the joint probability of A and B point seven times point seven or point seven squared, which is point four to nine, exactly the odds you have if you're going to invest colors in the Roulette wheel black versus red. There's no advantage whatsoever.
That's the simplified math of it. So I've made that analogy in my career probably several thousand times. I don't think be honest with you, and I want to be honest. I don't think I've ever convinced anybody that is the math.
I do like the analogy, but I got one more question, a little forward looking. You know, even when I do research on funds ETFs, you know, the way that data is kind of evolving is making my job a lot easier. And so how do you see the role of you know, independent firms, you know, like Horizon evolving as data becomes more commoditized, and you know AI really changes the research landscape.
Well, AI is not going to change the research landscape. I mean, in a very small way. It makes things easier. So let's not forget in the I'm old enough to remember it wasn't that long ago. If I wanted to read the ten Cuba Company, I couldn't get in on a computer. I had to write a letter to the company and they'd send it to me. I had to wait sometimes a couple of weeks. Today it comes up in seconds. But just because the data is available doesn't
mean the people know how to interpret it. So it's really a question of interpretation, and it's really a question of focus. And a lot of things that you would think are straightforward are not straight forward at all. And you can see that I have this hobby, and if you practice my hobby, you can see that here's my hobby. I go to a library and I read newspapers of fifty sixty seventy one hundred years ago, and they're interpreting the events of the age. And I tell you, when
you read it, it's like reading science fiction. So they say where historians say the history is the art of surprises, and the reason is that the people were living that era, they had the information, they just didn't understand the consequences of the data. So, for example, within our memory, we had data. We knew that the communist world or their economies were not succeeding. And who could have or who
would have predicted the full Berlin War. Who would have predicted that they would come that you could walk into in the city of Shanghai and buy a big mac. There was a time not that long ago if you had said that to someone, they would have thought you had lost your mind, And yet it happened. Matter of fact, if you go back a little further, you can go back to let's say nineteen seventy, the consensus wisdom in the political action in the United States of America is
universal agreement. Have you let what they then called Red China or Communist China into the United Nations, it will destroy the United Nations. Wasn't very long before the American ping pong team is playing in China, and the President and the National Security Advisor go to China, and next
thing you know, we have diplomatic relations with China. We knew about the cleavage between the Civil Union and China, we could have drawn the right conclusions, but no one drew to us conclusions because to draw a conclusion that outside of your historical frame of reference is extraordinary difficult. And I would argue, with all data we have, it's more difficult today than it was in the nineteenth century
when they had no computers. And I'll explain why a nineteenth century investor, a well educated investor, a nineteenth century investor would have read Varatus and Thucinities and Plutarch, and their historical frame of reference would have been several thousand years. Our historical frame of reference, because we have so much data, is really maybe a few decades. There are very very few people in the world investing that have a historical retrospective.
So if I said something about the if I mentioned the Punic Wars or the Peloponnesian Wars, I would say most educated people, even those with advanced degrees, wouldn't have the slightest idea of what I'm talking about. So how can we expect those people to look at the then Soviet Union in a way different than what we had experienced in the last couple of decades, and yet that's what was needed. So I don't think artificial intelligence and the ready access of data is going to do very much.
I think it's three to reverse. I think this overwhelming flood of data that people have their fingertips, they've lost, and I think we'll continue to lose historical context. Let's not forget we talk about China. China is a culture and a civilization. It's five thousand years old. So if you were to take the typical act investor, and China's a very big part of world economy and ask them, could you give me a precie of what happened in China the last five thousand years, how many people would
be able to speak intelligent on that subject. I don't think the answer is very many.
Oh, it's definitely interesting and thought provoking. I thank you, but this is great. I thank you again for joining me.
Okay, my pleasure anytime.
And I also want to thank our listeners. If you liked the episode, please share it, subscribe and leave a review. And if you'd like to see more of our recent search on the terminal, go to b I fund Go for fund and Active Research until our next episode. This is David Cohne with Inside Active