Sarah Ketterer Discusses Investment Management

international investor. If you were at all interested in understanding how to use quantitative strategies as part of a value portfolio build, or if you're just interested to hear about how someone put a company together over twenty years and grew it to over fifty billion dollars, then you're going to find this conversation to be absolutely fascinating. So, with no further ado, my interview of Sarah Kettra This is Master's in Business with Barry Riddholts on boom Berg Radio.

My special guest today is Sarah Keta. She is the CEO and co founder of Causeway, a fifty two billion dollar asset manager. She's responsible for all of the investment research across all sectors at the firm. She was named morning Star International Manager of the Year in twenty seventeen. She is also a member of the Stanford University Board

of Trustees. She is co chair of the l A World Affairs Council and town Hall Director of the Los Angeles Philharmonic Music Center Foundation, as well as chair of the Investment Committee. Sarah Ketterer, Welcome to Bloomberg. Thank you, Marry. Let's start a little bit with your background. You you have an interesting work history. You come out of Stanford and then talk where you got your m b a. And eventually end up at Merrill Lynch where you were

running one of their international investment firms. Tell us a little bit about that. I've finished graduate school thinking I wanted to be an investment banker, which turns out I didn't know it then is ideal training to be an investment manager. And the distinction is one is a transactions business, banking, and the other is very much a deep thinking, valuation

centric investing type business. And the banking didn't after a few years inspire me, so I left to start a database business, which if I could be I could have an avatar. That's what the avatar would do, because that's a wonderful business. Right now, I'm just a consumer of data but that turned out to be as many startups are money losing and I needed to work living. I was living at the time in New York City, so

I got a job at hotch Kiss and Wiley. My late father, John hotch Kiss was the hotch Kiss and George Wiley his business partner, and they had a firm that was thriving but had no international equity. So I got hired to bring my data and help start international equity. You alluded at what I was about to ask you, how did working in a data startup impact your view of investment? Well, I had a very good idea looking at all that data, how much it needed to be

cleansed and categorized, and that was beyond my scope. This was this was the nineteen nine when the tools we have today did not exist. So I was delighted to hand over the data and move on to the basics of asset management. So how did Hodgkiss and Wiley eventually become affiliated with Merrill Lynch. It's true of many investment managers, particularly the time when they're run by aging founders. The founders want to settle their estate, and this was true

of George Wiley. Both extraordinary investors, But he was in his early seventies when I arrived, and it was time to do something with what they'd built. So they sold it to Merrill lynch In and therefore I became an employee along with a person who became my business partner, Harry Hartford. We met each other in and then by we were working for a completely different firm, and they ran it, it seems more or less from the outside as an independent subsidiary. It didn't get subsumed into the

greater mother Meryl or how did that play out? Yeah, it was rough, a bit rough, because Meryl had aspirations for asset growth. And what I've learned over the last couple of decades is asset growth should never be your number one goal if you're an investment manager, even secret goal. Your goal should always be satisfy your clients and the assets will come. And Meryl found that Hotchkiss and Well I didn't have the ability to grow fast enough and

ultimately decided to sell it. And so what happened then I had a hard time. By that time, I couldn't look my clients in the eye, nor could Harry and say, ah, this is going to be good for you we're going to now be part of this other firm that's known for its growth investing. We we just couldn't do that. It was beyond our abilities to to tell a lie.

So we concocted a to just be began to brainstorm how would we want to see a great asset manager, What would it look like, what would be the characteristics? And we had an idea of best practices and worst we'd seen them all and choosing the best. We put together a business plan for a Causeway and left in two thousand one and got some seed capital and spent the first three years losing lots of money but hiring some of the best people in the industry. Losing money

as an operational firm, not necessarily, it was good. Two thousand one post the technology, media and telecommunications bubble was an excellent time to start a value oriented manager. We had the wind at our back and value stocks did very well. We owned a lot of what are It's interesting because back then value with low beta intended to be consumer staples and other industries that today are untouchable

valuation wise, they're too expensive. And those stocks stayed extremely well, and we grew very quickly and we also had the benefit of being unique in that. Causeway even from two thousand one has been a convergence of fundamental investing along with quantitative research. So tell us a little bit about that. How do you emerge quant research with fundamental really bottoms up your stock picker? Essentially, how do you merge quantitative with bottoms up stock picking? What we do fundamentally is

very bottom up in its orientation. But I learned this was back in the late nineties before forming Causeway, that many of our competitors had no idea what kind of risk they were taking. And that's where quant is so incredibly precise and effective, because our quant colleagues showed us right from the start they could disaggregate the risk. They could show us what sort of risk factors we had

in the portfolio systematic risk factors. We knew all about the idiosyncratic the company specific, but when it came to how much cyclicality we were taking, or volatility risk, or value risk, or or any other of these major market

risk size risk for example, that was illuminating. Now today it's sort of whole hum humdrum, But in the late nineties that was a revolutionary and so our bottom up process is very much fundamental stock selection combined with quant risk control, and therefore the portfolio is inherently diversified, so it's less risky, less volatile than a portfolio assembled without using a quant overla comment, that's the case, and then quantitatively we use fundamental to make the quant decisions more

accurate because our quant approach in emerging markets, these are very broad portfolios that are the stocks are effectively assemble statistically and fundamentally, we're actually meeting with the companies that are in that portfolio, not all, but many, making eye contact with management, probing them on their corporate governance efficacy. And this makes our quant we believe, over the long term, much more effective than just a pure computer driven process.

Quite quite interesting. Let's talk a little bit about the company you founded in two thousand and one. What's it like being a woman co founder and CEO in finance that just seems to have an awful lot of dudes running everything. And I use that word especially because it seems to be just rampant and there aren't a lot of people like you running fifty billion dollar farms. Yes, that's true, and not only do we recognize it a causeway.

It does help having a female CEO, no doubt, because it shows the other women in our organization there is there's no limit, there's no last ceiling. Then go all the way to the top. But we do find that the pool of women to choose from is pretty small, even in graduate schools of business, that there are fewer women than men almost universally, and have those have those numbers kind of a little bit, but not a whole lot of nowhere near fifty as much as the graduate

schools would like to think otherwise. And that means the pools already smaller from a recruiting perspective. And of those many are interested in other careers. They're enchanted by technology, and finance seems to have lost some of its luster. But there are groups of these women out there and it is up to us to find them. So for a while we thought of it like an ocean of graphic experiment. We would tag them in like the whales, and where did they go? Exactly where did they go?

And uh, that didn't turn out to be very successful. But a former client of mine absolutely brilliant idea. This is Seema Hangarani. If she ran the city of New York's equities for years. Their pension fund started something called Girls Who in Vest, and then we Causeway got behind that. So we not only have been an early supporter financially, but we're also we can take these interns. Is the fourth year we've had an internet usually arising sophomore junior

in college, a young woman brilliant. They have to get through a tough application process, so Barry, in effect, we are seating the pipeline. What's your involvement with Girls Who Invest? You're on one of the advisory boards. I'm on their advisory board and it's an honor to be a part

of that organization. It's very inspiring for the women in my organization because they can see that Causeway is actively involved in something that's quasi philanthropic for us in that these young women are so young, they're nineteen or twenty years old. We can't hire them for years. They need to finish college and then typically we expect them to get their cf A and or an NBA before they're hirable as Causeway analysts. So that's years and years from now.

But you guys are long term investors. We are. This sounds like another long term investment where you're thinking in terms of decades, not quarters. Well, this is again if you're going to go, if you have to think about the problem and in a long term perspective, this is how to deal with it is get women in college who are connected through social media to let each other

know how exciting this is. And after our interns the next year they get another job and investment management and so forth, and best of all for us, so of course there's something in it for us other than having more women. It's a brand building exercise. It's reputation enhancing. So they tell their friends, who tell their friends how great it is to work a causeway, and that in turn gets back to the employees. So it's a virtuous

cycle in terms of culture and reputation. And girls who invest is four years or five years old for four and a half, so you're five years away from seeing the first um harvest, so to speak. Of women who entered this as this group, as as interns, made their way through the process and eventually will be getting hired. And apparently the retention in the industry is very high.

They're not deciding to go to something else, which to me is a testament to what they were, what they learned in their four weeks on one of these university campuses over the summer and their first internship, and how much they enjoyed the industry. So it'll take some time, but we started with thirty interns and this last summer was a hundred fifty interns and rising quite quite interesting.

Let's talk a little bit about the Causeway portfolio. Um your global value portfolio has about fifty one holdings, average size about seventy billion dollars. What do you do with that sort of portfolio, what do you use for a benchmark and how do you expect clients to judge your performance, because that's not the most typical international portfolio. Yes, are both our international our global portfolios are fairly concentrated Global, more soil international because it has the enormous US market

to choose from. As well. A number of value stocks out there has gotten larger over the last few years and especially true in twenty nineteen year to date, meaning investors have abandoned these stocks. They don't want chemicals, they don't want autos, they don't want banks, and especially don't want them outside of the US market. And for a

value manager, this is the time. I haven't seen anything like this, nor have my colleagues since the two thousand when these stocks were all Dialue stocks were abandoned, or the end of two thousand and eight when they were they were left for dead. So that's one of the reasons why we have such a large market average market cap you mentioned seventy billion dollars. These are some of

these are very large companies. You've heard of them. You've German giants like b A, S f Or or Volkswagen the parent company, if not only Volkswagen Brown but portion Audi at the forefront of electric vehicles at Barclay's Bank or Lloyd's in the UK now downtrodden due to Brexit, but sound financial institutions. The market is treating them as if they are all going to shrink and just as if their growth rates are negative, which is true of

the entire value index. So let's use a couple of those examples because I want to dig into your thought process. Volkswagen has their big diesel scandal, the emissions rigging scandal, the stock gets clawbered. You immediately look at that as an opportunity. What is the internal process like when your investment committee sits down and says, let's talk about Volkswagen and do we want to step into this mess. We

divide fundamental research into six clusters. Their sector oriented and our industrials cluster looks after automobile, so the it also covers consumer discretionary and the head of that as a excellent portfolio manager named Jonathan Ang, and he saw this problem. We didn't know the company was committing fraud in September off when diesel Gate was announced, but it took us a couple of weeks and with Jonathan leadership, to do the research to determine based on prior recalls of vehicles

that the sticky accelerators at Toyota. Remember Whens Congress had keep those cards in the garage. They're dangerous. They were. They turned out the drivers couldn't tell the break from the accelerator. But that is similar yeah, GM, the sticky the ignition switches, and some of those incidents caused deaths.

In this case, it's a pollution problem. So we were able to make an assessment of both the monetary damages associated with the fines and regulatory problem fees, as well as the recall costs, the marketing spend but the reason why we went into that stock is emblematic of what we do would causeway. Fundamentally, we find companies with great

assets with tremendous financial strength. So that company, Volkswagen, had twenty four billion euros of net cash on the balance sheet before they went in net cash, so that means they had no net debt when they went into this scandal, and they had operating margins a third of that of their best competitors. That to us is a it's a flashing red light of wow, this company is really poorly managed.

And if we can be there at the time when new management steps in and runs the business more efficiently, if we can influence them as soft activists making not talking about next quarter, but talking about the long term investors multiple years exactly. We have a two year price target on all two hundred stocks we follow closely, of which that you mentioned the fifty one in the portfolio, they are a subset of that. And we went to management and said, you have a crisis on your hands.

What are you going to do about it? And they had to replace all their senior people and then some But this this company, if it weren't for the fact we were in a trade war, and the and the global investment community seems to be worried deeply about recession. This stock would be much higher than it is today, are you? Are you guys still well? First of all, VW has done pretty well, hasn't it. It's put on from its lows about fifty in local currency terms. Not

too shabby. It isn't too shabby, but it could be much better. So I assume you're still along the position. Still along the position, let's talk a little bit about the state of the world, um, both here and in Europe. Um you mentioned earlier, the trade war and tariffs is having a problem a lot of Europeans who are fearful of recession. UH Germany is either in recession or about

to be. And who knows what the UK is going to do to themselves with their Brexit, whether it's a hard Brexit or or a heart of Breaxit it looks like as the choices, how do you deal with this sort of global mayhem and distractions when you're investing internationally? Well, to some degree, the more mayhem the better if you're a value investor, because that's when invest other investors discard great companies and our mantra as value investors is there's

always a price. There's a price for everything, no matter what it is. At some point in time you say that's just too cheap. I think the biggest problem for Europe is that investors appeared to have become despondent, and the quintupling of central bank balance sheets from early two thousand nine has led to this wave of money washing over the globe. And as rates have fallen, savers in Europe and an aging population have panicked and decided they

need to save more. So now there's this glut of savings, and that's a lot of people looking for low risk investments that they can retire on, and there just isn't enough low risk investments. Hence the price goes up, and guess what falls the yield. And that's one of the reasons why bond yields, not just sovereign bonds, but corporate bonds, mortgage bonds all over Europe and in Japan are negative yielding, and that scares equity investors and then they panic more

and they sell off the cyclical stocks. And we think this is a tremendous opportunity to own some of these great companies, whether they be financial institutions or or manufacturers at crisis level valuations, and yet looking at the businesses, how much better managements have become over the years. How much more impressive is their financial strength? They're not even comfortable.

The banks have three to four times as much capital as they did in the Eurozone crisis in and there's nothing wrong with the Brits, thank god, they have the I think the best economy in all of Europe. Whether they're alone or together, it doesn't matter. So when we when we look at Europe, how do those valuations and yields compared to what we see in the United States? The SMP just sore. It's yield notch a little above the ten years the tenure yield is falling this past summer.

What do yields look like on quality value companies in Europe? The banks have a very high yield and likely to be higher as they continue to improve their asset quality and cut costs further, which is one of the few areas of control they have. They can't control rates, but they can definitely control their costs, and as they generate more cash, we expect them too. As the US banks have already done, returned that to shareholders, so their yields

are taking higher. What's the average yield of a decent sized bankst somewhere around three to four percent, so not Sometimes yields get too high. It's almost a warning sign either the dividend is going to get cut or there's some of the problem. This is rational within the realm of what makes sense. Well, I don't know how rational it is. If the tenure German government bond is negative seventy basis boids, that's a tremendous amount, but it looks

at the industrial is. One of my favorites to mention is the German Chemical Company b A s F. They are, They're a giant across the whole panapoly different kinds of chemicals from from organic to agricultural, healthcare related. They're phenomenal integrated business. And that davidend deal is over five percent and nobody seems to be at all interested. What's the fear?

Why are people afraid of buying an internationally diversified industrial life that it's there's the crowding effect isn't just within the US market globally, it is the US market, the US market and the US dollar have attracted a huge amount of buying attention, and part of this has to do with what's happened to the composition of investors. You're talking to me as if we make saying decisions. I

certainly believe we do. But we're making these discretionary type decisions fundamentally in our quants are doing so, they're creating a portfolio systematically with also fundamental risk control. So in every way, shape or form, there's some type of valuation effort underpinning our portfolios. That's not true with a lot

of what's happening in markets today. We see not just the advent of or the massive increase in indexation, which, as you know, as stocks get larger and index they just attract more money and more buying, and conversely, as they fall, they fall further. But the the momentum trend following has been extraordinarily active, So more momentum trend falling and then money behind that. And as these European stocks to the point sell off, then they tend to sell

off further. So if value, if if fair value is some sort of line that continuum, these stocks have been trading so far below and they continue to fall versus fair value because because they're falling already. So momentum is a strange beast. And as there are more algorithmic, more computer driven trading globally, we've noticed more market much more the way of market inefficiency. So we're willing to take positions in these securities and we expect that, saying investors

will prevail. But it's really tough to see this happen. So investors like Michael Burry have said indexing is a bubble and it's going to blow up. You seem to be eluding that the more we index, the more opportunities are created for active management, if there are that many more identifiable inefficiencies. I get asked at every single client

meeting these days, what's the catalyst for value to outperform? Well, frankly, I wish I knew, but there are many possible catalysts, and one is simply that the very expectsive growth stocks disappointed earn these terms and then they become the victims of momentum selling. He doesn't take much in order to get that gap, massive gap to close between value and growth, and we just you could drive a truck through it now. But but I do think that as value turns up

and it attracts more money. This could end up being a sort of change reaction, and we saw this from the end of February of two thousand nine. Is value stocks just took off, and the more cyclicality back then the better. Just remember markets are tremendous discounting mechanisms, so in advance of whatever the event, typically that event is already priced into the markets. And that event now is recession. You hinted at the concern of recession in Europe. Let's

talk a little bit about that. Is this a distinctly European concern? China and the US should we be concerned about recession? We've we've had the yield curve inverted now for depending on which pair of bonds you look at for a couple of months. What do we think about the possibility of recession? Recession could easily happen in the US. I don't see why not. In fact, it's so funny

everyone is so panicked about recession. It strikes me that they've forgotten history because recessions are there's simply what happen. And in healthy economies, healthy economies expanded, then they contract, and then they expand again, ideally the expansions overwhelmed the contractions. But the as for China, if they have a recession, we may never know about it. I'm not sure those statistics will be revealed. And that you don't buy the

Bernie made Off school of statistical analysis. The Chinese seems to try to stay far away from that as possible, but they we do a lot of on the ground research and so well. Were already see the concern small to meaum sized businesses have, and that's one of the

reasons why they're, for example, advertising less. There are lots of different ways of measuring the health, but one way or another, recessions are just a transient effect, and out of that comes recovery, and the recovery gets discounted by markets, typically four quarters at least in advance. If you want to own the beneficiaries of recovery, you need to buy them during the dark, gloomy periods. So that's interesting. Look, it's been over a decade since we've had a recept question.

As you point out their cyclical they're they're not to be feared, and yet it seems like the US Federal Reserve and the White House are horrified by the thought of recession. Is that just concerns about re election or is there a real fundamental reason to be concerned about

the first recession following the Great Financial Crisis. My colleagues and I don't see the same type of financial leverage that unwound the global economy in two thousand and eight, But there are other risks out there, and there is plenty of debt, certainly in the corporate sector. The way we look at this cycle is, let's just say there's

a slow down. It may just be something psychological that all you have to have is purchasing managers and those in charge of Catholic expenditures to decide to pull back. So investment slows, and consumers may be concerned about the price of goods, they may slow their purchases. It doesn't take much um in this country. And as for Europe, I mean Italy has sort of gone going through a recession. Germany maybe in one now. Whether they can spend their way out of it, this is sort of the hundred

million dollar question. Will the government's there decide that says it doesn't cost them anything to borrow, In fact, they get paid to borrow, which is again the bizarreness of this. Will they take advantage of that and engage in enough fiscal stimulus to revitalize their economies. Just a little fiscal stimus would be phenomenal for investor excitement because there's been

so much bunker mentality. Let's let's talk about that. Because following the financial crisis, look, we know the kinges playbook what you're supposed to do after a crisis. Europe, especially the UK, seemed to have forgotten about that and they went on austerity instead of saying, oh, the private sector is pulled back, we will temporarily step in to fill the gap. What what happened there? Why was the psychology so backwards and how much of that is still lingering

or how much of that is fixable? As the other question, these are aging populations. But my colleagues and I draw a very deliberate distinction between Europe and Japan. Japan a closed economy no significant immigration versus Europe with three million immigrants in the last five years. Europe has still the potential not to stagnate as Japan has, and it hasn't

been that awful in Japan. It just hasn't been great in terms of growth, they sort of tip on the edge of deflation continuously, which again is it both a monetary phenomenon and a psychological one. But Europe doesn't have to grow very quickly. For European listed stocks some of them to do very well. When you say not very quickly, I think two percent would be nominal, would be more than enough, I think. And there's no inflation really in

the in Europe now, very nothing that's really measurable. There's some background, but inflation we're pressed to find it anywhere in the developed world. So is deflation the bigger concern than inflation? Deflation? Are we or Europe going to turn Japanese? Is that unique? And I don't think so. And there's a sufficiently there's an influx of immigrants and a younger

population and the companies in Europe. And here's where I draw the distinction with Japan all those If I think back to the early part of my career and that of my more senior colleagues from the early nineties, we worried so much about Japan and why didn't we have an index weight in the Japanese market? Our clients would ask us. And you may remember Japan from the late eighties early nine and taking it all back to Japan

with them. They there was no need to worry because by capping, by putting a floor under the any kind of downside in that economy, they capped the upside. Or think of it this way. Too much capacity and no willingness to really consolidate. And will the Europeans follow that path? We think less likely. They will allow some bank consolidation, they will have to have the job cuts necessary, And the Brits, the UK in particular, has been good about that.

They have more labor flexibility and mobility than anywhere else in Europe and less regulation. And as they pull out of the rest of the EU, that will be one less market that has the chokehold of EU regulation. So what does that mean in terms of the growth in in the UK? Will they still be able to export on a competitive basis to the rest of Europe? What's

to to someone on this side of the Atlantic. It looks like the UK, second only to Germany, has been a huge beneficiary of the EU and they managed to maintain their own currency in central bank. They seem to have had the best of both worlds. What why Brexit? Why get out that? Like so many different possible economic scenarios. This one has a lot of politics behind it, but the idea of blaming globalization or immigrants seems to be a very popular way for politicians to get ahead. And

it's a lazy demo, but it's effective. It's very you know, it's it's part of the greatest hits because it's worked so well over the very fact, we couldn't have anticipated it would take the it's three years plus post their referendum in June to make a decision. That was a tough one, but the UK were that we have the largest in our international fund, the largest active weight, which is our which is the weight versus the benchmark, So

the greatest overweight is in UK listed stocks. They're not all indigenous UK company In other words, these companies operate multinationally. They're like yeah, yeah, many of them are global in scope, and their revenues are either tied to or somehow related to the US dollar and maybe oil and gas businesses or pharmaceutical businesses. So there's the pounds sterling weekends, all other things being equal. Sadly they never are. These companies

are even more profitable. But we've also liked there are companies in the UK where the specter Brexit hangs over them and that's made them especially undervalued. But one way or another, what we do know about the vast majority of politicians elected democratically is that they'd like to stay in office, and cratering an economy is not typically a way of staying in office. So there we are going

to be negotiating. I assume the Brits will be negotiating right up until the eleventh hour i end of October, if not before then, and then they will strike a deal and the deal will be to spend the next

two years working out a trade arrangement with Europe. So when many investors look at things like trade wars or Brexit and they see confusion and uncertainty and we don't know what's going to happen, I get the sense you look at these sort of disruptive events as saying, hey, creating all sorts of opportunities to buy otherwise great companies at a great discount. It is a huge opportunity and

is long. What's crucial is the financial strength is there because we have no way of knowing how long we'll have to wait client meetings, clients will look a little limp and broken, like what's wrong with your value managers? And and this is true what we do quantitatively in emerging markets, we have more of a value emphasis, and

it has been like swimming upstream. But that's okay because when value snaps back we see this historically, it does so very quickly and the rewards are significant, so it does pay to wait. And those that income that from dividends is very important to assure a certain level of patients. So value is underperforming growth for what ten years now? Is that about right? And the US has just about outperformed everything internationally, So you're in two of the most

challenging sectors there are. International has been battling up hill. Values battling up hill. You mentioned clients look broken. How much time do you have to spend explaining mean reversion? And this too, shall pass to to your clients. The vast majority of our large institutional clients. I'm paraphrasing, but I think they've said something to the effect of they

look at values, they have to have it right. They know that they it's painful for now, but eventually, like an insurance policy, Okay, we don't really know when you're going to have the hurricane, but you want to make sure you're covered in terms of property insurance, and you'll pay the premium, which is some underperformance for some period of time that you're looking at that as an insurance premium. Yes, and I suppose I value went through consecutive years about performance.

They look at their growth exposure in that very light. I recall back in the late nineties hearing the sky Warren Buffett was all washed up, and that was whenever you start to hear that, you know you're late in the value under performing growth cycle. And it's a matter of time. And and for the decade plus since then, value did really well. Um, and now we're on the other end of that. Are you expecting this to turn anytime soon or we have no idea when value will

reassert itself. Yeah, well, we don't know, but every quarter that goes by. And this is particularly true of this summer, the July August period nineteen, where value just seemed to take another sharp leg down and the risk aversion levels in markets spiked up. In other words, investors would buy negative yielding bonds because that was the supposed risk free asset.

They're they're buying consumer staples and healthcare and of course real estate they can't get enough, and then dumping everything else. And again I'm not sure this is a this is a group of people sitting in a room making decisions. But rather some of this is very momentum tread following

software that just does what it's told. But that opportunity now has become so long arch we think of it in terms of statistically, in terms of valuation gaps and how many standard deviations from the long term mean is it? And we're now getting to the point where extreme levels and the more extreme the valuation gap becomes between growth and value, the more likely it is that that big premium for growth will shrink. I have a bunch of questions we didn't get to, but there were two in

particular I wanted to ask you about. Let's talk a little bit about corporate culture. So you have an ensemble approach, how does that affect your corporate culture and how does the culture affect the way you invest? I've then I believed in teamwork ever since grad school. That's what they specialize in at the Touch School at Dart mess is doing everything in teams. But it wasn't until I got to the world of investment management and saw the other side of the coin, which is, if it's not team,

it's star system. It's one or two people making all the investment decisions. And what I didn't like. There are two reasons I don't like that and didn't want to build a nord in my business partner Harry Hartford want to build a business around that is because one, it's too risky for clients anyone. If the star gets up and leaves, your business is over. So that's no good in the star also, and this is the second reason, he or she or maybe it's a couple of stars.

As humans, we have biases. We have investment biases. Some people are are very short term and how they think, Some are long term. Some are maybe a little gullible and believe management too often, and and others are maybe too skeptical to the point of cynical. Whatever the biases are, you don't want to have any one person's biases or one or two people embedded in your client portfolios all

the time. So that's one of the reasons why we dispersed the responsibility for portfolio management amongst in our fundamental portfolios amongst six different heads of these research clusters. And it's not as if people have a sleeve. There's stocks have to compete with everyone else's stocks in the group. So and everybody is subject to the scrutiny and the

and the professional criticism of other colleagues. But for example, when financial institutions are extremely cheap and we think they have a promising future, Connor Muldoon, who runs our Financials and Materials cluster, he will have more stocks in the portfolio than say, maybe Ellen Lee, who's looking after consumer staples, because staples generally across the globe are very expensive right now.

But as if the tables turn and it turns out that people realize that Diageo isn't worth twenty five times earnings and they'd rather uh sell that and own something else, we'll have a chance. Ellen will have a chance to get more of her stocks in the portfolio. So that's why we work in a ranking system the highest risk adjusted return stocks down to the lowest, and the returns come from the work that each one of these six

cluster groups are doing. With the oversight and the critique of all all of my other colleagues in research and quant colleagues, as well participate. So when you mentioned portfolio construction from these six sleeves, it's not like I have to have five from each sleeve. You this is done very soon. That would be a disaster there, but that's how some funds run. We're gonna have X of each. So then there's a wizard on top who decides how much sleeve should be at any point. Is that the

so we don't have. Thankfully, there are no wizards there. We're not born equal, but we're definitely then there's no one making an allocation decision. The allocation and our international fund and on our global fund is entirely a byproduct of that bottom up stock selection process. So stocks compete with each other. If we have a we talked earlier today about Volkswagen. If Volkswagen's return is has a certain let's say it's a double digit percentage return per year,

and we know what the risk is. We know it's risk of just a return. It has to compete with the next stock on the list. Maybe it's Barkley Bank in the UK as another large return but even more risk. So when a risk adjust a return basis the stocks, this ranking gives us as a portfolio management team the roadmap, we now know that we should have larger weights in the stocks that are higher ranking and less weights in

those that are lower ranking. And as the stocks ranking changes over time because their share prices typically rise and converge with their price targets, that means the return diminishes and the stocks naturally fall on the ranking, So we have to sell them and then recycle proceeds back in the higher ranking stocks. So so that's by sector. What

about by that's a national region. That's the same process that the process So when the stocks are researched by sector, then they get put together into a long list or this ranking, and then it's from that we select the fifty stocks ago in the portfolio. How does how does the regional aspect of that play out? Is it? So, for example, you mentioned you were overweight the UK. I'm assuming it's not a macro. There is no there's no

regional allocation. The only region of the world where we have a specialized team, and you could guess this is China, and that is largely that's that is a function of the fact that there are so many stocks there and it requires a lot of local knowledge to get through the mall. I mean three thousand new stocks for investors to cover, and the and the indices are including larger and larger percentages of them. And it used to be foreign investors were a huge disadvantage with A shares and

B shares. How has that changed in China? A couple of years ago, the Hong Kong Shanghai Connect program allows investors to invest northbound as well as a southbound into Hong Kong, So we can from Hong Kong invest directly into those A shares on behalf of our clients. And that opens up a whole new investing panorama because formally you had to get a specific license to buy those if you were a foreigner. And this is all part of the actual opening up of the financial services sector

in China. It's a two steps forward a step back. But how is China valuation wise compared to places like you mentioned Italy and the UK. Well, if you would ask me what I considered to be the next great frontier in terms of of undervalued stocks that are misunderstood. As much as we like all the developed world, the

greatest number of them reside in the Chinese market. They're they're literally hundreds of phenomenally well managed businesses, often with a family or family members owning large percentages of the business, so private sector, not state controlled, and completely misunderstood or not well followed. That will correct itself over time. There'll be more and more investors focusing in on the Chinese market, but for now, the alpha opportunity is enormous, really, so

that's that's quite interesting about China. The another area of the world I want to ask you about um that also tends to be neglected by US investors is India. What do you think about what's been going on over there, both politically and economically, as well as their valuation situation the Indian market we it's represented in our Emerging market portfolio, and the last election turned out to put Prime Minister Motive back in place, which is good. Has done a

good job. The demonetization are taking some of the cash out of the economy. Has been helpful. But it's in India we see a distinction. They're just more stocks in China and the and the enterprising and ambitious nature of management makes them the Many of these Chinese companies, and I'm generalizing broadly, but they're in a huge hurry to be to China. Yes, China to deliver profits for investors, and we see that less so in India. Just just it's just the size of the Chinese market is parallel

to it will be, we think, like the US. It will be. There'll be two large stock markets in the world in ten years, and we may not be talking about India in that light. Really, is that there's that much of a there's that much of a difference between China and The pushback I get on that is Oh, but Sarah, there will be a recession. China will slow it.

So what I mean you come out of recessions, and what they do is they tend to clean out any misinvestment where their money has gone into poor return projects or businesses. Those will fizzle and the in the Darwinian process, the better ones will come out of that. I don't remember whose quote I'm about to steal, but I love love the expression recessions or where capital returns to its rightful owners. And there's some some degree of truth in that. Um So, So, we've seen the US outperform the rest

of the world for a long time. Um how long can this continue? It? It's been a solid decade. Are we almost done, or we halfway through, or do we have no idea whatsoever. Were given the extreme valuation gap to the degree of ur want a bargain, it definitely um. They're more of them outside the US. It's one of the reasons why in our global portfolios we are such a large underweight. I think we're at least fifteen percentage points underweight the US market, and that also seems to

make clients a little nervous. But we have to go where the most undervaluation resides. As for when the US market is the laggard, not the winner, it could happen at any time. It's certainly a recession wouldn't be taken well. And if it's if you think about some of the leaders in the US, especially in the technology area, this was one of the misperceptions that gripped investors in the late nineties. They really thought technology stocks were we're defensive

what some they didn't weren't. Just because they grow year of a year, it doesn't mean they're speculative it's a defense. Well, it's not just it's just that many of them are cylical there they depend on advertising, or they depend on some levels of consumers. Simmer demands that that may wane, doesn't mean it's gone forever, but at at lofty valuations, there's a level of vulnerability in those stocks that we

haven't tested in years. So when I speak to value investors about the US, they sort of fall into two camps. One is the oh, the US is wildly overvalued, We've never seen anything like this, And the others are the US is at the upper end of of fair. It's pricey,

but it's not Where do you fall? The answer this question somewhat depends on where interest rates go, and if they continue to fall, investors may get more and more nervous and defensive, and they will want to hide in what they consider to be the current both the currency and the market, where they can be the greatest shelter. On the other hand, if we just have an economic slowdown and then come out of it, it's all bets are off on the US market, it could end up

not looking like it deserves its valuation. But I'm not sure it really, frankly, really matters as long as there are value opportunities globally, and there's there are plenty of them today. We see it in our I talked about that ranking we have the two year price target, and all the stocks we follow we're following two globally at any point in time, including US companies, and the returns are huge for for the value segment. It doesn't matter whether they're in the U S or out of the US.

If investors don't like them, they also don't like them in the US. The sites are set very narrowly on economically defensive and or growth oriented, so not not value, even even though we've seen value really be a good place to hide during recessions, be it uh, the dot Com crash or the Great Financial Crash. Value now directly linked with cyclicality, and because those have been the cheapest stocks and the cynical stocks are considered to be very

vulnerable to economic slowing. But again, I'm convinced that that slowing is already discounting the price, and I would expect nothing less from markets. Quite quite interesting. Let's get to our favorite questions that we ask all of our guests. Um hopefully these will be a bit revealing about you tell us the first car you've ever owned, your making model.

I laugh at that question because it's the security question for a lot of my password recreaval somebody else said that, and I I'm fascinated because I'm waiting for the first guest to say I've never owned a car, so it's sort of like my canary in the cold line. But you're the second part up. I can't tell you, Barry, is that car. I brought it to college and in my great independent period. Well, you know, I'm not going to take this to JF. Loup. I'll just change the

oil myself. So I crawled underneath and unscrewed a plug and that was the transmission fluid. There you go. So I learned a lot about cars very quickly. That's that's pretty funny. You um, you know the secret to doing an oil changes. The oil is in the the engine block, not in the fans for casing, right, um tell us the most important thing that people don't know about Sarah Keta. Well, I don't like to sit I think this is the longest period I've been in it. You I'm fidgety. You

make me look like an amateur. Yeah. I have a stand up desk at so do we? So do I in the office. It's funny. First one in my office and I there was a certain amount of skepticism of scoffing at me, and then it then it took off and everybody has one. They're they're pretty much everywhere. And as long as it's not the treadmill desk, that's the treadmill desk is terrifies me. When eye contact of their in motion, that doesn't work for me. Um, who are some of your early mentors? I assume your father a

hot kiss. Well parents I had. My parents were brilliant and inspirational and worked very hard. They they sent all the right messages to their kids, so I was really really lucky. And in terms of investing, my father had

this curious hobby. He was an amateur race car driver, and he drove on all the tracks around the United States, and a couple of times he drove at Lament and his driving partner for a number of years was the late Bob Kirby, who was one of the co founders of Capital Guardian Trust Company, the Capital Group, and one

of the most extraordinary and greatest longevity investors ever. And I had lots of time with Bob sitting around sort of sitting on a couple of stack of tires and we talked about investing, and he he was the he's known for his coffee can portfolio. He just put it in there and seal it up and it'll be fine ten years later because of transaction costs, which we know

today of course have come way down. But this idea of being long term and owning thinking about the company is if you owned it all, you didn't just own a few shares. They're not names their stocks. That is stuck with me for years. Did you spend a lot of time traveling with your dad while he was going so other kids took vacations to fun places. I went to tracks? Really do have you spent any time on trash yourself? Not driving, just sitting and walking walking around?

I am I'm surprised. I don't have a hearing problem. So you mentioned your mentors. What investors influenced the way you think about putting together a portfolio? Every investor I've worked with, including my current colleagues, I worked with the most remarkable team of people, and they're all a little different. We deliberately chose them because they fit together nicely, and they there It's a very diversified group, but they inspire me to this day, along with our rising core of analysts.

There the remarkably clear thinkers, and they're innovative, and they can look at a problem from a variety of angles. So I I'm convinced, and I tell this to clients. This team isn't the same team it was five years ago. Yes, we've added a few more people. They look like the

same people, but they're so much more experienced. Some of my most amazing colleagues started in the late nineties, which, as you can recall, was the Asia financial crisis where stocks were just coming a part of the seams where yeah, yeah, there was no started with Thailand, there was investors sold indiscriminately and to see both indiscriminate selling where evaluation doesn't matter and its cousin indiscriminated buying just complete an investor.

Right that that that was an interesting era. UM let's talk about everybody's favorite question, Uh, tell us about the books you enjoy reading, fiction, nonfiction, investing related or otherwise nonfiction. Perhaps the most helpful to me was Daniel Kahneman's The Signal in the Noise. The it not the signaling noise. It's thinking fast and fast and slow. I'm not thinking

so economons thinking fast and slow. I didn't really understand behavioral economics, and he got a Nobel Prize for his work in behavioral economics and social sciences and economic sciences. And this idea of loss of version never really occurred to me, that people were asymmetric and how they think. And I found that really useful, not only thinking about investor mentality, but also in managing a team of people.

How does loss of version or risk aversion impact managing a team, especially when it comes to decision making and the concern about making about any type of loss or mistake. And this is true in a group setting, the hesitancy of someone bright to make a comment because it could be wrong, which seems to overwhelm there. They're to participate.

We want them to my colleagues, and I want everyone there, no matter how junior, to know that their comments are valued and whether they're wrong or right, it's their participation is crucial because everybody else thinking interesting? What other so thinking fast and slow is one? Yeah? And then I was Nate's silver. That kind of got jumbled in my head. But Nate Silver, the signal and noise. Yeah, some predictions are right and others aren't. But understanding how statistics can

manipulated and investors can use data very erroneously. That couldn't be more relevant than today. We at Causeway, we hired a data scientists and and data experts software engineers to back him up to make sure that as a team, both fundamentally and quantitable, we have the data we need. But if we work with it incorrectly and we find false what we think our signals, which are actually noise, will be misled. It's using that data is so important and not to be misled by it. And that book

was revolutionary for me, quite quite interesting. Any others, Oh, I have a like a million books like everything that the fiction wise that Robert Galbreth a K. J. K Rowling ever wrote a wonderful those are so you're Harry Potter fan. No, no, no, this is all her mysteries are Cormer and strikes my goodness. This was the one she did underpen name, and people figured out it was

Robert Galeah why she chose a man's very interesting. You'll have to have her on your show and ask her if please make an interest, um, tell us about a time you failed and what you learned from the experience. That I get most upset with myself as a portfolio manager when I don't have enough confidence in the decision, so not owning enough of the some great companies when it's when you look backwards you think, oh, it's so obvious, but at the time struggling with should we should be not?

And especially in areas where you can keep these in the portfolio for a long time, like some of these healthcare stocks. That's the frustrating hindsight biases. Always, Um, what do you do for fun? What do you do when you're not picking value stocks? I enjoyed being with my family and then when they kick me out, then I'm hiking. Okay, Um, tell us about what your most optimistic today within the finance industry and what are you most pessimistic about. I'm

most optimistic about my team. I mentioned them earlier. But to have such talent and such dedicated talent. We have twenty one partners at our firm, and that's deliberate rather than keep it narrow out of over a hundred employees, now over a hundred employees, thirty six investment professionals, and

not all the partners are investment professionals. Some lead very key areas, illegal and operate our our CEO is an important partner of our for the that team is everything that those people up and down the elevator every day and in the human capital business are really all we have for our clients. And I'm so proud of them, and I'm so excited to work with them again. They've because we've been through such torture as value managers in

the last few years, they're more. Their quality and their depth and their experience level I think now is unmatched. And as for pessimistic finance wise, not really, not really anything. I'm so I'm so optimistic about being a value manager now, but I think about my life and my eight year old loves baseball, the one sport I didn't want them to play. I had to be sitting through so many games. Let's talk about advice you would give to a millennial.

Someone comes to you and says they're interested in the career and finance. What sort of advice might you give them? M I give them too much advice, but I had to distill it to one piece of information. It would be read read more. Read everything you can get, not just the Wall Street Journal in the Financial Times and the Economist every week, but go and read the books written by famous investors, read the biographies, read tomes that deal with different segments of market history, so that you

can fill in the gaps. If you're in your twenties, you don't know much yet. In fact, you really only know a period generally of falling interest rates and rising markets. Not not the norm. In other words, well not not my norm and um our final question, what is it that you know about the world of investing today you wish you knew thirty years ago. I wished I've taken Chinese. I would love to be a fluent Mandarin speaker. Uh, it's not just that's a huge population, not just as

an important markets. Much of the talent. Many of the talented people we hire were born there. So and I took French and German, which is beauty of full languages both, but they're not nearly as helpful and it's tough for a tonal language to grasp as an adult. It takes a lot of time that I don't have. So I'm listening in my commute and when I'm walking anywhere. I have, but it's gonna take me at this rate, it's gonna take me time. I also wished I don't not to

fret about Japan because I didn't need to. It took care of itself. We were chronically underweight as an international manager, took tremendous criticism, and but we did the right thing. Quite quite interesting. We have been speaking with Sarah Kettera. She is the co founder and CEO of Causeway Capital Management.

If you enjoy this conversation, well, be sure to look up an Inch or down an inch on Apple iTunes and you could see any of the previous two hundred and fifty or so conversations we've recorded over the past five years. You could see that pretty much wherever Finer podcasts are sold Bloomberg, SoundCloud, iTunes, Spotify, Overcast, Stitcher, etcetera. We love your comments, feedback, in suggestions. Write to us at m I be podcast at Bloomberg dot net. Check

out my weekly column on Bloomberg dot com. Check out my daily reads at Ridholts dot com. You could follow me on Twitter at rid Halts. I would be remiss if I did not thank the crack staff that helps put this together each week. We would not be able to do this without the help of Attica val Bron, who is our project manager. UH Michael Boyle is my producer. Michael bat Nick is my head of research. I'm Barry Ritolts. You've been listening to Masters in Business on Bloomberg Radio.