We are live. This is Value After Hours on Tobias Carlisle joined. As always, by my co-host, Jake Taylor. Our special guest today is Dan Rasmussen of Verdad. How are you, Dan? Great. It's great to be here with you guys and special with Jake's pink sweater. Welcome, Dan. Often, I'm not often the right foot. You've been on the show before, but for folks who don't know, why don't you just give us a brief outline of who you are and what is Verdad?
What are you doing here? Yeah, what the hell am I doing here? I guess like you guys, I have a deep and abiding interest in deep value. Condolences. I know. But for Dad, as Edge Fund, we manage a little under a billion dollars and assets are spread out about a third of the money is in microcap deep value strategies of which the majority of that money is invested in Japan, which I'm always happy to chat about. Then we have a crisis strategy, which is
another third of our capital. That dumps money into the US market whenever the high yield spreads blow out, past 600 basis points, which we first did during COVID. Then the rest of the business is high yield credit. We have a quantitative approach to high yield credit. Then we have a multi-strat hedge fund, which we just started, which is long short factor strategies and multi-asset class. That's sort of the spectrum of things that we do, but
in Boston. I really enjoy all of your guys. I read it every Monday morning when it comes out. All the research pieces that you guys put out. I would just start off the show by saying everyone should sign up for that if they want to keep up on so much better than doing reading academic papers. Just read for dad's stream instead. Thank you, Jake. We write every Monday and we try to do a mix of we do a lot of our own
research and share what we're finding. Then we summarize other people's research when it's good and interesting. I was just joking with Jake that we've been accused of educating people's biases that perhaps we were to the things that we write are too confirmatory of our worldview. I think that's probably true of most writers. Welcome to the show. That's what we do. Change the show's name to confirmation bias. What are we still doing? Why don't we stop there? I think you and I have fairly similar
approaches in the sense that it's quantitative deep value. A lot of the research is probably US focused in it began in the US anyway just because that's the longest and best data said. I think that the question that I have had and many people have had is that value really has sort of seems to have broken down somewhere between it depends on how you're counting it. 2010, 2015 through 2020 perhaps. I feel like there was a little bit of a recovery
late 2020. I feel like it's probably still ongoing but certainly last year was weaker for deep value, better for the growthier stuff. How do you see, do you think that's a fair description and what do you think of the drivers? Why are we where we are? Yeah. I would say I think the worst period was 2018 to 2020. The value winter where value just got decimated and not only did value get decimated but the opposite of value worked
if you were just long. I think the sort of frustrating thing about the stuff that worked was it was sort of we all think we're really smart and educated and we're thinking about analytically and we're analyzing things and the stuff that worked was just like, you know, stuff you're seeing on TV or stuff. It was just like, yeah, I've used Zoom the other day and that seems cool. Maybe I should buy Zoom stock. I think I think some
many Amazon packages like that must be a great business. Let me start like getting, you know, buying Amazon stock. I mean, it was just frustrating right because you're like,
well, that's not how the market's supposed to work. Right. Markets are supposed to be sort of efficient and all that stuff sort of supposed to be priced in and the glamorous stuff isn't supposed to work and, you know, I'd like to think that like doing all this work to find some like exotic microcapped trading and half times book that nobody's ever heard of that there's like a monopoly on in some random industrial part would be rewarded
that is of like spirit. It's going to be on a screw that goes into a billion dollar plane. Yeah. And then exactly exactly. And yet instead the opposite was true. And then I think, you know, starting and then you had, you know, in the US, you had a real value recovery after 2020, you know, really no, you know, October, November of 2020 was huge and then,
you know, 2021, 2022 were quite good for value. And 2022 was great because there was like the vengeance of all the stuff that I hate all of like got totally obliterated. And, you know, like all the like they even had annoying names, annoying tickers where the tickers was actually some word like laser or something and you're like, you know, God, this really this thing has to just burn and hell and in 2023, 2022, like it really
did. And then and then in the US last year was all about growth again, all about growth and the growth year and the crappier the growth thing was the better it seemed to do frustratingly. And I think, you know, the saving grace for us was that internationally value at a really good year. So really good year. So if you were long deep value microcaps in Europe or Japan, you had a great 2023 and a lot of the growth stuff in those countries, a lot of
international growth investors had a lot of money in China, which got hammered. And so, you know, value looked pretty smart internationally. So it's a little bit different. But yeah, in the US again, it felt like the deeper value you were, the more you got obliterated relative to the benchmark right? And I mean, nobody knew it was hard to lose money and investing in stocks last year, but relative to the benchmark value under performed last year.
Probably the only place that was a little bit sad with a small and micro is had he feel about small and micro? Yeah. And I think the other thing that's worth noting is the size premium has been fairly negative, right? And so, and I think that, you know, when you're thinking about value, especially deep value, you're getting a bunch of factor exposures along with your value, right? If you want to own value, you're also getting small size almost inevitably, right? Because that's
where all the really cheap stuff is. You're also getting lower earnings growth. You're often getting high leverage levels. And so you're getting this other, you know, mix of factors along with it. And I think the the size factor, which is, you know, over long periods of time has been a fairly reliable winner has also been a sharply negative. And so if you've been going outside of the benchmark to own smaller things, you've been getting hammered. And I think the smartest thing
as it turned out to have done over the last five years, right? I think, you know, you even think of the sort of smart growth investors who all said, hey, it looked the index is too overweight, like seven stocks and the benefit we provide you as active growth managers diversifying you out of this top heavy index. But actually, the right thing to do is to say, hey, that the indexes in top heavy enough, we should own double our benchmark weight in these five stocks. And then we're
going to really kill it. That was the right answer. No one did that. There's, I know one guy who did it. But but but almost nobody else did. And so you had this, you've had this sharply negative size factor, which I think is also sort of unintentionally heard a lot of value investors. Dan, do you feel like, you know, if you want different ways of imagining reversion to the mean,
and you have, you know, the last 10 years of what kind of worked. And then you have the, if you looked back at the last 100 years, those things are like completely opposite of each other. What's your argument other than just purely reversion to the mean as a, as a, you know, kind of exist existential force in the universe. What would be your thesis for why we should expect the next 10
years, perhaps to look more like the last 100 and not like the 10 before it? Yeah. So I come back to, you know, I'm not, I'm not, I'm not a believer in reversion of the mean for reversion of the mean sake, right? I think that we can go sort of on a deeper philosophical level. And my deeper philosophical levels that there's a lot we don't know about the world and our vision of what we know really stops when the future starts, right? It's really hard to predict the future, really, really,
really hard to predict the future. And if you're a smart quant and can go back test things, you can put in a lot of, you know, ideas and you can see how hard it is to predict the future by looking at how many of your back tests fail or like how many of your good ideas don't work, right? And I think if you think about some very simple rules that you might come up with, right? You might say, you know, gee, I think the US is outperformed last year. So it should outperform next year.
Or like US stocks always outperform or write it. And you run that through a, you just realize it's it's not true. It's too simple, right? I mean, and I think the fundamental reason for this and why sort of value it works in my mind is that one of the things that's most unpredictable is future growth rates of companies. Future growth rates of companies are totally unpredictable, right? Now,
it doesn't seem like that because we have in our mind, Microsoft and Amazon and Facebook. And so we think, oh, gee, you know, this has been very stable long term growers surely growth is predictable. But it really isn't even within the technology sector revenue growth earnings growth. It's just not it's not persistent. It's not predictable. You can test that any which way, right? So if you stop and say, well, gee, you know, I don't know what the future is going to hold on a company level for
revenue or earnings. I think it'll be crazy for me to say I really know that the US market is going to be the best performing marketer or really to pick any region and just say, hey, that in 2024, that region is definitely going to be the best. You know, what's the logic for that, right? And you come up, I mean, you know, and I think the same with sectors, right? So it's just really hard to predict what's going to happen with any sort of fidelity, right? And the world is so unpredictable.
And so then I think if you think about what that implication for that is, like if you start with a position of future nihilism, okay, let's assume I know nothing about the world. I absolutely know nothing and nothing is predictable and everything is totally random. Well, then if you bought a pool, a bunch of companies at five times earnings and a bunch of companies at 25 times earnings, right? A year from now, in theory, the multiples should adjust for some other random new set of
expectations. And so everything should be sort of scrambled. And if everything scrambled, the cheap stuff is going to be much more likely to be scrambled up and the expensive stuff we're likely to be scrambled down on the random distribution. And so value is going to work because of this resorting. And I think over time, if you look, and that's how value works, right? You take the universe of value stocks and a decent chunk of them end up resorting out of value. And that's
going to make your money. I'm with growth stocks, a big chunk of them resort down out of growth because they, you know, the growth doesn't live up to expectations. And so I think that for me, you know, value is a way of betting on unpredictability of saying, hey, it's a humble way of investing, right? You're sort of saying, hey, gee, I think there's a lot we don't know. I think there's a lot we could be surprised by. I don't think we should feel too confident in our forecasts. And I think
to go back to sort of the other side of the trade where people have been very confident, right? And they've been saying, hey, we really think that large cap US tech is the place to be. And it's really growing a lot. And that's going to really reward equity investors. And the frustrating thing is that they've been right. And so they've felt that the world is very predictable and that that predictable predictability will continue. But even if you look at the predictability of the revenue
and earnings growth rates of those companies, right? They're really random. They've been really high, but they've been quite random. They haven't been necessarily predictable. And so I think, you know, you come from this place where you say, gee, I don't know what's going to happen. I think the world is unpredictable. Values the right way to bet. And I think when it comes to thinking about size as, you know, I think of size as, which is obviously it's related with value, but I think,
you know, there are a number of ways to think about that. One is to think that, you know, there are a lot more small companies than large companies. There's a lot more randomness associated with it. There's a lot more volatility. And so, gee, if you're taking that risk in smaller stocks, you should be more rewarded to the upside when that random occurrence happens, then you wouldn't a much more large stable
stock. And you'd think that the large stable stock would be more efficient or less volatile than anyway. So I think there's an argument that taking this value risk within small caps gives you this really asymmetric set of outs. And if you just keep making that bet over and over and over and again, you're going to be right because there's your betting on a fundamental truth about the
world, which is that the future is unpredictable. It just is. You can't predict the future. And there are very narrow ways, ways you can, but by and large, it's unpredictable and values a way to express that bet. Let me get a shout out to our, we get people from around the world with, like, giving a little shout out, Petitec for Israel, Dino in Townsville, what's up, Madeleine Floreau, the Senator Mingo, Winnipeg, Manitoba, Canada, Pittsburgh, Norberg, Sweden,
woolen gabbat, really. I'm going to get a good view. Pretty cold right now. Hodgerika, that's a tough one. Norwich, Pritzjuer, Toronto, Manitoba, Chamnitz, Germany, Valpariser, Kauai, Hawaii, or Kursa, Estonia, Hamburg, Germany, Vakaville, Canada, Catown, Ann Arba, Colorado, Moutencane, Soutencane, so I think I always get that wrong. National Tennessee,
Chippewa Falls, Toronto, Brisbane, what's up? It's a couple of good questions in here, Dan, and then I also have some to pray us, what does Dan think about the illiquidity factor versus the size factor? Some research indicates that liquid small does horribly well, illiquid small outperforms. Yeah, I think that, look, I think size and liquidity are very correlated, right? So where do they become
uncorrelated? What are, like when you actually, like, what are the liquid small microcaps? They're almost all growth stocks, right? They're really highly traded growth stocks, and so yeah, they do kind of suck, but do they suck because they're small and illiquid or do they, like, they suck for another reason,
right? And I think that my view is that size and liquidity shouldn't theory be competitive advantages for investors that can do it because large funds can't trade in these things, and analysts aren't going to cover them, so you're going into a much less efficient part of the market, and where very small changes can drive really big changes now comes, so if you think about where there's the most asymmetry, it should in theory be in the most
small and illiquid things. Yeah, I like that answer. I think that there's, we're often measuring symptoms rather than causes, and I think size itself is almost a, is probably just a symptom of value, but that's a little bit beside the point. Here's a good question. I think this is right in your, right in your, in your, like, value, like, that's a good word. Why would the size factor work in an environment where companies are staying private for longer than in the past and private
equity buys out many of the best small micro companies? Yeah, so look, I think there has been a change in the quality of the small cap index, and we've written about this. I'd say more of the problem is actually the introduction of a lot of crap and small companies recently, there's been a lot more biotech IPOs and small tech growth IPOs, which are generally bad. And I think there's some truth to some of the best small caps do end up getting acquired, right? But there's still
really big selection opportunity, right? So, you know, there's still, I don't know, 2000 stocks in the Russell 2000 and 500 stocks in the S&P 500, right? So, you know, there are four times as many, right? I mean, in theory, that should be, you know, whatever it is that you're looking for, you should be able to find some version of it, and it's more likely that you're going to find some version of it in the small cap universe, the large cap universe if you're being selected.
So, I think that might be a good argument for saying, hey, gee, the quality of the Russell 2000, as a whole is worse, but is it necessarily an argument for stock selection within the small cap universe? I don't think so. I think another thing that's worth noting is that private equity backed companies in particular are really low quality, as we would think of measuring quality. They tend to be really low profit margins. They tend to have a huge amount of debt. They tend to be smaller
than the average small cap by a lot. And so, you're looking at company, they do tend to grow a little bit faster. Now, some of that's inorganic, some of that's organic, but you're looking at, you know, low margin, highly leopard microcaps. And recently in the past few years, private equity is really focused on two sectors, Tertek and healthcare. So, outside of that,
you know, the world's your oyster, and there are some sectors, right? Like, take biotech or energy, where, you know, there's just, there are many more interesting public things and there are private things. Now, if you want to buy a microcaps software company, yeah, there are no microcaps, good microcaps software companies that trade, you know, in the US, really, right, or very, very few, right? Those are all owned by private equity and maybe healthcare technology, right? But,
but those are the real growth tech. Those are the real sexy areas, the glamour stocks, right, that are being taken private and known there. And, you know, would you really want to own those? I mean, I guess a lot of people are saying they should that you want to put 40% of your money in them, but I take the other end of that, end of that trade. So, I think it's a mixed bag. I mean,
I think there's certainly truth to the degradation and quality within small cap indices. But, I think that's more an indictment of owning the whole index rather than indictment of stocks, selection, just given how many stocks there are. Getting flashbacks to one of my favorite talks that you ever gave, which was basically dismantling private equity. And you pulled no punches. It was hilarious. Yeah, well, they finally had a bad year. I mean, 2023 was a bad year for private
equity. It's one of the first, you know, times in recent years where you've seen them take it, take it on the channel a little bit. But I think the, you know, you look at, you know, there's this like docu, we were talking about in the office yesterday, this docu sign buyout is coming out, right? And they're going to pay, I think docu sign has like 800 million of free cash flow. And they're paying, I think they're putting on like eight billion of debt to finance the transaction
on 800 million of cash flow. And like they have all these things like docu sign is way too much, you know, way too much SG&A costs. So they're going to, you know, dramatically increase margins or, you know, whatever it is. But like you think of like eight billion of debt or something, right? And like at 10% interest, that's like almost all the free cash flow of the business is going to debt service. And are they going to get 10%? I mean, maybe it's maybe it's a 10% 8 billion at 10%
for 800 million of cash flow. But she think of the risk, right? And that's like a premiere, you know, big premiere buyout that's happening right now. And the bigger companies are better in quality. And they're, you know, they have more free cash flow and they have higher margins than the smaller companies. So think of that as like a case study and what private equity is doing right now and just say, how much exposure would you want to have to that? It, gee, it seems pretty
risky in this environment. I don't know right to it doesn't seem like there's a lot of room for air. It doesn't seem very humble. It doesn't seem like it's anticipating that your Excel model might not be right. If you play devil's advocate on this, like let's invert it. And let's say that I forced you to only, you could only invest your kids college funds in a private equity market of some kind. What strategy would you, you think could actually end up doing okay over the next 10 years,
net of fees? Yeah, well, I've always thought that, that, you know, value times leverage is a good thing. Right? If you like value and you like small cap, but then, you know, a marginally levered company with two or three turns of debt isn't a problem if you pay six times even before I don't have an issue with that, right? Generally, a company can pay off debt. So, I'm okay. Like I like old school P.E. Right? I think that was a great idea. Obviously,
it worked really well, right? Yeah. And so I said, I'd say like, well, where can you buy small companies that are cash flow generative at low prices today? Like certainly Japan, right? I mean, Japan is just everything is cheap in Japan. Now, everything's public in Japan too. So most of the buyouts there are take privates, but generally, yeah, you can get great bargains there. I think Europe is still decently cheaper than the US. I mean, it's, it's, there's less capital chasing deals there.
And then I'd say probably within the US, there are sectors that are left for dead, you know, the private equity, you know, as an asset class, you see the LP community react as a herd to certain things, right? And so there are a bunch of take privates that went bust in like,
oh, eight, right? So then a lot of LP said, please don't do take privates. And so you've, you know, you saw sort of a move away from take privates the last few years and then every private equity firm and their mother got really into energy in 2012 and 2013 and then got totally burned in 14 and 15 and then all the all piece that never do energy again, you know, and so I bet there, I, you know, I, I, I was suspect there's a lot of interesting energy private equity deals out
there. So, you know, I think it's just a matter of, you know, where the value opportunities are. And I think it's, you know, these days, it's anywhere X US tech and US growth where multiples are really crazy. But, you know, the minute you get out of that, there's a huge drop off to everything else. Do you feel like that cyclicality though kind of almost makes it not a good candidate for PE because inherently you're going to want to lever it up, which means you need consistent
cash flows to, to sort of make the math work without crashing the whole thing. Yeah, I think, I think you either, you have to lever it reasonably. And I think honestly, just have to get lucky on the sector time. You're not going to get rich, leveraging reasonably. Yeah, but I think you've got to get the timing right. Right. So, if you like look pre 2010, energy was like by far one of the best performing buyout sectors for PE because, you know, they basically, you know, buy stuff
when oil is at 20 and then oil will go up to 80 and they'd offload it. And G, if you, you know, if you're revenue went up 4X and you were levered 80%. You know, you look pretty smart. Absolutely. Loot killing. And there were a lot of chemical deals that followed sort of a similar trajectory. So I think, you know, those volatile areas can work really, really well if you get the timing right. And now how do you get the time maybe if you're, let's say, not if you get the
time right, if you get lucky on the timing. And so having some exposure to those things, you know, can more than make up for a lot of losses. But, but G, you know, I think it has a lot of people, a lot of value investors, you know, myself included, right? Like you looked at energy in 2016, it's cheap. And then you looked at it in 2017, instead of cheap, then you looked at it in 2018, instead of cheap, like how many years do you have to keep doing something that's kind of absolutely
smoked and like carried out, you know, in a coffin. And then like by 2020, everyone's like, look at all the cheap energy companies. And you're like, I cannot look at another cheap energy company. Yeah. Like it never works. Energy is a terrible sector. And then like all of the energy stocks go up like 5X, right? And maybe you didn't know as much exposure to it because you've gotten so absolutely shlacked on it for the past five years. And that's just how markets work, you know,
what's like. And you know, it's, it makes them so challenging, especially as a value investor. Yeah, you're the cat that's not going to be sitting on that cold stove either after. There was a, there was a time in the, in the long value winter when one of the arguments that I had that I found pretty compelling. And I'm just interested. How you think about this? But one of the arguments was there are so many people who know that value works as a factor. There's so much money
in value as a factor. All of the values stocks are bit up beyond where you should be able to generate any sort of absolute return out of them. And so the true contrarian is now hunting in the most expensive quintile, desile, whatever. And they're taking from that, you know, the better companies out of that most expensive quintile. And the, there's a gentleman by the name of Partham Mahanran. I think
he's a, he's a professor of finance, possibly into Toronto, I think. And he has the, I think he calls it the growth factor where he would take it's essentially the same as a peer Trosky's F score. I think he called the G score was the F score where you take rather than taking the cheapest and finding the best and the worst and finding the ones that can survive you take the most expensive and long short. Traditionally, it had generated most of its returns probably as it expect from the
worst of the most expensive. But there was this period of time through 2019 and 2020, where, you know, the, and cliffassness wrote about this the fact that things were trading inverse to their fundamentals, which had been a thing that he'd observed in 1999 and 2000 as well. So they're trading inverse to their fundamentals. But he's saying, Partham Mahanran, take the most expensive, the best of the most expensive had these two phenomenal years through that period of time. And I
thought at the time, I remember thinking, this is a, this is a very compelling argument. And here it is, it does seem to be working. I don't think it's gone as well since. But what do you think? I mean, I think there are other things that work. I mean, it's a matter of your time frame, right? I mean, I think if you look and say, Hey, I, I have a new, I have a new quant strategy where I only look at 2018 to 2023. And that's where I, you know, drive all the lessons, right? Like,
what would you come up? What would you come up with? Right? Like I have no idea. You know, right? You know, like a day expiry options. Right. Yeah. Yeah. Shoring fall. You know, I don't like you come up with some random ideas, right? And then you'd say, well, how robust is that? Right? Is that going to work next year? Is that going to work out of sample? Right? If something that's like, it's like energy, okay? It didn't work 2015, 16, 17, 18, 19, 20. Then I'm
certain it's not going to work in 2021. And then all of a sudden it does because the world's surprising and it never does what it's supposed to do. And I think that as, you know, people that are trying to make good investment decisions, you know, there's this constant tension between what worked recently and what the sort of long term lessons are. And then the people that are, you know, following the long term lessons are always wondering if something changed. Am I wrong
this time? Or can I just can I just continue on with what I, you know, generally know works or should work, right? And I think, you know, within that context, right, the factor that I think both has worked recently and worked over the long term is the quality factor, right? That's why everyone and their mother from the quant world is launching a quality fund or a quality ETF. I think GMO just announced it, right? Like I mean, because it's smart, it's reasonable, it's
worked in the long term, it's worked recently. And that's probably going to stop working randomly right about now because of that. But, you know, I think that, you know, as value investors, that's the tension that we've been living with. And I think, thank God, you know, we had a great, great value years in 2021 and 2022 and for international value investors in 23. But, you know, absent that, you know, you start to come to doubt some of these things. And so I think for me,
it's, it's how is it that you find the things that you believe in? You know, what are the things that you believe in? How do you come to believe in them? And I think for some people, right, I think it's, you know, there are a lot of investors that say if I really know about a company, I can really believe in it, right? I can learn everything there is to know about Berkshire Hathaway.
And then no matter if Berkshire Hathaway is up or down, I'm still going to own it, right? And so I think part of being a good investor is learning about what are the things that, you know, how do you get to believe? Because ultimately to win, you got to stick with something for a very long period of
time, right? You know, you can't change, if your, if your strategy is to change your fundamental beliefs every two or three years, like you're definitely going to get destroyed because you're always going to be betting on, you're always going to be betting on the thing that worked recently that everyone else has psyched about and that that ends up crashing. Just a bit. Exactly.
And I think, you know, for me, and I think for a lot of value investors that's saying, hey, let's look at this, you know, very long time series of multiple markets and like, let's really pressure test this and you say, wow, like the teeth statistic on these regressions is insane. And like the sharp ratio on this is a long short factors insane. And the reliability, this is so strong, right? And you kind of think, inclusion, this is like the best things in sliced bread,
which it basically looks like from the quantitative data, right? And then you live through a period where it doesn't work. You could write a whole book on it. Maybe several. Exactly. I don't know if anyone here has done that, but, but yeah, I think that's sort of where where I come to, right? It's finding about what it is that you believe in and how it is that you get to believe. I think that's
such wise advice because it's, it's you're going to be tested on your beliefs. And so if you don't, if you can't, if you don't understalt, sand yourself enough to figure out, why is this something that you can stick by? Where the market will absolutely call your bluff on that? Yeah. Just just changing tack a little bit. Japan has been cheap for a very long time. It's been attractive to value investors probably for a decade or so. But there's been some recent changes where,
I don't know who the, I think it's the Nika. I don't actually know who is driving these changes, but there's a requirement that they get, they're trying to buff book value. They're undertaking buybacks. Do you want to bet us what those are? Yeah, this is like my favorite. My favorite thing ever, right? Like the government has identified there's a problem.
And the problem is that Japanese stocks are too cheap. And the solution is that they're going to really, really mad at all the companies that are stocks are too cheap and they've published plans that are going to not be so cheap in the future. And if they stay cheap, they're going to tealist them or they're threatening to de-list them. I doubt they'll actually de-list anyone. So I just love it, right? I mean, it's just fantastic. It's like, you know, it's like, I totally
agree. Everything that trades at below book should trade at least at book, right? I'm like, I'm 100% with it. Now if the US government could pass a mandate, the New York sections, that everything that trades above five times book had to trade down to five times book, the restore rationality to the US market, then I'd really be with it. But you want to catalyst. I give you the ministry of finance. Exactly. And so, and now I think that, so I think that, you know,
and then you look at sort of can they achieve that, right? Like, can these companies actually get to book? And the answer is, yeah, like they can just increase dividends. Like they have a lot of room to increase dividends, a lot of room to increase buybacks. They have a lot of cash on the balance sheet. Like it's actually there's a pretty clear path. And so, you know, will it
happen? I don't know, probably not perfectly. Nothing's predictable. But, you know, G, if you're wrong and you bought a big basket of stocks, a trade at halftime's book, you know, you're not going to get hurt falling out of the basement window. I said right before something terrible happens. Can't lose. I can't lose until tomorrow when you find out that you were you did lose. But because that's the way Mark gets for. But, but no, so, so I think that's a really interesting
interesting phenomenon, right? And now, and I think the other thing that's worth noting, right, is if you look at like we talked about the decrease in quality of US small caps, right? If you look at like any quality metric and aggregate among Japanese small caps, like dividend yield, you know, return on assets, it's like this, right? And it's like the last three years or so,
right? Like everything is going on upward trajectory margins are rebounding return on assets is increasing dividend yields are rising like everything is going in the right direction right now in Japan for a whole variety of reasons. So I think that that the baseline was so bad. The baseline was so bad, yeah, exactly. And so there's a lot of room to run. So I think there's,
you know, a great reason to be excited about Japan and to feel more comfortable there. And it's a great, a great place for micro cap investors because half the market or if not more is micro cap. And it's very liquid. And so there's a lot, a lot to like about it from my perspective. I mean, a company could get to one time's price to book tomorrow if they wanted by you could, you could borrow money and then do a dividend of that exact amount. And you move your book value
down to exactly where your market cap is. Yeah, and given that debt is free and there's basically no bankruptcy in Japan, there's pretty much a path for every company to do that. My impression was it was having some positive effect that companies were doing these things,
doing the buybacks. And I thought that there was some take privates too. We're basically though, you know, back there was like the 80s again and the US 80s in Japan in 2023, 2024, where they're basically there are guys who are buying out all of the external shareholders with the cash on the balance sheet of the company, which is like that's that's my way to create a raiders find something that's. Yeah, there's a lot of that going on. So it's an exciting, it's an
exciting place to be. And finally, finally, after years of Japan being boring backwater, maybe finally it'll start well. I mean, it has been working the last two years. And I think there's reason I think it's going to keep working. I've read that some Chinese investors are actually getting money out of China to buy Japanese stocks, which is kind of an interesting blow. Yeah,
and I think of, you know, where's your money safe internationally? And my joke, when we have a colleague who's a marine, and I joke, there's a US marine base in the country you're probably going to get your money back, right? Like, and, you know, Japan's got a nice big marine base, right? You know, like we can be able to pretty safe in most European countries. You're going to get your money back, right? You know, Japan, you feel pretty good, you know, China? I don't know.
Yeah, we feel about China. I mean, definitely certainly a lot cheaper than it was two years ago, or three years ago. I mean, I think it's 50% off from then. Yeah. So we did this big, you know, emerging market crisis investing research. And we found that, you know, when a company is, when a country's equity market has dropped 50%, you know, it tends to be a pretty good investment most of the time. Now, we then bifurcated that further and said, gee, you know, there are what we
call idiosyncratic crises and they're global crises, right? Nidiosyncratic crisis is, it's just that country. Like everyone else is doing fine. And just that country is blowing up for some reason. And the results are materially worse in those situations. Now, they're still good. Like the base rates are still good, but a lot riskier. Whereas the global crisis, it's a lot safer, right? You want a global crash. Everything's getting cheap because everybody's panicking rather than
visit coup. You got it, right? Or they just voted in a new constitution that confiscates property or something, right? Like not a good outcome for you. And so I think, you know, I would say with China, like now, the market has dropped 50%. It's pretty clearly interesting, right? Now, I think the fact that it's the only country that's down 50% right now, or, you know, one of two or three, you know, makes me nervous because it's self-inflicted and it's self-inflicted. But, you know,
the people that inflicted this couldn't inflict more. There's no reason to think that's going to stop. So I don't know. I mean, I think I think I went from being extremely bearish and never put a dollar in China to more neutral to saying, I don't know. I mean, I think it's probably worth the risk to say. I mean, at least the risk, let me put it differently. The risk is probably fairly priced right now. That doesn't mean it's a perfect investment or a total slam dunk,
but it's no longer... You're no longer looking at a market where you say, hey, nobody's taking into account the risk that this X-Yersie could happen. It's like, no, I think people are. It's probably fair. And maybe they've overreacted even a little bit relative to the existential risk that truly exists. Right. And I think probably, you know, on like a dollar, you know, on a, you know, US dollar basis is Chinese, our Chinese company revenue is going to grow more than US company revenues.
Probably. There's probably more growth there. I'd imagine. JT, you got veggies for the people? No, I then want to come back to a little bit more crisis. The people's republic. I do. I do. I trust. And, you know, I've saved this, been saving this segment just because I
knew Dan was coming on and it's a little bit more academic. But this is a, it originally came for me sitting there one day, basically staring at my navel and wondering, like, do simpler businesses with shorter 10Ks actually produce better investment results as a base rate as opposed to, you know, 800 page proxy, you know, that you have to dig through. And I did some searching with the help of my friend Peter and we discovered that interestingly enough, 10K file size per se has no return
predicting power. However, the change in 10K file size significantly and negatively predicts future stock returns. So if the 10K size bumps up a bunch, the future, there's more earning surprises and more cash flow surprises to the downside that that happened. And this comes from a May of 2022 international review of finance paper called the information content of 10K file size change. And it's by two, I believe Chinese researchers and I'll attempt their names and I'm going to
butcher it, but it's a Juan gone and be who we again, I apologies. What they found was that the median length of the annual 10K report that provides the comprehensive disclosures, including the ultimate financial statements is more than doubled over the past 10 years. So that's kind of interesting. Already our 10Ks are twice as long as they were 10 years ago. I don't know what to make of that exactly. Any, any ideas if that's good or bad for your civilization, more shit to dig
through. Anytime there's a new disclosure, it's not like a like COVID, so now there's a disclosure for COVID and every single thing. It's not like any other disclosure had to be taken out. You just keeps on accumulating over time. Yeah, these like legal barnacles in the 10K. Exactly right. So the authors, what they want to empirically investigate does this disclosure length benefit shareholders and they started the US stocks into quintile portfolios yearly from 1994 to 2014.
According to their most recent 10K file size changes, then calculated a time series average of equally weighted quintile portfolio returns over the next 12 months. So that's the methodology. And it turns out that it's broadly consistent with the managerial disclosure obfuscation explanation, which is basically that dreaded Friday evening dump. Where are they? Where they'll just crap out some big material changes and try to hide it in the news flow.
But it does hold that typically managers, they tend to release good news in a timely manner and then hide bad news in these vague and noisy disclosures. The more likely it is, the more likely it is that there's obfuscation and reducing the readability. They looked into that as well. And basically you're you're burying signals of bad news in large amounts of distracting information. So so there you go. There is a little bit of correlation. Right. It's confirmed. Right. Well, yeah, probably.
I feel like that's right. Tell us a little bit about your crisis strategy. What's the signal that turns it on? Yeah. So we look at when high yield spreads go over 600 business points. This is that my way, yes, option of justice spread that fed publishers. You got it. How often do you see that? So that seems to be it's a coincidence indicator. It seems to it sort of blows out as the as the crisis sort of gets going and winds off. And so when when typically do you get over 600 basis points?
It got to be a lot of stress. You know, COVID was the last time it happened. And then prior to that in 2015 during the energy, you know, blow up and then 2011, 2012, the Eurozone debt crisis in the08. So those are the recent times that's blown out. And I think, you know, there's some really interesting things when when spreads blow out that much. You know, one thing we've actually just been looking at is, you know, equity momentum as a factor.
And if you bifurcate or try for Kate, the history into three states of the world when high yield spreads are below 600 when they're 600 to a thousand or they're over a thousand when spreads are below 600 momentum. Behaves really normally. It's really positively correlated, you know, stocks that have been doing well continue doing well. When you go over 600 basis points, momentum stops working. There's just no impact of momentum from 600 to a thousand.
And then from like a thousand over, it's like a massive negative massive like like 4x the power of what it was under 600 on the other end. So, you know, there's just huge reversals when stocks go, you know, when spreads go over a thousand. And so generally what you're seeing is when spreads go over 600, they tend to blow way through 600 600 600 is just a way a way point and they end up going up to the, you know, a thousand or 2000 in the case of08. And then you start to get these
interesting effects and you get these big reversal effects that start to happen. You get a huge liquidity premium right because the high yield spread is a real, it's just a direct measure of liquidity premium essentially right or the small size premium because high yield bonds or the small cap value bonds, the small cap value equivalent in bonds right. So when the spreads are blowing out, you're just getting a direct indicator of like wow value and size are really cheap right now or
the, there's a really big premium. And so, you know, if you think that the world's going to kind of come back to normal, which probably will, then you can make a huge killing buying the cheapest most beaten up stocks when spreads have really blown out. And it's quite reliable in a way that's much more reliable than normal times. Yeah, do you wonder about the, or at least I wonder, you know, using this kind of this mechanism to turn it on and off. And it's, I think of this
like spring that over time started out pretty law. I mean, you know, treasuries at 15% and now it's, the spring has been compressed down to treasuries at zero. And I know that's the six is the delta. But does that six, does the significance of the six change as the spring, you know, compression changes at all? Yeah, nothing that I can, nothing that I can observe. I mean, you could see score it or something, but I think you're still going to find that 600 is sort of one standard
deviation north and kind of always has. Okay. Makes sense. I really like that most recent you guys did on, I thought that was a really clever inversion of what does 7% bond yield by you as far as credit quality goes. I've found that to be, I feel like that's something like Buffett would have done at some point and written about. Thank you, Jay. Just to show the deterioration and the changes over time of like credit quality for that same 7% yield. Very, very interesting. Yeah. And
yields are, yields are a funny thing. It's like, you know, everyone believes in efficient markets. And then you tell them about bonds and then their heads go nuts and they stop realizing that they should be skeptical of anything. And someone says, gee, you know, do you want to, you know, buy this 13% yielding bond and you say, wow, you know, treasuries only yield five. You don't create like sign me up. I mean, I want to love to get a 13% yield. And then the person selling
it's like, and it's a contract. So you're guaranteed to get your money back. Because everybody it's always honest. They're contracts. I'm a coupon. It tells you exactly how much you're going to get. And you say, well, if efficient market theory were true, shouldn't all bonds no matter the yield of the same expected return? Right. I mean, right. Like, let's, let's have a little bit of skepticism here. But, but, you know, again, normally smart investors, whatever reason often lose their heads
when it comes to bonds. So I think the message we're trying to get across is like, you know, target a target a credit quality or target the exposure you want. Don't, don't get focused on the yield. It's going to mislead you. You're going to make, you know, bad decisions if you just start thinking in terms of yield. But, you know, you look at the private credit industry and they've realized that, you know, people are suckers for a big promised yield. But, you know, you look at past
instances where people have offered very high yield products. Right. It's, it's not like, I mean, how many, how many, you know, billionaire pawn shop payday lenders do you know versus how many, you know, billionaire PIMCO type people, do you know? Right. Like, it turns out it's a lot better to buy the less risky bonds than the really, really, really, really risky ones. Bulls yield, as you've called it before. Exactly. Yeah. How do you implement the, the high yield credit?
Is that the, is that the way that you're doing it? He promises 13%. Yeah. Promise is 13%. We raise as much money as we can. I like it so far. One, two terms of leverage. Yeah. And then, yeah, we add a little leverage on top. And then if it stops working, we raise a new fund and buy the bad debt from the old fund. So, so basically, I think, you know, it's like factor investing anywhere else except you, you have, you're given the value, right? Like, right, right away, you're, you're
given that. So what you really want to know is controlling for the yield. What's the quality? Right. And so you're really basically, you're just inverting it in some way, what you do in an equity world. And so, and it turns out that in terms of bond market, some of these things are, it's actually a little bit simpler, right? Like, so one of the key things that you want, you,
you really want credit is size at a given yield. So if you have two bonds that both yield 7% and one of them has a billion dollars of market cap and one of them has 15 billion of market cap, you really want the company to 15 billion of market cap. It's much more likely to get upgraded to investment grade. It's much less likely to go bankrupt. And, you know, similarly, return on assets, for example, or gross profit to assets, those types of metrics, you know, if you have the same yield,
gee, much for other shoes that come to the 10% R.O.A. than a 2% R.O.A. And if you stack up a few of those pretty simple, pretty obvious metrics and then you just rank the bonds by yield and then, you know, so you take all the bonds that are given yield bracket, rank them by quality, you know, you're going to get a really good clean premium relative to the index. And that's what we do. It's a very simple approach, but it's very powerful. And I think, you know, one of the things that's interesting
at credit is it's more predictable than stocks. These things work more reliably in debt than an equities. And so, you know, I think you can, you can see these factor premiums more reliably there. And it's just a bit of a sort of more equity than the Monserge JC. I was just going to say is that the, and there's like a kind of a sweet spot at like double B,
is that yeah, exactly. So there's a there's a there's a level at which yield. So increasing yield improves your total return up until the low end of double B. And then increase the yield actually decreases your total return, which we call Fools yield like it's it's this triangle where like a 15 percent yielding bond actually returns worse than a 6 percent yielding bond on average. Right, so you find that sort of fulcrum point where you're yield, you're maximizing total return,
not maximizing yield. And then with at that yield point, you sort by quality. That's essentially our strategy. But you know, what's this Fools yield concept is really fascinating. And it turns out that like no one really knows how to price an 18 percent like if someone's an 18 percent, what's the bankruptcy risk is that 33 percent or 28 percent. It's just quite strong. It's just like it's probably going to go bankrupt. And probably there are too many idiots that thought an 18
percent yield sounds really good. I'm going to go buy that, right? And so it ends up being that that stuff ends up kind of ending up with shitty outcomes. Whereas the much higher quality stuff is just more consistent does better over time. This might be a state secret, but how does Dan get the daisiful of his bonds? You know, you can get a lot of data from capital IQ has like the last 10 years of bonds pretty well. And then anything other than that Bloomberg has the only really reliable.
You kind of have to trade bonds. You really need Bloomberg. Do you want to tell us a little bit about the multi-streat fund? That's launched. That's just a little bit. Yeah. Yeah. We launched it about two years ago. So it's we've changed it. We tried some things that didn't work. And then we've really been improving the model. But what we've sort of come to is that, you know, I think a lot of investors are very focused on
expected return, right? You want to maximize your expected return. But expected return is also really hard to predict as we've talked about, right? It's really hard to know if you like take every stock and try to rank them by expected return, sort of what all equity investors are trying to do. It's really, really hard. And if you look at like the R squared on factors, right? How well factors predict the expected return for stocks? You know, you're getting in the, you know,
five to 10% R squared range, right? Like it's a real edge, but it's a lot of noise. It's a lot of noise. It's not much. It's really hard to predict. And what we've learned is that actually what's much easier to predict is correlations and volatility. So if you just take a weighted average correlation matrix, right? You say, hey, like let's give it a half life of like a month or three months and look at the correlations between stocks and bonds and oil and value and size and whatever.
That correlation matrix is pretty stable on it. I mean, it changes over time, but you can predict next month's correlations pretty well with that sort of weighted half-life type history of recent correlation matrices such that the R squared on that might be, you know, it's hard to think of what an R squared means for correlation matrix. But if you think of some equivalent, you know, you're probably getting into like 70 or 80% R squared. Like you can really predict correlations pretty darn
well by relying on correlations. And then volatility is also really predictable, right? So last month's volatility, you take in the VIX and you take in recent like last month's volatility, you can get a 40 or 50% R squared predicting next month's equity volatility. And if you try to predict bond volatility and oil volatility and whatever, you're going to get pretty good at that too, right? It's just pretty autocorrelated. It's pretty, you know, it moves a lot, but it's autocorrelated.
So if you say, well, gee, let's imagine I can't say I have no view on expected returns. Like I think stocks return what they long-term average as I think bonds are turned long-term, I think oil turns long-term average, everything just has a long-term average return. So I think the market follows a random walk, right? I have no view of anything. But I think that volatility and correlations move around a lot. And you run that through an
optimizer, you're going to get very different portfolios every different month, right? Because stocks and bonds, if stocks and bonds are really highly correlated, you know, gee, you're going to take down your exposure to one or the other because you don't need both. And if stock volatility goes up a lot, right? And you have the same expected return forecast, then your forecast of sharp dramatically went down. So you're going to say, well, gee, I want to take down my equity allocation,
not because I have not because I have any negative view on equities, right? I have the same expected return view. But for that volatility, they're just less of a good buy right now, right? I'm just getting less sharp for the same, you know, products. I'm going to reduce my weight. Maybe I'll take it
up and something that's less volatile than normal. And so what we started is basically building this giant database of every single stock categorized by factor, bonds, both sovereign and corporate with factors and then commodities, oil, copper, gold and currencies, you know, the major tradable currencies and saying, hey, let's run an optimizer where we look at their volatility and correlation structures. You take some rough benchmark and then say, gee, can I improve outcomes because
I'm really good at predicting volatility and correlations? And the answer is, gee, yes, you can. You can really, really dial up sharp. And you'll take bets that, you know, you might be really, you know, for example, you know, right now we're, we're quite short, the Mexican peso. We have no view on the Mexican peso, right? We, we, in fact, our model is told that the Mexican peso is a 0% expected return, always, right? Like we'd never have a view. It just happens that right now the Mexican
peso is really negatively correlated with a lot of bets that we want to take, right? So we, we like value and it turns out that the Mexican peso, you know, when value does well, the Mexican peso does badly or something, right? So it ends up loading up on the Mexican peso to diversify our value long, right? And you're like, I never would have thought of that. Like that's totally nuts to me. It's not a big sense. It's what I've been missing. Yeah. It's what we've been all been missing,
clearly. But, you know, the, when you think of why I did that, it actually makes a lot of sense, right? And it, it actually works decently well. So what we've been trying to build is, and then we've said, okay, well, gee, now what if we can actually predict, have some edge and expect a return, right? Is there some way where we can make better, expect a return forecast? And we looked at, you know, everything we could try to predict, and we time value, we time size, can we time
treasuries, we time high yield. And for 90% of things we found that we couldn't to no ability, nothing we came up with, we threw the kitchen sink at it and nothing worked at a sample, just all failure, right? Like with no ability to predict whether Japan's going to do better in the US next month, we have no ability to predict the US equity intercept. But for some things,
they are predictable or more predictable. So momentum, right? I just described you have equity momentum works really well under 600 basis points, not well up between 600,000 as reversals over 1,000. You plug that in, you're actually a big improvement in your ability to forecast momentum returns. And then you can apply a sort of similar logic. One of the logic we talk about how yield spreads is size. You know, when high yield spreads go, when they're going widening,
blowing out, you know, size does worse. And when they're coming in, size does better. And when spreads are really wide, size does better, when they're really tight, size does worse. So, you know, and then gee, you can actually get like a 10% r square and predicting the size premium, for example. And then, you know, oil is another example where oil is really driven by high yield spreads and high yield spreads blow out, oil sells off when high yield spreads come in oiled as well.
When high yield spreads are bumping around, oil just goes randomly oscillates and dramatically unpredictable way. But, but you know, you start to layer on all these things and you accumulate all of them into rules and you write software to trade them. That's what we're trying to build is to try to build all these insights into a, basically software that can trade all of these ideas and understand the volatility and correlation matrix across, you know, 39, you know,
correlation pairs. And that's, that's, that's the essence of what we're trying to do, which I'm pretty excited about. It's been a huge, huge research effort, both building out the infrastructure to do it, you know, doing all the research and then, and then learning how to actually trade it and how to make it work. Did you say that the higher oil prices correlate with high yield spreads or is it the other, is it positive or negative correlation? It's the change in spreads predict
changes in the price of oil. So, when spreads are widening out, oil sells off and when they're tightening. Interesting. I would have probably thought the opposite of that actually. Like, I've heard, you know, the idea that, that oil is perhaps its own kind of fed funds rate. Like so when it spikes, that's kind of like often kills, kills the economy when oil strikes spikes. Yes. So, we're saying
the same thing. So, right, when when high yield spreads blow out, the economy is doing badly or starting, you know, it's predicting the economy is doing worse. Growth is slowing and that's when oil starts to sell off and do really badly. I think we're saying the same thing. Well, I was actually a spike in oil prices. Receive your thing. It's causal. Yeah. Like it precedes an economic, you know, hiccup. Yeah. I don't, I haven't seen, I wouldn't, I wouldn't, I've tried that and I didn't see
that. But the opposite that oil as a contemporaneous thing when the economy starts to slow or do badly, the oil sells off, which makes a total sense that it would. And that actually makes a really good hedge against equities, right? Because it's one of the things that, you know, you can short oil when high yield spreads start blowing out. And it's really a beautiful, a beautiful hedge. Do you have any worries about with all these correlations? I kind of call it teleps turkey,
kind of problem where, you know, it seems like these things are all working. And then you have like a huge reversal that kind of like, you know, give back 10 years worth of it working. Yeah. I don't know. I mean, I think that, I think that from what we've seen correlations are pretty stable. Not they change, but they're autocorrelated. They're pretty autocorrelated, right? And relying on last month's correlations, for next month's correlations seems pretty reasonable. So then the
question is like, are there big jumps for correlations? Yeah. Just continue as, yeah. Dramaticly change. And, you know, one way to test that is to like use the VIX to predict a correlation matrix or something or predict. And I think what you find is that you don't really need to do that because the markets, you know, like even during COVID, the correlations are changing. But, but you can adjust with them, you know, just even adjusting on a weekly basis, you're
going to be fine. If you're reacting to those variables and other ways, the same thought occurred to me, but I was wondering whether it was something you can deal with the way that you're allocating your assets to the extent to which you have leverage and you have derivatives that've got leverage in them. You can probably find a way to construct it without that being concerned. But that was the
thought that I had if there's always, there's no free lunches. I think it's just the, is probably the first rule of finance that there's a cost somewhere and it may be that it's something that has that sort of behavior that Jake described that. Yeah. Yeah. Till it's sticky. Yeah. That's probably the right risk to be thinking about. But I think fundamentally if you're just saying,
hey, I'm diversifying across multiple asset classes. And the other thing that I'm doing is that when volatility spikes, I reduce my exposure, because I think the sharp ratio has changed some very humble by my expected return forecast. Most of those discontinuities should be accompanied by spikes in ball. And so if you have a model that really dramatically de-risks every time, balls spikes, you know, probably, you know, I think there's there's less risk of getting totally destroyed,
especially if you're, you know, bats are diversified across multiple asset classes. But we'll see, we'll see. We'll find out by done together. And on that note, Dan, we've just come up on time. So if folks want to follow along with what you're doing or getting contact with you, what's the best way of doing that? My Twitter ad for dad cap. And you can sign up through my Twitter bio to our weekly
research. How about encourage that? It's Dan Rasmussen for dad capital. Thanks very much for your time. Thanks everybody else to JT. We'll be back next week, same bat time, same bat channel. See you folks.