Common Sense from Uncommon Investors

• Causeway Capital (Sarah):

  • Manages $40 billion in active global and emerging markets equity.
  • Differentiates by combining fundamental analysis (financial statements, management interviews) with quantitative computer models.
  • Identifies significant valuation bifurcation: defensive sectors (consumer staples, utilities) trade at excessive premiums, while cyclical stocks are undervalued despite intact balance sheets.
  • Notes that passive investing and "smart beta" dividend strategies have created pricing inefficiencies, ignoring lower-yielding stocks with potential for dividend growth.
  • Projects cyclical stocks offer the primary opportunity for investors with a three-year horizon, dismissing defensive equities in the current environment.
  • Cites Volkswagen's post-Dieselgate crash as an example of active management's value in ignoring emotional passive selling to discover undervaluation.

• Crescent Capital (Mark):

  • Manages over $20 billion, having applied high-yield investment principles from Drexel for 25 years.
  • Views market volatility and fear as optimal entry points for investment.
  • Currently working on a $500 million mezzanine commitment for a large sponsor involving complex inter-creditor dynamics that other firms are avoiding.
  • Invested $100–150 million of fund capital in this deal, sharing the remainder with LPs to maintain capital discipline.
  • Identifies sovereign debt as a primary risk in low-yield environments, noting historical default rates and the false perception that countries never default.
  • Predicts the most successful investments made in Q1 2016 will define future returns.

• Hamana Capital (Kyle):

  • Manages $12 billion, focusing on structural anomalies and unconventional situations globally.
  • China Analysis:
    • Reveals a cash balance of trade deficit of $125 billion in 2015, contradicting the reported $500 billion surplus due to bank settlement data.
    • Estimates the Chinese banking system (on and off-balance sheet) at $34.5 trillion against a $11.5 trillion GDP, more than twice the size of the US system pre-2008.
    • Identifies asset-liability mismatches at 9% of the system (vs. 2.5% in the US pre-crisis), growing at nearly 60% annually.
    • Warns of an impending loss cycle given the system's 1100% growth over 10 years with no prior losses.
    • Notes 8 of 16 defaults in 2016 were state-owned enterprises (SOEs), including federal ones, with no government bailouts, challenging the "omnipotent sovereign" belief.
    • Highlights that 90% of the $4.5 trillion wealth management product market rolls over in less than a year, creating fragility based on retail investor confidence.
  • Strategy involves "swimming upstream" 98% of the time to identify mispriced risks in sovereign debt and complex balance sheets.

• Canyon Partners (Mitch):

  • Manages over $20 billion, specializing in complex instruments, securitizations, and non-bank capital.
  • Characterizes the post-2008 macro environment as having endogenous structural risk where the system is increasingly fragile.
  • Outlines a three-tier balance sheet dynamic:
    • Central banks provide an insurance policy via accommodation.
    • Money-center banks pay for this via regulation and balance sheet contraction (e.g., European bank balance sheet capacity to GDP exceeds 300%).
    • Non-bank systems (shadow banks) must fill the liquidity gap, creating both opportunities and the risk of sudden liquidity evaporation.
  • Investment philosophy focuses on securities tied to external liquidity sources (interest, amortization, collateral, covenants) rather than mark-to-market capital markets.
  • Sees regulation as a catalyst for opportunity, where banks are restricted from lending, creating gaps for alternative asset managers to fill.

• Michael (Unidentified Firm, ~$12 billion):

  • Distinguishes between cheaply accessible "knowledge" and expensive "insight" requiring context and imagination.
  • Views volatility as a friend that allows active managers to adjust positions within a probability spectrum after deep fundamental work.
  • Argues that achieving a 5% annual return is increasingly difficult due to the "deflation" of the Keynesian bubble and the quieting of the over-the-counter derivative market due to regulation.
  • Notes that leverage ratios (BIS) and risk capital constraints are muting the growth drivers that previously supported massive compounding.

Talent and Hiring Priorities:

• Canyon (Mitch): Seeks individuals who view accounting as a dynamic "stock-flow system" rather than static data, capable of overlaying investment banking corporate finance skills on value investing to engineer resilient capital structures.
• Crescent (Mark): Prioritizes team fit and relationship-building skills over raw intellect; hiring is contingent on a candidate's ability to collaborate within the firm's culture.
• Hamana (Kyle): Looks for team members capable of questioning dogmatic views and applying common sense to solve complex endowment funding challenges.

Macroeconomic and Strategic Trends:

• Passive vs. Active: Passive strategies (ETFs, indices) are accused of creating significant pricing inefficiencies and ignoring fundamental risk, whereas active managers are required to perform price discovery.
• Banking Structure: The US financial system is financed by private/public markets rather than banking, unlike Europe where banking capacity is constrained; this divergence creates distinct investment opportunities.
• Regulatory Impact: Dodd-Frank and Basel III regulations have forced money-center banks to reduce balance sheets, creating a "shadow banking" opportunity for alternative lenders.
• Sovereign Risk: Historical data indicates sovereign defaults are common over 1,000+ year periods, yet the market continues to price them as risk-free, presenting a major risk for passive investors.
• China Sovereign Debt: There is a growing disconnect between official statistics and cash reality, suggesting a potential 30–40% write-down for investors exposed to the Chinese system.