Guest Interview, Edmund Simms at Valuabl

Writer of Valuabl, Author of The Little Book of Big Bubbles, and Fund Manager

Good morning,

Today I am thrilled to share a discussion I had with Edmund Simms, the author of the Little Book of Big Bubbles, a fund manager, and owner of the Valuabl newsletter. Having spent time across multiple corners of the market (hedge funds, mutual funds, and VC) Edmund now runs his own fund, which opened its doors in 2016.

We talk about how that journey played out, what “value” really means, correlation and standard deviation, luck & skill, the delivery business, bubbles, and a lot more. Much like the writing style I have come to adore in Valuabl, Edmund offers up an array of witty analogies and imagery in his responses to today’s questions. I hope you will enjoy this as much as I did.

Edmund Simms at Valuabl

Conor: Hello Edmund, thanks for taking time out of your day to answer some questions for Investment Talk readers. You are a fund manager, you have authored a book, and you also write the Valuabl newsletter. So, there’s a lot to pick through today, but for the benefit of the reader, I thought it would be great to hear about your backstory. I know you’ve spent time across hedge funds, mutual funds, and VC, and later opened up a long-only fund in 2016, so it would be awesome to hear about that journey, and what incentivised you to open a fund.

Edmund Simms: It’s my pleasure, Conor. I hope to give stimulating answers and avoid boring your discerning readers.

I will start at the beginning. I grew up in the middle of Australia. My father was a drover and my mother was a jillaroo. We moved to a small town just south of Sydney when I was seven. By adolescence, I had decided against becoming a fireman and set my mind on golf, becoming respectable but not good enough for the American professional tour. I had a keen interest in maths throughout school, so I enrolled in a mathematics degree at the University of Sydney.

The friends I made at university mainly studied business, economics and finance—it fascinated me. I added these courses and a concurrent second degree in finance. Struggling to figure out my style and approach, I decided to work in as many roles and read as many books as possible until I figured myself out and found a congruent approach. By cold-emailing hundreds of people in the industry, offering to shout them a coffee and not poach more than 20 minutes of their time, I got information on how they thought about their role and where they thought I would fit.

I first took a position at a boutique quant-fund run by two brilliant American fellas. The work was fascinating, and they were patient with me. They spent a profligate amount of time debating with and teaching me. In the end, though, I decided the quant world wasn’t for me so went to work for a capital placement agent, for a venture capitalist, for a startup, and then finally in the value team of an international mutual fund. This one struck a cord, but I was still restless.

Australia is beautiful but geographically and culturally isolated. I wanted to see the world. Further, the desire to start a fund and do it my way was percolating in the back of my mind. I tossed up between moving to London or New York with the mutual fund and settled on London. After a year there, I left that team to strike out on my own. And here we are.

Conor: Before we dive into your investing style, I’d be curious to hear you riff on how you found each of those environments (HF, MF, VC, and operating your own fund) and the different skill sets required for each. I ask this, because I know we have a lot of younger readers, who might not be sure which direction they want to head.

Edmund Simms: I am lucky. I was in small teams at small shops. My mentors were operators and deep thinkers who were generous with their time and knowledge. I cannot speak to the general environment, if there is one, of each stream. My advice is to think about the problem in reverse: what would you most regret doing when you look back from your deathbed? I am yet to meet anyone who says, "I wish I spent more time working for the boss I didn't respect," or, "I wish I spent more time on busywork."

It's natural to want to find the optimal path. But there are so many roads that it makes looking at the map overwhelming. Instead of trying to make every shot a miracle one, to use a golf metaphor, look for the water hazards and avoid them. Sure, the fat bloke in the cart on the adjacent hole might not be impressed, but who cares. In his own words, Jack Nicklaus was a lousy bunker player but an excellent lag putter—so he aimed away from bunkers and to the fat part of the green. Figure out what turns you on or off, and play the game in a way congruent to that.

Conor: You have stated in the past that you simply buy “value”, in the order of anywhere between 5 to 15 uncorrelated positions.

Can you talk to us about what “value” means to you, why correlation (or lack thereof) is so important, and how you tend to think about positioning/discovering that balance of non-correlation?

Edmund Simms: Value is the gap between what something is worth and the sale price. Value is a duffle bag stuffed with a half-million in cash that I can buy for $100,000. We intuit this every day but seem to forget it apropos stocks. The squiggly lines gyrating seductively across our screens seem to reach out from the pixels and enchant us like the lights on a casino floor.

If I offered to sell you a suitcase of money, you wouldn't go to your Bloomberg, look for the price of money bags, and consider whether you could sell it to someone for more in the future. You would ask, "how much cash is in there, when will you deliver it to me, how can I be sure, and what are my other options?"

If you accept my offer, many things can go wrong: what if I'm a shyster, or something happens to me on the way to make the drop, or there is less cash than you expect? You want protection by risking as little money as possible and ensuring a large gap between what you expect and pay. Moreover, you wouldn't want to put all your eggs in my one basket; you would diversify. If I'm a crook, my partners probably are too. If I am caught in an inferno, so are the others in my building. You would look for deals on other bags in faraway places that can make the drop regardless of what happens to me. Correlation and value are about protection.

You want protection if your assessment of me and my promise to make the drop is wrong. If I tell you there's a million in there, but I lie, and there's only half, you'd still have made a satisfactory return paying a quarter—the value side of the equation. But if something happens, and all the people delivering bags of cash to you are on the same bus as it explodes, your business is toast—the correlation side of the equation. The calculus of this cash-dropping empire you're building becomes more nuanced as the overlap between bag-droppers and potential return increases. Where do you draw the line between diversifying and increasing returns? If some friends of mine can give you large bags of cash at hefty discounts, you have to weigh that opportunity against how likely we are to be in cahoots to rip you off.

I demand new opportunities for my portfolio to meet two criteria: First, they must be substantially undervalued. Second, they must either increase the portfolio's expected excess return, the expected annual rate of return above the risk-free rate, or decrease its volatility. The opportunity for return must be better than what I already have, or it must reduce the total amount of risk I face. There are mathematical approaches you can take here. I use a quarter-Kelly ratio. But the underlying reasoning is more important.

Conor: In an interview with Commonstock, you were once asked what uncommon investing views you hold. To which you responded:

“I don’t care about business quality. Your assessment of the business’s intrinsic value should include your quality assessment insofar as it affects value. If I am paying less for the same future cash flows on a risk-adjusted basis, I don’t care whether the business is a superstar or a stinker. If investors generally believe that a particular company is excellent, then it’s unlikely you’ll ever be able to buy it with a significant margin of safety.”

I was hoping you could possibly expand on this somewhat for us, maybe throwing in some specific examples of when you found this to be true?

Edmund Simms: Money doesn’t have a memory. It doesn’t know whether it came from a business with stout competitive advantages or you found it in a puddle on the side of the road. The crucial thing is how much a company is worth and how much you pay. Imagine, if you will, that your great-aunt Hortense has died. In her will, she proclaims that you can buy her house from her estate for a dollar on the condition that you never sell it. The house is rundown, haunted, sits on the edge of a cliff, and a grotesque older man with hooks for hands is the manager. Thrillseekers rent the house occasionally, and there is a small profit leftover which gets paid out to you each year.

Many analysts wouldn’t even consider looking at this asset. There’s no growth. There’s no price action because you can’t sell it. The manager is ugly. Climate change might accelerate the erosion of the cliff edge and collapse the house into the ocean. The asset is a stinker: “Buzz! Your business, woof!”

But you got it for a buck, and your return is enormous.

Of course, a better business is a better business. But that’s not where the puzzle ends. The second half of the equation is how much you pay. Many people are looking exclusively at companies they think are high quality. Because of this, these businesses tend to cost too much, while crummy ones get overlooked. A recent example is Frasers Group PLC (LON: FRAS, £3.2bn market cap). Formerly known as Sports Direct, it’s a British clothing and sporting goods retailer. It was run by its pudgy and incorrigible founder, operating in a declining industry in a country written off by many because of a rapidly shifting geopolitical landscape. By my estimate, in 2019, it was worth at least £6 per share but was trading below £2.50.

Conor: In that same interview, you remarked that the ability to recognise when one is the benefactor of luck, and not skill, is an underrated competence in investing. Sometimes we have a thesis, it doesn’t play out like we planned, but the stock market rewards us anyway. The foolish thing to do, would be to ascribe that reward to one’s own insight.

Obviously, sometimes we don’t get so lucky. I would love to hear about your process for identifying instances when you might be wrong, and the steps you take once you believe that might be true.

Edmund Simms: It’s impossible to separate luck from skill in the short term and with a small sample. My approach is to do the best job I can at playing a good hand, betting when the odds are in my favour, and assuming that every outcome over the short term is luck.

A wrong decision leading to a profitable outcome can be worse than a good decision that leads to loss. It conditions you to believe you know more than you do and are in control of more than you are. Overconfidence is a killer. It is the cognitive bias that Daniel Kahneman, a titan of psychology and behavioural finance, says he would most like to eliminate. “It leads governments to believe that wars are quickly winnable and capital projects will come in on budget despite statistics predicting exactly the opposite,” he says, before adding, “but it is built so deeply into the structure of the mind that you couldn’t change it without changing many other things.”

I worked as a croupier for a year when I was at university. For this job, all the blackjack dealers learnt to play statistically perfectly. Seeing people make the wrong call but win and attribute it to their brilliance, my moustache, the colour of their socks, or anything else unrelated was a sign they were going to lose it all. Routinely, these people doubled down again and again until it was all gone. Overconfidence is expensive.

We’re all dumber and less in control of the world than we think. Accept and embrace it.

I use a few unusual strategies: First, before I look at a stock, I commit to buying or selling it if it meets or misses my value and diversification criteria. Second, I only check the portfolio once a month unless specifically buying or selling something. Third, I value everything in my portfolio quarterly and from the ground up. Like using a stencil, you always trace off the original, never the copy. If a bias or a mistake crept into my previous work, I don’t want to build off and magnify it.

Conor: Whilst we are on the subject, my mind draws to diversification and downside protection. You spoke about owning a fairly concentrated basket of un-correlated companies. Some investors view their portfolio as a plethora of small bets, oft ignoring correlation. Others, like yourself I assume, view their portfolio with more of a risk-adjusted tint. The standard deviation of a portfolio doesn’t decline all too much if an investor continuously stuffs highly correlated stocks into their basket. As such, you could have someone with 50 stocks, enduring more volatility than someone with, say, 10 stocks, but with a greater focus on non-correlation.

What is your view of managing the standard deviation of your portfolio and diversification more broadly?

Edmund Simms: Investors need to ask themselves what their goal and time horizon is? Are you trying to beat the market, copy it, or have fun? If you’re trying to copy the market, buy an index and move on. If you’re trying to beat the market, the more stocks you own, the harder it is to do. By definition, you cannot outperform a basket of all the stocks by holding all the stocks.

Investors will want to consider how to diversify their bets best while giving weight to the best opportunities. As I outlined above, you can do this mathematically or intuitively. Modern Portfolio Theory (MPT), and mathematical derivations of it, get a bad wrap. It’s fun to parrot your inner Buffett or Munger and dunk on these approaches. But they work. Some have argued that Buffett has used an intuited version of MPT.

There is statistical evidence that adding assets with similar expected excess returns but little correlation or covariance to your portfolio improves your overall risk-adjusted expected return. A paper from the University of Cagliari, Italy, in 2020 demonstrated that the Kelly and Tangent Portfolios both dramatically outperform the Minimum Variance and Equal Weighting portfolios. Other studies show that marginal diversification benefits, the additional benefit of adding another asset, drop logarithmically. You get a considerable advantage going from one investment to two. But going from two to three, the marginal benefit drops. Additional research suggests that following a purely Kelly approach can be ruinous if the position sizes are too large because of overconfidence. The evidence suggests using a partial Kelly ratio is the best way to combat this.

Conor: Taking a step back for a moment, you share a lot of research outside of managing the fund. One avenue for that is the Valuabl Newsletter, to which I am a happy subscriber. You’ve been writing this since mid-2020, and I personally feel it’s one of the most underrated newsletters out there, with a lot of great valuation and macro work. I don’t say that lightly either.

Tell us about why you decided to create Valuabl, and maybe what your aspirations for the newsletter are?

Edmund Simms: Thank you, Conor. That is a stunning and humbling compliment.

I deeply admire great thinkers and crisp, persuasive writers. I want to be like them. I am not, but I will keep trying. Clarity of prose follows clarity of thought. Writing helps me to think, and thinking helps me to write. I get immense pleasure and satisfaction from it.

My hope for Valuabl is for it to become a financial and business-focused version of The Economist, brimming with deep analysis and investment ideas presented engagingly. On only two scores can Valuabl hope to outdo its rivals consistently: the quality of analysis, and the quality of writing. Both will always need to improve. I want Valuabl to educate, challenge and entertain investors long after I'm gone and one day become a pillar of the financial world.

Conor: Back in April, you shared a great write-up on Deliveroo, one of the UK’s food delivery competitors. For the Americans reading, think UberEats, Postmates, or DoorDash.

Delivery businesses like this are cumbersome. My view is that it’s a race to the bottom, the unit economics are not great, and to be successful one has to be the outright leader. At times, I feel that even 4-5 players in the market are far too many. With these businesses relying so much on external liquidity, liquidity which is now drying up, and evident consolidation already taking place, what are your thoughts on this space and what needs to happen before a clear, profitable leader is established, either in the EU or US markets?

Edmund Simms: For the last decade, capital has been abundant, increasingly cheap, and easy to get. At the same time, the short-haul delivery app market has had few barriers to entry. A small group can get together, build an app, and connect porters, customers, and restaurants. Thanks to these conditions, many delivery startups have spawned and expanded rapidly.

There are localised network effects that will drive the industry towards native oligopoly. It's no skin off the customer's nose to have four or five food delivery apps and switch between them. Still, that proposition is much more difficult for restaurants where even two or three concurrent systems become cumbersome. Deliverers, similarly, will struggle to manage more than two or three simultaneous roles. As a couple of companies take hold of a region, the efficient scale of that market becomes unattractive for new entrants to go after. It's a gangland turf war. Get your area and hold it.

Once the incumbents have taken control of the region, it's a race to the bottom. Price and convenience matter and excess profits will be difficult to generate. For the last few years, these companies have subsidised delivery costs with investor capital—this will stop as capital markets discriminate and costs to the consumer and restaurant will rise. These companies' economics and potential profitability are closer to typical delivery and logistics businesses than software as a service than many hope. These are labour intensive delivery business models applied to an adjacent market with a shiny app.

Conor: You also authored the book ‘The Little Book of Big Bubbles’, where you cover every bubble from the Romand Land Collapse in 33AD, to the Tulip Mania in 1637, the Japanese asset bubble of 1986, and even the beanie babies bubble in the mid-1990s.

Firstly, I am curious what motivated you to write that, and if you could boil down the world’s history of financial bubbles into one paragraph, what would be your core takeaway?

Edmund Simms: In early 2020, I had the early stages of a working hypothesis that there was a large and global residential land price bubble building. I decided to study past bubbles to figure out their similarities, build a framework for identifying bubbles that would have worked in the past, and see if my hypothesis held up against that.

My notes became a series of articles in Valuabl, but I wanted to share the lessons of history more accessibly and with a broader audience. So I decided to publish them as a short, easy to read recount and analysis of the main ten financial bubbles of the last 2,000 years. The core lesson is that human nature doesn’t change. Bubbles form, and we find ways to deceive ourselves that this time is different. Every bubble I studied followed the same arc: a fundamental shift caused a movement, speculators got involved and the pricing mechanism became a positive feedback loop driving prices up until it collapsed unexpectedly. Then the cycle rinses and repeats.

There are two conditions for a bubble: first, the pricing mechanism must be a positive feedback loop. People are buying because they expect the price to go up; and second, the expectations of the future implied by the price must be highly unlikely or impossible.

Conor: The book naturally concludes with the housing bubble of 2008. At the time of publishing, the events of 2020-2022 were (and are) still unfolding.

In a relative sense, these last two years might not have been as crazy as prior events, but there are pockets of the market that took aggressive elevators up in 2020 only to topple down the stairs violently in 2021/22. What have you made of these last two years, and do you think there were/are signs of a bubble in particular industries or asset classes?

Edmund Simms: The last few years have been dramatic for financial markets. Low-interest rates set off a chain reaction of rising prices and declarations of a new paradigm. Some of these pockets of the market were bubbles as they met the criteria and followed the bubble arc to a tee, but in aggregate, we didn't see an all-encompassing stock market bubble as big as some. The inflexion point was a rise in the price of money. Stock prices haven't come down; instead, the cost of money has gone up. This reversal has made many investors question what it is they own.

It is ghoulish to say, but the good thing about equity and stock market bubbles is that they inflate and deflate rapidly compared to others. In contrast, land price and credit bubbles are like great oil tankers on the ocean: they're huge, slow turning, and when they sink, everything gets slicked.

We are at the moribund of the largest, by my reckoning, global land price bubble ever. It's been building for a quarter-century in some places, which is in line with how long past land price bubbles have expanded, and a sustained rise in the rate of interest could pop it. I have penned ten pieces on the topic over the last 18 months for Valuabl and am comfortable letting those writings stand as my will and testament on the subject.

Conor: The last official question now, and I ask this one selfishly, as I do with all guests who are from, or reside, in the UK. The culture of investing in the UK is odd. There are over 10M residents funding a cash ISA account in the UK, compared to fewer than 2.5M funding stocks and share ISAs. For those unaware, a cash ISA is essentially a tax-exempt interest account on cash, whilst stocks and shares ISAs are an account that allows for up to £20K (~$26K) to be invested in stocks each year, with income and gains exempt from tax.

This alone blows my mind, but the UK generally has low participation rates. What are your thoughts on why this might be?

Edmund Simms: I will highlight two of my unusual views on this that your readers might find intriguing:

First, the average American is less risk-averse. Entrepreneurialism and optimism are abundant in the United States. That attitude, combined with deep capital markets and a myriad of opportunities, makes every part of the equity investment lifecycle across the pond attractive.

Second, like Antipodeans and Canadians, Brits have enjoyed a longer-running residential land price bubble in countries with a distinct cultural focus on homeownership. Why would you put money into stocks when houses earn more than the average wage, have outperformed equities, can be lived in, and are, in living memory, a no-loss proposal backed by the government and banking sector?

Conor: Lastly, where can readers find you and your work, and do you have any concluding items you’d like to say?

Edmund Simms: Readers can connect with me on Twitter (@ValuablOfficial), on Commonstock (commonstock.com/valuabl), and by subscribing to Valuabl (valuabl.substack.com), my fortnightly journal of the financial markets.

It’s been a pleasure sharing my thoughts and ideas with you. I hope you found them intriguing at the very least. I will leave you with the words of the great man, Leonardo da Vinci: “The noblest pleasure is the joy of understanding.”

Conor,

Author of Investment Talk