Hi, I'm Murdoch Gaddy and thanks for listening to the Rate of Change with York Wealth Management.
The Rate of Change is a podcast which explores the ever shifting momentum of financial markets
through the eyes of the leading managers in wealth management.
In today's Rockcast, I'm really excited to speak with Nick Thompson, the portfolio manager
at Lakehouse Capital Global Growth Fund.
Lakehouse Capital is an Australian-based fund manager launched in 2016.
They have a long-term investing approach targeting asymmetric outcomes for a high-conviction
strategy in mid- to large-cap growth companies outside of Australia.
Based on January's fund fact sheet, the fund has averaged 13.6% for the past five years,
saw the highs of 2021 with returns in the 30% region before experiencing a drawdown
alongside most gross managers due to a rising rate environment.
Recently the fund's up 10.9% for the past month while still being down 15% for the year.
Today we dive into some interesting topics which are the forefront of most investors'
minds such as where they think the market's going in this rising rate environment, how
the fund is positioned to either defensively deal with the volatility and take advantage
of this volatility, and we also cover specific holdings in the portfolio.
I found the conversation on Google and Microsoft fascinating, specifically regarding chat GPT.
For a giggle, I asked chat GPT via OpenAI to write a one-of-a-kind investment quote
based on Lakehouse's investment approach in the style of Warren Buffett and Howard
Marx.
Successful investing requires a combination of rational analysis and emotional discipline.
It's not about trying to predict the future, but about recognising and valuing the opportunities
that are present to you and having the patience and conviction to hold onto them for the long
term.
Quite remarkable, isn't it?
So with that being said, I hope you enjoy our conversation with Nick as much as I did,
so sit back and relax and enjoy it.
Nick Thompson, welcome to The Rate of Change with your Cloth Management.
Good to see you Murdoch, great to be here.
Why don't we kick things off and why don't you tell us a little bit about yourself and
how you got into financial markets?
Yeah, sure.
Look, I think for me getting into finance was very much sort of a natural progression
from early on.
My father, he worked in the industry, so I was always around from a very early age, even
by high school.
I kind of became fascinated with really trying to understand what drives asset prices, aside
from underlying fundamentals.
It was pretty clear to me that there was also a significant sort of irrational and erratic
nature to markets that was largely related to human psychology.
That curiosity naturally led me to Sydney University, where I studied commerce and then
after that I did an additional year where I did finance honours and I was studying behavioural
finance.
In terms of my professional experience to date, prior to Lake House, the bulk of my
experience was with Dakota Capital.
They're an investment firm that focuses on private markets.
I was there for about six years and we typically had more of a distressed lean there in terms
of our investing style.
I actually joined that shop pretty early on, was employee number four.
I was also fortunate enough with them to actually get the opportunity to live and work over
in New York towards the end of my time at Dakota, which was obviously a great experience.
Fast forward to 2018 and I joined Lake House Capital.
Ever since then, it's kind of been head down, bum up, very interesting markets and I've
been directly focused on the Global Growth Fund.
New York, New York.
Something like that.
Good place to cut your teeth.
Very much so.
So let's talk about Lake House Capital Growth Fund.
What is the philosophy of the fund?
Our approach is very much anchored around our philosophy.
I mean that we are long term concentrated and seeking asymmetric setups.
So that is in situations where we feel we have multiple ways to win and few ways to
lose.
In terms of I guess what makes us unique, I would say there are a few things, but I
think the big one is really our focus.
That really starts by being clear on where we don't want to invest.
So we'll typically avoid commoditized, cyclical and capital intensive industries.
Bank, airlines, real estate, auto manufacturers.
As the reality is, the bulk of companies in these industries just aren't good businesses.
Their fortunes are often determined by a number of external factors that are beyond their
control and over the course of the cycle, they tend to earn pretty poor returns on capital.
So for us as long term investors with very much a long term time horizon, it's a risk
we're not really willing to take investing in those types of businesses.
Instead for us, we focus on trying to find companies with one of three core economic
models and that's really centered around network effects, extremely loyal customers and unique
and enduring IP.
We believe that these core economic models are the primary driver of companies resilience
and durability and over the long term allow them to earn excess returns and compound shareholder
capital.
So that's why we have a deliberate focus on them and this is what we refer to as our fascinations
in house.
So I guess to give you a sense on one of them, extremely loyal customers, just so it's a
bit clearer to you because it can sometimes sound a little foreign.
What we're really looking for there is really companies that have products and services
that are deeply embedded in either an individual's life or a business's process.
So companies that are really kind of maniacally focused on customer satisfaction and retention.
Obviously the more mission critical these products are, the deeper the lock in as there's
pretty significant costs in terms of operational risk and also time and money to change to
a competitor.
When you find these companies, they tend to be in a very powerful position and there's
a number of things they have, but the top three I'd say is very valuable, recurring
revenue streams tend to have a significant degree of pricing power and also often under
appreciated in terms of their ability to develop new solutions or cross an upsell.
So I think we think a number of the companies we have in our portfolio are almost akin to
sort of modern day digital utilities in that sense.
And really I'm talking about our enterprise software holdings, our e-commerce positions,
our payment processes for example.
So I guess that gives you a sense of the philosophy and the type of companies we're after there.
Enduring IP, give a bit of colour around that?
Sure.
So I guess on the IP front what we're really looking for is businesses that have intangible
assets that essentially lead to pricing power but aren't captured on the balance sheet.
So I think brands, patents come to mind, I think the most obvious one for people to really
relate to is consumer brands.
So if you think about MS with their Birkin handbags that will go for anywhere from call
it $20,000 to $60,000.
The question you have to ask is why is MS able to sell that Birkin handbag at extremely
high gross margins and make a ton of money?
Why are people willing to pay for that?
And in our view it's the unique and enduring IP that they have and that they've built
up over more than a century in terms of building up that brand.
I guess to really think about it from the consumer's perspective it's what does that
do for the individual?
And at the end of the day it says, hey, look at me, I have a lot of money and it turns
out people will pay a decent premium if they can have a product that conveys that social
status to other people.
So that's kind of an example of something on the IP front.
So with the mandate of the fund, how is it structured?
We have a pretty broad mandate in terms of what we can invest in from a geographical
and industry perspective.
That said we have typically and most likely will continue to be sort of skewed towards
developed markets.
We do have a bit of emerging market exposure but that's typically around about 15 to 20
percent of the fund.
But we are long only.
So that is we do not hedge, we do not short, we do not use derivatives or options or anything
else there.
It's purely long only.
And as I said earlier on, high conviction concentrated approach.
So we'll only ever have between 20 and 30 positions in the portfolio at any one time
and at the moment we're kind of on the lower bound there around about 20, 21.
I guess the only other thing from an investor's perspective is maybe around liquidity.
So the fund is not listed but we do have daily liquidity so a very liquid fund.
What's the size of the fund?
Two hundred and fifty million.
Is that AUD or USD?
AUD.
And how can investors access direct?
Is it on platform?
Yes, we are on platforms and they can also come direct.
So there's plenty of different ways to invest but we do not have a leak at the moment or
anything like that.
It's not listed.
Would you consider that?
Or actually here's a question, right?
Because a lot of people want to know pros and cons between having a listed version of
the fund compared to just having a private.
Why has Lakehouse chosen the private path?
I think that is just the way we did it initially and the way the fund is set up.
I think we've had discussions about possibly doing a leak.
I wouldn't say it's something that we won't do.
It obviously has some access benefits for investors.
Makes it much easier for them to trade just like another stock day to day.
So I think we've thought about it.
But to be honest, I don't think we've had a huge amount of inbound demand that has made
us think that this is something super necessary we need to do.
I mean most investors are pretty happy with direct access to the fund and also the platforms
that we're on like the NetWells of the world and everything.
Is there an amount of money in the fund where it essentially reaches a cap and then the
fund doesn't make sense?
Or is it essentially an unlimited fund?
You have the capacity to run billions?
I think for the global fund, we're only 250 million in AUM.
So one thing I will say to you with certainty is that capacity is not an issue for us.
If we were sitting here having discussions around hitting our capacity limits, I would
be a very happy man.
What is the capacity limit?
So look, we've got a small companies fund, which you would obviously you're familiar
with.
That's got a capacity limit around four to 500 million AUM and that's really liquidity
driven, right?
You rule yourself out of certain opportunities and it gets a bit harder to run the strategy.
So we've made that sort of decision there.
The fund is open at the moment though.
Look, there's a number of different ways you can calculate capacity.
For us, we tend to be mid and large cap focus.
So it's incredibly liquid.
I mean, we're talking, you know, it might be 10 plus billion before that would really
become a concern for us if we were thinking about constraints or our ability to invest
in the smaller end of the market.
How's the performance been with the fund?
Since inception, we've caged, I think it's roughly around 12% after fees, which compares
to our benchmark of need to recheck the latest exact numbers, but roughly around 8%.
So I think there's about 4% of alpha there.
So, you know, in terms of what we're trying to do for investors, you know, we're very
happy with it.
It's really generated decent, not just absolute, but relative returns to our benchmark.
So we're quite happy.
The fund is a little bit over five years old now, which is also pleasing.
It's a decent track record.
We get a little less questions about being very young.
So we're pleased with that.
Probably 2022 was a challenging year though, as it was for many equity managers, especially
long only and growth focused.
But you know, thankfully, things have started to turn around the last few months.
We've seen a few green shoots and yeah, we'll see what happens from here.
It's been a very interesting past five years.
That is true.
I can tell you I've lived it.
Actually, this is a very good point regarding on those five years.
A lot of people want to know as well as how do you manage the volatility in the portfolio?
Do you have the you have the capacity to go to cash?
How much cash could you go to?
Have you gone to and essentially how are you managing the volatility we're saying?
You know, a lot of people consider volatility risk.
I would definitely argue against that and say, you know, the volatility we see in markets
day to day is more or less an opportunity as long as you capitalize on it in the right
way.
So, you know, risk for us is permanent impairment of capital that's investing in a business
where the fundamentals deteriorate or, you know, the whole thesis goes south and we take
a serious hit to our capital that we invested.
Volatility, you know, does not bother us so much, obviously, for the end investor.
They want to try and minimize that because it's never comfortable.
But for us, you know, it's really trying to take advantage of that volatility.
And when we see, you know, what we consider, you know, extremely high quality growth companies
out there, you know, true compounders that we'd really love to own, you know, sometimes
that volatility provides the opportunity for us to actually get established.
Any examples?
Yeah, I mean, plenty of examples.
If you even go back and look at, you know, and this is one thing I spend a bit of time
on and I'm quite passionate about, but people think, you know, if you look at the top 10
businesses in the world, you know, people often wonder why you would ever invest in
them.
They kind of say, well, how can there be any edge or alpha investing in those companies?
But even prior to the pandemic, if you looked at the top 10 companies and said, OK, how
far do they swing from trough to peak in any given year?
You know, most of them are moving 40 or 50 percent.
And you know, that is just they're crazy swings.
And I can tell you that the underlying economic value of those businesses is not shifting
as much.
You know, there's a lot of short term trading flows, narratives that really drives that.
I think for us right now, one of our larger positions is Amazon.
You know, we think it's one of the most attractive and dominant companies out there globally.
You know, they're the number one cloud infrastructure provider and also e-commerce player globally.
And, you know, fast approaching one of the big boys in digital advertising as well.
It's obviously been sold off on concerns around near term profitability and some cost impacts
that it's had on the back of the pandemic.
But in our view, you know, we think the growth potential three and five years out and where
the business will be is still very much intact from an earnings power perspective.
So it's very much a case of temporary issues providing, you know, what we think is one
of the highest quality businesses at a very attractive price.
And that's, you know, to be honest, one of our ideal situations to lean into.
And that's why it's one of the largest positions at the moment.
So when money comes into the fund, say a new investor allocates via the fund or goes direct,
what happens with that money?
Does it on the day the money gets allocated and spread across the portfolio, as soon as
the capital comes in, do you pull the capital and essentially wait for, I don't know, a
pullback in a particular company, which you like then allocate?
How's the process work?
Oh, I'll actually briefly touch on what was part of your previous question, because I
realized I just didn't answer it now after you brought up cash again.
But look, we've got a range of five to 15% indicative for our cash, but we can go above
that up to 20 or slightly below five on the lower bound, depending on our conviction levels
and how we're seeing the opportunity at any particular point in time.
So that has been in flux over the years.
When the market got incredibly hot in our view, our cash position naturally built up
and that wasn't necessarily saying, hey, we're going to start building up cash because we
think this is just getting unsustainable.
It was more a factor of just finding it hard to try and find opportunities bottom up out
there where the returns stacked up and the math worked.
Equally at the moment, we're very much on the lower end of that bound.
So we're down around about 5% and that's because we think the opportunity is incredibly compelling
at the moment.
We're seeing plenty of companies and places to allocate capital.
To your question around flows, they're not normally that significant on any given day.
I mean, obviously we've got daily liquidity, so flows are quite spread out.
But to the extent we get cash in, that just simply goes into our cash account and we won't
be making a decision based on that.
So unless it was an incredibly large chunk of money and we needed to because it was going
to breach our required range of that ruffle, 5 to 15 or 5 to 20%, we're not really forced
to do anything because we got some new money in or anything like that.
It's very much driven by the opportunity set and what we see in front of us.
Yeah.
And the reason why I like understanding this is because it touches on behavioral psychology,
which is what you said you majored in, right?
Sure.
I'm a big believer that the markets are not rational.
The markets are not rational.
So with behavioral psychology, can you give an understanding about how you're remunerated,
how the funds remunerated?
And the reason why we ask this question is when money goes in, people want to understand
what type of opportunity you're taking, what level of risk you're taking to hit your targets
so you get more money in your pocket.
But how does that translate into the returns in the fund for the investors?
I think the first thing I'd just say around alignment starting out before we get into
performance fees and how we're remunerated, I think for myself, my personal investment
in the Lake House Global Growth Fund is my biggest asset and that includes anything from
stocks to real estate, whatever.
So I am very much personally invested in the fund, I will eat my own cooking and live or
die by those returns we will generate.
Obviously, I believe we will do very well over the long term.
So I'm happy to be there.
But on the performance fee side, look, we earn a performance fee if we outperform the
benchmark.
So we have a 15% performance fee there.
So it's very much a performance fee culture at the end of the day.
If we're not outperforming, that compensation is basically the bulk of our incentives.
So we need to really perform to get paid at the end of the day.
And I don't think anyone is really in this business to underperform, to be honest.
What's the benchmark?
So the benchmark is the MSCI or Country World Index in AUD terms, as the fund is in AUD
as well.
So look, we've historically done that well.
One thing I will say is that we also have a high watermark, which we think is best practice.
So at the moment, it wouldn't surprise you that given the year we've had, we're significantly
underwater, which means we need to get back to that level before we could ever capture
fees again.
So it's not on an absolute basis relative to the benchmark.
We do have a high watermark.
The market's had a pretty big bounce since before Christmas.
So they might have pushed it up a bit in your favor.
It's going in the right direction, but it's a long game.
We've got some ground to catch up.
So to be honest, anyone who invests, it kind of gets a bit of a free kick on that.
It's the way the fund's structured and we think it's the best way to do it to ensure
that we're aligned with our investors.
We wouldn't feel comfortable if the market's had a drawdown and we were able to reset,
you know, essentially where we take performance fees.
It wouldn't make much sense to us.
So I think having the high watermark is the way to do it.
And with the fund itself, who owns the fund?
Is there a Chinese wall?
Good question.
The Chinese wall is owned by the Chinese company, the Chinese bank house capital is
actually owned by the Motley Fool, who is the parent company in the US.
But in terms of resources and work and everything like that, in terms of research, there is
absolutely no crossover.
So we do 100% of our own cooking.
It's actually the businesses are actually regulated in different jurisdictions.
So we're actually by law, not even allowed to talk stock.
You know, we're very much, you know, the boutique here that you see is what we're running with.
There's no other resources or anything like that or relationships.
So speaking of cooking, how do you actually cook the steak in a day to day basis?
Look, I guess in terms of what we're looking for out there, I kind of talked already to,
you know, the economic models that we're trying to find.
And I think I kind of gave a bit of an intro there on that.
But beyond that, what I would say is, you know, there's a number of different attributes.
We're looking to invest with and also looking to avoid.
So you know, as I said, we're looking for those asymmetric setups.
So obviously, I guess I'll speak to the upside first, really what we like to see.
You know, one thing would be gaining share of a growing market.
It's obviously not the be all and end all but all else equal.
If you have a company that's gaining share within a growing market tends to be that they
are doing something right, that they have a unique value proposition that is really
resonating with the market.
Obviously there are a number of other factors you need to think through in terms of, you
know, the industry structure, the rate of innovation in the industry, what are the economics
associated with their growth.
But it's definitely a positive market we like to align ourselves with.
You know, one other thing we have a penchant for is founder led businesses.
You can look at a number of studies that show that founders tend to outperform and that's
no surprise, no founder, you know, no business is really cared for like any other by its
founder.
And obviously in most cases there you have pretty strong alignment in terms of insider
ownership.
So not all our companies are founder led, but when we like to, you know, when we can get
it, we like to have it, I guess.
And then one last thing I'd just say is, you know, pricing power, which is effectively
a distillation of, you know, a company's competitive position and the industry structure.
So I think, you know, by and large, when you find companies that have pricing power, the
ability to push price increases onto the end customer without impairing demand.
You typically have a high quality business, especially from a competitive standpoint.
And, you know, that's something we have, we think we have in spades across the portfolio
and it's definitely served us very well over the last few years in the higher inflationary
environment.
I guess just quickly on the downside, a few things we would avoid.
Reliance on leverage, pretty self-explanatory, but really reduces the tail risks and also
provides I guess more optionality to businesses, particularly in tough times like we're in
now.
If you don't have a constrained balance sheet, it can often allow you to go on the offense,
particularly if your competitors are hurting.
Another one would be concentrated customer bases or a reliance on someone else's business
for a critical piece of infrastructure.
So if you found a company that you thought had a great product, was doing really well,
growing really fast, but you know, for their distribution, they relied 95% on one partner.
That's a key risk that, you know, we're not really willing to take because it can obviously
change overnight and have drastic impacts for the business.
And then one other thing I'd just say is around cyclicality.
Once again, just removing that tail risk.
So that gives you a sense, I guess, of the elements we're looking for and looking to
avoid in any typical investment.
Let's stay on the companies before we pivot into the wild world of macroeconomics.
Can you give a couple of examples regarding companies that are currently in the portfolio
that meet that criteria of what you're looking for and how they're performing?
I think a great example here would be Mercado Libre.
So it is actually one of, actually it may be, depending on the day, the largest position
in the fund.
So I think it's probably a good one to talk to.
But you know, for listeners...
If anyone hasn't heard about Mercado Libre, I just have to bring this up because it's
been in the papers quite a bit.
So essentially, they had their largest competitor fall 80% in one day, I believe.
And I believe it was due to a $3.88 billion accounting scandal.
Yes, you were referring to Americana's there.
There were some issues they had on their supply chain financing or something of the like.
But it basically looks like it was just internal human errors, or at least what they've said.
But you can't really plan for that occurring, can you?
You can't.
And these things do happen.
But look, I mean, I think how you really manage for that is the quality of management.
And Mercado Libre, I would say, being founder led, and also having that founder very aligned
through owning about 8% of the business, kind of helps take away some of that risk that
there's going to be that oversight.
He's been doing this day in, day out for the last 23 years, building this business up from
when it was a baby.
And he has a good $5 or so billion of equity on the line.
I think it just puts a different degree of oversight there in our minds.
But yes, you're right, you can never completely rule it out.
But a bit of an update there, they've recently, I think it was on the 20th of January, formally
filed for bankruptcy Americana's.
So obviously that's been a bit of a boon for Mercado Libre, given that they were one of
the largest competitors in the Brazilian e-commerce space.
So a nice positive to have, but obviously we weren't planning for that one.
Have you looked into the numbers, like percentage wise, how big an impact that was going to
have positively for the company, for Mercado Libre?
Hard to know now, given they haven't reported, they actually report later this week.
So we will get some fresh numbers, but we have seen some traffic share numbers and their
traffic has spiked along with the decline in Americana's.
So there's initial indications there that they've benefited pretty materially, as you
would expect.
But maybe just back on Mercado Libre quickly and I might just run through in terms of the
business.
But yeah, like I said, I think it ticks a lot of the boxes for what we're looking for.
And those that aren't familiar with the business, it's the leading e-commerce player in Latin
America.
But in addition to having that core marketplace, they also have a number of ancillary businesses
that strap on around that with advertising, payments and shipping.
And importantly, in our view, not only do these increase their market opportunity, but
they're also pretty important in terms of increasing the stickiness of the platform
to consumers and merchants alike.
So the business has been incredibly successful to date and executed very well, to give you
a sense.
Obviously, they were a pandemic beneficiary, being an internet first company.
But between 2019 and today, so over the last three years, roughly, they're 4.5x their revenue
base.
So growing at a very, very healthy clip.
In terms of what we like about the business and the boxes it ticks, look, it's founder
led, it's gaining share of a growing market.
It also has some very strong network dynamics at play, thanks to its marketplace and also
its payments business, and also has a very long growth runway.
And that really comes from the fact that not only is it still very early in Latin America
in terms of overall penetration levels of e-commerce, but there's also a material percentage
of the population that remain unbanked.
So plenty of opportunity for them.
I think one last thing I'd just touch on to kind of bring it home is really about valuation.
I think with the broad based drawdown that we saw in 2022 across the market in general,
obviously, valuations have come back a lot, but that's been very acute with a lot of internet
and growth businesses.
And our view would be that the baby's kind of been thrown out with the bath water there.
Your fundamentals haven't mattered too much or your competitive position or whatever dynamics.
And I think Mercado Libre is an example of that.
It's trading it despite continuing to execute very well and going from strength to strength.
It's trading at about five times forward revenue, which is the cheapest.
It's basically been its entire history outside of the GFC.
So a very compelling valuation.
And we think the risk reward here is incredibly attractive and hence why we've got a very
large position.
What are the big techs in the portfolio?
So we actually have a few names.
So we have Amazon and also Alphabet, some of our larger positions.
I think you also mentioned Microsoft as well.
Yes, Microsoft we added towards the midpoint of last year.
And let's discuss chat GPT.
I'm sure there's not a person that's listening to this has not heard about artificial intelligence
pretty much taken over the headlines.
I believe the statistics on it was 16 years for the World Wide Web to rack up 100 million
users and what was it 100 million in 60 days or maybe even 30 days.
It might have been a month.
I did see that stat flying around.
Look, it's obviously, that's incredible.
Ever since it's been released in the consumer model, it's had incredible success.
And I think blown a few minds with the responses everyone's seen online.
Can you give me the color around what is chat GPT and essentially the impacts it has on
these big tech companies.
Some are discussing whether or not like say Google with Baird to use it to monetize it
immediately whilst Microsoft's gone down a different angle.
And what are your thoughts?
Chat GPT is a large language model, what they call a LLM.
So I'm sure you've heard that term thrown around and everyone's probably equally confused
what they're even talking about with large language models.
But the actual definition is an artificial neural network, which they train on a vast
data set to basically generate natural language responses to queries.
So you've got a lot of data scientists and whatnot training these data sets such that
when you put in a certain query, you'll get something that comes back in a relatively
conversational tone.
So look, it's definitely taken the hype cycle by storm.
Everyone seems to have forgotten about crypto and then the metaverse and now we're onto
large language models pretty quickly.
So I think things are definitely, we seem to move the hype cycle seems to be moving
a little bit quicker these days.
But there is clearly something beneath it in terms of the technology, obviously, I think
where exactly that all goes, not many people know right now, I'm sure like chat bots and
various business functions or work processes.
The question is, to what degree can they be automated and done better by a system like
this?
And I'm sure we'll see a lot more of it in the years to come.
I think our direct focus right now is really, you know, around chat GPT and its ability
or the potential that it could disrupt Google's core search business.
Good question.
I'm not as convinced as most people out there.
But look, Microsoft held an event last week where they announced that they're going to
incorporate an early version of chat GPT into Bing, which is their search engine and essentially
run with that.
That led to a pretty vicious share price response to Alphabet.
I think the company lost, call it 100 billion or a bit over 100 billion in market cap just
last week alone.
So people are pretty nervous.
And I think uncertainty is high.
But you know, I'd say their ability to disrupt search is probably being exaggerated to some
degree at this point, not least because, you know, Alphabet themselves is largely regarded
as a leader in AI and he's been spending a ton of money and working on such technologies
for an incredibly long period of time.
So they would clearly have the technology there to roll something out similar themselves
if they wanted to.
And indeed, I believe they will.
They obviously already kind of are.
They tried to do an event in response to Microsoft's last week, which wasn't exactly that convincing
and had a few errors in it.
And I think fumbling that response, they were clearly rushed, kind of led to, you know,
fed into the uncertainty around the business.
But there's still a way to go in terms of the technology to get it to a point where
it can disrupt search.
And I say that for a few reasons, but you know, it's incredibly computationally intensive
and expensive to incorporate a large language model like chat GPT into search.
I think the estimates I saw is roughly it's, you know, eight to 10 times more expensive
than a search query.
There's also the fact that, you know, the data sets that you're running off are typically
somewhat dated.
So it's not giving you information of the day it might be to the end of say 2022 or
something, which obviously is not ideal as well.
So there's a few constraints like that.
And then, you know, obviously when you really step back and think from first principles,
okay, well, what is Google's dominance in search really predicated upon or protected
by?
So I think a lot of it comes back to, you know, the hardware and the operating system,
you know, advantage that they do have.
Also the fact that, you know, they largely have the brand equity and the consumer mind
share when it comes to search and arguably the best search product.
So when you put all that together with their data advantage, it's not entirely clear to
me how Microsoft's going to disrupt that.
I think one key stat is just 61% or a little over 60% of, you know, search queries are
actually done on mobile, where Microsoft has absolutely no presence.
So unless they're willing to pay Apple the 15 to 20 billion a year that Alphabet pays
for, you know, the priority placement within the Safari browser, it's unclear to me how
they're exactly going to steal that pot from Alphabet.
So there's, what I'm saying is there's a lot more to it than just a fancy technology and
this is going to be so much better than search.
Let's roll it out.
I think, you know, there's a lot more hype and it's a bit exaggerated right now in terms
of the disruption risk to Alphabet.
Well, isn't that the biggest question?
Like what is it?
What does it actually do?
Is it like, you know, the Colonel's secret recipe, you know, is that the code or is it
actually the thing that's makes this thing so fascinating is the data set, as you mentioned
before that it can go through.
So if say I'm using it right now to figure out which fund manager I'm going to use, right?
Are you saying that the AI is only there as the data set, which you can access or is it
the algorithm?
I think it's both.
I think it's the data set that it can access and also how well it's been trained.
So there's a few different variables here.
I think the reality is we'll probably have numerous versions of chat GPT like, you know,
talks in the future with different companies, different companies offering them.
But it's hard, right?
I mean, even at the moment, you know, there's instances where if it doesn't know the perfect
answer, it will hallucinate and make things up.
Now that could be a bit of a problem if you really rely, you know, if you think about
Google search, it's a utility, right?
And what you want is speed, accuracy and reliability.
And that's why I just think, you know, people are making a bit of a leap here to think that
suddenly tomorrow, you know, Microsoft being because it has.
What's interesting about that is I've heard a couple of people that are, you know, either
portfolio managers, data engineers, or just anyone that requires a large data set.
Some of them actually just for a giggle have had Google up and then had chat GPT up and
they're asking the exact same questions.
But what they're experiencing is via Google, you're getting the answer, but also 15 ads.
Whilst chat GPT, there's no ads and essentially refines and changes or I could put up this
podcast transcript and remove all the arms, the arms and, you know, maybe a comment I
shouldn't have made quite cleanly and it puts it up.
And it can even rewrite the entire works of Shakespeare, you know, in the language of
Harry Potter.
It's fascinating.
But I suppose the question I'm asking, I really like to hear your thoughts on is that's on
the search component, but you also have a myriad of other companies out there.
Does this artificial intelligence have the potential to improve the efficiencies of these
businesses?
Because what do you think?
Is it purely a search engine or does the individual who's doing their job now have a better source
of information to fine tune everything?
And then do the companies internally become better?
Like as an example, in the States, in America, they banned kids and universities for using
chat GPT because kids were spitting out perfect 100% essays.
There's a lot of use cases, I think that, you know, when you really think through it
opens a lot of trap doors and questions, even some moral and ethical ones, right?
Like can you ask, you know, for instance, what information do you block?
Which is obviously a decision Google has to make as well.
But if you're asking chat GPT St. Nefarious around how do I build a bomb or xyz.
Elon Musk said that.
Yeah, so you get into a lot of, you know, different areas.
And I think over time that will all be worked out.
But to your bigger point, I think this will, you know, it'll end up permeating, you know,
not just the consumer's life in sort of whether it's search or whether it's even just a different
use case of writing text or, you know, different things like that, but definitely within businesses.
I mean, call center functionality, I could see how this could easily, you know, once
you've trained the models and it's at a certain level and it continues to learn itself and
compound, I mean, be way better than having human call centers, for example.
Right.
So there's definitely big areas that I think it will change whether we're there yet with
the technology.
I don't know.
But yes, obviously, my primary concern being with my with my investor hat on is really
around, you know, what could this potentially do for or against any of our portfolio companies?
And that's what we're kind of thinking about right now.
But I think, you know, we'll continue to read widely and there'll be a lot more that comes
out around it.
As for the narrative around this disrupting Google search.
This isn't the first time we've seen such a narrative, right?
We had it when there was vertical applications back in the day when people said, oh, the
trip advisors of the world are going to weed up search and search is going to decline.
Didn't prove to be the case.
Google just strapped on, you know, various vertical search things onto its own platform.
And also with Alexa, we're going to shift a voice and suddenly Google's not going to
have a world.
You know, if you jump at that first sort of headline every time, you're going to find
yourself, you know, jumping out of all these incredibly dominant businesses very frequently.
Right.
So I think it takes, you know, it's worth taking a step back, deep breath and actually
thinking through, well, hang on, what does this technology do?
What does it really mean?
Is it really a search, you know, purely a search functionality, you know, and going
through the elements.
And I think when you do that, you realize that it's not as clear cut as maybe some headlines
are suggesting.
Do you own any social media businesses in the country?
We do have a small holding in Facebook.
So here's a question, right?
If the metaverse clearly didn't work, if Facebook pivots and essentially incorporates
chat, GPC or the AI into essentially what they're doing, what does that do for the company?
Well, that's a good question.
I mean, there's maybe that's kind of what I was getting at earlier.
Maybe a lot of businesses just incorporate this chat GPT like functionality into their
websites or applications.
And everyone's kind of running it.
I mean, but at the end of the day, if you don't own anything that's proprietary or unique
and it's all relatively like a commodity, then that's not going to be a great business.
Right.
Yeah.
So I think you've got to think through the barriers to entry and what it's really offering
and then who could really monetize that in a proprietary sense.
And I have no idea at this point, but to your point exactly, I'm sure Facebook is meta.
So from what you're saying, it sounds like it's more like a tool that will essentially
improve the inner workings of these businesses, which I think is fascinating in comparison
to something that could be quickly monetized.
I think so.
But from the consumer facing side, it's hard to exactly see where it fits in.
I mean, maybe you do go to google.com and you've got Google search and then right on
the right hand side, you have, you know, BARD, which is or whatever, you know, their GPT chat
GPT functionality as well.
I'm sure you will see that.
Well, let's put a pin in this because I think we'll talk about this for the next hour because
it's just mind blowing because to your point, you don't, I don't think anyone knows where
this is going, but it's fantastic.
Fascinating space.
It's going to change a lot of things, so I definitely want to keep an eye on it.
Let's talk about things that definitely change.
Let's discuss China.
It was the first one into the crash and it appears it's potentially one of the first
ones out of it.
So I believe as long as I've known your favorite company in the entire world, it's probably
been Tencent.
So how is Tencent going and what's your opinion on what's happening in China now?
Yeah, sure.
Look, yeah, we've been bullish on Tencent for a while.
We think it is a fantastic business.
One thing I will preface that with is obviously it's a mainland China stock, so it comes with
other risks, right?
So that's why it's never been a very large holding in the fund.
But to your bigger point on China, yes, I think what we saw in 2022 for them was almost
the perfect storm.
They had a pretty acute real estate slowdown, very significant regulatory crackdown, COVID
lockdowns round two.
It was really hard for it to get much more pessimistic for them.
You had some incredibly cheap valuations over there.
I think Tencent, if you stripped out their portfolio, you were talking a seven, sorry,
a single digit PE.
And that was largely on what was trough earnings as well.
So since the country reopened a couple of months ago, we've seen that kind of rip completely
the other way.
I think even businesses like Tencent, now up roughly 100% out of their October lows.
So there's definitely been a bit of a shift there in sentiment.
I think over the next, you know, we're still comfortable with Tencent.
It's a moderate holding in the portfolio.
And I think China is probably in a good place to perform over the next, you know, short
to medium term.
I think the longer term there though is definitely in my mind becoming more cloudy.
And I just think the ongoing decoupling that you're seeing between the East and the West
is certainly raising the geopolitical risk.
So that's something we're thinking about a lot as to whether we really want to have
that mainland exposure.
You know, now we're very comfortable with it and we think it's a phenomenal business
and we'll do well.
But it's definitely saying we're monitoring closely.
Obviously, the other option is to get exposure to China through companies that are not listed
there.
We do have that as well, like an LVMH, which, you know, the Chinese seem to have an insatiable
appetite for luxury.
And you know, LVMH has been a big beneficiary there.
And that's obviously, you know, that's also performed very well for the fund as well.
Thoughts on UK and Europe?
Any exposure in the fund there?
We do have some exposure.
So I just mentioned LVMH and obviously a lot of our businesses are global.
So they sell all around the world.
But we also have Hemnet, which is a Swedish online property portal.
So think of the REA.
Basically, you can think of REA group here without a competitor.
So they're about 10 times the size of the next closest platform.
So more or less, you know, consumer facing monopoly, great business, very stable end
market as well.
So we very much like that.
But our Europe and UK exposure at the moment is probably on the lighter side.
And that is a deliberate decision.
The inflation picture around the world is very different.
The US has largely rolled over here.
Maybe we're about to roll over China.
No real inflationary problem at all at the moment.
Europe, bit of a basket case.
Obviously they have the issues in the East, given the war with Russia and Ukraine, but
also a pretty significant energy crisis.
So inflation over there is taking a real toll and it's a region that we've been underweight
for a little bit now.
Very wary about.
So I think I read a statistic that about 80% of central banks worldwide are currently in
tightening phase.
So what's your...
Certainly feels like it.
So how's it impacting the fund?
And I suppose, what are your thoughts on macroeconomics and where rates are going and the bigger picture?
I think on the macro front, look, we're by no means macro investors.
You know that very much business focused bottom up analysts looking for companies and focusing
on the fundamentals.
But what I would say with that is it's impossible to ignore the macro, particularly in today's
world, right?
We're always looking at it.
So definitely, if I had to kind of sense our macro or how we think about it, it's very
much macro aware, but micro focused, right?
So it does shape things we do, like I said, with Europe.
But I think on the interest rate front, I think inflation is more or less yesterday's
war.
I think last year, central banks were going incredibly hard to tamp down on inflation
and raise rates.
And I think, you know, in our view, we're probably closer to the back end of that called
the seventh or eighth inning.
I think you largely saw that with Power's press conference recently.
The market obviously reacted well.
And whilst I would say he didn't say anything that was too optimistic, to be honest, very,
very nuanced.
What he did was he provided some certainty, I think.
And really, that's all the market or all investors really wanted to see, which was, you know,
just some certainty about where rates would end up and at least know that the rate of
change, for lack of a better word there, better saying, I should say, was slowing down.
And as soon as they saw that, you know, it kind of, I guess, gave a lot of people who
were sitting on the sidelines, there's plenty of capital out there just waiting for this
to end to lean in.
So I think the inflation and interest rate picture is improving from here.
I think the bigger risk as we look at over the next 12 months is really the recession
risk.
So, you know, the question now is we've had this incredibly steep and quick ramp in interest
rates.
What's the demand destruction going to look like on the other side?
And, you know, to that point, I think it's incredibly hard to know because you have a
lot of mixed signals.
So, you know, on one hand, you have the yield curve in the United States, which is basically
the most inverted it's been the last 40 years, which is telling you the next 12 to 18 months,
there is a seriously high probability of a meaningful recession.
But then on the other hand, you look at the consumer data, the employment data, and it
just continues to be incredibly strong.
You know, the fact that the last print we had for the US unemployment rate, 3.4, 3.3,
mid threes call it percent is the lowest unemployment's been since 1969 kind of tells you everything
like the labor market over there is red hot.
So I think, you know, that's the real risk from here thinking about the recession and
just how sticky inflation proves to be on the downside given wage inflation will probably,
you know, stay stay at least warmish on the other side.
I get this question all the time.
So essentially, what what does this rally we've seen almost doubling from the lows
Tesla a number of different tech companies, right?
So is this a bit do you think this is a bear market bounce?
Or do you think this is the beginning of a long slowed recovery?
Or do you think this is trend is still down?
Because we also from the research we're currently receiving, there's also talks, as you said,
with inflation situation of potentially companies suffering a profit crisis, just as you said,
the impact of discretionary spending.
And then potentially, if that occurs, it would hate to see it, but potentially a credit crisis
of some sort down down down the end.
Do you think that's where this is going?
Or do you think this is the beginning of the recovery?
Or what's your current opinion?
Yeah, I think on that, obviously, the markets have had a really good start to the year.
I don't think I or I should say we at Lake House have much of an edge in terms of predicting
recessions, credit crises or anything like that.
In fact, I would argue that, you know, if you look back over history, you know, no one
really has a consistent edge there.
And even if you do, trying to make money off it can be quite a tricky game.
So you know, for us, it's all just bring it back to fundamentals.
Like I said, despite all the doom and gloom, you're constantly getting headlines saying
this or that is about to occur.
The recession is coming, which, you know, if you're betting on that's fine.
But it's also the most predicted recession of all time.
But you know, for us, the portfolio companies continue to grow, I think over the last quarter,
the weighted average revenue growth across the portfolio is still north of 20%.
So things are still very healthy from a fundamental perspective.
So I'm not too sure where we go from here.
We do have an inflation print this week, and there is an extreme amount of volatility out
there.
So things could change quickly.
But you know, my personal sense is that, you know, I think I'm starting to get much more
constructive here from a risk perspective.
And I say that for a few reasons.
But you know, at least in the US, inflation appears to have peaked.
And that's the most important market given the Fed sets the cost of capital for the rest
of the world.
You've also got freight rates, commodity prices that are down significantly, which is a pretty
good forward looking indicator for where inflation is going.
You've already got a 5% terminal Fed funds rate priced in versus 0% 18 months ago.
So a lot of that dislocation we saw and that value adjustment has already played out.
And then you already have, you know, the NASDAQ down 25% and valuations at much more attractive
levels than what they were.
So I think right now, if you can focus on fundamentals and tune out the noise, and really
if you know, if you can take that three to five year view, I think, you know, it'll prove
a pretty good time to invest.
I'm definitely more constructive right now.
So using that exact theory, what has been the most recent allocations of the portfolio
of which company?
Sure.
So in terms of recent additions, we've added Hemnet, which I mentioned, we've also
added Charles Schwab, which is one of the largest discount brokerages, an asset, well,
turning into almost an asset management firm over in the States.
And we've also added to a number of our higher conviction positions.
So talking the Amazons of the world, CoStar, ServiceNow, Constellation Software, really
a number of positions that we feel, you know, have been sold off pretty, not irrationally,
but just, you know, sold off way more than they should have been.
Fundamentals are holding up quite well.
And for these businesses, we feel that whatever comes down the pike, they're pretty well placed
to deal with it.
And, you know, that's not just due to our philosophy, but, you know, if you have, you
know, the world we're talking about right now, and it depends who you ask, but if we're
looking at slower growth, maybe, you know, moderating, but pretty persistent, higher
inflation than we've had previously and higher interest rates, the question is, well, what
kind of business do you want to invest in in that environment?
And we definitely feel we're in the right companies to deal with that.
And I'd say, you know, the things you want to secular growth, you know, businesses that
can continue growing, even if you get the broader economic weakness, high gross margins
and pricing power, so you can deal with inflation, definitely, you know, maybe dominant businesses
that are at least dominant within their markets.
And I say that from the perspective of, you know, not only are they best placed to, you
know, survive a recession if we get one, but the ability to play, I wouldn't underestimate
the ability to play offense when everyone else is playing defense, you know, if it is
a very tough market, and a lot of your competitors are reeling and you're able to reinvest and
really try to capture the upside coming out of that, you know, rapid market share gains
can happen.
And then the last one I'd just say is minimal leverage, obviously, in a rising rate environment.
It's obvious, if your capital structure gets strained, you're going to come under pressure.
So I think those are the four kind of key things.
And I'd say it's pretty consistent, not only with how our philosophy and strategy has always
been, but we think we've positioned the portfolio accordingly such that whatever plays out,
hopefully our businesses will continue to thrive and grow for many years.
And you know, that will play out in share prices eventually over the long term.
So they're the things that you're currently looking at.
Is there any themes that aren't in the portfolio now that you're considering?
A lot of themes that many people are discussing, obviously, as you said, you're not going to
touch airlines.
So what about in the renewable space, you've got all the cars, the lithium batteries, solid
state batteries starting to pop up everywhere.
What about cybersecurity?
Anything like this you're considering or just not on your radar?
Look, I wouldn't say it's not on our radar.
We'll look at anything.
As I said, we're really searching from a bottom up perspective, looking for those core economic
models first, and the businesses that are set to benefit from those secular trends.
So you noted a few there.
Cybersecurity, we've looked at it here and there.
We don't own any direct plays there in terms of, you know, pure cybersecurity companies.
But there's obviously a huge opportunity there.
I'd say, you know, the rate of change in the industry for us is something we kind of struggle
with.
It does kind of move pretty quick.
So it's hard for us to really feel like we have an edge in predicting how that's going
to turn out.
But we do have some exposure through the likes of Microsoft, for example, which has, you
know, an absolutely massive cybersecurity business in and of its own right, right now.
So we kind of get a bit of that without having to take the direct bet on any individual player.
But it's very conceivable we could going forward.
I mean, it's a very attractive market and there's some businesses there, which I know
you're familiar with, like the cloud players of the world and whatnot that are, you know,
very high quality and there's some opportunities.
So we'll always, always be looking.
Just to finish off, is there any thoughts you want to leave our listeners with?
Yeah, look, the only, I guess the only one thing I would say is that, and I was kind
of touching on this earlier, is really just around the macro and uncertainty that's out
there.
Obviously, sentiment's incredibly depressed and there's a lot of fear.
But I think at times like this, what really pays is to take a step back, deep breath and
focus on fundamentals.
So if you can find those companies that you think are still performing very well, momentum
is strong, their competitive position is strong and you think they have, you know, great opportunity
and potential over the next three, five, 10 years to continue growing and they're trading
at what is very, you know, very attractive valuations today.
I think it's a time to lean in.
So I'm not suggesting that the bottom is in or I have any magical crystal ball.
But you know, when everyone is fearful is often the time as Warren would say that, you
know, opportunity presents itself.
So I just think, you know, now is not a time to put your head in the sand.
Markets are forward looking.
By the time all these storm clouds have dissipated and we're back here talking like it's a good
old glory days, markets will be 30, 40, 50% off their lows and, you know, we'll be back
to back on the cycle.
So just like chat, GPD, nobody knows, but up, up it goes.
Nice one.
You should should trademark that.
If anyone wants to learn more about Lake House or the global strategy, how can they find
you?
Lakehousecapital.com.au.
We try to be pretty transparent in everything we do.
So we pump, we publish a monthly letter.
You can see our top 10 holdings there.
We also talk about, you know, the material holdings when they report each quarter.
So definitely try to be transparent with investors.
And we've got quarterly webinars we run so they can find all that information there.
And I think it gives you a pretty good sense of what we're about.
Thanks Nick for coming on the rate of change.
It's been really enjoyable hearing your thoughts and I hope you have a great day.
No problem.
Thanks Murdoch.
It was a pleasure.
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