In this Vodcast - Alistair sits down with Michael Dee, Director of Pythagoras Investing, and they discuss volatility in the market and how Michael uses his unique methodologies to invest with volatility.
Hello, welcome to another ACY Securities podcast or video cost. Today. I have am lucky enough to have Michael Day with me from Pythagoras investing, and we're going to be talking about volatility. So to get straight into it, Michael, what is it that Pythagoras investing does? And what is your role in the company? Cool.
Pythagoras investing makes recommendations in the stock market and we do that by using mats and we use the mats to construct volatility and within volatility, we know that share prices react to changes in volatility, not the other way around. Okay. So therefore we can predict, share price behavior, and we use it. We just trade ahead of it, either buying or selling.
I would love to hear a little bit more about that, but for now we're going to find out a little bit more about you. So what, how did you sort of start investing?
Yeah. Okay. So we're going back here. We are going back. I, I, my first degree was in accounting and for anyone who's done an accounting degree, you know, that that's not really all that interesting, but one of the things that I did was become quite interested in the listed market. And I learned from a friend who had been investing for several years and he was reasonably successful and he was just an a genuine thinker about things. And so at the time, so we're talking about the early nineties. We had the listing of APN news, which doesn't exist anymore, Fairfax, which doesn't exist anymore, a Woolworth's and quite a lot of other companies that came out of John Belvins' Adelaide steamship. And so I happened to strike a relationship on purpose with a good broker who was able to get me a flow of IPOs or, or initial public offerings.
And I was only able to get two or three or $5,000 worth, but as a final year student at university, and then a first year accountant making a few hundred dollars here and there was just a great thing for me, that's the pub money on the weekends, but it says my interests, alight. I, I suddenly became quite disinterested with accounting and I lasted one year in a chartered accounting firm. And I pretty much resigned on day 365. And I went back to study and I did what was FINSIA as graduate diploma. And I did a marketing degree and I did my CPA for some reason. I'm not sure why all in a year. And then I started working full-time as an investment analyst and portfolio manager in south Australia.
Okay. And when it comes to a very first investment that you ever made on a listed front, what was that? Do you remember what it was from back then? Look, I was trying to remember this I think it was probably IPN news or Australian provincial news, which were just regional papers. I suppose that very first one you've done would have had to have gone somewhat successfully because otherwise you probably wouldn't have continued to invest now in, at that time were a bit different from what they are now. It used to be that you'd put your money aside for two or three months. It was a fixed price offering. And the time in the market was such that it was important that they were successful for the long term benefit of the broker and also for the company.
So, snd what did, what do you find different between IPO's back then and now when they happen? Yeah. So if we won the clock forward 25 or more years, the time to market is much, much finer. So you can put your money down and in a number of weeks, you're going to get a result on the market. Now that's a great innovation, but what it means is that there's a lot of price soundings that happen at the institutional level. And there's typically a bit of preference that's given to institutions over mums and dads. So these days the pricing is much finer. The profitability of an IPO is much more subject to the whims of the market. And the investment bankers role is different. It's more about creating profitability for the firm, as well as creating a very fine outcome for the company.
Okay. So you find that there's obviously a pretty big difference. You still invest in IPO's today,
Less. So I find it's less acceptable to me to actually put my money down for any extended period of time. So even a matter of weeks, isn't all that exciting. Right.
And what do you generally invest in today? Have you got some preferences that you would steal with an outliers that might be a little bit different to others? So it's quite broad. It's all in Australian equities and I have a heritage in small companies. So I, I enjoy small companies and the offerings that come out of that part of the market. But what I've learnt over the years is you don't have to take the sort of risks that small companies pose. You can still make excellent returns in big companies. So I invest in big miners. I invest sometimes in bio-techs, I invest in a rather dull and boring things as well. It's very much subject to the environment we're in and the opportunities that present, but Tigris helps me with that.
And how do you sort of assess the risk when it comes to some of these companies? Naturally, if we go for the idea of a I biotech sort of firm, they are sort of the thing that's going quite big right now, but there is some level of weighted risks that we're seeing at the moment when it comes to the idea of in the middle of a pandemic, we have, you know, a lot of sort of tech companies trying to produce something that might help with the tracking and monitoring of, of, of a virus. But also we're seeing on the medical side of things, I'm trying to track vaccines. Have you found anything that has really paid to your interest at the moment in that sort of realm?
Yes. You've, we've got a resurgence of interest in biotech, which goes in cycles. So biotech is a pro cyclical style of stock. When the market's running hot, they tend to be the ones that run hotter. Okay. Now we're in an environment that's not really been hot, we've been in an environment which has been unique to coronavirus. Yes. So we've got an environment that isn't conducive to bio-techs naturally, but people are interested in them because they think they might catch the next 10 bag, 50 bags or a hundred bags. Now for those who don't know, a 10 bagger is just 10 times your money. Now the reality is that whenever I've sought to make a 10 bagger, I almost invariably haven't. And so one of the things that again, the mathematics of volatility allows us to do is make investments in these stocks, be in them at the time where the opportunity is right for making money and be out when it's not. So just as an example, not a recommendation me. So blast got down to $1 at the height of the pandemic, it's now in the mid $3 range. And so that's not a natural thing that would happen. It's quite artificial based on this race for the solution for coronavirus.
In terms of what you're trading with these days. Can you tell us a bit about how you, your day to day sort of trading might go? What sort of equipment are you using? What sort of software are you looking for and, or using as well? Is there any specifics that challenge how you might go about it? Sure.
If I keep it to the answer to just trading as opposed to [inaudible] cause they're quite separate.
Okay. I'm happy to hear both. Okay. I'm quite interested in hearing both. Okay.
So, so if I start with just my trading, there's not a lot that I need that once upon a time you really needed an Iris terminal. You really needed a lot of things that weren't able to be acquired on the internet right now I can achieve just about anything for free on the internet. And so for me, that's very straightforward. I use an online broker and I'm very aware of having a hin and making sure that I've got control over where those stocks are invested. But other than that, I'm really looking for someone who doesn't provide me. Advice just gives me the execution that I require. That's different. We have probably we have six servers that run a pretty heavy mathematical code and I've now employed my seventh programmer. So we're very, very heavy into the technological side of things at the reality. And the reality is to the client that doesn't matter, they get a simple buyer or a simple cell with a price range or a timing.
They're looking for that sort of simple side spoon-fed almost solution versus at your end, it's incredibly tech. So do you find a lot of challenges with having to run that sort of software when it comes to being able to sort of make some of the calls or the advice that you do give, is it still come down to, you know, the there's still obviously got to be a human element that's involved in it? Do you find that, that sometimes that data conflicts.
There's no day-to-day human involvement. The thing that we find is that the internet framework or the texting framework or the emailing frameworks sometimes just don't work, or our servers can decide that today or this morning's not a great time to be working. So there are those normal challenges. And just out of interest, this pandemic has actually caused us the most number of problems because things are not getting fixed quickly. So it's been quite challenging in that regard. When it comes to sort of the rules that you apply to your own trading, you know, do you have any principles or I suppose, rules that, that you sort of live live by, that you sort of use in your day-to-day trading or are there perhaps certain ones that might impact how you would consider looking for a potential investment or an opportunity?
That's a big question. If I think about the things that I'm attracted to, I'm very attracted to companies at a fundamental level initially. Yes. And if I can't understand it, I won't touch it. Right. So there's, that's a rule that I abide by secondarily, if it doesn't make money, I'm less inclined to be interested unless I see a massive opportunity. If I'm looking at the day to day, I'm looking at the volumes that are trading in the stock, I'm looking at the size of the stock, and I'm looking at the behavior of the way that trading actually occurs on the basis that I've been caught in the past with stocks that really don't trade very often. And as much as you might, we should to trade when you're trying to exit, or we should to try. And when you want to enter, it doesn't necessarily happen that way.
So I'm very sensitive to those things in terms of the way I work, I'm very much intuitive with the way I look at the markets when I've got a an opportunity to buy, I will monitor for five or 10 minutes, two or three times a day. And I get a feel or a sense for the market, and I'm sure you would as well. You can see I'm almost through what's going on. And so for me, I find that quite simple and straight forward for other people that don't believe they have it, you don't need it. It's just that it's something that gives me a little edge. I think the best way I can describe that same sort of feeling is that I sort of formulate a picture in my head of what a, an economy is or a businesses and who the competitors might be almost like a mind map, I suppose, of that situation. And unless I have that image where I can literally shut my eyes and go, that's what it looks like, then it becomes a case of, I don't know enough about what it might be that I'm considering looking at. So stick to, to what, you know, sort of principle can, seems to be a common theme that I'm finding with a large number of investors and keeping in mind with this, you know, sort of this picture in my own head. What, what, what's the picture on your head about the current market that we're seeing right now?
It's interesting. Look, Market has overreact. That's certainly true of equity markets. We knew that in the middle of March I wrote a note it's probably a little bit inappropriate, but the title of the note was the lunatics are out of the asylum because that's literally the way I felt in the middle of March. There was no rationality. We had a set of circumstances that weren't great. We didn't know enough, but we certainly didn't deserve to get down to 4,450 on the ASX 201 week later, I wrote another note, which was lunatics be gone because my logic at that time was we saw enough of what was going on in China to understand that this doesn't last forever, it'll play itself out. And if you can hold the line and hold your hope and start to build some resilience in your own decision-making that this will finish and then map yourself into the future and think, and this comes to your point of view.
Can you see in your own mind that coronavirus would finish and if it would win, and if, if, when, what would it look like? And what would it start to look like more broadly? And therefore, what would it look like for the economics of each country of each environment of each sub markets? So for me, I started to develop a lot of confidence in it, and that's why lunatics be gone, became the the title of the note. Now that was the 26th of March. Now that happened to be the bottom of the market. I'm not saying that for any other reason, other than my logic was we could see the other side. And I think that's so important because this, the seeing of the other side is the thing that makes the difference between, oh my God, where's the bottom. And, oh my goodness, I can now see that we're going to have a lead out of this.
So for me, I initially started to, at the way, the Chinese market was behaving a couple of weeks after that. And I noticed that they were no more than 10% down at the lowest point. And I looked at America and Australia and the way we were all behaving and the way we typically behave is that overreact. Yep. And then I made a comparison to China and I came up with a target of 6,450, I think about the middle of April, which probably sounded crazy. And maybe it was but I've recently upgraded that to 6,800 on the ASX 200 on the weekend. And that is because, and that's for February of 2021. So what I'm saying is that we're going to be 5% down by the end of 12 months of what it has been an extraordinary period. Now, I'm not saying it's going to be up every day.
It just can't be. In fact, I'd be very uncomfortable if it was up every day, I'm already starting to feel uncomfortable with the number of positive days that we're experiencing at the moment. But just as when every day is a negative, you know, that we're one step closer to a turn every day that it's positive where we're one step closer to a turn. Now that just means that we've got more volatility and more uncertainty. And we've got lots of events to look at for that. Not only we've got the U S election we've got the potential reigniting of the trade wars with China and America, China and Australia. We've got skirmishes on the Himalayan borders between China and India. I firmly believe we're going to end in trade war between China and India as well. There's so many geopolitical events that are sitting out there when it comes to trading in general and how your thoughts are about, you know, general investing and whatever it was if you had a time machine and you could go way back to when you first started and you could go to yourself and grab yourself by the Scruff of the neck and shake yourself and say, Hey, you should do this, not this. What would that piece of advice be?
Again, a probing question. I think it actually comes back to behavioral biases. And by that, I mean, one of the things that you have to be is a bit counter to most things that are going on. And therefore, if we took the oil market, for instance, as, as an example when oil was down at about 11, $12, I filled my boots with oil stocks when people were afraid of oil. And that was, that was only something that I could do because of the experience I had to this point that I could look at it and say to myself, okay this is the situation we're in and really think it through and think about the planes and trains and automobiles that we're not using at the, that we will use in the future. And therefore the oversupply of oil relative to what will be normal supply of oil relative to a demand profile.
So therefore when I say bean counter, that's what I mean to be able to have a view, to stake a flag in the ground and say, well, this is my view, and these are my reasons, and this is why I'm now very comfortable to choose that stock and trade them as you go. So that would be probably the first one. And I think another one, again, behaviorally biased is instead of being affected by the crowd and the crowd. And if I took you to an example that tech rec or pre free the tech wreck was the tech bubble. But through that period, I read literally hundreds of prospectuses and hundreds of business models and went through literally hundreds of businesses that were in that market. Yeah. And this is probably where my avoidance or my lack of interest in stocks that don't make money comes from because the number of strategies and business models that I come to understand through that period was just incredible. But as a fund manager to stand against that part of the market, that was absolutely going, gangbusters took real guts and real tolerance, and it probably lasted two years and those things grind you down. But I would also tell myself, stick to what, you know, stick to what you believe, choose the correct companies and make sure you you actually stay true to yourself and true to your own investing nature rather than get caught up in the herd mentality, which says, wow, it's going off, which I suppose is what we're seeing right now when it comes to, you know, the pushing up a price across equities across the board. And when we're seeing, you know, nearly 30 times in some instances or some days of daily trading volume. So yes, there is a little bit of herd mentality going on and a little bit of self-fulfilling prophecies. Now I have a question I like to sort of ask everyone who comes on the show and it's really got to do with how you would invest $10,000, a hundred thousand dollars and a million dollars if that's all you had. And if there are any differences between how you would invest that. So I suppose the is one to start with of the $10,000. What would you do with $10,000? Would it be a trip to Vegas or would it be a, would there be a, something a little bit more on the profile there for it to be an investment?
It's probably sounds unusual, but for a guy who makes recommendations and trades for a living, I think I've been to a casino once and I've probably put down a sum total of $50. And that was my experience. And I really don't have an interest. If I had $10,000 is interesting because my youngest daughter is now 18 and she came to me in the last half a year and said I would like to understand more of the stock market. And so we agreed, we'd put in some money together and we would do exactly this, this $10,000 problem. Now given her interests, we really did go to a biotech and we made a little bit of money, but again, remember we were going to try and make double our money. And after a while we made a little bit of money and I said to her, look, this is not working for me.
And she said, well, it's not working for me either. So what we actually did was we cut it into four and we waited for a little while and then the pandemic was on us. And so when that started, we just did some simple things. And like, when I said to you, you don't have to take small company risk. You can still make good money. So I tell you what we bought. We bought some Rio and we bought some Woodside and beach, petroleum and Santos, and we took one giant bet on the oil market. Now it still wasn't diversified. It was, it was very, very commodity driven and it was very oil driven. So we still took extra risk, but the reality is two months later, we've made 50% return. And so and there's one other we had in there, which was Afterpay, which we bought it just after the turn at about 1350 and sold it at $40. So we did pretty well. Yeah. I've been enjoying after pains, carry myself for a while now, but I kind of look at it and think, eh, I've got to wait until the next thing, but now zip codes are apparently they're going to be looking to do a push into the U S now as well. So that might see some good things for them to come yet big markets with no money. Absolutely. That's the concern that I have for a lot of them at the moment. Now, the next one is obviously a hundred K. So in the 10 K question you were looking at sort of a little bit, probably higher risk to try and get as much return as possible. We're talking about doubling our money in a very short period of time with a hundred K it's a much, it's a much larger sum. So would that risk profile change, or would you still be looking at doing the same thing? Would it be much greater diversification? What do you think would change?
Sure. The reason why it was so focused with such a little amount of money. So, and that's, that's a logical thing to do. In a hundred grand, the example, what I would do is then broaden the breadth. And so I would I would actually add other sectors. I still wouldn't make investments in stocks that I didn't believe in, for instance, I'm not a believer in banks. At the moment I've, I think moral suasion is actually from the government is going to lead to a bad debt position, which I don't want to have to fund. So I wouldn't go to the banks, but I would broaden investment horizon. Some renovators some of the construction style of companies rather than the house builders and actually build the portfolio out from a diversification point of view rather than keep that concentration, but just magnify the beds.
And I know you're going to ask me the next question, which is what if it was a million and that would just expand your diversification from there. I've run portfolios that one and a half billion and sometimes 10 billion. It, once you magnify the numbers to a certain scale, you're not looking at the numbers, you're looking at the percentages. So one of the rules of thumb for me in my own portfolio that I run my Superfund is anything greater than 25% as a single bet is highly unusual and is only for a very specific set of reasons and for a very specific time. So as an example, Rio, I took quite a large bet in when it was down in that low 80 and high 70 in the same sort of period in through the pandemic. I really went hard on that, but I try to keep stocks at about a 10% position and I'll have the occasional bit well where it'll be one or 2%. And to me that's a, well, if it doubles, I'm happy if it halves, it's not going to hurt me too much. Yeah. Yeah. Okay.
So it is a case of you diversify yourself very differently across the broad, and you increase the amount of sectors that you're going to be looking at, and you might change within those. So would you do the same in the 10,000 you'd post, you basically stuck with one sector, but then split it across four or five entities, same sort of thing applies for each thing, if it was going to be, you know, if it was in the million dollar case, it'd be a hundred grand split across four or five in one sector and then keep going that way. So if you're in multiples or would you then look at perhaps looking at, you know, putting some into property and then some into something else or into ETFs or whatever it may be. So if I just answer your direct question, the a hundred thousand, I would have say 10 or 12 stocks, and if it was a million, I would probably only have 15 to 18 because I think you start to get a firstly, there aren't that many viable companies and I'm because I'm trading them, I'm not always owning the same company through that period of time. So I will change depending on the outlook of the individual.
And, and of course there's also that sort of rule of thumb that anything over sort of between 20 and 30 stocks, you don't really balance out your beta risk anymore than if you had a hundred stocks. Yeah. That, that, that risk still applies the same. Once you get that low, you have diversified so much already that it's not going to get reduced that risk anymore. So that's, and you've got an amount of work that comes with owning a stock, owning 10 stocks and owning 20 stocks. And I've always found again, sort of rule of thumb for me is once you get north of 20, you're actually creating a lot of work for them.
Absolutely. And if you're not keeping up to date with it, you're not in the know and you can't have that picture in your head. So when a strategy does change for you in terms of these sort of things, would there be like when it comes to sort of, you know, the 10 K the a hundred K the $1 million question, what would change your strategy ultimately into something completely different? And do you think it would be different because of the current environment now, like what you're doing today with the pandemic sort of situation and what you're investing in now, is that entirely different to what it was 12 months ago?
Okay. Yes, it is. At the time of the real striking of the pandemic. And I'm talking about through March, I took a lot of time to deeply think about the stocks that I wanted to be in and the sectors that I've wanted to be in and didn't want to be in. I've never been afraid of holding cash. And to me, cash is an equally valid investment by compare it, but comparing it to anything else, if it's in cash and it's in the bank, I know where it is, and I know it's safe. And I know it's just there, unless you're in Greece, in which case get a mattress unless it's there waiting for the opportunity to arise and I've genuinely run portfolios for people where I've had 90% cash. Yeah. And, and I've also had clients ringing me when I was running those portfolios on a Sunday morning saying how much cash have we got because you can, you believe this market. So people who understand the style of investing are very, very happy to be working their way into the market when things are tough. Yeah. Now, therefore, all of that deep thinking led me to a number of different areas that I definitely didn't want to be in. And it led me into areas that I hadn't really considered all that carefully. So I'll give you one car sales was one that I looked at and I thought, you know, effective monopoly has been a very expensive stock. It's traded very well with Pythagoras.
It's done incredibly well. And for us, I've looked at it and thought got from $19 to 12. And so during the pandemic it showed us an opportunity. And I thought to myself where I can write a new cars aren't going to be bought because people haven't got the jobs, but second hand cars will. And when you look at the way that businesses behaved and the movement of eyeballs as behaved, the second hand car market is actually very, very resilient. Now, if I'd looked at it at that 12 months ago, I wouldn't have looked at with that knowledge and understanding, and I was a little bit attracted, but always thought it was just that little bit too expensive when it got to $12, it was actually showing me more of what it was. And it was giving me the opportunity and having done that little bit of work it's actually turned into, you know, a 35% return in not a lot of time. So yes, I did look at things differently and I did things differently. And I looked for all of those qualities that I thought that would be required to see out the pandemic. And then once I'd chosen those stocks, I used Pythagoras to try them.
Okay. So there is obviously difference between what's then, and what's now, but in terms of something a little bit off topic here what's the most recent book or TV show that you've really enjoyed because I know not everyone can always live and breathe the markets nonstop. So, you know, people need to know that we do watch TV or the other than CNBC or, or anything along those lines, a addictive this industry. And, and it can actually consume you far more than what most people would realize, but very easy to run into burnout. Yeah. But if you love it, it's less of a problem. Yeah. And but when you're tired, you're tired. And so for me, I've been watching Ozark or Ozarka.
Over years, so you're still watching a finance-related show. I don't know if that counts, but we'll let it slide. I did enjoy it. I'm still enjoying it, but I suppose we're all looking for entertainment that just gives us that little bit of time off when it comes to the entertainment side of stocks, do you like things like Netflix and Stan and any of those sort of publicly listed ones, or I suppose Amazon can be looked at from Amazon prime to perspective.
Look, I I invest only in the Aussie market. I acknowledge that there are opportunities therefore, that we miss out on. But if I take the concept to its root and that is, do I like media and, and entertainment? The answer is yes. Okay. And the answer is yes, because they're economically sensitive and therefore they have an inherent volatility. And when they've got volatility, one thing I know is you can make money out of them rather than being dead pan and boring.
We'll come back to the volatility in just a few moments. What's a, have you got any sort of trading books that you would recommend to someone that might be looking to get into trading for the first time? Or is there a book that's your favorite that might've been about investing in performance ratios or whatever it may be. It could have even been an accounting book that gave you a lot of interest in helped you along your way. That's made a difference towards where you are today. Sure.
The short answer is no, not really. I, what I did, which was probably the most beneficial thing was even though I, I didn't enjoy my study. It actually helped me enormously because when I read financial accounts, it sounds lame, but the numbers actually sing to me. I can actually, they mean something to me where so many people read financial accounts and, and they don't mean anything. So, so that's a wonderful thing and that's a wonderful discipline and I wouldn't ever change it, even though I never really got to use it in a professional sense. I think the biggest, most beneficial thing I did was that I got right into strategy and company strategy, how it worked, why it worked and what you needed to have a strong, sustainable, competitive advantage, and even things as simple as Michael Porter's five forces, which has probably a bit of off topic.
Yeah. Well, not really. I actually know the book. Now it's meant to have been debunked, but to me that doesn't matter because it leads you so many different places. And so I did a four day intensive at one of the universities and thoroughly enjoyed it. And I found that, just thinking about those things made, investing that much simpler than it. Wasn't funny.
Well, it's funny you mentioned it because like, I actually do, I suppose, I mean, I've, I've used five forces before from, you know, Byron university education at different times, and there's obviously been the talk about, you know, there's also seven forces and then sometimes it's three or four, whatever. It may be the variety of different ones you can look at, but the principle foundations that I've always used or take or adopted from the sort of five forces ideology is to really how you think about an economy and how it works. And sometimes how a particular business works as well. And it sort of goes towards building that picture inside my own head. So I've always tried to sort of explain that to some of the other people who always ask me questions or some of the students have sort of these variety of different things, but I've always found that. Interesting. What do you think is your best trade you've ever had? Hmm.
Okay. I think probably Wally Parsons and there's two sides to this. I had it at the float and I bought it continuously from $1 70. I think the float was yep. And I owned it right the way to $50 and the GFC struck. And it was a most wonderful position. But your next question I'm sure would be wonderful worst it's in the same trade. It's the same trade.
I had the same experience. Mine was Lockheed Martin corporation. And it was, you know, based off sort of looking at military technology things. And it was the best side of it ahead because that's probably the single most profitable position I've had in my early days, but it was the worst trade I've had because I got out way too early thinking like, oh, I'm a bit excited here. You know, this is going back 10 years ago.
Well, It's slightly different in that. I had, I had left the stable working environment and started my own business in 2008. And so as the GFC happened, I was pretty happy sitting on a, on a nest egg of a number of different stocks, including Wally. And so from $50, it went to eight and that hurt a lot. And I kept it through the whole thing because probably I'm a little bit inept in my thinking as to the recovery. But at the end of the day, I it turned into what was the worst trade I'd ever made because I really should've sold a lot of times on the way down even on the way up.
It's funny how it's almost everyone ask that when it's the best and the worst, it's almost always, this was the best because I did all the analysis. It was right. And then some sort of understanding or some change or whatever it may be happened, which dictates it to end up also being the worst. It's quite funny how often that happens.
And the thing is you can easily fall in love with the stock. Yeah. And one of the disciplines that I don't believe in anymore is bottom drawer investing. And that was one of the things that for me changed my thinking and changed my outlook because at the time of the GFC, it was very, very common that people would say, I'll buy it for the bottom drawer and obviously just forget about it. And one day you'd retire and it'd be worth a fortune yeah. That no longer could be the case. And, and the reason is the GFC really showed us how internationalized business really was. And if you think just for a minute and I, and I know you would have been there and looking at it at this time, but it astounded me, the fact that one insurance company in America could actually bring down the entire network of insurance companies, the world over.
And if you just think about that for a minute, even if that doesn't mean a lot to you, but just think about that for a minute. There were ships sitting in ports that couldn't get insurance so that they could leave the port to deliver the goods through no fault of the owner of the goods or the shipping company, or even the captain of that ship. So the, the, the, the internationalization, the geopolitical, the effects that can actually occur as a result of these massive indebted changes were just so colossal and persist that I don't believe that you can bottom door investors.
So I suppose in some respect what we're seeing now with the pandemic and that globalization of economies and how they all integrate with one another, including, you know, the supply chain element of things, it's almost like completely different catalysts that has started the problem, but we're running into similar issues now where now, instead of, instead of it being that the boat can't leave Harbour is that the boat can't actually get into the hub because no, one's going to let him in now, but again, it's run into the same sort of consumer level issue. And the underlying causes of it are always seem to be different in every recession we go through, regardless of what it might be. Now, we've sort of gone through a couple of different things about how you invest in and what you do. So now I'd like to sort of move our our topic choices towards more about what Pythagoras investing does with volatility and what you do for volatility. So for the first thing is for our listeners and viewers today, what do, what, what is volatility? Sure.
The, the colloquial definition of volatility is really related to change how much change there is. And we use that in our normal everyday language. Yep. It's not what I do. And it's not what I mean when I talk about volatility. But it's important to understand because price change is meaningful for some reasons, but not a lot. Now it seems appropriate. You talk that we talk about volatility and Vicks. Now CVOE, you would know the VIX volatility, it's horribly technical. I don't really want to go into the mechanics of it, but I tried to replicate that in the Australian market. And one of the things that I realized during the time of the GFC was it's a wonderful implement or wonderful tool that tells us what was it tells us nothing of what is about to happen. I saw it as a reactionary device and doesn't actually help you sort of do the forecasting that's wrong element.
So in the GFC VIX was 12, 12%. It jumped very quickly to 30 then to 60 and 90. And if memory serves, I think it peaked at 110. Now at any point, if I could have drawn meaning from the fact that from 110, it was going to go to 90 and then 80, I could have actually done something because the one thing that I know about volatility is if it's reducing, that means uncertainty is reducing. If uncertainty is reducing, then prices are naturally levitating. So that experience with the VIX and the disappointment of the weeks actually led me more to trying to construct what would be a predictive piece of information rather than a reactive piece of information. Okay.
So, what sort of information do do you sort of look to get out of volatility via this predictive nature?
So if I just expand a little bit more, we create volatility in our proprietary way on every stock that we look at, and there are hundreds of them and we measure and track and interpret the changes that occur over time for each of those stocks. Now I stopped might go 50 or 60 days of rising volatility and that meaning, and we can use the, the understanding of that meaning to trade the stock along the way. But if you can think of a most basic definition of volatility and the way we would use it, we could look at this chart. Then what we see here is that with a volatility that changes from falling to increasing.
The one thing that we know is volatility increasing means uncertainty, rising uncertainty, rising means that share prices will begin to fall. Yep. Now, most people can understand that as a concept yes. For rigorous investing. That is our most basic decision. And from there, there are about 130,000 lines of code that go into looking at a mathematical preconditions as to what should occur as a result of these style of trades that occur. So what it means, and this is quite important is that change in volatility, precedes a change in price. Now that's the complete opposite to what is understood more broadly
And especially it's complete opposite to what you would see in on the absolutely because the VIX is not giving you any forward understanding as to what's coming. So in a simple way, what we're doing is taking that change. And we can look at that change there and using that to make our prediction of the share price behavior. And then what we do is we buy or sell in this case ahead of it. So that's quite simply how it works when you sort of get that information to sort of determine, know whether you're going to buy or sell ahead. I suppose that's sort of a level of a trading decision. Is there more that goes into it that outside of, you know, the volatility side of things as well, do you have the sort of fundamental sort of look at these stocks? Do you have more data that you assess or analyze.
Believe it or not, it's all in the price, literally all in the price. And there's a, there's a famous theoretician that believed that and we've proven it to be true. Now, that's not to say that we don't actually look at any fundamentals when choosing stocks, because people want to be choosing the best stock they possibly can. And so in discussions, people would tell me of their interests and preferences and why they liked certain stocks. And in those discussions, the, the names that they want to subscribe to come out of it that way. So there's, there's a fundamental overlay in choosing it a little bit of that
Spoon-fed sort of side that a lot of people want to hear, but the reality of the situation is, you know, how they actually do it is more important to what should be more important to them than they realize.
And so once, once they've chosen their stocks, we supply them with the recommendations. Now that might be in the order of 30 to 40 buys or sells over the course of the year, it's very seldom buy and then sell it's more often than not buy three, four or five times and phase themself or diversify themselves into a stock before the sell comes.
So, Michael, what are some of the key metrics that you would look for in a given scenario? Can you give us a bit of an example about perhaps a try that you've conducted recently or anything like that? Sure.
This chart is actually an interesting example. So this is a two milk in March and April of 2020. And so this is just demonstrating how we work. So remember, we're actually taking volatility, the changes in volatility, and we're working with the share price behavior to buy and sell. So that first orange blob there at 1665 is a cell. And that coincides in actual fact with the OPEC meeting. When I look back in time, of course I didn't didn't really know of this at the time. So the OPEC meeting was actually a thing of real substance because for the first time, since 1960, the Saudi Arabians actually went up back on their cartel. And that actually caused quite a lot of difficulties. And the ramifications around the world were quite enormous. And stock markets started this slide, as we know.
So then negative oil prices that came in with it, absolutely negative oil prices. In hindsight, I suppose we're really looking at that sort of factor. I mean, your, your voltage index has gotten a riot and you've sort of managed to use it in this way, but, but how does the, you know, oil
Prices affect milk?
Yeah, I see what you're saying. So the, the reality is every shoe share price around the world failed to perform through this period. Yeah. And so the events can be small or they can be big. Now these price events, if it's a managing director resigning or a senior official absconding with money, of course, we all know what the answer is, but there's a lot that's hidden in price. That's disclosed through the use of these volatility indices. Now this one was telling us that the share price was about to fall. There's nothing particularly specific about eight to melt through this period, but it was the right time to sell. As you can see now from 1665, the system then turn around after the price had fallen one and $2 and started to accumulate again. Now these are what I call the little smiles that are going on in the stock market.
All of the time I called them that not only because of the shape, because they make me smile because I know they're a formula for making money for our clients. Now this particular example, the share price got down a dollar and the system started to buy again. And then it got down almost $2. And it four times within the coming few weeks, the market had dropped 18% and our clients get to pocket a return on those each on average of 9.2%. So the opportunity was there and, and available for many to take advantage of. So now it doesn't stop there. Not long afterwards at the start of April, you can see there's another set of buyers. And again, just by coincidence, there's another four. Now those buyers are done at similar prices. There's no small air other than I still smile because a formula for making money, but non not long afterwards, the price is up another $2. And so therefore you're predicting the volatility is predicting forward all of the time, the activity in the share price. And then it's giving you an opportunity to sort of bank some cash and then re-invest as it goes along as well. So it sounds like it's something that's absolutely fantastic for some, some different types of investors out there that certainly be interested in it. Now, this is, it's also interesting to sort of see that this has all occurred in a period of time where volatility levels were likely in some of the highest we've seen in a very long time, especially around, you know, we've had the oil price is going negative. We've had stock, market's not handling things very well and that over reactionary sort of nature has occurred. So what's, what do you think has really sort of, has, has that improved the situation for the way that you look at volatility, the higher, the volatility, the better it is on, on your site? Or is it more of a case of, you know, if you go back say 12 months ago where volatility wasn't quite so extreme was the conditions better or suit into how you look at volatility better than if I just backtrack for a minute, it's the change in volatility that Ford forecasts the opportunity. So it doesn't matter whether it's 20%, 40% or 70%, it's what comes next.
Therefore, then the idea of tracking an actual VIX index adds no way to what, how you operate. So
From our point of view, it's what comes next. Therefore, you might find that the returns are magnified because the extremes of human behavior have actually found their way into the stock market. So you're getting the greater opportunities, the deeper discounts and giving yourself the better opportunity to make bigger returns. But yeah, so it's relevant. It's just different.
What would you give, what sort of advice would you give someone today who might be looking to invest? So let's, let's take your daughter for example, because you were saying that she was recently getting to investing and was asking you questions. What was some of the advice that you may have given her? What would be the primary thing that you think would be if you're looking to invest, this is what you should look at or, or should at least understand in terms of choosing a stock or the actual trading?
I think just investing in general. So if someone was interested in getting into investing of what market it was, what would be the core thing that they need to go and research, they need to understand. Yeah,
I think it goes back to that. The question of what would, what advice would you give yourself, but choose a stock. That's in a sector that's in an upswing whether that's because of its strategic, competitive advantage, or whether it's in an area that's going to be improving in times to come, but make sure you've chosen a stock that's as solid and well understood by you as you can. And then the logic is you don't need to own it a hundred percent of the time. No, this chart shows you that you don't need to wear the risk. And, and in fact, if you look at the 1665 sell, the reality is you would have looked at that and gone, wow, that's a fantastic time to assault. Absolutely. But what knuckle time, which is what I call those options, Right? You know what I'm hanging on, hanging on to your seat as tight
As possible. So as a client, I'm sure there were several clients who were sitting there saying, why should I buy now? But look at the results. So from my point of view, I think there are, you don't need to be invested all of the time. You don't need to take big, risky swings at stocks that you don't understand, or you you're doing it because you're going to try and make a 10 times your money. That the reality is if you make a few 9%, a few, 4% lose 1% over the course of a year, you can actually a massive return. That's actually sufficient to make you very, very happy, but not take the same risk as what everybody else has. It's a little bit case of stick to what you know is sort of the repeating element that I sort of hear amongst them.
Yup. Because those price cycles, if you go now and look at a chart as, and I'm sure you would have already done it, but others who are listening, go and look at a chart and just see how often these little substructures are there. They're giving you the opportunity for your retirement. And that's the bit that I love about it. All right. Well, in terms of the most significant opportunities or challenges that you think the industry is really facing from your perspective, what do you see as being the next sort of one to three years?
If I, if I take it from the perspective of the funds management industry, yeah. I think fee pressure is, is now accelerating. And what that means is that people don't have the capital to be able to reinvest in what is fundamental research. Yeah. And the problem with fundamental research as we talked about earlier, was that if everyone knows the right answer at the right time, and you're all reacting, then returns are hard to come by. And it's no wonder these poor fund managers are actually having so much difficulty outperforming a stock market. Yes. It's kind of that idea of, mass education of one thing leads to the mass population doing that same thing.
And then when they're all the same thing, no one can get it done and you all just end up being disappointed. So if you've got fee pressure, you've got less, less travel expenditure, less ability to fundamentally research at the same time. The information is not all that valuable to you because everyone knows it at the same time. So you've got actually quite a quandary of over the next few years as to how this industry really develops now, out of nowhere, it seems, but really out of decades, passive investing has happened and passive investing is just buying an index or a replication of, of an index. And that being your main form of investing. So going into something like S and P or the ASX directly,
Yes. Could even choose a sub index, an it index or a banking, whatever it is that really takes your fancy. Yeah. And what that's saying is fund managers can add value. And therefore what we'd rather do is pay very small fees. And with those fees, we'll enjoy that as a part of our return, if you will, which I suppose to a certain degree, it's why, you know, when it comes to performance structures and how much money, you know, you would expect as a fund manager to be generating for you in return, they're always aiming to beat the most leading index that there is at the current time.
And that's what they're tasked to do by and large. But the problem is that by everything going to passive investing, firstly, passive investing is only as smart as the benchmark and the benchmark is a momentum based thing. And it's a success based thing. And if you look at our index, for instance, the ASX 200 I think CSL there's 13% of the index resources are 18%, roughly banks are 25%. Now, again, with my view of banks, why would I want to allocate 25% of my money to a sector that's going to struggle with bad debts. So by trying to be cheap with our solutions, by being disenfranchised with active managers and the fees that they charge, we're kind of throwing the baby out with the bath water. Yeah. And the reality is there are some incredibly talented people who can add value as active managers, and they're the sort of people you want to pay and you want to pay them well, because if they do well you're going to do well, but these are the paradigms that are playing out within the industry. And there's no very simple answer. And now we're seeing the future fund becoming what is now an Uber long-term investor, ignoring stock markets, ignoring benchmarks, and actually just looking for CPI plus or something similar. So there are a myriad of different problems that are on the horizon.
And naturally we are also getting sort of companies these days that don't necessarily generate profitable revenue, such as like Uber, which obviously puts a big challenge in there that, you know, you've got stock prices going up, but no real performance backing, at least in the numbers side of that, that indicates why it should be. It seems to be more hype driven than it does to be. And the reality is with a stock like that, if you can't prove through a set of modelling that they will be profitability and that there will be a reason to justify the price you've got a problem on your hands. Absolutely. Let that be somebody else's problem, not yours.
So everyone who watching this video do the research now. Thank you very much for joining us today. Michael I've thoroughly enjoyed. We look forward to sort of seeing what your expectations might be in the near future. Perhaps in, we'll get back together maybe six to 12 months and see if your what the challenges are that you're facing. Then a very different to now and have a little bit of a chat there and see how it's all sort of progressing along. And of course, I hope you've enjoyed today's video from ACY Securities, and we look forward to you seeing another one in the near future. Have a great trading day ahead.
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