[REPLAY] Deep Basin Earning Alpha in Energy - [Invest Like the Best, EP.81]


This week we are excited to re-release episode eighty-one Patrick's conversation with deep basin capital. Oh hello and welcome everyone. I'm Patrick o'shaughnessy and this is invest like the best. This show is an open ended exploration of markets ideas methods stories stories end up strategies that will help you better invest both your time and your money you can learn more and stay up to date and investor field guide dot com. Tom Patrick o'shaughnessy is the CEO of o'shaughnessy asset management. All opinions expressed by Patrick and podcast guests are solely their own opinions and do not reflect the opinion of o'shaughnessy asset management. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions clients Kashani Asset Management May maintain positions and the securities discussed in this podcast. I guess this week are Matt Smith and Ian Singer of deep basin capital a hedge fund specializing in the energy sector. I I met that almost ten years ago and in that time I've grown to respect him as much as any investor that I've ever met now having spent time with Ian who specializes in oil and gas exploration companies and the rest of the deep basin team. I have similar respect and admiration for all of them. Debase does almost is the exact opposite of what us wants to in fact their entire goal is to build a portfolio of mostly idiosyncratic or stock specific risk the very thing OSC wants mostly removed from portfolios portfolio's deep basin positions the portfolio to make a series of carefully constructed bats long and short without taking market risk style factor risk or even commodity risk. They use a hybrid fundamental and quantitative process which we explore in detail. This is definitely another good example of who we are all against in public markets. What makes this story store. Unique is that we are investors deep basins management company and so have a clear interest in their ongoing success listeners know that I want to be as transparent as possible on this podcast cast so even spend a little time telling the story about how it all came together a few years ago I have learned a ton about investing for my countless hours with this team and hope that this conversation tation gives you a glimpse into what is happening at the cutting edge of investing in the world of hedge funds. Please enjoy this conversation so as you think about the energy space specifically talk about the features of the universe that you're starting with me define what that is. How many companies is it and what makes makes that an interesting playground. If you will for assessing long short opportunities if you think about as an analyst what you strive to do is find a place place where you can add value where you can do something that is repeatable. You can do something that is differentiated and where you can find yourself in a more repeatedly on the right side of an investment than on the wrong side until the odds in your favor having spent some time in media and telecom and and then industrials materials and then for eight or nine years energy I've just found that not only was his sector where I'm passionate about all of the intricacies of the business business and the complexities of the global energy chain but it happens to be a sector where the complexity scares people and if you dig in and you construct a portfolio to remove some of that complexity what's leftover can be very long term structural idiosyncratic investments on the long side and short investments in structural advantage businesses on the long side and structured disadvantaged businesses and you can do it and we certainly certainly try to here in a way that's free and clear of oil and gas prices free and clear of interest rates and part of our education pseudo was building a hi idiosyncratic risk portfolio. You know read the buffet letter when it came out and you know he I think he still spent some time on Alpha and Beta and I would I would I'd say I care a lot about the attribution and the nature of the returns are processed that my process is an analyst generated an energy like no the second. I've been a part of understanding these businesses at a very atomic level allows you to build informed views and very low variance models models of what the future prospects for the business look like and that allows us to have insights that we think are valuable and and Alpha for generating and the Beta piece is the removal of all those things like oil gas interest rates systematic risk in many cases we purposely to try to get rid of staff accuracy portfolio at what's left are these repeatable we think asset driven insights of his businesses and unlike any other sector we've seventy seventy businesses that make the same product and upstream in the US liquid Canada another fifteen you can build a very elegant portfolio and really isolate specific nuances that you're trying to achieve in a portfolio and we can stay energy investments far longer than most investors can because we can take out lots of the bad things that can happen the energy sector her for me but one of the interesting things about energy as an investment space is that everything is always changing all the time and there's lots of places where that's true but the assets change under these companies over the matter of you know three months maybe six months technology changes changes every sector and that's true energy unlike other sectors a lot of the data that shows how and why those things are changing are available and to the extent that you can stitch that data across a lot of different sources together into into a coherent sort of analytical space you can really get it deep understanding for how and why those assets are changing and what the prospects x for each of your companies are and just like any other sector where data work is being done. It's easy to draw lots of different conclusions from similar sets of data data and so part of what we do is paint that coherent picture across a lot of inputs and continually calibrate those inputs put into what companies are talking about and that calibration effort takes a lot of time a lot of focus. A lot of systematic sort of pieces is in place to capture all of those things and the result is you continue to have a more informed better dialed in version of what the company's prospects are and that allows you to be on the right side of how those stocks move a lot more times than not and the ability to integrate a lot of disciplines together to give a really robust picture of what each of those narratives jobs are but ultimately informed by what the ground level data pieces are painting is a unique thing to energy and we've spent a lot of time putting all those pieces together and throw in with the energy sector volatility looks like on top of that and you have a pretty robust space for Alpha generation or one of the things that's fascinated me. Just talking to Matt over many years is like you said that global complexity of this especially where you've got one player that's incredibly opaque hake you may not necessarily know what's happening in the region and has a huge impact on commodity prices etc at the risk of getting overly simplistic but I just think it's useful since we're GONNA talk about out how to attack a sector from an constructed portfolio around a sector. Maybe we could just spend a few minutes on what the parts of the ecosystem are so I don't WanNa take for granted that people yeah no the key differences between upstream midstream downstream service companies etc so leave it to you to decide what those categories are but maybe just a couple minutes on the taxonomy Zannini of the space just so that if we use these terms later on in the conversation we'll have sort of a record of what the map looks like the chain really is dominated by in terms of market capitalisation but also in terms of whether economic rent lies upstream wound gas producers they go out and explore for acquire oil and gas resources in the ground and they hire services companies like slumber J. Halliburton etc to exploit those services companies are there for many service companies and they've largely bit like debase in become more focused on leveraging technology than traditional service companies that were just iron and if slumber I'm Jay in that regard is certainly about as much technology leader as there is from services were you. They help you exploit the rock and produce oil and gas molecules. Midstream stream companies are next the natural gas needs to flow through pipelines much of it has to flow through processing plants that separate the methane which is the actual natural gas stream from ethylene propane butane isobutane natural gas liquids many of which go into different processes like chemical raw materials or refining process and so there are multiple layers of separation with processing and these gas molecules flow through pipelines into power plants home home heating needs your stoves and they flow into industrial plants etc will can really move via truck train or pipeline and and once they get to the market. Obviously they're going to refineries. It's going on ships tankers. It's being used for ultimately converting gasoline distillate jet fuel asphalt etcetera era so upstream services midstream downstream which includes refining chemicals that all the way through the power plants where gas powered turbines in Tilles these were whether it's our local distribution company that delivers gas to you or whether it's utility the delivers electricity to you all of it starts with really natural gas coal nuclear clear etc eventually love tearing apart businesses kind of the engineering idea the stats background technical background etc as you think about energy the businesses themselves what what is unique or interesting about them. We've joked that it's like maybe structurally some of the worst businesses in the world. Maybe describe why that's the case and any other relevant features that make energy companies distinct distinct from the broader market all of the traditional investment principles I came up learning you know sustainable competitive advantage fi forces the importance of management's management's ability to build a team process and allocate capital to the resources to generate earnings free cash flow dividends returns of capital etc if you look GATT the upstream business and it's changing a little bit but if you look at the upstream business largely they're awful businesses they are depleting assets price takers none of the US MP's for instance set the prices for their products period and that will never change they really control how they allocate capital two exporting rock they control the frequency or cadence in which they drill wells intern wells into cash cashflow ultimate recycling the ground but these businesses are not ever going to be anything but depleting deep cyclicals and they have to be treated as such as be treated treated with great care. I think we could go on and on about why somebody would land an upstream company the fifth turn of leverage on the underlying Ebitda when it's very hard to move forward ten years cover the debt unless they go out and acquire finding resource which currently can't underwrite when you lend the money ten years. There's interesting conversation we had about the high yield markets were energy but the important takeaway though is long only setting or credit setting or private equity setting and we certainly have great respect for lots of smart investors in space but we try to do specifically is in a hiatus credit risk or Beta neutral portfolio. Were you care about the oil risk and the natural gas risk that your portfolio polio exhibits and in this case we purposely try to make sure it's roughly zero you can actually get rid of a lot of the bad stuff about these businesses and and what's leftover are some very interesting value creation companies kissing more about that idea of isolating unique value creation post neutralization of commodity oddity risk. Just curious like what exactly I may overuse this. We've been on the road a bit here recently seen company so not as of late but if you think about out modeling financial institutions and as long as you have good command of their assets and liabilities you can generally have a good understanding of their sensitivity to a given change in treasury curve to their cost capital and understand how that impacts earnings and in the context of portfolio if you do that enough times with financial institutions institutions you can actually build a portfolio of national institutions where you can really tweak your exposure to treasury curve building a portfolio of energy businesses. This is very similar particularly with upstream fairly upstream heavy with what we're doing so far. Each of these businesses has a fundamental sensitivity which we call elasticity the city like a complexity measure to a given change in oil prices or natural gas prices and that is to say at sixty dollars crude. Yuji resources generates rates a couple of billion dollars of free cash flow with that it can reinvest in the ground and generate future wells producing grow production and ultimately they can return cash to shareholders but that there's a measurement. There's an objective measurement modeling exercise that you can do and understand the value in Nashville these businesses at the Strip using using the prevailing oil and gas deck. You can sensitize that which we do for every one of the business models to understand exactly how value changes for a given change in cruel gas prices similar to the idea of understanding financial institution sensitivity interest rates and if you care enough to take the added step after you you find investments that you like on the alongside and investments that you like on the short side with very little tweaking you can actually achieve portfolio where if as a shock and oil or shocking gas you can be fairly agnostic to it and that seems to be increasingly to us a value added way of isolating the company specific if investments that we're trying to make in. I know you spend have spent a ton of time. Upstream specifically a curious for your take on that part of the ecosystem and sort of the levers that you you think that one most interest you what why are you fascinated by these businesses and two from an investment perspective the sorts of things that you like to spend your time on so as you you mentioned his constantly awesomely changing which is probably a good thing right like if you're in a competitive landscape you want it to constantly change because then your skill can shine so. I'm curious how how you think about it. The things that you think are most important to focus on an as we think about Alpha Alpha always requires the broad market has got it wrong so maybe structural ways or or structural mistakes that markets tend to make specifically in that space at a core level. What is interesting along. The lines of assets are changing all the time in companies are changing the way they do things all the time and I mentioned this before we have information well level data across the united the states and Canada and even other countries were we can look to see how those things are changing and more interestingly and more importantly why they're changing changing and so I spend an inordinate amount of time going through data to understand all those things and more or less rebuild. Ild All of the companies that we have in our investment universe from the well level up and you know whether it's two hundred million dollar market cap company that has one hundred Richard Locations are Exxon Mobil. That's the approach and every company is interesting in that regard and how they're exploiting their resource and how they're developing their longer term development programs beside that resource is really interesting something that markets have a bias on for really any any sector is taking a base case and extrapolating that base case too far into the future and we've found that is a commonly repeated repeated mistake in energy and if you think about a depleting asset days which you know we talked about as part of why they're structurally not great businesses. The genesis of that is a decline curve for every single well so the asset base is made up of a bunch of individual assets that are declining winning at some pace which means that when you add all those things together you have a large decline rate for every upstream oil and gas company that they are fighting by investing more capital into other declining assets base case is very very important because you're decline rate is your base case and as wells change over time not just at the beginning of their life but forever there are always times is where people don't understand what the base of the company is and you know we spent a lot of time understanding those deep points where aware activities that companies have done years ago are affecting what their prospects are today and you know. That's a that takes dedication. It takes a lot of carefully elite controlled modeling so that you can isolate all of those things across all your company's all at the same time at it's interesting work and it's nuanced work and the data sets are rich in so for an analyst with the technical background. It's a playground sort of every day to find something interesting to think about or talk about and you know with lots of companies with lots of assets. There's always sort of some new idea percolating to the top of the list. It's a great excuse to talk about data and the quantitative side of all of this and the importance of it. It's an extremely hot topic in all sorts of investment circles. Today I think that almost every successful long term asset managers thinking thinking about how to incorporate systematic tools quantitative methods data itself into their process to make it better than energy is especially interesting area for this particular idea hi dea so maybe you could describe washy get into how you think about building a portfolio now evaluating businesses with this call it man plus machine model. It's just a term that people have have kind of glommed onto which is you mentioned. The legacy from citadel love very systematic thinking structure thinking around fundamental work. Now you've got this incredibly you reach sets of data within energy but from all over the place for my perspective extremely complicated and probably requiring some deep contextual knowledge actually do anything with one of the questions we all the time is like well. Anyone can access this data whether it's an purely quantitative strategy or or in a kind of hybrid like yours you you house. How are you going to have any edge something. That's just free for anyone to access or even if it's not free need to pay for it. It's not overly expensive. How do you answer that question about the use of data and the edge that you derive from in the process going back to this concept of being students of our businesses and whatever sector does you follow the goal is to have an informed arms low variance model of what exactly is transpiring in the operations and financial results businesses and if you own if you imagine owning a company completely clearly outright hundred percent of it you know exactly what's going on in the business from day to day. You have a good sense of the prospects for the business looking forward to hopefully hopefully it's a business where you have more control over the product prices that you're selling and you have a competitive advantage but in this case energy the sector happens to be a sector again endowed with this incredible access to the data. The data represents access to the building blocks of our businesses. You mentioned in certainly oil and gas wells are readily available eligible but because readily available doesn't make them easy two-wheeled having a pure data set and bigger data set obviously the the the hardest wheeled but having said data in of itself is not a solution is not useful investment process. You have to be able to distill the data down into its normalized component parts and be able to take that and turn it into a cohesive mall for the business by wrapping financial statements around the data or put it in simple terms if these companies were factories if they were manufacturing companies understanding exactly how many widgets can be produced used the cost to produce widgets number of people required the length of the manufacturing line cost of distribution Saturday getting to the end market in the case of energy we have have most of what we need to build very inform models and starts with his own gas well data. So what insight are you trying to glean as the welded it gets updated so I certainly understand stand okay. These companies are predicated on successfully finding and and extracting minerals from the ground is pretty pretty straightforward and their uses are pretty straightforward. So what are you learning through those data updates. That's interesting and compelling. Are you building. Some sort of web of understanding of the viability of a certain set of acreage is or regions wins. What is the insight that's different than just getting sort of an updated proven resources or updated asset value or something like that. It's sort of a lot of what you just described live but really when data are updated for all of the wells across all the we get a couple of things one we get more current understanding of what the production of the company is just the aggregation level of analysis. How much are they producing and you know there's some context value that can be discerned from knowing what that level is but more importantly we can understand how different time periods of wells are changing and if you understand how a resource base or the productivity of our resource base is changing over time you start to uncover bits about the second derivative of the prospects of company and really that's really important thing because the second derivative is what makes deltas in cash flow for the business. If the well is going to cost the same but produce less their cash will be lower their economic return will be lower the ultimate valuation will be lower and conversely if they spend the same in the well produces more than you expect but then it also gives you insight into how a company is developing in their asset on a single acre or a unit of acres where a company is drilling. They don't just drill one well. They drill a number of wells in a defined system how they drill those wells at what depths at what horizontal lateral spacing informs how that productive system will produce hydrocarbons and when you can evaluate how how they've done that the type of technology that they've used in the wells to actually get their production and you can see what those changes in productivity the are you really start to paint a very rich picture of what is happening why it's happening and how to take those things things to forecast what will happen in future so a second key component of this. We've really focused on your assessment of the value of the assets of an upstream business or evaluate the business more generally speaking the second key component here is market price so the opportunity is going to be the gap between your assessment and the markets assessment so we have price but how do you take price sort of back into what that means. The market is estimating about the businesses wells about their assets etc so that you can gauge the with and maybe duration of that mismatch of that gap between your expectations and the markets you asked about Mollison. Basically one of my favorite investment books is is by Michael Matheson all expectations investing and it quickly summarize you writes about using security prices to understand the embedded the price implied expectations and if you know any industry sector I followed if you build or care to build a strong model that captures the operating assets and financial performance of of the company you have the jumping off point for iterating to understand what the market must believe today at at reasonable assumptions holding all constant with the market must believe today about for instance production growth or what the market must believe today. If we know production growth costs and Capex with the market I believe about oil price and better they're in or cost or Catholics managers etc and is helpful because that iterative process is required with this living breathing set of companies as these assets change. You're going to go mad if you don't try to slow it down and understand as things change what it means for the change in the value of the business but also what the markets understanding is and you're constantly trying to recalibrate and find these big disconnects where the market doesn't doesn't see the assets quite how you see them yet so we're we're entering an important topic which is the idea of investing energy businesses is values the growth what what's important all the different factors the problem with these businesses most not the more structural technology companies like Schlumberger. The problem with upstream offers from companies is that the intrinsic value of the businesses falls within the commodities fall. There's no margin of safety when the commodities fall which is what we've really seen. Can you know play out over the last four or five years so when you go through evaluation exercise and distill all of these well data and turn them into operate quarterly operating and financial remodels when you're building a model for you g again to carry that example forward. You're modeling the next fifty years by quarter. You're taking all of the known components components of the assumptions that the well data the cost capital expenditures et cetera and you're turning it into a practical version of what you think the operating financial results will be for that business at if there's one endeavor that we have here one pursuits. We tried to do that with as low as possible and what you get. It is largely an objective exercise and so that's a major. I think it's an important takeaway which is that modeling and Energy Business. Modeling Upstream Company is largely an objective exercise is if you care to use the data. LLC You to do it. oftentimes people screw it up by injecting speculation on commodities but in reality most of what you need to know is out there and available to you so if you go through the key to wrap financial statements around the data and you have a good picture of what the companies is producing and generating for cash flow on the prevailing strip strip the strip prices are the Ford commodity futures prices were all participants in the market are voting each day okay and they come up with a price for crude oil in both physical and financial terms seemed natural gas if you use that paroling strip which is frankly if you own one hundred percent on one of these companies. It's worry would go out and hedge the casual business which is why we use the stroke. If you model business in this way the next fifty years by quarter obviously things can change change and you can. There's a margin for the farther you go out but you can start to build an understanding of how differentiated using objective assumptions make your appraisal versus. The current market price the stock and that's where it gets exciting for us is building an appraisal of net asset value. That is what we what we find with wildly different now. We don't just show up each day and buy cheap knives and sell expensive ones. The key is is than finding where revisions to market expectations when the revisions are so extreme that they will force market around our point of view on on the asa exit value just wanting to add absolute price absolute valuation is as you can tell from Matt's description. It's pretty difficult in a in a market market. That's as fluid as energy. Where there's geopolitical factors influencing price saw of of the commodities there's actual supply demand factors Erzen all sorts of other things in a long short approach the ability to take valuation and use it in a little bit of a relative of space is important and being able to take the commodity component out of valuation via the way that we structure our portfolio folio is a key thing to do when we just want to isolate undervalued or overvalued operating performance and when we look at as Asmat said we look at overvalued undervalued companies based on how we appraise those assets? That's really what we're doing. Maybe talk about how you then are building an actual portfolio. We've talked about what it's neutral true which is Beta for the most part commodities interest rates etc fact style factors but how are you than actually taking your working acknowledge your company models all the work you guys do constantly and relentlessly and turning it into an actual portfolio if you can readily force rank these businesses says each day in terms of the market's price versus your appraisal. It's the jumping off point four starting to think about portfolio construction. We tend to to sink a lot about quality. We tend to think a lot about the idea of longevity of a business a lot of these businesses again because they're depleting. How how many future wells they have a drill to generate returns that are as good or better than their current return on US capital is an important feature of how we think about the sustainability inability of each of our businesses and their bill to grow and and do so within the context of their balance sheet covenants. If you think about the world though where you you need to be mindful full of the portfolios sensitivity to crude natural gas and remove those you can't just by quality and short bad companies. You can't just buy a company short backup and you certainly you can't just by management teams that you like and short bad management teams what we try to do is balance out and be style agnostic and find truly we disconnected undervalue businesses on alongside and over by business on the short side but where it could be in the realm of expensive companies where you know something that may look expensive on near-term. Ev to Ebitda is growing so quickly. It's cash flow stream that in three years it's multiple compressors substantially stanchly and it looks inexpensive that juxtaposed with a company that looks incredibly low multiple today but has no prospects to grow production and it's a depleting set of assets so three years from now it's cash flow is less multiple cases of this where what looks like a value proposition today in several years in the upstream business can actually look like a catastrophic destruction value and vice versa oftentimes expensive companies look more interesting from multiple perspective than chief companies because of this idea of longevity and Sustainability Mesic clarifying question there so one of the things that I've always fascinated with his understanding why the value factors an example works and when you dig into it those a lot of competing explanations for this one is that the riskier companies who you're compensated for that risk structurally was a behavioral explanation so people get get overly pessimistic about the prospects of Salo p stock but ultimately like your buying future fundamentals when you buy the stock today and one of the interesting things about say buying low p e stocks is that fundamental tend to mean revert at the market level so if you've got really bad recent trends odds are that it will be a little bit better with an average in the future and that's just a very broad generalization but when you pair a low price paid today with the tendency of bad recent fundamentals which is what values stocks tend to have to mean can revert it ends up being this great deal and you end up earning four percent annualized return over a really long sample even when everyone knows about this so it's it's an open secret that value investing acting works but what you said is is quite different than that. which is that in many cases you might find companies? Let's say it's a one that looks expensive on Vida today but has much better prospects so the opposite of mean reverting fundamentals so maybe you could unpack that a little bit more as to how you might go about identifying that kind of company relative to the more more meaning like broad sample of mean reverting companies the interesting thing about low multiple stocks and especially the upstream universe. You know we talked a lot about assets. Sets can change all the time. There is an element of upstream oil and gas where companies sometimes have assets in geological section that there is no promise to the upside you know the probability of the prospects of that resource improving have been statistically rendered to be very low and so a low multiple stock that has underperformed because it's working don't necessarily have a fundamental reason listen for mean reversion because their prospects are not in a mean reverting type of areas not a consumer stock that is gaining and losing market share over time and into a company with a physical asset that potentially doesn't work and so as they continue to spend money on that asset and it renders sub economic onomic results. It's multiple actually inflate over time and you're sort of doing something. That's counterproductive to what real value investing is has and so part of what we do is try to discern when a company with a low multiple is for a physically geologically weekly structural reason or if it's just the market doing something silly with a stock and so you know we're not factor investors but were very where factors actors we recognize that value can be extremely positive tailwind to investing but figuring out whether it's structural that it's a valid quote unquote value stock or if it's just market perception is where we can come in and really add value with our analysis and there's a Maoist talking a little bit about portfolio construction and how it's not just about buying companies and selling bad companies but finding pockets of dispersion in all all of those areas a good company that has better prospects in a good company that has declining prospects. That's too highly valued companies that can be on different different sides of a trade or to low valued companies that have separate operating prospects can be on different sides of a trade and you're not making a factor bed that is true. Alpha and data's what our process and our whole systematic approach to this business is set up to do. Oh we certainly appreciate some of the long term tailwinds like in described that low multiple stocks have had I think energy energy. There's there's a bit of a wrinkle and that is the price you're paying for. As cash flow today has very little to do with the earnings possibilities awesome abilities for the business five years from now or ten years from now and when we stress this idea of building a fifth year model for each company granted the margin origin of potential outcomes is very wide understanding the prospects of Yogi or pioneer diamondback energy or resources which is quite topical what their ability will be to reinvest their cash flow today to generate earnings next year five years from now ten years from now is of critical importance the longevity of the assets. Let's relate back to the multiple. You should be willing to pay on any metric for one of these businesses and so it's hard about just thinking about pure low multiple appea- or low multiple investing. Is You know it's a moderately efficient market. We know we can argue either side of that but the markets trying trying to price and understand the Utah cash for growth of the earnings growth these businesses all the time the amount of capital. They may need to fuel that growth looking at these these businesses today a low multiple business again may have limited business prospects at a four times company if they only have three years of wells to grill to generate returns earns and then they have to go out and make an acquisition of more acreage or of a company to backfill. They're depleting production. It doesn't matter if you're buying a low multiple companies because they're probably going to have to create a deal of when the time comes and so I think we we try to think about the long term earnings earnings and cash flow potential these businesses we try to pay as low a multiple as we can for longs today and it's high amount was we can't rush today but each of the each of the companies are so different in terms of their resource in rock and their locations in those in quality of those and the prospects for those that comparability ability something if you're careful with peas or VVD or of cash flow multiples. Let's talk a little bit about leverage the portfolio level not at the company level so back to the way hey that traditionally speaking hedge fund portfolio should be constructed which is neutral to a ton of stuff so if you were unlevered you would basically earn return. That's the return spread between your lungs and your shorts. Hopefully we hopefully favorably in your direction. Obviously it's very common than to apply leverage to that unlevered return stream of the difference between long shorts. How do you think about that exposure How systematic is that thinking much change through time. What's like a rough range. This is a topic that we definitely have uncovered before said be interested to hear perspective. I think there are two parts of us and then you can add anything but the first part is the amount of gross leverage but you apply to your underlying equity. Um should be a function of the breadth of ideas ideas in the conviction you have in those in our case in recent critic way so the number of names the more names the more conviction than more timeliness of the ideas the ideal you invest followed today and tomorrow the market comes around your point of view on every investment. It's obviously never happens so think about it like a life. Insurance portfolio flu or you have duration matched longs with duration match shorts hopefully building a portfolio where you have lots of ideas is the first driver of how we think about. I leverage the fewer ideas. Ideas are scarce. You know we do not want to lever the returns of our investments on the underlying equity. The second layer I would say is been quite important recently as we've gotten into less stable higher risk our cost CAPELA regime particularly Jan January and February February how much you lever the portfolio swimming you have a breath of ideas should be lower in times of extreme stream regime uncertainty which we have every bit of that today yet. There's sort of the two sides there's a statistical approach a mathematical approach to risk and leverage and there's a fundamental approach and Matt talked a lot about the fundamentals having a breadth of ideas having conviction in them having some fundamental l. stability in the broader macro landscape and then eluded to the statistical side. We are always looking to provide a target risk risk and from there we can back into what the portfolio needs to do against our risk management calculations and leverage a lot of times holding the fundamental pieces of this constant falls out what that volatility target is if you can highlight the dollar's volatility that you need to generate with your portfolio and then use a statiscal risk management model to estimate to me what that portfolio volatility is. How would you assess the changes like in your relative careers in the Hedge Fund industry what it may be the positive and negative changes changes that you've observed the met you I over the entirety of your career. Now feels like it's gotten harder over. You're using data in two thousand five. When I started professionally investing asking the vice I meant as she egger website you could go electronically poll financial statements and then you get on a plane go see management teams. Today we still go spend a tremendous amount the time in the field with public and private companies to understand what's happening in the energy ecosystem but the the major change that's allowed debase into exist has been this incredible programmatic to these building blocks for businesses of your data and certainly you've seen statistics where the availability of data has grown exponentially and will continue to we've seen that with energy assets with the data that's necessary and frankly it's why small operations small single person or two person teams have a hard time wielding energy data in a way that systematic it takes a fair amount of tieman process to to do it so the major changes has been the availability of facts about businesses to allow us to exist on this sound. I think the the rule of eighty twenty is sort of leaving in some cases and the Investment Universe you have so many people that are specializing in sectors and going to pretty significant lengths to derive an edge that getting last twenty percent right is the edge itself and I eighty percent isn't really it's not yeah exactly and and so I think from a positive side when you work in the asset management field broadly but particularly for hedge funds that are doing a an extraordinary amount of work and trying to find some edge. You're working with a lot of really smart people and the number of smart people and their smartness it seems to be increasing and so you know from my seat that's a good thing and it really makes you constantly fight complacency and then it's a good driver. The negative side changes over the last call it five years. Maybe maybe the only thing I would say is that you know there's there's a lot of aggregation. That's happening where independent fund managers are going to you know. Large platforms platforms are great places. Is there smart people. They've got great resources. They've built by really smart really thoughtful people. They have good returns but it's changing the way that the market works in some cases and how the quantity profiles are transpiring and that's a advantage and a disadvantage in some ways it creates two different profile volatility but in some ways it's better for markets to have some fragmentation to them and that's a change that I think is not necessarily a great one when running very clear changes is the role that passive flows are playing an increasingly driving securities prices some of it can you just paying very low fees for in our case the XL e the SNP energy sector spider or the H. Services ETF. When there is material buying and selling Bellingham those indices we see the correlations of the stocks contained therein as as picking up and driving and overwhelming really in most of what's going on fundamentally in the short run. We've spent time trying to build a portfolio that were we pay attention to our exposure to specific passive indices etc to try to mitigate that happens but we frankly like that in January specifically there were tremendous reflationary forces sources that market started to bet on and we're buying aggressively buying passive energy exposed indices now that's not worked out very well in the recent past Asan in late January February but it caused tremendous distortions in the pricing of some of the securities embedded in those indices and subsequently these companies had to report earnings provided forward-looking outlooks and many cases in any benefit they saw from the passive index inflows flows was turned into serious downside stock price moves when when the companies reported earnings for instance in February so we we try to use and and surveillance and understand what's going on in factors what's going on passive fund flows and we try to use those to our advantage when because as they tend to cause distortions and miss today more than more than I can recall at any point in my career so close to the couple questions on the firm culture is something that fascinates me and then I've gotta the closing question that I ask everybody will close with that so maybe I a question on culture so I think it's probably something that's it's. It's a little bit fuzzy and very qualitative. You're trying unallocated. Let's say to assess the culture of asset management business but there's just no doubt that a strong culture is something that can help firms weather storms can give them even a greater boost and good times so as you think about being just you know a year or two years old with the basin what are like the core cultural elements like if I would not ask the rest of the team mm-hmm if you had to describe the firm's culture and a couple of words like what kind of words would they use. The first one that comes to mind is intellectual honesty and sort of honest wrist holding of everybody to that standard and the byproduct of having that be a real pillar of what we do. Is People art afraid to be wrong. There's no love lost or egos hurt when opinions changed based on the presentation of new information and you know so that type of environment really helps foster intellectual curiosity and removes the negatives of emotion from what is an intellectual pursuit suit and that's a great thing to have. I think we have that in spades and Matt can talk about some of the personal attributes but you know from my perspective. The fact that we've we've all worked together before and you know we have a aside from just being intellectually honest hungry professionals we all strive to be good human beings and that means holding yourself accountable and being honest and being forgiving and understanding and I think everybody at this firm has all of those things that allows intellectual honesty to really be a core component of of our success. I would probably probably add just a couple of traits. One is and this is is really informed by our past experiences that we reflected on but we are obsessive about process adherence. If there's one thing that really gets an energy flow down it's when it would be if I were to decide to take a big swing at what OPEC's going to do in the spring when Russia's going to give in on or take backer renege on the cuts extreme process adherence. We've found found is the most important pillar of sustainably repeatable investments in this sector. There are certainly temptations to have commodities. We we talk about amount of time. Now we use it to get out of the portfolio but we see that temptation thankfully it's now totally institutionalized and and it certainly was from the very beginning but this obsession with processes something that happens daily the second piece that I think is important is there's meaningful passionate about the subject matter. I've been a student of investable sickle companies since I started my career and over long time it's really been focused on energy and that make me very narrow in my focus but it's something that I've come to be very passionate about Yin Graham Koby. Everyone is mostly mostly devoted their careers to this discipline and the sector at this point and for good or for bad we love talking about digging in on trying to get it right and investing in these energy businesses in this idiosyncratic way I find it incredibly important to be as transparent as humanly possible on this podcast cast and so there's an important feature that we haven't talked about which is that both our family and in our business our direct investors in your business and so I thought a fun way to handle that rather than me. Just you know disclaiming it in the introduction or something like that which I'll also do is for you to maybe just tell from your side that story very quickly because it's a neat story on that's been incredibly credibly interesting an amazing way to learn for me and for our business as well so maybe you could just ended a few minutes on that as something fun but also in the second transparency from from the beginning of my career through early seventeen or even really sixteen mile long term goal was always to build a sustainable investment firm where I can be a key the determinant of the culture of this process adherence that I described end of the type of people who surrounded by each day and that that is something that in the case of deep basin I wanted to capitalize like technology company when I left my prior firm and early sixteen sat out a year on a non on compete I thought about who I wanted to be when I grew up and a critical piece was I wanted to surround myself by people who challenge me and make me feel stupid each Wjr Day and I knew where to find some of them but I was grateful to be introduced in early seventeen to Kobe planning our team Garrison Travis Atis and the members of our operate team and in order to pursue build the business that I really wanted to build. We had some options on some. LP type seeds traditional seeds and we were thankful when we sat down and put our heads together with with you and Union Dad that you you saw the vision that I had that we had for the firm and frankly needed to be capitalized like a technology business and like no other seed that we evaluated having a very long-term permanent capital partner that is like no see that you know I saw when i I started thinking about doing this and certainly the fabric of the people were in business with is important to me and it was important when we started to build this team in culture we believe in order to build a sustainable investment franchise to invest in these businesses that were so passionate about we needed to build a team team in process and sufficient mode around business which required a significant technology investments and that's why I describe it as effectively capitalizing like tech company but we spent almost a year building significant technology that allows us to do today you know keep our eye on the horizon and have the head space based to take risk and that for that. We've been very grateful. I appreciate the story I mean. Obviously I want to be transparent. Given that that we have a vested interest in your success in our view is that the future of of this business is far more collaborative. Maybe than it's been in the past. We're lonely business so we're not directly competitive but we found just tremendous value and being open to experimental and new ways of collaborating with other investors second. You end up learning so much more than if you tried to just view everyone everyone a competitor so it's it's been a remarkable experience that the last question that I ask everyone's lesson I'll ask each separately is for the kindest thing that anyone's ever done for you. I'll go first. I think it was the second date that I went on with my now wife and we decided to meet at grand central for officers at the bar there and we were going through our meal and we had a few drinks and we're having a great time and we went to leave and the waitress came up to us and said you know you guys is are all good and said what you mean. We just had like two dozen oysters like very definitely not good. She's another gentleman across the table from you that said he reminded you of him and his wife when they were young and he paid for your tab. You know security. My wife is pregnant with our third and as I think about you know the fourteen months or thirteen months since we started the bill de Basin. You know the kind of thing by far that's ever been done for me is my wife enabling and encouraging me to pursue my dream which has been building a team and process and culture where everyone can come and be passionate about this very in many cases people may think very myopic pursuit which is systematic fundamental investing in these energy businesses in repeat away my wife. I'm lucky very simple. Things make her happy. She loves families. She loves to read she loves to Cook and and I'm thankful that she has encouraged me to go out and do this but she married me and that I consider the kindest thing anyone's ever done for me. This has been really fun as I knew it would be. Awesome awesome deep dive into a very particular kind of investing so thanks for your time guys. Thank you thank you BAJIC. Everyone Patrick your again to find more episodes of invest like the best go to investor field guide dot com forward slash podcast. If you're a book lover you can also sign up for my book CLUB AT INVESTOR FIELD GUIDE DOT COM forward slash book club after you sign up to receive a full investor curriculum right away and then three to four suggestions of new books every month you can also follow me on twitter at two Patrick Underscore Osieck S. h. a. g. if you enjoy the show please leave a quick review for us on itunes which will help more people discover invest like the best. Thanks so much for listening

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