Outlook for Fixed-Income and Equities Investing

EMS:
Absolutely. So to kick off the conversation, tell us a little about the firm and how you got to where you are today.

BN:
Yes, So Narwhal Capital was started in 2005. It's a registered investment advisor founded by Matt Burton. Matt performed very well during the global financial crisis in 2008 and 2009 and gradually expanded the team client base and really kind of catered to high net worth families and institutions. About 10 years ago, Narwhal removed investment minimums. It was previously $4 million. And since that time we've actually grown significantly, both from an assets under management perspective and also from a just pure client count perspective. So when I joined in 2016 from a firm in Oregon, we actually had five employees and a little less than a hundred clients. Today we have close to 20 employees and 350 clients, so we've grown a lot over the last seven, eight years. I'm still an analyst and portfolio manager at heart, and I still do a lot of that work, but I'm increasingly involved in more of the strategic direction of the investment team, the firm overall. I'm also much more involved in client conversations. So that's a little bit about what I do and where the firm is today.

EMS:
Well, congrats on the firm's growth, Ben. So as a follow-up question, love to hear your overall outlook for investing.

BN:
Our team thinks that we're in a regime where capital is increasingly scarce. This is a big change from the past decade, and so the companies that are going to perform best are those that are going to be able to manage this scarce resource the best. So this contrasts with size being a primary determinant of success over the past decade. Previously, if you were the biggest company you could lever up, you could buy back stock. You didn't just have to invest in the best projects, you invested in all of the projects. Today, you have to really make sure that your every dollar is valuable and you're allocating each of those dollars appropriately if you're a CFO.

And similarly, on the investment side, the investors that are going to perform the best are those that can allocate investment capital the best. In other words, it sets up a favorable backdrop for active management over passive management. In the years between the NASDAQ bubble and the global financial crisis, actually active managers actually outperformed the S&P 500 on average according to some research that we're able to find. This happened as we rotated from a historically high amount of market cap concentrated in the largest 10 companies. And I think that we have a similar setup today. In fact, you could argue we have a more enticing setup today because an even larger share of capital is concentrated among the largest 10 companies in the world.

EMS:
Ben, based on that, where do you see some of the greatest opportunities looking ahead and why?

BN:
So I'm actually going to start on fixed income. Usually fixed income is shunned, and at least it certainly has been over the last 10 years. But in fixed income, there are real returns again. You have an investing public that generally doesn't understand fixed income, at least on the retail side. You have years of low interest rates, which have basically resulted in an atrophying of these skills. And we know this. And when you go to any investment student run investment foundation, and there might be 80 people in the student investment fund, 75 of them are on the equity side and five of them are on the fixed income side. So it's really difficult to find young bond traders these days, especially on the retail side. On top of that, you have buyers of dead instruments that are under stress. Jamie Diamond says JP Morgan is sticking it out in mortgages, but many banks are actually getting out of the business.

The Federal Reserve is reducing its debt holdings, and then private equity and private debt funds may also see their buying capacity reduced over time as capital starts to drive up, as I mentioned earlier. So this I think will create lots and lots of opportunities for active managers who can identify those instruments where the natural buyer has exited the market and they can be opportunistic in allocating capital. So I think that's probably one of the greatest opportunities right now, especially on a risk reward basis. And equities, I'm very optimistic longer term on the United States. I know there's this whole thing about baby boomers retiring, but I'm also optimistic about the growth of the millennial generation. The largest generation in history and what that means for new household formation. We already started seeing that a lot in 2021, 2022, and I think that will continue, although maybe not at the same rate that it had happened then.

But then over the next 10 years, they're going to be entering the prime working years, they're going to be having kids, starting families, buying homes, and I'd love to see the growth that we saw in the nineties when the baby boomer generation was thriving. So in the near term, we need to navigate this scarce capital environment, and that means focusing on cash flow, strong balance sheets, and good capital allocation. Kind of that classic value investing mindset that didn't really work very well from 2012 to 2022. So we've been doing a lot of work researching companies in that space. We also own smaller businesses that generate large, steady cash flows with fundamentals in different pockets of the market, in consumer staples and industrials, and even in oil and gas. And so we're navigating that scarce capital in the near term while also trying to remain optimistic over the long term.

EMS:
Ben, indeed, it definitely is a very interesting time with everything going on right now. So given that, what are some of the greatest challenges you face and what are you doing to overcome them?

BN:
Probably the biggest challenge right now is balancing that long-term optimism and with the short-term realities. There are a lot of great ideas out there, a lot of people who are really passionate about what they do, but we are fiduciaries of client capital and we need to allocate our client capital in the way that delivers their best return on investment in a risk adjusted way. And so we need to balance that long-term optimism with those short-term realities. And a lot of times that means saying no to opportunities, whether that's on the private side or on the public side, because at the end of the day... And another challenge is balancing that long term and need for the short term, because ultimately, if you never outperform on the short term, by definition, you're never going to outperform on the long term. At some point you have to outperform.

And so when communicating with clients, it's important to one, set those expectations, but also deliver on those expectations when it's feasible. And then finally, and this kind of goes back to the first point in terms of balancing long-term optimism, and that's balancing conviction with risk management. Sometimes there's a great idea, you have a lot of conviction in that idea, but you have to be measured in your approach because there are a lot of risks in the world and you have to stick with some frameworks that allow you to manage that risk and manage the portfolio accordingly.

EMS:
Ben, to shift gears a little bit, I wanted to discuss ESG and DEI, which is top of mind for the investment community right now, and wanted to hear what your firm is doing to address these important topics.

BN:
So let's take them one at a time. So on ESG for example, when we go through and do a pitch to invest in a company, we don't want to set out for a loss where we come in one day and the stock is down 25% because they have a massive environmental liability. A lawsuit went against them, they did something bad in terms of their management. And there's examples today that we could call out and we want a management team where there's appropriate corporate governance and regulation of that management team, and they don't have a carte blanche to do whatever they want. And so we do a great deal of fundamental research on the front end. We actually use a lot of Bayesian inference on the management side. And ultimately what that means is these outcomes can give us a lens through which we can actually view the ingredients that are going into those outcomes.

And where those ingredients are is the management team, is how the business is run, and those ESG principles. So that's something that we pay a lot of attention to. And in terms of diversity, equity and inclusion, again, we placed a really strong emphasis on avoiding management teams with Group Inc. There was a recent example. I remember I was on a conference call with investor relations and they had been doing... It was a company whose customer set was wholly different than management of this company and the management of the company founded the company, but they'd founded it 40 years ago. The world was different 40 years ago.

And I was talking to the investor relations representative and I said, "Well, what are you doing to address problems A, B, and C?" And there was basically no response other than to say, "Just trust us. We've done it pretty well for the last 40 years, and we know what we're doing." Well, the company is now bankrupt. And I think that that's one of those things where you need that refreshing of blood, you need diversity of thought. You need to bring in other voices because otherwise you're, if you don't adapt, you're going to die. And we don't want to sign clients up for a company that's going to die. So that's how we approach ESG and DEI.

EMS:
Ben, we've covered a lot of ground today and wanted to see if you have any final thoughts you'd like to share with us.

BN:
Yeah, thank you for the time. First of all, I appreciate the opportunity to speak with you. At Narwhal, we expect to continue to grow. We spend a lot of time over the past few years building out infrastructure that allows us to scale while still retaining that dynamism. So when I talk about fixed income being able to adapt and identify those opportunities on, on the equity side. And one of the things that kind of differentiates us to your point on DEI is we tend to hire young, hungry, smart people and provide them a canvas. That's what we ultimately want to do. We want to provide them a canvas from which they can grow, add fresh ideas, and not just out of being nice. We want them to actually be able to come in and contribute and have a meaningful impact on what they're doing.

We don't want anyone here just to fill a box. We want someone to actually contribute. So we're constantly looking for new opportunities to allow the firm to grow, to expand in terms of different business lines. On the investing side, again, we're looking to just navigate this near term, make sure that we are great stewards of capital just as we want the companies that we invest in to be great stewards of capital. And over the long term, I think that I fully expect that as a country we'll do well. I think the companies that we invest in will do well, and I certainly hope that our firm will do it well also.

EMS:
Well, Ben, I wanted to thank you so much for sharing your perspective with our listeners, and thank you for listening to the EisnerAmper podcast series. Visit eisneramper.com for more information on this and a host of other topics. And join us for our next is EisnerAmper podcast when we get down to business.

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