Paul O'Connor:

Welcome all again to another installment of the NetWealth Portfolio Construction podcast series. I'm Paul O'Connor and I'm the head of investments for NetWealth, which covers the responsibility for our investment menus and the products NetWealth issues as a responsible entity. Eric Almeraz from Apis Capital Advisors joins us on today's podcast. Eric founded Apis Capital with Daniel Barker and is a managing partner and director of research. Eric's industry experience spans over 24 years, the bulk of which has been with Apis Capital. Prior to founding the business, Eric and Daniel worked together at J&W Seligman and Company where he served as a global research analyst. From 1997 through to 2000, he worked at the Capital Group of companies as an equity research associate responsible for industrials, chemicals, and travel and leisure industries. Eric received his MBA from Columbia Business School and his BS degree in accounting and finance from the Leonard N. Stern School of Business at New York University.

He has also served as an adjunct professor at Columbia Business School since 2013 teaching the applied value investing course. Eric's also a CFA charter holder. Apis Capital is a US-based boutique global equities manager established in 2004, co-founded by Daniel Barker and Eric. Apis Capital offers both global long/short and global long only equity products to retail, wholesale and institutional investors. The manager's history is in long/short investing with the majority of the firm's US 560 million in assets under management being in their flagship long/short strategy. Apis Capital also offers a long only variant managed with the same underlying investment process. Apis has partnered with Ironbark Asset Management in Australia to provide distribution services for their funds. Both Apis Capital's core strategies are available on the NetWealth super and IDPS investment menus, being the Apis Global Long/Short Fund and Apis Global Small Companies Fund.

Global small companies have long been considered a fertile grant for active stock pickers. Given there are almost 4,000 securities in the MSCI World Small Companies Index across 23 developed markets with a market cap of over US $8 trillion. The index has generated sound performance, returning almost eight and a half percent since inception in late 2000. The index is heavily dominated by US small caps, which make up almost 59% of the index, while Japanese small caps are the next largest country component of the index, making up about 13 and a half percent. This index, given its breadth of countries and industries and number of securities, has long been a fertile ground for active managers.

From a portfolio construction perspective, many diversified portfolios have an exposure to global small caps with the aim really being to generate alpha in addition to the large cap exposures in the portfolios. Global small caps have historically demonstrated the potential to perform global large caps and mid-caps, partly due to higher growth potential of the companies, but should also be considered due to the increasing concentration in global large cap stocks, which is mainly due to the large exposure they have to the technology sectors and specifically the MAG 7 stocks. The caveat being that global smalls are more volatile than their large cap and liquidity is significantly lower. The higher volatility though does create opportunities also for shorting securities, so I can appreciate why Apis Capital offer both a long only and long/short global small company strategies. Maybe for starters, Eric, can you provide our listeners with a brief overview of Apis Capital and what you think actually differentiates you from other investment firms?

Eric Almeraz:

Yeah, sure. Thank you, Paul, and thank you for that great introduction. I don't think I could have done better myself. As far as Apis Capital and what we do different, if you take a step back and you look at the world of stocks out there and you just run a simple screen, there are about 21,000 stocks that trade in the world. It's a huge vast pool of securities. The amazing thing is about 19,000 of them, or around 90%, actually are below 10 billion in market cap. So the vast majority of stocks that are trading out there are actually what most people would consider small cap stocks. When you look at professional investment managers, particularly long/short equity, and you look at hedge funds, just taking say the top 500 hedge funds, about 200 of them are actually focused on stocks doing long/short equity and not a single one of them is really focused on these small cap stocks, which I think there are a couple of reasons why.

One being that it's not a strategy that's ever going to be huge. It's never going to scale to tens of billions of dollars. It's also hard to do. It takes a lot of late nights, it's a lot of translation and travel and it just requires a lot of hard work and experience to do this. There's a lot of cultural differences and customs to get familiar with around the world. And so my partner Dan and I, we started doing this back in the '90s. He was at General Electric at their pension fund in the mid '90s, and as you mentioned in your introduction, I had worked at Capital Group in the late '90s. We got a very early start in this space getting familiar with this large swath of companies. Of course, we don't know every one of them in there, but we're familiar with enough of them that we've really developed some edge in this space.

We decided in 2004 after working together a couple of years that we wanted a strategy where we could cover industries across the globe. And you think about different industries like for example in mobile phones, you've got Apple competing with Samsung. Apple in the United States and Samsung and Korea. You can't really understand that industry without covering those companies, and so you've got to really look in different countries to do that. As uncomfortable it is to maybe translate a Korean document for most people, it's really necessary in order to understand these industries because they're very global. When you get into the small cap landscape, there's very, very few people, if any other people doing that besides Apis Capital, and so we really see ourselves as one of the first, if not the only, and really the only ones continuing to do that today, especially with a 21-year track record. We've been able to deliver significant alpha, a 10.7% return in the US strategies versus an 8% for the index over 21 years, but we've done it with two-thirds of the volatility in our hedge fund, but the market's been down five years over that period of time and we've only been down two. And so it's worked really well and we continue to find really interesting ideas in that space.

We haven't grown so large that we can't replicate those returns. There's no reason why we shouldn't be able to continue to do this in the future.

Paul O'Connor:

Interestingly, the comment you make there about I guess capacity at the end of the day and that the larger fund managers, global asset managers just find that the capacity is too constrained in the global small cap space and hence why there aren't a lot of strategies available in the market. But I guess that's where it plays well to a boutique manager like Apis Capital where you don't have the large overheads obviously of a global asset management business.

Eric Almeraz:

Absolutely. No, I completely agree and we are a boutique firm. We have myself and Dan of course who own the firm. We're the two partners. And then we've got four analysts on the team who work with us and have been with us for going on six, seven years now. And then we have an operations staff of additional three people, one of whom is our CFO, Richard, who's been with us since 2006. But the way we've built this team is with senior people who really know their stuff. They're skilled craftsmen at this job. I almost think of it as an artisan craft in a way. We don't think we'll ever need to add more people from a strategy standpoint in order to handle more names or anything like that. We do think it is capacity constrained with the flagship strategy. It has about half a billion dollars in it today and we think that probably gets up to around a billion or so. We also have a long only strategy with just under $100 million and I'm talking in US dollars, which we also think has about a billion dollars of capacity in it.

Paul O'Connor:

What inspired you and Daniel to actually found the business?

Eric Almeraz:

Yeah. It's a great question. Dan actually hired me out of business school in 2002 to join him at Seligman and he was running a small cap global fund as well as a emerging market fund. These were both long only products. And as we started working together, we kept seeing these situations where you learn something in one country about a company that really had implications for that company's competitor or supplier or customer, which might be located in a completely different country. So one of the earliest examples was a company called Ranbaxy in India. It's a pharmaceutical company that makes generic drugs and they filed against the patent on Pfizer. And as we went down that rabbit hole to understand what was going on, we realized there was this really interesting opportunity to go long a company in India and short Pfizer on the back of this patent challenge, and this was in I think around 2002, 2003. That example along with a number of other experiences that were very analogous to that really inspired us to say, hey, we want a product where we can follow these industries wherever it takes us. If it's a dynamic between a Korean company and a German company, we want to be able to take advantage of that.

So to follow the industries wherever the headquarters is regardless of the country. And to be able to do that long and short, those two attributes were really important to us to really leverage this approach. What we found also was that the greatest alpha was available in these smaller cap companies, and it's really because they're not well covered. The largest companies, the trillion dollar plus market caps, they have 60 analysts each company. When you get below 10 billion, the average is closer to six. It's a 10th the coverage, and it's just emblematic of how much coverage there is and how many eyeballs are actually looking at these companies.

Paul O'Connor:

So maybe for the listeners, can you explain your investment thesis and how this has evolved over time and where do you see the firm heading over the next five to 10 years?

Eric Almeraz:

We're very much fundamental bottom-up. I've been teaching at Columbia University in their investing program for over a decade, and I guess I've drunk the Kool-Aid a bit there, but at the end of the day it's really about cash flow for us. The one common factor throughout our portfolio, whether it's long or short, is we're interested in what's happening with the cash flows and that ties back into if a company has a strong barrier, strong moat to the business, returns on capital, the capital intensity, all the things you've probably heard from many other managers, but at the end of the day what we care about is cash flow and so we run every name through a discounted cash flow model. And that overarching philosophy really permeates the portfolio, as I said, long and short. We'll do our valuations. We do care a lot about growth as well in our names.

It's probably the best way to avoid a value trap is to be involved in something that's growing on the long side and the counter is also true on the short side. Names that might look cheap if they're shrinking often get even cheaper and cheaper. So that growth focus is also very important, but at the end of the day it's very much about cash flow. Now, to your question of how has that evolved over time or in the future, I don't think cash flow ever goes out of style, and I think what it does do is it helps you stay focused on what is maybe overstretched in the market. For example, when tech got really rich right after COVID, we traded out of a lot of those names and started looking at industrial names, which had gotten really cheap. It wasn't that we were making a sector call. It was simply where we were finding the best valued cash flows. And that's allowed us to move in between what might be considered cyclical areas versus more growthier, compounder areas. We like that flexibility because we think it keeps this strategy evergreen and there are enough names amongst those 19,000 that there's always something interesting happening somewhere in the world, either long or short, and we're able to take advantage of that.

Paul O'Connor:

What key metrics or indicators do you look for when evaluating an investment opportunity, and are there metrics specific to global small caps? I mean you've mentioned cash flow and cash flow is king, but what other metrics or indicators are you looking at?

Eric Almeraz:

You have to be pragmatic and you've got to be realistic about one, what the market is looking at. So I think if you're valuing something on cash flow, which we're always going to do, you also need to be aware of what the market is focused on. It might be some kind of multiple, like a PE multiple or EV EBITDA multiple. So from a valuation standpoint, we often will do two separate valuations. One a bit more multiples driven, typically based on whatever the convention is for that particular stock, and then of course we'll do our cash flow evaluation. There's a whole, call it a list, of factors you're going to take into consideration when you're doing that, many of which are qualitative. We want to talk to management, we want to understand what the capital allocation philosophy is of management. That's a key input into evaluating these companies. Doing a really thorough competitive analysis is extremely important too. Making sure that we understand who they're competing with, what the competitive advantage of the company is, et cetera.

So that type of work requires just a lot of phone calls and sometimes traveling around the world to really understand it. We're going to look at all the traditional financial metrics. Things like return on capital and margin development. I am kind of a stickler for incremental margins. Maybe that's something that I actually put a lot of value on, so it gives you a sense of just the mix of fixed costs versus variable costs and the potential of what the company can do as they grow to scale. That's a factor I think is important. But a lot of the KPIs are industry specific. It might be vehicle sales or unit measures of tonnage production or something like that.

Paul O'Connor:

We've certainly experienced volatility back in the market in 2025, and I guess really it's interesting that it's more driven by geopolitical events. In a market like today's, how do you navigate risk both on your long book and your short book while still finding growth opportunities?

Eric Almeraz:

Yeah. I'm going to assume that by risk you mean just general volatility in the market driven by whatever exogenous event is happening. The first thing that I always tell people is take a look at our track record. You've got 21 years that stretches back through the financial crisis, the housing crisis in 2008, 2009. You've got a track record of us investing through the European financial crisis or debt crisis. The whole COVID crisis as well. There's a lot of periods of pretty extreme volatility where you can see how we did and I think we held up quite well through all those periods. The way that we've done that, one aspect of that is just the virtue of the segment of the market we're operating in. We're not stuck in the hundred or 200 biggest companies the way I think a lot of managers that run just tons of capital might find themselves.

We have 19,000 different companies potentially to really sift through, and as I said earlier, there's plenty of ways to avoid or at least take advantage of what's working. An example of that recently was as the United States withdrew from NATO, the European countries began looking for other sources to procure all of the armaments that they were shipping into Ukraine and they actually turned to Korea to fill the gap. That's a perfect situation for us. It has nothing to do with the US politics or whatever tweet is coming out of the United States, and it is a dynamic between Korea and Europe, so there's really no direct tariff impact on any of that. We love situations like that where we don't have to make a call on that type of situation. The thing about these small cap names is ... And I've heard this statistic before. I haven't generated it myself, but I believe it. About 40% of small caps are actually losing money, and there's actually quite a bit of debt within small caps, but it's concentrated in the top 10 most indebted companies.

And when you think about that, what that means is there's just a lot of disparity amongst the different companies and if you go there and try to buy an index, of course you'll be exposed to that, but if you actually hire someone to pick through those stocks, it's not that hard to find some great companies. You just actually have to put in the work to do it. And I think you can avoid a lot of this macro top-down risk. You don't have to take interest rate exposure, you don't have to take a risk around tariffs, et cetera. You can find other ways to make money in this market.

Paul O'Connor:

And I guess the fact that 40% of the market are not turning a profit also gives you a fertile opportunity for shorting securities.

Eric Almeraz:

Absolutely. No, it's a fantastic place to short. I mean, I think that if you just consider the bad operators out there, maybe the fads and the frauds and the pumps and dumps type stocks, the vast majority of those are in the small cap space. So right there you're fishing in a pond that's rich with fish. I think there are also names that are not covered well. So a lot of times you can bring something to the story that others haven't necessarily seen. We had a pretty big short a couple of years ago, which we've continued on. It's been a very good theme for us in the renewables area where, like with a lot of industries, China has decided to completely dominate that market without any regard for making money, generating a profit.

So there's a whole list of companies within China within that supply chain, particularly around manufacturing solar panels, that have just massively overbuilt capacity and because of their government relationships and because they're not necessarily driven by economics, they continue to produce these products at a loss. And that dynamic created a lot of interesting shorts within China, but has also had an impact on companies around the world in that space and created all kinds of short opportunities all around the world, almost all of which are in that smaller cap sub-$10 billion space. And so you take a theme like that, you really understand it, you look at it from a global perspective, you can find all kinds of wonderful ways to make money from something like that.

Paul O'Connor:

I guess spending your life looking at the global small cap index, you must see a lot of emerging trends and technologies. So what are you particularly bullish on at present, Eric?

Eric Almeraz:

I don't know if it's so much a technology. Sometimes you see interesting regulatory changes. I mean, I'll give you a recent example that I think has some potential to generate some good returns. We started looking at the kind of archaic old industry of cement. It's not something you necessarily would think of as technology, but the cement industry in particular in Europe is an industry that's consolidated and it's probably 10 years behind the United States, which has become very consolidated. But it's consolidated so much that the companies are generating peak profitability, peak margins, despite only operating at 60% utilization, and that's really unusual in a cyclical industry like that. It's actually very difficult to transport cement, so if you build a plant and you're able to keep competition out of about a 300 kilometer radius, you develop what is essentially a monopoly in that region. What has happened in that market though, which is sort of the regulatory change that is interesting is there is essentially a carbon credit required by the European Union for anybody emitting carbon and cement happens to be probably the worst offender.

There's not a whole lot they can do about it because it's just part of heating up limestone. When you do that, it releases carbon and there's not a lot that the cement manufacturers can do to stop that. As they increase the burden of these credits, and they've been doing that by essentially removing free credits. Each year they remove more and more. The companies are having to buy these credits and the price is going up. So 120 euro ton cement actually requires another 35 euro of carbon offset in order to meet those regulations. That's raising the price of cement across Europe and it's keeping competition out. Nobody in their right mind would build a new cement plant in Europe knowing that they have spend that much money and the plan is for that price, that 35 euro a ton to continue going up significantly over time.

Some people are forecasting it could rise as much as triple or quadruple. Some firms have tried to build carbon capture plants. Heidelberg just did that in Northern Europe and it was extremely expensive. It required a lot of government subsidies to do it. And the scuttlebutt is that that cement is selling for triple or quadruple the price of standard cement just because it's so expensive to make and because there's demand for that type of cement. Over time, we think that the entire market is going to lift higher as a result of this. On top of that, in January of next year, they're going to introduce a carbon border adjustment, which means anybody importing cement into Europe will also have to start offsetting their carbon emissions, which is just going to further tighten that market up. Against this there also appears to be a cyclical upturn, maybe just the very beginnings of that in the building permits. And if we get peace in Ukraine, hopefully soon at some point here, that would be another source of demand which would even further tighten that market. And you can buy these stocks for eight, nine times earnings, which is just kind of shocking to me. I think there's some great investment opportunities in that space.

Paul O'Connor:

Maybe moving to everyone's favorite topic, AI, how do you see AI and machine learning impacting on investment strategies over the next decade?

Eric Almeraz:

It's really interesting. I mean, we don't use it to make any investment decisions. It's not tied into any kind of automated portfolio management or anything like that. That's not how we run our portfolio. I remember the days when people used yellow legal pads to build their spreadsheets by hand. I worked with some of those guys in my first job. Spreadsheets came out initially just through Microsoft DOS. It was just a black screen and people would type in numbers. It would slowly crank away and give you a result, and then they moved to Excel spreadsheets.

What it did was really just kind of I think make people more efficient. It allowed you to go beyond spending time writing these numbers out by hand so that you could do something more in an automated way. And I can see the germ of that really with AI and just being able to search the internet, for example, for information in a much more efficient way than Google can do that manipulate data in a way that would take you a lot longer to do in a spreadsheet. Things like that, some of these rote tasks get a lot more efficient with AI. From an investment standpoint, we've mostly looked at this as an opportunity to revisit a lot of power grid investments. We see that as a shortage that's just going to go on for a long time, and we've had a number of investments around that both in and outside of Europe, Asia and North America. I don't see why that's not going to continue.

Paul O'Connor:

And the power grid being linked to AI given the amount of energy that's required?

Eric Almeraz:

Correct. Exactly.

Paul O'Connor:

Okay. Contrarian investing requires, I guess detailed proprietary research plus a dose of courage. So does Apis Capital have a contrarian investment belief that you hold that others in the industry might disagree with?

Eric Almeraz:

It's an interesting way to phrase it and I talk a lot about this actually when I'm teaching too. The idea of being contrarian, I don't think it has to be that you have necessarily an argument with someone out there who's got an opposing thesis. I think a lot of it has to do with what metrics are you actually focused on? If you're obsessing about a PE ratio, but you are underestimating the long-term growth of a company, you're going to have too low of a PE ratio. And an example of that is when Microsoft in 1993, if you look at their financials, they were trading at about 30 times earnings, which was about double the market. It looked expensive. But the reality is you could have paid 200 times and you still would've made a 12% return every year for the next 30 years. It was about understanding how fast that company could grow, the returns on capital and the capital needs of the business and how much cash they were going to throw off, and really ultimately the potential for them to build their business on the back of the PC boom originally.

So when I think about contrarianism, it's really more about do you just have a different view than what's implied in the price? And if you can establish that view, then you can usually make money. We've had situations in the past where the earnings that we're estimating based on what we understand of the company are just dramatically higher than either what's being published by the sell side or what's implied in the valuation, and those are the best opportunities. That's always the best feeling when you find a situation like that. You just kind of know mathematically as your thesis plays out, you're going to make money.

Paul O'Connor:

So perhaps you don't need the dose of courage. You just need some conviction in your views.

Eric Almeraz:

Yeah, I think of it more as confidence rather than courage.

Paul O'Connor:

Maybe can you share a success story or even a challenging investment decision that's taught you a valuable lesson that you stays with you today?

Eric Almeraz:

I'll give you an example with an investment we did back in 2017, 2016 timeframe. We were looking at a market for silicon wafers, and these are the wafers that go into making computer chips. And I remember this was a market that I had looked at maybe 10 years earlier in 2007, 2008, and it had been about 10 years of downturn in this market. The market overbuilt capacity and really struggled to make money for many, many years. And I remember looking at this really just glancing at it. It was the kind of thing I would look at every year or two just to see if anything had changed. What I noticed was that the utilization of the factories was actually starting to approach full utilization. And really kind of on a hunch as I was living in China at the time, and I called one of the producers in Taiwan and I said, "Why are you not raising price?"

And he said, "We're actually thinking about doing that. We're telling our customers we're going to do it." And I said, "Does anybody believe you?" And he said, "No. They won't place orders. They still want to buy on spot. They don't believe we're going to raise price." And I said, "That's interesting." And so then I called the competitor in Japan. The one in Taiwan was called Global Wafers, and the one in Japan was called Sumco. I called Sumco and I asked them the same questions and they told me the same answer. And then I called the one in Germany. I got the same answer again. And the interesting thing about that, I guess the lesson if you will, was it took a really long time, it took many, many years for this industry to get to the point where it was ready to start raising pricing and you actually had to stay on top of it.

Because no one was covering this at the time. They had forgotten about all these names. The stocks were languishing. They were beaten up. The industry had consolidated a bit, which was a good sign, but the stocks had not reflected any of that. We started to put on some positions because we were learning that the price increases were imminent and you could do the math, and what was clear was that if they got even anywhere near what they had done in the prior cycle, the stocks were on low single digit multiples, just wildly cheap. The street might've been looking for two Euro a share for the German company, which was called Siltronic, and I maybe had six or seven in my estimates, which was much, much higher of course. They ended up doing over 10, and that was the power of that cycle, but you had to stay on top of the industry and really kind of check in with some frequency, and that was a bit of the lesson that I think stuck with me and I've continued to try to take advantage of it. Just spend a few minutes looking at something that hasn't worked for many, many years, can produce some pretty incredible opportunities.

The other thing that was an important lesson there was the managements had been through that downturn and all these people were pretty beaten up from having gone through that experience, and they did not want to go through it again. So when the cycle started to work again, all of them were very committed to not adding capacity. And I think that that was also something that was an interesting lesson. That these managements learn lessons from their past experiences and they do change their behavior over time.

Paul O'Connor:

Yeah. And I think that's a great example of proprietary research at the end of the day and getting to know companies, but also industries and different, I guess, themes that are playing through the industries.

Eric Almeraz:

Absolutely. Yeah. I couldn't agree more.

Paul O'Connor:

How do you determine when to take a long position versus a short position in a particular security? And I guess the focus more being, you've spoken a bit about what you look for in growth opportunities in securities. I'm particularly interested in how you determine a short position.

Eric Almeraz:

We actually have three different types of shorts that we look at. The first one is a melting ice cube. And if you think about a company that's really kind of in slow decline, we started looking or thinking about this framework going all the way back 10, 15 years ago after looking at a lot of companies in old media like newspaper companies. And when you looked at these at the time, they were really starting to just lose their prominence as a result of the internet and people moving to online media. The bulls in that space were looking at the valuation. They were looking at the cash flows and saying, "Wow. These companies are cheap. They should be longs." Despite whatever the headwind was. But what we discovered was that when you have a situation like that, the companies get really ... They tend to be caught flat-footed.

They have a hard time taking that cash flow and paying it out. They keep trying to reinvest it or save the business. And what might look cheap ends up resulting in just a lower and lower share price. And you can have situations where you've got a company with a 20% free cash flow yield that just looks wildly cheap, ends up going bankrupt just because of poor capital allocation decisions. And so those melting ice cubes I think have been a good source of returns on the short side over time. They often are companies that look cheap, but that are just slowly shrinking for some kind of competitive reason or displacement from a competitive product. The second group of companies is broken growth, and this tends to be cyclical companies or companies that were over earning. An example I like to give is Peloton, which as many people know, they make exercise bikes.

They sold an awful lot of these in COVID as people were stuck at home and the sales jumped up, the share price spiked up in anticipation of that sustaining. Of course it didn't. These ended up being coat racks for a lot of people in their living rooms and the revenues then collapsed after that. A situation like that is really about getting that inflection right and understanding what true underlying sustainable revenue and earnings are. The market oftentimes gets carried away with those types of names. They can be like a Peloton, like a fad, or even a cyclical company that's just overbuilt capacity. And then the third and the last category is really the battleground shorts. We think of these as sort of your obvious shorts. It doesn't even require a whole lot of deep analysis to understand that the business doesn't make a lot of sense, but they tend to be really volatile.

You think of like a space travel, something like a Virgin Galactic or something like that where it's just unlikely to ever be a viable business. The valuation doesn't really make sense unless a whole series of extraordinary events occur. And the issue with shorting those is really about volatility management so we tend to keep those extremely small. Those can be 10, 20 basis point type positions just in an effort to manage the volatility. Those were a fantastic source of returns for us in 2022 for example. We made money as a firm and it was really on the short side driven all by the short side and that category of names, many of those were down 70, 80, 90% that year.

Paul O'Connor:

So I'm assuming all of your short positions are individual stocks and you'll never short a country, for example, a country's small cap index.

Eric Almeraz:

Yeah, that's true. The only exception we would make is maybe like a 1% type placeholder if we felt like we were ... Within the hedge fund, I should say. If we had just a bit more exposure than we wanted in a country, but it would be a temporary placeholder. But the vast majority, 99.9% of our longs and shorts are all bottom up stocks selected to make money on a standalone basis. We don't do any pair trades, we don't do any merger arb or anything like that, and everything is a plain stock. We're not doing any kinds of derivatives or any securities like that.

Paul O'Connor:

So risk management is a key component of any active investing, but I guess even more so when you're managing a short book of securities. What are some of the key risk management strategies that you use when managing the long/short portfolio, Eric?

Eric Almeraz:

Sure. I mean, I think obviously there's a few important strategies, but one of the most important is make sure that what we're doing is liquid. We're pragmatic people and we know that you're going to make mistakes and you want to be able to make sure that you're not stuck with them. And so liquidity is key. You also have to keep in mind in small cap, obviously you're investing with other people and sometimes they decide they just have to get out for whatever reason. Might not have anything to do with fundamentals. So liquidity is also, or is always, I should say, an important feature of the names that we're involved in. That's why I said earlier, we're only involved in publicly traded equities and everything that we have trades every day. I think the other thing that I would say that we've just learned over time is incrementalism is really important, and it goes along with that pragmatism.

We don't jump into something full-fledged right away. We will slowly step into it and if it's working, we typically will add to it. So there's a little bit of a momentum approach to managing the exposure. If it's not working we'll typically starve it or reduce it. Again, there's not a hard and fast scientific rule to this, but generally as we're just adding and reducing positions over time, you'll see an ebb and flow towards the names that are working and away from the ones that aren't. That helps with the risk management too. I think that everybody knows that the momentum tends to sustain over time, and I think being incremental helps to address that. We have very few hard and fast rules. We actually started this strategy obviously 21 years ago when we launched. We've never had to make any significant changes to this strategy, but we've evolved over time.

Some of the things that we've learned is not to cut your flowers in the bloom. So if you have something that's working really well, it gets up to your target price, instead of just kicking it out all of a sudden because it hits your target price, make sure you go back and really understand the assumptions that you've made. Make sure you really understand the inputs into the model and understand what's implied in the valuation. There've been times when something has hit a target price and we really take a very close look at it and appreciate maybe there's a lot more upside, maybe we're wrong about the outlook and we're just being too conservative. And that's helped us to make some pretty significant money over the years. Also, when the thesis changes, you've got to move on. We document everything. We're very big on documentation, so whenever a name goes into the portfolio, we make sure that it is written down exactly why it's there.

We write down our assumptions, our argument for the thesis. We'll put down our financial forecasts. And each analyst has to do that for their name, including myself and including Dan. And we sit down at the end of the year and we go through those one by one and we talk about why we were in that position, what worked, what didn't. And really it's an effort to learn from our mistakes, to evolve and to make sure that there's no thesis creep. You don't want to buy a name, watch it, get cheaper, and then try to rationalize why you should stay there. Sometimes when the thesis changes, you just have to move on.

Paul O'Connor:

I guess it holds you and the whole investment team quite accountable as well having that clearly documented the thesis behind the positions you've taken in securities. So certainly makes sense to me there, Eric.

Eric Almeraz:

Absolutely, absolutely. No, it's an important exercise that we go through as a team.

Paul O'Connor:

Maybe in the interest of time, we'll close the podcast, but as a final question, how do macroeconomic factors such as interest rates or geopolitical events influence your long-term strategies and positions in portfolios?

Eric Almeraz:

It's always a question that comes up because of course, we're looking globally at these securities and we're typically involved ... I should mention we're typically involved in the more developed Asian countries. So you'll find a big presence in Korea, Taiwan, and Japan. We'll occasionally do something small in a place like Hong Kong on the long side, but for the most part, Chinese positions have been on the short side. And we'll look occasionally throughout Southeast Asia or in Australia, but generally it's Korea, Japan, Taiwan. And then Western Europe is the second area of focus, and it's all the typical countries you'd expect in Western Europe. And then of course, North America. You don't generally find us in the emerging markets, Latin America, Africa, of course, or Middle East. You're not going to find us active in any of those areas. So when we think about macro, I just wanted to frame it in the context of those countries.

What we do to address that is we've got a macro checklist. It's essentially about 15 indicators that we look at once a month as part of a portfolio review. We spend a day going through the portfolio review and look at each name, and we start that conversation with a discussion of our checklist. And on that checklist is really just lead indicators. We want to talk about what's working and what's not in the world. The idea behind that is not to necessarily position ourselves, but it's to understand where we're exposed and where we have headwinds versus tailwinds to our portfolio. And as we talk about the names in the portfolio, we'll talk about what's happening maybe at a macro or a geopolitical level within that country so that we appreciate and understand that exposure and we can measure it. But beyond that, we don't spend a whole lot of time thinking about our macro calls. We don't think we bring a whole lot of edge to that.

Paul O'Connor:

I guess fraught with danger, trying to run a portfolio based on a view on the global economy or a geopolitical event. So I can certainly appreciate your comments there, Eric. But thank you very much for joining us on today's NetWealth Portfolio Construction podcast. Been a really interesting discussion there. I think you really articulated well about the breadth of the global small cap index and hence really the opportunities for active management in taking both long and short positions there. So I found the discussion really interesting, Eric, there. And also particularly too, I have wondered over the years why there are a small amount of global small cap strategies available on our investment menu compared to mid and large cap strategies. I mean, we'd have a handful of small cap global small strategies, but we have thousands of mid and large cap type strategies there. So I think you've articulated it well that it really is the domain for boutique managers due to the capacity issues. So thanking you, Eric, for your time and your insights this morning.

Eric Almeraz:

Absolutely, and I appreciate your time, Paul. Thank you so much for taking the time to speak with me.

Paul O'Connor:

To the listener, I hope you've enjoyed today's installment of the podcast and got a bit of value out of the discussion between Eric and myself. I wish you all a great day ahead and look forward to you joining us on the next installment of the podcast series.