Wild Lions and Zoo Animals: The Case for Skin in the Game: QAV AU #930

QAV AU 930, U.S. 63 — Haren Bhak­ta

[00:00:00]

Cameron: Well, wel­come back to QAV. This is, an inter­view that I’ve been look­ing for­ward to for a cou­ple of weeks, wel­come to the show, Haren Bhak­ta from insideownership.com, com­ing to us from Orange Coun­ty in Cal­i­for­nia.

Wel­come to QAV, Haren.

Haren Bhak­ta: Thanks for hav­ing me on

Cameron: Ah, it’s a, it’s a, a priv­i­lege and an hon­or, sir. So why don’t you tell every­one quick­ly what insideownership.com is about, and then we get into it

Haren Bhak­ta: Sure. Well, I cre­at­ed a stock mar­ket index sim­i­lar to the S&P 500 in that, uh, it tracks the per­for­mance of the 100 largest com­pa­nies from the S&P 500 based on, uh, the phi­los­o­phy of s- skin in the game. So the, the lead­ers of the orga­ni­za­tion own a large dol­lar val­ue, and we take the 100 largest from that [00:01:00] sub-sec­tor of, of the S&P 500

Cameron: And what prompt­ed you to do this exer­cise, Haren?

Haren Bhak­ta: Yeah. Well, it all start­ed because I attend the Berk­shire annu­al meet­ings every year since 2017. I’m a huge War­ren Buf­fett fan. I bought a lot of Berk­shire Hath­away because I believe in War­ren Buf­fett and his skills and invest­ment phi­los­o­phy, and I’ve got­ten so much from him. So I was sit­ting in the meet­ing in 2024 when I thought of the idea, and, um, I was sit­ting there in the back of my mind, uh, with a gen­uine fear.

What am I gonna do with Berk­shire Hath­away when War­ren Buf­fett dies? I don’t believe in the com­pa­ny the same way with­out him. I mean, it, you know, he’s cre­at­ed this, this beau­ti­ful com­pa­ny with, you know, beau­ti­ful prin­ci­ples and cul­ture, and, uh, I just don’t [00:02:00] believe in the com­pa­ny the same way with­out him.

And 2024 was the first meet­ing with­out Char­lie Munger. He had passed away, like, five, six months ear­li­er. So I was sit­ting there afraid, and at some point dur­ing the meet­ing, it hit me that the S&P 500 will actu­al­ly be buy­ing more Berk­shire Hath­away when War­ren Buf­fett dies. And the rea­son for that is the S&P is what’s called free-float adjust­ed mar­ket cap, mean­ing they exclude his shares when they count the size of Berk­shire.

But when he dies, those shares will be labeled free-float­ing or, you know, they’ll be dis­trib­uted to foun­da­tions and sold and become free-float­ing shares. There­fore, the S&P will be buy­ing or expand­ing the mar­ket cap of Berk­shire. And I just thought, who in their right mind would want more Berk­shire Hath­away after War­ren Buf­fett?

We should want more with him. In the same respect, um, [00:03:00] we should want more Tes­la with Elon Musk and, and not so much with­out him, right? Who would want more Tes­la with­out Elon? Who would want more Meta with­out Mark Zucker­berg? Or more Ama­zon with­out Jeff Bezos, right? We want to ride these guys’ coat­tails, and when they’re not part of the orga­ni­za­tion any­more, we prob­a­bly don’t want as much expo­sure to them.

So I came home and decid­ed to launch an index that reflects that, that we’re, we’re on the same side of the table as these, uh, super val­ue-cre­at­ing CEOs.

Cameron: And you, you don’t have a lot of faith in Greg Abel’s, uh, admin­is­tra­tion of Berk­shire Hath­away then? Did you sell when War­ren retired at the end of last year?

Haren Bhak­ta: No, War­ren Buf­fett is still, he may not be the CEO, but he, he, he’s still in the office every day. He still made a huge, uh, cap­i­tal allo­ca­tion deci­sion recent­ly. He put, I believe, $30 bil­lion into [00:04:00] Google or Alpha­bet, and that was his deci­sion. So he’s still very much involved. So, you know, it’s not this fast-mov­ing thing where I see where a CEO like War­ren Buf­fett could retire and all of a sud­den, uh, the com­pa­ny goes to shit, or, you know, um, I don’t know if I can say that word or not.

But basi­cal­ly, it’s a slow-mov­ing thing where cul­tures slow­ly fade and erode. And with­out War­ren Buf­fett, right now, he’s still part of the, the com­pa­ny, but once he leaves, we will slow­ly see the cul­ture erode of Berk­shire. And not just that, so they’ve always made good acqui­si­tions, and they have some nice, you know, good high-return­ing, uh, on cap­i­tal type of com­pa­nies.

But these type of acqui­si­tions are not gonna come in the way to Greg Abel. N- there’s a lot of founders that sold their busi­ness­es to Berk­shire [00:05:00] because they want­ed War­ren Buf­fett to be the own­er. Specif­i­cal­ly, Berk­shire was the only, uh, play in town for them. They did­n’t wan­na sell to pri­vate equi­ty. They did­n’t want to auc­tion off their busi­ness.

They want­ed a per­ma­nent home in Berk­shire, and that, War­ren Buf­fett built that rep­u­ta­tion. Now, I don’t believe Greg Abel’s gonna get those oppor­tu­ni­ties unless, you know, he has to build that him­self, but that’s, that remains to be seen. So they’re not gonna get that future, uh, cap­i­tal deploy­ment that War­ren Buf­fett was able to deliv­er by get­ting these acqui­si­tions at very rea­son­able prices, where pri­vate equi­ty would’ve had to pay much high­er prices, but these own­ers did­n’t wan­na sell to pri­vate equi­ty

Cameron: Fair points you make there, Haren.

Haren Bhak­ta: Yeah

Tony Kynas­ton: Yeah, there’s a lot of good things to talk about here. Um, I guess my first ques­tion is, you, you men­tioned a num­ber of large com­pa­nies there which are big [00:06:00] play­ers in the S&P 500 any­way. What kind of over­lap is there between your index and the S&P 500?

Haren Bhak­ta: There’s a lot of over­lap. So I w- I would, I would con­sid­er the S&P 500, or I should say the Inside Own­er­ship 100, which is my index. I con­sid­er that basi­cal­ly the S&P 500 with the skin in the game fac­tor. So for exam­ple, Nvidia, Google or Alpha­bet is the largest posi­tion, and sec­ond is, is Nvidia in my index, and then you got Ama­zon, Meta, and Tes­la.

So it does look a lot like the S&P, only that we sig­nif­i­cant­ly over­weight some of these com­pa­nies where the, the own­er­ship is high and sig­nif­i­cant­ly under­weight or exclude com­plete­ly some of the com­pa­nies where there is no own­er­ship left. So for exam­ple, Microsoft. Microsoft is not in the index because, uh, there is no own­ers left at Microsoft.

Bill Gates is, [00:07:00] is com­plete­ly removed and, um, the, the board and CEO, um, yeah, they’ve, they’ve done well, but, um, they also don’t own any shares. So what we see is, um, as the world changes, uh, they may not par­tic­i­pate in that change because it real­ly takes own­er­ship to cre­ate dis­rup­tion and inno­va­tion. That’s what I find.

And, uh, when the world changes, these low own­er­ship com­pa­nies get left behind. And I have a lot of exam­ples which we can get into

Tony Kynas­ton: Sure. So what, what kind of, um, per­for­mance dif­fer­ence then is there between your top 100 and a com­pa­ra­ble S&P index?

Haren Bhak­ta: Yeah. Well, the Inside Own­er­ship 100, now it’s only been live two years, right? I only thought of the idea in, in, uh, 2024. So pri­or to 2024, this is, this is, uh, back-test­ed. Now, this is not, uh, some com­pli­cat­ed algo­rithm, uh, that we, you know, reverse engi­neered. This is sim­ply tak­ing the own­er­ship [00:08:00] of the, the lead­ers of the orga­ni­za­tion and allo­cat­ing the port­fo­lio accord­ing to that own­er­ship.

So, um, we went back to 2004 till today, and what we dis­cov­ered is that, uh, $10,000 invest­ed in the S&P would have been around $75,000 by the end of 2025. $10,000 in the Inside Own­er­ship 100 would have been $110,000. So I had more than 300% in cumu­la­tive out­per­for­mance over that time peri­od

Tony Kynas­ton: Right. And so you’re rebal­anc­ing your index at the same time as the S&P rebal­ances, or is there some oth­er method?

Haren Bhak­ta: Exact­ly. We use the same rebal­ance sched­ule, so we’re, we’re bal­anc­ing on the third, the third Fri­day of, uh, every quar­ter. So

Tony Kynas­ton: Right

Haren Bhak­ta: yeah, March, June, Sep­tem­ber, and Decem­ber

Tony Kynas­ton: And I under­stand you’re launch­ing an ETF to allow peo­ple to invest in your index going for­ward

Haren Bhak­ta: The ETF is launched. The ETF launched,

Tony Kynas­ton: [00:09:00] Okay

Haren Bhak­ta: yeah, the ETF launched about a month and a half ago.

Tony Kynas­ton: Okay, good.

Haren Bhak­ta: Yeah. The ETF is live. The tick­er sym­bol is O‑W-N, OWN. Yeah. Own­er­ship, so it, it was a per­fect. I was actu­al­ly quite sur­prised the tick­er sym­bol was avail­able

Cameron: Yeah, nice grab

Tony Kynas­ton: What, what do you attribute to this out­per­for­mance by own­er founders? Why do they per­form bet­ter? Why, why was Microsoft bet­ter under Bill Gates than it is under who­ev­er runs it now?

Haren Bhak­ta: Well, I think this guy named Sam Hinkie said it best. He said peo­ple are pow­er law, and the best ones change every­thing. So peo­ple are pow­er law. So even the index­es, the, the indi­vid­ual stocks with­in the index in them­selves are pow­er law dri­ven. So there’s this Uni­ver­si­ty of, uh, sor­ry, Ari­zona State Uni­ver­si­ty pro­fes­sor who did a study.

He stud­ied all US stocks over the course of 100 years, over a cen­tu­ry. [00:10:00] What he dis­cov­ered was that 4% of all stocks deliv­ered all the wealth cre­ation over that 100-year peri­od, and the oth­er 96% deliv­ered or matched US Trea­suries. So it’s amaz­ing. So, you know, we see that play­ing out today. We see the, the Mag Sev­en real­ly car­ry­ing the results of the entire index.

So it’s not sur­pris­ing to us or, you know, to me to see that, uh, you know, stocks are dri­ven by the few minor­i­ty, right? It’s, it, it. And, um, this is why it’s very hard to beat the stock mar­ket for stock pick­ers, right? Because, you know, we, we. I, I think I prob­a­bly used to think that, uh, you know, half the stocks under­per­form and half the stocks out­per­form and, you know, it’s 50/50.

But no, that’s not the case. It’s real­ly 4% deliv­er­ing all the extreme gains while every- every­body else is kin­da just earn­ing trea­sury rates, right? Um, but where acad­e­mia got it half right [00:11:00] or half wrong is that humans exhib­it even big­ger pow­er laws. So the few extra­or­di­nary lead­ers real­ly change the world.

And what we see is, you know, you got the Jeff Bezos­es, like I men­tioned, um, Bill Gates, um, you know, Steve Jobs. They’re able to ral­ly peo­ple around them and cre­ate some­thing new and dis­rup­tive, and it changes the world. And, um, Apple is real­ly the only one that I could see where post-Steve Jobs, the, the com­pa­ny had con­tin­ued to do well.

They’re the excep­tion to the rule. But what I found is that there has been cas­es where a, a super CEO, as I call them, could pick a suc­ces­sor. How­ev­er, I have not found a case yet where the suc­ces­sor could pick their suc­ces­sor and have it turn out well. I have not been able to find one yet. And I’m sure there, there, there must be some­thing [00:12:00] out there, but there has­n’t been some­thing that’s, that, that’s been, um, enor­mous any­way.

And, uh, there’s a lot of cas­es where, uh, the. once the, the, the guy respon­si­ble for the suc­cess of the orga­ni­za­tion leaves, the com­pa­nies com­plete­ly erode. And the best exam­ple I have is IBM. So IBM in 1984 was the largest com­pa­ny in the world by a fac­tor of two and a half. It was more than two and a half times larg­er than the next largest com­pa­ny in the entire world.

This is how dom­i­nant it was. So this would be like Nvidia being a $12 tril­lion com­pa­ny today, right? It was dom­i­nant. And, um, a lot of peo­ple don’t know this about IBM, but, you know, Thomas Wat­son Sr. found­ed IBM, but it was his son, Thomas Wat­son Jr., that took IBM pub­lic in the ’50s. And he ran the com­pa­ny as CEO until [00:13:00] 1971, but he remained on the board until 1984.

So 1984, like I men­tioned, uh, peak IBM, two and a half times larg­er than the next largest com­pa­ny. He retires in 1984, so own­er­ship leaves. Fast-for­ward eight years, IBM is not even in the top 10 any­more. Just eight years, we’re talk­ing about the most dom­i­nant com­pa­ny to ever exist, is not in the top 10 eight years after Thomas Wat­son Jr.

retires, right? Now, today, IBM is not even top 25. And, um, anoth­er exam­ple I have is Intel. Intel was run by, uh, Andy Grove as CEO in the 1970s. Now, had you invest­ed $10,000 when he became CEO, 10,000 turned into sev­er­al mil­lion by the time he retired in 1998. In 1998, Intel had 90% mar­ket share for the PC micro­proces­sor busi­ness, right?

They were dom­i­nant. They were a monop­oly. He even wrote the [00:14:00] book, um, Only the Para­noid Sur­vive. It’s, it’s a great book. I r- I rec­om­mend that one.

Tony Kynas­ton: Mm-hmm.

Haren Bhak­ta: It’s about, uh, strate­gic inflec­tion points. And any­way, he retires 1998. Fast-for­ward 27 years today, Intel has done noth­ing, right? It’s, it’s a flat stock. Uh, zero returns for 27 years.

So this is what I mean when those respon­si­ble for the suc­cess of an orga­ni­za­tion leave, the com­pa­ny is, is not the same. Now, we see Nike today. Nike stock, uh, Phil Knight retired about four years back, uh, com­plete­ly gone from the board and every­thing. Nike stock is down 70% from its high. We’re talk­ing about the biggest bull mar­ket in, in stock mar­ket his­to­ry, and the, the, one of the biggest and bright­est world-class brands Nike is, is down 70% post-founder.

So this is what I mean when, when those respon­si­ble for the suc­cess of an [00:15:00] orga­ni­za­tion leave, it’s not the same com­pa­ny

Cameron: Is there a cer­tain amount of sur­vivor bias in this though, Haren? Like, there are, um, plen­ty of exam­ples of founder-led com­pa­nies that explod­ed or implod­ed. Um,

Haren Bhak­ta: Yeah. Yeah

Cameron: you know, one of the more recent ones. Adam Neu­mann sort of destroyed that. I, I, you know, I’m, I’m an ex-Microsoft guy, so I, I, I can go back to ’90s and 2000s era com­pa­nies, but Black­Ber­ry was one that was

Haren Bhak­ta: Black­Ber­ry, the founders had retired when they blew up, by the way.

Cameron: Mike

Haren Bhak­ta: founder.

Cameron: Lazaridis,

Haren Bhak­ta: yeah, they found, they, they left in 2012, I believe, and in 2013, um, or 2012, Thorsten Heins, I believe that was his name, took over Black­Ber­ry and, lev­ered up the com­pa­ny. What’s that?

Cameron: rev­o­lu­tion though, right? 2007,

Haren Bhak­ta: [00:16:00] they, did, but they did­n’t.

They, they missed it, but they did­n’t implode. Now they implode after the founders left, right? Um, in fact, the founder, we’re talk­ing about a $5 bil­lion com­pa­ny at, at, at its like, um, around 2013, I believe. It, it could have been maybe a $10 bil­lion com­pa­ny. But the founder want­ed to s- get out of the phone busi­ness and cre­ate what he said a text mes­sage 2.0, and what he meant was what What­sApp became.

What, what, what became What­sApp.

Cameron: Yeah

Haren Bhak­ta: uh, you know, What­sApp even­tu­al­ly sold for, for $19 bil­lion to, to, to Meta. So he had the right idea. He want­ed to get out of the phone busi­ness because he knew he could­n’t com­pete with, with Apple. And, uh, when you get non-own­ers who, uh, think com­plete­ly inside the box, um, they, you know, that’s all they know, so then that, that’s what they wan­na do.

They wan­na run with, [00:17:00] with, uh, the phone busi­ness when, um, the founders knew that, that they could­n’t com­pete, and the founders resigned and sold their stock in 2012

Cameron: You’ve also got A- Apple 1.0 too, when Steve was uncer­e­mo­ni­ous­ly shown the door, uh, in 1986 or when­ev­er it was, when the Mac­in­tosh lost a lot of mon­ey and did­n’t work. You got Pelo­ton, you’ve got Under Armour, you’ve got. So I guess my ques­tion is,

Haren Bhak­ta: Yeah, so own­er­ship, yeah, so to, to answer your ques­tion, own­er­ship is not a panacea, but, but what I. It’s not a sil­ver bul­let, no. But nei­ther is mar­ket cap, right? The S&P is focused on mar­ket cap, we’re focused on the insid­er. So it’s not a panacea, it’s not a sil­ver bul­let. But I looked at every sin­gle hun­dred bag­ger, and a hun­dred bag­ger means that a stock went up 100 times your mon­ey.

So you invest $10,000, it turns into a mil­lion. And I looked at, um, every one I could [00:18:00] find between the year 2000 and 2025. I, I found 21 of them. So we had Trac­tor Sup­ply, um, obvi­ous­ly NVIDIA, Net­flix, uh, Mon­ster Bev­er­age, Apple, uh, Ama­zon, Google, um, uh, O’Reil­ly’s, the car, uh, parts com­pa­ny, uh, Uni­ver­sal Insur­ance, some small com­pa­ny, uh, Wis­domTree, which was like ETF com­pa­ny at the time.

Uh, every sin­gle one except for two, uh, two, uh, out of the 21, 19 of them had own­er­ship above 5%. So while own­er­ship is not the panacea, um, it’s not the sil­ver bul­let, but it’s required, almost required to have extreme out­lier returns. So y- you’re not guar­an­teed to get high returns from own­er­ship, but you’re vir­tu­al­ly guar­an­teed not to get it with­out it

Tony Kynas­ton: It’s a good way of look­ing at it.

Haren Bhak­ta: [00:19:00] Yeah

Tony Kynas­ton: D- so, so what’s the, what’s the secret sauce in, in insid­er own­er­ship that’s dif­fer­ent to a board of direc­tors who, you know, did­n’t come up with the com­pa­ny? is it

Haren Bhak­ta: Yeah. Yeah. Well, yeah, I, I

Tony Kynas­ton: can dis­rupt their own com­pa­ny? Do they, do they feel like they can take longer term bets?

What, what do you think is the rea­son?

Haren Bhak­ta: I think the, the lat­er part what you said, so i‑i-it’s that when you’re a board with no own­er­ship, you are judged every quar­ter, you are reward­ed for every quar­ter or every, or every year, and you tie your bonus­es to, you know, annu­al met­rics, you begin to think annu­al­ly.

Cameron: Short-ter­mism.

Haren Bhak­ta: sig­nif­i­cant out­lier returns, you can­not think annu­al­ly.

You have to think in decades. So Jeff Bezos, for exam­ple, is very com­fort­able fail­ing on projects in the near term because he knew. He was per­fect­ly fine tin­ker­ing, what’s called tin­ker­ing, to, to [00:20:00] inno­vate, you have to tin­ker. You have to have small errors, and small errors reduce your, your, your, uh, quar­ter­ly per­for­mance, right?

Your num­bers. And he was per­fect­ly fine not show­ing a prof­it for, for two decades, but he knew he’s cre­at­ing enor­mous val­ue. In the same way Mark Zucker­berg has poured hun­dreds of bil­lions of dol­lars, um, into, uh, well, I, I should say t‑tens of bil­lions of dol­lars into failed projects like, uh, the Meta­verse, right?

Um, but, uh, he’s able to think long term, and he’s able to make these cap­i­tal allo­ca­tion dec-deci­sions and piv­ot when they’re wrong. Um, Ama­zon failed with the Fire Phone, but they tin­ker and tin­ker, and then you end up with AWS. So Jeff Bezos built two world-class com­pa­nies. A lot of peo­ple don’t talk about that.

He built, yes, the, the Ama­zon retail store, which is genius in, in and of itself, but he also cre­at­ed AWS, right? [00:21:00] Um, and that comes from tin­ker­ing. It comes from tri­al and error and, um, short feed­back loops. So that’s how you cre­ate inno­va­tion, is hav­ing these short feed­back loops. And in order to have short feed­back s- loops, uh, peo­ple work­ing direct­ly on the prob­lem need to be deci­sion-mak­ers.

And this is why you can’t inno­vate through com­mit­tee. You can’t, uh, inno­vate through a board­room vote. It, it, it comes down to a sin­gle per­son work­ing on the prob­lem, and very often these peo­ple, these founders are the ones who cre­at­ed the ini­tial prod­uct in the first place, under­stand and are able to com­mu­ni­cate with, with those around them w‑working direct­ly on the prob­lem, and there’s not like 18 lay­ers between them and, and the peo­ple direct­ly work­ing on it

Tony Kynas­ton: Do you think there’s also some kind of, uh, insti­tu­tion­al for­give­ness for own­er founders? What I mean by that is, why could­n’t a com­pa­ny, say, for exam­ple, Berk­shire Hath­away [00:22:00] after War­ren goes, why could­n’t Greg Abel say, “I’m not gonna give quar­ter­ly fore­casts. judge me on my quar­ters. I’m gonna take decades long views of this com­pa­ny.”

Why, why could­n’t he then be as good as War­ren Buf­fett? Is it because War­ren gets the chance to try, fail, try, fail, and the share­hold­ers still flock to every year?

Haren Bhak­ta: Well, with War­ren Buf­fett, he cre­at­ed Berk­shire by cap­i­tal allo­ca­tion. He did­n’t real­ly invent any­thing, although he kind of invent­ed a way of cap­i­tal allo­ca­tion with, with the insur­ance busi­ness and using float, and no one real­ly had done that before. So, um, I think Greg Abel is more of a, uh. What do they call that?

They call that a, uh, a care­gi- care­giv­er or care­tak­er, I should say. Sor­ry. Care­tak­er. He’s, he’s a care­tak­er, right? Now, he could­n’t have cre­at­ed a Berk­shire him­self, right? [00:23:00] Uh, obvi­ous­ly ’cause he did­n’t. But, uh, he is a hard­work­ing guy, com­plete­ly dif­fer­ent from War­ren Buf­fett. War­ren Buf­fett is a cap­i­tal allo­ca­tor.

He com­plete­ly stayed out of the busi­ness­es that he pur­chased. To the fact of abdi­ca­tion, so, um, some­one asked War­ren Buf­fett back in, I think it was like 2005, he asked him at the annu­al meet­ing, “You know, you guys own 11% of Amer­i­can Express, yet your fur­ni­ture store, which you guys own 100% of, does­n’t accept Amer­i­can Express.

How does that make any sense? Like, why?” And War­ren Buf­fett had a sim­ple answer. He says, “I don’t tell my sub­sidiaries what to do.” And that’s how far r- removed he was, and he said that, “When I find a, a bat­ter that can bat 400, I’m not gonna tell him how to hold, how to hold the bat.” And, uh, Greg Abel is telling his bat­ters how to hold the bat.

So it’s not gonna be the same com­pa­ny post-War­ren [00:24:00] Buf­fett. It’s not, ’cause he g- uh, War­ren, uh, he’s get­ting involved. In fact, if you read the last annu­al let­ter, he talks about how he hired a, um, in-house coun­sel. Now, War­ren Buf­fett nev­er had an in-house lawyer, and, um, so we see the cul­ture already shift­ing.

War­ren Buf­fett pre­ferred one-page or maybe two pages at the most type con­tracts. H- he’d nev­er had these long, lengthy con­tracts with, with, um, you know, when he bought a com­pa­ny or when he, uh, c- came up with a com­pen­sa­tion plan for a pur­chased, uh, sub­sidiary. He would have these one-pagers, and that’s it. Uh, and it’d be more of a hand­shake type of deal.

But, you know, um, that’s War­ren Buf­fett. He, he was able to do that. Uh, you know, uh, we can’t expect Greg Abel to do that ’cause he does­n’t have the skills for that. But, um, I’m sure he’ll, he’ll take care of the com­pa­ny just fine, but can we real­ly [00:25:00] expect, uh, the type of, of, uh, future per­for­mance, um, that maybe, uh, War­ren Buf­fett could have.

You know, a young War­ren Buf­fett with today’s Berk­shire at its size, I believe would’ve still cre­at­ed enor­mous val­ue. Um, but, uh, you know, maybe, I think a young War­ren Buf­fett today at, at Berk­shire’s size today would turn Berk­shire into the largest com­pa­ny in the world. Um, there’s vir­tu­al­ly impos­si­ble for Greg Abel to do that.

He’s gonna

Tony Kynas­ton: do you think there’s also an ele­ment of risk-tak­ing that’s, that’s there with War­ren that’s not there with Greg? And, um, I’m pick­ing these as kind of hypo­thet­i­cal exam­ples real­ly,

Haren Bhak­ta: So while War­ren Buf­fet­t’s alive, um, I believe that if the mar­ket, uh, had a huge cor­rec­tion, uh, a big mar­ket c- cr- uh, crash, I believe that, um, they could make a $200 bil­lion acqui­si­tion, like one [00:26:00] shot, one big com­pa­ny, $200 bil­lion, here’s a check, um, now it’s our com­pa­ny. There’s no way Greg Abel would ever make any­where near that size of acqui­si­tion, um, ever.

Uh, so yes, while War­ren Buf­fet­t’s alive, they may still get some big ele­phant and, um, you know, obvi­ous­ly he’s not gonna do it now where, where equi­ty prices are, but they will make a huge acqui­si­tion if we were to get a 2- uh, 2008 or, um, a 2000 type cor­rec­tion, you know. Uh, they will make a big acqui­si­tion, but a Greg Abel will make a bunch of tiny ones, um, if, if, if War­ren Buf­fet­t’s not around

Tony Kynas­ton: You, uh, do you have any red flags that you put on the behav­ior of own­er founders? We’ve had a cou­ple of exam­ples in Aus­tralia where com­pa­ny run by its founder has, uh, basi­cal­ly implod­ed because the founder’s become [00:27:00] dis­tract­ed because they’ve let per­son­al issues, um, you know, uh, and, and bad cor­po­rate gov­er­nance over­whelm the busi­ness and the, and the shares have gone down dra­mat­i­cal­ly. Do you screen for any kind of bad behav­ior or strate­gic changes, uh, in your index?

Haren Bhak­ta: Yeah. Well, for one, I cre­at­ed a pas­sive index. So I’m tak­ing the S&P 500 and t- just sim­ply tak­ing the top 100 from there based on, on the dol­lar val­ue of own­er­ship and pro­por­tion­al­ly weight­ing the port­fo­lio accord­ing to that dol­lar val­ue. So it’s very sys­tem­at­ic, it’s rules-based. We’re tak­ing the emo­tion out of it.

So I don’t make any addi­tion­al screens. But one thing I could tell you is that a lot of entrench­ment and, uh, bad cor­po­rate gov­er­nance takes place with a lot of high own­er­ship com­pa­nies in, in the small cap and mid cap are­na. By the time a com­pa­ny reach­es the S&P 500, it does­n’t. I, I, you don’t see that entrench­ment [00:28:00] where with founders and, uh, uh, uh, big own­ers, um, uh, very often in, with­in the S&P 500 cohort.

You get that entrench­ment more so in small cap land, and the rea­son for that is to get large cap, to become a large cap, you real­ly have to have it fig­ured out, right? Um, you, you, you don’t get to be a $100 bil­lion com­pa­ny and, um, you know, uh, have the wrong kind of behav­ior as a founder-led com­pa­ny. Now, um, you do see entrench­ment form, uh, once those founders leave, um, and you get, uh, entrenched boards and what­not who own very lit­tle stock with their own mon­ey, but con­trol these mas­sive com­pa­nies.

And, um, that actu­al­ly, that points me to a huge sys­temic prob­lem that’s tak­ing place right now, is that cor­po­rate Amer­i­ca and the US is being con­trolled by three share­hold­ers who don’t vote any­more. So [00:29:00] Van­guard, Black­Rock, and State Street are tak­ing extreme mar­ket share from stock, um, investors or active man­age­ment and indi­vid­ual stock pick­ers as well.

So what we’re get­ting is that 25% of cor­po­rate Amer­i­ca, they’re now the largest share­hold­er who, who does­n’t vote. So War­ren Buf­fett talked a lot about, um, how mediocre CEOs are the biggest val­ue destroy­ers, and the rea­son for that is mediocre CEOs stay in for a very long time. You know, if you have a bad CEO, uh, they typ­i­cal­ly get replaced.

How­ev­er, that was, he said that back in 1997. Today, you could have a ter­ri­ble board who own no shares on their own, uh, be per­ma­nent­ly locked in because there’s no longer a mech­a­nism to remove them. No one votes any­more, so, um, they auto­mat­i­cal­ly vote for incum­bents. So it’s very hard for activism to [00:30:00] replace a ter­ri­ble board, and this is a huge skin in the game prob­lem that I, I, I don’t think enough peo­ple are talk­ing about

Tony Kynas­ton: Yeah, right. I c- I can see that. Um, do you take the type of share that the own­er has into account? Like if they have a, a, a class A share ver­sus a class B share. So are you, are you tak­ing con­trol into account in putting togeth­er your rank­ing?

Haren Bhak­ta: Yeah, we, uh, don’t like con­trol. Um, what we want is, is skin in the game, when we want dol­lar val­ue of own­er­ship. So what we look at is dol­lar val­ue. We don’t give any addi­tion­al ben­e­fit for con­trol­ling shares. Uh, we wan­na make sure that, um, you know, if a CEO owns, uh, a very small per­cent­age of the com­pa­ny but con­trols all the vot­ing pow­er, we look at that as a neg­a­tive.

We want them to have skin in the game. We want them to have a dol­lar val­ue in the com­pa­ny, eco­nom­ic val­ue

Tony Kynas­ton: Okay, very good. I, I agree with [00:31:00] you there too. Um, do, do you look at how active the share­hold­er is in run­ning the com­pa­ny? So is there an extra screen? So some­one might, like one of the Wal­mart kids might have a large stake in the com­pa­ny, but they’re not real­ly exert­ing effec­tive con­trol. Do you have a, a kind of screen for con­trol as well as share own­er­ship?

Haren Bhak­ta: Well, uh, Wal­mart, for exam­ple, is still tech­ni­cal­ly a fam­i­ly-run, uh, com­pa­ny. So, uh, Rob Wal­ton, son of Sam Wal­ton, um, was on the, was the chair­man of the board for a very long time, and the fam­i­ly owned 40, or owns 40% of Wal­mart. So Wal­mart, for a very long time, was a very big posi­tion in our index, um, because it’s still fam­i­ly-owned and they’re on the board, so they are over­see­ing the com­pa­ny and they’re ma- they’re able to main­tain the, the cul­ture.

So going back to the cul­ture, it’s, it’s the own­er­ship that allows a com­pa­ny [00:32:00] to main­tain the, the, um, great cul­ture that, that helped cre­ate the busi­ness in the first place, right? Um, even­tu­al­ly all retail­ers, uh, go out of busi­ness, right? Sears. How did a sin­gle store, um, by Sam Wal­ton in Arkansas rise up to over­take Sears?

All the, all the, uh, advan­tages a huge retail­er had, yet it still gets over­tak­en by a new founder, right? Because, uh, even­tu­al­ly cul­tures erode and, uh, soon, or not soon, but even­tu­al­ly Wal­mart’s cul­ture will erode as well because once it becomes bureau­crat­ic, um, CEOs, uh, will take the pay­day in rais­ing prices and rais­ing mar­gins and tak­ing the big bonus­es that come with it, right?

How can they resist? Um, and that’s what destroys retail­ers [00:33:00] or future val­ue, is by tak­ing, um, you know, high­er prices now and high­er mar­gins, but that’s not what cre­ates sig­nif­i­cant val­ue for retail­ers. Retail­ers, um, have an e- eco­nom­ic moat called, uh, coined by Nick Sleep. I don’t know if you heard of him, but, uh, he called it economies of scale shared.

So, that means you, you get scale by sell­ing more, and as you get more cus­tomers, you reduce prices. You’re shar­ing the eco­nom­ics of scale, economies of scale with your cus­tomers. So the cus­tomers are being reward­ed with low­er prices. In return, you get more cus­tomers and you get more scale, and then you share those cost ben­e­fits again with your cus­tomers, and it cre­ates this self, um, uh, you know, self-ful­fill­ing prophe­cy where, um, you just become enor­mous like Ama­zon, right?

Um, so basi­cal­ly by shar­ing the [00:34:00] scale with your cus­tomers, you end up cre­at­ing this enor­mous share­hold­er val­ue in the long run. But it does make your com­pa­ny look less suc­cess­ful in the short term, right? And if you’re judged every quar­ter, you’re gonna take mar­gins when they come, and you’re gonna forego that, that long-term val­ue cre­ation because you’re almost forced into it

Tony Kynas­ton: Yeah, I’ve heard it called the dou­ble loop effect in, in Aus­tralia. Sim­i­lar sort of con­cept where you give back, mar­gin gains back to your cus­tomers.

Haren Bhak­ta: Yeah, yeah. War­ren Buf­fett talked a lot about that with Geico as well. He, he talked about how, um, you know, if they earn too much on, um, on, uh, the pre­mi­ums, their, their expense ratio was, was, uh, a lot bet­ter, they would reduce their prices and give some of those sav­ings back to their cus­tomers [00:35:00] in order to take mar­ket share.

So insur­ance is, you know, at least car insur­ance is all about mar­ket share, right? So, um, they kept reduc­ing prices when they could to con­tin­u­al­ly take mar­ket share away

Tony Kynas­ton: You, you’ve men­tioned a lot of own­er founders from tech com­pa­nies. Is, is your index skewed toward the tech sec­tor? And if it is, what hap­pens when the, when even­tu­al­ly the AI boom

Haren Bhak­ta: You know, a lot of peo­ple ask me, you know, did you out­per­form sim­ply because high own­er­ship favors tech­nol­o­gy com­pa­nies, because tech­nol­o­gy com­pa­nies have, have more own­ers? Um, for one, that premise is wrong. Um, I launched the Inside Own­er­ship Tech­nol­o­gy Only index as well. So I have two indices on my web­site which you could che- you could check out.

We can com­pare the Inside Own­er­ship Tech­nol­o­gy index direct­ly to the S&P 500 Tech­nol­o­gy only, and the Inside Own­er­ship Tech­nol­o­gy one out­per­formed S&P 500 Tech­nol­o­gy only, [00:36:00] and that’s because high own­er­ship cap­tures more of the inno­va­tors, more of the high return out­liers. So it’s not that high own­er­ship.

Uh, it’s not that tech­nol­o­gy com­pa­nies have high own­er­ship, it’s that suc­cess­ful tech­nol­o­gy com­pa­nies have high own­er­ship, and that’s because, um, it’s gen­er­al­ly new­er com­pa­nies with either founders or still ear­ly in its life cycle where it’s cre­at­ing these enor­mous returns and inno­va­tion, right? Um, if we look at the top 10 com­pa­nies in the US by size, um, with now the inclu­sion of SpaceX, Anthrop­ic and Ope­nAI, they’re not, you know, two of them aren’t pub­lic yet, but they will be.

But if we look at when they were found­ed, they were found­ed after the year 2000, or on aver­age around, around that time­frame, right? If we look to Europe, where there’s been no inno­va­tion, no returns, [00:37:00] um, the aver­age top 10 com­pa­ny in Europe was found­ed in 1920s. So the point is, when you’re cre­at­ing sig­nif­i­cant val­ue and dis­rupt­ing what’s, what’s hap­pen­ing in the world, um, it takes a new­er com­pa­ny or a, a founder or owner/operator to real­ly cre­ate that type of val­ue

Tony Kynas­ton: You still see, though, a, a skew­ing towards tech com­pa­nies in your own­er­ship index?

Haren Bhak­ta: It does because again, uh, tech com­pa­nies are, are typ­i­cal­ly new­er, at least the suc­cess­ful tech com­pa­nies are new­er. So we’re get­ting more expo­sure to com­pa­nies ear­li­er in their life cycle and then, um, less of them when they’re in their, uh, lat­er stages of the life cycle. For exam­ple, Microsoft, um, now Apple, we’re under­weight­ed Apple because, uh, Tim Cook is now, uh, retired as CEO.

[00:38:00] So, um, these com­pa­nies are on the lat­er side of their, of their life cycle

Tony Kynas­ton: So because of the tech weight­ing, would you con­sid­er not doing your, your index for, say, a, uh, a Euro­pean stock mar­ket? Is it, is it just gonna work bet­ter in the US because of the pre­pon­der­ance of founders in tech there?

Haren Bhak­ta: No, I’ll be launch­ing one in Europe as well. Uh, I’ll be launch­ing one, uh, inside own­er­ship. I think investors will want an inside own­er­ship weight­ed index across all dif­fer­ent mar­kets around the world. So we’ll be cre­at­ing a Euro­pean one, an Aus­tralian one, um, Chi­na, Japan, uh, South Amer­i­ca. Every mar­ket should have an, an own­er­ship weight­ed one.

Now, some of these oth­er coun­tries like Chi­na and India, um, there is a lot of, uh, cross-hold­ings between dif­fer­ent com­pa­nies, and it’s a lit­tle bit hard to inter­twine. So that’ll be some work in progress. But Europe, Europe and, you know, some of these [00:39:00] devel­oped worlds will be eas­i­er to, to launch indices using own­er­ship

Tony Kynas­ton: Very good. I think I’ve asked all my ques­tions. Do you wan­na chip in now?

Cameron: Well, uh, just the last point I want­ed to make, ’cause I did do some research on this. You know, again, as a dot­com guy, um, tech guy, I, I just remem­ber all of the founder-led fail­ures like Web­van and Cis­co and Sun Microsys­tems and all these com­pa­nies that were gonna take over the world and had mas­sive val­u­a­tions for a decade and then explod­ed. And, uh, you know, one of the things that we do at QAV is whilst we score com­pa­nies, we give them an extra score if they’ve got high insid­er own­er­ship. We’re also big on look­ing at val­ue. We want. As val­ue investors, we wan­na buy them when we think we can get them at a dis­count to their intrin­sic val­u­a­tion, but we’ll give them an [00:40:00] extra score if they have high insid­er own­er­ship. But I was doing some research on, uh, you know, uh, um, the, the uni­verse of insid­er own­er­ship com­pa­nies and how it’s per­formed. I came across a Bain & Com­pa­ny report, the Founder’s Men­tal­i­ty research, which I’m sure you’re aware of.

Haren Bhak­ta: Mm-hmm. Mm-hmm.

Cameron: Bain did a sam­ple of publ- a glob­al sam­ple of pub­lic com­pa­nies over a 25-year peri­od, and they did, um, looked at an index of S&P 500 com­pa­nies where the founder was still active­ly involved, and it per­formed more than three times bet­ter than oth­er S&P 500 com­pa­nies over a 15-year win­dow, rough­ly 2.1 times bet­ter in total share­hold­er returns over the decade lead­ing into the mid-2020s.

So, uh, it, there seems to be good evi­dence that there are suc­cess­es, there are fail­ures, but over­all, high insid­er own­er­ship, [00:41:00] um, at least with S&P 500 com­pa­nies, there is sig­nif­i­cant out­per­for­mance over a, a decent peri­od. So, yeah.

Haren Bhak­ta: Absolute­ly. I mean, War­ren Buf­fett said it best. He said, um, “The best way to think like a share­hold­er is to be one,” right? And you want your man­agers to, to think like share­hold­ers, right? Uh, and the best way to think like one is to be one. So, you know, obvi­ous­ly that, that when you own a big part of your com­pa­ny, you’re gonna treat your com­pa­ny bet­ter.

Cameron: Mm-hmm

Haren Bhak­ta: the best anal­o­gy I like is, is a, a hired CEO could be com­pared to a zoo ani­mal. Now, a zoo ani­mal gets fed every day, whether it suc­cess­ful­ly hunts or not, right? Uh, in the same way, a hired CEO gets their base salary, gets a quar­ter­ly bonus, and, uh, some­times a gold­en para­chute, right? But a owner/operator CEO, they’re a wild lion.

They’re trained to sur­vive. They’ve already proven that they can sur­vive in the world. They’ve cre­at­ed val­ue already. So when they [00:42:00] don’t suc­cess­ful­ly hunt, they feel the pain. They starve. And that’s what you want in a CEO. You want them to feel the pain and, uh, again, they’re clos­er to the prob­lem, so they do feel the pain a lot faster than, than, uh, a hired CEO

Tony Kynas­ton: Maybe you should. Sor­ry

Cameron: is starv­ing, uh, or Elon, uh, um, I mean

Haren Bhak­ta: He’s not starv- he’s not, yeah.

Cameron: don’t think they’re starv­ing.

Haren Bhak­ta: They’re not starv- well, they’re, they’re, but they’re suc­cess­ful­ly hunt­ing

Cameron: I’ve seen Elon’s waist­line. He’s, he’s, uh, he’s not

Haren Bhak­ta: Yeah,

Cameron: you know?

Tony Kynas­ton: Maybe

Haren Bhak­ta: yeah, yeah

Tony Kynas­ton: to, uh, from OWN to Hunger Games.

Haren Bhak­ta: Yeah.

Tony Kynas­ton: Index,

Haren Bhak­ta: Yeah.

Cameron: Yeah, but the flip side to your anal­o­gy, your zoo ani­mal anal­o­gy, is you said before, like if, uh, if a hired gun CEO makes a $5 bil­lion bet and it fails, he gets fired or she gets fired. If Zuck makes a $5 bil­lion bet on the meta [00:43:00] uni­verse, the meta­verse, and it fails,

Haren Bhak­ta: That’s right. That’s right

Cameron: you know, piv­ots into some­thing else,

Haren Bhak­ta: That’s right. Yeah. Jeff Bezos said it, he said it, to, to be suc­cess­ful, um, you have to be will­ing to be mis­un­der­stood. And unfor­tu­nate­ly, uh, non-skin in the game CEOs, they just don’t have the lux­u­ry of being mis­un­der­stood,

Cameron: Yeah

Haren Bhak­ta: right? So,

Tony Kynas­ton: yeah

Haren Bhak­ta: it, it is a lit­tle bit of the chick­en and the egg and, um, it’s not m- maybe not even their fault.

Like, they, they don’t have the lux­u­ry of being mis­un­der­stood. They have to make deci­sions with con­sen­sus, and that’s not how big dis­rup­tive deci­sion- or com­pa­nies get made through con­sen­sus, right? So i- yeah, it’s, it’s, you know, prob­a­bly not their fault. Um, if, if they have some bril­liant ideas that will make the com­pa­ny look not so attrac­tive in the near term, well, they’re not gonna be able to make it.

And, um, yeah.

Cameron: From a geopo­lit­i­cal per­spec­tive, I mean, the anal­o­gy [00:44:00] is not great, but, you know, I look at it as the dif­fer­ence between Chi­na and the Unit­ed States in the last 40 years. I mean, there’s a short-ter­mism, short-term think­ing that comes with a lib­er­al democ­ra­cy because you need to get reelect­ed in a few years, and the

Haren Bhak­ta: Yeah, Chi­na, Chi­na’s able to think in hun­dred, yeah, in, in cen­turies, right? W- we’re, we’re think­ing every four years.

Cameron: Yeah

Haren Bhak­ta: well, how, how do we make the econ­o­my or, or polit­i­cal land­scape look good for four years, uh, so we can get reelect­ed? Um, while Chi­na is think­ing in, in, um, essen­tial­ly, uh, cen­tu­ry time­frames, right?

How do we make our coun­try-

Cameron: Deng, Deng Xiaop­ing, when he took over in the late ’70s, said 50 years. You know, he had a, he had a 50-year vision, and they’ve pret­ty much stuck to that 50-year vision, um, reli­gious­ly for the last 50 years.

Haren Bhak­ta: Yeah. Yeah. And I mean, you, we, we see Chi­na has, um, w- I think gone up by a [00:45:00] mag­ni­tude of 100, um, from over that 50-year peri­od. I mean, it used to be, um, the num­ber 10, maybe even 15 glob­al pow­er, and now it’s num­ber two. So this rose up the ranks very rapid­ly, right?

Cameron: Hmm. I’m

Tony Kynas­ton: Hmm.

Cameron: I’m doing a pod­cast lat­er on in the week, um, on, on break­ing down Zbig­niew Brzezin­ski’s book, The, The Grand Chess­board that he wrote in, uh, 1997, I think, which remark­ably got a lot of things right, um, except the rise of Chi­na. He did­n’t think Chi­na was gonna be able to com­pete with the Unit­ed States in the next 30 years.

So he was, uh, you know, he was an intel­li­gent guy and fore­saw a lot of things about Amer­i­ca’s glob­al hege­mo­ny. But the one thing he, two things he got wrong. One is, let’s l- maybe we should­n’t have fund­ed the Mujahideen. The oth­er thing was, uh, Chi­na caught up way faster than [00:46:00] he expect­ed them to.

Haren Bhak­ta: You know, in, in, in, in, uh, real­ly quick­ly in 2020, uh, War­ren Buf­fet­t’s, uh, annu­al meet­ing or Berk­shire’s annu­al meet­ing, uh, Buf­fett put up, um, a, a table of stocks o- of the top 10 comp- or top 25, I think it was, back in, uh, 1970. And then anoth­er one. I’m sor­ry, I think he went back, I for­got what year, maybe 1980, and then, um, 2020.

And, um, you know, what he asked was, or what he said was, “30 years from now, 2050, I think we’ll see a lot more Chine-” I think there was, like, one Chi­nese com­pa­ny on that top 25, or maybe it was, like, two. But he’s, uh, uh, he said, “The one dif­fer­ence I think is in two, 2050, we’re gonna see a lot more Chi­nese com­pa­nies on this, on this top 25 list.”

Cameron: Mm-hmm. I think

Haren Bhak­ta: want­ed to add that part. Yeah

Cameron: Well, [00:47:00] Haren, thanks for com­ing on and it was a great chat. Uh,

Tony Kynas­ton: Yeah

Cameron: out your web­site, insideownership.com. You’ve got the, uh, ETF up and run­ning, as you said, and you’re gonna start launch­ing them in dif­fer­ent geo­gra­phies, so par­tic­u­lar­ly our Amer­i­can and Aus­tralian lis­ten­ers, check that out, sign up for your, uh, email releas­es, and, uh, keep an eye on it, and con­grat­u­la­tions and good luck to you.

I hope it, uh, I hope it does well. We’ll have to get you back on a year and you can give us an update on how

Haren Bhak­ta: Awe­some. Look­ing for­ward to it. Yeah

Cameron: Ter­rif­ic. ​