David Allen

So I sort of fell in love with geopolitics way back when and started watching crude, obviously, with intent back then and even in the 80s when I was in college.

And what that does is it creates a real vacuum. And that's one of the premiums that Octane is meant to gather for investors, which is the carbon risk premium. And on top of that, there are other risk premiums. There's obviously the equity risk premium. There's the small cap premium. We are an all cap value shop. And of course, the value premium. So this, we think there's a gigantic white space in the market. We don't want to see a world in which there's no traditional energy. I think Jamie Dimon himself told Congress that it would be a hellscape if we lived in a world without the ability to burn hydrocarbons. And so I launched the firm as a pure reaction, a market reaction to this dearth of capital that's going to these publicly traded companies.

And I think that's going to help me as I roll out the CTF and start marketing it.

We rented a house in Jamaica 10 years ago and I had one of those little dinghy sailboats. I made it probably 25 feet. But it is fun. And I think I would love to learn to do it.

So it's interesting. Trim. There's another corollary word to sailing. But I think you'd love it and you should let me know when you're out here.

Let's call this 2021. The reason the U.S. has a smaller carbon footprint today than in 2005 is because of these companies that you're selling. You're selling these companies. They're trading at six and a half price to earnings. They're making a lot of money. Wall Street got smart about sending blind money to the oil patch after 2015, 2016. There were tens of billions of Wall Street dollars went down. These were the pioneer days of Aubrey McClendon. And they bought really expensive acreage. And all they cared about was production. And, a third of them went out of business. There was a knife fight between the Permian and the Saudis in 2015, 2016.

The second episode happened during the pandemic. And I wasn't really interested in the space until after the pandemic. When the C-suite in the oil patch actually got real about returning capital to shareholders. So it's interesting you asked me the question. I was doing my homework. I was still at my other firm. And I would call these quants that I know a lot of them. I currently serve as chair of the CFA Society of New York. We have 11,000 members. We were co-founded by Benjamin Graham in the 1930s. And I called these quants. And I said, here's what I want to do.

I want to have a long-only equity portfolio. I think I want to do all cap value. And we can talk about that too. The utility and efficacy there, Brad. And I would call them and they say, well, yeah, we can put something together. We'll have some coders put together. And I said, I don't want a black box for a couple of reasons. First of all, 2 Sigma or BlackRock can invent something much better overnight and update it a lot better. And more importantly, I can't sell a black box if I didn't design it. So I went back to the very basics and I built a very simple decision tree. And the decision tree may be something like what you'd build if you had a greenfields approach to investing in the energy sector.

The first node is PE. We want relatively stable E and a cheap P. So that's the first basket. We get a data feed from Empirical Research Partners. It's a curated data feed on about 170 names that trade in the U.S. We buy ADRs, but only of developed world companies. So however much I'd love to be in Petrobras for their gorgeous field, I don't want to lose 500 basis points overnight if the people in Brazil change their minds about Petrobras. So with that all cap value approach, the first decision tree node is price to earnings.

We want cheap price to earnings. The second is probably the most important node, which is do they have a strong balance sheet? Now, by definition, Brad, all of these companies are price takers, right? So if you're an upstream company, you're selling into a commoditized market, very volatile commoditized market. If you're a refiner, you're selling into a wholesale gasoline or diesel market. Then the third decision tree, which is really important as well, and I alluded to this before I started the business, I wanted to make sure that the oil patch companies were doing this. The third decision tree is, are they returning capital to shareholders? And what we've seen is most of them have, one way to do that is to bring down share count.

Another way, obviously, is to eliminate debt. we have some companies in the portfolio that had, 40%, 50% debt to equity, and now they're actually have negative debt. In other words, they have paid down almost all their debt, and they have excess cash on their balance sheet. These are really nice situations to be in, and it's also a situation where they can really weather the commodity storm. And let me just go back to, I mentioned the upstream. I also mentioned refiners. If I were describing what we do to an Aunt Sally who doesn't have a PhD in finance, I would say, you may have a great company, large cap integrated company, oil company, that's trading at 13 or 14 times price to earnings.

It probably should be there. It probably should trade at a premium. What we're trying to do at Octane is replicate or at least approximate the financial exposures of that company, but do it piecemeal. And I wrote a white paper on that called Somewhere Under the Radar. And that's not about energy, but it's about the most important thing that I think has happened in my career, which is the rise of passive. So I grew up eight minutes from Vanguard's headquarters in Valley Forge. And in Somewhere Under the Radar, I talk about a widget conglomerate that's trading at $100 billion market cap. It's in every big index. When the German pension fund buys a global equity beta through MSCI World, they're putting, 80 cents into this widget conglomerate.

But the widget conglomerate, you can replicate their business by taking pieces of that and putting them together. So what I've manufactured in this 30-stock portfolio at Okta, and it is probably more volatile than your integrated company. But what I've done is I've taken the cheaper pieces, put them together so that there is some modicum of balance in the broader portfolio while getting a major discount to the mega caps that have been driven up from this passive active world that we live in.

Now, this is where a little bit of art comes into the science because if we're looking at six or seven subsectors, if you have, let's say, a scale refiner, a household name refiner that ends up in, for example, cows and other successful ETFs, great cash flow, great buybacks. You probably know that they're building a lot of refining capacity in China and even the Middle East. But here they're not building any more refiners. California wants to either take theirs over or have them go away. I'm not sure where they're going to get their fuel, but that's beside the point. So within these different subcategories, you basically get a feeling for what sort of debt load they can handle.

So a refiner with all that in-the-ground equipment sort of irreplaceable from a footprint standpoint can actually take on more debt than a pure upstream play. So we're looking at relative debt-to-equity ratios within subcategories. The other thing that we try to do, we try to lean into categories which we think are very stable and can do really well even if crude suffers. So today is a really good example. Crude is down about 3%. And we are kind of flat. And the reason we are is refiners have a bid to them today. Why?

If you have a soft upstream cost, your crack spread looks relatively decent. The other thing we've gotten into as really a picks and shovels play is we've got about a 15% exposure to tankers. Now, it's really funny. Mr. Market, I know you know this, Brad. Mr. Market is omnipotent but not omniscient, right? So when crude is falling out of bed, Wall Street in general sort of hates all the broad category. But when you look at, okay, if you've got a six-month, a nine-month, a 12-month time horizon, which we certainly do, certainly anybody buying these ETFs should have an equity-like time horizon because this stuff can be volatile.

We look at if you've got soft commodity prices for the hydrocarbons, that's really good for tankers. Why? Because the arb of getting the stuff from Shrevesport, Louisiana to mainland China or even to Indonesia, the arb goes higher and the tankers will make their money. The other thing about, if you've been through a couple of capital market cycle, the thing that destroys tankers margin is an overbuild. We don't believe there's an overbuild in that category. So the tankers is a beautiful place, both clean and dirty, where we've put, as I said, 15% of the portfolio. We also have 16% in coal.

As Australia and the UK are winding down and shuttering their very last coal plants, China has 300 brand-new coal facilities on the books, and these will have at least 40-year lives. Brad, we still get about 10% or 11% of our grid that's powered by coal. I know we're retiring them, but if we spend a little bit more money, we can scrub them, make them a little bit cleaner. So we still like coal. The developing world is – to the developing world, coal is the hydrocarbon of their future. And I'm not saying that tongue-in-cheek. It's just a fact of life.

And one more thing about – when you look into the microeconomics of these companies, there's one holding that we have that just six years ago, two-thirds of its business was domestic and one-third seaborne thermal coal. They flip that on its ear. So these people aren't dumb. They see the retirement of these coal plants, and they're cash flowing just beautifully, paid down almost all their debt. So there's some really cool stories when you open up this broad category that the world seems to hate. And the other thing, I published a video yesterday on how behavioral finance – when you tack on the idea of behavioral finance into the sustainability movement and GFANCE, which is Glasgow Financial Accord for Net Zero, it's not going to happen.

And about 30 blocks away from me at the UN, there are a bunch of dignitaries that flew in on big fancy jets, and they're talking about how, the plumber in Ohio shouldn't ride around in a big diesel truck. And it's a bizarre thing. One more thing, if I may, about sustainability. I know the UN pension very well. In fact, one of my advisors at Octane, and he's up on the Octane website, octane.nyc, was the former head of sustainability at the $80 billion UN pension plan. And we're trying to be very apolitical at Octane. It's hard sometimes. We really try to be. The odd thing is, all the people sitting – it's climate week here in New York, and everybody's here for the UN General Assembly next week.

We talk – a lot of people talk about the United Nations principles for responsible investing and the United Nations 17 sustainable development goals. And it's not a trick question, but I ask these people, and I run into them all the time, do you remember what the number one SDG is, the number one sustainable development goal of the United Nations is? I'll tell you what it is. It's reduced global poverty. Now, if somebody can reduce global poverty and end fossil fuels, that would be a wonderful miracle. It's not going to happen. It's not going to happen for another 90 years. I hope technology happens, but it's not going to happen now, which is why we're quite comfortable, for example, with a 16% exposure to coal.

And if things get ugly in volatile periods, we have no problem moving into cash or parts of the portfolio into cash-like instruments or money markets. And so we want to give the advisor an ETF option, both for market cap weighted indexes like THIR is, the index rotation, and like our other ETF, THLV, which is an equal weight sector approach. To kind of pair it along their large cap equity exposure and know that there are kind of true low-vol products that can help turn down the volatility quite dramatically in periods of volatility. The only reason we built the suite, we brought it out to market is because traditional low-vol, I'm not picking on anybody, so I'll pick two.

But the two big titans, your USMVs and your SPLVs in the world, if you look at 2020, if you look at 22, they experienced the same drawdown as the S&P. And that's not what people think low-vol is. Low beta seems to be acting. Beta doesn't matter, in our opinion, when the market falls apart. It seems that everybody dumps everything anymore. And so that's really what the product is. Correlation of one. Yeah, yeah, it really turns into a correlation of one. And so we, yeah, we're excited about it and hope to, we've had some success early. I think we've, it's been out for 48 hours now. There's about 17 million in there and hoping to get this thing chumming along.

And yeah, so we're excited.

I don't think timing our products is the right thing because if you can time, then you might as well do what we're doing yourself. I think the vast majority of the time, our products are fully invested. So it's not like, these things are turning off the off switch a lot. They're going to turn off the off switch when, markets are going to go through that like snap drawdown 15, 20, 25, 30%. That's when you're really going to love us.

How often are you rerunning the screen? Is it an annual, is it an annual screen? Is it a month? Like how often are you kind of re-scrubbing your list? Weekly. Weekly. Okay. Yep.

And the other cool thing about the value lens is, is look on, look on Morningstar Pro, who owns what, and there's a company called Oxy. We don't own it. It's no longer a value stock. And you look at all the, the, the, the one organization is buying it. It's Berkshire Hathaway. Right. And chase it up to about, I'm not sure what it is, maybe 13, 14, 15 times price to forward earnings. And you see all the huge, all the large cap value managers, Dodge and Cox, all the great ones go just do this step down function. And because Berkshire Hathaway is so big, what are they a trillion dollars that they just, anything they touch is no longer value. It's a very, very interesting dynamic.

But, but to your, to your point, we're sort of agnostic as where we, where we lie in all cap. there, there really are a lot of opportunities. And speaking of all cap, and I asked you what your hypothesis was for THIR. I think we've got more than a hypothesis. It's not easy, but it's simple. There are $38 billion of holders of the XLE. And the XLE, as is, is the subset of SP500 and energy. And Okta was built to be the little brother of your XLE allocation. And so we were talking to RAs now, they've got big allocation to XLE because they recognize a systematic and structural underway to energy.

And most of my career since 87, it's been between, let's call it six and 16% of the SP500. In 1980, it was 27%. And today it's less than 3.7%. And you can't have a conversation on Wall Street without talking about AI data centers. I'm sorry, these things don't run on windmills. I'm sorry, UN. They don't run on windmills. So we need more and more traditional energy. I love nuclear. Nuclear does not, it's not, it doesn't have a place in this portfolio now. However much I love nuclear. But if you hate, if you hate carbon in the atmosphere, you got to love nuclear. But it's sort of a long winded way of saying the opportunities are great because we can't build big tech without cheap, dependable, reliable energy.

So we think it's a nice tailwind for us. And the structural underweight is something, again, apolitical. A lot of people out there in RIA land and even institutional allocator land acknowledge they want to get that beautiful, cheap beta exposure to U.S. growth. It comes with a cost, right? You may have gaps in your portfolio. So we don't think energy is thematic. We think it's fundamental. And we think that most people out there have a structural underweight.

And when crude gets ugly, when cost of borrowing goes up, those are more volatile than others. So we really did want to tamp down idiosyncratic risk. And by doing that, we have the ex-ante limit of 500 basis points when we put on a new position. Does that make sense?

Now, let's say we've got 300 basis points. It looks a little bit more big that we can complete with the other 200 basis points. So, and the flip side is true also. we can let the market come to us. And what's crazy about the way the market's trading with momentum, we've owned stocks in a separate account for the ETF that have reached like a little bit beyond our price target. We've sold all of it. And I think, the 0.72s and two sigma get a hold of the momentum and it goes up another 20%. You just sit there and say, well, if we had a long short fund, we'd probably be selling now. But the market's so much fun.

Every day is different.