The Value Perspective Podcast – with Django Davidson
Hi everyone and welcome to the latest episode of The Value Perspective Podcast, where this week we are joined by Django Davidson, a founding partner and portfolio manager at Hosking Partners. After graduating from the University of Oxford, where he studied geography, Django joined Deutsche Bank – becoming a director at just 27 years old. Influenced by reading Berkshire Hathaway and Buffett Partnership letters, Django transitioned to the ‘buy’ side – first joining Algebris before helping Jeremy Hosking establish Hosking Partners in 2013. Today, Hosking Partners manages approximately £6bn of assets. In this episode, Juan and Andrew Williams chat with Django about: his journey to, and the history behind, Hosking Partners; the power of the ‘capital cycle’ framework; how that framework can address human biases and aid decision-making; using the capital-cycle mindset for value investing and other active strategies; and, finally, market environment considerations over the last five years. Enjoy!
Authors
JTR: Django Davidson, welcome The Value Perspective Podcast – it is a pleasure to have you here. How are you?
DD: Very well. Thank you for having me on.
JTR: We recently had Admiral founder Henry Engelhardt on the pod, who emphasised the importance of acknowledging feedback and taking it on board. One piece of feedback I have received on the pod is I usually co-host episodes with other members of the Value Team but I rarely introduce them – so, before we go any further, I am going to say hello to this episode’s co-host Andrew Williams!
AW: That’s incredibly kind of you, Juan! And I am very pleased to be co-hosting this episode.
JTR: Thank you very much for coming! Django, let’s start by hearing a bit about your background and journey – how did you end up being an investor?
DD: Well, one of the stories I told at the London Value Investor Conference we met at recently was a story about my childhood, where I was taken along by my mum to a lot of miners’ strike demonstrations. It’s the early 1980s, my mum is raising money for the miners who are striking and we’re trying to solicit donations from people who support them. This was a time of real polarisation between those who supported Maggie [Thatcher] and her attempt to smash the miners and the unions and those who were on the other side. And my main memory from that period was being on one of these stalls and someone coming up, giving money and me saying to them, Who do you support – the miners or the police? And they said, Oh my dear boy, of course, I support the miners – that’s why I’m giving money to you guys! And I said, I don’t – I support the police – and I really meant it. And it was that early contrarian instinct that made me very curious about getting into investing – about expressing contrarian ideas, being on the other side of big ideas – and that led to a career in investing through, first, working for an investment bank; and then for a fund that was affiliated to The Children’s Investment Fund, called Algebris; and then joining Jeremy in 2013 to set up Hosking Partners.
JTR: I want to delve into some of those details but, before we do, where does ‘Django’ come from?
DD: This is another nod to my unconventional background! My mum is a committed Marxist – she’s a university professor at Bristol – and my dad is a musician, and Django Reinhardt was a Belgian jazz legend from the 1920s. One of the things about being a non-conformist and having contrarian brain chemistry – which I hope we can talk about in the context of the capital cycle soon – is that, when you have very non-conformist parents, the way you rebel against them is to be very conventional! So my way of rebelling was to become a finance guy – and, in fact, they did say the most rebellious thing I could do would be to join a golf club! I haven’t yet done that but I am on the waiting list – so ‘peak rebellion’ should come in my mid-40s!
JTR: You mentioned you started your financial career at an investment bank – where was that and what were you doing there?
DD: Having such a non-finance background – a musician dad and an academic mum – I didn’t really know much about finance but I was always desperate to get into it. So, age 16 – a bit precociously – I wrote to every investment bank in the City saying, Would you take me for an internship? I still have the letters, actually. And they all said, No – obviously – but that rather painfully energetic approach to internships carried on. When I was at university, I did an internship at Cazenove, which was a real eye-opener – in fact, Andrew and I were talking earlier about the original Cazenove building, with the liveried, top-hatted doormen, which is bit different from the new Cazenove building!
So I did lots of internships while I was at university and then got a job at Deutsche Bank doing corporate finance, which I did for a few years. I then moved into the banks team at Deutsche, which is where I really started getting exposure to stocks, and I was just very lucky. I have been so lucky in so many areas of my career but what was lucky here – although it sounds odd – was being a banks analyst during the financial crisis. In the land of the blind, the one-eyed man is king – and suddenly I was someone who knew just that tiny bit more about banks than others, which gave me this extraordinary ability to talk to clients and that was how I got in touch with Algebris, who had some bank investors at the time.
JTR: And how was that transition from the ‘sell’ side to the ‘buy’ side?
DD: It was like diving into a swimming pool on a boiling-hot summer’s ay! I mean, it’s a proper intellectual pursuit being on the buy side. I don’t want to be rude about anyone on the sell side but it is a different game.
JTR: And now you have been at Hosking for almost a decade – for those who may not know much about the business, could you tell us a bit about it and what sort of investors you guys are
DD: Our eponymous founder is Jeremy Hosking, who is an extraordinary investor and contrarian. If I’m a contrarian, I’m a sort of Stoke City contrarian – Jeremy is a Man City contrarian! He is an extraordinary thinker, an inspirational investor and he is our founder – and his real contribution to investing knowledge is this ‘capital cycle’ framework, which he developed with his colleagues in the early 1990s at Marathon. So Jeremy and his partners set up Marathon in the mid-1980s and the company went on to great success – and, in the early 2010s, Jeremy moved on and set up Hosking Partners, which really continued the intellectual journey he started on at Marathon.
That journey was the expression of an unconstrained, diversified capital cycle investment approach with a global fund – we just have one fund, one product – and the investment philosophy really is 40 years-plus in the making. And, again, you’re talking about luck – I’m incredibly lucky to have worked with Jeremy and the whole team at Hosking Partners and learned this approach. My favourite period was in the early 2010s in Dublin: Jeremy had bought very, very well just after the financial crisis – for the price you’d pay for a two-bed flat in London now, we got this amazing five-story Georgian building – and we sort of sat there, set up the firm and I was so lucky to be able to learn about this approach from Jeremy.
Don’t just be contrarian – be contrarian and (mostly) right
JTR: The capital-cycle framework is celebrated, I would say, partly because it resonates so well with many people, but also because there are two key books on it, one – a bit like Seth Klarman’s Margin of Safety – is out-of-print and can now only be bought for hundreds of pounds on eBay. Had you come across that book before joining Jeremy – and did you have anything to do with the second one?
DD: So the first book you’re referring to there is Capital Account, which is a collection of Marathon investment letters edited by [former TVP Pod guest] Edward Chancellor. I recommend it to everyone and, if you’re very devious and scuttle around the internet, you might be able to get it for less than $500 – but I shouldn’t encourage that! It is a must-read and, yes, I had read it before I approached Jeremy. I had been sort of ‘cyberstalking’ Marathon for a while and it is one of the great later-in-life learnings – this ‘wisdom bullet’ from Charlie Munger – that, when you find a big idea, take it seriously. There are just a handful of really big ideas and, while our industry really pushes you to go to the next meeting, read the next research report – you know, be a busy fool – actually what you should be doing is focusing on those handful of big ideas.
And the capital cycle, I would say, is one of those big ideas and Jeremy and the team got on it early; Edward Chancellor did a terrific job of articulating it; and it’s a great framework – not just for investing, Juan, but also for life. You know, if you have this contrarian brain chemistry, you want some guardrails. You don’t want to be contrarian for contrarian’s sake – that’s basically just a recipe for being a difficult person! You want to be contrarian and right – or at least contrarian and right more often than you’re wrong. And the capital cycle lens – this way of looking at industries, companies or, indeed, big life decisions is a great framework for just offering you these guard rails, for keeping you on-track and, you know, for improving outcomes.
AW: Django, when we spoke at the London Value Investor Conference, I noted down a quote I wanted to check with you today – buy you’ve almost just said it again. You said: “You need to be contrarian and right, not just a contrarian – and it’s the capital cycle that allows you to do that.” Hopefully you stand by that! Please could you explain more why you believe it is so powerful in an investing context?
DD: Sure, Andrew – and maybe, for those who are not familiar with the idea, I should just step back and give a quick spiel on the capital cycle. It is a very simple framework: what it says is that, the more capital that goes into an industry, all else being equal, the lower the returns for the remaining capital in that industry. So, you know, the 10th ball-bearing factory will lower the returns for the remaining nine – that, I think is pretty self-evident and I guess most people can get that. It also works in reverse: as capital is removed from an industry, returns improve. Then, overlaying the industry capital cycle, which is effectively an expression of the competitive forces within an industry, there is the stockmarket cycle – so, as valuations of companies in the stockmarket improve and rise above their replacement cost, more capital is attracted into the industry.
That is because promoters and entrepreneurs will say, Hey, if I build a wind turbine, rather than it being valued at 100, which is the cost of making it, it could be valued by the stockmarket at 900. If you look at some of the peak enterprise value (EV) to sales multiples of wind-turbine makers, which was something we talked about at the value conference, that is broadly what happened. And so these underlying industry cycles, which are effectively return-on-capital cycles, are amplified by the stockmarket. And it is the interplay of those two forces that sees these great waves of capital misallocation on the upswing – and then on the downswing, when you can identify terrific value opportunities, where the stockmarket will be valuing businesses at discounts to replacement costs, where capacity is being withdrawn, where forward-looking supply is being curtailed. And often that happens when the demand outlook is arguably depressed – you don’t get that sort of industry activity without there being some bad news around – but that is the real upside in this framework.
Can the capital-cycle framework help correct human biases?
AW: In this podcast, we often explore decision-making in uncertain conditions – and you touched on a few different threads we could pull out there. Firstly, then, human biases impinge on our ability to make good decisions so how can the capital-cycle framework help you correct some of those biases, as an investor? And, as a follow-up to, how do you incorporate probabilistic thinking into your process?
DD: You could think of capital-cycle analysis as being an expression of raw industrial economics, on the one side – the returns on capital for an industry or a company – and, on the other side, as a behavioural psychological framework: the idea that price is information and the chasing of higher returns. The fusion of these two allows you to take a step back from the shorter-term noise, if you like – of valuation metrics, of short-term earnings, of corporate news flow – that is really not long-term information. To give you an idea, you might look at an industry like, say, mining, where the outlook for the particular commodity is depressed and its key use case is in an industry that is declining so there is a really depressing demand outlook.
Concentrating only the demand side of the equation, you might say, This isn’t an industry that holds any interest – but capital-cycle analysis would focus you away from demand and on to the supply, onto the capacity, and you might see that, actually, the mines or supply of this particular commodity was falling and that capacity was being shuttered. Now, it’s very unlikely this capacity, once shuttered, could come back on and therefore the demand for this commodity, which – who knows what demand is? – will likely remain pretty inelastic and therefore the pricing outlook is quite interesting. So it is a ‘wood for the trees’ framework, as opposed to a treasure map to a sort of ‘no brainer’ investment.
On the probabilistic side, it isn’t a probabilistic framework, unfortunately – it’s not a treasury map – but it allows you to weight the odds in your favour and express a view from a different perspective to that of many other market participants. It’s a cliché but, you know, time horizons are short – all of the data will support that in terms of stock turnover and so on – and, generally, bankruptcies and industry distress are seen as negatives, certainly on a short-term perspective. But if you have the ability and the clients – and that’s an important point that I hope we can come on to discuss – to look at a longer-term perspective, you can make these contrarian decisions where the odds are better than implied by a shorter-term, more single-stock, analytical approach.
AW: That’s really interesting – and perhaps we should move on to talk about that client point now because hearing you describe that then, for me, the capital cycle is by its nature very long-term. So, potentially, it keeps you away from certain things that a lot of investors might be interested in – but it also allows you to have that longer-term perspective. And I think the ‘framework versus treasure map’ analogy works very well there. Still, as you said, there are also some potential downsides there in that, if you’re looking that long-term, you may be able to see through that noise, but you need clients who are able to do that too. So now seems a good time to talk a little about that and how you communicate your objectives with your clients – and how you go about finding the ‘right’ clients for this strategy?
DD: This approach works in an unconstrained and diversified portfolio. It is quite difficult to be a capital-cycle investor with a 10 or 20-stock portfolio – and it’s actually really interesting that the increasing fetish for concentrated portfolios is a terrific opportunity for capital-cycle, unconstrained, diversified investors. That’s because so many of these ideas aren’t possible to put in a 20-stock portfolio – you know, good luck finding a copper mine, say, or a deeply distressed industry, in which you suffer a potential permanent capital loss, in a 20-stock portfolio! You can’t do it – you’re skewed towards higher-quality companies. And we are very lucky at Hosking Partners to have some investors who are bought into that – and they are very unusual. They are indeed contrarian investors because, as we know, there is this ever greater drumbeat towards more concentrated portfolios – it’s almost like an expression of investor virility: how concentrated your portfolio is!
So, number one, our investors are actually pretty thoughtful and they’re willing to be contrarian. I have to be thoughtful and careful about what I say but, you know, we have some very smart Australian investors who have terrific long-term capital. It’s not permanent – but it’s as close to permanent as you can get in the institutional world! And that mix of very thoughtful long-termism combined with high-quality capital – I’m talking about the superannuation industry here, which is just the best way of doing savings. I wish the UK would follow it – although that’s another podcast! But having this quality of capital and quality of thinking behind the capital – and a ‘shout out’ to all the guys down in Australia – is the enabler of what we do. You need high-quality capital to express this philosophy – it’s not possible to do with people who are short-term.
Passive investment flows through a capital-cycle lens
JTR: I am obsessed with this next question – I have been asking it to pretty much every guest we have on the pod – but I would like to hear your thoughts on ‘passive versus active’. In particular, have flows into passive become so big, or has the pendulum swung so much towards passive, that price discovery is being lost and markets are less efficient? And are we thus witnessing the demise of active management?
DD: Well, if you’ll forgive me, Juan, perhaps I could use a capital-cycle lens to address this! So let’s apply some capital-cycle analysis to that very important question. It is pretty clear that there has been a lot of capital allocated to passive, the valuations of the mediators of passive flows are very high, the proliferation of product is very high – that all seems unarguable. Equally, the number of active managers that are going out of business, that are seeing outflows – I mean, that set-up is very clear. Listen, I don’t want to be yet another active fund manager moaning that, you know, their very delicious eight-course lunch is being eaten by passive! You know, the active management industry has overround for decades and it’s having a reckoning – and it doesn’t feel like we’re anywhere close to the end of that.
My addition to this debate – if that’s not too pompous – would just be the following idea: often in these capital cycles, you get cycles within cycles. So an example there would be within the general capital cycle, within the oil industry, the offshore drilling industry is this sort of distilled, super-amplified cycle – and we can talk about that, if you like. And to your question, within the active management world, I think value investing is the distilled, amplified space – it’s kind of the ground zero of your question. And, if you look at what’s happening in value investing – whether it’s storied value investing firms shuttering and becoming effectively family offices for their founders; whether it’s the taking private of previously listed value managers – Pzena being a good example there; whether it is the morphing of previously value-oriented strategies into effectively quality-growth strategies to retain AUM – all of those indicate that, within the value-manager world, the cycle looks pretty interesting. I’m not making comments about, you know, the value factor and all of that good consultant stuff here – but just within the world of active value managers.
And I’d love to get your view on this, Juan: in emerging markets – where there is less competition in terms of active managers, and particularly in terms of active value managers; where there has been, effectively, a decade-plus drought of capital coming in, in terms of new active managers – some of the opportunities are reminiscent of these situations where, sometimes, you get these Ben Graham-type net-nets in reasonably large companies. And that tells me that opportunities are arising because of the withdrawal of capital. Perhaps emerging market value managers are the apotheosis of this trend – I’m sure that would be music to your ears!
JTR: Well, absolutely it is! What is really interesting about the point you are making is, as we all know, less competition leads to inefficiencies – which goes to your point about moving into segments of the market where capital has been in retreat. So with value emerging markets, less competition means more inefficiency so there is a wider set of opportunities for those who want to do price discovery – and those inefficiencies are very much across the board, if you are willing and have the right mindset and process to look for them and actually pursue them. I want to flip my previous question a little bit to something I heard from Henry Kravis, one of the founders of KKR, on another podcast. He was asked, if he was young again, what sort of business he would be starting – and he actually said he would never launch a fund because, at the moment, the industry is overcrowded, with too much competition and just too many funds doing the same thing. Given that, how would you view the active management industry through your capital-cycle lens? Do you think Kravis is correct?
DD: Well, I’m not about to start having an argument with Henry Kravis! I think he’s earned the right to be listened to. Listen, I’ve got a kind of personal story that is pertinent to your quote – and thank you so much for highlighting this to me. You are absolutely right – this is one of those ‘laser bolts’ that should make everyone in our industry sit up and take notice. So here’s my personal story on that. Six years ago, we had an intern come and work for us – superbright guy, won a history prize at Oxford, he was at Harvard doing an MBA, and he came to work for us for the summer. I’m still in touch with him – he’s an absolutely brilliant guy. He had done investment banking after leaving university and he wanted to go into private equity – and why wouldn’t you? You know, it’s where all the glamour, money and razzamatazz is.
So he just came for a summer and we did some emerging market deep-value investing. We were looking at a PGM [platinum group metals] miner called Sibanye Stillwater, which was buying its closest competitor, Lonmin – and I just remember these numbers because it was such a moment for both of us. We went away and looked at this acquisition, which was a classic ‘capital cycle’ – the industry was consolidating; there were huge synergies between the proximity of these mines; there was a lot of supply discipline that would have come as a result of this merger; the price of PGM miners was low; and Sibanye was issuing 15% of its equity – about $200m – to buy Lonmin.
And here’s what they got for that $200m: they got a smelter – replacement cost value about $2.2bn; they got about $700m of above-ground ore; they got several million ounces of in-ground PGMs; together with a load of other interesting go-forward synergies – and, of course, the costs. So, all in, they were paying about $200m for somewhere in the order of about $4bn of value – and it was like a Ben Graham net-net. We were sitting there with low interest rates and with stocks at super-high valuations – and I had just done some, you know, back-of-the-envelope maths while, because he was so hard-working and disciplined and brilliant at analysis, he went away and did a really deep-dive on it. And he said, Django, this just can’t be right – something must be wrong.
And I was like, No, no – that’s it. We are now in a pond where no-one is fishing. It’s incredibly difficult to do this sort of investing, to get people to invest in these companies, and it was a ‘Eureka moment’ for me – you know, a Ben Graham, net-net, 1929 depression-era valuation. And it nearly turned him! Of course, he didn’t turn – he went into private equity – but it nearly turned him into a value investor! And my guess is, the current crop of PE investors who are in, you know, their late 20s, early 30s – if any of you are listening – if you use the capital-cycle framework as a life-decision framework, you would be getting out of PE and into deep-value investing – that’s just what the capital cycle would tell you to do. The difficulty is, you’ve got to find somewhere that’s hiring! That’s going to be the challenge – but therein also lies the opportunity.
Capital cycles and the path – or maze – to a lower-carbon society
JTR: I think that goes to the heart of all our confirmation biases! I’m going to be a bit cheeky with my next question, starting with a quote I once read in a book: “One precondition of rational choice is free will, which in this context means making purchase and sale decisions solely on the investment merits. To the extent that the portfolio manager’s decision is not based on an independent view of how to maximise portfolio returns, it is to some extent coerced – and just as coerced confessions often have little to do with truth, coerced sales have little to do with an efficient market.” We have seen a trend in markets over the last four to five years and I was wondering if you could give us your thoughts on how this fits in the capital-cycle framework and has that sort of behaviour benefitted your investment style?
DD: I’d make two points here. The first is, I am the father of three young boys and I want to leave them a planet that’s in at least as good a condition as I inherited it – and hopefully in a better condition – because the planet is our greatest natural resource and we want to look after it. The second response is, Well, how do you get there? And, if you are a capital-cycle practitioner, there are some considerations when responding to very prescriptive views on how to achieve a lower-carbon world – you know, one of the phrases we use internally is, The route to net zero, or indeed a lower-carbon society, is a maze not a path. It’s going to take a lot of nuance for us to get there – and I know we promised we wouldn’t use the acronym! But if I were to conceptualise ‘ESG 1.0’ and ‘ESG 2.0’, I would say ESG 1.0 is very prescriptive and ESG 2.0 – which it feels we’re moving very rapidly towards. It’s amazing how and a bit like Hemingway – How did you go bankrupt? Slowly at first and then very quickly!
And we seem very quickly to be ending up in ESG 2.0 World, which is much more cognisant of the capital-cycle implications of curtailing capex to the largest section of the energy that we produce – that, by curtailing capex to that all-important area of our economy, we are raising the forward-looking prices of that energy. And that is not a good thing for an energy transition because – and this is another ‘wisdom bullet’ – in order to do an energy transition, you need a surplus of energy. If we are going to build a wind turbine today, it takes us about seven years’ worth of the energy we have put in to before we get it back – there’s a seven-year payback. So we need a lot of energy today and I think – as your quote alluded – ‘coerced confessions’, forced sales, irrational sales, will only make that energy surplus harder to achieve. And it will only increase the price at which we fund the energy transition, by which I mean the actual cost of energy we need to do these things.
So I feel the debate is moving on – and moving on really rapidly. One of the most genuinely rewarding parts of the job over the past few years has been working with clients to help them understand our way of thinking, and how that has helped them explain to their clients that this has to be a more nuanced debate. You know, what are we? We are fund managers – we invest in secondary bits of equity! In moments of depression, then, you can wonder, why we are doing this! What are we adding to the world? And I feel a more nuanced view of ESG is actually going to help a lot of people, particularly those at the lower-income end of the spectrum – you know, the one and a half billion people whose primary energy source is burning wood. For those people who want to move up the energy-consumption ladder, we need to think very carefully about this to make sure we bring everybody on board. This is a global problem and we have got to get everyone on board for it.
JTR: Presumably, by definition, the capital-cycle framework will take you to those pockets of the market where the capital is being pulled out and going in a different direction – and you guys will be more inclined to go to those industries where maybe the opportunity set is better because there is less competition, capital is not there and returns have been depressed, which means that potentially, in the future, they are going to be much higher?
DD: Yes – and that question has reminded me of a failure of my own in this podcast, which is to explain there are two very important elements to the capital cycle. One is the industry capital cycles I have outlined – and, obviously, you want to avoid periods of excess and buy into periods of consolidation. There are a handful of industries and firms, however, that manage to avoid these ‘competitive assaults’. We call these ‘beat the fade’ companies – sometimes they are referred to as being in the top half of the capital cycle – and my colleague, Luke Bridgeman is very good at articulating this difference. With these companies, new capital often finds itself unable to come in and compete – and I can give some good examples there, if that would be interesting.
Amazon and Costco are obvious examples of companies with whom potential competition finds it very hard to compete – but there are a number of others and they are not necessarily monopolies. This is important to say – this is not a question of, you know, having the sole toll-bridge across a river. These are companies that operate in the ostensibly pretty competitive field of retail, but for whom returns are structurally and consistently higher through their model – and the shared economies-of-scale benefits of Amazon and Costco are well-documented and I won’t repeat them here. But that is an important foundational tenet of the capital cycle: that when you come across those companies or industries, they are as attractive as industries that are turning – and, in some ways, they can be more attractive because, as long as that competitive superiority sustains over a long period of time, you are going to have a very attractive forward-return runway.
AW: Then the obvious follow-up question would be: where is the capital cycle directing your attention today and what sort of areas are you looking at?
DD: So let’s use those concepts of the ‘bottom half of the capital cycle’ – industries where capacity is being withdrawn and forward-looking returns are interesting – and then the other half, which are these companies that have managed to ‘beat the fade’ and move away from the natural mean-reverting tendency that applies to the vast majority of companies and industries. In that first half of the bucket, we have been doing a lot of work outside of the US – and two areas spring to mind. Last year, we were the largest foreign investor in Sri Lankan equities as there is a country-level capital cycle going on in Sri Lanka. They have just come out of an IMF programme, they’ve had a sovereign default – there are a lot of reasons to be negative on Sri Lanka. There has also been a massive adjustment in the terms of trade and the underlying economy, already battered by overleverage and some questionable infrastructure development, was then killed during Covid – and we started to see really classic capital-cycle capacity-withdrawal and industry consolidation and a lot of just Ben Graham-esque style valuation. So that has been really interesting.
In Japan, there is a similar country-level dynamic. I won’t repeat all of the reasons Japan is exciting at the minute – I’m sure you are very familiar with them. The way we have expressed it might be of interest, however – and that is, we just go back to this idea of being unconstrained, diversified and applying the capital cycle. We have gone into Japan and built a portfolio – primarily of small and mid-cap companies. Many of them don’t have English accounts and their general investor relations is less than energetic! But the value is real – and this desire of Japanese companies to avoid the shame of being named by the Tokyo Stock Exchange for not taking the actions required to move up their returns is real. And, again, there is this idea of being diversified – if you’re running a 20-stock portfolio, you might find one Japanese small cap. We think the idea here is the cycle, however, and so we have expressed it across this basket of stocks.
In terms of industries, we talked earlier about PGMs. That had a boom and is now going through a bust and, at the minute, we are seeing a lot of supply come out of PGMs in South Africa, particularly. These deep mines in South Africa are like two miles’ deep and it’s 60 degrees down there – this is really intense mining – and, once these shafts have closed, that supply is gone forever. And while we could all debate the outlook for internal combustion engine cars and for battery electronic vehicles, when you have this supply curtailment tailwind, you have quite an interesting set-up. So that is an interesting industry capital cycle. At the top half of the capital cycle, meanwhile, we have been doing some work recently on the French spirit companies. Over hundreds of years, if you look at, you know, the cognac makers or any of these fine French spirit companies, they have built up formidable barriers to entry. These are not total but there are reasons to think that, if you have exclusive supply agreements with specific domains in Champagne or wherever it happens to be, then you have a long-term competitive advantage – and the valuations of a lot of these companies have collapsed. So that is an interesting ‘top half of the capital cycle’ area we are taking a look at right now.
Acknowledging the length of cycles – and a ‘material’ book tip
JTR: We are coming to the end of our session but, before we ask the final question we put to all our podcast guests, I wanted to ask you, since cycles can potentially be very long in nature, how do incorporate that consideration into your investment framework?
DD: Here’s a really simple but underused framework for that: a really simple way to bookend how long a cycle might be is to look at the longevity of asset lives within an industry. Let’s look at an offshore drilling rig – of course, it depends what rig it is and we could get very complicated and lost in the weeds – but let’s say it has a 25-year asset life. Or let’s look at a copper mine – the average life of a copper mine is maybe 30 or 35 years. Let’s look at a streaming box-set – that might have a six-month life! Let’s look at, you know, protein shakes or whatever the latest fashion is – a good anchor on how long a cycle could be is the ultimate longevity of the asset. How often do these assets need to be replaced? At what point does natural asset-scrapping, for example, cause the supply of capacity to curtail?
And my colleague Luke, who’s done some terrific work on the shipping industry, has had some brilliant insights into the natural shrinkage in many areas – particularly, the tanker fleet – that come about as a result of new environmental rules, just natural asset replacement. And that is often a really helpful way to start thinking about the cycles in industries. The flipside to that is, well, there’s that great Keynes point about the market staying irrational longer than you can say solvent – so you have to have clients who have a time horizon that you know works with yours. And listen, that’s not easy – the hardest part of this job, I think, is managing that relationship. You know, you’re only as good as the client capital you’ve got – so you can take the best investor in the world and flighty capital and not have a very good record.
JTR: Would that mean the framework is less well-suited for a sector such as technology?
DD: Well, technology is harder because the cycles are shorter – but that doesn’t mean the framework doesn’t apply in technology. In fact, Jeremy’s original insight – his ‘Eureka moment’ – came to him in the early 1980s when he had moved to California to run a portfolio of, basically, busted tech stocks. He’s like 24 or something and he inherits a sort of 70-stock portfolio – most of them are down, you know, 50% to 80% – and Jeremy’s got to work out what to do with these things. And then he starts thinking, Well, why are they all down so much? You know, there was such promise – there were such great stories told by the investment banks that were bringing these companies to market! – why didn’t these demand stories play out?
That’s when the capital cycle idea formed. And I think, because the capital cycle is supply-led, broadly speaking – not in all cases, but broadly speaking – you can quantify the supply in most industries. Whereas a lot of technology investing is forecasting demand – and I’m being rude but I’m doing this to make a point. A lot of technology investing is story-based investing: for example, AI will eradicate the legal industry – it’s a shocking narrative that makes you sit up and, you know, all of your friends get upset. That’s a bold story that very successful promoters can use to raise money and so on – but that’s not what the capital cycle is. So with technology, which changes very fast, which means stories and narrative change very fast and all of that stuff – we’re just trying to move away from that. We just try and close our ears to that.
AW: Django, thank you so much for coming into the studio to talk to us – it’s been a fascinating conversation. Before we let you go, as Juan mentioned, we ask all of our guests for a book recommendation or two from whatever genre you like? What would you recommend and why?
DD: OK, the book I recommend reading is Material World: A Substantial Story of Our Past and Future by my great mate and best man at my wedding, Ed Conway – so it’s a totally biased recommendation! The reason you should read it is it will give you a window into the material world, which is so poorly understood by even very highly educated people. We live in the ethereal world. We spend far too much of our time on these things – he says, holding up his iPhone – and we don’t understand what’s in them. And it’s shocking – well for me, anyway. I was shocked – I have been an investor in this world for over a decade and there are many things in there that astounded me.
Why the book is important is that, if we are going to make all of the changes in our society we want – whether it’s, you know, the electrification of everything or the reshoring of various industries or whatever – we need to understand the material world, we need to give it more attention and we need to understand how critical and inelastic our demand for a lot of these materials is. It’s a terrific book, it takes you through six of the key materials and some of the insights and vignettes are classic – and I think everyone will really enjoy it. If you don’t want to read it, I’ve done a podcast with Ed about it – but that’s not as good as reading it!
AW: Well, I have read it already and would second that recommendation. It was certainly one of the stand-out books of the last 12 months for me – no doubt about it.
JTR: Django Davidson, thank you very much for coming onto The Value Perspective Podcast. This was absolutely fascinating.
DD: I’ve really enjoyed it. Thank you, guys.
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