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Archive for the ‘Spectator Articles’ Category

Anything but gilts

My latest piece in The Spectator discusses what might make a future trade of the decade to match that which was the standout (and therefore widely ignored) long term trade at the time of the Prince Charles- Princess Diana wedding in 1981. Then the trade was to buy UK Government bonds; now, I argue, it would be to buy anything but gilts, and concentrate on assets which can withstand the inevitable arrival of inflation.   Note that I am discussing here the best long term buys and sells facing investors today, not which asset class might do best in the next few months (when I fear that a new deflation scare, which would be positive for gilts, remains a distinct possibility).

Written by Jonathan Davis

May 22, 2011 at 9:07 PM

The wonders of pet food – and other things

What is so wonderful about pet food as a business? Why is the fund management industry “broken and not fit for purpose”? Why should you only invest in businesses which operate in industries where there is at least one dominant privately owned company? Terry Smith, the outspoken City broker, has plenty to say on these and other subjects in my latest interview piece for The Spectator. You can read the longer unedited version of this article by following this link to the Independent Investor website.

Written by Jonathan Davis

March 27, 2011 at 10:31 PM

Q and A with Jonathan Ruffer

Most subscribers to my blog know that you can find an archive of my FT columns on the Independent Investor website. I have also added there a transcript of an interview with Jonathan Ruffer, the founder of Ruffer Investment Management (now Ruffer LLP), which formed part of the research for my most recent contribution to The Spectator, which appeared in last week’s issue.

Ruffer has been pursuing its distinctive absolute return approach to investment since 1994. Results to date have been outstanding: double digit compound growth with low volatility. Here is an extract from the Q and A, describing in Ruffer’s own words how his team predicted the onset of the credit crunch well before it happened:

I think the trouble with human beings, and certainly with the market, is that the market is an idiot savant.  If it picks up a thought, it can get almost immediately to the most sophisticated implication that derives from that thought. But if it isn’t thinking that thought, something can be crashingly obvious and nobody picks it up. A good example of that, something that we called to the detail, was the credit crunch of 2008, when we had a double-digit return despite being a long-only house. The truth is that, although the timing of 2008 wasn’t obvious, the event itself was fantastically obvious.

Once every generation or so what happens is that whole societies decide to borrow money. You get an inflection point when greed turns to fear, everybody runs for cover, and everybody wants to sell the collateral. What happens is not just that asset prices go down, but that the markets glitch up and that rocks a financial system to its very foundations.  Put like that, the credit crunch was obvious. Read the rest of this entry »

Written by Jonathan Davis

October 18, 2010 at 10:40 AM

The Budget: A Start Down The Road

There was nothing in George Osborne’s emergency Budget on Tuesday to contradict the idea that the transition from Labour governments to Conservative (or in this case Conservative-led) ones tends to be good for the investing classes. The fall of the Callaghan government in 1979 was followed after an initial period of uncertainty by the start of an 18-year bull market that was resilient enough to survive two nasty recessions, the 1987 crash and our undignified exit from the ERM in 1992. There were similar bull markets for shares in the mid-1930s, following the formation of a Conservative-dominated National Government, and in the Eden-Macmillan years in the 1950s.

This time round, the stock market response is again likely to be positive, once it has had time to digest unpalatable items such as the rise in capital gains tax for higher-rate income tax payers. Raising the top rate to 28% rather than 40% or higher is less of a sop to the Lib Dems than many Tories had feared. Osborne’s measures are generally a boost for the private sector. Indeed, by leaving the onus on the private sector to lead the UK out of economic recovery, he has firmly rejected neo-Keynsian solutions in favour of hitching the administration’s fortunes to those of its natural constituency.

The proposed year-by-year cut in corporation tax down to a record low of 24 per cent, and the commitment to ‘simpler rules and greater certainty’ for companies generally, are all to the good. At the macroeconomic level, his vigorous assault on the fiscal mess that Labour left behind is what markets had expected. The devil is in the detail however and the numbers will be rigorously scrutinised for fault lines. It will take time therefore before we can judge whether the results succeed in confounding the jeremiahs of the economics profession, who insist that keeping the public spending spigots open for longer is essential to avoid a second recession, as Geoffrey Howe’s famous 1981 budget was eventually able to confound the nay-sayers of the day.

Prospects for those whose investment horizons do not extend beyond home shores are certainly better than they were under Gordon Brown, but not yet as good as those whose do. UK companies which have succeeded in surviving the debt crisis have rarely been in better shape financially, and in many cases shares look reasonable value. If what Keynes called the corporate sector’s “animal spirits” can be roused, and sterling remains competitively priced, then there is room for profits and investor returns to exceed expectations.

But the fortunes of the UK will remain constrained by the burden of public debt and the painful side-effects for employment and growth of Osborne’s campaign to diminish it. At best it will be a case of two steps forward and one step back for UK plc, forced to compete in international market against less constrained rivals. The weakness of the euro is already doing wonders for German industry, for example.

Fortunately, twenty years of free-moving global capital flows have significantly increased the correlation between the performance of the main asset classes in different countries. Innovation has also greatly increased the range of markets in which private investors can readily invest. That cuts both ways: almost half BP’s dividends before the current disaster were being paid in dollars to investors outside the UK. No UK investor any longer has to place a binary bet on the success of Osborne’s strategy however.

Despite gloomy headlines about possible meltdown in the eurozone and fears that the US economy may be heading for a second recession, the global economic news has been good. The annualised rate at which global industrial production has been recovering since the darkest days of the credit crisis has been unprecedented. Giles Keating of Credit Suisse points out that car sales in the three largest economies (Germany, Japan and the US) are still well down on pre-crisis levels, yet in the eight largest emerging markets they are growing strongly. Taken together, global sales of cars in these 11 economies are already back above their pre-2008 average.

Indeed, so well are low-debt and emerging economies doing that some are already starting to confront the problems of too rapid growth, through interest rate rises and tighter monetary control. China’s attempts to control its real-estate bubble have captured most of the headlines, but the Chinese are not alone. Brazil grew at an annualised rate of 10 per cent in the first quarter and interest rates there are heading up; so too in Australia and Canada. The evidence to date has confounded the many who doubted that there might be a V-shaped economic recovery.

In the absence of serious mistakes by governments and central bankers, not something that can alas yet be discounted, the odds on further recovery are improving, but with the indebted developed world continuing to lag the developing world. It is true that many investors remain to be convinced. Risk aversion explains why, although share prices are still handsomely above the lows of early last year, yields on government bonds remain stubbornly low.

So too, with the notable exception of gold, are the prices of most commodities. That is not a pattern you would expect to see if sustainable economic recovery was now a universally accepted fact. Banks in the eurozone remain vulnerable and will need to be recapitalised, while the blundering way that the EU and ECB have handled the Greek debt crisis is not an encouraging omen.

Experience shows that a good investment strategy has several elements: an understanding of value, since buying cheaply is the only thing that guarantees good returns; diversification, to protect against mistakes and unforeseen risks; a longer-term focus, for consistency and the avoidance of pointless trading costs; and a strategy that matches the investor’s temperament and tolerance for risk. One Budget can make only so much difference. 

Looking back to 2000, no more than half a dozen good strategic calls, some running contrary to consensus opinion at the time, would have ensured a profitable decade. One was to buy and hold government bonds, which have been in a more or less continuous bull market since 1981. Another was to buy and hold commodities, which despite recent stalling, remain in one of their generation-long cyclical upswings. A third was to be out of equities when valuations rose above historic norms, as they were in 2000 and 2007, while increasing (for those with the tolerance to ride out short-term volatility) the proportion in emerging markets.

Property remained a good bet for the first half of the decade, but killed anyone with excessive leverage when the credit crisis hit. Sterling, surprisingly perhaps, ended the decade at almost the same price in dollars at which it started, and needed no long-term strategic call. Wine and art had a terrific decade.

Anyone who got those calls right could easily have trebled their wealth over the period — not bad in a decade when mainstream asset classes and allocations produced disappointing returns. The credit crisis of 2008 underlined how the diversification value of so-called alternative assets such as hedge funds and private equity proved illusory when trouble hit. Many turned out to be nothing more than debt-leveraged equity holdings that proved difficult or impossible to sell. 

Looking forward to the next decade, some of these trends, including the rise in emerging markets, are set to continue. Current prices for emerging-market equities still leave room for long-term gains. So too do prices of many large dividend-paying companies in developed markets. Equities in general are certain to enjoy a better decade than the one just finished: there has never been an example in history when a decade of flat equity returns failed to produce above-average returns in the next one.

Other trends will reverse completely. For the first time in nearly 30 years government bonds in the main issuing countries look extremely unattractive on anything but a short-term view. Bonds issued by stronger, more politically stable emerging countries look better value. However firmly the new government wrestles with the public finances, all historical experience will have been defied if higher inflation is not part of the eventual solution. Unfortunately inflation-linked bonds, one obvious hedge, are currently dear.

The factors behind the global commodity upswing remain in place. Expect higher prices over at least the next five years not just for gold and silver, which are bulwarks against the monetary debasement now being practised around the world, but also for oil, timber, industrial metals and agricultural commodities. Although the UK’s ability to devalue has given us a helpful jump-start over eurozone competitors, the longer term implication is that the dollar, sterling and the euro (if it survives) may continue to weaken over the next decade relative to the currencies of faster-growing or resource-rich developing countries. The UK’s fortunes are looking up after this week’s Buidget, but economic miracles sadly need more time to gather real momentum. It is a start, but no more

Written by Jonathan Davis

June 25, 2010 at 5:57 PM

Climbing The Great Wall of Worry (Again)

The Spectator recently asked me to contribute an article on China for its investment section.  You can read it here, with some subsequent comments of my own at the end.

One tried and tested rule in investment is that the bigger and more widely shared the worry, the less likely it is that the concern will be realised. Remember Y2K and the Sars epidemic? Both produced warnings of apocalyptic disaster on a global scale. Neither turned out to be anything like the threat in reality that doomsters had originally predicted.

Contrast that with the sub-prime banking crisis, whose dimensions only became popularly apparent some time after the crisis had already broken. In the years when investors should have been worrying about the uncontrolled lending habits of the biggest banks, most were too busy loading up on anything they could buy with cheap credit to take any notice of the impending disaster that their own insouciance was helping to bring about.

On this measure, if nothing else, investors considering putting their money into Chinese shares today should not have much to worry about. In the media, and in dealing rooms around the world, whether China’s economy is overheating and the Chinese stock market moving into “bubble” territory have been popular topics for months. Industry data shows that foreign investors have been pouring money into funds that invest in China for some time, reinforcing the increasing involvement of domestic Chinese investors.

The amount invested in China funds doubled in the course of 2009, driving the Chinese stock market higher, and prompting concerns that it could crash for a second time, just as it did in 2007-08, when the Shanghai Composite Index fell by 70% in 12 months. Market pundits such as Jim Chanos, a New York hedge fund manager, and economist Nouriel Roubini, both notable for being among the few to predict the global financial crisis, have lent their support to the proposition that China could be the next big stock market “bubble”.

On the other side of the argument are those, such as Jim Rogers, co-founder of the Quantum fund, or Jim O’Neill of Goldman Sachs, who argue that what the world is witnessing in China is a spectacular change in economic status that offers investors opportunities on the same scale as, say, the United States in the late 19th/early 20th century. Those who focus on the short term risks –corruption and cronyism, the lack of transparency, dodgy accounting, intrusive government – are, they say, simply missing the point.

After 30 years of rapid growth, the Chinese economy is poised to overtake Japan this year as the second largest economy in the world, and in two decades or so is likely to catch and overtake the United States as well. While there is no guarantee that economic growth will produce correspondingly high returns for investors, a point that is reinforced by numerous historical studies, it does not mean there won’t be many moneymaking opportunities in the years ahead.

The United States in the early 1900s, says Rogers, are “right where China is today – a Wild East compared to the Wild West”. Investors should not lose a sense of perspective. “Imagine how uncertain America’s world appeared to the world in 1908. China seems just as fraught and chaotic and fraught with challenges today..…In 1907, in fact, the US economy collapsed and the naysayers were jubilant. But even those who bought at the top [of the stock market] came out way, way ahead” over time. In other words, even if the Chinese stock market were to fall again by 50%, which it could well do periodically in the years ahead, those with the patience and the nerve to see it through could still be considerably richer than when they started.

This ongoing debate has been fanned afresh by the news that Anthony Bolton, arguably the most successful investment manager in UK history, has been tempted out of retirement to manage a new China fund for his employers, the giant American fund management group Fidelity. His China Special Situations fund is looking to raise $1 billion, some £650m, from UK investors between now and the end of the current tax year.

That makes it the largest investment trust launch in UK history, and as befits Mr Bolton’s reputation is being given the full-on marketing push that only the largest global fund management groups can muster. As well as blanket advertising in the media, this includes making commission payments to brokers, dealers and bankers who recommend the trust to their clients, something that is rare for an investment trust launch (although standard practice for unit trusts and other types of funds).

With Mr Bolton pinning his reputation on its success, and Fidelity taking no chances that it will fail for lack of marketing effort, nobody seems to doubt that the fundraising will meet its target. The question is what happens after that. Could the Chinese fund conceivably prove to be a success to match that of his UK and European funds, both of which produced exceptional returns over a long period? £1 invested in the UK fund grew in value 160 fold over the course of Mr Bolton’s 28 year tenure as fund manager, beating the UK stock market by an unprecedented margin of 6% a year.

Could he repeat the trick this time round? One obvious problem is that while he is uprooting his family to move to Hong Kong, Mr Bolton has only committed to run the new fund for a minimum of two years, leaving what happens subsequently open to doubt. Another is that he does not speak Chinese, or indeed any foreign language, and will need to rely on his local colleagues for scuttlebutt and face to face dealings with the management of local companies if they do not speak English (though many do).

There are unhappy precedents of similarly high profile funds being launched and then coming a cropper. The fund industry has an unfortunate reputation for tapping private investors for money when it is easiest to do so, rather than when it is in the investor’s best interest. Typically this means after a particular market or sector has had a spectacular run of good performance, which by its nature increases the likelihood of future disappointment.

The sceptics argue that this could be just such a time as far as China is concerned. The Chinese stock market is still at barely half the level it reached at its peak during the speculative run up in 2008, which is a long way from any sensible definition of a bubble. Yet several well respected professional investors who have managed funds in Asia for many years, such as Angus Tulloch at First State Investments in Edinburgh, or Hugh Young of Aberdeen Asset Management, have been urging caution.

With the Chinese authorities now attempting to rein in the spectacular lending spree that Chinese banks were ordered to embark on in the autumn of 2008 (a commandment which, unlike Gordon Brown’s pitiful attempts in the UK to prod the banks into lending more, the banks have implemented with frightening efficiency), their argument is that Chinese shares have run ahead of themselves and look vulnerable to China’s new monetary squeeze. This may not therefore be the best time to be moving into the Chinese market.

While he is well aware of the risks, Mr Bolton remains undaunted and indeed enthused by his new venture. He has no financial need to return to fund management and the decision to put his reputation on the line in a country that he has only got to know in any depth over the last few years reflects his confidence that hunting for undervalued companies in China will prove to favour his contrarian stockpicking style.

If the timing of the launch is not perfect, in his view there is no compelling evidence that the Chinese market is seriously overvalued. One comfort for sterling investors, he points out, is that that the Chinese currency is sure to strengthen, even if nobody knows exactly when or how the Chinese authorities will sanction the move. When that happens it will boost returns to sterling investors, which are likely to be considerably higher than those on offer from mainstream equity markets in the UK and US.

An important consideration in taking the plunge into China, Mr Bolton argues, is that with GDP of $6,000 per head, China has now reached the point at which, historically, developing countries have entered their fastest period of economic growth. If past precedents are anything to go by, this will also be the period during which an emerging middle class will embrace the consumer society, leading to the rapid appearance of many profitable new businesses in sectors such as retail. While the risks of corruption, collusion and political interference are all too real – many of the largest companies listed in China are former State-owned enterprises – he reckons he only needs to find a relatively few big winners to generate above average long term returns.

The track record of Chinese funds is impressive enough to give some credence to sceptics about the timing of Fidelity’s launch. Most China funds have delivered five-year returns of between 10% and 20% per annum, notwithstanding the emerging market meltdown in 2008-09. Many of the funds with longer track records have doubled their investors’ money, albeit with considerable volatility. Over the last ten years Wall Street and the London stock market have by contrast returned next to nothing.

The one certainty is that the Chinese stock market, like Wall Street in the early 1900s, will be volatile for many years to come. Those with a limited tolerance for that kind of risk should obviously steer well clear. For those who understand the nature of the beast, whether they buy into Mr Bolton’s new fund now, or wait for a better opportunity to invest in one of the many other readily accessible China funds now on offer, the upside remains considerable.

Update/latest view: A number of financial advisers appear to be cautious about investing in the new Fidelity China Special Situations fund run by Anthony Bolton, preferring to wait and see how the launch plays out before committing client money. Their worry is that the Chinese economy may be overheating and this is not the best time to be putting money into an untried fund. The argument on the other side is that  Mr Bolton, though a relative novice in China, is a tried and tested  stockpicker whose methods are well suited to exploiting anomalies in an emerging and inefficient market – a good bet for risk-tolerant investors with long term horizons.

Written by Jonathan Davis

March 26, 2010 at 3:26 PM