WEBVTT - The Capital Cycle Is Turning 0:00:02.600 --> 0:00:07.520 Bloomberg Audio Studios, Podcasts, Radio News. 0:00:17.560 --> 0:00:19.799 Welcome to Marin Talks Money, the podcast in which people 0:00:19.800 --> 0:00:22.600 who know the markets explain the market. I am Maren 0:00:22.640 --> 0:00:25.280 Somerset Web and this week I am speaking with Luke Bridgman, 0:00:25.440 --> 0:00:29.080 Senior partner and portfolio manager at Hosking Partners. I invited 0:00:29.200 --> 0:00:33.480 Luke on because they are a very interesting group of investors. 0:00:33.520 --> 0:00:37.760 At Hosking. They invest based on the capital cycle. We're 0:00:37.760 --> 0:00:40.120 going to talk about that, what it means, how it works, 0:00:40.159 --> 0:00:43.080 and at the same time we talk about everything from 0:00:43.120 --> 0:00:45.920 why they're invested in Japan to oil and in particular 0:00:46.000 --> 0:00:49.800 about dram memory and about shipping. Luke, Welcome to Marin 0:00:49.800 --> 0:00:50.400 Talks Money. 0:00:50.680 --> 0:00:51.920 Great to be here. Thank you, Mary. 0:00:52.360 --> 0:00:54.560 Well listen, Luke. I asked you on because I think 0:00:54.600 --> 0:00:57.480 a lot of our listeners are quite interested in capital 0:00:57.560 --> 0:01:00.360 cycle investing. We've written and spoken about it a few 0:01:00.360 --> 0:01:04.320 times in the past, and looking at the massive levels 0:01:04.360 --> 0:01:07.760 of capital spending going on, particularly of course in the 0:01:07.840 --> 0:01:11.160 AI area, it seems like something we probably should begin 0:01:11.400 --> 0:01:14.040 to focus on. So that's the reason that I thought 0:01:14.200 --> 0:01:17.000 I want to talk someone involved in a capital cycle 0:01:17.040 --> 0:01:20.319 style of investing, and you came to mind so I 0:01:20.400 --> 0:01:23.520 wonder if we could just start by me asking you 0:01:23.600 --> 0:01:26.800 what exactly is it that you do at Hoskin and 0:01:26.880 --> 0:01:28.800 how does the investing style work? 0:01:29.080 --> 0:01:32.400 Great? Thanks Marin. What we do at Hosking is is 0:01:33.040 --> 0:01:36.119 very simple. We have a single strategy and that's global equities. 0:01:36.640 --> 0:01:39.399 We do that with a team of five portfolio managers, 0:01:40.040 --> 0:01:43.039 and we are slightly different from other firms in that 0:01:43.280 --> 0:01:48.360 we are all global generalists investing across the whole world 0:01:48.360 --> 0:01:52.600 without specialization, using this capital cycle approach, and we do 0:01:52.680 --> 0:01:55.840 this with a very diversified portfolio of about four hundred stocks. 0:01:56.480 --> 0:02:00.000 If that answers the question, it begins to answer the question. 0:02:00.720 --> 0:02:03.280 But the second bit is to explain because we do 0:02:03.440 --> 0:02:07.400 not have a fully expert audience. We have educated amateurs 0:02:07.400 --> 0:02:09.799 at our audience in the main. So now we need 0:02:09.840 --> 0:02:12.120 to explain exactly what it is that you mean by 0:02:12.200 --> 0:02:13.440 capital cycle investing. 0:02:14.000 --> 0:02:16.280 Okay, so the capital cycle is based on the very 0:02:16.320 --> 0:02:21.200 simple paradigm. The high returns tend to attract capital, and 0:02:21.320 --> 0:02:26.680 that capital competes away those returns to the point that 0:02:26.720 --> 0:02:31.920 the returns fall due to obsolescence or bankruptcy or merger. 0:02:32.360 --> 0:02:35.079 And then in the absence of competition, the returns recover 0:02:35.480 --> 0:02:38.880 and the cycle begins again. And that's not rocket science. 0:02:38.960 --> 0:02:42.960 Is very simple. It's a simple observation about business and economics. 0:02:43.800 --> 0:02:46.840 As capital cycle investors, we're really focused on where that 0:02:46.880 --> 0:02:50.080 doesn't work, and that means we're really looking for two 0:02:50.120 --> 0:02:54.480 types of situation. Broadly speaking, we're looking for high return 0:02:54.680 --> 0:02:57.320 companies where capital can't get in. So those are sort 0:02:57.320 --> 0:03:02.200 of Warren bufferty Moti barriers to entry. Situations where there's 0:03:02.200 --> 0:03:05.040 some reason why capital can't come in to compete and 0:03:05.080 --> 0:03:08.000 the returns can be sustained for higher than the market 0:03:08.040 --> 0:03:10.720 recognized in the price. They're able to beat the fade 0:03:10.760 --> 0:03:14.720 and show persistence. And then we're also interested in situations 0:03:14.760 --> 0:03:18.399 where returns have been beaten up and capital has been withdrawn, 0:03:19.120 --> 0:03:21.360 and that gives us the confidence to make the bet 0:03:21.400 --> 0:03:23.639 that the returns are going to pick up sooner than 0:03:23.639 --> 0:03:26.200 the market is given credit for. And so the benefit 0:03:26.600 --> 0:03:29.320 of the capital cycle approach is that it's able to 0:03:29.840 --> 0:03:33.960 plot all companies somewhere in this sort of view of 0:03:34.000 --> 0:03:37.440 the world, but it makes it incredibly versatile. That's the 0:03:37.480 --> 0:03:40.800 governing principle, the lens through which we see the world, 0:03:40.800 --> 0:03:44.880 which allows us all to be generalists trying to take 0:03:44.920 --> 0:03:47.040 advantage of this huge opportunity set. 0:03:47.320 --> 0:03:49.960 So in a sense, you're looking at investing through the 0:03:50.040 --> 0:03:52.840 lens of supply rather than through the lens of demand. 0:03:53.200 --> 0:03:54.880 I mean, I was actually on a podcast the other 0:03:54.960 --> 0:03:56.480 day talking to someone about this and saying that one 0:03:56.520 --> 0:03:58.880 of the very first things that I learned when I 0:03:58.920 --> 0:04:02.080 first started as a stop in Tokyo was to look 0:04:02.200 --> 0:04:05.600 in particular at semiconductor stocks and to say, when these 0:04:05.640 --> 0:04:07.920 things look cheap is when you shouldn't be buying them, 0:04:07.960 --> 0:04:10.360 and when they look expensive is when you should be 0:04:10.360 --> 0:04:14.240 buying them, because given the way the capital cycle works, 0:04:14.400 --> 0:04:18.240 you want to be selling them when they are incredibly popular, 0:04:18.360 --> 0:04:20.720 making powers of money and holds more capital that's coming 0:04:20.720 --> 0:04:23.159 into the market, because that's when you know that prices 0:04:23.240 --> 0:04:26.080 will soon fall, whereas on the other end, when they 0:04:26.080 --> 0:04:28.480 look very expensive, they're not. But sorry, yes, when they're 0:04:28.520 --> 0:04:31.280 not making any money, that's when you want to be 0:04:31.520 --> 0:04:33.800 to be buying them, because there's very limited amounts of 0:04:33.800 --> 0:04:34.599 capital in the market. 0:04:34.680 --> 0:04:38.040 Right, Yeah, Yeah, you're completely right. Two points. Yes, it's 0:04:38.080 --> 0:04:40.320 about supplier rather than demand, So we're sort of able 0:04:40.360 --> 0:04:44.159 to observe those things which are observable we can count 0:04:44.320 --> 0:04:47.320 factories being opened, we can look at job hires, we 0:04:47.360 --> 0:04:50.640 can see the reverse in terms of bankruptcies or failures. 0:04:50.760 --> 0:04:52.520 We can see the amount of debt being raised or 0:04:52.520 --> 0:04:55.520 the amount of equity being issued, rather than trying to 0:04:55.560 --> 0:04:57.279 predict how many widgets are going to be sold in 0:04:57.320 --> 0:05:00.120 North America in two years time. But you're also right 0:05:00.160 --> 0:05:05.440 that it's something which is inherently contrarian. And if we 0:05:05.480 --> 0:05:09.839 see high returns as capital cycle investors, our first thought is, 0:05:10.080 --> 0:05:12.520 you know, how likely are those returns to be competed away? 0:05:13.200 --> 0:05:16.360 Where we see poor returns which are hated and neglected 0:05:16.360 --> 0:05:20.080 by everybody else, we ask ourselves, well, could they be wrong? 0:05:20.120 --> 0:05:23.039 And is there an opportunity for returns to recover because 0:05:23.320 --> 0:05:27.159 capital has been withdrawn from this particular sector. So, as investors, 0:05:27.440 --> 0:05:32.200 taking contrariy decisions is emotionally very very difficult, and if 0:05:32.240 --> 0:05:35.720 we have some sort of intellectual or rational tool which 0:05:35.800 --> 0:05:39.480 helps us to make emotionally difficult decisions, then that's got 0:05:39.520 --> 0:05:40.520 to be something in our favor. 0:05:41.000 --> 0:05:43.279 Yes, well, that's why we always say that good fund 0:05:43.360 --> 0:05:46.479 management as much as that character of strategy, don't. 0:05:46.320 --> 0:05:48.080 We Yeah, I think that's very true. 0:05:48.880 --> 0:05:52.680 Right, So let's move that on to talking about did 0:05:52.680 --> 0:05:54.680 you write this piece about the share prices of the 0:05:54.720 --> 0:05:57.480 three companies which dominate the global deram membory thing was 0:05:57.520 --> 0:05:57.800 that you? 0:05:57.920 --> 0:05:59.200 Noh, yeah, I did. I did write that. 0:05:59.440 --> 0:06:00.480 Yeah, worry about that? 0:06:00.560 --> 0:06:00.680 Well? 0:06:00.880 --> 0:06:03.479 Excellent, of course you wrote it, and it's excellent. This 0:06:03.640 --> 0:06:05.760 is the area when we're talking about the capital cycle. 0:06:05.839 --> 0:06:08.240 We look at companies such as the easy you talk 0:06:08.279 --> 0:06:11.520 about Micron and Skhiinex and Samsung. And obviously there's been 0:06:11.520 --> 0:06:13.640 a lot going on in career over the last couple 0:06:13.680 --> 0:06:15.839 of weeks while I've been on holiday, so the cost 0:06:15.839 --> 0:06:17.760 bit is now down from its peakback in June, right, 0:06:17.800 --> 0:06:20.960 and some of these big, big companies have had rather 0:06:21.080 --> 0:06:26.000 nasty negative momentum moves recently. But nonetheless, the conversation is 0:06:26.040 --> 0:06:30.640 about the extent to which these companies that currently dominate 0:06:30.680 --> 0:06:33.680 the memory market will be subject to an old fashioned 0:06:33.720 --> 0:06:34.440 capital cycle. 0:06:34.800 --> 0:06:37.800 Yeah. It's a fascinating subject because we've been investing in 0:06:38.240 --> 0:06:42.120 the memory semis, by which I mean the manufacturers of 0:06:42.200 --> 0:06:44.880 DRAM in particular, and those are the two Korean companies 0:06:44.880 --> 0:06:48.239 Samsung and sk Heinex, as well as Micron in the US. 0:06:48.480 --> 0:06:51.680 But we've been investing in them since inception, which for 0:06:51.839 --> 0:06:55.239 us is twenty fourteen. It's a really interesting sector because 0:06:55.279 --> 0:06:57.120 to understand that, you really need to go back to 0:06:57.200 --> 0:07:01.520 the discovery of DRAM, which was by In funnily enough 0:07:01.560 --> 0:07:05.480 in nineteen seventy and despite being the pioneer in this industry, 0:07:05.600 --> 0:07:09.440 it actually exited fifteen years later in nineteen eighty five 0:07:09.880 --> 0:07:13.119 to focus on logic chips, where it saw itself having 0:07:13.400 --> 0:07:16.960 a greater advantage. And the reason why it exited DRAM 0:07:17.040 --> 0:07:19.280 despite having been the pioneer is that it just saw 0:07:19.720 --> 0:07:24.240 more and more competition coming into this highly commoditized market 0:07:24.320 --> 0:07:28.120 for memoryships, which were all interchangeable and which we're suffering 0:07:28.160 --> 0:07:33.080 from excess investment. There was a constant progress in what's 0:07:33.080 --> 0:07:36.120 called Moore's law. The number of transistors you can get 0:07:36.160 --> 0:07:39.880 onto a chip shrinks at a fairly regular pace every 0:07:39.920 --> 0:07:44.160 two years, broadly speaking, and so the constant need keep 0:07:44.200 --> 0:07:47.800 investing with the latest technology before you'd even really made 0:07:47.800 --> 0:07:50.880 a return on the previous investment cycle. And this led 0:07:51.040 --> 0:07:55.320 what had been thirty DRAM companies around nineteen eighty five 0:07:55.680 --> 0:08:00.560 when Intel exited, to fall to just three years later 0:08:00.640 --> 0:08:04.600 in twenty twenty thirteen, twenty fourteen s and that was 0:08:04.640 --> 0:08:07.080 because they couldn't keep up with that pace of investment, 0:08:07.160 --> 0:08:10.120 and so the lack of a return on capital meant 0:08:10.160 --> 0:08:14.280 that they were either forced into bankruptcy or gobbled up 0:08:14.320 --> 0:08:16.760 by other d round companies until there were just three left. 0:08:17.200 --> 0:08:21.000 And then what happened at that point was the physics 0:08:21.040 --> 0:08:24.440 really reached its natural limit and it became more and 0:08:24.520 --> 0:08:28.760 more difficult to shrink the number of transistors on these chips, 0:08:29.200 --> 0:08:32.319 and that gave the three surviving companies the breathing space 0:08:32.400 --> 0:08:37.840 to slow down. And the capex was still very high, 0:08:37.920 --> 0:08:41.240 which was a significant barrier to entry, preventing other companies 0:08:41.240 --> 0:08:43.480 really from coming in. And we can come onto the 0:08:43.559 --> 0:08:44.719 Chinese companies. 0:08:44.400 --> 0:08:46.079 Later, Oh yes, that's the plan. 0:08:47.240 --> 0:08:50.280 But in the meantime it allowed them to generate a 0:08:50.320 --> 0:08:53.800 return on capital rather a return of capital. And so 0:08:54.440 --> 0:08:59.400 the chip industry is still cyclical. It's based on and 0:08:59.720 --> 0:09:03.440 mark cycles, and chip companies need to run their kit 0:09:03.520 --> 0:09:05.640 at a full capacity, so you get a mismatch between 0:09:05.640 --> 0:09:08.800 supply and demand. But that's just a normal inventory cycle. 0:09:09.480 --> 0:09:12.560 But because the market had consolidated because no new capital 0:09:12.600 --> 0:09:15.840 was coming in from outside, what we found was that 0:09:15.920 --> 0:09:20.080 through each cycle, the reternal capitul in each got higher 0:09:20.240 --> 0:09:22.560 and in each low as well, which was a fairly 0:09:22.559 --> 0:09:26.960 attractive phenomenon. So as long term investors, we were able 0:09:27.040 --> 0:09:29.920 to trim at the peaks and add at the bottoms, 0:09:30.280 --> 0:09:35.360 which we did fairly successfully up until twenty twenty two 0:09:35.559 --> 0:09:39.400 in November when chatchpt first launched itself on the world, 0:09:39.960 --> 0:09:44.200 and we saw the beginning of a huge demand cycle 0:09:44.320 --> 0:09:47.679 which we're still in and that has turned these companies 0:09:47.720 --> 0:09:50.080 into trillion dollar companies. I'm not sure where they are 0:09:50.160 --> 0:09:54.240 to dating. The share prices are moving very violently because 0:09:54.240 --> 0:09:57.600 of all of the retail participation and momentum in the market, 0:09:57.920 --> 0:10:00.880 and so that's really put our previous approach to the test. 0:10:01.280 --> 0:10:04.000 And what we're trying to do is actually keep doing 0:10:04.000 --> 0:10:06.440 what we have been doing, which is trim as the 0:10:06.480 --> 0:10:10.120 prices get higher and higher while retaining exposure, so that 0:10:10.160 --> 0:10:12.520 we probably will be adding at some point in the 0:10:12.520 --> 0:10:15.600 future if prices fall dramatically further from where they are. 0:10:16.000 --> 0:10:19.240 So when you say that that it challenged your previous approach, 0:10:19.280 --> 0:10:21.040 I mean you still refer to this as a cycle. 0:10:21.360 --> 0:10:25.600 This is not a permanent increase in demand constantly. Are 0:10:25.640 --> 0:10:27.719 still a cycle. It's just a matter of figuring out 0:10:27.760 --> 0:10:29.600 what sort of cycle it is and how long a 0:10:29.679 --> 0:10:30.320 cycle it is. 0:10:31.360 --> 0:10:33.839 And there are wheels within wheels here, there's this sort 0:10:33.840 --> 0:10:37.040 of capital cycle life to've been describing their inventory cycles. 0:10:37.080 --> 0:10:40.560 There are product cycles, they're economic cycles. But we've got 0:10:40.600 --> 0:10:42.480 to try and keep an eye on the bigger picture 0:10:42.520 --> 0:10:44.640 in terms of the capital cycle. And I think the 0:10:44.640 --> 0:10:47.640 thesis remains intact that there are still just three d 0:10:47.760 --> 0:10:51.000 RAM companies, but we've got to recognize that there is 0:10:51.240 --> 0:10:54.960 exuberance in prices. There is the threat that the Chinese 0:10:55.280 --> 0:10:58.400 will catch up, and there is the risk that other 0:10:58.440 --> 0:11:02.640 ship companies may try to come into the memory market. Yeap. 0:11:03.040 --> 0:11:05.400 Where we take some comfort for the time being is 0:11:05.480 --> 0:11:09.520 just the huge amount of capital and know how required 0:11:09.600 --> 0:11:12.960 to compete with these companies. And even if they themselves 0:11:12.960 --> 0:11:15.760 are going to lose discipline in terms of capex, and 0:11:15.800 --> 0:11:19.440 we're fairly confident that they are aware of their own 0:11:19.520 --> 0:11:21.960 sins in the past and determined not to repeat the 0:11:21.960 --> 0:11:24.959 same mistakes. Never say never, But nevertheless, the amount of 0:11:25.000 --> 0:11:27.640 time required to bring on new capacity is long in 0:11:27.760 --> 0:11:31.120 terms of building these new fabs and equipping them and 0:11:31.160 --> 0:11:33.520 getting them going, and so on, so we've got some 0:11:33.679 --> 0:11:34.400 time yet. 0:11:35.040 --> 0:11:39.280 Yeah, so you're not too worried about the Chinese competition 0:11:39.400 --> 0:11:40.000 coming through. 0:11:40.679 --> 0:11:43.320 I think at the moment the view is that as 0:11:43.400 --> 0:11:47.560 the Chinese advance, so too will the incumbents, and so 0:11:47.720 --> 0:11:50.600 catching up will always be difficult, and there's much less 0:11:50.679 --> 0:11:55.280 value in the previous generation of chips than the leading edge. 0:11:55.559 --> 0:11:58.040 But I think you'd be foolish to assume that the 0:11:58.120 --> 0:12:01.439 Chinese aren't capable of eventually catching up. So it may 0:12:01.480 --> 0:12:02.880 simply be a question of time. 0:12:03.200 --> 0:12:06.640 Yeah, only say the end that, of course, superprofits will 0:12:06.679 --> 0:12:10.440 eventually bring on new supply, because they always do, with 0:12:10.520 --> 0:12:13.640 inevitable consequences for returns and ultimately for share prices. 0:12:13.679 --> 0:12:17.120 But that's a way of Yeah. I mean it's interesting 0:12:17.160 --> 0:12:20.760 speaking to the companies themselves. They are so conscious of 0:12:20.840 --> 0:12:23.840 having screwed up previous cycles. They are now entering into 0:12:24.320 --> 0:12:27.599 so called long term supply agreements with their customers to 0:12:27.640 --> 0:12:30.520 try and keep everyone on the same page and make 0:12:30.559 --> 0:12:34.720 sure that supply matches demand. But very difficult to do them. 0:12:35.120 --> 0:12:37.240 Yeah, because you have that vague feeling, don't you, that 0:12:37.280 --> 0:12:39.240 there may be an earnings bubble in here, and you 0:12:39.280 --> 0:12:41.160 look at the valuations going back to what we were 0:12:41.160 --> 0:12:43.760 talking about at the beginning, is that historically, when a 0:12:43.800 --> 0:12:46.640 company like this is look cheap, regardless of the fact 0:12:46.679 --> 0:12:49.079 that it's had an extraordinary share price run, you look 0:12:49.120 --> 0:12:50.960 at the p and you go, oh, four times six times, 0:12:50.960 --> 0:12:53.240 that looks very cheap. But I think historically that has 0:12:53.240 --> 0:12:54.040 been the time to sell. 0:12:54.679 --> 0:12:58.160 Yeah, I mean, mid single digit pe looks very cheap. 0:12:58.200 --> 0:13:01.880 But on the other hand, much higher price to book 0:13:01.960 --> 0:13:04.400 multiples than we're used to. I mean, previously priced to 0:13:04.400 --> 0:13:07.199 book multiples peaked in this industry at about three times, 0:13:07.760 --> 0:13:10.320 and they are six, seven, eight times at the moment. 0:13:10.880 --> 0:13:13.960 And if you can put capital to work and the 0:13:14.000 --> 0:13:17.520 stock market's going to give a value to that capital 0:13:18.040 --> 0:13:20.560 six times what you just put in, then that's a 0:13:20.559 --> 0:13:22.080 great incentive to overinvest. 0:13:22.559 --> 0:13:25.880 Yeah. Okay, well we'll watch that one and we'll keep 0:13:25.920 --> 0:13:29.800 feeling sorry or worrying about the Korean retail investors. I've 0:13:30.160 --> 0:13:31.599 been on holiday and one of the things that have 0:13:31.640 --> 0:13:33.280 stood out to me on my return has be this 0:13:33.440 --> 0:13:36.400 number that three percent of adults in career received a 0:13:36.400 --> 0:13:38.880 margin call. It seemed extremely worrying. 0:13:39.400 --> 0:13:43.319 Yeah, I mean, that's human dimension to that, which is horrifying, 0:13:43.400 --> 0:13:45.880 But clearly there's a huge amount of exuberance in the 0:13:45.880 --> 0:13:47.920 market at the moment, and that's partly a phenomenon of 0:13:49.520 --> 0:13:52.679 momentum and indexation and all those phenomena we're. 0:13:52.480 --> 0:14:07.960 Familiar with and reminded that diversification is super useful. Right, 0:14:08.240 --> 0:14:10.640 What else is interesting at the moment for you? I mean, 0:14:10.679 --> 0:14:13.120 I see looking at the fund fact cheap for the 0:14:13.160 --> 0:14:17.960 hosting Global Equity Fund that Japan is still the top exposure. 0:14:18.360 --> 0:14:22.400 Yeah, I mean, that's really one of the themes in 0:14:22.440 --> 0:14:25.800 the portfolio. Trying to interpret the four hundred stocks in 0:14:25.840 --> 0:14:29.160 our portfolio and grouping them into themes, and Japan is 0:14:29.200 --> 0:14:31.560 one of those. But there are different ways to slice 0:14:31.880 --> 0:14:35.640 to slice the portfolio. We've been overway Japan for about 0:14:35.640 --> 0:14:38.640 four years, and like I'm sure many of your other guests, 0:14:38.880 --> 0:14:42.000 Japan has gone from all the purpose of corporate Japan 0:14:42.040 --> 0:14:44.920 has gone from providing full employment to the Japanese working 0:14:44.960 --> 0:14:48.960 population to providing returns on capital for the retired Japanese 0:14:49.040 --> 0:14:53.480 population as the demographics have aged and valuations have been 0:14:53.560 --> 0:14:56.240 very cheap, and there's been a massive tailwind from the 0:14:56.240 --> 0:15:02.560 combination of activism by overseason vesters and domestic institutions wanting 0:15:02.720 --> 0:15:07.600 to improve return on equity by Japanese corporates. So we've 0:15:07.680 --> 0:15:10.320 really been taking advantage of that, and I think that continues. 0:15:10.760 --> 0:15:12.840 And the interesting question is which other countries are going 0:15:12.840 --> 0:15:15.560 to be next, whether it's career. Malaysia has a value 0:15:15.640 --> 0:15:16.680 up program as well. 0:15:17.000 --> 0:15:19.640 Yeah, well Career has a program now very similar to 0:15:19.640 --> 0:15:22.880 the Japanese one, pretty much copied, right, so you may 0:15:22.960 --> 0:15:24.920 begin to see things broaden out in career. 0:15:25.320 --> 0:15:27.600 Yeah, And I mean an interesting thing in career is 0:15:28.200 --> 0:15:30.560 coming back to the memory semis. They've been making so 0:15:30.760 --> 0:15:36.920 much money that their unions have successfully negotiated profit participation 0:15:37.120 --> 0:15:40.880 in the pay of their employees. And these super profits 0:15:40.920 --> 0:15:43.960 are going to result in I think a huge amount 0:15:44.000 --> 0:15:48.760 of wealth filtering down into the Korean population, which should have, 0:15:49.080 --> 0:15:51.000 you know, pretty strong ripple effects on the rest of 0:15:51.000 --> 0:15:51.960 the Korean stock market. 0:15:52.440 --> 0:15:54.960 Yeah, which would be interesting. Let's go back to Japan then, 0:15:55.080 --> 0:15:58.840 and what sectors have you got exposure to, entrepaneur is 0:15:58.840 --> 0:16:00.840 this just across the board, We. 0:16:01.240 --> 0:16:05.800 Have pretty broad exposure. We have really been able to 0:16:05.840 --> 0:16:09.520 take advantage of the diversified nature of our portfolio to 0:16:09.600 --> 0:16:13.880 have quite a lot of more audiosyncratic risk, by which 0:16:13.920 --> 0:16:20.240 I mean really size and liquidity, so smaller cap Japanese 0:16:20.240 --> 0:16:27.080 companies where other people running more concentrated strategies would find 0:16:27.120 --> 0:16:29.840 it difficult to put money to work. Because we have 0:16:30.320 --> 0:16:33.800 this broader portfolio, we can invest in those companies and 0:16:33.880 --> 0:16:37.520 take advantage potentially of the work of other activist investors 0:16:37.560 --> 0:16:40.120 who may have been working with the company behind the 0:16:40.160 --> 0:16:44.560 scenes for several years in some cases, and also situations 0:16:44.560 --> 0:16:47.720 which might be relatively liquid because of a family sheholder 0:16:47.800 --> 0:16:51.480 or something. Because we have over fifty stocks in Japan, 0:16:51.600 --> 0:16:56.120 we're not reliant on any one situation paying off within 0:16:56.160 --> 0:17:01.040 a certain timeframe, and so we can manage that liquid risk. 0:17:01.080 --> 0:17:04.240 I think a little better thanks to the diversification. But 0:17:04.520 --> 0:17:07.359 it tends to be more domestic companies, but we also 0:17:07.440 --> 0:17:10.600 have export facing companies as well. But yeah, across all 0:17:10.640 --> 0:17:11.440 sorts of sectors. 0:17:12.160 --> 0:17:14.240 And it's interesting, isn't it that Japan is one of 0:17:14.240 --> 0:17:16.920 the places where small caps have started to auform larger 0:17:16.960 --> 0:17:19.359 companies rather like in the US. Not in the UK 0:17:19.480 --> 0:17:22.399 unfortunately as usual, but in Japan and the US you've 0:17:22.400 --> 0:17:24.120 started seeing a bit of a shift from very large 0:17:24.119 --> 0:17:26.720 companies at performing to the small and medium sized companies 0:17:26.720 --> 0:17:28.560 at performing at the last couple of quarters. 0:17:28.920 --> 0:17:32.280 Yeah, I mean, you still find companies in Japan with 0:17:32.320 --> 0:17:35.240 negative enterprise values, and some of these small companies just 0:17:35.280 --> 0:17:38.239 have very inefficient balance sheets which result in just very 0:17:38.320 --> 0:17:41.560 cheap valuations, and they really have been overlooked, whereas some 0:17:41.600 --> 0:17:45.000 of the more successful world beating Japanese companies are still 0:17:45.040 --> 0:17:49.400 trading it really quite phenomenal valuation multiples which haven't yet derated. 0:17:49.680 --> 0:17:53.240 And so there's a degree of rotation and mean reversion there. 0:17:54.160 --> 0:17:56.360 And then there's even though the market has performed very 0:17:56.359 --> 0:18:00.119 well recently, there's also the possible additional kicker from a 0:18:00.200 --> 0:18:01.040 strengthening Yan. 0:18:01.600 --> 0:18:04.280 Yeah, careful what you wish for, but I mean I 0:18:04.359 --> 0:18:08.440 think certainly Japanese financials well positioned to benefit from that, 0:18:09.080 --> 0:18:11.720 in particular at the large banks, but the pace at 0:18:11.760 --> 0:18:14.119 which that will happen, a manner in which will happen 0:18:14.600 --> 0:18:17.920 is unclear, and so that again, having a diversified portfolio 0:18:18.240 --> 0:18:21.359 in the context of a larger global portfolio gives us 0:18:21.359 --> 0:18:23.080 some sort of comfort. 0:18:23.160 --> 0:18:25.040 And careful what we wish for. What should we be 0:18:25.040 --> 0:18:26.480 worrying about with a strengthening yan. 0:18:27.080 --> 0:18:30.160 Well, there is a huge amount of debt in Japan 0:18:30.359 --> 0:18:33.200 which is one of the reasons why interest rates haven't 0:18:33.240 --> 0:18:36.560 yet managed to rise to the level needed to stabilize 0:18:36.560 --> 0:18:41.119 the currency, and so there are those perennial fears that 0:18:41.640 --> 0:18:44.840 the BOJ will lose control of the exchange rate. On 0:18:44.880 --> 0:18:47.919 the other hand, there are huge amounts of assets belonging 0:18:47.920 --> 0:18:50.960 to Japan overseas, and if they would come back, then 0:18:51.160 --> 0:18:54.840 that would have the opposite effect. So it's really interesting 0:18:54.880 --> 0:18:56.439 times to be investing in Japan. 0:18:57.040 --> 0:19:00.000 I suspect that almost everyone who listens to this podcast 0:19:00.200 --> 0:19:02.240 it's invested in Japan, because we have been going on 0:19:02.280 --> 0:19:05.480 about it for a very long time, very long time. 0:19:06.000 --> 0:19:09.080 There's a wonderful chart. I like this chart enormously in 0:19:09.160 --> 0:19:11.919 the fact cheap for the fund which has bubbles on 0:19:11.960 --> 0:19:15.400 it so we can see where the fund is allocated, 0:19:15.680 --> 0:19:17.840 and I'm interested to see there are quite big bubbles 0:19:17.880 --> 0:19:19.800 for both mining and oil. 0:19:20.480 --> 0:19:22.960 Yeah, if you remember, I was saying, we're really looking 0:19:22.960 --> 0:19:26.080 for two sorts of situations, high return situations where those 0:19:26.080 --> 0:19:30.480 returns can be sustained, and lower return situations where we 0:19:30.560 --> 0:19:33.119 have confidence that the returns are going to pick up 0:19:33.160 --> 0:19:37.320 sooner than the market things is likely. And mining and 0:19:37.400 --> 0:19:41.360 shipping into examples of that. Latter mining went through its 0:19:41.359 --> 0:19:46.800 supercycle when China really opened up and everyone started is 0:19:46.880 --> 0:19:52.000 selling resources to China, and naturally, human biases being what 0:19:52.080 --> 0:19:54.560 they are, this results in massive having investment ad buys 0:19:54.680 --> 0:19:59.119 mining companies, which resulted in terrible returns, which results in 0:19:59.200 --> 0:20:04.720 punishment and capital starvation. Until mining companies were trading ten 0:20:04.800 --> 0:20:07.359 years ago at big discounts to well, they should be 0:20:07.440 --> 0:20:10.359 valued at discounts book value in some cases, and the 0:20:10.440 --> 0:20:14.359 return of capital discipline and the opportunity for investors like 0:20:14.440 --> 0:20:17.960 us to get involved in the large mining companies which 0:20:18.040 --> 0:20:21.560 had got religion again in terms of understanding capital discipline, 0:20:21.840 --> 0:20:25.200 and they've been a feature of portfolio for a while. Obviously, 0:20:25.240 --> 0:20:27.439 the time taken to bring on a new mine is 0:20:27.520 --> 0:20:30.280 measured in the years, if not decades, and again it'll 0:20:30.359 --> 0:20:33.160 run like memory semmes. That gives us the confidence that 0:20:33.160 --> 0:20:35.560 that picture is not going to change too quickly and 0:20:35.600 --> 0:20:39.720 they're going to have the opportunity to sustain high returns 0:20:39.440 --> 0:20:42.720 for a while. Yet shipping is something similar. I mean, 0:20:42.760 --> 0:20:47.520 before the financial crisis, abundant liquidity and very very low 0:20:47.560 --> 0:20:50.480 barriers to entry. This is not a high quality sector. 0:20:51.080 --> 0:20:53.560 Meant that a huge amount of money flooded into shipping. 0:20:53.640 --> 0:20:57.200 You could borrow money from your bank, you'd get some 0:20:57.240 --> 0:21:00.320 sort of credit from the shipyard which didn't require money 0:21:00.359 --> 0:21:03.440 up front. You could raise money in the equity market 0:21:03.480 --> 0:21:07.919 fairly quickly, so anyone could could raise a capital to 0:21:08.080 --> 0:21:10.760 put in an order for a ship, resulting in massive 0:21:10.760 --> 0:21:15.040 over ordering. Financial crisis happens with Lehman, Yet the ships 0:21:15.080 --> 0:21:17.560 continue to be delivered from the shipyards even after the 0:21:17.560 --> 0:21:23.240 financial crisis. A massive oversupply claps in shipping rates bankruptcies, 0:21:24.040 --> 0:21:25.960 and then a full storm and around so of twenty 0:21:26.040 --> 0:21:28.800 sixteen when private equity felt that it could get involved 0:21:28.800 --> 0:21:31.680 and take advantage to the distress, which resulted simply and 0:21:31.800 --> 0:21:34.440 more ordering in the deferral of the recovery. But the 0:21:34.480 --> 0:21:37.160 great thing about ships is that they have a finite life. 0:21:37.560 --> 0:21:41.879 Typically for a blue chip customer, twenty years is the limit, 0:21:42.240 --> 0:21:45.280 which from an investment point view is fantastic because it 0:21:45.320 --> 0:21:48.760 means we have visibility into the future. We can see 0:21:48.760 --> 0:21:50.879 not only how many ships are on the water today, 0:21:51.040 --> 0:21:54.080 but what their age is and when they're likely to 0:21:54.720 --> 0:21:58.240 need to be scrapped. And so we've been really investing 0:21:58.240 --> 0:22:01.760