The Adventurous Investor in Conversation returns with another episode in which I catch up with Liberum’s alternative funds analyst Shonil Chande to discuss his recent study looking into buybacks and investment trusts. SEE LINK directly above to play the 25 min conversation.

Macro Matters: earnings continue to surprise to the upside

I wanted to start with this chart below (from the Daily Shot). It shows the sheer quantum of interest rate rises in a historical context. It's hard not to look at this and think a) my god that’s steep and b) surely it’ll peak very soon and then come down rapidly. This is probably why equities have had a decent few months although it’s also true that global equity markets are currently struggling to find direction. The slight fly in the ointment with this Panglossian way of looking at markets is that in no other era were interest rates so low, for so long. So the exponential increase is a mathematical necessity and tells us nothing about what might happen next.

Chart 1

Anyway, who knows what will happen to macro rates (inflation and interest)? What we can sensibly comment on is what’s happening to corporate earnings, especially in the trend-setting US market. And on this score, the news is surprisingly good. Here are analysts from Deutsche Bank in the US

“Earnings growth remains weak on a yoy basis but rising sequentially. Earnings growth on a YoY basis rose in most regions from Q4 to Q1 but remained modestly negative in the US in the low single digits, and negative in EM in the low double digits. In Europe, it has slowed to a near stall. In the US, as we highlighted last week, the level of earnings, adjusted for seasonality, rebounded strongly from Q4 to Q1 (+5.4% QoQ), recouping more than half the decline since the Q2 2022 peak. In Europe, earnings on a seasonally adjusted basis stayed flat in Q1, but this largely reflects the impact of Energy earnings falling on the back of lower oil prices. Excluding Energy, the level of earnings in Europe rose for the second quarter in a row but remained in the range it has been in for a year. European earnings continue to benefit from growth in the Financials.

Have downgrades ended? Consensus estimates for forward quarters continued to be cut through the earnings season but at a modest pace compared to the historical norm and especially mild compared to the large cuts in each of the last 3 quarters. In fact, 2023 estimates in the US and Europe have ticked slightly higher as the Q1 beats have more than offset cuts to the forward quarters. The consensus for 2023 growth remains near zero for the US and is slightly negative for Europe. On the other hand, in Japan and EM where consensus growth expectations are much higher (6%-9%), estimates have continued to fall. Forward estimates for China have fallen again after a short-lived upgrade.

Chart 2

Analysts at SocGen have also produced a handy ten-point summary about what we’ve learned from the current US earnings season – the bottom line is that its largely good news:

1.            6/10 US equities have been reported so far.

2.            Strongest beats in six-quarters: We are seeing the strongest EPS beats in six-quarters with 82% of firms beating EPS (on lowered estimates).

3.            2023 expectations near 0: the strong season has put a pause on the downgrade cycle for the 2023 EPS expectations near 0% growth. 2023 EPS was downgraded by 8% over the past six months.

4.            Alpha generation: stock that beat were up +0.7% vs Misses -2% on L/S basis. But no strong outperformance on those that beat.

5.            In Styles: Growth is at the top with 78% EPS beats while Value is at the bottom with 53% beats.

6.            In Sectors: Staples (95% of firms beat EPS) is the strongest in number of beats; followed by Materials (93%) and Communication services (92%). At the bottom are Financials which saw 60% of firms beating EPS and Utilities (70%).

7.            EPS momentum: Past 4 weeks have seen the most positive change on 12m Fwd EPS for Consumers (Disc and Staples), Industrials, and Tech; While negative for Energy and Financials.

8.            Profit Margins: The mean reversion on profit margins continues and the margins are now back to trend levels. Compared with history, margins stay well above average levels.

9.            Artificial Intelligence boom: From our newsflow indicators, AI has continued to see an exponential rise during the reporting season (see Trading AI-hype).

Chart

10. Long story short: Strong season with EPS beats is a confirmation that inflation-driven slowdowns do not create a major EPS shock. We expect EPS growth of nearly 0% this year with three-quarters of negative growth. S&P 500 in the 3500-4200 range, renewed bull market only after a recession in 2024. Growth over Value, Defensive Growth over Cyclical Growth, Staples over Financials, Energy and Industrial over Consumer cyclicals are high conviction allocations.

As for major listed corporates in Europe, the numbers also seem to be surprising on the upside.

Here’s the highly regarded Graham Secker from the European equities team at Morgan Stanley in London on what seems like another surprisingly good set of European corporate earnings:

On track for a record quarter. 62% through earnings season, 1Q numbers are currently posting their biggest beat in over 15 years. Nevertheless, MSCI Europe is down ~2% since the beginning of the season, further reinforcing our view that this strong outcome was already priced in by the market.

41% sales beat, moderating through the season. A net 41% of companies have beaten consensus expectations at the top line now, an outcome that is still above the previous quarter (25%) but below the first three quarters of 2022 (average 59%). Weighted revenues are 2.6% above expectations at the index level, with the median stock sales numbers beating expectations by 2.1%.

Record 42% EPS beat. A net 42% of companies have beaten consensus EPS expectations so far this quarter which, if maintained through the end of the earnings season would be the biggest beat since we started compiling data in 2007. Weighted earnings are currently 13.4% above expectations at the index level, with the median stock coming in 9.5% ahead of consensus numbers.

Those of us with a more bearish disposition have to face reality – we expected a fairly sharp decline in corporate earnings which would then push down share prices. Earnings ARE declining but not by as much as we expected – yet. Maybe if we do slip into a recession – and that’s only a probability rather than certainty – then those earnings downgrades will roll on in!

More on De-dollarization

One of the central debates of our time is the focus on US assets amongst financial investors. Put simply, we’re all a little bit too US-centric although that’s only a function of ‘following the money’ i.e. US equity markets dominate developed world equities as do US bonds and dollar trade flows.

Thus the endless debate about the slow demise of the dollar is in fact just a proxy for a much deeper concern with this US-centric worldview. If the dollar starts to fall from its hegemonic position, then maybe US equities and US bonds might follow.  And of course, there’s a geopolitical element to this – if the US is relegated from a dominant hegemon to a muti-polar world, then there are myriad political and economic consequences.

My guess is that multi-polarity is real and that the US dollar is not as hegemonic as it was, but it’s also clear that the dollar is still pretty damned dominant on most common sense measures.

For instance take the dollar’s role as a global reserve currency, where the dollar‘s share has declined once adjusted for price changes. But as analysts at DWS point out once we look at this in nominal terms, the decline doesn’t look very significant at all! The chart below from DWS shows the currency reserves of central banks worldwide, as far as they are reported and can be assigned to a currency.

“It's a picture of stability, but depending on which starting year is used, it can certainly be used to tell stories about the dollar's decline. Questions such as "Will there be a dollar crisis?" and "What would be the macroeconomic scenario of a sudden collapse of the greenback value?" have not only been the subject of market chatter in recent decades but also of profound economic debates]. "We expect steady de-dollarization to continue in the coming years, reflecting in part the growth and increasing financial literacy in the rest of the world," argues Dr. Xueming Song, currency strategist at DWS.”

Graphic: A reassuringly boring picture of the dollar holdings of the world's central banks

* Data up to Q3 2022

Nevertheless, one doesn’t have to buy into the whole “End of dollar hegemony” argument to accept that we moving into a more multi-polar world. I think, in a funny old way, the US would quite like that as the pressure on it to be the global policeman is unmanageable. Ditto for economic power – if I were the US Federal Reserve I’d be a bit miffed at constantly having to bail out our friends and frenemies.

If we accept this change then we also need to accept that the global commercial rules set down after Bretton Woods are changing. National security considerations are becoming more and more relevant. US-based analysts for investment bank Morgan Stanley reckon that these slow changes open up opportunities for investors:

• “The ‘great productivity race’ will benefit some sectors but challenge others: Efforts in the US to re-, friend-, and near-shore critical industries have strong political support. But these initiatives narrow the geographical options for US multinationals, making cheap labor – particularly for skilled manufacturing – harder to find and exacerbating an underlying US economic challenge. Similar historical conditions have pressed companies to focus on improving productivity through the development, diffusion, and integration of new technologies. We expect US companies to invest in infrastructure and new technologies, AI, in particular, to boost productivity. Companies that rely on labor and lack substantial financial resources will likely be challenged by this dynamic.

• “Security as an investment theme: Global policymakers continue to pursue initiatives (non-tariff barriers, export restrictions, tax credit incentives, etc.) aimed at protecting advantages in key technologies and diversifying access to key materials and products. This spend on de-risking to achieve ‘security’ could reach $1.5 trillion across the US and EU. Our analysts see 80 critical infrastructure stocks that should benefit from this transition.

• “Change may create regional beneficiaries, like Mexico: Countries with sizeable labor pools, competitive wages, and proximity to end markets stand to attract investment as multinationals reorganize their value chains to accommodate geopolitical constraints. Our strategy and economics colleagues argue that Mexico and India are key potential beneficiaries.

Defaults rise and peak Gig economy

I’ll finish the Macro roundup with two very interesting charts which I think tell us that the old economic order is changing under our feet and something new is emerging – quite what that new thing looks like is anyone’s guess.

The first chart is via Adam Tooze’s excellent substack and shows that the volume of US corporate debt trading at distressed levels — a risk premium of at least 10 percentage points over the benchmark for bonds, or a price of fewer than 80 cents on the dollar for loans — has surged some 28% since last month’s banking crisis to around $300 billion, according to data compiled by Bloomberg. That figure stood at up from about $74 billion a year ago. This is probably a grim warning to all those tempted to buy into private credit and debt funds - defaults are rising fast.

Source: Bloomberg

The second chart focuses on the gig economy, which looks like it's peaked. Clearly, many of us don’t really like the uncertainty that goes with the more flexible, gig economy.

Source: BofA Global Research   

Investment Ideas: Buybacks, Microsoft, and buying into gold ETCs

Do buybacks work for investment trusts?

At the top of this note from today, you’ll see a link to my latest Adventurous Investor in Conversation with Shonil Chande, alternative funds analyst with Liberum.

Our topic?

Do share buybacks work for investment trusts and their investors? Shonil has been digging around in the data for alternative funds and as you’ll hear in our discussion he concludes that buybacks can be effective but only in certain circumstances. I also talk about buybacks in my column for Citywire this week.

To listen click the link at the top of this newsletter.

Buying into gold ETCs

Investors have always been attracted to gold in uncertain, turbulent markets. Look at classic portfolio combinations such as the Permanent Portfolio, which are designed to protect against the ‘unexpected’, and you’ll see that gold is one of the four equally weighted components. If nothing else, if things go really bad and we all head for the hills – or to the bunkers – then gold is also portable and instantly recognizable. Yet gold is also viewed by most professionals as the financial equivalent of a barbarous relic and something which an alien from Mars would struggle to understand as a safe haven. More quantitative finance-driven types tend to be a little more understanding of the shiny stuff, pointing out that in certain economic regimes such as the unsettled 1970s, gold did provide diversified returns in a more inflationary environment. But they also quickly remind us that gold’s relationship with macroeconomic ‘regimes’ is highly contingent i.e. it depends on lots of conflicting processes and influences. In this vein, the problem with gold is that its alleged hedging properties – especially against some types of inflation – come with lots of caveats and complications. Yes, it is a good inflation hedge especially against hyperinflation but not necessarily with all forms of stagflation. Gold is also heavily impacted by the absolute level, and direction of, interest rates. And then there’s the dollar which exerts its own gravitational force.

Put it all together and you end up with an asset class that does have value in volatile times but is ‘complicated’, as my kids would say i.e. it works sometimes but not always. That said, it’s clear that gold has retained its value in recent years and hasn’t fallen away as it has after previous highs. And according to Gerry Celeya, chief strategist at Tricio and one of the best quant-driven technical analysts out there, gold is looking more interesting from a short-term point of view. He suggests watching the “ $2,072/oz. area all-time high to see if this holds off gold bugs, with support layered at $1,980/oz., $1,930/oz. and then $1,800/oz. ahead of the $1,600/oz. zone. A sustained break above $2,072/oz. would leave risk at $2,200/oz. and higher open, yikes!”.

I personally have no set view of what will happen to gold next month, next year, or even in the next decade. I don’t regard it as a barbarous relic and would note that plenty of central banks buy the shiny stuff as an insurance policy – if it’s good for pointy-head central bankers, it must have some utility. Equally, though I am aware that gold doesn’t produce any cashflows, and apart from limited use in jewelry and to a lesser degree industrial processes, it doesn’t have much functional utility except as a sum of all our fears. In simple terms then, gold is useful some of the time but pointless most of the time. Whether it will be useful in the next six months, I leave it to your judgment.

But if you are attracted to gold, I would suggest checking the table below which lists the various gold-based trackers – these are usually exchange-traded commodities and are usually, though not always, physically backed. This means that for every £1 you invest – or more typically $1 – you get £1 of physical, allocated gold in a vault somewhere (less the charge for expenses of running the ETC). The location of that vault does have some relevance – most of the time those vaults are in the UK or the US but some investors like the option of owning physical gold in a jurisdiction such as Switzerland which is highly unlikely ever to try and confiscate your gold – as the US did in the 1930s.

The cynic might suggest ignoring this concern with jurisdiction and focusing only on the cheapest tracker but there are some other considerations worth bearing in mind. First, do you want to invest in a dollar-denominated tracker – the most common – or a sterling-priced one? An alternative might be to invest in a tracker which hedges out the sterling risk – a sensible strategy when sterling is weak, less so currently. Some investors also like to think they are not investing in gold whose provenance on ESG grounds hasn’t been verified – thus responsibly sourced gold from say the Royal Mint here in the UK might seem attractive (HANetf offers a Royal Mint ETC). Investors might also find themselves attracted to the largest ETC by market cap (from iShares) – thus almost certainly guaranteeing the smallest bid-offer spread and most liquid trading environment. Last but by no means least, gold equities might also be attractive – they have very different return characteristics though they tend to be more volatile in terms of pricing. The table below lists your main gold ETC options for UK-based investors.

More on Microsoft: investors like what they see

Regulars will know that I’m a reasonably big fan of Microsoft, one of the most over-owned stocks on the planet. I think its economic moat is huge and getting bigger all the time, especially as it builds up its AI business and its cloud business. Here’s an interesting take on the software giant from Manchester and London’s fund manager Mark Sheppard:

“Following results, Morgan Stanley released an excellent note on their forecasts for Cloud Computing growth up to 2032.  The graph below is a salient summary of the Investment Thesis for MNL LN:

Cloud Computing grows at 17% CAGR, Valuations travel in tandem, and +AI drives similar Semis growth, which in turn drives EDA growth. The story really is as simple as that.  It is up to Investors to asses it's validity and likelihood. The big questions for MSFT are:

·         Can they continue their relentless push of AI initiatives (Copilots in advertising, security, etc.) that are driving market share in Enterprise; and

·         How much share can Azure take off AWS (which further erodes the AMZN bull case)?

·         How many more quarters does Cloud Optimisation continue for and how much more deceleration is to come?

·         How does the regulation of AI develop?

“It amazes us that UBS seems to be calling the end of Cloud Computing growth when only ~20% of IT workloads have shifted to the Cloud.  UBS is either very smart or very dumb, time will tell. The other very positive development we are seeing is consolidation in the cyber security market.  As Keith Weiss of Morgan Stanley put it:

“We are increasingly perplexed as to what exactly each of the numerous log management, cyber security companies actually does that none of its competitors can do equally as well.  We were at TMT this year when after dragging Richard to two log management companies in a row who said almost identically the same thing, Mark then assured him that the next meeting Mark suggested would be a fresh break only for the third company to spout rote what the previous two had just said before!  There was much eye-rolling!  Anyway, this all begs the next question, can AI do it better and cheaper?  We think the resounding answer to that question is Yes it can!”

Get full access to David Stevenson's Adventurous Investor Newsletter at davidstevenson.substack.com/subscribe

NEXT WEEK I’m out of the country on a business trip so there will be no letters until the week after next.

To make up for it though I have a bumper issue today – starting with another excellent discussion with Joachim Klement from Liberum, this time on ESG investing.

Earlier in the week, we talked about investment truths, to which we largely ended up agreeing. This time we start by disagreeing but in the end, probably find ourselves in agreement – impact and sustainable investing have huge potential if we can somehow work our way past the whole ESG debate. It’s a fascinating discussion for just over 30 minutes – as with the earlier episode there’s a slight echo (entirely due to a technical snafu on my side) but it’s really minimal this time and very easy to listen to.

As for further reading for the weekend, I have an abundance of interesting pieces which is why there are no short factoids – we’d end up with a letter that was way too long if I did include them. So, to business….

The SJP Difference

 I’ve somehow managed to avoid writing anything about St James Place (SJP) for two decades. To be honest I’ve never really had much time for their offer but I know many people who love the service levels. But it’s hard not to view their product set as more than a tad expensive, with initial charges of 5% plus annual charges for funds wrapper products mostly in the 1.5 to 2% range – though their Diversified Assets (FAIF) product has an annual charge of 2.42%. I’ve gone on the record in the past to suggest that the total cost of advice should never exceed 1% per annum while fund fees should never really be too much above 75 basis points.

The excellent Yodelar service has done a great deep dive into the SJP offering, with the following devastating conclusions:

·         80% of St James’s Place unit trust funds rated as poor performing

·         High charges and poor performance across their entire range of funds

·         80% of SJP funds performed worse than half of same sector over 10 years.

·         15% of all St. James’s Place funds returned losses over 10 years

·         75% of SJP funds yielded returns below the sector average over 5 years 

·         St James’s Place initial fee more than twice the industry average

·         £100 billion managed by St James’s Place is held in poor funds

·         Restricted advice with no onus to provide comparative performance.

You can read more at Yodelar here: https://www.yodelar.com/insights/st-jamess-place-review?utm_medium=email&_hsmi=250481932&_hsenc=p2ANqtz--urBDyPhS61TygVT4FOMONoRp486-pQ7u43Z_z-ik61tIE0nzgCNjZKJwBFDl2B5J8S40PBGoMIF3C_o9T58l0FAkdh-8Spc38BrceDVx9HI6RQ0I&utm_content=250481932&utm_source=hs_email

Liberal girls are depressed

There’s a fascinating note from the social psychologist Jonathan Haidt called Why the Mental Health of Liberal Girls Sank First and Fastest. You can read it HERE. It’s a great paper and part of a wider debate around political affinities and mental health issues. Needless to say, its fairly controversial stuff but there’s a brilliant summary from the folks at The Progress Network of Haidt’s article:

“It’s his latest examination of the data showing that rates of anxiety and depression in young people spiked after 2012, which Haidt pins to the introduction of smartphones and social media. This new piece attempts to explain why, out of all Gen Z groups across gender and political affiliation, liberal girls are the most depressed, and were the first to become so ten years ago. “I think,” Haidt writes, “there’s something about the messages liberal girls consume that is more damaging to mental health” than those consumed by liberal boys, as well as moderate and conservative boys and girls.

Still, however, all of those groups are more anxious and depressed than in previous generations. Haidt posits that something in the cultural air—he calls out the “three great untruths” that words are violence; emotions are reliable guides to reality; and society is comprised of victims and oppressors—has done two things.

First, moved Gen Z’s locus of control from internal to external. This means that instead of feeling a sense of agency, like we are the captains of our own ships, someone with an external locus of control feels that “strong forces or agents outside of themselves will determine what happens to them.” Second, led to a sharp rise in self-derogatory beliefs like I feel I can’t do anything right and I do not have much to be proud of.

Haidt may be right or wrong that there is something in the zeitgeist, particularly in the liberal social media one, that is causing what he calls “reverse CBT.” Here he is referring to cognitive behavioral therapy, a common therapy technique that teaches how to rework thought patterns to stop “cognitive distortions” such as catastrophizing and black-and-white thinking. Instead, he says, Gen Z is learning to emphasize such cognitive distortions.

If Haidt’s theory is right, however, it suggests that we can reverse the "reverse CBT" by finding strategies for rewriting the “captain of your own ship” narrative for Gen Z and subsequent generations. “

More at

Crime: throw away the keys?

Crime is turning into a central issue in the US political debate, with attention focused on Washington DC – which is undergoing something of a crimewave at the moment which has prompted various legislative moves in Congress.

One can of course be slightly cynical about this – Republicans bashing inner-city Democrats, linking up the immigration debate to create wedge culture war issues. But I think that is a fatal misreading of the situation.

Throughout much of the developed world from Sweden to the UK crime is becoming a hot topic – and astute political parties pick up on the general sense of unease. The Labour Party in the UK for instance, I think, has sensibly avoided all the defund the police nonsense and explicitly committed itself to more police, more crime busting and critically attacking the sources of community-wide anger: low-level street violence, burglary, and low-level fraud. This is a winning strategy in my book – for too long we in the metropolitan liberal classes have said that crime is falling, that prisons should be emptied out at all costs, that prison doesn’t work, and that we should stop worrying about crime and focus on correcting inequality. Turns out that that doesn’t wash with most people.

As a magistrate with many decades of experience, I accept that we should be putting fewer people in prison and I also think that convicting lots of young people leaves them saddled with a long-term criminal record which is a terrible state of affairs. But I also think that locking up persistent violent offenders for longer periods of time, largely to keep them off our streets makes sense. Sure we all need to care about the human rights of criminals but the human rights of victims are not served by letting persistent offenders out on the street to, in some cases, terrorize local communities. For too long we’ve failed in that balancing act and the public knows it.

A wonderful example of this comes in the graphic below from the blog of Scott Alexander who cites a tweet showing British attitudes toward crime….the numbers are truly amazing and include the following…

“…….about 15% who want prison time for not wearing a seatbelt, 47% who want prison time for sexist abuse on social media, and 80% who want prison time for possession of a knife (and 18% think it should be over five years)! Meanwhile, in actual Britain, a guy with multiple previous violence convictions who brutally assaulted a cyclist and then stomped on her head while she lay unconscious was let off with community service. This is an interesting contrast to see in a democracy!”

The graphic below is absolutely amazing. Of course many people have long favored hanging killers but the numbers below are fascinating. 

This segways into an interesting debate about how far we go to provide a hostile environment to criminals to stop them from doing stuff we don’t want to do. In the US for instance the liberal American Purpose publication has an excellent article about revisiting James Wilson’s broken windows theory which I think might make a phoenix like re-emergence within the public debate.

Another example is the ongoing debate around the horrific murder rate in El Salvador which has fallen back sharply in recent years because of an especially brutal/effective set of policies by its leader Bukele. On one side is the classic liberal point of view admirably expressed by the FT in a recent investigation into a huge new prison being planned - which to be fair does sound pretty horrific and like something out of a dystopian sci fi film:

“ If it reaches the 40,000 capacity advertised by the government, each inmate will have just 0.6 square metres within shared cells, according to FT calculations. That is a fraction of what is expected for humane incarceration and less than half the minimum required under EU law to transport midsized cattle by road. “Forty thousand is too many to manage in one place, period. Under any circumstances,” said Martin Horn, a retired administrator who ran New York City’s prisons, including Rikers Island, one of the world’s largest.”

Yet Bukele is hugely popular in El Salvador because of the stunning recent decline in the murder rate. Hobbes might have had a few things to say about the conflict between the human rights of criminals and the need for the state to guarantee the basic human rights of citizens not to be in fear of the ‘jungle’ and getting murdered. The commentator Richard Hanania – a conservative of sorts – is especially vocal about Bukele and his ‘success’.

“The year before Bukele came into office, El Salvador had a murder rate of 51 per 100,000, making the entire country about as violent as modern Detroit, which is such a basketcase that you can take a virtual tour of the ruins of the city or see them in a coffee table book. El Salvador was growing at about 2% a year before 2019, which is terrible for a developing country, and a quarter of its GDP comes from remittances from the US, which is one of the highest numbers in the world. But, since the gang crackdown, The Washington Post reports that, the real sea change is on the ground, where citizens report that extortion has all but disappeared. Salvadorans have gained a palpable sense of security in their everyday lives at the expense of due process, democracy and transparency. Most seem to be fine with the trade-off. Bukele himself is immensely popular, as is the state of emergency he has declared. Protests against him have fizzled.

Ideally, you’d like to be able to fight crime while also protecting human rights and not creating opportunities for the arbitrary abuse of government power. In the real world, this is usually asking too much of governments in developing countries. Previous Salvadoran governments have tried more limited crackdowns before with limited success. Just look at how much trouble the US has had keeping inner-city dysfunction under control since the Warren Court started creating new rights for criminals in the 1960s. Now imagine trying to accomplish the same with a government that is orders of magnitude poorer and starting out with the entire country being as violent as Detroit.”

More at

And a follow-up as the debate kicked off :

Indoor Farming melts down

As a verified food tech evangelist – do visit my sister website www.futurefoodfinance.com – I have wasted many column inches singing the praises of indoor and vertical farming. The idea here is to build a closed-loop system, mainly in urban areas (though not exclusively) where you only need water and lots of LED lighting to produce fresh greens and some fruit. On paper, it sounds like the future as it radically cuts pollution and emissions although it also requires a huge capital expenditure on state-of-the-art urban farms.

The slight catch is that it doesn’t seem to be working as well as we evangelists might have hoped. One industry publication a few weeks ago carried the following story about the share prices of listed indoor farmers : “AppHarvest saw a decline of 25.71%, while Local Bounti lost 17.21%, Kalera PLC lost 7.50%, Urban-gro lost 4.19%, HydroFarm lost 4.91%, CEA Industries lost 3.17%, and Agrify Corp lost 9.61%. On the other hand, Edible Garden Ag made gains of 11.59%.” Yikes.

And those numbers are just for one week in March! Every month brings more bad news as operators in this space close down – the latest is Fifth Season featured in a piece by the Fast Company managzine.

“AppHarvest, which runs high-tech greenhouses in Appalachia growing tomatoes and greens, said in a recent quarterly report that it had “substantial doubt about our ability to continue as a going concern” unless it could raise more money; the company is currently being sued by investors who argue that it misled them about its viability. AeroFarms, an early pioneer in the space, pulled out of a proposed SPAC deal last year. In the company’s May 2021 investor presentation, AeroFarms, which was founded in 2004, estimated just $4 million in 2021 EBITDA-adjusted revenue—and $39 million in losses.”

Its tough out there! More about the vertical farm meltdown here:  https://www.fastcompany.com/90824702/vertical-farming-failing-profitable-appharvest-aerofarms-bowery

Winning Wars

Now that we’re all armchair military experts because of the Ukraine conflict, I suppose we should up our game and actually learn about how wars are won – especially the high-intensity war currently being fought in the East (low-intensity wars are more typical of the post 9/11 environment).

I thoroughly recommend an excellent overview by Austin Vernon – I have no idea if he’s an expert or not but he sounds convincing. Here are several useful strategies for fighting an existential war:

* Cheap Precision

In total war, boutique weapons won't be able to destroy enough enemies even if they are tactically successful. It is also challenging to produce and transport the mind-boggling mass inaccurate weapons require. The sweet spot is accurate but cheap weapons. These can be classic smart weapons like GPS-gravity bombs but also include an Abrams tank that can reliably kill adversaries 3000 meters away with unguided shells.

* Avoid Unreliable Systems

An enemy can grind unreliable weapons into the ground by forcing a high tempo. The twenty US B-2 Bombers could deliver a one-time nuclear strike but could not eliminate thousands of Chinese ships, bases, and troop concentrations because of their low sortie rate and limited numbers.

* Manage Survivability vs. Expendability Carefully

There are many tradeoffs when designing weapons. The math tends to push design choices towards cheap, less survivable systems or pricier, long-lasting ones. Survivability can come from the ability to take damage (like having armor) or from deception (stealth, electronic interference, speed).

The cheap system could lack the capability to score any kill against superior weapons or end up still being too expensive. The expensive one could be more vulnerable or less effective than hoped. What capabilities a country has and its strategic position matter when choosing.

A classic comparison is the US Sherman tank and the Soviet T-34 in World War II. The Soviets saw that tanks on the Eastern front rarely lasted 24 hours in battle and took planned obsolescence to the extreme to make the T-34 cheap. The US designed the Sherman for reliability and repairability. Engineers carefully designed engines and suspensions for durability. The number of Shermans in Europe kept increasing because mechanics would have "knocked out" tanks back in battle within days.

* Focus on Mass Production

An adversary can make a powerful weapon irrelevant by sheer numbers if it is challenging to produce. Historical examples include the Tiger Tank, Me-262, and sophisticated cruise missiles.

The need for easy-to-manufacture designs is even more critical for expendable munitions. Neither Russia nor Ukraine have top ten economies, yet they are drawing down global munition stocks. Each side must carefully manage consumption and substitute away from bespoke weapons like Javelin missiles for more available systems. Imagine the top two economies duking it out.

The enemy can often fight harder than you think and regenerate more forces than you hope. The conflict can rapidly devolve into a lower-tech slugfest with alarming casualty counts if you can't produce enough capable weapons.

* Have Appropriate Designs Ready

The US won World War II by increasing the output of weapons already in production or well into development. It took too long to bring new designs into mass production. And it was much easier to expand the output of systems already in production than ramp up programs coming out of development. The several-year penalty for new designs could cost millions of lives or the war.

I also thought this next section was revealing – the importance of industrial power:  

Ammunition will be the most voracious microchip user. There are only so many chip types in a JDAM or GMLRS rocket. The military should buy capacity options for the chips we know we will need instead of subsidizing the broad industry, which may or may not produce viable chips for military applications. That capacity can provide starvation rations while chip manufacturing capacity expands by several orders of magnitude.

Traditionally the military takes over commercial ships for transport in wartime, and we protect the shipbuilding industry to "maintain capacity." There are a few deficiencies in that plan:

* Commercial ships now dwarf military shipping. How helpful is a 25,000 TEU container ship or a Very Large Crude Carrier that can only use a few dozen ports globally? The military will need floating harbors to handle transfers from large ships to smaller sustainment vessels that deliver supplies to the Navy, Air Force, and Marines. Another issue is that most military cargo moves on pallets rather than inside containers. All services must speed up containerizing logistics and eliminate remaining break bulk and pallet shipping. The ability to move supplies and fuel from safe ports in the US without using fixed transshipment facilities would provide a survivable logistics chain.

* There is a shortage of US-flagged ships to take over because of the Jones Act and labor regulations. There are ~5x-10x more American-owned ships that fly the flag of other countries to avoid the rules. Make it easier for these ships to fly the US flag!

* Shipyard productivity is awful because of a lack of scale and competition. We'd be better off ending the Jones Act and buying more ships if we want more capacity. More manufacturable ships will increase dollars spent in shipyards by expending less on overhead or expensive systems vulnerable to combat damage. Also, few have grappled with the reality that all combatants have a minuscule fraction of the shipbuilding capacity ultimately required for total war. Even if China builds more ships today, the amount added by both sides will be similar since everyone is effectively starting from zero.

You can read much, much more at https://austinvernon.site/blog/peerwareconomics.html?ref=the-browser

Whilst on the subject of war I also thoroughly recommend a fascinating interview with a couple of Ukrainian artillery commanders about the war in the East.

(I): How realistic is it to hit a moving target?

 (O): For a firing battery, there is no difference, but artillery luck also works here. If you calculated everything correctly – the enemy’s speed of movement, the flight time of the shell – then the result will be fire, sparks, and smoke. That is, it is what it should be.

(I): So you managed to hit a moving column the first time?

(Serhiy): Not always. That’s why we needed “eyes”. We also called civilians and asked: “Do you see this section of the road?” “I do.” “If a shell hits in a minute and a half, can you tell us at least roughly where it exploded?” “I can. Then the person would describe the place of the explosion, and we would open a Google map and see: yes, there is such a place behind the vegetable gardens.

(O): We had an 18-year-old boy in Motyzhyn whom we reached through the store’s phone number on Google map and said: “I don’t believe you.” So we turned on the video link, showed him our ID, uniform, and chevron, and he said: “I don’t believe you”.

Then we convinced him and worked closely together for about half a month while fighting in Motyzhyn. And every local in the village knows someone else, and that person knows someone else, so there are already people passing on information. So at first, I called from my number, and then we got a separate phone, and then it was not enough, so we got a second one.

Sometime in the fall, I called this guy from Motyzhyn and said: “Come, let’s get acquainted.”

The full interview is here:

https://wartranslated.com/pravda-com-ua-interview-ukrainian-colonel-oleh-shevchuk/?ref=the-browser

And finally, on the subject of war let’s turn to Mexico. It is supposedly a close friend of the USA but it is also home to some extremely powerful, militarised crime gangs that the Mexican state is struggling to contain. So, let’s put two and two together and come up with…5. And attack Mexico. That at least is the idea behind a bill called Authorization for the use of Military Force (AUMF) which aims to target the cartels and put an end to the flow of fentanyl into the U.S, sponsored by Reps. Dan Crenshaw of Texas and Mike Waltz of Florida.

“First, the proposed AUMF lists nine specific cartels across Mexico and Central America and authorizes the president to “use all necessary and appropriate force” against them:

The Sinaloa Cartel.

The Jalisco New Generation Cartel.

The Gulf Cartel.

The Los Zetas Cartel.

The Northeast Cartel.

The Juarez Cartel.

The Tijuana Cartel.

The Beltran-Levya Cartel.

The La Familia Michoacana, also known as the Knight Templar Cartel.

But the bill would not provide a free-for-all license to attack these organizations at the whim of an Army commander near the border or the captain of a Tomahawk-equipped destroyer traversing the Gulf of Mexico. “It becomes just an authorization to actually create a strategy,” Crenshaw says. “We don’t create the strategy necessarily. That’s the president's job. So it’s just the first step.”

The authors say they took as a model the United States’ approach to tackling the drug cartels in Colombia in the 1980s and ’90s, which Crenshaw said worked “because we had a strong partner in the Colombian government. This is what we’ve been lacking in Mexico.” In Mexico’s case, by contrast, the cartels are embedded in many areas of government.

“And so in Mexico, I think you’ve got to leverage [the Mexican government] more. I think that’s one of the reasons AUMF is useful. Because it lets them know we’re serious,” Crenshaw said. “The problem with this Mexican president [Andrés Manuel López Obrador] is he doesn’t apparently want to solve the problem.” So the AUMF approach puts pressure on López Obrador to act, in hopes of something more like a Colombia-style collaboration with the United States.

The bill’s other author, Mike Waltz, was even less charitable toward Mexico, to put it lightly. He told me, “We have essentially an ungoverned narcoterrorist state directly on our border, and I would posture that if ISIS or Al Qaeda sent chemical weapons that killed 80,000 Americans, we would probably be thinking about it and doing something about it.”

More at

Eloi vs Morlocks

As a sci-fi freak, I of course read HG Wells's Time Machine at an early age and became slightly obsessed with the way that the human race had divided into two distinct races the Eloi and the Morlocks.

This idea of the bifurcation of the human race is a common trope for sci-fi authors – Richard Morgan in Altered Carbon in effect posits the idea that a genetic elite of wealthy types has evolved slightly differently from the rest of us.

Most readers would think this is all absurd fiction but I think it’s a very real fear. Combine genetic advances alongside better nutrition, more effective medications, and weight loss treatments and you have the making of a genetic divide – the rich who can access all kinds of tech-enabled services and the rest of us.

Step one is already here – the rich are frequently thin and in good physical shape. They also seem to be taking lots of Ozempic the so-called new anti-fat wonder drug. Put simply they ‘look different’.

US-based journalist Oliver Bateman on UnHerd – a self-confessed hard-core fitness dude – has a great piece about the super-rich and these new drugs.

“In short, this appears to be yet another sign that the elite are headed toward some sort of crude transhumanist utopia, complete with gene therapy and designer-baby selection. Some may scoff that this is science fiction, but this future looms: once they’re sufficiently fine-tuned, gene editing tools will likely eradicate heart disease, muscle wasting, neurodegenerative disorders, and other conditions in embryos that are still in utero — but their price will be nothing short of staggering. Similarly expensive gene therapies will enhance the overall performance of already-healthy humans, raising ethical questions about whether these procedures should “improve” a person or merely “fix” a condition. The rich, of course, will leave those debates to the philosophers and pay upfront for the best bodies that their considerable resources can buy. Already, news stories abound of billionaires pursuing immortality, with a few commentators trying to sanitise the pursuit by arguing that the research will somehow benefit even the least of us.  

I have first-hand experience in the big-bucks world of anti-ageing science, and I can state unequivocally that the most compelling benefits are not going to trickle down. In 2017, I worked for a transhumanist medical organisation, producing marketing content related to stem-cell therapy and other forms of anti-ageing medicine. I received several treatments myself, and while I can only speak anecdotally, they significantly relieved decades of aches and pains related to hard training. And these were one-off procedures, not the monthly “Cadillac plan”, which involved steroids, growth hormones, and Botox. Wealthy clients would walk in as untrained, middle-aged slobs and, less than a year later, boast gym-hardened physiques that might take unenhanced trainees a decade to develop.

More at https://unherd.com/?p=464794

China is a peaceful nation and has no intention of getting involved in other nations’ polities

The thing I find so annoying about the Chinese government and its solemn declarations about nonintervention and pushing back on human rights challenges is that it’s a bare-faced lie. And the spokespeople know it. The Chinese regularly interfere in other countries, helpfully for instance sending police units to small pacific island states to curb ‘crime’. And the various Chinese front organizations regularly interfere in domestic politics. Take Canada for instance where the Chinese government has very clearly been sticking its oar into the local political process and interfering with the local conservative party:

“[Erin] O’Toole’s Conservatives came to voters in 2021 with an extensive position that called for a 180-degree turn away from the Trudeau government’s China-centric policies. Among other things, O’Toole’s policy called for restraints on Chinese state-owned enterprises in Canada, a ban on Huawei from Canada’s core 5G infrastructure, closer relations with Taiwan and the establishment of a foreign-influence registry.

Beijing was furious. Chinese ambassador Cong Peiwu blasted O’Toole for adopting a “hostile” blueprint that was aimed at “smearing” China. The Chinese Communist Party’s propaganda organs referred to O’Toole’s policy as catering to a “toxic atmosphere” that would surely invite a “strong counterstrike.”

These same lines of attack were taken up by Joe Li, a councillor in Markham, Ontario and spokesman for the Chinese Canadian Conservative Association who maintains close relations with several prominent figures affiliated with the United Front Work Department, Beijing’s overseas influence-peddling operation. In the days after the Conservatives’ election loss, the knives came out.

Speaking on behalf of the CCCA, Li said the Conservative policy under O’Toole was a “hatred message.” Li said Canada should not criticize China’s human rights record, that “Canada started the war” that led to the Michaels’ abduction by apprehending Huawei heiress Meng Wanzhou, and that China was right to be sending warplanes into Taiwan’s air-defence zone.

While O’Toole’s ouster was seen mostly as a rebuke from the party’s right flank for moving too close to the centre and losing the election in the bargain, the coup was initiated by Bert Chen, an Ontario member of the party’s national council. One of Chen’s complaints was O’Toole’s China policy. But well before O’Toole’s election to lead the Conservatives in 2020, wealthy Chinese businesspeople were suddenly showing up among the Conservative party’s donors and membership rolls.

One recent immigrant who stands out is Ted Jiancheng Zhou, a property developer with condominium projects in Ontario and China. Zhou, who boasts intimate connections in China’s Communist Party hierarchy, was among the hundreds of super-rich Chinese who maxed out their legal contributions to the Liberal party during Trudeau’s “cash for access” engagements with pro-Beijing Chinese millionaires in 2016.

But then he appeared to switch. Although he wasn’t yet a citizen and had been in Canada less than five years, Zhou established ten separate organizations across Canada devoted to drawing Chinese-Canadians into the Conservative party. The NDP and the Liberals asked federal Election Commissioner Yves Côté to look into whether Zhou’s activities were in violation of election spending laws, but the complaint went nowhere.”

More at

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The latest episode of my Adventurous Investor in Conversation is with the excellent Joachim Klement, a strategist at investment bank Liberum. He also runs a superb blog Klement on Investing which I thoroughly recommend. Joachim is a font of knowledge about investing, drawing on academic research and translating it into easy-to-understand concepts all investors can grasp.

Our conversation is in two parts – today’s episode is on investing principles. In the episode above we discuss what the weight of academic research tells us about investing and how that analysis informs some basic investing rules. It’s an excellent primer on how to invest properly – obviously with no investment advice intended!! The second part will be released on Friday and features a long discussion of ESG investing, which I am deeply skeptical about, but Joachim is more receptive to.

One note on the recording – because of a stupid technical snafu on my side, there’s a tiny echo on Joachim’s side. It’s absolutely not a problem to listen to but not ideal. Enjoy!

Note 1: Literacy Capital – Deal validates existing track record

A few months ago I drew attention to a small listed private equity investment trust called Literacy Capital that invests in small to mid-cap UK private businesses. It’s in effect an outgrowth of the Paul Pindar family office and has quietly built up a striking track record on realizations. Moving forward, talking to the principals behind the fund – where they are very heavily invested – I was struck by how optimistic they were about deal flow in the next year.

Since then the shares have slipped from a chunky premium to NAV to a small discount of 6.3%, with the market cap of the fund at £236m on a share price of 394p. The good news is that the deals keep coming in, proving their existing portfolio valuation.

The latest news is that the fund has sold a significant stake in Kernel Global to Three Hills Capital Partners”.According to fund analysts at Liberum, this deal “values BOOK's stake at £28.6m, representing a 3.7% uplift to NAV. BOOK will receive £19m in cash, which will be used to repay the RCF and make additional investments. The sale represents a 9.8x net return to BOOK and a 6.7x cost based on cash proceeds. The original investment was in 2018.  Kernel Global was BOOK's fourth-largest investment, at 7.6% of NAV, as at 31 December 2022. The company is involved in the recruitment ecosystem.” Kernel was Literacy’s fourth largest investment (equating to 7.6% of NAV).

Literacy says it intends to use the cash proceeds to repay the amounts drawn under its Revolving Credit Facility, before recycling these proceeds into new investments. It says “this [deal] represents a highly profitable and  successful investment for Literacy, demonstrating the team’s commitment to actively managing the portfolio and recycling proceeds to fund new investments in the pipeline.”

I think Literacy Capital could be a great long-term investment but I’m ever so slightly wary on the timing front. Sentiment towards private equity is still very poor and although the fund has slipped to a small discount, that 6% discount is minuscule compared to the huge discounts at say Oakley Capital Investments (which I also rate very highly). That said, Literacy Capital is absolutely a fund worth keeping a very close eye on.

Note 2: Plus 500 – still a great hedge against volatility!

I’ve been quietly adding to my holding of Israeli-based, London-listed ‘fintech’ platform Plus500. I don’t plan to explain too much about this platform as I think most readers will have heard about it by now – it’s a leading spread betting platform that has been expanding into new geographies and verticals (share dealing). A particular focus is on expansion in the US where Plus500 has been steadily building its franchise.

My investment logic is also very simplistic and built on two arguments: the shares are a play on volatility and the business churns out cash. On the volatility point Plus500 tends to make much more money when markets are turbulent, whipsawing up and down on fear of regime change. The more volatility, the higher the trading. This relationship doesn’t feed through directly into the share price though as you can see in the table below – year to date the Vix is up 14% while Plus500’s share price is down 4.93%. On a side note BH Macro – which is a more obvious play on volatility than Plus500 - has produced better numbers than Plus500.

Another reason for investing in Plus500 is that it produces a huge amount of cash. At the moment the business is sitting on $930m in cash, much of which is needed as regulatory capital. Last year it produced over $450m in cash - a fair chunk of that is returned to investors by a regular share buyback programme.

Key numbers:

Ticker: PLUS

Share price £17.16

Cash $930m

FY 22 Sales $832m

FY 22 Netfree cashflow $454m

FY 22 Valuation : £1.6bn

Recent results for the year ended 31 December 2022 were also impressive – the headline numbers are in the table below.

Plus500 Financial Highlights:

Here are some key headlines for the year plus500 which was headlined by strong revenue and EBITDA growth:• Plus500’s ongoing ability to attract and retain higher value, long-term customers is evidenced by:- 87% of OTC2 revenue derived from the Group’s customers trading for more than a year- Consistently strong levels of Customer Income3- Record annual ARPU achieved during the year• The Group reached another major commercial milestone, with over 24 million worldwide customers now registered on its trading platforms since inception, providing significant potential value for Plus500 over time, through utilisation of new proprietary retention, activation and monetisation technologies• Customer deposits increased to $2.3 billion (FY 2021: $2.1 billion), with average deposit per Active Customer  growing to a record high of approximately $8,000 (FY 2021: approximately $5,000), highlighting on-going customer loyalty and confidence in Plus500• In FY 2022, over 85% of the Group’s OTC revenue was generated from customers which used Plus500’s OTC platform on mobile or tablet devices and over 82% of OTC customer trades took place on mobile or tablet devices

Significant progress made in accessing the substantial institutional opportunity in the US futures market:• New B2B business line with major revenue opportunity – in addition to Plus500’s long-standing proprietary B2C technologies and offering, the Group has established a new commercial model, business vertical and strategic position developed by the Group as market infrastructure provider, delivering execution, clearing and brokerage services for institutional clients• Outstanding achievement in FY 2022 in becoming a full clearing firm member of the CME Group exchanges and the Minneapolis Grain Exchange (MGEX). This extensive range of clearing capabilities will help to deliver the substantial potential opportunity for Plus500 in the US futures market

US gas play: CNX Resources

Regular readers will possibly remember that I own shares in US unconventional shale operator DiamondBack. I absolutely concede that natural gas operators are still involved in a carbon-intensive industry, but in my view, natural gas is a stepping stone energy source on the way to a net zero economy. On that theme, I have another potential business worth examining: CNX Resources.

A few weeks ago I attended the annual investor meeting held by Phoenix Asset Management – I’m a non-executive director of the Aurora Investment Trust, a fantastic, largely UK-focused equity fund managed by Gary Channon. Phoenix also runs a few other investment funds including the listed Castelnau fund – again, where I am a non-exec – plus an innovative global equities fund called the  Huginn Fund which is managed by James Wilson, one of the firm’s partners who has been with Phoenix since 2013.  Building on Gary Channon’s long-term, value-driven approach according to Phoenix, “ James looks to identify wonderful businesses managed by honest & competent management in both the UK and abroad. Once identified, James waits patiently for an attractive price at which to invest.”. You can find out more about the fund HERE.

At the event, earlier this month James presented his latest conviction holding =- I think it’s his largest from memory - CNX Resources. I’ve just started to have a look at this business but from what I can see so far, this does look like a classic ‘compounder’ business, built on solid financials in a volatile industry.

In terms of reserves, the business is entirely focused on the  Marcellus and Utica shale acreage in Pennsylvania, West Virginia, and Ohio. CNX’s core sweet spot is in Southwestern Pennsylvania and on paper, the business has 15 years of production inventory at the current run rate of 25 new wells per year. On a side note, the Marcellus basin is potentially world-class: the most recent EIA estimate for the Marcellus shale resource is in the area of 450 tcfg (trillion cubic feet of gas). For reference, the largest gas field in the world is estimated to contain 1,236 tcfg, which is the South Pars field under Iran and to a lesser extent Qatar.

The Canonsburg-based natural driller is led by CEO Nick DeIuliis who runs the company in a very different way compared to other peers - his mantra seems to be unusually conservative and prudent, building on the strategy outlined by CEO William N. Thorndike Jr., founder of private equity firm Housatonic Partners and the author of "The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success." This involves thinking about the long-term financial performance of CNX, not just quarter by quarter, which means that in practice the business hedges away its output over many years. DeIuliis also focuses on free cash flow and other financial metrics.

Share basics:

* Share price: $15.5

* Ticker CNX

* PE: 15.55

* Interest cover 20.3

* RoE: 49.7%

* 2022 sales $3.9bn

* 2022 EBITDA $377m

* 2022 free cashflow $669m

* proven developed reserves by 5%, or 315 Bcfe, to 6,221 Bcfe

* 2023 guidance EBITDAX $1.1bn to $1.25bn, total capex between $575m and $675m and free cash flow of around $375m in 2023 or $2.20 a share

* forecast PE is 7.5

* gearing 80%

The USP for CNX?

I’m acutely aware that the US unconventional energy space is a deeply turbulent one, with natural gas prices extremely volatile even on a day-by-day basis. This makes financial forecasting extremely difficult. There’s also the ever-present challenge of diminishing reserves - see below - which can undermine long-term assumptions about inherent value. That said, I think we can roughly list the USP’s of the business as follows:

1.       CNX is producing lots of cashflow - CNX has Generated ~$1.6 Billion in Free Cash Flow since Q1 2020

2.       The business boasts a conservative balance sheet with extensive buybacks and debt under control. Weighted average senior unsecured debt maturities of 6.5 years as of Q4 2022, $681m in debt due in 2026/27. Total debt: $2.18bn

3.       Low cost production

4.       Predictable revenues by an extensive hedging program: In 2023 around 80% locked in at $2.37 per mcf, in 2024 around 70% locked in at $2.28 per Mcf and over 60% through to 2026. Only falls off in 2027. Programmatic hedging strategy.

5.       The business has been buying huge amounts of shares: CNX has repurchased 57.0 million shares for $868 million( since Q3 2020 at an average price of $15.24. 24% reduction in total shares outstanding since Q3 2020

One other angle that is worth noting is that the business doesn’t seem to be terrifically interested in exporting its natural gas from regional ports. Unlike many operators in its space, it has stated that it wants to focus on supplying to the East coast region by replacing other more carbon-intensive energy sources. Its mantra: “The CNX vision includes a robust strategy of using local production to displace foreign oil, build new industries, and revitalize the Appalachian region. “

Challenges?

The big obvious challenge here is that, as I said above, CNX is in a volatile industry. That scares off many traditional value investors although one suspects that its prudent financial approach might win over some investors. Above and beyond the industry dynamics CNX also faces some other headwinds. I’d focus on three:

·         Output has been volatile – Output is currently running at 555 bcfe, but over the last few years its share price has suffered because a key bore in central Pennsylvania failed to produce the expected output. The business says these worries are now behind it and it finished 2022 with 580 billion cubic feet of natural gas production, down from 590 billion cubic feet in 2023 due to the challenges. As one report on the business noted “CNX, like all natural gas companies, has to drill and produce enough new natural gas to offset the normal drop in gas flowing from older wells. CFO Alan Shepard said weather and operational challenges in the hydraulic fracturing operation will make the first quarter its lowest production of all four quarters. Shepard said it expected to return to the average production around the middle of 2023.”

·         Emissions: There’s no getting away from the fact that CNX is involved in the energy complex and thus isn’t likely to appeal to any investor with a strong ESG focus. But CNX is trying to improve its carbon footprint by reducing methane emissions which are down by 31% - the company says the Appalachian Basin is the lowest methane intensity basin in the US. The CNX vision includes a robust strategy of using local production to displace foreign oil, build new industries, and revitalize the Appalachian region.

·         The shares are heavily shorted – 15.4% percent of the float is short, amounting to 25.6m stock. My guess is that the stock is widely used as a proxy for the gyrating natural gas price.

I’ll finish with Q4 update from the end of January which is summarised in the graphic below - the numbers seemed to be well received by Wall Street.

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Adventurous Investor in Conversation: Craig Roberts on Vietnam Podcast on Vietnam

One of the few consensus calls within the broad emerging/frontier markets space is that Vietnam will likely be a big beneficiary of any reshoring/China decoupling trend. Its ideally suited to benefit from foreign direct investment looking for an alternative to China and also has a vibrant domestic consumer economy. At the geopolitical level, it doesn’t have any obvious Taiwan-style vulnerabilities - and in fact, many Taiwanese businesses are big investors in Vietnam.

To get a better take on what’s happening locally, earlier this week I caught up with Craig Martin from Dynam Capital which runs the fund Vietnam Holdings one of the biggest listed London funds focused on Vietnam. In the podcast we discuss:

-          China decoupling

-          The local real estate market

-          Local consumer markets

-          Valuations relative to other emerging and frontier markets

It’s well worth a listen and it’s a great background to why Vietnam is arguably the most interesting frontier market open to Western investors.

Google vs Microsoft

Mark Sheppard, the tech-focused fund manager at the Manchester and London Fund has just released a useful primer on the likely impending showdown between Google and Microsoft’s Bing over AIs and different chatbots.

“It is now a War.  We see several possible outturns including:

IF MSFT start to gain traction with Search activity utilising Edge/Bing THEN it would be logical for them to apply pressure on GOOG with a view to making Search zero margin so they crush the "cash cow" that feeds GCP (GOOG's cloud platform) and hence MSFT becomes the clear No1 in AI.  To do anything less would be negligent for Nadella (CEO of MSFT).  Low to Medium probability.

MSFT makes little traction and GOOG holds on to its share of the Search advertising market BUT this will require a meaningful response to the threat from GOOG which not been seen as yet.  As before, we would classify this response as a Required Action Point for us to continue holding GOOG.  Medium probability.

MSFT gains traction in a cohort of higher educated professionals who switch to BING.  This cohort tends to focus on Search for commercial, scientific, enterprise and work related matters.  In time, the Search market splits into: Consumer controlled by GOOG; and Enterprise controlled by MSFT.  MSFT strengthen their position in this Enterprise segment by integrating their AI search capabilities throughout their other Enterprise software applications.  Low to Medium probability.”

For the record, I hold both Alphabet and Microsoft.

A new addition to the Alternative Funds Trading list  - Chrysalis Investments

If you are brave enough to be a growth investor - a tough vocation in the current climate - then I think at some stage you need to have some exposure to the world of private businesses, preferably fast-growing ones which might turn into tomorrow’s tech leviathans. The best way to get this exposure is through a venture capital firm, a handful of which are listed on the London stock market. Arguably the most high-profile firm in this space is called Chrysalis Investments. I say high profile because it has been in the media for two main stories. The first was a massive row about the fees the managers generated when times were good and shares in the fund traded at a massive premium. The second story is that many of the key investments in the Chrysalis portfolio have had a horrible 12 months and have seen their valuations absolutely plummet. As a consequence, the share price is down 67% since its peak in September 2021, when the shares were trading on a premium.

At this point, I have to say that the controversy surrounding both the fees debate and the recent performance is entirely justified. The fee structure was clearly skewed only to the upside and made the managers a small fortune. In essence, the renumeration package was, in my humble opinion, indefensible. Thankfully it has now been negotiated. According to fund analysts at Numis the headline performance fee has been “significantly from 20% to 12.5%. Significantly, the high-water mark of 253p has been maintained and further protections have been put in place to prevent a repeat of performance fee payouts in the event of a subsequent NAV decline.”

As for the share price plunge, this was also warranted. Chrysalis focused on late stage, pre IPO firms - well known names include Klarna and Starling. The portfolio is a high quality one and I can see why investors got excited, but times have changed. There is close to zero chance of an IPO for a year or more and many late stage VC backed investments have experienced massive writedowns. Until very recently I was of the view that the whole VC industry was ins elf denial and was refusing to put sensible valuations on businesses. I still think this is largely true and but less so of late stage, post Series c 9and D) deals. Crucially Chrysalis has introduced much more rigour to its valuation process and its board is to be applauded for taking an active stance on howe to value private businesses.

My core view is that whatever number VCs quoted in late 2021 and the beginning of 2022, you should discount by at least 80% if not 90% to get to a sensible value. That’s still not true for Chrysalis - that would probably take us closer to 60p a share - but Chrysalis is much closer to what I regard as a realistic VC valuation. In sum the funds NAV was down 41% in the year to September 2022, predominantly due to the impact of a down funding round for Klarna (-56p), with the rest of the portfolio collectively down 46p, including write downs to Starling and declines in listed holdings (THG, Wise and Revolution Beauty).

The upside is that Chrysalis has a great collection of mature private businesses in sectors such as Insuretech, Fintech and Cybersecurity.I realise hardened cynics will rightly say these sectors were over sold and valuations got out of hand, but there is real disruption afoot in all three of these spaces and I think the long term potential for change is huge. And crucially many of these businesses are what I regard as high quality.  Again according to Numis “as of 30 September, 35% of the portfolio was profitable, 32% funded through to profitability based on company budgets, and a further 14% have a cash runway of around two years. The remaining 19% were either expected to either be funded by Chrysalis or other investors, or will be sold.” I would cite one example - I bank with starling and having banked with many others, regard it as quite the best online bank. Its technology works, its accounts are competitive and its even communicative with its clients.

chart above - Chrysalis share price in black, 20 day moving average in red and 200 day MA in blue

The fund recently announced a 31/12/22 NAV of 128.3p, reflecting a 13.2% decline over Q4. Four holdings comprised an 8% decline in the NAV, with much of this driven by 'the external valuer and the independent valuation committee's transition towards a more market-based approach, and away from a price of recent investment approach' according to analysts at Liberum. FX detracted 2% from NAV. The portfolio's funding requirement remains c.£20m, against holding cash of £66m, or 9% of NAV.

Analysts at Jefferies observed that four key holdings drove the recent decline in the NAV: Graphcore, Wefox, Deep Instinct, Featurespace. They estimate the NAV to be around 127p at the moment.  Even more recently Chrysalis announced that it has agreed to invest a further £20m in Starling Bank via a secondary market transaction as another shareholder (Jupiter) exits its position following a change in its investment policy. Liberum analysts report that as a a result of this transaction, Starling Bank will account for 15% of the portfolio vs. 12% as at 31 December. Chrysalis's liquidity position will drop to c.£61m, being £49m of cash and the remainder the listed holding in Wise. Liberum also reported that “were the independent Valuation Committee to apply the 'price of recent investment' approach to its stake in Starling, it would result in a "modest uplift" in the company's NAV vs the 31 December value.”

Fund Facts

-          Price: 68p

-          Ticker: CHRY

-          Formal discount : -47%

-          My own estimate of true underlying value in worst case analysis: 50p

Market Cap : £406m

Top Ten holdings:

-          Starling Bank 20.6%

-          Klarna Holdings : 19.1%

-          Wefox 11.2%

-          Smart Pension 9%

-          The Brandtech Group 8.2%

-          Graphcore 4.8%

-          Featurespace  3.2%

-          Tactus Holdings 3.2%

-          Wise 2.7%

-          Cognitive Logic 2.6%

My take: The chart above shows the share price for the fund since the start of the bear market - you’ll also see the 20 day moving average in red and the 200 day moving average in blue. The fund has traded as low as 52p, and if there is another bear push, we could see the share price push below 60p again. My own sense though is that we are not far from the bottom and although I have penciled in a worst case / base-case valuation of 50p a share, I think there is some evidence to suggest that the worst may be over for some - not all - of the companies in this basket. I should also emphasise that I highly rate both Starling Bank and Klarna - both are fantastic businesses with a very solid business franchises and real fintech survivors. There are risks of course with such a volatile fund but my own sense is that the downside is now more limited, the upside potential very substantial and there is much better board oversight of the valuation process. Buy with a target of 100p by the end of 2024.

A defensive play: investing in the Healthcare sector

The healthcare sector had a good bear market. Most healthcare funds – bar biotech funds – produced positive returns for 2022. And although healthcare as a sector has underperformed the market so far in 2023, many large healthcare firms like UnitedHealthcare are releasing more than decent numbers.

But there is a more important long-term argument for looking at healthcare as a sector. Although it contains within it a broad range of niches (biotech and data services through to old school big pharma), overall the sector has strong defensive characteristics in a slowing economy wracked by higher than expected inflation. As a broad sector it comprises lots  of companies with resilient margins and high pricing power. I think this argument has best been put by StoneX’s spiky strategist Vincent Deluard who has crunched the sector level data. After his interrogation he reckons that healthcare is more recession proof, especially compared to everyone’s favourite defensive safe haven consumer staples. According to Deluard “pharmaceuticals have maintained 15-20% margins throughout the past 40 years. They have almost no exposure to energy and basic material costs: their main expenses are research and development, marketing, and lobbying….the US healthcare sector is [also] monopolistic or oligopolistic with great price-gouging pricing power. Inflation in drugs prices and medical services has been twice that of the broad consumer price index in the past forty years. “

I would also add that on most valuation metrics the healthcare sector doesn’t look too far out of whack in terms of valuations. Sure, the historic sector PE for say the US majors is currently around 22 – which is a bit on the high side - but that falls to a forecast 16.81 times earnings for 23. In sum, healthcare tends to outperform in a recession, has pricing power in a more inflationary environment, is benefitting from strong secular growth drivers (we are all aging !) and is nit egregiously over valued. So, if you buy into this thinking, what are your choices in funds land?

So, if you buy into this thinking, what are your choices in funds land?

Your first decision is whether to look at the broad healthcare sector including both biotech and mainstream pharma/health services or stick to one sub sector. Mainstream pharma/health services is more keenly priced (on a PE multiple) but is less exciting. Its classic defensive investing. Biotech by contrast is much more exciting and growth oriented but is volatile and risky. Personally, I have a preference for the biotech space as I think its now two years into a bear market and due a reversal but I entirely understand why defensive types might run a mile.

Within the biotech (and medical devices) space you also have an additional choice. Do you focus on ‘mainstream’ biotech and innovation firms or do you go all next generation and only focus on those funds with a focus say on genomics? In ETF land that probably is echoed in a trade off between the Invesco NASDAQ Biotech UCITS ETF (mainstream biotech) or iShares PLC NASDAQ US Biotech UCITS (also mainstream) and more innovative portfolios such as the iShares Healthcare Innovation UCITS or the Legal & General Healthcare Breakthrough UCITS ETF.

Next up you have to decide which geography to focus on. This is a simple choice - the US, Europe or the world. If you are focusing on biotech, then it’s basically the US and a long tail of smaller UK and European firms. In the ETF space, your default choice is a fund called X-trackers (IE) PLC X MSCI World Health Care while in the active space its Bellevue Healthcare Trust PLC and Polar Capital Global Healthcare Trust PLC. If you are thinking of investing in healthcare broadly (including biotech and big pharma) I think your best choice might be to invest at the global level, so you don’t miss out on innovative UK and Swiss firms. The main world ETF is the X-trackers (IE) PLC X MSCI World Health Care ETF.

One last crucial question - active vs passive ? In the table below I have broke out performance for the range of ETFs and actively managed funds over various time frames starting from the last month to the last five years. I would make two observations.

The first is that by and large passive has performed as well as most active funds. There is no obvious active advantage at work. That said I think the Polar Capital Global Healthcare Trust has an excellent track record and has produced consistently great results. Its also prudently managed and has a defensive, income focus. Over in ETF land I also think the track record of the iShares S&P 500 Health Care Sector ETf, ticker IHCU, stands out. It invests in a deep, liquid pool of well run US businesses and this shows in the performance data.

In the next table below, I have broken out the top holdings for the iShares fund S&P 500 Healthcare ETF versus the Polar Cap fund.

Get full access to David Stevenson's Adventurous Investor Newsletter at davidstevenson.substack.com/subscribe

Last week I caught up with Charlie Morris, who many of you will know has been an influential voice amongst active private investors. Here’s his biog from the excellent Multi Asset Investor website:

Charlie Morris is the Editor of The Multi-Asset Investor. Prior to this he was the Editor of the Fleet Street Letter, a market newsletter for private investors published by Southbank Investment Research with a wide readership. He is also the Chairman and Chief Investment Officer of ByteTree, which he founded in 2014 as a platform to deliver independent, robust and thought-provoking market analysis.

Charlie has 25 years of fund management experience and is a pioneer of multi-asset investing. At HSBC Global Asset Management, he launched the Absolute Return Service in 2002, which grew to over $3 billion.

Charlie recently set up Bytetree Asset Management which is probably best known for its crypto exchange-traded product - working alongside 21Shares.

I thoroughly recommend having a browse around the Bytetree website - https://bytetree.com/ - if only to access its tools.

Here’s a tip - go to the top right-hand side of the page, look for the Terminal tab and click. You’ll then be taken to a free to access data terminal which features lots of technical info on crypto. Now look to the left hand side bar and you will see ETFs, and under that heading Scores. Click on that and you will come to a dashboard which shows you the best ETFs using Bytetree’s scoring system, which borrows heavily from technical analysis.

In the graphic below I’ve screen captured the top ETFs from Tuesday the 24th of January. According to the Bytetree system, Industrials ETFs are looking strong along with a high dividend, low vol ETF tracking US stocks.

Anyway, it’s well worth listening to our 30 minute + chat where we speed Charlie’s views on the investment universe :

-          We discuss why Charlie is bullish on US equities

-          Gold looks to be a steady bet

-          Why crypto is here to stay

-          And why Japanese equities - one of my favorites - are not a sure fire win

At the bottom of this article, I have also included an automated transcript of the interview - it’s not edited, so please treat it with some caution. But you’ll get the ‘gist’ of the conversation. Go to the bottom of the email.

Music Funds - a useful reference point

One of my strongest buys for 2023 is the Hipgnosis Songs Fund. As I have said more than a few times, I have had some reservations about the fund in the past, not least that it is in a specialist market with a paucity of active participants, which in turn makes establishing a ‘market’ price for its private assets tricky in the extreme. At some point though those concerns are factored into the price and at 86p a share - on a 41% discount - I think there is now a sufficient margin of safety. I have a 100p target for the shares.

But those concerns I mentioned above have not entirely gone away and thus I’m always interested in any market benchmarking of rates and yields on music collections. This is where the excellent Matt Hose, funds analyst for Jefferies comes in. Earlier this week he reported on a transaction that does give us some hint of what a ‘market rate’ might be. Over to Matt:

“One of the difficulties in assessing the portfolio valuations of music royalty funds SONG and RHM is that transaction comps are hard to come by. Sale prices for high-profile music catalogues are often made public, but the level of underlying income is not. As a result, transaction multiples are rarely visible. However, one notable exception appears to be Dr. Dre's catalogue, with Variety reporting that the rapper and record producer is selling 'a collection of music income streams and other assets' in a $200m-$250m deal. The assets are reported to generate nearly $10m annually, therefore implying a 20x-25x multiple. If correct, this would provide a useful comp for the pricing of top-tier catalogues. While it is only a single data point, it appears at odds with the view that catalogue pricing is softening, so in turn, would help validate the funds' valuations.”

China

By the time you read this, we’ll be at the end of the Year of the Tiger and into the Year of the Rabbit. According to Michael Pettis, an economist based in Beijing, the “Year of the Tiger is supposed to be a turbulent but successful one, and while it was certainly the former, I think it may not have been the latter for a lot of people. The Year of the Rabbit is supposed to be financially complicated and a good time to cut losses. Make of that what you will.”

I’ve had quite a few investors write to me asking me how they can invest in Chinese equities through an accessible listed fund. I have to say that I am deeply, deeply, deeply (enough deeply’s ed) cynical about Chinese equities and corporate governance. I can entirely see why investors might want to look past these concerns but for me, they are real and ever-present - you are in effect investing your money into the Chinese Communist Party and its tentacles in business. I genuinely believe the CCPs’ Marxist rhetoric - its not lying about its dogmatic communism. That should be warning enough for any investor.

The excellent American based China hand Dexter Roberts I think nicely sums up this view as follows:

“But if you listen to the leadership, take their words at face value, including their clearly stated goals for where they want to take China and the party’s role in that, the unavoidable conclusion is that the loosening of control now will be temporary, and the longer term direction will be further tightening. There is a curse that comes with watching China over many years, which I have been doing since the 1980s (it’s similar to the occupational hazard that comes with teaching modern Chinese history and politics, as I do at the University of Montana.) You can’t help but start to see some of the same attitudes, same beliefs, same policy choices mirrored across generations of Chinese leaders. And one constant has been the primacy of the party over all, a party that must regularly assert its dominance, even when doing so comes with real costs.”

But I also accept that on a speculative basis, Chinese equities might be cheap. By some reckonings, Chinese onshore equities are now cheaper than they were in 2016. And it doesn’t take a genius to work out what might happen this year as zero Covid bites the dust.

The first quarter will be genuinely horrible but then there will be an almighty roar as China gets back to business. This will result in an inflationary pulse globally and then a massive surge of exports. No doubt the CCP will be keen for 2023 and 2024 to be years that everyone enjoys - pushing up central bank liquidity to help push the system along.

Plenty of respected observers think the same - according to Pettis, “I actually expect this year's reported GDP growth to be higher than the target, perhaps closer to 6 percent than to 5 percent and, more importantly, for the "high quality" growth component to be substantial, as we get a partial revival of last year's terrible consumption. This will be similar to – although not nearly as extreme – as what we saw in 2020.” That sounds fairly positive to me!

Here’s Dexter Roberts again, summing up the market consensus - and issuing the necessary caution!

While growth for all of 2022 came in at just 3 percent, well below Beijing’s earlier target of 5.5 percent, the last quarter of the year registered a rise of 2.9 percent, above analyst forecasts of 1.6 percent.

“The outlook for GDP growth in 2023 has improved compared to our prior outlook,” says ING Groep NV’s Iris Pang, who is now predicting a rise of 5 percent in 2023. “That is not to ignore the fact that China still faces considerable headwinds, including external demand, with recessions likely in the US and Europe this year.”

“China’s fourth-quarter GDP should be viewed with both concern and a degree of relief. The overshoot relative to expectations will assuage worries about a crash,” say Bloomberg economists Chang Shu and Eric Zhu. “High-frequency indicators suggest that the economy may have have bottomed. We see a solid rebound taking hold in 2Q23.”

But some are expressing skepticism about the veracity of the numbers, citing discrepancies. For example, while most industries fell in December, the figures showed industrial production overall rose. Car production dropped by 16.7 percent, but still sales grew by 4.6 percent. And while cement output did shrink, down 10.8 percent, that number was dwarfed by a 28.3 percent drop in housing sales.

So 2023 should be a good year for Chinese equities and we’ve already seen a surge - which might last longer and go much higher. Where does leave investors?

What are your choices?

This week I’ve tried to provide a guide to what you should be looking for ina Chinese equities fund.

The first question you need to ask is whether you will use an actively managed fund - preferably an investment trust - or a passive, index-tracking fund.

Cue our first table below. This shows the top four funds (active and passive) over various time frames in terms of fund performance. What’s obvious to me is that active funds do not consistently outperform all passive funds - quite the contrary .

In fact I would say it’s a toss-up between active and passive but if I had to pick an active fund I would probably pick Fidelity and its China Special Sits fund. One point to note - over the last month, actively managed investment trusts have trounced ETFs.

Your next decision is which index to track - assuming you have gone down the ETF route. In the next table below I’ve mapped out the main indices tracking Chinese equities. I have no particular preferences - it entirely depends on what you think works for you. If pushed I suppose I might say that I prefer the MSCI China A shares index.

The table below maps out the main passive and active funds available in the China equities space. On the ETF front I have deliberately excluded funds with an AuM of less than £100m.

My overall observations would be as follows:

-          If you are looking for the cheapest ETF then I would go for ticker CNUA - the UBS (Irl) Fund Solutions PLC UBS ETF MSCI CHINA A USD ACC

-          If you are after the largest ETF by AuM then I would go for iShares MSCI China A UCITS ETF, ticker IASH

-          In terms of performance I rate the X-trackers X CSI300 Swap highly, ticker XCHA. Its TER is a lowly 0.5% but it is a swap-based product which puts some folks off !

-          In investment trust land the Fidelity China Special Sits fund is the biggest and in my view the best.

Charlie Morris's interview as a transcript

Please note this is an automated transcript and has been very lightly edited but is machine-generated!!!

David Stevenson  00:00:00    Hello and welcome to another installment of the Adventurous Investor in conversation. This time we're talking to Charlie Morris  . Um, he used to be at HSBC running an absolute returns fund, um, and has been running various funds in the absolute return space for many years and has also been building up quite amid reputation in the whole crypto space. Um, he's even got an e TP in exchange trader product with 21 shares, which is a combination of both, uh, Bitcoin and Gold. But, um, in this episode I talked to Charlie more about his overall asset allocation views and where he thinks the key markets are going. So absolutely worth listening to. Also worth checking out his website, which is, uh, over a bite tree. And that's B y t e Tree, bike Tree. Um, they have a brilliant, um, newsletter called the Multi-Asset Investor. So join me as we talk about all the asset classes, including crypto and gold and US equities with Charlie Morris  , Charlie, um, Charlie Morris  on, Byre, welcome. And um, I thought we kick, kick straight off with the, I suppose the 64 trillion question, which is overall for kind of risk assets, things like equities, and by default I suppose we mean US equities cuz they're the largest bit of the most liquid market on earth. You bearish or bullish at the moment? 

Charlie Morris  00:01:30    Um, David, I'm bullish and Oh, 

David Stevenson  00:01:32    Right, right. Why? I mean, cuz I, a lot of people are bearish at the moment, aren't they? They're all people, boring, cynical types like me are sort of going, oh my God, we're just about to have recession earnings, us corporate earnings about to get good kick in. So why are you bullish? 

Charlie Morris  00:01:47    There's lots of reasons. I mean, I think to illustrate, um, that I'll start off by saying I've been a be two years. Yeah. And, um, and I've recently turned the corner and, and that's market evidence that gets me there more than anything else. Why was I bearish beforehand? Well, the main reason was the bond yields were going up very, very aggressively. Yep. And that's stabilized. Why have they stabilized? Well, lots of reasons, but the big one is probably inflation. Not 20%, but more like six and heading south. Yep. We've seen the energy prices in Europe down 80% since last August, 50% down in the last month. That's the, the, the, the North Sea, uh, gas price. So, you know, life's not near as bad as it was a few months ago when we had soaring bond yields, which caused the blow up of the UK Gils market. 

Charlie Morris  00:02:35    All of these sorts of problems. Um, and, and so there's been some stability, uh, over there. Add to that the reopening of China, which confuses our recession. Cause you were gonna have, you know, western world slow down at the same time. Yep. And sudden you've got this countercyclical force kicking in. So not, not not simple, um, different things happening in different places as always. Um, but I think that the, the, the extreme bear argument has been given a kicking. Yeah. I'm not, I'm not a mega bull by any means, but I do think we've got a period of stability and right now that means prices going up. And what I'm saying actually is more that there's a rotation within markets rather than, um, a straightforward bull market. And that rotation is huge. And to illustrate that, you've got companies like Microsoft and Apple, if you add the value of those two companies together, you know, in recent times you find they've been worth more than the United Kingdom stock market, which is just beyond, beyond ridiculous. When our cashflow, you know, are combined profits of our companies are materially larger than those two companies. Despite, I'm not, I'm not saying they're not successful and great, this is a huge rotation outta, outta uh, uh, big tech into old economy. And that old economy is not just Britain, it's Britain, it's Europe, it's Japan, it's Asia, it's emerging markets. 

David Stevenson  00:03:52    So is this the rest of the world argument? The r o w which is Yeah. So basically rotation not only outta growth into value, I'm saying that with kind of air, air apostrophes, um, but but rotation out of us into rest of world. 

Charlie Morris  00:04:05    Absolutely. Right. And I, and I'd say the other point is the dollar, the dollar's hugely overvalued, um, on a purchasing power parity going back half a century. Yeah. And you're talking nearly 40% at one point last year. Um, it's on the way down. Doesn't matter what they do to interest rates, uh, the dollars overpriced. And um, you know, so you put those things together and you realize that the reasons to be really bearish a year ago are no longer, uh, valid. So yes, recessions, inverse deal curves, I see that. But are there, is there are some of those things gonna be tempered? Cause it's not as bad as we thought? 

David Stevenson  00:04:39    Um, what about the other, the other big asset class bonds? Um, I mean, I suppose, uh, your, your view on anybody's view on bonds is I suppose has to be tempered to use your expression by what interest rates are gonna do. Um, none of us really know what's going on in the minor central bankers. And I'm not entirely sure central bankers know what's going on in the minds of central bankers. But, um, is your sense that the consensus, which is the interest rates will probably in the US peak at about five, a little bit above, bit bit below you at UK for maybe a little bit above, maybe a bit below, and that they'll stop rising and then possibly head down even if slowly at first. Do you think that consensus is right? 

Charlie Morris  00:05:21    Well, no, not because I know what's gonna happen, but just because the consensus never been right. 

David Stevenson  00:05:26    Yes, exactly. 

Charlie Morris  00:05:28    . Cause it's never, ever been right then why it's gonna be right this time. So I think that's the important point there. Um, I dunno, I really don't know about bonds. I'm really, I'm really quite cautious on duration because if you already said you got an inverted curve, and so there's a lot that could go go wrong with, with, um, with duration and at the short end. Yeah, there's a bit of excitement to be happen. Not much. I get that. Um, earnings may be coming under pressure, so therefore credits, you know, I I can see it's going up short term. But again, is it underpinned? Not really. Is it dirt, heat? Not really. The bit of the bond market I do like, um, um, is, is, um, inflation link bonds Yeah. In the United States. Yeah. And, and you know, I I I've been a bit of a fan of gold really since about 2018 and now I'm seeing go very overpriced against us tips. And of course, you know, you can lock in now one and a half, 82%, uh, real yield in in tips. And that's, that's a big number. You have to go back 3 0 8 to get that. 

David Stevenson  00:06:28    Do, do you think ju just, just wanna just dwell on tips for a second in inflation, um, uh, only recently Duncan McKinneys over at Rougher has been making the argument that, um, that, and, and he's not the only one actually Albert Edwards SocGen has been making the same argument. The inflation, as you said, might come down because of all the base effects. You've already talked about declining energy, price, all that kind stuff. But they might ratchet back up again and we might be in a more stagflationary era, um, just on that narrow inflation point. What, because that, if that is the case and none of us know, cuz none of us have a crystal ball that works. Um, but if we are have moved to a more stagflation in your environment, there are profound consequences for lots of portfolios here, which is supposed to point rro making. What do you make of that narrow point? Do you think we're, we're we are, we might get a breather, but then it we are gonna see sustained inflation pulse through or, or, or, or, or just did not know. No, like most of us, 

Charlie Morris  00:07:22    So I I've studied the 1970s like, like they have and what we saw in the seventies was, was inflation was volatile and all emerging markets that have had what is inflation, it's an inefficient economy. Yeah. No, inflation is a super inflation efficient economy. Sometimes it can be marked by capital flows, you know, like Switzerland, you don't really know if they're, they're, they're affectionate or not. But everyone throws money at them. Yeah. all looks great. Um, but, you know, an affect economy like Japan long term has had lower, lower, lower inflation than other places. Uh, the UK is an island off the coast of a big continental, um, economic powerhouse. Our inflation's always been slightly higher than Europe cause they're a bigger trading block, of course. They're more efficient than we would be. And historically, Ireland always had higher inflation than we did because they were a small economy, uh, separated by sea. 

Charlie Morris  00:08:09    So there, there is something in that and inflation, when you lose control of it basically tends to be volatile. Yeah. So it's already the level so much, it's the fact that it chops and changes and, you know, gmo, GMO being the big US value manager. Yep, yep. Um, they had, uh, this wonderful s and p valuation, uh, model that they trotted out once and it seemed to work, it probably stopped working off that paper, but, but, um, it was really good. And one of the inputs was the volatility of inflation. And so they said, so basically what, what the conclusion being that when inflation's volatile, you dunno what's gonna happen. Therefore you've gotta have a, a low evaluation on asset prices. 

David Stevenson  00:08:46    Yeah. So do you think inflation's gonna be volatile? 

Charlie Morris  00:08:49    Yes. 

David Stevenson  00:08:50    Okay. I'll answer that question back to tips. Um, so, um, should we own tips versus gold? Now, does, does effective, are you saying that tips is a better bet than gold 

Charlie Morris  00:08:59    On valuation argument? And that valuation, uh, relationship between tip tips and gold goes back quite a long time. The only reason you wouldn't, the only, the only reason why I'm, you know, why that would be completely wrong is because you believe something's changed in the gold market. You believe that, uh, that the US treasury treasuries have been weaponized following the invasion of Ukraine. The Russia had its reserves, uh, confiscated. That's not a very nice thing to happen. And, um, and sort of poor form in sort of battlefield, um, um, civilly if you like, compared to what we're used to. You know, you don't 

David Stevenson  00:09:35    Don't need s**t Central bank shiv anyway, 

Charlie Morris  00:09:37    Central Bank, Shiv, 

David Stevenson  00:09:40    . 

Charlie Morris  00:09:40    And, um, it's an important point. So if you are now, um, an economy or a country that, that doesn't quite agree with our values, then, then you would say, well, I'm not going to park my reserves in their bones anymore. I'd do something else. So maybe it's right that, that that gold goes to a prolonged premium. And we saw in q3, you know, 399 tons of gold bought by central banks. Yep. You know, the biggest buyers being Turkey is be Pakistan and, uh, a guitar. And then we, we started to see China admit to higher, uh, reserves as well. So we've got these big numbers coming through and you kind of think, okay, if all of them are gonna pile their reserves into gold at any price, then something's changed. They didn't have to, they don't have to obey the sort of natural forces of the tips model. 

Charlie Morris  00:10:32    And the reason why the tips model work, by the way, is because golden long-term tips have the same objective. Yeah. Which is, you know, to protect you against the destruction of capital over time, uh, or the value of money over time. So, um, there's a, there's complete logic there. Um, but I, but I would think that tips are also going to to, you know, deliver what they're, deliver that contract provided you, not in any any of the state. So if you are, if you're on the, their side, tips are great. If you're not on their side, maybe you have to go for God. 

David Stevenson  00:11:01    Okay. Um, just going, tips are obviously denominated in dollars. So that's the segue. You sort said that dollars are dollar, the dollar is overvalued. And I, I have to agree with you, uh, and I suspect actually even in the US Federal Reserve might agree with you as well. Um, but that's separate issue. Um, what's undervalue, 

Charlie Morris  00:11:18    Um, on the currency side? Yep. The Japanese yen, by long way, the Swedish Croner as well, the pound was less so now, but you know, the pound whenever it's been undervalued, which has been sort of 92 er m um, and, and the other great time was off the credit crisis and, and, and Brexit. You get these sort of brief periods, uh, where it's undervalued and it tends to be an equity bear market because the pound tends to be, um, overvalued during bull markets because we're a financial center. Um, right now the Swedish pro seems to be dirt cheap. Uh, and the Japanese yen is the elephant in the room that everyone's talking about. Um, and that's, that's down to, as you, you know, David, it's the, you know, yield curve control. Yeah. You can't keep the 10 year bond yield, um, at levels of the markets doesn't want. And, and you know, you get an er m type moment when the market says no. And it, you know, the, the, the Japanese has got away with us for a long time. Very, it's a very simple reason that everyone else had low bond yields. Yeah. Now, you know, America, Europe, Britain, 

David Stevenson  00:12:14    Charlie, I get that. But why hasn't it happened yet? Because, you know, um, you know, on, on u on uk, US government, even European government bonds, you can get pretty good yields Now, um, I I quite like sort of long duration US treasuries, they're paying decent yields. Why would you own Japanese, um, government securities unless you had to? 

Charlie Morris  00:12:34    So no one does, I mean, it's, it's hilariously a sort of slightly illiquid market, but they're there. They're big, they're a big asset first. Um, and, and it's one of those things that, you know, some people will tell you that Japan's a most deadly country in the world, but you know, this is a left pocket right pocket situation. Yeah. You know, if you own a trillion in one pocket and you owe a trillion in the other pocket, you know, you, you you are, you are flat. And that's kind of where Japan is. Um, so they're not really, they're, they're an extremely wealthy nation. But I, but what what they can do is, you know, we we we've learned about printing money in recent years. It's a funny old thing. You just sort of ask a computer to do it for you and suddenly a few zeros pop up, 

David Stevenson  00:13:10    That's the button. Yeah. 

Charlie Morris  00:13:11    But there you go. And that's what they're doing. And they're buying all these bonds off themselves each week. Um, but I think the speculators have, have, have caught wind of this. But basically when the, when the yield goes up on long-term Japanese debt and that makes the end more attractive. And so the undervaluation reversed to mean, and, and we've seen this in previous sort of cycles like 2008 and so forth, you know, people like to borrow money in yen because the Japanese like to keep their currencies soft and their exporters and so forth. And when it's payback time, which is whenever there's a, a soft economy, uh, the yen goes through the roof. Yeah. So, um, so I think that the Yen's a very interesting trade right now as part of risk of, so things do go wrong than theen are, 

David Stevenson  00:13:50    Would that extend to Japanese equities? 

Charlie Morris  00:13:53    That's more confusing. So you don't wanna win the box, you do wanna win the currency. I think the Japanese equities are somewhere in the middle. Yeah. It's, it's probably the banks, um, ironically are probably in a better place than, um, than the exporters, for example, which are gonna suddenly, you know, find themselves less competitive. But I think that it, it, it's gonna be a mixed response. It was very clear once upon a time that, you know, that the yen went up and, and the Japanese stock market went down. But, but that's not really the point we wanna know is you take, take the Japanese stock market in pound sterling and the world index in we British and, and, and, and the world index in pound sterling, and which is better? Which one do you wanna word? And and that's the question, aren't Japanese equities better than the world or worse the world? 

Charlie Morris  00:14:36    And they've been worse since 1990. Yeah, it's 20. We we're getting to the 23rd year of Japanese equity underperformance versus the world, sorry, 33rd year. That's a hell of a long time, David. Yeah. So at some point we're expecting that to turn. And some people would say that actually Japanese equities are, are undervalued and it's a real opportunity. Cause um, when they stop doing this funny money business then and it starts to go to sort of normal situation, they actually become really attractive. Um, I'm somewhat on the fence when it comes to Japanese equities, but I'm certainly happy to interview. 

David Stevenson  00:15:10    Um, I just wanna sort of also just deal with the issue of what, what investors actually invested practically if you're a private investor. Uh, and on your Byre website before we, we, we started going online, we, we showed a quite interesting et TF tool, um, which, which looks at, uh, effectively a technical, correct me if I'm wrong, mainly technical analysis, but with some value kicking around as well. And you're looking at 20 day, 30 day, 200 day moving averages and you select the ETFs using that tool, which I hardly recommend people go and look at, and I'll put it in the program notes. Um, what's your tool at the moment suggested they should invest them in ETF land? 

Charlie Morris  00:15:45    Yeah, well, so I write a, uh, so we've got some tools on the website, thank you mentioning those. But we also do search, I write a think called the, the multi-asset letter. And that's stats. You know, obviously I use some of the tools that we've built, but there's also, you know, proper fundamental old school kick the tires analysis, what's in the etf, what do the individual securities look like, what's the, what's the value and so forth. And I like dividends and, and please elaborate. Tell you why. And back 19, I think I loaned dividends and maybe I was, maybe I was a bit lucky I didn't predict covid, but I was very skeptical about income funds at that time. You saw a lot of companies, you know, with these, um, overly high payouts, the foot, do you remember the Fusi was very criticized for having all these big dividends Yeah, yeah. 

Charlie Morris  00:16:29    For these companies that couldn't quite manage them. And then Covid came along and it was an excuse for everyone to cut their dividend. Not just here, but everywhere. And, and, and, and, and, um, income funds, you know, were absolutely, uh, destroyed over, over Q2 or q1, Q2 of 2020. And then, you know, when you flush out the entire dividend system and companies, even companies that didn't actually need to cut their dividends did it anyway. Um, what what comes outta the other side of that is, is dividends are probably pretty damn rock solid across the board. Yep. Uh, and that will last, that's a force that's gonna last a few years. And so these, these income funds and dividend ETFs, um, I always bit skeptical of them at that time. Could Wood Woodford was of course a big casualty of, of the income fund. Um, and I think it's a really good time to be looking at dividends because they get you into value. 

Charlie Morris  00:17:21    They keep you out of growth, they keep you out of defensive, you know, what's done too well in the last two years. These sort of big, big defensive stocks and um, uh, uh, and gold possibly. And, and some of these, some of these things. And the dollar has done too well in recent years. And, and those are probably the areas you don't wanna be. So if you can get the value and get to the dividends knowing that they've been flushed out and they're back on the way up, um, that's what I think is gonna work well, regardless of where the economy's really strong, already weak, I doubt it's really strong, but I think it might not be really weak. And therefore, you know, being paid away in undervalued stocks that can appreciate it a little bit and you get paid, you know, decent coupon each year. What's wrong with that? 

David Stevenson  00:18:01    Well, and in fact, I mean, I, I'm a big fan of dividend Arista crafts, this idea that you invest in companies that have consistently prioritized dividends over progressive dividends over a long period of time and just patently just keep sending the checks out. And in fact, in us, which is not a big dividend paying culture, um, you know, Europe's a much bigger dividend paying culture. But in fact, if the, you look at US ETFs actually dividend aristocratic ETFs or, or, or, or more complicated dividend screens than just a simple, I'll buy the ch the biggest dividend yield they've done, they did really well in 22. Um, a and there's no reason to think that they won't do well along with buyout orientated, sorry, buyback orientated DV ETFs, which is roughly the same kind of idea. Um, one, one other, I suppose they're just two, two questions before what we finish off with, with the inevitable question about crypto. 

David Stevenson  00:18:47    Cause we're, we, we can't not talk about crypto particularly as you have a ETP that looks at the, is on the relationship between gold and, and risk weighting and, and bitcoin and, and that kind of stuff. Before I get there, there are two things. Um, one which is both equity orientated, both secular themes. So one tech and the other one is the kind of energy transition, industrial metals, decarbonization, reindustrialization, whatever word you wanna use for it. So let's look at tech for instance. First we, we started off talking a bit about the big tech ofs. Um, is it important to distinguish, do you think, between tech companies that actually are producing substantial learnings and I'm doing reasonably well. It's an argument I would make that there, there's a, there's a small handful of companies like Alphabet or Google, like Microsoft that actually do make shed loads of money. 

David Stevenson  00:19:38    Yeah. A a and they've made a bit less money because they're being hit by digital advertising, but they, there's some deeply profitable businesses. Yeah. And then there's a longer tail of tech companies. I mean, there's some shocking statistics about the number of companies, small cap tech companies for instance, or mid-cap tech companies in America that don't produce any profits. Yeah. Um, and the longer teller companies that frankly never will have never produced, oh, my phone's going. Um, have, uh, the, the rookie era of all podcasts, um, that have never produced, uh, profits and certainly never produced cash. And, uh, once you distinguish between the, the cash generating tech giants and the rest, 

Charlie Morris  00:20:16    Absolutely. They're completely different animals. And I think that's another reason to be bullish. Your, your opening question was why you, you know, why are you bullish? And if you take, um, ark the, the Kathy Woods, uh, yeah. Nonprofit tech stocks or the Goldman Sachs nonprofit tech index or whatever. Yeah, yeah. You know, it's back to where it was five years ago, it went through around 

David Stevenson  00:20:36    60, 70%. Yeah, yeah, 

Charlie Morris  00:20:37    Yeah. It went through the roof, it went all the way up to the moon and it's back, come back down again. And so we flushed that out. And when did it peak? It peaked in February, 2021. So that's just under two years ago. Two years is a long time for a stock market to adjust. Yep. Um, the average age for a bear market is 14 months. The really bad one's gone for three years, but, you know, two years that'll do. And so think you've had most of the, um, of, of of, of, of that reversal. And that's face it that, you know, most people will say happening that stocks like Peloton or Beyond meat went up 200 times or whatever on the back of stimulus checks and this sort of thing and covid and weird stuff. And, and that's all gone away. So, you know that that, and that money kind of rotated into the big tech that you described with loads of profits into, into, into Apple and Google. And, and that is where I see the, the, the, um, remaining high valuations. And that could take years to unwind. These dogs don't have to go straight down, they just have to go nowhere for years. 

David Stevenson  00:21:39    Yeah. No, well, meta is a good example of that. Um, I, and I think the, I I guess you'd be right about this week, but I think that the, the canary in the coal mine is biotech. Cuz biotech also basically went into a swoon about February 21 in fact, and has spent the last two years going nowhere. And there, there is some evidence now that, that we've, that we're beginning to see a kind of culling of the companies. You're beginning to get valuations, you know, back down below net cash rabbit. So I, I would suggest that people look at biotech as particularly one area where the, if that turns, that's a, that's a sentiment indicator. The other one I wanna talk to you bit about decarbonization, this whole kind of industrial metals thing. It's come back again in the last couple of months and it's very much powering the miners. 

David Stevenson  00:22:20    Yeah. So I watch, you know, funds like BlackRocks, world Mining Fund quite carefully, big co a big con, a big kind of a glomeration of the big mining names. And, um, it had a bit of a rough patch at some point in 22 it sort of come back around again. And, and, and in the New Year, predictions, uh, uh, there's lots of people including me saying that, you know, industrial metals, um, everything to do with this kind of, you know, decarbonization, reindustrialization, retooling, everything. That's a big secular long-term ball theme. It will be volatile. But it's an interesting theme. Do you buy that argument? 

Charlie Morris  00:22:53    Yes and no. I mean, uh, if I just go to biotech, I'm glad you mentioned that cuz that recently went in our portfolios. 

David Stevenson  00:23:00    Oh, right. Oh, good. So we 

Charlie Morris  00:23:01    Agree biotech was, cause biotech peaked in 2015, as you remember. Yeah. And there was, and that, uh, fairness, the, that 

David Stevenson  00:23:09    Fair enough. Yeah. Uh, Elizabeth Hong, 

Charlie Morris  00:23:11    That sort of thing. And today the biotech index is roughly the same level as it was eight years ago, but the sales price is high. Yeah. So it's a classic, um, growth sector that has grown into its price. Yeah. Um, on, on the, on the, the commodities, the metals in particular, I suppose I am in the long term bull argument, but I wouldn't say our exposure is particularly high at the moment. It's not zero, but it's not particularly high. It was high, um, 18 months ago, two years ago. We've taken a lot of profits out of commodities. And I'm sitting here right now scratching my head whether that's, whether that's wrong. You know, should we be thinking about precious metals with industrial metals? That's one of the big questions. You know, are we getting full signals? Um, or, or, or, or not. But I say the other point is that if you look at the World Mining Index, um, it's the, it's the same level as it was in 2011, just like markets and all that. So they all go together. Europe, uk, Japan, emerging markets, mining, energy, all of these things have just done nothing in a very long time. And I think if you diversify and put 'em all together in the pot and diversify, you'll be fine these next few years. 

David Stevenson  00:24:17    Yeah. Okay. I wanna finish on, um, , arguably some would say the, we mentioned Kathy was an ark and, and the, the, and the kind of food tech guys that blew up. Well of course the big blurp in the last couple of months has been crypto, hasn't it? Um, a spectacular blowup. Um, now I, I think we would both agree from different ends of the argument that it's different than the other tech company. It's a tech, uh, sectors. It's got different dynamics. Um, a and in fact your E T P, which is who 21 shares, sort of looks at the dynamic, which is that relationship between gold and crypto. Because of course crypto is also an expression of people's desire to get away from monetary fear to money, fear. So there's lots of other things going on in crypto than just the sort of straightforward tech bubble. Um, are we at the trough? 

Charlie Morris  00:25:04    I think so. I mean, let's break this down. I mean, if you go back to the 2013 high, which was a thousand dollars to keep it simple and the low is $200, again, rounding, rounding numbers. So that's an 80% fall. And then it goes up a hundred times for 20,000 and it falls for 3000 and then it goes to 68,000 and falls to 16,000. You know, 16,000 is roughly where the high was in 2017. So you kind of had a slap period over five years and it went to 20,000, actually went to 19 something, but it was only there for a couple of days. And so, um, you know, it it it's just done. What it has does every fourth year you had this four year cycle that seems to keep on coming around every, every, every up here in the four year cycle. What you can read about is how the four year cycle's never coming back, and then it comes straight back . And so, and it, it probably relates to the Harvey cycle. We'd, we aqueous supply halves in, uh, April next year. So, you know, if it was stupid and dead and worthless then, then it would be stupid and dead and worthless. 

David Stevenson  00:26:10    And can I just ask on that point, the stupid dead and worthless argument. Uh, I, I've been wrestling with this and lots of people have been restless. I mean, Noah Smith, the Bloomberg economist, wrote a really good piece about it, um, saying, you know, is it fundamentally a pointless exercise? Yeah. Because if it is a pointless exercise and it could go all the way to zero and, and no Smith is by no means are not a, a, a supporter of, of crypto, I think made some very powerful arguments I'd agree with, which partly we look at things for the, the, the prism of the developed world. If you live in Zimbabwe, Venezuela, the other countries, you probably think it very differently. Um, there's also the fact that there's this whole, you know, decentralized finance stuff. I is is the use case still there? Both as a currency? Yeah. Because it's, it's got its currency, uh, kind of functionality and then it's got, its kind of defi, you know, wider system functionality. Are both of those, uh, foundations still there? 

Charlie Morris  00:27:05    There there's a lot going on. There's a lot going on in crypto. And um, I would say that going back to the beginning, we just had this attempt to replicate gold, um, over the internet digitally. And blockchain enabled that to happen. You know, what is gold? Gold is the original FinTech. I mean, gold, you can make the same arguments about gold being pointless. Um, but for 5,000 years 

David Stevenson  00:27:29    His and Warren Buffet has made that argument. Yeah. . 

Charlie Morris  00:27:32    Yeah. I mean he, and he does that very amusingly, you know, you go to Africa or someplace and stand around, um, the, the, the, the vault and guard it when it's just been in the ground for thousands of years. Fine. But he's also made the argument about Bitcoin. Where, where he, where he showed why he didn't understand Bitcoin. Cause he said, I wouldn't buy all the Bitcoin for $25. And I went through his accent again. Now, why would it be a really bad idea to buy the Bitcoin? Because you destroyed the network. So the intrinsic value of Bitcoin is zero. Okay. That's obvious. But the network value is enormous. Yeah. It's a bit like if you go onto, uh, uh, WhatsApp or, or whatever have you, if you owned all the accounts, so you'd only text yourself if you owned all the telephones. You can only call yourself the idea, the value in Bitcoin is his ability to exchange with others. Yeah. And that is hugely valuable. And we look back at things like WhatsApp, um, when Zuckerberg bought it, you know, 10 years ago for 18 billion, the time he went, God is crazy. And nowadays everyone thinks, I wish I'd done that. 

David Stevenson  00:28:34    Yeah. I was about to say, yeah, what a great investment. I personally think that's the most valuable bit of his portfolio at the moment. Broadly. 

Charlie Morris  00:28:40    Yeah. And, and so this idea of networks which have been enabled by the internet, um, are are extremely powerful. And to your point, you know, some, if you're living in Venezuela, you have a different opinion of Bitcoin. If you, if you're, uh, if you're in Nigeria or Ukraine, Russia, you might have a different view. If you're living in a city like, uh, like London, New York, Tokyo, you, you would have a different view. And you might see it as pub, you know, pub of speculation. But, but that's fine. That provides liquidity. Other people will see it as mathematically important. Others would say it's a, oh, what, what, you know, what do we do with surplus wind on a windy day? You know, you can't, you can't stall the surity. Oh, but we couldn't mind Bitcoin. We could store the money. Uh, and that would, that would be useful for, for funding green projects. You know, this idea that we could actually have cyclical demand for energy useful to non for energy. There are so many useful things about it. And then you've got clever people like, um, Alan Howard, and I think many people would think that he was stupid. Uh, he's a big fan of 

David Stevenson  00:29:37    Bre Howard, 

Charlie Morris  00:29:37    Of Bre Howard, you know, he multi billionaire. And, and he, he, he's got a big bet on this space. Cause he thinks it's how the future of the financial system will operate. Mm-hmm. , and, and I share that for you. I think that, that what we are doing is we're building something. It is wild west, but that's the regulator's fault. It's government's fault for staying out of the way and just trying to shut it down and failing by the way. Yeah. Um, and, and so what you, what you, what you've got is a is, is, is a potential to have the tokenization of everything, every bond we've discussed, every currency, every share, every ETF will end up being tokenized in some way, will be driven by this space. Your har Hard Landsdown or AJ Bell portfolio, um, will be, will be backed by crypto. I'm, I'm not talking about big, uh, I'm not talking about Bitcoin. I'm not saying everyone's gonna Bitcoin no infrastructure around that. The digital, 

David Stevenson  00:30:24    This decentralized finance, the this kind of this and Web three and various other terms that get used to describe it. So you still think that that, that that functionality, that foundation is there. 

Charlie Morris  00:30:35    I think that that's the end game for this. And you know, it's obviously not ready today. It's, they're obviously not ready today, but, um, it's pretty impressive what's happened. And many of the skeptics, you know, Isabella Kavinski from the Financial Times, who's now dependent, you know, his, she's changed her tone from just sort of laughing at it to being pretty constructive and saying things like perpetual swaps are really quite impressive that come out of the, you know, he's been lots of innovations, uh, in crypto that have been amazing, but all the things that have gone run wrong have been bad people. 

David Stevenson  00:31:07    Yeah, yeah, yeah. And that's good. And by the way, that, that could beru equities, so, you 

Charlie Morris  00:31:12    Know, systems, it's, it's been bad people. There's a real shame. And, you know, regulators, I think that if they embraces the bill little, um, there's, this is a classic, you know, if you go back David to the nineties, you know, all I remember is, you know, people sort of turning their nose up at these internet stocks, , of course it was amusing that pet stock on was worth a trillion dollars or whatever. I mean, of course it was quite funny, but, and, and ridiculous at the same time. But everyone knew it. Um, you know, no one took it seriously, but everyone knew that it was going somewhere. There was a vision of, of where this internet thing would would go. And it just went much further than we ever thought it would, would, you know, it's, it's, the internet today is much better than we ever thought it would be back in the late nineties. 

Charlie Morris  00:31:57    And so I think that's quite an important, um, uh, point. But, you know, back then people would say, oh, I like the internet thing, but I don't like these internet stocks. And today that you'll hear 'em say, oh, I like the blockchain, but I don't like crypto. And you say, well, how are you gonna get crypto without, how are you gonna get blockchain without crypto? These are the projects you, blockchain doesn't build itself. It's people, it's innovation, it's teams. Mm. Um, uh, and why have we got crypto? This is the final point. You know, you probably wish you'll never ask me about this David in a minute. . But, but, um, but, but why have we got crypto again, regulators? I mean, how many stocks did we have on the London stock market 20 years compared to today? How many stocks were in the US stock market compared today? I haven't got enough on the top of my head, but I think we're about 

David Stevenson  00:32:41    There, there, there were a lot more , there 

Charlie Morris  00:32:43    Were a lot more stocks back in the day. And, you know, if you were a youngster with a project and a bit of, uh, uh, entrepreneurial spirit, you could go and get an I P O where you could find your company, you could do it, but now you can't. Now you need sort 10 year track record and the E es G 15 pages on your policy. Yep, yep. You know, board of diverse people from all over the place. And it's just absurd. You know, you're trying, you, you're trying to build a young business and you've got this sort of, you know, this huge burden to, to comply with. You'll never get IPO away as a, as a, as a young, enthusiastic entrepreneur. And indeed all the great companies that come through Silicon Valley that didn't even hit the market until, until there were tens of billions. Yeah. So the world's changed. And crypto still offers a young entrepreneur an opportunity to, um, get cracking. 

David Stevenson  00:33:27    And I must admit, the, the, the, the where I sort of end up agreeing with you is, is that capitalism has a fantastic track record of throwing money and very talented people at something, of which 95% of it is in is completely rubbish. Never gets anywhere, fails, never generates any profits for anybody, but the 5% sticks to the wall and the 5% grows and grows and grows. And that's the internet. That's, that's, that's pretty much every big capitalist created destruction impulse. Yeah. Capital. Phenomenally good at that. And, and the, the, the, the trick is to know, um, to know the businesses that succeed, but if only we knew the answer to that one, Charlie, then we'd all be very rich. Each two 

Charlie Morris  00:34:06    Individuals made it be easy, wouldn't it? And everyone says they're go and choose the 5%, but the smart people don't even bother. They, they say, well, I know I can't choose the 5%. Yeah. So I'll try and get, I I'll go to the 30%. I'll just try and avoid the total rubbish, you know? Yeah, 

David Stevenson  00:34:18    Yeah, yeah. Absolutely. And that's the way it works. Okay, Charlie, one last question then on the crypto thing. Um, this is my kind of left field question just to leave everybody with. What's one thing in the last three or four months, which, which has happened that you think is really interesting and that you would recommend that people just look at, take some time to look at it and think, Hmm, there's something there that's really very, very interesting. 

Charlie Morris  00:34:44    So that's fine. I mean, there's so many things you, I could answer that, but I'm gonna stick with Bitcoin. Cause it's the big, it's the big one and it's the world's second most liquid alternative asset. It's value is its liquidity, it's value is its network. If it dried up and stock trading, it would be worthless. You can cut and paste the Bitcoin code, um, and, and you and I, uh, could, can launch our own, um, uh, a sort of crypto thing. No one would care. No one would trade it. And, and, and it would be worthless. But, but Bitcoin isn't because it's the one that's got that respect. So I'll go and look at our data, our live data on bike three.com and click terminal. It's free of charge. And watch that blockchain tick away. And you know, I I, I challenge you to think that thing's worthless. If you actually go look at this, look at the stats, look at it in real time. Crazy. Every day, every day. Ev every, every minute of every day. Uh, for 14 years, this thing is just purry. 

David Stevenson  00:35:40    Very interesting. Charlie, Charlie Morris  , thank you very much.

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In Conversation with Mark Mahaffey from Hindesight

Last week I caught up with an old colleague, Mark Mahaffey, who after a successful career as a trader set up the Hinde capital Gold Fund with Ben Davies. He’s now publishing an excellent investment newsletter, also on SubStack, which is focused on UK equities and dividend investing. In this 25-minute episode, we also discuss why he thinks a permanent portfolio - gold, cash, bonds, and equities in equal measure - is still his favourite portfolio idea.

Here's a bit of background about the Hindesight Newsletter:

“Written and edited by Mark Mahaffey, the HindeSight Letter has been an invaluable source of market commentary for over seven years. The newsletter is a monthly dive into not just what’s happening in the world of money and why it matters for your money, but there’s also a unique portfolio add and close alert allowing a real-time view of the why’s and crucially, when’s of closing and opening positions in FTSE 350 companies. Written with humour, style and in a way that’s simple yet powerful, it’s equally understandable for money managers and DIY investors alike.”

Adventurous Investor subscribers get a special deal on this newsletter with a 3-month, 90-day free trial. I thoroughly recommend the newsletter……

The free trial can be accessed using this link: https://hindesight.substack.com/1d62856d

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Buy list ideas Part 2

Time for the second part of my review of investment ideas for 2022, covering the period from July 1st through to December 1st.

I’ve deliberately avoided the very latest December ideas as it’s way too early for any analysis of results. Overall, I’m fairly pleased with the results, though it is very early to make any firm conclusions.

I suggested 13 ideas and the average return of the 13 ideas over the period is 9.8% in price terms. The actual total return will be much, much higher as it features a gaggle of high-income, dividend payers such as Riverstone Credit and BioPharma. I would estimate that the total return is probably well above 12.5%.

The biggest disappointment has been the loss of just under 9% on the Hipgnosis Songs Fund - I suggested this in a newsletter in September and it’s down 8.7% over the last two and a bit months. I was careful to caveat this suggestion by explaining my concerns BUT I do think the even bigger discount is now compelling. I stick with this idea and believe very strongly now that Hipgnosis will sooner rather than later either be taken over by a big corporate looking for entertainment content OR a leading private equity player looking for a cheap portfolio.

In terms of winners, I’m very pleased that my two favourite fintech plays - Funding Circle and LendInvest have both bounced off their lows to produce short-term gains of 52% and 25% respectively. I reaffirm my target of 80p for Funding Circle and 100p for LendInvest. I’m also still of the view that Riverstone Credit Opportunities will see its share price rise to closer to 100p and NAV - I have a target of 98p for the shares in the next 12 months.  

Useful Income funds list from Liberum

Last week the fund sales desk at Liberum put out a useful short note consisting of a screen of alternative listed funds that tick various boxes, namely a decent discount, a high dividend yield (over 7%) with dividend cover above 90% (I’d prefer 100%). In the resulting table below I’ve also added whether the fund highlighted is on my own preferred list - most of which are.

Looking down the list of funds that don’t feature in my watchlists, I’d make the following comments:

-          Abrdn Property Income/Alternative Income REIT. I’m generally avoiding all property-based REITs at the moment as I think we are at a very dangerous moment for most property based funds

-          Real Estate Credit. I do think this fund is worth a closer look but for the same reasons as above (REITs) I’d be wary about this fund as I believe we might see a sudden uptick in defaults

-          Blackstone/Marble Point. I think there is certainly a place for CLO funds but my preferred vehicle is the Fair Oaks Income fund which has an excellent track record

-          Marwyn is an interesting special situations private public equity vehicle with a decent track record. It trades at 42% discount to NAV despite having around 46% of the portfolio as cash. I’m not sure though this really qualifies as a regular dividend payer so wouldn’t make my list. That said on valuation grounds alone this looks interesting.

An Inflation Pivot at 4 to 6% and what that means for precious metals

A few weeks ago I was struck by the following comments from US economist Paul Krugman in the New York Times about future inflation targets. Krugman is on the side of those who think inflation will moderate and get ‘under control’, largely because the central banks are pushing us into a recession, lessening demand-side pressure. I’m probably inclined to agree with that consensus view though I understand why others think it a misguided position. Krugman’s big point though is that we need to discuss what ‘under control’ means. Will we be happy to get core rates back to 2% or maybe aim for a higher rate like 3% or even 4%?

“As it happens, a number of economists, myself included, have long argued that the 2 percent target is too low. This isn’t a radical position; many of the advocates of a 3 or even 4 percent target are as mainstream as they get. Recently, Olivier Blanchard, the former chief economist of the International Monetary Fund, made the case for 3 in The Financial Times.”

One of the most consistent stories I hear from economists now is that we should be realistic about how far we can afford to crush inflationary price pressures. I get the sense that a target of 2% is long gone and that in reality, central banks will be content - rather than ecstatic - if rates came down to a 2 to 4% band, though a 3 to 5% band might also work for them.

This represents a major shift in thinking with some potent investment implications. We are collectively a long way from the hyper inflationary scenarios mapped out by some hard money types but we are possibly in a more persistently inflationary environment than many of us imagined. As it happens a 3 to 5% range for inflation is usually fairly good news for equities as an asset class. Its also fairly good news for central banks and governments who can use these higher rates to depreciate the real value of accumulated sovereign debts. The problem with this new informal target range - publicly they’ll stick with a 2 to 3% range - is that by its nature inflation is unpredictable and its liable to blow out of that range quite quickly as geopolitics interferes.

If we are in a new normal of 4 to 6% - which I think is possible, even probable - then we are in both a more volatile world and a more inflationary world which augurs well for precious metals and especially gold and silver.

We can already see some of this thinking creeping into the spot price of gold, which as I write is a smidgeon under $1800 an ounce. In technical terms, it’s now trading above its 20-day moving average and a tiny bit below the 200 day MA.

If we think the 4 to 6% scenario is possible or even probable then I think these prices could start to push above $1800 an ounce, into a trading range between $1800 and $2000.

Solid progress for gold will be even better news for its more leveraged sibling, silver prices - traditionally silver has a high beta to gold (it outperforms in bullish markets). If that is the case then you’ll get even more leverage from silver (and gold) mining equities: top of that list would be UK-listed Mexican play Fresnillo, followed by Newmont (its mainly focused on gold but produces a lot of silver as well) which is already on my investment list plus my own favourite First Majestic Silver, a US and Canadian listed miner. This miner has a roughly 50/50 silver-gold mix of output from mines in Mexico and Nevada. The Canadian-based miner says it wants to be the world’s largest primary silver producer.

There is though one major flaw in this logic or should I say potential headwind. As I said, it seems logical to me that we are in a more volatile world where inflation targets will be hard to stick to. There is though a very real chance that inflation rates could collapse if we enter a global recession - with central banks re-opening the QE taps. In that scenario, gold will be hit hard and silver pulverized. So the downside risks are great but with China now haphazardly re-opening, I think the odds are higher that we’ll see a surprise upside inflationary blast in 2023.

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Adventurous Investor in Conversation with Michael Sieg: The renewables opportunity in developing Asia

First up we have a fascinating Adventurous Investor in Conversation podcast with Michael Sieg, the Swiss-based CEO of Thomas Lloyd, who also has a UK-listed fund called the Thomas-Lloyd Energy Impact fund, ticker TLEP - it just a few weeks back raised an additional $35m in equity.

I think that the renewable opportunity is absolutely huge in developing Asia and Michael talks through their core target countries: India, Vietnam, and the Philippines. We discuss why these markets are so interesting and the obstacles to progress in peers such as Thailand, and China.

My sense is that UK investors have been slow to grasp the sheer size of the opportunity and the margins on offer. Perhaps that’s because of concerns about corporate governance or just the usual domestic myopia. But if we are going to make meaningful progress on net zero within the next few decades, then the developing world is where the action is.

Have your voice in helping shape the funds you love

My colleagues at Doceo are launching what I think is a great idea - for full disclosure, I am an investor in Doceo. They are building an investor panel which can then form the basis of future focus groups for funds. The idea here is to actively canvas investment trust investors’ views about their favourite funds. If that’s reason enough (!) then Doceo will also be paying for investors to participate in their panels. Interested?

More information is below:

 Doceo is a growing platform for investors to gather information and inspiration in the investment trust sphere. Short-format curated video interviews directly from fund managers provide invaluable insights into the inner workings of fund portfolios and the strategies under which they are being run.

 Now, Doceo is providing a medium for you, as investors, to shape the future of investment trusts. This new initiative represents a unique opportunity to voice your opinion to key decision-makers within your favourite funds. Through surveys and paid focus groups, you can have a real impact on key issues within the trust.

Sign up here to be paid for your opinions. After all, they matter.

More listed VC red ink

The red ink continues to flow, with three leading listed VCs reporting numbers on portfolio valuations.

First up we have the poster child of UK-listed VCs Chrysalis which has reported NAV for the year-ending September 2022 of 147.8p, -15.7p, and -9.6% Q/Q (June 2022: 163.5p) and -41% Y/Y.  As of 17 November, the estimated NAV is c.144p, a further reduction of c.3% from 30 September.

Matt Hose at Jefferies observes that Starling Bank looks by far the largest driver of the NAV weakness during the quarter, marked down by c.40%, and so appearing to reflect a £1bn valuation, down from £1.8bn on 30/06/22.

Next up we have Molten Ventures and their interim results which confirmed Gross Portfolio fair value decrease of -12%*, -17% gross of FX impact.

Last but by no means least we have US-listed VC Suro Capital which announced on Nov 8th third quarter numbers as of September 30th 2022. Net assets totaled approximately $221.8 million, or $7.83 per share, at September 30, 2022 as compared to $9.24 per share at June 30, 2022 and $14.79 per share at September 30, 2021.

So that is a near 15% decline quarter on quarter and a 47% decline year on year.

There are also some interesting comments from CEO Michael Klein , with my own highlights in bold:

“As we previously mentioned, the first nine months of 2022 were the worst for equity markets in the past two decades. Simultaneously, there is a continued dramatic slowdown in the IPO market, with less than 40 IPOs in the US during the third quarter and more than 60% of IPOs being withdrawn, year to date. As macroeconomic challenges persist, we expect continued acceleration in the repricing of private securities. We are beginning to see bid-ask spreads start to narrow as increased discounts are reflected in the asking prices of private securities on the secondary markets.”

I stick with my core view that we won’t see the trough until valuations are down at least 80 to 85% from the end Q3/Q4 2021 valuations. That’s probably still another 20 to 30% away from current valuations.

New retail bond…on PrimaryBid

The retail bonds market also known as ORB was one of those great ideas that never really took off! In Europe, retail private investors are huge buyers of individual corporate bonds, so the idea was that the LSE would provide a dedicated marketplace for individual issuers. Many years later and trading volume has shriveled and bar a few charities, there haven’t really been any big new issuers for years - with the exception of a few hardy pioneers such as LendInvest.

In an attempt to rekindle this market, the app-based service PrimaryBid has jumped into the market and offering investors access to a new issue of retail bonds by credit provider International Personal Finance PLC. What’s eye-catching about this new issue is the coupon- a mighty 12% per annum for the next five years.

Their previous issues had been yielding below 8% so this represents a big jump - for fairly obvious reasons. Below you’ll see that I’ve included a couple of screenshots from Sharepad of IPF’s balance sheet and cash flow.

I make no comment on the issue except to say that 12% is certainly generous (implying higher risk, one would presume)  and the balance sheet looks fairly manageable. The problem I suspect is the cash flow - especially free cash flow - which looks a tad anemic in my view. We’re heading into a global slowdown/recession in Europe and surely that must leave the business exposed to growing credit losses, especially in troubled East Europe. Again I am no expert on the business but one can see why this has a 12% yield.

 Details of issue

Issuer? International Personal Finance PLC, the holding company for a global consumer finance helps people excluded from mainstream finance to access simple, personal, and affordable credit

Coupon? Senior unsecured Sterling-denominated notes due 2027 paying 12%. payable semi-annually in arrears on 12 June and 12 December

Redemption date ? 12 December 2027

Rollover for existing bond investors ? Yes. Existing Sterling-denominated 7.75 per cent. notes due 2023 (ISIN: XS1998163148) can exchange their 2023 Notes for new, retail eligible, senior unsecured 12 per cent. Sterling-denominated notes due 12 December 2027.

Settlement date? 12 December 2022.

Rating? The New Notes are expected to be rated BB- by Fitch and (P)Ba3 by Moody's Investors Service.

The New Notes have a minimum initial subscription amount of £2,000 and are available in multiples of £100 thereafter.

How to apply? The Primary Bid app

IPF’s balance sheet

IPF’s summary cash flow

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Adventurous Investor in Conversation with Andrew Craig of Conviction Life Sciences

Earlier this week I managed to finally catch up with Andrew Craig of Plain English Finance and putative manager of what could be the first fund IPO of 2022 - Conviction Life Sciences. This has just this week launched an offer with a focus on buying into small to mid-cap listed biotech firms in the UK and Australia.

Andrew has identified a target list of more than a dozen really interesting firms where he thinks the market has got valuations completely wrong.

A good primer on the fund is a recent FT article here: https://www.ft.com/content/5d149923-f9d5-4199-be62-067d86c137fe

It’s a really interesting discussion with Andrew and I’ll be returning to the subject in a future MoneyWeek article. We don’t only talk about the fund and that biotech opportunity but also about the broader shift towards the life sciences and the inability of the markets to put a sensible price on companies below the radar of big US investors.

Important - please see the disclaimer at the bottom of this newsletter before listening to the podcast

What’s next in tax land

None of us should have been surprised by the tax changes announced in the budget. The government has identified a big black hole and they’ve enacted some fairly radical measures which will hit wealthier types. That redistribution focus feels about right (they’ve also not cut as much spending as I thought they would) but it obscures the fact that really, everyone - including basic-rate middle-class taxpayers - is going to need to pay much more if they want the public services we need. Just focusing on the top band taxpayers simply feeds the myth that the rich can pay for everything - they can’t and they won’t.

But I expect more pain to come and if I were a betting man - which I’m not - I’d wager that sooner rather than later we’ll get equalization of CGT and Income Tax rates, the end of higher rate pensions tax relief (long overdue in my book) and an even harder look at EIS reliefs.

Alternative Proteins

Regular readers will know that I also co-founded a website dedicated to the emerging changes in our food and agriculture system - its called www.FutureFoodFInance.com

I’ve long been interested in alternatives to meat ranging from plant-based ones through to cultured (lab-grown) meat.

Partly for that reason I recently hosted Agronomics virtual capital markets day.

You can see the recording of that capital markets broadcast here: https://events.masterinvestor.co.uk/past-events/agronomics-capital-markets-day/

I talked to six Agronomics portfolio companies about everything from precision fermentation-producing egg yolk to cultured alternatives to tuna. Now, I do have some doubts about the timescales and costs of cultured meat but I also think that this new technology (and engineering) could be a huge game changer if the scale-up process and pricing work.

But first, these clever, pesky startups need to get past regulatory approval. That’s been a long time coming but at long last, we are now seeing some first signs of progress. This week for instance another Agronomics portfolio business called Upside Foods “received a 'No Questions' letter from the US regulatory body the US Food and Drug Administration ("FDA"), accepting their conclusion that their cultivated chicken is safe to eat. This is a momentous achievement for UPSIDE Foods and a pivotal moment for the entire cultivated meat industry. This represents the first company to achieve a green light from the FDA in the US, and a validation of the sector shifting from research and development, towards commercialization”.

According to the Agronomics team

“We expect this to be the first of many FDA approvals for the sale of cultivated meat in the US. The FDA's decision is a major milestone in the evolution of the global cultivated meat sector and another step towards the commercialisation of cellular agriculture. The news comes almost two years after the Singapore Food Agency (SFA) gave regulatory approval to Eat Just's cultivated chicken, which is now sold through its subsidiary GOOD Meat. At full-scale commercialisation, cellular agriculture has the capacity to make a meaningful contribution to the world's food production sustainably. It is projected that by 2040, cultivated meat could reach 35% of the global meat market.”

More at www.agronomics.im

Iran - what next

Whilst all our attention in Europe has been focused on events in Ukraine and Russia, much of the Middle East has been looking eastwards at Iran.

Arguably, another third major Iranian revolution is brewing as a legacy regime gets ever tougher in its crackdown. If the Islamic regime falls - and is replaced y a secular regime - the impact would be truly tectonic. Until now I thought it might be replaced by a more mildly religious regime, partly because the mullahs seem to have deep support in the provinces and amongst the working class.

But that might be changing according to Ali Ansari, who is a Professor of Iranian History & Founding Director of the Institute for Iranian Studies at the University of St Andrews. He is also a Senior Associate Fellow at the Royal United Services Institute.

In a guest column for Professor Lawrence Freedman’s newsletter called Failures of Imagination, Ansari suggests that this time it really is different….

“The protests in 2009 were at times larger, but less frequent and less immediately violent. This time round, the anger is palpable and the demands much more fundamental. Few people are seeking reform. Their demand for civil, political and human rights, echo the revolution of 1906 not 1979, (many indeed explicitly refer to Constitutional Revolution as their intellectual point of origin), and the fact that these demands are being reiterated by a new generation over a decade after the crushing of the Green Movement, is a testament to the enduring power of ideas. They are also explicitly secular and replete with pre-Islamic nationalist motifs drawn in part from the country’s highly popular historical mythology. In a revealing admission, interrogators have admitted they have no idea what young people are demanding, so alien are these to their own Islamic world view.”

And what of the chances of success for the wannabe revolutionaries?

“The Islamic Republic is facing a perfect storm. It could show strength by conceding errors and promising to reform. Some have suggested that it may just choose to relax or indeed reform the mandatory veiling laws. But history and ideology will work against that – the regime has chosen to see the relaxing of the veil as an existential challenge to its core Islamic doctrine. Moreover the veil is emblematic of a much wider problem with women’s rights and rights in general. The sort of changes now being sought would undermine and effectively overthrow the wider Islamist project  being pursued by the Islamic Republic.  While an assured Supreme Leader might have an ‘epiphany’ and force through systematic change, an ailing one is in no position to try.

“So, the regime will attempt to double down on repression, trusting in its security forces and Islamic militias to keep faith in the system. If these begin to fracture with the fatigue of fighting an enemy it does not understand and cannot seem to control, then the regime will be in serious trouble. There are already attempts to call on the regular armed forces to back the people and to split from the ideological guardians of the revolution, the Islamic Revolutionary Guards Corps.Vacillating between the deep anxiety and arrogance that characterises paranoid regimes, it will continue to blame foreigners, and denounce their opponents as heretics and traitors, while reassured by a conviction that the protestors lack stamina and will sooner or later fade away. Like their ally Putin, they have assumed that their opposition will prove incompetent, and the West will lose interest. But like Putin, they may find their opponents are more competent and determined than they appreciate and that, with little left to lose, they too can count on reserves of strategic patience. These protests are deeply rooted, the anger is well grounded.  The authorities of the Islamic Republic have been anxiously fighting bushfires for well over a decade keen to avoid them spreading. It is too early to predict what the outcome of this round of protests will be. What we do know is they are broader and deeper than before, encompassing a much broader swathe of the public. They represent a culmination of decades of political corruption and economic neglect.

“If momentum is maintained and state violence increases (which few doubt), there will come a time when the cracks in the beleaguered state edifice begin to grow wider with sympathy strikes and fatigue in the security forces leading to defections. At this stage the supportive hinterland will come to life, leaders will emerge, and manifestos defined. Few doubt that fatigue has set in, but neither do people believe that the endgame for the Islamic Republic will be quick or tidy. Even if the current round of protests subside it will not be long before another begins, such is the lack of imagination possessed by the authorities. For Iranians who are beginning to think the unthinkable and imagining a future beyond the Islamic Revolution, the fundamental rights they are fighting for are not simply an idea whose time has come, they are long overdue.”

More at

Battery powered kettles

Economist and commentator Noah Smith has decided to invest in a battery startup - with a difference. The firm is called Impulse and its invented battery-powered kitchen gadgets, starting with a kettle…

“….batteries have now reached the point where they’re able to discharge energy very fast. The variety of lithium-ion battery that Impulse uses is kind of like the battery in an electric motorcycle — optimized for rapid discharge instead of for weight or efficiency. You wouldn’t use these batteries to power a car. But they’re great for home appliances. In fact, these rapid-discharge batteries give Impulse one of their major selling points: enormous power. Impulse’s first product, a battery-powered stove, provides a demonstration of how this works. Gas stoves heat up food faster than traditional electric stoves. Induction is even faster. But Impulse’s battery-powered stoves can just heat things up incredibly quickly. Here’s a demo where their stove boils a liter of water in an open pan in 40 seconds — 10 times as fast as a gas stove!

“Not having to wait for water to boil seems like a big plus, in addition to being able to cook stuff that requires high heat. High power seems like it will also be a selling point for other electric appliances — dryers that can dry your clothes quickly, heating and air conditioning systems that can change the temperature of your house rapidly, and so on. This isn’t directly relevant to the climate, but I think the advantages of battery-powered appliances over their traditional gas-powered cousins will speed up adoption. It’s nice to own stuff that’s good for the environment, but it’s great to own stuff that’s extremely high-performance and also good for the environment. That was how Tesla broke through and started the EV revolution.

“(As a proud corporate shill, I should mention that Impulse stoves also don’t have the annoying buzzing sound that traditional induction stoves make, because batteries allow them to run off of DC instead of AC. Again, not directly relevant for the climate, but good for speeding up adoption.)”

More at Noahopinion (subscription needed)

Nuclear power and “Disaster-ous” misunderstandings

A double bill of nuclear power stories.

For the record, I am a passionate supporter of more nuclear power. I think it’s absolutely essential we build many, many more nuclear power stations, especially in the developing world. I also think the opposition to nuclear power is fundamentally flawed - and in some cases intellectually dishonest.

I can understand why the UK Treasury has doubts because of cost overruns but to me, that’s a motivation not to give up on the technology but to put extra effort into getting the costs down and work out how to build many more.

Back to the objections.

Perhaps the most dishonest attack on nuclear power is that it’s unsafe. It isn’t especially in comparison with its alternatives. On this subject, it’s worth reading Julia De Wahl who most recently worked on Starlink at SpaceX. She is an active angel investor and was an early employee at Opendoor and consultant at Bain & Company.

“Nuclear energy’s reputation has been dealt several major blows by the nuclear disasters of Three Mile Island (1979), Chernobyl (1986), and Fukushima (2011). Overblown response and media coverage to each of these events led to a vast misunderstanding of what happened at these events, and how damaging they actually were.

The accident at Three Mile Island in 1979, for example, killed a total of zero (0) people. The incident released negligible amounts of radioactivity — the estimated dose of radioactivity experienced in the local area is equivalent to ⅙ of the amount you’d get with a chest x-ray, and far below the level of background radiation typically experienced in a year.

However, the dramatic evacuation response, permanent shutdown of the reactor, and lack of clarification or attempts to accurately report what actually happened means many Americans still believe Three Mile Island to be a true “disaster” and reason to ban nuclear power plants. It didn’t help that Jane Fonda’s film China Syndrome, depicting a horrific nuclear meltdown, had debuted 12 days earlier.

Two other accidents, Chernobyl in 1986 and Fukushima in 2011, are similarly misunderstood, and Fukushima in particular, blown quite out of proportion. Chernobyl was operating without today’s safety standards. The plant didn’t have a containment dome, which would have helped to prevent the escape of radioactivity. Even more shocking is what caused the accident: the operating team was running an “experiment” that involved switching off automatic safety mechanisms and simulating an emergency. They did this without training or planning. The initial steam explosion killed 3, while 28 firefighters died from acute radiation syndrome (ARS). 15 died from thyroid cancer in the first 25 years after the accident.

The nuclear plant Fukushima Daichi suffered a meltdown from the flooding induced by the tsunami, however only 0 or 1 people died from the accident, with far more damage and loss of life caused by the overblown evacuation response to the accident. The earthquake that caused the tsunami that led to the Fukushima meltdown was the largest in its recorded history, leading to over 15,000 deaths and a massive toll on the built environment of Japan, including many industrial areas.

Despite these accidents, when compared to other industries, nuclear energy is very safe “

More at https://juliadewahl.com/nuclear-energy-past-present-future?utm_source=substack&utm_medium=email

I also recommend a fantastic article by a former opponent of nuclear power now turned supporter Bryony Worthington. It’s in the latest edition of the excellent Prospect magazine. Worthington carefully and systematically works through how we can deal with the safety concerns, and worries about cost:

“If we want to eliminate any (already remote) chance of a hydrogen explosion, as occurred at Fukushima in Japan in 2011, then we can take water away as a coolant and use liquid metals, salts or carbon dioxide instead.

If our concern is dealing with (the very low volumes of) toxic nuclear waste, reactors can be designed to use the spent fuel, a process that has been proven to work in the US and Russia but not yet commercialised because of the relative ease of using new fuel.

If the concern is that nuclear fuels may run out, even though this is a distant prospect, then reactors can be designed to breed more fuel than they use. Such reactors have been built but not prioritised due to high fuel availability. In India, however, so-called “breeder” reactors are seen as key since they enable power from thorium, an element found in large quantities in that country.

If we want to avoid another Chernobyl, then… there is no chance of another such disaster, because that Soviet-designed RBMK reactor had many uniquely dangerous features that will never be replicated elsewhere. Nuclear power has one of the best safety records of any form of power generation, and—measured by deaths per terawatt hour of electricity produced—only solar is (marginally) safer. Public awareness of this fact is very low as media coverage has tended to distort our perceptions of risk.

If we want to reduce costs, then we can focus on building standardised reactors in a production-line facility, similar to that of a shipyard. We can also speed up deployment that way too.

If we want to power isolated sites or sea- or space-faring ships, then we can use nuclear batteries that generate power for decades—if not centuries—without needing a refuel. (Though not nuclear-powered aeroplanes, because of the weight.)”

More at https://www.prospectmagazine.co.uk/essays/i-campaigned-against-nuclear-energy-in-the-2000s-now-ive-changed-my-mind

What caused Britain’s Industrial Revolution

As a self-confessed economic history nerd, I’m constantly drawn - like a moth to the flame - by the myriad explanations as to why the industrial revolution happened in the UK. There have been lots of factorial explanations ranging from coal availability to trade policies but I’ve always thought this underestimated the sheer quantity of engineering and scientific researchers beavering away in amateur laboratories or workshops.

The good news is that a bunch of US academics have recently released a paper affirming my own hunch about amateur (and professional) geniuses. It’s called Why Britain? The Right Place (in the Technology Space) at the Right Time and it’s by Carl Hallmann, W. Walker Hanlon, and Lukas Rosenberger.

Here’s the conclusion…

“Did it matter that in the early decades of the Industrial Revolution many British researchers worked in technology areas, such as steam engines or textile machinery, rather than technologies such as papermaking or chemicals? We argue that the answer to this question is that, yes, it did matter. Specifically, we show that the distribution of British inventors within the technology space differed in fundamental ways from the distribution of inventors in the most natural comparison country, France, and that this distribution had a meaningful impact on the difference in technology growth rates in the two countries.

….our findings may also shed light on why these advantages slipped away in the late-nineteenth and early-twentieth centuries. It seems likely that the structure of the innovation network was slowly evolving over the nineteenth century, with the rising importance of chemical and electrical technologies that characterized the the Second Industrial Revolution. This change in the technology space away from the mechanical technologies may help explain why Britain found it increasingly difficult to maintain its position as industrial leader. One interesting direction for future work is assessing the extent to which slow-moving changes in the underlying innovation network may have undermined Britain’s advantages and contributed to the erosion of British leadership in the late nineteenth and early twentieth century”.

More at https://conference.nber.org/conf_papers/f171957.pdf?utm_source=substack&utm_medium=email

Important Disclaimer for podcast above

Important information

This podcast is for information and discussion purposes only and should not be considered an offer or solicitation of an offer to buy or sell shares in the capital of Conviction Life Sciences Company Limited (the "Company"). In particular, this podcast does not constitute an offer to sell, or the solicitation of an offer to acquire or subscribe for shares in the capital of the Company in any jurisdiction where to do so would be unlawful.

Certain elements of this podcast are an advertisement and do not constitute a prospectus or an offer in respect of any securities and are not intended to provide the basis for any decision in respect of the Company. No reliance may be placed for any purpose whatsoever on the information, representations or opinions contained in this podcast, and no liability is accepted for any such information, representations or opinions. An investment decision must be made solely on the basis of the prospectus issued by the Company which you must read to fully understand the potential risks and rewards associated with a decision to invest in the Company's shares and which is available on the Company’s website at www.clsc.uk, subject to certain access restrictions. The FCA's approval of the prospectus should not be understood as an endorsement of the Company's shares.

This podcast is intended only for listeners in the UK and Guernsey. It should not be accessed, and is not for release, distribution or publication, directly or indirectly, to or from US persons or in, into or from the United States, any EEA member state, Australia, Canada, the Republic of South Africa or Japan or any other jurisdiction where it is unlawful to distribute this podcast.

The Company operates under the Companies (Guernsey) Law 2008, as amended, and is not regulated as a collective investment scheme by the Financial Conduct Authority of the United Kingdom. Your capital is at risk with this investment. The value of shares and a return from them is not guaranteed and the share price can fall as well as rise due to stock market movements. When you sell your investment you may get back less than you originally invested. The price of shares in the Company is determined by market supply and demand and may be different to the net asset value of the Company.

In participating in this podcast, Plain English Finance Ltd ("Plain English Finance") has relied upon and assumed, without independent verification, the accuracy and completeness of all information available from public sources or which was otherwise reviewed by Plain English Finance. The information presented in this podcast may be based upon the subjective views of Plain English Finance or upon third party sources subjectively selected by Plain English Finance. Plain English Finance believes that such third party sources are reliable, however no assurances can be made in this regard.

Past performance is not a reliable indicator of future results. Forecasts are not a reliable indicator of future performance. Investments in the Company are subject to risks associated with investments in the biotechnology sector. This podcast may include statements that are, or may be deemed to be, forward-looking statements.  The words "target", "expect", "think" "anticipate", "believe", "intend", "plan", "estimate", "aim", "forecast", "project", "indicate", "should", "may", "will" and similar expressions may identify forward-looking statements.  Any statements in this podcast regarding Plain English Finance's current intentions, beliefs or expectations concerning, among other things, the Company's prospects, growth, strategies, general economic conditions and the industry in which the Company intends to invest, are forward-looking statements and are based on numerous assumptions regarding present and future business strategies and the environment in which the Company intends to invest in the future.  Forward-looking statements involve inherent known and unknown risks, uncertainties and contingencies because they relate to events and depend on circumstances that may or may not occur in the future and that may cause the actual results, performance or achievements of the Company to differ significantly, positively or negatively, from those expressed or implied by such forward-looking statements.  No representation or warranty, express or implied, is made regarding future performance or the achievement or reasonableness of any forward-looking statements.  As a result, listeners of this podcast should not rely on forward-looking statements due to the inherent uncertainty.  Save as required by applicable law or regulation, neither Plain English Finance nor the Company undertakes any obligation to publicly release the results of any revisions to any forward-looking statements in this podcast that may occur due to any change in their expectations or to reflect events or circumstances after the date of this podcast.  No statement in this podcast is intended to be, nor should be construed as, a profit forecast.

Certain elements of this podcast are financial promotions and are not intended to be investment advice. You should read the prospectus (referred to above) before investing, especially the risk factors set out therein.

The financial promotions contained in this podcast are issued by Plain English Finance Ltd (registered office Stag Gates House, 63/64 The Avenue, Southampton Hampshire SO17 1XS; authorised and regulated by the FCA with reference number 564876). Plain English Finance does not give investment advice so you need to decide if an investment is suitable for you. If you are unsure whether to invest, you should consult a financial adviser.

By listening to this podcast you will be taken to have represented, warranted and undertaken that you have read and agree to comply with the contents of this disclaimer.

The information in this podcast is valid as at 11 November 2022. 

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Adventurous Investor in Conversation: David Cornell of ICG on Indian equities - what next?

Indian equities constantly amaze me. They’ve done very well over recent months despite all manner of headwinds, not least higher oil prices. India is also building up its tech hub status, moving upstream from its strengths in software and digitization to hardware and manufacturing.

But Indian equities also always seem hugely overpriced to this cynical observer. What should investors do Buy high or wait?

This week I caught up with David Cornell, of Ocean Dial who runs the India Capital Growth investment trust - compared to rival funds from Ashok, JPMorgan, and Abrdn, ICG is more focused on mid-cap local equities. As a listed fund it’s done terrifically in recent months (although the Ashok fund has been the undoubted star in recent years), so I thought now might be the time to catch up with David and find out what’s the next big story - and explain those high valuations.

Listen using link/button above….Please note that David’s audio is a bit fuzzy in places because of the internet but it’s completely listenable……

Valuing Spotify

The following statement from a recent Roundhill Music fund announcement caught my eye: “Streaming subscriber growth continues to be the fastest growing area of the music business, and this week alone Spotify grew its premium subscriber base by an extra 7 million in Q3 2022, 1 million above its target. Spotify, the largest of the streaming services, now boasts 433 million active users, including 188 million subscribers (an increase of 15 million so far in 2022), across 183 markets.”

So, to be clear, music streaming shows no signs of going ex-growth. Which should be great news for Spotify investors.

Yet Spotify’s share price has continued to head lower and it’s now worth about $15 bn. Turnover is likely to be around $11.7 bn in 2022 rising to $13.5bn in 2023.  The business has in the past struggled to make a profit but in the last annual results had operating positive cashflow of $367m, free cash flow of $276m and cash on the balance sheet of $2.7 bn. Set against that is long-term borrowing of $1.78bn. Forecast EBITDA is likely to hit negative next year at-$316m (in 22) before moving into the positive at $69m in 23.

Putting a value on Spotify is a tricky exercise. Conventionally speaking even at $15bn it is overvalued as its struggles to make a profit. It generates lots and lots of revenue but gives the vast majority of it away to IP owners. Yet it is also steadily building its podcasting franchise and is showing some progress in incrementally increasing its advertising revenues as a % of total sales - though those numbers might be hit in a recession.

Conventional valuation metrics don’t get us very far with Spotify. I like per-user metrics such as Spotify is now worth around $75 per subscriber but that number is also frankly slightly meaningless. The only way we’ll break the logjam is to either

a) get Spotify to increase its net margin from those streaming revenues, possibly by renegotiating a deal with the IP owners or

b) accept that Spotify has huge strategic value to the right buyer who will want to access those users and deals.

I haven’t bought any more Spotify shares recently - and I’m sitting on a reasonably large loss on the old shares - but if the share price breaks below $75 a share I’d be tempted back in.

Literacy Capital

Last week I met up with the father and son team - Paul and Richard Pindar - behind the small listed private equity fund Literacy Capital. In a recent FT column, I was honest enough to say that I didn’t know much about this fund although recent performance has been excellent. Having dug around a bit more into the workings of the fund and met the key individuals I can say with some conviction that I am impressed though currently ambivalent about the price you pay for the shares.

Literacy Capital has a fairly unique strategy - its focused on UK small to mid-cap private buyouts where, typically, the family/owner wants some kind of realisation event but doesn’t want a ‘typical’ large PE transaction with all that that entails i.e stripping out cost, lots of rolling businesses into each other, putting on leverage.

Literacy Capital is very focused on the UK domestic economy and its typical ticket price for investment is between £2 and £10m. It also very carefully builds up the portfolio companies by bringing in expertise and investing in growth where necessary. In terms of peers, I suppose Oakley Capital does similar stuff but with much bigger tickets and across Europe while EPE is probably the nearest competitor - this listed PE boasts a very patchy track record, to put it mildly.

The fund came to the Specialist funds segment a few years ago and to date has a great track record and has consistently beaten its peers in terms of NAV growth - its increased NAV by 57% in the last year and over the last quarter increased NAV by 11.3%. Not unsurprisingly given these numbers, for many moons the fund also traded at a whopping premium though this was largely a function of a tightly held share register where the Pindars are big shareholders and deploying their own capital - Paul built up Capita.

Crucially the fund also has a close relationship with a charity - also run by the Pindar family - called Bookmark which provides reading and learning support to children. The fund donates 0.9% to the fund on an annual basis to the charity, alongside the management fee which is also 0.9%. There is no performance fee either - a big plus in my books. Crucially the fund is not terrifically keen to issue vast swathes of new shares to grow in scale - the founders seem happy to stick with their investment and use realizations (and leverage) to generate spare investment cash.

The current portfolio is valued on an EV/EBITDA multiple of 8x. According to house broker, Singers, the portfolio of companies should be able to generate earnings growth of 8-12% NAV growth PER QUARTER prior to multiple expansions and exits.

In stark contrast to the dire predictions of UK domestic economic gloom, the portfolio companies do seem to be trading very well with most of the portfolio reporting very good momentum. Over the last 12 months, those companies generated EBITDA growth of 40%+ pa (for each top 10 investment). According to Singers, virtually all performance has been from underlying earnings growth rather than any multiple expansion.

Crucially Literacy Capital is now trading at a discount for the first time in many months. On the screens, I can see a price of 379p versus NAV of 384.9p. By comparison, the average discount for UK listed direct PE funds is currently running at 21% if we include 3i and 29% if we exclude 3i.

That suggests to me now might not be the right time to buy the shares. Let’s assume that the fund continues to see progress in the portfolio companies even as the UK domestic economy slows down. That would suggest more incremental NAV increases over the next few quarters. The share register is fairly tight so I don’t see much liquidity in the shares and given the fund’s very low profile I don’t see a long queue of investors lining up to snap the shares up in an illiquid market.

That suggests the discount could widen as NAV growth continues. In that scenario, once that discount got into double figures I’d be a very happy buyer of the shares. To be clear, Literacy has a compelling strategy, and its unique structure means it has brilliant long term alignment with your interests i.e no performance fee, founders have put their capital on the line and are not keen to keep diluting in order to chase AuM. I’d ideally like to see how the portfolio businesses develop over the next tough 12 months but on paper this looks like an absolutely core long term holding when the price is right.

New Global equities fund from Ekins Guinness

In this newsletter, I frequently allude to the excellent asset allocation research by Charles Ekins of Ekins Guinness. His job day job, alongside running the top level macro numbers, is to run a fund that I have profiled before in my Citywire column - HERE. The existing fund is called the  TB Enigma Dynamic Growth, and uses exchange-traded funds to make the key asset allocation switches.

Ekins is just about to launch a new fund called the  TB Enigma Global Sector Rotation Fund which will be a global equity strategy that allocates to, and switches between, 11 Global Sectors. The Sector selection is actively managed but implementation is through cheap liquid global sector ETFs which reduces stock-specific risk. The logic for launching is that Ekins believes that different sectors are influenced by different factors.

“For example, there are obvious economic-based differences between Energy, Technology, Consumer Staples, Financials, Healthcare etc. These typically give rise to differences in Sector performance, which provides the investment opportunity that this Fund tries to capture. The Value and Trend characteristics of each Sector can be measured and compared. We already advise professional investors on Global Sector selection and already use this Global Sector selection strategy within the equity component of our TB Enigma Dynamic Growth Fund (which has returned 29.1% from launch in July 2017 to 27/10/22 and is ranked #22 over 5 years, #19 over 3 years and #17 over 1 year out of 151 funds in IA Flexible Sector).”

I have to say the timing of the fund launch is brave, given not only prevailing market sentiment but also Ekins Guinness's own bearish views but Charles reckons that he feels “the timing is good now that many equity markets have fallen this year (eg the S&P Composite is down 19% this year). Our Global Sector model is still fairly defensive, focused on Healthcare, Energy, Industrials, Financials and Consumer Staples. Having favoured Technology for a long time before this year, we have been cautious about Technology all year. At some point, there will no doubt be opportunities to rotate back into the “growth” sectors such as Technology and Consumer Discretionary.”

The Fund is available through platforms, through T. Bailey Financial Services or via application forms on their website.

Amedeo Air Four Plus Ltd (AA4)

Last Friday I noted that Elliott has been busy snapping up shares in the various Doric Nimrod funds - now it’s also been revealed that it’s also bought a chunky stake in AA4, the Amedeo fund, ticker AA4.

This is currently trading at around 34.5p a share, with a dividend of 5p a share paid quarterly, which equates to a yield of 14.2%. working out what AA4 is really worth is a difficult exercise, full of lots of details and uncertainty.

The key variable seems to be what the terminal value of its big planes might be when they come off lease to either Emirates or Thai Air (the latetr had gone into administration after Covid). So, what’s in the portfolio?

This currently comprises 12 aircraft at 31 March 2022 - six A380s (leased to Emirates), two B777s (leased to Emirates) and four A350s (leased to Thai Airways).

Using broker’s reports from Liberum (the house broker) and Jefferies, these are the various bits of the puzzle I have been able to pull together:

-          The 5p dividend is backed by income from leasing out the planes to Emirates (A380s and 777s)

-          Earlier this year Emirates agreed to acquire Doric Nimrod Air One's A380 aircraft for £25.3m at the end of the current lease term

-          AA4's return-condition payments (half-life) for its A380 fleet are $17m. In relation to AA4's A380 aircraft, the lease return compensation and redelivery costs are much lower than $30m (DNA1 A380 sale price) according to Liberum

-          AA4 has previously reiterated its view that it does not expect to receive any income from the Thai aircraft after expenses and debt service costs, but there is scope for the recovery of equity value. The airline is making power-by-the-hour (PBH) payments in 2022 before switching to a fixed payment from January 2023. The PBH payments have been sufficient to cover the quarterly interest and expenses.

-          Thai went bust but has renegotiated its deal with AA4, committing to a six-year extension on the leases, taking them to 2035/2036, with a debt refinancing due to take place on three of the four aircraft at the point of the original lease expiry in 2029.

-          The Emirates-leased A380s and 777s are generating income, but potentially have no equity value. The six A380s have junior debt balloon payments of either $35m or $40maccording to Jefferies. Jefferies analysts reckon zero valuation is “overly prudent” and they have modeled residual values of $25m for each of the A380s (i.e. $15m to equity).”

-          current residual cash of £43m, or 12p per share,

So where does this leave us in terms of final valuations?

According to Liberum, in July 2022,” based on relatively conservative assumptions with respect to AA4 (no equity value for A380 after debt repayments and $12.5m for A350), we estimated an IRR of 14% from a 32.5p share price.” An older form a few months ago following results states: “We believe there is potential for an increase in distributions over time as we estimate recurring earnings of £26m (vs. £17m of annualised distributions). We believe AA4 is gradually building up cash reserves within the A380 SPVs, to ensure there is enough capital to meet obligations on the junior debt. Even on relatively conservative assumptions (no equity value for A380 and $12.5m for A350), we estimate an IRR of 14% from the current share price.”

Jefferies's take isn’t radically different:

“IRRs are understandably heavily contingent on the timing and size of the A350 sales proceeds, ranging from 8.9% to 24.5% under the various scenarios. Notwithstanding these high returns, there are still sources of potential upside. For example, cash could be returned earlier, either in full or in part, and/or some equity value could accrue on the A380s.

Exhibit  - AA4 scenario analysis for A350 sales

Source: Jefferies

So, in essence, this all comes down to two issues

1)      whether the Emirates planes have any residual capital value. Possibly/probably not but maybe there is some upside?

2)      The value of those A350s being sued Thai. According to Lberum they’ve seen these planes “transacted at c.$100m in sale-leaseback transactions. Jefferies also warn that “it is currently unclear whether the A350s will generate any income after debt servicing costs in the 2030-2036 period. In the absence of net income from these aircraft, the fund as a whole would not generate any income given the leases on the A380s and 777s would have by then expired”

The two tables below put some more flesh on the bones of valuations of those plans and debt repayments.

I don’t have any firm conclusions except to note that Elliott is a canny operator and almost certainly didn’t buy into AA4 based on what I would call the base case scenario - this is that there is no residual value for any of the planes and thus all you can really rely on is the income stream of dividends for the next five to six years (which would probably only just about cover the current share price). Using the various scenarios mapped out by Jefferies I’d probably err on the cautious side, using a 2036 scenario with an emphasis on Iteration 1 or 2 which suggests IRRs of 8.9% or 11.5%.

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What next for EM equities? Adventurous Investor in Conversation with Carlos Hardenberg of the Mobius Investment Trust

I’ve been keen to talk to someone in the know about the state of emerging market equities for ages. On paper, all the macro factors spell doom and devastation: strong dollar, high inflation, restive populations, China, and of course ever more expensive debt.

My core view is that active managers have a really tough time at the top-down, macro-level working out how to invest on a country-by-country basis. Precisely because geopolitics plays such a large unpredictable role I sense that active managers are on to a hiding trying to second guess what President Xi or PM Modi will do next.

In that case, I can see why beating the index is a hard task and why some managers - notably Fundsmith - might give up. But once we descend down into mid and especially small caps, the game changes. Sure, country allocation matters, but you can afford to see past this big-picture stuff and just pick the most interesting businesses, even if they are in ‘unpleasant’ geographies. Another plus for active stockpickers is that the passive funds in the EM space are still heavily weighted towards Greater China (China, HK and close trading partners like Taiwan and South Korea) while active managers can diverge dramatically from this China exposure - which is certainly true for the Mobius Fund.

Anyway, yesterday I caught up with Carlos Hardenberg from Mobius to talk EM equities and it makes for a fascinating conversation. Well worth a listen….Click on the play button above!

A misunderstood fund: Riverstone Credit Opportunities

Over the last few years, we’ve seen a profusion of god-awful terms used to describe an attempt to make investing more ‘sustainable’. There’s the dreaded ESG which is largely a data-driven process of scoring and filtering, and then there’s sustainability itself which I understand to be a broader term used to describe a corporate approach to a more long-term approach to thinking about a corporates environmental footprint.

And then there’s impact where you define a particular objective - say reducing carbon emissions or building energy storage - and then invest to achieve that direct impact. To be clear, many of these terms have some overlap but there’s also the very real possibility that you might invest in a company with a fabulous specific impact - say selling electric cars - which has dreadful union relations, poor ESG scores (especially around the S bit) and represents the very epitome of an unsustainable business model over the ultra-long term.

This massive confusion has caught lots of companies and funds in a real bind - are they sustainable, impactful, or ESG-focused?

I’d humbly suggest that the Riverstone Credit Opportunities Income fund is caught in this trap of investment language, made doubly worse by a misperception in the market. First that misperception - I’d long assumed that the Riverstone Credit fund lends money to businesses in the hydrocarbon economy, especially in North America. That’s clearly a big no no for many investors, especially in the ESG space.

But after talking to the managers behind the fund, it emerges that that perception isn’t actually true. In fact, one could argue that if you care about impact investing, then an investment in the fund could actually make sense. How so? Because, put simply, most of its current loan book consists of either ‘green’ loans or loans’ designed to make a legacy industry more ‘sustainable’.

The two charts below I would argue flesh this point out. The first shows the most recent loan activity on a loan-by-loan basis. The green emphasis is obvious - battery manufacture, solar development, plastics recycling, wind turbine fabrication, and reducing SO2 emissions. There’s also a sustainability-linked loan - the bad bit of which is that the business makes money from unconventional energy companies which use copious amounts of water in the production process. The good bit is that the water company is trying to reduce water usage.

The second chart shows the overall portfolio mix. Green and sustainability-linked loans (which may have some link to the hydrocarbon economy) comprise just under two-thirds of the loan book.

Now some of those loans in the sustainability bucket are, as I said, linked to the hydrocarbon economy. I happen to think that it is worth investing in businesses that make these legacy industries more sustainable -- that is a clear plus for impact investing. But one can also argue that these sustainability-linked loans fail most ESG tests and that the borrowers themselves are not, corporately, sustainable over the long term as the industry they rely on will eventually fade away (it’s argued). Also, it is worth noting that just over a third of the loan book is still lent to businesses within the traditional hydrocarbon economy.

So, where does this leave the fund using my trinity of terms? I think it is having an impact but it’s clearly got some negatives on traditional ESG scores. Your guess is as good as mine but I would argue strongly that it’s unfair to typecast the fund as a lender to the hydrocarbon economy - its clearly moved well away from that model.

Having got that perception bit out of the way, let’s get to the investment argument. A couple of weeks ago I suggested buying BioPharma Credit because it ticked some key boxes :

-          It produces an income yield whichis very generous even in an era of higher interest rates. The dividend yield on offer is well in excess of any likely endpoint for the yield on risk free assets.i.e well in excess of 6%.

-          It has a track record of getting repaid. Remember, the easy part is lending money, the difficult part is getting that money back. BioPharma has an excellent track record in that part

-          It  lends money at high rates to borrowers who can usually afford the debt because its cheaper than equity

-          Last but by no means least, most loans are floating rate and senior secured with early repayment penalties attached

Rverstone Credit also passes these tests. The management firm behind the fund has lent out $2.3 billion in 55 transactions to date and the loss rate over all those years is in the single digits. In the fund itself, there has only been one small loss out of more than 20 loans. In fact, many loans - as with BioPharma - have been repaid early. The two big tables below show the realization track record of the fund.

Basic Facts : Riverstone Credit Opportunities Income PLC

·         Ticker: RCOI

·         Target yield around 7 to 8c

·         Managers : Riverstone Credit Partners - have invested $2.3 billion in 55 transactions to date

·         RCOI’s target unlevered 15% gross IRR - 18.8% IRR on realized investments

·         NAV : $1.02

·         RCOI paid $1.7 cents for Q4 2021 and $2.0 cents for Q1 2022

·         Current Discount - 16%

·         Average duration of loans: 2.8 years

·         Gross yield on loan from initial investment 12.3%

·         100% secured loan book all floating rate

As I write this, the shares are trading at around $0.81 a share against a NAV of $1.02. The shares have paid a quarterly dividend of 2c for the last two quarters and I think it looks like the fund will carry on paying at that level for the rest of the year. Even if we assume a lower dividend of around 7c a year (a rate that was paid in previous years) then the net yield is 8.6%, whereas if the dividend hits 8c a year (possible in 22) that’s a net yield of 9.8%.

Also, being a tad cynical here, the fund is sub scale with a market cap below $100m. The fund has been busy buying shares but one has to wonder whether the message I mentioned earlier - this is not a legacy hydrocarbon lending fund - is getting through. That raises the possibility that at some stage, unless the managers can raise fresh capital, they might be tempted to close the fund and then slowly run off the book and close down the fund. If that were to happen, there’s a good chance that investors would get closer to NAV on the wind down, minus the inevitable last-minute stings in the tail as the loan book is run down. Given the 20% plus discount though those stings in the tail are probably manageable. My own hope is that the fund actually grows in size, especially after the managers have re-educated the market to the idea that this fund is actually an impact-focused lending fund.

There are some very obvious risks with this fund - I’d highlight the following:

-          Currency risk if the dollar weakens

-          Liquidity risk, in that the shares aren’t heavily traded and it’s a fund on the specialist fund segment of the market

-          A recession and increased rates might push some borrowers into losses and trigger credit defaults

-          Energy prices might tumble in a recession hitting the borrowers in the loan book, especially in the legacy hydrocarbon positions

I wouldn’t want to underplay any of these risks, but I think they are in the share price already. In the meantime, you might pick up some discount tightening and that dividend yield.

One last side note - a transaction from just yesterday highlights the fund’s strengths. It fully exited a green loan to a company called Circulus for an IRR of 16.6%. RCOI originally committed $12.5m (15% of invested NAV as of 30 June 2022) in August 2021 to finance the production of recycled plastics packaging. Circulus refinanced this loan with a different lender. The bad news is that this is a big repayment and thus the fund has a lot of cash on its balance sheet again (a similar challenge for BioPharma). If that cash isn’t reinvested soon, that could drag down the dividend cover. That said, the funds managers seem very confident of the pipeline for new loans especially as the higher interest rate environment is generating more demand for their product. And remember that as the loans are floating rate, the yield is going up.

Infrastructure, Renewables, tax and interest rate increases

The big story in funds land in the UK has been the dramatic repricing of risk in the infrastructure and renewables space. An unholy trinity of factors has come together to maximize uncertainty. There’s the obvious issue of inflation (probably a net plus for many funds), which has prompted increased rates, which in turn will result in increased discount rates (a net loss). All of this has been in part a result of increased energy prices (a plus) which has now brought the threat of windfall taxes in its wake (a net loss).

My guess is that these factors will all come out in the wash and we’ll probably end up roughly back to where we were minus the large premiums. As I discussed in a recent Citywire column, the emphasis will now be to focus on funds that generate NAV growth rather than look and feel a bit like bond surrogates which really only ever pay a boring 4 to 5% dividend yield.

But that still leaves lots of unanswered questions, not least whether the market has overreacted in pushing lots of very credible, successful funds into deep discounts. Luckily plenty of talented fund analysts have been weighing into this debate in recent days, so much so that I thought I would highlight some of the most interesting recent comments.

Let’s start with the looming threat of windfall taxes or caps on renewable energy prices. Personally, I think the government is crazy not to levy windfall taxes on the whole energy sector, renewable or otherwise, but fairly and equally. Let’s be honest, even many industry executives think a windfall tax makes sense!

 The rumor mill suggests a price cap is coming, which I think is the less favorable option, as it sends the wrong price signals, but hey what do I know? Matt Hose, funds analyst at Jefferies has been doing the sums on a price cap and come to the following conclusion on NAV impact for renewable funds:

“ Although capped prices of £50-£60/MWh would be close to those captured by the funds pre-2021, they would still entail material downside to near-term cash flow assumptions. This is particularly for the 2022-2025 period, where the forward curve is used, after which the assumptions revert to around £50/MWh (real) anyway under consultants' forecasts. As such, the degree of downside to NAVs would be contingent on the price/duration of the cap, the extent of near-term fixing/hedging arrangements, and the current 'haircut' taken to the forward curve. If we very crudely remove the portfolio valuation increases taken over the previous four quarters due to the higher forward curve, we estimate a NAV impact (before any offsetting factors) of 10-15% for UKW, and 5-10% for TRIG, remembering the latter is only 60% exposed to the GB market. The impact for solar funds BSIF, FSFL and NESF, would be considerably less than this though, given a high degree of PPA fixing”.

Next up we have the impact of rising interest rates and the inevitable re-pricing of risk via increased discount rates. According to the funds team at Liberum:

“Discount rates will inevitably increase from Q3 and the extent to which these are raised will have a significant impact on NAV per share. On average (in isolation), as displayed in the table below, a 1ppt increase in discount rates would have a -5.9% impact on NAV per share, when viewed in isolation. The sensitivities are as at Jun-22 (JLEN and NESF as at Mar-22).”

Looking at the table below, the biggest impact would seem to be on UKW and TRIG with JLEN the least impacted.

What about the core infrastructure (non renewables) funds tasked with providing a stable, inflation-linked return from a diversified portfolio of public/private assets?

The attractions ate obvious - a yield of between 4.5 and 5%, a great 15-year track record, and a record of progressively increasing their dividend payouts. The downside is that these core funds have traded at whopping premiums in the past and have diversified away from really boring PFI projects to riskier projects with more economic exposure.

Killik and Co’s fund analyst Mick Gilligan has been running the numbers and thinks that both INPP and HICL are still worth investing in despite all the worries about rising interest rates and higher discount rates. More to the point, he thinks both are still great hedges on rising inflation.

Gilligan makes the important point that we need to see all the moving parts of the valuation mix for a fund: yes, higher interest rates will push down valuations, but higher inflation will also make those income-producing, RPI-linked assets more valuable.  However, as Gilligan points out, “the market tends to adjust share prices quickly for the discount rate element of the NAV calculation but be slow to readjust for any inflation related benefits. “

“HICL provides strong inflation linkage and low correlation to wider equity markets. In the 12‐month period to its last financial year end (31/3/22) the portfolio demonstrated a 0.8x inflation correlation (i.e., a 0.8% rise in portfolio value for every 1% rise in inflation above HICL’s long term assumptions which are currently 5.25% in the UK this year, falling to 2% for 2030 onwards) and a 0.36 beta against the FTSE All Share Index (i.e., a rise or fall of 0.36% for every 1.00% rise or fall in the UK stock market).  The inflation linkage helps to protect against a higher interest rate environment caused by persistently high inflation.  

“INPP - The largest portfolio allocation (39%) is to Public‐Private Partnerships (PPP). The majority of these are availability‐based assets, meaning that International Public Partnerships receives contractual payments if the facilities are available for use.   The contracts are usually structured with annual inflationary increases. The portfolio also holds several regulated assets across Energy Transmission, Gas Distribution and Wastewater. These are generally monopolies with returns determined by a regulator, which takes account of inflation.   INPP has an excellent record of dividend increases. It has increased its dividend every year for the last 13 consecutive years. It also offers high inflation linkage at 0.70x (i.e., an increase of 0.7% in portfolio value for every 1% rise in inflation above INPP’s long term assumptions which are currently 2.75% in UK RPI”

The table below from Killik highlights the funds with inflation-protecting qualities such as BBGI Global Infrastructure (BBGI), SDCL Energy Efficiency Income (SEIT) and Capital Gearing Trust (CGT). 

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