Oil & Gas: International Petroleum, MAHA Energy, Deep Value Driller

October 17, 2023 in Audio, Diary, Discover Great Ideas Podcast, Equities, Europe, European Investing Summit 2023, European Investing Summit 2023 Featured, Ideas, Member Podcasts, Transcripts

Nils Herzing of Shareholder Value Beteiligungen AG presented his investment thesis on the oil and gas sector at European Investing Summit 2023.

Nils highlighted three ideas: International Petroleum Corporation (Sweden/Canada: IPCO), MAHA Energy AB (Sweden: MAHAA), and Deep Value Driller AS (Norway: DVD).

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About the instructor:

Nils Herzing is an Executive at Shareholder Value Beteiligungen AG (SVB), a long-term oriented, publicly traded value investment vehicle. Prior to joining SVB, Nils was Partner and first employee at Active Ownership Capital (AOC). Before that, he was the manager of a Family Office located in Regensburg, Germany. In 2013, he graduated with a B.A. in Management, Philosophy & Art. In the same year he founded the Herzing Value Investment GmbH. Afterwards, he earned an MSc in Finance from the EBS Business School and EDHEC Business School during which he passed the first two levels of the CFA Program. Since 2016, he has been a CFA Charterholder. In 2017, Nils co-founded ForkOn GmbH, the first vendor neutral SaaS forklift fleet management solution. From 2018 until 2022, he has severed as a board member of the supervisory board of PBKM (Polski Bank Komórek Macierzystych) S.A. and Vita 34 AG.

Economic Historian Brad DeLong on His Book, Slouching Towards Utopia

October 6, 2023 in Audio, Equities, Explore Great Books Podcast, Full Video, Interviews, Meet-the-Author Forum, Member Podcasts

Economic historian and UC Berkeley professor J. Bradford DeLong discussed his book, Slouching Towards Utopia: An Economic History of the Twentieth Century, at MOI Global’s Meet-the-Author Forum.

Research director Alex Gilchrist hosts MOI Global’s Meet-the-Author Forum. The event brings together members and a select group of book authors in the pursuit of worldly wisdom. We are delighted to have an opportunity to inspire your reading.

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About the book:

Before 1870, humanity lived in dire poverty, with a slow crawl of invention offset by a growing population. Then came a great shift: invention sprinted forward, doubling our technological capabilities each generation and utterly transforming the economy again and again. Our ancestors would have presumed we would have used such powers to build utopia. But it was not so. When 1870–2010 ended, the world instead saw global warming; economic depression, uncertainty, and inequality; and broad rejection of the status quo.

Economist Brad DeLong’s Slouching Towards Utopia tells the story of how this unprecedented explosion of material wealth occurred, how it transformed the globe, and why it failed to deliver us to utopia. Of remarkable breadth and ambition, it reveals the last century to have been less a march of progress than a slouch in the right direction.

About the author: 

J. Bradford DeLong, an economic historian, is a professor of economics at the University of California, Berkeley. He was a deputy assistant secretary of the U.S. Treasury during the Clinton administration. He writes a widely read economics blog, now at braddelong.substack.com. He lives in Berkeley, California.

Lawrence Cunningham on His Book, The Essays of Warren Buffett

October 6, 2023 in Audio, Equities, Explore Great Books Podcast, Full Video, Interviews, Meet-the-Author Forum, Member Podcasts

Lawrence A. Cunningham discussed his book, The Essays of Warren Buffett: Lessons for Corporate America (8th edition), at MOI Global’s Meet-the-Author Forum.

Research director Alex Gilchrist hosts MOI Global’s Meet-the-Author Forum. The event brings together members and a select group of book authors in the pursuit of worldly wisdom. We are delighted to have an opportunity to inspire your reading.

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About the book:

A modern classic, The Essays of Warren Buffett: Lessons for Corporate America is the book Buffett autographs most and likes best. Its popularity and longevity over three decades attest to the widespread appetite for this definitive statement of Mr. Buffett’s thoughts that’s uniquely comprehensive, non-repetitive, and digestible. New and experienced readers alike will gain an invaluable informal education by perusing this classic arrangement of Mr. Buffett’s best writings.

About the author:

Lawrence Cunningham’s two dozen books include The Essays of Warren Buffett, which Cunningham self-published into an international best-seller that he has arranged for translation into a dozen languages.

An influential thought leader in both value investing and corporate governance, Cunningham’s other notable books include Quality Investing (long time best seller with AKO Capital), The AIG Story (with Hank Greenberg) and Margin of Trust (which Warren Buffett singled out for special mention in his 2020 letter to Berkshire Hathaway shareholders).

Cunningham ​advises companies, boards and shareholders, currently as the founder of Quality Shareholders Group and special counsel at Mayer Brown LLP. He has served on numerous corporate boards, of both private and public companies, including Constellation Software Inc., where is currently vice chairman, and Kelly Partners Group.

Gwen Hofmeyr on Her Book, The Halfwit Crustacean

October 4, 2023 in Audio, Equities, Explore Great Books Podcast, Full Video, Interviews, Meet-the-Author Forum, Member Podcasts

Gwen Hofmeyr discussed her book, The Halfwit Crustacean: Inside the Mind of a First-Year Investor, at MOI Global’s Meet-the-Author Forum.

Gwen is as an analyst at Folly Partners, the family office of Andrew Wilkinson and Chris Sparling, the founders of Tiny.

Research director Alex Gilchrist hosts MOI Global’s Meet-the-Author Forum. The event brings together members and a select group of book authors in the pursuit of worldly wisdom. We are delighted to have an opportunity to inspire your reading.

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About the book:

The Halfwit Crustacean is a book about Gwen Hofmeyr’s investment beginnings, as she recounts all her most embarrassing mistakes made during her first year as a budding investor. From costly micro-trades to a fortunate kiss from Lady Luck, The Halfwit Crustacean provides an unorthodox look into the chaos of the retail investing world.

“Gwen’s gripping and down-to-earth account of her beginnings as an investor contains a glimpse into the mindset of a highly self-aware, talented investor. By revisiting mistakes and examining forthrightly what went wrong, Gwen takes us on a journey that is bound to make each of us a better investor. The reader will find the lessons contained in this book to be invaluable. A must read for anyone looking to learn and grow as an investor!” –John Mihaljevic, CFA

About the author:

In her professional life, Gwen works as an analyst for Folly Partners, the family office of Andrew Wilkinson and Chris Sparling, who are co-founders of the up-and-coming Berkshire Hathaway of internet businesses, Tiny Capital.

Airlines: A Smooth Takeoff, But Turbulence to Follow

October 4, 2023 in European Investing Summit

This article is authored by MOI Global instructor Stuart Mitchell, investment manager at S. W. Mitchell Capital, based in London

It is widely acknowledged that the European airline industry is recovering swiftly. But it remains to be seen whether the recovery will lead to sustainable improvement in the sector. Despite their return to profitability, airlines face a number of future concerns which should give one pause for thought – demand, capacity and operational problems to name a few. While many of the factors governing the near-term recovery look positive to industry analysts, the longer-term outlook cannot be taken for granted.

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This thought piece is a confidential communication issued by S. W. Mitchell Capital LLP and is for information only. It was prepared by S. W. Mitchell Capital LLP only for, and is directed only at persons that qualify as Professional Clients or Eligible Counterparties under the FCA rules, including appropriate institutional investors and intermediaries. It is not intended for the use of and should not be relied on by any person who would qualify as a Retail Client. No person receiving a copy of this newsletter may copy it for transmission to another person. This document has been prepared from sources which are believed to be accurate, however in producing it S. W. Mitchell Capital LLP may have relied on information obtained from third parties and accepts no liability for the accuracy or completeness of such information. It is the responsibility of every person reading this document to satisfy himself as to the full observance of the laws of any relevant country, including obtaining any government or other consent which may be required or observing any other formality which needs to be observed in that country.Past performance should not be seen as an indication of future performance and will not necessarily be repeated. The value of investments and the income from them may fall as well as rise and is not guaranteed. The investor may not get back the original amount invested. Changes in rates or exchange may cause the value of investments to fluctuate.S. W. Mitchell Capital LLP is a Limited Liability Partnership registered in England No. OC312953. Registered address 38 Jermyn Street, London SW1Y 6DN. Regulated and authorised in the UK by the Financial Conduct Authority.The material provided herein has been provided by S. W. Mitchell Capital LLP and is for informational purposes only. S.W. Mitchell Capital LLP serves as investment sub-adviser to one or more mutual funds distributed through Northern Lights Distributors, LLC member FINRA/SIPC. Northern Lights Distributors, LLC and S.W. Mitchell Capital LLP are not affiliated entities.

Roshan Padamadan’s Musings on Crossover Investing

September 28, 2023 in Private Equity, Venture Capital

This article is authored by MOI Global instructor Roshan Padamadan, chairman of Luminance Capital, based in Singapore.

Roshan is an instructor at European Investing Summit 2023.

Crossover investors have this challenge often: How to compare ideas across asset classes?

There are two aspects to a comparison across asset classes:

– A comparison of fixed and variable return, which is more related to psychology (e.g., an 8% fixed return may well be more acceptable to many than a 10% average return, which can vary between 5-15%)

– Variations in liquidity or other conditions

Variations of this challenge exist within an asset class, too:

– How to compare securities across countries? Some countries have higher inflation than others.

– How to compare across sectors? Some sectors fluctuate a lot more than others.

Technically-minded investors will use beta, risk premia, cost of hedging, etc. to guide them through this maze.

I will use plain language illustration here to make some points. Investors have choices, such as whether to accept:

Asset A: An IRR of 5% from a government bond
Asset B: A 10% fixed coupon payment from a private unlisted corporate; monthly coupon
Asset C: A 15% (on average) return from an public listed equity

Traditional finance theory says that riskier instruments should offer a higher return to attract investors. Most people will say C is riskier than B; and B is riskier than A. They may say this even without studying the assets – the offered return is higher, therefore it must be riskier.
(Bias: They are assuming the market is efficient when they say this – they do not expect a bargain to be lying around)

Risk is in the eyes of the beholder. Warren Buffett may beg to differ on the riskiness ranking. He states his investment objective as beating inflation after taxes. He is :
• Mostly in C (doing closer to 20%, than 15% – which is a phenomenal achievement over 50+ years).
• With a sprinkling of A: just over USD 100bn, keeping some powder dry to buy more C, when the time comes.
He usually avoids A, as he feels government bond yields do not outperform inflation in the long run, especially after taxes.

Tax impacts

Taxes are very specific to investors and affect asset class choices too. Many East Asian countries (Singapore, HK) do not have capital gains taxes in the tax code for individuals. Many large asset owners in the USA have tax exempt statuses, being a pension fund or an endowment, etc.

So, in reality, the ranking is not as simple as A>B>C.

How investors think

Investors are not computers. They invest on the basis of, among other things:
• What they know
• What others are doing
• What the laws constrain them to do

They regularly make irrational decisions – but they are rational when you consider broader objective functions in life – stay in a job, stay married, have fun with your kids, have time to travel the world, and so on.

What they know:

Ideally, a profit maximising investor should invest around the world. It is highly improbable that the country they live and work in is always the best country in the world for investment opportunities. However the home bias is well documented. Most people invest 80-100% in their home country.

If you invest outside your country and lose money, you will get no sympathy from your spouse/your manager. This, in a simplistic way, explains the Home Bias. It takes a lot of concerted effort to learn things about a new country. There are language and regulatory barriers too, that hamper a global approach to investing.

What others are doing:

Keeping up with the Joneses is there in every facet of life. Homes. Fashion. Stocks.

An extreme version of this is the FOMO factor – Fear of Missing Out.

Meme stock investing has been around for centuries. People have made – and lost- money in so many bubbles and crazes throughout the years. Bubbles also have their uses: Britain has a good railway network due to the massive overbuilding in the 1850s. Indian IT Enabled Services benefitted from the super low costs of voice and data after the dot com bubble burst in 2000 (the bubble brought the funds for massive investment in undersea cables and transcontinental data capacity).

You may think institutions are paid to be sane and sensible, and don’t follow (‘foolish’) trends. This is not borne out in the real world, where there are many cases of (famous) fund managers who were fired or pushed aside when they did not back the craze du jour. e.g. the dot-com bubble.

Passive investing has increased from 21% of funds run by investment companies in the US in 2012, to 45% in 2022. To me, this is an unsustainable fraction. If everyone wants to copy everyone, there is hardly anyone left doing original research. Everyone just follows everyone else, like lemmings.

If you are indexed, you are a closet momentum investor. Today, this means buying NVDA at USD 1.2 trillion. (Sure, they will sell a lot of chips, but the chips last for a long time. It is a durables company, trading at a consumables multiple).

What the laws contain them to do:

Institutional investors have handcuffs on them. No retail investor would buy negative interest rates bonds, but this was a mainstay of European banks for almost a decade (2014-22). Insurance companies had no choice but to buy them, as only Government bonds are allowed in calculation of certain solvency ratios.

Retail investors are subject to the laws of their residence such as limits on overseas remittances, etc. e.g. If you are a Chinese resident, you do not have permission to take money out of the country and buy Coca-Cola. There is a general permission for upto USD 50,000 per year, meant for tourism and general spending – but NOT for investing. India has a more generous limit of USD 250,000 per year, which can be used for investing as well. Every person’s situation is different based on his/her residence, nationality, domicile (an UK tax law concept), source of income, etc..

Mandates limit the freedom of fund managers, as it is not their money. For this reason, a lot of opportunities cannot be exploited. Here is not the law of the land, but the terms of their management contract that limit choice. e.g. a Dividend fund has to sell a stock even if the dividend is stopped just for one quarter. (Which is why you see strange behaviour such as General Electric cutting its quarterly dividend (in 2019) from 12 cents to 1 cent. Why 1 cent? This allows dividend funds to continue holding them, if they want)

Assessing variable vs. fixed return

One core challenge in crossover investing is the relative value of a lower fixed return over a higher variable return. This choice primarily depends on the investor’s circumstance — and not on the instruments per se. One cannot say that it is always wise to take the former, or the latter. The answer is, it depends.

Some investors may very well be happy with Asset A, if their total demand from their portfolio is only 5%.

However, if they can calculate and get comfort that Asset B may very likely not lose more than x% in a given time frame, Asset B can be less risky than Asset A.

For example, Asset B:

The coupon is paid monthly.
In 6 months time, 5% of principal is received.
In 12 months time, 10% of principal is received.
This covers the expected coupon from Asset A over 2 years. Over time a buffer is created, that can compensate for the perceived higher risk of Asset A over Asset B. Also, the cash flows that come in can be invested too, in Asset A, or any asset of choice. This choice is of value too.

An alternative scenario:

If, for example, Asset B is available to invest, with a credit guarantee that costs 2%, Asset B becomes B-1, yielding a net 8% per annum.

B-1 can be considered superior to A in all aspects of risk and return. (Assume same tenor as A; and that the credit guarantee is from a high quality insurer in this example, say, AAA)

If you believe governments are zero risk, please be aware that this is no longer the case for international investing. Governments are low risk ONLY in their home currencies.

As a global investor, we only have 9 countries left at AAA, as agreed by all 3 Credit Rating agencies : 7 European nations, Singapore, and Australia.

Asset C is abhorred by people who hate volatility. The 15% average hides periods when the asset can fall 30-50% in a single year. On the flip side, it could – and does- go up by 20%-60% in good years, to make up the long-term average. The key is to survive. Along the way, if money needs to be consumed for needs, selling at the bottom, or at a low price, will mean significant erosion – and the investor will end up far below the 15% average. That 15% average is only available if you stay invested, without withdrawals.

A variation of investing in Asset C is to average in over time. Easier said than done.

People find it easy to average into a stock when the markets (and the stock) are going up. Their earlier investments have risen in value. They can see they are richer.

Averaging is much harder on the way down. People find themselves paralysed with fear. You are becoming poorer by the month, and your averaging process says you should buy more of, say, Alibaba, while property bonds are blowing up in China. Your net worth has fallen. You think, maybe I should pause on this buy. This inaction will mean you will end up far below the average 15% return indicative of Asset C.

You may be aware of studies that show that dollar-weighted investor returns are far below that of the index.

Meeting income needs

If the investor has an income need of 5% of capital every year, it is possible to construct an income variant of C, let us call it C-1, with a dividend yield of 5% per annum. While dividends are not as sacrosanct as government bond payments, we can use this construct to compare:

A: Yields 5% every year. Capital value fluctuates,* but is guaranteed at maturity.
B-1: yields 8% every year. Capital value remains constant.**
C-1 : yields 5% every year. Capital value fluctuates all the time.

* Due to interest rate risk, government bonds can still lose you money, or sink you, even without defaulting. See Silicon Valley Bank (2023), First Republic Bank (2023) for lessons on mark-to-market impacts. Even though the banks held the government securities in a Hold-to-Maturity bucket, the loss that they did NOT have to recognise due to rising rates worried depositors. The capital ratios were not hit. The accounting rules were made to protect the banks. However, depositors did not want to take academic comfort, and left with their funds. The banks were forced to sell bonds at a loss/ accept that their capital ratios were insufficient.

** It is an illusion that the price is stable because the private company bond is unlisted. If it were listed, you will see the same type of fluctuations as asset A (with higher amplitude). Typically, private assets show higher Sharpe ratios due to lower price volatility. Just remember that it is not reality. Illusion in, illusion out.

In this new set, B-1 seems to beat C-1 for yield investors. This will be true for all investors for whom variation of capital will be unacceptable.

For people who still need income, but can live with the fact that their asset values may fluctuate, C-1 is the way to long term wealth creation. The 5% yield covers income needs, while the remaining portfolio will grow at about 10% each year – on average.

Of course, now you cannot get 15% per year- you took out 5%, so now Asset C has less money to grow itself. C-1 may grow at 10% a year – on average.

Think needs, not asset classes

Keep an open mind, and learn about different types of structures – they can help reduce, or transfer risk, and you can even beat Government bond yields – without necessarily taking on more risk.

Hopefully this article helps you think much more clearly about crossover investing.

Over time, I hope it helps investors, where they don’t just say: I never do bonds/ I never do equities/ I do not do unlisted securities.

Break it down into what you need — income, capital protection, etc. Learn about risk transfer measures, and guarantees, if available, or hedging tools (e.g. covered calls, etc).

• You can even create a bulletproof debt instrument from a risky young company with the help of a liquidation preference.***

• Distressed debt can behave like equity.

• Some stocks have stable dividends that give them a bond-like aura.

• Covered calls can be used to create artificial dividend (harvesting theta)

• Some bonds are listed, but never trade, making a mockery of the listing requirement. (Everyone plays a game, as if listing it lowers its risk profile. Only real liquidity is real liquidity – just having an exchange ticker is not liquidity. Just another illusion)

The number of combinations is infinite.

*** Note: Liquidation preference gives special terms to a class of investors in a capital structure.e.g. If that class is the top 5% (say) in a company, then the company has to lose over 95% of its value before that named class would see any erosion in its capital. While not risk-free, it is fairly high on the margin of safety.

Once you expand your toolkit, you can build up things in a modular way, which mixes the different asset classes and structures in a way that meets your requirements — and maybe exceeds them.

Happy crossover investing to all.

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Europe’s Higher Profitability Among Firms Trading at Deep Discounts

September 27, 2023 in Diary, European Investing Summit, Letters

This article is authored by MOI Global instructor Brian Chingono, partner and director of quantitative research at Verdad Advisers, based in New York.

Brian is an instructor at European Investing Summit 2023.

Financial theory suggests there are two ways to outperform the market: either by purchasing a stream of income at a substantial discount or by paying the market price for a stream of income that grows faster than expected.

These two approaches underpin the standard “value” and “growth” styles of investing. We’ve written extensively about the main challenges to the growth approach: the lack of persistence in earnings growth and the difficulty of forecasting this growth over time. The main challenge to pursuing a value investing strategy is that cheap assets can remain cheap for extended periods of time, leaving investors to wonder if they’ve bought a value trap or a melting ice cube.

We believe the best safeguard for value investing is to prefer cheap stocks that have a higher return on assets. While growth in earnings generally lacks persistence beyond random chance, measures of asset productivity have been shown to persist over time. In the same way, while a software engineer at a startup may not be able to predict the growth rate of his future earnings, it’s likely that his productivity in churning out code will be similar from one job to the next. In the profitability research pioneered by Robert Novy-Marx, firms with more productive assets outperformed over time, especially if those firms were purchased at low valuations. Owning these more productive assets can be anxiety reducing: their income streams tend to be more steady, and fears of a fundamentally broken business model can be assuaged by the obvious qualities of the business.

Larry Summers once quipped that Japan was a nursing home, Europe was a museum, and China was a jail. And, while we tend to agree with his dismissive attitude toward China, we’ve found reasons to think more highly of Europe and Japan. Notably, we find that value stocks in Europe and Japan are more profitable, with Europe being particularly impressive. Among firms that trade at a discount to book value, Europe has a Gross Profit/Assets ratio of 18.5%, which is 1.5x the profitability of North American value firms. The differences are even more stark in terms of EBITDA/Assets, with Europe’s value firms delivering a 6.4% return on assets, almost 3x higher than North America’s profitability among value firms.

The chart below compares the average level of profitability (i.e., return on assets) among firms that trade below book value. By focusing on firms whose stock price trades at a discount to book value, we can hold the valuation component fixed in order to isolate the variation in profitability among value firms in different geographies.

The figure below shows the results of this analysis across major developed markets. The bar graphs measure the median amount of profitability among companies that trade at a discount to book value. The circles above each bar reflect the median profitability of all stocks in each market. As a robustness check, profitability is measured two different ways, first in terms of gross profit per dollar of assets and second as EBITDA per dollar of assets.

Figure 1: Profitability Across Geographies and Among Value Firms (August 2023)

Source: S&P Capital IQ and Verdad analysis

Value stocks everywhere are less profitable than the broader market. But we see that European and Japanese value stocks are significantly more profitable than North American value stocks. Indeed, because the North American market has a long tail of unprofitable biotech and venture-backed firms, the median return on assets is higher in international markets at 8% EBITDA/Assets in Europe and Japan versus 4% in North America.

After decades of stock market outperformance in the US relative to international markets, capital has flooded into the US market while largely shunning international markets. Today, the North American market trades at 3.9x Price/Book versus market averages of 1.9x in Europe and 1.4x in Japan, according to data from MSCI. In our view, this makes international markets much more attractive because decent returns on assets can be found at reasonable prices.

We believe Europe is particularly attractive by this measure because the valuation multiples of cheap stocks in Europe have barely changed since the dark days of COVID. Even as fundamentals have improved for Europe’s value stocks over the past three years, multiples have remained depressed because of the economic uncertainty created by the war in Ukraine since early 2022. As a result, there are disproportionately more stocks with attractive profitability metrics in Europe that trade at a discount to book value.

The stagnation of valuation multiples among Europe’s cheapest stocks over the past three years means that valuation spreads within Europe remain at historically wide levels, as shown in the figure below. Measured as the spread between the cheapest 30% of stocks and the most expensive 30% by Price/Book, the valuation spread in Europe reached its most extreme level in 2021 when value stocks traded at 0.8x Price/Book. Today, Europe’s value segment still trades at 0.8x Price/Book, according to data from S&P Capital IQ. So even as fundamentals for Europe’s value stocks have improved over the past three years, they remain extremely cheap relative to growth stocks, with spreads more than two standard deviations away from their 48-year historical average.

Figure 2: European Valuation Spreads (1975–2023)

Source: Ken French data library and S&P Capital IQ

We believe that the combination of historically wide valuation spreads in Europe and higher levels of profitability among Europe’s value stocks bolster the case for upward mean reversion going forward. Historically, mean reversion in multiples has supported significant outperformance of value relative to growth, as shown in the above chart. And even if the mean reversion process takes time to play out, investors in European value stocks can earn a higher return on assets while they wait for multiple expansion.

Today, Europe’s value stocks deliver a 6.4% return on assets, measured as EBITDA/Assets. After any capital expenditures, the residual cash component of these earnings can be distributed to investors through dividends, share buybacks, and deleveraging.

Cash distributions appear to be significantly higher in Europe, with the MSCI Europe Value Index offering a dividend yield of 4.7% versus 3% in other developed markets tracked by MSCI. In today’s world of higher cost of capital—where investors finally get paid to wait—we believe Europe’s cheap and profitable stocks offer an attractive place to earn more bang for your buck.

Disclaimers: This does not constitute an offer, solicitation or recommendation to sell or an offer to buy any securities, investment products or investment advisory services. This information generated by the charts, tables, and graphs presented herein is for general informational and general comparative purposes only. This document may contain forward-looking statements that are based on our current beliefs and assumptions and on information currently available that we believe to be reasonable, however, such statements necessarily involve risks, uncertainties and assumptions, and investors may not put undue reliance on any of these statements. References to indices or benchmarks herein are for informational and general comparative purposes only. Indexes are unmanaged and have no fees or expenses. An investment cannot be made directly in an index. The information in this presentation is not intended to provide, and should not be relied upon for, accounting, legal, or tax advice or investment recommendations. Each recipient should consult its own tax, legal, accounting, financial, or other advisors about the issues discussed herein.

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The Importance of Low-Cost Energy

September 27, 2023 in Equities, Letters

This article is authored by MOI Global instructor Daniel Gladiš, Director at Vltava Fund, based in the Czech Republic.

Which is the poorest country you have ever visited? For myself, I would probably nominate Lesotho and some remote parts of Tibet. Why do I ask? Because I think that recalling how poor people live in many places on the planet will give you a better understanding of what I want to write about here.

Let’s start by looking at the 20 most populous countries in the world. Nothing surprises us in this ranking. First is China (1.4 billion inhabitants), followed by India (1.4 billion), the USA (336 million), Indonesia, Pakistan and so on down to Thailand in 20th place with its 70 million inhabitants. Interestingly, however, is that only 3 of these 20 countries can be described as rich. They are the USA, Japan, and Germany. The other 17 are designated middle- or lower-income countries. Indeed, only a relatively small proportion of the world’s population lives in rich countries. The majority of people are middle-rich or poor.

The differences between countries become even more pronounced when we look at their energy consumption. Among the large countries, the USA ranks first with annual per capita energy consumption of 295 GJ. Japan and the EU each have annual per capita consumption of about 150 GJ, China 90 GJ, Brazil 60 GJ, India 20 GJ, Nigeria 5 GJ, and Ethiopia, for example, 2 GJ. Nigeria, which has almost twice the population of Japan, annually consumes only 6% of the energy that Japan does. There is a rather close correlation between countries’ wealth and their per capita energy consumption. This is a fairly intuitive and unsurprising conclusion.

But now imagine that people in poorer countries have the ambition and desire to live more comfortable, richer, and better lives. These ambitions are quite natural, and we, as people living in what can be considered a rich country, must be rooting for them. The successful fulfilment of these ambitions, however, will entail significant growth in energy consumption. If China managed to reach the same standard of living as we have in the EU, and if Chinese per capita energy consumption rose to the same level, this additional consumption would itself equal the entirety of energy use in the United States today. If, for example, India wanted to catch up with middle-income Brazil in standard of living, that would represent additional energy consumption equal to all energy consumed in the EU today.

Producing this additional energy will not be at all easy. The world is already facing a deficiency. It is estimated that some 600 million people have no access to electricity at all, and around 3 billion people suffer from chronic shortages of all types of energy, not just electricity. These 3 billion people live at a relatively primitive level in terms of energy consumption, with energy consumption per capita equivalent to that of Germany and France in 1860. The whole situation is further complicated by global demographic trends. Over the next few decades, perhaps as many as 80% of all births will occur in Africa, which is by far the poorest continent and with the lowest current energy consumption.

So, the reality is that the world is suffering from chronic energy shortage. Future energy demand will be most affected by rising living standards in the poorer two-thirds of the world. Growing demand is likely to be met by an inability for supply to keep up, by inadequate infrastructure, and by the fact that energy resources are not evenly distributed across the planet. Some parts of the world, such as Canada, the USA, and Australia, have a surplus of energy resources, while others, especially large parts of Africa and Asia, have a shortage.

If you look at a graph where the x-axis shows GDP per capita in particular countries and the y-axis represents energy consumption per capita in the same countries, then you can easily see that there is a very close direct relationship between the two. The individual countries form a nice band in the graph going from the bottom left to the top right. The richer the country, the greater the energy consumption. At the beginning of the band will be poor countries such as Sierra Leone, Somalia or Burundi, somewhere in the middle will be middle-income countries such as Indonesia, Brazil or Iran, and then at the end will be the richest countries such as Norway. Moreover, the graph will clearly show that there exists no rich country with low energy consumption.

You may be thinking that there is nothing startling about this. The richer a country is, the more energy it can afford to consume. The close relationship between wealth and energy consumption is not really surprising. But what if the causality is the other way around? What if countries do not consume more energy because they are richer but that they are richer because they have more energy at their disposal? If we look back at the development of civilisation and the growth of its wealth, we find that this accelerated significantly sometime after 1800. This was primarily because new and cheaper sources of energy began to appear, and also because they became available to a deeper stratum of the population. This would confirm the notion that the basis for the growth of wealth in society, and the basis for human development in general, is the widespread and common availability of low-cost energy. If we are to give the poor two-thirds of the world’s population any hope of gradually approaching our standard of living, then the world needs every bit of energy it can produce.

The rich world’s current drive to rapidly replace fossil fuels with renewable energy sources can thus succeed only if the living standards of rich countries are lowered and if poor countries are denied their aspirations for a better life. We who live in rich countries can afford to lower our high standard of living if we want to, but indirectly forcing poor countries to remain poor seems to me immoral and selfish. After all, the world is not just California and Germany, but, above all, two-thirds of its poor population. And that population suffers from a lack of the infrastructure necessary for its further development.

Václav Smil, a Czech scientist living in Canada and one of the world’s leading generalists, who studies, among other fields, those of energy, the environment, and population development, says that world civilisation rests on four basic pillars. These are not artificial intelligence, nanotechnology, instant messaging, or talk of colonising Mars. They are, quite prosaically, ammonia, cement, steel, and plastics. These have several things in common. The world cannot do without them, there are no adequate substitutes for them, their production is extraordinarily energy intensive, and they cannot be produced without using fossil fuels. This is simply the reality. It is common for the rich West, which has become accustomed to a life of affluence, to be completely unaware as to the needs of the poor majority of the world, or even to ignore them quite deliberately. It is difficult for many of us to imagine that the main problems for a large part of the world’s population are things like poverty, poor nutrition, malaria, tuberculosis, inadequate education, lack of health care, medicines, and childhood vaccinations, and so forth. Things we long ago forgot that can even exist.

To improve life in the poorer two-thirds of the planet, a lot of investment will be needed, including investment into infrastructure and investment into the supply side of energy production. This will not be possible without the use of fossil fuels. Yet, particularly in the rich countries, we are seeing political pressure to discontinue their production. Companies in extractive industries and their managers are being shamed, they are being presented as the very embodiment of evil and, in some cases, even the companies’ own shareholders are pushing for production cuts. Banks refuse to finance them and insurance companies refuse to insure them. Investors are forced, in various direct and indirect forms, not to invest in their shares.

The plain fact is that none of us can survive even a single day without using fossil fuels and their products. Among other things, it is estimated that without the existence of fertilisers (the main raw material for the production of which is natural gas), the planet would not be able to feed more than 4 billion people. Unfortunately, fossil fuels are essential to life, and they do not, and will not in the foreseeable future, have a suitable replacement. Therefore, massive investment into fossil fuel extraction will be needed to meet the needs of the world, and especially its poorer two-thirds. This is the conclusion I have come to by observing how the world works. It says nothing about what I think about it, what I like or dislike, or what I wish or imagine. In fact, such subjective considerations are altogether irrelevant to investing. Investing is not based on what one wishes would happen, but on what one thinks will happen. These are for the most part two very different things.

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Dede Eyesan on His Research Report, Global Outperformers

September 26, 2023 in Audio, Equities, Explore Great Books Podcast, Full Video, Interviews, Meet-the-Author Forum, Member Podcasts

Dede Eyesan of Jenga Investment Partners discussed his research book, Global Outperformers, at MOI Global’s Meet-the-Author Forum.

Research director Alex Gilchrist hosts MOI Global’s Meet-the-Author Forum. The event brings together members and a select group of book authors in the pursuit of worldly wisdom. We are delighted to have an opportunity to inspire your reading.

The full session is available exclusively to members of MOI Global.

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About the book:

Since the creation of the first modern stock market in 1611, economies have developed marketplaces to buy, sell and invest in shares of companies that shape how the world functions. Technology and digitalisation meant financial institutions and investors no longer needed a physical space, paper or even their voice to trade these shares. The holding period of shares also decreased; once an eight-year average holding period is now only 5.5 months. Innovative trading strategies, access to leverage, passive investing and algorithms also play a much more significant role within capital markets and have many implications.

Despite the changes and progress we have experienced, some principles remained constant; future earnings and cash flows drive the stock market returns over the long term.

This research aims to examine history to understand what works and drives the best companies, by studying the past decade and assessing the companies that returned more than 1,000%. We then split our analysis into four parts. In the first part, we conducted a factor analysis via a quantitative top-down assessment of the 446 companies that returned more than 1,000%. Critical factors such as profitability, growth, multiples and size were studied to determine if there are contributing qualities or attributes among outperformers. The results in this section can help with your searching and screening process for future outperformers.

The second section examines the global outperformers from a geographical viewpoint. We split the world into 13 economic regions and assessed the macro and micro factors that may have driven their overall returns. Our approach in this section is more qualitative, and we focus on answering the big questions, such as why India has been the best-performing country since the start of the 21st century, why smaller populated countries like Israel and Sweden performed better than more populous countries or why Mexico was missing despite being the 15th largest economy in the world. The goal here is to enrich our perspectives of global investing and capital allocation from a geographic view.

The next chapter, which is the most extensive section, explores global outperformers from an industry lens. We divide the stock market into the 11 sectors (defined by Global Industry Classification Standard GICS) and investigate which sectors did better, why they did and what it means for future global capital allocation. We also included case studies of 26 companies analysing their respective business models, investment cases and lessons to be learnt about investing in outperformers. We added relevant snapshots of their financial statements and other metrics that provide an accounting perspective of investing in outperformers. As you will see, investment ideas came from unlikely areas like emerging market airports, South Korean music labels, Nordic farmers, and Greek energy companies. We explored each of these in the case studies.

Finally, we conclude our research by sharing ten lessons we learned from the overall study. Our goal is to be better investors of the future, not the past, and we review how the information and wisdom gained from the assessment of history can make us better investors for the future.

About the author:

Dede Eyesan founded Jenga Investment Partners during his second year at the London School of Economics (LSE). Since then, Dede has led Jenga from just an investment club to a UK-incorporated investment firm with a global mandate of investing on behalf of clients in listed companies. His passion for entrepreneurship and investing since his first stock purchase at age 10 led him to found Jenga. He manages the Jenga Global Fund and the client Separately Managed Accounts (SMA). Dede holds a BSc in Accounting and Finance from the London School of Economics and an MSc in Entrepreneurship from Bayes Business School, City University of London.

J.Dennis Jean-Jacques on Investing in Dislocations

September 26, 2023 in Diary, European Investing Summit, Letters

This article is authored by MOI Global instructor J.Dennis Jean-Jacques, founder and chief investment officer of Ocean Park Investments LP, based in Stamford, Connecticut. Dennis is an instructor at European Investing Summit 2023.

An Omaha Encounter with Susie Buffett

I have an aunt on my wife’s side of the family who lives in Omaha, Nebraska. Over 20 years ago, in 2000, I attended my first Berkshire Hathaway meeting. Rather than stay with Aunt Lafae, I decided to stay in a hotel. That year, the hotels near the old Omaha Civic Auditorium, where the annual shareholder meeting was being held, were unusually low in capacity. Few people decided to make the pilgrimage to Omaha in 2000 because Warren Buffett, according to many publications at the time, was not as relevant in the modern era. This was the height of the dot-com bubble. Perhaps would-be attendees at the annual meeting convinced themselves that value investing was outdated. That value investing was dead. Again.

The low attendance gave those of us who attended, and me, the opportunity to fully experience the weekend activities, bond with colleagues and make new friendships. At the Berkshire meeting, sitting in a sparsely attended auditorium, I walked up to the microphone and posed a question to Warren and his partner, Charlie Munger. I thanked Buffett for continuously sharing his knowledge and asked him a specific question about business moats. Buffett gave me a detailed answer and ended with: “… And I thank you for coming.” A statement, which I suspect, had a bit more meaning to Warren given the low attendance at the annual meeting that year. My question to Buffett and his full response has since been posted at various places online including here.

Soon thereafter, an older woman approached me and asked if I would like to meet Warren. I did not know who she was at the time, but I agreed. She and I spoke briefly, and we walked to another room. Today, on my desk, sits a framed picture of me and Warren Buffett backstage after that meeting and the woman who introduced us, Warren’s wife, Susan T. Buffett smiling over my left shoulder in the background. I learned from our conversation that day, how much of a committed champion Susie was for women rights and equality for all.

I firmly believe if there had not been a brief Omaha dislocation in attendance at the Berkshire annual meeting from the those who normally attend, I would not have had the opportunity to publicly thank Warren and meet Susie Buffett. Susie became ill and passed away a few years later.

Investing During Market Dislocations

Dislocations are special, vintage periods presenting unique opportunities to participate in activities that one, otherwise under normal circumstances, would not have been afforded the opportunity to participate. In the public markets, it is often a vintage opportunity period that plants seeds for future outsized returns when there are forced sellers and fewer buyers.

For many investors to maximize opportunities during dislocated markets, the challenge is to 1) employ the right temperament that is consistent with a patient and opportunistic investment process; 2) actively prepare and be informed when such dislocated opportunities are occurring, and 3) have your capital for investment structured in a way that you are liquid enough to take advantage of opportunities. The objective is to capture asymmetry where the downside is lower, and the upside is higher. However, you are not going to capture asymmetry consistently without having the right mindset.

Having The Right Temperament

It is important to know how you are wired, your behavioral tendencies. The number one skill and most enduring in value investing is having the right temperament – the right patience, self-control, and judgement to decipher fact finding from storytelling. A temperament for emotional steadiness and delayed gratification. Value-based dislocations are grounded on an ascertainable, intrinsic worth of a company that has been severely disjointed from its public share price. For the appropriately tempered value investor, there is limited appetite for storytelling and speculation about key assessments such as business quality and management excellence. They want to see the facts; business track records. It is like buying the highest grossing farmland during a real estate correction or buying five-star travel-related assets during a shelter-in-place pandemic. You know an Omaha dislocation when you see one. Temperament is vital as an investor because you should be comfortable being in the minority in such dislocated situations to allow yourself to think independently.

One mistake I see investors make during dislocations is drifting into groupthink and speculations. In the public markets, reality is often processed through group perception, or storytelling. As Ben Graham discusses in the very first chapter of his 1949 classic book The Intelligent Investor, speculative investing is an exercise in persuasion. Shareowners make money if future buyers are persuaded to agree with a higher perception of value. The hope of the speculators is that future would-be owners will be persuaded by narratives and stories. Unsurprisingly, key star contributors of this game of speculation are the very best storytellers which might include certain Wall Steet pundits, fast money traders, and even management teams. Value investors speculate less and think independently more.

Humans have evolved and survived because we like to think and act the same while staying in groups. This is how we are wired. Resisting that urge for groupthink can be difficult for some. One way to neutralize this is to be an independent researcher with genuine curiosity about companies and how they generate value for shareowners. Indeed, value investing is more like being an investigative journalist or a critical historian than it is being an economist. You must be willing and eager to read everything there is to know about a particular company, its management team, and the industry. Dislocated opportunities do not come routinely. When they do, you must be prepared to jump on it.

Actively Preparing for Opportunities

Preparing to put capital to work during market dislocations is a bit different than in other environments. For one, it could be frustrating once you realize that after extensive research is done on a particular company, no one knows when such accumulated, detailed knowledge will be put to good use. Yet, much of your ability to assess situations will be based on how well you were prepared – assessing companies several weeks or even months before any expected dislocations or special opportunities would occur.

Having a research framework is critical. Keys to any research framework is evaluating the quality of the business and company moats; knowing why the market is offering you the company at such a price; understanding the company’s true worth as well as the catalysts needed to get the shares to fair value are important. But the assessment of your downside protection, your margin of safety is most important.

During dislocations if you are knowledgeable and assess the downside correctly, the rest will take care of themselves. While listed equities are consistently discounted during broad market swings, during market dislocations, the goal for value investors is to identify those companies who are truly impaired and should be discounted and those that are only temporarily disconnected from their true worth. Your job is to know the difference. Few things in this profession are as satisfying as buying shares of a great business during a dislocation when your downside is the least and your upside is the greatest.

If you missed the last dislocation, don’t worry, there will be another. Market dislocations happen more often than people would believe. Many recall the major dislocations such as the global financial crisis, the pandemic, or most recently, the summer of 2022. But since the GFC in 2009, including the great bull market run that followed, the S&P 500 was down at least ten percent every 18 to 24 months. Being down 10% for the broader market does not seem much of a dislocation, but if one looked deeper into the numbers, during those times, some very valuable companies were down over 40%. Certain investors missed these opportunities because if, for example, you were running a long only portfolio, you were likely nursing a performance drawdown as well with the market.

Having The Right Fund Structure in Place

Warren Buffett has seen significant market corrections and dislocations in his career. Yet, during those times, he leans forward often underwriting new positions. Indeed, the structure of Berkshire’s funding source is different and unique. It seems that each time during tough performance periods, Buffett is out in the markets planting seeds for future outsized returns. It is clear that Warren structures his life’s activities, and investable capital in such a way that when market dislocations appear he is prepared, knowledgeable and ready to act. Fund structure matters. A lot.

Some investors use high cash levels as part of their portfolio construct to protect capital in order to prepare for dislocated opportunities. At times, some funds hold as much as 20% to 30% of their portfolio’s capital in cash. With treasury bills rising to the mid-single digits lately, that seems quite attractive. However, I am not sure how consistently T-bill levels will remain at such levels or if fundholders are content paying active management fees on such high, inactive cash levels.

Another solution is to run a low net market exposure portfolio construct to generate adequate return as one actively prepares for market dislocations. Low net exposure often refers to portfolios with long and short positions with net exposure to the equity market of less than 20%. Indeed, some of the best low net strategies have less than 10% market exposure while adequately compounding and preserving capital, particularly during significant market dislocations. There are a number of well-known hedge fund platforms and long short managers who do this well. It is a skill that can be acquired, but many value investors tend to shun away from shorting stocks. This makes a lot of sense in one context. But given our objective, this is a mistake.

Warren Buffett and his mentor, Ben Graham, both shorted stocks heavily. As for Buffett, he shorted stocks consistently to help preserve capital until he was able to structure his investable capital and access permanent capital.

Running a low net portfolio construct is a way to compound and preserve capital, as well. In addition, there are other benefits to being a long-short manager, such as gaining a differentiated perspective. Troubled companies and those artificially held up in an overly euphoric market are often the first to be repriced. Second, shorting companies makes investors better analysts. For those investing with a long-short investing capability, up to half of what you do every day is look at companies that are likely to run into fundamental hardships. In such situations, you can still put that knowledge to work. This ability to act gives an investor more conviction when they come across a really good long idea. Indeed, long-only investors may not get the same benefit partly because everything they come across, subconsciously starts as a potential buying opportunity. It reminds me of the old adage: if you give a person a hammer, everything looks like a nail.

The third advantage, and perhaps most important, is investing during dislocations: Short positions allow one to hold on to long positions longer in a portfolio that is able to withstand steep market declines. Needless to say, if the market is being dislocated and your portfolio is relatively unaffected, you are more emboldened to add to your very best long ideas or seek new ones that are being thrown out by distressed owners. With the right long-short structure, preserving capital going into market dislocations is perhaps an underappreciated structural advantage.

A Final Word on Dislocations

There are significant inefficiencies during market dislocations. A value investor with the right temperament and fund structure is uniquely positioned to capitalize on those inefficiencies. Great ideas do not happen every day, every month, or even every year. When they do appear, however, it is best to have been actively preparing by compounding and preserving your investable capital.

One needs to participate in a number of dislocated markets over a time period to generate outsized returns for their fundholders. Once again, temperament and behavior are critical. It reminds me of Buffett’s “punch card” approach. Warren provides an analogy where an investor has a fixed number of slots in a punch card that represents all the investments that can be made in that investor’s lifetime. Once the investor punches through all the slots on that card, he or she cannot make any more investments. Buffett then makes an important point about good investment behavior. In that punch card scenario, the investor would really think long and hard about when to use each opportunity to invest and to load up when she does. Some value investors think those unique opportunities often come during market dislocations when there are motivated sellers and few buyers.

Back in Omaha, Nebraska, the Berkshire Hathaway annual meeting attendance “dislocation” that I experienced two decades ago has long been corrected. In fact, last year, the nearest hotel room I could find was across state lines in Council Bluffs, Iowa. Needless to say, Aunt Lafae has been getting early calls from me, at least once a year, to prepare her guest room.

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