current generation of analysts and portfolio managers. The process starts with how the firm recruits analysts. Win has interviewed more than 100 research candidates since January 2011, but he has extended offers to only four. Asked what he looks for in analysts, he said their math skills must be intuitive; they must have the ability to sum up an idea succinctly; they must be able to think creatively and employ allegory; they have to function in some ways like investigative reporters — and their bosses must give them enough tools and rope. (As an interesting aside, James Chanos talked last year at Valuex Vail about how he loves to hire analysts who used to be journalists, because they know how to dig deep for the story.)
At Harris the analyst holds a highly respected position — in fact, many senior people, including portfolio managers, the director of research and even the previous CEO are analysts too. It was refreshing to hear that analysts are not evaluated on the outcomes of their ideas so much as by the quality of their ideas. An analyst who brings an idea that is poorly reasoned is not valued as much as the one who brought a well-reasoned idea that happened not to work out. That is, Harris puts more value on the process than on immediate outcomes. Twice a year the firm’s analysts have to write a devil’s advocate memo on one of their large holdings. The holdings are debated in the open and then voted on by the three most senior investment people in the room. If a stock fails the vote, it is sold.
Germany, Europe and Mother Russia
I always look forward to Hendrik Leber’s presentations. Hendrik runs a value investment fund named Acatis Investment out of Frankfurt, but he invests globally. In preparation for the conference, I asked him if he could talk about investing from a European perspective, so he did.
Hendrik believes that there is no immediate danger of Europe’s monetary union falling apart, but he notes that problems in the EU go far beyond the PIIGS (Portugal, Italy, Ireland, Greece and Spain); they are in countries that don’t recognize their problems: Belgium, France and the Netherlands.
He was not very bullish on Germany because it is so dependent on exports. (German exports to China are expected to reach $70 billion in 2013.) And Germany has an “idiotic” energy policy, as Hendrik puts it: In 2011, after the Fukushima Daiichi nuclear disaster, Germany decided to walk away from nuclear energy and toward alternative sources, but it has not found those alternatives yet. Because nuclear power plants supplied one quarter of the country’s electricity, the lack of growth in the energy supply has been hurting the German economy. German companies are opening factories in countries that have stable energy policies and cheaper energy — mainly, the U.S. Ironically, by lowering its dependence on nuclear power, Germany has increased its dependence on Russian natural gas. If Germany were any other European country, it would not be a big deal, but Russia has in the past used the natural-gas spigot as a bargaining weapon in negotiations with its neighbors.
Hendrik also discussed Germany’s own version of a social security crisis. The country has an off-balance-sheet-debt problem: its liabilities to the beamte, or civil servants. However, unlike most German public employees, who are subject to the same rules and laws as workers in the private sector, beamte belong almost to a special class, and they usually perform services that only the state can provide (such as issuing official documents or teaching state-approved curricula, for example). Like U.S. postal workers, beamte cannot be fired. The German government pays for the bulk of their health care, and they don’t pay certain taxes, but they give up the right to strike. (I strongly believe that all government employees should give up their right to strike, but that is a topic for another discussion.) Beamte are well compensated and receive a good pension that is guaranteed by the state, not by public insurance. You know how this story ends: The government made promises that it will have a hard time keeping. As the beamte get older, the German government’s liabilities to them are starting to outweigh the country’s explicit debt of €2 billion ($2.6 billion) by a factor of between two and five.
Hendrik presented three stocks in his presentation. Two of them — German chemicals company BASF and U.K. bookmaking company William Hill — looked very interesting but only mildly undervalued. (According to Hendrik, they had little margin of safety.) They are perfect watch-list, buy-at-lower-price stocks. The third one, Pharmstandard, a Russian pharmaceuticals company, looked very interesting, and I’d be lying if I said I was not tempted to take a look at it. But to me, after the Yukos incident, when Russia confiscated one of its largest private oil companies and jailed its founder, Russia became uninvestable.
P.S. After I wrote the preceding, I got an e-mail from Hendrik, who told me that Pharmstandard had fallen victim to Russian corporate governance. Shareholders were basically told that if they don’t agree to a proposed spin-off, the company can buy them out at an 18 percent discount or they will get unlisted shares of the stock. Predictably, the stock collapsed. This is white-collar mugging; there is no other way to put it. The company effectively says, “You are a shareholder as long as you agree with management; otherwise we’ll screw you.” Now Russia is uninvestable to me for another reason: Its corporate governance makes Tony Soprano look angelic.
Jim Chanos and the Commodities Supercycle at Valuex Vail
This year James Chanos, president and founder of New York–based hedge fund firm Kynikos Associates, gave the Valuex Vail attendees an update on the Chinese bubble: It is alive and kicking. Jim estimates that Chinese spending on residential construction is currently running at 20 percent of GDP. He got to that number using simple math: 20 million condos constructed at an average retail price of $80,000 totals $1.6 trillion, or 20 percent of GDP. Just think about this for a second. For the U.S. at the height of the real estate bubble, the comparable number was slightly above 6 percent, and today it stands at less than 3 percent. And China has been building empty cities even though its labor force participation rate (and thus household formation) started to decline in 2012, so fewer families will need new housing.
In his presentation Jim said that Chinese policymakers recognize that the national business model is flawed, but with high off-balance-sheet debt originated by local governments, endemic corruption and nonaccrual accounting (the Chinese record GDP when things are built, not when they are sold), it may be too late to do anything.
Meanwhile, rural-to-urban migration runs at 15 million people a year, but these migrants are in the bottom earning quartile and thus cannot afford $80,000 apartments. And, with the usual Chinese twist, some of the migration occurs only on paper, with bureaucrats changing rural disricts to urban ones. So even fewer condos are actually needed. China is creating its own version of the auction-rate securities that helped bring down the U.S. housing market. Long-term projects are financed by wealth products: High-yielding five-month certificates of deposit not explicitly guaranteed by the government are sold by small banks and trusts, and consumers starved for yield are buying them. This mismatch of duration is dangerous, and the story has a predictable ending. The Chinese banking crisis is one failed wealth-product rollover away. (I’ve written about this in the past, but it is worth repeating that the biggest risk to the Chinese bubble is social instability. A lot of people who are buying these wealth products are being fleeced. What they will do when their savings are wiped out is a big unknown.)
Speaking of the Chinese banking system, on June 20 the interbank lending rate in China jumped to 30 percent. Some of the rise was directly caused by the government as it tried to curb wealth-product lending, but the bulk of the jump was spurred by rumors that Bank of China had defaulted on its interbank loans. The rumor proved to be untrue, and the interbank rate declined, but I keep thinking that there is very fertile ground for this suspicion. Banks probably looked at their own loans and thought, “If your Bank of China loans are as bad as ours, then the rumors may be true.”
At Valuex Vail, Jim provided some very interesting numbers. In Tokyo in 1989, at the height of one of the most grotesque real estate bubbles in modern history, property was valued at 375 percent of GDP. In pre-crisis Ireland that number was 350 percent; in the U.S. in 2007, it was 180 percent. In China today it is more than 400 percent.
At Kynikos, Jim is short stocks tied to global mining capital expenditure. He believes the commodities super cycle is ending, as China is the largest consumer of hard commodities, and
