Value Investing

Mawer Funds: Boris Godunov – The Prince That Never Dies

Mawer Funds 2014 annual letter titled, “The Prince That Never Dies.”

Mawer Funds – The Prince that Never Dies

The Case Of Dmitry Ivanovich

Medieval Europe was not an easy era to be the heir of a feudal lord; it was not uncommon for a claimant to be made to disappear.

To the enterprising, however, a disappearance was a prime opportunity for career advancement. Born a meager nobleman? Not a problem. Simply persuade the people that you are the missing Lord or Prince and, when you ascend the throne, get rid of anyone who would say otherwise. It was remarkable how quickly the public could forget the past. And yet no case was more unbelievable than that of the three Dmitrys, which occurred between 1603 and 1611, when no fewer than three men claimed to be the resurrected Dmitry Ivanovich, third son of Ivan “The Terrible” of Russia.

The case of the three Dmitrys transpired because of an act of evil committed by the Russian boyar, Boris Godunov. A cunning man with a long, dark beard and an unquenchable thirst for power, Godunov was the brother-in-law of Feodor I, the second son of Ivan “The Terrible.” Originally in Ivan’s inner circle, Godunov was a brilliant strategist who was ruthlessly addicted to power. When Ivan IV died and Feodor I became tsar, Godunov used the youth’s mental illness to become the behind-the-scenes ruler of Russia.

Since Feodor I had no direct heirs, Godunov’s only threat to absolute rule was nine year old Dmitry Ivanovich who was next in line to the throne. In order to secure his future as tsar, Godunov needed to take care of Dmitry. He had the little boy murdered and elected himself as Feodor’s successor.

But Godunov’s problems with Dmitry were only beginning. In 1600, rumours began circulating that the young prince had miraculously survived the assassination attempt and had risen again! On cue, in 1603, a young man came forward claiming to be the missing prince. His story proclaimed that Godunov had mistakenly murdered another boy in his place, and he had travelled from monastery to monastery to avoid capture. False Dmitry I was not only able to gain the sympathies of the Russian public, but of England as well. It was this widespread support that enabled him to acquire an army of his own and eventually become tsar. Not bad for an upstart with no real royal blood. Regrettably for this Dmitry, his reign as tsar would be cut short by Godunov allies who disagreed with the appointment.

“…as the fear of uncertainty declines and jealousy and greed takes over, asset classes perceived as “riskier” are becoming more popular again.”

Dmitry Ivanovich would miraculously rise not once, but twice, after this. This was crazy. Not only were all three imposters ambitious enough to fake a royal identity, but the Russian public was willing to believe in each subsequent resurrection as well. As the False Dmitrys demonstrate, people will believe what they want and are quick to forget the past.

This apparent shortness of memory is a lesson seasoned investors know well. Even after a market collapse, when investors feel the sting of losses keenly and become hesitant, there comes a time when investors acquire the stomach for risk again. It does not matter how much pain the last crisis caused. Risk appetite eventually returns.

The past year appears to have marked the return of risk appetite. Nearly four years after the U.S. subprime market burst, triggering a near meltdown of the financial system and a global recession, the shock finally appears to be wearing off. Investors are forgetting 2008/2009. And as the fear of uncertainty declines and jealousy and greed take over, asset classes perceived as “riskier” are becoming more popular again.

The return of risk appetite is evident on a number of fronts: equities are now at or above long-term average valuations; low quality borrowers are raising debt in public markets at a rapid pace; and synthetic products like collateralized debt obligations (CDOs), the very products that helped undermine the financial system five years ago, have re-emerged. Even Cinda, the state-backed bank in China that takes on bad Chinese loans, was able to go public with huge interest from investors who were trying to gain exposure to China’s bad loans.

The renewed confidence can also be seen by looking at the nature of equity returns last year. In 2013, all of the Mawer equity mandates produced double-digit returns – our small cap mandates even generated over 40% each. How could this be possible in a year of lackluster economic growth and mediocre corporate earnings? While it would be great to say that all our equity investments posted stellar earnings growth, in reality, they broadly benefited from re-pricing in the market.

To some investors, the return of riskier investments may seem as crazy as Russians believing in a thrice-assassinated prince. But is this resurrection really so out of the ordinary?

We don’t think so. Risk appetite may be labelled a rational process, but in our experience it is much more a byproduct of the human condition. A human condition
that is inherently prone to cycles of behaviour.

If risk appetite truly has returned, then it is important for our clients to understand how this might affect the odds of investment success. That is why we spend some time in this year’s annual letter exploring the appetite for risk, how it evolves, and how it relates to the investment landscape. By exploring these factors, we hope our clients will be in a position to make better decisions than our 16th century Russian counterparts.

Mawer Funds – A Bet With Boris

To properly appreciate risk appetite, it is important to first distinguish between “risk” and “uncertainty.” This can be accomplished by a simple thought experiment.
Imagine you are hanging out with Boris Godunov at a coffee shop in Moscow. Ever the gambler, Boris hands you a die and offers you a deal. If you roll a 1, 2, 3, 4 or 5, Boris will pay you $50,000. But if you roll a 6, Boris gets your house and your second child. You have no idea what is going to happen when you roll, but you know you have six possible outcomes. This is risk. It happens when you know the future distribution.

Mawer Funds: Boris Godunov - The Prince That Never Dies

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