Why higher rates are good for the world (and which stocks can do well)

In episode 23 of Stocks Neat, Co-Portfolio Manager Gareth Brown and CIO Steve Johnson sit down to discuss the opportunities available for investors in the current interest rate environment, following our CIO Letter, "Reasons to welcome the death of TINA”.

In October, yields on US Government 10-year bonds hit 4.98%, a level not seen since the mid-2000s. With rising yields has come weakness in equity markets as investors take advantage of risk-free returns. So does the death of TINA mean disaster for equity markets? You might certainly think so. For Steve and the Forager team, however, we feel far more comfortable with TINA in the ground.

Listen to the full episode to find out why.

“We are living in a world where capital has some element of scarcity to it, and people are making sensible decisions about where to allocate capital and what businesses get it.”

Transcript

Just a quick reminder, this podcast may contain general advice, but it doesn't take into account your personal circumstances, needs, or objectives. The scenarios and stocks mentioned in this podcast are for illustrative purposes only, and do not constitute a recommendation to buy, hold, or sell any financial products. Read the relevant PDFs, assess whether that information is appropriate for you, and consider speaking to a financial advisor before making investment decisions. Past performance is no indicator of future performance.

[EPISODE]

[0:00:39] SJ: Hello and welcome to episode 23 of Stocks Neat, a Forager Funds Podcast, where we talk about the world of investing, and one in every few episodes. Anyway, try some whiskies. As you can probably hear in the background there, we do have one to try today, which will be nice after a few months of not being able to fit it in. I'm joined by Gareth Brown, portfolio manager on our international fund. How are you, Gareth?

[0:01:04] GB: Hi, Steve. Hi, everyone. I’m well, thank you.

[0:01:08] SJ: Yesterday, we'll try a whisky, and then we're going to talk about some very pessimistic geezers who probably need a few whiskies, and finally, why they're part of the world and ours might begin for a better decade than the past one with a more normal interest rate environment than we've seen for a very long time. Gareth, what are we drinking first?

[0:01:27] GB: We are drinking a Glen Scotia, I believe it's pronounced. We are drinking it because it was one of the affordable whiskies at the bottle shops downstairs. It's from the Campbelltown region in Scotland, which I don't have a lot of experience with, which is, there's a peninsula, the Kintyre Peninsula, I think it is –

[0:01:44] SJ: Is it like Campbelltown in Southwest Sydney?

[0:01:46] GB: Oh, yes, but one less L. It’s Campbeltown. I'm not really sure, though.

[0:01:51] SJ: You're getting pretty close to the southern highlands by the time all of –

[0:01:53] GB: Well, it's actually on the – my brother's down that way. We call it North Canberra. There's a peninsula that sticks out almost all, going all the way to Northern Ireland, the Kintyre Peninsula. Campbeltown was apparently, once called the whisky capital of the world, because there was a lot of distilleries there pumping out more quantity than quality. Apparently, there's only three left. This is one of them. I thought, it was right near the island of Ireland on the West Coast. I thought maybe it's going to be quite a PD affair, but having a smell of it doesn't smell particularly PD at all.

[0:02:24] SJ: Yeah, right. Interestingly, no age on this whisky again, and I'm seeing more and more of this. I had a guy in Dan Murphy’s the other day, convincing me that it all meant nothing. But I think it's a direct consequence of the explosion of consumption of whisky. It is obviously, you get this massive pickup in demand to sell something that is 10 years in a barrel. It is not easy to expand the amount of production you’ve got so –

[0:02:47] GB: Especially in places like Tasmania and even other Australian distilleries that have come out of nowhere over 20 years, that don't have the history, to have the age.

[0:02:56] SJ: Yeah, so the solution is you sell gin in the early years and to start selling younger and younger whisky. It'll be interesting to see how this one tastes, but we'll get into that later. Gareth, the investment that you and I have owned in the portfolio for a very long period of time, we no longer own and we're quite disappointed about it.

[0:03:17] GB: Correct. Blancco Technologies Group. I feel like, we've discussed this a few times, so I won't bore everyone with too much detail.

[0:03:22] SJ: Yeah, I think the stock itself is maybe less interesting here than the dynamic that's created the situation, yeah?

[0:03:27] GB: Just for a quick background, this was an idea that Steve and I first came across it actually in a broker meeting in 2017. It was getting absolutely thrown out by everyone in the UK, because that had some very serious issues there of misstating revenue. We did a lot of work on it. We were the only buyer in the market there right at the bottom. As we got to know the business better and as we held it for a few years, we really got more convinced about the runway behind this business. It wasn't just a baby with a bathwater type trade. It was a business that would grow for years and years.

We've done very well out of it. Cannot complain. We feel that the takeover, so there was a private equity business bid for it, we feel that the takeover is proof of concept that we were on the right path. Very disappointed about the final price and the board’s unwillingness really to fight tough about, or to get a better price, so it was quite difficult. We put a lot of work into trying to corral some opposition here and it was just hard to get people over the line, to be honest, so it was very pessimistic in that part of the world at the moment. That's the story of this podcast, I think.

[0:04:33] SJ: Yeah, there were a couple of interesting things before we get to that pessimism about the takeover's rules in the UK that are a bit different to what we have here. They have a takeover's panel, the same way we have a takeover's panel, which I think has been one of the great additions to Australia's financial services market, because it allows people to act very, very quickly and it's very cheap, rather than having to go to court.

Our takeover's panels got, I think there are 12 guidance notes that probably run to 20 pages in total. The guidance notes in the UK are maybe 200 pages. I think there's some really good rules in there. It's about transparency, about not being able to lock people up, about having a very competitive process. There are also some things in there that I think in this particular situation, have been counterproductive. One of those in particular that any board of a company that receives a takeover offer has an obligation to discuss with their shareholders the fact that they have received that and get feedback on what that shareholder thinks. It's less here, I think the board makes a decision on behalf of shareholders can have that negotiation.

In the UK, you're almost obliged to go and talk to your larger shareholders and say, “What do you think about this?” If those shareholders turn around and say, “I've had enough of this and I want out,” it's very, very hard for you to turn around and say, “Sorry, we want more money from the bidder.”

[0:05:55] GB: In this case, there was two shareholders, particularly about three that hold 40 something percent of the register. I was surprised. They were surprised that they went as cheaply as they did that they looked patient capital to me. Maybe they have a difference of opinion with us on the final value.

[0:06:10] SJ: Kind of the Soros Fund.

[0:06:11] GB: Soros and Inclusive Capital, which is the famous hedge fund/whatever over in the US. Yeah, I was quite disappointed that did work against us. Once Francisco, the bidder locked up those big three shareholders, it was very hard for someone else to come in.

[0:06:27] SJ: They were 40 – What was the number?

[0:06:29] GB: 45?

[0:06:30] SJ: 45% between them. When the bid landed, it said, we've already had commitments here of various. The biggest two were locked in. The third was a, I will do what I want to do, but I indicate support, basically.

[0:06:43] GB: It made it very, very difficult, I think, to negotiate a higher price out of them. I think, it also makes it difficult to get another bid. They were committed to that, unless the price was at least 10% higher from someone else. You were on the phone a lot. I mean, we were unhappy with the price. We've had a lot of takeovers here in Australia for context that were 70% and 80% premiums to the prior share price.

[0:07:08] SJ: They're going through in the UK like that as well. I mean, SCS the other day, I think, it was a 60% premium announced. That's not uncommon, even in that part of the world.

[0:07:17] GB: This was a premium to a price that had been down a lot over the previous six to 12 months. It wasn't even anywhere near the 52-week highs for the stock. It was a disappointingly low price for what we felt the business was worth. It was also timely in terms of here. They launched the bid here before the company had released its full year results. Normally, they put those full year results out before the bid ended, but they just refused to do that this year.

[0:07:39] SJ: That was one of the issues I went to the takeover panel with. That was a really pleasant experience. I wrote to the takeover panel. They got back to me within four hours and showed me the rules why they didn't have to do it. But it was just, I mean, I didn't get the outcome I wanted, but it was a good experience with the panel.

[0:07:54] GB: You still jumped on the phone trying to convince, so the threshold here was they really needed to get to 75% of the register. At that level, they can force the listing and most people are not forcing on that. We were trying to convince effectively two-thirds of the remaining half of the share register not to vote in remaining portion, not to vote in favor of this. You jumped on the phone. I think the most interesting bit about all of this was some of the feedback you received from some of the other fund managers about their plans here.

[0:08:24] SJ: Yeah. I mean, basically, I walked them off the ledge. They're all going to kill themselves. Just really, like, oh, yeah, this is a horrible price, but there's not much you can do about it. It was so pervasive. I think against that context of they all feel that nothing in their portfolio is working. These are domestic UK-focused portfolios for the most part. Nothing seems to be working for them. Even a 23% premium, almost an exciting bit by itself.

[0:08:51] GB: Well, and the liquidity that comes with it, that was another common bit of feedback here. It's okay, yes, I'm going to get a gain here. This is my portfolio, hasn't had a gain anywhere for a long period of time. Secondly, a lot of fund managers' portfolios are shrinking. People are taking money out of UK funds, particularly small cap funds over there. You're sitting there in a stock like Blancco that was very tightly held amongst a pretty small number of institutional holders and there wasn't much trading going on at all. These fund managers are sitting there saying, “Well, the rest of my portfolio is shrinking. I'm getting outflows. Here is my offer here that's going to give me some liquidity. I'm just going to take it”

[0:09:28] SJ: Moving the hand.

[0:09:30] GB: The other thing, I think is interesting over there is just the lack of retail volumes in any of this stuff. This stock, when we started adding things up, you can get to a very high percentage of the register.

[0:09:40] SJ: It's almost all institutional.

[0:09:41] GB: Amongst institutions. It's a pretty interesting business and a size at which here in Australia, I think it have a decent retail mafia listed in the stock. You just don't see that at all in some of these companies in the UK.

[0:09:53] SJ: Now, I go on to that ADVFN. I guess, it's a UK version of a hot copper. Just go and have a look and see what people are saying about stocks from time to time. It was just crickets. This is a deal that had been announced. There was one comment in the whole takeover period. No one’s watching.

[0:10:09] GB: This was about 5% of our portfolio by the time it went through, we’ve accepted the bid, collected the cash. What does it mean for you about that market? I feel like, yes, things are getting taken over. The pessimism is very, very, very well entrenched over there.

[0:10:26] SJ: We love the opportunities that we're finding in the UK. But B, we're trying not to make the position ridiculously large, right? It is a bet on a country that we don't want to own five or 10 times what the index has in the UK. We want to be overweight it, but not ridiculously so. The way we thought about Blancco was it wasn't predominantly UK exposure, because it had such a big, global customer base, maybe 10% of the revenues were UK, or even less. We are trying to maximize the opportunity set that we have there in the UK. There are really cheap stocks. It's not just at the small end of town. There are really cheap small caps.

Just to give you two examples that are in our portfolio in small amounts, we own Tesco, far and away the largest supermarket group in the UK. 12 times this year's earnings, a dividend yield of 4%, and they're spending even more than 4% on buyback. You have a dividend, plus buyback yield approaching 10%, 9% or 10%, which is being returned every year to shareholders from a supermarket business. We think you're going to get 13%, 14%, 15 type percent returns over the next decade in a business like that, where it’s a very low risk business. The largest bank in the UK, Lloyd's, which we own a small amount of, even cheaper five times, six times earnings tops, the dividend plus buyback yield is more than 15%. Your comparison with your Australian banks is really, really interesting. It trades at a discount to tangible book value. All the Aussie banks trade at premiums.

[0:12:03] GB: Well, two times.

[0:12:04] SJ: Yeah, big premiums. I keep using this term in internal meetings. This is a post crisis bank. I think that's really, really important. It's gone through all the pain of the GFC nearly killed big sways of the UK banking sector. Lloyd's shares are still down 90% since 2006. The balance sheet has been entirely repaired. All those past shareholders got wiped out, and you've got this business that's the loan to value ratios of the mortgages they write are lower than what we write here in Australia. The multiples of family income are lower than what we write here in Australia.

They don't do anything other than just plain vanilla stuff, because they don't want to take on the risks, because that environment is so – they've gone through that near-death experience in the GFC. They don't want to do it again. From our point of view, we think the market gets more excited about this one day. But in the meantime, we're going to collect, I don’t know, 15% type returns from dividends and buyback, which grows our APS. One day they'll get excited about it. For now, we –

[0:13:08] GB: It's quite interesting to me that we've done a bit in this sector over the years. We've owned Lloyd's on multiple occasions, three and four years ago. It was a really, really interesting setup. Similar valuations today. You're looking at saying, this is a low multiple. It's a discountable. It's probably the best bank in the UK. But still working through some of the penalties from some of their prior behavior kept cropping up all the time. You still didn't have enough capital at that point in time. The profitability was being crimped by all these costs that they had, so you weren't getting paid fat dividends.

You come back to it a few years later, the price hasn't moved, but the cash generation, it's actually there. You're not anticipating that it's going to come in the future. Everyone is just saying, “I don't know what's going to make it work.” What's most interesting is that you don't need the price to work. You just sit there and collect your cash from it every year. I think you are right at some point. That sentiment changes, but in some ways, the longer the better, because you keep buying back as many shares as you can for best price.

[0:14:07] SJ: For sure. We talked about this the other day internally, but we haven't owned a lot of banks in the history of this fund. But we've looked at a lot. Back in 2013, 2014, 15, there was the Euro crisis. I could find banks that were maybe almost as cheap as this, but that'd be like a weird Austrian company, like three different banks that aren't shares in each other, and it was a completely locked up structure, small banks. I looked at a bank in Greenland. I looked in the bank in an island off Finland. You had to go to these weird, quirky places to find anything that made sense.

Those high street market leading banks now are at those valuations. It just doesn't make a lot of sense to me. These are really utilities. They're banks. There's risks there, but you want to own these things in that period after crisis, not before crisis, obviously. I think that one, maybe this is pure anecdote, but banks in Europe that did best through the GFC were the Scandinavian banks. The reason they did well through the GFC is because they had their crisis in the early 90s. They were really risk adverse at that time. They sailed through the GFC, no problems.

That's how I feel about Lloyd's today, and other European banks. They've had this thing in the last 15 years that just weighs on the mentality of the board, on the regulators, on the management, on all the senior people in the organization. Nobody wants to go and touch the next landmine. I think that works to our advantage.

[0:15:37] GB: Yeah. People might remember here in Australia that a regulator came out a few years ago when interest rates were falling really fast and saying, we've got serviceability criteria that the banks need to work towards. But because interest rates are so low, we also want to put in place a multiple of income threshold that banks can't lend more than six times someone's income to them to buy a house. For reference, just in terms of the maximum that Lloyd is doing in the UK is four times four.

[0:16:03] SJ: Typically, three and a half. They're basically not writing any new mortgages in London, because the prices are too high. That's how risk adverse they are. The capital of the market, far and away, the biggest city in the country. They're not doing a lot of business there, because they can't make the risk metric stack up. It's music to my ears.

[0:16:22] Stay tuned. We'll be back in just a sec.

Are you a long-term investor with a passion for unloved bargains? So are we. Forager Funds is a contemporary value fund manager with a proven track record for finding opportunities in unlikely places. Through our Australian and international shares funds, investors have access to small and mid-sized investments not accessible to many fund managers in businesses that many investors likely haven't heard of.

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[0:17:05] GB: Well, let's try this whisky. Then we will move on to why some of that perception and even profitability of these businesses might be about to change. I reckon, everyone says this whole aging of whisky things, you can tell the difference.

[0:17:18] SJ: You can tell the difference in age.

[0:17:20] GB: Yeah. I think it's that it's the alcohol smell, of it or taste of it, it's stronger in newer whiskies, I think.

[0:17:27] SJ: Yeah. Although, they typically water these things down to that 40, 40-ish percent anyway.

[0:17:32] GB: Yeah, it's the same percentage, but it just –

[0:17:35] SJ: Smell it. I mean, this costs –

[0:17:36] GB: What’s your ranking? It's not cheap.

[0:17:37] SJ: It's not cheap, but it's not pricey. It's 80 bucks or something, wasn't it? I think it's nice.

[0:17:45] GB: It's not the LD special. Let's try that on the next podcast. I'll bring that in. I've heard it's good. My grandmother drinks it.

[0:17:50] SJ: We have a Australian sparkling wine and a Italian Proseccos.

[0:17:53] GB: Okay. My CIO letter to the last quarterly report. I think this is actually directly relevant to that conversation we were just having. There are sectors and markets around the world that have just not worked for the past decade. I hear a lot this perception of low, falling interest rates have been driving this massive appreciation of asset prices. That has been true if you look at tech companies in the US, or even wider US indices. But it's not true at all for large swathes of the market.

You take the whole Aussie market. We started our fund end of 2009. Market was already up 40% by the time we actually started in October from its lows. This is not picking a particularly high, or low point. The average return per annum over that period has been seven and a half percent, including your dividends and your dividends are 4% per annum here in Australia. You've got three and a half percent a year of compound gains in a period where the perception, I think, is that asset prices have gone nuts.

The UK for an equal weighted index has almost gone backwards over that period of time. There are markets that have done well, but there are ones that have done really, really poorly as well. I think, rather than that being unrelated to what's gone with the interest rate cycle, I actually think in a lot of cases, it is a direct consequence of lower rates. Yes, the multiples of people have been willing to pay for businesses have been higher, but it's the profitability that's been the problem in a lot of these places.

[0:19:26] SJ: The competition that arise, because of those low rates for capital.

[0:19:30] GB: Yeah. I think the commonality between the Aussie market, the UK, is you have a lot of miners, a lot of energy companies.

[0:19:37] SJ: Financial services.

[0:19:38] GB: And a lot of financial services, and those industries have really suffered from a low interest rate environment. I think it's changing really, really quickly and investors in some of these places have not picked up on some of the beneficiaries.

[0:19:51] SJ: You mean, you look at the banks, the profitability over the last couple of years is up significantly. The key driver there is being the net interest margin. That's the difference between what they pay on their deposits and what they receive off their loans. A big chunk of a bank's deposit base is typically zero, or very low interest rate. As interest rates go up, they get a higher rate on their loans. They're not necessarily paying a lot more on the deposit side, or at least for part of their book, so it fattens out the gap between those two, and that's where the profit all comes from. Then maybe take another example, at the other end of the extreme, we talked about gulf and marine services. I don't know if you've had that on your list to talk about here, but for a long period of time, the low interest rates created a very strong competitive pressure in terms of just bringing on new assets that compete in the same space. That's all dried up, because interest rates have risen and no one can make it stack up at the current rates of return. Now, all of a sudden, these companies are making more money than they used to. They're paying more on their debt, but their revenues have exploded.

[0:20:53] GB: Yeah. There was a book that came out a bit more than a decade ago now, called Capital Returns: Investing Through the Capital Cycle. It was a collection of investor letters that have been written by Marathon Asset Management put together by Edward Chancellor. It's worth a read. I didn't love the book. I think the concept is better than the book itself. They could have actually written a book, rather than just put all these letters together, because it felt quite repetitive to me. The concept really struck home. I think it's, even when it's implicit more than explicit, it's been something that value investors have been doing for decades in terms of buying things that are under-earning.

The whole concept of the book is in asset intensive industries, money comes in. There's too much capital, too many assets, so it earns lower returns on that capital. The lower returns force the capital to leave, or no new capital to come in. Then the returns go back up and you buy these businesses at the bottom of the cycle and you sell them at the top. You can make a lot of money investing that way. That book came out in 2012, sort of the end of an era of very good value investing returns.

For me personally, as an investor, some of those asset-heavy businesses were some of my worst investments over the subsequent decades. We bought things with big discounts to NTA, and just saw the profits never really recover. 

[0:22:15] SJ: The bigger picture lesson here on that book, I think – I've not read the book. I've read quite a few of marathon letters over the years, but gluts create shortages and shortages tend to create gluts. That's the way the capitalistic cycle works in those things with strong price competition.

[0:22:33] GB: It just didn't happen for a period of time. We own boom logistics, which is an ASX listed company that owns cranes. I think it has other problems other than this in that all of its labor is unionized, and the unions are very good in that particular industry, especially at extracting every single dollar of profit out of it. It also just – they were earning nothing two and 3% returns on the value of those cranes. Still, you'd rock up to every meeting it'd be, someone else had bought a new crane, there’s new cranes coming into the market from overseas, operators, and people could borrow the money to buy that equipment at 2% and 3% per annum. The rates that they needed to charge to be profitable on that, probably with some efficiencies as well, but were very, very low. So low that to compete with them, boom, was almost making nothing. It just didn't change.

I think we first bought that stock in 2014. If you look at the last 10 years of its history, I don't think it's made a profit in any one of those 10 years. The correction piece just didn't come. I genuinely believe that lower and lower interest rates were a key impact on that. As it's reversed, it hasn't helped boom logistics just yet, but MRM, which is an offshore oil services company listed here in Australia, which share prices up through four-fold over the past 12 months. You mentioned Gulf Marine Services and our international fund has done very, very well as well. Those companies are now making lots more money and still not seeing any new supply coming to their markets. Given the depth of the –

[0:24:05] SJ: Uranium’s another example there, probably. We just had a very, very long crunching bear market in that. Still probably not at the prices that are bringing in new supply. It's just that the cycles are long in that –

[0:24:18] GB: I think when it's gone on, when the dips have gone on that long, everyone's very skeptical about any sign of a recycling as well.

[0:24:24] SJ: Cycle’s dead. The cycle’s dead.

[0:24:25] GB: Yeah. It goes back to your banks. I think for us, the great opportunities here are these companies that are really cheap, but they're also actually, I think, good businesses. They're not – I think boom is probably always going to earn lower than the industry average on assets, whereas I think, Lloyd's, with its dominant market position and market share in the UK, whatever the industry rate of return on capital is, they're going to earn 3% or 4% percent better than that, because they are a more efficient, better run, more established business.

What's happened is, I think the industry rate of return as rates have gone up has gone from 6, or 7, to 10. Lloyd's goes from 10, to 14, or 15. I think those sorts of businesses that are better operated in those sorts of spaces are easier ways to make money out of this. I'm sure some of the stuff at the other end might be multiples of your investment as well. I think you can own businesses like this, pretty safe in the knowledge that even if interest rates go back down here, you own an okay business that was doing okay returns on capital before this happened.

[0:25:28] SJ: My feeling here is that if you're disappointed, okay, you don't get 15, but you get a eight over the next decade. There's always tail risk in financial services, because of the leverage inherent in it. I just think that the time, I think about this marathon perhaps would. I think the time board is now, not 10 years ago, not five years ago.

[0:25:48] GB: It is contingent. We were talking about this yesterday, but contingent on rates staying higher for longer. Yes, you might do okay out of the woods if interest rates go back down. It's certainly been helpful in those multiples you were talking about are on much higher earnings because of higher rates. Do you have a view on the likelihood of this hanging around for an extended period of time?

[0:26:09] SJ: I guess, two things here. That partly have you that as a hedge to the other things that are in the book. I think that's part of the, I guess, the art of portfolio management here. We have a lot of businesses that are just direct beneficiaries of lower interest rates. Here's one that typically benefits from higher interest rates and maybe suffers a bit from lower rates. Those two things pair quite nicely. Not that this is ever going to make up half my book, but it's nice to actually have something on that other side, because most stocks benefit from lower interest rates, not higher interest rates.

Then the other thing is that, I guess, that tradeoff between maximizing the return on tangible capital and paying out lots to shareholders and growing their loan books. The environments, there are environments where they'll have that choice that they can actually invest in their book, rather than pay it all out to shareholders. That may come in a more economically buoyant time. Managing that tradeoff is a big part of it. That is also linked to the interest rate cycle as well. I don't really have any grand insight around that, but they're all part of the variables that influence the stock.

[0:27:15] GB: Do you think rates stay higher, or not?

[0:27:17] SJ: Prepare for both, I think. That's what I like to do, rather than have a bet around that. All the talk here in Australia at least is, and in the US as well, rates might need to go higher again. There's so much pessimism in the UK. Maybe it works differently. I don't quite know. I want to be prepared. I want to have things that benefit and suffer in different environments that pay off at different times. Then a couple of things that are completely syncretic from those cycles. That's my non-answer.

[0:27:48] GB: I mean, it's not historically crazy. It's not like we're sitting here in interest rates at 10. It feels to me, and I genuinely hope that this is normal. We live in a world where at least people are making capital has some element of scarcity about it. People are making sensible decisions about where to allocate capital and what businesses get it. I think that is good for the wider economy. I touched on productivity in that CIO letter that I think you want good economic ideas that add value to be the ones that are getting money and stupid spec ideas to be not getting money. I don't think it's healthy for all of that money just to be burnt.

[0:28:29] SJ: Agree.

[0:28:30] GB: I really hope that we, from here on, in a more normal environment for interest rates. I genuinely think that there are – for me, it feels like a more prospective market to be making money. I do not want everything to go back up the student prices again. There's a lot of people winching about underperformance of small caps, and it's certainly impacted our overall portfolio performance over the past five years. As you look forward into the future, what you want is low prices. I don't feel like it's tough, but it's not dysfunctional. There are stocks that when they deliver the earnings and everyone sees the cash flow, the share price goes up. Maybe it doesn't go up as much as it would have gone up in a low interest rate world, but the market is rewarding things that are performing well and generating cash, and you can make money out of that and go and find the next thing that's undiscovered.

[0:29:18] SJ: I agree with you. Higher interest rates generally. Conservative investors have a choice. They can just go and put the money the bank and earn something. There's none of this, you have to invest in equities, because you're going to get eaten alive otherwise. Now, of course, what really matters is real rates of interest, not nominal rates of interest. Inflation is biting into purchasing power at the moment. We'll see how that plays out over the next few years.

What I like, bet from this situation is there's far less asymmetry in the range of outcomes. When you're down with interest rates in the floor, can they go to minus 10? No, probably not. Can they go to plus 10? Yes, there's a lot of pain for you, right? Whereas, here we are, the range of potential outcomes is a little less skewed. It's a little bit more normal. The concept that you intrinsically get, but maybe if some investors don't get is gains today are by default there at the expense of gains tomorrow. The value of an asset in 50 years’ time is going to depend on the cash flows then, and whatever market gets put on then. If you get, if your stock doubles, triples, quadruples today, the returns over the next 50 years are going to be lower than they would otherwise be.

Having low price starting points, just applies to your favor over the years. It's a good environment for us to be able to move investments around, harvest where we've made good and maybe too easy money and move it into other things. What you don't want is this situation where, “Oh, should I sell that? I'm not sure. The returns don't look great, but I've got nothing else to do with it.” That’s a horrible situation to be in. It's just it's not been the case with the last, at least 12 months where we – there's been no problem. If we want to sell something, it's been no problem finding other interesting ideas to replace it.

[0:31:02] GB: Yeah. I think the best sign of that is when we're putting up ideas and we're saying, “We think this is going to make you 13%, 14% if you hold it forever. And we're saying that's not enough, because there's other things that'll do better for that.” Then that for us in the portfolio. I actually just – we're running a little bit long here, but touching this quickly, because I have a half-written blog post sitting on my computer from zero interest rate world saying, when the inequality argument was at its peak saying, these rich people are not as rich as they think they are.

[0:31:31] SJ: It’s all market to market.

[0:31:31] GB: It is all market to market. The asset prices were high, but your income producing capacity was really low. I think more people get it now, because they're sitting there, my portfolio is actually generating more income than it was two years ago, because I'm earning more on the fixed income with cash.

[0:31:43] SJ: It's down 40%.

[0:31:45] GB: it's down substantially on what it was. Yes, you could have sold it all and bought some Lamborghinis, but I do think from most people that income producing capacity is important. To the extent, everything goes up, it's not actually creating more income producing capacity for you. The perfect world for us is you find the ones that do go up and you redeploy it into the ones that haven't worked. You can only do that, I think, in a market that's not lifting all boats.

[0:32:10] SJ: Yeah, great. All right, Gareth, we will wrap that up there. I'm off overseas in a couple of weeks’ time, heading to Chicago for a conference with Harvey and then back via Tokyo for a few company meetings. What's on the agenda for you?

[0:32:23] GB: New ideas. It's been the focus for the last, well, it's always an important focus in this job, but it really is that whole conveyor belt. We got the opportunity to drive that fast style. We've got some things that have worked out really well for us that we don't necessarily need to keep owning. We're just constantly trying to work out where the best place for fresh monies.

[0:32:43] SJ: Yeah. It’s been one other good thing about Blancco, that takeover has happened in a period where the market’s fallen quite substantially. Relatively, it's done a bit better for us than the disappointing premium we received.

[0:32:54] GB: Great.

[0:32:55] SJ: Thanks for tuning in, everyone. As always. As through any questions to admin@foragerfunds.com. We'd love to hear your feedback, or any suggestions for future topics. Thank you.