Investing for the Long-Term: Lessons from Scottish Amicable

I was in my second year of uni when I was called in to meet with Iain Ross, the head of Scottish Amicable in Australia. He had an appointment with our CEO, who was on the phone with his chairman. At the time, I was studying for my Master's in finance and was taking a unit on investment. Scottish Amicable was in the news for having a countercyclical approach to investments. Ross was a highly trained and experienced investment actuary who had spent his career with Scottish Amicable. What I vividly remember from our conversation was Ross' view that investors should focus on the fundamentals and not just the current trend. If you're only going to replicate what everyone else is doing, then "stop and buy the index." Instead, if you're interested in real, long-term gains for your investors, you need to understand the fundamentals and look at where the markets will be in a decade. If you're investing for generations to come or for the retirement of many people, you're not looking for a simple return over three to five years but rather for the decades ahead.

In some senses, those who believe in investing in the fundamentals and taking a long-term view run the risk of their portfolio underperforming in the short term, and the current investment guidelines for superannuation funds run the risk of being criticized in the media for underperformance. In recent decades, we have become incredibly short-term focused and worried about quarterly reporting, just like in the United States.

Having spent my formative professional years in a diversified long-term resources company, I learned the importance of having a mix of long-term and short-term performance goals. I do remember being told that if the company invests in a long-term position in oil fields, coal mines, shipping, or retail, we will invariably have times when the market believes each of these is the wrong thing to be in. For my employer, what was critical was to have the right set of assets. Global investors were already looking for industry stocks rather than conglomerates.

Today, investors in the clients of Projects RH don't invest in conglomerates. They are generally looking at single standalone assets or sets of like assets.

We emerge from history

The reality is that most things worth having cannot be created in one quarter and seeking performers solely on this basis is unrealistic.

Currently, there is a low price for lithium and nickel, but a high price for copper and gold. There will be a rush to invest in copper projects because many believe its price will rise. The question is, will this lead to oversupply and if so, for how long? One of the key factors in the extractive industries is that you deplete your resource, and it needs to be replenished to stay in business.

Despite the current surge in investing in sodium-ion batteries and not seeing the future of lithium-ion batteries, many are moving away from investments in lithium. The reality is that we will need both, and lithium is becoming increasingly rare commercially defined. The disadvantage of sodium-ion batteries is that they are large and heavy, making them unsuitable for long haul transport uses. Sodium-ion batteries have a great future in association with bulk power storage, where size is not an issue.

In countries like Australia, where cars cover large distances between refueling stops, the future of lithium is secure. Lithium is relatively scarce and primarily found in China, Chile, and Australia. We are already seeing a recovery in the prices of lithium stocks before the commodity's price increases.

A hard cold start

Going back to basics, a countercyclical investment is something that performs well when other things around it do not. At times, it is confused with the concept of recession-proof stocks such as consumer staples, utilities, and health. A true countercyclical investment actually performs better when the general economy performs poorly. A classic example would be the business of receivers; it should pick up when the banks fall, as high interest rates lead to business failures and the appointment of receivers. The values of other businesses fall as they need to focus more on paying higher interest rates rather than dividends.

In modern business, we see many products that have cycles. The boom and bust of mining are common to many of us, but given the lead times associated with construction, an activation of mining projects when the values of investment falls, a countercyclical investor will be looking at projects which have been closed because of uneconomical conditions, not completed with the expectation of cost-effectiveness in normal times.

This approach is different from the conventional rule that investors would want to invest in companies with costs in the quartile of companies in a specific industry, which by definition should make a higher profit.

From an investor's perspective, however, the purchase into this stock will be at a higher price because they're already performing well or better than their peers. A true countercyclical investor would look at producing a new asset or reactivating an old one. They are looking for gain, and exit is 5-10 years.

The Global Experience - Post Covid-19

COVID-19 was something that most companies and investors could not prepare for. While it did demonstrate the fragility of supply chains and commodity pricing, it also caused delays both from the fact that people could not meet to work on a project and that the financial sector became increasingly cautious. In many parts of the world, the lack of cash flow resulted in good projects and companies being closed with receivers and liquidators appointed. A countercyclical investor would look at these businesses and determine why the management failed really. In many cases, seasoned investors found that the management were not wanting to save; they were not prepared for an unexpected event. Such management had been cautioned not to raise too much capital too early as it would reduce the return to their existing shareholders. Such was the conventional wisdom, and one can expect that it will return.

Investors found many projects that meet the criteria of being basically good projects. At Projects RH, we have been very pleased to work with them so that they understand just how good they are.

One of the impacts of Covid 19 wants to change supply and demand patterns plus see availability of cash to support distressed projects. Further down the timeline, many of the commodities that they supported were found to be oversupplied as demand fell away. However, in many of the wasting assets such as mining, the fact that certain commodity assets were not replaced is seeing the price of that commodity increasing in the medium-term.

The need for mountains of copper, gold, cobalt

At Projects RH, we are working with companies involved in addressing the new energy industry, which is necessary to meet most nations' commitments for moving towards carbon neutrality. Taking a longer-term view, most of us understand that there will be a need for basic energy minerals. Even if they are cheap today, they will not be in the future. These should be priced based on their replacement price. Given that we know the lowest cost is mined first, the price should rise. This rarely, if ever, happens as most commodities are priced off spot markets rather than long-term contracts. History shows that in real terms over time, most commodity prices rise.

The New Challenge

Given the challenge we face, a smart countercyclical investor would be looking at the replacement cost of minerals and saying, "It will take me five years or more to get a replacement project into production. Therefore, my alternatives are to invest in existing assets and bring them forward or invest in them and hold until I am ready to come into production quickly when their price rises." Critical to this is understanding the whole cost of the investment. For most, it is the same as land banking. As long as the carrying cost of the land is less than the increase in value, we are ahead of the game. The same is true for minerals and other resources.

An Investor´s Perspective

In the world of Projects RH, our clients are the companies seeking investment. So, we provide materials for their potential investors, and we act as part of their team.

Most of our clients focus on two types of investors: 1) funds and institutions, including family offices, and 2) wealthy individuals and specialist funds.

Generally, the experience of Projects RH with general investors, which are most professional investors, is they are focused on the current position and what they will be able to report in the next three quarterly reports. As such, there is genuinely little interest in a countercyclical investment strategy.

On the other hand, some specialized funds (e.g., a gold fund) and wealthy individuals generally look to have 10 assets, with most of them having about 10% of their portfolio. These investors are looking for longer-term returns and generally have a 5 to 10-year perspective on their investment. In that they generally believe that there will be a price cycle which will provide the time to realize again and exit the investment. They see this gain as outperforming a passive strategy.

"Smart money" or "dumb money"

For Projects RH's mining, energy, commodity, and specialized services clients, understanding the investor's mindset is critical as we work with them to prepare their investment materials. Typically, these clients seek funding from wealthy individuals, family offices led by founders, or specialized funds. Such investors are sophisticated and knowledgeable about the industries they invest in, seeking a robust business case in the long term with sufficient funds to finance the project. This ensures healthy contingencies, eliminating the need for additional funds from investors when short-term challenges arise.

Critically the clients of Projects RH need to understand the profile of those who they are seeking to have as their shareholders.  One of the things we say to our clients say “yes I want smart money”. Unfortunately, the industry term for the opposite is “dumb money”. For management there is often beliefs that dumb money is best or so leave me alone and I can get on with the business. Whilst this may be true, the thing about smart money is they are able to see other parts of the same sector and foreshadow issues you will have but more importantly if there are problems such as cost overruns because machine parts aren't available they will understand and generally make further funds available if required.

Clients of Projects RH need to understand the profile of their potential shareholders, seeking "smart money" over "dumb money." While management may prefer the latter, smart money invests with insight, recognizing potential industry issues and providing additional funding if necessary.

In the mining industry, "the resource is where you find it," and likewise, companies cannot choose their place in the price cycle. Smart management and investors understand this and work together to ensure long-term success.

Which should a company prefer: a smart investor who challenges them and asks lots of questions before they make the investment, or an investor who simply gives them the money? The answer lies in the former because they are conscious of what the company is doing. They will love it, stick with it, and not just dump their shares if anything goes wrong. Yes, they may be a pain to management, but if something goes wrong, they will have been involved and will understand it. Do you think the company should take smart money over dumb money, despite the fact that smart money may have more requirements and be high maintenance?

Companies should prefer smart investors who challenge and question before investing. They are more likely to stick with the company, even during challenging periods, having been involved and possessing knowledge of the business. Despite requiring more attention, smart money provides greater value than dumb money in the long run.

By Paul Raftery, CEO of Projects RH. We are happy to receive questions of comments at paulraftery@projectsrh.com