How to Profit When Cycles Turn – Django Davidson on Capital Cycle Investing

Django Davidson (0:00)

So it's a very simple discipline which focuses on supply.

So we've got this quip, supply is measurable, but demand is storytelling. I can count the number of semiconductor fabs, I can count the number of ships, I can count the number of copper mines. I can't predict what happens to the demand for copper, the demand for semis, the demand for oil tankers. But if I see that discipline supply, that curtailment of supply, the lack of new supply coming, what I do is increase my odds of a better investment outcome in the future. And it's very unusual because most of this industry, as I'm sure you'll know from many of your guests, the industry likes to focus on demand, what the future is, your view of the future.

And of course, that's fascinating and we all like to hear different ideas. But ultimately, it is a story, whereas supply is measurable. If you're in a supply-constrained industry, whatever future happens to hold, if there's any increase in demand, you will benefit from it as a supply-constrained industry. And what the capital cycle does is improve your odds for being right.

Wilfred Frost (1:14)

Welcome to The Master Investor Podcast with me, Wilfred Frost, where we celebrate and learn from the success of the greatest investors and business leaders in the world, giving you, our listeners, The Edge. The Master Investor Podcast is sponsored by LSEG, Interactive Brokers, The World Gold Council, and BNY Investments. Please do remember the views expressed in this podcast are for general information purposes only. Nothing in the podcast constitutes a financial promotion, investment advice or a personal recommendation. More on that in the show notes.

My guest today is Django Davidson, the founding partner and portfolio manager of Hosking Partners, formerly of Deutsche Bank and Algebris. Hosking Partners is the $8 billion AUM investment firm founded by Jeremy Hosking of Marathon fame back in 2013

They're focused on capital cycle investing, which I'm looking forward to learning a lot more about. Django is also my dear friend, and I'm delighted to welcome him to the podcast. Django, thanks for joining us.

Django Davidson (2:21)

Thank you for having me, Wilf.

Wilfred Frost (2:22)

I'm really a delight to have you here, and I want to get into your different style of approach at Hosking in detail, and also just briefly reflect on the performance. Over 10 years, you're up 13% per annum, the All Countries World Index up 12.5% per annum, so slightly ahead of a pretty impressive benchmark performance. But in the shorter term, the last year, the last three years, you guys have absolutely smashed it. Over the last 12 months, up 40%, the index up 22%.

So it's really coming together of late in particular.

Django Davidson (2:58)

It is. And I think it is down to a kind of reappraisal of capital in this higher interest rate world. When the cost of capital was free, when interest rates was zero, a lot of these capital cycles, which we can come on to talk about later, were a little bit stymied. As interest rates have normalized, the creative destruction that underlines this capital cycle investing has really come back.

Wilfred Frost (3:23)

So what is capital cycle investing?

Django Davidson (3:26)

So the capital cycle is a very simple framework for making rational decisions in cyclical situations.

It's kind of like a lens, a pair of glasses, a way to see the world. And what the capital cycle says is that all else equal, the more capital that is chasing an opportunity and industry that's going into a theme, the lower the returns for the remaining capital in that sector. So if you have one ball bearing factory, you'll have high returns. But if you have 10 ball bearing factories, the returns will be lower for all of the factories put together. And so what our approach does is to try to very simply focus on returns on capital over the long term, as we think that is what determines a share price over a long period of time.

Wilfred Frost (4:23)

And how do you know when you're still at the start of an upswing? So when you get to two ball bearing factories or three, how do you kind of judge when you think, well, it's not going to slow down until there's 100 versus five or six starts to be the tipping point?

Django Davidson (4:43)

Well, these cycles take a long time to play out. So if you, as a cycle matures, so as lots of capital is coming in, as competition rises, as returns start to fall, it takes a long time for the agents who are in charge of these companies, who are backing these investment projects to adjust to the new reality, which is that there is too much competition. And so what we often find is there's often a long lag between the conditions that create lower forward returns or on the flip side, higher forward returns.