The Art of Heroic Unpopularity

Enough of writing about baggers that I missed out on. This one I bought at 180p September 2015. 18 months later (March 2017) it is now worth £8.25…It’s more than quadrupled.
And what is more, the company I bought: Burford wasn’t undergoing some high risk restructuring plan. The strategy stayed the same. My point being that some overleveraged mining companies have been baggers, but you couldn’t predict that – if commodity prices had kept falling, then they could have failed. But Burford has been a lower risk, high performer.
The assets on Burford’s balance sheet are legal disputes. A legal dispute which you expect to win, is an asset just like any other asset. Its value is uncertain, but then again I can’t think of ANY asset whose value is certain.
Many people like owning “real” assets – they like the certainty, because they easily recognise the value of buying a house. Property is the most obvious tangible asset. You can see it in the physical world. You can touch a real asset (hence “tangible). The same goes for gold or even famous paintings painted by Dutch masters. Owners feel there will always be a certain marketable value.
Except when there isn’t. Houses are mostly valuable because of their location.  Doctors in London like to signal their success by having a surgery in Harley Street.  Hedge funds do the same, Mayfair offices signal that they are serious players. Exactly the same house in Central London is worth multiples more than if you moved it brick for brick and put it in the middle of the desert. Actually this happened in the 1960’s with the former London Bridge, which was sold to an American millionaire, Robert P McCullough. The old London Bridge is now in Arizona.

And location is a rather intangible thing – areas that were once unpopular neighbourhoods become desirable, mainly because of the other people living in the area and vice versa.  The clue is in the word “neighbourhood” – the neighbours make the area what it is. Similarly, the price of gold bears a very weak relationship to the cost of digging it out of the ground. Instead, the price of gold relies on the confidence that other people think that gold is precious too. Works of art are tangible, but their worth bears no relationship with how much it costs to paint a picture. It’s all about the perception of value. If a picture turns out it is fake, a great work of art can lose its value overnight, but it is the same picture.

And my perception of value is why I bought shares in Burford. The financials looked attractive, with the company reporting returns on invested capital of 60% in 2014. But this doesn’t seem like a business that you can just look at the numbers, you have to trust the management. They seemed to be doing something different to every other company that I’d looked at. But the Chief Executive could write well. He can explain that it is better to take a probabilistic view of their assets :
Any individual legal claim is highly risky and difficult to predict, and we strongly discourage speculation as to the result … Litigation investing is best done through widely diversified portfolios, not on the basis of single case speculation.

Moreover, the payoffs are attractive. As a plaintiff, it’s possible to lose 100% of your costs on a legal claim where the judgement goes against you, but they can’t lose more than that. But when a plaintiff wins, they can receive multiples of their legal costs. It’s like a work of art, it might be worthless because no one wants to pay for it. But the value of a creative piece of work: a song, a painting or most bizarrely The Physical Impossibility of Death in the Mind of Someone Living   can be multiple times what it cost to make.
Litigation is an inherently asymmetrical undertaking, which is one of the drivers of the economics of our business generally: the “investment” in a piece of litigation is often just the costs of pursuing the claim, and no rational actor pursues a claim in litigation that does not have a value significantly above those costs. Thus, losing a piece of litigation results only in losing the costs, whereas winning typically results in receiving a multiple of those costs.

An example Burford management give in the 2016 Annual Report is that they invested $18m in a claim against the Argentinian Government for expropriating (a lawyers’ word for government stealing) YPF, a publicly quoted Argentinian oil company. Burford have sold on a minority interest which implies a market valuation of $400m, compared to their $18m invested.

What might this claim be worth?

This claim is hard to value. In 2012 the plaintiffs who Burford represents owned just over 25% of YPF. Repsol, a Spanish oil company, who owned twice as many shares, sued the Argentinian government, who settled with them for $5bn. A very rough calculation shows that if the Argentinian government settles on the same terms with minority shareholders, this claim would be worth $2.5bn, of which Burford would receive around half (ie $1.25bn). But this asset is highly uncertain, the $400m market value (20x what Burford invested) of the claims implies a less than 50% probability that the $18m invested will be worth anything. Burford could end up paying more than the $18m to pursue the claim, but still lose.  Nevertheless those are the odds and asymmetric pay-offs that I like.

Heroic ventures from The City of London

It also seems to me what equity investing was originally intended to be. The history of the London Stock Exchange begins with financing heroic ventures where there was a significant probability of loss but also the possibility of asymmetric high returns. Understandably merchants wanted to pool risk. In 1550s, the first joint stock company was formed the Muscovy Company. Sir Hugh Willougby led 3 ships and found his way via the Lofoten Islands, where they were separated by a storm, to Murmansk where his ship was discovered by Russian fisherman, with the crew frozen to death.
Edward Chancellor, Captain of the Edward Bonaventure, the third ship of the expedition, made it through the storm to the White Sea and the Bay of Archangel, then 600 miles over land all the way to Ivan the Terrible’s court in Moscow. Which rather emphasises that the venture had several possible outcomes, and why members preferred to contribute money to a joint stock company, to spread their risk. Control and ownership were separated, and the capital was divided into shares and freely transferable. ** I am sure at the time most people thought this was unlikely to succeed, both the pooling of risk and the journeys themselves. But the Muscovy Company later reached the Caspian Sea, and the idea caught on The Eastland Company of 1579 enjoyed a monopoly of trade with the Baltic; the Turkey Company established in 1581 reached Aleppo, Baghdad and Basra. On the last day of 1600 the East India Company was formed.

So why not buy more?

So, if Burford was such an obviously good idea, why didn’t I buy more? The same reason other people didn’t buy more. It just takes time to get your head around some concepts, such as “legal disputes are an asset”. Rather than “intelligence”, I think this is more to do with “imagination”. The slightly weird, unpopular ideas, joint stock companies, reinsurance, securitisation or even litigation finance. Ideas like this when they start out are often huge opportunities. Commercial ideas like this often succeed because some people can “get their head round” the idea, while others take longer.
There is a parallel with art and music. Whether it is Van Gogh’s or French Impressionist paintings, in the art world we see it takes time for concepts and styles to be appreciated. With paintings this seems to take generations (it helps if the artist is dead, and unpopular in his lifetime, because then supply of his work is restricted).

Everything in its right place

But even with music albums like Radiohead’s “Kid A” or Bowie’s “Heroes” don’t immediately jump out as “hits”. They are not viral like “Gangnam Style”. Then they grow on you, as they are repeatedly listened too. They are just on the edge between unfamiliarity and recognition, on the edge between discordant noise and music.  But never over the edge, everything in the right place.
My favourite example is Bowie’s single: “Heroes”.  This song was not a chart hit when it was released, it peaked at number 24 in the charts over an 8 week run. It failed as a single in America. Bowie himself noted “It’s a strange phenomenon…Many of the crowd favourites were never radio or chart hits; “Heroes” tops them all.”****

And because of this, these works have much greater longevity and influence than the catchy but empty attention grabbing hits.  Economists believe that all available information is captured instantly in a share price, but the success of Kid A and Heroes suggests otherwise.  Often share prices can change wildly in value with no new information, the existing story is re-framed, the onus of proof / benefit of the doubt shifts.  Economists who think this is “rational” live in their own bunker.

Bowie’s creativity and imagination did not stop at music. Before others, he could see the potential of the internet for building new communities, the long term implications for copyright, the threat to intellectual property. Bowie bonds, securitisation and setting up his own website in January 1998. In 2002 he suggested that music would become like running water or electricity’ anticipating the rise of Spotify. **** Always experimenting, risking failure, but looking for upside too.

The physical possibility of death in the mind of fund managers

Traditional value investing is about buying unpopular companies because they are “cheap.” Flawed companies trading at less than the value of their tangible assets.  Assets you can touch and sell off in a “fire sale”. But I think there’s another type of unpopular investing – buying companies where eventually others will get their head around the value. People like Buffett and Soros, who otherwise have very different methods, seem to share this trait. And Neil Woodford.
In 2009 Invesco, where Woodford used to work, he took a 45% stake in the Burford IPO. Without his backing, the venture probably would not have got off the ground. A good fund manager should be able to spot an IPO like Burford and back it to the hilt, as Woodford did. This isn’t about picking winners with 100% certainty, but backing enough businesses with a chance of success and asymmetric payoffs. A portfolio approach to the risk of loss.

Sadly, Woodford is a rare bird – most fund managers who I have met show poor judgement. With the rise of index trackers and quant funds, traditional fund managers face an uncertain future. One way an active fund manager can survive is if they market themselves on their ability to fund good investment opportunities at the IPO stage. Index trackers can’t do this.  I don’t think there is a technology solution to this either, a machine learning algorithm could not have backed Burford at its IPO. Backing the right IPOs is more art than science.  Perhaps this threat also presents an opportunity?

Standing by the The Wall

There is one similarity between Buffett, Woodford and Bowie: they don’t feel the need to live in a prestigious location. Buffett’s office is in Omaha, not New York. Woodford’s office is in a run of the mill business complex on the outskirts of Oxford, not Mayfair. And Bowie? At the height of his success, he quit Los Angeles. Unlike everyone else he didn’t want to live where all the successful film makers and music producers lived…he didn’t need location to signal his success like a Harley Street doctor. He left for a backwater. Not quite Omaha or Oxfordshire, but Hauptstrasse, Schoneberg, Berlin in the middle of the former DDR.  And it is generally agreed that his three Berlin albums are among his most inspired work. 

“Genius thrives in a space shielded ever so slightly from the need to win a popularity contest”. ***

Seeing what others can’t see. But then when you keep showing it to them, they can see it.  Sailing where others fear to sail, opening up a trade route route and a secondary market for capital of uncertain value.  Or hearing, what on repeated listening, becomes “Heroes”.

* How Pleasure Works – Paul Bloom
** The Stock Exchange Story – Alan Jenkins
*** Hit Makers – Derek Thompson
**** Starman: David Bowie – Paul Trynka

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