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This book contains a collection of reports written by investment professionals at Marathon Asset Management. What makes these reports stand out, in my opinion, is an analytical focus on the ebb and flow of capital. Typically, capital is attracted into high-return businesses and leaves when returns fall below the cost of capital. This process is not static, but cyclical — there is constant flux. The inflow of capital leads to new investment, which over time increases capacity in the sector and eventually pushes down returns. Conversely, when returns are low, capital exits and capacity is reduced; over time, then, profitability recovers. From the perspective of the wider economy, this cycle resembles Schumpeter’s process of “creative destruction” — as the function of the bust, which follows the boom, is to clear away the misallocation of capital that has occurred during the upswing.
Edward Chancellor

Investment Philosophy


1. Capital Cycle Revolution

The following essays describe the operation of the capital cycle in a variety of industries, from cod fishing to global brewers and wind turbine manufacturers. A common theme linking these pieces is the importance of understanding how competition — or the supply side — evolves over time, and the role it plays in determining both industry and individual company returns on capital. In addition, some of the essays highlight the malign influence of regulation and the potentially disruptive impact of technology on particular industry capital cycles. An understanding of the capital cycle helps to identify and avoid speculative bubbles. All too often, high returns attract capital, breeding excessive competition and overinvestment. In recent years, for instance, there has been an epic burst of capital spending in the field of resource extraction. Four of the articles presented below highlight the dangers posed to shareholders over the last decade by ever rising levels of investment in the mining and the oil and gas sectors.
Edward Chancellor

2. Value in Growth

Capital cycle analysis, as it originally evolved at Marathon, looked to invest in companies from sectors where capital was being withdrawn and to avoid companies in industries where assets were increasing rapidly. The insight being that both profits and valuations should generally rise after capital has exited an industry and decline after capital has poured in. In other words, capital cycle analysis was all about the drivers of mean reversion. Yet the same mode of analysis can be used to identify companies which, for one reason or another, are able to repel competition.
Edward Chancellor

3. Management Matters

Like many other investors, Marathon never tires of quoting Warren Buffett. One particular comment of the Sage of Omaha has become something of a mantra at the firm: namely, Buffett’s observation that “after ten years on the job, a CEO whose company retains earnings equal to 10 per cent of the net worth will have been responsible for the deployment of more than 60 per cent of all capital at work in the business.” What this means is that investors should pay particular attention to the capital allocation skills of management.
Edward Chancellor

Boom, Bust, Boom


4. Accidents in Waiting

After the financial crisis erupted, the Queen famously asked on a visit to the London School of Economics why the problems hadn’t been spotted in advance. The true answer — one which the Queen presumably was not supplied with — is that economists had developed a deeply flawed paradigm for how the economy operates. Economists posited a world of equilibrium and rationality, in which money and the operations of finance were essentially inert. This academic model turned out to be far removed from reality.
Edward Chancellor

5. The Living Dead

Capital cycle analysis is strongly influenced by J.A. Schumpeter’s notion of creative destruction, namely that competition and innovation produce a constantly evolving economy and spur improvements in productivity. From this perspective, an economic recession serves a useful function as — to use a rather hackneyed image — the forest fire burns away the dead wood and weaker trees, allowing healthy young plants to grow and prosper.
Edward Chancellor

6. China Syndrome

Given the importance Marathon attaches to rational capital allocation and the need for supply-side discipline, it is not surprising that very few investments have been made in mainland Chinese equities over the years. Many of these firms are state-controlled. As a result, the efficiency of capital allocation and the interest of outside shareholders (particularly foreigners) tends to be subordinate to the state’s policy objectives.
Edward Chancellor

7. Inside the Mind of Wall Street

Marathon’s capital cycle approach leads to a natural wariness of investment bankers. After all, Wall Street is in the business of supplying capital to hot areas of the stock market and generating fees from dubious financial engineering. Both these activities have always struck us as inimical to the interests of long-term shareholders. From the perspective of a bemused buy-side onlooker, it was clear to us that the typical Wall Street banker during the early years of the new millennium had little interest in protecting the interests of clients. Rather, the game of banking had become all about fee generation, regardless of the consequences. A whole chapter in Marathon’s previous publication, Capital Account (2005), was devoted to investment bank antics.1
Edward Chancellor


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