Frying in Hell and Investing in Oil Companies

Last night and this morning, the national media were dominated by the news from the Intergovernmental Panel on Climate Change that we are all going to fry in a rapidly rising world temperature unless we change our ways. CO2 emissions continue to rise and even to limit temperature rises to 1.5 degrees Celsius requires unprecedented changes to many aspects of our lives.

The suggested solutions are changes to transport to cut emissions, e.g. electric cars, eating less meat, growing more trees, ceasing the use of gas for heating and other major revolutions in the way we live.

So one question for investors is should we divest ourselves of holdings in fossil fuel companies? Not many UK investors hold shares in coal mines – the best time to invest in coal was in the 18th and 19th century. That industry is undoubtedly in decline in many countries although some like China have seen increased coal production where it is still financially competitive. See https://ourworldindata.org/fossil-fuels for some data on trends.

But I thought I would take a look at a couple of the world’s largest oil companies – BP and Shell. How have they been doing of late? Looking at the last 5 years financial figures and taking an average of the Return on Assets reported by Stockopedia, the figures are 2.86% per annum for Shell and 0.06% per annum for BP – the latter being hit by the Gulf oil spill disaster of course. They bounce up and down over the years based on the price of oil, but are these figures ones that would encourage you to purchase shares in these businesses? The answer is surely no.

The figures are the result of oil exploration and production becoming more difficult, and in the case of BP, having to take more risks to exploit difficult to access reserves. It does not seem to me that those trends are likely to change.

Even if politicians ignore the call to cut CO2 emissions, which I suspect they will ultimately not do, for investors there are surely better propositions to look at. Even electric cars look more attractive as investments although buying shares in Tesla might be a tricky one, even if buying their cars might be justified. Personally, I prefer to invest in companies that generate a return on capital of more than 15% per annum, so I won’t be investing in oil companies anytime soon.

But one aspect that totally baffles me about the global warming scare is why the scientists and politicians ignore the underlying issue. Namely that there are too many people emitting too much air pollution. The level of CO2 and other atmospheric emissions are directly related to the number of people in this world. More people generate more demand for travel, consume more food, require more heating and lighting and require more infrastructure to house them (construction generates a lot of emissions alone). But there are no calls to cut population or even reduce its growth. Why does everyone shy away from this simple solution to the problem?

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Pay-outs from Labour’s Dividend Plans

I said in my last blog post that the Labour Party’s plans to take 10% of a company’s shares and pay the dividends into an employee trust did not make much sense. I have actually worked out what the implications of such a scheme would be on a few large UK public companies. These are the figures (after 10 years and assuming 10% of the total dividend is therefore paid to employees):

  • BP pays £6.15bn in dividends and has 74,000 employees: £8,310 per employee.
  • Shell pays $10.87bn in dividends and has 92,000 employees: £9,846 per employee.
  • M&S pays £304m in dividends and has 84,000 employees: £360 per employee.
  • Tesco pays £82m in dividends and has 448,000 employees: £18 per employee.

The latter two do of course have many part-time employees. How they might be treated is unknown so I have assumed they get an equal share. Tesco has also been paying a low dividend of late because of past financial difficulties but even if it returned to previous levels, the pay-out to each employee would be low – hardly sufficient to motivate them.

In the case of the oil companies where they have relatively few employees in a capital- intensive business, the pay-out would exceed the £500 cap in year one, so it would be mainly the Government that benefited.

This seems a perverse result to say the least. Are M&S and Tesco employees so much less worthy than BP and Shell employees? Whether an employee got any worthwhile share of the dividends would much depend on the kind of company they worked for.

Another odd result is that the Government would collect a lot more in tax (the amount above the £500 cap) from capital intensive companies than from those with lots of employees.

The more one looks at this, the more perverse this scheme turns out to be.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Hedging Against Brexit

As we edge towards an abrupt Brexit as agreement with the EU has turned into a game of chicken, it’s worth considering some options. Or as my M.P. Bob Neill said about divorce on Twitter “the current system of divorce creates unnecessary antagonism in an already difficult situation” (he was talking about personal divorce in the UK as head of the Justice Committee but our EU divorce is looking very similar – acrimony is the word for it).

Perhaps the Prime Minister will find a way through to a sensible settlement now she is reported to have personally taken charge of the matter. But as investors we should not rely on such a chance.

One solution is simply to move your share investments into companies that are listed overseas and do most of their business elsewhere than the UK. Don’t wish to buy overseas companies directly? Simply buy one of those “global” investment trusts or trusts focused on particular sectors – Europe, the USA, China, India, et al. Or ensure you invest in UK companies with large exposure to overseas markets other than the EU – there are lots of those.

One aspect that caught my attention this week was the suggestion that the UK should stockpile food and medicines to ensure there were no shortages. But taking food alone, fresh food does not generally keep for very long unless you have a refrigerated warehouse. Even then there are limits. As one supermarket chief was reported as saying in the FT today that it was “ridiculous” and showed “complete naivety”. The reason is simply that supermarkets and their suppliers operate “just in time” systems where deliveries often depend on overnight shipping of goods from Europe. Likewise car manufacturers and other engineering companies rely on complex supply chains that depend on the same “just in time” processes and very quick delivery times. There is a solution to this problem which is to store more items. Non-perishable goods can be stored for a very long time to provide a buffer to the flows of goods. One hedge tactic might therefore be to invest in warehousing companies – Segro and Tritax BigBox REITs come to mind (I own them), although Lex in the FT suggested today that “optimism is already baked in” to the share price of Segro after their interim results announcement. The share prices of those companies have been driven by the internet shopping boom where goods are held in warehouses rather than shops, and rapid delivery is essential. More warehouse demand caused by Brexit might add another wave of warehouse building and increase rents.

When it gets nearer the date next March for Brexit, perhaps we should be doing some personal hoarding of French cheese, Dutch salami and German sausages to guard against short-term supply chain disruptions, but I doubt I will be panicking. UK producers can gear up and many other suppliers in the rest of the world will suddenly find they are much more price competitive. Tariffs on imports of food from outside the EU can currently be very high (e.g. an average of 35% on dairy products which is why you don’t see much New Zealand or Canadian cheese in the shops lately – see https://www.ifs.org.uk/uploads/publications/bns/BN213.pdf for details).

That does not mean of course that food will be much cheaper as the UK Government might impose some tariffs to protect our own farmers, but you can see that it is quite possible that the supply chains will rapidly adapt once we are outside the EU regime. But long haul supply lines will require more warehousing and more dock facilities.

Or our Government could take the Marie Antoinette approach to food shortages – “let them eat cake” she said, or “let them buy British products” instead perhaps. Was that not a past Government campaign which could be revived? Such “Buy British” campaigns ran in the 1960s and 1980s to inform my younger readers. I am of course joking because so far as I recall they had little public impact. They did not have any influence on the preference to buy German or Japanese cars, although many of the latter are now made in the UK. But in a new post-Brexit world we should expect some surprises and the need to change our habits.

One joker suggested we might need to eat more non-perishable food, i.e. tinned peaches rather than fresh. But that just shows that there are ways around every problem. If the current heat wave persists we will of course be able to grow our own peaches. But betting on the weather is as perverse as betting on the outcome of Brexit. All I know is that we are likely to survive it. Hedging your bets is the best approach.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Investment Platforms Market Study

The Financial Conduct Authority (FCA) have just published an interim report on their study of “investment platforms”. It makes for very interesting reading. That is particularly so after the revelations from Hardman last week. They reported that the revenue per assets held on the platform from Hargreaves Lansdown (HL) was more than twice that of soon to be listed AJ Bell Youinvest. HL is the gorilla in the direct to consumer platform market with about 40% market share. HL earns £473 per £100,000 invested while Youinvest earns only £209.

That surely suggests that competition is weak in this market. Indeed the FRC report highlights that investors not only have difficulty comparing the charges of different platforms, but they do not seem too concerned about high charges as they focus more on other aspects of the service provided. It also says on page 23 of the report: “Our qualitative research also found that consumer satisfaction levels are sometimes linked to satisfaction with overall investment returns, which tend to be attributed to the performance of the platform. This suggests some confusion about consumers’ understanding about platforms’ administrative function as opposed to the performance of investment products. So it is possible that consumers’ relatively high satisfaction levels with platforms could be influenced by the positive performance of financial markets in recent years”. In other words, the consumers of such services are very complacent about the costs they pay at present.

Another piece of evidence that this is not a competitive market obtained by the FRC was that they found that when platforms increased or decreased prices it had no significant impact on flows in and out of the platform. No doubt some platform operators will read that with joy, but others despair! 

Indeed when I made some comments on Citywire effectively saying I thought it suspicious that there were so many positive comments about Hargreaves Lansdown in response to an article reviewing the Hardman news, particularly as they were clearly much more expensive than other platforms who provided similar effective services (I use multiple ones) I was bombarded with comments from lovers of the HL service. Bearing in mind that platform charges can have a major impact on overall returns in the long term from stock market investments, you would think investors would pay more attention to what they are being charged.

One particular problem is that switching platforms is not only difficult and a lengthy process but can also incur charges. This is clearly anti-competitive behaviour which has been present for some years and despite complaints has not significantly improved.

The FRC summarises its findings as:

  • Switching between platforms can be difficult. Consumers who would benefit from switching can find it difficult to do so.
  • Shopping around can be difficult. Consumers who are price sensitive can find it difficult to shop around and choose a lower-cost platform.
  • The risks and expected returns of model portfolios with similar risk labels are unclear.
  • Consumers may be missing out by holding too much cash.
  • So-called “orphan clients” who were previously advised but no longer have any relationship with a financial adviser face higher charges and lower service.

That’s a good analysis of the issues. The FCA has proposed some remedies but no specific action on improving cost comparability and the proposals on improving transfer times are also quite weak although they are threatening to ban exit charges. That would certainly be a good step in the right direction. Note that a lot of the problems in transfers stem from in-specie transfers of holdings in funds and shares held in nominee accounts. Because there is no simple registration system for share and fund holdings, this complicates the transfer process enormously.

One interesting comment from the AIC on the FCA report was that it did not examine the relative performance of different investment managers, i.e. suggesting that lower cost investment trusts that they represent might be subject to prejudice by platforms. They suggest the FCA should look at that issue when looking at the competitiveness of this market.

In summary, I suggest the platform operators will be pleased with the FCA report as they have got off relatively lightly. Despite the fact that the report makes it obvious that it is a deeply uncompetitive market as regards price or even other aspects, no very firm action is proposed. But informed investors can no doubt finesse their way through the complexities of the pricing structure and service levels of different platform operators. I can only encourage you to do so and if an operator increases their charges to your disadvantage then MOVE!

The FCA Report is present here: https://www.fca.org.uk/publication/market-studies/ms17-1-2.pdf

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Brexit – Good or Bad?

Prime Minister Theresa May convinced her ministerial colleagues to back her Brexit vision, but now our Brexit negotiators David Davis and Steve Baker have resigned and there are grumblings from the “hard” Brexit wing of the Conservative Party. Like no doubt many Brexit supporters I am somewhat puzzled by this outcome mainly because it is not at all clear what the plan is in detail, nor what the ramifications are. But it’s worth reading the letter sent by Mrs May in response to David Davis’s resignation letter. It included these words:

“At Chequers on Friday, we as the Cabinet agreed a comprehensive and detailed proposal which provides a precise, responsible, and credible basis for progressing our negotiations towards a new relationship between the UK and the EU after we leave in March. We set out how we will deliver on the result of the referendum and the commitments we made in our manifesto for the 2017 general election:

  1. Leaving the EU on 29 March 2019.
  2. Ending free movement and taking back control of our borders.
  3. No more sending vast sums of money each year to the EU.
  4. A new business-friendly customs model with freedom to strike new trade deals around the world.
  5. A UK-EU free trade area with a common rulebook for industrial goods and agricultural products which will be good for jobs.
  6. A commitment to maintain high standards on consumer and employment rights and the environment.
  7. A Parliamentary lock on all new rules and regulations.
  8. Leaving the Common Agricultural Policy and the Common Fisheries Policy.
  9. Restoring the supremacy of British courts by ending the jurisdiction of the European Court of Justice in the UK.
  10. No hard border between Northern Ireland and Ireland, or between Northern Ireland and Great Britain.
  11. Continued, close co-operation on security to keep our people safe.
  12. An independent foreign and defence policy, working closely with the EU and other allies.

This is consistent with the mandate of the referendum and with the commitments we laid out in our general election manifesto: leaving the single market and the customs union but seeking a deep and special partnership including a comprehensive free trade and customs agreement; ending the vast annual contributions to the EU; and pursuing fair, orderly negotiations, minimising disruption and giving as much certainty as possible so both sides benefit.

What exactly are the moaners complaining about if that deal can be achieved? Their concerns seem to be focused on points 5 and 6 above. Will adopting common product standards (or whatever EU standards they might determine subject to UK Parliamentary consent) really hobble the UK and make it difficult for us to negotiate trade deals with other countries? I do not see why – it just means that exporters to the UK will need to comply with UK/EU regulations just as UK exporters to the USA now have to comply with US products rules and regulations. What is so difficult or damaging about that?

Note that only industrial and agricultural products are covered by these proposals. Services are not so such matters as financial regulations where the EU has been particularly inept will presumably fall into abeyance unless we decide to conform. But such phrases as “A commitment to maintain high standards on consumer and employment rights and the environment” do need explaining more – does this mean we have to accept EU regulations or what in those areas?

With those reservations otherwise my view is that if Mrs May can achieve her objectives this would look to me to be a reasonable outcome as it will meet the main objectives desired by Brexiteers. Sovereignty and the ability to lay down our own laws and regulations in most areas and in a democratic way will be returned to us. Would anyone care to explain to me why it is otherwise?

But whether these proposals can be agreed with the EU is another matter of course. Perhaps David Davis has resigned because he sees the impossibility of getting their agreement to this “fudge”. The borderless objective in Ireland looks particularly problematic. We need a clearer explanation of how that might work in practice.

My conclusion therefore is that this might be a way forward, but the game of Brexit negotiations is a long way from being concluded.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Beaufort Settlement Improved, But…..

It’s good news that PWC have revised their proposals for the administration of Beaufort and the return of client assets. No doubt due to the efforts of ShareSoc and others. But it still leaves many issues that need properly tackling. These are:

  1. The Special Administration Regulations that allow client assets to be used to cover the costs of the administration. Client assets should be ring fenced and they are what they are called – client assets not assets of the broker or bank.
  2. The fact that most investors now have to use nominee accounts and they are therefore not the legal owner of the shares they hold. We need a new electronic “name on register” system and the Companies Act reformed to reflect the realities of modern share trading.
  3. The UK needs to adopt the Shareholder Rights directive as intended, so that those in nominee accounts have full rights. The “beneficial owners” are the “shareholders”, not the nominee account operator.

We must not let these matters get kicked into the long grass yet again due to the reluctance of politicians and the civil service to tackle complex issues.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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GKN and Melrose – The Reality

Melrose has won the battle to take control of GKN although the Government might yet step in to halt the takeover. On what grounds is not exactly clear. Never having held shares in either company, I thought it worth looking at the facts rather than the hyperbole surrounding this deal as there seemed to be some myths being propagated.

Is GKN a key business in the UK’s engineering and technology infrastructure based on a long history of innovation? Or is it a financially poorly performing conglomerate that was vulnerable to a bid?

It has been said that GKN produced Spitfires in the Second World War but in reality they did not develop the plane but were just one of several assembly plants that were subcontracted to produce it in volume, In the 1960s I well remember the company under the name Guest, Keen and Nettlefold and in Birmingham they had large factories producing nuts and bolts. Hardly high-tech engineering even at that time. Later they did make a success of car parts production particularly with constant velocity joints (CVJs) as used in the Mini and other front wheel drive vehicles. But they are now proposing to split off the driveline business and merge it with another company. They plan to focus on the aerospace business. You can see a “polished” version of the history of the company here: https://www.gkn.com/en/about-gkn/history/ . In reality a long history of dubious diversifications, followed by later rationalisations.

The recent financial performance has been disappointing. Reported earnings per share in 2017 were the same as five years previously with a trough in between. Dividends in that period grew slowly and at the current share price equate to about 2% yield. Return on assets a measly 5.6% last year, and even that was an improvement on previous years. Although the financial prospects based on analysts’ forecasts might be slightly improving, is it not simply a case that institutional investors might have become disillusioned with the management in recent years and seen an opportunity in the Melrose bid to improve the financial returns?

There will no doubt have been some activity by share traders, arbitrageurs and hedge funds of late who might have influenced the outcome. But that’s capitalism in action. Holders, even long-term ones, sell to higher bidders.

Personally I oppose any suggestion that short-term holders should not be allowed to vote, and the use of other “poison-pill” mechanisms that can defeat takeovers. If I purchased a share in a company last week, I want to be able to vote it! I may not have known that a bid was coming and how I vote will depend on the arguments put by both sides. Clearly in this case GKN simply lost the argument.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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