Weekend Reading #6

Photo by chuttersnap on Unsplash

This is the sixth edition of our weekly newsletter, Weekend Reading, sent out on Saturday 2nd March 2019. Sign up here and receive a copy each week direct to your inbox.

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Our core investment themes.

3 months ago we began our journey as Three Body Capital, jammed with a lot of good ideas and unadulterated enthusiasm. We can barely believe the positive response we’ve had from all over the world.  

In the coming months we plan to offer our first investment products, which will focus on transformative investing in Emerging Markets. 

As you might have gathered from our blog posts and research pieces, we believe that in order to earn the right to manage money on behalf of clients, we need to be FULLY aligned with them as managers. That’s why we’ll be launching ZERO management fee, performance fee-only investment products. If our investors make money, we earn the right to share in their success. If they don’t, then we don’t get paid. The ultimate implementation of skin in the game. Simple.  

Our investment products will be thematic in nature and most instruments we hold will stem from our 4 core themes, permeating both the long and the short side. So let’s dig into these themes and why we believe they will drive returns.

1. 'Real' AI

'AI will most likely lead to the end of the world, but in the meantime, there'll be great companies.' – Sam Altman, President of Y Combinator and Co-chairman of Open AI

We are being bombarded on a daily basis with news flow and hype surrounding the next general-purpose technology and the world’s smartest brains are locked in debate as to whether Artificial Intelligence presents an existential threat to the human race, or history’s greatest opportunity for us to evolve and improve our lot. 

At Three Body Capital, we have great fun observing this exercise but honestly, we don’t lose too much sleep (at this stage) about the philosophical and sociological implications. What we care about is how to boil it down to company level opportunities. In other words, how do we make money out of it?

Take for example Chinese search company, Baidu. A year ago the buzz was that autonomous driving technology would transform their business completely. Now it’s clear (as it was to us then) that even though they may have made great strides (and in time it may prove really beneficial to the company), the reality is that for today and for some time, 70% of their earnings are advertising dollars generated by their stagnant and declining search business. Despite the recent dramatic rebound in Chinese internet names, Baidu has lagged significantly following poor results. This is an example of how NOT to invest in the hype-driven theme of AI. We are reminded here that the ‘disruptive innovation’ narrative presents as many short opportunities as it does longs.   

At the heart of the AI theme for us is a fundamental question – which companies will benefit the most from machine learning in terms of non-linear earnings opportunities? Despite a healthy dose of skepticism, we are extremely positive when it comes to real-world use cases for AI and its ability to optimise existing business models. We believe that when correctly implemented, AI can lead to large amounts of operating leverage, possibly more than we have ever seen before, given the exponential nature of the technology and its ability to learn from itself. 

The flip side applies too – dozens of publicly listed companies will lose out as a result of AI, not to mention the second and third order effects of the technology. We expect a small number of major winners and a large number of losers, creating exactly the type of dispersion in publicly listed share prices that we love to capitalise upon as experienced hedge fund managers.

2. Finance 2.0

'Asking a banker about cryptocurrencies today is like asking a horse breeder about cars in 1900' – Reddit user

Much of the narrative surrounding blockchain technology has focussed on the cryptocurrency bubble and subsequent burst. This suits us fine. At this early stage it’s clear as mud to us which cryptocurrency will win, or which company will benefit most and leverage the technology to its fullest. We believe the crypto market needs time to develop and visibility will improve as we move forward and action consolidates around key players and blockchains, but make no mistake, we see this as one of our generation’s great opportunities and a source of great wealth creation – and destruction. We will be on top of this theme as it evolves and be ready (from a multi asset perspective) when we feel the opportunity is best.

The seemingly distant threat of cryptocurrencies is not even the most pressing threat to the banking establishment. Alternative payment systems are already here in the form of an emerging fintech ecosystem catalyzed by Alipay and Wepay in China and are being driven home by a new breed of startups in the West, like Revolut and N26. Whatsapp is also copying the Chinese strategy and launching its payments strategy in India for example (ironically to compete with the Chinese, who have been there for some time).  

The financial services industry is changing from top to bottom (refer our piece on the Future of Asset Management). And while it’s unclear right now who the winners will be, what we do know is that there will be LOTS of losers. We expect the traditional banking system to be severely challenged and this creates a fantastic opportunity across Emerging Markets where we expect changes to be felt most profoundly. Goodness knows why nobody is talking about this.

One of the largest components of the MSCI emerging markets index is banks and many of these are large, cumbersome, slow moving and poorly managed. What’s even more interesting is that the age-old argument in favour of owning these banks and paying premium valuations is that they are growing rapidly due to changing demographics in EM. But what happens if alternative systems emerge to address the burgeoning middle classes and the growth takes place outside of the traditional banking ecosystem? What happens is that real money can be made on the short side for us and our investors!

3. Competition for time

'I really think our best way is to win more time by having the best experiences in all the things that we do.' – Reed Hastings, CEO of Netflix 

‘Free time’ is a misnomer. Time, it turns out, is not free. Once we accept this insight, things get very interesting.

When were you last bored? Every evening we go home and face a choice of what to do with our time until sleep bridges the gap to the next day. A decade ago it was simple - watch TV (whatever’s on), read a book, go to the gym, head out for dinner or perhaps catch a movie at the cinema. Falling access costs and the rise of new media forms (both formats and distribution channels) has led to a content revolution. We now have access to world class content, available at our fingertips, anywhere and everywhere. 

Competition for our attention and our time has reached record levels. Today we can choose to watch a show on one of many platforms, from Netflix to Amazon, to traditional TV. We can read any book at any time thanks to Kindle. We can play increasingly sophisticated video games, we can bring the casino into our homes, the choices are endless. So much so, that we risk becoming paralysed by choice.

What’s happening is that there is now not only cross platform competition for our time, but also cross-sector competition. The opportunity cost attached to watching another episode of Game of Thrones is reading or watching an investment research piece, or listening to a podcast. Three Body Capital is competing for your time with Netflix and Fortnite. Netflix’s CEO Reed Hastings has observed that his biggest competition for your time isn't other streaming services... it’s sleep!

This theme gives rise to multiple investment opportunities across Emerging Markets, both on the long and the short side, as content increases its penetration into people’s lives, displacing other activities and stealing wallet share.  

4. The Great Game

'It was the rise of Athens and the fear that this instilled in Sparta that made war inevitable.' – Thucydides 

There was a time at the turn of the millennium, after the Asian financial crisis and the fall of the Berlin Wall, when the Washington Consensus movement drove a fairly uniform shift in policy across Emerging Markets to pro liberal, free-market, reformist policies as initiated, encouraged and proliferated by the USA. 

This trend ultimately gave rise to the Emerging Markets asset class as we know it. It’s a category that lumps together all countries which are classified as ‘developing’, according to a set of criteria decided by MSCI. We believe this method of viewing and classifying markets is dead. 

The last decade in particular has been characterised by the rise of China, not only as an economic powerhouse, but rather of the Chinese system of governance and international relations. This alternative approach to the US model has been gaining as a counterweight in a multipolar world. Unlike many other observers, we believe that the Thucydides trap, albeit a possibility, will not be the most important development to watch for. China vs USA is not a zero-sum game and we believe both countries will continue to get stronger and increase their dominance over the rest of the world. This will force other countries to loosely choose between the American way and the Chinese way.

This widespread process of ideological change and adaptation will lead to an enormous bouquet of opportunity for us in terms of sector and stock specifics across emerging markets.

Blurred lines.

As a team we have always been intellectually curious and eclectic in our approach to gathering information, ideas and investment theses. Our core themes are not an exercise in reductionism. We know the world is unimaginably complex and interconnected – it simply doesn’t operate along clean lines and discrete categories. There will be many other themes embedded in our ideas and portfolios but the ones we have discussed will be the biggest as we start out.

Perhaps the biggest opportunities for us as investors will lie in the blurred lines between our themes, where disciplines overlap each other.  

For more detail on our ideology and process, feel free to get in touch. We'd love to hear from you.
  
Beyond the obvious.
+How I bought my first security token
+China’s massive Belt and Road initiative
+OneWeb just joined SpaceX and others in the satellite internet race
+One of Wall Street’s most popular trading strategies is now failing
+Nike embraces esports with League of Legends sponsorship deal