Mining Journal: How did you end up working in the natural resources sector?
Henry Steel: I am fortunate in that I knew what interested me early on. There was no obvious route into the natural resources sector for me though when I had some time off between school and university, I wanted to take the opportunity to work for a mining company, preferably in Russia as I had studied Russian for a few years at school and loved it. It was hard to know where to begin so I simply emailed the CEOs of the world's largest mining companies telling them a bit about myself, my ambitions, and requesting an internship. I was slightly shocked at the response: Rio Tinto took me on for some time in London, De Beers in Moscow and Anglo American in Johannesburg and Kinshasa. It was a complete adventure at the time and I greatly enjoyed it.
I had always stayed in touch with previous employers and during my final year at Oxford University I interviewed again with Rio Tinto and managed to secure what BP would call a ‘turtle role', that of the executive assistant. I had read a lot about the role at BP and also that Harry Oppenheimer had given out such roles at Anglo American. I viewed it as a great entry point into the industry given the access and education I would get under an executive I hugely respect.
During my time at Rio, I was offered a scholarship by London Business School to complete their Masters in Finance program part time. When that finished, I joined Odey.
MJ: Why do you think there is so much opportunity for investing in the mining sector now?
HS: Over the last 10 years, investors have seen a huge amount of capital destruction in the natural resources sector. Not only has the natural resources index fallen over that period, but further, the long-only household name institutional funds covering the sector have generally underperformed their indexes. It has been the perfect storm.
All of this has caused financial capital both to leave the sector and to rotate from active funds into low-cost, passive ETFs. Hence we have seen buy-side and sell-side teams shrink, resulting in a huge brain drain from the sector. The sector is now very unpopular with everyone, whether buy-side, sell-side or new graduates thinking about their career. It is therefore vastly under-researched and hence many traded securities in the space are hugely disconnected in both directions from their fair value.
In my view, this has created a big opportunity for those with the right toolset to take advantage of, and is exactly what I seek to do with my fund.
The empirical evidence is certainly there - the sector has one of the highest dispersion of stock prices relative to other sectors - and so far we have seen strong returns because of this.
MJ: As an investor, how do you think about the risks of investing in the sector?
HS: For me, there are risks one wants to be taking and risks one does not want to be taking. We want to be taking risks where we think we have an edge over other participants in the market, and we do not want to be taking the risks where we don't.
For the fund, the risks we don't want to be taking are commodity price risk and macroeconomic risk. We don't think we have any edge whatsoever over the direction of a commodity price, nor about the macroeconomic outlook of the economy, and hence these are not risks we want to expose either ourselves or our investors to.
However, we do want to be taking stock specific risk - that is the idiosyncratic risk associated with a single stock.
We spend all our time researching companies and engaging with management, and we do not want to be distracted by outside noise.
It takes 6 or more months of research into a single company before we will take a position in it, and engagement with the management of that company is key. I certainly find that management who are willing to engage and debate on the detail of their company are, by far, the highest quality, and are the ones who have delivered the biggest returns for the fund. It seems obvious that management who are transparent, want to show off their company, up for a debate and know the details inside out, are the top quality ones, but there are actually only a few of them in the industry like this. Unsurprisingly, they are also the ones who have personally been the most successful, as well as their company.
My portfolio is therefore constructed around this core philosophy, which translates to a portfolio with a balance of longs and shorts, which uses commodity futures to strip out any residual commodity price risk.
We are acutely aware of not replicating factors in the portfolio. For example, a portfolio with small positions in BP, Shell, Exxon, Chevron, Total, etc. might look like it is diversified but the reality would be that it was hugely exposed to just the oil price, with little stock-specific risk and big single-factor downside risk.
The right checks and balances throughout the investment process are also essential - for us this includes a review of our investment cases by an advisory board of former industry CEOs and CFOs who also have their own personal capital at risk in the fund.
MJ: What concerns you about the mining sector at the moment?
HS: There is a strange paradox that rapidly rising commodity prices are in fact the greatest danger for the industry. Rising prices reward poor quality management, poor quality assets and poor quality balance sheets the most, given the inherent leverage in such businesses.
Rapidly rising prices also create an environment where shareholders push management to grow, both organically and inorganically, which not only destroys shareholder value through management overpaying for other businesses but also through pushing more supply into the market.
I have seen this repeatedly since I began working in the industry and nothing will stop this, it is simply a mixture of misaligned incentives and a classic example of a capital cycle.
To a large extent, it means investors in the commodity space will not see a decent return on their capital over the long run, which is depressing for those invested in long-only natural resource funds.
MJ: How does ESG feature in your investment philosophy?
HS: ESG is nothing new to my investment process. In fact, E, S and G are three of the many components that are core to any investment, whether in the public or private markets, and are just one part of our investment process. I struggle to see how any fund manager can argue that E, S and G are somehow exclusive to the investment process of any company or can be outsourced to a separate "ESG team". If one wants to achieve long-term profit maximisation, particularly in the natural resources sector, all stakeholders must surely be aligned.
MJ: Shorting stocks is controversial. Do you think it adds value to society?
HS: There is generally a large misunderstanding of how shorting works. Most outsiders see it as hedge funds making profit at the expense of other investors, and that somehow short sellers are the cause of permanent share price falls, but the reality is actually far from this.
Some advocates of short selling believe the practice provides for a more efficient market: there are more buyers and sellers in the market, but that isn't the reason it adds value to society in my view.
Personally, I find it more than perplexing some of the lies that some companies are willing to tell in order to boost their short term share price.
Short sellers, particularly those who air their views publicly, help to educate potential buyers of the stock about the reality of the facts. That way, short sellers can arguably help prevent potential investors from stumbling into bear traps, and keep management in check.
Also, to some extent they also help police the financial markets. For example, a shareholder of a company isn't going to report management to a regulator for fraud, they will simply sell the stock if they uncover it, but a short seller may well do so.
Outside single stock shorts, shorting, using commodity futures can also help reduce the volatility of returns and allow us to focus on the stock specific risk and strip away risks we don't think we have any edge on, such as market risk and commodity price risk. This helps the fund deliver strong risk-adjusted returns that are uncorrelated to any other asset class - which is what investors want, and are willing to pay for.
MJ: Which stock are you most excited about in the space from a long perspective?
HS: Difficult question! As you can imagine, there is a strong competition for capital in a concentrated portfolio. At a push, I would probably say I'm most excited about Labrador Iron Ore and Inter RAO, and have case studies for potential investors wanting more detail.
Henry Steel is manager of the Odey Concentrated Natural Resources Fund. firstname.lastname@example.org