Ardevora’s Lang on thematic changes to his portfolio

Ardevora Jeremy Lang

Investment, at its simplest, is about risk and reward. For us, risk is driven by how well management behaviour fits a company’s current environment. For reward, it is driven by how well either investor or analyst behaviour reflects those risks. We think behaviour is not solely governed by rational reasoning.

As we pull our thoughts together, patterns can emerge, linking the reasons why management, investor or analyst behaviour looks interesting for groups of stocks. Following a recent portfolio review, a couple of themes have emerged: changes in the semiconductor industry and the impact of leasing on the automotive industry.

Making chips (semiconductors) used to attract the wrong sort of management behaviour. High growth opportunities would bedazzle managers into taking risks, often with disappointing results. Part of the problem was a relative imbalance of power between chipmakers and those who use them.

The chip industry was initially dominated by demand from computer makers, then by mobile phones. During the computer era, Intel harvested most of the profits, leaving the rest to feed on scraps. During the smartphone boom, the rapid dominance of Apple and Samsung gave them considerable bullying power over the industry, making it tricky for chip companies to secure consistently good returns. Throw in the TMT boom phase of the late 1990s, and the combination has made for a tough, disappointing period for most since 2000.

A lengthy period of disappointment can batter management behaviour into an unusual shape. In our view, the majority of chip businesses have adopted behaviour more consistent with modest ambitions, consistency, and stability.

Instead of chasing growth, many chip firms have shifted focus to building safer, stronger, less risky businesses. There has been a wave of consolidation, creating larger, broader businesses. Further, new markets have opened up as chips become imbedded in more equipment, from lights to cars.

While there are still a few commodity-like chipmakers around, the industry is typified more by large diversified companies, making a plethora of specialist chips for a widening array of niche applications. Behind them, strong, robust companies have emerged, making the machinery required to make chips.

These companies have also indulged in a wave of consolidation, strengthening positions in particular niches in the production chain. The result is that profitability has gone up, and risk has gone down throughout most of the chip production chain.

The other theme throwing up “odd” looking stocks is car leasing. A pattern of rising profitability and lower risk has emerged in parts of the car sector. Making car components used to be a risky, low profit margin business, but two trends have altered risk and profitability since 2008. First, like in chips, there has been a wave of consolidation, creating strong niche businesses. Second, the rising use of automotive leasing has changed consumption patterns for cars.

Leasing changes the psychology of a car purchase decision. Instead of an angst-filled, intermittent, high-cost decision involving a trip to a bank and the sale of an old car – buying a new car is increasingly like a monthly subscription, with an upgrade trade-in at the end.

The shift seems to have encouraged consumers to trade-up to more expensive, feature laden cars. More value-added, feature-orientated component makers have benefitted. Some car makers have also done well – generally the premium branded Germans – but they have had to build very large financing operations to accommodate the shift to leasing.

Leasing, in our experience, is an activity prone to optimism bias, especially if the lease is provided by the same company as the product. There is an incentive to be lax on creditworthiness to shift your product, and to make over-ambitious assumptions on residual values. Hence at this stage, it looks much lower risk to play the positive impact of leasing through appropriately positioned car component makers.

Jeremy Lang is founder and partner at Ardevora Asset Management