Edward Chancellor is a financial historian, journalist and investment strategist. In 2008, he joined GMO’s asset allocation team. He graduated from Trinity College, Cambridge with first class honours in Modern History, and from St Antony's College, Oxford with a Masters of Philosophy in Modern History. He is a former deputy US editor for Breakingviews.com, and worked for Lazard Brothers in the early 1990s. Edward is the author of Capital Account, Devil Take the Hindmost, and Capital Returns.
Let’s start with the basics: what is the Capital Cycle theory? I’d seen it explained in different ways over the years, but never this clearly and obviously. I feel kind of dumb for not understanding sooner the seemingly larger investment implications of this theory. What’s a real life example that most clearly illustrates a successful investment using the Capital Cycle theory framework? Additionally, what do you make of the game theory aspects of individual companies faced with competition over-investing in their industry? How does the Capital Cycle theory of investment different from value investing? Isn’t the goal of both to buy during peak pessimism? For Capital Cycle, you’re buying when management is pessimistic and not re-investing in a low return environment. For value investing, you’re buying when the market is depressed about the future prospects of the business. What’s the difference, if there is one? Where have investors gone wrong when using the Capital Cycle theory? I’m imagining a technologically obsolete industry facing extinction, say the wagonwheel industry. At some point there were no real returns on invested capital in that business to be had. Might we mistakenly expect a low point in the cycle to rebound when really it’s heading to zero? Other than in-person meetings to determine if the subject is even on their radar, how do you properly evaluate management’s capital allocation skills? Let’s take Jeff Bezos. He’s been re-investing in Amazon continually for a few decades with very distant future return prospects. Is that good capital allocation or madness? How can we tell the difference?