FINANCIAL REVIEW – Australia
GMO co-founder Jeremy Grantham.
Why should long-term smart investors be worrying about Morocco’s near monopoly of phosphate and the effects of the US putting ethanol-based fuel into energy-guzzling SUVs?
The same reason they should be worrying about Egypt: it all is part of the world’s intractable problems of feeding everyone by 2050.
GMO chief Jeremy Grantham has returned to his big picture fears, which he revealed more than a year ago, that the world is facing a major food crisis in coming decades. And he is taking his fears seriously, suggesting long-term investors aim for 30 per cent of their assets in resources – and that they should be preparing for reduced long-term portfolio returns.
He argues the estimated increase in food consumption by 2050 to keep up with demand “is just not going to happen” given the difficulties faced. Long before an extra 60 per cent rise in food output is reached, “rising prices will have made food too expensive for hundreds of millions”, Grantham says.
To balance the books, the entire world must consume less meat; it must cut food wastage; and major food-producing countries will need more investment in sustainable production.
Poorer countries also need to curb population growth but Grantham’s pessimistic conclusion to all the challenges is: “The main contributor to reducing the food imbalance between supply and demand is once again likely to be price: more of the poor will eat less and some, regrettably, will eat nothing,” he says.
If it were just a case of more starvation in poor countries perhaps a few hard-hearted investors might not be worried.
But if food pressures are followed by rising fuel prices, he forecasts “the risks of social collapse and global instability increase to a point where they probably become the major source of international confrontations”.
Rich nations could do more. Grantham says putting a single tank of pure ethanol into an American SUV displaces enough food calories to feed an Indian farmer for a year.
Then there are the effects of climate change – droughts, floods and extreme heat – which have proved more devastating for food production than rising global temperatures.
With this bearish view on food, he is very bullish on resources – more so than he was a year ago. In his own foundation, Grantham is moving to a target of 30 per cent in resources, comprised of: 15 per cent in forestry and farms, 10 per cent in what he calls “stuff in the ground” and 5 per cent in resources efficiency plays.
He prefers forests and farms as they benefit from rising commodity prices, rather than mining and oil companies, which need to keep replacing their stock in trade every year. He would not buy coal and tar sands since it is likely their use will be curtailed as climate damage becomes increasingly apparent.
Despite the rise in metal supplies and some slowing in demand, Grantham still expects a sharp rise in resource prices in real terms, enabling resource stocks to outperform the market.
While he is cautious about the immediate downside risks in resource stocks (“downside results have a disturbing habit of being twice what you counted on”) he recommends investors take a seven- to 10-year view and average slowly into resources over a one- to three-year period.
He is convinced rising resource prices will worsen the prospects for the balance of someone’s portfolio, by squeezing profit margins and reducing overall growth.
And lower overall GDP growth may mean lower returns on all capital, which could have serious implications for longer-term investors, such as endowments (especially in the US) and pension funds around the world.
What kind of companies might be better placed to absorb this pressure from higher resource stocks? Grantham says GMO prefers quality stocks with lower resources costs as a percentage of total revenue and a higher base from which to resist pressure on margins.
Smart investors will be questioning whether big investment institutions will acknowledge the long-term fears and adopt a similar approach to Grantham.
He admits in his letter that GMO as an institution can’t impose 10-year horizons on its clients.
The reason is that any investment manager taking such a different long-term view creates too much business risk for a company or career risk for individual managers. As an investor, it’s safer to be wrong – as long as you are in the company of other managers.
Smart investors who have a genuine long-term view – even out to 10 years – ought to take time to consider the threats Grantham outlines. While the consequences of the world getting it wrong in the next decades may be catastrophic, the consequences for someone’s long-term portfolio may also be life-changing.
The trouble is there are many pressures working against the world’s ability to manage the crisis. And Grantham doesn’t hold back on his reasons for taking a pessimistic stance on the future challenges.
“We are badly informed; passionately prefer good news and easily evade unpleasant facts; our views are easily manipulated by vested interests; we are sometimes desperately inefficient; and we are apparently corruptible as heck,” he complains.
“It is on this assumption of ordinary, unenlightened humans that our global food outlook and, in consequence, our future political instability, looks so dangerous.”
The Australian Financial Review
BARRIE DUNSTAN
Barrie Dunstan is one of Australia’s most experienced business and investment journalists. He has been an associate editor and columnist with The Australian Financial review AFR since 1987 and specialises in superannuation and funds management. He also writes on personal investment and has published three books for investors.
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