Bruce Flatt, CEO of Brookfield Asset Management, says going against the crowd and maintaining a contrarian approach is often a very lucrative strategy in investing, if accomplished.
He also says companies should seek profitability rather than growth, because growth does not necessarily add value.
Brookfield Asset management is a leading global alternative asset management firm with a focus on real asset sectors of real estate, renewable power and infrastructure.
Flatt says while most investors follow fashion, those who do not follow fashion but follow value tend to earn much greater returns in the long run.
He says there was never a secret recipe or a particular strategy that his firm followed over the years to become successful in real asset investing. It was based more on a value thesis, where his company tried to learn and develop a strategy that worked for it.
“The number one thing that I would say to anyone is that there’s never a right strategy in investing. It’s whatever strategy fits you and what you want to do. For us, though, we generally have always operated with a methodology where we try to walk away from the cliff. One should always look for opportunity away from where the crowd is going, and not go with the crowd. In real asset investing, that’s a very important lesson to learn,” he said in a presentation made at the Talk @ Google, whose video is available on YouTube.
Talking about the investment guidelines that his company developed and followed over the years, Flatt says it is important to identify places where companies have a competitive advantage and invest in those areas.
“It is best to always invest on a value basis with a goal of maximising return on capital and look to buy assets or find assets that have cash flow inherent in them or can be built within the business,” says he.
Measure success to know where you stand
Flatt says it is absolutely essential to measure success to know where you stand against competition. There are four things that can be looked at to evaluate this.
First, companies should measure success based on total return on capital over the long term, which would prevent them from making the mistake of looking at short-term objectives within the business.
Next, companies should try to encourage its people to take calculated risks, which should be compared with the return that one might get out of the investment.
To be successful, it is also important to sacrifice short-term profit, if necessary, to achieve long-term capital appreciation.
And lastly, companies should seek profitability rather than growth, because growth does not necessarily add value.
Follow this business philosophy to become successful
Sharing his views on the business philosophy that one should follow, Flatt says it is important to build a business and all relationships based on integrity as running a business for the long term needs strong relationships, both outside the company and with the people within the business.
It is also important to attract and retain high-calibre individuals who can grow with the company over the long term and ensure that these individuals think and act like owners in all their decisions.
It is necessary to treat the client and shareholder money like it’s their own before making a business decision.
Keep business model very simple
Flatt feels it is crucial to keep the business model very simple.
Referring to his own company’s business model, he says they try to utilise their global reach to identify and acquire high-quality real assets on a value basis and finance them on a long-term, low-risk basis.
Further, they enhance cash flows and value of these assets through their leading operating platforms and source equity from clients seeking exposure to property and infrastructure returns. This strategy, Flatt says, should be repeated over and over with assets with similar cash flow characteristics.
Competitive advantage key to remain ahead
Revealing why they have been better than competitors, Flatt says it has been because they use competitive advantages in everything they do.
Although size of a company does not necessarily generate profitability, given the scale of their company, they have been able to use size as a differentiator.
The global businesses they have built over the years have enabled them to move capital to locations where it is scarce and allowed them to take ideas and turn them into actionable opportunities, Flatt says.
They have also been able to use global unrestricted funds, which have allowed them the freedom to seek value where available.
Also, people-enabled execution capabilities have given them a strategic advantage to be able to run the businesses and operate them efficiently.
“Often our investments are longer term and are more illiquid than others. So, our advantage is that we’re willing to be longer-term investors, and we’re willing to have something that’s illiquid versus what others might accept. Often they’re larger in size, and that’s not attainable by others. And most of the time, when we’re making investments, it’s not fashionable. Most investors follow fashion. If you cannot follow fashion and follow value, the returns will be much greater over the longer term,” he says.
Invest in real assets to generate strong returns
Flatt says real assets have a strong return profile to invest into, as they earn good cash-on-cash yields and can be contracted for longer durations. Also, cash flows adjust with inflation or by other means and assets are scarce and often appreciate in value.
The private nature of these assets ensures low volatility and the returns are far greater than other options available to institutions, he says.
Flatt feels it is a very good time to be a real estate investor, as institutional capital is growing exponentially and increasing percentages are being allocated to real assets due to the returns they offer.
“The most important things that are happening is that the institutional plans are putting more money into real assets. And if you look back to 2000, the percentage in their portfolios in general was 5%. Today, it’s 25%. And we think that number will be 40% by 2030. And what’s happening with that there’s this therefore an exponential increase of money being taken out of equities and bonds going into these type of real assets as they can offer 6% to 20% returns,” he says.
Things to watch out for before investing in real assets
Flatt offers some guiding principles which he says should be kept in mind before investing in real assets.
He believes investors should buy great quality assets even if one has to pay a little more for it.
Next, he suggests investing in assets assuming they will be owned forever, an approach that would enable investors to look at them with the long-term fundamentals involved.
Also, he feels while buying a real asset it is essential to buy it at less than the replacement cost. “It most often indicates value because the competitive product that will ultimately compete against you will cost more than what you paid. So you should be able to either earn a higher return or out price your competition during the investment. And that’s probably the number one thing, which is why in our business what you’re always trying to do is to move your capital to the places where others are not,” he says.
Flatt also warns investors to avoid misfinancing their assets as it is of utmost important to ensure surviving the market downturns.
While looking for investment opportunities investors should look to acquire assets where capital is scarce as it is the best indicator of the right time.
“In 2016, we bought a graphite electrode company in the United States out of bankruptcy. And at that time, the steel market was incredibly under stress. But we were able to purchase it and it was really only because there was nobody else in the market that would put capital into the steel industry at that point in time. We’ve now taken it public at eight times the price that we paid,” he says.
Flatt advises investors to keep a balance between being too positive or too negative while investing in real assets. He also feels investors have a tendency of getting too influenced with news media and stories which needs to be kept in check.
Flatt believes real estate businesses are difficult to operate but hard work and smooth execution can be a key to earning decent returns.
Avoid these mistakes while investing
Flatt thinks making mistakes is a very common thing in investment and it is important to learn quickly from them to avoid huge losses.
“It’s not possible in investing not to make mistakes. So we try to limit the number of mistakes and try to limit their effect,” he says.
Flatt lists out some of the common mistakes that investors generally make.
According to Flatt, investors get attracted towards a bad business believing that it will be okay if acquired cheaply.
Also, often investors start too large in a new business or a market leading to losses later.
There are times when investors get the compensation incentive plans wrong and occasionally they are not as strict on the financial covenants in an up market as they should be.
There are also times when investors take on an undue development risk in unstable or new jurisdictions.
Various investment opportunities lie ahead
Flatt believes that the world around us is constantly changing and is continuously growing and evolving which has opened up various opportunities for investors.
There are significant retail real estate opportunities and the integration with retail and the internet will bring significant opportunities over the next 10, 15 years, he believes.
Secondly, there is a great opportunity in the renewable power industry as it has changed dramatically over the past 10 years.
Flatt also feels that natural gas revolution particularly in North America has resulted in changes across industries which is going to continue globally.
And also there are a number of real asset technologies that can be deployed to make operational improvements and enhancements within the businesses, says he.
Buy great investments and leave the rest to the power of compounding
Flatt concludes by saying that the most amazing thing that the investment world has is the compounding of return.
“The wealth that can be generated through compounding of returns is significant. It’s amazing what it accomplishes if you don’t make too many mistakes or lose capital on the way through and you just keep compounding a return. And it really is an amazing concept in the world of investing,” he says.
Flatt finally advises investors to continue buying great investments and holding them for compounding returns.
“Don’t pay taxes by selling them. And don’t look for fashion when you make them,” he says.
Source: Economic Times