In conversation with Seamus Murphy, December 2020
What is the ‘Carraighill Approach’, and how does it set Carraighill apart as an investment research firm?
The Origins of the Approach
The origins of our approach to investment research came about in 2007, during the global financial crisis. Up to that point, analysts generally focused on picking stocks; and research firms employed economists to tell them what was happening in each individual country. I was one of the former, generally saying that stocks were exceptionally cheap/expensive relative to their earnings growth prospects. Economists operated separate to this and focused on country fundamentals and growth.
There was limited collaboration, and often different conclusions reached. Most missed the fundamental overvaluation of property prices, an idiosyncratic risk that was present and inherent in the financial sector and property-based investments at that time. Focusing only on company earnings would have missed this and its impact.
Being based in Dublin, I was lucky enough to eventually spot the catalyst that caused the Irish property bubble to pop. This was a collapse in transaction volumes. Looking back, it was probably luck as much as skill and happened during a meeting with a real estate agent.
In 2010/11, I tried to develop a back-to-basics approach to country cash flows and how they are all interconnected. How can I explain it all simply? At the time I called it the ‘Matrix’. This was my attempt at grasping the basics of economics. In the early stages of my work, it became apparent that government and the economies in Ireland, Greece, Portugal, and Spain were going to be under severe pressure in the absence of ECB intervention. It was also increasingly clear that a crisis was coming for the Euro and the Eurozone.
In 2013 I set up Carraighill with a colleague of mine who returned from the US, Cathal Carroll. Our initial focus was to reconcile the Hungarian national accounts and the central bank/ banking system numbers. How did they all connect? This was hard, as the financial system uses IFRS,(International Financial Reporting Standards) and Economics uses ESA 2010 (two separate accounting systems). The data was vast.
Our work on Hungary was the genesis of the Carraighill Approach and for the first time we fully understood the links between the financial and economic systems of an entire country. For the largest Hungarian bank – OTP – at that time, this was important as the country was emerging as an industrial stronghold in Europe with strong household cash flow, low credit penetration, and a well provisioned banking system, and the stock had an exceptionally cheap valuation.
Identifying this structural investment opportunity set the next stage of our development – to consistently understand and define investment risks and opportunities in this way to both provide insight and make money for Carraighill clients. This is also very hard, but we knew it could now be done. We expanded the team to focus on this aim. The answer lay in a deep understanding of the data and the willingness to continue to question the status quo.
The Greek Crisis, Turkey & The Rise of Digital Payments
This proved very helpful in Greece in 2014, when everyone wanted to own the Greek banks. We went through the country top down and the individual stocks bottom up, but quickly realized that the household sector was spending more than it was earning and poverty levels were rising rapidly. SYRIZA was a fledgling party at that time, but its left-wing policies appealed to a population that was becoming increasingly isolated and poor. We knew Greece was in major difficulty – even after the first bailout, but the stock market thought differently. This position in Greece is still maintained today. We have been short select Greek banks fundamentally for a long time. Household cash flow remains negative and poverty levels high. The equity of these opportunities is probably worthless.
The lesson from this is that some of the risks in the system are not necessarily apparent in the short term, as we are all inundated with noise every day. Everyone has an opinion on what is important. The risks are also varied, and one can easily miss important insights and key vulnerabilities. If you understand the structural drivers, we have a better chance of navigating the cyclical turns.
Sometimes it can be frustrating as these interdependent factors can bubble away quietly, or even fester, for quite some time. It might be five years. It might be seven years, it might be ten years, but ultimately when those structurally influencing factors turn into the inevitable hurricane, you are ahead of it. It is just having the data available to spot the catalyst to change investor psychology. Turkey is one of these now. We think the end game is in sight. The longer-term data is telling us the direction of travel and the cyclical data suggests the hyperinflation probabilities are now much higher than normal. Interest rates must rise significantly further to avert this outcome. That may happen, or it may not. That is now a political choice, made more difficult by the much higher unemployment/ inactivity levels.
Another example of our structural view includes the rise of digital payments as an area of growth both within and outside Europe. This is due to demographics (young people) and the higher choice, quality, convenience, and price that this channel offers. This has very positive implications for the companies that provide these services, but also it influences ones view on retail property valuations. We have developed monthly data series for each country back to 2010 in nominal euro millions to follow the evolution of this trend.
Where we are Going
In addition, the data expertise developed within Carraighill at an individual country and Central Bank level has led the entire Carraighill team to become more open minded about investment opportunities in other areas. This includes non-fiat currencies, particularly gold and bitcoin. Are “We all going Turkey?” as the productivity of new debt collapses? We will review opportunities in these areas including the global exchanges into 2021 and beyond. Finally, we also structurally believe in the requirement for long-term large-scale consolidation within global banks as interest rates are likely to remain low indefinitely, and probably fall to negative territory in the UK and the US (ultimately) before an inflationary cycle takes hold. As this happens, the return profile of unprepared banks will fall in these regions.
We never stand still and try to keep learning. That is our culture. We will expand our geographic reach and we will expand our sector coverage in time.
The Carraighill Approach is our framework for thinking. It allows us to focus on individual company ideas from a very different perspective. We want to give our clients a high return of insight and ideas for the time we invest.