The Butcher, the Brewer, the Baker — Panmure House Panel (August 2023)

James Anderson with Russell Napier, Anna MacDonald and host Merryn Somerset Webb — Edinburgh Fringe, 26 August 2023

Context. Recorded live at Panmure House — Adam Smith's only surviving home — sixteen months after Anderson left Baillie Gifford. Anderson's chosen Smith quote: "As capitals increase in any country, the profits which can be made by employing them necessarily diminish" — and his question: why has it stopped being true? On China he is unusually candid: "my level of confidence is very low... I underestimated the united degree of hostility in America." On what fund managers are for: "trying to create great companies that move the world forward." On where he is investing now: distressed unquoted companies and renewable-energy first movers.

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Context. Recorded live at Panmure House — Adam Smith's only surviving home — during the 2023 Edinburgh Fringe, sixteen months after Anderson left Baillie Gifford. Each panellist brings a favourite Smith quote. Anderson chooses "As capitals increase in any country, the profits which can be made by employing them necessarily diminish" — and asks why, for the first time, it has stopped being true (corporate profits at all-time highs, $600bn a year transferred from labour to capital). He discusses China with unusual candour ("my level of confidence is very low... I underestimated the united degree of hostility in America"), invokes Giovanni Arrighi's Adam Smith in Beijing, and closes with where he is investing now: distressed unquoted companies and renewable-energy first movers that are "becoming sustainably, in every sense, very profitable for the long run."

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MERRYN SOMERSET WEBB: Welcome to Merryn Talks Money, the podcast in which people who know the markets explain the markets. I'm Merryn Somerset Webb. This week, we bring you a lightly edited version of my panel, The Butcher, the Brewer, the Baker and Merryn Somerset Webb, held at Panmure House in Edinburgh — the only surviving residence of Adam Smith; he lived there between 1778 and 1790, dying there in 1790. We taped this panel on the 26th of August as part of the Fringe Festival in Edinburgh. And by the way, the quote that title is based on, one of his most famous: "It is not from the benevolence of the butcher, the brewer or the baker that we expect our dinner, but from their regard to their own interest."

[Merryn introduces the house, the evening, and Adam Smith — his defined-benefit pension (£60,000 a year for two years of tutoring), his bestseller celebrity, "the Niall Ferguson of his time". Her guests: James Anderson ("no longer at Baillie Gifford... chair of Kinnevik"), Russell Napier (Anatomy of a Bear, founder of the Library of Mistakes), and Anna MacDonald (UK small-cap investor). Each guest has brought a favourite Adam Smith quote.]

Anderson's quote: "As capitals increase, the profits made by employing them necessarily diminish"

MERRYN SOMERSET WEBB: And then we will proceed to talk over each other for about 40 minutes. We are going to start, we agreed to start with you, didn't we? We did. With James's quote. Right, James.

JAMES ANDERSON: Good to be here. Well, just as a very two sentence introduction to the quote, when I told Marin that I had read The Wealth of Nations, she immediately disqualified it on the basis I was forced to at university. And I think that was probably justified. But rather surprisingly, I still have the addition from 45 years ago. And I found, when looking up my quote in it, that I hadn't at that time marked it, despite marking most items on that page. So I suppose it proves how one tastes change over the course of time. But the quote is a short one. As capitals increase in any country, the profits which can be made by employing them necessarily diminish. Now, Smith at the time, in his usual manner, produced a lot of evidence for this. And he thought it was a natural outcome of the increasing competition that provision of capital would allow for. But he also pointed to specific examples of both sides of it. He thought that capital would be very highly rewarded in America because, relative to the burgeoning scale of the population and the potential, there wasn't enough capital. Whereas he cited two interestingly contrasting but still perhaps valuable examples in the cases of China and Holland as being countries which had got as far as they possibly could. But why am I interested now? I'm interested now because for all Smith's absolute brilliance and insight, and I'm not in any sense at all trying to be derogatory about that. Which is lucky, over the years. Yeah. But this is not what has happened. We are an environment, particularly in that most capitalist or oligarchic society of America where corporate profits are at an all-time high as a percentage of anything. And the standard figure, of course you can quarrel with this, is that over the last 70 years, since 1950s, went out the level where, in and of itself, $600 billion a year has been transferred from labor to capital. But before we move on to why he's been so wrong this time, isn't it fair to say that historically he has been right in that corporate profits have always been reverted in the past and writers like me and you as well Russell as well, we've been waiting, haven't we?

MERRYN SOMERSET WEBB: For profits to mean revert, i.e. the returns to capital to fall and the returns of labor to rise and things to normalise. And this is the one time we can point to where it simply hasn't happened. Corporate profits have kept rising and real wages have kept falling.

JAMES ANDERSON: There are two things, Merryn, that over the course of my career, I've assumed would revert and haven't. One is what we're just talking about. The other is the fees of fund managers. Which I would just like you on. But you know, some degree, I think it is about the raw political power of those who are in industry. And plainly that applies very heavily in America. And I think, you know, the whole current Biden phase is many ways trying to reinforce that. Some of it is about the role of fund managers themselves, which I think the rise of professional fund managers and asset managers controlling much of what's goes on. There's a guy called Brett Christophers who writes fascinating books about how the whole infrastructure, which we pay more for and get less out of, has been structurally changed. Some of it is, to my mind, a slightly less maligned feature, but is part of the business models of the great platform technology companies, which are very hard to disaggregate and drive down.

MERRYN SOMERSET WEBB: But I think it's a really important mystery and you're putting it in the context of this mean reversion one. It only makes it more interesting and I'll be very interested in what all three of you has. But I think it's one of the central least examined dilemmas of our current era.

RUSSELL NAPIER: But it is, I'm actually looking for the quote here. I try and have a quote for every occasion. And there is a section by Adam Smith that's right about this where he says that once a government, once business gets its hands on government, things no longer work like they should. And this is the road to hell, business having political power. Absolutely. And again, in the current context, I think a quote about the same stage of the development of the argument is that we should criticize workers far less for getting the rewards that he eventually regards as a good thing for the development of prosperity and companies far more. So there's been a lot written, as you'd well know, in the last 18 months about this, as how far its corporates jacking up their prices that has actually led inflation or exploited the conditions that you could in the inflation, rather than it being wage-led, which somebody mean brought up in the 1970s, it's amazing how little it has translated into higher ways. Well, in the US, there are statistics for this, which is wonderful, because they always produce statistics. So the first intervention by the state was really the Interstate Commerce Commission to try and regulate the railways that they partially at the push of William Jennings Bryan. So you can try it from 1892 today. So does anybody want to guess which president had the most actions to try and break up all agopolis, effectively reduce the power of the corporation and effectively reduce, be a catalyst for mean reversion? Do we have anything to do with Reagan? I think Reagan. Is there a reversal? No. Jimmy Carter. No. No? That's basically all the presidents. Dwight Eisenhower. Which is fascinating, because he's a Republican. But I know that his Republicans believed that to have a proper republic, the corporate couldn't be that powerful. And what was driving it was the not, it wasn't, no one ever accused the general of being anti-capitalist. It was to have competition. And I don't think we have that quote, but Smith, right at the core of Smith is competition. What is capitalism without competition?

MERRYN SOMERSET WEBB: I don't have an answer to that, but it isn't capitalism. It's a very huge reminder, thank you.

RUSSELL NAPIER: Eisenhower was the man who drove that as a Republican. And he writes a lot about how it is natural for the businessmen to want to get rid of capitalism. Real capitalism is natural for businessmen to gather together and create oligopoly. What was his final words to all of us before he left office? To be where the military industrial complex? That's a Republican speaking. Okay, so what turns it around? I mean, I've been writing for years that at some point Labour will get its power back and at some point we will see this pendulum swing because pendulums always do swing.

Carlota Perez, the state, and the CHIPS Act

MERRYN SOMERSET WEBB: And there's been hints over the last couple of years and certainly in the UK that Labour is beginning to get its power back and wages are now rising slightly faster than inflation. So do we begin to see the return of consistently rising real wages or is that impossible in a low productivity economy? Certainly not impossible. Just the question is what are the consequences of it? It's not impossible. I don't think this evidence was a high productivity economy. I certainly don't remember it as such, even though I was quite a young man at the time.

RUSSELL NAPIER: Okay, so this reset is impossible. I don't think quite impossible. So to bring in another person who's written thought a lot about this, the great 83-year-old Carlota Perez and the interaction between financial controls and power with technological innovation. Her hypothesis, and she's just halfway through a 600-page history of this, is that you absolutely need the state to come back in this context. And her argument is that, in fact, the state has always been critical in resetting the balance, but you need a state that is not controlled by the bourgeoisie or the oligopolists.

MERRYN SOMERSET WEBB: But we also have a problem in that sense at the moment that that's not the direction that the state is going in. At the moment we have a state that gets involved in more and more and more things.

RUSSELL NAPIER: Everything is that you've written about this, haven't you, the socialization of risk that the state never stops with the intervening? We're talking about intervening the way you're talking. Two different things. How do you do things or should the states stop oligopolists? They're two different things, actually. It seems more interested in the former than the latter.

MERRYN SOMERSET WEBB: Exactly. So we have the wrong kind of state? Well, currently. Currently. That sounds optimistic. No. I mean reverts. States mean reverts as well. States mean reverts as well. So it's interesting, isn't it, with the CHIPS Act and the Inflation Reduction Act in the USA, how the US is now so relying on its sort of might and its dollar power and everything to feel that there's no limit to how much debt there can be in the public sector. And in fact, I don't think we really understand what new levels of risks there are going to be around the level of debt in the US because it's not so much privately held.

Anna's quote: "Great nations are never impoverished by private... prodigality and misconduct" — China

ANNA MacDONALD: This is going to be an awful lot of public debt now. I think that brings us quite nicely to my quote, actually. Mine's a bit longer. Great nations are never impoverished by private, though they are sometimes by public prodigality and misconduct. Almost the whole public revenue is in most countries employed in maintaining unproductive hands, such as the people who compose a numerous and splendid court, great fleets and armies, and are all maintained by the produce of other men's labor. All the frugality and good conduct of individuals may not be able to compensate the waste and degradation of produce and occasioned by this violent and forced encroachment.

MERRYN SOMERSET WEBB: Okay. That was a long one. Lucky I didn't ask you to memorize these quotes. This is also absolutely true, but what are you getting at?

ANNA MacDONALD: Well, there's numerous examples where this is relevant, I think. I mean, we're just talking about one, then we could, I mentioned chips and our IRA, and we see this all over the place. But actually I was going to relate it to China, which their economy is now three quarters the size of the US is. Just to put into context the growth it's been through, it was a 10th of the size in 1980, despite having a population four times greater at that point.

ANNA MacDONALD: And we've been used to seeing 8, 10% growth in GDP, but I think what we're really surprised about now is that the economic growth has not returned in the same kind of way that we would have expected after the pandemic. Adam Smith talked about violence and forced encroachment. I mean, I think we really saw the draconian nature of what China's ever more centralized government could do during COVID. And I think that they're just making one policy mistake after another at the moment. And the more centralized power you have, the more yes-men that she has around him is going to just layer further problems upon the economic growth story of China. I think we all thought China was gonna overtake the US at some stage, but I don't even, I can't see that happening in any kind of time horizon. And I just think that this, that we have now a huge, it's still a very large economy with an increasingly policy, increased policy error. And we've started seeing big disruption in the property market, and we're seeing more obfuscation. When Chinese don't like data they're publishing, they stop publishing it. They stop publishing consumer confidence data. Just like Scotland. They stop publishing consumer confidence data in April. So, and I think it's, I think that it's just, I think there's some risks to it. I think the risk globally, we're already starting to see the effect of on more industrialized European countries in terms of their growth trajectories. But also I think that she's the way he's building is caught around. And I think if there is actual economic discontent and a growing feeling that your children are not going to be better off than you are, there could be some kind of political ramifications. And the most likely to me is that he would sort of shore up some support by invading Taiwan.

MERRYN SOMERSET WEBB: Okay, I was hoping this is gonna be a more optimistic search, I don't think that's true. Listen, let me build something optimistic out of that. What about if that means that China once again starts exporting deflation to the likes of us? And one of the great drivers behind our previous great moderation was the fact that we were getting a deflationary impulse out of China, right? And that allowed our central banks to think they were geniuses, which of course they still do, and that's fine. Maybe we'll get back to that with a little help, external help.

RUSSELL NAPIER: And that could be a positive driver bringing down inflation across the West. But yes, but also, but it's driven by very low growth. And I think that if we didn't have, for example, if we took the US out of the global equation at the moment, we'd all be in stagflation. And yes, while these deflationary impulses from China might be helpful, we're at the same time at this, we're still putting quite inflationary things into the Western economies in particular.

MERRYN SOMERSET WEBB: Russell, you're pretty depressed about China as well, aren't you? Anything positive to drag out of what's happening with the Chinese economy?

RUSSELL NAPIER: Anything positive to drag out of what's happening with Chinese economy? No. Thank you. Thanks. Look, I just mentioned debt, so that sometimes things structurally change. So we go back to 2007 as we roll into the GFC. China's debt to GDP ratio was 140%. The US at that stage is already at about 240, and I think gets peaks at 280. But we take the snapshot today, and the US hasn't actually changed much. People will be surprised by that. But China's gone from 140 to 290. So that growth that it's manufactured over the last, whatever that is, not 14 years, has been heavily driven by debt. And it's very hard to divide the public and private sector in China, but it's genuinely seems to be in both the public and private sector. So the problem with the slowdown is it's what we might call a debt deflation. The risk is a debt deflation, which is something that Irving Fisher sort of talked about in 1932. So the risk is a debt deflation. Now, no politician in their right mind would force their economy through a debt deflation, because it tends to create great social unrest. I'm going to stop here and ask you to explain. So on the upside... You have to stop and explain a debt deflation. A debt deflation is really when the asset prices start to fall and you've borrowed over the asset price. And you then have people having to liquidate to pay back the debt. That leads to actually a contraction and a supply of money because banks actually then contract. The supply of money then leads to more deflation. And this is what happened in the United States from 29 to 33. Nobody knew how to solve it or well, Fisher wrote something, but it came too late. So if he goes this route, the risk now is it's not a slowdown. There's so much debt in the system, it becomes something more egregious than that. If you had a slow-motion version, maybe it looks a little bit more like Japan has for 20 odd years. But I was going to say something optimistic. Okay, go on, let's have it. I don't think he can force his people through that. I think he's going to print a lot of money and inflate it all the way. I mean, that's where he has to end up. I think it's too dangerous even for the Chinese Communist Party under Xi, which is a very powerful organization. I think that's too dangerous a thing for him to try and pull off. So he'll try to reflect the economy, but for me that means the currency probably has to fall. Okay, and what will that mean for the rest of us? Well, I think they'll put tariffs on China. I think that's as simple as that. That economy's too big. It's too big this time to grow via a lower exchange rate on exporting. I don't think we can cope with it. I don't think we want to cope with it from this purely political economy. Well, political economy, we can't let China grow the way it has grown. So that's not economics. I think that's politics. So I think some restrictions on its ability to export its way back to glory are highly likely. This message is brought to you by Apple Card. Apple Card lets you earn daily cash back on every purchase every day. Applying the wallet app on iPhone today. Subject to credit approval,

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Anderson on China: "my level of confidence is very low"

MERRYN SOMERSET WEBB: What do you say to this, James? You've always been an investor in China or in Chinese companies, shall we say?

JAMES ANDERSON: Yeah, my level of confidence is very low in making judgments about this. We all know and Adam Smith certainly knew you could spend your entire career learning about China and still not have a clue. So I think that, you know, fund managers are used to dealing with uncertainty, but this is truly deeply, deeply unpredictable. And I don't know whether what you're talking about, which may well come about, leads to wholesale political revolution. You know, throw in another book because it has Adam Smith in title. There's an Italian-American scholar called Giovanni Arrighi who wrote a book called Adam Smith in Beijing, which in a sense was thinking through some of these issues. And the quick question you kept coming back to was would the Chinese bourgeoisie ever turn out to be in charge of the economic development of China? And I think that is a question we need to keep in mind. My one deep negativity about it, and I feel, you know, I should be honest about this, I didn't realize the implications over on, the Russian, Russell used the word politics. I think I underestimated the united degree of hostility in America towards China. One thing they agree about at the moment and the consequences of that and which, you know, ultimately back Anna to the CHIPS Act and the like is about China more than anything else. But beneath that, I wouldn't underestimate the human capital. And again, I think this is quite consistent with what Al Smith would have thought about it. In fact, he goes on, this was part of the very longer quote that actually that the individual will work hard enough to try and compensate for the damage that the state does. Like the unknown principle of animal life, it frequently restores health and vigor to the constitution in spite not only of the disease but of the absurd prescriptions of the doctor. So the doctor being the state and the animal being our individual animal spirits. And it feels like that across the West as well. The industry carries on in spite of running them because of the existence of the state.

MERRYN SOMERSET WEBB: But there is by way on that matter, there's a podcast that we did a few months ago with an author called Peter Turchin about the oversupply of elites in the West. And that feeds in very neatly to this quote as well about the vast number of people now working in high status but unproductive jobs across the West. And that might get far worse with AI. Absolutely. If all these lawyers don't even have a job. And they're all gonna have to go and work in the charitable ESG sector, aren't they? A lot of them. So that podcast is very much about the way that as we continue quite rightly to educate and educate and educate, we end up with an awful lot of people who feel like they should have more status than they actually do because there aren't actually enough productive elite jobs to go around. And Peter, and not everyone in this room will agree with his views on this but this has led very much to the rise of discussions about ESG, discussions about sustainability, the rise of the third sector, the huge charitable sectors across the Western countries at the moment. Huge numbers of people are shuffling bits of paper around to possibly to some game, possibly not but not working in what we might have considered previously to be productive jobs and very worthwhile while reading. You're nodding away, but I can't believe you're agreeing with me on this.

Elite overproduction (Peter Turchin) and the export of elites

JAMES ANDERSON: Well, I think his diagnosis of the problem may well be pretty correct. I think we probably haven't got time to examine where I agree, where I differ from you on the ESG part of it. The one thing I suppose one should show and I don't know whether it came up in your discussion but if I read Peter Turchin's book rightly is he thinks that this was going to peak in about like 2024, 2025. He did think, yeah. Now I'm not sure if you put AI on top of that that he wouldn't need to push that out a bit. You know, I only think he's going to peak with a lot of social unpleasantness. But then.

MERRYN SOMERSET WEBB: And he's very interesting as well and on the way we have previously exported our elites when we've had too many of them, particularly Scotland has been excellent at educating people very well and then getting them to leave. Not as good as Northern Ireland. LAUGHTER The question is whether we have a big city log of it. Maybe they've all left. We have a final quote. I can't think of any timeways. Yes, we do need to move on to your quote, Russell.

Russell's quote: enlightened self-interest is "reason, principle, conscience — the man within"

RUSSELL NAPIER: I'm going to explain why I've picked it first so you can have it in context. So Smith is always associated with a phrase called enlightened self-interest. And then every economist in the world gets to define it and tell us what it is. So I'm going to give you what I think is Smith's definition of enlightened self-interest. And you can tell me whether you think it's the same one that is widely used by economists. And he says the following. In terms of this is about all of us. Nothing to do with economics, it's to do with us. When we are always so much more deeply affected by whatever concerns ourselves than by whatever concerns other men. What is it which prompts the generous upon all occasions and the mean upon many to sacrifice their own interests to the greater interests of others? It is not the soft power of humanity. It is not that feeble spark of benevolence of which nature has lighted up in the human heart that is thus capable of counteracting the strongest impulses of self-love. It is a stronger power, a more forcible motive which exerts itself upon such occasions. It is reason, principle, conscience, the inhabitant of the breast, the man within, the greater judge and arbiter of our conduct. Not the rational economic man. I don't know what that definition is off but it's not of a rational economic man and that is his definition of enlightened self-interest and we've replaced it with something else. And so I think there's a problem at the core of economics. Now I'm not, this is not a straw man. Economists, some of them know this. Things are changing, we're making progress but we can now make quite a lot of progress on this because of advances in neuroscience. He calls it the man in the breast so the man in the neuroscience isn't gonna help you with that but in terms of working out how we actually believe and how we're not rational and this is not behavioral finance is something much bigger than that. We can now make some scientific progress on this and begin to have a more nuanced understanding of what we do every time we make an economic transaction.

RUSSELL NAPIER: So I think it's quite exciting that we can get, I would guarantee that Smith was living in this house today spent all his time with neuroscientists trying to understand this. I mean, he would know that you couldn't perfectly understand it but he would know that we could perhaps better understand it. So that might lead us to a day when one day one economic model might actually work.

MERRYN SOMERSET WEBB: Well, no, probably not. Because the reason the economic models are wrong is because they assume this kind of automaton where all automatons and the reason that they wouldn't wanna go away from the automatons is it would make life more difficult in models but it may take us to a world where we rely less on models. So that would be in my opinion, a major step in the right direction. So not necessarily a model that works but realizing the fallacy of the model rather than betting the whole global financial system upon it which is what we've come to do on occasion.

RUSSELL NAPIER: It's interesting, we have at the moment that Bank of England are doing a big review of their models because they've been so unbelievably useless for the last forever. So they're doing a big review of the whole way in which they model but it's hard to see how without taking this into account they can make a model but it could be any more accurate. We're in the very early days of this. I don't think, there's definitely progress being made by philosophers and sociologists, neuroscientists but we're at the early stages of this. So we are trying to do something about it here in Edinburgh with that thing called the market mind hypothesis but it's a little start of it. It's a little step in the right direction but it's time we started asking the right questions. If you read this, you ask different questions of economics. What questions are we gonna ask that we don't ask now?

MERRYN SOMERSET WEBB: What questions are we going to ask that we don't ask now?

RUSSELL NAPIER: So let's say that one ran an economics course and one was teaching it in a normal way and one looked at this quote and thought, well, we're asking the wrong questions. Which of the questions that you would now want to ask? We would ask the questions as to what is the man in the breast? I mean, that's the broadest definition I can give you. How does that work? Because it's not rational. He says specifically it's not self love. It's not rational. It's principle and conscious. So how do we better understand that? Particularly in a group setting because we know it changes in a group setting and we'd be asking those questions and then the allocation of resources which is what economics is would be more understandable to all of us and the models might be less relied upon. Isn't this the bit that government is supposed to do? Government is supposed to understand a bit and overlay it on top of it? I mean, the models and the economists have captured the government. I talked about how the businesses have perhaps captured policymakers thinking like an economist.

MERRYN SOMERSET WEBB: You know, it's rational. What's wrong with rational? And you know, it's not rational because it's based upon something which is a foundational error. Well, a foundational error because it was plucked from one of Smith's books and yet when he defined it at the other book they decided to ignore it. So I think the government's also using the models or overaligned upon the models. So anything they do and anything they do to self correct potentially adds to the, let's call it the disturbance in the force sewing. It's interesting, isn't it? You know, whenever you, people talk about Adam Smith and when the beginning of all the books on him, the introduction to Wikipedia page, et cetera, they all talk about him as the father of economics, the father of capitalism, et cetera. So he somehow invented a theory when part of what we're talking about is the fact that he didn't invent anything. He simply attempted to describe the existing human condition. So when we have conversations as we have in the show before about socialism versus capitalism, et cetera, it's a misunderstanding of the fact that there's no choice in this. What he's doing is describing. And he spends quite a lot of time talking about judging how a country is performing based on how it's treating its less well-off citizens and how, and the sign of actually a great wealth and maturity of the country as if it will look after those who are, who struggle to become, who can't be economically productive themselves. But I think it's fair to say that if you cut up any of his works into article size, none of them would be published by any of the economic journals that you need to dig.

What are fund managers for? — "trying to create great companies that move the world forward"

JAMES ANDERSON: And Russell, I found what you said to be fascinating and trying to think it through. But doesn't it also apply to us and as you have been much of your career as practitioners of finer? So we're not just as much a prison of a certain ideology. I mean, my view would be that we absolutely need to get away from this view that success as a fund manager is defined by whether you've outperformed by your peers in the last three months or even last calendar year. And that what we should be here for is trying to create great companies that move the world forward.

MERRYN SOMERSET WEBB: That's what we're for. We've financialized everything.

MERRYN SOMERSET WEBB: I only half agree with you on that. I think I'm making progress. Absolutely. Yes, the fund manager is there to make sure that capital is directed towards companies that will do great things and improve the world, except what you say. But they were also there to invest in such a way that the likes of us get up four or five percent every year and survive our retirements. And these are different things and youthful very much on one side, but most of my readers are not necessarily looking to invest at the beginning of great companies. They're looking to get their five or six percent of existing companies that are being run in a reasonably good way.

JAMES ANDERSON: I think, as ever, you put it extremely clearly, the differentiation. But to quote somebody else, a frequent visitor to Panmure House, John Kay, who is not involved in much of the economic sophistry that's come to dominate us, aren't you better, Marin, getting to that return by having both an adequately diversified portfolio, but above all, that obliquity comes into this. If I try and make my company's share price go up, it doesn't happen. If you try and help build great companies, at least sometimes it does happen. So, you know, I'm not sure and this would take much longer

RUSSELL NAPIER: We need more time than we have for this, yeah. But if we had Smith sitting here and James and I described how capital is currently allocated by the system and Smith was there and then we stopped and he'd say, what do you call this system? Because he wouldn't call it capitalism, particularly the index fund. You know, the idea that that's the efficient allocation of capital. We got so far away from the efficient allocation of capital, he wouldn't know what it is. I really don't think he'd know what it is.

Anna: UK small caps — "unbelievably unrewarding"

MERRYN SOMERSET WEBB: More than half a day, what would you call it? I'll have to come up with a pithy name for it. You're good at this. I'll come up with a pithy name. I think we can do this. Anna, you've always invested in a different way. I mean, this has been your job is not to go anywhere near index funds or companies that are going to provide everyone with their free 4%. But you're actually always worked at the coal phase of doing exactly what James is suggesting, getting into smaller companies that are doing interesting things at the beginning.

ANNA MacDONALD: Is that for you that's real investing? It absolutely is. But over the last couple, two, three, four years in the UK, it's been unbelievably unrewarding. And the UK market has gone over the last decade from about 9% of the market to about 4% and the sector, the part of that, the mid and small cap sector is even smaller. And it's been extremely dispiriting. And I can't actually, it's quite interesting if you global allocators don't seem to consider it even though it's quite cheap, a very interesting place to be. Occasionally, a stock will get bought, but that actually just sort of de-equitizes this market even more. But they're wrong, aren't they? Because there are lots of really great, small companies in the UK. Yes. There's a fantastic, innovative, creative. There is, absolutely. But it just doesn't, is not being recognized by valuation. Undervalued. And it's very, if we're talking about the listed public sector, it's very dispiriting. And it's the, I think management teams they perhaps don't see their future on the public markets because of the way that there is this, just it's some quite relentless selling pressure that's been experienced.

MERRYN SOMERSET WEBB: And there's also not been the same kind of long-term given or the patience that's required by investors perhaps because they have, you can see unbelievably dramatic stock price reactions to any kind of disappointment, and doesn't this, I'm one of the things that we talk about a lot in my columns, in my podcast, and with all of you, it's about valuations, which I need thoroughly disapproved of James, and that's fine. But what you're talking about is a sector in the UK, smaller companies, and I see the UK market as a whole, that is unpopular globally. Unpopular globally. Hence cheap, and as Russell always tells us in difficult times, you want to hold cheap stocks, right? Over a long time. Over a long time. They can get a lot cheaper. Yeah, and it's a tricky thing. If you can get 5% risk-free at the moment. A nice savings account. Nice savings account that raises the bar and what you might expect that you need to get from something which is smaller cap investment does tend to be briskier. Yeah. We're nearly done, so I was just going to finish up by asking each of our guests the question that I know you want to know the answer to, which is where should you put your money now?

Where to put your money now

MERRYN SOMERSET WEBB: We're nearly done, so I was just going to finish up by asking each of our guests the question that I know you want to know the answer to: where should you put your money now? Anna.

ANNA MacDONALD: What's the investment? Anna. Where should they put their money now? After talking about smaller companies, I feel I should give a shout out for smaller companies for the, as a long-term component of your portfolio, but I do also think there's absolutely no real excuse to be sitting with too much cash at the moment and that you could buy a zero coupon so it's not paying you any interest. Ten-year bond in the UK at the moment, which will give you a yield of about 4% a year and you will not pay any capital gains tax on.

RUSSELL NAPIER: So. What's it, depending on where inflation goes? Well, yeah, yeah, but you know, I think it would be better than holding cash. Probably almost anything. Russell. So I think we're trying to work out what one of the most predictable things is. So this will be the one I get most wrong. So we are going to a fully blown Cold War with China. As long as Xi Jinping is president of China. So if that is true, you'd buy old economy stocks in the developed world because for a prolonged period of time, they will be very profitable. That will lead to massive investment that hopefully James's companies can, the three companies he's mentioned can do this in a low carbon way. But, you know, there was a lot of stuff we're not going to be buying from China now for a very prolonged period of time. And China has destroyed returns for lots of companies. I say old economy, it can be anything. So I should just rephrase it. People who've competed with China and seen their returns destroyed by China, we should be looking to invest in those companies.

MERRYN SOMERSET WEBB: So by UK manufacturing. You almost said that for a while. Yeah, or maybe even steel. Steel, decarbonised steel. James, what should we buy now? What's going to make us rich?

JAMES ANDERSON: Well, yeah, I absolutely accept your critique of my position. And, you know, it's really important that you have what suits your own circumstances and you have an adequate mixer in these things. But I just mentioned two areas. And I think of incredibly interesting. And in some cases, they do combine the two. The first one, and you've written about this at various points, I think this wholesale reversion from buying unquoted and young companies is just leading to some extraordinary bargains in what's going on. And for any company now doing worthwhile tasks trying to refinance itself, there is so much power on the part of the owners of capital that the valuations are frivolously low. So I think there's that. The second one, which actually, I promise you, I genuinely do think this. It's not just to try and cheer people up. I think one of the least noticed features of the last five years has been that actually companies involved in renewable energy technologies and those revolutionizing industries, like the ones I was talking about, have gotten a position where their profitability and their advantages from first being first movers are genuinely very striking. Tesla is the most obvious example, but it's not just that. And I think this is partly, and it may even come back to my quote, because there are so many traditional investors who won't put capital into this. The whole venture capital industry in Silicon Valley hates the fact that you have to build physical assets rather than just having a piece of software. And so I think that actually these technologies are both working in driving down the costs of decarbonizing technologies well below traditional fossil levels, but also the companies who are actually being brave enough in inventing the future are becoming sustainably, in every sense, very profitable for the long run.

MERRYN SOMERSET WEBB: And I think there is a huge amount to be done in that work, which is partly why I'm investigating it. Okay, optimistic note to end on. I'm afraid we do have, and I've already run over by a couple of minutes, and I can see Caroline looking at me. So we have to stop there. Any other urgent questions to pop up and ask us at the end, but all that remains is to say thank you so much to my guests who I think Adam Smith would thoroughly have approved of.

[Closing credits and promos omitted. Panel: Merryn Somerset Webb, James Anderson, Russell Napier, Anna MacDonald; recorded 26 August 2023, Panmure House, Edinburgh; produced by Bloomberg / Merryn Talks Money.]