In this week’s episode of Opto Sessions, Kiril Sokoloff, chairman and founder of market research firm 13D Research & Strategy, discusses the thematic investment strategy that has helped him to anticipate some of the market’s major trends of the past 40 years.
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As one of the first to start investing thematically, Kiril Sokoloff has made a name for himself as a thematic investing expert. The global investment strategist began investing in themes when he founded 13D Research & Strategy in 1983, a market research firm that has consistently identified the most significant trends in global economies.
“Over the last 40 years, I don’t think we’ve missed a single major technological transformation.”
The accuracy of his calls has helped the firm to achieve phenomenal success by often going against the consensus.
Sokoloff’s contrarian outlook has played a key role in allowing him to correctly anticipate some of the market’s biggest events and trends over the past four decades, from the commodities’ supercycle peak in 1978 to the internet and ecommerce boom in the mid-1990s.
Some of his most notable investment calls were made during the early days of his career, including when he correctly anticipated an inflationary blow off due to tax cuts and deregulation in the US in the early 1980s. Sokoloff had foreseen a period of disinflation and an ensuing takeover boom that nobody was prepared for.
A proven thematic investing track record
Following the success of his early forecasting, Sokoloff founded 13D Research & Strategy to be a firm that specialised in finding investment opportunities within Schedule 13D filings, which is a form filed with the SEC to disclose a person or group that has acquired more than 5% of a company. By 1986, over the span of three years, the firm made more than 178 recommendations that were taken over while using this strategy.
In 1995, his focus turned to Asia, where he identified the emerging Asian Financial Crisis. At the time, Malaysia had finished building the world’s tallest building and was constructing the world’s longest building, which to Sokoloff was a traditional sign of a major secular top.
He then understood the great opportunity China represented and co-founded the first pure Asian hedge fund, during a period where the Hang Seng rose from HK$3,000 in 1990 to close to HK$12,000 in 1993. This was followed by, among other achievements, investing in internet and ecommerce companies in the 1990s before the dot-com crash, and oil in 2002, when it was only $20 a barrel, riding the trend to over $140 at its peak in June 2008.
“Many times, a theme is investing in the solution to an economic problem. The economic problem isn’t going to go away, so it’s driven by the need to fix it.”
13D’s thematic investment strategy
Sokoloff has often found that the secret to uncovering emerging investment themes is in the smallest of details. While these developments may seem trivial and insignificant to some, he has a honed talent in seeing the impact of these miniscule factors to the bigger picture. “One of my strengths is to understand what the key driver of things is,” he explained.
He believes that the trick to identifying the next big investment trend is to pick out the single factor that will be the chief driver of a whole cycle. “There’s so many different factors, variables, countries and geopolitics that you have to be very humble,” Sokoloff said.
However, Sokoloff admits that he believes the firm’s execution on investment themes is not as good as its ability to spot the next big thing. “It’s very hard to do both well. I’m focusing the big things and that’s what I find interesting. My own view is I try to be simplistic.”
Investing in disruptive innovation
By far the biggest theme today is disruption, and Sokoloff had been at the forefront of it. In 1988, he spotted the very early signs of a digital revolution. “We understood the digital age was coming,” he recalled. “[At the time] I tasked one of my colleagues, who’s been with me almost from the beginning, to focus on what [Joseph] Schumpeter’s called ‘creative destruction’ and what we now call disruption.”
As the digital world began to take shape, it was obvious to Sokoloff that there was going to be huge disruption. “It started with the recording industry,” he explained, adding that from there it spread from industry to industry.
“We were overly optimistic about how quickly some of it would happen. I could not understand why retail bricks and mortar lasted as long as it did. It just seemed to me that ecommerce and long-distance learning were so obvious. This was 1997 and 1998. Some of these things took longer, some were faster.”
For the past 25 years, innovation and new technologies have remained a focus of 13D Research & Strategy. “Right now, [we’re watching] gene editing, artificial intelligence, blockchain/Web 3.0, the green energy revolution, 5G and technologies like that,” Sokoloff said.
An example of a recent thematic investment that Sokoloff is bullish on is electric vehicles (EVs). Instead of investing in the carmakers, though, he’s approached the space by gaining exposure to the producers of some of the commodities that are essential for EV construction.
“I look at the four metals and I see that maybe there can be a replacement for lithium or cobalt coming down. Copper is key to electrification, but I know there’s a huge deficit out there. [Personally] I’ll just go with copper, but for our clients, we recommend EV metals themselves,” he said.
An investment anomalies theory
Sokoloff has a number of theories on the markets. One of the most interesting is his anomalies theory, which involves finding situations when what should be happening is not happening or vice versa.
The best example of this investment theory was from 2002. “The whole world was in a recession and yet commodity prices didn’t go down. I thought that they should be going down and so I started studying what was going on.
“I saw that China was investing massively in huge amounts of commodities and emerging markets were ready to take off. So that was a classic [example of] something that should have been happening that wasn't that led you to an understanding of the truth.”
Sokoloff has found that today’s markets are very deceptive because they’re dominated by algorithms. “There are a lot of false breakouts and false breakdowns. There’s a lot of correlation trading going on, which makes absolutely no sense because it's based on a short history. Markets can be very, very confusing and we have to be very careful.”
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Below is an edited and condensed transcript of the Opto Sessions interview with Sokoloff.
Opto: As one of the first, if not the first individual, to invest thematically in the markets, what led you down this road? What interests you about investing in this way?
Sokoloff: “Themes are very much compatible with my intellect and are a great way to invest. I started investing in themes when I founded 13D back in 1983.
Stocks were incredibly cheap [back then] because interest rates had gone to the moon. [One of the themes that we were watching] was disinflation. I wrote a book in 1982 — Is Inflation Ending: Are You Ready? — as there was maybe four people who believed that disinflation was possible in early the 80’s.
[At the time] bonds were the best investment you had ever seen in your lifetime. That’s what got me into thematic investing, and it’s just ratcheted forward… But as a firm, we [cover] a lot of different themes, so I have a large group of analysts who are doing their own theme work.
[Since then] there’s no question the game has changed… The odds favour a very hard recession, and the Fed is making a massive policy error. But as I say, you have to be flexible based on the market’s action. I might change my mind. We have to be very flexible and humble.”
Opto: What are your thoughts on the exponential age, this period of rapid technological innovation? Are some companies going to shine regardless?
Sokoloff: “We’re in a period like the early 2000s, when the technology continued to advance but technology stocks did very poorly. For some reason, and I can’t explain why, one decade of outperformance leads to the next decade of underperformance. I wish I could understand it. Market tops almost always seem to happen at the end of a decade. This time, because of Covid-19 and the Fed’s stimulus, it was pushed out a year or so… I think that we are in a new era.”
Opto: Looking at global opportunities, not just those in the US, which nations do you think have the most upside potential over the next decade?
Sokoloff: “The US by far outperformed in the last decade. I would not expect that to continue into this decade… Of course, China is the largest manufacturer. It’s a dominant factor in electric vehicles, but there’s a catch 22 here and ‘Mr. Market’ is such a cynic.
If we do have peak oil and the ESG movement in effect is foreseeing the continued underinvestment in fossil fuels, the only way out is — if you’re not willing to find more fossil fuels, which we may not be able to find anyway — to go with electric vehicles.
I’ll give you a small statistic here. Of the 1.4 billion vehicles in the world, 95% of them use liquid fuel, which is oil, and 60% of oil demand comes from transportation. How many electric vehicles do you think there are? As of May, last time I looked there were 16 million versus 1.4 billion. How long would it take? There’s also a huge bottleneck in copper, lithium, cobalt and nickel. I want to invest in the bottlenecks.”
Opto: Can you please take us through your investment strategy process when searching for thematic investment opportunities using the example of how you foresaw the transformation of the telecoms industry?
Sokoloff: “It’s the way my brain works. I’ll see something that is minuscule and other people don’t think it’s important but to me the lightbulb goes off and the whole world opens up.
In 1988, I read a short paragraph that said it took 70 years to create a landline system in the UK, 50 years in the US, 30 years in Japan and 20 years in South Korea, but you could do a mobile phone system in 1.5 years. All of a sudden, I understood what this meant. It meant that all of human knowledge would be available to all of humanity and that the mobile phone system would basically spread around the world and the mobile device would be the vehicle for it.
Opto: Can you explain to us this theory of contagion and how you’ve used it when you’ve been investing?
Sokoloff: “That’s a very interesting thesis. In 2002, I read that there was a 500-year flood in eastern Europe. That was 500 years, not 50 or 100, but 500 years. Are insurance companies reserved for this kind of shift? Under my theory of contagion, if an outlier event continued one more time, then it was a contagion, until proven otherwise.
Look at what’s happening now. The UK is as hot as ever and forest fires are all across Europe. The south-west of the United States is in a drought, there’s droughts in California — the worst in 1,200 years. It just goes on and on and on. We have kept a list of all these extreme weather events rather than getting involved early on in the debate over climate change.
That’s certainly why we were able to write a report 10 days before 9/11, which was titled ‘Islamic Fundamentalism: The World’s Greatest Threat’, and we mentioned Bin Laden and so on. The reason why we were able to do that was because I noticed that there was an increase in hostilities between Israel and Palestine that had never been higher. I looked at the attacks that had been occurring in the US. The USS Cole had been attacked, the American embassy in Saudi Arabia, etc.
I saw a global contagion of these kinds of things. That’s what you look for. It’s the universe giving you the signals. But most people don’t pay attention or connect the dots. I love doing that. I’m good at it. It gives you insight into the future. The future’s all there. If you quiet the mind.”
Opto: Let’s move on to some of the themes that you focus on today. You’re watching a theme on rethinking supply chains and deglobalisation. The Covid-19 crisis has made nations aware of the risks of not having control of their supply chain and encouraged trends such as protectionism, reshoring. Can you tell us more about this trend and its repercussions?
Sokoloff: “Supply chains that are being reconfigured are very expensive and building anything these days is very expensive. Obviously, there’s a recession that may become less expensive. But essentially, if I’m right, ingredients for building factories, LNG plants, etc. keep going up.
The idea of reshoring in the US is a very good step, but I don’t think people have any idea how inflationary it’s going to be because everything is so much more expensive in the US and by the time it gets built, it’ll be vastly more expensive than what was in place in China. It remains to be seen how this will unfold, because if you’re trying to fix inflation with higher interest rates and curtailing credit use and you’re having reshoring of activity, that’s going to be inflationary. How is that supposed to work?”
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