Executive Summary:

For more details please refer to our recent refer to our recent Fossil Fuels at a Time of Transition paper.


There has been a shift in the investment environment over the last few months. Having dominated Value for the best part of a decade until November 2021, Growth has since underperformed Value by 14%. This has been epitomised by the fortunes within market sectors: the two sectors that delivered the best returns in the prior decade (Technology and Consumer Discretionary) have delivered the lowest returns since November 2021, down 11 and 13% respectively.

Many investors, recognising the elevated levels of risk in global equity markets, are now considering Value as an alternative to Growth. That makes sense – long out of favour, the latent potential within Value is considerable. However, we would urge some caution. Not all Value is the same – not all will do well in the environment we face. Investors might wish to dig a little deeper into the Value they propose adding.

In this note we take a concise look at the new investment environment, its impact on equities overall, the many facets of Value and why we expect our risk focused quality Value approach to deliver strong performance (absolute and relative) from here.

Please find our more in our Investing at an inflection point paper.


What would you do to improve the way the global corporate system works?

At Kennox, we see great strength in the current corporate system, which includes the creation, growth and interaction of an enormous range of companies. Whilst there are unquestionably significant problems, these corporates are an essential part of the market-based ecosystem that has steadily increased living standards for so many across the globe for so long.

For this system to continue and to thrive, it is imperative that (enough) investors focus on risks over the long term. Decisions that risk this long-term sustainability should be discouraged, and ones to protect it encouraged. It’s not that every player needs to think in the long term, certainly many won’t. But there needs to be a critical mass of considerate and balanced long-term investors – these are essential to protect the benefits that so many individual companies, and all together the entire corporate and market-based system, bring to society.

What needs changed? Here are a few concrete actions that Kennox would suggest that would encourage this long-term thinking and behaviour:

The corporate system isn’t broken but it could certainly do with improvements. Let’s think ahead and protect it.


Kennox suggests that there might be other ways to view ESG and inflation than the accepted narrative currently in the markets. Maybe it makes sense to consider the idea that wishful narratives are crashing into the inevitability of hard realities.

Perhaps the situation with natural gas in Europe is a good example for ESG. A widely-accepted narrative recently has been that natural gas has no redeeming features, therefore no one can invest in the supply of gas (witness the dramatic drop off in capex across the industry in the last few years – almost a trillion $ at peak down to $450bn pre covid and an estimate of $350bn in covid). That looks like wishful thinking – there is currently no scale affordable alternative to fossil fuels. Obviously, but inconveniently. Does it not look like many investors are assuming that buying a highly-rated ESG fund will solve this prickly little dilemma? The real ESG question is how much pain we want to take as a society, and who should bear that – questions along the lines of can we consume 20% (or 40%) less energy? Should our energy be 20% (or 40%) more expensive? How do our hospitals, ambulances, and fridges deal with intermittent power? Etc. This has enormous societal implications, so let’s at least talk about the real issues – not the distraction of how the rating companies have come up with Telsa as ESG-brilliant and Shell as ESG-uninvestible. It is just a distraction from the bigger question.

On inflation, we at Kennox have neither economists’ nor academics’ biases, so let’s go back to the very basics. What if inflation is too much money hitting too few goods? And what if this money comes from the enormous leveraging that the world has undertaken in the last few decades (the Institute of International Finance global debt data is not a bad place to look here, especially the bounce in the pandemic)? This would explain why all asset prices look expensive, with bonds especially inexplicable in our minds. If this money is all an illusion (or a wishful narrative as per above), then the only two ways back to reality are inflation or asset prices falling – these are the only two ways to realign the financial system and the real world, ie the narrative to the hard realities. So to the key question: is this much global leverage sustainable? That is what the market needs to consider on inflation – and worry a lot less about “transitory” or not, 2% or 4% yoy, CPI or RPI? No one can know the answer, whatever they say, but having all your eggs in the “it’s all fine” basket looks a bit less than comfortable (to us certainly).

What is interesting is that it is possible to position in such a way that can benefit from these situations. In a market that looks very pricey, we can find investments that look very inexpensive. In a world of eye-wateringly high leverage, our portfolio has dramatically less leverage than the market, and very low absolutely, with, for example, half the companies having net cash on the balance sheet or negligible levels of net debt. If there is inflation, some of our companies do well, not simply avoiding being hurt, with energy or gold mining holdings being examples. It is this type of non-consensus thinking, and the stomach to take and hold positions in the face of market pressure and fashion, that affords this type of opportunity (for a bit more colour, please refer to the 3Q21 Quarterly commentary).


Kennox’s investment style is logical, sensible and powerful, built upon fundamental human behaviours. Psychologists and behavioural economists observe that not-entirely-logical traits and irrational quirks slip regularly into human behaviour. For Kennox, key to note are that people:

This behaviour leads to opportunities where the financial markets overshoot – and where Kennox can take advantage. Judiciously practiced, bargain-hunting value investing exploits these opportunities.

Kennox seeks out the pricing/valuation advantages that arise from these quirks. There are stocks where the market prices in a negative- to terribly-negative outlook but where the much-more-likely outcome is more benign (or even positive).

Most often for Kennox this is exhibited in the form of short-term headwinds. The extrapolating mind of the market views any headwind as an ominous and permanent risk. This gives a price drop. This price movement transforms into a genuine opportunity only when we assess that the headwind is temporary and the long-term risk profile has not changed – or even improved, as survivors face decreased competition. Kennox refers to this as the J-curve, where temporary headwinds turn to tailwinds as the industry eventually cuts backs supply and/or demand recovers.

As these investments involve short term operational risks (ie the uncertainty or extrapolation that gives the price opportunity in the first place), we aim to minimise other risks (buying sector leaders, with conservative management, low leverage, etc). This ends up with very strong risk-adjusted return profile – ie we can have our cake and eat it too.

Lastly, as stewards of our clients’ capital, we view ESG issues as serious long-term risks, threats to the viability of the franchise. Similar to any other risks, these can be misdiagnosed by herd-following investors. Kennox is able and willing to take a stance against consensus where warranted.

This framework sounds simple, but logical and independent-minded decision making, and the fortitude to stick with it, is not easy, and should neither be discounted nor taken for granted. Kennox is able to take advantage of the market’s quirks – quirks such as extrapolation, uncertainty and herding – by being logical and methodical, patient, and most importantly, entirely aligning our investment process with our beliefs in the world around us.


Intractable societal problems are complex, and any solution will involve painful trade-offs with no easy answers. “Ethical” issues such as diversity, climate change, inequality across groups or genders are especially complicated – if simple and easy answers existed, surely the problems would have been solved by now.

To make it more complicated, ethics are inherently subjective. Individuals can and do hold enormously differing views to each other. Which one should prevail? Groups across geographies, religions, and societies actively disagree with each other’s ethical views. And society’s ethics regularly evolve or change outright (ie opium used to be legal, US’s prohibition of alcohol, the legality of homosexuality, euthanasia).

Any solution therefore must consider a multi-ethical framework, ie there are no universally-accepted ethical absolutes.

Even in ambiguity, Kennox can have a sensible and logical framework. We lay out our thinking as follows:

Kennox & Sustainability

Sustainability lies at the heart of all Kennox investment decisions and we are signatories to the UN supported Principles for Responsible Investment.

The basis of our entire investment process is analysing the core issues for a company, both strengths and weaknesses, to best understand the sustainability of its earnings and its franchise. As long-term investors, ESG-related factors are a key ingredient in this assessment, affecting as they do the future sustainability of the company.

Start with the big picture/Is the whole industry investible or not: We will invest only in companies that bring overall benefit to society. Aligned to the 17 UN Sustainable Development Goals, if we assess that a company or an industry causes significant net harm to society at large, we will not invest at any price. This assessment is viewed as the widest balance of all its activities and interactions with stakeholders, including employees, customers, suppliers, the environment, and other aspects of society at large. For example, under this framework we will not invest in gambling, tobacco, pornography or armament companies.

Kennox must be willing to take contrarian positions: Kennox is willing to take a stance against views in the marketplace if we assess that consensus to be misguided. For instance, if we assess that a company or industry provides a service that is suboptimal on one measure in the view of the market, but overall necessary to the smooth functioning of our society at large, Kennox will judge this industry to be investible. The case for fossil fuels falls into this at present – exclusion on ethical grounds is inconsistent with absolute dependence today.

Any assessment is complex and subjective: In essence, our assessment is to consider the strategic issues that a responsible and sensible company director faces to ensure the sustainability of the business franchise, as measured over decades, not quarters. By its nature this is a complex, often qualitative assessment, and always involves trade-offs and balancing a wide range of interests. In this area, Kennox’s view is that pragmatism is worth more than idealism.

Once we assess an industry to be investible, it is important that our investee companies be responsible and progressive, especially in the difficult areas (ie fossil fuels): Once Kennox assesses an industry to be investible, Kennox will seek out the leaders and engage with them to improve as much as possible, encouraging them to be progressive.

ESG should be fully integrated into the investment process: Our investment team is fully responsible for both the Kennox ESG policy and its implementation – there is no better way to ensure that ESG is fully integrated in all aspects of our investment discussion and decision-making.


There are times in every investor’s career when the values that drive their approach are brought into particularly sharp relief. Now, as markets become increasingly distorted, is one of these times. Geoff and I have been managing the Kennox portfolio for coming on 14 years now. We have 100% of our equity investments in our Fund and are pleased to have been joined along the way by co-investors able to identify with our approach – our long-term objectives for both risk and return, where we think we have an advantage over the market and the values we adhere to as we go. (Summed up: think long term; our edge is in the unloved; enact sensible decisions; be a true steward of capital).

A few points on this:

We care about the very long-term result (10 years+) and our very long-term objectives are around the absolute not the relative. We are not distracted by short term benchmarks, i.e. the “neighbours getting rich” risk. We do care very deeply about preserving and growing our clients’ capital, in that order, and the risks we undertake to do so.

It is imperative that any investor knows their advantage over the market. Ours is to look at areas that are behaviourally difficult for a lot of investors. Many are looking for the shiny new thing, but there is great opportunity at the other end of the spectrum, in the areas that are unloved or overlooked because the outlook is obscured, where companies are facing temporary headwinds. We spend our time assessing if these headwinds are temporary or permanent. One is a fat-pitch opportunity, the other a disaster. That this is very different to what a lot of the market does (particularly at present when growth and winners have been so richly rewarded) is especially attractive to us – being fundamentally different means our style can perform even in difficult markets, the timings of which are near impossible to predict.

We spend a lot of time on research but we understand that our competitive edge isn’t going to come from knowing more about a company than anyone else. Rather, it’s how we use the knowledge. It is about being able to differentiate the woods from the trees, the important from the noise; how to balance an understanding of huge numbers of moving parts (inherent in any company in the world), mix that with the uncertainty of change in the future, take an independent view, and distil down into clear-headed decisions.

We are able to look dispassionately at the world and willing to back our convictions when we see a disjoint between the prevailing market narrative and the likely real world outcome. Our opportunities will come in the mismatch between Ben Graham’s weighing machine and voting machine. This is our advantage.

Lastly, as long term investors (our turnover is c.10%) we see ourselves as true stewards of the opportunities we find: we need and want to be responsible owners. We have no interest in micromanaging management but will speak up and challenge on the strategic and material, forcefully if necessary. We are very clear, ownership rights bring responsibilities.

We welcome all investors who share these values to invest alongside us. In the long term we are certain that these behaviours and values will be fruitful in financial terms and, we certainly hope, have a positive impact on society as well.

Charles L. Heenan, Investment Director
Kennox Asset Management


There are times when there are “fat pitch” opportunities available in the market, opportunities arising when the prevailing narrative in the market doesn’t match up to the likely practical outcomes in the real world. The market’s narrative can become beguiled by enticing but ultimately false promises, by misdirected thinking that is likely to be significantly different to the path of operations and these “real world” outcome. The wider this disjoint becomes, the “fatter”/greater the opportunity.

At present there are several such opportunities in global stock markets, but one of the biggest that we’d highlight is the current situation for energy. Energy share prices are suffering from crushing combination of two narratives: a terrible operating environment running into an ESG view of energy producers cast as inexcusable villains. This narrative looks misdirected, on both sides.

On the operating environment, there are good reasons to believe that the current operating environment headwinds are short term and will not be permanent. Fossil fuels provide about 80% of global energy needs and we do not have a scale, affordable and reliable alternative at present. It will take decades to solve the problems of finding the best new technologies, ironing out intermittency and reliability issues, and creating new infrastructure on a global scale.

The difficulties of 2020 were driven by weak energy prices due to a lockdown-induced demand shock. Lockdowns will end and the temporary dampening effect on demand will at least abate. At the same time, mentalities on the supply side have changed, and capex spend to maintain output has been savaged. Estimates of close a $1tn spent on upstream in 2014 halved after in the late teens, and was about $300bn in 2020, a third of the peak. This does not look sustainable when demand is off 5%, and that in a pandemic year. The outlook for strong players well positioned versus the rest of the industry is nowhere near as difficult as the market is assuming.

On the ESG side, climate change is a complex issue with no easy answers nor pain-free options. There certainly isn’t just one “right” answer: it will take many different approaches and angles, and it will involve a wide variety of players (including all of corporates, government, and consumers). There will be a transition in global energy provision over time, but evolving away from this 80% of our energy supply, with no clear solution even visible at present, will take decades.

In this context, we feel it is entirely responsible, indeed commendable, for companies to continue to provide a product that is essential to modern life, until this transition is complete. To deny this interim period where fossil fuels are needed is to be deluding oneself that the cost and reliability of energy is not core to modern society: heating houses, growing food and transporting it to the table, powering hospitals and ambulances, enabling clean water. If in doubt, check in with someone who has lived with a persistent or prolonged blackout recently. And it is easy to forget how much of an impact on quality of life inexpensive power can make, in the form of transport or heating or cooling or cooking, to anyone trying to live on a meagre income.  

In this world, a company like Shell looks extraordinary. Shell is working to be part of the solution, and we feel it is one of the best at balancing all the issues involved. At the same time, even in the pandemic-induced distortion, its operations continue to generate robust returns. Providing the energy to power our society, playing a core role to finding the solutions of the future, at these valuations and this level of scepticism in the market, the opportunity is enormous.


2018 saw the passing of a giant in the fund management industry, John Bogle of The Vanguard Group, who was seen as the father of passive investing. He had many interesting insights into the investment industry, one of which was to break down investment returns into constituent parts (back in the June 2013 issue of CFA Institute publication). This idea resonated with us as a useful academic exercise to help investors understand where their returns are generated by different investment strategies. It was also interesting that in the opening paragraph he says: “History shows that the long-term returns of stock markets will reflect intrinsic values – a virtual certainty. But short-term variations in that relationship are equally certain, and they can endure even over decades”. Perhaps this is only the more pertinent nearly 6 years further into the current bull market.

The theory is this; Investment returns can be broken down into capital return (an increase in the share price) and dividend yield. The capital return can in turn be broken down into two parts: a growth in earnings (i.e. assuming the PE multiple stays the same, the share price will increase to reflect the increased earnings); and an expansion of the PE multiple (i.e. even if the earnings remain the same, the share price will increase in line with the change in the PE multiple). Bogle shares a study of US stock market returns by decade from 1900 to 2010, and a few points are interesting to note. The first is that nearly half of all returns over the 110-year period come from the dividend yield (4.5% of 9.2%) with almost all the rest coming from growth in earnings. The impact of the changing PE multiple (what Bogle calls the “speculative return”) is essentially 0%. This is, of course, what you would expect over such a long study. PE multiples fluctuate over time but cannot move in the same direction forever. Note, however, that in each individual decade, the impact of the speculative return is significant, and often larger than either of the other two return elements.

The speculative return reflects a change in sentiment over the period and is inherently difficult to predict. That said, in all but two of the eleven decades, low starting valuations resulted in a positive speculative return (i.e. in years when the starting PE was lower than 15x and the dividend yield was larger than 3.5%, then a positive speculative return ensued). The two decades in which this wasn’t the case were the 1990s (where starting valuations of 15.2x and 3.2% would predict a slightly negative speculative return, but the tech bubble at the end of the period resulted in rapid multiple expansion); and the 1910s (where starting valuations of 13.6x and 4.3% would predict a positive speculative return, but WWI resulted in falling share prices).

Active investors aren’t constrained by overall market valuations and can manipulate their portfolio to take advantage of Bogle’s observations. Companies’ earnings multiples and dividend yields are known – investment decisions can be made on the basis of valuation. Looking at the empirical evidence, these same valuation metrics also provide an investor with the best possible chance of benefitting from a positive speculative return. What’s more, by manipulating the portfolio over time (by selling companies where valuation metrics deteriorate, and buying companies with favourable metrics), it is possible to maintain a portfolio with advantageous valuation characteristics, so positive speculative returns can persist over time.

Managers should also look to increase the probability of benefitting from earnings growth. There are two ways of doing this. Either by buying companies with depressed earnings (where “growth” is effectively a reversion to mean) or by buying companies that look set to benefit from strong market positions and attractive product offerings. Kennox follows the first of these approaches as depressed earnings are usually coupled with low valuation metrics (i.e. we can have our cake and eat it), whereas the second approach is usually associated with higher valuation metrics. As such, growth-based stock selectors must realise strong profit increases to avoid being diluted by a lower dividend yield, and over time, a lower speculative return.

We are writing this at a time when, for the best part of a decade, value-based approaches have underperformed, and speculative returns have favoured more expensive stocks rather than those with lower valuation metrics. This brings us back to Bogle’s opening remark, that it is not impossible for short-term variations to endure for a decade or more, but that long-term returns reflect intrinsic value is a virtual certainty. We most heartedly agree.


As Investment Directors at Kennox, we have 100% of our equity wealth in the Kennox Strategic Value Fund. Our objective is to make excellent, risk-adjusted returns for us and our co-investors in the Fund, delivering annualised performance over the long term which is in the high single digits or better (currently 9% net of all fees). At the same time, we are conservative individuals and we look to accomplish this with as little risk as possible. We believe that we have the best chance of achieving both – excellent annualised returns with limited risk – by sticking to a clear but powerful philosophy.

Core to our investment philosophy are two key tenets: quality and valuations. Quality, because we believe equities are risky (reducing quality increases the risk) and valuations, because the price you pay is the primary driver of returns you will make.

The valuation of a company, fundamentally, breaks down into two components: an assessment of a company’s earnings and the multiple an investor is being asked to pay for those earnings.

Typically, when discussing earnings, investors are referring to 12 month trailing, current or 12 month forward. At Kennox, when we look at earnings, our focus is on Sustainable Earnings: a conservative estimate of what profits (and cash flows) we expect the company to deliver in the future on a ten- or twenty-year time frame.

With a focus on the sustainability of earnings, we are naturally biased against peak earnings. In our company analysis, we discount peak earnings significantly seeing them as a risk better suited to growth managers and, in our view, best avoided. Why? Because at peak earnings, a company will almost always be facing increasing competition as new entrants are attracted to the most profitable and fastest growing sectors and industries (Capitalism 101).

For the Kennox value philosophy, it is much more logical to hunt for companies trading on off-peak earnings, where competition is likely to be shrinking and headwinds decreasing. In other words, we look at a company and ask if it can make earnings in the future that are merely unremarkable compared to its own past. This is not building in any heroic assumptions. Instead, by design and temperament, we are able to take an independently formed, long-term view and stick with it.

As this approach is naturally long-term in nature, we are not worried about the timing and shape of the earnings, i.e. if the earnings are lumpy or are shrinking in the short term. On the contrary, it is often only due to these shrinking earnings, and ensuing negative news, that we will get the chance to buy at exceptional valuations.

At Kennox, exceptional valuations mean not paying more than 12x our view of Sustainable Earnings of a company. There is substantial risk in overpaying, something that appears to have been forgotten judging by today’s market levels. Conversely, there are exceptional returns to be made from buying quality assets inexpensively. We are happy to invest when we find sensible and conservative valuations that imply returns that are commensurate with equities risk.

There are situations where we will get high quality companies at genuine discount prices. However, to really equate to an exceptional opportunity, there is one more, and most important, step – our detailed assessment of the level of quality.

In our assessment of quality, we look for certain hallmarks: a strong franchise, conservative management, low levels of debt, and a long-term track record demonstrating the ability to survive through multiple cycles. It is our aim to have each portfolio position exhibit these.

But to drill deeper on quality: we must truly test our conviction level on our evaluation of those Sustainable (non-peak, possibly-not-growing-in-the-short-term) Earnings, i.e. the quality of the franchise. We conduct in-depth analysis of the strategic positioning of the company’s products currently; looking across its customers, competitors, distribution, supply chain; always including studying past financials for clues and hints, going back two cycles or more; factoring in potential disruptors (new entrants, changes in laws and consumer preferences and working practices, costs); hunting out all the factors that contribute to the future success or failure of a business. In short, we drill down into all the fundamentals that will drive a company’s future profits on a long-term view. This takes time but, for us, is essential. It is only after we have done all the work that we really know our conviction levels about the quality of our Sustainable Earnings – that the headwinds are temporary, that the individual company has enduring strengths that will in turn be able to generate significant profits.

If we’re being offered the share at 12x or less, we have a compelling case. Where we can make exceptional returns is if the company’s profits can move back up to peaks or beyond, or if the shares are re-rated. Being self-reinforcing, these two often coincide, providing some truly mouthwatering returns. And importantly, this can occur irrespective of market direction or economic growth: our stocks have worked through their individual headwinds, giving them the ability to perform even in difficult times (as was our experience in 2008). This is one of the joys of our investment philosophy – in our decade working together, we have seen this outcome many times. We expect to find many more such opportunities in the future.

Our focus on paying only conservative prices and of assessing the quality of earnings on a longer-term view (often via a disregard for the lumpiness and timing of earnings) presents a coherent, logical and sensible value investment strategy. Because this is very different to what most investors do, the market will continue to offer up excellent opportunities for our style in the future. If we are selective about these opportunities and only pick the very best of them, we have a good chance of achieving our objectives – excellent risk-adjusted returns through all market conditions over the long term.