Family Dynasties

TR – Hello, I’m Tom Record and I’m here with Tom Morris. Welcome to Global Infusions, an investment podcast from the Liontrust Global Fundamental team that takes a long-term view of today's stories.

Last episode we chatted about water and how the stuff of life has defined countries, politics and livelihoods. This episode we’re chatting about families… from the Pinaults to the Waltons by way of Mars – dynasties running big businesses. If your taste buds are tickled or you have any questions for our next episode, please do send them in via your client contact or through the contact us link on the Liontrust website.

So sit back, grab a cup of tea and remember that when we talk about individual companies we are not making a recommendation to buy or sell shares and that some of these companies may not be held across Liontrust’s global fund range.

TM – So perhaps we should start with an industry dominated by families – luxury goods.

TR – The likes of Gucci, Versace, Louis Vuitton, Dior, Fendi, YSL.

TM – Exactly – all started off as family businesses, in fact all the ones you mentioned are named after their founders, and really traded off the personal brand of their original designer.

TR – But designers are often pretty poor business people, and lots of luxury family businesses eventually succumb to infighting, bad brand management, and financial problems.

TM – Yes exactly. There are some exceptions – Hermès for instance is still controlled by the family, as is Ferragamo, but most of them end up in the hands of big luxury holding companies.

TR – Yes – Ferruccio Ferragamo, Salvatore’s son is still the company’s president… and of course the two biggest of those luxury holding companies, LVMH and Kering, are themselves controlled by families – the Arnaults and the Pinaults. Only, these are families of business people, not designers. It’s been fascinating to watch Kering reinvigorate brands that have somewhat lost their way over the years.

TM – Yes, Gucci’s a good example that has been carefully stewarded by the Pinault family since 1999, when they won out over the Arnaults in a war for control. And while we’re talking about founders’ names – we need to say that the original Mr Gucci was called Guccio Gucci, which is an A+ name if ever I saw one.

TR – Indeed! We’re seeing the same gradual brand improvement stories at YSL, Bottega Veneta and Kering’s whole stable of luxury brands which are slowly nurtured to extract long term value rather than maximise short term profitability.

TM – The real benefits of a long term family owner coming through.

TR – One question worth asking is why are so many of the iconic Italian luxury brands are now owned by foreigners? Even Versace sold out to Capri Holdings in 2018, which is the parent company of Michael Kors.

TM – Part of it is surely family pride and rivalries – it would have made sense for someone to have created an Italian version of LVMH, and bring together Gucci, Versace, Fendi, Valentino etc – but that would require them to get on, and agree to work together, which can be too much to ask when it comes to families.

TR – Exactly. Now, some of these families are a little more dysfunctional than others and sometimes their feuds damage the companies they own and then the news makes it into the public domain. Some of their histories read like mystery novels.  Have you come across a book called Nemesis?

TM – No that’s not one I’ve heard of.

TR – Well it’s the story of Aristotle Onassis and the things that he and his family may have gotten up to that make the mind boggle.  From his businesses in shipping and airlines to outlandish parties and relationships, courting multiple women, the challenges with the Kennedy family and Marilyn Monroe, murder, interactions with terrorists… an astounding view into a bizarre family.

TM – And you mentioned the Kennedy family there.  It’s amazing how the Kennedys have been able to remain a family at the top of US politics for generations.

TR – yes the US is full of political dynasties, even though it ditched royal ones a long time ago. The Bushes, the Clintons, the Tafts, and there are loads more at state level.

TM – Even the fictional president in the West Wing, Josiah Bartlett, was part of a family line supposedly going back to the declaration of independence. Politics and business both depend a lot on brands, and family names can be some of the most powerful brands of all.

TR – While we’re on the topic of feuds, we should mention the Ambani brothers.

TM – Ah yes, Mukesh and Anil, part of one of the most important business families in India.

TR – They were heirs to the Reliance empire, founded by their father in the 1960s, and now encompassing energy, chemicals, telecoms, media, retail and textiles. To give you an idea of the scale, its revenues are about 3% of Indian GDP.

TM – As I understand it, the problem was that when their father died without a will, both the brothers thought they should be the main heir, and they started fighting over how to divide the group. In the end, their mother had to mediate, giving Anil the telco, finance and power businesses, and Mukesh got Reliance Industries, including the energy and chemicals units.

TR – Things went a lot better for Mukesh, who is now one of the richest people in the world, but not so well for Anil, who attempted to declare bankruptcy in 2020.

TM – It was an amazing divergence of fortunes. In the end, Mukesh even launched his own extremely successful telco, Reliance Jio, while his brother’s went bust in 2019.

TR – So there’s a bit of a dichotomy going on here with family control.  On the one hand you can see the benefits of having a long time horizon to really invest for success, as the Pinault and Arnault families have done so successfully. On the other hand it’s highly unlikely that the best person to run a company will come from the handful of family members that a founder can pick from, and splitting a company between children can also destroy a lot of value, Reliance-style.

TM – Yes, this is the argument that Alfred Chandler pushed in the 1960s for why Industrialised Britain lost out to a more dynamic USA and Germany. Our colleague Tom Hosking pointed out that while a lot of Chandler’s specific evidence has been debunked, his overall conclusion does seem intuitively true – that it is possible that a family member is the best person for the job, but it’s pretty unlikely.

TR – And that Credit Suisse study that we were chatting about around the desk supports this view – companies controlled by families do seem to have grown faster historically than non-family businesses of the same age.

TM – Yes – younger, smaller companies obviously tend to grow more quickly than older larger ones, regardless of whether they are run by families or not, but it does seem like family ownership helps when you’re comparing apples with apples, i.e. a 50 year old company to another 50 year old company.

TR – And that raises the question of what to do when there is no next generation to pass the legacy on to.  A few episodes ago we were discussing how Japanese companies are using something similar to a dating app to find potential non-family heirs when they don’t have a suitable child of their own.

TM – It’s a growing problem, particularly as the most common cohort of business owners are 69 years old!  Plus you have long lines of family control – was it one company that had been in the same family for 52 generations?

TR – Yes… it’s 52 generations and 1300 years that Nishiyama Onsen company has been operating.

TM – That still amazes me. Now we can’t have a discussion about families without mentioning one of the most famous and successful business dynasties of all – the Waltons of Walmart.

TR – Yes they still control Walmart via family holding companies that own just under 50% of the shares, giving them a net worth of around $200bn.

TM – And I’ve always thought that they’re rich in a very different way to tech billionaire families like the Zuckerbergs and the Musks. The Waltons are swimming in cash, thanks to the Walmart dividend, which pays them about $3bn a year. They don’t have to sell shares to raise cash to do things with – it just rains down on them every quarter.

TR – It is incredible to think about. And the use of the family holding company is a good way of keeping the equity quite tight within the family while minimising inheritance disputes.

TM – Indeed.

TR – We should also mention the Mars family, who still fully own Mars the company – they didn’t even list half of it like the Waltons.

TM – Ah yes – the most interesting thing about Mars is the way it’s changed its focus over time. I think most people still think of it as a chocolate bar company, but for a while now their biggest business has been pet care.

TR – Yes they own Pedigree Chum dog food, Whiskas cat food, and big chains of vets across the US.

TM – Yes and I’m sure part of their success has been down to their shrewd choices of external CEOs. They realised that the family was unlikely to contain the best person for the job, and so they mostly restricted themselves to the board.

TR – The FT had quite a fun article recently profiling the outgoing CEO of Mars – he said that top management and family members are expected to eat the pet food when touring factories, to check on its quality. Apparently it tastes like pate!

TM – Ha! That is proper attention to detail. So to finish off on families, I just wanted to mention a stat that caught my eye on the prevalence of family controlled companies – a study at the Indian School of Business found that 91% of companies listed on the Bombay Stock Exchange are family controlled, vs 35% of Fortune 500 companies in the US.

TR – Quite a gap. I think the reason for this is that historically you’d typically have a promoter family who takes some responsibility and brings the company to the stock exchange and then retains control. The promoter concept was changed by SEBI, the regulator last year, which shows the evolution of the corporate landscape in India away from families over recent years.

TM – it will be fascinating to see how it develops.

TR – So let’s move on to the news – Tom what do you have for us this episode?

TM – Well the first thing I want to mention this month is another advance in AI. We’ve talked in the last few episodes about Dall-E and Stable Diffusion, which both generate images from text prompts.

TR – With surprisingly excellent results.

TM – Yes well they next step is AIs that can generate videos from text descriptions. Meta demonstrated one this month, imaginatively called make-a-video.

TR – And is it any good?

TM – Well to paraphrase Darth Vader I’d say it is impressive, most impressive, but not a jedi yet. Generating videos is obviously way harder than generating still images, and make-a-video is able to either produce a video from text, or produce a video from an existing still image. They can look a bit crude, but this is version 1.

TR – Sounds cool.

TM – It is, and it’s also a significant move for Meta, which needs to make it easier for advertisers to make video ads, so they can be placed amongst all its new video content on services like Reels.

TR – Interesting – that would solve a big sticking point for advertisers used to simple static images and is similar to what they did with Canvas to make it easier for small businesses to upgrade those old static images into more of a full screen experience on mobile.

TM – Exactly. When Instagram first introduced Stories, it took a while for advertisers to learn what types of ads worked in that format. The same thing is happening now with short form video, and AI video ad generation will help.

TR – Agreed. So the first story from me today is tied into Darth Vader, films and Bruce Willis…

TM – a somewhat random combo, Tom.  Go on…

TR – OK, so James Earl Jones has just licensed his voice to be used for Darth Vader, and despite rumours to the contrary, Bruce Willis decided not to license his face – yet.

TM – So these will be used in future films. I suppose that makes sense for a 91 year old to license something so iconic.

TR – Exactly, and it’s already been used to reproduce Val Kilmer’s voice in Top Gun Maverick… It’s going to make it harder and harder for new actors to compete as they have not just today’s actors but all actors from all time to compete against.

TM – And the license revenues for a great actor’s face or voice could grow ever larger over time. So next I wanted to follow up on our discussion about water from the last episode, and in particular the woeful performance of many of the UK’s water companies.

TR – The ones that lose a quarter of their water to leaks, and pump raw sewage into the sea.

TM – Yes those ones. So the regulator announced at the start of October that 11 water companies, including Thames Water and Southern Water, will have to return £150m to customers as a penalty for missing pollution targets.

TR – Well, it’s nice to see the regulator acting in a way that will force the companies to listen.

TM – And it’s worth highlighting that not every company did a bad job – the regulator is actually allowing Severn Trent Water and United Utilities to increase customer bills as a reward for meeting targets.

TR – So the classic carrot and stick – but I still think the companies are allowed to get away with too much.

TM – Me too.

TR – So the next thing from me this episode is about energy, and in particular the amount of energy that each person in the world uses.

TM – OK, so what they eat, use to warm their homes, for transport.

TR – Exactly – the whole caboodle.  So globally, the average person gets the benefit of 34 gigajoules of energy.

TM – That sounds like a lot!

TR – It is!  It’s as if every person had 60 people working nonstop, day and night for them, all the time. Each of us benefits immensely from the output of that energy.

TM – Equivalent to 60 people?!? What would that be in Watts?

TR – That’s just over a KW all the time… for every hour of every day.

TM – So equivalent to a hairdryer?

TR – Yup

TM – Now, The last thing from me today is a bit of a follow up on our episode a few months back on bad rules.

TR – I think I can guess what this might be – LDI?

TM – Exactly. The UK has been pretty chaotic for the last few weeks after the new government’s mini-budget caused ructions in markets.

TR – And to be clear, it was a flawed and very poorly communicated mini-budget that missed a lot of steps of scrutiny before being presented.

TM – Yes absolutely, but the scale of financial turmoil that it created did seem a bit disproportionate to the scale of the budget. It felt like something else might have been going on too.

TR – And it turns out, there was.

TM – Indeed, and that thing was a blow-up in the pensions industry caused by excessive leverage taken on as part of interest rate hedges – something called Liability Driven Investing, or LDI for short.

TR – So Tom, can you explain what that actually mean in practice?

TM – Well pension funds are made up of two parts – a pot of liabilities, which represent all the pension payouts they have to make in future, and a pot of assets, things like shares and bonds, which they intend to use to fund those payments.

TR – Simple enough.

TM – Yes it should be. The problem for pension funds over the last 20yrs is that falling bond yields have made the pot of liabilities get bigger, as all those future payments are discounted back to today using lower and lower interest rates, making their present value get larger and larger.

TR – So the maths works like this – if you owe £100 in 10yrs time, then discounting that back to today, to get the present value, using an interest rate of 6%, gives you about £56. If the interest rate falls to 3%, then the present value increases to about £74. So your liability suddenly looks a lot bigger.

TM – Exactly. And this was very painful for pension funds, as their liabilities grew, but their pot of assets couldn’t keep up, so deficits started growing, representing a shortfall in funding. To deal with this problem, financial engineers came up with LDI, a type of hedging that pension funds could take out that would pay out if government bond yields kept falling, allowing their pot of assets to grow in step with their pot of liabilities, stopping deficits from getting worse.

TR – And as yields kept falling, LDI became a very popular investment product, with about £1.5tn of pension funds following it.

TM – £1.5tn! Gobsmacking. So the problem with hedges is that they work in both directions. In this case, pension funds had set up LDI to pay out as government bond yields fell. But it seems like very few people stopped to think about what would happen if interest rates ever started going up.

TR – I guess it just hadn’t happened in so long that people had stopped even imagining it.

TM – Well the answer is that LDI strategies start losing money as yields rise, keeping the pot of assets in step with the liabilities, which shrink as bond yields go up. Now that wouldn’t be a problem as long as it happened slowly, but after the government’s mini-budget, UK government bond yields started moving up very quickly.

TR – Triggering margin calls for pension funds using LDI… The funds had to put more collateral into their LDI portfolios to keep them afloat.

TM – Exactly. And to make matters worse, LDI involves quite a lot of leverage, which means that gains and losses are magnified. So as government bond yields went up, pension funds started losing money in their LDI strategies, which then required more capital to be put into them. So pension funds had to start selling their other assets in order to raise cash. And one of the most common investment for pension schemes is government bonds.

TR – So they had to sell government bonds, which would have driven prices lower and yields higher, which would have created more losses and margin calls in their LDI strategies, triggering more margin calls, and even more selling of government bonds and other assets.

TM – Exactly – a doom loop. Eventually the Bank of England had to step in to steady markets.

TR – Scary.

TM – Yes, and at the end of the day it’s a failure of regulation. Pension funds should never have been allowed to take on so much leverage inside these LDI products. In my view regulators were yet again asleep at the wheel, letting all this systemic risk build up, like a dry bonfire, which eventually got lit by the spark from a poorly conceived budget.

TR – Fascinating, but awful really and an example of financial innovation effectively undermining  what I think of as one of pension scheme’s greatest advantages – being able to be long term when everyone around them isn’t. Right, the last thing from me today is similar to the cosmic whale noise that emanates from black holes, but this time with real, Baleen whales.

TM – I’m intrigued…

TR – Well, it’s quite difficult to track whale populations, and a group of researchers from Trondheim in Norway have worked out a cunning way to identify the number and locations of Baleen whales using fibre optic cables.

TM – So the subsea cables that carry data under the oceans can be used to identify whales?

TR – Yes the researchers used “distributed acoustic sensing” to listen for whales and then determine their number and position.

TM – Something useful from all that dark fibre that’s not being used for anything else.

TR – Absolutely. Thank you for listening to Global infusions - a podcast that believes that the best discussions are had over tea and cake. We hope you've enjoyed your cuppa and our thoughts on families. Please do subscribe through Apple or Spotify and with that we wish you goodbye!

TM – Goodbye!