Capital Returns: Investing Through the Capital Cycle

Understand ‘Capital Cycle’ investment through the book “Capital Returns” by Edward Chancellor

October 13, 201912:34 pm

When I first read the book Capital Returns in early 2018, I could not make much sense out of it. But now after analyzing so many companies and having seen the bear market & economic slowdown, investment on the basis of capital cycle makes a lot of sense. The author has picked up the concept used by Marathon Asset Management, an asset management company based out of London ,UK. The book “Capital Returns” mainly talks about the investment approach of the fund which is based on the expansion and contraction of capital cycle. Capital cycle typically follows two phases ‘Expansion’, where the industry production/servicing capacity is increased and ‘Contraction’ where the capacity is reduced by selling assets.

The author of the book, Edward Chancellor is a financial journalist and his other book “Devil takes the hindmost- A history of financial speculation” is another masterpiece.

More about 'Marathon Asset Management'

Capital Returns: Investing Through the Capital Cycle

How does the "Capital Cycle" works?

Capital Returns: Investing Through the Capital Cycle
Fig.1 "Capital Cycle"- How does it work

Capital Cycles follow the pattern as showing in Fig.1.  With excess profitability, company or industry’s returns increases(returns imply how much excess the company earns on its cost of capital or assets etc). Envy causes competitors to start investing and increase capacity. Increased capacity causes imbalance to shift in favor of demand leading to decline in profits and thus, business/industry to exit capacity & consolidate. Reduced investment & hence lower supply, leads to increase in profits.

If someone who understands this aspect of capital cycle would be the one to take advantage of change in situation.

Obviously, it requires actively tracking the industry. Basically, capital cycle investment approach ask for to take into account asset growth/decline at both the company and sectoral level. 

Capital Returns: Investing Through the Capital Cycle

“Capital is attracted into high return businesses and leaves them when return fall below the cost of capital. The inflow of capital leads to new investment, which over time increases capacity in the sector and eventually pushes down the returns. Conversely, when returns are low, capital exits and capacity is reduced, over time  then profitability recovers.

The theme of the book is to invest in “Sector which is witnessing capacity contraction and not expansion”. The author makes a point to invest basis on the supply side and not on the demand side of the sector opportunity. The logic behind this is “its futile to determine demand as experts even after trying to predict the demand with so many tools have failed to give even the slightest of the right picture a big margin, both on the  lower and upper side. While supply side can be calculated much more accurately by taking into account the capacity of key players in the sector.

To validate this point, the author makes a simple example of expansion in global shipping industry led by the increasing Chinese share of global trade which caused the daily rates of Panamax(a class of ships) to rise 10 time between 2001-07. As a result, capacity exploded leading to over capacity & eventually brought down the Panamax daily prices by 90%.


You can read more about Panamax here:Link

A classic example wrt Indian perspective would be of the Indian paper industry where supply was constraint between 2001-2010, because of which a lot of new capacities came up in the early 2010s with upgraded technology and higher scales for better profitability. This led to overcapacity and then to industry consolidation. In this case Marathon fund would have invested when the industry was consolidating. But it took another 3-4 years, for the demand to catch up to the excess capacity. The needle moved in the favor of supply from 2015 onwards.


No new capacities have come in the last 4-5 years in the printing & writing segment. And whatever the existing capacity was, has already been absorbed.

Capital Returns: Investing Through the Capital Cycle

Marathon Asset Managament- Investment Philosophy

The fund looks to find investments in depressed industries at a positive inflection point in the capital cycle and in sectors with benign and stable supply side fundamentals.

The investment process at Marathon funds is not to buy stocks that are cheap on accounting measures(P/E, P/B, P/S, etc) but based on the capital investment or contraction cycle.

On the other side, they also look at high return companies and want to make sure if the high returns are sustainable. Pricing power has been the most enduring determinant of high returns of these investments.

Other key pointers from the book "Capital returns"

Long range demand forecasts are likely to result in large projection error. Supply forecasts are much more certain than demand.

The fund looks for generalist as investment mangers as they are less likely to suffer from reference group neglect and better able to employ an understanding of capital cycle dynamics.

There is a saying ” There is no cure for high prices like high prices”. We have seen such cases in Crude oil, Steel, GE etc


Investors who adhere to one particular style are likely to end up in trouble, sooner or later. They just look at whether the market is efficiently valuing their future earning forecasts.

Another interesting point they make is the during the peak part of the cycle companies buyback shares only to raise fresh equity at the trough. Buyback, in general, pushes the prices upwards. Capital Returns: Investing Through the Capital Cycle

Capital Returns: Investing Through the Capital Cycle

Although, the concepts presented by the book makes a lot of sense but usually such concepts are more related to commodity business. No doubt, when one buys at the time of capacity contraction, the Share prices will hardly anything and one can make load of money but again I repeat its easier said than done. 

Another point is the long holding period which might act as a deterrent to many.

Interview of Edward Chancellor for his book “Capital Returns”.


Shekhar Yadav

I am a full time stock market investor. The blog is an extension of my research, thoughts & opinion. Please don't consider anything on this website to be an investment advise.

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