Question: What are your views on the market reaction to the coronavirus?
Make no mistake: The human toll of Covid-19 has already been unacceptably high and could worsen. As investors, however, our minds remain on what we believe is most important when investing—namely, balancing risk and reward and coaching ourselves and others to make good decisions.
Prior to the start of the coronavirus-related market turbulence, we had regarded sharemarkets, in general, as expensive and trading at extremes. Heading into this period of volatility, we had been positioning our portfolios away from the most expensive asset classes and markets, favouring better priced investments and cash.
While it is easy for investors to react to alarming headlines and panic when events such as this outbreak occur, we believe that taking a more measured approach is key. While there are many ways this virus can impact the assets in which we invest, it is important to separate permanent damage which will impact the long-term fair value of an asset from temporary damage which will be forgotten.
What we have seen is indiscriminate selling across all equity markets, with all global sectors losing value regardless of their underlying investment merits. As valuation-driven investors, this has created an opportunity for us to buy assets that are now cheaper than what they were at the start of the year, indeed, some markets have not been this cheap in years. While markets could remain volatile for some time, we believe that it’s important to look beyond short-term market events and instead be on the lookout to buy unloved assets that have attractive long-term expected returns.
Question: Since the start of the coronavirus, is your positioning helping or hurting us?
Since the volatility in markets began, the multi-asset portfolios have lost value, reflecting the large broad-based declines we have seen in sharemarkets and other assets. Generally, the portfolios have not fallen as much as markets have, which is little consolation when overall returns are still negative. We have observed that on days when sharemarkets have recorded losses, the portfolios have performed better than the market indices, that is, the portfolios have lost less value than the market indices. This is what we would expect and is entirely consistent with the way that we have been managing the portfolios, which is focused on reducing losses during periods when markets are falling and avoiding expensive assets.
While markets have declined on most days since the start of the volatility, there have been several days when markets have strengthened considerably, and on those days, the portfolios have tended to not keep up with sharemarket indices, owing mainly to investments in energy shares which have performed poorly owing to plunging oil prices. While the price action so far has been indiscriminate, we would expect our positions to perform well once the market begins to focus on fundamentals.
Importantly, our healthy levels of cash have provided a buffer as markets have declined and allowed us to actively buy in response to cheaper prices when others can’t or won’t.
Question: What would you say to people who are tempted to move fully to cash at this time?
We view market volatility as an investment opportunity. Warren Buffett always says that he likes his stocks the way he likes his socks: on sale. So, often market volatility means lower prices. It’s a funny thing that in the stock market or the share market, people actually want more of something when the price goes up, and less when the price goes down. We think that’s exactly the opposite of how you should think about it. So, generally when prices fall, it means you’re able to buy stocks or shares, fractional ownerships of companies, at better prices. We view it as a positive, not a negative. And so we prepare for the volatility by demanding good prices before we invest, and that allows us to have capital or cash available to take advantage of the market opportunity.
So, it’s really important during periods of market volatility that you don’t overreact, that you don’t sell out your investment at the bottom. That’s the worst thing that people can do. Our research shows that those that sell out at the bottom and then buy back in, say, a year later when they feel more comfortable, do much worse than those that stay invested. So, we’re here to provide resources to support you in keeping your clients calm and sticking to the plan you have in place for them. In the short term, markets are going to move around a lot, and it’s very important that you take a long-term approach to investing. Our view is that when we have periods of market volatility or where prices fall, it’s often a time where you should be adding more to your investments rather than taking them away.
Question: When is the right time to buy assets?
Anyone that proclaims they know the perfect time to buy is likely lying or has been very lucky.
Our approach is to focus on probabilities: we change our positioning according to how extreme an asset is priced. In other words, we may buy an asset if we find it’s attractively priced; if its price falls, we may buy more because—all else equal—it would have grown more attractive. We buy when we are being rewarded for the risk of taking on that investment.
Question: Have you made any portfolio changes yet?
The current volatility has, once again, highlighted the importance of effective portfolio management, asset class diversification and pricing in risk to protect capital.
Heading into this period of volatility, we had been positioning our portfolios away from the most expensive asset classes and markets, favouring better priced investments and cash. However, since the market volatility began in late February, we have seen rapid and meaningful declines in Australian and global sharemarkets. We have seen indiscriminate selling, with all global equity sectors recording losses regardless of their underlying fundamentals. With these declines, we’ve taken the opportunity to increase the portfolios’ exposure to growth by adding to Australian and global sharemarkets, most notably global energy shares, which have seen dramatic price declines.
Question: Where to from here?
It is impossible to attempt to predict how long or how severe the coronavirus episode will be. It is possible that investment markets will be volatile until we see a peak in the number of infections.
It is important to remember that we manage portfolios for the long-term. Instead of trying to predict or guess how this global coronavirus outbreak will unfold in the short term, we are focussed on valuations. As a valuation-driven investor, we invest when an asset is trading below what we think it’s worth. We avoid popular and expensive investments that tend to do well when markets are rising strongly. During periods when markets are declining, our valuation-driven approach should help to minimise losses in the portfolio and preserve capital for members. Preserving capital by avoiding losses is key to achieving long-term wealth goals.
Over the past decade, we have seen a steady rise in global sharemarkets; most notably, we have seen the longest rise in U.S shares in history. It is important to remember that there are times when markets can and do fall, and that market declines are a normal part of the business cycle. While market weakness is uncomfortable, it is important to keep a focus on the long term, rather than be distracted by short term events.
We are closely monitoring markets and the portfolios to ensure that we take opportunities to buy good assets at cheaper prices.
Since its original publication, this piece may have been edited to reflect the regulatory requirements of regions outside of the country it was originally published in.
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