Article

Lessons learned from recent market volatility

The members of Charles Stanley’s Collective Research Team who specialise in due diligence and questioning active fund managers got together and wrote down what they had learned following recent market turbulence.

| 5 min read

Never let a good crisis go to waste.

Winston Churchill

Stress in capital markets leads to plenty of soul searching. After a period of wide market losses, investors correctly ask themselves whether anything could have been done differently. Were we too exposed to a company or specific investment style? What factors do we like in a fund manager or company? Have our investment ‘red lines’ been re-drawn following the recent rapid changes in the world? Does the new emerging world backdrop mean I now need to be prepared to accept less upside for better drawdown protection? Despite being a long-term investor, am I more sensitive to shorter-term movements in valuation than I thought? Does my quality growth philosophy need refining or redefining?

We can’t re-run the past but it’s important to try and ‘future proof’ our investment processes as best we can. An investment process should also be regarded as a living, breathing organism – one that needs to adapt to the evolving environment so it cannot remain static over time. Clearly, extended bull markets can lead to complacency amongst investors – with less time spent on the mechanics of the approach.

The best fund managers ‘hit rate’ in stock selection rarely exceeds 55%. Warren Buffett – widely known as ‘the world’s greatest investor’ – has a career ‘hit rate’ of just 60%. Even the all-time legends of investing make plenty of decisions that don’t work out. Obviously, the magnitude of wins versus losses is key here too. It is why we should always retain a sense of humility. We will always get plenty of things ‘wrong’ as it is an absolute inevitability of being in our profession in such a rapidly changing and evolving world.

Here is a summary of the thoughts from members of the team. These are factors that will be considered alongside the regular reviews of our investment process and due diligence that ultimately produces the ‘Preferred List’ of recommended funds provided to Charles Stanley’s Investment Managers.

Lessons learned

  • Groupthink is arguably more evident today than ever. Are there any contrarians left?
  • Exchange-traded funds (ETFs) have proved themselves as solid and reliable instruments, coping beyond what was expected of them – both structurally and operationally – in testing market circumstances.
  • Stubbornness with fund selection can be a blessing or a curse. On balance, longer-term investors that have carried out good due diligence on a fund should be on the patient end of the spectrum when holding through market turbulence.
  • No such thing as ‘too big to fail’. Extreme market inefficiencies are not the exclusive preserve of small or mid-sized companies. Major businesses with market valuations north of $100bn can also see an excessive fall in their value in a falling market.
  • Macro sentiment, like fashion, is very fickle. China is an excellent example of the cyclical nature of top-down enthusiasm/revulsion for a region or sector.
  • Sector/asset-class rotation. Performance always rotates quicker than you think it can. It is amazing how quickly lost ground can be made up by rapid action in a falling/rotating market.
  • ‘Principles over Profits’ is a bull-market myth. Some investors have abandoned their ESG principles very swiftly, much more so than expected.
  • Interest rates are even more influential than appreciated. This is both in terms of what benefitted when ‘on the way up’ and what has suffered ‘on the way down’. But, beyond just the mechanical effect of higher interest rates on models that determine analysts’ equity valuations, when the opportunity cost of holding cash is close to nil it fuels speculative behaviour by market participants via holdings in emerging asset classes such as cryptocurrency and non-fungible tokens (NFTs).
  • Owning a sizeable amount of assets under management in any fund shouldn’t make it immune from Preferred List removal.
  • Peak popularity of fund management houses, fund managers & investment styles is a dangerous mix.
  • Investor psychology never changes. Ever.
  • Portfolios should be all-weather. They shouldn’t be positioned for one particular scenario and proven to be ‘right’ or ‘wrong’; there should be exposures that will work even when the conditions an investor expects do not play out.
  • Grey hair matters. The benefits of experience should never be overlooked.
  • Adopt a mindset that strives for ‘adequate returns’. Consistently delivering adequate returns becomes extraordinary.
  • True diversification is not derived from geographic diversification. Always maintain a style blend within equity exposures at all points.
  • Keep balanced. Funds delivering ‘super-sized’ investment gains will always give at least some of that back - trim outsized winners and rebalance.
  • Beware of buying a listed equity trust at a premium. Be patient, and a better entry point will tend to present itself.
  • Retain absolute discipline with fees on equity/bond funds.
  • Retain a healthy scepticism of thematic funds. Single-sector or sub-sector thematic funds are often a salesperson’s dream, but they can quickly turn into an investor’s nightmare.
  • Valuations matter eventually. It’s never different this time.
  • Bear markets are inevitable. Both for indices and funds alike.
  • Don’t invest in active funds if you can’t wear long spells of underperformance. This can stretch to years.
  • We can’t predict the short-term behaviour of actively managed funds. We have no direct line into a fund manager’s mind. We shouldn’t ever make decisions that suggest that we do.
  • Retain humility at all points. Don’t get ahead of yourself when things are going well. The industry is a brutal leveller.
  • Time. Periods of market stress always shorten our time horizons. Thinking in ‘years’ contracts to ‘days’ very quickly.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

Lessons learned from recent market volatility

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