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Money managers are not paid to forecast, but to adapt

Over the past few weeks, I have had a number of conversations with clients and a couple of you have made very valid comments and I think it makes sense to expand on them.

hand flipping wooden cubes with NEW NORMAL word

by
Simon Martin

30.09.2020

Over the past few weeks, I have had a number of conversations with clients and a couple of you have made very valid comments and I think it makes sense to expand on them.

A couple of clients have asked why we appear to be ‘blasé’ about the US presidential elections given our stance on the American economy and our weighting in American assets. This is a really important question and we have certainly not set out to create an impression about being blasé. But in simple terms, many of the themes we are looking at are multi-decade long themes that will surpass the term of the next US president (and hopefully the next two). If President Trump wins a second term, he will only have 4 more years in the White House and will undoubtedly focus on his legacy, as he will not have control over the senate which he has enjoyed in his first term. It is also widely anticipated that Joe Biden will only run for one term. So, in effect, we are only looking at 4 year period, whereas we are considering issues that will be affecting investments for up to 20 to 30 years.

We also have to consider some basic facts. Whilst there are profound differences in style and substance between Republican and Democratic policy, just as there was between Barack Obama and his successor Donald Trump, the curious thing is that financial markets tend not to agree with this assessment. If we look at compounded returns of the major US assets classes, we can see that equities, as measured by the S&P 500, delivered roughly the same rate of return during the Obama years as under Trump, 12.38% annualised for Obama to 13.87% for Trump. Long dated bonds also delivered positive returns in both presidencies. In short, both equities and bonds thrived under both a Democratic and Republican Presidency. Under President Obama, the 3 best performing sectors were consumer discretionary, technology and healthcare. Under Trump, the 3 best performing sectors have been technology followed by consumer discretionary and healthcare. Under Obama the 2 worst performing sectors were financials followed by energy and you will not be surprised to find out that under Trump the two worst performing sectors were exactly the same.

At the start of the Trump administration, Big Tech was widely seen as being openly hostile to him. As a result, following the 2016 election, one common fear was that Trump would unleash regulatory “hell” on big tech players. Investors now fear that a Biden presidency will be hard on big tech.

With a former property developer in the White House, many investors expected better performance from the real estate sector (it fell to 8th place under Trump) and with Trump’s promises to ‘Make America Great’ again, bring manufacturing jobs home and impose tariffs on unfair competition, investors might have expected the industrial sector to thrive under Trump. However, industrials finish sixth just as they did under President Obama. In short, all this raises the question of whether the time spent discussing and worrying about US politics is really time well spent?

The simplest conclusion to draw is that the occupant of the Oval Office doesn’t matter when you are looking at companies such as Amazon, Apple, Microsoft, Exxon, Chevron, Citibank or even Goldman Sachs. Irrespective of who wins the Presidential election, both candidates need the US economy to continue to grow. They both need a strong stock market and they both will have to deal with the on-going coronavirus crisis and will no doubt continue to play hardball with China, their main competitor.

We could therefore spend a huge amount of time trying to second guess issues that could have very little effect on medium to long term market sentiment. I am sure the market will wobble as we run-up to the election but the research house Gavekal said in a recent note “money managers are not paid to forecast, but to adapt” and this is especially true when it comes to politics. Hence why I have used that quote as the title for this market commentary.

Adopting a longer-term perspective is also important when we look at the wider issues, as it is very easy to get distracted in these markets with the media obsessing on what is facing us today. We, therefore, have to ignore what we have previously referred to as recency bias.

We can all relate to what has just happened or is happening now, especially as we tend to judge our investment outcomes in binary terms; i.e. we make money or lose money, we outperform or we underperform, our judgement was good or was it bad. This type of thinking is sometimes flawed because of the role of luck in financial markets. If we make a decision when the odds and evidence are heavily in our favour and it doesn’t work out, that doesn’t make it a poor decision.

Any dose of random activity can heavily dilute the information provided by outcomes alone. We must always remember that a prudent investment approach means making decisions based on what we expect, and others are made just in case something else might happen. We hope that the combination is in the appropriate balance and that it does not hinder performance! The need for investors to diversify is often framed as a means of smoothing investment performance or tailoring a portfolio to a specific appetite for risk. Diversification, however, across a range of assets and securities is an acceptance that we cannot predict the future and we will be wrong about many things. The more confident we are, the more concentrated our investments. With perfect foresight, or in fact perfect hindsight, we would only invest in one security. (This year that would have been Amazon, but next year it could be a completely different company. We just don’t know which one, so the natural implication is to keep Amazon and buy another, just in case. Hence a form of diversification is built into the portfolio.) If you want to understand an investor’s or fund manager’s confidence, you should simply check their portfolio concentration.

Consequently, diversification means holding assets and securities that sometimes appear to be laggards and this is an intended policy. We can think of such positions as failure or costs. Alternatively, we should consider them to be holdings that would have fared better in a different scenario to the one which transpired.

As investors, we all have opinions on markets, stocks and funds. Diversifying risks appropriately is challenging because it forces us to make decisions not only that we think are likely to be wrong and costly, but that we want to be wrong and costly. This is often difficult to justify. It is tough to tell a confident story about our view of the world and then make investments that seem contrary to it. For example, why have we just been talking about concerns about inflation when we are still holding conventional government bonds?

It is exactly the same concept as insurance. We all willingly pay for insurance every year in the expectation that we get compensated in the event of an accident, tragedy or misplace something. This is exactly the reason that we buy certain assets in the portfolio; we hope that the scenario that they are held for doesn’t transpire but we have to hold them just in case it does. If we are a natural risk-taker then we may take the chance that these events will not happen, and we don’t hold insurance. Over many years that could be a perfectly valid strategy and hence we save money, or, in the case of investments, we make more because we have all of our money concentrated into assets that go up. However, if we learn anything from this year, it is the fact that we have to expect the unexpected. What to some people appears to be ‘just a virus’ has caused economies to go into complete lockdown and sadly resulted in the deaths of nearly 1 million people around the world! Some people may have just carried on with life. Other people take the virus incredibly seriously and have religiously followed government advice, kept themselves isolated and hence kept themselves safe. They may feel that they have missed out on a lot of things and been overly cautious. It is too early to say who is right or wrong. We have opinions based on how we view the media, but we don’t know for definite, and may not for some time to come.

From an investment perspective, the virus has resulted in one of the sharpest and quickest falls in stock market history, followed by a very sharp recovery. The fact that the recovery has been led by US technology shares does not mean that that was the right thing to hold and that those assets will continue to dominate over the next few years. We have to still hold the insurance, the diversified holdings in other parts of the world because ultimately there are sectors that we feel will do much better or equally as well over the next 10 to 15 years.

We hope that you have read about the investment themes surrounding Asia and emerging markets and naturally people question why we are so preoccupied with Asia and Emerging markets over the UK and USA. The simple truth is that the current population of Asia is 4.6 billion people, the equivalent of just under 60% of the world’s total population. 50% of this population lives in an urban area and more importantly, the median age is 32 years. As you can see from the following population density map, 60% of world’s population lives in a relatively concentrated area which, when you add in the America West Coast, means that the Pacific Rim will dominate economic returns for many years to come. They will spend more on goods that the populations of Europe and the USA combined.

graph - world population density

We have also talked about ageing populations and the need to want to feel well for longer and this is a key theme that we will continue to revert to.

However, the next big theme that we feel will dominate, and one that we are actively researching and will go into in more information in the coming weeks, is decarbonisation. The reason why we think this is so important is due to the fact that an opportunity exists to generate attractive investment returns. Over the next 25 to 30 years the global economy is expected to spend $50 trillion on this issue. To achieve net-zero carbon emissions by 2050, this amount of money will need to be spent in a wide range of activities from wind, wave, solar power, electric vehicles, battery, semi-conductors, carbon storage, carbon credits and biofuel. Many of these industries are in their infancy and will grow phenomenally the same way that technology has grown enormously over the past 25 years.

For example, 30 years ago, people barely knew what a computer was, a decade ago you couldn’t buy a plane ticket online or book an Uber or rent an Airbnb on your phone. In 1995, only 16 million people had access to the internet (that was equivalent to just 0.4% of the world’s population.) In June of this year, 4.8 billion people had access to the internet, equivalent to 62% of the world’s population. In addition to the huge growth in technology adoption, there is still scope for 38% of the world’s population to get access to the internet. Of a world population of 7.8 billion, 5 billion people own a mobile device and 2.6 billion use social media, hence there is still growth to be had in that sector.

Despite the ongoing growth potential provided by technology innovation and productivity improvements, at this moment we feel that the growth potential from decarbonisation is even bigger. Imagine this level of growth from items like electric vehicles, solar panels on roofs, clean energy power stations and industrial size batteries. We will go into these figures in far more detail over the next few months.

So, in conclusion, we are not trying to appear blasé about issues like the presidential election and Brexit, but as investors, we are concentrating on the medium to long term future, not the past, present or immediate future. Our themes are full of companies that will disrupt and have the ability to outperform if we get on the right side of them.

The demand for renewable power will continue to grow throughout the world and hence new companies will evolve and grow into their sectors. However, we still need to consider the diversification story. In addition to the huge growth potential that these themes provide, we still need to hold investments that will limit downside, may underperform and may not actually grow. This could lead some to underperformance relative to our chosen benchmark but in other situations, those are the investments that we want to be holding if the worst-case scenario evolves. We also want to be holding investments that will grow in the long term, we may invest early in some of these sectors, and we may not get all of them right, but we feel that the research that we are doing into these themes will ultimately drive the returns.

At the end of the day, we cannot predict outcomes so why waste our ‘worry’ time on them. America will still be there in December, it may be a bit different, but the average American will still keep spending, complaining on about whoever is sitting in the White House and how badly they are dealing with coronavirus. Sensible investing is not about predicting a single path and trying to maximise returns if it comes to pass, it is about ensuring that we are appropriately positioned for a reasonable range of outcomes. We have to have a view, but it needs to be heavily tempered with an acknowledgement that the future is inherently unpredictable. Afterall the best investors are those that have a balanced view on life, they understand what they don’t, and cannot, know and their decisions reflect this. They are comfortable making choices that they feel could be wrong and that they hope don’t come with too high a cost.

This doesn’t absolve us from making mistakes, it just means that we are human. We always strive to do our best, especially when we are building portfolios that will take advantage of more sustainable trends and not just the binary outcome or trying to react to a short term fluctuation that might or might not have an impact on the markets.

Finally, it’s not just the youth who are dominating technology…

According to Guinness World Records, Sir David Attenborough has broken Jennifer Aniston’s record for the fastest time to reach a million followers on Instagram. At 94 years young, the naturalist’s follower count raced to seven figures in four hours 44 minutes on Thursday.

He has 4.6m followers and is using technology to tell people to change our ways!!

As per usual I hope you found this of interest. I also hope it has set out a foundation about the decarbonisation theme that we hope to expand on over the next few weeks.

If you have any comment or questions, please do not hesitate to call us. We genuinely do welcome feedback and comments as they are really important as we develop these themes.

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

The value of investments can fall as well as rise. Investors may get back less than invested.

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