Seneca the Younger - ‘We should not, like sheep, follow the herd in front of us, making our way where others go, not where we ought to go.’
After a long period of relatively stable markets, the last few months serve as a stark reminder of how volatile markets can be. During a bear market, the more markets fall, the more fearful we become. We see big portfolio losses as a threat to a comfortable retirement, so we cut our losses and run. Our emotions are too strong to allow us to rationalise the situation.
But while the circumstances clouding the market have been dark, falling markets create opportunities for investors who can take a long-term view. In simple terms, many companies will likely be significantly cheaper to buy now than they were three months ago. We believe this value-oriented strategy of adding selectively to assets which are assessed to be undervalued will give us an advantage on the market’s recovery.
Value in a downturn
As value investors, we cannot control how participants in financial markets choose to price the assets we own on a day-to-day or quarter-to-quarter basis. What we can do is attempt to determine the value of the assets we invest in on your behalf and decide if today’s price is attractive, relative to that value.
Our assessment of that value may be overly optimistic, so we look to pay significantly less than this amount to give ourselves a margin of safety. In today’s markets, what we can offer is a sober analysis of value, and the courage to act on our views. Act we have, and act we will continue to do.
Valuing the investment opportunity
The relative outperformance of ‘growth’ as an investment style versus that of ‘value’ has been well documented in recent years. At the end of March, the 10-year total return of the ‘value’ style lagged the ‘growth’ style by its largest margin in 35 years, surpassing that of the underperformance witnessed during the dot-com bubble at the end of the 20th century. On a price-to-book basis, value stocks now stand at their deepest discount to growth stocks for the data we have available. While this may seem bleak on the face of it, there are now real value opportunities for investors across a range of markets and sectors. Rather than worry about market events outside of our control, the sole focus of a value investor should be focused on assembling a collection of assets that we believe to be significantly undervalued.
Conviction will pay in future
Investor confidence has been significantly reduced and we have seen indiscriminate selling across most markets. Over this period, we are working hard to position portfolios in a way that our investors can benefit significantly when we enter the next bull market. To do that requires remaining rational when those around you are at their most irrational. Our belief is that bottom-up, value managers are well suited to take advantage of the current market environment. This is particularly true of investment trusts, some of whom are able to pay dividends to their shareholders despite the current headwinds and are less vulnerable than open-ended funds in the event of investors rushing to liquidate their holdings.
Despite the volatility, we have continued to add to both equities and specialist assets, which trade at very attractive prices relative to our assessment of their fundamental value.
In addition to investing in existing UK equity holdings, we are finding new opportunities trading on extreme valuations, which will also provide some diversification to how and where our collection of UK businesses generates their revenue. Our purchase of Origin Enterprises is an example. On simple metrics, the company trades on a price to earnings ratio of just 8x. Yet, revenue should be resilient in the current environment due to the critical nature of the services the business provides to the food supply chain.
An important part of the portfolio is our allocation to gold assets. We believe physical gold can maintain its purchasing power in a world of central bank induced monetary debasement.
Within our overseas equity allocation, we have seen the reopening of two funds for new investment. To ensure long term performance isn’t compromised by having too much money to manage, the managers are very careful to control the size of their funds. The opening of these funds for investment tells us that today’s opportunity is an attractive one as does our own internal analysis of their holdings confirms this, and we are adding to the funds.
Within specialist assets, we have been selectively rotating from some of the stronger performers into those where the disconnect between market prices and value remains very wide. The Merian Chrysalis fund is a good example, in the COVID-19 crisis the trust had dropped down to trading at a discount to its initial public offering price and its last stated asset value. Whilst many of its portfolio investments have little or no debt and the vehicle itself also has cash on its balance sheet. This kind of activity reminds us of the quote used by Benjamin Graham at the start of his book ‘Security Analysis’: “Many shall be restored that now are fallen, and many shall fall that now are in honour.”
Value investing is at its most challenging during difficult periods of performance. As investors in the funds alongside our clients, we endure these periods alongside them. The investment process and conviction in the value investing philosophy is what instils confidence that this investment strategy will, in the end, come safely to port, despite today’s storms.
Seneca the Younger - “If a man knows not to which port he sails, no wind is favourable.”
Steve Hunter is Head of Business Development at Seneca Global Income & Growth.