The wisdom of the cliché

Stock market clichés are ten-a-penny and no-one seriously thinks they should build their investment strategies around them. Still, sayings such as “never catch a falling knife” and “the trend is your friend” usually have their roots in a certain truth. They became clichés because they were repeated regularly – and in response to what investors were actually seeing.

I pick those two adages in particular because they have a resonance for anyone considering buying shares in an investment company right now. For much of last year, the investment companies sector was struggling; you could certainly make a case for a potential recovery, but buying felt like catching a falling knife. In recent months, however, many funds appear to have turned a corner, enjoying a sustained upswing. Maybe now the trend really is your friend.

Data crunched by the investment platform interactive investor reveals that a string of investment companies have delivered returns of more than 20% since November. It cites the best performing sectors as Property Securities (up 27% on average), Growth Capital (up 20%), North American Smaller Companies (up 19.5%), European Smaller Companies (up 16%), and Biotechnology and Healthcare (up 13.5%). Those are pretty handsome gains for such a short period.

The question, of course, is whether we are now seeing a friendly trend or a phenomenon described by another cliché – “a dead-cat bounce”, where you get a short-lived recovery following a significant correction.

Investors will need to take a view on that individually. But at the beginning of 2024, it does feel as if market sentiment may have made a decisive shift. Suddenly, analysts and investors are looking forward to interest rate reductions, rather than worrying about persistent inflation and the potential for further monetary policy tightening. That sets the stage for increased interest in “risk-on” assets – those regarded as more prone to volatility – after a period in which safety-first was the priority.

In which case, investment companies should benefit. Often regarded as more volatile holdings than other types of collective funds – partly because share prices can slip to discounts to investment companies’ underlying assets – they suffered disproportionately during the extended risk-off period. That effect should be reversed as investors become more upbeat – and judging by interactive investor’s data, that may already be happening.

Naturally, there are no guarantees. Disappointing inflation data in the UK this week suggests central banks’ battles may not yet be won; UK equities suffered as a consequence. Globally, the hostilities now taking place in the Red Sea are an early setback for anyone hoping 2024 might see reduced geopolitical tensions; from an economic perspective, disruption on one of the world’s major trading routes could hardly be less welcome.

Still, investment companies have been out of favour for too long given their strengths: an enticing long-term performance record, low charges, attractive yields, and an excellent governance structure. Investment companies’ unique ability to take on gearing is also worth noting in an environment where interest rates are expected to fall, and markets are beginning to rise.

Moreover, one additional bonus right now is that investment companies’ difficulties have forced down valuations. Shares in the average fund currently trade at a discount to the value its underlying assets of around 11% – think of that as a new year sale, enabling you to buy at prices that are unlikely to remain so low for long.

All of which brings us to one more cliché, though this one comes from the great Warren Buffett so may deserve a little more respect. “Be fearful when others are greedy and greedy when others are fearful,” the sage of Omaha once said. We’re still in the latter camp right now, but with investors’ confidence improving, that may not be the case for long.