Rudi's View | Jul 02 2020
This story features FISHER & PAYKEL HEALTHCARE CORPORATION LIMITED, and other companies. For more info SHARE ANALYSIS: FPH
Lessons Learned From 5.5 Years All-Weather Portfolio
By Rudi Filapek-Vandyck, Editor FNArena
Excluding any unforeseen calamities with the June 30 finish line in sight, the FNArena-Vested Equities All-Weather Model Portfolio should finish financial year 2020 with a positive return of circa 4% and only a slight negative performance for those turbulent past six months.
This will be well-above the performance of the ASX200 Accumulation index over both periods, which remains deep in the negative on both accounts.
On my observation, most professional investors have found beating the index over the year past a tough challenge. In many cases the relative underperformance has now been stretched to 3-5 years, which is a long time in today’s 24 hours news cycle-driven world.
5.5 Years ago, the All-Weather Portfolio started off on the promise of an average total investment return of 7-8% and it is pleasing to note that, three mini-bear markets down the track, total return is keeping up with that promise.
For many investors, 7-8% on average over time may not sound like an extremely attractive proposition, but when the industry numbers will be released post FY20, many achieved returns over the past five years will be noticeably slimmer.
This is the point where I could pump up my chest and tell you all how fantastic my skills are in reading market sentiment and trends, but the opposite is likely more accurate.
In fact, if I compare the actions and strategy behind the All-Weather Portfolio with the ruling narratives that dominate daily news cycles in and around financial markets, the Portfolio could never possibly have done as well as it has.
For starters, there is no black box wizardry going on behind the scenes. We don’t use technical analysis. We don’t even try to assess where the next burst in positive momentum is likely taking place.
Because the Portfolio is carried by a specific focus on quality and sustainability, its composition is limited to a small group of stocks only, with resources stocks and other cyclicals off limits.
We don’t buy low and sell high. In true old Warren Buffett-style tradition, we often buy on above market average Price-Earnings ratio, and then keep the stock for many years in the Portfolio.
Buy “expensive” and hold on?
If you think about it for more than a few seconds, this should not be a Portfolio that is performing as well as it has.
So what exactly is The Secret?
I don’t think there is a “secret” as such, but below are a number of observations and conclusions I have drawn from the past 5.5 years of managing the All-Weather Portfolio.
1) Quality Beats Valuation
Too many market participants are too focused on scooping up “cheap” stocks. Sure, we all like a bargain, and a share price that falls to an extremely low price level will (at some point) rally higher, but sustainability and continuity are usually not included.
Cheap stocks, according to the value-investor’s narrative, are most beneficial entry points for long-term returns.
But when societies go through tectonic changes, and economies and business models are being disrupted on a daily basis, “cheap” looking stocks are simply the equivalent of the price discounted block of cheese at the local supermarket.
The expiry date is near. Don’t plan too far ahead. It’s a short-term fix, at best, not a long-term sustainable value creator.
Instead, it pays to identify high quality companies with a multi-year runway for growth, don’t get too spooked when valuations get temporarily a little bit bloated, and stay the course.
The best performing stocks in the Portfolio were trading on a PE multiple well above the market average when purchased, and they are still owned today.
2) Don’t Lose Your Focus Because Of Technical Analysis
I’d be homeless and roaming the streets by now with an empty coffee cup in hand, begging for change if I had to pay a dollar each time one of the stocks in Portfolio got hit by a negative trading signal stemming from technical analysis.
On my observation, technical analysis works best for low quality, highly speculative, small cap stocks. Probably because most of such stocks have nothing else going for them.
Quality, larger cap stocks can fall through the 200 moving average, or be rejected at a certain pivot, but as long as profits and fundamentals remain intact, it’s nothing but short-term market noise.
Pay attention, because so many others do, but don’t lose your focus or conviction because of short-term trading impacting on the share price. Positive fundamentals shall prevail.
Plus, of course, Quality companies surprise positively more than they do not. The latest example, as I am writing today’s story, is provided by Fisher & Paykel Healthcare ((FPH)) shares rising by more than 6% after releasing FY20 financials on a day when screens are almost universally coloured red.
3) Timing Trends Is Really Difficult
Plenty of books and newsletters out there that educate investors about cycles, changing trends and the investment clock, but putting it in practice proves a lot more difficult most of times.
At the beginning of the year the general idea was to jump on board oil and gas stocks, which then fell the hardest.
Only a few weeks ago strategists were re-weighting model portfolios towards more exposure to banks and miners.
Guess which sectors are among the weakest performers in June?
Robust, non-cyclical all-weather performers won’t keep up with those high beta, cyclical exposures when sentiment moves into Risk On mode, but on the other hand, they don’t fall as deeply when market sentiment sours either.
The latter means the Portfolio doesn’t need to make up as much to turn positive after a period of extreme volatility and heavy down-draught.
In simple terms, Quality and robust businesses are more resilient during tough times, and quicker to recover. These core characteristics are mirrored in how their share prices behave during downturns and bear markets.
This, I believe, is one of the key factors supporting the Portfolio’s performance.
A second factor lays with mega-trends; they run for many years, and create long-lasting mega waves along the way.
It’s so much easier for any management team to obtain labels of quality and excellence when their business is carried by such positive mega-trends. But every investor should be aware that the opposite very much holds true as well; irrespective of a "cheap" looking share price.
4) Accept Your Mental Barriers
Suppose you are convinced a share price has overshot to the upside, why would you not sell all your shares?
Because if the long-term growth trajectory of the company remains intact, that share price will end up a lot higher in years to come.
In other words: today’s over-valuation is but a temporary, short-term phenomenon and if the share price doesn’t pull back far enough, you won’t get back on board.
On my observation, quality companies in great shape are most likely to surprise on the upside, and they will take you by surprise shortly after you sold out.
Selling all your shares automatically creates a mental barrier, which makes it much harder to get back on board.
Taking profits in Xero ((XRO)) at $48 in September 2018 would have generated a nice profit, but today the shares are trading at $87. What if I subsequently had failed to quickly buy back in during the pullback?
I could potentially have missed out on the next 80% in additional upside (and the shares have been higher).
Many investors, on my observation, are too easily guided by short-term considerations. Of course, it’s only worth sticking around when companies deliver on their promise and potential, and there will be doubt and disappointments along the way.
One of the ways to deal with constant uncertainties is to adopt a holistic, portfolio-oriented approach. This means you can deal with falling share prices, and small disappointments, because the Portfolio as a whole is performing.
Keep the following motto in mind: for an underperforming company, it’s never too late to sell, while for a consistent, solid performer it’s seldom too late to buy.
5) Risk Management, Not Trading
Irrespective of what transpires inside or outside the share market, you will be selling and buying shares, irregularly or otherwise.
There is, however, a difference between trading the Portfolio or simple risk management.
Over the past 5.5 years I have mostly sold shares to reduce risk when the odds seemed to move in favour of a large drawdown (when Cash is King), or to skim a bit off the top of a temporary overheating market darling.
I sell out completely when I believe the future trajectory of a company has been severely damaged, or when I have to conclude that buying in was a misguided decision.
We all make errors, but the worst one is sticking around because the share price is now lower than when we joined the register.
We must accept things do not always turn out the way we envisage them. Changes are happening every day. Some cannot be anticipated; in other cases, we might have been blinded by whatever.
I tend to sell quickly, without regret, and move on.
Part of my Portfolio management also consists of getting rid of dead wood and disappointments when another bear market hits (we had three since 2015) in order to concentrate on the High-Conviction holdings.
6) Know Your Stocks
Marcus Padley once wrote a story about the one stock portfolio. The idea is to get to know everything about that one company, so you know what moves it, what is important and what is merely noise or market tribulation.
It’s a rather extreme concept, but I see a straightforward similarity as to how I keep track of the companies I own in the Portfolio.
You first select them because you believe in their growth prospect, and once you own them you keep track of them, so you get to know them better as time goes by, learning new things, discovering fresh insights.
The true value of investing with a long-term horizon is that you accumulate knowledge and insights about the investments you own. On the premise, of course, that you continue reading and paying attention to research updates and fresh developments.
As the old saying goes, you can copy somebody else’s stock tip, but you cannot copy their conviction. That conviction to not sell out when Xero shares hit $48 can only come from your own knowledge and personal insights.
7) Regrets, We All Have A Few
The best comparison for investing is a round of golf. It’s never about being perfect. It’s about making sure that the mistakes you make don’t destroy all the positive achievements.
Not being perfect also means we all end up with a few regrets, every now and then, in hindsight. In golf parlance: that’s simply par for the course.
My regret is called Macquarie Group ((MQG)), without any doubt the highest quality financial institution in this country.
When the covid-19 lockdowns arrived, and a new bear market seemed to have been thrown upon us, I sold out of Macquarie shares because I envisaged multiple years of asset write-downs and challenging deal-making conditions.
Of course, things turned around rather quickly since, and as yet another example of the human brain creating barriers, the Macquarie share price simply rallied away from me.
Regrets, we all have a few. That’s simply the nature of this game. But if the overall performance of the Portfolio isn’t too bad, we should not dwell upon them for too long.
The share market being the fragile, unpredictable and mercurial beast it is, there will be opportunities to get back on board, patience permitting.
But before that can happen, we must have Macquarie on our radar in the first place. This too is where my personal narrative differs from the ones that are dominating the general focus and commentary.
I don’t look for “cheap” stocks, and then jump on board. I have a pre-selected list of quality stocks I’d like to own. Then the story begins…
(This story was written on Monday 29th June, 2020. It was published on the day in the form of an email to paying subscribers, and again on Thursday as a story on the website).
(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions. All views are mine and not by association FNArena's – see disclaimer on the website.
In addition, since FNArena runs a Model Portfolio based upon my research on All-Weather Performers it is more than likely that stocks mentioned are included in this Model Portfolio. For all questions about this: firstname.lastname@example.org or via the direct messaging system on the website).
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For more info SHARE ANALYSIS: FPH - FISHER & PAYKEL HEALTHCARE CORPORATION LIMITED
For more info SHARE ANALYSIS: MQG - MACQUARIE GROUP LIMITED
For more info SHARE ANALYSIS: XRO - XERO LIMITED