1. Put the odds in your favour by knowing what you don’t know
In 2016, the U.S. election and Brexit highlighted just how uncertain the world can be—and how market expectations can be wrong. When positioning their portfolios for these types of macroeconomic events, it is important for investors to realize what it is that they actually know.
Here are three principles to consider:
- “Bet” when you have an edge.
- Diversify otherwise.
- Realize that most of the time you don’t have an edge.
In investing, it is not enough to be “right”—you also want an edge. An edge occurs when you have an insight that is different from the collective view of the market. It happens when you have information that gives you confidence that the odds displayed in the market are wrong. At Mawer, we systematically seek to act on an edge by buying wealth-creating companies, run by excellent management teams, priced at a discount to their intrinsic values.
The inherent complexity of macro events often make them and their consequences difficult, if not impossible, to predict in advance. When we don’t believe we have any special information on the way an event will unfold or the impact it will have, we know that making a one-way bet is not an advisable strategy. In these cases, it is most prudent to diversify. With diversification, you hold assets that should perform differently under different scenarios. Using this strategy, you have not positioned yourself for one outcome only; it requires giving up some upside in order to protect most (but not all) of the downside.
2. When in a hole, stop digging
This levelheaded strategy is difficult to execute but can be critical to successful investing.
In every investor’s experience there is a point when a stock you “like” will start to deteriorate. Our learning is: don’t immediately start “chasing.” When a stock is coming down in price, it is doing so because the market, made up of a collective of thousands of individuals, is saying the price should be lower. Now, there are times when the market is wrong and your previous viewpoint could be right; but, often, the market is telling you something. Something you may not yet know.
As fundamental investors, our natural instinct is to presume that we know the story on a stock. After all, we’ve likely spent hours of analysis trying to understand it. But when a stock begins to deteriorate, our lesson over time has been to have patience and not act immediately.
3. Focus on long-term themes not short-term noise
The day to day events that dominate investment news are like waves crashing onto the beach; unique, absorbing…and ultimately inconsequential. Most investors would be better off focusing their attention on understanding the longer-term drivers—the investment tides—than trying to predict the impact of today’s events that will hardly matter in ten years. Increased knowledge of the tides can help investors better understand the true nature of the risks in their portfolios and the companies in which they invest.
For example, several important themes took root in the last year: we saw policymakers publicly acknowledge that we are reaching the limits of the effectiveness of monetary policy; governments around the world have shown interest in using fiscal policy to stimulate growth and redistribute wealth; and a rising tide of populism and anti-globalization sentiment has spread through western nations. These developments may have meaningful consequences to the investor.
Prudent investors are focused on tides, not waves. They seek to understand the long-term themes so that they can better identify the companies that should be wealth-creating over the long-run.