Value Perspective Quarterly Letter – Q3 2022 – Global

Our quarterly note covering the Global markets

02/11/2022
AdobeStock_135255774-Q3Global

Authors

The Value Perspective team

The revolution is here

“There are decades where nothing happens; and there are weeks where decades happen.”

This quote, oft attributed to Lenin, wasn’t referring to the final weeks of the third quarter of 2022, but it easily could have been.

The UK has taken up far more than its fair share of column inches in the global financial press, and mainstream media, for all the wrong reasons. The final week of September saw UK gilt yields rocket after a disastrous reception to the new UK Chancellor’s unfunded tax giveaway. This triggered a shockwave for UK pension schemes that use liability-driven investment (LDI) strategies – which use derivatives to allow pension schemes to increase their exposure to gilts, without necessarily owning the bonds outright. Ultimately the Bank of England (BoE) splurged £65bn to provide liquidity to the gilt market and halt a potential downward spiral.

It was a dramatic finale of increasing global macroeconomic uncertainty in a quarter that saw inflation go from ‘transitory’ to ‘definitely here’, and interest rate expectations the world over move higher at a record-breaking pace.

Markets have reacted

Year-to-date, the 30-year UK  gilt index is down 43%. $33 trillion has been wiped off global stock markets. The Nasdaq is down 32%. The MSCI Asia ex-Japan index has fallen more than 40% since its peak last year. Three-quarters of large US companies that went public during the pandemic bull market are now trading below their offering price despite hefty post-IPO price spikes (the median return of more than 400 listings is -44%).

It is evident that markets are stressed and investors are nervous. It is at times like this that Hyman Minsky’s ‘paradox of tranquillity’ comes to mind: That stability itself creates instability because investors take on more risk assuming the future will be as benign as the recent past, which in turn increases the risk that volatility will cause instability in the financial system. The latest evidence of this is gilt yields moving more than a percentage point in a few days. Some UK pension funds were levered in a way that did not fully respect the potential for wide moves, purely because of years’ worth of low rates and relative calm. And those benign financial conditions gradually encouraged this hidden leverage to build-up.

Accept and prepare for the natural uncertainty the world will always offer

The lesson for investors of all shapes and sizes is we cannot know where the next crisis will come from. What we can say though, is that it is probable that more than a decade of cheap money has caused the build-up of risks in other corners of the financial system.

There is some good news though. Equity investors can protect themselves by focusing only on stocks with genuinely attractive valuations and, via rigorous analysis, purchasing only those that have sufficient balance sheet strength to see them through whatever lies ahead. It pays to be prudent.

An abundance of opportunities

The equity market drawdown means there are plenty of new stocks appearing on our valuation screens. But while there are plenty of opportunities, only fools rush in. Our process is our guide in this regard. One of our seven red questions has always been about balance sheet strength. We interrogate the balance sheet before any company enters the portfolio. This focus on truly understanding a company’s financial position is important at the best of times, and even more so today. For example, when looking at cyclical businesses (such as the new purchases this quarter), we will only add exposure where we are compensated for the potentially turbulent times ahead.

Short-term discomfort for long-term benefit

Our hunting ground for new ideas is out-of-favour areas of the market. Finding these stocks can be very rewarding when the discount at which they trade to fair value closes, but this tends to take time. This point is particularly pertinent today, as we have been taking profits on some of the holdings that have performed strongly over the past couple of years, and are gradually buying into new opportunities that are appearing as a result of the current market turbulence.

We encourage all clients to think long-term.  Our investment horizon is 3-5 years and the value style (being inherently contrarian) can often result in difficult periods of performance. We do take some comfort that the fund’s two year performance numbers remain strong; a time period where, in aggregate, the alpha from our stock picking has had a helpful tailwind from our style bias.

A diversified portfolio that is well-placed for an uncertain future

Overall, your portfolio is well-diversified and retains a larger-cap bias. The majority of the companies that we hold are ‘global’ in nature. This should help to limit the damage from ongoing volatility in the currency markets.

In an environment where moves in sterling and gilts in particular have reminded investors of previous emerging market crises, we are in no doubt we are living though uncertain times. However, over recent years we have taken advantage of valuations to increase diversification and our process has meant we have avoided many of the stocks that have fared the worst in this drawdown. We are also being cautious as we lean into areas that stand to benefit your portfolio greatly over the coming years, even if that feels uncomfortable today.

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Authors

The Value Perspective team

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On 17 September 2018 our remaining dual priced funds converted to single pricing and a list of the funds affected can be found in our Changes to Funds. To view historic dual prices from the launch date to 14 September 2018 click on Historic prices.