10/7/2021 11:00:00 PM

CIO Report: Behaviour is key during these volatile times

September was a difficult month for global markets as concerns around the Chinese property market took hold, inflation concerns and an impasse on the US government debt ceiling all caused a sell-off in markets. There was a solid move to more cyclical assets away from structural growth, which generally hurts our investment returns in the short term.

Significant drawdowns

2021 has been an interesting year to navigate. Within the advance of the markets with little volatility underneath the surface, there have been significant drawdowns. For example, the Goldman Sachs Growth Software basket is down -13% at the time of writing, but was also down -27% in February 2021 and -20% in May 2021. 

In February, the US 10-year rates increased substantially from 1% to 1.5% in a month. Similarly, in May, investors were concerned about inflation affecting the valuation of high-growth companies, so similar concerns to what we are witnessing now.

Learn to trust the process

Managing your emotions is paramount in times of volatility, especially as price action can question your investment thesis on a stock. I have learned that price action is quite telling that something is going wrong in the business (in the small-cap universe, adverse circumstances can lead to permanent impairments to valuations). Other times it is just market-wide volatility that is a buying opportunity. 

Trusting the process and revisiting the original thesis in a clear way (acknowledging inherent endowment bias), and doing thorough checks on a company is necessary before you can step in confidently and buy when a stock is falling. 

You must also be realistic that you will never pick the bottom and acknowledge that a stock will likely keep falling in the short term before recovering.

Short-term noise

Also, another consideration is how much noise to react to. Throughout a year, there are many transitory issues that can impact a business in the short term, i.e. 0-12 months. However, in the long-term, it will have no bearing on the investment case.

An example of this now is supply chain issues and wage inflation. Yes, it impacts companies, especially retailers, but most companies in the same industry will face identical pressures. This knowledge is temporal information that will have low relevance in 12 months.

Trying to trade around this news flow is difficult as often the share price will be down 10-20% by the time the extent of the information is widely known, therefore limiting the effectiveness of a sell decision. You must also know when to decide to buy back in, and the share price will also likely be up 10-20% before the inflection point is well-known. Although with enough foresight and nimbleness it is possible to add value.

The more pertinent task is to seek knowledge that has a long half-life. For example, what characteristics of companies allow them to have competitive advantages and use pricing power to maintain margins in an inflationary environment? This information is more valuable and can help identify patterns in business models that set them apart from the competition and allow them to earn superior returns over time.

Overall, we welcome volatility and continually aim to manage our emotions to take advantage of situations where the price is divorced from intrinsic value. Once again, thank you for entrusting your capital with us.

Information is current as at 30 September 2021. Pie Funds Management Limited is the manager of the funds in the Pie Funds Management Scheme. Any advice is given by Pie Funds Management Limited and is general only. Our advice relates only to the specific financial products mentioned and does not account for personal circumstances or financial goals. Please see a financial adviser for tailored advice. You may have to pay product or other fees, like brokerage, if you act on any advice. As manager of the Pie Funds Management Scheme investment funds, we receive fees determined by your balance and we benefit financially if you invest in our products. We manage this conflict of interest via an internal compliance framework designed to help us meet our duties to you. For information about how we can help you, our duties and complaint process and how disputes can be resolved, or to see our product disclosure statement, please visit www.piefunds.co.nz. Please let us know if you would like a hard copy of this disclosure information. Past performance is not a guarantee of future returns. Returns can be negative as well as positive and returns over different periods may vary.