2nd December 2022
Regular readers and investors will know our ‘Time for a Different Approach’ mantra. This is not a temporary marketing message we thought of in January 2021 in order to promote our low allocation to conventional fixed income instruments during a period of pitiful nominal yields, and our consequential high allocation to alternatives. Despite a material shift in our asset allocation this year in response to rising bonds yields that has effectively reversed that allocation to bonds and alternatives, we continue to promote our differentiated approach as we believe there are so many things that make us different to a large number of institutional investors. One of those differences is keeping things simple. In the very early days of Hawksmoor our colleague, and founder of HFM, Richard Scott, had a firm belief in common sense, and that has been an enduring base line for everything we do within HFM. It sounds obvious but as Voltaire allegedly said “Common sense is not that common”.
We read lots of research and one commentator we have high regard for is Howard Marks, founder and Co-Chairman of Oaktree Capital Management, a US asset manager with $163bn AUM. His books and regular memos are rooted in common sense and often rail against what is taught in economic or business schools. His latest memo entitled “What Really Matters?” LINK HERE, was a good reminder of what DOES NOT matter when it comes to investing. I thought I would highlight three particularly relevant points to our process and philosophy:
- Short-term events and short-term performance: We have written before about why macro investing is hard to make money in the short term because not only do you need to predict the event itself happens, you need to know when it will happen and what the market reaction to it will be. Marks believes the market reaction is the hardest element because you need to know what the market’s expectations are of such an event happening in order to be able to bet against it and make money. As that is almost impossible consistently, just focus on your area of expertise, such as security selection, and look beyond the short term. Marks writes that as the short-term can be dictated by a number of random events, no-one should attach much significance to returns in the short term, “Deciding whether a manager has special skill – or whether an asset allocation is appropriate for the long run – on the basis of one quarter or year is like forming an opinion of a …. racehorse based on one race”. With our process founded on valuation, which we know is not a good short-term market timing tool, we completely agree and are currently investing into areas that display historically cheap attributes that are likely to lead to good long-term returns, but we have no idea what that means for the next few months.
- Hyper-activity: It follows that if you are not overly obsessed by short-term events, then dealing activity shouldn’t need to be high. Marks suggests investors should develop the mindset that you don’t make money on what you buy or sell, but what you hold. He also refers to a study by Fidelity in 2020 that reported that of their clients, those that experienced the best returns between 2003 and 2013 were either inactive (those that forgot about a pension they had) or dead (where the assets had been frozen while the estate handled the assets). Whilst dying is a bit extreme in return for better performance, it suggests trading less might improve long-term returns. We agree to an extent as we know that there is a cost in dealing, but we feel that we must react to significant changes in valuation such as we have seen in recent months. When relative valuations across asset classes change, we feel it is beholden on us to react accordingly, hence the rotation out of alternatives into vanilla credit and equities this year.
- Volatility: Marks defines risk as the probability of a bad outcome, similar to our own definition of a permanent loss of capital, and that volatility is not risk. He points out that the only relevance of volatility comes back to the previous point of short-term performance. If investors share the same long-term time horizons as the manager and do not need to withdraw capital (such as for lifestyle reasons or to repay debt), then “volatility is a temporary phenomenon and most investors shouldn’t attach as much importance to it as they seem to”. This is particularly relevant to bond investing, an asset class in which Marks is well-renowned. Most bond investors will buy a bond yielding say 8% and will receive that 8% yield over its life regardless of whether the price goes up or down in the meantime (assuming it doesn’t default of course!). Volatility can be viewed as a positive for long-term and active investors as any price falls allow managers to buy more of that bond or equity at lower prices that should enhance long-term returns. In our presentations for our Global Opportunities fund, we quote Charlie Munger (Marks attributes the quote to Warren Buffett, but it’s the same thing) as saying “We prefer a lumpy 15% return than a smooth 12% return”. Marks adds that anyone who would prefer the opposite should ask themselves whether their aversion to volatility is for financial or emotional reasons. I would add that many institutional investors have volatility targets or limits that will therefore force them to prefer a lower return.
The fund management industry is excellent at over-complicating things that can hamper managers from doing what they should all be ultimately seeking to achieve, generating real returns for investors over the long term. Keeping things simple is one of the keys to our long-term success and we are comforted in our approach when we read similar sentiments expressed by a highly regarded asset manager such as Howard Marks.
Daniel Lockyer – Senior Fund Manager
For professional advisers only. This article is issued by Hawksmoor Fund Managers which is a trading name of Hawksmoor Investment Management (“Hawksmoor”). Hawksmoor is authorised and regulated by the Financial Conduct Authority. Hawksmoor’s registered office is 2nd Floor Stratus House, Emperor Way, Exeter Business Park, Exeter, Devon EX1 3QS. Company Number: 6307442. This document does not constitute an offer or invitation to any person, nor should its content be interpreted as investment or tax advice for which you should consult your financial adviser and/or accountant. The information and opinions it contains have been compiled or arrived at from sources believed to be reliable at the time and are given in good faith, but no representation is made as to their accuracy, completeness or correctness. Any opinion expressed in this document, whether in general or both on the performance of individual securities and in a wider economic context, represents the views of Hawksmoor at the time of preparation and may be subject to change. Past performance is not a guide to future performance. The value of an investment and any income from it can fall as well as rise as a result of market and currency fluctuations. You may not get back the amount you originally invested. FPC699