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Picking bottoms

11th November 2022

Every day is a school day when it comes to investments.  The ‘market’ changes daily based on a wide variety of inputs such as corporate news, economic data and political events, with the latter perhaps playing too big a role in recent weeks!  The fact that we come into work every day not knowing what will appear on the screen is what makes this a fascinating and stimulating industry.  However, just because the market changes every day, doesn’t mean we are compelled to make changes to our funds’ portfolios every day.  Having a trusted investment philosophy and process allows a much more measured approach during volatile times like this, but, like Rome, that process wasn’t built in a day, but over years of lessons learned.  A few pertinent elements of that process have sprung to mind lately;

  • Humility. Now, we are not saying we are more humble than everyone else (as that isn’t being humble obviously!) but almost everything we do stems from knowing that there is so much we don’t know.
  • Fully invested, long-only portfolios. Having large cash balances or using derivatives for hedging purposes can cause irrational behaviour.  I know from past experience that cash in excess of 10% or an index future short position of as little as 5%, can cause investors to lose sight of the 90-95% of the assets invested.  Do you celebrate the market going down to justify the cash or short position, while ignoring the falls in value across the majority of the portfolio?
  • Control the controllables. This means we focus on the valuations of the underlying asset classes and strive to have a portfolio full of cheap assets that offers more of an upside than downside if we are wrong or too early (perhaps the same thing!).  Macro investing involves getting two decisions correct, first that the forecasted event happens as you expect, and second, the market reaction to that event happening is as you expect.  Investors rarely get one, let alone both right on a consistent basis, so we steer clear of holding assets where returns are reliant on a macro situation playing out.
  • Market timing. Linked to the previous point, we’ve all seen the evidence to prove that ‘time in the market’ is more profitable than ‘timing the market’.  It is almost impossible to call the bottom and we know from past experience that once the bottom is in, the recovery can be sudden and sharp.
  • Longer investment horizon. No-one really knows when markets reach a nadir, until afterwards, so we want to be fully invested to capture that inflexion point.  Being early can be painful in the short term so we have to invest looking beyond the next few months and rely on our investors having the same amount of patience as we do.

The reason for highlighting these elements of the process is that we have come across an increasing number of fund managers with whom we invest, and those we don’t, that are all very optimistic on their respective asset classes but are very wary of moving to a fully invested position yet.  Most are saying the respective nadirs are going to be in Q1 2023, and that’s when they will get really excited.  But market lows tend to coincide with very poor sentiment when it will feel really uncomfortable to suddenly turn bullish.  Recoveries from low points can be very sudden and sharp for that reason.  For example, UK Smaller Companies bounced 50% within 4 months of the market lows during the GFC, much of which was probably attributed to those on the side-lines still waiting for the bottom eventually capitulating and jumping on board.  Managers that are not invested will suffer poor relative performance and that will be annoying for investors in their funds who have made an asset allocation decision and want to be fully exposed to that market’s returns.

So, when we hear managers talking about trying to call the bottom, it represents a bit of a dilemma for us as we want to respect their opinion given, they are the experts in their specialist area and are much closer to the coal face, but when we get excited about an asset class, our process leads us to start allocating gradually rather than trying to ping the bottom with a full allocation.  Thus, if those funds are not fully invested and the recovery happens when no-one expects it, we are not capturing the upside for our clients.  Regular dialogue and communication with our underlying fund managers is therefore crucial.

Notwithstanding those caveats, today we are fully invested across a number of asset classes where each are at valuations that represent the cheapest they’ve been in a very long time, or ever in some cases.  These include, but are not exclusive to, UK smaller companies, Asian and Emerging Market equity income, Japanese smaller companies, mortgage backed securities, investment grade corporate bond funds, and private equity investment trusts.  Of course there are reasons for them looking cheap, not least we are now in a higher interest rate and inflationary regime not seen for decades that has implications for the pricing of any ‘risk asset’.  Following the process does lead to periods of underperformance at times when assets get cheaper, as we are experiencing now, but if we don’t invest in them now I’m not sure when we would.  Not investing requires a contradictory macro call coming good, or incredible belief in one’s ability to pick the bottom.  I’m not sure who said it, but the phrase “only monkeys pick bottoms” seems particularly relevant in today’s market.

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. FPC681.

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