'The farther back you can look, the farther forward you are likely to see.' (Winston Churchill)
We have spent time recently reading the letters of some of the investors we highly respect, from the turbulent period from late 2007 to 2009.
Despite all of the handwringing, not to mention the many books and indeed blockbuster movies memorialising that period, there are always useful new insights to glean.
For example, you will likely remember the run on UK bank Northern Rock on 14 September 2007. You may not recall that in the month following the first bank run in the country for 150 years, the FTSE100 index finished up 7%.
Indeed a full year later, the same index had dropped only a modest 15%. Just a day later, however, Lehman Brothers collapsed, causing global equity prices to plunge.
The interesting point here is that though Northern Rock later proved to be the canary in the coal mine, many investors were not incentivised to heed the warning, preferring to suspend disbelief and stay invested for fear of missing out on further stock market gains (after five years of sharply rising markets).
We have no fear of missing out on rising stock prices, having our own money invested in the funds we run, and therefore spend our time worrying about capital preservation and paying careful attention to the warning signs.
This mindset of capital preservation is why we don’t lose too much sleep over not owning the popular internet companies known as FANGs. (Facebook, Amazon, Netflix and Google, the latter now known as Alphabet).
One of our former colleagues, whom we hold in the highest esteem, was fond of repeating Warren Buffett’s aphorism that ‘investment is simple, but not easy’.
‘Simple’ in the sense of buying a share in a high quality business and watching that company compound capital over time.
But ‘not easy’ because of the distractions of short-term punditry and the temptations of cheap companies of inferior quality, to name but two malign influences.
Buying stocks that fit into a catchy acronym, unfortunately falls into the category of easy, and is highly unlikely to be the route to long-term fortunes, just as the Nifty Fifty concept proved to be merely a mirage over forty years ago.
The current fashion for buying Exchange Traded Funds (ETFs) is reminiscent of portfolio insurance thirty years ago, the popularity of which was a contributory factor to the 1987 stock market crash.
Shares are fundamentally an illiquid asset, representing claims on the longterm cashflow generation of a business.
While the stock market matches buyers with sellers unwilling to wait for that cash to flow through to them via dividends, this liquidity cannot be guaranteed.
Stock market index ETFs go a step further, promising daily liquidity in a portfolio of shares. Much like portfolio insurance, which promised the ability to exit from the stock market instantaneously without having to sell your shares, the rise of index ETFs in recent years has offered investors the ability to exit at the click of a button.
However, if at the yell of ‘fire’ many people head for the exits at the same time, ETFs will be forced sellers of stock, far in excess of the offers to buy the underlying shares, quite possibly creating a vicious cycle of further selling.
We don’t know when or where the canary will appear this time around, if indeed it hasn’t already dropped off its perch.
But we are convinced that strong balance sheets and business owners who have proven themselves risk aware in the past will prove their worth sooner rather than later.
Dominic St George manages a range of funds for Stewart Investors, including the Worldwide Equity fund. In the three years to the end of February the fund has returned 43.5% versus a sector average of 36.1%.