“This stock hit its 52-week low today, I should look at it”. This is often what I tell myself at work. Buying stocks that have fallen a lot is just what value investors do. Isn’t it?
Value investors look at stocks that are out of favour. As Warren Buffett has said “you pay a high price for a cheery consensus”. If you want above average returns you must be prepared to go against the market – be a contrarian.
The reality is that buying plummeting stocks assuming that the market is being too pessimistic, or just plain wrong, often ends with disastrous results. Particularly in the current buoyant market.
Falling knifes are now sharper
The MSCI All Country World Index, a proxy for global stocks, is up 180% since the end of 2008. Price volatility, often a source of opportunity, is hitting record lows. As the below note from Morgan Stanley points out, the index’s volatility is at its lowest level since 1996.
“After the weakest of August wobbles, global equities have been pushing higher with almost unnerving consistency. MSCI ACWI is up for 23 of the last 30 days, the best streak in over a year. It’s done this with a realised volatility of just 4.2%, a reading that, outside of three days in 2014, was last matched in 1996. Happy days.”
Such an environment makes it tough to find cheap stocks. As analysts work even harder, fewer stones are left unturned. At the same time, given most equity funds are required to be fully invested at all times, even the second or third-best investment opportunities become investment grade.
When competition for new investments is high, the worst performing stocks are likely to be value traps – stocks that look cheap but deservedly so. If buying an unloved stock now on the premise that Mr Market is wrong is particularly risky, how should we be positioning our portfolios?
While the International Fund has grown from $43m in 2014 to $177m today, the Fund can still invest in smaller companies. ‘Small caps’ are usually less researched due to their low liquidity and so can offer greater returns. Although competition from other funds for such investments has increased lately, the Fund’s ability to invest globally has mitigated this. Some of the Fund’s newer small caps are discussed in the September quarterly report. These are not beaten up stocks going through trouble, but good businesses at reasonable prices.
Unlike the International Fund, few other equity funds are able to hold unlisted assets. If one of their investments delists they must sell no matter what. As the Fund’s investment in Winthrop Realty Trust shows, from time to time this dynamic offers opportunities to pinch cheap stocks from forced sellers. Holding unlisted assets has risks such as limited reporting and zero liquidity. But the Fund’s ability to do so can come in handy.
Absent low-risk outright bargains, quality blue chip stocks bought at reasonable prices can be a sensible place to invest and wait. As explained in this post, some of the Fund’s holdings such as Alphabet (Nasdaq: GOOG) are unlikely to double tomorrow. But if the economy suddenly cools down, their businesses should hold up better than others.
The above strategies are hardly revolutionary and the Fund’s 30% cash holding is high. But this is not the time for beaten-up bargains. While we wait patiently for the bargains to return, cash and quality make for a sensible combination.