Giselle Roux* says while managers work through probabilities and scenario modelling, the serious wealth is in those who can achieve good outcomes without the herd mentality.
The performance of an equity portfolio since the mid-February sell-off depends on its constituent group at that time and then changes made later.
Inevitably, the speed and volatility of the adjustment made it hard to carefully consider what should be sold and bought.
Imagine that the bulk of the holdings had been in sectors such as food retailing, food and beverage manufacture, household and personal products, biotechnology, telecommunications and IT.
This eclectic mix would have held up relatively well.
While it is not a cohesive mix, it has a bent to lower-growth companies that, on aggregate, tend to match the rate of economic growth.
It’s doubtful many would have considered this an optimal mix in the heyday of 2019.
On the other side of the ledger have been the hard-hit sectors of consumer services and durables, real estate trusts, insurance and retail.
Once again, there is nothing to build a picture around these sectors as a group.
But within them there were stocks that had long been favoured by the market representing attractive themes such as travel or media and consumer brand preferences that had shown their capacity to maintain their status — Nike, for example.
Equity managers are now in a game of probabilities and scenario modelling.
Does one resist the call to realise stocks that have been beaten up on the basis they have been dealt a bad hand and it will pass, or slide into the relatively safety of the sectors that are less affected?
Valuations of defensive stocks are unappealing to growth managers, while the earnings certainty in the other sectors is low.
Yet the leadership of growth is narrowing.
There are plenty of charts showing that Amazon, Apple, Alphabet (Google), Facebook and Microsoft have accounted for all of the recovery in the S&P 500.
To be fair, they and a few others have been the predominant cause of the outperformance of the US market for the past four years.
Yet they are not without challenges.
Valuation is one — and never ignore the regulatory cloud — while many are dependent on consumer and advertising trends, which may change in coming years.
Fund managers may capitulate and include these stocks in a portfolio regardless of their stated process, as the risk of underperforming and losing clients is too great.
Overcharging for this momentum-driven fixation is inappropriate, as some do via high and, even more egregiously, performance fees.
The real money is in those that can achieve satisfactory outcomes without the herd mentality.
To cut to the chase, one can these days hold big tech stocks without fees and then find a complementary fund manager with companies that don’t have the same profile yet are in a similar growth theme.
This path assumes the nature of companies that dominated the past 10 years will be those that do now, which comes back to the debate on what a global equity portfolio should look like at present.
Lost souls of the past decade yearn for the return of value stocks.
The characteristics are low price-to-book and price-to-sales ratios with relatively higher dividend yields and lower price to earnings.
It’s not hard to spot the flaws in these ratios and most so-called value investors have a much more intricate view of value, yet it has been clear the investment universe at large has been reluctant to take on strategies that rely on turnarounds or a change in sentiment.
Big downturns in equity markets have often been associated with a regime change in leadership.
The temporal resilient nature of old-fashioned companies such as supermarkets sits at odds with what we have assumed will be future trends.
Is healthcare and biotech the new information technology?
The resurgence of attention to this sector is easy to understand but, akin to IT, a small handful are likely winners with many more failing.
The over-reaching hand of governments is a new reality, which — unlike the unfolding of IT into everyday activity — will cast a shadow over such a sector.
Equity portfolios in terms of sector exposure, dressed up as pure stock selection, have been a feature of recent years.
Yet investors are told to diversify, implicitly tolerating some component underperformance which will be redeemed under alternative scenarios.
An equity portfolio that claims to capture all conditions is belying reality.
Traditional roles of growth and defensive equity allocations are appropriate even within changing circumstances.
Expectations that funds do magic tricks by changing positions in weeks underplay the complexity of what we have seen.
Nonetheless, an evolution is appropriate and it is incumbent on the manager to give a coherent rationale.
* Giselle Roux is an investment strategist and contributor to the Australian Financial Review.
This article first appeared at www.afr.com.
