Holly's Blog - Bastard Ratios, Haribo and Cherrypicking
19 Aug, 2022
On Wednesday this week, I had a chat with someone who I think has the job title of Global Macro Thinker at a large asset manager. I say – I think – because in hindsight it sounds like a very odd job description. But it’s amazing what you accept as normal when you are sitting in posh City offices, surrounded by earnest men looking at multiple large flashing screens. I was also eating an extremely large bag of Haribo at the time, so was probably speeding too.
I asked him to cheer me up. Where were the investment opportunities and the good news stories?
The bad news is, the summary is Not Much. He thinks inflation is a spike and a short-term problem so interest rates will not keep rising. The UK is not looking great. Nor is Europe. The US is arguably looking less bad. (Note: that’s not the same as good.) And China is ‘in a mess’ but interesting if you have a long-term outlook and are patient. He thinks oil stocks will probably do OK, as will commodities. Basically nasty regimes and companies look better than the average.
Finally, he thinks that the 40 year bull run is over and we are going to have to learn to accept lower returns as the norm.
By this stage, I had eaten about 15 fizzy Cola bottles so felt a bit sick for multiple reasons.
Every cloud….
Every month we publish the ‘bestsellers’ – the most bought funds, investment trusts, ETFs and shares across leading investment platforms.
If we look at the bestselling shares in July, it was all about oil companies, miners and financials. If you want to know why financials typically find favour when rates rise, just consider what I think of as the Bastard Ratio. Take the number of minutes it takes your bank to text you about increased mortgage rates after the Bank of England announcements. And the number of minutes it takes them to text you about the higher rates they are paying you on the cash in your current account. And you get a Bastard Ratio of something like 1: 1 billion. That is basically why many financial firms do well when rates rise.
The only fund to appear in the bestselling lists for all 4 major platforms in July was Fundsmith Equity. Still riding high. This fund has a 74% allocation to the US. Software and consumer essentials make up over 40% of the holdings – these are things thought to be pretty recession-proof.
People have written for decades about how ‘utilities’ are good defensive investments. Traditionally these have included electricity, telecoms and water – recession-proof firms which people need at all times. This article from Invesco is interesting – argues that technology now has utility-like qualities which makes perfect sense. Name me one COO who is going to cut Microsoft subscriptions, as they hop onto Teams to discuss how to cut costs and headcount!? And actually – back to Fundsmith and the fact that 5% of this fund is in L’Oreal. I’d also argue that my face cream is just as much a utility as electricity – I am not going to have a dry and wrinkly face, however tough things get! (On this basis, wine is also a utility but I understand that may be pushing it a little….)
So despite the clouds, common sense should dictate to us that there are still lots of companies who will continue to do well and offer up some silver linings.
Cherry picking
Back to my Global Macro Thinker man – he was also quite down on passive funds. Arguably he would be, because he works for a nice posh active asset management company with lovely offices. BUT. I have a lot of sympathy with the argument that in a rising tide, you can just jump into the investment market and go along for the ride. Up it all goes over time and why spend a lot of money on people trying to pick the best – when the average is pretty good?
However, I think you don’t need to be a technical whizz to see that things are becoming more polarised and volatile. There are tons of example out there.
Oil companies – for recent, global, specific reasons have done very well this year. The Nasdaq has quietly shot up by about 23% since June – all those interest rate rises helping it recover from a bruising spanking at the start of the year as valuations were questioned. The aforementioned Bastard Ratio helping financials in the short-term. It’s quite sector-specific. And region specific. With lower forecast returns across the board, I suspect that passive funds may slightly lose their shine over coming years and successful active stock pickers will become highly valued again.
If you think that you want to pay people to cherry pick the best for you, and not just go with a passive fund which backs every horse, here’s a final tip. The worst thing is paying a posh active manager who then behaves like a chicken and is so scared of making a bad call that they stick with the flock. This is known as index-hugging.
Look for the number called Active Share which is expressed as a % on any fund. This measures the difference between the investments in a fund and its corresponding index. If the FTSE 100 was 100% HSBC (oh just humour me) and my UK Equity Fund was 100% in Barclays, I would have an active share of 100%. You generally want an active share of more than 80% or you’re paying someone to faff around with no conviction.
Once a month we produce a slightly more technical funds newsletter with bestsellers updates and featured topical content. If you’d like to get this, as well as your weekly dollop of Boring, you can sign up here.
That’s it from me folks and I’m now off, taking a little break for the summer. Yes of course I’ll be heading to the beach for a couple of days as the heat subsides, the rain comes and the sewage spills. Such fun! We’ll be back in early September – over and out!
Holly
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