We have written extensively about risk, volatility, and valuations over the last several years. From our perspective, it’s important to continually talk about the fundamental values that drive our decision making.
Along those lines, we wanted to share a bit more about the process of evaluating a company and the decision to invest. This quarter, our portfolio manager Nick Fisher walks through his in-depth analysis of Peyto Exploration and Development and why he recently decided to add it to portfolios. Meanwhile, Alex Bridgeman, our newest employee, highlights why a modest allocation to a company like Peyto is a good idea that not every investor is able to make.
We love investing in companies that offer clear paths for growth at cheap prices today with great management teams. It’s how our minds are wired, and we are always on the hunt for new, undiscovered opportunities.
We have recently increased our focus on looking for smaller, undiscovered, and cheap companies to add to portfolios. The “small” part is the newest edition to our process, and we believe there is a ton of value to be found in companies that are below Wall Street’s investment radar, companies they can’t invest in.
2018 had a little bit of everything. The beginning of the year got off to a roaring start with the fresh excitement of the new tax law and corporate tax cuts. But the party was short lived and concern creeped in around both trade and monetary policy. By the end of the year, 90% of global assets had a negative return.
It used to be so simple and straight-forward: republicans believed in free trade; Trump and the Clintons were friends; my car took regular gasoline; and the market always went up.
Now the republicans sound like democrats. The democrats sound like republicans. The Clintons won’t ever be invited to another Trump wedding. My next car will plug into the wall. And evidently markets go up AND down. Next thing you know, dogs and cats will be living together.
Not a lot changed in the 2nd quarter since our Q1 letter. What has changed is the market’s perception of global trade. This has undoubtedly impacted the trading narrative around the US Dollar and consequently commodities and emerging market stocks, the very assets we are most excited about. The fickle nature of “Mr. Market” often allows us the opportunity to buy when prices are down, as we maintain our value discipline. As Warren Buffett says, when prices go down we should get excited (and buy more), but we often do the opposite. We view this current downturn in emerging market stocks as a major boon to prospective 10-year returns.
I have previously discussed the biggest risk in today’s markets is that investors will be unable to achieve their goals. In terms of retirement planning, either investors will have to work longer or save more, and current retirees will risk outliving their funds. High valuations, and thereby low expected returns, are the culprits. We have been positioning our clients to weather this environment and fortunately, the significant increase in volatility recently seen is here to help.
The first three months of the year have reminded everyone that volatility is not just a myth: it actually exists. January opened the year on a tear, only to erase nearly all the gains in February. March saw the S&P 500 turn negative on the year.
This quarter, Nick goes wildlife tracking. In addition to searching for the proverbial lion in the grass, he’s noticed some subtleties in the investment environment that have shown themselves in the evolution of our portfolios. We are feeling great about our current stance and highlight how a conventional 60/40 portfolio with US growth stocks and interest-rate sensitive bonds is actually incredibly risky.
Our goal as a Registered Investment Advisor is to provide our clients with the best risk adjusted returns in the pursuit of achieving their goals. We try to be agnostic regarding how investors achieve their return and many of our clients invest in real estate as part of their overall strategy. Many we have spoken with recently are increasingly cautious when it comes to acquiring new real estate investments. This is a result of either prices being too high relative to potential rents and/or a worry about the Federal Reserve’s change in monetary policy. So, how worried should we be? Do high prices and higher interest rates justify caution?
As a quick follow up to our quarterly newsletter, I thought I would take the opportunity to update you on our investment thoughts in light of what appears to be a regime change in monetary policy expectations. To recap, we said that:
We expected inflation to become more of a concern than it has been in the recent past given the coordinated global growth we have seen.
Given the “goldilocks scenario” of ideal investment conditions, investors were bound to be surprised by a change in inflation expectations and potentially monetary policy.
All assets are priced from US short-term T-bills (we call this the “risk-free” rate). If these rates move up rapidly, asset prices may come under pressure. This pressure is further magnified by the fact that valuations are extremely high.
2017 was a great year for our portfolios. And while the rising tide should hopefully raise all boats, we feel exceptionally proud of what we owned last year and where returns came from.
But change is on the horizon and an evolution is beginning in the portfolio that we are both excited about and preparing for. Jeremy Grantham, the co-founder of GMO, highlights this change that Nick will dive into much deeper in his report:
“Be as brave as you can on the EM (emerging markets) front. Be willing to cash in some career risk units. Bravery counts for so much more when there are very few good or even decent alternatives.”
We are preparing our portfolios to respond well whether we continue to muddle along or see inflation rise quicker than most are forecasting.