Traditionally, shares of stable, predictable and thus less glamorous businesses tend to be the most attractive after long bull markets but, points out Jeremie Teboul, that is not the case this time around
Producing higher investment returns relative to the average of the world's equity markets is a relatively self-explanatory goal - the objective of doing so without greater risk of loss is much more nuanced.
After all, the historical risk of loss cannot be accurately measured because most risks never materialise. As a result, clients tend to look at significant declines in the price of a fund as a proxy for historical risk of loss. Simply looking back at these measures can, however, be misleading in that stockmarket environments are always different.
The Japanese equity boom, which peaked in the early 1990s, and the TMT bubble at the close of that decade both presented long-term opportunities for discerning investors who underperformed during the euphoria phase to meaningfully outperform during the ensuing decline.
Focusing on large sectors that were ignored during the rush into rapidly rising parts of the market offered many opportunities to buy businesses that were trading at significant discounts to their intrinsic value.
Today, such opportunities are far more challenging to find as the bull market that began in the wake of the global financial crisis continues to age. Faced with uncharacteristically low interest rates, investors have been attracted by the steady and predictable dividends offered by shares of stable, predictable and therefore less glamorous businesses as a good source of annual income.
On the other end of the spectrum, investors have been willing to pay high prices for riskier companies with heightened economic sensitivity or secular challenges, believing they are highly exposed to accelerating economic growth.
Put simply, the areas of equity markets that have historically been attractive in the advanced innings of bull markets do not presently offer meaningfully lower risk of loss, as they have in the past.
Margin of safety
The risk we are most concerned about is permanent impairment of capital - the risk that, in time, a share ends up being worth less than we paid for it.
In the current environment, we have found a margin of safety in a number of businesses that possess wide moats and are led by outstanding management teams, or that are out-of-favour due to temporary conditions. While stock prices could fall meaningfully in the short or medium term, these businesses possess economic characteristics that will help protect investors' capital.
Some - such as Air Products and Chemicals, and Berkshire Hathaway - hold large cash balances that can be readily deployed towards attractive investment opportunities in the event of large declines in asset prices. Meanwhile investments such as Charter Communications, CDK Global and Rolls-Royce Holdings are undergoing transformations that should enhance their intrinsic value.
Other investments such as Amazon.com, Priceline Group, MercadoLibre and JD.com benefit from innovation and secular change. Lastly, some investments, such as the US health insurers and Sberbank of Russia are available at attractive valuations due to concerns about uncertain conditions in their industries or countries.
Businesses that rely on ongoing access to capital are at greater risk of suffering permanent capital impairments. Investors are better-served finding companies that possess strong characteristics and are well-positioned for a range of long-term outcomes.
The best time to prepare for a period of distress is before it happens - not in the heat of the moment. As painful as short-term losses may be, they often present compelling opportunities for investors who can be patient and capitalise on temporary turmoil, while keeping in mind the single biggest risk to investing - the permanent impairment of capital.
Jeremie Teboul is an analyst at Orbis Investments
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