Equity market strategies in a world of change

The speed at which events are taking place and change is happening around the world can appear dizzying, says Andrew Brenton, CEO, Turtle Creek Asset Management.

"There are decades when nothing happens; and there are weeks when decades happen," said Lenin. This is true of markets as of everything else and it poses fundamental questions to investors about how and where they should be investing in a world of change.

We have always recognized that change is constant. And yet we also have always believed that some things remain true amid that change. This framework for thinking has helped us to navigate many extremely challenging market situations historically and I believe will also serve us well in the current circumstances.

To explain our way of thinking and how it can be applied to markets now, I would start off with one fundamental observation. It is typically better to be invested for the long haul in public equity markets than to try to time the market by exiting and sitting on cash at certain times. 

If you look at the historical analysis, there were actually only two short periods in the 20th century, 1929 and 1999, when it would have made sense to do this, and it is almost impossible to correctly time the market. Typically investors who try to do so crystallize their losses during downturns and miss out on subsequent upturns.

Public equity markets typically offer the best long-term compound returns. The S&P 500, for example, has averaged somewhat over 10% a year since 1920. An investment of $100 invested in the S&P 500 at the beginning of 1920 would now be worth over $2 million. And that is despite all the extraordinary market volatility that there has been since 1920, including the Great Depression.

But it is obviously better to own the best companies in public markets rather than all of them including the worst ones via the index, as long as you can judge which ones are better. That is essentially the case for active, informed management and it rests upon another fundamental observation, which is that markets inevitably misprice. 

Those mispricings happen because markets are still ultimately driven by human emotions including fear and greed, and because not all market participants can process all relevant market information all the time, and nor can they be clairvoyant about the future.

And this creates opportunities for investors who want to get the best companies at good valuations.

A time of crisis in markets is often also a time of opportunity for investors. The greater the market volatility, the greater the potential mispricings. Of course there are serious economic consequences from a crisis which impacts everyone, and no-one would wish for that state of affairs.

But it is still important to be able to invest for the future during a crisis, and often the best time to buy stocks is when others are selling them.

I have laid out the case for active management in public equities. But it is also important that portfolios are continually optimized.

The markets are in a continual state of flux, and efficient management of portfolio takes advantage of these changing price signals by optimizing holdings and minimizing risk.

And it is also critical that those investments are based on a fundamental assessment of the companies based upon their intrinsic value. Being able to value companies in this way allows us as investors to judge which firms are most mispriced by the market.

In terms of which markets to invest in, as a Canadian firm we know North American public equity markets best, and have always focused on those. These markets are also the biggest and deepest in the world and offer, in our view, access to some of the most dynamic and innovative companies internationally.

And in terms of our focus, we believe that the mid-cap space is fundamentally attractive. Beneath that, there is often too little information about individual firms, and there is much greater turnover of smaller firms in the markets. Small-cap indices probably overstate returns because of survivorship bias.

Conversely, we have never spent time looking at the mega-caps, not because we think they are more efficiently priced but because our investment approach is predicated on direct one-on-one interaction with senior management and we simply wouldn't have that kind of access with larger cap companies. 

So I have laid out the case for actively managed value investments in public equities, focusing on North American mid-caps, in a process which continually optimizes portfolios and minimizes risk.

Our belief is that although market conditions are continually evolving because of macro factors such as inflation, war and recession, sticking to these fundamentals offers a path through the volatility, just as it has always done so in the past. 

In this world of change, plus ça change, plus c'est la même chose - the more things change, the more they stay the same.

By Andrew Brenton, CEO, Turtle Creek Asset Management.