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The new year: strategies for a volatile market
3/22/2019 12:45:40 AM
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By Fund Library News Wire  | Wednesday, January 02, 2019


By Felix Narhi, CIO & Portfolio Manager, Penderfund Capital Management

Now that we are in the late innings of the longest bull market in S&P500 history, investors are increasingly fearful that this may finally be the beginning of a long overdue bear market. The ongoing pessimistic drumbeat about trade wars, global growth slowdown and political uncertainty is starting to weigh on the market. At Pender, we are following strategies similar to those we outlined during the last big market correction in early 2016.

We believe there will always be individual securities in any cycle of the market that will be either unloved, underfollowed, or misunderstood, and therefore potentially mispriced. To find compelling ideas or continue to hold onto existing positions, we believe you need either an analytical or behavioural investment edge. Sometimes you need both. In normal times, when the markets are relatively tranquil, we spend most of our time trying to find idiosyncratic “needle in the haystack” opportunities in the market, primarily leveraging our analytical edge.

When investors get spooked and stampede for the exits en masse, the broad opportunity set widens. But it sure doesn’t feel like an opportunity. This is the time for “the tide goes out” investing. Suddenly the “haystack” is full of “needles” in plain sight, but very few are willing to take advantage of these opportunities.

These are the times when many companies that are both well followed and well understood become unloved . These are the times when the “spreadsheets, reasoning, formulas, or metrics” that backed up an investor’s conviction in tranquil times seem like a quaint mirage from a bygone era. These are the times where analytical rigor provides little comfort, but where a behavioural edge makes all the difference. This is what Buffett was referring to when he said, “Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.”

In a bear market, if you want to benefit from the part ownership of a profitable enterprise over time, behave like a landlord. You don’t have to sell a great asset for money you don’t need, just because you receive a string of idiotic offers. On the other hand, you should consider buying when you find sellers who are willing to accept low-ball offers for great assets. This is the buy low part of the maddeningly obvious “buy low, sell high” strategy.

Unfortunately, the wisdom of this strategy seems to be least obvious, or foolhardy advice, during the gloomy part of the market cycle when you need it most. Periodic corrections provide opportunities for investors to either upgrade their portfolios or put money to work in better valued long-term opportunities. As in 2016, we are once again deploying cash as a strategic asset class into securities as prices fall into our buy zones.

Indiscriminate selling during corrections often takes down both great and mediocre companies alike. This provides a good opportunity to upgrade a portfolio. When valuations converge, we are happy to sell our mediocre, but still very cheap companies, to accumulate positions in long-term wealth-creating businesses, when they are also attractively priced. For example, “compounders,” as a percentage of the Pender Value Fund, are near an all-time high.

In some cases, we are buying back into the very same names we sold in the past year or two, but at a big discount. This is one of our favourite sources for “new” ideas. We find recycling previous ideas can be a relatively low risk, but lucrative strategy for us over time. After all, we have already done our homework on those companies, so we know the issues and key drivers much better than some new stock that just popped up on our radar screen.

In some cases, investors don’t need to do anything to still get a potential boost from savvy market cycle transactions, thanks to the actions of the management teams of their holdings. Consider the Liberty Group of companies, which represent the investment vehicles of one of the best modern-day investors, John Malone.

Over time, he has played the stock market cycle like a maestro. His companies habitually buy back their own shares when the cycle goes south and the stock gets cheap (buy low). Then they occasionally issue back some of that stock when the market gets enthusiastic again (sell high). Patient shareholders have been the big winners over time. According to a recentBarron’s article, John Malone’s Liberty Media Corp. (NASDAQ: LMCK) returned 24% annually from May 2006, when it took its current form, through to Nov. 8, 2018, whereas the S&P 500 had gained 8.5%, including dividends. It is hard to calculate exactly how much Liberty’s 24% annualized return is driven by the management’s capital markets activity, but it’s safe to say that it’s probably material!

The accompanying graph shows CNN’s Fear & Greed Index over the last three years. The index is a composite of seven indicators for gauging the stock market’s emotions. At the time of writing, we are at a “13,” near to the very extreme end of the fear range and one of the lowest levels historically. We have overlaid our market cycle view onto this index. From our vantage point, the tide is clearly out. Markets do not usually stay in a state of extreme fear for long, but emotional decisions during such times often sabotages the long-term plans made many investors in calmer times.

Felix Narhi, CFA, is Chief Investment Officer and Portfolio Manager at PenderFund Capital Management. He works alongside David Barr, Pender’s President, in setting the direction of Pender’s overall investment strategy. This article first appeared in the Pender blog. Used with permission.

Notes and Disclaimer

© Copyright 2018 by PenderFund Capital Management Ltd. All rights reserved. Reproduction in whole or in part by any means without prior written permission is prohibited.

Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the simplified prospectus before investing. The indicated rates of return are the historical annual compounded total returns including changes in net asset value and assume reinvestment of all distributions and are net of all management and administrative fees, but do not take into account sales, redemption or optional charges or income taxes payable by any security holder that would have reduced returns. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. This communication is intended for information purposes only and does not constitute an offer to buy or sell our products or services nor is it intended as investment and/or financial advice on any subject matter and is provided for your information only. Every effort has been made to ensure the accuracy of its contents. Certain of the statements made may contain forward-looking statements, which involve known and unknown risk, uncertainties and other factors which may cause the actual results, performance or achievements of the Company, or industry results, to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements.

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