Weekly Digest

Brain on, tape off

Lorenzo La Posta

15 October 2018

Thus far, October has proven to be an unpleasant month: rain falling from the sky, financial markets falling off their paths and investment managers falling off their chairs. Whenever everything seems to be falling apart, it is of foremost importance not to let irrationality, anxiety and hurry undermine investment decisions. Rather, the most effective way to ride the rollercoaster without being bounced off is to fasten your seatbelt, isolate yourself from the screaming kids, separate the important information from the noise and act rationally upon it. Upon real information, only.

Month-to-date all major equity and bond markets have sold off, the VIX index (Wall Street’s so-called ‘fear gauge’) has increased more than 115% within a week and the media are knocking at the vet’s door to check if the bull is dead. Often in these situations investment managers feel the urge to adjust their portfolios in response to an altering environment. Speed of reaction is crucial as it can sometimes draw the line between outperformers and laggards; however, being quick at repositioning will only be effective when done rationally, with a solid basis and meaningful reasons for it.

Unfortunately, understanding whether something has actually changed in the market environment is harder than it sounds and distilling the real, useful information from the noise requires rational and meticulous analysis. Career risk is one of the main drivers of this adjustment urge: managers who do nothing during market downturns might look careless and negligent while the ones trading a lot might appear as if they are at least trying. After all, why hire experienced investment professionals if they just sit and wait? The reason is that sometimes doing nothing is the best thing to do. Have you ever queued at the supermarket, thought that the queue next to yours was “clearly moving faster”, switched to that and realised that your new queue was now proceeding slower than your old one? If there is no valid reason why one queue should flow faster than the other, then the best plan is to stick to yours. Changing queue has a cost (leaving the current position to end up at the back again) as much as continuously tweaking a portfolio just for the sake of it does: trading costs pile up and potentially erode a significant portion of returns, precious time is diverted away from research and the portfolio drifts away from the previous allocation that was the product of rational and rigorous analysis.

Here at Momentum we believe that portfolio management requires continuous monitoring, relentless research and a calm, rational thought process. As such, we want to be constantly aware of each portfolio’s alignment to its objective and risks while at the same time testing our assumptions, challenging our holdings and incorporating new information as soon as it becomes available. In addition, focusing only on meaningful, value-adding information allows us to be efficient in responding to a changing environment as this October appears to be. Since the first signs of increased market stress appeared, as high-grade bonds sold-off and risk-assets were dragged lower, we have been working to understand what (if any) risks have changed and how our portfolios will fair across possible future scenarios. Although markets and economies evolve tirelessly, high-conviction portfolios with quality components supported by extensive research should prove a safer route to travel along.

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