Portfolio manager Alec Cutler, from our offshore partner, Orbis, reflects on the Orbis SICAV Global Balanced Fund’s performance over the period. He explains that while we can’t predict world events and their timing, Orbis works hard to create moderate and lower-risk portfolios that incorporate analysis of various scenarios into their assessment of individual securities.
The Orbis SICAV Global Balanced Fund has delivered moderate positive returns year-to-date, outpacing its benchmark, but that year-to-date performance obscures month-to-month differences. In March, the Fund participated in broader market declines. While we care deeply about relative performance, the absolute decline this month is real and is not pleasing.
It is hard to delineate the start of well-anticipated events such as this one. When did the US-Israeli war with Iran actually start? Was it the day missiles first flew, or was it weeks before, when the marshalling of US military equipment started? As the US military presence grew, oil- and gas-related securities outperformed, including the currencies of major exporters such as Norway, Australia and Brazil. The Orbis SICAV Global Balanced Fund participated more than fully in that outperformance, but, frustratingly, did not outperform in March.
It would be wonderful if we could predict both world events and their timing. Armed with that dual prescience, we could design the perfect fear portfolio for specific risks. Sadly, we lack that prescience, so targeting a specific scenario would mean carrying holdings that are poorly suited to much more likely environments. Investors who do this wind up providing clients with a “stopped clock” portfolio that is wrong the vast majority of the time, but occasionally very right. This typically comes at the expense of clients’ long-term returns.
Of course, we also avoid greed portfolios, which are filled with investments that are highly levered to some popular theme.
What we can do is work hard to create moderate and lower risk portfolios. While we don’t know which scenarios will come to pass, or when, we can incorporate our analysis of those scenarios into our assessment of individual securities. For example, we started buying oil and gas producers in the British North Sea last summer. We did so because they were undervalued and on the basis that there is increasing pressure on the UK government to repeal its counterproductive windfall profits tax. A secondary benefit of holding the North Sea producers was their contribution to the resilience of the Fund amid growing geopolitical tensions in the Middle East.
While it is exciting to think about “fat tail” scenarios, our day job is to find securities trading for far less than they are worth under a broad spectrum of environments, and then constantly adjust them to maintain a Fund that we believe is likely to produce superior long-term returns with no greater risk than our benchmark.
Whether our portfolios outperform over the specific dates for some bearish event is out of our hands. As value investors, the pattern we see often unfolds in three stages. First, our portfolios outperform as anticipation of an event builds. They then underperform when the event actually hits, as “risk-off” investors seek whatever assets feel most comfortable. Then, finally, the dust settles and the portfolios resume outperformance. It doesn’t always happen that way, but that’s the devil we know.
As we are never sure of the timing, we are constantly looking for investments that can display relative strength in times of turmoil owing to their inherent and fundamental merits. We do not seek investments for their past behaviour based on “factors” or correlations. This sometimes sets up a frustrating performance profile during “risk-off” events. The events currently unfolding in this war serve as a good and timely example.
We have recently been building material positions in the Australian dollar, Norwegian krone and Brazilian real. That is owing to them being materially undervalued and because of the superior yields on offer via their sovereign bonds. But the third attraction is their resource wealth. These attributes should have held these bonds and currencies in very good stead when the war broke out, and all had been strong in the lead-up to hostilities. But when fighting broke out, all three sets of bonds and currencies sold off materially against the US dollar.
Why?! Well, Mr Market shifted into “factor mode”. In times of stress, when events on the ground are most complex, the market ironically seeks simplification. It tends to do this by leaning heavily on heuristics and factors. The primary heuristic employed in this case was THIS IS SCARY + AVOID ENERGY IMPORTERS = HIDE IN US DOLLARS. Once this die is cast, the factors kick in, enforced by big quantitative investing models and amplified by momentum. In this case, factors dictated: US DOLLAR UP = ALL OTHER CURRENCIES DOWN. As leaning on heuristics is much easier than assessing the relative merits of things, the indiscriminate nature of the moves is the market’s equivalent of shooting first and asking questions later.
Gold was caught in the same game. Despite having as strong a heuristic case as the US dollar of being the safe haven asset to hold, with bond yields rising and the US dollar strengthening, the factors part of the process dictated reflexively selling gold. DOLLAR STRONG + YIELDS UP = SELL GOLD. It did not help that gold had been a strongly favoured asset in the months preceding the war, and became the thing that held up and could be liquidated to make margin calls. While it remains to be seen, when the market shifts to “ask questions”, we should not be surprised if gold’s safe-haven credentials reappear in prices.
Times of crisis and their induced market sell-offs are inherently unstable and unpredictable. This is especially true for wars. As the turmoil continues, financial markets may well flip between “shoot first” and “ask questions” multiple times. Each time, the list of perceived safe havens may change. Rather than predicting which assets heuristics will favour, we will continue to focus on challenging the fundamentals and valuations of what’s holding up best in the Fund, and taking advantage of overshooting market reactions. Our focus is on maintaining portfolios that we believe are most likely to outperform their benchmarks with no greater risk of loss.