June 2019

Thought For The Month

Recently, I sat on a panel which was asked if we thought our jobs would ultimately be replaced by computers. A fellow panellist offered to deal with that googly and explained how he believed the most likely outcome was a combination of the best parts of humans and machines. Fortunately, the MC then moved on to the next question and my input was not required. I was planning an apparently glib, but genuine, response which centred on the fact that a computer cannot hold a client’s hand when everything appears to be going wrong and the client is at risk of a rash dose of capitulation.

As I considered the question a bit more, the answer became rather more complex. I assume the questioner was saying why not just buy an ETF rather than a fund. The arguments for and against indexation are well known and I do not intend to revisit them here. But someone looking to purchase a Value ETF must have a very firm view on which type of Value they are keen on. The choice is far from straightforward. For example, ETF.com lists 63 Value ETFs traded in the US market alone and while the list covers a multitude of sins, the largest component of that list is US Large Cap Value. Even then, very distinct choices must be made as in just the three months to 8 July, the difference in total return between the best and worst ETFs in that sub-sector was just shy of 10%. The reason for this significant dispersion in just the very short-term is that Value means many things to many people. Some prefer price to book, some price to cashflow, some price to earnings and so on.

One could obviously pick the value metric which back-tests the best, but back-tests assume perfect liquidity and the buyer also assumes the future will look very like the past. But, for example, while price to book was historically an excellent value metric, recently its popularity and relevance, even among value investors has waned. Value investing has many challenges currently, but I am far from convinced that indexation is one of them even if their bedside manner were to improve.

Tesco has not yet been a great recovery story but is at least nicely off its lows. It is also no longer the stock that attracts most client scrutiny (M&S has taken on that mantle). Or, to be more precise, we no longer have to defend it as a structurally challenged, highly indebted, badly managed business. Instead, we are told, it is many competitors’ favourite stock and not contrarian at all. As I’ve said before, our dirty secret is that we only make money if other investors agree with our views and the weight of their money pushes a share price higher. We are not embarrassed running with the pack if the shares remain good value.

Contrarians are naturally drawn to companies with significant challenges and consequently can often find themselves focusing on the most distressed player in an industry. However, a bit of imagination, a push against the conventional wisdom and a few changes to the spreadsheet and the prospect of significant upside suddenly becomes apparent. Yet often an industry is out of equilibrium and supply must leave to correct matters. Often it is the distressed player which is responsible for that supply reduction. We do not always have to buy the equivalent of the cheapest house on the cheapest street to benefit from a change of fortune for an industry.

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