Two wild quarters to start the year have created vastly different impressions of the investment environment. After the severe selloff in the first quarter, risk and avoidance were top of mind. After massive monetary and fiscal policy responses were revealed beginning late in March, however, the mindset of investors quickly reverted to a belief that policymakers would save the day and investors should carry on.
After several iterations of risk spikes followed by progressively easier monetary policy reassuring investors, it’s fair to question how long this pattern can continue?
In the Market Review for the second quarter I highlighted some recent research by Mike Green from Logica Funds which provides a great deal of perspective. In short, Green believes that passive investing has fundamentally altered the market structure in important ways. This has had the effect of favoring momentum over value, undermining the usefulness of security selection, and creating enormous systemic risk.
This has positive and negative implications for Areté’s business. On the negative side, it creates headwinds for security selection, value investing, and active management, all of which are part of Areté’s core mid cap service.
On the positive side, the value of investment expertise and independent thinking have never been greater. While there may be less immediate need for security-specific expertise right now, there is an enormous need to be able to put the wild swings of the first two quarters into context, to manage risk, to investigate what is happening above and below the surface, and to report the findings to investors in a clear and cogent way. These are also core parts of Areté’s value proposition.
One of the things I have done to respond to the situation is to create a weekly newsletter which I call Observations for clients and close friends. From a service standpoint, this is designed to share the research and insights I develop in the course of doing research every day. I originally intended for these to be primarily shared indirectly in the form of stock selection, but the situation has changed and this seems to be a more useful vehicle now. I am also considering the possibility of offering it on a subscription basis to people who are not currently clients of Areté.
I have also been thinking a lot about how to best manage the mid cap strategy in this environment. While I have been reasonably pleased with the defensive positioning and the focus on gold stocks, I am increasingly concerned that this pattern of ups and downs without meaningful resolution could go on for some time. A big assumption I have been making is that at some point, there will be a change in regime in which value starts working agin and security selection becomes more effective.
Based on Green’s research and what I observe myself in terms of market action and policy responses, I am concerned that the necessary regime change will take longer than anyone cares to wait around for. I absolutely believe such a change will happen, and it could happen relatively soon. However, I do not think it is appropriate to make a singular bet on that one possibility.
So, in addition to everything else, I will also be researching ways to better harness some of the prevailing forces without taking on unnecessary risk. I don’t know how possible this is, but I don’t want to assume it doesn’t exist without doing the work.
If you want to stay apprised of my thinking on this subject (and plenty of others), please send me an email and I will put you on the distribution list for Areté’s Observations.
Thanks – I appreciate it!
David Robertson, CFA
CEO, Portfolio Manager