Investing in Turbulent Times

We are currently bombarded with negative news, globally as well as in South Africa. There’s a lot of noise about the poor global economy been weak, poor demand from China with significant ramifications for resource based economies, economic and political woes in South Africa, etc.

It is natural then that investors or potential investors find themselves in with difficult decisions to make and will often react in panic mode or simply look on in awe. However, it is often during these times that the best investment opportunities come about, precisely because investors are behaving irrationally. All assets are been painted by the same brush and been sold off because of the panic in the market.

In this blog, I will briefly discuss the approach that I generally take during these times. But firstly, I must add a warning: no two crises are the same. They may similar, but in all likelihood, they are not the same. In addition, it’s not always the case that a crisis will present opportunities for acquiring quality assets at bargain prices.

In a previous blog, Growth at a Fair Price, I discussed how you should seek high quality companies that have the best chance of taking advantage of certain sectoral changes taking place in the economy, provided you can get them at a price that is reasonable.

What to do?

Now the first thing to do during a crisis is Not to Panic. Rather try to understand the crisis and ask yourself whether this situation changes any of your key investment themes. And, how does it affect the valuation of the companies that you already own or those that you would like to own.

The reality is that even in difficult and turbulent times, the economy still functions, maybe at a slower pace, but it still functions. People still need to eat food, travel for business reasons, conduct banking services, meet their healthcare needs, government still needs to function to provide basic services, etc. This does not represent Dooms Day.

So, you have to try and figure out which companies could possibly come out stronger when conditions improve. Similarly, some companies may in fact be permanently damaged by the crisis, so if you have any of those in your portfolio, for whatever reason, this may be time to sell these, so that you can raise some cash to buy those that you think will come out stronger after the crisis has abated.

EXAMPLE: In the recent collapse of African Bank, the market painted all businesses that focussed on the low income banking market with the same brush. In fact, Capitec which is in a similar market to African bank, but with different business and risk assessment models to African Bank, was in fact sold off quite steeply just before and after the African Bank debacle (around August 2014).  This was a great opportunity to buy a quality business at a bargain basement price. African Bank was also a major competitor to Capitec and with African Bank now out of the way, Capitec could take advantage of growing its market share with clients that it could be selective about and with the ability to adjust their pricing to be more appropriate for the kind of risks they were taking.

You will also notice that there were similar opportunities during July 2015 and December 2015. The best opportunity however was during the African Bank crisis, when all businesses in the low-income banking sector were being valued with the same criteria. However, in retrospect we realise that Capitec had and still has a very different business model to African Bank. Well done if you bought Capitec during this period!

Source: Reuters

What if the Crisis lasts for longer?

In hindsight, it’s always easy to know what you should do. But, because of the significant noise and lack of information that you may have during a crisis, it’s not clear that you should be filling your boots with a particular stock like Capitec in the example above.

However, if during your analysis you do see value in the stock, but you are unclear how the market will play out and you also assess some additional risk; an approach is to acquire a portion of what you want to acquire initially and build up your position as the situation becomes clearer to you. In this way, if the market goes up, you start participating with the portion that you’ve bought already, but if it comes down further, you could be buying the quality business at cheaper prices.

If for some reason, your analysis is incorrect, at least you have limited the losses that you could have incurred and you would learn a valuable investment lesson.  In investing, you want to avoid permanent loss of capital, but you should take a great opportunity when it is presented to you.

Charlie Munger, Warren Buffet’s partner, says that that biggest risk that investors face is that they do not take enough risk when a great opportunity presents itself. How many times don’t we kick ourselves, because we didn’t act when we needed to? ‘If I had just bought PSG and held on to it, after it listed’, for example.

Be alert to opportunities when they present themselves, and by definition you will be doing something different to what the herd in the market is doing.

If you’re an investor through unit trusts or managed funds, you may want to seek professional advice. Just don’t make any panic decisions!

Stay true to your investment philosophy

Remember, as you go through your investment journey, you should be developing your investment philosophy. In turbulent times, your philosophy and more so your resolve to sticking to your philosophy will be severely tested. If you have a philosophy that’s worked for you thus far, you should ask yourself why you should abandon it during turbulent times. Similarly, if you are investing based on a set of investment themes, then you should stick to these themes unless you have analysis suggests that you should be changing some of these themes.

So, the basic rules to follow:

1. Don’t panic
2. Analyse what is happening and how it could impact your investment portfolio
3. Use the opportunity to raise cash
4. Use the cash to buy those businesses that are likely to come out stronger after the crisis is over
5. Be bold when good opportunities are presented to you (but you’ll have to drown out the noise}
6. Time your transactions based on your level of confidence
7. Have the patience to see out the turbulence

Current Market

Whilst there are opportunities for investing in the current market, the biggest issue in today’s market is that central bankers have far too much influence on the direction of the markets. So, my assessment is that if normality does come back to central bank policies, the current market could see further correction. A caution that I would provide is that it is very difficult to predict when the central bankers will stop quantitative easing, so you should be very selective when investing in these markets.

Ideally be invested in those businesses that would withstand any change in central banker’s policies.  It also would not harm, if you have some cash that you could deploy when ‘normality’ returns to markets. Unfortunately, there’s no gurantees.

Sabir