Partially obscured or poorly analysed ‘stealth factors’ cannot be accurately discounted in stock and bond valuations via the normal price discovery process. They are destined to lie dormant for a while, before eventually popping-up to trigger an asymmetric return profile following an earnings or other surprise. Alternatively, these ‘stealth factors’ may manifest themselves gradually in the form of major secular trends. These include the post-2010 fall in the cost of capital within fast moving consumer stocks (FMCGs), major changes to the structure of bank earnings, a fall in the natural real rate of interest (r*) which is in turn exerting a profound effect on equity valuations, and structural changes in the prices of sovereign bonds, gold, volatility, etc.In each case blindsided analysts are faced with a binary choice: ‘recalibrate’ their models to the new market-traded prices, or risk irrelevance, and possibly their jobs. What follows is asset ‘pricing’ that masquerades as ‘valuation’ – a process which only entrenches the underlying problem. Deep seams of alpha are laid down for those few ahead of the game.
A forever problem
A key concern for all investors is missing market moves that consensus can only explain after the event. It’s especially irritating when the drivers have been visible for some time, but their significance was somehow lost or not fully recognised by mainstream analysts. Instead of receiving accurate and unbiased forecasts, investors end up with elaborate but retrospective sell-side explanations for past events; typically delivered under a cloak of superiority woven from obscure acronyms, a jumble of financial ratios, and a mountain of statistics. All presented within a reassuringly thick research report.The two most important questions remain unanswered:1. Which assets are most likely to perform?2. Where is the next accident?
Large brokerage houses routinely process vast pools of information, which renders their dismal failure to accurately forecast asset prices something of a conundrum. By synchronously turning the handles of standard valuation models, there can be no doubt that the sell-side helps markets digest prodigious quantities of new information. Over time, however, the rigidity and homogeneity inherent to these conventional techniques, biases sell-side analysts to develop systematic blind-spots. These conceal the poorly understood, unprecedented, and sometimes uncertain factors that are so often the final arbiter of asset prices.Forecasting failure is all but inevitable.
Why is the sell-side so dismal at predicting asset prices?
The difficulty lies not so much in developing new ideas as in escaping from the old onesJohn Maynard Keynes
Can one systematically do better? Our short answer is Yes. Success is like rearing a delicate flower; space for true investment flair must be set within a consistent and disciplined framework. Markets are dynamic in nature, sometimes capricious, sometimes hyper-rational – a process which continually leads investors into unchartered waters where new opportunities and risks must be identified and carefully managed. Safe navigation of troubled water lays the foundation for long-term investment success, in which light we are proud of our strong performance throughout the 2000 Tech-bubble, the 2008 GFC, European Crisis of 2011/12, and most recently 2020. Each of these crises featured new problems requiring new solutions, 2020 arguably more than most. Overall, post-1996 returns have exceeded our targeted 300-500 basis points outperformance per annum versus benchmark. We hope there’s plenty more to come and believe our approach provides a stable platform for durable long-term performance.
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If you are as intrigued as we are by fast-moving markets but disappointed that sustainable returns remain elusive, then please feel free to get in touch. We look forward to discussing what you hope to achieve, what you wish to protect against, and what true success might look like for you.