Reinvesting When Terrified

This comment, from The Prince of Wales on a visit to the Ukrainian Catholic Cathedral in London, sums up exactly how I’m sure many of us feel about the terrible events unfolding in Ukraine. Unfortunately, as difficult and distressing as it is to comprehend recent events, our job remains, to the best of our abilities, to try and deliver investment returns for our clients over time, regardless of the backdrop in which we are operating and it is this, rather than the dreadful humanitarian aspects of recent events, that will be the primary focus of this note.

One of the articles that has had the most influence on our investment thinking over the years had the title ‘Reinvesting When Terrified’ and was written by legendary contrarian investor Jeremy Grantham of GMO. He wrote it in March 2009 in the heat of the Great Financial Crisis and we highly recommend it to all investors.* The essence of his argument was, in times of crises, it is imperative to have a plan and to stick to it. Without such a plan it is all too easy to become paralysed by the awful headlines of the day, by extreme market volatility and the threat of near-term losses to do anything and, the sad reality of investment life is, that it is typically periods of shock, fear and distress that create outstanding investment opportunities for the future.

We started running the VT Tyndall Real Income fund just over 2 years ago, at the beginning of February 2020. To say that it’s been a roller coaster ride thus far is apt, but doesn’t really do justice to the extraordinary environment we have been operating in. As our tenure began, the world was starting to realise that Covid-19 was going to develop into the first truly global pandemic in over 100 years. The effects on populations, policy makers, economies and markets were, as we now know, profound. In the case of markets, the UK’s FTSE All-Share index fell -36% in just 9 weeks. The more domestically orientated Mid 250 (ex Investment Trusts) index fell -44% over the same period, as highlighted on the chart below.

This period was a particularly painful one for our portfolio which was positioned pro-cyclically and where, during the period, we took the decision to ‘compound our error’ by continuing to purchase more and more of those cyclical franchises as their share prices fell, often precipitously.

Our ‘plan’ at the time was as follows, and we think it has relevance to the circumstances we find ourselves in today. We obviously had no expertise in virology or epidemiology and had no knowledge of how long the pandemic might last, how severe the consequences etc. However, we took the view that the businesses we were buying had strong franchises, led by capable management teams and would likely, in all but the most extreme scenarios, emerge eventually in a strong competitive position. In a great many cases, these shares were being offered for sale at -40% or more from recent highs and that, to us, was a medium-term opportunity too attractive to miss.

As you can see from the chart above, the market bottomed surprisingly ‘early’ in the context of how the pandemic subsequently unfolded around the world and went on to recover extremely strongly, particularly once we got sight of vaccine success in late 2020. Thankfully, our portfolio performed incredibly strongly over this period too.

Hindsight is a wonderful thing, but we can confirm that it felt utterly awful buying shares on a daily basis only to see them lower again day after day thereafter, not knowing when the selling might end. We clearly take no pleasure in the volatility such a process adds to our portfolio returns. However, at the risk of sounding trite, equity ownership allows for a share in all future cash flow generation of a business, not just cash flow over the near term which may be at risk due to current events.

Buying in to those future years of cash generation at a 40%+ discount to recent prices strikes us as the sort of opportunity that only happens a handful of times in a career and, therefore, we feel compelled to act, irrespective of the potential ‘risks’ to near-term performance and volatility. These are the opportunities to generate outstanding investment returns whenever the particular crisis eventually subsides. We are not remotely clever enough to know exactly when that point will be, but we feel strongly that the upside potential is more than sufficient to accept that near term volatility.

As we contemplate markets today, our ‘plan’ very much resembles that outlined above. As you can again see from the previous chart, parts of the overall stock market have already fallen significantly from recent highs, with the MID 250 (ex IT’s) index already down nearly -25%, back to levels first reached over 5 years ago in 2017, and a great many individual shares are down considerably more.

Once more we must profess to lacking expertise, but this time in geopolitics and the devastating art of war. Again, we offer no opinion as to how this terrible event will ultimately end or over what time frame that will occur. We suspect many readers will have seen charts like the one below recently, highlighting the reaction of stock markets (in this case the S&P 500 in the US) to the outbreak of other military conflicts over the last 80 years or so. We offer no conclusion here, we merely present the cold, hard facts as they occurred in previous periods which we are sure were, in many cases, extremely terrifying at the time, albeit possibly without the degree of media coverage afforded today with the addition of services such as Twitter, Instagram etc

Over the last few weeks, we have been buying more of our preferred businesses as their share prices have fallen, often aggressively. Companies such as Melrose Industries, an automotive and aerospace supplier, who have done a brilliant job in an incredibly challenging environment, only to see their share price c. -45% lower than recent highs. Similarly, DIY retailer Wickes, making excellent progress as an independent business in a still buoyant market, whose shares are also down c. -45% from recent peaks. Likewise, UK house builder Vistry Group who, despite the headlines, are currently having one of the best periods for sales in their history, where the shares are down more than -30% from the peak and where the prospective dividend yield is now higher than the P/E ratio.

As previously, it feels highly uncomfortable making many of these investment decisions today. We do not welcome the heightened levels of volatility and we cannot tell you exactly when things will turn for the better. However, whilst this ‘opportunity’ has presented itself rather more quickly than we would have liked after the previous one, we again feel strongly that it is an opportunity not to be ignored and one which, in the fullness of time, will provide outstanding returns for our fund.

To conclude, we have nothing but admiration for the courage and bravery that ordinary Ukrainian people are showing, in the face of daunting odds, in the desperate fight to retain their liberty. We hope that Britain will do all we can to assist them, and we hope and pray they succeed. For investors, we leave you with the outstanding conclusion to Jeremy Grantham’s 2009 article: