A year on from our stringent Level 5 lockdown, much of 2020 seems surreal. While there are many aspects we may prefer to forget, reflection reveals valuable lessons, particularly when it comes to how we react and handle ourselves and our investments in times of crisis. In this article, our portfolio managers share some learnings from the year that will always be synonymous with COVID-19.
Maintain a targeted asset allocation
Liquidity gives one optionality in times of crisis. In early 2020, as all asset prices fell due to COVID-19, cash was very valuable as it could be invested in the market. When the market is crashing, there is usually very high uncertainty. During 2020 it was hard to know how much further markets could fall, and it was easy to find reasons why they could fall a lot more. This made it hard to know when to “pull the trigger” on moving more cash to equities.
In most cases it is better, and less stressful, to have a targeted asset allocation, rather than trying to time the market. Combining this with periodic rebalancing adds the advantage that one is automatically buying when prices are low and selling when prices are high.
Skate to where the puck is going
Bull markets are normally born out of pessimism and do not want to take investors along at the start. It is difficult to envisage a more pessimistic scenario than 2020. As the market was collapsing in March, not many would have foreseen that, a year later, it would be making new highs.
Successful investors must skate to where the puck is going, not where it has been. In this case, it was to correctly appreciate that the extraordinary monetary and fiscal response would remove a significant part of the extreme downside risk in asset prices. Missing the puck because you ideologically oppose these measures was a mistake.
I like to step back and ask myself: If books about 2020 are written in five years’ time, what will they say about investors’ behaviour with the cold eye of history? I think they will say that many assets were selling at great prices.
While there will be long-term consequences (perhaps much higher global inflation) of the actions authorities have taken, I believe we still own several cheap local shares.
Distinguish between the facts and the noise
Market conditions like those in 2020 really test your firmest convictions. Substantial returns were on offer for those who could distinguish between the facts and the noise – and were right with their high-conviction beliefs. My first takeaway from 2020 was that this is easier said than done. The over-abundance of information plays havoc with our emotions and our behaviour.
The second lesson for me was that having liquidity to capitalise on high-conviction opportunities is crucial.
Even in times of crisis, focus on your long-term view
The commitment to a disciplined, long-term-oriented investment strategy is key – even more so during times of crisis, when irrationality dominates.
Our approach to the Nigerian stocks we own is a case in point. As COVID-19 struck and the oil price collapsed, the share prices of our main holdings in Nigeria, particularly the banks, halved in naira terms. The correlation between Nigeria’s stock returns and the oil price is very high: Besides being a large direct contributor to economic activity, oil represents near two-thirds of government revenue and almost 90% of Nigeria’s foreign exchange income. Close to 50% of banks’ loan books are exposed to oil (directly or through funding the supply chain). Furthermore, a high oil price increases the supply of foreign exchange, supporting the sustainability of other non-oil sectors that rely on imports to operate, and also prevents the currency from blowing out.
As the oil price collapsed to a multi-year low, many investors dismissed the Nigeria investment case, causing the share prices of Nigerian stocks, and banks in particular, to collapse. For us, this presented opportunity. A year on, this thesis has played out: The weighted average return on our Nigerian bank holdings is up 77% in US dollar terms since the March 2020 lows.
The lesson may seem banal, but it holds true: Even in the worst of times, stick to your long-term view.
Be greedy when others are fearful
In his 1986 letter to shareholders, Warren Buffett famously spoke of being fearful when others are greedy, and greedy when others are fearful. These words are as true today as they were then, and for the same reason: human emotion. Much like a contagious disease, greed and fear can rapidly spread through the investment community, coming to dominate our decisions irrespective of the underlying value on offer. The last year provides an apt example:
Just over a year ago, at midnight on March 26, 2020, South Africa went under our first COVID-19-related lockdown. At that point in time, no one had a clear idea of how long the virus would be with us, nor of the social, human or economic impact. Fear and uncertainty were heightened, and this reflected in our equity markets. The JSE began 2020 offering what appeared to be attractive valuations, and yet by the end of March 2020, it had declined a further 21.4% as fear spread. In many respects we are no closer today to knowing when life will return to normal (if ever), but sentiment in markets has changed materially.
Those who stayed invested, or were fortunate enough to have capital to deploy and be greedy, have been healthily rewarded. From the end of March 2020 to today, the JSE has returned 54% including dividends reinvested. In dollars, those returns are even greater at over 80%, as the rand has strengthened from R17.86/US$ to below R15/US$ over this same time.
Be greedy when others are fearful.
Stay the course
The lessons from 2020 that most resonate for me are that sentiment is fickle, many things seem obvious in hindsight, and the importance of sticking to your process. By the end of the first quarter of 2020, many markets had declined over 30% year to date, there was a lot of uncertainty, and investors could find many reasons not to invest at the time. Many frontier equities looked cheap relative to their long-term histories and to our normal earnings estimates. A year on, and investments made at the time have returned handsome returns.
Incepto ne desistam – “may I not shrink from my purpose”, or more colloquially: “Stay the course.”
Don’t be afraid to sell too soon
One of the most joyful experiences is to be on the right side of an investment mania or bubble in its early stages. The last 12 months offered great opportunities in this respect. Governments and central banks have abandoned all sense of traditional financial prudence and are spending and printing money as if there is no tomorrow. Almost by accident Modern Monetary Theory has become the new orthodoxy. Private savings have soared during the pandemic and in a world of low and even negative interest rates, money is flowing into equities and property. The green and IT revolutions are dramatically disrupting a long-established economic order and much of these investment flows are heading their way. Tesla and Bitcoin are the poster children of this new era. Their prices have moved upwards without regard to rational investment metrics. Generally, the tech sector of the market is priced for perfection.
We are in the middle of an investment bubble. Sooner or later bubbles burst, but great fortunes can be made by selling at the top. So one’s instinct is to hang on for a bit longer. The danger is that bubbles pop when you least expect them to do so. Already we have seen a sudden reversal in US bond markets, which took most investors by surprise. Even the pessimists thought we could wait until the northern summer before selling. The most difficult decision is to sell too soon, but many great fortunes are based on the application of this precept.
Look for quality assets at bargain prices
At times, 2020 felt like an investment rollercoaster. The indiscriminate selling of February and March gave way to a violent rebound, with many markets now setting all-time highs. Even if, in the early days of the pandemic, you had correctly called the economic fallout, ultimately you would have been on the wrong side of the trade – so much so that in some areas, asset prices now seem increasingly detached from the reality on the ground.
The recovery has been uneven, though, with the financial impact set to be more longer lasting on some businesses, industries and countries than others. A crucial decision that had to be made last year as markets fell was whether an asset was just caught up in the selling pressure, or whether it was cheap for a reason. Investors may only have a few opportunities in their careers to buy quality assets at bargain prices. This is when the value of a thorough investment process, when married with conviction, can become evident.
Sometimes, the best thing to do is nothing
South African bonds had a tumultuous time in 2020: starting off with pre-budget jitters, escalating into a complete meltdown due to COVID-19 and the Moody’s downgrade, getting rescued by the South African Reserve Bank, and finally screeching into green territory at the end of the year as the Biden victory in the US and vaccine approvals breathed some optimism back into the markets. This enormous amount of volatility presented opportunities for those who could hold their nerve.
What I did right was buying bonds throughout the first half of the year at extremely cheap levels. With the benefit of hindsight, I exited too early: It would have paid off to be a little less risk-averse. Given the excellent entry levels, I would have benefited from bonds continuing that strong run right up until February this year. Therefore, I have learnt that sometimes, the best thing to do is nothing.
Keep a clear head when there is panic
The first time that COVID-19 was mentioned in the overnight Asian markets, we discussed it in the investment team morning meeting that very day. At the time, shocking as it may seem now, it appeared as though it could have been a benign story that would have limited impact on the markets.
I remember very clearly what Sandy McGregor told me later that day: “Stop all of my buy orders. I won’t invest in anything until we know what this thing is.”
Given the extreme market sell-off that was to follow, that was the right call, and speaks to Sandy’s years of experience in the industry and his expert judgement.
For me, what 2020 reaffirmed was the investment philosophy of Allan Gray and of value investment management: Keep a clear head when there is panic, buy assets when they are undervalued, and have the courage to stay the course. Irrationality will not prevail forever.
Admit when you are wrong
Any good investor must have the ability to change their mind. Allan Gray started buying Naspers shares in 2013, after telling clients for years that we thought the share was overvalued, and after the price had increased from R150 to R600. In this case, we had been too dogmatic about not buying a share on a high price-to-earnings (PE) multiple. We had also underestimated the growth potential of Tencent, and our assessment of Naspers’ management was too pessimistic.
Changing your mind means admitting that you were wrong. This is difficult, but investors should make a habit of admitting mistakes. Of course, there is a balance between changing your mind and sticking to your guns when the price of a share moves against you. Changing your mind based on new evidence is healthy, but changing your mind because the share price has influenced your mood can be fatal.