Successful investors learn from history
Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
Historians are very keen to identify the consequences of past crises. Plagues seem to be a special focus. The Antonine Plague (165-180) allegedly caused the beginning of the end of the Roman empire; the Black Death (1347-1351) killed feudalism; some argue that the Great Plague of London (1665-1666) led to the introduction of capitalism from Holland.
Good investors learn from history. And they learn from historians, too — not least to avoid the confirmation bias that leads you to see these tenuous causal links where often there are none.
During major crises, if you are to protect your wealth and exploit opportunities, you have to anticipate the consequences. Like historians, you are often working with insufficient or poor data. You will have to extrapolate. Just remember, the trend is not destiny.
Readers commenting recently have asked for some practical illustrations of how professional active fund managers approach this challenge and how they justify their fees (well, that is the polite summary).
There are many different approaches to building portfolios. Some use algorithms and charts, seeking out patterns in numbers. The way my team runs money — akin to the most common approach — is to attempt to identify those sectors with long-term growth prospects. These trends are often driven by demographic, environmental or regulatory change and little affected by the economic cycle.
Having identified strong investment themes (we have around 10 in the portfolio typically, but we monitor them closely because they wax and wane over time), we then invest in companies within these areas that have shown they have high barriers to entry and so can generate attractive and sustainable cash profits.
What does that mean in practice? For the past few years these criteria have led us to invest heavily in technology companies and healthcare businesses — areas that, you may have noticed, seem well placed to adjust to a post-Covid world.
They have helped us avoid many sectors that will see significant challenges and that may struggle to return to full capacity or previous profit margins for some time — if ever. We sold all our travel-related investments this time last year as tourism numbers seemed excessive and the environmental impact of cheap flights was becoming noted by politicians. The issue of biosecurity was not high on the agenda, but it was there. There is always an element of luck as well as judgment in investing.
The current crisis may feel like a turning point, but it is accelerating existing trends, leading to more of the same in equity selection: the weak still getting weaker and the strong stronger.
There will be some changes, though. Some sectors will find it hard to return to normal, while others now seem more vital to our future plans. The prospect of pubs and restaurants having to apply social distancing rules for some months ahead is heartbreaking for someone like me, who has spent rather a lot of my life enjoying their hospitality.
I also will not be in any rush to get on a plane when flights resume. However, the lesson from history is that we will get back to something like normal after a while. So sectors such as travel that have been abandoned by markets may be worth a review by investors who know they can hold shares for three to five years.
On the other hand, some existing trends have probably been ratcheted up a level by the crisis. Online ordering of goods seems likely to take a permanently higher share of spending. Home working, having been practical for years, may have become the norm and commuting permanently reduced.
This is shaping the way we invest. We have bought telecoms companies that look set to prosper on the back of our increased dependency on broadband communications. I do not imagine us buying any central London office property investments any time soon.
And what can we learn from history? Too many investors confine their studies to American and European history. Tulip mania and the Wall Street Crash will not tell you how to cope with a pandemic (and the Black Death is too long ago to present a useful case study). I would recommend studying Asian markets, too. It is why I have been to Japan at least once a year since 2002 and often to China.
Asia has recovered from Sars, Mers, avian flu and swine flu in the recent past. We have learnt from that experience that after all these pandemics life eventually returned to normal; even travel returned to normal. But we know, too, that they did not just bounce back. Japanese companies have often been criticised for having very strong balance sheets — but these balance sheets are what you need to cope with periodic crises.
On the economic front, European economies have not faced the deflationary slump we now face. But global fund managers investing in Japan have decades of experience of investing against a background of deflation. Although Japan’s economy has grown rather slowly compared with others, the country has a multitude of world-class businesses that have proved excellent investments in recent years — particularly companies dominating industrial automation. Investors buy companies, not countries, and can still make money in stagnant markets.
This way of managing money takes time — it is a combination of general study and detailed company research. If you want the chance to outperform market indices you have two choices — do it yourself or pick a professional manager to do it for you. As ever with history, past performance is no guarantee of future performance (the regulator’s way of saying trend is not destiny). Professional fund managers live with this reality every day — and any short period of outperformance will have among the skilled leaders a number of lucky managers.
But study how a team performs against the benchmark index over time, through bull phases and bear phases, and you will gain a better-informed assessment of whether they show consistent skill or whether you would be better off choosing stocks yourself. Whatever you decide, my advice would be that of the veteran sergeant in Hill Street Blues, the US cop show of the 1980s: “Let’s be careful out there.”
Simon Edelsten is co-manager of the Mid Wynd International Investment Trust and Artemis Global Select Fund. Views are personal.
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