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Volatile friends

03 December 2014

Investors often fear volatility, but Tye Bousada, co-manager of the St. James’s Place Global Equity fund, explains why there is a lot to love in market uncertainty.

Markets have rallied since the brief bout of market volatility back in October; but for many investors, the correction was an uncomfortable episode. EdgePoint partner Tye Bousada, who co-manages the Global Equity fund for St. James’s Place, discusses why these periods of stock market uncertainty are good for long-term investors and provide welcome opportunities.

Q. What are your thoughts about the recent bout of market volatility and what impact has it had on your portfolio?

A. If we stopped a hundred people on the street and asked them for their definition of investment risk, most would probably say stock market volatility. We do not think that definition makes any sense at all. We think the true definition of risk is the possibility of a permanent loss of capital. We like to say that volatility is the friend of the investor who knows the value of a business and is the enemy of the investor who doesn’t. We absolutely love volatility; it can present us with great opportunities. But that’s not to say we’re not sympathetic to the fact that most of your clients hate volatility.

The recent, short-lived bout of market volatility provided the opportunity to increase the weighting of 13 of the 34 companies in the portfolio, establish two new positions and reduce the cash weighting from over 12% to below 8%. We were not nervous; we were extremely active as the share prices pulled back. It comes back to understanding the value of a company in the same fashion that an average consumer would understand the value of a cup of Starbucks coffee. That’s how well we have to know the value of our businesses to be able to capitalise on volatility.

Q. Is there much opportunity for investment growth in current market conditions?

A. We have warned in recent years that it will be increasingly hard to come by growth. Recently, we have been proved right, and we believe that things are going to be slower for longer than people would hope or expect. But we have to find businesses that will be bigger in the future than they are today, irrespective of what happens in the economy. When we find these businesses we have a proprietary insight or an idea that is unique to us.

We continually look for these proprietary insights, although they are not easy to come by. We only own 30-35 businesses in the portfolio, each of which we own for an average of five years. In the past, we could look at 100 businesses and find five good ideas to invest in, but that is not a normal operating environment; recently we have to look at around 300 businesses to find one good idea, which is a more normal environment. We have to work extremely hard to come up with our proprietary insights, but they are there if you look hard enough.

Q. How do you view valuations at the moment?

A. We don’t see the market as either expensive or cheap.  We don’t have judgements or opinions on that right now; it’s middling. What we see is an opportunity to be selective in the marketplace and this is very normal in our minds; not compared to the last five or six years, but compared to a much longer period of time.

Q. What would make you sell a business?

A. We sell a business for one of only two reasons. Firstly, if we have made a mistake and we can no longer stand behind our investment thesis and our ownership position in the business; then, we exit it immediately. Secondly, as part of our continual appraisal process, we ask whether the worst idea in the portfolio should be replaced by the best idea that is not in the portfolio. The factor that makes a position the worst idea might be as simple as valuation. We’ve had several positions over the last two years where values appreciated, which vindicated our investment thesis, and we sold and put the proceeds into new ideas.

Q. You said that the cash weighting in your portfolio is around 8%. Is that the normal level?

A. No, our average cash holding is 3-4%, but over the past couple of years a couple of factors have arisen. Firstly, we’ve had strong price rises for the portfolio holdings over the period. We run a concentrated portfolio so performance has been driven by a number of holdings appreciating significantly; when our investment has been realised, we’ve exited those positions and replaced them with new names. However, the exit and replacement don’t always happen at the same time, especially in periods when the market has risen sharply. Secondly, we’ve had a couple of merger and acquisitions and a couple of our holdings have been bought out. In this situation, we may have 3-5% of the portfolio coming back in cash all at once – and it can’t be redeployed immediately. In a normal operating environment, our cash holding will be circa 5% or less.

The opinions expressed are those of Tye Bousada and are subject to market or economic changes. This material is not a recommendation, or intended to be relied upon as a forecast, research or advice. The views are not necessarily shared by other investment managers or St. James's Place Wealth Management.

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