Long-term investing in companies, not short-term trading in markets
Short-term volatility can create significant market inefficiencies that can be capitalised upon for longer-term gain, says Simon Brazier (pictured), Portfolio Manager of the Investec UK Alpha Fund…
While constructive on the UK equity story looking forward, in my last viewpoint I cautioned that we must learn to live with higher market volatility than that to which we have been accustomed. However, for investors prepared to take a medium- to long-term view, this short-term volatility can create significant market inefficiencies that can be capitalised upon for longer-term gain.
We certainly saw a return of that volatility in the last quarter, with the FTSE All-Share Index falling by 10% in just one week in the lead up to August’s ‘Black Monday’. It is exactly in these sorts of market conditions that it is important to take a step back and see the wood for the trees. We need to remember that we are long-term shareholders in companies, not short-term market traders, and it is the consistently strong operational performance of the companies we own that will drive long-term value for us as shareholders, not short-term shifts in market sentiment.
That is why we shouldn’t fear short-term volatility, and by staying close to the companies in which we invest, we build conviction in our assessment of a company’s long-term worth.
Volatility is nothing new
Volatility in UK equity markets is nothing new, and there is strong evidence to support the fact that we have been here many times before. What has changed recently, however, is the market’s speed of response to news flow. This has been driven by a combination of factors, including the increasingly global nature of markets, frequency and accessibility of news, short-term focus of market participants and significant growth in high frequency trading strategies and electronic trading platforms. It is easy to get lost in this noise, but, more than ever, what we believe ultimately matters is the intrinsic value and competitive advantages of the individual companies in which we invest.
The importance of meeting and understanding companies
Capital allocation, and management’s ability to generate cash and re-invest that cash effectively, is one of the most important factors in driving long-term shareholder wealth. We spend a lot of time focused on this, and typically conduct several hundred meetings each year with company management. These meetings not only give us valuable insight into company strategy, corporate governance and the key factors driving growth and profitability, but also help generate additional ideas through company management’s knowledge of industry developments, competitors, suppliers and customers.
We evaluate a management team’s experience and track record in capital allocation as well as their remuneration incentives and how they deal with environmental, social and governance issues. This helps to provide us with an in-depth understanding of a company’s strengths, weaknesses, opportunities and threats, thereby giving us the conviction to hold these companies for the longer term.
If we have conviction in the underlying long-term operational performance of a company, short-term sentiment driven market weakness simply allows us to add to our position at a more attractive price. One recent example of how we have put this into practice is BT.
Case study: BT
BT has been a significant holding of mine for several years, as first Ian Livingston in 2008 and now Gavin Patterson have transformed the business from a poorly run, underperforming utility with a huge pension deficit into a much leaner, efficient and more cash-generative business with attractive growth prospects.
Even though BT is a domestic UK telecommunications business with no exposure to China, the stock fell broadly as much as the market in the week around ‘Black Monday’, as fears over the break-up of its Openreach infrastructure division coincided with general equity market jitters. Having spent a lot of time recently with BT’s management team we are confident in the long-term outlook for the company.
With its strong balance sheet and cash generation, its planned acquisition of mobile network operator EE and its successful investment in TV sports content, we believe it is incredibly well positioned for ‘quad play’– delivering the bundle of broadband, TV, home phone and mobile phone to its UK subscriber base. Given the initially strong take-up of fibre-optic broadband, its reach across the UK, the relatively low costs and decent download speeds, we believe the risk of Openreach being separated from BT is overdone and, as BT’s dividend yield moved back up closer to 3.5%, the August sell-off provided the perfect opportunity for us to add to our long-held position.
Warren Buffett once said that ‘games are won by players who focus on the playing field – not by those whose eyes are glued to the scoreboard’. We will continue to focus on companies, and not on short term gyrations in prices. In particular, as we highlighted in our first quarterly report earlier this year, we will focus on those companies we believe are able to generate cash and re-invest that cash at high rates of return. Especially during periods of short-term volatility and fair-to-high market valuations, we believe stock selection and a long-term company focus is critical. Ultimately, these are the companies that, in our view, will be the long-term winners and most likely to compound long-term shareholder wealth. During periods of heightened volatility, we simply buy more