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Necessity is the mother of invention – TAM Asset Management

By James Penny, chief investment officer at TAM Asset Management

I think we can all agree markets are not what they used to be – not at all. All I seem to read in the financial press is comments on the new paradigm we are in and how 2022’s market is more challenging than it has been throughout the past decade. This comes at a time when DIY investing has been on a tear which poses obvious risks to these investors.

At face value, I would tend to agree with the assertion around this market having fundamentally shifted based on the single fact that the two biggest components of capital markets – equities and fixed income have, in the case of equities, faltered and in the case of fixed income appear to be in full retreat. Under the surface, it’s plain to see that with the absence of inflation, the role of the central bank since 2008 has been to simply backstop a market.

Now inflation, at levels not seen for 20 years, is back in full force and central banks are having to part from their role as a market stabiliser and actually do the job they were put on this planet to do which is control inflation. That realisation is proving a bitter pill to swallow for the markets.

Looking at fund performance in 2022 it’s clear funds whose gains have been the best over the past decade (high growth) are now anything but and in some instances, those dogs of the past decade (value) are now having their relative time in the sun. While the aggressive selloff in growth stocks is regrettable, it has served to remind investors that what goes up does eventually come down, and vice versa. Even if it has taken a decade to do so.

Mainly the selloff is being driven by a palpable fear around the prospects of growth stocks surviving eight rate hikes and a global economy which looks to be slowing down and, in some instances such as the UK, slowing to stall speed.  Thrown in a full blown armed conflict, a Chinese zero-Covid policy and a cost of living crisis and one has exactly the sort of backdrop which would cause the beloved Nasdaq to enter full correction mode or why government debt has had one of its worst starts in its history.

Looking at the performance of equity funds in 2022, it’s clear who is a growth manager and who is a value manager. Nothing earth shattering, but with such a narrow collection of managers outperforming this market it is alarming how few “true blue” value managers like Pzena Global Focused Value fund, Schroder Recovery fund and Havelock Global Select were still holding the line on value investing.

What is interesting was the cohort of funds labelled as “style agnostic”, while others might call them “unconstrained”. One might expect this subset to be faring in the middle of the performance table between growth and value as they exercise their flexibility to take advantage of the shifting dynamics in this volatile market. Alas, the performance of many in this realm is much closer to that of a pure growth investor than that of a value one.

Why? I would hazard a guess that responding to the client pressure of always delivering outperformance almost every equity manager who has wanted to consistently outperform a benchmark and thus keep their career on track has been forced into the growth end of the market to survive the past decade.

While this has helped spur momentum into growth stocks since 2008, the market today could herald the reverse as managers quickly re-task their funds from de facto growth funds back to true style agnostic vehicles. This gets supercharged when one considers the massive distorting force passive investing has had on the rise of growth stocks and how, in reverse, the algorithms are selling larger and larger volumes of the losing stocks in exchange-traded funds just to keep the weightings balanced.

Alarmingly, outside of the potential for capital loss, it does pose a conundrum around risk and how much one has been taking and reporting for their clients.

Take two balanced funds with 50% equities: one fund manager has been allocating 50% heavily to growth funds (as most have) and a portion of these unconstrained funds; the other the same 50%, but with a deliberately barbelled investment approach using researched growth and true value funds. The former manager’s volatility in 2022 is going to be multiples higher than the latter manager despite them both owning just 50%.

Safe to say the latter manager will also be achieving lower levels of volatility with lower levels of capital loss which form the backbone of a well-diversified investment fund in times of volatility.

The issue with risk in its conventional guise is it is always rear looking and, in that respect, owning a growth portfolio has delivered stellar numbers with apparently little-to-no volatility and now that same portfolio will look drastically different from a risk perspective.

If we believe we are in a new market paradigm, it stands to reason this market is going to necessitate a change in how we manage client portfolios from both a return and risk metric as well as how much active versus passive is being used.

Importantly, this should spell an uptick in clients using more active model portfolio solutions to protect capital, but it also puts more pressure on these active managers to have to work harder to justify their higher fees which can only be to the benefit of the end client. Perhaps that’s a silver lining to clients in this new market.

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