When I mention the names Floyd Mayweather and Connor McGregor, four words come to mind: Top Arrogant World Champions. Both of them are regarded as some of the best in contact sport. Both of them put on a pair of gloves and get into a ring. Both of them want to see their opponents hit the floor lights-out as soon as possible in a match. The difference between them is that one of them is an expert in Mixed Martial Arts (MMA) , and the other, an expert in boxing.
If you point out only the similarities between these sports, however, you run the risk of offending the other in his field of expertise. McGregor made this mistake in 2017 at age 28, when he decided to challenge the 40-year old Mayweather to come out of retirement and take him on in a boxing match.
The same principle can be applied to the investment world. I see an increasing amount of criticism in the press aimed at certain equity funds with regard to their recent underperformance. Before I continue, I want to make it clear that I do not intend to justify any fund’s underperformance and I that I will not be mentioning the names of any underlying funds in this regard. The purpose of my column this week is to provide investors with the opportunity to ask the right questions before simply selling out of these funds out of fear.Of course, Mayweather didn’t have to make too much of an effort to beat McGregor and the reason was quite simple: McGregor wasn’t a good enough boxer. But that does not mean that he isn’t a great MMA fighter. Saying that, I doubt whether Mayweather would last long in an MMA cage. Both of them are amazing fighters in their respective sports.
The truth is that stock markets often find themselves in different “rings”, no different to the Mayweather and McGregor challenge. We would typically consider it to be value environment where funds that hold shares with lower price earnings ratios (P/E), lower price to book ratios and lower enterprise value (EV) and earnings before interest, tax, depreciation and amortisation (EBITDA) and EV-to-EBITDA ratio (EV/EBITDA) have performed better than the rest of the market.
When we see shares with strong historical price movements making even more gains, it is typically seen as a momentum-driven market. It is important to note that these differing cycles often take years to change. Does that mean that value shares are weak, just because they don’t experience the same price movements as momentum shares in a momentum-driven market? Of course not.
Let’s use a passive fund as an example. If you had invested in a passive fund that only invested in value shares a year ago, you would have performed much worse than the MSCI All Country World Index, for example, one year down the line. But that doesn’t mean that these value shares are poor investments. There are several factors, such as lower interest rates, quantitative easing among others, which have caused higher priced shares to become even more expensive. It is for this reason that passive funds that selected shares based only on their historical price movements, have performed much better in this momentum-driven environment.
I’m not saying that all fund managers have underperformed just because we found ourselves in a momentum-driven market. I am saying that you should do your homework properly in order to determine exactly what the mandates are of the underlying funds you are invested in, to avoid being an MMA fighter that finds himself in a boxing ring.
The opinions expressed in this document are the opinions of the writer and not necessarily those of PSG. These opinions do not constitute advice. This is intended as general information and does not form part of any financial, tax, legal or investment related advice. Although the utmost care has been taken in the research and preparation of this document, no responsibility can be taken for actions taken based on the information contained in this newsletter. Since individual needs and risk profiles differ, it is always advisable to consult a qualified financial adviser before taking action.