Gravity is not uniform

With a recent lull in work I had time yesterday to take a look at my own pension plan. I was interested to see how individual investments and assets had fared during the recent sell-off in global equity markets. I am a very adventurous risk investor by nature and have limited exposure to bond funds and no holdings in multi-asset investments. They will be for the future when I contemplate retirement. I have absolutely no plans to hang up my boots yet.

I had last valued the portfolio on 6/9/18. Markets rallied towards the end of September, they fell sharply in October and have drifted lower in November.

Looking at the funds I hold, smaller companies have been the clear losers from 6/9/18 to 22/11/18. My holding in the Baring Europe Select fell 12.9%, the BMO US Smaller Companies lost 10.5%, the JP Morgan Smaller Companies investment trust was down 17.8% and the Standard Life Investments Global Smaller Companies fund shed 18.1%. Why have smaller companies been hit so hard in this sell-off? In part this is due to their perceived higher risk, with investors switching to safe haven assets. In addition prices and valuations of smaller companies have risen sharply in the last five years and as such they were especially vulnerable to a correction. Finally smaller companies are much more geared to the local economy in contrast to large companies which are more globally focused and typically have strong overseas earnings. In the UK, Brexit uncertainty and a weak pound favours larger firms.

It is important to say that aside from a selective flight to quality, in a sell-off investors tend to dump stocks indiscriminately. Undoubtedly many smaller companies have been sold without due consideration of their fundamentals* i.e. how good their businesses are. Being confident that fundamentals always come to the fore I am planning to do nothing with my smaller company funds. I will hold them with an expectation of recovery. In the meantime I am happy to sit on paper losses.

The other big falling sector unsurprisingly was technology and my holding in the Polar Technology investment trust was down 15.9%.

It was interesting to see value investments holding up relatively well. They fell modestly. The Fidelity American Special Situations was down 3.7% and the Schroder Recovery shed 3.2%. To remind you a value investment style focuses on undervalued, recovery and out of favour stocks and these have been in the doldrums in the last five to seven years compared to growth stocks, which have been getting expensive. Historically value has outperformed growth** and this may be a reversion back to this trend.

Finally it was a surprise to see a number of my funds rise in value over the last two and a half months. The biggest was my iShares MSCI Brazil ETF, a traded security that tracks the MSCI*** Brazil index. It is a rare example of a passive investment that I hold in my pension. It is up 23.9% since early September. A number of commodity funds investing in gold and silver were modest risers as was the M&G Emerging Market Bond fund.

So what is my conclusion? Gravity is not uniform. In a sell off not everything falls to the same extent whilst some assets may defy gravity and drift upwards. It illustrates the importance of diversification and holding negatively correlated assets in a portfolio. Overall my pension fell by 5.6% from 6/9/18 to 22/11/18 so it hasn’t been an unmitigated disaster.

*Fundamentals refers to the strength of a business and takes into account a variety of economic metrics and qualities such as cash flows, profits growth, dividend cover and sustainability, balance sheet strength, barriers to entry of competitors and strength of the company management.

**A growth investment style focuses on companies with an expectation of a higher than average dividend growth and share appreciation in the future even if they appear to be expensive. The document from Janus Henderson describes value and investment styles.

***Morgan Stanley Capital International. MSCI have created a number of stock market indices which Exchange Traded Funds (ETFs) and index trackers seek to replicate the performance of.

The content of this blog is intended for general commentary only. Nothing in this article should be construed as personal investment advice and the funds mentioned that I invest in are not intended to be recommendations. You should seek individual advice based on your own financial circumstances before making investment decisions.