Everything Everywhere All at Once
– David Wanis, June 2022
“I very frequently get the question: ‘What’s going to change in the next 10 years?’ And that is a very interesting question; it’s a very common one. I almost never get the question: ‘What’s not going to change in the next 10 years?’ And I submit to you that that second question is the more important of the two — because you can build a business strategy around the things that are stable in time. … In our retail business, we know that customers want low prices, and I know that’s going to be true 10 years from now. They want fast delivery; they want vast selection. It’s impossible to imagine a future 10 years from now where a customer comes up and says, ‘Jeff I love Amazon; I just wish the prices were a little higher,’ or ‘I love Amazon; I just wish you’d deliver a little more slowly.’ Impossible.” – Jeff Bezos, Amazon founder, July 2016
Investors frequently focus on the constant change in markets. Investors spend less time considering what is not going to change in markets. Like Jeff Bezos, we would submit this is the more important question and building an investment approach around things that are stable in time is more likely to work.
What Changes in the Investment World?
During most months it feels like Everything Everywhere All at Once.
Business Cycles (GDP, interest rates, inflation, exchange rates), Politics and geopolitics, Technology, Market players (politicians, executives, fund managers, bankers), Demographics, Themes (Dot Com, BRICs, Commodity Super Cycle, SaaS, Digital Disruption, Crypto), Investment structures (public, private, venture, ETF, LIC, LIT). The list goes on and on. On any day you can pick up a newspaper or a broker report and read thousands of words on the fleeting and ultimately long-term inconsequential changes in the investment world.
What is Likely to Remain Stable Over Time?
We think there are three constants for investors to consider: 1) human behaviour, 2) investment arithmetic and probability, and 3) costs.
Human behaviour: Having invested through a few bubbles and crashes now (tech bubble in the late 1990s, the US housing bubble in 2005-08, the commodity bubble in 2010 and the latest post-COVID bubble) and studied some of the more prominent examples of history, it never ceases to amaze how consistently humans behave. The cycles of fear and greed and the response to market events governed by instincts formed thousands of years ago continue to repeat. Each cycle is updated for modernity, but people are constant and respond to the same stimuli. Humans are adapted to focus on change and susceptible to act in ways unproductive to long term investment outcomes. There are hundreds of books, papers, and studies on behavioural bias in investing, but reading about them is not enough. Investors should consider deliberate actions and processes to reflect and control these biases. We have many embedded in our investment process from complex systematic models to pre-trade checklists to help us make more objective, unbiased and consistent investment decisions.
Investment arithmetic and probability: Investing is grounded in some pretty solid foundations around discounting future cash flows. Wild share price swings come not from an argument about the math, rather the uncertainty (hence probabilities) about the key variables – future company cash flows and the appropriate discount rate.
Occasionally – usually in the middle of a bubble – the very idea of discounting future cash flows at a discount rate becomes questioned and “new math” attempts to justify the unjustifiable.
We have yet to see an example of when forgetting to consider investment arithmetic and probability resulted in a superior long-term outcome. Eventually valuation always matters. There are high prices where great businesses become lousy investments. There may also be prices where lousy businesses become great investments, but this is a much harder game as the potential to be stopped out (equity goes to zero) means the logic of business quality vs price is not symmetrical. In small caps we believe it is better to focus only on the good businesses as the risk of total failure from low quality enterprises is far greater in this part of the market.
Costs: Many finance professionals like to avoid talking about costs because investment costs are their revenue. Longwave included. Costs in all their forms (transaction costs, spreads, stock-based employee compensation, fund management fees, taxes, custody, accounting etc) are constant and unavoidable. Understanding what costs stand between an investment idea and realised net returns and minimising them where appropriate and possible will always improve investment outcomes. As inflation moves through the economy, the friction from costs is going to increase. Pretending they don’t exist won’t help.
In a world that will continue to change and surprise, an investment approach should consider the consistent behaviour of humans, foundational investment arithmetic and probabilities and the influence of costs on the investment outcome.
What do Longwave Clients Value Over Time?
We have built both our investment approach and our fund objectives around things that are likely to be stable through time. Regardless of what else happens, we believe our clients will continue to prefer More Consistent Alpha at Lower Fees and this is the focus of our fund. Today, tomorrow and 10 years from now, we can’t imagine a client who asks us to deliver lower alpha. Who asks us to make our performance more volatile. Who asks us to charge them a higher fee.
This communication is prepared by Longwave Capital Partners (‘Longwave’) (ABN 17 629 034 902), a corporate authorised representative (No. 1269404) of Pinnacle Investment Management Limited (‘Pinnacle’) (ABN 66 109 659 109, AFSL 322140) as the investment manager of Longwave Australian Small Companies Fund (ARSN 630 979 449) (‘the Fund’). Pinnacle Fund Services Limited (‘PFSL’) (ABN 29 082 494 362, AFSL 238371) is the product issuer of the Fund. PFSL is not licensed to provide financial product advice. PFSL is a wholly-owned subsidiary of the Pinnacle Investment Management Group Limited (‘Pinnacle’) (ABN 22 100 325 184). The Product Disclosure Statement (‘PDS’) and Target Market Determination (‘TMD’) of the Fund are available via the links below. Any potential investor should consider the PDS and TMD before deciding whether to acquire, or continue to hold units in, the Fund.
Link to the Product Disclosure Statement: WHT9368AU
Link to the Target Market Determination: WHT9368AU
For historic TMD’s please contact Pinnacle client service Phone 1300 010 311 or Email firstname.lastname@example.org
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