Five strategies for a changing investment landscape

Investors can benefit from a more active investment approach to generate attractive long-term returns, amidst expected higher market volatility this decade. We share five strategies that highlight how.

It seems some investors may have been lulled into a false sense of security, believing that equity markets are returning to an extended period of lower volatility1 and higher returns, amid receding inflation, interest rate stabilisation and an equity bull market in the past 12 months.2

These trends could encourage investors to use the same playbook as they did when interest rates were lower. That is, embracing momentum-based strategies, such as passive investing, and following the ‘investment crowd’ in pursuit of short-term returns. 

These strategies can expose investors to significant risks, especially in a changing investment landscape. After more than three decades of falling interest rates, the tide has turned. Investors will need to be far more discerning as to where they allocate capital and consider focusing on stocks with attractive valuations relative to their long-term fundamentals. 

We believe a fundamental shift in the investment landscape is underway. 

The period between 1990 and 2020 was characterised by historically low inflation, influenced by:

  • Globalisation as more companies ‘offshored’ their manufacturing operations by building long, complex global supply chains 
  • Cheap fossil fuels and abundant commodity supply
  • Higher geopolitical harmony

This meant an extended period of low interest rates and falling cost of capital.

In contrast, the current decade is characterised by higher inflation, elevated interest rates and increased cost of capital. We’re seeing:

  • A supply chain reconfiguration by companies returning to onshoring or ‘near-shoring’
  • A war on carbon with mandated energy transitions
  • Rising geopolitical conflict

As a result, the tailwinds that benefitted asset prices between 1990-2020 have become headwinds. This change could lead to higher volatility in equity prices this decade as markets adjust to the new investment landscape. 

Volatility can be a source of additional returns for long-term investors who have the expertise to identify genuine valuation anomalies and capitalise on short-term market sentiment. 

Here are five strategies to consider:

1. Use volatility to your advantage

Capitalising on periods of higher volatility through active investing can help amplify returns over the long term. In these more difficult investment conditions, short-term investor sentiment can create an opportunity for active managers to take advantage of periodic market falls and undervalued stocks. 

This strategy requires a more active approach and has implications for portfolio construction, where investors should consider having sufficient cash to a) withstand periods of higher volatility, and b) take advantage of market downturns.

2. Manage risk through valuation 

PM Capital believes valuation is the best form of portfolio risk management. That is, buying quality companies when they have a bottom-quartile valuation relative to their true value. This can provide investors with a margin of safety against downside risk. 

Owning undervalued companies means investors are better positioned to preserve capital during volatility, take advantage of opportunities and build long-term wealth as the market eventually re-rates undervalued companies. 

This is where active managers with a demonstrable, long-term record in identifying valuation anomalies come into play. 

3. Review passive investment strategies 

Near-zero interest rates from 2015 to May 2022 were a tailwind for equity markets. Key indices rose as unusually low rates boosted asset prices and some sectors with price momentum, such as tech, outperformed. These conditions supported index investing.

However, as the global investment landscape changes, markets will become more volatile. Most index funds aren’t designed to capitalise on volatility and nor do they make investment decisions based on company valuations or consider company fundamentals. Passive investing can also mean exposure to indices with high sector or stock concentration, and owning overvalued companies. 

4. Be prepared to hold unpopular ideas 

Buying undervalued companies during volatility often means investing in unloved sectors and stocks. PM Capital, for example, increased its holding of European bank stocks in 2020 and 2021 during market weakness. As fears of European recession grew, bank stocks there were deeply out favour. 

By sector, European bank stocks had the highest weighting in PM Capital’s Global Companies Fund at end-January 2024. The MSCI Europe Banks Index (EUR) has an annualised return of 22.4% over three years to end-January 20243, reinforcing the benefits of buying quality companies when irrationally oversold. 

5. Be patient

The phrase “long-term investing” is often misused. At PM Capital, long-term investing means buying good companies at bottom-quartile valuations and waiting until they achieve top-quality valuations before selling. Often, this means investing with patience through industry cycles that may take a number of years to play out to their full potential. 

This mindset of genuine long-term investing – combined with an active approach to capitalise on short-term market sentiment and volatility – can deliver powerful returns over time, as both our experience and investment results have shown.4

If you would like to join one of PM Capital’s upcoming adviser Market Insight roundtables, register your interest here.

 

Notes

1 As measured by the Cboe Volatility Index (VIX).
2 12 months to 22 February 2024. Description of ‘equity bull market’ based on gains in S&P 500 Index in US.
3 MSCI (2024), “MSCI Europe Bank Index (EUR): FactSheet.” At 31 January 2024.
4 Information on PM Capital’s fund performance since inception is available at www.pmcapital.com.au

This insight is issued by PM Capital Limited ABN 69 083 644 731 AFSL 230222 as responsible entity for the PM Capital Global Companies Fund (ARSN 092 434 618), the PM Capital Australian Companies Fund (ARSN 092 434 467) and the Enhanced Yield Fund (ARSN 099 581 558), the "Funds". It contains summary information only to provide an insight into how we make our investment decisions. This information does not constitute advice or a recommendation, and is subject to change without notice. It does not take into account the objectives, financial situation or needs of any investor which should be considered before investing. Investors should consider the Target Market Determinations and the current Product Disclosure Statement (which are available from us), and obtain their own financial advice, prior to making an investment. The PDS explains how the Funds' Net Asset Value are calculated. Past performance is not a reliable guide to future performance and the capital and income of any investment may go down as well as up.