Timeless Tactics: Preparing Your Portfolio for Market Downturns

In episode 29 of Stocks Neat Co-Portfolio Manager Gareth Brown and CIO Steve Johnson discuss several investing maxims, and how these might apply to portfolio positioning in prior and current markets.  

Topics covered include cleaning portfolios to include only high conviction ideas, selling when you can, maintaining cash in the portfolio, how to deploy cash in a downturn, and identifying diversity breakdowns that result from cross-sector correlations. 

Additionally, Gareth and Steve analyse some recent portfolio changes and the driving factors behind these shifts, before responding to a couple of questions sent in from listeners. 

Listen to the full episode to find out more. 

"I think you can deploy your cash first and then you can start thinking about recycling from more defensive, resilient businesses into some things that are offering higher prospective returns. Getting increasingly aggressive about that as you go through that part of the cycle.”

Transcript

[INTRODUCTION]

[0:00:03] ANNOUNCER: Just a quick reminder that this podcast may contain general advice, but it doesn't take into account your personal circumstances, needs or objectives. The scenarios and stocks mentioned in this podcast are for illustrative purposes only, and do not constitute a recommendation to buy, hold, or sell any financial products. Read the relevant PDFs, assess whether that information is appropriate for you, and consider speaking to a financial advisor before making investment decisions. Past performance is no indicator of future performance.

[EPISODE]

[0:00:40] SJ: Hello and welcome to episode 29 of Stocks Neat, a Forager Funds Podcast, where we talk about the world of investing and once in a blue moon, try a whisky. Joined by Gareth Brown, my regular co-host here. Hi, Gareth. How are you?

[0:00:54] GB: Hi, Steve. Hi, everyone.

[0:00:56] SJ: You're a bit disappointed today, I think when I said I'm not feeling up to having a whiskey this afternoon.

[0:01:00] GB: It's okay. I've got a couple of small bottles I'm taking on a camping trip this weekend, so me and my brother and my kids will watch me. We'll give it a try on a weekend camping trip in the Blue Mountains.

[0:01:10] SJ: Oh, very nice. Very nice, indeed. I need to get one out of. Just moved back into our house after a long stay in the suburbs, while doing a renovation.

[0:01:20] GB: Just let us know when you want us around.

[0:01:22] SJ: I'll do that. But yeah, I'm not feeling 100% today. I'm going to skip the whiskey and we've got a lot on it Forager at the moment, de-listing of funds and things. What's been happening outside of work?

[0:01:32] GB: Usual kiddie stuff. Lots of sports. Just busy life.

[0:01:36] SJ: Busy, busy, busy. Good. Well, today we're going to talk about preparing for market downturns. There's nothing about the past couple of weeks that should be the slightest bit concerning for people, I'd say, as there’s been a few percentage –

[0:01:48] GB: Very normal.

[0:01:49] SJ: - for, given the rally that we've had, most US indexes in particular, still significantly above where they were, even at the start of this calendar year, not even counting the rally from the last few months of last year, but there's more talk out there about things being overstretched and the rally that we've had and inflation coming in hotter –

[0:02:08] GB: Poor budget deficits.

[0:02:09] SJ: People starting to worry and talk about market crashes and things. I thought that's precisely why it's a good time to do this podcast. It's actually very early days if there is going to be any correction here, and you need to think about your portfolio well before you're in the midst of a very significant market downturn. If you haven't been thinking about the potential risks, I think, the opportunity for you to do something about any shortcomings in your portfolio is still there as we sit here today.

That's why I thought it'd be an interesting topic for a podcast. We've got an email, half entertaining, but I thought it also had some pretty interesting insights from a broker overnight, where he was talking about the top 10 bits of advice that he –

[0:02:49] GB: Top 10 cliches, wasn't it?

[0:02:51] SJ: Cliches that he was passing on from veteran traders after he's years in broking. We've picked a few of these each to have a bit of a chat about today, because I thought there was some truth to some of them and some entertainment to others as well.

[0:03:02] GB: I think we need to put into context the position where we are today. Obviously, we went through that 21-22 downturn. Rightfully, we're embarrassed about our performance. Did not prepare for that downturn adequately and strongly committed to never letting it happen again, so we can talk a little bit about some of the differences of portfolio positioning if that is helpful.

[0:03:27] SJ: Yeah. I think embarrassing is the right word. One of the most important things, if you went from the start of that 2021 year to now, you'd look at the fund's performance and say, it's perfectly fine. One of the keys, I think, to protecting yourself against those very significant market falls is being willing, even happy to miss out on the last bits of bluffs when markets are going up. It was probably the most concerning thing for me at the time was that we were actually performing so well that year into, I think it was plus 78%. A lot of it came in –

[0:04:05] GB: The last few months.

[0:04:06] SJ: - the last few months of that year. Yeah, it was a period that we certainly don't want to repeat ever again. We run concentrated portfolios. Our investors are more tolerant than most of volatility. Our performance is going to be volatile. It's part of the way we generate outsized returns.

[0:04:23] GB: Well, we want to get paid for it, for taking on those risks. I mean, one of the things I've highlighted here is a message that you sent to the team and the internal channel, back in March 21. I won't read it in full, but the start of it was, you said, “I think we should take note of the way our portfolio performed last night.” This was after a rough night in March 21. “And consequently question ourselves about where this might go horribly wrong for us. I think we're all convinced that there are parts of the market that are in a proper bubble, but we also think we don't have much exposure to it. Are we at risk of waking up in six months’ time down 30% and asking why we didn't see it coming?” Then you go into various subsets here of how the portfolio was positioned at the time.

That’s one of the hard things for us about this is that about the performance in 21 is that in many respects, we did see it coming. We just didn't execute properly on that. Now, it partly misses the point there, because the market rallied at another 25%, or 30% subsequent to that warning and we did very well out of that. But there was writing on the wall. We didn't pay enough attention to it. We didn't position properly for it. I guess, part of today is to talk about how we're doing better this time.

[0:05:37] SJ: It's quite interesting psychologically, I think, that you can sit there and be very conscious of a bubble around you and –

[0:05:44] GB: Yeah, I'm fine.

[0:05:46] SJ: Yeah, your own narrative. It's a narrative bias, right? You tell a story about the things that you own and why you own them. That's why for me, my role as CIO of this business, something that there was a lot of reflection about out of that episode. Maybe this is probably a topic for another podcast, but how as an organization do we embrace some things about my DNA that have been successful historically, without imposing on everyone. I think most funds management businesses have a CIO that is making all of the decisions and overruling people all the time and a lot of them have quite dysfunctional cultures, I think. We don't want that. We want to build a business that's got great people in it and where the business is a lot bigger and a lot more than me.

We also need to work out how that discipline can be imposed on us as an organization, rather than me making decisions day-to-day. That's something we've given a lot of thought to and just the types of portfolio limits that we have. I think you actually need some broad parameters in place, rather than you will make up a story for every single individual stock that you own about why you own it and some broad parameters, I think, help. Even just really simple things, like market multiples and where is the market trading today? How much risk exposure?

Now in the early days of Forager, we had years where the funds were – the Aussie fund was up in years where the market was down. I don't buy the whole were your small cap and you're illiquid and therefore, you have to perform badly in down markets. I think if anything, if you're really disciplined about valuation, you're not making market calls, but you are, if you're disciplined, generally taking on less risk at the top and more risk at the bottom, just because there are more opportunities and less opportunities. I want to see that out of our portfolios in future again as well.

[0:07:35] GB: How do you want to get into this? Do you want to go through the maxims first and then talk about portfolio positioning, or do you want to do it the other way around?

[0:07:41] SJ: Yeah, let's do that. Or we can do it a bit of each as we go along, but maybe pick your first interesting bullet point out of that email. There's Stephen Holt from bed. We should give him a plug for it, because we can't steal his content without saying who it was. He’s a London-based broker for you.

[0:07:55] GB: Yeah. I'll start with maxim number six. A few small positions can kill performance when things get choppy. Most traders, investors carry minor, low-conviction holdings on their books. This is the long tail of things with 1% and 2% positions. For reasons only known to the gods, these are often the positions that do worse in a volatile markets. Cleaning up portfolios to reflect only high conviction ideas and having excess capital to invest is a good idea in such periods.

Just, again, rings true to our 2021 experience. We got involved in a lot of stocks there that performed very nicely for us, but they were risky situations. They paid off. We sold 75% of our holding and then kept a small token for reasons still unbeknownst to us. We recycled into some potentially similar ideas and would be much better off if we had sold out entirely out of those things that we thought had reached fair value and put it into completely different kind of ideas, or kept it as excess firepower.

[0:09:02] SJ: Yeah. I think those things that you don't have a lot of conviction about when they start performing badly, it gets harder and harder to actually do something about it. Once the share price is down 30% and your anchor to the old price.

[0:09:12] GB: I only have a percent in it.

[0:09:14] SJ: I knew I made a mistake, but now it's time for me to get out. I think tidying up all of that stuff when things are going well is a really, really important one. So, that you've got a bunch of stocks that you can sit there and say, if the market is down 30% here, I'm really, really happy owning this business, irrespective of what happens to the share price, because I know in five or 10 years’ time, my returns from here are going to be very good. Yeah, cutting out that stuff that you've lost confidence in or whether the thesis is not playing out, because if you're dead right, it tends to go even worse.

It's not even up to the gods. I think if you think about the setup with some of those businesses, it's not just you that's feeling uncertain and uncomfortable with what's been going on that have been disappointing a little bit. They're the ones that everyone's going to dump, once they start to panic and are looking for places to fund other ideas as well.

Okay, the first one I picked was this point number three, sell when you can, not when you have to. I guess, it's related to what I was just saying. You put a quote in here, a fun fact. The origins of this saying and Shakespeare’s, as you like it, sell when you can, you are not for all markets. Apparently, that was advice for a young woman considering a marriage proposal, but it also holds true for the grizzled trader sitting in front of an all red screen.

That's why I thought today's podcast was just at the right time. Markets are only down a little bit. Still a fair bit of optimism out there. Still up year to date. If you've got changes that you need to be making to your portfolio, it's actually a pretty good time to be doing it. Still getting healthy prices for a lot of stocks out there and you don't want to be sitting there when things are getting dysfunctional, from our perspective, where we're trying to sell larger volumes of some smaller companies in markets that are not performing well.

[0:10:53] GB: Especially applies at the smaller, illiquid end of the market, where we often find our best value.

[0:11:01] SJ: Another Australian fund manager that you and I both know well and respect a lot, Tony Scenna, he put the same thing in a slightly different way. If you're going to panic, panic early.

[0:11:10] GB: Beautiful.

[0:11:11] SJ: I think that was good advice.

[0:11:13] GB: Should we move on to seven?

[0:11:14] SJ: You are up next.

[0:11:15] GB: Number seven, stock markets look out six months, so prices lead fundamentals. It is always tempting to say, markets have it wrong when valuation’s suddenly swoon, but the only acceptable conclusion to that statement is, and here are the precise catalysts I expect to occur in order to prove that my conviction is correct. It's very hard to do that just now, because geopolitics is chess compared to the market's checkers. Asset prices are linear. They can only go up or down. Humans are far more complex.

I mean, I think this is a truism that people with any experience in markets understand that bad news is delivered, but it's less bad news than always expected, stocks go up. We are talking about things that are anticipatory machines, and they do tend to look out three, six, 12 months. Sometimes there's a wisdom in those movements that might be beyond your reach.

[0:12:06] SJ: I actually think the rise of artificial intelligence, I've talked about this a lot on previous podcasts, I do feel my instinct is that it's happening earlier and faster in terms of advanced warning signals that things are changing.

[0:12:20] GB: A really need term stuff.

[0:12:21] SJ: We talk about it a lot at the bottom and maybe we don't talk about it as much as we should at the top as well, that when everyone's sitting there saying the economy is looking great as all this momentum. We have talked about all these stimulus programs coming in the US. It's not the end of the stimulus program that's going to move share prices. It’s someone getting a glint that they're running seven and a half percent budget deficits over there in the US, inflation stays high. People start to say, “Well, inflation is going to stay high, while the government's running these massive deficits.” We've got to do something about this as soon as there is a glimmer of that, then the stocks that I've been benefiting from it are the ones that people sell first. That could be, this is six months, that could be years before the actual backdrop for those businesses gets worse.

I have picked this, number five, next. A little capital goes a long way when markets are volatile. A lot of capital goes a lot further. Though, having some, I took this as A, having some cash in your portfolio takes away some of those psychological challenges, I think, around selling stocks that are already down and some of the problems with that. Maybe more importantly, deploying it pretty slowly, particularly in the early parts of any downturn, I think, we're nowhere near even a point, I think, where people would be getting slightly excited at the moment in terms of bargains being out there.

If when things are down 5% or 10%, you fire all of your bullets and you're sitting there when it's down 20% or 30%, wishing you had more ammunition. I just think that gradual, I'm going to do a little bit by little bit by little bit here and I'm going to keep my last bullet for a genuinely think this is a proper market panic.

[0:14:05] GB: Or perhaps, never even. The point of that last bullet, right, what's that theory that everyone was wild for 15 years ago that Thorpe used in his black check betting? I've forgotten the name of it. But basically, having some firepower for the bargains of a lifetime is a really important part of it. Layer in, and you probably don't deploy that last bullet very often. If ever, maybe at the bottom of a depression type situation.

[0:14:32] SJ: Yeah. I think over your lifetime, you’d probably cost yourself returns, keeping something always for the once in a lifetime event, because you're going to miss 10 –

[0:14:42] GB: As long as that event doesn't include a depression, where the markets are down 90 and something percent.

[0:14:47] SJ: Yeah. Yeah. But also, having a portfolio that doesn't have to be just cash, right? I think you can deploy your cash first and then you can start thinking about, well, for us, particularly –

[0:14:57] GB: Can I go up the risk of –

[0:14:58] SJ: - recycling from more defensive resilient businesses into some things that are offering higher prospective returns is the next phase. Getting increasingly aggressive about that as you go through that part of the cycle. I think in terms of how we're set up today, versus 2021, it is a key component of us planning for doing much better if this downturn becomes more serious this time around is not just the amount of cash you hold, but also the nature and type of business that you hold in the portfolio as well.

He actually had 11, not 10. I think you've picked one here that was a bonus item, Gareth. But I think one that maybe resonated with you, particularly around the crying. You shouldn't be crying.

[0:15:42] GB: Instead of crying, you should be buying.

[0:15:44] SJ: That’s probably not advice for this point in the cycle.

[0:15:46] GB: No, 100%. I agree with that. But it's something that you need to keep in mind. You need to sell before the market tops and start selling before the market tops. You definitely need to start buying before the market bottoms. I think the idea of waiting for it to turn, that first move in the market up is usually a gap up and it's a lot of the, let's say, the lowest risk part of the return profile from these panics, I think – I'm not going to bother reading everything else he said around that, but I think you need to start firing bullets at some point and into a depression, or into a really nasty environment. We don't have that yet, but you need to be ready for it, I think.

[0:16:30] SJ: Yeah. I mean, you think back to that 07, 08, 09 period, there were probably 10 bounces off bottoms, right? That you always look back in hindsight and say, “Well, I could have waited for that bottom and then I bought 10% up and I would have made a lot of money.” But what you could have done is fired that bullet five times, because you've had all these false recoveries from the bottom. I really think having just an investment process that's based around what return am I going to get here, you will ultimately, I think, time a lot of these things –

[0:17:06] GB: Better.

[0:17:07] SJ: - reasonably well, but you won't do it by trying to say, this is the day where the market is going to turn and I'm piling in because of that. You'll do it, because you've allocated little bits of capital, little bits of capital more and more and more aggressively just because the prospective returns on offer are great. Then you'll turn around and do the opposite at the other end and you're going to miss bottoms and you're going to miss tops, but you should be able to generate better than market returns by doing that.

[0:17:32] ANNOUNCER: Stay tuned. We'll be back in just a sec.

[MESSAGE]

[0:17:35] ANNOUNCER: Are you a long-term investor with a passion for unloved bargains? So are we. Forager Funds is a contemporary value fund manager with a proven track record for finding opportunities in unlikely places. Through our Australian and international shares funds, investors have access to small and mid-sized investments not accessible to many fund managers, in businesses that many investors likely haven't heard of. We have serious skin in the game, too, meaning, we invest right alongside our investors.

For more information about our investments, visit foragerfunds.com. If you like what you're hearing and what we're drinking, please like, subscribe, and pass it on. Thanks for tuning in. Now back to the chat.

[EPISODE CONTINUED]

[0:18:15] SJ: I remember that 2020 COVID meltdown. You and I were having lots of late-night Zoom calls at the time. You actually said to me, “I don't know if today is the day, but I'm telling you that within three days of today, this is going to be the bottom. It just feels like we're hitting maximum pessimism.”

[0:18:34] GB: Yeah. We took cash down to 0.3% or something at the time, I think.

[0:18:39] SJ: It's interesting, though, isn't it? I think you start all of these things with, and now's a good example, worried about inflation. You're weighing up a whole bunch of, I think, very real issues for the value of stocks and where markets are and is it right or wrong? I think there's good arguments on both sides of that. You go through a recession and it's, well, how bad is it going to get for this business? There is a point, though, where it just becomes completely unrelated to what's going on with the business, or with the economy. What is it that, I guess, gives you that feeling, or the gut feel that you're at that point?

[0:19:15] GB: You know, when people are talking about hard landings versus soft landings, my eyes just glaze over. That's not a period of peak panic for me, when you're discussing that stuff. What I'm looking for, what we saw in 2021, what we saw in the bottom in 09, we saw pretty much in the tech wreck as well in the early 2000s, just a real diversity breakdown. Everything is moving down in the same direction. People aren't thinking about valuation. They're just selling. Those things can't – they can't move that way indefinitely, or they don't tend to at least. I mean, maybe there's some slight bankruptcy risk as well. But it brings me to maxim number two, which was Stephen's list. When stock markets decline quickly, correlations always go to one.

This simply means that every sector and market cap range sees losses. There are no hiding places, just pockets that lose less money than others. When things get truly difficult, like back in 2008, not even historically non-correlated assets like gold can rally in the face of a stock market selloff.

When we talk about correlations, it's just a fancy word. Correlation of one is just a fancy word for everything moving together, or in the case of a crash, everything moving down together. I'm not quite sure he's nailed the cause and effect here. I don't know whether stock markets’ correlations go to one, because stock markets’ selling off, or whether the stock markets’ selling off, because correlations go to one. It doesn't really matter. I don't think there's any predictive power in trying to untease that. 

Whatever, there was a massive breakdown in diversity. Everything was being sold off. I didn't know for sure that the market was going to bottom. I might have made that claim about the three days, but I knew it was time to put money to work into the face of that. I fired two of three bullets that I had. I had all my cash set aside and I'd separate it into three bullets. I fired one of them the week before the bottom and I fired one in the week off the bottom. Then the third one, I never fired, which worked really, really well. I had another bullet there in case markets sold off another 20%, or 25%.

I think we're both wired for these markets. You're just looking for that bit where it's so lopsided that on the balance of probabilities, you're going to be right. We can see it in our flows. I mean, in that month, or I don't know if it was month, or the week of the bottom, it was me and one other person put money in. We don't. No one puts money into that panic. You can see that in the microcosm of people's behavior, how it impacts the whole market.

[0:21:48] SJ: Yeah. The other thing I really notice in those times is the gaps that you get in pricing. For me, that's a sign of a really dysfunctional market, when decent-sized businesses are trading down 10% one day and they're up five the next. I think it's suggestive that there's people doing a lot of things out there that are not, I'm sitting there valuing this stock and buying or selling it on that basis. It’s, I'm trying to meet margin calls. I'm trying to fund things here and I've just got to sell and take whatever price.

[0:22:17] GB: That's why the correlation is trend to one, right? If someone is getting called on one stock and they're not going to cover them, they need to sell their other stock. If they can't do that, they need to sell their gold. If they can't do that, they need to sell their house, maybe.

[0:22:28] SJ: Yeah. I get that it's all down, but gold's never down as much as the stock market. I do think there is a case for that. Okay.

[0:22:37] GB: Are you just telling me there's a case for gold? Was it?

[0:22:40] SJ: No. I'm not telling you that at all.

[0:22:41] GB: You once – you threatened.

[0:22:41] SJ: I’m just saying that the migration for me from the better quality, they will hold up better for my experience than your less liquid –

[0:22:51] GB: Certainly, in any reasonable timeframe and probably even in the very short time, I agree with that.

[0:22:58] SJ: You can also just be much more of a price maker at the smaller end of the market. In those periods, we've had conversations in institutional land. We don't get on a screen and put our orders into a broking machine. You still send an email, or call a broker to execute for you. A lot of the trades that we do will happen via what they call block trades as someone has a large amount of shares to sell, and they ring around and say, “Is anyone interested?” Or email around and say, “Is anyone interested in buying their shares?” In those sorts of markets, you can set your price pretty much and say, “Okay, it was last traded here and I'm offering you 15% less.”

[0:23:33] GB: Yeah, exactly.

[0:23:35] SJ: You can usually sell the bigger liquid stuff that you've got at something close to – it might be down, but it's closer to wherever it's trading it.

[0:23:41] GB: Yeah, if you offer a 1% discount in normal times, they tell you to get stuff. On one of those days, you'd be at 85 cents on the dollar, and you'd probably get your stock.

[0:23:49] SJ: Yeah. Exactly, right? Look, it's a long, long way from here to that sort of market for sure, but we will see them again and having your portfolio prepared for it is really important. I think the other mistake that I see a lot of is actually spending too much time predicting the next meltdown and missing out on the benefits of owning real assets over a really long period of time. That fee was probably at its peak. October last year, almost, that there was a big crash coming and nobody wanted to do anything until they saw –

[0:24:20] GB: Evidence.

[0:24:20] SJ: - interest rates coming down and inflation coming down. I think the risks, just because the price levels are higher now than they were back then, but people are less worried about a lot of those things. But overarching philosophy for me, you can adjust things here. You can make those changes. You can cut the stocks. I think it's a great thing to cut your least conviction ideas. You should be doing that all the time, but it's a great little warning signal. 

Markets are down a bit. Okay, how am I going to feel here if they're down 20 and this stock’s down 40 or 50? I'm going to really be kicking myself, because I didn't like it that much anyway. Tidying up all of those things is a great idea. But don't get caught in the, I'm going to 50% cash because I think I can predict the next downturn. We could be sitting here in three or four months’ time and markets are doing perfectly well, not getting worse from.

[0:25:05] GB: Do you want to talk a little bit about how we're positioned over changes over the last few months?

[0:25:09] SJ: Yeah. Great point.

[0:25:10] GB: I think it's probably going great. I think the background here is not by discussing this because there's been a little panic this last few weeks. It's more like, we were buying high-quality businesses at 13 and 14 times of earnings six months ago. Now, especially the American ones, they're probably trading at 24 or 25 times earnings. We need to reflect on whether that portfolio is the most robust to whatever the future throws at us. We have shifted that portfolio quite a bit in the last few weeks and months. We're up to about 8% cash. It had been three and fours the last little bit. I think that's about right.

For this kind of environment, I wouldn't necessarily want to see it too high, as long as we can find other things to do. When I reflect on the ideas that we've added over the last few months, so we've added four new stocks. Two of them are large cap liquid. I would call them resilient businesses. One of them is a mid-cap business that's a little bit spicier and one small cap that is very much idiosyncratic. We've got a theory around something. We'll talk about that another time, but the focus of where we've hunted for new ideas has been a little larger cap, a little more liquid, a little bit more defensive than you might otherwise expect from us.

I guess, the general shift in the portfolio towards that, I've been trimming some smaller positions in the UK and bumping up our position in the supermarket group, Tesco, for example. I think that's a really resilient stock business at a price that should give us a very adequate margin of safety into most environments. It's the thing I want to own a little bit more of now than six months ago.

[0:26:58] SJ: There's been three that I can think of anyway. Just cutting some of those, this thesis is not working here. Or price is up so much that it's actually time to move on.

[0:27:07] GB: Or, we've got down to a one and a half percent position and it's a waste of time and let's move on.

[0:27:11] SJ: Yeah. Tidying up some of that smaller stuff as well. To be clear, I want to reiterate what I said at the start, if markets absolutely tumble here, we will be – our fund’s returns will almost certainly be negative alongside that in that period of time. It's not about not going down. It's about being better a place to take advantage of the opportunities that come your way.

[0:27:35] GB: Well, we're moving on. Perhaps, we put out a tweet earlier today asking for our IDs for the blog. We got time to discuss any of the comments that have come through, or should we save that for another day?

[0:27:46] SJ: Sure. Fire away.

[0:27:47] GB: I mean, you've gone through this list –

[0:27:48] SJ: We’re only 28 minutes in, so they tell me we need to be less than half an hour.

[0:27:51] GB: One of the questions that I thought was quite interesting, and actually there's two of them. They're related. We'd love to hear your thoughts on the impact of ETF index investing, basically, on active management industry in whichever direction you wish to take it. We could be talking about the struggles that some fund managers are having. We could be talking about some of the bargains they're getting thrown up as a result. Then we had another question asking very much the same about the flows into super funds in Australia, which is, I think, really the same topic. Potential distortions to markets. Maybe start with you, because it's more of an Australian story, that one. But the ETF one is a global story.

[0:28:33] SJ: Sure. I wrote back to that tweet. I think it's a great topic for a whole podcast and maybe the next one we do. Let's touch on it here. I think coming back to the active versus passive, and most active managers find it very hard to do anything other than dismiss the trend. I'm more of a supporter of it as a core of most people's portfolio than most active managers. I do think there's some really interesting consequences for active managers to be thinking about in terms of where you play and how you play and where there will still be advantages.

The super flows, flows in general are an interesting one. I was having a conversation with a mate the other day that was telling me markets can never go down while all of this money is coming into the moon. I think people make this mistake of thinking that the overall level of the market is like a swimming pool. The value of it is full of all of this money and the more money that you put in, the more it's going to be worth. It's not really like that. The value of the market, you've got to think about it as there's a pipe going in.

[0:29:35] GB: Second derivative.

[0:29:36] SJ: It's the price of that water that's going into the pool every day that people are using to dictate the whole pool. You can have filled it up five times in the past week, but if someone decides that that water is worth less than it was when you put it in, then it's worth less as of that day. It really is that concept of a stock of money that's in the market that is the one that people get wrong. It's a reflection of the price that people are willing to trade at on any given day. That can change 20% tomorrow.

[0:30:02] GB: Yeah. I think maybe to build on that point and to bring it back just to what we were talking about early, my feeling on ETFs and even super flows is that they make it tougher for the active manager 80%, 90% of the time. Then they contribute to the massive diversity breakdowns that you see every few years that we are capable of harvesting better than most. I think that's part of the story here. I think we need to just recognize that maybe markets are less – they present less inefficiency from day-to-day, but then they have these wild rides that are maybe more extreme than in the past.

[0:30:42] SJ: Do you know when does the Australian's super system start becoming net out rather than in?

[0:30:49] GB: No idea.

[0:30:50] SJ: I thought that year that point in time wasn't that far away, right? 

[0:30:52] GB: They keep putting that percentage up, right?

[0:30:54] SJ: That's true. People living longer.

[0:30:56] GB: Yeah. It's being built up from limited, right? It's been one way for 30 years, or more. I'm not sure when that is. I thought that was interesting, some of the stuff around what's the super fund for builders?

[0:31:10] SJ: CBUS.

[0:31:11] GB: CBUS. They have backed a development of office towers in Melbourne, where they – I think they might have had a 25% anchor tenant, but 75% untenanted and they've – It's a strong asset. We're backing these. I just think, that's a situation to me that looks a little crazy. That's a behavior that if it was a developer, let's say, you'd call them a little bit crazy. Then they're doing that with the retirement saving of people that are, to the eyeballs, exposed to the building industry in this country. It just fails diversification principles. It's interesting. There's some asset that super funds take that, yeah, it's hard to see that it's the right decision, at least in the short and medium run.

[0:31:58] SJ: Again, it’s maybe another topic for a full podcast, because this whole valuation of unlisted assets is also a disaster waiting to happen. I'm pretty sure that at some point in the next 20 years, there will be a liquidity crisis around these illiquid assets that they all own because, so my wife's in Australian super. They pretty much give her daily liquidity. They've changed some of the rules recently, because people were very sensibly, including my wife taking advantage of it over the years. They were giving you daily liquidity. You can go in there and say, “I want to change my portfolio from 100% equity's allocation to a conservative, I want it to go from 30% unlisted private equity assets to all equities.” You can do that any day and get the underlying assets that they own are very illiquid.

They claim it's all long-term money, therefore, we don't need to worry about it. But if they get changes on mass where a whole heap of people go, “I don't like where you're valuing this infrastructure asset, or property asset. I'm going to shift into liquid traded assets.”

[0:32:56] GB: I'm pretty sure that the inverse of that is what happens. Your wife takes the money out. The fund manager that's managing the balanced funds slightly tweaks up the property exposure, or do you not think that goes on a bit?

[0:33:10] SJ: Yeah. So, they don't have to actually move in.

[0:33:11] GB: It actually results in other people getting a different investment portfolio. I fear that's going on anyway.

[0:33:17] SJ: That's probably true. One expose on the front page of the paper and people will start thinking more about it, and I think they’re going to have to be truthful about the underlying liquidity of what they own and get more truthful about the valuation. It’s crazy.

[0:33:31] GB: Well, they haven't been in recent years. That's for sure.

[0:33:33] SJ: Yeah, you had listed infrastructure stocks that were down 30%, because rates were going up. Property stocks down 30% and 40%, talking off as property here. They're valuing this stuff at down five, down 10, because –

[0:33:47] GB: Long-term asset.

[0:33:47] SJ: - they didn’t have to sell it. All right. On that note, we will wrap up for today. Thank you for tuning in. Thank you for the idea suggestions and they're actually a couple of great topics for podcasting future. Stay in touch. Thanks a lot.

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