Dear Fellow Shareholder,
The 2018 Winter Olympics in PyeongChang wrapped up recently, and I am still in awe of the athletic prowess demonstrated by the 2,900 athletes who competed. Across the 102 events, these athletes demonstrated incredible skill. But focusing too much on the skill sells these athletes short. What is truly remarkable is their ability to perform at such a high level, under pressure, and sometimes in the elements.
Many Olympians get one shot in their entire life to perform for just a few seconds for a shot at a medal. The lucky ones get additional chances four or eight years later. This makes the cost of failure, psychologically, extremely high. Not to mention, the cost of failure physically can be serious (think downhill skiing or skeleton).
The pressure doesn’t end there. The PyeongChang Olympics grabbed headlines for its bad weather, too. It was the coldest games since the 1994 Lillehammer, Norway games. It was so cold and windy that numerous events had to be rescheduled several times! Eventually, some events had to take place in blizzard-like conditions. Still, thanks to endless training, muscle memory, and focus, the athletes were able to perform.
Blizzard-like conditions for stocks
Calendar year 2017 was a remarkably balmy year for stocks. The largest peak-to-trough fall was less than 3% for the S&P 500 Index. Global stocks, as measured by the FTSE Global All Cap Index, did not experience a down month the entire year. Astoundingly, 9 of the 10 lowest volatility readings on record (as measured by the VIX) occurred in 2017. In July, the VIX broke through its 23-year low, and in November, it closed at its lowest level ever. The market weather in 2017 was as calm as it gets.
And then came February 2018. Early in the month, global markets dropped between 2% and 5% on several days. The VIX more than tripled. Intraday market swings were breathtaking. Stock-price volatility continued throughout the month and finished with a 4.4% decline. This was a storm, to be sure, but far from a storm of epic proportions. Clearly, the preceding year of sunshine had lulled investors into a false sense of security, and at the earliest hint of a break in the calm, investors sprinted to the exits. More than $14 billion was withdrawn from equity mutual funds in the first week of February alone.
Just as Olympic athletes have no control over the weather on their day to compete, your fund managers have no control over the weather in the market. Yet, both the gold medal and your investment dollars hang in the balance anyway. The cost of failure is high. We must perform.
The Olympic Athletes of MFAM
Our strategy for dealing with market volatility is to:
- Know what we own and why we own it,
- Know what we want to own, and
- Keep our long-term mindset.
I know of no way to predict market volatility. It is simply a random variable inherent to investing. However, labeling something as random does not minimize its potential emotional impact. Watching asset prices swing wildly can be unnerving. What we do know is that asset values do not change nearly as dramatically as asset prices. Knowing the businesses and competitive dynamics underlying the stocks we own helps us keep our focus on value instead of price. Clearly articulating a thesis for why we want to underwrite an investment helps keep us focused on the fundamental business drivers, which are almost never tied to market prices. In short, maintaining a business focus instead of a stock focus dilutes the emotional impact that can come with vacillating prices.
Keeping a list of what we believe to be the highest-quality businesses in the world is another key way we deal with volatility. We spend each day trying to identify the types of businesses we’d like to own, and we vet them rigorously. Rather than scramble to conduct research during turbulent times, we simply turn to our wish list and see which opportunities are best. Of course, we weigh these wish-list companies against the opportunities in the ones we already own and act accordingly. True to form, your managers were net buyers during the February sell-off. We made purchases in four companies (three were new) and sold only one. Having this process in place allows for volatility to be an opportunity rather than a threat.
Finally, we deal with volatility by having a long-term mindset firmly embedded in our philosophy and culture. In fact, our core investing belief is that “independent research, conducted with a long-term mindset, can outperform.” As illustrated by the table below, history demonstrates that, while stock returns can and do vary wildly over annual (or shorter) periods, they have consistently been positive and healthy as the time frame lengthens. When your horizon, and behavior, extends beyond five years, your probability of earning positive returns skyrockets. Maintaining a long-term mindset further forces us to search for the type of businesses – high-quality ones – that are most likely to stand the test of time and generate those rewards.Pride in our performance
I have no idea if you, dear investor, think our team has earned a gold, silver, or bronze medal. (If so, I’d like to think you’ll play our anthem, “Survivor” by Destiny’s Child, in celebration.) Regardless, I am proud of the training our team puts in each day, our behavior in volatile times, and our commitment to managing portfolios of the highest-quality businesses on earth. Thank you for your continued trust.