Football managers, small-caps, stock picking, dividends and Ray Dalio
The best investment research, blogs and podcasts this week
You don’t need to be a massive follower of Premier League football to know that clubs are ruthless when it comes to firing their managers.
Just take Chelsea FC.
Some would say it’s only a matter of time before current manager Graham Potter is shown the door. Since his appointment six months ago, Potter has overseen Chelsea’s worst run of form since 1995.
Chelsea’s previous manager was Thomas Tuchel. He was appointed in 2021 and took the club all the way to a Champions League victory. But 15 months later he was fired after losing three of the first seven games of the current season.
Talk about savage!
But Chelsea is far from alone. At the time of writing, nine Premier League managers have been sacked this season alone, which is about average.
With so much money at stake, myopic club owners rarely see things through a long-term lens. Such a high rate of attrition means most managers know there’s a hatchet hanging over them before the ink has dried on their highly lucrative contracts.
You might think this kind of insane short-termism is unique to the beautiful game, but you’d be wrong. Research shows something similar happens with chief executives of quoted companies, too.
According to a study by Vidhan Goyal and Angie Low the average CEO tenure fell from about 10 years in the 1970s and 1980s to just over six years in the 1998-2005 period, and continues to shrink.
Part of the reason is thought to be that company boards and investors are simply getting less and less patient.
The research examined a decade of data to 2004 covering CEO turnover in listed firms. It found that companies with a high proportion of myopic (short term) investors (as measured by the portfolio churn of those investors) were more likely to replace their current CEOs.
Crucially though, the research found the decision to dismiss a CEO leads to “worse operating performance, which is even poorer when investors have short horizons”.
To make matters worse, the study also found that new CEOs tended to respond to investor short-termism by taking greater risk and by investing aggressively into physical assets (rather than R&D and patenting activity).
In other words, they were prepared to give those myopic investors what they wanted by acting for the short-term and spending heavily... rather than building for the future.
Football managers (and investors) be warned.
Small-caps poised to outperform?
This is an interesting short video with Mark Niznik and Will Tamworth who run the UK smaller companies fund at Artemis - Could UK small caps be first to recover?
As you’d expect, there are some bullish views on the outlook for smaller stocks - and suggestions that the data is pointing to positive times ahead if history is anything to go by. Here are some of the takeaways (the bold is mine)
There have been eight recessions since the 1950s, and small-caps have underperformed in five of them. Last year small-caps underperformed more than they did in any of those previous recessions
Recession is already priced into small-caps - and this is a good buying opportunity
In seven of the past eight recessions, small-caps outperformed by an average of eight percent the following year. So small-caps do bounce back strongly from recession
There have been seven years of outflows in the small-cap market, and a lot of negativity towards the UK. Historic returns have been driven down to very low levels. Historically, when five-year returns have been negative buying at that point has resulted in an average return of 55% over the following 12 months
Will Tamworth [paraphrasing]: On the subject of AIM stocks, one company we are excited about at the moment is H&T, the UK market leader in pawnbroking - 10 times the size of its nearest competitor, Ramsdens. Enormous amounts of capacity have come out of the pawnbroking and consumer credit markets as a result of moves by the regulator. But H&T’s proposition is much more secure. It may not seem like a growth company but it grew its pledge book by 49% last year and it’s trading on a P/E of just 8x.
Takeovers. The Artemis smaller companies fund has seen 22 takeovers over the past four years. There were just six in the previous six years.
M&A provides a tailwind to performance but is also third-party validation of the valuation opportunity they see.
The most recent flurry of takeovers have involved trade buyers, not private equity buyers, which they argue are less sensitive to interest rates being higher and more volatile. As long as that valuation gap continues they expect the level of takeover activity to continue.
If you need any more ideas on ways to play small-caps this year, you could try this from… ahem… me, for interactive investor this week - 10 cheap small-cap shares ripe for recovery. That article takes one of James O’Shaughnessy’s old-school growth-value-momentum strategy screens and reboots it for the UK market. There’s some interesting stuff out there but the risk with small-caps is real.
2023 will be a year for stock pickers
It’s hard to escape the sense that some active money managers are taking last year’s sell-off as a cue to take a few potshots at the outlook for passive funds this year.
The argument goes that weak market conditions make it much more of a stock-picker’s environment, which is exactly what you get with active management (of course!).
Fund flows continued favour passive funds last year, but could the current conditions play more into the hands of active managers? This note from AllianceBernstein - Activating Equity Portfolios for Higher Rates and Inflation - makes the case that it could. In particular, they reckon:
“… a higher cost of capital will necessitate corporate discipline, as well as an active approach to identify those companies with pricing power, earnings and profit margin sustainability, lower debt and company-specific business momentum.”
“Active managers can incorporate fundamental research on individual businesses with forward-looking perspectives on sector and style exposure that backward-looking benchmarks cannot.”
“…high margins, slower economic growth and input cost pressure will squeeze profitability for many companies. Equity investors must actively find companies that can maintain margins should these conditions persist.”
“…investors should revisit global equities in their portfolios, as they may pack a bigger punch. However, country-specific macroeconomic conditions and a company’s regional revenue exposure may vary, highlighting the importance of an active approach.”
“Many defensive equity portfolios rely on standard, backward-looking or rules-based recipes for reducing risk. However, these may not be the best way to cushion the downside.”
With prices volatile, don’t forget dividends
Tumbling equity prices last year did wonders for the profile of dividend strategies. Not only did downward price pressure push up the average yield across the market, but solid income stocks, especially in the FTSE 100, were some of the strongest, safest options in weak conditions.
Dividend payouts have substantially recovered from the mass cuts that spread through the market in the dark days of Covid. And with inflation, higher rates and recessionary pressures putting share prices under pressure, yield is back in focus.
This note from Vanguard - Dividends and the long-term benefits of diversification - offers a few reminders about the long-term compounding effects of reinvested dividends:
During the 20 years to 31 October 2022, 67% of total returns in the UK market came from reinvested dividends
In the US - a traditionally growth-led market - 39% of the total returns generated by the S&P 500 index came from reinvested dividends over the same 20 year period:
In the US, dividend growth has outpaced inflation by five percentage points over the 20 years 30 October 2022 and 2.1 percentage points over 100 years
In the UK, real dividend growth has been less stellar than in the US, but has nevertheless outstripped inflation by 0.6 percentage points over the 20-year period
Richard Dennis’s Turtle Trading Strategy Explained
Remember the 1983 film Trading Places…? Dan Aykroyd and Eddie Murphy starred in a tale that was widely believed to have been inspired by a real life wager between two traders called Richard Dennis and Bill Eckhart.
Dennis reckoned he could train a group of novice investors to make money just by using a disciplined trading strategy. He famously said: “We’re going to grow traders just like they grow Turtles in Singapore”. And the Turtles were born.
If you ever wondered what Dennis’s famous Turtles strategy was, then this article from Bradnon Beylo at Macro Ops this week will tell you - Richard Dennis’ Turtle Trading Strategy Explained.
Here’s the low down:
Trading Principle 1: Trend Following
The system uses a combination of technical indicators to detect long-term market trends and determine exit and entry points
Trading Principle 2: Position Sizing
The Turtles used a position sizing method known as the “1% risk rule” - meaning that they shouldn’t risk more than 1% of their account balance on any trade.
Trading Principle 3: Entry & Exit Rules
The system would generally time entry trades based on breakouts and then time exits using trailing stop losses.
Trading Principle 4: Risk Management
The system emphasizes risk management, controlling losses, and preserving capital. Trades would be closed if they moved against the trader.
On the upside, the system has the potential for high returns in multiple asset classes, with controlled risks and the potential to automate it. On the downside, it requires discipline and patience and can miss short term opportunities. Check out the whole article for much more detail.
Lower growth but more stability - Ray Dalio’s All Weather portfolio
Ray Dalio, the boss of hedge fund giant Bridgewater Associates, runs an All Weather portfolio designed to take the sting out of market surprises. What it lacks in growth it makes up with the comfort of low volatility, and has performed well over time.
The idea behind it was to create a multi-asset portfolio with global exposure that could ride the waves of bull and bear markets, and rising and falling inflation. There is an extended story behind it here: Bridgewater - The All Weather Story.
But if you want a breeze through the basics, together with ways of constructing an All Weather portfolio of your own, this post by Nick Maggiulli (Of Dollars and Data) is worth a look: Ray Dalio All Weather Portfolio [The Definitive Guide]
Here are some of the findings from Nick’s research:
Since February 2006, the All Weather Portfolio has compounded at a rate of 6% a year
During the Great Financial Crisis, the All Weather Portfolio declined less than half as much as a 60/40 (U.S. Stock/Bond) portfolio (and it was similar during the Covid crash in 2020)
In bullish markets, the All Weather Portfolio underperforms because it only has a 30% allocation to stocks
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