The dramatic moves in asset prices that we have witnessed over the last few days can be very unsettling. But for the long term investor these price changes should be viewed as an opportunity to improve future investment returns by buying high quality assets at discounted prices.
Warren Buffett famously said that investing is ‘simple but not easy’. One of the key difficulties the investor faces is the need to retain a long term outlook when others are panicking about momentary price changes. Another is the ability to differentiate market noise from fundamental changes in the return potential of an investment. At present, we believe that the sharp decline in recent days represents the former rather the latter.
The decline in prices has been attributed to many factors, most notably the bursting of the Chinese stock market bubble and concerns over the impact of this event on the global economy. While rapid sell off in China may have acted as a catalyst for the decline, is appears to us that the real reason for the decline was the lack of investors prepared to buy global equities at the previously inflated prices.
The market fall that we have seen over the last few days is bringing prices back to a level where they may be considered attractive by the long term long term investors and hence interesting to us. However, before we become too sanguine about returns in the near future, it is important to note that such sharp declines in price seldom stop when equities reach fair value, but like a pendulum tend to overshoot the neutral point as prices are pulled lower by the herd mentality of market participants.
As a consequence, purchases made in the midst of the market downturn may well result in short term capital losses. However, we believe these short term losses are a worthwhile price to pay to access superior long term opportunities.
How are Morningstar Investment Management Reacting?
At Morningstar, we have long been concerned about the elevated price of assets when compared to our assessment of their long term return potential and consequently many of our portfolios have been somewhat cautiously positioned. We are therefore able to capitalise on the recent market turbulence and use it as an opportunity to improve the expected risk adjusted returns for our investors.
With this in mind, we are currently reviewing all of our portfolios. However, we are cognisant that turmoil in capital markets can last for some time and in extreme cases may have a significant negative impact on the real economy, creating a feedback loop and ultimately reducing the expected return from equities and property. We are therefore not buying indiscriminately, but rather seeking out the best value opportunities in order to increase returns within a consistent risk budget.
Alongside our search for good buying opportunities, we are also seeking to lower our exposure to the most overvalued assets, especially those that have benefitted from the recent period of volatility. Chief among these are long dated government bonds which appear very overvalued and are a potential source of funding for new purchases.
