Dan Kemp: Sport and investing have a lot in common, with Warren Buffett frequently drawing on lessons from baseball to illustrate his approach. At Morningstar Investment Management, we think managing a portfolio is more closely aligned to test match cricket which takes place over five days rather than a few hours.
The aim of a test batsman is normally to defend their wicket for as long as possible, scoring only when the return they can generate in expected runs outweighs the risk of taking a shot. Sometimes the opposition bowlers provide lots of opportunities to score and at others the batsman has to work extremely hard to avoid getting out. This is very similar to the situation faced by investors. Sometimes there are lots of opportunities for gains and at other times, maintaining the value of the portfolio is the key consideration.
As the key determiner of a good opportunity is the value offered by the current price of an asset versus its long term expected return, we naturally find more opportunities when prices are low and investors are gloomy than when this situation is reversed. Viewers may therefore be surprised that we remain defensive despite the recent decline is many asset prices. This does not reflect the fact that we have become timid, but rather that in our view, many asset prices have merely moved from very expensive to expensive and therefore do not represent attractive opportunities to ‘score’ yet.
Cash plays an interesting role in the current environment and we are generally maintaining a higher cash weighting then normal. This cash not only provides additional stability to the portfolios but also enables us to add investments when opportunities appear.
However, this defensive approach is not the whole story of the match. We do see good value in some emerging market assets, most notably government bonds denominated in local currencies, as investors appear to have become overly concerned with the latest geopolitical developments.
Closer to home, we also continue to see good value in UK shares (at least relative to other areas), despite the fact that the UK has delivered better returns over the short term than most other markets.
So, as we step out on to the field again, we are constantly reminding ourselves that investment is a long-term game. We must concentrate on each ball and only seek to score when the reward exceeds the risk of swinging. The fact that markets are cyclical only reinforces this message and explains why we remain defensive.
