The Rugby World Cup is still in the early rounds and my English colleague Mike Bell clings to the hope that his country can win (it won’t). Its inspired him to write the below and ask is the winning team the one with the bigger, heavier players or the fast and nimble ones? The correlation with investing couldn’t be more relevant given the recent rotation from growth to value stocks in equity markets reversing a persistent trend. Rising valuations across asset classes along with a muted economic outlook have complicated the asset allocation discussion, but in this environment should investors bias towards value or growth, large or small cap, to battle through what could be a bruising final quarter.
Mike Bell, Global Market Strategist, J.P. Morgan Asset Management
Being vertically challenged, I was never likely to fulfill my childhood dream of playing rugby for England. While many smaller players are fit, fast and skillful, they are a relatively rare sight on an international rugby pitch. The reasons are obvious enough, while the best small players might have electric pace and score lots of tries, they are vulnerable when defending cross field aerial kicks and situations right on the try line, where much bigger attacking players must be knocked backwards to prevent a try. For this reason, international coaches tend to pick more large players than small ones.
At this late stage in the economic cycle, a similar approach to stock selection probably makes sense. While small cap stocks can be exciting to watch in attack, when markets are rising, in defense it’s the largest companies which tend to be most sturdy. In the U.K., for example, small cap stocks have under-performed large cap stocks in each of the last three recessions.
Yet while the advantage of size, when the going gets tough, is well recognised among international rugby coaches, it is under appreciated by many investors. Indeed, the average U.K. fund currently has about 50% invested in mid and small cap companies, compared with only about 20% in the FTSE all share. This late in the economic cycle, that’s like picking a team with a back line made up entirely of scrum halves to defend against a team with several backs weighing in at over 16 stone and standing well over 6ft tall. There’s perhaps room for two or three smaller players but not half the team.
Then there’s the question of experience. Every team is always on the look-out for the next young rising star, someone with the flare and boldness of youth to try something daring and get the crowd on their feet and the points on the board. But history shows that when it comes to crunch time at world cups, experience counts. The average number of caps for a World Cup winning side in the professional era is 744, nearly 50 per player. Having been there before and therefore not being overwhelmed by the magnitude of the occasion has often proved critical in the closing stages of the tournament.
Likewise, investors are always looking for the next rising star, and are keen to cheer the young and fast growing companies willing to challenge the status quo and disrupt the way things have always been done. These exciting growth companies often perform very well, indeed they have outperformed the market for most of the last decade. But when it gets to the closing stages of the tournament, some growth stocks can crumble under the weight of expectations.
Meanwhile, the wise old heads, the more experienced players, tend not to lose their cool when the pressure is really on. These players are like value stocks, less likely to score a spectacular solo try, but equally unlikely to give a pass that gets intercepted or miss a critical tackle when it really matters. For investors, these cheaper value stocks, where the expectations are much lower than for growth stocks, have generally outperformed during market sell offs.
While it’s not the case when considering the size of a company, when it comes to valuations “the bigger they are, the harder they fall”, as many a rugby coach used to say encouragingly to me. Indeed, during stock market panics, the PE on the more expensive growth stocks tends to fall relative to the PE on the cheaper value stocks. That’s not to say you shouldn’t have any young, growth stocks. The winning team at each of the last four world cups has had at least one player with less than two years of international experience. In 2011, New Zealand had three! It’s just that by the time you get to a world cup final, history shows you want the majority of your team to be more experienced. Of course, the more experienced players still need to be good enough. Likewise a focus on quality, value stocks, avoids those that are cheap for a reason and should have hung up their boots.
So within equities, while your squad should have a balance of different types of players, large cap, quality, value stocks are more likely to close out a tense World Cup final, holding the fort when the try line is under siege.
Flexibility can also be key, different approaches are required under different conditions. While a fast paced style of play with lots of long passes might work well in the sun, during a downpour the old ‘stick it up your jumper’ approach might be more appropriate to hold onto the ball. The same is true with investing. Long only funds will struggle if their asset class is falling, whereas flexible strategies can adapt depending on the conditions. Global macro funds, that can position for rising or falling markets and flexible fixed income strategies have the ability to shift the way they play giving them the potential to perform well whatever the weather.
Finally, as a fan there’s the question of how to get home from the game. Anyone who’s ever been to Twickenham will know that you need to budget a couple of hours for the queue at the train station (pub) after a game. On arrival, as the fans arrive dispersed over several hours there’s no problem getting out of the station but as thousands of people all head to the station at the same time after the game, getting out takes ages. Of course you could leave the game early but then you run the risk of missing out on a great try in the final minutes of the game. However, mobile technology has provided a neat solution, you can now leave the game five minutes early and watch the end of the game on your phone as you walk back to the station to beat the crowds (remember to look up while crossing the road though).
The investing equivalent to joining the crowds at the station is trying to sell when everyone else is. Going underweight risk assets like equities and credit, is like leaving the stadium early, made trickier with investing by the fact you can’t see the exact time left on the clock, so you risk missing out on any final returns in the late stage of the bull market. Moving to neutral in risk assets at this stage in the cycle is equivalent to watching the last minutes of the game on your phone on the way to the station. Of course, the tighter the game, the less likely you are to want to leave a little early but if your team are comfortably ahead in the later stages of the game, as risk assets are in this cycle, the less bad you’re likely to feel if you end up watching a final try on your phone.
In summary, at this stage in the game, avoiding over-weights to risk assets, owning flexible strategies such as global macro funds and flexible fixed income strategies and focusing on large cap, quality, value stocks within your equity exposures should improve the odds of you being ahead once the final whistle blows.
Love the rugby analogies. Finding the right adviser is like finding the right coach. Getting the right selections to play smart is the really difficult task, just ask the Wallabies.
Yes I love the rugby analogy also ! The problem we have experienced with Michael Cheika is the constant changing of players or stocks. Consistent with your theme by this late stage we needed to settle on a team of quality, experience, value with a sprinkle of youth/growth. Yes and I agree we also need a big/large no 6 at this time !
Great analogy. Very well presented. Love Michael Cheika and the way he runs down refs, players and his negativity. I just hope he keeps getting up the noses of the referees, the public, his supporters and even some of his players. Long may it continue. By the way did I mention I am a All Black fan?