Recently I sat down with the chief investment officers of two very different investment companies. One was a large cap-focused, long term investor managing a portfolio that has existed since 2003, with some holdings going back much further, and one was the manager of a small cap-focused LIC that started in 2013.
These two individuals have different approaches to investing and I put the same hypothetical to them: Put yourself in the shoes of a SMSF investor. You’re in pension mode, the bulk of your portfolio is ASX top 100, and the market has fallen like it has. What do you do?
The two managers were Tom Millner from BKI Investment Company and Sebastian Evans from NAOS Asset Management. Their responses were almost identical.
As long as you know that you are holding quality businesses, do nothing. Both said they would sit tight and not do a thing. The lesson here is not to be reactionary to market gyrations. The advice from Millner about what to do about the January market movements was simple: “Hope you’re still on holidays and don’t do anything silly. The worst thing to do when people are in that situation is to panic and dispose of good quality companies.”
In market corrections, good companies get thrown out with the bad – but if you are patient, the good companies will rebound a lot faster than the bad. As Millner said, “Be patient and focus on quality blue chip companies.”
Evans echoes Millner’s thoughts, and says investors need to step back and take a deep breath. “As a group I wouldn’t say we are bearish and I think personally going into reporting season, reporting season will give people a lot more comfort. Everyone gets caught up in the emotion and you can’t make decisions based on your emotions. I think when people see the facts and the figures, and see company XYZ is growing, it's not growing at a rate of knots but they’re doing 5 to 10 per cent growth with a reasonable balance sheet, then I think I need to relax.”
Is it a good time to add to positions if you have cash? Millner is adamant, “Definitely, definitely. If you look at valuations of the top four banks, Woolworths, Wesfarmers, Telstra’s, the valuations are significantly lower than when they were 12-15 months ago when people's confidence was sky high,” he says.
Evans takes it a step further stating if you don’t have cash in times like these, it never hurts to sell your poorer quality holdings in order to add to your quality holdings - even if that means selling them at a loss and taking the pain. It will improve the quality of your portfolio and your own state of mind, as well as meaning you are holding higher quality stocks.
The message is simple from the portfolio managers, and from the Eureka team as well: Stick to quality companies and keep your cool.
Look to invest in businesses and industries you understand and in companies with strong balance sheets, good cash flow and low levels of debt. Millner stresses the importance of low levels of debt. “A company can’t have too much debt because when debt gets too high the first thing to go is your dividend. You have to raise capital most of the time so you have to issue more shares and you dilute existing shareholders and future earnings. The whole thing starts to unwind if that quality component is not there,” he says.
So continue to be patient and remember to have faith in the high quality businesses you have identified, even when it’s tough to do so. To see Millner’s and Evans’ full responses to the above hypothetical question, you watch the full interviews through the viewers at the top of this piece. Their responses come at the start of both interviews, but do watch the rest for Millner’s views on the banks, his favourable outlook on BHP, Woolworths and Masters, and Wesfarmers UK expansion. Watch our interactive with NAOS Asset Management for Evans’ small cap growth investing ideas.
To view Eureka Interactive with Sebastian Evans, click here.
To view Eureka Interactive with Tom Millner, click here.