How are we reacting to difficult markets?

How are we reacting to difficult markets?

It has been an interesting few weeks in global equity markets. In Australia, as in other countries, we have seen some violent swings in equity prices, with most of the swings being in a generally downward direction.

At a time like this, there is a powerful natural tendency to adopt a defensive stance. Everyone wants to protect their capital from losses, and if markets are belligerent, perhaps they should not be trusted with that capital?

Acting on this natural urge is probably one of the most destructive things that investors do. Research has shown that the tendency to sell when markets have gone down, and buy when markets have gone up, has a devastating impact on long-run investment returns. In simple terms, it biases an investor towards selling low and buying high.

In The Montgomery Fund, we have the ability to move funds in and out of cash, and so have an opportunity to respond to the recent price gyrations. To avoid the corrosive effects of emotion, we follow a very simple plan in deciding when and how to move into cash. The process is driven by valuation: when quality equities become cheaper, we will hold less cash; when they become expensive, we will hold more.

This simple approach makes it easy to determine how we should respond to market movements, but more importantly, it presses us to act ahead of time. By our reckoning, equities have been a little expensive for some time, and many months ago our process led us to move a significant part of The Fund into cash. We have been whinging tiresomely about the “cash drag” ever since, but in the last few months the benefits have been apparent. While it hasn’t avoided all of the turmoil, The Montgomery Fund has fallen much less than the market so far in FY16, and is positioned to take advantage of bargains should things get cheaper still.

There’s no guarantee we will see the sort of bargains we’re looking for, and if the market recovers quickly we will again feel the weight of cash holding us back. However, we are sleeping comfortably through the current excitement, and feel well-placed to act rationally if the market falls further.

It won’t work every time, but in the long run we’re confident that investing rationally should deliver better results than the alternative.

Tim Kelley is Montgomery’s Head of Research and the Portfolio Manager of The Montgomery Fund. To invest with Montgomery domestically and globally, find out more.

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Tim joined Montgomery in July 2012 and is a senior member of the investment team. Prior to this, Tim was an Executive Director in the corporate advisory division of Gresham Partners, where he worked for 17 years. Tim focuses on quant investing and market-neutral strategies.

This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.