Secret of getting ahead is getting started, said Mark Twain in his famous quote. But he left something unsaid that is far more important from an investing perspective. Once started, what is key is “staying put”. Like the proverbial Zen paradox, the best way to move ahead is to stand still. Switching strategies (from value to momentum or vice-versa or from small to large cap etc.) to suit the flavor of the season is a recipe for disaster, esp. in the investing world. Rolling stones hardly gather moss. In stillness, there is greater dynamism.
Value Is Dead, Long Live Value
In 2017, in the peak of the bull market for small-caps, value investing was applauded as a glorified virtue. Through 2018 to 2020, in the bear market (in small and midcaps) that followed, it was vilified as a vice. Now, with the search for the next small-cap winners gathering gusto, tide is turning for Value. In every cycle, it is natural to get tempted to switch sides based on the tides. More so, because it sounds very logical and profound to tame the tides by switching loyalties. Such switching may look smart in the short-run, but takes a heavy toll in the overall long-term returns. This is because, tide is so swift and fast when it turns, one ends up always late (when switching) however smart one is. Second challenge is, only in hindsight one will know if the cycle had really turned. The easier thing to do is to stay the course to get the most out of the eventual turn (every cycle eventually turns, however deep or long it can be), though harder to execute emotionally. Switching strategies would have worked in the markets if the navigation is through a rearview mirror. Unfortunately, investing is all about driving forward through an often hazy windshield.
Let us look at the live case of 2018-20 small-cap cycle to illustrate this point. Small-cap index made a bottom after two long years of a bear market in late March on the onset of pandemic lockdown. At that time, the already emerging consensus trade of “quit small-caps and move into large-caps” got added ammunition in the form of Covid to gain further momentum. It appealed to the logic of even seasoned investors who had seen multiple cycles. Panic selling followed in small-caps. Precisely when everyone quits, cycle bottoms and turns.
When a strategy under-performs for a very long time, the biggest pressure point for the fund managers and investors come precisely at a point when the cycle is about to turn. For us, such a pivotal point came in March-April. In the investor calls during that time, many questioned our prudence on sticking to a failing strategy. Now the same investors are happy that we stuck to it. Questions will quickly turn now to why we couldn’t be more aggressive in allocations. Such time is not far away.
Look at what happened to the consensus trade. Post March, on year-to-date, Nifty is up 50% odd, while small-cap index is up by near 70% (from March lows). This differential return is likely to be much bigger in individual cases, as rarely anyone does instant switching. Instead of clinical switching, one often ends up trying to out-smart / time the market. This adds heavily to the switching costs and thereby results in a much higher differential than indicated by the indices performance given above. It doesn’t stop here. If the small-caps continue this out-performance (which it does for a reasonable time after tide turns, as seen in past cycles), this prescient, yet misguided switching would have dented a huge hole in investors returns over time.
No better time than now to revisit what we wrote in our blog post in the month of March. It connects so well to the essence of this piece. Here it goes….
“To borrow a phrase from one of the seasoned stock pickers, value investors are like a group of beasts now that is being hunted to extinction. Why? It is not difficult to fathom the reasons. Value as a strategy has been under-performing for an extended period of time since early 2018, because of flight to safety and polarized market dynamics. Even the last man standing out is being tested for his tenacity. Should the last few standing be worried? No. If one sets the clock back and look at the past 2 decades, one would find that neither this narrative (that value investing is dead) is new nor the crowded trade in quality is new. There has been only one thing that has been constant across cycles. That is, every strategy has a day under the sun and only thing that has always worked all the time is “reversion to mean”. It is a question of time before market takes its fancy to value, though it is difficult to predict the time of the turn. Seasoned investors understand that every strategy has its time of out-performance and has its time of under-performance. The key is to stick to a strategy and not to flirt around with the flavor of seasons. Stay the course to smell the roses, however hard one is being hounded”.
Happy Value Investing!!!
This article of mine was published in moneycontrol.com. Glad to share the link:https://www.moneycontrol.com/news/business/markets/heres-why-sticking-to-a-strategy-is-key-to-generating-long-term-returns-5852381.html