Lukasz De Pourbaix 0:05
Welcome to Fidelity sound bites straight to the point monthly podcast where we talk about all things markets and investments. I'm Lucas de Pourbaix, the Global Cross Asset Specialist here at Fidelity. And I'm pleased to be joined today by Paul Taylor, Portfolio Manager for the Fidelity Australian Equity Fund, and James Abela, Portfolio Manager for the Fidelity Global and Australian Futures Leaders Strategies. Welcome.
James Abela 0:28
Thank you, Lucas.
Paul Taylor 0:30
Lukasz De Pourbaix 0:31
How are you guys going?
Paul Taylor 0:32
Oh, well, good.
Lukasz De Pourbaix 0:34
Very good. Well, today's topic is an interesting one, it's a bit of a different take on markets. And it's really talking about crisis. And when we talk about crisis, there's different sort of connotations with that. And as you know, in periods of crisis, emotions take over, be it in people's personal lives are be it in investments. And we're in a sort of interesting period, at the moment where there's a lot of things in flux, there's macro economic environments’ looking interesting at the moment, we've got, obviously, geopolitics - a whole bunch of things. And, you know, we've got two investors here that have managed portfolios through a whole bunch of different crises over time. So let's talk about all things crisis.
And maybe we start off with sort of roll back a little bit and look at history and maybe touch on some previous crisis that we've experienced and, and what implications there were for markets and so forth.
So James, maybe start with you, if maybe we can point to your experience one of the previous sort of periods of crisis. And what we saw in that period, both from a market perspective in terms of how investors behaved, it'd be great to get your insights on that.
James Abela 1:47
Iv’ve probably got a little bit shorter history than Paul’s. For me, the big one was certainly the financial crisis, the financial crisis, 2009 was the big one. And then we kind of had the big swing, also the Greece crisis 2016. And then obviously, the COVID crisis, that's just we've just gone through. So a lot of them are similar. I mean, Paul said before, like, history doesn't repeat, but it does rhyme. And a lot of those times are very similar, you kind of go down all high beta high risk, high gearing gets hit really hard. Quality, defensives do really well on the open, and then you kind of get to the bottom, and then you know, then you start to get the sequences of events that occur after that. So you get, you know, indiscriminate selling, but quality does basically work, and then you have real momentum failure, and then you get bottoming out, then you get the recovery, and then you get normalization. And they got kind of go through these five phases of the market. And as an investor, you gotta be kind of thinking one to two steps ahead of the market. And that's really what the challenge is, as an investor, because the things right in your face generally on the screen, or the panic is right around you, as well. So you've got to think what's, what's likely to happen next. And you need to think like think like that, which allows you to work through things.
Lukasz De Pourbaix 3:04
And think about actually the Global Financial Crisis, is an interesting, because after the fact, everyone sort of says, oh, that was all sort of, we knew that was happening and it was all very clear. But at the time, it wasn't so clear, but at the time it wasn’t so clear.
James Abela 3:13
It wasn’t very clear. You had bankruptcies, like I was in Financials you had Macquarie Bank was $25, so did CBA, CBA did a capital raising, Babcock and Brown went bankrupt, Allco went under. So like things are really happening. Like, it’s, it’s like today, like there are things that are, you know, pretty serious that are happening around the world. So you’ve got to, you know, go through that and think about that as well. So, yeah, it’s all encompassing. Yeah.
Lukasz De Pourbaix 3:41
Paul, from your perspective, looking over history, and again, you’ve been in the markets for a long time and see different sort of crisis’s - what's an example that sort of resonates in your mind in terms of crisis in the past? And again, what was some of those reactions at the time?
Paul Taylor 4:06
Lucas it's a really interesting topic. So, you know, I've been at Fidelity now 26 years. And I think over that 26 years, I've seen about 10 different crises. And each crisis, they told me is a one and 100 year event, so they're obviously coming along much more regularly then probably anticipated. All a little bit different. So my, the one that I that sticks in my mind actually was probably my first ever one. So I started with Fidelity back in 1997. And that was when the Asian crisis hit. So that that probably sticks with me because you know, young guy just out of business school, you know, fresh eyed, not really knowing, you know, too much about the world and getting hit and I, I was covering the engineering sector that for that crisis, and the engineering and industrial companies got hit quite hard because all of their growth was about Asia. And the Asian crisis was just taking away their growth. So I had to get on top of it very quickly. The beauty of being at a firm like Fidelity was I had an opportunity to speak to a lot of portfolio managers who had been around a long time. I still remember spending a lot of time with Rich Fenton who was our deep value manager in the US on it. And he said, look, you just got to get you know, and that's in that environment in that scenario, you have to get comfortable with the balance sheet, they need to have the balance sheet to get you to the other side of the crisis. And that's been pretty consistent across a lot of different crises. But you also once it hits trough valuation, often you just got to step off the cliff. Because, you know, in a crisis, you're probably going to lose profit, you know, the profits aren't going to be there. So don't worry about profit-based valuations, this was really hard asset backed valuations like EV - enterprise value to book; enterprise value to sales, you know, net tangible assets. And then once it hits trough, if it's troughs at 0.5 EV to sales, then you just it goes below that, you just got to step off the cliff and buy the company, as long as it's got the balance sheet. And that was the, you know, that's always the critical, critical point. So, and I guess the other thing I learned from a lot of these different crises is also, you know, be focused on the second derivative. So the second derivative is acceleration, deceleration. So not necessarily things are getting worse, they might be getting worse, but they're getting worse more slowly. That's often the point that markets focus on that when acceleration starts to slow
Rate of change.
Exactly, James. And that's, that's, you know, that's a lesson I've learned to all of those different crises as well.
Lukasz De Pourbaix 6:44
And as you mentioned, you were a young, up and coming analyst at the time, and I guess, on a behavioral, because there's the sort of the very sort of mechanical, you know, balance sheets and so forth. But there's also a behavioral element, there's when, when it feels as an investor that, you know, the world sort of falling in, you know, it's all red on the on the screen, so to speak. How do you manage that aspect in terms of, you know, holding and trying to sort of block out the noise? You know, look at fundamentals at a time when, you know, every news item is some guy with a with a red screen in front of them all in their head? Because the markets are going wild. So how do you manage that? interested in your thoughts on that?
Paul Taylor 7:31
Well, it's a very good question. It's an important question. And both James, and I have been through this many times. , the way I was thinking about it is, to your point, investment theory is actually not that complicated, it's pretty simple. We all know what we've got to do at different points of time, it's actually very hard to execute on the behavioural side, right? So when markets are collapsing, you know, there's, there's a market saying, don't try and catch a falling knife. And a lot of the time, you know, I go back to the Asian crisis, they were falling knives. And you got to step in and buy into that, it's very difficult sort of psychologically. A great Warren Buffett quote is “you've got to get greedy when everyone else is cautious, and cautious when everyone else is greedy”. So when things are collapsing, that's your opportunity. It doesn't mean you should just buy everything, you know, indiscriminately, but go in, spend the time analyse it, look at the balance sheet, look at the strength of this company for the long term. And then when it's right you need to be stepping into it and, getting rid of the emotion. Focus on the important, focus on the facts, , focus on the long term - Having said all that, it's still hard to do. And, you know, as you know, I've been through as I said, I've been through 10 different crises, it's still hard to be stepping into a really negative environment. But you know, you just stack the odds in your favor when you do do that.
James Abela 9:38
And yeah, it's a lot of it's controlling your own behaviors in terms of you know, don't panic, sell; don't try to time the market. And don’t try to extrapolate. When the market becomes very short duration you've got to push duration out. So when the markets thinking, yeah, very short, very panicky. Then you go okay, let me push myself out to what's gonna happen in two years. What's likely to happen in two years from now, and that's where, some opportunities can certainly come up when you think longer term. like I know a portfolio manager within Fidelity that did panic in the financial crisis, and went very significant cash, very significant defensives, very, very low beta, and then the market bounced in March 2009. And that portfolio then underperformed by 15% on the way up. And it really was terrible outcomes, those 15% the way down 15 was on the way up was 30% below, basically, once it had recovered. And it just shows that if you do panic, and you do kind of seize up and then try to act at one point in time, that can be very, very damaging for a portfolio, you need to try to level your emotions out and try to be very balanced. And then you're trying to think about a year or two ahead. So pushing your duration out for me is one of the key lessons. Paul mentioned, like balance sheets got to make sure those are going to survive for the ones you're backing. So they're kind of a couple of lessons. And yeah,
Lukasz De Pourbaix 11:05
I think you make an interesting point, because at the moment, and I know we've all been speaking to clients, different clients in the market. And certainly, from my perspective, I do sense that there are some clients out there given this sort of macro economic uncertainty, given you know geopolitical risks, and cash rates are higher at the moment. So we have seen some investors out there sort of say, you know what, it's all too hard. I'm feeling a bit scared. I'm just gonna put it in cash. But, I think to your point, the interesting one, is that what’s when do you get out of cash?
James Abela 11:37
Yeah timings very fast.
Lukasz De Pourbaix 11:38
So yeah, as you say, rebound quite well. Yeah. So that's that timing element
James Abela 11:43
Yeah. So so it's not timing the market, it's time in the market. And like I said before, you get paid for ROEs and return on capital, you don't get paid for trying to time the asset allocation shifts. So that's where Yeah, it's basically time in the market
Paul Taylor 11:59
That's the thing I've found as well. If you get that timing wrong. I mean, a lot of the performance in one year can come in, you know, a couple of weeks.
But if you're not there for those couple of weeks, you're in trouble. And you just don't know, really you don't know when that's you just don't know when that's going to come
I mean, it's like, you know, I would say in any portfolio, there's a place for cash, there's a place for equities. I would always say you got to think more long term about that. Don't get worried about what the market, you know, equities have been the greatest deliverer of wealth we have
Had anywhere in the world.
As an asset class
Paul Taylor 12:41
As an asset class and you got to back that. But you know, that doesn't mean cash is not an important part of your portfolio. But fundamentally, once again, just think long term rather than get caught up in any short term panics or concerns.
Lukasz De Pourbaix 12:54
Yeah, absolutely. Because the timing just becomes, most people don't get it right. It's always difficult. I think one of the interesting things to sort of discuss a little bit is you mentioned both of you mentioned sort of the focus on fundamentals, focus on those, you know, the facts, get back to the basics in this sort of environment. And maybe it's worth, you know, the investment process, and it's probably one of those things, that's sort of not the most exciting thing, sometimes for people to talk about, but it is a bit of a bit of your rudder , during periods of crisis and volatility, and it’s refocusing back on the process. And maybe we can just recap very briefly, the top three things maybe from a process perspective, both of you think about in terms of your portfolio's
Paul Taylor 13:41
So you really, you know, what, what we, you know, at Fidelity, we're fundamentally bottom upwe’re have stock pickers, and the way we do that is we get out and meet with the companies, I always also say that, you know, I'm, you know, my worst day is sitting at my desk watching stocks go up and down, because I'm not, not doing anything productive. And in fact, the market is acting on me and that's where the emotion comes in. My best days are when I when I'm out talking to companies and going through and understanding how they make money. So, the fundamentals of what we do is really get out talk to companies, talk to their competitors, suppliers, distributors, understand the business model, understand what drives the profitability, understand where the trajectory is for that business and then model it. And, you know, macro tense, I mean, from my perspective, you can make money picking the right macros is very, very difficult. And a lot of the time macro really drives the sentiment. Doesn't drive the long term fundamentals of the business. So coming back, trying to differentiate companies based on those fundamentals. One of the other things I think is interesting in a crisis is what tends to happen as you go into the crisis you tend to get compression so everything. James, I still remember the GFC going through together. At the worst of the GFC every company was on the same multiple. Yeah. So the market was basically saying, I don’t believe anything anybody’s telling me, it's gone super skeptical.
James Abela 15:18
Yep. In a crisis, everything goes to a correlation of one.
Paul Taylor 15:21
Yeah, just everything was in trouble.. But then the really interesting thing is, you know, for a stock bigger actually coming out after that, when you get the discernment. That's when you go, well, this company’s got 20% earnings growth, this company’s got no earnings growth, they’re on the same multiple, you know, it’s, it becomes really obvious where you should be heading. And that’s what we do. That’s what our process is about. Our process is about separating those companies looking for the quality countries, quality management teams, earnings growth, industry structure, and basically saying, well, they're all in the same multiple so let's go, for the one that's got a lot more earnings growth, that might have good structural long term growth as well. Our process is get out meet those companies. So we're meeting the whole market every quarter, rating one through five ones are strong by five strong sell, maintaining our own proprietary earnings, cash flow valuation, balance sheet model. And that really industrialises the process so that we can look for the differences, look for the discernment, see where the opportunities are right across the whole market.
James Abela 16:27
Yeah, it's very interesting Paul. So Paul and I went through that crisis and those common financials and banks of banks and insurance, right there
The pointy end
at the pointy end, it was very interesting time to do financials. I remember sitting in a room for like two and a half hours with Paul, back then. And we said, like CBA, Macquarie, like you need, we need to buy them. They've got strong balance sheets and structural leadership. They've got deposit deposits in their favour. They'll both trading at $25. And they were the winners at that point in time. But like Paul said, everything goes to correlation of one in a crisis. But $25 they were back then. And now they've gone through $100, like over time, so they've gone up four times from the bottom. Within the crisis point, everything was just going down. 40, 50, 60%. So yeah, I remember that day was a big day.
Paul Taylor 17:15
Well, back to that as well. I mean, CBA bought Bank West and which was probably the buy of the century. So they stepped up. I mean, you talked about the capital raise, they raise the capital to buy Bankwest. That's right. But that was probably the buy of the century.
So we done well,
So in crisis comes opportunity. For the companies and for investors.
Lukasz De Pourbaix 17:36
Absolutely. And if you sort of reflect on the environment at the moment, and there is a couple of sort of wobbles in terms of the macro - we talked about geopolitics and so forth. Having been through different crises in the past, are we in a bit of a crisis at the moment?
James Abela 17:56
There's, there's definitely a crisis, there's definitely and I mean, we've had like I mentioned, those market crises, there's, then there's obviously wars and geopolitical uncertainties. But then there's also factor styles that shift. So from quality and momentum and trending markets, to value markets and markets that are very fearful. So the fear and greed that gets talked about. And those factor styles are very big, then you've also got macro, the macro fears are very big now compared to many years before. So the last 20 years never had high inflation, high wages growth. What we've got now and interest rates at these levels that we are at today. So, yeah, it's for me, it's definitely you need to stick to your process. So for me, you're managing the portfolio through either the correction recession, a financial crisis, or a macro shift or a big factor shift. You need to stick to your process. So for me, I have Quality, Momentum and Transition and Value as the four groups. They all behave very, very differently in those kinds of environments. But you need to basically still be overweight Quality and like try to buy and hold Quality, and always have evaluation triggers and the valuations where you want to buy more of them. You always need to be aware of high risk, financially leveraged, operating leverage, high beta or management making poor decisions. You always need to be aware of them. But then you as Paul mentioned, when you go down, then you can buy those cyclicals or those high Quality names, that when they go up you know, they're gonna bounce pretty strongly. So we've had Qantas that was at $1 at one point, and it's gone to five. You know, small cyclicals, small mid-cap cyclicals have gone up three to four times from the bottom. And that's what happens when you get to the bottom. But then when the market starts to recover and starts to roll through the normalization, those calling names can continue to grow because they've got earnings, but those high-risk, high-beta names will start to fade. And those medium cyclicals if they're doing well, in the sort of momentum phase they can I keep holding on as long as I got the earnings. Value tends to not do as well. And that factor starts to decline because the hurdle rates going up. So that tends to be what you need to focus on in terms of those three major phases as you go through the market, definitely stick to the facts. And stick to what you know, as well, because a lot of things, there's actually a lot of history in a lot of companies that you can see what's you know, what, what they how they've handled time. And how they behave, you know, gives you more comfort over how you should behave.
Lukasz De Pourbaix 20:37
So I, if I was to sort of wrap, wrap it up, and some summarize some of the key things I've got from both of you, and then correct me if I'm wrong, but I'm sort of hearing one is, you know, crisis can be opportunity. When you get stocks on, you know, correlation goes to one, everything goes down, The Good, the Bad and the Ugly - in that period, being active, having a strong process driven approach, can really then sort of separate the good from the bad and that opportunity is there So one is opportunity. Two is timeframe, I think that was an interesting one as well, because, you know, you've got to keep that investment timeframe in mind and when you are in a crisis, your timeframe sometimes can sort of suddenly in your brain go very short about a week or so, again, keeping that focus that sort of resonated with me, as well. And obviously, the whole timing. It's an old adage, time in versus timing the market. But it's so true in a crisis. To both examples you pointed out .
James Abela 21:43
And listen to what Paul said about equities being a very strong performer. It's been a great asset class over many decades.
Paul Taylor 21:51
Yeah, Lucas, that's, I think they're all three strong points. And I wish I'd said it as well as you had. But on the last point, the other thing, I think, is when you think about it, so I talked about the last, you know, 26 years, five years with fidelity 10 crisis, and we've gone through 10 crises, some of the biggest, you know, the GFC, was one of the biggest downs in the history of stock markets, in the history of Australian stock markets. And the pandemic was quick, short and sharp, but it was still a big, you know, relatively big down. Now, through that entire period, you know, equities are up, you know, 10% a year for that entire period. So we've gone through 10 crises, a couple of the biggest ever, and we're still doing 10%, we still don't do this every year. But it's all about when you buy in, and when you sell out. So if you bought in at the top of the GFC, and then sold out at the bottom, you're obviously negative, but just holding equities that entire, you know, 25 year period, you've done, you know, round 10% a year. And I think that's, that's the big lesson to me. And the other lesson is the compounding. So when you do 10% a year for 25 years, , you know, you're talking about, you know, your numbers being up, you know, sort of 6, 7, 8 times in that period. So it's, you know, stick with it. It's all about the long term compounding is one of the you know, actually to me, that's the
James Abela 23:17
The 8th wonder of the world, isn't it? The power of compounding.
Paul Taylor 23:21
The power of compounding. Yes. And that's, that should be a key lesson in all schools, I think, yes, that little bit per year, for a long time, makes a big difference.
Lukasz De Pourbaix 23:32
So it's a long game, not a short game.
So with that, thank you very much to both of you for taking the time and I found it fascinating, I think very relevant in the current market environment. And thank you to our listeners for joining us today. If you have any questions or feedback, please email us at PodcastsAustralia@fil.com. Otherwise, we look forward to you tuning in to next month’s podcast.