One of the really fun events on the Street is the "Up the Down Market" dinner held annually in Vancouver, Calgary, Toronto and Montreal in support of the Down Syndrome Research Foundation. The focus of the evening is a game based on a stock market simulation developed by professors and students at the Sauder School of Business (University of British Columbia). It is a life-like experience, with prices determined by the buy and sell orders, and it provides a good illustration of how security prices can occasionally get detached from their true value.
At one stage in the game, a stock my Steadyhand team and I had been accumulating (Jack's Energy Shack) dropped to $10, down from its starting price of $25. While it appeared that Mr. Market had delivered bad news, the opposite was true. The price decline had given us an opportunity to buy more, such that we now had a large holding at a low price. We didn't know when Jack's would recover or, indeed, if it would at all, but we'd done what we wanted to do - build a portfolio where the reward/risk balance was heavily in our favour.
In the trenches of the buy side, there are times when we get a chance to buy a company or entire sector that we like at a depressed price. When that happens, we're delighted. It's what we live for. But the excitement wears off the longer the price stays down. After a few rounds of buying (perhaps at a lower price each time), the position gets maxed out - it isn't prudent to own more, no matter how cheap it is. So our down-and-out stock is now a large holding that doesn't have any friends. But in real life it's not like the dinner game where we only had to wait one glass of wine to find out if we were right or not. In the real world, a fundamentally sound stock can stay out of favour for two or three years.
If we stick it out and the stock eventually doubles or triples, clients will regard us as being disciplined and patient. If it doesn't, we're just plain stubborn.
As it turns out, we sold Jack's Energy Shack at $60 and went on to finish second in the game (out of 31 tables). We left the room oozing discipline and patience.
Because of the extreme market swings over the past two years, all portfolio managers have had a period when they were seriously offside. The funds that performed admirably in 2008 and the first part of this year (i.e. went down less than the rest) have lagged seriously behind in the past six months. That's because the less cyclical, conservatively financed companies that held up well during the market crisis didn't get a full liftoff when the "Dash for Trash" started in March.
As the performance numbers come in for the third quarter, the data are going to be rich with information. In the Globefund tables and the institutional performance surveys, we're almost certain to see that last year's leaders are this year's laggards. There will be exceptions - funds that did well or poorly in both periods - but they will be rare. That's because the managers that got the first part right would have needed to completely overhaul their portfolios to keep up with the leaders on the way back up. That's hard to do at the best of times, let alone when we were all gasping for air amid the unprecedented volatility.
The value of the data will not come from the recent results - last quarter's performance is a great predictor of, well, last quarter's performance - but rather what it reveals about the managers' actions and medium-term returns, and how that matches up with their marketing brochures. More than any other period I've seen, their wares are exposed for all to see.
I'll be looking to see if a fund's volatility was in keeping with its objectives and approach. All funds went down more than expected, but there is still information to be gained from the relative pecking order. I want to see if a fund's recovery is reflective of its decline. Markets haven't nearly returned to where they were two years ago, but the funds that were hit the hardest should have had the most octane on the way back up. We now have a fuller picture as to what the round trip will look like.
Just like any one round in the game, the Sept. 30 results are just a snapshot at a point in time. Indeed, it's a group shot where some of the funds look better than they really are while other funds' beauty just doesn't show through. How they look that day is not as important as how they got there and what they're going to look like in future pictures.
Tom Bradley