You are already likely to be well aware that the worst time to sell out of an investment is just after a crash, but hanging on in there is easier said than done when the market only appears to be going in one direction. And despite warnings to the contrary, many investors find themselves giving in to fear and selling out just as the market reaches its lowest point.
Barings’ Darryl Lucas described the impact of such behaviour as potentially “ruinous”, even if investors soon see the error of their ways and quickly buy back in. He conducted research showing that if you put $1,000 in the S&P 500 30 years ago and remained fully invested, reinvesting dividends, the $1,000 initial investment would now be worth about $17,600. However, if you missed the 10 best days in the market, that investment would now only be worth about $8,800.
Source: Barings
“You might as well not have bothered,” said Lucas. “You might as well have gone into high yield or something, so you could have had a lower drawdown profile over time.”
Barings launched its Global Dividend Champions strategy three years ago in an attempt to pre-empt this behaviour, with the fund aiming to participate in the powerful returns from equities over the long term while reducing the downside in falling markets to prevent investors from panicking.
Lucas (pictured) said the fund does this through holding a set of resilient and predictable companies “whose fate is in their own hands”, meaning they are not reliant on wider macroeconomic factors. Unlike with other funds, his starting point is looking at the potential risks to a company, which he described as “a homage to his background as a credit analyst”. This begins with the way he analyses financial statements.
“Rather than using earnings, we use cash flows,” he said. “And we make a range of adjustments to the financial statements so that we can get a better picture of the economic reality, because no company's business reality is exactly as it is presented in a financial statement
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“There are so many accounting choices you can make when you're putting together a statement. We try to undo as many of those differences as possible so that we get a level playing field for all of our companies.
“This gives us a much better picture of the actual reality of the business. For instance, its true indebted position rather than just the accounting sort of fiction that's presented on the financial statements.”
This scepticism doesn’t stop at the financial statements, and after visiting current and potential holdings, analysts at Barings will test any statements made by the company management. For example, they will meet with competitors, where possible, and scour forums related to their product to verify claims about customer satisfaction.
“It's not good enough just to listen to what a company says and then buy the shares, because it's a pitch,” Lucas added. “They'll tell you their story, just like I'm doing now, so you're trying to work out if there's any sort of truth to what the management is saying.”
Next, he carries out stress tests on each company under a range of different scenarios in an attempt to gain a picture of the intrinsic risk of each investment. He said his job as a fund manager is to read and incorporate as much information about a company as he can, which the wider team will use to develop scenarios with the potential to threaten their business model.
For example, if the manager is looking at a consumer staples business, he will test the implications of a slowdown in emerging market consumer demand, or of competitors destabilising pricing, and what effect that will have on margins. He said history can act as a useful guide here.
“One of the nice things about the financial crisis was that you actually got to see how companies fared when times were tough,” Lucas continued. “That's about the only nice thing.”
“So we absolutely use the financial crisis as a benchmark for how bad things could potentially get. And we recreate the revenue progression and the margin progression in companies in the portfolio during that time just to see what that will do to the dividend growth or the fair value of the shares.”
Barings Global Dividend Champions has made 30.4 per cent since launch compared with 30.5 per cent from its MSCI World benchmark and 26.72 per cent from its IA Global sector. However, Lucas said the rally of the past three years has not been the best backdrop in which to judge whether the fund has been a success.
Performance of fund vs sector and index since launch
Source: FE Analytics
“It's surprising that this fund has kept up with the bull market since launch because I think this sort of product does its best work in broader periods of economic stress. I think that's when you'll actually see the value of owning more predictable businesses,” he finished.
The $28m fund has ongoing charges of 0.85 per cent and is yielding 2.16 per cent.