What can investors do to safeguard their investments in the face of a market correction? Simon Edelsten shares eight strategies.
1. Don’t let valuations outrun value
It is human nature to get carried away by hype. In 1841, Charles Mackay noted of investors, who were swept up in the enthusiasm of a series of investment bubbles that later popped: ‘The hope of boundless wealth for the morrow made them heedless and extravagant for today.’ This is the age of disruption and many companies are turning traditional industry on its head, but there comes a point when people start to buy the story and disregard the numbers. Valuations run ahead of value. Have the courage to sell when that happens. You may feel like a fool for a while as prices continue to rise, but when a market corrects it is the most overvalued stocks that tend to fall the furthest.
2. Rebalance regularly
Run your winners, but don’t let successful stocks grow so overweight that they take up 7 to 8 per cent of your portfolio. It can leave you very exposed if that stock hits particular trouble. Our target limit is about 2.5 per cent. As a consequence, we’re not too vulnerable to a shock fraud, a daft tweet from Donald Trump or other state interference that could send a stock reeling. There’s little excuse to be over-concentrated when the global equity market has so many good opportunities.
3. Beware of cyclicals
Some industries, such as housebuilders and travel agencies, move in cycles. Don’t be too exposed to such stocks. They force you to be a market-timer and that’s not a risk that you need.
4. Debt asphyxiates firms in a downturn
Companies with high levels of debt are vulnerable if interest rates rise suddenly. High interest repayments can strangle the life out of a firm. Vet the debt in your portfolio.
5. Invest like a dragon
It is remarkable how often entrepreneurs on Dragons’ Den generate great ideas that can be easily copied. It’s one of the most common factors in persuading a dragon to keep their money on the little coffee table beside them. Follow their lead. Look for firms providing products and services that people will always need and with high barriers to entry, whether that is powerful brands or unique technology. If inflation hits, these businesses are better equipped to raise their prices because no one can undercut them.
6. Be fickle
Scan the components of the FTSE 100 at its launch in 1984 – around three-quarters of those companies have experienced an acquisition, merger, takeover or bankruptcy. And yet markets often value companies on the basis that they have been around for years and will be around for years to come. Be sceptical of valuations on that basis, and don’t fall in love with a stock just because it rewarded you well once.
7. Look ahead
Henry Ford famously said: ‘If I had asked people what they wanted, they would have said faster horses.’ It’s very easy to get so focused on how fast the horses in your portfolio are going that you fail to notice the cars about to overtake them. If you’re managing your own money, look ahead. I spend a lot of time reading about technological changes that could undermine the investment themes in our global equity portfolio, or, alternatively, become the themes of tomorrow.
8. Old bores have a place
It’s good to be forward-thinking, but a portfolio of exciting young prospects is risky. It can pay to have a balance that includes a few old bores – businesses that may be dull but well run, with experienced management teams that know what they’re doing, and do it well. A sensible portfolio is often a boring portfolio, and it’s always diversified.
Of course, the best way to make money is to not lose it in the first place. Following these rules – and particularly focusing on valuations – won’t immunise you completely against losses, but experience has taught me that it can mean that you lose significantly less than most.
Simon Edelsten is manager of the Mid Wynd International Investment Trust.