If my last note was an ‘ode’ to resilience and patience, this note is an ‘ode’ to optionality.
Last week I read a fascinating piece called ‘Complexity Investing’ by Brad Slingerlend and Brinton Johns.
I took a lot from their work, but the one thing that really struck me was the section on resilience and optionality. Clearly investors need to be resilient, so we can withstand set-backs, but do we also need to embrace optionality?
Slingerland and Johns discuss optionality in the same way a venture capital firm might, with the potential of a large pay-off from a small number of investments, recognising a number of these investments may also go to zero. They argue that by optimising for both resilience and optionality investors can avoid the illusion that they can predict the future. It is an interesting concept and one that seems particularly appropriate when investing in new technology. Indeed, we can see this essential philosophy in action when we look at the portfolios of a number of strategies we invest in to capture innovation and disruption.
However, this is not the only thought that came to me when reading their piece. Since the start of the year we have met many clients and the level of caution amongst investors continues to strike me. Despite very strong returns last year, it seems investors remain quite cautious. You simply don’t see the euphoria or optimism you would expect after such a strong year.
Furthermore this is not just an Irish phenomenon. The cover of Barron’s, a US investment publication, in early January struck a cautious, conservative tone, with ‘Safety First’ the headline message.
With most investors seemingly focussed on what could go wrong, should we also ask what could go well? It is fair to say valuations for equity markets are not cheap in an absolute sense, but the starting free cash flow yield today from US equities is higher than US 10 year bonds, and pretty much the same as US corporate bond yields. This doesn’t happen very often and when it has future returns from equities have been quite strong.
I’m also intrigued by the idea that we are still relatively early in a very long term bull market. Over the last 100 years, we can observe that markets have periods when they deliver very strong returns and periods when they essentially deliver nothing.
This may strike readers as somewhat simplistic analysis, but it is interesting to note that these periods typically last 16-20 years and arguably markets only broke out from one of their ‘nothing’ periods in the middle of the last decade, following essentially no return from 2000 to 2016 for global markets, in price terms.
I’m further intrigued by the idea that a number of technology platforms are converging today and that we are on the cusp of a leap forward in productivity and growth for a number of sectors.
Maybe this is too optimistic, but shouldn’t we explore the potential positives, as well as the negatives? Perhaps we should only assign a small probability to the most optimistic case, but we shouldn’t dismiss it entirely.
As long as we build resilient portfolios for clients, allowing us to withstand set-backs, we can retain optionality and then ask “what could go well?”
As always, please do not hesitate to contact us with any queries or questions you may have.
Brewin Dolphin Capital & Investments (Ireland) Limited (trading as ‘Brewin Dolphin’ and ‘Brewin Dolphin Ireland’) has issued and is responsible for production of this publication. Brewin Dolphin is authorised and regulated by the Central Bank of Ireland. Brewin Dolphin is a member of Euronext Dublin and the London Stock Exchange.
This publication should be regarded as being for information only and should not be considered as an offer or solicitation to sell, buy or subscribe to any financial instruments, securities or any derivative instrument, or any other rights pertaining thereto (together, ‘investments’). This publication is classified as a ‘marketing communication’ in accordance with the European Union (Markets in Financial Instruments) Regulations 2017. This means that (a) it has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and (b) it is not subject to any prohibition on dealing ahead of the dissemination of investment research. Brewin Dolphin does not express any opinion as to the present or future value or price of any investments referred to in this publication. This publication may not be reproduced without the consent of Brewin Dolphin.
The information contained in this publication has been compiled from sources believed to be reliable, but, neither Brewin Dolphin, nor any of its directors, officers, or employees accept liability for any loss arising from the use hereof or makes any representations as to its accuracy and completeness. The information contained in this publication is valid as at the date of this publication. This information is subject to change without notice, its accuracy is not guaranteed, it may be incomplete or condensed and it may not contain all material information concerning the matters discussed herein.
This publication does not constitute investment advice and has been prepared without regard to individual financial circumstances, objectives or particular needs of recipients. Readers should seek their own financial, tax, legal, regulatory and other advice regarding the appropriateness or otherwise of investing in any investments or pursuing any investment strategies.
An investment in any of the investments discussed in this publication may result in some or all of the money invested being lost. Past performance is not a reliable guide to future performance. To the extent that this publication is deemed to contain any forecasts as to the performance of any investments, the reader is warned that forecasts are not a reliable indicator of future performance. The value of any investments can fall as well as rise. Foreign currency denominated investments are subject to fluctuations in exchange rates that may have a positive or adverse effect on the value, price or income of such investments. Certain transactions, including those involving futures, options and other derivative instruments, can give rise to substantial risk and are not suitable for all investors.
Brewin Dolphin (or its directors, officers or employees) may to the extent permitted by law, own or have a position in the investments (including derivative instruments or any other rights pertaining thereto) of any issuer or related company referred to herein, and may add to or dispose of any such position or may make a market or act as a principal in any transaction in such investments or financial transactions.
Brewin Dolphin’s conflicts of interest policy is available at www.brewin.ie/conflicts-policy-summary
The value of your investment may go down as well as up.
Past performance is not reliable guide to future.
You may lose some or all of the money you invest.
Our investment may be affected by changes in currency.
Any income you get from this investment my go down as well as up.