What to think about when markets are volatile

For many investors, 2022 has been a tough start. January began with the second biggest rotation from growth to value stocks in 50 years 1 , driven by rising inflation and the prospect of higher interest rates. Later in the quarter, markets were stung by Russia’s invasion of Ukraine which led to a further dramatic increase in the price of energy. This has added more momentum to rising inflation which is now reaching a 40 year high in the US and UK and is causing a very real cost of living crisis. Furthermore, the lockdown in Shanghai is also fuelling inflation by further stressing already stretched supply chains.

It’s hard to look beyond the vast humanitarian issues caused by Russia’s invasion, but the question for investors has been how to manage their portfolio in a period of intense uncertainty and market volatility.

‘Time in the market, not timing the market.’

The first piece of advice is to remain calm and not make knee-jerk decisions. At Tribe, we’re keen believers in the mantra ‘time in the market, not timing the market.’ We don’t believe there’s value to be had in jumping in and out of markets around macroeconomic news flow. In fact, this is probably detrimental over the long run as it forces the investor to make two difficult judgements: when to sell and then when to buy again. It increases the likelihood of being wrong and missing out on a rally. This is important as some of the largest rallies in markets follow dramatic falls. Research shows that if, over the last 30 years, you had tried to time the market and you had missed just the ten best days, you would have roughly halved your return 2 .

Asset allocation

It’s also important to assess asset allocation. The recent sell-off has affected both equities and bonds: high inflation makes profitability more difficult for companies, and it erodes the value of fixed income assets in real terms. One asset class that has proved resilient is Alternatives. What we’ve seen, particularly within our Alternatives at Tribe, are investment opportunities that are less linked to the concerns of the global economy, combined with high, inflation linked yields and strong macroeconomic narrative. Whether the issue is tackling homelessness, building solar energy capacity in the UK or participating in the growing market for carbon credits, we believe diversifying income streams and exposures should build resilience within portfolios. Read more in our ‘Opportunities in Alternatives’ piece.

Quality companies

Another important thing to think about is the quality of the underlying companies that you invest in. By quality we refer to balance sheet strength and fundamental ability to generate strong, predictable cash flows. Tribe’s investment philosophy is simple: we look for well-run companies that are working to solve global challenges. Given that inflation erodes the value of your capital every year, the longer it takes to generate cash means the more detrimental high inflation can be. This explains why high growth companies which don’t generate cash, particularly speculative technology businesses, have been hardest hit over the last few months. Our approach is different: we want to focus on those companies that are driving fundamental change. Given society’s requirement for businesses such as clean energy, medical equipment, and infrastructure we believe there is a natural robustness to these sectors that mean they will ultimately weather the short-term volatility. In addition, we keep a close eye on the profit margins of our companies. We prefer those companies that are well managed with high and resilient gross margins. Put simply, if the overall costs of producing a company’s goods is relatively low compared to the price they are sold at, this means that any increasing costs used in production have a much lower effect on the overall profitability.

Higher inflation, rising interest rates, land war in Europe, lockdowns in China and a number of globally significant elections in 2022 have created a difficult market environment. There have been very few places for investors to hide and this is reflected in sentiment. However, the invasion of Ukraine has brought forward the transition to cleaner energies, greater energy security and accelerated investment into innovative solutions like hydrogen. At the same time consumers are more aware than ever of the role they play in combatting climate-related and social issues. So, as long-term investors, we’re happy to look through the short-term volatility. We remain focused on identifying well managed businesses that will be supported by the ever-growing focus on sustainability from consumers, corporates and governments.