The Rotation Story – twists and turns
Posted by: Brian Dennehy
The attention on Value-style funds has generated a flow of questions. In this blog I answer one from Paul, in particular how we sometimes have to adapt, and buy funds before they formally have momentum, as judged by our Dynamic Fund Ratings. (In the other Value blog this week we update the Value funds list, and analysis.)
Paul has a few good questions on Value fund investing, and at the outset sets the scene spot on:
“My understanding is that momentum is just identifying the top performing funds over any given 6-month period, regardless of the type of fund (growth or recovery/value).”
But years like 2020 require that we adapt as investors. Nine years out of ten using momentum (Dynamic Fund Ratings) to select funds is ridiculously simple and effective across most sectors.
But in the 10th year we have to adapt. Myself and Gold Members did this in different ways in 2020, but I will take one journey which would have given a decent return in the end, but was quite uncomfortable:
By March 2020 many of us were 100% in cash, as stop-losses had been triggered across the board.
The big issue was then when to buy back in. The FE approach is usually buy-back in 30 days. For my part I over-rode this, concerned about much sharper falls. So I was left with the much more difficult task of identifying a low-ish point to buy. (With hindsight, I would have been much better off applying the 30 day rule, as the market lows were mid-March)
Identifying a low point to re-enter requires judgement, and is fraught with difficulty. One very successful indicator from decades past was “negative divergence”. I won’t get bogged down with what that means now – it suffices to say that this indicator never flashed “buy”. Bugger.
Now it was necessary to look out for more subtle signs. Valuation differentials were huge between different investment styles – and the main battleground was Value vs Growth. It made sense to assume that Value was the place investors needed to be for the upside (on which there is loads of detail in the Value ebook
). But when
After the initial sharp bounce in markets, from March 2020, there was a lot of drifting sideways. Uncertainty was also extreme. This wasn’t just about the pandemic, and economies and markets. At a more practical level was the issue of liquidity
, which I had highlighted on many occasions since 2018 (OKAP
is good on that). Liquidity in simple terms is “who will buy when I want to sell?”. And will funds be suspended and platforms stop trading? Very practical issues.
By the Autumn, it seemed to be all about the vaccine – this was the cavalry for which we all waited patiently. Once you have the vaccine you can see to the other side of the crisis. Before news on the vaccine evidence was quietly building, but seldom noted in the media, that the best companies in the UK were coping OK. And these companies were one’s which were very cheap, and had been ignored by global investors since 2016.
By October there was evidence that key sectors were being bought, in particular banks. This was the genuinely smart money doing what they do best, and I highlighted this in October.
Then came the vaccine news, Pfizer Monday, 9th November. The outlook was transformed overnight.
It was time to buy Value-style funds, and more generally funds linked to a recovery in the UK domestic economy, which included smaller company funds.
Within a small number of days, it was already clear that these Value funds were bouncing hard, and Growth-style funds were being left behind. This was what the history of Value funds said should happen (again, see the ebook
) but there was no guarantee.
Now we use Pfizer Monday as the inflection point from which we keep a close eye on that rotation from Growth to Value, to ensure it is sustained. By April you should see this in the Dynamic Fund Ratings, looking back 6 months.
Which then leads me on to Paul’s next question:
When does Momentum investing not work?
Some say it doesn’t work at turning points. But nothing systematic works at turning points! And investors of all styles should be very largely in cash at those points.
So you have to do a bit of homework, and answer one of two questions, ideally both:
How can I identify a market bottom?
When markets are sharply lower, what styles or sectors should lead the bounce?
On the second question, the answer will not always be Value-style funds. But with valuations so low, absolutely and relatively, plus the need for huge government aid to support the real economy, the answer was reasonably clear.
Also this week we have updated our list of Value funds, and you can see this and our updated analysis here