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Market uncertainty – never comfortable, but potentially profitable

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There are several potential headwinds that are weighing on investor minds currently, with slowing economic momentum, trade wars, central bank policy, and political risk, all adding to a general sense of market uncertainty. Meanwhile, at a company level, disruptive innovation as well as regulatory and competitive challenges, are also creating stock-specific uncertainty.

However, as an investor in the U.S. large cap equity space – the most efficient area of the most efficient market in the world – it is this kind of environment that has historically provided some of the best opportunities to generate alpha. Uncertainty creates potential pricing dislocation opportunities, as investors’ reaction to bad news can be punishing, and potentially indiscriminate, in this environment.

 

Seizing opportunity from uncertainty

Importantly, a key area of focus for us is to identify innovative companies – those that we feel have the potential to deliver long-term, compound growth by virtue of their novel ideas, services or products. They bring potentially disruptive uncertainty to their industries – a rare attribute, but one we embrace.

Identifying companies that have these capabilities demands research that goes beyond the day-to-day headlines. News stories can create small pockets of opportunity but rarely does anything significant emerge from this short-term company ‘noise’ that will ultimately prove helpful in gaining a deeper insight into its long-term growth or profit profile. In our experience, capitalizing on disruptive uncertainty in the U.S. large cap space is only consistently achieved by having a deep understanding of companies’ fundamental businesses and the distinctiveness of proposition they offer.

 

Looking beyond the short-term market ‘noise’

Facebook is a great example of this in practice. Shares in the company fell from US$210 in mid-2018 to US$125 over the course of the next six months, due to concerns about its approach to data privacy and protection. Poor decision-making in the first instance, and a distinct lack of transparency in communications once the issue was discovered, weighed heavily on the stock.

However, beyond the immediate negative market reaction, we sought to revisit and retest our initial investment thesis and positive long-term view of the company. This involved further analysis into why so many companies use Facebook for advertising, its principal source of revenue. During a series of visits to companies across the country, most confirmed that advertising with Facebook represented either the top or second most significant return on their investment. Understanding this, we developed the opinion that it became clear that the data privacy breach would not, of itself, see companies withdraw what is effectively their most profitable avenue for growth.

As a long-term investor in Facebook, we also had a good understanding of the potential impact of major issues on daily/monthly average users. In this instance, despite the very public backlash, we observed only a relatively small negative impact on average user numbers. Fast forward to today, despite going through 12 to 18 months of difficulty, Facebook recently reported accelerated revenue growth, as of Q2 2019.

 

“One of the ongoing attractions is the innovation and potential market disruption that is coming from the large-cap area of the U.S. equity market”

We believe that near-term market performance will largely depend on a resolution of the U.S.-China trade dispute, which is weighing on sentiment and eroding business confidence and capital spending. Overall, we are cautious but optimistic that there are still sufficient market drivers in place, while the more volatile market conditions could potentially present attractive buying opportunities for long-term investors. Our rigorous process is rooted in bottom-up, fundamental research. In addition to uncovering underappreciated idiosyncratic stories, this approach also helps prepare us to take advantage of the market’s tendency to overshoot on both the downside and the upside.

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The specific securities identified and described do not represent all of the securities purchased, sold, or recommended for the portfolio, and no assumptions should be made that the securities identified and discussed were or will be profitable.

Key Risks – The following risks are materially relevant to the strategies highlighted in this material:

Transactions in securities of foreign currencies may be subject to fluctuations of exchange rates which may affect the value of an investment. The strategy is subject to the volatility inherent in equity investing, and its value may fluctuate more than a strategy investing in income-oriented securities.

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