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Handling setbacks

Date: 22 March 2023

As I said in my first podcast of this year, the only thing one can forecast with absolute certainty is that there will be a left-field event that none of us will have predicted, and of course Silicon Valley Bank (SVB) has provided us with that event. I’m not going to provide you with another deep dive on SVB or financials today, I’m sure most of you are inundated.

Today I want to talk about the how these sorts of events can give us some of our best insights into how a fund manager operates. For every underperforming investment, there can be plenty of excuses from the manager, from the market not yet appreciating the value of the stock, to them finding a better alternative and upgrading the portfolio, selling the laggard as a consequence. But when a stock goes to zero, there can be only one conclusion - the manager made a mistake.

For fund selectors, the conversation with the manager in these circumstances can be very illuminating. First, do they accept that this was a poor decision? Every situation is different, but anything other than full honesty really does not go down well - in most instances this is a case of  putting hands up and admitting mistakes were made in the analysis.

Of course, every manager makes mistakes, which is why a good hit rate for the proportion of successful investments is only around 60%. But none of us like admitting mistakes, and even in such extreme circumstances, we see managers unwilling to admit that the analysis was faulty. One well-known UK value investor has regularly told us that if they do not have one per year, they question whether they have taken enough risk.

Secondly, these situations really put the spotlight on the level of stock analysis. For those of you who spend any time on Twitter for example, you will find multitudes of in-depth analysis on SVB now being produced on the shortfalls of the company. As a generalist fund selector rather than an expert banks analyst, this is helpful in probing holders on their knowledge of these issues in their own analysis, something which is less available in that detail for other stocks. It makes our jobs much easier to probe the weaknesses of the initial thesis. It’s unlikely that we would consider changing our conviction in a manager off the back of one extreme stock event, but it gives a unique chance to really assess the analysis the manager undertakes, and that in turn informs the overall picture of the manager.

Then there is the risk management. How was the position sized initially, added to, reduced? What is the oversight and were there challenges on ideas? Again, all of these factors are a lot clearer when we have a clear result.

SVB feels like a fairly shocking event, a bank the size of many large European banks going bankrupt. However, I think it’s made even more headlines because we just are not used to stocks going to zero very often, certainly not large stocks. The period since the financial crisis in 2008 has seen far fewer such events, with data from S&P Global showing that even since 2010, the number of US corporate bankruptcies has been in steady decline, with 2021 and 2022 at the lowest level over that period. As we finally exit the period of easy money, I suspect we will see more such events which, of course, are part of the natural cycle, but equally which we have got used to seeing far less, bar fraudulent circumstances.

There can be no positives from a large company collapsing, but it does produce some very interesting insights. Such events allow us to get a much closer look into a manager, whether that be their temperament, analysis, risk framework or other aspects of their process. For those of us lucky enough to see fund managers face to face routinely, this is an opportunity not to be wasted to understand that manager a lot better. I suspect we will be given more opportunities in the next few years.

This is a marketing communication and is not independent investment research. Financial Instruments referred to are not subject to a prohibition on dealing ahead of the dissemination of marketing communications. Any reference to any securities or instruments is not a personal recommendation and it should not be regarded as a solicitation or an offer to buy or sell any securities or instruments mentioned in it.

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