The uncertainty caused by stock price changes is a persistent concern for many investors. When the stock prices have risen for a long time, a drop in stock prices is speculated. Correspondingly, once the prices have collapsed, they are feared to hit rock bottom.
As professionals, we are wrestling with the same feelings. Especially, since we are investing the hard-earned money of our investors. This article introduces the Sifter Fund’s way of thriving with a 100% equity portfolio through good and difficult times.
First, it is important to grasp where the uncertainty springs from and where we, as investors, can make the difference.
Uncertainty springs from a lack of knowledge and control.
In Sifter’s investment process, we have acknowledged that the stock market cannot be controlled. However, we can have an impact on investment decisions, what to own, how to monitor, and when to sell. Let’s review how does a systematic investment process reduce uncertainties?
1. Stock market cannot be controlled
The first piece of advice is to understand and accept the nature of stock markets. Long-term investors know that markets live their own wild lives and often overreact.
Collapses of more than 30% have occurred in the equity markets approximately every ten years. Small market corrections (-10%) occur annually and smaller ones (-5%) even more often.
Tiny corrections are usually explained through an economic or political event, without scientific evidence concerning the reasons for the correction. This has more to do with market psychology.
An investor trying to speculate with market fluctuation correctly is doomed to fail in the long term. Usually, the timing of the purchase and sale of stocks goes wrong more often than right.
Historically, after a heavy correction in stock prices, the market has risen rapidly and many investors have missed the best days of the new recovery.
A long time in the stock market is often better than timing the stock market correctly.
Learn more: Should you buy or sell?
2. Stock selection – do you own expectations or solid business returns?
During boom periods, many investors tend to put money into hot stocks which seem to rise daily. The aim is to sell the stocks and obtain robust profits before a possible collapse. In practice, this rarely succeeds. Moreover, the uncertainties experienced by the investor usually increase as the price movements of hot stocks are rather drastic.
The Sifter Fund has a systematic investment strategy. We search for high-quality businesses among the 65,000 listed companies, which have shown a strong track record of making money and whose future can be quite accurately analysed.
The importance of fundamental business analyses is crucial when the company is selected for the long-term portfolio. The portfolio must include strong companies which can make a profit also in the downcycles. Investor’s uncertainty is reduced when the stocks are selected carefully based on fundamental analysis.
Read more about the company selection: How to choose stocks?
3. Stock monitoring – how does the future look like?
Many investors seem to have the wrong idea about monitoring stocks. They focus almost exclusively on share prices. Of course, the development of share prices is significant, but the most important thing to a long-term investor is the growth of the company’s capacity to make money.
Companies are living organisms. Their earnings model and competitive advantages may suffer. Also, changes in the industry may diminish their capacity to make money.
Analysing and monitoring companies is a full-time job and it’s also psychologically taxing work. There is little room for feelings, and uncertainty is always present. At Sifter, uncertainty is minimised with help of two things:
- We know the companies – we have conducted fundamental analyses
- Sifter has clear processes and criteria when to sell and buy
When the stock markets are on the edge, you should know the companies you own. Unexpected news and a decrease in stock prices will not lead to panic while we know that the high-quality companies owned by us are healthy and have effective competitive advantages.
Learn more: 5+1 ways to keep an eye on equity investments
4. Selling stocks – when to sell a stock?
Many investors purchase undervalued stocks while believing that their prices will go up again reaching the previous level. Often, there are reasons for the undervaluation and the increased risks are reflected in the prices. A sharp drop does not guarantee that the stock price would ever rise to the previous level. In the worst case, the investor clings to the stocks and even purchases more of the stocks to bring down the average price.
Long-term investing does not work if the portfolio includes companies with poor or weakening money-making ability.
Typically, uncertainty increases when an investor holds the wrong kind of stock for too long. You have to be careful not to fall in love with a stock. You may lose your focus and nerves. A frog won’t turn into a prince, no matter how long you wait.
If you realise that one of your investments is getting on the wrong track, you should sell your holdings in that company. The sooner you sell, the better off you will be.
This is what we do at Sifter. We sell our holdings in a company when we believe its ability to make money in the future is diminished or when we find a better company to replace it with.
Learn more: When to Sell Stocks – 5 Primary Reasons
Long-term quality investing – minimized uncertainty and good risk-adjusted returns
If you are looking for exciting investments, Sifter’s peaceful, systematic style may not suit you. However, for the Sifter Fund and its investors, it has suited well.
During the last 18 years, the Sifter Fund has offered an average annual return of 9.8% after all fees (19.6.2003–23.8.2021).
This period has included both the financial crisis (-40%) and COVID-19 spring (-30%). Correspondingly, the year with the highest increase was 2019, +31.4%. High-quality companies survived even the decrease caused by the COVID-19 year with flying colours and Sifter generated a return of more than 10% (2020). Even in the COVID-19 year, we stuck to our stock 100% and made only a couple of profitable trade-offs in our portfolio.
All in all, high-quality companies have historically done extremely well. We are not saying that long-term quality investing is the best or only way to invest, but we see that its most significant benefits are:
- the long-term quality investing is reducing uncertainty as the selected companies are extremely strong,
- returns of the Sifter Fund are historically on average 1% higher annually than the global index (MSCI ACWI) in 2003–2021.
The Sifter Fund has a team with eight members who work according to predetermined processes and guidelines. In other words, Sifter investors have outsourced the management of part of their wealth to this team and benefit from its full expertise for a reasonable price.
If you want to read more about this, we have prepared a guide addressing this style of investment: Long-Term Quality Investing Guide