After a very strong Jan/Feb, I decided to consolidate our gains rather than risk the whipsaw effect of trade war negotiations where Trump would constantly tweet one thing and do another. Moreover, the US is thought to be in a late stage of a very long economic boom while Europe and China’s economic data is trending downwards. As a result, further gains in Mar/April was foregone but we were spared the wild whipsaw of May to Sep.
The US surprised the market by increasing tariffs in May causing a 8.5% drop in a month, but the parties started talking again in June/July. And to make sure he remains unpredictable like a professional poker player, Trump decided to slap additional tariffs of 10% in August followed by an immediate Chinese retaliation, again shocking the market. To add to the bearish backdrop, HK protests were also escalating in Aug/Sep.
The turn came in Oct when the US-China are rumoured to be moving towards a partial trade deal. At this point, the market was exhausted in guessing what Trump and Xi would do. To be prudent, I decided to wait until news are confirmed before adding risk. In November, the key event focus was the additional tariffs that would kick in on 15th December if negotiations fail. At the end of November, the Fund’s returns are about 2% higher YTD than the market.
Negotiations finally were successful at the last minute on 13th December and the market rallied hard. Unfortunately our defensive positioning that served us well for most of the year led to the Fund lagging the market rally in the second half of December. Since then, we have been adding risk and have caught up to the market.
Mistake or Prudence?
To be clear, I’m not satisfied with the results for 2019. Even though the play from Jan to Sep was good, the outcome in Q4 was poor. It feels like when Manchester United played well for most of the match, but lost 1-2 to Man City due to a late goal conceded. Ex-ante, would I have continued the defensive strategy? In one sense, yes – because the 20% probability of a further 20% drop in the market is a real tail risk that needs to be managed. A failure of negotiations in December, leading to additional tariffs would almost certainly collapse the market. My mistake was rather not thinking enough about the returns foregone if I was wrong. On hindsight, it’s was probably best to buy call options on the market, which was cheap anyway, to take advantage of a bullish event.
Looking Forward
2019 was a cruel year for many fundamental, value based funds and family offices that I know. For those funds, cheap stocks got cheaper but in a rally they were the laggards. For family offices, their conservative approach meant low single digit returns. For both, the inability (or unwillingness) to think broadly and use a wide range of financial tools (fixed income, options, ETFs, leverage etc) meant lost opportunity.
For Acre, I pride myself in being able to deliver strong consistent returns. This means not being down in a down market, and beating market returns in an up market. That requires being nimble and open-minded yet maintaining an investment process, while that very process is also gradually evolving. As such, in 2020 I would be using more of the tools above and making improvements to the investment process, without compromising on prudence to deliver on Acre’s goals. Happy to have a discussion of what the above is for anyone who might be interested.
Looking forward, 2020 would likely be a year of economic consolidation and continued low rates, with the progress of the Phase 2 trade deal and the US impeachment / elections as the political risk backdrop. The Wuhan flu situation would also need to be closely monitored. On the upside, fiscal stimulus is likely the next lever to pull in terms of government support. As such the broad environment is still conducive for equities and fixed income even though markets have rallied and yields tightened. Therefore, careful selection and flexibility in avoiding risk events is important to generate returns.
2020 should be an interesting year to generate returns, and having learnt some lessons from 2019, I am confident that we’ll be well poised to do better this year.