Woodsford Capital Annual Letter 2021

伍治坚证据主义 2022-01-15 00:51

Thousands of experts study overbought indicators, head-and-shoulder patterns, put-call ratios, the Fed’s policy on money supply…and they can’t predict markets with any useful consistency, any more than the gizzard squeezers could tell the Roman emperors when the Huns would attack.
Peter Lynch

Here is the world stock market total return in thelast 3 years (MSCI ACWI): 26.7% (2019), 16.4% (2020) and 18.4% (2021). Surprisingly good, isn’t it? Consider that that the whole human race has just experienced the worst virus pandemic in the last 100 years, with millions of people dead and more than 300 million people (still increasing by more than 1million every day) being infected, it is fair to say that the equity market has delivered a positive surprise.

If we pick the country that has the highest COVID death: Untied States (800K+ so far). Here is the equity market performance(S&P 500) over the last 3 years: 31.4% (2019), 18.4% (2020) and 28.7%(2021).

It seems that COVID infections and deaths are totally disconnected from equity market returns. The question, is why?

The short answer is that global governments and central banks have responded to the pandemic with unprecedented monetary andfiscal stimulus.

To put the above numbers in perspective: During 2008~09, major central banks launched Quantitative Easing as a reactionto the global financial crisis. By the end of 2009, the total assets of FED, ECB, BOJ and PBOC combined have ballooned to about $9 trillion, a historical high by the standard then. By the middle of 2021, however, the same fourcentral banks’ total assets reached a whopping $30 trillion, more than 3 timesthat of 2009.

From the above, it looks like investing is so easy: central bank and government easing leads to rising equity markets. Simple, right?

The reality, however, is a bit more complicated.Consider the following:

From the beginning of Sept 2021 to the beginning ofOct 2021, the S&P 500 dropped 5%+ in a month. The worrying headlines were all over the news: Dow drops 500 points on September’s final day; S&P500 suffers worst month since March 2020; Janet Yellen warned of economic catastrophe should Congress fail to raise debt ceiling; China Evergrande Group had billions of dollars of debt coming due; Supply chain to the US hugelydisrupted by COVID pandemic, and so on…. Under such a barrage of negative news flow would an investor be expected to keep calm and stick to their beliefin the long-term prospective return of the equity market? It of course variesfrom investor to investor, but I wouldn’t have been surprised to see many startto worry about their holdings and consider reducing the equity exposure in their portfolios.

Such worries do not come from thin air. There are seemingly justifiable reasons for investor concern, over and above negativenews headlines and sentiment. For example, the CAPE ratio of the S&P 500, a common valuation measure, was at 38 in December 2021, second only to thehighest value of 44, which was achieved in December 1999.

In June 2021, the combined market valuation of public listed companies, whose Price to Sales Ratio (PS) exceeded 20 times, reached anunprecedented high of $4.5 trillion, even higher than the equivalent ratio inDecember 1999 ($3.6 trillion).

This poses a simple question - are we in the midst ofan  equity market bubble?

The picture could look even more scary if we look atbond valuation. Here is a list of major government bond (10Y) yields as of Dec1, 2021:

In most industrialized countries, the government bond nominal yield is next to zero and the real yield is negative. The investment community and pundits have been crying for a bond Armageddon moment for quite afew years, if not longer. Will the reckoning finally come, to cause global equity market turmoil?

On top of equity and bond valuation, we still have COVID-19, the seemingly eternal subject. Even though more and more people indeveloped countries are vaccinated, the COVID virus spread still causes frequent disruptions to day to day life. After the new variant, Omicron, wasfound in South Africa in November, Israel and Japan closed their borders to all foreigners, regardless of where they came from. Other countries put uprestrictions on those travelling from certain high risk African countries. 

At the same time, Europe and the US witnessed a vertical spike in virus infectionsafter Christmas and were forced to implement various lock down measures to slowdown the spread. There is no visibility as to whether and when we cancompletely get out of the darkness and go back to normal life. Can businesscontinue to sustain and grow under such uncertainties? Do we still the risk ofan off-the-cliff drop in business activity, consumer confidence and equity market valuation once governments are forced to withdraw stimulus?

Or will we see a repeat of 2020 & 2021, with yet more stimulus and subsequent strong equity markets?

All these questions, in my opinion, are almost impossible to answer knowingly. My belief, as I have often written before, isthat it is futile to try to predict stock market movements in the short term. Investors who are obsessed with pattern recognition, or current sentiment, to predict where the market will go, will inevitably end up being fooled by randomness.

This is exactly one of the reasons why it is so difficult to make money trading equity markets, even in a bull market. If welook back in history, there is no-doubt that we have been in one of the longest bull markets in history: MSCI ACWI up 101% and 223% in the last 5 and 10 years (closing Dec 31, 2021) respectively. However, not many individual investors canconfidently claim to have reaped such returns in the same period. In anutshell, as many studies have shown, the majority of investors fail to makemoney in a long and rising market.

There are a few reasons for this. No bull market goes up in a straight line. There are always periods of drawdowns and that’s usuallywhen the investors are shaken out. From 1928 to 2020, for example, the USequity market suffers a drawdown of more than 20%, once every 4 years, on average. If we define a drawdown event of more than 20% as a bear market, then over that period, during a quarter of the time, the US market was in abear run. In a perfect world, any investor would get fantastic return if they could foresee the coming of such drawdowns. In reality, however, no investor, professional or not, has been proven to have such capabilities.

Another very important feature of any bull market, is that one never knows how long the bull market will last. For example, the 1940s bull run (measured by S&P 500) lasted 26 years (1942 to 1968), the 1980s bull run lasted 18 years (1982 to 2000), and one can argue that the currentbull market has run for more than 10 or 20 years, depending on whether youstart counting from 2000 or 2008. Every year since around 2010, I receive the same questions from some of my investor clients: do you think we are at the end of a bull run? The stock market looks toppy, right? I am just afraid thatit is too expensive to buy into the market now?

Unfortunately, such worry is not helpful in enhancingthe return for the investor: if you miss an up year of 20%, it is equivalent tolosing 20%.

I know my smart readers would say: well, so I shouldjust buy an S&P 500 index ETF, or MSCI World index ETF, and sit on it for50 years, right? In fact, that is not a bad idea. For example, this is what Warren Buffett wrote in 2013:

My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. I believe the trust’s long-term results from this policy will be superior to those attained by most investors—whether pension funds, institutions, or individuals—who employ high-fee managers.

The problem, however, is that we are all not Buffetts, and even Buffett would be doubted. For example, Buffett openly admitted that hemade a mistake to have purchased Heinz Kraft. Back in the first half of 2020, Berkshire Hathaway sold its multibillion dollars stakes in the four major US airlines, only to see their stock price torebound sharply afterwards. There is simply no way that any sane investor wouldbe comfortable to simply follow Buffett’s investment advice on paper withoutany questioning or doubting.

Which brings me to a more pragmatic solution that wehave been promoting for a number of years: design a highly systematic and diversified portfolio, to be managed at a very low cost, and then hold it forthe long term. I believe such an approach ensures that we minimize any humanerror related to emotional reactions to market volatility, we diversify theinvestment risk across asset class and different countries and therefore minimize drawdowns and reap the benefit of capital market returns over the long term.

Sounds simple and boring? Well, on one hand, it isexactly like what Charlie Munger used to say:

Take a simple idea, and take is seriously.

But on the other hand, once we take the ideaseriously, it is not that simple anymore. There are quite a multiple of factorsto consider and implement, such as WHT implication, domicile jurisdiction selection of the ETF for the investor, how to screen and sort ETFs and makesure the selection is always up to date, how to minimize cost in trading, how to implement an optimal rebalancing strategy. But most importantly, it is a deep understanding of how the market and diversification work that underpinsthe foundation of our products, which needs to be effectively communicated toeach of our investors.

Lastly as usual, let’s take a look at some performance comparisons:

The above table shows the returns of well-known multi-asset funds including our own WFS 10 and WFS 20. They are comparable as all are multi-assets long only strategies. WFS follows a transparent approach to designand execute its strategy, by using a list of screened high-quality / low-cost ETFs that remain visible to you at all times, in your own managed accounts. Our charge is the lowest across the board. The above is a real life example of how to achieve solid and superior return in a volatile market: keep the cost down, have discipline, always diversify and be patient.

Finally, on behalf of all of us at Woodsford Capital, I would like to thank all our investors: your steadfast support is what keeps us going, and I enjoy my interactions with all of you enormously and look forward to many more in the years ahead. I wish all my readers a happy, prosperous, healthy and lucky new year!



Zhijian Wu

CEO, WoodsfordCapital Management