Padley: Prepare for a 'quiet bull market'

After a wild year with the shortest bear market and fastest recovery in history, Marcus Padley from Marcus Today suggests things could be quieter in 2021. But that doesn’t mean investors can remain complacent. He stresses that investors must remain vigilant and be prepared to act.

“Under our ‘Quiet Bull Market’ theory we are fully invested … We are in some of the sectors that still have upside to the expected recovery. That means being overweight resources, energy, travel, tourism, some REITs as well as having solid health care holdings and some technology.”

As Padley points out, "there's no reason, just because the calendar is ticking over, that anything changes because it's January 2021, not December 2020", and he expects last year's trends to flow into next.

In this Q&A, he contrasts his experience of broking with that of managing funds, shares some of the key themes to watch next year, and explains how he’s positioning portfolios to take advantage of those trends.

With your funds management business reaching $100m of FUM, you've hit a level where many managers start to become more 'mainstream'. Should we expect Marcus Today to adopt a more traditional funds management approach?

There comes a time when liquidity, the ability to buy and sell a holding in a stock without pumping or destroying the share price, starts to change the way you manage money. It takes you "up the market capitalisation curve". With $100 million of FUM, it's not a big issue yet, but even we have started to move prices. 

Australia is not a liquid market so when you're chasing growth in small or mid-caps, rather than "replicating the average" in big caps, which is what 90% of the industry does, liquidity issues force change. The freedom to exploit individual stock opportunities becomes limited by the ability to take a meaningful holding compared to the size of the fund overall.

When millions turn into billions, some stocks just must drop off the radar. It takes too long to enter, and too long to exit. More significant funds can't trade small stocks, they can only invest. Investing in small and mid-cap companies becomes a genuine long-term investment, which means they have to get it right because they get trapped.

Investing at the smaller end of the market also creates less reliable year-to-year returns, which is very undesirable. Certainty sells funds, volatility doesn't. Net result, as funds get bigger, they get less interested in smaller stocks and more involved in the biggest stocks. In so doing they move towards the averages where there is little edge to be had and a mountain of insipid competition. We are not there yet, if we make a mistake in a mid-cap stock we can still change our minds, but it is inevitable that as we get bigger, the opportunities shrink, we will hold more stocks, we will hold more large stocks, performance will become more predictable, more in line with the market, and more average.

As the Mandalorian says - "This is the way". You can't fight it.

How has your philosophy on investing developed over the years you've been managing a fund? Do you think about it differently as a fund manager to when you were a broker?

Completely differently. Broking is a completely different game. As an institutional broker in London, my job was to grease the communication lines between UBS Phillips & Drew and the English and Scottish institutional fund managers. That did not require much financial acumen on my part.

Rather than teach me about discounted cash flows, UBS Phillips & Drew sent me on a one-week residential course on how to sell financial products which included being taught how to host an expensive client lunch. I knew more about the wine list at Quaglino’s than the value of a stock. 

Interestingly most institutional brokers used the traditional formula of ordering the second most expensive wine on the wine list so as not to look too tacky. We were told to order the most expensive, and the head of equities would get upset if our company credit cards hadn’t run up the cost a small Rolls-Royce by the end of the month.

Things have changed since the heydays of 1985 of course, but that was the skill. Keeping relationships sweet without pretending for a moment that you had an opinion about a company's discounted cash flow valuation. All that was left to the analysts and the corporate finance bods. My job was to introduce them, flog the corporate deals and take the orders. I went through the '80s in ignorance of basic financial principles, but at the time it didn't matter, as long as I could order a good bottle of Chateau Lafite Rothschild.

I jest of course, but the big difference between the sell-side and the buy-side is simple. Anyone who runs funds will tell you the same truth; the difference is a "Responsibility for performance". Running funds is a responsibility that puts you through every emotional state you can imagine, from punching the air in delight to sleepless nights. I have learned deep respect over the last few years for fund managers. Taking responsibility for other people's money is onerous and it takes maturity. It is a process you must go through to learn, an intellectual property that can only be gained through experience.

I'm sure if I had sat down with Geoff Wilson, David Paradice or any number of other passionate, caring fund managers 10 years ago and asked them to give me the five things you have to know about managing funds, they would have scared me off ever starting.

As time goes on it gets easier. The key to surviving the rollercoaster, personally, has been to harden up. It's a tough job. You cannot take it home, you cannot allow it to invade every moment. To survive it you need a framework, an investment philosophy, a structure you work within and a process that routinely handles and addresses the unexpected bits that can cause you so much pain and stress. You also need colleagues to be part of this process, colleagues you respect, that have experience, that have objectivity, who are bold enough to contribute, that are prepared to share the responsibility and that you trust. I could not do it without the daily involvement of the Marcus Today team.

In your view, what defines the difference between investing and trading, and can trading have a legitimate role to play in investor's portfolio?

Investing or trading, it’s all the same to me. If you want to play with words it's a question of timeframe, short or long, and after that it’s just semantics based on people’s relative positions. Someone who day trades sees someone who trades over a week or a month as an investor. Someone who buys and holds sees anyone who ever sells anything as a trader. If you want to play with these words you have to come up with your own definition but don't expect anyone else to agree with you.

In the end it really doesn't matter, investment is not about trading or investing it is about probabilities. It is about doing the work to narrow the probabilities in your favour.

There is no certainty, so that's the best you can do. Narrowing the probabilities as much as possible in favour of a stock going in the direction you want it to go on your own timeframe whatever that might be, vigilantly reassessing that decision regularly, and being flexible enough to admit when you got it wrong and change the decision. There is no room for pride or prejudice in investing. There is no room for emotion. There is no room for anchoring. All weaknesses of the retail investor. There is nothing but logic, probabilities, and constant reassessment.

All of us are long-term investors, we want to buy a stock that goes up forever, but you are blinkered, and some people are terribly blinkered if you think the only way to invest is to buy something and never sell it. It is simply not logical. You must constantly renew, refresh, reassess, sell, and buy. There is no trading or investing, there is simply the process of investment and there is no benefit in defining yourself with some meaningless wordy description that limits your actions. Making money out of the stock market requires both buying and selling, not just buying. So, of course, "trading", if you choose to call it that, has a role to play in everyone's portfolio.

What are the most important investment themes for investors to watch in 2021?

This is a very clickbaity topic for this time of year and in order to get clicks I know, I should "wow" you with something radical that gets tongues wagging.

But there's no reason, just because the calendar is ticking over, that anything changes because it's January 2021, not December 2020. 

But let me give you a couple of realistic predictions anyway.

The highest probability prediction is that the themes that are trending at the moment will continue to trend. There is no point you heading off down some lonely contrarian road with your investments just because it's the New Year. Believe what is happening now, invest in that and the odds are that you will be more right than wrong. What is happening at the end of 2020 will likely continue to be true in 2021. So here are the current themes that are likely to persist and deserve more faith than some wild clickbait fantasy:

• We are seeing the foundations of what we hope will be a 'quiet bull market' developing. We hope that will persist and at the moment we are fully invested to exploit that expectation. Until it changes.
• Central banks will remain on 'maximum stimulus' settings until they affect a global economic recovery founded on a global vaccine rollout. The money-printing has our backs. Risks are low.
• We expect less political volatility. Biden is not a personality, he is the returning establishment, and with Janet Yellen as US Treasury Secretary we can expect four years of nothing happening, which Wall St will love and all fund managers and investors will relish after the last four years of political instability and unpredictability.
• Stay with cyclical sectors for the recovery. A global economic recovery to a pre-pandemic norm is the best bet at the moment. There are still opportunities in sold-down sectors like energy, financials, media, travel, tourism, REITs and cyclical sectors like resources.
• Technology remains fundamentally overvalued but is in an up-trend, stick with it until it ends.
• Don't live in fear of a major correction. Just be awake when it starts. The stock market is not about predicting the top, it is about reacting to the top. Stay awake.

How are you positioning your portfolios to take advantage of the opportunities ahead?

As our investors and Members know, under our 'quiet bull market' theory we are fully invested, and with our focus on outperformance rather than average performance, we are currently huddled in some of the sectors that still have upside to the expected economic and social recovery from this year’s pandemic. That means being overweight resources, energy, travel, tourism, some REITs as well as having solid health care holdings and some technology. We reassess it on a daily basis, but at this point, 'Economic Recovery' is the theme. It's not a prediction, it's a hope based on probability. That's as good as it gets in the stock-market.

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