To trim or not to trim

Fundsmith’s famous three rules for investing are:

1. Buy good companies

2. Don’t overpay

3. Do nothing

Warren Buffett’s favourite holding period is forever.

These two outstanding managers rarely sell and generally don’t trim.

Whilst these two managers similar views are important for reducing tax and trading costs, the issue it presents is potential overvaluation in a portfolio. Coke got to 48 times earnings in 1998. It took 17 years to get back to their highs. Are there lots of Coke style multiples in today’s market?

We think there are.

The question as to whether to trim for a retiree or pre-retiree needs to factor in valuation risk as part of portfolio management.

If you are a retiree or pre-retiree with a portfolio of overpriced assets, your wealth may be at risk.

The concept of buy and hold makes sense in most market conditions, however many do not have sufficient assets in retirement to ride the waves of markets when markets get to extreme levels of over valuation.

For someone in or approaching retirement, sequencing risk is enormous. If you retire at the top of the market, you may not get the retirement you planned. Multi decade long drawdowns have occurred in various markets throughout history. If you don’t plan or have a strategy for managing these risks, you may be severely disappointed.

Drawing down on your assets during market drawdowns can eat away at your capital faster than most comprehend.

One way to manage sequencing risk is to use a dynamic asset allocation to reduce exposure to potentially overpriced assets. A static asset allocation of 70/30 may not work as well as it has in the past with rates so low and asset prices so elevated. Using a dynamic asset allocation may be a more sensible strategy.

Knowing the fair value of your investments is paramount for this strategy to work.

The low returns on defensive assets makes this strategy potentially more difficult.

Valor generally invests a client’s entire wealth. This distinction over other asset managers who often only manage a fraction of a client’s wealth is important. It means we can more accurately match a client’s risk profile with more appropriate investments for their stage of life.

We aim to combine a preference for long-term ownership of wonderful companies, similar to Buffett and Fundsmith, with a dynamic asset allocation strategy. We have owned a number of the companies in our portfolio for nearly a decade. We simply trim around the edges of these companies when they rise above their long-term average valuations and add back to them when they dip below their long-term average valuations. This has meant we often outperform on the downside and slightly underperform on the upside when we are generally more cautious.

In 2018, we trimmed twice before the two market corrections in February and November, then reallocated back during the market dips. This led to a 5.5% return for our growth portfolio during a market down year.

In January 2020, we were trimming due to some of our holdings rising above their fair value.

Our caution then led to our March performance of -2.9% in a -20% market fall.

Unfortunately, we were too cautious during the March 2020 crash and whilst we avoided most of the crash, we didn’t participate in the rally as much as we should have.

We find ourselves in another strong market rally today. The markets look expensive on most measures. Having some dry powder for likely market volatility at some point in time is probably warranted, particularly for those that are in or nearing retirement.

Before 2020, we have never owned gold. Due to the historic levels of monetary stimulus, we have replaced a portion of our defensive component in gold to protect against the enormous fiat debasement which appears to be occurring around the globe.

As Buffett suggests on how to become wealthy:

Close the doors. Be fearful when others are greedy and greedy when others are fearful.

We are observing a potentially unhealthy bout of greed in global markets today. Be careful out there…