The Downing Fox Investment - Q1 January 2023 

We live in grim times – what to do?

One of my guiding investment principles is “follow the money”. By that I mean find out what investment experts are actually doing with their own money, not what they say they’re doing. It’s amazing how different these can be.¹  

It’s useful at this time of year: Investment outlooks are everywhere. You should ignore them all. All but a few, that is. Some are invaluable.  

What separates the wheat from the chaff?  

The ‘wheaty’ authors are usually good investors walking their own talk. The chaffsmiths tell you one thing, while doing something else with their own cash (and, interestingly, what they’re doing often turns out to be more damaging than what they’re telling you to do). 

In that spirit, and in these testing times, I thought I’d explain what I’m doing with my money (rather than tell you what you should be doing with yours). 

First, if you’re an adviser, I know you’ll appreciate a good fact find. Here goes:  

I’m in my late forties; I’m married; I have no plans to retire early; I have a high tolerance for volatility (but not risk: Risk is different to volatility - it’s far riskier); and I’m a few years shy from my two kids entering the financial vortex of higher education. 

I’m exposed to UK residential property through our house, but no other properties, and I hold cash for the vague unpredictabilities of life (all sterling, but I should hold US dollars too – we’re not the island we used to be). I also have a little gold - the result of letting my imagination walk down some very dark paths.  

Everything else - my “investable wealth” in the industry jargon - is in equities. 

That’s mostly my pensions and ISAs (as well as Mrs Evan-Cook’s and the kids’). These used to be invested in the funds I managed at Premier, my previous company. Long ago I figured out it was both easier and better to invest it all into my own funds. In line with what I said above, I found it improved both my returns and those of my funds’ holders.  

And that’s the plan at Downing. It’s the plan, rather than the reality, because we’re currently in the process of launching the Downing Fox funds². So, until then, I can’t eat my own cooking. Rest assured, my money will be first through the doors on launch day. 

Instead, I’m currently parked in a competitor’s fund of funds. A competitor I know and trust, and who has a similar investment philosophy (and no, I’m not about to tell you who that is). Almost all that fund is invested in equities, specifically through well-managed, highly active funds. 

That, in a nutshell, is where my investable wealth is today, and will remain for the foreseeable future: In well-managed, highly-active equity funds. 

Why Equities? Why Active? And Why Now? 

Now, if you’ve invested with me in the past, none of this will surprise you. I always hold well-managed, highly-active equity funds. I wholeheartedly believe it’s the best way to secure not just the returns that a market tracker will harvest you, but a meaningful amount beyond that too. Meaningful enough to compound an acceptable retirement pot into a generous one, for example. 

But I think it’s especially relevant given the current onslaught of political and economic pickles (the Polypickle?). 

Why?  

It’s useful to split that question in half: Why am I holding equities? And why am I holding them through actively managed funds, not trackers? 

Why Equities? 

It probably hasn’t escaped your attention that inflation is back. And not just a light dusting either – we’re neck-deep in it.  

Its resurrection walloped financial markets last year, be they equity or bond. But inflation’s real damage isn’t caused by falling financial asset prices, it comes from the prices of everything else – food, fuel, healthcare - rising faster, and for longer, than the financial assets you use to buy them. 

In short, as far as your stored wealth is concerned, high inflation means standing still is not an option.  

To be fair, standing still has rarely been a good option - particularly in the UK, which has had a long love-in with inflation. But there were times, like the last decade, when it was no more than mildly corrosive to your financial health, while there were others, like the mid-noughties, when it was harder not to outpace of inflation, as interest rates on bank accounts exceeded CPI. (Standing still back then meant withdrawing cash to stuff in your mattress). 

But with inflation in double digits, standing still today means heading backwards. Quickly. 

This is why I want my own capital to move forwards. Quickly. And not just quickly; reliably too. Ideally more quickly than inflation, but with our last CPI print coming in over 10%, that’s a big ask. So at least as quickly, or the same ballpark anyway. The best way to do this, in my book, is by holding equities. 

When you hold a share in a company, you hold the right to a slice of its future profits. If it’s a good company in a resilient industry, those profits will rise over time. That might be because the company gets bigger and/or better, but also because they’ll be able to raise the prices of their products to counter the inflating costs of their inputs (labour, raw materials etc). If they can do this, their share price will rise to reflect the higher profits they make. Such a company is, over the long term, inflation proofed. 

Put like that, it’s a no-brainer. Clearly it’s not a no-brainer though, or I wouldn’t need to write letters like this. What makes this a some-brainer is the short-term volatility of share prices: It’s true that, for good companies, profits rise somewhat steadily over time, and that their share prices eventually rise to meet those higher profits, but share prices walk a wilder, more unpredictable path than profits along the way. 

You might even call them hysterical: If it looks like profits will drop a little, share prices often drop a lot. The relationship looks something like this: 

This means that, while a decent equity can give you long-term protection against inflation, in the short-term it’s a lottery. 2022 illustrated this: The violent return of inflation, along with some other macro nasties, shocked investors, causing equity prices to drop sharply. 

So if you’d bought equities in the hope they’d provide short-term protection against an inflation shock, you were probably disappointed (“probably” because some equities did OK last year). 

The answer is simple: Stop worrying about the short-term.  

I appreciate this sounds glib: It’s far easier said than done, especially when your wealth is receding rapidly and the press are screaming blue murder. Doesn’t mean it’s not true though. These charts, which I created for a Citywire column last year, illustrate the point: 

Source: Morningstar, MSCI World Index, Total Returns 31.12.2019 to 31.12.2020.

If these were three separate financial products, which would you choose for your clients? 

Number 3, right? Who’d volunteer for the emotional distress of the other two? They are, however, all the same thing: The global stock market in 2020. The only difference is how often you checked: daily; monthly; or once a year.  

Those troughs are when the real mistakes are made: It’s all too tempting to sell out, as the newsflow is invariably bleak, and getting bleaker. But you’re usually locking in losses by denying yourself the rebound. And even if it does fall further, the newsflow will still be dark (it’s always dark at the market trough, it doesn’t improve until months later), so eventually you’ll miss the bottom, and then the recovery. If you keep making this mistake you can forget about inflation: It can do what it likes; you’re causing more than enough damage by yourself. 

So stretching your investment horizon is better for your emotional and financial health.  

Once you’ve stretched your time horizon, thereby dulling the siren song of short-term noise, equities have historically proved the best asset class for keeping up with inflation³.  

That’s why I’m currently holding as much as I can. 

Why equities through active funds, not trackers? 

I mentioned above the benefits of holding a good company. Unfortunately, not all companies are good.  

But that’s not the only problem: Sometimes the share prices of companies that are good can rise too far. If this happens, a good company can become a bad investment, as its share price will likely drop to bring it back into line with reality (if it’s a genuinely good company, this loss might prove temporary. But “temporary” might mean as long as 16 years, as it did for Microsoft after its temporary share price peak in 1999 – see chart). 

Source: Morningstar, Price USD, 31.12.1999 to 31.12.2022.

However, when you buy a tracker, you’re accepting that you’re not just buying good companies at reasonable prices, you’re also buying all the bad companies and all the overpriced good ones too. It’s part of the deal. 

There may be sensible reasons to do this, primarily that you don’t have the interest, expertise or time to sort one from the other. But, if you do, it’s perfectly possible to build a portfolio with more exposure to good companies at reasonable prices than the market tracker, and therefore lower exposure to bad or overpriced companies. 

This is always a useful and important thing to do. But, with profit-killing inflation on the prowl, and large parts of the market looking too expensive, I think it’s unusually important to do it today. 

I, however, can’t do it. Because I have no expertise in analysing companies. But what I do have is expertise in analysing fund managers, which means it’s not too hard to find disciplined, experienced investors who can do that for me (and who don’t charge too much for doing so). 

So that’s what I do. I find exceptional investors who think hard about the quality of the businesses they hold and the prices they’re being asked to pay for them. Then I trust them to do their job. 

What I should end up with is a broad selection of companies that are more likely to cope with inflation, and less likely to hurt when their share prices adjust back down to a reasonable price. It won’t be 100% perfect – nothing ever is - but if I do it well my selection will, after charges, outpace the good-the-bad-and-the-overpriced collection held in a market tracker. 

That’s how I, personally, am dealing with the threat of inflation. 

I appreciate that doesn’t answer every question. Like what you should hold if, even after really trying to stretch your investment time horizon, you still can’t stomach the short-term price swings of a 100% equity portfolio.  

Good luck for 2023, 

Simon Evan-Cook, Fund Manager, Downing Fox Funds* 

 *subject to FCA approval 

^[1] In my more combative days, I remember taking umbrage with a well-respected journalist writing for a prestigious national newspaper. I generally liked what he wrote, but his tone on active investment management was relentlessly negative, constantly implying that holding actively-managed funds was no more than financial self-harm. I finally hounded him into a meeting, in which he confided that he merrily invested in some of the same active funds as I did (the ones that were obviously run by exceptional investors), and was chuffed with the results too. Who knew?! Certainly not his readers.

^[2] Expected end of Q1. But this is a whole other story: Investing used to be the hard bit of fund management, but recently the setting up process part has made the investing bit feel like a cake walk, even in markets like last year’s.

^[3] Pedants corner: There are some caveats to this: Clearly if you were a non-Russian holder of only Russian equities, for example, you’d grab a real loss of ‘only’ 10% with both hands right now. But for UK equities collectively over the last century or so, it applies.

Risk warning: Opinions expressed represent the views of the fund manager at the time of publication, are subject to change, and should not be interpreted as investment advice. Please refer to the latest full Prospectus and KIID before investing; your attention is drawn to the risk, fees and taxation factors contained therein. Please note that past performance is not a reliable indicator of future results. Capital is at risk. Investments and the income derived from them can fall as well as rise and investors may not get back the full amount invested.  

Important notice: This document is intended for retail investors and their advisers and has been approved and issued as a financial promotion under the Financial Services and Markets Act 2000 by Downing LLP (“Downing”). This document is for information only and does not form part of a direct offer or invitation to purchase, subscribe for or dispose of securities and no reliance should be placed on it. Downing does not offer investment or tax advice or make recommendations regarding investments. Downing is authorised and regulated by the Financial Conduct Authority (Firm Reference No. 545025). Registered in England No. OC341575. Registered Office: St Magnus House, 3 Lower Thames Street, London EC3R 6HD.