James Athey: The certainty of uncertainty

Uncertainty is a paradoxical concept in the world of investing – specifically when it is used as a reason not to act. The implication is that at times there may be certainty. If something is certain then by definition it is “in the price” and as such its occurrence will have no bearing on the future return of assets. Only acting when the outcome is certain should be a surefire way to the poorhouse.

Successful long-term investing is less about certainty and uncertainty (call those black and white) and more about subjective probabilities (the infinite shades of grey in between). Even in a world of unusually high uncertainty it should be the case that there is a price attractive enough for an informed investor to take-on the odds. I’ve over-simplified hugely but this notion is part of the basis for billionaire investor Howard Mark’s approach to investing. He doesn’t claim to know what’s going to happen in the future but he feels able to broadly assess when the odds are significantly stacked in his favour (usually that means when things have got really bad in the economy and risky securities issued by corporates are available at fire-sale prices) and at times such as these he will act aggressively in spite of the perception among the masses that uncertainty is everywhere.

An even more perplexing paradox of recent times is the idea that uncertainty, say around the path of inflation or monetary policy, might be too high to invest in the bond market while simultaneously a company known to be in bankruptcy is able to sell newly minted shares to a willing investor base (yes Hertz I am looking at you). Personally I would take an uncertain future that might work in my favour rather than the near certainty of buying securities with an expected value of 0 because the issuer of them is already in bankruptcy.

It is abundantly true that we are in a period of heightened macro-economic uncertainty – particularly relative to the post-crisis doldrum years when economic data and market volatility were persistently dull. There are good reasons for this – the journey that we have been on from a global economic perspective, particularly in relation to global supply chains, and from a government policy perspective has been unprecedented in history. That has resulted in an inflationary environment unlike any that many of us have experienced and this is testing 'central banks fortitude' in a multitude of ways. Can they really deal with inflation when doing so risks rendering their government’s fiscal laxity unaffordable. The UK got a whiff of what might happen if markets revolt during the fast and furious period surrounding Liz Truss’ ill-fated premiership. No government or central bank wants to see those vigilante forces visited on their shores.

Thus, our contention is not to make light of the issues nor to claim that we have specific foresight over and above the next market prognosticator. Rather our belief is that it is possible to navigate these choppy waters with a cautious and balanced approach to investing. Diversification isn’t a dirty word. At the time it may feel uncomfortable reducing exposure to an asset or an asset class which is performing better than all the others but doing so is a necessary means of achieving superior long-term returns.

It is in that context that we view the opportunities within the bond market as attractive. Yields are high relative to recent history and over time this will act as a headwind to economic activity. This presents the possibility to earn attractive income as well as achieve a boost to returns from capital appreciation. Meanwhile in many cases the valuations being attached to company earnings in the stock market provide investors with very little margin for error in the event of either company specific or economy-wide challenges ahead. Market pricing is making a diversification into bonds attractive even if the future remains clouded in uncertainty.

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This article is provided for general information purposes only and should not be construed as personal financial advice to invest in any fund or product. These are the investment manager’s views at the time of writing and should not be construed as investment advice. The opinions expressed are correct at time of writing and may be subject to change. Capital is at risk. The value and income from investments can go down as well as up and are not guaranteed. An investor may get back significantly less than they invest. Past performance is not a reliable indicator of current or future performance and should not be the sole factor considered when selecting funds.