Thursday 28 Mar 2024
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This article first appeared in Forum, The Edge Malaysia Weekly on February 27, 2023 - March 5, 2023

To put it quite bluntly, the Year of the Tiger was not kind to investors. As if a global pandemic weren’t enough, geopolitical tensions, supply chain crunches, interest rate hikes, stagflation and a climate crisis are pushing us headlong towards a looming global recession.

Nonetheless, there are key lessons to be drawn from the events that have unfolded during the past year. If the insights from these developments can be distilled into a strategy that can inform our investment decisions moving forward, we would put it into three words: Back to basics.

Benjamin Graham’s The Intelligent Investor, probably one of the most famous books on value investing, was published in 1949. But the modern world begs for more, as technology stocks no longer offer the 10X lustre, and economic boom-and-bust cycles get shorter.

These are a few investment nuggets, based on what top-tier value investors, venture capitalists and seed funders often eye before they park their dollars in a start-up or investee.

Inflation

Inflation has widespread effects on both consumer and business. Consumers are able to afford less and the cost of doing business goes up, affecting a company’s eventual profitability. Businesses that do well are those that have high elasticity of demand. They are able to pass the additional costs to consumers. Once there is inflation, central banks would raise rates to tame demand. Funds will flow back to banks and they will fare better too, as with companies with cash, and sectors such as commodities, energy and real estate. Those that will suffer include growth stocks, tech stocks and companies with high debt.

Company leadership

Value investors often review the credentials of a company’s CEO and top executives to ensure they have a proven track record in delivering consistent growth, regardless of economic conditions. Early-stage venture capitalists and seed investors also pay close attention to the calibre of the founding team, as the start-up will not have much operating history to evaluate. 

A strong team will provide a competitive edge resulting in a higher chance of success, ultimately leading to a higher valuation. An outstanding team will shine when times are good but, more importantly, during challenging times, and will be able to steer the ship out of the storm, or land the plane safely.

Moat

All value investors would be familiar with the proverbial “moat”, which is something that provides the company an added competitive edge against new market entrants. This has always been an important factor for consideration prior to making an investment. However, we increasingly see that this “moat” can be taken down by various unavoidable circumstances, such as intervention by governments, deglobalisation, antitrust laws and so on.

Government intervention

Tech companies with moats can come in the form of amassing and exploiting a large amount of sensitive data, compelling network effects and other forms of disruptive technologies. 

However, companies like Didi (ride sharing), Ant Financial (fintech) and Tencent (gaming) were penalised by the Chinese government in various ways. Large social media platforms — for example, Meta (Facebook) and Twitter — have been criticised for influencing political sentiment, inciting hatred, spreading fake news and so on.

Companies that produce staple food items, or even utilities, might also be affected by government intervention; for example, incurring a price cap, limit or ban on exports, which would not bode well for the company. This becomes a risk for investors.

Deglobalisation

Geopolitical tensions, especially between advanced economies (China and the West), further add a degree of complexity for multinational corporations. First, there were tariffs, then outright bans (for example, Huawei and various semiconductor companies). Using the electronics industry (which has been the most affected) as an example, its supply chain is complex and such a ban would have a widespread effect. China is also a large market and being unable to sell products there stifles the growth of a company. Another example is Broadcom’s takeover of Qualcomm that was blocked by the US government.

Chinese companies enjoy a large market in their home country, and some might get listed on American stock exchanges (China American Depository Receipts) to get access to the deep liquidity there. Due to tensions between these two countries, such companies are at risk of being delisted and suffer from devaluation.

Antitrust

Antitrust laws are there for a reason. They prevent the formation of monopolies and cartels that might engage in price fixing, stifling competition. The latest is Microsoft’s US$68.7 billion acquisition of Activision Blizzard.However, from an investor’s point of view, growth of certain companies that we invest in might be limited. This is especially so for large companies with a significant market share.

Climate crisis

Much needs to be done and a lot of money is required to achieve net zero in 2050. The Intergovernmental Panel on Climate Change (IPCC) of the United Nations says US$2.4 trillion (RM10.6 trillion) is needed annually until 2035 in order to cap the temperature rise at 1.5ºC. Investors cannot ignore this and must include environmental, social and governance (ESG) factors into their analysis.

Strategic investments

Private equity or venture capital firms provide strategic value to the companies they invest in, in the form of networks, know-how, market access and so on. Private investors can do the same, where you can invest in a sector that you know well, get in touch with the management and work with them to build more value into the company.

Don’t be scammed

The worst possible outcome is losing 100% of your capital to scammers. Always be wary and ensure you know what the underlying asset is that you are investing in, no matter how many layers of derivatives it is wrapped in. Stay away from things you don’t understand and, if in doubt, ask a professional. Keep track of what the risk-free rate is, and if the promises are much, much higher than that, then there’s a high chance that it is a scam. Check also that the fund is licensed by the respective authorities.

Stagger and stay

Fundamentally, it is important to stay invested, but not to speculate, and have a long-term view. For example, the S&P 500 returned 326.72% from 2010 to 2022, or 11.97% annually. Portfolio construction, which correlates with risk level and time horizon, is important, as is diversification — not just companies, industries and geographies, but also asset classes. It is impossible to time the markets exactly but we can stagger our entries and exits to smoothen out the peaks and troughs.

Conclusion

The world and capital markets have become so much more complicated. Information is disseminated at breakneck speed — this includes fake news that can go rapidly viral via social media networks. Many investment “tips” are available online, influencing young investors with accounts that are easy to set up and free to trade. Trading bots are able to react quickly and execute trades based on a huge amount of input. Many of these events have the capacity to affect market movements.

We must be wary of current affairs, or we can seek advice or outsource to others — for example, professional managers — invest in mutual funds or exchange-traded funds.

These are points to ponder, perhaps assign a sensitivity to them, and use them to help make better investing decisions.


Dr Michael Gan has more than 20 years of entrepreneurship, corporate advisory, corporate funding, M&A and private equity investment experience. He is a venture partner with Kairous Capital, a regional venture capital firm.

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