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As a follow-up on Guy Wagner’s recent publications on the impact of the coronavirus on stock markets, I would like to further elaborate on some elements mentioned in his articles. This from the viewpoint of an equity fund manager with a scientific background. I will stay within my circle of competence and not further comment on the overall stock market or economic implications, as these subjects have been extensively covered in Guy's articles.

Guy Wagner: The main problem of the virus is not the virus but the age we live in

From a scientific view there is certainly reason for concern, but no reason for panic. Currently it seems that, based on medical evidence and simple mathematics, a majority of the population is going to be exposed to the virus over the next 1-2 years. It will continue to spread until a sufficiently high part of the population has been immunized, either by catching the virus or through vaccination (which should be available in spring or summer next year). The focus has to be to limit the speed of propagation, as it risks to overstretch our medical and nursing capabilities. There is a high chance that at some point the virus will impact yourself or people around you, but the fact is also that it will not likely do much harm when it arrives.

The frightening part is the loss of reason and the wave of fear that has already thrown the masses of society into a spiral of panic. People don’t seem able to act rationally anymore; altruism has become a foreign word and scientific facts are often ignored. But you really shouldn't be surprised to see this wave of fear, suspicion and self-interest, as the world has turned into a strange place where the US president can endlessly spread lies with impunity and were scientifically proven facts, such as man-made climate change, are put into question.

As investors, our working hypothesis has to be that, as bad as the current situation might seem, eventually the current crisis will resolve, the virus will be contained and the situation will normalize.

 

Guy Wagner: When it comes to our funds, we think that the best way to deal with this situation is to concentrate on what we can control and on our investment process. We still believe that the best (only) way for an investor to protect his/her long-term purchasing power is to invest in shares of quality companies.

I would like to elaborate a little on our process and our way of investing. As you can already see from the few lines above, a subject like the coronavirus outbreak can become emotionally charged very quickly. To make matters worse, the market correction, especially on the Japanese market, has been very severe, which further emphasizes negative emotions.

In this situation it is important to adhere to a strict investment process, as it prevents emotions to impact investment decisions too much. It is also the only thing we can really control in this very uncertain market situation.

Our investment process is built around two main pillars: the quality of the fundamentals of the companies we invest in and their valuation.

First, the focus on valuation prevents us from overpaying for companies and allows us to seize investment opportunities when they arise, for instance in stock market corrections like the current one. The current crisis does not significantly impact the intrinsic values of the companies. These values are not based on the results of one or two years, but mostly on the cash flows the companies are estimated to generate after the pandemic is over. The stock prices we see currently flashing red on our screens don’t tell us what a company is worth; our valuation model however does. When fear continues to drive down stock prices further, our process allows us to be ready and to discipline ourselves in order to buy stocks when they trade with a sufficiently high discount to their intrinsic value. This could even look like a wrong decision if markets continue to tank, but as long as we are right over the long term, we don’t care.

Our investment process also guides us in buying shares in what we like to call quality companies. Nobody is able to quantify and forecast the short-term impact of the pandemic on the economy and stock markets. It clearly has the potential to severely impact company results and investor sentiment for a certain period of time. This lack of short-term visibility is not specific to the current situation. We are convinced that making short-term predictions is a vain exercise and that they only way to be successful investors is by taking a a long-term view. We stick to our process that allows us to identify companies that offer the potential for profitable growth, not only for one or two years, but for longer periods of time, capitalizing on strong competitive advantages and favourable investment trends.

We might be facing a situation where “the tide goes out and where we find out who has been swimming naked”, as Warren Buffett once put it. Companies could go out of business or have trouble to continue reinvesting in growth opportunities due to declining cash flows. The companies we invest in have solid balance sheets, that allow them to weather any kind of crisis. Their competitive advantags will permit them to stay profitable and generate high levels of free cash flow and thus help them to emerge stronger from such a crisis than most of their competitors. They can capitalize on a strong brand power, captive customers, large networks, technological know-how or cost advantages in order to generate attractive long-term returns for their shareholders.

Steve Glod, Equity Fund Manager

Steve joined Banque de Luxembourg's Financial Analysis and Asset Management department in 2001. Since 2011, he has been in charge of Japanese equity investments for the Bank's funds range. Between 2005 and 2010, he was co-manager of US equity investments for the Bank's funds range. Steve has a degree in Mechanical Engineering with a specialisation in business management, and a doctorate in technical sciences from the Swiss Federal Institute of Technology in Zurich (ETH Zurich). He obtained the CEFA (Certified EFFAS Financial Analyst) diploma in 2002.

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