In December, the United States and China reached a preliminary agreement on trade. Nothing has been signed so far, but the additional tariffs on Chinese goods threatened by Trump were cancelled and the formerly imposed tariffs have been promised to wind down gradually. Knowing Trump’s unpredictability, a positive outcome in the trade war was a relief for markets. Especially for Chinese stocks. The episode is likely far from over and additional drama is likely to follow this year.
As a result of the good news in December, the month was favorable to stocks. The HCP Quant fund rose 2.23% aided by the news of the trade deal. The benchmark index MSCI ACWI SMID VALUE Total Return gained 1.96% in euros, which is explained by its high US weighting. In the US, the S&P 500 Total Return index rose by 1.06% in euros, and Europe’s S&P Europe 350 Total Return index gained 2.07%.
In July’s investor letter, I wrote about The Scottish Salmon Company, which had received a buyout offer. The HCP Quant fund approved the offer and the Norwegian kronas were deposited to the fund’s account in December. This buyout has been concluded for the fund.
The year 2019 was not a good one for HCP Quant. When it comes to markets, the year 2019 was a repeat of 2018 in the sense that large companies outperformed small companies, and value companies again lagged behind growth companies. US markets were still amazingly strong. Valuation levels are high across the pond and using the cyclically adjusted price-to-earnings ratio, the expected returns are very low. For now, markets do not seem to care about this.
The above graph shows HCP Quant’s development compared with its benchmark index year to year. The year started gleefully with the fund outperforming its benchmark index for approximately the first four months. This was followed by an escalation of the trade war with China, which pushed stocks down. In May, HCP Quant dropped 11.59%. Since touching bottom, the rebound starting in the beginning of June was stronger than that of the benchmark index. But in August, the markets fell again before the fund had caught up with the benchmark index. August’s drop was almost as bad as the one in May, 10.98%. The reasons were identical. Since the new bottom 9.10. the development has been better than the benchmark index.
HCP Quant has swung upwards and downwards more markedly than its benchmark index. The fund’s portfolio is concentrated, so this is its defining characteristic. The drops in May and August were so notable and fast, that they triggered stop-losses in many positions, realizing losses. Situations in which stocks come down across the spectrum are not the optimal use of a stop-loss, if a strategy attempts to stay maximally invested, which is the case for HCP Quant. When markets come down widely, this does not necessarily mean that there is anything wrong with individual companies. The purpose of stop-losses is to cut off a single company’s losses within the portfolio. When all stocks come down simultaneously, the cash realized from selling a losing company does not immediately held, as the new investment target falls in tandem with other companies. It is still better to realize the chosen strategy simply and systematically than start developing exceptions for bending the rules. These often have an even worse outcome.
There were two buyouts in the portfolio last year. In addition to The Scottish Salmon Company, Acacia Mining was bought out by Barrick Gold in an all-share deal. This was an interesting case. Barrick Gold is a large-cap company. Its market capitalization is some tens of billions of dollars. In the share exchange, HCP Quant received a company’s shares that it could not own as they did not fulfil the investment criteria. Barrick Gold is not a small or mid-sized company, and neither is it sufficiently undervalued. Therefore HCP Quant was forced to sell the Barrick Gold shares. The shares’ holding period was therefore shorter than usual as a result of this.
HCP Quant will continue with its chosen strategy. By investing concentratedly in small and mid-cap value companies. It has not been the most practical investing strategy. If big growth companies keep appreciating, the coming year looks tough. Return expectations in developing markets, small-cap companies and value companies are better than in a long time. Whether or not a turn occur is a big question mark.
Wishing you success in 2020,
HCP Quant portfolio manager
“Struggle is temporary. Sacrifices are like investments. Give up the short-term comfort for the long-term win. Be patient and stay focused.” – Unknown
(This post is a translation of the Finnish-language HCP Quant investor letter.)