It can pay to be out of fashion. An investment in out of favour stocks can be emotionally hard and requires patience, but is usually the most rewarding. The allure of the latest market theme may appear to gratify a range of our emotions associated with success and certainty.
A theme may be a compelling story, but when this story is known to the market, all the good news is likely to be more than priced. We believe that in order to outperform the market, it is vital to identify a way to avoid this allure at all costs.
Valuation anchor is the key to exploiting thematic market preferences
We believe it is the market's shorter term thematic preferences that can drive share prices to extremes of valuation in both directions. It is these price episodes on the cheap side that reveal the best opportunities for our patient valuation driven approach to exploit. Whilst market themes are temporary in nature, it is the realization of value that is sustainable. Amid complex and uncertain environments, we are all prone to making judgment errors. Overconfidence can influence expert judgment, especially when it comes to predicting stock market fluctuations, and this makes it is very hard to consistently time the market by identifying themes. However valuation extremes are observable and exploiting these episodes is repeatable, when combined with a well defined decision making process.
No information advantage - errors in judgment can arise from our strong preferences
We live in a world full of real time information that constantly bombards us. On the surface, having more information might appear useful in helping us to make good decisions. However, we don't always have the capacity to incorporate all information. On top of this, we are all subject to forming strong preferences around which information to pay attention to and which information to ignore. The market behaviour behind these choices is what we are most interested in understanding and what we look to exploit.
Skill or luck?
Having an awareness of the cognitive influences on our judgment is not enough to promote good decision making. What we choose to do and choose not to do in making a decision can be the difference between demonstrating skill - which is repeatable - or being subject to luck - which is random and temporary.
In making skillful investment decisions, we need to identify a way to put the weight of probability in our favour. We need to mitigate the potential for errors in our judgment which are subject to luck. We can achieve this by adopting a carefully conceived decision process that anchors our judgment.
Valuation anchor brings durability that stands the test of time
An anchor is something to base a decision around. In our approach, we choose to anchor our decisions around valuation and this helps to reduce the influence of our personal preferences and biases.
By anchoring our decisions around valuation we mitigate cognitive influences that become impediments to good judgment. We reduce the impact of luck by putting the weight of probability in our favour.
Importantly, our decision process is repeatable and durable across time and different market environments.
To outperform the market you need to be different to the market.
Opportunities exist where changes to the market's risk perceptions and expectations have caused a meaningful dislocation between the price and underlying intrinsic value of an asset. We call times like these behavioural price episodes and we focus on the most attractive valuations..
Valuation separates our decisions from emotions that drive herding behaviour
A valuation anchor separates our decisions from the emotions that give rise to biases that form pricing beliefs and drive herding behaviour.
- Valuation is an objective reference that focuses our analytical resources on the most mispriced opportunities, which tend to be out of favour with the market. A valuation anchor helps to remove personal preferences
- Valuation frames our discussion around what matters most and facilitates a consistent and objective test of the information we choose to use. It helps us to avoid the market's thematic narratives
- Valuation mitigates the illusion of knowledge and control - we avoid succumbing to the belief that having more information will improve decision making and that people can influence outcomes of uncontrollable events
Durability of approach
In following a well defined and disciplined approach we have identified and eliminated impediments to good decision making.
Our approach exploits hard wired human behaviour which universally influences human emotions and decision making. Our approach is not bound to the persistence of any particular thematic market behaviour. A discipline around price and valuation ensures the approach avoids fully priced assets that result from changes in thematic market behaviour.
This gives our approach durability and enables our edge to be repeatable over time and cycles.
For professional clients and information purposes only.
This does not constitute an investment advice or recommendation, nor shall it be relied upon as including sufficient information to support an investment decision.
This information does not have any regard to specific investment objectives, financial situation or particular needs of any person. Investors may wish to seek advice from a financial adviser before making any investment decision.
Past performance is not indicative of future results. Investment products are subject to investment risks, including the possible loss of the principal amount invested. An investment is subject to investment risks, including the possible loss of the principal amount invested.
This advertisement has been issued by Eastspring Investments (Luxembourg) S.A. acting through its UK branch whose offices are located at 125 Old Broad Street, EC2N 1AR, London, United Kingdom. Eastspring Investments UK Branch is authorised and supervised in the UK by the Financial Conduct Authority (FRN 605525), it is an ultimately wholly-owned subsidiary of UK based Prudential plc, whereas such entities are not affiliated in any manner with Prudential Financial, Inc., a company whose principal place of business is in the United States of America.