Why unloved investments deserve more attention
'WYSIATI' behavioural phenomenon among investors
It is easy to buy well-loved investments. The US stockmarket, for example, offers companies such as Apple, Microsoft, Tesla, and Google parent Alphabet - all of which have well-known, well-loved products and well-known, well-loved stocks.
We might excuse investors for thinking the US stockmarket will only ever go up, given its performance in recent years. Yet, of course, that is not true.
Buying these stocks today - or continuing to hold them - can feel like a good idea because of a behavioural phenomenon known as WYSIATI - What You See Is All There Is.
What investors see in these companies is strong past performance - so strong that it is easy to then substitute a hard question ('What investments will likely do well in the future?') with an easy question ('What investments do I want to own?').
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After all, it is more fun to talk with friends about your Tesla stock than about an obscure uranium mining company, or easier to talk about owning an ETF that tracks the US stockmarket than one tracking the somewhat more turbulent one on South Korea.
A warm embrace?
However, we believe that unloved companies - or entire markets - are what investors should embrace, rather than the well-loved ones. And that is especially true in today's market environment.
We believe the aggregate risk/reward picture has deteriorated after a decade-plus bull run in major stock markets and a four-decade fall in interest rates that left many major markets near or below 0%.
Lower rates have led to higher leverage, with US corporate debt recently reaching record levels. Access to capital remains easy, and governments' ability to respond to a potential economic downturn is constrained by already-low rates.
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That would push any economic stimulus efforts onto fiscal spending - this at time when politics seem increasingly polarised.
Nevertheless, investors have bid up many well-loved markets today, with US stocks being a prime example, in our view. Based on our fundamental research, we estimate that the US market will struggle to beat inflation on average over the next investment cycle of about 10 years.
Yet this market returned more than 30% last year in US dollar terms, further stretching its valuation away from what we see as its fair value.
Meanwhile, the South Korean market... well, it returned less than half that of the US market in 2019, and has risen only about 6% on average each of the past five years. This is not a pretty investment, but it is a market we like for the future.
Our expected return estimates for South Korea are among the highest of our 200-plus coverage universe. Trade war-related negative sentiment dented South Korean stocks, but that came on top of questions about the nation's corporate governance issues.
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We believe investors have overly punished this market on both accounts. Also, exports of semiconductors, a major driver of the Korean economy, declined sharply in 2019, but Morningstar equity analysts predict that the demand/supply balance will improve in 2020.
Picking the unloved
Hollywood movies unrealistically portray many things, of course, but one particularly relevant to this discussion can be found in the romantic comedy genre with the archetypal teen crush movie in which Cool Boy likes Cool Girl, but actually the Timid Girl has been overlooked. Cool Boy tries and tries for Cool Girl before eventually realising that the Timid Girl was the right one for him all along.
The unrealistic part is what happens after Cool Guy gets together with Timid Girl. In the movie, Timid Girl's transformation is immediate and transforms into a beautiful swan within a single-filmed shot.
With investing, the transformation is rarely so swift. Instead, valuation-driven investors can expect to be misunderstood by peers. That is, buying an unloved investment is not necessarily easy because rarely are investors immediately rewarded for having had the insight to see through to what is really important.
What is needed in these situations is the discipline to stick to your process. At Morningstar Investment Management, that means we look to buy more when prices fall further, we regularly update our assessments, and we are willing to change our minds when new information arises.
In the end, investing is the opposite of romance - dispassionate, rational, and unsentimental. Love your partner, love movies if you like, but do not love your investments. Even if they are unloved.
Dan Kemp is chief investment officer, EMEA at Morningstar Investment Management Europe
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