Asymmetrical risk-reward ratio
Typically, it goes like this: More risk, more reward—less risk, less reward. Or, in other words: no risk, no fun. Who dares wins.
When this principle doesn’t apply, the ratio between return or performance and the necessary risk is asymmetrical.
In April 2017 we saw another constellation—as has been the case repeatedly in the past 12 months—with an asymmetrical risk-reward ratio.
Buy and hold at the stock market in Europe meant initially:
All investments would bear the full risk of a significant price decrease if the first ballot of the presidential election in France produced an unfavorable result. The scary pair Le Pen/Melanchon didn’t materialize, but Melanchon fully used his potential and, as forecasts had predicted, achieved almost 20% of the votes. Not far off from second place.
The stock market fell on the days before the first ballot and rose on the days after. With the indexes, all this unfolded within a few hours, with individual stocks it took several days. In net terms, buy and hold resulted in a price gain of 1% for the DAX in the month of April.
Mellinckrodt’s risk-averse strategy showed a better risk-reward ratio. Only two-thirds in stocks on the day before the election with a corresponding lower risk of loss in case of a negative election result. The day after the election immediate dissolution of the hedging (fees 0.35% of the fund volume) and purchase of individual titles including French stocks. The price increase of stocks below the indexes started with a delay and turned out to be much higher than that of the DAX and CAC 40. As a result, our fund appreciated in the following days. Price gains of over 3% in April—despite an investment profile with lower risk.
Stocks from the area Internet of Things (e.g., Comet and Lam Research) contributed to the appreciation. For nearly the past year, they’ve been showing a very positive development regardless of the general situation of the stock market. And not only because valuations have been rising: revenues and profits have been improving and so has the outlook.
You may say these two approaches don’t make a big difference.
That’s true, and there will certainly time and again be cases in which the risk-averse strategy will bring less of a return than buy and hold. However, when it’s not about a portfolio addition but rather a significant portion of our own assets, then we feel that buy and hold is too risky. Just look at the chart below. It represents the price development since the all-time high of the DAX in the spring of 2015. At that time, buy and hold showed a downward trend of almost 30%. And Kahneman’s prospect theory explains why most investors sell at such lows—which is in contrast to the tale that the protagonists of passive investments tell. We are trying to manage the fund in such a way that our investors as rarely as possible wonder whether or not they should sell to be on the safe side. The safety of the capital that we have been entrusted with is a key topic for us every day, not just two or three times a year.
Poll question:
Will Macron make it?
Probably yes, but we can’t be certain. He won the TV debate based on points. The question is, however, whether those French who feel at a disadvantage feel the same way. If so, then he’ll win. If, however, the majority has perceived Macron as arrogant, then he has made no progress …
Nevertheless, we believe he’ll make it.
The question is, however, if that’s even relevant. Other topics (China, the Fed, and Brexit) may play a much bigger role. The opening of the negotiations in Brussels this week smells like surprises from all around the English Channel—not only from Buckingham Palace. Not to mention the big media topic “sell in May.”
We have started positioning a bit more defensively than we did late last week and have decreased the stock quota to under 90%. In addition, we can adjust the hedging through futures at any time when necessary. On the other hand, our position is not as defensive as it was before the first ballot of the presidential election when our net stock quota amounted to only two-thirds of the fund volume.
Maybe Macron is elected and stocks drop. The stock market calls this “sell on good news.”
Whatever. The world economy has been in full swing, and we continue to anticipate price increases until the end of the year.
But, unfortunately, we don’t know whether or not the second quarter will offer considerable buying opportunity. Regardless of this question it can be expected that especially U.S. investors will make an even bigger shift toward European stocks, which will certainly contribute to rising stock prices in Europe.
On Mellinckrodt
New investment topic
The positive development in the area of Internet of Things was probably not lost on you. Comet, Inficon, and Lam Research are companies in which we have invested in order to participate in this development. In addition to these chip manufacturer suppliers, we have identified another topic which we believe may hold long-term potential. It’s the topic internet video.
All parents know that young people consume more videos than they read texts. With technology drastically improving, videos will soon be consumed not only via wireless network but anywhere at any time. The expansion of telephone networks to a more powerful standard is getting off the starting blocks and together with a new wireless technology new possibilities will open up. This, in turn, means new business opportunities for various suppliers. In this context, we want to mention our involvement in Teradyne, one of the leading businesses for test systems in the chip industry, first and foremost. According to Teradyne, the new video technology is one of the main reasons for their increasing business volume. Overall, manufacturing is becoming more complex, and that, in turn, is good for the manufacturers of test systems. More testing will be necessary for manufacturers to ensure that everything works.
German Opportunities
We often get the question why our fund is named Mellinckrodt German Opportunities.
Historic reasons play a role and so does the fact that Swiss German Opportunities would sound even more cumbersome. But opportunities have another definition besides just considering in which country a company is headquartered.
Picture our tools for examining investments as multifocal lenses: On the top, we see the market and its sentiments through our lenses. On the bottom—close up—we read with our private equity lenses the information that companies and their observers offer us.
With decades of experience we understand certain topics and industries. And we’re deep drillers when it comes to companies which are active where we are—in Switzerland and Germany, that is.
From the sum of all things that we see through our multifocal lenses—and also from what we hear, of course—we deduce information that we use to achieve our goal.
Our goal: DAX performance with half the volatility.
How does that work—what’s in the fund?
We only buy stock that is market listed. This distinguishes us from classical private equity funds.
The universe for comparisons is Stocks Europe (e.g., Stoxx 600); not only the eurozone, which Switzerland isn’t part of.
The focus which we mainly deduce our information from to achieve our investment goal is the emphasis on industries and topics in which Switzerland and Germany are traditionally strong and which we’re well versed on.
Because we look at topics, we don’t stop at national borders. If we like a Jacquet Metal Service from Lyon more than Klöckner & Co. from Duisburg, then we buy the French stock. Besides, both companies are active all across Europe. The biggest market for the French company Jacquet with around 50% of the total company revenue is—believe it or not—Germany. France contributes only 10% to its revenue. Europe is actually more interwoven than it oftentimes seems at first glance. We stick with our topics, compare companies and buy those that we believe show the best risk-reward ratio. The following overview illustrates the structure of our portfolio regarding the last three months.
