Stay the course with long-term stock market investing in volatile periods, because history has shown changes in behavior during a crisis may not last long beyond it, says Dennis Lynch, head of Counterpoint Global at Morgan Stanley Investment Management.
It may be tempting to make portfolio changes during stock market selloffs, but if you’re an investor focused on companies with sustainable competitive advantages and long-term secular trends—and those companies continue to maintain strong balance sheets even in a crisis—it’s important to prioritize that far-horizon investment outlook over knee-jerk modifications, says Dennis Lynch, head of the Counterpoint Global team at Morgan Stanley Investment Management, which had $90 billion in assets under management as of May.1
While the coronavirus pandemic triggered broad selling across markets in the first quarter of 2020, Lynch’s Morgan Stanley Institutional Fund Growth Portfolio, which manages $11.6 billion in assets,2 shielded against losses better than benchmarks by sustaining its long-term conviction in companies that have secured or invested in reliable cash-flow streams, Lynch says. The strategy also helped the fund weather volatility in the first half of the year; it declined 3.8% in the first quarter, compared with a 14.1% drop for the Russell 1000 Growth Index and surged 58.3% in the second quarter, compared with a 27.8% increase for the benchmark. The portfolio has also outperformed on an annualized basis since investment team inception in 2004 through the second quarter of 2020, returning 15.3% versus 11.3% for the index.3
The real theme is to remain open and flexible about what's going to happen next and not get too convinced of anything.
While investors who focus on short-term stock market momentum may have rebalanced portfolios during the period, Lynch and his team have learned from decades of investing that staying the course can potentially be beneficial. The lessons learned in previous downturns, such as the 2008 financial crisis and the bursting of the dotcom bubble in the late 1990s, can provide valuable perspectives on how to position for recovery and return to whatever “new normal” may emerge.
To be sure, Lynch acknowledges the allure of certain trends gaining steam in the COVID-19 environment, and he also points to dispersion—or the difference in individual stock returns compared with those of their peers—as an opportunity to enter new positions or add to existing ones. But he also cautions against investing too heavily based on fresh assumptions. History shows that changes in behavior during a crisis may not last, he says.
“We think the secular themes that most of our companies are benefiting from might be accelerating, but we don't want to get too crazy about that notion because too many large conclusions can be a mistake,” Lynch said recently on his first-quarter call with investors. “We’re making very few changes. The real theme is to remain open and flexible about what's going to happen next and not get too convinced of anything.”
Most companies held in Lynch’s portfolio have significant cash on their balance sheets, which should allow them to absorb economic shocks in the wake of the pandemic—perhaps even finance growth, according to Lynch. He challenges the common assumption that older, larger companies fit this profile best. Bigger businesses, he points out, may have invested in stock buybacks before the global health crisis, meaning that they have less dry powder, compared to companies that held on to their cash reserves. Some also may have issued debt, potentially putting them at a disadvantage if they now need to borrow more.
In addition to cash-rich companies, Lynch likes to prioritize businesses that can profit from long-term trends and offer customers advantages, such as greater efficiency, lower costs, or both. He favors the technology sector, in particular, companies with e-commerce, delivery or cloud computing services, all of which experienced increased demand from sheltering consumers hungry for digital connections and commerce.
While adoption of software as a service (SaaS) offerings are accelerating because of a stay-home environment that necessitates virtual communication and collaboration, many companies were already investing in digital transformation before the coronavirus outbreak to modernize their infrastructure, improve efficiency and harness data for business decisions, according to Lynch. Though investing in SaaS has increased in the past several years, it’s still a small piece of total technology infrastructure spend, which is one of the reasons he sees more potential for continued growth in businesses that offer and use cloud services.
We're not making tactical changes; we're continuing to make long-term decisions.
Lynch has been putting his perspectives into practice. The fund recently added two cloud-based software businesses to its top holdings, and its 10 biggest positions account for around 48% of the portfolio. It also added to investments in companies that may gain from increased consumer streaming activities, video usage and gaming. Tech as a theme also spans its healthcare and consumer discretionary holdings—the fund’s second- and third-largest weightings—with investments in surgical robotics, cloud-based business management providers in life sciences and e-commerce platforms.
Lynch expects significant short-term volatility, as the corporate earnings picture comes into sharper focus. However, sticking to a long-term investing strategy can serve as a guiding principle through swings on a monthly or quarterly basis.
“We're not making tactical changes; we're continuing to make long-term decisions,” he says. “We're going to continue to own the companies we think are the best-in-class for the next 5 and 10 years and that have significant upside from here.”
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