Worries about the explosive growth in the number of coronavirus (COVID-19) cases have gripped global markets. Unsurprisingly, our funds have had a tough week as shares of high-growth companies sold off hard (a tough reporting season for us in Aussie smalls hasn’t helped either).
Our view on the COVID-19 situation is a balanced one. On the one hand, we expect the virus to blow past containment efforts, creating a genuine public health crisis and introducing short-term risks investors would do well to observe. On the other hand, we remain long-term optimists. We’ll expand on both views but start with the current situation and how we’re thinking about risk.
We won’t bore you by rehashing what is already well covered and understood in the news. For that matter, we’ll be looking at this through the eyes of investors. We wish for a speedy conclusion to the crisis and comfort for those who are suffering but you’re reading this article for the investing angle, so that’s where we’ll focus.
It strikes us that containment efforts will fail, however, that is not a universally shared view even though the virus has gained momentum outside of China. For example, White House economic advisor Larry Kudlow said Tuesday night that “We have contained this. I won’t say [it’s] airtight, but it’s pretty close to airtight.” And some have been in outright denial: Cambodia’s prime minister personally greeted passengers disembarking from a cruise ship that other countries would not allow to port. At least one passenger tested positive shortly thereafter.
We don’t profess to be epidemiologists, however, common sense observation points to COVID-19 being well outside containment. Bearing in mind that none of us knew this virus existed less than two months ago, consider the following:
- 41 countries have reported cases including all members of the G7.
- The list of countries that reported their first known cases just this week includes Spain, Switzerland, Croatia, Kuwait, Bahrain, Algeria, and Afghanistan.
- Italy went from zero to 322 cases in less than a week.
The cat isn’t just out of the bag: it’s had kittens. A vaccine is also unlikely to come to the rescue before the virus spreads widely given the riddle must first be solved, properly tested, and then scaled and distributed. If anything, the meta-question on everyone’s mind should probably shift from whether the disease can be contained to how the world will handle a pandemic that may prove endemic.
That said, while the disease has spread to a degree that containment no longer seems viable, that won’t stop countries from trying. Practically speaking, the primary mechanism of containment — encouraging or outright forcing people to stay home from work, school, and other public places — would lead not only to decreased consumption but wide-ranging dislocations to global supply chains.
As long-term investors, it would be easy to look past these issues as speed bumps, and over a long enough time horizon for most companies that is probably true. But there are exceptions. For example, companies with strained balance sheets and highly discretionary or easily substituted goods or services could be permanently hobbled by a one-two combination of supply and demand issues.
There’s no escaping that a sharp downturn in consumer demand, supply chain hiccups, or a steep pullback in equity prices are all short-term negatives for ours or anyone else’s equity portfolios, however, our strong bias towards companies with solid balance sheets, very loyal customers, and digital-first business models should help to soften the blow when it comes to fundamental operating performance.
We are also mindful that new consumer habits might be formed by those who are suddenly stuck at home. Namely, that consumers who previously had little interest in social media, online shopping, or streaming content might suddenly have good reason to be open-minded. For businesses that have self-reinforcing scale or network dynamics, pulling forward adoption is a lasting enhancement, not just a one-off. Again, given our bias towards businesses operating in markets with rising adoption curves, some of our holdings could find they have a medium-term tailwind after a short-term headwind abates.
As you might imagine, our team has already had in-depth discussions about the holdings at both funds to better understand our exposure to the above factors. We’ve reduced one position partly on concerns about impact from COVID-19 but have, for the most part, been selectively buying more shares in existing portfolio companies. The funds entered the month with conservative cash positions — 15.0% at the Lakehouse Small Companies Fund and 13.9% at the Lakehouse Global Growth Fund — which makes for plenty of dry powder.
Despite the grim headlines and our view that COVID-19 will be on the minds of markets for longer than many anticipate, we remain long-term optimists. Even if our view is correct, we expect most of our portfolio companies to continue to gain share of growing markets over the medium- to long-term. For that matter, we may well be wrong, and it is worth remembering that if investors swam to the side of the pool every time there was something to worry about none of us would ever be in the water.
Lastly, none of this is operating in isolation: interest rates have plunged as investors probably rightly anticipate a loosening up of monetary and fiscal policy to help stave off economic slowdowns. Indeed, if history is any guide, we expect Beijing to pull forward an immense amount of spending to help re-accelerate growth. Also, while we have low expectations of a vaccine in the coming year, it is a relief to know that so many talented, dedicated scientists and medical professionals are working towards better treatments and hopefully a vaccine.
In the meantime, we’ll largely continue to stick to our knitting: backing well-run businesses with bright long-term prospects and letting the fullness of time do the heavy lifting for us.
Disclaimer: This report has been prepared by Lakehouse Capital Pty Limited (ABN 30 614 957 603, authorised representative of AFSL 400691) and by its officers, employees and agents (collectively “Lakehouse”) for the sole use of its clients as a record of the performance of their investment.
The information included in this message has been prepared without taking account of the reader’s objectives, financial situation or needs. All of the commentary, statements of opinion and recommendations contain only general advice. Past performance is not indicative of future performance.
The responsible entity for both the Lakehouse Small Companies Fund (ARSN 615 265 864) and the Lakehouse Global Growth Fund (ARSN 621 899 367) is One Managed Investment Funds Limited (ACN 117 400 987) (AFSL 297042). Investors should read and consider the Funds’ product disclosure statements, which are available online, before deciding to invest in or redeem units from the Funds.