Don't Pick 2022's Winners, Avoid The Losers

2021 was easy for investors; chances are 2022 will be more challenging

22 December, 2021 | 10:29AM
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Caution signs on road

“My boss used to say: ‘Successful investing is avoiding avoidable mistakes,’” recalls John Rekenthaler, vice-president of research at Morningstar. And deciding to be a winning stock picker next year might be one of those mistakes.

The last year and a half “was easy for investors,” says Philip Petursson, chief investment strategist at IG Wealth Management.

“You could pick just about anything and do well. Year-to-date, very few companies are down.”

He continues: “Many friends tell me how well they did since the pandemic, and I reply that when everything is going up, that doesn’t impress me. What impresses me is when you still perform when the range of returns in the market is from -50% to +50%.” 

Philip Petursson makes a sports analogy to illustrate investment success in the long term:

“Tennis is not about hitting winning shots, he says, but about reducing errors. Just make sure you get the ball over the net. For example, guys with massive serves, in the long run, don’t win; they make too many mistakes. The investor who avoids errors puts himself in a better position to outperform the market.”

Headwinds Getting Stronger

Of course, high-valuation potential winners can be alluring, and recent economic conditions have greatly advantaged them. “But the coming market will be more challenging for high valuations,” Petursson predicts, because of higher interest rates and inflation that will act as a headwind on high-valuation and high-growth companies.”

We may be moving out of an easy market. And it won’t help with "picking winners", something Petursson doesn’t recommend. “There are so many variables that can go wrong. An investor will do better in avoiding companies that pale in comparison to their peers.”

The key error to avoid is chasing performance, notes Rekenthaler, aiming for big increases in prices and rushing in to buy.

For example, a “winner-picker”, he says, “will buy Tesla, but that can prove dangerous at this moment.” Avoiding errors is not just about avoiding losing stocks, it’s also about avoiding “management” mistakes, proposes Rekenthaler: paying high fees, holding concentrated portfolios, trading too much and cranking up one’s tax costs.

Rekenthaler refers to Cathy Wood’s ARK Funds, winner-picker extraordinaire, whose top performer ARK Genomic Revolution ETF (ARKG) gained 157.4% in 2020. But for 2021, that fund is down more than 35%. “She’s a star," he agrees, "but not a successful one this year, though she’s still ahead of the game.” The fund has seen outflows for most of this year.

But ARK-like funds don’t abound, and investors would do better to seek out slow-burning, steady-as-she-goes performers rather than pyrotechnic virtuosi, our specialists say.

Solid vs. Fragile

Tim McElvaine, founder and manager of McElvaine Value Fund prefers to think of stocks “in terms of solidity versus fragility rather than in terms of risk."

In his view, a winner is not necessarily a solid player and he can carry a lot of risk, risk that is revealed when conditions sour. He’s a classic deep-value investor whose first consideration is not a stock’s upside power, but its downside resilience.

Deep-value investing of the type McElvaine practices is only one way of avoiding mistakes. Other key criteria are quality and stability, Petursson highlights, where companies present a strong and healthy balance sheet, strong proven management, low leverage, high recurring and predictable revenue streams, wide moats and dynamic market positioning that keep competitors at bay.

Forgetting about downside protection is one of the key errors Rekenthaler lists. “Most mutual funds don’t do much better than the whole of the stock market," he recalls. "At least, some don’t do worse, and a few show good resistance.” That aligns with Warren Buffet’s two cardinal rules of investing: 1) Don’t lose money; 2) Never forget rule number one.

For the above reasons, Rekenthaler advises investors to steer toward mutual funds.

“They used to be about finding winners and setting up risky funds. ARK is like what the mutual fund industry used to be. But the major difference between stock pickers and mutual funds is capital protection. A mutual fund might hold a few losing stocks, but you will never see it go to zero, because managers aim at avoiding losses and mistakes.”

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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