Naive OptimismGuest Post
This year’s Burgundy Forum – our 20th annual Client Day event – recognized the careful balance between rationalism, cynicism and optimism as it pertains to behaviour and diversity of thought. Keynote speaker and author of The Rational Optimist: How Prosperity Evolves, Matt Ridley, explored how human nature drives us towards the horrific headlines, despite the evidentiary support that poverty, pestilence and war are trending downwards. In conjunction with Ridley’s presentation and Burgundy’s recent extended China research trip, Richard Rooney’s closing remarks meditated on how Burgundy’s investment approach balances our search for quality with market noise, human instinct and the challenging investment environment in Canada and beyond.
The following is an excerpt from Richard’s speech. The text has been lightly edited and condensed for this post.
As Burgundy clients are well aware, Warren Buffett has a knack for making statements in a forceful and memorable way. One of my favourites is:
“Bearish arguments always sound sophisticated.”
In my experience this observation is profoundly true. If you listen to a pessimist outline his reasons for gloom, they are always well thought out and usually backed by reams of statistics. The contrary is also true. Optimistic, bullish investment arguments often sound naïve. They are also usually qualitative, referring to the abilities of management or the strength of the business.
A good question to ask yourself is this: Who should I have listened to for investment advice over the past 35 years or so? Was it the sophisticated bears or those naïve optimists? I think we all know the answer to that. So, how should a rational optimist approach the challenges of investing in 2019? I think we have two perfect test cases: the unloved Canadian equity markets and the unlovable Chinese equity markets.
Canada has been a tough place to invest. In addition to being prone to bubbles and cycles, this market is poorly constructed for the consumer- and technology-led bull market that began in 2009. The Canadian market’s largest weightings are in mature industries like banking, insurance and various commodities, which has led to a very difficult decade. Our federal government’s major gift to the equity markets has been the new, untried cannabis industry. Few other sectors have benefited, and our energy industry has suffered badly.
Canadian investors have traditionally overweighted Canada in their portfolios compared to its global footprint. That stance has changed as institutions have sold off Canadian equities to go global and invest in alternatives. Canada Pension Plan, for example, now has less than 2% of its assets invested in Canadian public companies.1 Indeed, there has been a receding tide in Canadian equities.
On the positive side, though, Canada possesses numerous companies that have strong market positions. The trade picture with our biggest partner also appears to be finally clearing up, with the prospect of ratifying the new United States-Mexico-Canada Agreement. Then there is the ultimate argument for our Canadian portfolios – they are cheap in a world where cheap is rare. Burgundy’s investment approach tries to balance value, growth and quality. This balance is very difficult to achieve, but if quality is too expensive, value is the place to go. We expect good things from Canadian equities in the future.
China has also been a tough place to invest. We are mindful of the Canadians who are being victimized by China’s arbitrary legal system in retaliation for a legitimate action by the Canadian government. We are aware of the trade measures being brought to bear by China against Canada. And, of course, we are aware of the titanic trade and technology war between China and the USA.
With these acknowledgements in mind, why did the members of our emerging markets team who spent six months living in China return with such a favourable conception of the place? The answer lies in their objectives. They were sent there to assess investment opportunities and to experience life in China on the ground, and both of these areas left them pleasantly surprised. Anne Mette and I strongly felt that Burgundy’s next CIO must have a much deeper understanding of China from the bottom up than I ever had. We achieved that goal.
Five years ago, nobody would have predicted that relations between China and the West would have deteriorated to the extent they have. And five years from now, who is to say that those relations will not be substantially repaired? The time to do the work is now. As long as our people are safe, we will continue to build our knowledge base. You are unlikely to see a major shift of investments to China anytime soon, but selective opportunities will be taken and we leave the door open to someday having dedicated Chinese investment mandates.
When it comes to the Canadian and Chinese markets today, the consensus from global investors is not a favourable one. Despite this lack of market confidence, we will continue to look beyond the temporary. For the last 25 years, we have concentrated on the economics of the businesses we studied, considering their corporate cultures, management capabilities, competitive resources and market valuations. If we continue to do so, while ignoring top-down narratives and outside noise, we will have a better grasp of fundamental risk than other investors, even the ones who sound sophisticated. The investors with the best grasp of fundamental risks should be the ones who best protect their clients’ capital.
I hope my arguments have been rational, optimistic and naïve enough to be persuasive.
Article by Richard Rooney, Burgundy Asset Management