Doug Goodwille from Kayne Anderson speaks to Drew Meredith from The Inside Network on market thinkers.
While a surging gold price is on hold as the world adjusts to a Trump presidency, all the factors that saw its price rise more than 50 per during his first term in office – trade disputes, fiscal deficits and geopolitical tensions – are almost certainly guaranteed the second time around.
What does High Conviction mean?
Often used to describe a particular type of investment style, e.g. the High-Conviction Equities Fund, conviction is all the rage in equity markets today. This type of strategy usually has between 20-30 stocks (or any other asset, for that matter) which are considered high-quality blue-chip investments that have a strong competitive position and high market share. It’s common for a manager to say their fund is a “high-conviction” fund housing a small quantity of stocks that have been “hand-picked” as their best high-performance picks for the next several years. Because the number of stocks is quite small, the individual performance of each company makes a rather huge difference to the performance.
A good example of a high-conviction fund is the ARK Innovation ETF exchange traded fund (NYSE Arca: ARKK), which has been hugely popular in 2020. This fund offers investors access to a highly concentrated portfolio of stocks that can invest in listed companies with a tilt towards “disruptive innovation.”
The flagship fund – Ark Innovation – returned nearly 150 per cent in 2020 in the height of the pandemic. At the time of writing ARK Innovation is down 23 per cent in just two weeks. The largest active exposures in the portfolio are consistent with the stocks that have the best rating by ARK. Portfolio construction guidelines limit the portfolio’s exposure to any one stock or sector. The result is a concentrated portfolio of between 15 to 40 stocks that the firm believes are likely to perform.
The portfolio is loaded with stocks that have skyrocketed, such as Tesla (NASDAQ: TLSA), Square (NYSE: SQ), Teladoc Health (NYSE: TDOC), Roku (NASDAQ: ROKU), and Shopify (NYSE: SHOP). “High-conviction” investing can create greater risks and does not always deliver the alpha that investors seek. Picking 20 or 30 stocks doesn’t automatically lead to a better outcome than a larger spread of investments. There is a large element of risk: all it takes is one bad stock plunge to ruin a year’s performance. On the other hand, at least the managers are being truly active and earning their fee. As in the case with ARK Innovation, it’s great when the fund manager gets it right but when they are on the wrong side, losses are magnified.
The qualitative characteristics required to have high conviction in a company include:
- Understandable business with reasonably predictable future cash flows.
- A business that has control over its own destiny and a buffer against uncontrollable events.
- A business that generates more cash than is required to operate.
- A business run by honest, trustworthy management who treat shareholders as partners.
According to Schroder’s “both the 30 stock and 75 stock portfolios …… would have the same level of ‘conviction’ if the same depth of research is conducted across both sets of opportunities. Clearly you would need a larger team of analysts to accomplish this across a larger universe of stocks.”
To them, skill rather than conviction is what matters most. “It’s no use having a high conviction in your stock picks but get them spectacularly wrong. Conviction should be a measure of the skill of the investment team and this is not measured by how many stocks you own, but by the consistency and persistence of beating the benchmark.”
