Seeking to generate value in a challenging market

Seeking to generate value in a challenging market


2018 was an exceptionally challenging year for international investors. In some respects it has proven even more challenging than the big financial crisis of 2008. During the financial crisis some asset classes still managed to generate appreciable returns, particularly US Treasuries which benefitted from the “flight to safety”. In 2018 the prices of both equities and bonds dropped as well as most other asset classes. In fact, according to Deutsche Bank since 1901 there has not been any other instance where so many asset classes went down as illustrated in the following graph (1). 

The S&P 500 was down 6% and other indexes did much worse with the Euro Stoxx 50 down 14% and the German DAX down 18%. The iBoxx Investment Grade bond index was down 4%. Commodities are often inversely correlated to the markets and gold is often a beneficiary in times of uncertainty. This year it was not the case. Those two asset classes traded down 14% and 2% respectively. Overall hedge fund managers did poorly, with the global HFRX fund index which includes all types of strategies down 7%. The HFRX Equity Hedge index which focuses on long-short managers was down 9%. 

Fortunately we have been very cautious about the markets for some time and had warned repeatedly about the risky mix of increasing interest rates and elevated valuations. All this being further exacerbated by macro risks such as a cooling of the Chinese economy and international political tensions. We therefore had limited exposure to equity markets as well as to long-duration fixed income. Overall our hedge funds performed better than the industry average, validating our careful selection of managers who have a real ability to manage risks and add value. At the bottom line, we managed to preserve capital and to largely insulate our portfolios from nerve-wrecking volatility.

We continue to believe that the same risks that were present at the beginning of 2018 remain now even after the correction. We continue to advocate caution although some opportunities are starting to emerge. Healthcare and biotech stocks in particular are trading at historically low valuation levels and offer a good entry point for the long term investor.

One of the most promising avenues to generate returns uncorrelated to the markets are investments into promising private companies with high growth potential. To the difference of the financial markets whose evolution depends largely on external factors the outcome of good private equity investments is a lot more under the control of the investors. 

One such opportunities is Paltop dental into which we invested some of our clients’ money over the last four years. The company, which is growing strongly and is already profitable, just merged with the American dental implant distributor Keystone to form a new dental implants player with the potential to become one of the industry leaders. The merger was reported in the Israeli press (2).

As the case of Paltop shows opportunities also exist in more traditional industries through technologic and managerial innovation. In terms of timing we prefer to avoid the highest-risk early stages and to enter at later stages where the feasibility of the venture is more established but the gain potential still high. Israel as the Startup Nation offers plenty of opportunities since many high quality professionals are eager to start successful, innovative businesses. The main limitation of such private investments is the above-average risk, the lack of liquidity and the relatively high minimal investment amounts. This prevents many investors from participating in them. Going forward, we want to take more and more advantage of such opportunities and we will think of possible ways to make them more accessible to investors who are not traditionally exposed to such investments.

While preparing for all types of scenarios we hope that 2019 will surprise us on the upside.

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