Time to go back to basics

HOLDING COMPANIES: VALUABLE TIPS FOR INVESTING IN VOLATILITY

Play ‘the right game’ or ‘your own game’, rather than the long game.

What are the considerations, if you’re a holding company, for investing in variable and volatile environments?

Market volatility

Despite its name, volatility doesn’t mean markets will always dip; it can lead markets in any direction – even up.

Volatility is unpredictability, typically measured by the standard deviation of an investment’s return.

The Standard & Poor’s 500 Index may have a standard deviation of about 15%, while a more stable investment, like a certificate of deposit, will typically have one of zero, as the return never varies.

1. Diversify, narrowly

Diversification is essential, particularly across uncorrelated asset classes. If you’re a holding company, manage that portfolio carefully.

More often than not, there’s concentration risk within a portfolio company, as acquisitions are made predominantly to enhance your market position or to create economies of scale. This can result in closely-correlated companies within common sectors.

I believe the answer lies in creating a comfort zone within change, rooted in ‘narrow diversification’.

Diversification in financial assets can be easily achieved through passive investing, but this isn’t the case for executive teams of portfolio companies. It may even have the opposite effect, where companies enter markets with little or no experience, and fail.

Holding companies can try to reduce their risk in a particular market via strategic acquisitions. It’s a good move to make acquisitions that diversify the customer base and open new opportunities and products to the holding company, while playing to your strengths.

This kind of narrow diversification means you’re exposed to the risks of the sector you’re comfortable with, while remaining more diversified within it.

2. Do what works for you

Should you play “the long game”? Well, match your investment horizon with the risk. Making longterm financial decisions based on short-term volatility data is risky, and visa versa. As an investor, play “the right game” or “your own game”, rather than the long game.

3. Make management ma er

As to investment opportunities inherent in volatile markets, it’s a good idea to decrease a company’s volatility through your management of the business. I believe volatility can be controlled to a certain degree, particularly, company-specific volatility. Hence we like to invest in companies where volatility’s self-made, then correct it ourselves.

4. Go solid, dependable

It’s advisable to invest in solid fundamentals. A company with a strong market position that enables it to be a price-maker, underpinned by solid and predictable revenue streams and good cash generation, is key to weathering volatility. It’s key to adapt/change your business’s commercial model to reduce your risk; it’s a lot easier for a company with a well-cemented market position and superior product to do this.

Bo om line

Take time to access an appropriate view of the directions markets are moving in, and consider how these could affect your sectors. This will help you avoid “short-termism” and ride out the moods of volatile markets.

Go back to basics and don’t get caught up in markets’ immediate sentiments.

Greg Morris is MICROmega Holdings CEO