Dear Clients,

I am writing to provide you with a portfolio update to shed more light on our investment strategy through the course of the pandemic-induced market selloff and our current thoughts, given the strong rebound in market indices and your equity portfolios.

Investment Strategy Overview

As a starting point, it is important to review our investment approach. We begin by evaluating general monetary and economic conditions to gain a forward-looking perspective on the backdrop for market performance. Layered upon this is our analysis of secular trends in consumer and corporate behaviour that contribute to the growth or decline of various industries. To best capitalize on the investment opportunities arising from structural industry tailwinds, we hone in on business drivers that contribute to the outsized profit potential of leading companies in these industries. No two businesses are alike. Some are structurally poised to profit greatly, especially in our globalized world, while others are relegated at best to the vagaries of the economic cycle. The key to success in investing is to stand apart from the crowd - to assess risk and reward in ways that others over or under-estimate. Consensus thinking only leads to sub-par investment performance because the best investment opportunities are regularly under-appreciated by the masses.

The Pandemic and the Economy

As mentioned in our last Portfolio Update, although COVID-19 is not the first pandemic the world has experienced, the scale of containment measures that took hold on a global basis were and are unprecedented. Mass closures of customer-facing businesses led to a sudden shut-down of large swaths of the global economy which, in turn, triggered the fastest market collapse in history. While many dwelled on the magnitude of the economic downturn resulting from the pandemic, comparing it even to the Great Depression of the 1930’s, we were careful to take note of the unique nature of the downturn. Having studied and personally invested through various economic crises and pullbacks, we observed that recessions are typically preceded by an asset bubble - the stock market bubble in the 1920’s preceded the Great Depression, the stock market and real estate bubble in Japan in the 1980’s preceded its long recession in the 1990’s, the sub-prime housing bubble preceded the Great Financial Crisis of 2008 etc. Every bubble was burst by tightening monetary conditions and the hardest hit casualties were typically financial institutions which had contributed to the bubble on account of lax or ill-informed lending standards. As financial institutions suffered massive losses, credit tightened across the board, limiting the flow of funds and lending to all customers, thereby causing the economy to contract.

This same “playbook” has not occurred with the COVID-19 economic downturn. The pullback was not brought about by the bursting of an asset bubble, but rather by forced business closures and “stay-at-home orders.” As such, financial institutions and businesses at the heart of the crisis have not been viewed as culprits who deserve “punishment” - e.g. Lehman Brothers in 2008 - but rather, are viewed as casualties of an unforeseen catastrophe. Thus the response to this crisis has not been about incrimination and punishment. Instead, there has been a spirit of co-operation and forbearance between governments, financial institutions, businesses and people. Governments have been quick to provide financial assistance to businesses and individuals, and banks have allowed for the deferral of loan payments by homeowners and business borrowers. The economic pain is undeniable as reflected in sharp spikes in job losses and business bankruptcies. However, we have not and do not foresee a systemic collapse. As we noted in our last update, it is wise of governments in the developed world to devise plans for re-opening their economies as dealing with a pandemic is like fighting a war; unfortunately, trade-offs have to be weighed and it is not feasible to keep things closed until all COVID-19 risks are completely eliminated.

This analysis gave us confidence that the macro-economic backdrop was and is nowhere as bleak as pessimists have predicted.

Your Portfolio

The following are some of the themes we had identified and positioned ourselves to capitalize upon even before the pandemic:

1) Growing momentum in the adoption of technologies such as cloud services, artificial intelligence, digitization and electronic commerce and payments as well as internet search and social media. We have thus been long-term investors in leading companies in these areas such as Microsoft, Amazon, Applied Materials, Adobe, Visa and Facebook. The growth opportunities for these companies are, in our assessment, truly outsized as they are global, not just domestic, and they are not limited by inefficiencies on account of size and instead benefit from scale and network advantages. Furthermore, they are incredibly innovative and forward thinking, and highly profitable.

2) The Consumer space is not uniform in nature and is, instead, comprised of winners and losers. Even before Amazon, many department stores were ceding market share to specialty retailers. We have never even been tempted to own the likes of Macy’s, JC Penney and Hudson Bay because their business models are simply outdated. In contrast, companies with compelling, premium products and services tend to stand out, especially with a strong direct-to-consumer (as opposed to wholesale) presence. In particular, consumer tastes have gravitated towards quality and comfort and brand recognition for leading companies can amass global appeal more quickly than ever before. This has led to our investments in companies such as LVMH, Canada Goose, Lululemon, Nike and RH.

Although business activity slowed considerably first in China and other parts of Asia, and then in Europe and North America, in the January to March time frame, interesting dynamics favouring the afore-mentioned companies soon took hold. The rapid shift to WFH a.k.a. “Work From Home” heightened the need for technology; e-commerce and e-payments adoption accelerated rapidly as did the digitization of workflows and processes; demand for streaming services soared; and the need for data centre capacity and technologies, including semiconductors, grew rapidly.

Furthermore, the heightened appreciation for comfort and quality in clothing, accessories and also in home furnishings, especially with people working from home en-masse, along with e-commerce being the main purchase method, has favoured our consumer investments, all of which have had a strong online presence even before the lock-downs.

Thus, it would be fair to say that our investments actually stand to benefit from the pandemic, certainly on a longer term basis, and in some cases, even on a near-term basis. What many do not realize is that the value of a stock is heavily weighted towards its long-term, not short-term, fundamentals.

Because the stock market sell-off did not affect all stocks on a uniform basis, in March, we were able to quickly sell down positions in companies whose challenges were temporarily under-estimated by the market and add to positions whose attractive long-term fundamentals were totally over-looked with focus being only upon their short-term challenges. These opportunistic changes have further contributed to the performance rebound in your equity portfolios.

 

Going Forward

Fiscal and monetary stimulus have helped to support the economy and capital markets. Although the amount of stimulus unleashed has seemed unsustainable, it is important to note that very low interest rates for government bonds mitigates the cost that governments, especially in the developed world, have to bear. Although the strong performance of markets such as the S&P500 and Nasdaq seem disconnected with the current economic contraction we are facing, we should note that technology leaders have contributed disproportionately to the upside; as discussed, these companies are actually beneficiaries of the pandemic. Many non-technology stocks remain well below their highs; some have further room to recover as the economy improves with the re-opening process, others will suffer more permanent damage, especially where the odds were stacked against them, even before the pandemic.

Our goal is to continue to capitalize on opportunities that are under-appreciated by the market, particularly on a longer-term basis. We have confidence that we will continue to add value to your portfolios on this basis.

 

In Closing

We would like to continue to extend our wishes for health and safety for you and your families. Should you wish to discuss anything with us, please do not hesitate to reach out.

Warm regards,

Woon Ai on behalf of Woon Ai Tsang Wealth Management Group