What do professional investors do when the world is on fire?

Kia ora, I'm Nadine Higgins and welcome to the Prosperity Project.

Where the water is going on right now in a run, and while we're at it, Israel, Palestine,

Russia, Ukraine, Afghanistan and Pakistan, the world sort of feels like it's on fire right now,

right? And at times like these, the traditional financial advice is,

sit tight, don't panic, think long-term. But what about the people who manage

money for a living? What are they thinking, doing or not doing when war erupts?

Sam Dickey is a senior portfolio manager at Fisher Funds, and he's with us on the Prosperity

Project. Thank you for being with us, Sam. When you get the notification in the night time,

or you wake up and read the news that Israel and the US have attacked Iran, what is your first

action? And thank you for having me on, Nadine, that is absolutely key because investors don't

and shouldn't position long-term portfolios, long-term investments for these sort of low

probability, very human tragedies, by the way, and often find it a bit awkward to talk about these

things through markets, leans, given it is a real human tragedy, but they're kind of

sort of low probability high-impact events, and it's really hard, in fact, impossible to position

your portfolio for that. So the very first thing you do is you triage your risk. So do I, if this

gets worse, for example, when in the risks manifest in many different ways, other than just the obvious

being oil, how am I positioned? If it gets much, much worse, which of my companies are most at risk,

most exposed to this, do I have any positions in my portfolio that I was kind of thinking about

selling anyway, they're on the way out, they might have served their purpose, that the thesis might

have played out, or the thesis might have changed. So do I have low conviction positions in my portfolio?

But equally, you've got to be really symmetrical here, so is there anything I was thinking about

buying yesterday, and it's just gotten a whole lot cheaper today? So those are the sort of things

you do is triage your risk and look to pay both defense if you don't think you're well-positioned,

and offense if you think you are well-positioned. So that's the old, by the dip strategy on the

opportunity side, that if you thought something was a good bit yesterday, and now it's 8% cheaper

while it's an even better bit today. That's right, especially in these events you find,

we often call them high correlation events, so often when people panic, everything goes down

together. I guess it's the opposite of a rising tide lifts all boats. I'm not sure what they're

saying would be there, but when you see that and you see sort of indiscriminate selling, and I'm not

saying that's necessarily happening here, but often with these low probability high impact events,

you'll see that, and you can get a great opportunity to buy a really good business at a cheaper price

today than it was yesterday. That said, we obviously knew that the US was kind of rallying the troops

for want of a bit of phrase. We just didn't know exactly what they were planning or when. So we

trying to triage the risk ahead of anything happening, or were you just kind of biting your time,

what goes through your mind? I think as a professional investor, you're always triaging your

risks, so you stress test your portfolios based upon numerous things, spikes in oil prices,

shocks in economic growth. Part of that is, Fisher funds are particular for 28 years, we've had a

real quality investment style, so what I mean by that is we're investing in companies with

really strong balance sheets, really long-term thinking management teams, wide and widening

economic modes, and long growth runways, almost irrespective of the economic backdrop. So

that sort of ethos and style is this form of stress testing, but outside of that we run scenarios

on a number of shocks, including a spike in oil prices. When you say a wide economic

mode, what you mean a company that's going to do well kind of regardless of what's happening in

the economy, do such companies exist? Are these the supermarkets? Everyone has to eat.

Well yeah, I mean that's a very defensive earning stream, but I guess a wide economic mode is

a certain specific set of circumstances, and quite unique set of circumstances that allows a company

to protect itself against the ravages of competition, or anything that might

eat into it's sort of super normal returns it can make. So for example, scale is a classic one,

and that sort of flywheel of scale. So if you're the biggest in the industry and you have the best

people working for you, you've got the ability to invest more in things like AI opportunities,

or bigger factories for example, which will drive down your cost to produce, and that sort of feeds

on itself, and you can drive up your margins and continue to take markets here. Another one is a

brand for example, so a really strong brand mode for example, it is a big mode. So Apple for

example, Gillette Coca-Cola, a third one, and this is sort of less well known as the super powerful

network effect. So what that means is for every new customer that you get on your product,

that makes it more valuable for the existing customers, and really simplistic, think about

Mastercard there that has a two-sided network effect mode. So if you didn't have a credit card,

what's your favourite restaurant just out the cafe, just outside here?

Oh, bread and butter.

Bread and butter, excellent, sounds very solid, very basic. I'm sure they serve more than that.

If you didn't have a credit card, and they had a credit card terminal, and then today you got one,

that makes the network incrementally more valuable for all of the merchants on the network,

and certainly for bread and butter, because you can use your Mastercard there. And equally,

if bread and butter didn't have a Mastercard terminal, and you had a Mastercard, and they got one

today, that makes the network incrementally more valuable for you. So it sort of locks you in as

a customer and a merchant. So those are some of the types of economic notes I'm talking about.

Obviously, the traditional advice to your, I hate this term, but for one to the better one,

mum and dad investors. So your average Joe who's got Kiwi Saver, maybe has a managed fund, whatever,

some individual shares, is to sit tight, do not make decisions based on what's happening today,

when you're actually investing for your retirement, kind of the keep calm and keep invested strategy.

I take it though, that's not what a professional portfolio manager can afford to do. So

are you looking for, are you buying and selling on the back of an event like this, or are you

sitting tight and waiting? Like, how does it work?

Well, I think going back to that first point is we're always triaging the risk, but equally,

these things weren't necessarily going to happen. There's been many events in history where you

expected something to happen, and it didn't, and a good example I always think of this is when Trump

was first elected. So the market was 100% convinced he wouldn't be elected. And in the unlikely

event that he was elected in 2016, the market was 100% convinced that the stock market would go down

very sharply. So they were wrong on both counts. He was elected, and then the ensuing 12 months,

the stock market went up 21%. So the point there is, even if you had tomorrow's newspaper yesterday,

you still wouldn't have made any money out of it. So I think it's, of course, we were always triaging

risks. They may not happen. And most importantly, and I think Ukraine was a good example of this,

the risks you expect to manifest may not manifest. And what I mean by that is,

the transmission mechanism there was going to be energy prices and soft commodity prices.

In fact, the oil price peaked before Putin invaded Ukraine, and soft commodity prices spiked

pretty rapidly, but about three months later, they were much lower than they were previously. So,

again, even if you got it right and knew that this was going to happen, often perverse outcomes

happen, and I'm happy to sort of talk through some of those other unintended consequences as well.

Yeah, and we will get to that after the break. But I suppose when it comes to ruckians in the

Middle East, which we know stranger to, is there, there's a typical set of knee jerk reactions,

right? You know, if we're talking about shipping channels like the Strait of Hummus,

if we're talking about oil producing countries, then there are some obvious ones that are sort of

the first cabs off the rank. That's right. And every time one of these things happen,

when you're triage in your risk, obviously, it's important to see what are the most acute

first round risks. And this has been well documented that oil and then the potential restriction

of supply of that oil will be the most obvious first round impact. And then, for example,

when you're triage in your risk, as a mum and dad or a semi-professional investor, you start to do

things like, well, which of my companies are economically cyclical and might be impacted by a

spike in oil prices, because all of spike in oil prices really is a tax on growth and a

potentially inflationary impact. So both of those things are not good. The second thing is,

am I invested in countries that are more exposed to a spike in oil price? So lots of countries in

Asia are still to this day, big net importers of oil, so they're short oil effectively. And that's

part of the reason why you've seen some of the Asian stock markets react really, really much

more savagely to this than the US. So the world isn't any less exposed to oil prices than it was

15 years ago, as there's this electrification move, still very much, if oil prices go up, as you say,

tax on growth, inflationary impact. That's right. I mean, we asked very much fossil fuel global

economy, although last year there was some good stance about how much solar was added around the

world and most of that in China, actually, incidentally. So we asked all very exposed a lot of

those Asian countries that used to be very short oil. And in fact, the US was very short oil

as well before the the shale revolution. So if you go back sort of 15 years ago, this would have

really hurt the US, for example, but now they're self-sufficient oil given the fracking and the

shale revolution, the domestic drilling for oil. I mean, they're invasion into Venezuela, did that

help? That's better positioned, no comment. Sorry, I don't mean to get you political, but you know,

it is often said that these things are motivated by things like access to fossil fuels. I'm absolutely

sure that the rumors are true on that. And some of those Asian countries, so big tiger economies

like India, for example, that used to be absolutely, it's Achilles heel is this kind of spiral effect

by the fact that they were very short oil. So they need to import a lot of oil. And there,

there would be an immediate reaction, their currency. So if the price of oil spiked, their currency

would usually weaken in response to that. And this is the sort of second round effect I was talking

about before. And that if you think about what happens there is not only is the oil price going

up in US dollars, but the Indian Rupee is depreciating against the US dollar. So the price of a barrel

of oil and Indian, sorry, Indian Rupee is spiking and that feeds on itself until you get a circuit

breaker. So the point there is India's insulated itself a lot more than it used to be in so's China.

So a lot of these countries are trying to balance the books on oil, but they're still short oil. So

like New Zealand, right? We don't have a refinery here anymore. The New Zealand dollars pretty

weak oil prices are high. This could have a very real impact on our inflation and our growth.

Yep. The price at the pump is just a real tax on growth. And it's,

and I guess what we need to watch for is that stag flationary impact. So

what I mean by that is it's a tax on growth. And I always think like this, how does it manifest?

So imagine you're sitting in a boardroom in middle America and you're about to sign off on a

a billion dollar capital project. You know, you're the chairman, you're one of the directors.

It might be a series of factories. It could be anything that's going to cost you a billion dollars.

And while you've done all the feasibility studies, it was sort of a line ball. It was a 55,

45 call. And just say today was the day you were going to sign that check, I reckon you might,

it might just give you pause, give them a full full blow on war. So it's that confidence transmission

mechanism as well. So it's confidence is a tax on growth. I mean, we literally will drive less

if the oil price spikes. And then if we see inflation coming through and oil sort of feeds into

a lot of other commodity prices and textiles, etc. Then you can have a slightly awkward scenario

called stagflation whereby growth is slowing, but inflation is going out. Yeah, which is a really

uncomfortable position to begin. We're going to talk a little bit more about those cascading

impacts that you mentioned after the break. We'll be back right after this.

Welcome back to the Prosperity Project. We're kind of talking about how you invest when it feels

like the world is on fire, which is to me how it feels at the moment. Sam, how much of what you're

deciding to do or not do when you're looking at your portfolios that you manage is based on data.

And how much is there any gut feel involved in it? We try and take out the gut feel as much as

possible. And in fact, that's a big part of a portfolio manager or fund manager's job is

I think my colleagues said it best once. Human beings are riddled with and swimming in bias.

It's just a truism. So we try and take away as much of that bias with with process and a scalable

and repeatable process. In terms of data, I always thought my boss and honkong used to say a

while he said, God can turn up with a hypothesis or a theory to a meeting, but everyone else

bring data. So we're always trying to prove everything. Yeah, okay. So what sort of data are you

looking at at the moment to try and figure out how best to invest in an environment that seems

extremely unpredictable? And I know some investors might be familiar with the volatility index,

the VIX does that tell you anything other than that everyone's panicking?

Yeah, I think that you said it well there is it does tell you that everyone's panicking and as we've

discussed, you're really saying, put your head out the window and tell me if it's rainy and

you put your head out and it's absolutely raining. So the fear gauge or the VIX is important,

but I think just seeing spiking commodity prices is it would be obvious that VIX would be

there would be a high VIX given this. Now what is happening is, you know, under the hood, there's

been a lot going on this year. So on the face of it, the S&P 500 is fairly flat, but you've seen

extreme dispersion going on. So what I mean by that is energy stocks are up sort of 25%

year to date and software stocks are down 20. So a 45% spread in big sectors is extremely unusual.

So we're seeing money rush around in a very concentrated fashion into very specific things.

Last year it was AI, more recently it's become memory and I do want to talk about career really

briefly. You know, memory was the key bottleneck for AI right now, if you remember two years ago,

when you typed into your chat GPT, there was no reasoning or thinking it was just, it was the

president of the United States in 1928, it was just boom. Now these models are all thinking and

reasoning and that requires a whole lot of memory and context and memory is the current shortage.

So everyone's rushing into memory stocks. People are this is before. So this is the

Nvidia's of the world. Well, it was Nvidia sort of more earlier on last year. I mean,

that was an obvious AI winner. Now it's, you know, high bandwidth with with memory

manufacturers like high nicks, like like Samsung, like Sanders, like micron. So that is

the money sort of rushed into the most acute bottleneck in the massive AI infrastructure buildout.

The other thing that people have been crowding into before this, this was four days ago,

was much lower quality companies in the US, companies with higher debt on their balance sheets,

who were going to be big beneficiaries of a potential cyclical recovery in the US. People are

clearly crowding into precious metals, for example. So the point is these things change every few

months. It's very aggressive and it's, it's, it's very concentrated investing, which is very risky.

And then some of that started to unwind. So this may have been the catalyst. So if you look at the

Korean stock market, which is about 45% of the stock market is two stocks, which is Samsung and

high nicks, that's down 21% in two days. Now you do not see stock markets for 21% in two days.

In fact, it was down 12% a day, which is the biggest one-day drawdown in its 46-year history. So

we're seeing some very extreme dispersionary moves below the surface.

The old saying used to be that if you're hearing stock tips from the Shushan boy, you know,

when everyone's figured out that Nvidia's the big play in AI, for example, you've missed it.

You know, everyone's made their money and you're last to the party and you're the one who's

most exposed. Is that one of the risks that this running around from this hot sector to that hot

sector is currently presenting? Very much so. It's a risk and an opportunity and that is a point

very well made. So when anyone's crowding into memory and crowding into career, crowding into

low-quality, small-cap companies in the US, you just know that at this stage, when it's on the

front page of the newspaper and has been for weeks and weeks and weeks, it really is the

potentially the greater fault it's by in these sectors. So you just need to be very weary.

So how do you get to be the one who's investing their first, rather than the one who's

reading it on the front page of the newspaper and joining the party a little too late?

Well, I think first of all, you've got to have a process and a style, right? And I think

this is one of the exciting points I wanted to point out is quality companies, as a bucket,

as a basket, as a group, are having their most acute underperformance in 30 years because

people are rushing into lower-quality companies. And high-necks is a good example, actually.

Phenomenal company, but if you look back over 15 years, it's made losses in two of those years.

It's had three or four times where it's profits have gone up by 500% in fallen by 85%. So

that's not something we'd call a blue chip quality company. So the flip side of everyone

rushing into this lower-quality staff and playing the Shushan person, the phenomenon is

blue chips are getting left behind. That's a huge opportunity. The second point is

I think you've just got to have a really decent margin for error, as sort of a famous investor

Ben Graham used to say. So what's your margin for error when everyone knows about a company,

that the valuation is expensive, it's a very crowded, and there's a lot of retail and

flighty money in there. You probably don't have much of a margin for error, and that's what the

Korean markets told you in the last couple of days. Equally, back in the mid-last year,

some really high-quality, cyclical trucking stocks in the US, like Old Dominion, for example,

the main freight here models itself on had been a three-year freight recession. They were still

quality companies, investors had given up fallen out of love with them, they were very cheap,

they were very under-owned, their earnings power was very under-stated. So when you've got a huge

margin for error like that, there's not a lot of downside and potentially a huge amount of upside,

and on that stock in particular, we haven't even seen the cycle turn yet, but the stock's up

70% from its lows, just on the sniff that the cycle might at least be bottoming. So look for

a margin for error. What do you make of gold at the moment? Because when everything's uncertain,

that seems to be where everyone flocks to, but it's a new record eyes every other day,

everyone's already there. So what role does that play in being a safe haven asset when

it's already expensive? Yeah, I think that's an excellent point, and this is the point

you and I are making on this crowding, so investor positioning matters. If you're being told

about gold by the shoe shine person, probably chances are it won't behave like it normally would

in a safe haven washout, and that's what we're seeing right now. But gold generally,

it's got three or four purposes. One is it's a safe haven, and it has had an extremely good track

record if you look back over a hundred years. So in the depression, in the 1930s,

in the 87 Black Friday, the Asian financial crisis, the GFC, COVID crisis, it's at least

held its value, but usually rallied throughout this period when equity markets are falling really

sharply. This particular little mini crisis we're going through at the moment, I don't want to make

light of it, but in terms of how the stock markets have reacted so far, gold hasn't worked

until your point. It's because people have crowded into it, and maybe the shoe shine person is

talking about it a little bit too much. You made a really interesting point there about what

history can teach us. We need to take a quick break, but we're going to ask their question after this.

Welcome back to the Prosperity Project. We're talking to Sam Dickey from Fischer Funds about how

to invest when it seems like volatility is the word du jour every day. But when it comes to the

Middle Eastern, I mentioned this already, Sam, that we have been here before many times in terms of

conflict and in oil producing countries and countries that dominate the state of Hormuz.

So what can history teach us or can it not? Is it the old past performance is not an indication

future performance? I think history is, frankly, the only guy we've got and there's always new

aunts. I think a famous US investor said it best when they said when it comes to geopolitics,

very few people on earth have a clue about what's going on and most importantly what's going to

happen, including sometimes the people who might be waging the war themselves. So if that we

wish... That's reassuring, isn't it? Well reassuring, but probably true. If we start with that is

the sort of our humble sort of level setter. I think history is important. So I think if you think

about the Middle East North African region in the last four decades or so, there's been 26 sort of

major sort of air strike, quasi wars, wars that have gone on. 26 in 40 years. Yeah. Wow.

And in 95% of those cases, the stock markets were higher three months later. So history does tell you

that. That's interesting. It's certainly not a guarantee of future performance as you said, but it's

context. The other thing that's really important is to the nuance. So which history, which historical

period should you compare to? So the first thing to think is what is the acute risk we're all talking

about? So Donald Trump? Is it erratic policy making, for example, it's going to be the transmission

mechanism. That was you have domestically put. Thank you. Is it, is it, or is it energy prices,

is it soft commodity prices? Is it a credit event where we see a big credit crunch, for example?

So it's important to kind of isolate the transmission mechanism, which in this case is probably oil.

And then you can start to competitor those periods. And I think it is helpful. But the nuance,

which you've pointed out a few times, is things like investor positioning coming into this is

really, really critical as well. How the markets have performed doesn't guarantee what is going to

happen. But what we know from history is that typically the share market is higher in three months

time. And I think you said, even if you had tomorrow's paper yesterday, it might not help you.

Does that bring us back to just go back to your goals, say the course, think of the long term,

without wanting and leave professionals like you to think about the frameworks and the forward

looking indicators and all of those things? I think, yeah, I really do think if you've followed

that process. So triad your risk initially, do I have any kind of loose risk or risk I'm not

that convicted on if you do. And if this continued for longer will that be impacted, will then

potentially you should tidy things up, equally look to play offense on the other side. That's the

first thing. The second thing is the framework look at history, look at how this is going to cascade

in terms of the risks and watch those road signs. So watch interest rates, watch other commodity

prices. There's lots of sort of real time inflation expectation indicators around the world.

There's lots of longer term inflation expectation indicators. There's lots of real time

economic activity indicators around the world. If you start to see inflation expectations picking

up and real time growth activity slowing down is that that director or chairman didn't sign that

that euphemistic check, for example, then it feels like maybe this is starting to cascade a bit.

And if you were to look into your crystal ball, what is it, what are those road signs telling you,

is this going to have an impact on growth, on interest rates, on consumer behaviour, or is it going

to be isolated to, you know, a few weeks, possibly awful human tragedy, but are we necessarily going

to see financial tragedy following that? I think look what I don't know, and I don't think

anyone does, but what historic analogs am I looking at? And certainly during Trump's regime, I think

we've learned that he doesn't really care about Wall Street. So if you think about to go back to

Liberation Day, he was really putting, you know, he was really driving hard on those tariffs and

ratcheting up the rhetoric with China, and Wall Street was selling off really aggressively, but he

didn't blink. He did blink when it looked like Main Street was going to be impacted. So you saw

people start selling the US dollar, the 30 bond rate was starting to go up, which is the primary

instrument that the 30 mortgages, which is 90% of mortgages in the US is set off, and credit

spreads were starting to widen as well. So it was becoming more and more expensive for businesses

to borrow, which was impacting consumers, and frankly, mortgage rates were going up. So he blinked

then. So I think look for those circuit breakers, and see whether he's going to blink this time,

and history would tell you that typically, I don't want to get into politics here, but typically

he might walk back when that happens, and that makes sense. You don't want to hurt your populace

because you might struggle in the midterm elections, for example, if you hurt your populace. So

I think circuit breakers are there. I think that was what you asked I couldn't.

Yeah, I guess there's a reason for the acronym TACO, right?

Hey Sam, it's been fascinating to talk to you. You're a very very smart man, and we appreciate

your time. That is Sam Dickey, with us from Fisher Fans. Appreciate your time.

And that is the prosperity project for this week. Thank you so much for tuning in.

Reminder that if you do have any personal finance questions that you would like answered,

or maybe you have a story to share, please feel free to send me an email,

nading.higginsatnzme.co.nz, and we will see you next time on the prosperity project.

A reminder that nothing we say here should be interpreted as financial advice.