Last year, we endured some major shifts in the market. Just 23 trading days resulted in the S&P 500 falling -34%. By June it had topped +40% (from its 23 March low). It can be disturbing when this happens in such a short timeframe, especially with the media going ballistic with doom and sensationalism. Is this usual?

Yes, it is. Large ups-and-downs occur all the time - though not for the past 10 years. So it feels unusual and can be tempting to time moves or cash out until things feel okay again. Here are the seven biggest market events over the last 90 years:

1. The 1929 Great Depression Crash lasted well into the 1930s. It's still by far the craziest ride in history. The market was up +32% in '29 until peaking in September. Then it fell -45% in two months. Then it rose +28%. Overall, the year was down just 8.3%. By four months into the next year the market was up +22%. It didn't last, as the next eight months would see a -44% drop. By December it was still down -25%.
2. 1931 had stocks rising in two months by +19%. It then flipped, closing around -57% by mid-December. That year is the worst year on record, finishing -44%. Would you have stayed invested? Another -51% drop over the next five months of 1932 would really test you! (This was THE bottom as it turned out.) Without warning or good news, markets rallied +112% in only 12 weeks. The S&P still fell again another -32% to settle for the entire year at -8.6%. Selling didn't subside in 1933 as there was another fall of -25%. After that, investors enjoyed a staggering +121% in July (and a bump of -29%) to finish the entire year +50% - one of the best years ever. 1934 saw another rise of +21% (and a fall of -29%). 
3. The '73/'74 oil crisis marked another rollercoaster of returns. Stocks fell -37% before bottoming in October, then rallied +21% the next month, ending the year at -26%.
4. 1980 saw stocks falling -17% only to rise +43%. The market was up +32% by year's end. 1982 witnessed a similar event with -17% followed by a +40% jump. Year-end stocks were up +20%.
5. The Black Monday crash of '87 saw the market falling -34% in only a week. It had risen +40% beforehand and ended the year almost +6% (after the worst one-day crash in history). 
6. The late '90s asset bubble had a +20% gain for five years straight up until 1999; yet in '98 it had a -9.3% fall before increasing +34% ending the last year of last century at +28%. As the dot-com bubble burst nudged by 9/11, three big 7. price swings occurred in 2001. Stocks fell -19% before rising +19%; then there was a -26% crash to close the year around -12%.
7. The 2009 GFC bottomed in early-March '09 at peak gloom but not before being slammed at -28% from 1 January. Prices then leapt +67%, closing the year at +26%.

What would you have done as an investor in response to each of these market events? Hindsight is a wonderful thing...

Three demographic discoveries that affect investments

To understand the drivers of the structural down-shift, we need to first look at the reality of the globe's demographic make-up. Our white paper discusses three demographic discoveries - and at least one of them will challenge long-held beliefs!

Discovery 1: The world population will grow for the next 30 years and there's not much that can be done to stop this. 

Discovery 2: World population will then decline and there is little that can be done to stop this if societies behave as they have done for millennia. 

Discovery 3: 'Peak Child' occured in 2011. There will never be a year in our lifetimes where more children are born. This has profound economic growth implications.

Learn more in our demographics White Paper: The GDP Downshift - Preserving Equity Returns

Disclaimer
Equity Trustees Limited ("EQT") (ABN 46 004 031 298), AFSL 240975, is the Responsible Entity for the Insync Global Quality Fund and the Insync Global Capital Aware Fund. EQT is a subsidiary of EQT Holdings Limited (ABN 22 607 797 615), a publicly listed company on the Australian Securities Exchange (ASX: EQT). This information has been prepared by Insync Funds Management Pty Ltd (ABN 29 125 092 677, AFSL 322891) ("Insync"), to provide you with general information only. In preparing this information, we did not take into account the investment objectives, financial situation or particular needs of any particular person. It is not intended to take the place of professional advice and you should not take action on specific issues in reliance on this information. Neither Insync, EQT nor any of its related parties, their employees or directors, provide and warranty of accuracy or reliability in relation to such information or accepts any liability to any person who relies on it. Past performance should not be taken as an indicator of future performance. You should obtain a copy of the Product Disclosure Statement before making a decision about whether to invest in this product.

Recently, there's been a lot of discussion about whether the significant government stimulus, combined with record low interest rates and unconventional monetary policy such as Quantitative Easing (QE) will finally result in rising inflation, something markets have not experienced for some time. After a number of false starts, it appears that almost every central bank is committed to these measures until they achieve their objective of realised inflation.

It's a risk of which investors should be aware. On a practical level, it means taking a look to see whether the assets in your portfolio are still match-fit in an environment of rising inflation. We have previously written on the critical role of the attacking defender as it relates to private debt illustrated through soccer, so we'll extend this soccer team analogy to explore this dynamic and the role private debt can play to help investors navigate an environment of rising inflation.

Moving market dynamics

Long-duration assets like government bonds, infrastructure, property, and high-growth equities benefit when interest rates fall by lowering the discount rate applied to all their future cashflows.  These are the first assets selected in your team when rates are falling. We have seen these champion investments perform exceptionally well over the bull market of the last 40-years, when interest rates have dropped from double digits to near-zero levels.

With the potential for rates to rise from zero and with the prospect of inflation, it's time for the coach and team manager - in markets, the portfolio manager - to make some difficult decisions about whether champion players in the twilight years of their career - for example sovereign bonds - should still be on the field, at least for the whole match. It may be time to re-evaluate whether your best past players are really your top choices going into a new season, or whether they should be retired, rested, or spend less time on the pitch because they've lost a yard of pace.

When inflation expectations rise, interest rates tend to increase, and the yield curve steepens. In these conditions, it's an opportunity to reconsider whether some of the long duration assets that have been tried and tested players in the portfolio are still fit for purpose. It might be time for short duration asset classes such as private debt to step into their role in the team.

In a rising interest rate environment, the value of long-duration assets like fixed rate corporate and sovereign bonds, fall in value because their future cashflows are discounted further than before. This isn't the case with private debt, which is short duration and senior secured debt, and in a rising interest rate environment does not fall in value, giving true diversification benefit.

Australian & New Zealand Private Debt: Appeal in a rising rate environment

The chart below illustrates various credit and fixed income investments with differing levels of duration. The longer the duration, the more sensitive the investment valuation will be to interest rate changes.   

     Source: Revolution Asset Management and Bloomberg. 'Aust & NZ Private Debt' is based on realised investment experience of the Revolution private debt strategy from December 2018 to May 2021.

In fact, the overall yield of private debt rises in line with interest rate movements upwards because the total interest earned on the assets is the floating rate benchmark plus the credit margin, instead of a fixed rate coupon. This is one of the most compelling reasons to consider an allocation to private debt in your current portfolio. The trade-off is that investors need to be comfortable with increased credit risk and the illiquidity that comes along when investing in private debt.

Like any soccer team, sometimes the coach or manager needs to bench certain assets because they don't suit the playing conditions. But when conditions turn, it could be time to bring them back into the team. Gold is a good example, which has historically served as a store of value when inflation rises. Perhaps it's also time to have an eye to the future and consider whether to promote up-and-coming players from the youth team. In this example, the coach or portfolio manager might examine whether an allocation to crypto currencies may add diversification to your portfolio in a QE world, but we'll leave it to others to continue this debate.

Re-positioning for the times

Overall, what's important is to have the right balance of attacking and defensive assets in a portfolio for the current conditions. You pick a different team when the game is played in rain and snow compared to when the conditions are fine. When it comes to investing, what's important is to choose the right assets for the prevailing economic and market environment.

Think of private debt as the attacking defender or wingback in the team, it provides the right balance in a portfolio because it produces uncorrelated returns to other assets, as we demonstrated in our previous article. It's an investment that's first and foremost a defender that aims to preserve capital, but at the same time, it can contribute to the attack and goals in the form of regular income that can either be spent or used to re-balance. Just as with soccer players, consistency is the key to selecting a fund manager that has the form for managing a portfolio through different conditions. At the same time, a good fund manager - and good players - will be well-balanced, durable and without weaknesses.

Private debt as an asset class is an especially attractive option, particularly when inflation is rising, something with which markets have not had to grapple for some time. Revolution Asset Management's goal is to be the attacking defender in investor portfolios by providing that winning and balanced combination of attack in the form of potential income, and defence in the form of aiming to provide capital preservation through all market cycles.

This article is for institutional and professional investors only and has been prepared by Revolution Asset Management Pty Ltd ACN 623 140 607 AFSL 507353 ('Revolution') who is the appointed investment manager of the Revolution Private Debt Fund I, the Revolution Private Debt Fund II and the Revolution Wholesale Private Debt Fund II (together 'the Funds'). Channel Investment Management Limited ACN 163 234 240 AFSL 439007 ('CIML') is the Trustee and issuer of units for the Funds. Channel Capital Pty Ltd ACN 162 591 568 AR No. 001274413 ('Channel') provides investment infrastructure services to Revolution and Channel and is the holding company of CIML. None of CIML, Channel or Revolution, their officers, or employees make any representations or warranties, express or implied as to the accuracy, reliability or completeness of the information, including forecast information, contained in this document and nothing contained in this document is or shall be relied upon as a promise or representation, whether as to the past or the future. Past performance is not a reliable indication of future performance. All investments contain risk. This information is given in summary form and does not purport to be complete. To the extent that information in this document is considered advice or a recommendation to investors or potential investors in relation to holding, purchasing or selling units in the Funds please note that it does not take into account your particular investment objectives, financial situation or needs. Before acting on any information you should consider the appropriateness of the information having regard to these matters, any relevant offer document and in particular, you should seek independent financial advice. For further information and before investing, please read the relevant Information Memorandum available on request.

IPOs can give you wonderful returns if you get them right, but burn your money if you don't. And that's clearly shown in the trajectories of the companies that have listed since the COVID-induced market lows in March 2020. Because, while there were some big winners - like Cettire (ASX:CTT), Aussie Broadband (ASX:ABB) and Universal Stores (ASX:UNI), there were also some clear losers.

Our process at the Montgomery Small Companies Fund is designed to seek out companies with an under-appreciated or undiscovered competitive advantage with capable management teams that are early in their value creation journey. The IPO market can be a good place to look. So what's been happening in this area of the market since the market's COVID lows and what did we do?

The IPO market since COVID 

The first IPO out of the blocks in the COVID market depths was a $30 million raise for Atomo Diagnostics (ASX:AT1) at 20c a share. AT1 listed with an agreement already in place to provide COVID diagnostic kits to needy European Government type customers. It seems that whatever solace the market is looking for at any given moment in time, there is an IPO for that! Day 1 turned out to be AT1's best day (so far) - trading at over 50c, but it's been downhill ever since, with the stock now trading 20 per cent below issue price at 16c or so today. Quite a journey. There is a message in the AT1 story.

The valuation regime of an IPO is an unknown, brokers do a good job to select IPOs that they can "get away" essentially giving the investor crowd what its craving, the flavour of the month. And brokers work hard to whip up demand, this can result in extreme pricing dislocation events. Our job is to be on the right side of that event. Picking those businesses that can go on to create that value for our investors in the Fund. The ones that go up and stay up.

There are many IPO events - we go through the stats below - so our process involves an initial screen, to see if the IPO candidate likely has the characteristics that we are looking for in the portfolio, before selecting which ones to spend the time and effort doing proper due diligence on.  Doing the work at IPO helps get an understanding of a company that can pay dividends down the track, even if we don't decide to invest on IPO, we try to do the work on as many as we can.

The stats: By our count there have been 110 IPOs since the market COVID lows in March 2020. 39 of these have been resource exploration plays, all but 2 have been sub $50 million market cap. Microcap resource exploration plays is not an area of the market the Fund goes hunting in. Too speculative. We don't look at those.

There have been 71 non-resource exploration IPOs that have listed since the COVID lows, 44 of these have had a market cap on IPO of greater than $50 million. That's our investible universe. Of these 44 listings, the median return since IPO is -3 per cent. 21 are above IPO price, 23 are under. The data says IPOs are not a one way bet, but the chart below also shows that if you get them right there are good returns available.

Distribution of IPO Returns post March 2020: IPO price to date

Source: Montgomery, Iress, Listings 1/4/21 onwards, ex Resource exploration with Market Cap > $50mn

Characteristics of IPO losers

One of the most common IPO errors observed in recent times is investors look to play "hot themes" of the moment.  Remember if you want it, there is an IPO banking team that has got the deal for you and during COVID times this was meal kits, e-commerce and buy-now-pay-later, amongst other things. An IPO on a "hot theme" can look good in the short run, but can come with longer term pain, as the hot money that chases these "hot" deals does what it does best and moves on to the next shiny thing. Consequently, most if not all of these types of new issues don't find a real investor base anywhere near their IPO price and end up firmly under water.

Youfoodz (ASX:YFZ), tried to capitalise on the market's appetite for meal kit delivery that boomed during COVID. Its IPO was "priced" at $1.50, it never traded within cooee of that, best print was $1.32. One way traffic since then. It's 71 per cent down, trading at 44c on my screen as I write, and takes the award for the worst post COVID IPO (to date anyway). My Food Bag (NXZ:MFB), New Zealand's "Youfoodz" provides further illustration of hot theme/hot money loser and is trading 28 per cent below its issue price.

Another that looked to cash in on the "moment" was internet retailer Adore Beauty (ASX:ABY). The business was listed on a high valuation, after being acquired by private equity for a much, much lower price only a short time before. At best you could say this was opportunistic. Nevertheless "investors" fluttered like moths around the e-commerce flame when it IPOd at $6.75 in October 2020. That did slightly better than YFZ, however like many moths the "upside" there didn't last long, ABY closed above issue on its first day, but never since and is now down 32 per cent on that IPO price. ABY is arguably now an illiquid micro-cap with a lot to do to re-build its reputation with investors after its warning that it's not growing at the rate investors expected. A downgrade in expectations before it even delivered its first set of full year financials as a listed company is a sin not easily forgiven by institutional investors.

A blog on IPOs wouldn't be complete without reference to Nuix (AX:NXL), but given the AFR has done such a good job of disclosure there (better than the prospectus it appears...), we don't feel the need to explain. Caveat Emptor.

We didn't do the work on any of the above.  Screened out early.

The Winners

IPOs can be lucrative too, as just as the price discovery process can be difficult for investors, that's the case for the IPO brokers and advisers too, and the business can be sold too cheaply at IPO. IPOs that have performed well include Cettire (ASX:CTT), Aussie Broadband (ASX:ABB), Maas Group (ASX:MGH) and Universal Stores (ASX:UNI). We didn't look at CTT (we thought the e-commerce model was just a child of the times and would quickly slow, time will tell) or ABB (sometimes we miss things). We looked at MGH but thought it was expensive, it's up 150 per cent so I suppose you'd classify that as getting it wrong! We invested in UNI.

Of the bottom 10 IPO stocks, 9 of those were "hot theme" stocks, only Harmoney probably doesn't manage to fit that description, although arguably it may have been pitched as such. On the flip side of the top 10 performing IPOs only 2 of them could be considered to be "hot themes" and 1 is a bio-tech (tough to value), the rest have proven business models, some with competitive advantage, many are well run by talented management teams.  That's what you need to look for.

Montgomery Small Companies Fund IPO report card

Of the 44 non-resource exploration IPOs since COVID with a market cap of greater than $50 million, we have looked at 23 of them, the rest we screened out, for one reason or another. We also looked at one sub that market cap level as we thought it could be interesting - a total of 24 active IPO investment decisions were made. We decided to invest in 8, of the 24 we reviewed.

Of the 8 we invested in, we made money in 6 of them, sometimes with very good returns.  As an aggregate across those 8 we have made 25 per cent return on total capital deployed, with the median return being 48 per cent. It's worth pointing out that only a small fraction of the Fund at any one time is committed to IPOs, for instance of the 8 IPOs we invested in, 5 have been sold, and we hold 3 which are collectively circa 2 per cent of the portfolio. Risk management is always important, especially with IPOs. Early stage companies have higher risk, so we size these in the portfolio so that if they go right we make good returns (see chart below), but if they don't work you won't see us telling you we have underperformed because an IPO didn't go the way we planned.  We acknowledge the work done by the advisors and brokers who partner with us, in bringing these companies to market, for the good ones that is, you can keep the bad ones!

What about our losers? Of the two IPOs we invested in that didn't work, we made minor losses on one, the other is Cashrewards (ASX:CRW), which hasn't worked (so far) but we continue to hold. We certainly don't get them all right.

Montgomery Small Companies Fund IPO report card: 75 per cent hit rate

Source:  Montgomery, Iress, Listings 1/4/21 onwards, ex Resource exploration with Market Cap > $50mn

Of the other 16 decisions where we looked but decided not to invest, 10 of those are under water, 6 made money, although 3 only just. We did miss 3 good opportunities that we did the due diligence on but for various reasons we didn't get over the line. Next time.

And we think that there will be a next time for quite some time. IPO banking teams at the banks and brokers report many IPOs in their pipeline, all looking for the right time to come to market. Whilst it's clear to us that investor appetite has moderated, particularly for loss making businesses, we see that as some "heat" coming out of the market. That's healthy and we expect a steady flow of IPOs for us to scrutinise over the coming months.