What we know and what we don’t know

Epistemology is the study of how we know things, how we know that what we know is true, and how we can justify our belief in what we think we know is true. These questions have baffled philosophers for millennia and I am not setting out to solve them. The present crisis the world finds itself in has been made worse, in my view, by our collective sense that we don’t really know anything about COVID-19 and the likely future course of events. My sense of this was heightened by the excellent briefing given by Health Canada on April 9th which served to emphasize the wide range of possible outcomes.

I don’t think anybody can accurately predict if an effective treatment for COVID-19 will be found in the short run, although we all hope for that. We don’t know when or if an effective vaccine will be developed (bear in mind there is still no vaccine for HIV-AIDS, a viral disease, after almost 40 years). We don’t know how many people will get sick, or how many will die. We don’t know how much the economy will contract (surely an unprecedented amount) or how long it will be before things return to normal. The growth in the unemployment rate is unprecedented, and we expect worse to come.

So it is fair to ask: What do we know?

We know that whatever happens with the current pandemic, people will have the same basic wants and needs that they do now. Regardless of the length or depth of the crisis, most people will want to return to their prior way of life. They will want to buy much the same things, enjoy much the same services and act pretty much as they did before COVID-19 struck.

We know that companies will be needed to satisfy those wants and needs. They will need to produce the goods and provide the services that consumers demand. We know that companies will need to employ or re-employ the workers who do the jobs that enable them to meet those demands.

In other words, we know that the economy will not dry up and blow away. It will be damaged, and certain sectors will be devastated in the short run. Some forecasts project that the output of goods and services will drop by as much as 30% during the current quarter of the year. Surely some companies that existed prior to March 2020 will disappear; but crucially, the needs those companies fulfilled will persist.

Since we know that eventually the economy will be up and running again, right now, our job as portfolio managers is three-fold:

  • To continue investing in sectors that can manage to make money even under current circumstances;
  • To avoid those companies that are less likely to emerge from the current crisis in reasonable financial condition;
  • To investigate and invest in companies that appear well positioned to do well even in the present circumstances.

Given the limitations to our knowledge that are noted above, we must use our best judgement as to which companies fall into each of these categories. We fully understand that some of our decisions will prove to be right and some wrong, since certainty is in even shorter supply than usual.

Our firm relies on a formal and rigorous process when making decisions regarding the buying and selling of securities for our clients. I can tell you, and you likely will not be surprised, that our Portfolio Management Committee has been meeting much more frequently than usual. We have been focused on the three imperatives listed above, and to that end, we have carefully examined the financial statements, business models and to the extent we can, the prospects going forward for the 50 or so companies that are in our portfolios. Our conclusion is that no company we currently own faces an existential threat – that is, none of them will go out business. We further expect that no more than a very few will be forced to cut dividends as a result of economic conditions. So far, only one of our portfolio companies has done so.

As a result of our discussions and analysis, we have taken steps to reduce our clients’ exposure to the travel and leisure industry. While we believe that after the recovery there will be a gradual return to travel and tourism, the ability of companies in the sector to survive until that happens is unknowable. We have closed our positions in Delta Airlines, Hyatt Hotels and Walt Disney. We had previously sold out of booking.com.  Our remaining exposure to this sector is limited to select market leaders, and we remain confident in their ability to navigate through the turmoil.

We went into the market downturn with very minimal exposure to the fossil fuel industry and we have not owned any oil or gas explorer/producers for a number of years. We do have positions in a number of companies that provide vital infrastructure for the processing and movement of petroleum products. These companies were badly hurt by the combination of a price war in the oil industry and the global market sell-off, but have since recovered to a great extent. We do not see any need to sell them.

Finally, we have made investments in the very stable rental apartment sector and in a video streaming company, and we are working continuously to optimize client portfolios.

I hope that when you look at your returns for the first quarter you will be pleasantly surprised. I know that many of our clients expect to see negative numbers of 20% or more. In the face of the most sudden and violent downward movement in the major markets in the past 33 years, we are more than satisfied at how our portfolios have held up.

As I write, the first part of April has produced positive market results. We don’t know if this is a harbinger of things to come or merely another sudden movement in an environment that continues to be volatile. We have confidence in our process and we know that a fundamental, unemotional approach to the market will generally yield good results over time. That is what we hope to achieve.