Is the post-Covid-19 reopening theme causing too many investors to bet on recovery stocks? I’d consider this investment trust instead.
One investment theme is to bet on shares of companies with recovery potential that could flourish as the pandemic fades. And the strategy looks like a potential winner given the progress we are seeing in parts of the world with vaccines. But is it too obvious? Former hedge fund manager and CNBC presenter Jim Cramer was one voice sounding a warning recently.
Covid-damaged businesses aren’t the only shares to buy now
Cramer pointed out that many stocks have risen a long way from the lows of last spring. And I reckon much of the movement has been driven by the tendency of the markets to look ahead. There’s a good chance many shares might have already factored in the progress we’ve seen in the fight against coronavirus. Cramer reckons the vaccine situation is fluid and the world’s path out of lockdowns and other Covid-induced constraints could still be long and tortuous.
If investors are dumping shares in some companies to rotate into stocks they see as Covid recovery plays, the tactic could end up looking like a mass attempt to time the market. And market timing is tricky. There’s often much that could happen to make life difficult for market-timing investors.
So, instead of investing only in lockdown and reopening themes, Cramer suggested investing in great companies with good management. He reckons well-run, “best-of-breed” companies often have the ability to adapt to anything, “including the long-awaited conclusion of the worst pandemic in decades.“
And that message chimes with advice we hear from other well-known successful investors such as Warren Buffett and Terry Smith. For example, the Smithson Investment Trust (LSE: SSON) (run by Fundsmith LLP and headed by Terry Smith) aims for a portfolio of resilient businesses with excellent performance potential.
Demanding selection criteria
Fundsmith aims to be a long-term investor and applies various quality and value criteria to stock selection. It looks for high-quality businesses that can maintain a high return on operating capital employed. And such businesses often have advantages that are difficult for competitors to replicate.
Fundsmith wants to invest in companies that don’t need high borrowings to generate returns. And it looks for those that can grow by reinvesting cash flows into the underlying businesses for a high return. On top of that, the fund manager insists on firms that are resilient to change such as technology innovation.
Once those criteria have been satisfied, Fundsmith aims to buy shares at a valuation that makes sense of a long-term investment. And to be fair, few stocks qualify against such high standards.
But two London-listed shares are among the top 10 holdings in the Smithson Investment Trust — Fevertree Drinks and Rightmove. And I’m tempted to run the calculator over those two companies now with a view to buying some shares for my own portfolio. I’m also tempted to simply buy shares in Smithson Investment Trust.
However, I’d do my own thorough research before buying. And I’d bear in mind that those stocks and the trust itself could underperform or even fall in value, despite Fundsmith liking the stocks in the fund and the businesses passing some of the fund manager’s selection criteria.