Keys to long-term wealth creation

Understand the relationship between valuation, volatility, and wealth creation risk.

Understand the relationship between valuation, volatility, and wealth creation risk.

The best way to profit from volatility and manage investment risk is through understanding fundamental intrinsic valuation. That is, buying undervalued companies when they offer a material margin of safety and rotating out of overvalued companies.

The link between valuation, volatility and wealth creation risk is underappreciated. Using intrinsic valuation as a tool to profit from share market volatility and safeguard against investment risk is central to long term wealth creation.

Start with valuation. The goal is to buy quality companies when they trade well below their long-term intrinsic value. Often, that requires buying out-of-favour assets.

Market volatility fuels valuation anomalies. Investor sentiment and market noise can cause the share prices to move away from their long-term intrinsic value. This often distracts investors who then either overpay for assets in upswings or sell too cheaply in downdrafts.

Some investors fear this volatility because they confuse it with risk to long term wealth creation. Whereas volatility simply denotes the change in asset returns from one period to the next and is largely a measure of swings in short term market sentiment.

The real risk for most investors is that of not generating sufficient wealth from their investments to fund a multi-decade retirement and meet rising living costs in an inflationary environment.

While long term fundamental risk needs to be carefully managed to achieve desired wealth outcomes, short term volatility should be embraced as a facilitator of buying undervalued and selling overvalued assets.

You may benefit from market volatility by using active fund managers who understand long term intrinsic equity valuations.

Reduce investment risk by not overpaying for assets. Buying undervalued assets sets portfolios up for higher long-term returns and helps preserve capital.

Investing in volatile markets requires conviction. Buying out-of-favour assets when markets are fearful or selling stocks when greed takes hold and the “herd” is driving prices to unsustainable levels needs fortitude.

Managing investment risk requires discipline and patience. It can take years for industry cycles to play out and for bottom-quartile valuations to revert to top-quartile valuations.

None of this is easy. Company valuation is complex and requires expert skill, but the hard work is worth it. Buying undervalued assets in volatile markets allows returns to compound over time and amplifies wealth.

As people live longer, they will need to build more wealth for retirement. That means having a higher allocation to carefully selected equities within portfolios to generate greater returns.

This requires a new mindset towards volatility and risk. In the short term, view heightened volatility as an opportunity for active managers to take advantage of mispriced assets. In the long term, view risk as the potential of failing to generate sufficient wealth for a multi-decade retirement in an environment of rising living costs.

Most importantly, understand the differences and linkages between valuation, volatility, and long-term risk in the wealth-creation journey.



Important Information

Source: PM Capital Limited is the investment manager of the PM Capital Global Companies Fund and PM Capital Australian Companies Fund. PM Capital is a leading active asset manager in global and Australian equities and fixed income.

This article is issued by PM Capital Limited ABN 69 083 644 731 AFSL 230222 as responsible entity for the Funds. It contains summary information only to provide an insight into how we make our investment decisions, and does not constitute advice or recommendations, and is subject to change without notice. It does not take into account the objectives, financial situation or needs of any investor which should be considered before investing. Investors should consider a copy of the current Product Disclosure Statement and Target Market Determination which are available from us, and seek their own financial advice prior to investing. Past performance is not a reliable guide to future performance and the capital and income of any investment may go down as well as up due to various market forces.

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