• Allan Gray Australia says investors need to think about risk and pay attention to stock weightings in 2023
  • In an era of higher interest rates the future is likely to be more challenging for investors
  • The contrarian fundie says careful stock picking can help mitigate risk of permanent loss of capital

While global markets have rallied at the start of 2023 after a tough year in 2022, contrarian long-term fund manager Allan Gray Australia is warning investors to not get over-excited just yet, think deeply about risk in 2023 and pay close attention to stock weightings.

Allan Gray Australian investment analyst Dr Justin Koonin said the last decade has been relatively easy for investors, with all the major asset classes rising in an era of low interest rates, low inflation and cheap money.

But Koonin believes the future is likely to be far more challenging, as rising interest rates start to take hold, economic growth slows, and ongoing geopolitical issues create potential for equity investors to be punished.

His view comes as Deakin University behavioural finance academic and Morningstar analyst Erica Hall recently told Stockhead “the halcyon days of ultra-cheap money are well and truly over”.

Allan Gray Australia Investment analyst Dr Justin Koonin


Risk management to be much harder

As the economic climate shifts Koonin said risk management will become much harder.

“Most investors tend to think about risk in terms of volatility”, said Dr Koonin.

“But there will always be volatility, that’s part and parcel of investing.

“We instead view risk as the potential for permanent loss of capital.”

Koonin said careful stock picking can help mitigate the risk of permanent loss of capital.

“Outperformance over the long term does not solely depend on the stocks picked but also significantly depends on the weight of the stocks in the portfolio,” he said.

“Hit rate – or the number of stocks in a portfolio that outperform – isn’t everything.

You can outperform with a low hit rate if the upside of the outperforming investment is large, and you can underperform with a high hit rate if you don’t allocate enough of your portfolio to those stocks.”

Allan Gray’s method for weighting stocks

Koonin said the fund manager’s method is to weight stocks so that those it thinks have a lower downside risk, both in absolute terms and relative to the potential upside, have a higher weight.

“While using this portfolio construction technique won’t eliminate volatility, it should help to reduce the potential for permanent loss of capital,” he said.

“We also make sure we are never overly diversified, as this can dilute returns.”

He said investors might consider having a more concentrated portfolio if they want to give themselves the best chance of capital growth over 10 or 20 years.

“In the short term, investors might feel uncomfortable if the market is up 10%  and their portfolio is down 10%  but they really need to think about the real risk, which is permanent loss of capital over the long term.

“Uncomfortableness might be the price to pay during 2023 for long-term outperformance.”