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I Learnt to Stop Worrying and Love the Market
25 May 2020
The Global COVID-19 Crisis (GCC) is teaching us many lessons – many of which will only be apparent years from now. As this event unfolds, the quality of information about it degrades at an exponential rate. As of writing, over 316,000 people have succumbed to this virus – but by the time you read this, the figure will be outdated.

Stability is a luxury in a volatile world and investors literally have to pay a premium for it. We can find stability by embracing inherently stable industries with high “earnings visibility” such as utility companies. One disadvantage is that as investors clamour to own these ‘safe’ companies, they bid stock prices up.

On a deeper level however, we can see how the “creative destruction” (a term first coined by famed economist Joseph Schumpeter) of free market economies is a process which is itself stable. Thus, although indices themselves do not change, their constituents do – dramatically.
For example, the S&P 500’s top three companies in 1990 were IBM, Exxon and General Electric. In 2008 Exxon and General Electric were still in the top 3 but IBM was replaced by a then up-and-comer in the world of IT: Microsoft. In 2020, Microsoft remains but Apple and Alphabet (Google’s parent company) have taken the reins.

Economic structures adapt to face new realities: at their core is a system whereby firms propose solutions to problems they see or anticipate. Free markets are the best conduit through which to distribute human ingenuity which can overcome adversity. The success of an economy is likely to depend on the extent to which this dynamic can unfold efficiently. Stimulus measures can help this process along – but sometimes policy can hinder it for better or worse, as when inefficient companies are kept afloat by the public.

This process of change in turn is reflected in indices where we can expect firms which do not or cannot adapt to lose their value (and index weight) over time. Meanwhile companies which prove to be more adaptable or just at the right place at the right time will increase in weight over time. If an investor or fund manager has an insight into this process which allows them to anticipate these changes, a return in excess of the index can be expected.

An advantage of index tracking, besides generally lower costs, is that the return relies on the economic process rather than specific human foresight. Hence, over the longer term the unexpected is accounted for – including unexpected longer-term effects of the novel coronavirus. The GCC is just the latest event in a long line of events to test human’s mettle in this regard, and is far from being the gravest.

Labelling index-tracker as ‘passive’ is then a misnomer if we appreciate that we are trusting in the economic process to adapt to new problems the new world will face. In a way then, these market-cap weighted indices can be seen as representing the process of change itself – we can just sit back and admire the show.

For information about Wealth Services contact [email protected]

Article was first published by the Sunday Times of Malta on 24 May.  It was written by Matthew Farrugia who is an Economics graduate and Investment Analyst at BOV Wealth Management Unit.

This article is not and should not be construed as an offer or recommendation to sell or solicitation of an offer to purchase or subscribe for any investment. The writer and the Company have obtained the information contained in this document from sources they believe to be reliable but they have not independently verified the information contained herein and therefore its accuracy cannot be guaranteed. The writer and the Company make no guarantees, representations or warranties and accept no responsibility or liability as to the accuracy or completeness of the information contained in this document. They have no obligation to update, modify or amend this article or to otherwise notify a reader thereof in the event that any matter stated therein, or any opinion, projection, forecast or estimate set for the herein changes or subsequently becomes inaccurate. Furthermore, past performance is not necessarily indicative of future results. The value of investments may go down as well as up and may be affected by changes in currency exchange rates. 

Terms and conditions are available from www.bov.com. Issued by Bank of Valletta p.l.c., 58, Triq San Zakkarija, Il-Belt Valletta VLT 1130. Bank of Valletta p.l.c. is a public limited company regulated by the Malta Financial Services Authority and is licensed to carry out the business of banking and investment services in terms of the Banking Act (Cap.371 of the Laws of Malta) and the Investment Services Act (Cap.370 of the Laws of Malta). 
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Bank of Valletta p.l.c. is a public limited company regulated by the MFSA and is licensed to carry out the business of banking and investment services in terms of the Banking Act (Cap. 371 of the Laws of Malta) and the Investment Services Act (Cap.370. of the Laws of Malta).