As if 2022 was not tumultuous enough, the first quarter of 2023 was marked by dramatic events, culminating in the spectacular demise of Credit Suisse. In just a weekend, UBS acquired a Pandora’s Box, and many investors were left with portfolios of AT1s (additional tier-one bonds issued by the bank) that took a hit. For those holding Credit Suisse AT1s, the loss was total and immediate.
The collapse angered some bondholders. Many have argued that AT1s sit higher on the capital structure than common stock (regular shares companies issue to the public for sale) and feel aggrieved that while Credit Suisse shares retain some residual value, their AT1s were completely wiped out with no hope for a rebound.
At Eu Capital, we believe that due diligence is essential when investing, whether it is in common stock or perpetual bonds. While the decision to invest may take only a second, the value of a quality investment decision rests on countless hours of primary research. Relying on hearsay or secondary research is the easy way out, but it significantly increases portfolio risk.
So, does diversification reduce risk in your portfolio? Does decreasing volatility reduce risk in your portfolio? We don’t think so. A diversified portfolio of cash, Chinese stocks and AT1 bonds is no better than a fully invested portfolio of five quality stocks. Bonds are known to have low price volatility until some AT1s are written off in a weekend.
We believe risk is reduced by fully understanding the businesses we invest in. If the underlying business is excellent, we want to be a part of it, even as minority owners with common stock. If the business is poorly run, we wouldn’t even want to lend it a cent, let alone lend perpetually with fine print conditions (as in the AT1s). At Eu Capital, we view the capital markets as a long-term investment in great businesses that create great value, not as a casino or a computer game formula. In the words of our favourite Mr Buffet, “Risk comes from not knowing what you are doing.”
Our portfolio is positioned to deal with the persistent inflation in today’s world, and our year-to-date return for 2023 is +19.1%. In our last update, we emphasised that the light was near. We thank our investors for sharing our conviction, being patient with us, and not panicking over the past year, especially those who have most of their net worth invested in our fund. We will continue to be vigilant in navigating this ever-unpredictable world. Ultimately, time in the correct market rather than timing the wrong market makes the difference.