The prevailing sentiment is very much risk-off. In fact, it is more along the lines of ‘batten down the hatches and reinforce the hull.’
With that being well accepted, the question investors will in many case still be wrestling with is exactly how should they go about putting up the defences?
One way to approach this is to get more selective within equities allocations at the individual stock level, more so than geographically or in sector terms. If we make the assumption that the majority view is correct, the emphasis should be on avoiding the pitfalls rather than trying to uncover diamonds.
If there was ever a time for investors to go above and beyond in terms of diligence rather than leaving it purely to equities fund managers it seems to be now.
Liberum has framed this task in a way that makes a lot of sense. The firm has identified twelve ‘red flags’ which investors need to watch out for when examining their equities allocations or the holdings of funds they have in their portfolios.
The process begins with a ‘qualitative assessment’ from auditors and is followed by eleven quantitative screens, with a finish with an evaluation of internal discount rates.
The eleven other flags are grouped into sub sets by the firm. Profit smoothing signs are one of these and include consistent adjustment of earnings, swings in the numbers of ‘doubtful debtors’ i.e clients which that have trouble paying their invoices, a build-up in trade receivable days and an increasing recognition of revenue not expected to be cashed in for over a year.
The next pair of red flags centre on working capital. Here investors should be trying to avoid companies which show mismanagement of inventory resulting in write-downs to stock, and a stretched supply chain being used to mask cash flow weakness.
