Investors appear indifferent to the possibility of antitrust actions being levelled against Amazon, or there being material changes to shipping prices, global supply chains, cybersecurity conditions, and so on. We believe Amazon is a great company, but view valuation risk at 110 times forward earnings, which makes it unsuitable for this strategy.
Similarly, for Netflix to justify its forward P/E ratio of 137, management would either need to execute a flawless marginexpansion plan, raising prices on consumers without relinquishing market share, or else continue down the path of rapid international expansion.
Ultimately, we believe that many technology stocks only gained low-volatility status through some degree of investor complacency, at a time when loose monetary policy was driving market gains.
Corrections have already begun – Facebook’s share price dropped in excess of 20% after revealing that user growth had faltered in the second quarter, and would likely continue to slow; Netflix plunged by double-digits for nearly identical reasons; and even Google’s seemingly invulnerable valuation sustained short-term damage. That Apple continues to prosper is a positive recommendation of our low-volatility strategy.
However, our position in Apple remains under 2% of total assets, meaning we continue to underweight the technology sector, not only in comparison to the index, but also to other low-volatility funds.
Why Low-Volatility Poses a BIG Opportunity
Classic finance theory, for all its wisdom, makes a bold and somewhat dubious claim in its depiction of the risk-reward relationship. It tells us that increased returns come at the expense of greater odds for failure, in an almost one-to-one equation. Market inefficiencies prove otherwise – and decades of ground-breaking research show that lower-risk securities can outperform by levering cognitive biases.
To put it in perspective, consider two hiking trails that meet at a common juncture. One goes through hilly terrain, where you’ll waste energy on steep inclines and declines; the other follows a gentle slope, which you can manage with ease and confidence. Most people would choose the latter, for efficiency, and to preserve their energy.