only the virus is new
This past week, filled with panic and stress, sent us down memory lane to other crises and abrupt market movements we’ve lived through since FAMA Investimentos was founded 27 years ago, in May 1993.
Within only a few months we were hit by the Tequila Effect, which saw the Mexican Peso drop 40% against the US Dollar in just a few days. The Bovespa index responded in kind, with steep and successive declines, eventually losing 52% in value (in USD terms). As we watched the events unfold, we were unsure how to react and certainly did not imagine a movement of such magnitude – we even questioned if we had made a wise career decision…
The market took about two years to return to its previous highs, but soon after that we were hit by the Asian crisis (1997), closely followed by the Russian crisis (1998). The Bovespa index lost 82% (!) of its value in US dollars. This period remains etched in our memories through a series of tragi comical episodes.
One of the decisions taken at the time was that the portfolio managers would change their daily routines: Fabio would work from 5am to 5pm and Mauricio from 5pm to 5am, to be able to follow developments of the Asian markets, albeit not too much effect other than to greatly increase stress and anxiety.
The internet was still in its infancy at the time and smartphones were still many years away. When Mauricio took a trip abroad, Fabio would have to fax him the updated portfolio a few times every day so they could discuss the positions.
Circuit breakers were activated eight times during this period, with four of those happening in September 1998 and twice on September 10th, the peak of the crisis. Markets were very different from what we see today, with much lower transaction volumes. Panic reached such levels that, when trading was allowed to resume, we saw no transactions simply because there were no bids.
In response to this, the Brazilian Central Bank raised rates by 20% in a single day, to 49.75%! Those were times when rates regularly hovered around 30% a year.
Stocks of moderate liquidity simply did not trade. There were no marginal buyers and the markets became dysfunctional. Some stock prices would remain unchanged simply because there was no trading but would drop 40-50-60% in a single day as the first bids reappeared, despite very thin volumes.
When it came to portfolio management, we generally knew what needed to be done, but despite the fact that our funds were fairly small at the time, liquidity conditions simply made it impossible to execute our plan. The main lesson from the Asian/Russian crises was that we had to be extremely conservative with our liquidity requirements. Even though we invested in low liquidity stocks for a long time, we’ve never had to implement any redemption restrictions or gates, and never had to distort our portfolio in order to pay redemptions.
Markets eventually started to recover in 1999 and returned to the highs last seen in 1997, but the next series of crises were once again around the corner. The devaluation of the Real in 1999, the dot com bubble bursting in 2000, the Argentine default in 2001, the September 11th attacks and markets panicking again in the months leading to Lula’s election in 2002. During this period the Bovespa index lost half its value in Reais and 75% in US dollars.
This period of crises was different for us than the previous one. The markets only panicked in early 1999, when the Central Bank intervened in the currency market. This unsuccessful attempt to calm markets really shook investor confidence and circuit breakers we deployed on January 13th and 14th. After this, the Brazilian stock market continued a slow and painful decline marked by a total aversion to stocks by local investors.
This period also taught us an important lesson: to have the courage to be contrarian. We had already bought out of favor stocks in the past, but it was in 2002 that we had our first experience in putting together a portfolio that defied common sense.
Our thesis was that Lula’s election would have a positive impact on employment and income and we expected government policies to add stimulus to the economy. We chose to buy Brazil, at odds with the sell consensus at the time. The results were very positive, but more importantly it gave us the confidence to think differently and to act according to our convictions.
From 2003 to 2008 we had our first 5 years of “peace”, at that point FAMA had spent 10 of its first 15 years facing crises.
The 2008 crisis was extremely severe, both in magnitude (a 75% drop in USD) and intensity (it took just 6 months). Just to get a sense of this, over a month’s time we saw 6 circuit breakers, with 2 on October 6th.
The subprime crisis was different to all the others we had lived through for two main reasons. First, this was a global crisis. Obviously, the previous ones impacted different parts of the world, but this one had roots in many parts of the world and bankrupted many financial institutions. Second, the credit freeze that happened practically over night and on a global scale was unheard of.
We had never been fans of highly leveraged companies and historically our portfolio was mostly composed of cash generating companies with solid balance sheets. The 2008 crisis taught us to worry about the exceptions also, as we witnessed the devastating effect a credit crisis can have on a company. From then on we became even more restrictive regarding the use of leverage.
Our losses in 2008 were significant but were due more to dysfunctional markets than to operating issues. Following our successful experience as contrarians in 2002, we did the same in 2009: when many literally believed the world would end, we bought a handful of strong, dominant, well established domestic companies. The following year we reaped our rewards, returning 118% and beating the Bovespa index by roughly 40%.
These good times did not last long. After the huge gains of 2009, the Bovespa index went through another negative period from 2010 to 2015. The Dilma administration, the Greek crisis and the “Car Wash” operation eventually leading to Dilma’s impeachment. There was no panic or circuit breakers then, but once again the Bovespa index lost 70% of its value in USD.
This great Brazilian recession also taught us an important lesson. Often times a good valuation, with ample margin of safety, is not enough for a good investment. An average, or below-average, company run by mediocre managers has ample capability to destroy value. Even when bought at a discount, the success of such investments ends up being very erratic and often times dependent upon exogenous factors (the mood of the market, liquidity conditions, etc…) rather than on its fundamentals per se. This realization allowed us to finally abandon the few remaining lower quality “bargain” positions.
As we approached the lows of early 2016, we acted as contrarians once again and sent out a letter to our main investors “calling capital” - our conclusion being that we saw an excellent investment opportunity. Our thesis was backed by lessons from 2008 - during a credit crisis, credit would be available only to those who do not need it. In other words, financial markets would restrict credit to more fragile companies and direct their lending capacity to companies that don’t really need it (and we believe this continues to be the case). The consequence of this was that high quality leading companies would accelerate their growth, despite the recessionary environment, by taking market share from weaker companies. With this positioning our portfolio had good results until the end of 2019. The selloffs of the period (“Joesley Day”, trucker’s strike, pre-election tensions) were so short that we can’t really call them crises, though we did see a circuit breaker in 2017.
We are now in the midst of another steep selloff. In less than 3 months the Bovespa index lost half of its value in USD. Last week we saw circuit breakers activated multiple times not only in Brazil but across the globe.
In the past we would question ourselves if we were adequately positioned, if we had too much risk in leveraged or less liquid companies, but that is not the case today.
During periods like this, prices tend to move more due to psychological than fundamental factors. We expect this volatility to open up opportunities to rebalance the portfolio, as we take advantage of price distortions.
Companies will certainly have their short term results impacted – some more, some less, but we do not see any significant change to the investment theses, valuations or even capital structures.
Since the beginning of the selloff we have used almost all of our cash balance. We finished exiting a position we had been selling for some time and promptly invested in another company – the right price finally blinked on our screens. We expect to execute other moves of this nature should prices continue to decline.
These difficult moments we are living through do not remind us of those times when we exchanged faxes with barely any idea of what to do or the time when we did not sleep at night passively watching markets on the other side of the globe or even the time when we froze along with the markets as liquidity disappeared and circuit breakers abounded.
We should always question ourselves if “this time is different”, in fact that is the phrase we most heard during past crises. Even though we have never dealt with a pandemic before, we do not expect this to unfold in a manner much different than in previous moments of history.
What is different this time is that when we examine our portfolio, we are pretty satisfied with what we see. In the coming weeks we will do our best to take advantage of the distortions the market might create and at the end we do not expect results to be different than those we delivered in the aftermath of previous crises.