Last week Tesla's $1.5bn investment in Bitcoin caused the value of the cryptocurrency to jump by $2,000. Lothar Mentel considers the implications for the international fund management industry
High levels of concentration within any fund, whether by sector or for an individual stock, ring alarm bells. If a fund is particularly exposed in one sector, Tatton IM would either exit completely or reduce the size of our investment. Tesla is a business that previously had exposure linked to the automotive cycle and battery development. This use of capital is not directed at increasing future manufacturing earnings.
It's important to understand the core competencies of a business. A car manufacturer investing in Bitcoin and changing its corporate structure to do so, is a major concern. By way of comparison, would Volkswagen become a cryptocurrency trading business in the same way? Too often in the past investors only find out about concentration or liquidity risk when it's too late.
For any sensible investor the key should be about visibility and timing. It may sound boring, perhaps, but investing your life savings is a long-term business. Fundamental to Tatton IM's investment process is to create repeatable, sustained returns. We look for unusual activity at both ends of the spectrum, whether it involves underperformance or unusual outperformance.
There are many potential uses for a cryptocurrency but the essential premise of Tesla is that it is an innovative EV car company. It has led the way in how we travel. Managing risk in multiple currencies is not new for any company. Airlines hedge oil prices. This diversification into cryptocurrency looks speculative.
Benchmark of best practice?
The risk management benchmark at portfolio level is the tracking error against the investment universe/ market index. A single, large holding that generates very different results to the rest of the market will show up as a major contributor to that tracking error.
But it can be complicated differentiating between tracking error (bad?) and alpha generating (good?) and, it's up to each fund manager to define their principles and stick to them. Running a winning stock is great for short term performance and gaining assets, but investors are buying when the momentum is at its highest and therefore most likely nearer the end point.
Consistent repeatable performance and long term investing is not about timing the market - diversification stops unwanted surprises on the down side but also speculative surprises, which lead to unwanted surprises. At Tatton, we are not driven or unduly influenced by one fashionable factor, because reversion to the historic mean is a truth that will happen. Investors are free to speculate some of their money but never bet your house on it or your life savings.
The key is not about speed in reacting to risk exposure, it's about avoiding it in the first place. We have been criticised in the past for not holding property funds and we are happy that our investors can't be exposed to sudden fund closures.
Similarly we exited Woodford 18 months before it hit the headlines because of risk management concerns - remember the local authority that invested into Woodford in the days before it blew up?
We are very mindful of investment trends and fashions; we may well miss the top end of the momentum drive but we are protecting long term interests and we operate a repeatable process. Bookmakers make their money by investors backing hot prospects that lose and that's not our business.
Lothar Mentel is CEO of Tatton Investment Management
