Volatility rope-a-dope

This article first appeared on Trustnet on 7 June 2021.

Rope-a-dope: Noun (informal) Origin (1970s), coined by Muhammad Ali

“A boxing tactic of pretending to be trapped against the ropes, goading an opponent to throw tiring ineffective punches.” Oxford English Dictionary

To train for his famous ‘Rumble in the Jungle’ with George Foreman, Muhammad Ali spent months taking hard, repeated hits to his body. Foreman, the clear favourite, was seven years younger than Ali and undefeated, with a 40-0 professional record. His key threat was his sheer power, particularly his body hits. The two men were the same height (191cm) and had approximately the same reach. The obvious strategy for Ali would have been to avoid close contact and use his superior speed. But Foreman was only too familiar with these tactics: he expected them and could prepare accordingly. He also knew that dancing and dodging was more energy sapping than closing off angles from the centre of the ring.

The response Ali and his coaches developed was the ‘rope-a-dope’ strategy. This involved Ali playing up his speed in public – even going as far as to mock Foreman as a slow-moving zombie – while actually preparing to lean back against the ropes and take hits. Ali trained to be so resilient that Foreman would tire himself out and so become vulnerable to his counter-attacks.

Training to face the inevitable

This is an extreme (and frankly brutal) example of what is called being ‘hit fit’. It is a concept that is well understood in professional sport and in the armed forces. With training, humans can build remarkable tolerance to physical and mental assaults. These are extreme examples of resilience; but given the clear evidence of its effectiveness, it can be a very useful model for investors to consider.

Ali’s strategy worked for a number of reasons. First, it was hard. There was a good reason nobody had tried it before. Yet while the training was tough, the short-term pain was payment for an increased probability of a large pay-off. Second, it was counter-intuitive. The first-order outcomes were negative, but the second-order implications were much improved odds of success. And, finally, it was unorthodox. Being different created a favourable asymmetry; Ali had created a fight that Foreman had not trained for and an element of surprise which unbalanced his opponent psychologically.

What lessons does Ali’s rope-a-dope strategy offer to investors? I believe market volatility is the inevitable fight with Foreman that all investors must face. We therefore must train for it. Rather than trying to avoid the fight (hedging) or dodging the punches (trading), we should instead spend our time building resilience to the blows that will come our way in the shape of market volatility. Then we wait for the opportunities to strike back (act on our fundamental convictions)…

As investors in disruptive-growth companies, periods of high volatility tend to be painful in performance terms – but they also tend to be mercifully short. As the market becomes fearful, it creates opportunities for us to buy disruptive, positive-impact growth companies at attractive long-term valuations.

Faith in the process: being ‘hit fit’

My fundamental view is that as time passes, the companies we own will continue to grow strongly (as they did this quarter), with the same (or even improved) visibility regarding their long-term prospects. This means that if share prices fall – given the rates we expect our investments to grow at – they will get cheap very quickly. In contrast, the earnings growth of cyclical recovery stocks will slow as the cycle matures. The market will then begin to question the sustainability of that cyclical growth (particularly in areas seeing structural decline like oil and gas), thus meaning they will get expensive very quickly.

It is difficult to know precisely how long the cyclical earnings recovery will last. But we are confident it is transitory. Contrast this with structural-growth trends in healthcare technology, the digitisation of commerce and enterprise workflows, health and fitness, education technology and solutions to the ultimate meta-trend: the Climate Crisis. We believe that the best way of protecting capital against the threats of structural decline, inflation or rising interest rates is by holding structural-growth companies that provide solutions to the world’s biggest problems at scale and build business models that can capture value from them. As such, the current volatility in markets – viewed through our eyes – is just a period on the ropes that we have anticipated and trained for.

Cultivating a culture of resilience

As a team that has invested together for six years, I believe our defining characteristic is our culture of resilience to volatility, which is explicitly built into our philosophy and investment process (see our white paper).

Our unorthodox approach has proven record: periods of volatility have enabled us to deploy capital in our highest conviction, long-term investment ideas. We did this in the final quarter of 2016 (the Trump Bump in cyclicals), we did it again in the final quarter of 2018 (when inflation and fears of rising rates hit risk appetite) – and we did it in the first quarter of last year (Covid crisis).

When facing George Foreman, the instinctive response is to try and dodge his punches but if those are your tactics, you’re probably in the wrong sport. Using a rope-a-dope strategy against volatility requires us to be psychologically ‘hit fit’. If we are, the metaphorical punches are rendered ineffective….and the opportunities to strike back become more attractive the longer the fight goes on.