Tag: evidence based investment

Brexit …

Brexit becomes reality and the markets react with heavy selling of risk assets, particularly British and European stocks and the pound. The fears have materialised and the issue is taking its toll on investment portfolios. That said, the worst thing an investor can do at the moment is acting based on emotions rather than careful analysis of the situation. With the extreme levels of volatility that we are seeing now, a bad decision can have very costly consequences.

Market Volatility

The markets’ reaction can be best observed on the pound’s exchange rate against the dollar. In the last days before the referendum, it appreciated from 1.40 to 1.50 (7%), as polls started to predict a narrow Remain victory. This morning after the actual outcome it dropped to 1.32 (12% down), but at the time of writing this article it is trading around 1.39 (5% up from the morning low). Similar volatility can be observed on stock prices (British, European and worldwide), commodities and other assets.

The Market’s Reaction Is Not Unusual

While the fact of Britain leaving the EU is unprecedented and extraordinary, the way the markets react to the decision is not unusual. It is similar to the way markets react to other surprising outcomes of scheduled events, such as central bank interest rate decisions or (on the individual stock level) company results. We see a sharp initial move triggered by the surprising outcome (this morning’s lows), followed by corrections and swings to both sides, as the market tries to digest further information that is gradually coming in and establish a new equilibrium level. These swings (although perhaps less extreme than today) will most likely continue for the next days and weeks.

What We Know and What We Don’t

At the moment the actual effects of Brexit on the economy are impossible to predict – we will only know several years from now. Even the timeline of next steps is unclear. The only thing we know is that David Cameron is stepping down as PM (that means succession talks and some internal political uncertainty in the coming months) and that the process of negotiations of the actual EU exit terms will be started in the next days or weeks.

We don’t know what the new UK-EU treaties will look like. There are some possible models, like Switzerland or Norway, but Britain’s situation is unique in many ways. We can also expect the British vote to trigger substantial changes within the EU, as the first reactions of EU representatives have indicated; therefore we don’t know who exactly we will be negotiating with. In any case, this is not the end of trade between the UK and EU countries. The EU can’t afford to not trade with the UK or apply punitive protectionist measures against us.

Where Will the Markets Go Now?

Under these circumstances, no one can predict where stocks or the pound will be one month from now or one year from now. Nevertheless, for a long-term investor, such as someone saving for their pension, these short time horizons don’t really matter. If you invest for 10 years or longer, our view is that you don’t need to fear the impact of yesterday’s vote. Leaving the EU might take a few percentage points from the UK’s GDP and from stock returns, but in the long run it won’t change the trend of economic growth, which has been in place for centuries.

The greatest risk that the Brexit decision represents for a long-term investor is not what the market will do. In any case, it will recover sooner or later. The main risk is the investor acting on emotions, under pressure and without careful analysis of all consequences. The investors who lost the most money in past market crashes such as in 1987, 1997 or 2008 were those who panicked and sold at the worst moment, when it seemed like the economy and the financial system was going to collapse. Those who were able to take a long-term perspective and stayed invested have seen their investments recover and even surpass previous levels.

Our Recommendation

We recognise that this is a momentous event and it will take time to fully digest the implications. For now, it is important that investors maintain their disciplined approach and do not act in haste to sell off their investments. This would only serve to crystallise losses which currently only exist on paper. We recommend that they sit tight unless their goals have materially changed. We also ask them to note that we are not taking this lightly and will be maintaining our portfolio structures under review in accordance with our overall investment philosophy. If we judge that changes need to be made we will provide advice as appropriate and this will be dealt with as part of our normal review process.

 

 

Bear Market Coming? Stick with Your Strategy

Following a multi-year rally, 2015 wasn’t particularly successful in the global markets and, so far, the start of the new year hasn’t been any good either. The UK’s FTSE 100 index is below 6,000, lowest in more than three years. It’s times like this when various doomsday predictions start to appear, warning against events “worse than 2008”, using words such as “crash” and “meltdown”, and pointing to factors such as rising interest rates, growing political tensions, China, rising commodity prices, falling commodity prices and many others.
The truth is that no one really knows what is going to happen. Not the TV pundits, not the highly paid bank strategists and stock analysts, not even the Prime Minister or the Bank of England Governor.
That said, when you have significant part of your retirement pot invested, it is natural to feel uneasy when you hear such predictions, especially if they come from an analyst who got it right last time and correctly predicted some previous market event (he was lucky).
When the markets actually decline and you see your portfolio shrinking in real time, the concerns may become unbearable. Fear and greed get in charge, both at the same time. It is tempting to think about selling here and buying the stocks back when they are 20% lower a few months from now. Easy money, so it would seem. Nevertheless, that would be speculating, not investing. The problem with the financial industry (and the media) is that these two are confused all the time.
Time in the Market, Not Timing the Market
While some people have made money speculating, academic research as well as experiences of millions of investors have shown that it is a poor way to save for retirement. When a large number of people take different actions in the markets, some of them will be lucky and get it right purely due to statistics (luck). However, it is extremely difficult to repeat such success and consistently predict the market’s direction with any accuracy.
In the long run, the single thing which has the greatest effect on your return is time, not your ability to pick tops and bottoms. The longer you stay invested in the market, the more your wealth will grow. You just need the patience and ability to withstand the periods when markets fall, because eventually they will recover and exceed their previous highs.
Time Horizon and Risk Tolerance
The key decision to make is your risk tolerance – how volatile you allow your portfolio to be, which will determine your asset allocation. While personality and other personal specifics come into play, the main factor to determine your risk tolerance is your investment horizon. The longer it is, the more risk you can afford and the more volatility your portfolio can sustain. If you are in your 40’s and unlikely to need the money in the next 20 years, you should have most of your retirement pot in equities. If you are older and closer to retirement, your portfolio should probably be more conservative, because you might not have the time to wait until the markets recover from a possible crash. It is important to get the risk tolerance and the asset allocation right (an adviser can help with that) and stick with it.
How to Protect Your Portfolio from Yourself
Because the above is easier said than done, here are a few practical tips how to protect your retirement pot from your emotions and trading temptations:
1. Have a written, long-term investment plan. It is human nature to consider written rules somehow harder to break than those you just keep in your head. It is even better if you involve your adviser to help you create the plan. Not only is an adviser better qualified and more experienced in the investment process, but another person knowing your rules makes them even harder to break.
2. Do not check fund prices and the value of your portfolio every day. This doesn’t mean that you shouldn’t review your investments regularly. But the key is to make these revisions planned and controlled, rather than emotion-based. You will be less likely to make impulsive decisions, which more often than not are losing decisions.
3. Maintain an adequate cash reserve. This should be enough to meet any planned short-term expenditure and also provide a reserve for unexpected expenses. It will help you avoid the need to encash investments at a time when investment values are low.

Would you like to discuss this article with an adviser?

The Seven Roles of an Advisor

What is a financial advisor for? One view is that advisors have unique insights into market direction that give their clients an advantage. But of the many roles a professional advisor should play, soothsayer is not one of them.

The truth is that no-one knows what will happen next in investment markets. And if anyone really did have a working crystal ball, it is unlikely they would be plying their trade as an advisor, a broker, an analyst or a financial journalist.

Some folk may still think an advisor’s role is to deliver them market-beating returns year after year. Generally, those are the same people who believe good advice equates to making accurate forecasts.

But in reality, the value a professional advisor brings is not dependent on the state of markets. Indeed, their value can be even more evident when volatility, and emotions, are running high.

The best of this new breed play multiple and nuanced roles with their clients, beginning with the needs, risk appetites and circumstances of each individual and irrespective of what is going on in the world.

None of these roles involves making forecasts about markets or economies. Instead, the roles combine technical expertise with an understanding of how money issues intersect with the rest of people’s complex lives.

Indeed, there are at least seven hats an advisor can wear to help clients without ever once having to look into a crystal ball:

The expert: Now, more than ever, investors need advisors who can provide client-centred expertise in assessing the state of their finances and developing risk-aware strategies to help them meet their goals.

The independent voice: The global financial turmoil of recent years demonstrated the value of an independent and objective voice in a world full of product pushers and salespeople.

The listener: The emotions triggered by financial uncertainty are real. A good advisor will listen to clients’ fears, tease out the issues driving those feelings and provide practical long-term answers.

The teacher: Getting beyond the fear-and-flight phase often is just a matter of teaching investors about risk and return, diversification, the role of asset allocation and the virtue of discipline.

The architect: Once these lessons are understood, the advisor becomes an architect, building a long-term wealth management strategy that matches each person’s risk appetites and lifetime goals.

The coach: Even when the strategy is in place, doubts and fears inevitably will arise. The advisor at this point becomes a coach, reinforcing first principles and keeping the client on track.

The guardian: Beyond these experiences is a long-term role for the advisor as a kind of lighthouse keeper, scanning the horizon for issues that may affect the client and keeping them informed.
These are just seven valuable roles an advisor can play in understanding and responding to clients’ whole-of-life needs that are a world away from the old notions of selling product off the shelf or making forecasts.

For instance, a person may first seek out an advisor purely because of their role as an expert. But once those credentials are established, the main value of the advisor in the client’s eyes may be as an independent voice.

Knowing the advisor is independent—and not plugging product—can lead the client to trust the advisor as a listener or a sounding board, as someone to whom they can share their greatest hopes and fears.

From this point, the listener can become the teacher, the architect, the coach and ultimately the guardian. Just as people’s needs and circumstances change over time, so the nature of the advice service evolves.

These are all valuable roles in their own right and none is dependent on forces outside the control of the advisor or client, such as the state of the investment markets or the point of the economic cycle.

However you characterise these various roles, good financial advice ultimately is defined by the patient building of a long-term relationship founded on the values of trust and independence and knowledge of each individual.

Now, how can you put a price on that?

Gravel Road Investing

Owners of all-purpose motor vehicles often appreciate their cars most when they leave smooth city freeways for rough gravel country roads. In investment, highly diversified portfolios can provide similar reassurance.

In blue skies and open highways, flimsy city sedans might cruise along just as well as sturdier sports utility vehicles. But the real test of the vehicle occurs when the road and weather conditions deteriorate.

That’s why people who travel through different terrains often invest in a SUV that can accommodate a range of environments, but without sacrificing too much in fuel economy, efficiency and performance.

Structuring an appropriate portfolio involves similar decisions. You need an allocation that can withstand a range of investment climates while being mindful of fees and taxes.

When certain sectors or stocks are performing strongly, it can be tempting to chase returns in one area. But if the underlying conditions deteriorate, you can end up like a motorist with a flat on a desert road and without a spare.

Likewise, when the market performs badly, the temptation might be to hunker down completely. But if the investment skies brighten and the roads improve, you can risk missing out on better returns elsewhere.

One common solution is to shift strategies according to the climate. But this is a tough, and potentially costly, challenge. It is the equivalent of keeping two cars in the garage when you only need one. You’re paying double the insurance, double the registration and double the upkeep costs.

An alternative is to build a single diversified portfolio. That means spreading risk in a way that helps ensure your portfolio captures what global markets have to offer while reducing unnecessary risks. In any one period, some parts of the portfolio will do well. Others will do poorly. You can’t predict which. But that is the point of diversification.

Now, it is important to remember that you can never completely remove risk in any investment. Even a well-diversified portfolio is not bulletproof. We saw that in 2008-09 when there were broad losses in markets.

But you can still work to minimise risks you don’t need to take. These include exposing your portfolio unduly to the influences of individual stocks or sectors or countries or relying on the luck of the draw.

An example is those people who made big bets on mining stocks in recent years or on technology stocks in the late 1990s. These concentrated bets might pay off for a little while, but it is hard to build a consistent strategy out of them. And those fads aren’t free. It’s hard to get your timing right and it can be costly if you’re buying and selling in a hurry.

By contrast, owning a diversified portfolio is like having an all-weather, all-roads, fuel-efficient vehicle in your garage. This way you’re smoothing out some of the bumps in the road and taking out the guesswork.

Because you can never be sure which markets will outperform from year to year, diversification increases the reliability of the outcomes and helps you capture what the global markets have to offer.

Add discipline and efficient implementation to the mix and you get a structured solution that is both low-cost and tax-efficient.

Just as expert engineers can design fuel-efficient vehicles for all conditions, astute financial advisors know how to construct globally diversified portfolios to help you capture what the markets offer in an efficient way while reducing the influence of random forces.

There will be rough roads ahead, for sure. But with the right investment vehicle, the ride will be a more comfortable one.

Article by

Jim Parker, Vice President, Dimensional Fund Advisers

Pensions Institute: ‘Almost all’ active managers fail to beat the market

Pensions Institute: ‘Almost all’ active managers fail to beat the market

This article confirms something that those of us involved in looking after client money have known for quite a while, namely that most active fund managers, despite charging extra for the pleasure, are incapable of beating the markets. This underpins our evidence based investment philosophy. To cut a long story short, the evidence from years of academic research, in many cases by Nobel Laureates, firmly suggests that the factor which has the greatest eventual impact on the returns (strictly variability and therefore expected returns, to those of you who are investment boffins) of a portfolio is the high level asset allocation, i.e. the split between equities and bonds. Strategies such as market timing (when should I buy or sell or should I hang on a little longer for the turn?) and stock selection (should I buy Tescos or M&S?) have been shown to have very little impact. Since these are the main methods supposedly used by active fund managers to add value, it comes as no real surprise that most of them fail. I say ‘supposedly’ because many simply track the markets and charge extra for doing so!

So, if you are looking for a portfolio that collects as much as possible of the market rate of return, according to the level or risk that you wish to take, start with the high level split. Then choose low cost funds and perhaps tilt towards sectors that have demonstrated an ability to provide extra returns given a certain amount of extra risk. Above all, avoid succumbing to the perfidious temptations of the financial porn which is regularly pushed out by the active fund management industry. They are thinking about themselves, not you.