Global investment markets have disappointed investors of late. So, where are we heading and are we likely to experience more disappointment and pain going forward? The typical incriminating question then being directed at the consultant or adviser often rings – “why did you not pro-actively have us switch to a conservative portfolio”?
Well, history has shown time and again, if you switch to last year’s top performer every year, you will end up with under performance. Switching investment portfolios to avoid poor or even negative returns always consists of two legs – switching ‘out of the market’ and switching back into the market.
Very often it seems obvious that the market has overheated and that a correction is imminent, yet timing the correction to avoid getting out half way down is the first challenge that even astute investors are likely to get wrong by a far stretch like one year, two years or even longer.
When the Fed instituted its monetary easing and large scale asset purchasing programs, reducing nominal interest rates to close on zero and pumping up to US$ 90 billion into markets monthly to prevent the US economy from stalling as the result of the financial crisis, it was actually a ‘no-brainer’ that it will only convert a collapse of markets to a long drawn out and painful recovery.
Had the investor abandoned the market at the trough and moved into cash at the time, he would have sacrificed a return on equities of 13.5% per annum to earn 6.4% per annum on his cash investment over a 7 year period, or in absolute values, his initial investment of N$ 100 in equities, that would have grown to N$ 240 by now, has now only grown to N$ 153.
O.K. you may say, this is a flawed argument because one should have moved back into the market. Well, most of this recovery actually happened over the first 5 years that returned 17% per annum and would have produced an absolute value of N$ 217 by October 2013 already.
Again this second leg is difficult to time, much more so than the first leg. 7 years ago you may have expected markets to go down even further yet they recovered with vengeance over the first 5 years with a very pedestrian subsequent growth of 5% per annum over the next 2 years!
So where are we heading and what should the investor do from here onwards? Let’s look at some interesting data. The following graph measures the Rand: US$ exchange rate against the FTSE/JSE Allshare Index.
Evidently they are very closely correlated over this period from 1987, barring the two periods of a sudden violent swing in the exchange rate. But look at the recent past where the Allshare Index is turning down while the Rand continues to weaken – a deviation from the general trend depicted by this graph.
A mind change is required to assure peaceful sleep and that is to focus on real returns rather than absolute returns. Attaining real returns will ensure that your wealth increases, which is most important in the face of prevailing market risks. Forget about double digit returns with an inflation rate of around 3%. Next be very clear on your investment time horizon – the longer this is the more you should invest in equity. Thirdly, experts would tell you to consider your risk appetite. Well, your risk appetite must be shaped to fit your income needs. If you cannot survive on a cash return on your investments, you have a problem and you essentially only have one choice. You need to increase your investment risk and adjust your appetite to this, and you must adapt your life style to reduce your cost of living.
Pensioners should consider what dominates there expenditure patterns and match their investments with the dominating future liabilities. In other words if 20% of your costs relate to medical expenditure consider investing 20% of your capital in health care. Remember that you should try to avoid investing in any equity that lingers around its peak; rather go for those that are on the way to the bottom.
So, all this means that as an active fund member and while still some distance away from retirement you should not shun equities but should be cautious, spread your risks as far as the law allows and focus on picking the right stocks. When approaching retirement or in retirement already, determine what income levels you require and what investment returns these dictate. If cash returns would meet or exceed your needs, you can increase your investment risk to the extent that your needs can stomach volatility. Be aware that cash returns may not always deliver real returns, in which event you would have to gradually reduce your cost of living to make good for the loss of purchasing power of your capital, or you would need to increase your investment risk by adding riskier asset classes such as bonds, property and equity. Finally do not panic because of volatility but stick to your investment strategy!