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Going long is the new black |
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09 August 2010 |
Oscar Wilde once said "Fashion is a form of ugliness so intolerable that we have to alter it every six months". In fact, it was just recently reported to me by an enthusiastic friend that 'greige' is the new black.
Oscar Wilde once said "Fashion is a form of ugliness so intolerable that we have to alter it every six months". In fact, it was just recently reported to me by an enthusiastic friend that 'greige' is the new black. Greige, in case you are as puzzled as I was, is apparently a blend of grey and beige. It's a relief one doesn't have to stick to this bizarre colour for more than a few months. This fickleness, if you take a look, is everywhere. Enjoying your latest Apple gadget? There'll be a newer, faster and more exciting version for you to play with in a few months. Taking out a mobile phone contract? Don't worry, you can upgrade or change provider in 12 to 18 months. If we're having such trouble committing to a phone service provider, then is it any wonder we are equally - if not more - fickle with our investments?
We may all believe the mantra about investing for the long term but our capricious investing pattern shows anything but adherence to this. The reality is that few people act with the long term in mind and stick with their investments over time. Instead, investors frequently turn over their portfolio, buying high and selling low. Why? Because people are addicted to the short term, especially that of short term performance.
It's why city analysts focus on corporate quarterly earnings results. It's why most manager bonuses are based on one year performance or less. It's why money often chases whatever is hot, whether it be emerging markets, tech stocks, gold or China. But a positive return in one month can be followed by a negative return the next. Investors who regularly make short term decisions based on short term returns will generally sabotage their long term investment results, because short term returns are unreliable (and often contrary) indicators of subsequent performance.
Short term performance chasers tend to be emotional and impulsive. When the investment benefits are not seen straightaway, investors get frustrated and switch to a different manager or strategy. It's not dissimilar to switching lanes when driving. You may think the lane to your right is moving faster, so you switch and cruise faster for a while only to soon come to a stop while the lane you switched out of is now moving faster. The problem is that short term performance chasing leads to underperformance not out performance, in part because the turbulence caused by the changes has dealing costs attached!
This trend of switching out just at the wrong time explains why, according to Dalbar over the 20 years to 2009, the average private equity investor achieved a return of only 3.2%, barely beating inflation, whereas the equity market rose by an average of 8.8%. Investors should realise that short term performance is probably due to luck rather than the skill or lack thereof of the fund manager. It takes a certain talent and conviction to pick out undervalued or potentially exceptional stocks, and these picks may not come to bear fruit for months or even a couple of years.
It pays to be patient, and those individuals who are not vulnerable to short term performance obsession are more likely to be rewarded. Markets tend to reward those who accept the greater uncertainty that comes with investing over a long term horizon. Case in point - Warren Buffett; he keeps his investment philosophy as simple as possible, moving only when markets are so far in his favour that he can hardly lose. Crucially, he's also incredibly patient and has built up his wealth over many years.
The longer the investment is held, the less likely the fund's performance is based on luck and the more likely it is to achieve its investment objective and decent returns. This also means less worrying about 3 month, 6 month or even 12 month performance. That is not to say funds should not be held accountable for their performance. But when evaluating a manager, a greater weight should be placed on his long term accomplishments and a smaller weight should be attached to short term returns. In the realms of institutional management, five year rolling average returns are king.
In a volatile investment market such as the one we've experienced over the past two years, it can be hard staying committed, and not let fear and greed guide us into making a bad situation worse. But this is the time for a different and more disciplined approach.
First keep in mind your investment objectives. What are you trying to get out of your investment? What is your goal? Write down your planned holding period. If you need the money in three years, it makes sense not to invest in an equity fund. Conversely, if the money is needed in fifteen years time, underperformance in an equity fund for two or three years should not rattle you.
If you tend to sell at the wrong time because everyone else in the market is selling too, try to make a conscious decision to have a contrarian view. Investors tend to follow the herd because it gives them a sense of safety in numbers. It may also make sense to stay clear of high risk stocks or funds that lead you to panic and become a forced seller.
Lastly, evaluate managers on not just their recent performance. Rather than reading too much into last year's performance, try and find funds that have low turnover and long manager tenure, investments that have trustworthiness, conviction, communication, transparency, governance structures and process. Buying funds that have invested in good personnel, research and risk safeguards are what will help you get value for money over the long term.
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And finally...... Our Compliance Manager had a life changing experience this week when he and his family survived an air crash. With the passage of time the story will doubtless become a tale of derring-do and bravery in the face of extreme danger although in reality, and rather more prosaically, the actual incident involved a plane at Edinburgh airport which somehow managed to reverse into the perimeter fence, badly damaging the tail fin. It was a somewhat ironic outcome to a journey undertaken with vouchers issued as compensation for the airline's earlier failings.
When interviewed about the incident, David said "My whole life flashed before me - although only at about five miles an hour." He added "Being a Compliance Manager that was quite fast enough for me, thank you very much".
David is very much looking forward to receiving yet more compensatory vouchers so that he can continue to demonstrate just how exciting life in Compliance really is.
Have a good week.
Aparna Ram
Investment Research Analyst
Seven Investment Management Limited
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