Market behaviour can be extremely erratic which can create a huge amount of uncertainty when predicting the future. In this insight, Lewis Grant, Global Equities Senior Portfolio Manager at Hermes Investment Management, explains why he therefore favours a consistent, boring approach over one that is fuelled by sentiment and hype.
Excitement in investment is rarely a good thing.
It can create hype which in turn can lead to irrational behaviour. If we take Bitcoin as an example, hype around investment in the cryptocurrency drove the asset class to grow at a phenomenal rate and for a while, this sentiment-led growth may have left investors feeling excited about potential returns.
Price momentum can act as an incredibly effective investment signal but it can also be a dangerous one. We believe it is important to remain emotionally unbiased as euphoria should not be the goal of investing.
That is not to say such hyper-growth investments need to be avoided altogether, but instead understood in a risk controlled portfolio and as part of a disciplined, diversified approach.
No Magic 8 Ball in investing
On any given day news outlets produce up-to-the-minute explanations of market movements. Fuelled by an insatiable demand for real time, knee-jerk comments, these outlets are expected to analyse the impact of seemingly small macro events on markets and report live reactions. But given how unpredictable these impacts can be, the market movements recorded can often be erratic and little more than noise, frequently reversing even within the same day.
These headline reversals demonstrate how hard it is to be certain when explaining the market even after the fact. Books continue to be written about the Global Financial Crisis and the market’s reaction – surely by now such an event should be understood? Given how difficult it seems to be to explain the market’s behaviour ex-post, consider how hard it is to predict the market’s behaviour ex-ante.
There is a huge amount of uncertainty in predictions, and investors need to factor this in to their portfolio construction process. Market behaviour is incredibly erratic – style drivers in the market change rapidly, investor sentiment can reverse for seemingly no reason, unanticipated tweets from world leaders can send the VIX spiking without warning. Diversification can help to insulate a portfolio against these unpredictable externalities.
Seeing the full picture
Even when looking at an individual company there will be many unknowable influences on its future prospects. Consider investing like trying to forecast the winner of the F1 Grand Prix. Mechanical and engineering knowledge could be applied to assess the ability of the car’s engine, tyres etc. just as we would use our accounting knowledge to assess the state of a company’s financial statements. The competence of the driver, in terms of skill and experience, would be considered as well as their ongoing control of the vehicle, like that of the senior management driving the strategy of a company. But can we as spectators truly observe all these variables and have a full understanding of how a company is functioning?
As an outsider to racing, we may see the high-speed glamour of the competition on the surface, but what we won’t see is the work of a multi-national team striving to be at the cutting edge of science, engineering, design and logistics and the challenges they face along the way. We can never truly know what is going on inside the enterprise. There are certainly things we can do as investors, such as engaging with companies to promote the best standards of corporate governance to minimise risks, but is it naïve to think we could ever fully know the inner workings?
There are many influences on a company’s future, only some of which could ever be predicted. Too many portfolio managers underestimate the amount of uncertainty and consequently overestimate their ability to make accurate predictions. This encourages overly concentrated portfolios where the true driver of performance becomes noise rather than the portfolio manager’s skill.
Consistency is key
Diversifying the portfolio and prioritising the consistency of short-term outperformance does not prevent investors from generating significant long-term gains. The power of compound interest can turn a small steady gain in to much larger and more exciting returns. And yet investors frequently favour higher risk portfolios, failing to recognise the damage that volatility can do to compounded returns. An investment that falls by 50% in value will subsequently need to double simple to restore the investor to parity. Likewise a portfolio that underperforms by 10% needs to subsequently outperform by 11.1% to return to break even. Volatility can significantly hurt the accumulation of an investor’s wealth.
An investment offering consistency also removes an element of timing from an investor’s decision-making process. When making an active equity investment an all-weather approach which can generate alpha in any market environment is a good investment at any time, whereas even professional investors have proven unable to reliably predict the forthcoming market environment.
Consistency also provides investors with comfort – they know what to expect from the portfolio and are more easily able to judge what we are delivering for them. Even long-term investors care about the short term, and many lose their long-term focus when their investments fail to behave in the short- to medium-term. This may be a boring approach for investors seeking the next hot game-changing company, but it is an approach that allows our investors to sleep easy at night.
Planning for the unknown
Predicting the market is inherently difficult, but it is not impossible. We just need to be honest about the degree of uncertainty in our predictions and structure our portfolios appropriately. It is perhaps a key message that many may not wish to discuss, but the accuracy of most portfolio managers’ forecasts is low. But that’s ok – with the correct structure and appropriate diversification even a small degree of accuracy is sufficient to generate meaningful outperformance.
The views and opinions contained herein are those of the author and may not necessarily represent views expressed or reflected in other Hermes communications, strategies or products.
What should I invest and How do I invest
By Imogen Clarke, The Fry Group
With all the uncertainty that has arisen from 2020, with lockdown threatening businesses and the warning of a second wave, the topic of investments has taken on new meaning. Nowadays, more people are concerned with what makes for a good investment, or, if you’re a novice, how to best invest.
For instance, you might be unsure about the reliability of the company you’re looking to invest in, as well as the long-term prospects of your investment.
If you are unsure of your investments, then it is best to seek advice from financial experts like The Fry Group, who deal with tax, wealth and estate planning. They will see that you have a strong financial plan in place to help meet your objectives. They will develop a strategy that is built around your needs and asses any risks that could hinder your plans.
There are some things you’ll need to consider for your strategy; for instance, are you looking to make investments that are more of a risk and will take longer to come to fruition? Or, alternatively, are you wanting a faster approach that will result in a steady income? Whether or not you decide to play it safe all depends on your current financial situation and whether you have the means to take more of a risk. Do you have any other debts that take precedence over your future plans? Is your investment strategy realistic?
With the aid of a specialist – or investment manager – you can design an investment concept that works for you and your goals, and start to build a regular income from your investments. There are four main areas when it comes to assets (groups of investments) that you can consider:
Your investment manager will test the risks associated with your investment, and if it proves to be a positive investment choice, then you will be able to invest more over time.
So, how do you decide where to invest?
According to The Fry Group, ESG investing (Environmental, Social and Governance) is a good option for investors looking to support businesses that meet their similar ethics.
The main areas of ESG investing include:
- Environmental challenges (climate change, pollution, etc)
- Social issues (human rights, labour standards, child labour, etc)
- Governance considerations relating to company management
According to The Fry Group, “Many investors choose to consider ESG investing in order to ensure any investment decisions reflect personal beliefs and values. As a result, they choose to support companies who are making informed, responsible decisions which take into account their wider societal and global impact. In this way investors can achieve peace of mind that their investments are creating a positive effect.”
ESG investing is also more relevant now than ever, as more businesses are looking to present themselves as an environmentally conscious corporation that recognises the values of their consumers.
As The Fry Group puts it, “In the past, ESG investing has been seen as a niche investment approach, for a relatively small number of people with specific requirements. This has changed significantly in recent years, with a growing awareness of environmental issues such as climate change and an increasing understanding of social issues and human rights. As a result, many people are increasingly interested in reflecting their opinions and lifestyle choices through the way they invest.”
So, if you want your investments to pave the way for your personal values and reflect your own morals, then this is the route to go down. But how does it all work?
There are four areas of ESG investing:
- Responsible ownership and engagement: when companies are encouraged to make necessary improvements.
- Avoidance or negative screening: whereby businesses are ‘graded’ based on how ethical their business practices are and are avoided altogether if their methods are not approved.
- Positive screening strategies:when companies meet the ESG goals and are approved for investments.
- Impact investment strategies: the purpose of this is to use investment capital for positive social results such as renewable energy.
You will need to take into account your own personal objectives as well as the objectives that meet the ESG investment criteria. And, in terms of financial performance, ESG investing can be hugely beneficial. Those who opt for ESG investing perform a more in-depth analysis into long-term and future trends that affect industries, meaning that they are better prepared for changes in consumer values when they arise. And, with all the unpredictability that this year has offered us so far, isn’t it better to do the research and have all angles covered?
Investment Roundtable: Live with Jim Bianco
With Q4’s macro picture still looking grim amid the return of exponential coronavirus waves in Europe and the U.S. and Europe, we speak with veteran macroanalysis strategist Jim Bianco, CMT for a data-driven deep-dive into the global economy and financial markets on Sept. 7th at 12pm EDT.
- Learn from Jim’s unique combination of quantitative and qualitative analytics which provide an objective view on Rates, Currencies and Commodities to make smart investment decisions
- Identify important intermarket relationships he is watching with respect to Global Equities
- Roadmap a global outlook for 2021 in view of socio-political backdrop giving viewers key takeaways and intermarket perspectives on global investing.
Jim’s robust technical analysis includes a broad look at trends and themes in the markets, market internals, positioning such as the Commitment of Traders (COT), sentiment, and fund flows. Don’t miss out on this exclusive session from one of the investment world’s most insightful thought leaders.
Equity markets react to a rise in Covid-19 cases, uncertain Brexit talks and the upcoming US election
By Rupert Thompson, Chief Investment Officer at Kingswood
Equity markets had another choppy week, falling for most of it before recovering some of their losses on Friday and posting further gains this morning.
At their low point last week, global equities were down some 7% from their high in early September. US equities were down close to 10%, hurt by the large weighting to the tech giants which at least initially led the market decline.
The market correction is nothing out of the ordinary with 5-10% declines surprisingly common. Indeed, a set-back was arguably overdue given the size and speed of the market rebound from the low in March. As to the cause for the latest weakness, it is all too obvious – namely the second wave of infections being seen across the UK and much of Europe and the local lockdowns being imposed as a result.
These will inevitably take their toll on the economic recovery which was always set to slow significantly following an initial strong bounce. Indeed, business confidence fell back in September both here and in Europe with the declines led by the consumer-facing service sector. A further drop looks inevitable in October – fuelled no doubt in the UK by the prospect that the latest restrictions could be in place for as long as six months.
The job support package announced by Rishi Sunak did little to boost confidence. Its aim is to limit the surge in unemployment triggered by the end of the furlough scheme in October. However, the scheme is much less generous than the one it replaces as the government doesn’t want to continue subsidising jobs which are no longer viable longer term. A rise in the unemployment rate to 8% or so later this year still looks quite likely.
Aside from Covid, for the UK at least, there is of course another major source of uncertainty – namely Brexit. Another round of trade talks start this week and we are rapidly reaching crunch time with a deal needing to be largely finalised by the end of October.
Whether we end up with one or not is still far from clear. That said, the prospects for a deal maybe look rather better than they did a couple of weeks ago when the Government was busy tearing up parts of the Withdrawal Agreement. With significant Covid restrictions quite probably still in place in the new year and the Government already under attack for incompetence, it may not wish to take the flack for inflicting yet more chaos onto the economy.
Markets remain unimpressed. UK equities underperformed their global counterparts by a further 2.7% last week, bringing the cumulative underperformance to an impressive 24% so far this year. The UK weighting in the global equity index has now shrunk to all of 4.0%.
It is not only the UK which faces a few weeks of uncertainty. The US elections are on 3 November. We also have the first of three Presidential debates this Tuesday. Joe Biden’s lead looks far from unassailable, a close result could be contentious and control of Congress is also up for grabs.
All said and done, equity markets look set for a choppy few weeks. Further out, however, we remain more positive – not least because the focus should hopefully switch from the roll-out of new lockdowns to the roll-out of a vaccine.
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