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Positives for 2021

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Positives for 2021

 

If Sleeping Beauty had been woken from her slumbers on New Year’s Day 2021, she would have been pleasantly surprised by the value of her global equity portfolio for however long she had been asleep.

 

Somewhat remarkably, over the past year, she would have been up for the year and blissfully unaware of the tragic pandemic that has tainted 2020 and caused such market ructions in March and April.  In fact, she would be wondering what the worry with investing was all about.  Take a look at the different outcomes that she might have experienced depending on how long she had been asleep for, in the table below.

 

Table 1: Sleeping Beauty’s slumbers – cumulative returns, after inflation to 30-12-2020

 

Time asleep1 year3 yrs5yrs10 yrs20 yrs30 yrs40 yrs50 yrs
Cum. return10%25%68%138%96%525%1,333%867%

 

Data: MSCI World Index in GBP adjusted for UK RPI. Morningstar Direct © Copyright 2021.  All rights reserved.

 

As investors, we should take a similar approach to looking at our assets, reminding ourselves that time and compounding are our friends.  Yet it is understandable that many investors still feel a bit nervous about the future, not least in the shorter-term with the recent literal assault on US democracy and the escalating pandemic.  Listening to the news can be depressing as well as somewhat repetitive.  Many of the more positive stories are often lost in the gloom.  Remember that it is always darkest just before dawn.

 

To redress the balance, here are five positive insights for 2021 and beyond:

 

First, and most obviously, the scientific community has done a remarkable job delivering the world with a suite of vaccines that provide a way out of the pandemic.  The UK has played a leading role, not only in vaccine development, but also identifying existing drugs that are, and will, have a major impact on treating patients including dexamethasone, tocilizumab and sarilumab (not easy to pronounce!).  A new double-blind trial is also underway in the UK looking at interferon beta, which initial indications show could dramatically reduce the risk of serious disease, which could – alongside the vaccines – be a game changer for managing Covid over time[1].  There is light at the end of the tunnel.

 

Second, we have learned many valuable lessons and built resilient processes and a logistics infrastructure for coping with any future pandemics, including bringing back or shortening critical supply chains for anti-biotics, PPE, vaccine manufacture, building community testing and delivering vaccine rollouts.  That has to be a good thing.  The pandemic also reveals how much we all need each other and what a powerful sense of community feels like.  How well would we fare without the people working in our local supermarkets or the lorry drivers and couriers keeping us supplied?  Or the hospital cleaners that expose themselves to the virus every day to keep others safe?  We will come out of this better prepared and hopefully more appreciative of the things we value such as family, friends, a round of golf, or a night at the cinema!

 

Third, with the pending inauguration of Mr Biden as President in the US, perhaps we will see a less bombastic approach to politics and the rebuilding of trust between democratic friends and allies that will help the free world to resolve some of the major issues that we face, not least how to manage relations with authoritarian states such as China and Russia.  Coming together is better than moving apart.

Fourth, perhaps we are at a positive inflection point in terms of social media, where something needs to change[2].  It is evident that those using social media, and the platforms themselves, have responsibilities that for too long have been blurred by the grey areas between free speech and hate speech and between being a technology platform and a publisher.  There is – post the storming of the US Capitol – a far greater sense that something urgently needs to be done.  In ten years’ time, we may well look back in disbelief at the wild west of the first 10 years of social media!

 

Fifth and finally, there appears to be an ever-increasing urgency to address climate change, with the UK at the forefront, not least with the presidency of COP26 in Glasgow later this year, and the government’s pledge to reduce carbon emissions by 68% of its 1990 levels by 2030.  In the past 10 years, the UK has reduced its carbon emissions by more than any similarly developed country[3].  It has also set a target for net-zero emissions by 2050 and pledged to ban the sale of new petrol and diesel cars by 2030. With the US reengaging, the momentum is shifting toward greater action, which also encompasses green finance and more sustainable investing.  That can only be a good thing.

 

Does all this mean that markets will rise in 2021?  The truthful answer is that no-one knows, not even the scientists!  But if we take a leaf out of Sleeping Beauty’s book, there is a pretty reasonable chance that the world will be in a better place in the not-too-distant future and when we look back – as an investor participating in the resilience, innovation and dynamism of the world – we will, most likely, be pleased with what we see.

 

If you have any questions, please don’t hesitate to contact Wells Gibson.

 

Risk Warnings

 

This article is distributed for educational purposes and should not be considered investment advice or an offer of any security for sale. This article contains the opinions of the author but not necessarily the Firm and does not represent a recommendation of any particular security, strategy, or investment product.  Information contained herein has been obtained from sources believed to be reliable but is not guaranteed.

 

Past performance is not indicative of future results and no representation is made that the stated results will be replicated.

 

[1] https://www.bbc.co.uk/news/health-55639096

[2] For anyone who wants to understand how social media works and the dangers that it poses to individuals and society as a whole, we highly recommend watching ‘Social Dilemma’ which can be found on Netflix.

[3] https://www.gov.uk/government/news/uk-sets-ambitious-new-climate-target-ahead-of-un-summit

Equity Markets and US Presidents

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When it comes down to the returns of stock markets under different Presidents – Democrat or Republican – does it really matter who is in power?  Should we change our portfolios?  Can we predict what is going to happen?  The quick answers are ‘no’, ‘no’ and ‘no’!

This is perhaps not really very surprising as the price of a company’s shares is based on the future cashflows that it will deliver discounted back to a present value, using a discount rate that reflects the risks associated with that company’s cashflows.  A Presidential term is four years, but a company’s cashflows run into the distant future.  Despite the partisan nature of US politics at this time, Democrats and Republicans are all still capitalists and believe in personal freedom, property rights and, yes – even if it does not feel like it at this moment – democracy.  In a broad political sense, Democrats and Republicans are simply variations on a democratic, capitalist theme.

Active fund managers may try to position portfolios to reflect world events, but predicting the future is very hard to do!  There was much talk of the ‘blue wave trade’ prior to the election to position for a Democrat clean sweep of all parts of government yet look how that seems to be turning out.  A few days ago, the prospect of a vaccine for Covid-19 sent airlines, banks and energy companies soaring and Zoom and other ‘lockdown’ benefiters, such as Ocado, down.

Random events and the release of new information moves the market’s view of cashflows and discount rates resulting in the movement of share prices.  Guessing against randomness is hard but taking on the known risk that equity returns are far less certain than holding cash, rewards investors who ignore this short-term noise and focus on the long-term.

The choice of the US President is important to some, but to the long-term investor it is largely irrelevant from an equity market perspective.

Coronavirus and Investing…

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The coronavirus is still very much with us, as is much of the economic dislocation occasioned by the resulting lockdowns.

Granted, we are evidently closing in rapidly on a vaccine, indeed, a number of vaccines.  However, it might be quite some time yet before most of us will get access to a vaccine, and frustration may abound. Furthermore, in the coming weeks we will have to go through a hyper-partisan presidential election in the US, with a variety of voting issues we’ve never had to deal with before.

So, before we’re further engulfed by these multiple unknowns, I want to take a moment to review what we as investors should have learned, or relearned, since the onset of the great market panic that began in February / March and ended when the 500 largest companies in the US, as measured by the S&P 500 Index, regained its pre-crisis highs in mid-August.

The lessons are:

    • No amount of study—of economic commentary and market forecasting—ever prepares us for really dramatic events, which always seem to come at us out of deep left field. Thus, trying to make investment strategy out of so-called “expert” forecasts — much less financial journalism—always sets investors up to fail. Instead, having a long-term Wealth Plan, and working that plan through all the fears (and fads) of an investing lifetime, tends to keep us on the straight and narrow, and helps us to avoid sudden emotional decisions;
    • The global equity market fell 26% in 25 days. None of us have ever seen such a speedy decline before, but with respect to its depth, it was just about average. When reviewing monthly returns data, this ranks 5th in the top declines dating back to 1970.  Declines of -49%, -35%, -33%, -29% have been experienced over that time period.  However, in those ~50 years to 30/09/2020, global equities enjoyed a cumulative return of 12,967% in nominal terms.  The lesson is that, at least historically, the declines haven’t lasted, and long-term progress has reasserted itself;
    • Almost as suddenly as global equities crashed, they completely recovered, surmounting its February 20 all-time high on September 2. Note that the news concerning the virus and the economy continued to be dreadful, even as the market came all the way back. I think there are actually two great lessons here:
    • The speed and trajectory of a major market recovery very often mirror the violence and depth of the preceding decline; and
    • The equity market most often resumes its advance, and may even go into new high ground, considerably before the economic picture clears. If we wait to invest before we see unambiguously favourable economic trends, history tells us that we may have missed a very significant part of the market advance.
    • The overarching lesson of this year’s swift decline and rapid recovery is, of course, that the market can’t be timed, that the long-term, goal-focused equity investor is best advised to just sit tight.

These are the investment policies you and I have been following all along, and if anything, our experience this year has validated this approach even further.

A word now, really just a repetition of what we’ve stressed before, about the US election.  Simply stated, it’s unwise in the extreme to exit global equities in which you’ve been invested during your lifetime because of the uncertainties surrounding the election.  Your chances of getting out the market and then back in advantageously are historically very poor, nor can Wells Gibson possibly help you in attempting to do so.

As we do before every UK or US election, we urge you to just stay the course.  As always, we’re here to talk through these issues with you.


Header photo by Sebastien Gabriel on Unsplash
Risk warnings
This article is distributed for educational purposes and should not be considered investment advice or an offer of any security for sale. This article contains the opinions of the author but not necessarily the Firm and does not represent a recommendation of any particular security, strategy, or investment product.  Information contained herein has been obtained from sources believed to be reliable but is not guaranteed.
Past performance is not indicative of future results and no representation is made that the stated results will be replicated.

Investing Using the Rearview Mirror

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If we could invest by simply looking at what has done well in the recent past – and by that we mean the past few years, not just months – then life would be so much simpler.  Unfortunately, rearview mirror investing is not the best way to build portfolios for the future.

If we take the past three years or so, looking through our rearview mirror, we certainly would not want to have too large a position in the UK or emerging equity markets or global commercial property or value or smaller company shares, which fared poorly on a relative rather than an absolute basis, compared to large companies in overseas developed markets.

Overseas developed markets lagged the broad US market, which in turn lagged growth-oriented shares, particularly technology companies.  In an extreme rear-view mirror scenario, a hindsight investor would invest heavily in US growth shares going forward.  That would be a very concentrated bet and would ignore the fact that all future growth expectations are captured in today’s prices.  These companies need to perform better than these expectations for prices to rise.

At the end of the 2000s the rearview mirror investor would have avoided the broad US and World developed markets, yet in the 2010s they were exceptionally strong performers and emerging markets and value shares suffered relative to the US and the UK was a laggard.  To want to place all your investment eggs in one basket – and in particular the one that has just performed best – seems a little naïve.  No-one knows what the 2020s will bring and diversification is a key tool in mitigating the unknown.

As such, at Wells Gibson we take a highly diversified approach when building our clients’ portfolios.  We also believe that limited exposure to more risky parts of the markets, including companies in emerging countries, smaller companies, and value (relatively cheaper) companies provide the opportunity, although never the guarantee, of delivering returns a little above the broad markets.  It can take some time for them to shine through.  If an extra return were guaranteed, there would be no risk to picking up the return (and it would not exist).

In an environment when cash delivers a negative return after inflation, and the expected returns for both bonds and equities are reduced as a consequence, these incremental returns are not to be sniffed at.  They happen to be all the things that have not done as well (in a relative sense) in the past few years, although they have still delivered strong absolute returns to investors.  Rearview mirror investors would avoid them to their detriment.  More fool them.

Do not look back and wish you had owned a different portfolio but take comfort from the fact that your highly diversified and soundly structured portfolio gives you every chance of a successful outcome in an unknown, forward looking world.

Header photo by Jonny McKenna on Unsplash
Risk warnings
This article is distributed for educational purposes and should not be considered investment advice or an offer of any security for sale. This article contains the opinions of the author but not necessarily the Firm and does not represent a recommendation of any particular security, strategy, or investment product.  Information contained herein has been obtained from sources believed to be reliable but is not guaranteed. 
Past performance is not indicative of future results and no representation is made that the stated results will be replicated.

Key Questions for the Long-Term Investor

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Key Questions for the Long-Term Investor

Focusing on what you can control can lead to a better investment experience.

Whether you’ve been investing for decades or are just getting started, at some point it is likely you will ask yourself some of the questions below.  Trying to answer these questions may be intimidating, but please be assured you’re not alone.  Your financial planner or advisor should be there to help.  While this is not intended to be an exhaustive list, it will hopefully shed light on a few key principles, using data and reasoning, that might help improve investors’ odds of investment success over the long term.

  1. What sort of competition do I face as an investor?

The market is an effective information-processing machine.  Millions of market participants buy and sell securities every day and the real-time information they bring helps set prices.  This means competition is stiff and trying to outguess market prices is difficult for anyone, even professional money managers (see question 2 for more on this).  This is good news for investors though as rather than basing an investment strategy on trying to find securities that are priced “incorrectly,” investors can instead rely on the information in market prices to help build their portfolios (see question 5 for more on this).Picture1

* Year-end WM/Reuter’s London Close FX rates used to convert original US dollars data to British pound sterling.  Source: World Federation of Exchanges members, affiliates, correspondents, and non-members. Trade data from the global electronic order book. Daily averages were computed using year-to-date totals as of December 31, 2016, divided by 250 as an approximate number of annual trading days.

  1. What are my chances of picking an investment fund that survives and outperforms?

Flip a coin and your odds of getting heads or tails are 50/50.  Historically, the odds of selecting an investment fund that was still around 15 years later are about the same.  Regarding outperformance, the odds are worse. The market’s pricing power works against fund managers who try to outperform through stock picking or market timing and one needn’t look further than real-world results to see this.  Based on research, only 17% of US equity mutual funds and 18% of US fixed income mutual funds have survived and outperformed their benchmarks over the past 15 years.

Picture2

Source: Mutual Fund Landscape 2017, Dimensional Fund Advisors. See Appendix for important details on the study.  Past performance is no guarantee of future results.

  1. If I choose a fund because of strong past performance, does that mean it will do well in the future?

Some investors select mutual funds based on past returns however research shows that most funds in the top quartile (25%) of previous five-year returns did not maintain a top-quartile ranking in the following year. In other words, past performance offers little insight into a fund’s future returns.

Picture8

Source: Mutual Fund Landscape 2017, Dimensional Fund Advisors. See Appendix for important details on the study.  Past performance is no guarantee of future results.

  1. Do I have to outsmart the market to be a successful investor?

Financial markets have rewarded long-term investors. People expect a positive return on the capital they invest and historically, the lower-risk bond markets and higher-risk equity markets have provided growth of wealth that has more than offset inflation.  Instead of fighting markets, let them work for you.

Picture3

In British pound sterling. UK Small Cap is the Dimensional UK Small Cap Index. UK Marketwide Value is the Dimensional UK Marketwide Value Index. UK Market is the Dimensional UK Market Index. UK Treasury Bills are UK One-Month Treasury Bills. UK Inflation is the UK Retail Price Index. Indices are not available for direct investment. Index performance does not reflect the expenses associated with the management of an actual portfolio. See appendix for index descriptions.  Past performance is no guarantee of future results. The graph is for illustrative purposes only, figures presented are hypothetical and not indicative of any investment.

  1. Is there a better way to build a portfolio?

Academic research has identified these equity and fixed income dimensions, which point to differences in expected returns among securities. Instead of attempting to outguess market prices, investors can instead pursue higher expected returns by structuring their portfolio around these dimensions.

Picture4

Relative price is measured by the price-to-book ratio; value stocks are those with lower price-to-book ratios. Profitability is measured as operating income before depreciation and amortisation minus interest expense scaled by book.

  1. Is international investing for me?

Diversification helps reduce risks that have no expected return, but diversifying only within your home market may not be enough. Instead, global diversification can broaden your investment opportunity set. By holding a globally diversified portfolio, investors are well positioned to seek returns wherever they occur.

Picture5Number of holdings and countries for MSCI United Kingdom Investable Market Index (IMI) and MSCI ACWI (All Country World Index) Investable Market Index (IMI) as at 31 December 2016. MSCI data © MSCI 2017, all rights reserved. Indices are not available for direct investment.  International investing involves special risks such as currency fluctuation and political instability. Investing in emerging markets may accentuate these risks. Diversification neither assures a profit nor guarantees against loss in a declining market.

  1. Will making frequent changes to my portfolio help me achieve investment success?

It’s tough, if not impossible, to know which market segments will outperform from period to period. Accordingly, it’s better to avoid market timing calls and other unnecessary changes that can be costly. Allowing emotions or opinions about short-term market conditions to impact long-term investment decisions can lead to disappointing results.

Picture6In British pound sterling. UK Large and Mid-Cap is the MSCI United Kingdom Index (gross dividends). UK Total Market is the MSCI United Kingdom IMI Index (gross dividends). Developed Markets ex UK is the MSCI World ex UK Index (gross dividends). Emerging Markets is the MSCI Emerging Markets Index (gross dividends). Global Real Estate is the S&P Global REIT Index (gross dividends). UK Treasury Bills are UK One-Month Treasury Bills. WGBI 30-Year UK Hedged is the Citi World Government Bond Index UK 1–30+ years (hedged to GBP). WGBI Five-Year Hedged is Citi World Government Bond Index 1–5 Years (hedged to GBP). Global Fixed Income Hedged is Bloomberg Barclays Global Aggregate Bond Index (hedged to GBP). MSCI data © MSCI 2017, all rights reserved. S&P data provided by Standard & Poor’s Index Services Group. Prior to 1975: UK Three-Month Treasury Bills provided by the London Share Price Database; 1975–present: UK One-Month Treasury Bills provided by the Financial Times. Citi fixed income indices © 2017 by Citigroup. Data provided by Bloomberg. Indices are not available for direct investment. Index performance does not reflect the expenses associated with the management of an actual portfolio.  Past performance is no guarantee of future results.

  1. Should I make changes to my portfolio based on what I’m hearing in the news?

Daily market news and commentary can challenge your investment discipline. Some messages stir anxiety about the future, while others tempt you to chase the latest investment fad. If headlines are unsettling, consider the source and try to maintain a long-term perspective. Picture7

  1. So, what should I be doing?

Work closely with a financial adviser who can offer expertise and guidance to help you focus on actions that add value. Focusing on what you can control can lead to a better investment experience.

  • Create an investment plan to fit your needs and risk tolerance.
  • Structure a portfolio along the dimensions of expected returns.
  • Diversify globally.
  • Manage expenses, turnover, and taxes.
  • Stay disciplined through market dips and swings.

APPENDIX

Question 2: The sample includes US mutual funds at the beginning of the 15-year period ending December 31, 2016. Each fund is evaluated relative to the Morningstar benchmark assigned to the fund’s category at the start of the evaluation period. Surviving funds are those with return observations for every month of the sample period. Winner funds are those that survived and whose cumulative net return over the period exceeded that of their respective Morningstar category benchmark.

Question 3: At the end of each year, US mutual funds are sorted within their category based on their five-year total return. US mutual funds in the top quartile (25%) of returns are evaluated again in the following year based on one-year performance in order to determine the percentage of funds that maintained a top-quartile ranking. The analysis is repeated each year from 2007– 2016. The chart shows average persistence of top-quartile funds during the 10-year period.

Questions 2 and 3: US-domiciled open-end mutual fund data is from Morningstar and Center for Research in Security Prices (CRSP) from the University of Chicago. Index funds and fund-of-funds are excluded from the sample. Equity fund sample includes the Morningstar historical categories: Diversified Emerging Markets, Europe Stock, Foreign Large Blend, Foreign Large Growth, Foreign Large Value, Foreign Small/Mid Blend, Foreign Small/Mid Growth, Foreign Small/Mid Value, Japan Stock, Large Blend, Large Growth, Large Value, Mid-Cap Blend, Mid-Cap Value, Miscellaneous Region, Pacific/Asia ex-Japan Stock, Small Blend, Small Growth, Small Value and World Stock. Fixed income fund sample includes the Morningstar historical categories: Corporate Bond, Inflation-Protected Bond, Intermediate Government, Intermediate-Term Bond, Muni California Intermediate, Muni National Intermediate, Muni National Short, Muni New York Intermediate, Muni Single State Short, Short Government, Short-Term Bond, Ultrashort Bond and World Bond. See Dimensional’s “Mutual Fund Landscape 2017” for more detail. Benchmark data provided by Bloomberg Barclays, MSCI, Russell, Citigroup and S&P. Bloomberg Barclays data provided by Bloomberg. MSCI data © MSCI 2017, all rights reserved. Frank Russell Company is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Citi fixed income indices © 2017 by Citigroup. The S&P data is provided by Standard & Poor’s Index Services Group.

Question 4: DIMENSIONAL UK SMALL CAP INDEX: January 1994–present: Compiled from Bloomberg securities data. Market capitalisation-weighted index of small company securities in the eligible markets excluding those with the lowest profitability and highest relative price within the small cap universe. Profitability is measured as operating income before depreciation and amortisation minus interest expense scaled by book. Exclusions: REITs and investment companies. The index has been retroactively calculated by Dimensional Fund Advisors and did not exist prior to April 2008. The calculation methodology for the Dimensional UK Small Cap Index was amended in January 2014 to include direct profitability as a factor in selecting securities for inclusion in the index. July 1981–December 1993: Includes securities in the bottom 10% of market capitalisation, excluding the bottom 1%. Rebalanced semiannually. Prior to July 1981: Elroy Dimson and Paul Marsh, Hoare Govett Smaller Companies Index 2009, ABN-AMRO/Royal Bank of Scotland, January 2009.

DIMENSIONAL UK MARKETWIDE VALUE INDEX: January 1994–present: Compiled from Bloomberg securities data. The index consists of companies whose relative price is in the bottom 33% of their country’s companies after the exclusion of utilities and companies with either negative or missing relative price data. The index emphasises companies with smaller capitalisation, lower relative price and higher profitability. The index also excludes those companies with the lowest profitability and highest relative price within their country’s value universe. Profitability is measured as operating income before depreciation and amortization minus interest expense scaled by book. Exclusions: REITs and investment companies. The index has been retroactively calculated by Dimensional Fund Advisors and did not exist prior to April 2008. The calculation methodology for the Dimensional UK Value Index was amended in January 2014 to include direct profitability as a factor in selecting securities for inclusion in the index. Prior to January 1994: Source: Dimson, Elroy, Stevan Nagel and Garrett Quigley. 2003. “Capturing the value premium in the UK”, Financial Analysts Journal 2003, 59(6): 35–45. Created Returns, converted from GBP to USD using the WM/Reuters at 4 pm EST (closing spot), from PFPC exchange rate.

DIMENSIONAL UK MARKET INDEX: Compiled by Dimensional from Bloomberg securities data. Market capitalisation-weighted index of all securities in the United Kingdom. Exclusions: REITs and investment companies. The index has been retroactively calculated by Dimensional and did not exist prior to April 2008.

UK ONE-MONTH TREASURY BILLS: Provided by the Financial Times Limited. Prior to 1975: UK Three-Month Treasury Bills provided by the London Share Price Database.

UK RETAIL PRICE INDEX: Provided by the Office for National Statistics; Crown copyright material is reproduced with the permission of the Controller of HMSO.