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.