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equities

Mitigating an Unknown Investment Future

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One of the hardest concepts to grasp in investing is that a ‘good’ company is not always a better investment opportunity than a ‘bad’ company.

If we believe that markets work pretty well, considering few investment professionals beat the market over time, and markets incorporate all public information into prices pretty quickly and efficiently, all of the ‘good’ and ‘bad’ news should already be reflected in these prices.

A ‘good’ company will have to do better than the aggregate expectation set by the market for its share price to rise and vice versa.  If a ‘bad’ company is in fact a less healthy company, it may have a higher expected long-term return, as risk and return are related.

It is perhaps evident that if the market incorporates the aggregate forward-looking views of all investors, it becomes very difficult to choose which companies, sectors, and geographic markets are likely to do best, going forward.

In an uncertain world, where equity prices could move rapidly, and with magnitude, on the release of new information, which is itself a random process, then it makes good sense to ensure that an investment portfolio remains well diversified across companies, sectors and geographies.

Many charts illustrate how deeply diversified a globally equity portfolio can be however if you do not know which companies are going to perform well, own them all.  However, in the US, the concentration risk of the S&P500, is quite different and is increasingly concentrated in a few names.

Given that all the future promise of a company is already reflected in its share price today, it is quite a risk betting a large part of your assets on just a few names, concentrated, for example, in the technology sector.  The top 8 technology shares in the US now have a larger market capitalisation than every other non-US market except for Japan!

Dominance of companies, sectors and markets ebb and flow over time.  What will be the next Amazon?  What regulatory pressures could these dominant companies face?  Is Donald Trump’s recent rage against Twitter the start?  No-one knows.

By remaining diversified, you will own the next wave of market leaders as they emerge and dilute the impact of ebbing companies.  Whilst it is always tempting to look back with the benefit of hindsight and wish we had owned more (take your pick), US tech shares, other growth shares, gold etc., what matters is what is in front of us, not what is behind us.

The safest port in a sea of uncertainty is diversification

As always please get in contact if you have any questions.

Photos by Peter Fogden and Matt Hardy on Unsplash.

Sitting Out an Equity Market Fall

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For many of our clients, the purpose of accumulating wealth in a portfolio is to provide a sustainable income either now or in the future that is, at the very least, able to cover their basic needs and hopefully a bit more.

The level of portfolio-derived income required is unique to each client.  Some of our clients have pensions from final salary schemes and possibly other income from other sources, such as property.  Other clients need to rely more fully on their portfolios.

Portfolio income comes from the natural yield that a portfolio throws off in the form of dividends from companies and coupons (interest payments) from bonds, and capital makes up any shortfall.  When markets rise, as they have done most years since the Global Financial Crisis a decade ago, portfolios may even grow after an income has been taken, although this will not always be the case.  When markets fall, it can begin to feel a little uncomfortable as dividends may be cut and equity / share values may be down materially, as we have seen in the first quarter of 2020 (albeit, the upturn in April has helped).

The cardinal investment sin at these times is to sell equities when they are down and turn falls into losses.  To avoid doing this, income required above a portfolio’s natural yield can be taken from bonds or cash reserves.

You first question might be, ‘How long might I have to do this for?’. 

The figure below, helps to answer this question.  It uses a range of regional (Europe, Asia-Pacific ex-Japan, Emerging and World) and major individual equity markets (US, UK, Japan) and plots the top 10 largest market falls for each and the time taken to recover back to the previous high, in, before-inflation terms[1].

Some overlaps obviously occur (e.g. the US is a material part of the World), but broad insights can be gleaned: most market falls recover within 5-6 years, some may take a up to a decade or so, and outliers can and do occur, such as Japan which took 27 years to recover (in GBP terms) from its market high in 1989.

Figure 1: How long will we have to wait?

Data source: Morningstar Direct © All rights reserved.

What is also evident is that, with the exception of Japan, these market falls all sat well within most investors’ true investment horizons.  Whilst Japan provides a helpful lesson that investing outcomes are uncertain, widely diversified portfolios do help to mitigate country-specific risks.  Even investors in their 80s should be planning to live to at least 100, giving them a 20-year investment horizon (today an 80-year-old woman has a 1-in-10 chance of reaching 98[2]).

The question of how much cash or bonds an investor should hold will vary depending on how important it is for them to meet their basic income needs and how important it is having more discretionary spending[3].  Using a sensible multiple of basic annual spending, and possibly additional discretionary spending, is a sensible starting point from which to reach a suitable minimum.  For those to whom certainty of income is critical this could be significantly higher and for those to whom it is less critical, it might be lower.  For all investors, it should be sufficient to ensure that they can sit out any market fall relatively comfortably, without having to sell their equities.

Sitting out an equity market fall is not so bad, when you know how long the wait might be and you come well prepared to sit it out.

As always please get in contact if you have any questions.

[1] MSCI World NR, IA SBBI US Large Stock TR, MSCI United Kingdom NR from Jan-72; MSCI Japan NR, MSCI Emerging Market GR, MSCI Europe NR, MSCI AC Asia Ex Japan GR from Jan-1988.
[2] https://www.ons.gov.uk/
[3] It will also depend on other factors such as their need to take risk, their risk profile, and their financial capacity for loss, all of which should be discussed in detail as part of the ongoing financial planning process.
Photo by Martin Zangerl on Unsplash

Today’s Market Falls in the Context of History

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It’s been another tough week for capital markets however, context is an extremely important tool when it comes to investing.

All investors around the world will be feeling the emotional pressures of the recent rapid equity market falls, either because they can remember previous falls and times of uncertainty, such as the Global Financial Crisis (2007-2009), or as younger investors, they have not yet experienced material market falls.

We obviously cannot see into the future, however the global equity market falls we have seen since January, of under 20% or so at the time of writing, sit well within previous falls since 1970.

In terms of expected ranges of outcomes, we generally estimate that 95% of the time annual equity market returns should sit within an approximate range of + 45% to – 35% albeit outliers do exist beyond these limits.

The table below provides numbers around both the depth and recovery times for each of the five largest falls since 1970.

Peak date Decline Trough date Recovery date Decline

(months)

Recovery (months)
Sep-00 -49% Jan-03 Dec-10 29 95
Jan-73 -40% Sep-74 Jan-76 21 16
Jan-90 -35% Sep-90 Jan-93 9 28
Sep-87 -29% Nov-87 Mar-89 3 16
Jan-70 -19% Jun-70 Jan-71 6 7
Jan-20 -19%

How deep or long the current fall will be, no-one knows.

There will certainly be more rises and falls to come.  Yet we should take some comfort from the fact that things have been just as challenging at times in the past, albeit for very different reasons.  Recovery times sit well within the investment timeframes of most investors.  It is worth noting that an investor in global equites today has, in nominal terms, more money than they did at the end of April 2018, despite the market falls in late 2018 and those recently experienced.

These are tough times for all of us and for our Nation, but the words of wisdom that we always return to at these times are those of the legendary investor John Bogle, “This too will pass.”

This will pass and from an investment perspective, the key message is to be brave and disciplined as a fall only becomes a loss if we sell.

Remember, we are always available to take your call or answer your emails.  Please feel free to contact Wells Gibson, if you have any specific questions or simply if you would like some reassurance.

Photo by Jerry Zhang on Unsplash