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Sensible Investing

The Big Five

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Investors love good stories and in recent years, many of these stories have centered around innovations that have fundamentally changed the way we live our lives.  Some examples might include the release of the original Apple iPhone in 2007, the delivery of Tesla’s first electric cars in 2012 and the launch of Amazon Prime’s same-day delivery service in 2015.

No doubt, many of you will have had conversations with friends and family around the successes, failures, and prospects of some of the world’s largest companies and the goods and services they offer.  In this article, we take a deeper look at the ‘Big Five’ tech companies – Amazon, Apple, Alphabet (Google), Facebook and Microsoft – through the lens of the long-term investor.

The ‘Big Five’, images from Unsplash [1]

In what has been a turbulent year thus far, some larger firms have come through the first, and hopefully last, wave of the ongoing pandemic relatively unscathed.  Those investors putting their nest eggs entirely in any combination of the ‘Big Five’ would appear to have done astonishingly well relative to something sensible like the MSCI All-Country World Index, which constitutes 3,000 of the world’s largest companies.  At time of writing, Amazon’s share price has faired best, increasing 75% since the beginning of the year.

These types of firms tend to struggle to stay out of the headlines for one reason or another.  Perhaps as a result, many of the investment funds found in ‘top buy’ lists have overweight positions in one or more of these companies.  Many of today’s most popular funds are making big bets on one or more of these companies, anticipating that the past will repeat itself moving forwards.

Sticking to the long-term view

The challenge for these managers, and others making similarly large bets, is that these are portfolios that will be needed to meet the needs of individuals over lifelong investment horizons, which for the vast majority of people means decades, not years. With the benefit of hindsight, managers who have placed their faith in these companies have stellar track records since Facebook’s listing on the market in 2012.

However, an interesting exercise would be to investigate the outcomes of these companies over a longer period of time, for example 30-years seems more prudent. This is somewhat difficult given that 30-years ago, 3 of these companies did not exist, Mark Zuckerberg of Facebook was 6-years old, Apple came in at 96th on Fortune’s 500 list of America’s largest companies and Microsoft had just launched Microsoft Office.

A partial solution to this problem is to perform the exercise from the perspective of an investor in 1996, which is the start of Financial Times’ public market capitalisation record.

The ‘Class of 96 Big Five’ consisted of General Electric, Royal Dutch Shell, Coca-Cola, Nippon Telegraph and Telephone and Exxon Mobil.  A hypothetical investor with their assets invested in either Coca-Cola or Exxon would have just about beaten the market over this period, those in Royal Dutch Shell, Nippon Telegraph and Telephone and General Electric were not so lucky.

This exercise is illustrative only, however a closer look is enough to see that almost no investor would want to stomach the roller coaster ride they would have been on in any one of these single-company portfolios.

Summary

The beauty of the globally diversified, systematic approach adopted by Wells Gibson, is that judgemental calls such as these are left to the aggregate view of all investors in the marketplace.

No firm is immune to the risks and rewards of capitalism; be it competition from Costco or Walmart taking some of Amazon’s market share, publishing laws causing Facebook to apply heavy restrictions on its users or some breakthrough smartphone entering the marketplace that is years ahead of Apple – remember Nokia?

Rather than supposing that companies who have done well recently will continue to do well, systematic investors can rest easy knowing that they will participate in the upside of the next ‘Big Five’, the ‘Big Five’ after that and each subsequent ‘Big Five’.

Those who can block out the noise of good stories and jumping on bandwagons are usually rewarded over time.

“But the problem that people don’t understand is that active managers, almost by definition, have to be poorly diversified. Otherwise, they’re not really active. They have to make bets. What that means is there’s a huge dispersion of outcomes that are totally consistent with just chance. There’s no skill involved in it. It’s just good luck or bad luck.”

Eugene Fama – Nobel laureate

Making Sense of Your Pensions and Investments

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Are you investing sensibly?

What constitutes sensible investing is different for everyone and depends substantially on your current financial situation, present circumstances, future goals and risk tolerance.   Having said that, there are universally applicable points to bear in mind.

The majority of people keep their savings in the same, low-interest rate bank account for years on end without looking for better returns elsewhere.  There’s a good reason for this – traditional savings accounts offer safety and security because they are very low risk.  Unfortunately, they also offer very low chances of earning any money.  In fact, the majority of savings accounts perform well below inflation, so in the long-term it’s likely your money will actually be worth less a decade after investment than it was when initially banked.

When considering where to invest your money, think about your goals and your needs.  Are you saving for something long-term – for example your pension – or something more short-term, such as a deposit for your child’s first home?  The length of time you’re willing to invest your money will affect how much risk is appropriate.  Short-term goals are often best kept low risk, i.e. held in traditional savings accounts.  Long-term goals on the other hand can tolerate higher risk levels, because most losses will be recouped over time and will generally be offset by gains.

However, many people are deterred from exploring alternative investment options because they fear they will lose their hard-earned money.  It’s a very real concern, as poor investment decisions can be very expensive.  There is a solution though.  To mitigate risk, it’s important to split your savings across different investment platforms.  Why?  Because different investment options have correspondingly different risk levels.  For example, investing in emerging markets is riskier than investing in UK and American markets, and investing in smaller or start-up companies is riskier than investing in more established, bigger firms.  The most sensible way to invest is to diversify your portfolio – by spreading your money across equities, commodities, bonds and other asset classes, you minimise risk and increase your chances of maintaining and building wealth in the long term.

Although the amount of risk you are willing to take is a matter of personal preference, a wealth planner such as Wells Gibson can help you understand all of the available options, so that your resulting portfolio reflects and aligns with your financial attitude.  Sometimes the potential returns on high risk products can be alluring, but unless you fully understand the dangers involved and are investing an amount you can afford to lose, then they are best avoided.   In particular, these kinds of investments shouldn’t be made without professional advice.  

Whilst diversifying your investments is the most sensible approach to long-term savings, it’s imperative that you don’t just place your money in these different pots then simply hope for the best.  Whilst the majority of investments manage themselves, it’s important to regularly reassess their risk levels – at least annually – and re-allocate your funds accordingly.   However, a watched pot doesn’t boil.  Checking your investments too frequently can lead to knee-jerk reactions – moving your money every time prices rise or fall in an unexpected way.   Remember that markets are always fluctuating, and the majority of long-term investments will cope with these fluctuations.

Even with this knowledge, it can be difficult to decide where to invest or what financial products to invest in.  Working with a wealth planner such as Wells Gibson can give you the confidence and reassurance you need to take the plunge.

Do you need help investing? You can contact us via email at integrity@wellsgibson.uk or by our online contact form on our website, which can be found here. If you would prefer to have a talk in person over video call, you can do so by scheduling an Exploration Call with us here.

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.

Why Owning a Broadly Diversified Portfolio Makes Perfect Sense

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At times like this when there is great uncertainty, wouldn’t it be great if we had the means to look into the future? Perhaps not some might argue. Unfortunately, we don’t know the future – no one does.

When it comes to investing, it can be tempting to run ‘what if’ scenarios in our heads, such as ‘perhaps I should move into technology and pharmaceutical companies – as surely these will do well’ or to pick out specific companies that appear likely to thrive in the future.

However, two challenges exist.  The first is that you won’t be the first person to have thought this and the combined views are already reflected in market prices. The second is that in making such focused bets you have a high chance of being wrong and missing out on the companies that actually end up driving future returns. Remember, 30 years ago Amazon and Google did not exist.

To get a feel for what these focused risks look like, academics are able to explore a vast amount of equity market data in the US, known as the Centre for Research in Security Prices (CRSP) database.

One such study[1] reveals some surprising and useful findings between 1926 and 2015.  Whilst investment wisdom and empirical evidence support the case that equities, in aggregate, outperform cash over longer periods of time, a closer look at individual equity returns tells a very different story. Here are some of the insights that the paper provides:

The median time that an equity/share is listed on the CRSP database is only seven years, during the period 1926 to 2015. That’s not long.

Just over 40% of all equities/shares have a holding period return that exceeds the return of cash (in this case one-month US Treasury bills) over the period that the equity/share was in the database. More than 50% deliver returns that are negative. The median lifetime return on any single equity/share was -3.7% p.a. That’s not good.

26,000 equities/shares have appeared in the CRSP database since 1926, yet only 36 survived the entire 90-year period. That’s not many.

US $32 trillion of wealth was created between 1926 and 2015, which has been generated entirely by the top 1,000 companies, representing less than 4% of the total number of companies listed over time. The top thirty companies (0.1% of all companies) accounted for around 30% of the total stock market’s wealth creation. That’s pretty concentrated.

This is why, at times like this, and in fact across all time periods, we believe it makes enormous sense to remain highly diversified, so as not to miss out on the next Exxon (the firm that has added most value to the US market ever), Apple or Amazon.

Now, let’s look at how the top ten US firms by revenue changed between 2000 and 2010 and again between, 2010 and 2020.  The results are so revealing.  Just look at the new companies making it into the top 10 in 2010 and then in 2020.  Look at the names which disappeared from the top 10 in 2010 and again in 2020.

Top 10 US companies by revenue over time (2000, 2010, 2020)

Source: Fortune 500

Correctly picking which few companies are going to be driving market returns over the next decade or two will not be easy, or likely. Even if you could, remember the majority of us are investing for more than 20 years.

At Wells Gibson, we believe it makes perfect sense to own the top companies by owning a broadly diversified portfolio which invests in thousands of companies.  Missing out on these companies, perhaps that don’t even yet exist, could make all the difference between a good investment outcome and a very poor one.

Please keep safe and don’t hesitate to get in contact if you have any questions.

[1] Bessembinder, H., (2017) Do Stocks Outperform Treasury Bills? WP Carey School of Business, Arizona State University.
Photo by Colin Horn 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