Getting down to business, investors are gradually bidding farewell to the cushion of central bank money printing that shielded returns from the real world. The bull market that the central bankers created all around the world is now drawing to a close. The last quarter of 2017 and the first three months of 2018 in world markets has reminded those of us who are old enough to recall what investing was like before the arrival of the ever-supportive hand of the central bankers. Today’s technology and data crisis, coupled with the US-China free trade skirmish and Russian diplomatic imbroglio would, in recent years, have been viewed by markets largely in terms of the reactions they triggered from the central banks. In this Alice in Wonderland world, bad news in the real world was often good news for financial markets. Today though, the central bankers’ comfort blankets are being steadily withdrawn, after the sixth US interest rate rise and the likely conclusion of the European Central Bank (ECB)’s massive money printing programme.
As Quantitative Easing becomes Quantitative Tapering, the real world can feel much more painful for investors. Gone are the skills needed in the past decade that lay not in analysing events or fundamentals themselves, but rather in trying to guess how Messrs Bernanke and Draghi would react to them. Fund managers became highly skilled US Federal Reserve (Fed) and European Central Bank (ECB) watchers and, rather like the Kremlinologists of the Cold War, they found themselves parsing every nuance of central bank language. Indeed, so large were the balance sheets that these men and women deployed that their statements were usually more significant for markets than those of the political masters they served. Both US president Donald Trump’s election and the Brexit referendum result, for example, were surprise real world results, but their effect on share markets was negligible.
But the wind is changing. The task for all fund managers today is to wean themselves off a diet of ‘Fed watching’ and return to analysing real world events, whilst estimating their impact on our clients’ returns. In the long run, this can only be good news.
Following the issue of the latest valuation statements as at 31st March, one or two clients have been in touch to express their (slight) disappointment at recent investment returns. Apart from the comments above on the changing economic landscape, we felt it might be useful if we set out a few thoughts on the subject of investment generally. We hope you find these interesting and, more importantly, reassuring.
In 1990 Peter Lynch gave a speech entitled: “Common Sense Investing.” Mr Lynch was a fund manager in America who ran the Magellan Fund for Fidelity, a global financial services group. He managed the Magellan Fund between May 1977 and May 1990, during which time he achieved an average annual return of 29% and the Fund grew in size from $18 million to $14 billion – making it the biggest and best performing mutual fund in industry at the time. Let me just repeat that average return figure – 29% per annum.
In his presentation Mr Lynch set out the ideas on which his stock selections had been based, the five most important of which were:
- Know what you own.
- It is futile to predict the economy, interest rates or the stock market.
- There is always something to worry about.
- Use your common sense.
- You have plenty of time.
Peter Lynch believed that investing is simple, but it’s not easy. One of his key rules was to watch out for where his wife shopped and what she bought. It’s important when your wife tells you that M&S has lost the plot in women’s fashion or children’s clothes. Much more important than taking notice of short term ‘noise’ and share price fluctuations. It’s also useful to respond to the realisation that you buy a Cadbury’s Crunchie every time you fill the car. These are not complex ideas, but common sense never goes out of fashion.
Bearing this in mind, you would have thought that, when Fidelity decided to survey all the unitholders in the Magellan Fund to obtain what they thought were going to be some glowing testimonials for a new marketing campaign, they received lots of replies from disgruntled investors. The typical client had earned a return of only two or three per cent per year whilst in this fund and they were consequently disappointed with Mr Lynch’s performance. But how could this be? Well, the Magellan Fund had great long term performance figures, but on an annual basis it was very volatile and highly unpredictable. One year it might grow by 60% and in the next 12 months it could fall by 10%. While this meant an average annual return of 25% over the two years, many private clients had invested just after a period of outstanding returns and just prior to a bad spell, after which they lost patience and decided to sell up at a loss. They forgot that they had plenty of time.
To underline that, the FTSE 100 Index (measuring the performance of the 100 largest companies listed on the London Stock Exchange) was launched on 3rd January 1984 at a base value of 1,000. It has since grown to today’s level of around 7,500, meaning that an investment of £10,000 is now worth £75,000. If you had reinvested all the dividends during the past 34 years, your initial £10,000 would today be worth over £175,000.
The first three months of this year saw the FTSE 100 Index fall approximately 8% due mainly to fears over rising interest rates and the threat of trade wars. When this happens it is very difficult for any fund to maintain 100% of its value. Over the course of March for example, the main US share index swung either up or down by at least 1% on eight days, following on from 12 occasions in February. To put this in perspective, in the 13 months to the end of January 2018 there were only ten days when that happened. We can expect heightened levels of volatility to persist for the time being.
It is true that stock markets have been down by far more than our portfolios, but the point of investing is to make money, not to find convincing ways of explaining away losses, no matter how fleeting those losses may be. So, apologies for any disappointment you may have felt when you read our last valuation statement, but please remember – you have plenty of time. Investing is an activity in which consumption today is foregone in an attempt to allow greater consumption at a later date and ‘risk’ is the possibility that this objective will not be attained. Risk should not be defined by short term fluctuations in share prices.
One client said to me that we should have seen the market falls coming and taken pre-emptive action in January. Quite right, but quite difficult to achieve. We don’t try to be too clever as a deliberate policy, because, as Paul Gascoigne once memorably remarked: “I don’t make predictions and I never will.” The amount of work done by a financial adviser should not be measured by the number of times he or she switches your investments around. Apart from anything else, the costs of doing so can cause significant erosion of capital and a high volume of portfolio changes can be as much an admission of failure as evidence of thoughtfulness. If the investment outlook hasn’t changed, why change the portfolio you have structured specifically to benefit from that very outlook and to guard against the dangers it presents? When asked by clients what we do all day, our reply is: “We worry.”
Having said all that, the world economy continues to grow in all regions, despite the best efforts of politicians and there are no signs yet of a recession. This will come at some point as we have enjoyed a remarkably long period of growth since the dark days of 2008, but the banks are in much better shape now than they were then and our carefully selected fund managers are well poised to take advantage of market volatility to pick up bargains that will make them (and therefore us) a lot of money in the future.
The risks posed by a potential war between Russia and America are in our view vastly exaggerated – Putin and Trump are simply not prepared to go to war over Syria, or indeed anything else. It is important that we keep our focus on our investment process and methodically follow our discipline even though short term performance is occasionally volatile. Buying ‘value’ may take time to work, but in our view the current intrinsic value of our typical client portfolio is significantly higher than its market price.
Finally, with Louis Arthur Charles Windsor in mind, what one piece of advice would you offer to a newborn infant?