INVESTING IN UNCERTAIN TIMES
As we enter a year of general elections (across the globe, but most importantly within South Africa) we expect to see the level of uncertainty increase. Politicians can often be considered a different animal at these times, with their clever use of words and making promises that result in both rousing fear and support at the same time. Words may be written, speeches may be made, and images “instagramed” all for the purposes of maximising votes. The risk of alienating certain sections of the voting population is often deemed worthwhile if you appeal to a larger portion of the voting population. These messages however cause a load of uncertainty, and with that a huge amount of negative sentiment. In this month’s Financial View, we look at how one should approach investing in the uncertain times that we may encounter.
Diversification
The often-quoted idiom of “Don’t put all your eggs in one basket” comes to mind. Uncertainty means that the future is just that – will the ANC win outright; will they be able to form a coalition with some small parties; do they form a coalition with the EFF; or the DA; or does the moonshot pact have enough support to move into power. These are all questions that the general South African populace is dealing with and trying to figure out the probabilities and their implications. What is known, is that almost every combination of political leadership will have different implications. It is not worthwhile focusing on just one scenario as others may come to pass.
In investing we protect against various scenarios by having a diverse set of asset classes within a portfolio. These different asset classes can then be further diversified into industry, geography and duration meaning that in any normal cycle there is a balance between upside growth and downside protection.
The Nobel Prize laureate, economist Harry Markowitz, is reported to have said, “Diversification is the only free lunch” in investing.
We are always up for free lunches but the theory behind the saying is probably what is important to focus on. Minimising losses is a critical part of investing. If you have R1 000 and you lose 50% of your investment, you need to achieve a 100% return to get back to your starting point of R1 000. By having asset classes that perform differently in different parts of the market cycle you will find that there should always be something in your portfolio delivering a positive return.
A well-diversified portfolio will have exposure to both local and offshore assets. It will have some exposure to cash, to property and to bonds. But most importantly it will have exposure to equities and that is the other thing to keep in mind during uncertain times.
Risk and Return
Uncertainty often leads to negative sentiment which makes us want to run for the hills. We often see investors selling out of all volatile assets and fleeing to the perceived safety of cash. Whilst cash will deliver a positive nominal return it often doesn’t outperform inflation, especially after taxes are taken into account. If your investments are not outperforming inflation, then you are getting poorer each year and are in fact going backwards.
The best asset class to invest in and that usually outperforms inflation is equities. Whilst the share price and profits of companies can be variable through market cycles, a well-positioned business is able to pass cost increases onto the consumer. Any of us who have been to the shops can attest to the fact that most companies increase their prices over time (or as we looked at a few months ago, keep price constant but reduce the volume of the product).
The human brain however is wired to avoid danger, call it our survival instinct. It is this trait however that often makes us bad investors – we tend to focus more on the downside and not on the upside.
This fantastic chart from Ritholtz Wealth Management covering the last great bull market shows how the stock market often is not influenced by bad news. Every one of these highlighted points is a negative headline. One may say that there is no such thing as positive headlines as bad news sells which further enforces the fact that we place a greater weight on negative news.
The big takeaway from the graph though is that despite the bad news, despite the negative sentiment the market always continues a progression upwards. Equity returns however never come in a straight line and the ride can be quite volatile at times but generally any chart on the market starts in the bottom left corner and ends in the top right corner.
Bill Miller the famous fund manager in the US probably summed up the attitude that we probably should try apply when he said “When I am asked what I worry about in the market, the answer usually is “nothing”, because everyone else in the market seems to spend an inordinate amount of time worrying, and so all of the relevant worries seem to be covered. My worries won’t have any impact except to detract from something much more useful, which is trying to make good long-term investment decisions.”
Conclusion
We are probably going to experience a lot of mood changes over this year as we deal with the trauma of campaigning and “electioneering”. All of us are going to get angry at points in time, especially if the powers that be keep trying to force through boneheaded ideas such as the currently proposed version of NHI. We may feel confused at times but the best thing for investments is to have an all-weather portfolio that can handle any scenario. More important though is to trust said all-weather portfolio to do its job and not try flee from equities. With the increased level of volatility does come the greatest opportunities and investment rewards.
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