Tag Archives: Investment Strategy
Why staying invested matters when markets fall
By Robert Wright /November 28,2022/
It’s natural to feel nervous when markets fall. News about inflation and rising interest rates may prompt you to make an emotional investment decision. But history tells us that markets trend upwards in the long run – and switching investment options at the wrong time can have a negative impact on your overall long-term investment return.
If you feel anxious when you see your balance drop and worry about your retirement savings, know that it’s a common reaction. And it’s natural to consider switching your super into a more defensive portfolio mix to avoid market turmoil. But doing so could mean locking in losses and missing out on the recovery which follows.
A year with a negative return can be stressful, although the general long-term trend is for markets to grow, not contract. The Australian share market has only recorded five negative years in the three decades since compulsory superannuation was introduced in 1992.
Here are three examples of market falls, and their following recoveries.
The COVID Crash 2020
Why did this happen?
In March 2020, the world started to realise how serious the rapid spread of COVID-19 really was. Governments enforced lockdowns, air travel was all but outlawed and investors desperately sold off their shares fearing these restrictions would hurt companies’ growth plans and profit margins.
What did it mean for investors at the time?
It all came to a head on 16 March 2020, when the ASX 200 recorded its worst day ever (down 9.7%)while in the US, the S&P500, Dow Jones Industrial Average and NASDAQ indices all lost 12% or more.
What was the best thing investors could do at the time?
Investors who switched to cash at the end of March, hoping to protect themselves, were 22% to 27% worse-off on average than those who held on through the drop. Share markets didn’t just recover – they grew to new highs. And people who stayed invested benefited from that growth.
Source: S&P Index Data Services. S&P/ASX All Ordinaries Accumulation Index. Date from 31 August 2017 to 30 June 2022.
Global Financial Crisis 2007 – 2009
Why did this happen?
The mid 2000s was a prosperous period for developed countries and mortgage lending became a lucrative business for banks. With house prices rising and regulators unworried about the potential risks, banks in the US began lending increasingly large sums to borrowers. included lending to borrowers with a high risk of default. US banks packaged up and on-sold those risky loans to investors.
Then in 2007 interest rates rose and house prices fell. Homeowners found themselves unable to make the repayments on their mortgage and owed more than their homes were now worth. As people walked away from their obligations, banks quickly racked up massive losses. The investors who’d bought the risky loans also lost money. The interconnectedness of global finance meant banks around the world experienced significant losses with some collapsing.
The resulting fallout remains one of the worst economic downturns since the Great Depression of the 1930s.
What did it mean for investors at the time?
The Australian share market fell 54% – a painful, drawn-out decline over 16 months from November 2007 to March 2009. But by 2013, US markets had returned to their pre-crisis highs. Australia took a little longer to regain its losses, finally breaking back above its pre-crisis levels in 2019. This may be because Australian companies pay a greater share of their earnings as dividends to investors compared with US companies.
What was the best thing investors could do at the time?
Staying invested during the Global Financial Crisis proved the best strategy, despite testing investor nerves. Yet anyone who switched their investments to cash locked in those original losses and missed out on the multi-year gains that followed.
Source: S&P Index Data Services. S&P/ASX All Ordinaries Accumulation Index. Date from 31 January 2007 to 31 December 2012.
September 11 attacks 2001
Why did this happen?
Almost 3000 lives were lost when four planes were deliberately crashed into strategic locations around the US on 11 September 2001. Almost all of these deaths were in New York, where al-Qaeda destroyed the World Trade Centre towers which sat at the heart of the financial district.
What did it mean for investors at the time?
In the days after the attack, markets dropped. The S&P500 fell 11% (extending the losses from the tech wreck earlier that year) while in Australia, the ASX200 lost 4.11% in a single session, before reaching a bottom on 24 September, 9.79% below its pre-attack level.
What was the best thing investors could do at the time?
Both the US and Australian share markets recouped all these losses only a month later. By taking a long-term view of investing, you can ride out any short-term dips in the market and take advantage of growth opportunities over the long term.
Source: S&P Index Data Services. S&P/ASX All Ordinaries Accumulation Index. Date from 30 June 1997 to 31 May 2002.
So, what’s the key thing to take away from these three examples? When markets fall sharply, it’s only natural to be concerned and think about moving money to less risky investment options – with a plan to switch back later. Yet as history has shown, it is important to consider staying invested at times of market volatility to enable your investments to benefit when the market rebounds.
Source: Colonial First State
Booms, busts and investor psychology: Why investors need to be aware of the psychology of investing
By Robert Wright /November 28,2022/
Up until the 1980s the dominant theory was that financial markets were efficient. In other words, all relevant information was reflected in asset prices in a rational manner.
While some think it was the Global Financial Crisis that caused faith in the so-called “Efficient Markets Hypothesis” (EMH) to begin unravelling, this actually occurred in the 1980s. In fact, it was the October 1987 crash that drove the nail in the coffin of the EMH as it was impossible to explain why US shares fell over 30% and Australian shares fell 50% in a two-month period when there was very little in the way of new information to justify such a move.
It’s also hard to explain the 80% slump in the tech heavy Nasdaq index between 2000 and 2002 on the basis of just fundamentals. Study after study has shown share market volatility is too high to be explained by investment fundamentals alone. Something else is at play, and that is investor psychology.
Individuals are not rational
Numerous studies by psychologists have shown that people are not always rational and tend to suffer from various lapses of logic. The most significant examples are as follows.
Extrapolating the present into the future:
People tend to downplay uncertainty and assume recent trends, whether good or bad, will continue.
Giving more weight to recent spectacular or personal experiences in assessing the probability of events occurring:
This results in an emotional involvement with an investment strategy. If an investor has experienced a winning investment lately, he or she is likely to expect that it will remain so. Once a bubble gets underway, investors’ emotional commitment to it continuing steadily rises, thus helping to perpetuate it.
Overconfidence:
People tend to be overconfident in their own investment abilities.
Too slow in adjusting expectations:
People tend to be overly conservative in adjusting their expectations to new information and do so slowly over time. This partly reflects what is called “anchoring” where people latch on to the first piece of information they come across and regard it as the norm. This partly explains why bubbles and crashes in share markets normally unfold over long periods.
Selective use of information:
People tend to ignore information that conflicts with their views. In other words, they make their own reality and give more weight to information that confirms their views. This again helps to perpetuate a bubble once it gets underway.
Wishful thinking:
People tend to require less information to predict a desirable event than an undesirable one. Hence, asset price bubbles normally precede crashes.
Myopic loss aversion:
People tend to dislike losing money more than they like gaining it. Various experiments have found that a potential gain must be twice the potential loss before an investor will consider accepting the risk. An aversion to any loss probably explains why shares traditionally are able to provide a relatively high return (or risk premium) relative to “safer” assets like cash or bonds.
The madness of crowds
As if individual irrationality is not enough, it tends to get magnified and reinforced by “crowd psychology”. Investment markets have long been considered as providing examples of crowd psychology at work. Collective behaviour in investment markets requires the presence of several things:
A means where behaviour can be contagious:
Mass communication with the proliferation of electronic media is a perfect example of this. More than ever, investors are drawing their information from the same sources, which in turn results in an ever-increasing correlation of views amongst investors, thus reinforcing trends.
Pressure for conformity:
Interaction with friends, monthly performance comparisons, industry standards and benchmarking, can result in “herding” amongst investors.
A precipitating event or displacement that gives rise to a general belief that motivates investors:
The IT revolution of the late 1990s, the growth in China in the 2000s and crypto currencies more recently are classic examples of this on the positive side. The demise of Lehman Brothers and problems with some crypto currencies/markets are examples of displacements on the negative side.
A general belief which grows and spreads:
For example, a belief that share prices can only go up – this helps reinforce the trend set off by the initial displacement.
Bubbles and busts
The combination of lapses of logic by individuals in making investment decisions being magnified by crowd psychology go a long way to explaining why speculative surges in asset prices develop (usually after some good news) and how they feed on themselves (as individuals project recent price gains into the future, exercise “wishful thinking” and get positive feedback via the media, their friends, etc). Of course, the whole process goes into reverse once buying is exhausted, often triggered by contrary news to that which drove the rise initially.
What does this mean for investors?
There are several implications for investors.
First, recognise that investment markets are not only driven by fundamentals, but also by the often-irrational and erratic behaviour of an unstable crowd of investors. The key here is to be aware of past market booms and busts, so that when they arise in the future you understand them and do not overreact (piling into unstable bubbles near the top or selling everything during busts and locking in a loss at the bottom).
Second, try and recognise your own emotional responses. In other words, be aware of how you are influenced by lapses in your own logic and crowd influences like those noted above. For example, you could ask yourself: “am I highly affected by recent developments? Am I too confident in my expectations? Can I bear a paper loss?”
Thirdly, to guard against emotional responses choose an investment strategy which can withstand inevitable crises whilst remaining consistent with your financial objectives and risk tolerance. Then stick to this even when surging share prices tempt you into a more aggressive approach, or when plunging values suck you into a defensive approach.
Fourthly, if you are tempted to trade, do so on a contrarian basis. Buy when the crowd is bearish, sell when it is bullish. Extremes of bullishness often signal eventual market tops, and extremes of bearishness often signal bottoms. Successful investing requires going against the crowd at extremes. Various investor sentiment and positioning surveys can help. But also recognise contrarian investing is not fool-proof – just because the crowd looks irrationally bullish (or bearish) doesn’t mean it can’t get more so.
Source: AMP
Alternative Thinking: Diversifying Beyond Traditional Asset Classes
By Robert Wright /November 28,2022/
Once a staple investment allocation, the traditional balanced portfolio of shares and bonds has had some challenges in delivering positive returns in today’s market environment.
Institutional investors, such as superannuation funds and endowments have been investing in alternatives for many years and it is a rapidly growing asset class in the global investing landscape. Individual investors are now looking to alternative asset classes to help diversify their portfolios and improve the probability of meeting their long-term objectives.
What are alternative assets?
Alternatives cover a broad range of asset types, which can include almost anything that does not fit into traditional, market-traded equity and bond securities. These include assets such as real estate, infrastructure, shares in private companies, private loans and debt, as well as alternative trading strategies, such as hedge funds and absolute return funds.
Why invest?
Each of these sub-categories can have very different risk and return drivers to each other as well as to traditional equities and bonds. By including an allocation to these asset classes, the diversification benefit can improve the expected risk-adjusted returns of the portfolio as a whole.
It is important to note that these asset classes are less liquid and more complex than traditional equities and bonds. Whilst it’s expected to generate additional returns or better risk outcomes for investors; the illiquid and private nature of many alternative assets generally suit investors with a longer investment time horizon.
We consider them appropriate for investors with a minimum investment horizon of five years and recommend a moderate portfolio allocation of 5-20% depending on the investment objectives of the portfolio.
Not all alternatives are the same
For most investors, a diversified allocation covering a wide range of alternatives can lead to better outcomes over the longer term. Illiquid or private assets mean that investment managers can take advantage of inefficiency or less transparent asset prices to generate more skill-based, idiosyncratic returns.
Conservative or more cash-flow based valuations can provide more portfolio stability and less sentiment driven ‘noise’ compared to the daily ‘mark-to-market’ price returns in equity and bond markets.
Alternative trading strategies can generate returns, even when markets are declining in value, by selling stocks ‘short’ or using other types of derivative instruments. Overall, these assets and funds can contribute to better returns, reduce volatility and build in more downside risk protection for portfolios.
The right mix and allocation of alternatives will vary, and the benefits of these asset classes also come with a different set of risks to consider which may not be suitable for all investors.
Source: Perpetual
What alternative assets bring to your super investment mix
By Robert Wright /November 17,2021/
Most of us have heard of the main asset classes: shares, property, fixed interest and cash, but alternative assets are less well known. However, these types of assets can provide further diversification and enhanced returns for your super.
Alternative investments are those found outside the traditional asset classes. Typical ones include real estate, private equity, venture capital, infrastructure, renewable energy, hedge funds, commodities, and private debt.
Generally, these are assets that aren’t correlated to the performance of the sharemarket, that is they can often perform when sharemarket returns are down or flat.
The net result is that alternative investments add an extra layer of diversification – you’re not ‘putting all of your eggs in one basket’ and seeing all asset class suffer at the same time.
Low returns pique interest in alternatives
In the current low interest rate environment, which tends to mean lower returns for cash and bonds, alternative investments can help members grow their super to retire comfortably.
Alternative investments differ to publicly available funds as they’re part of the private investment market and aren’t easily accessible for individual investors. They typically include:
Infrastructure
Infrastructure assets are known for providing long-term, stable and predictable cash flows. Opportunities can be found within energy production and transmission but are also emerging in newer sectors such as agriculture infrastructure and renewable energy, particularly wind-powered energy and a selection of solar-power opportunities.
Private equity
The private equity sector invests in companies that are not publicly traded. The advantage is that by investing at the start of a company’s lifecycle, it’s possible to generate strong risk-adjusted returns and benefit from high earnings growth when compared to listed markets.
Real estate
Real estate has a low correlation to shares but is often considered to be a good hedge against inflation. The asset class has evolved over time to include publicly listed and real estate investment trusts (REITs) that include data centres, childcare and storage facilities, as well as commercial real estate debt, which provides loans to commercial borrowers who need funding for real estate purposes.
Performance can lift when using alternative assets because alternatives are generally less impacted by daily market movements in the way that other assets are. Shares and bonds can be quickly affected by changing market, social and economic events, such as the COVID-19 pandemic for example. Therefore, the overall volatility, or the ‘roller-coaster ride’ of increasing and decreasing valuations, should reduce when funds include a proportion of alternative assets in the mix.
Not all alternatives are equal
Of course, alternative assets need to be carefully researched and reviewed in order to find the most appropriate options for each particular fund. They need to be carefully weighed up against other asset classes and sectors to ensure the most appropriate levels of risk and reward that will support investors to achieve a comfortable retirement.
Source: IOOF