In times of uncertainty, misinterpreting market data can send investors running for the hills, writes John Husselbee, as he argues consistency of performance is impossible for fund managers but consistency of process is essential.
There is a basic equation about creating panic that goes as follows: high stakes plus major events, where the causes are confusing or unknown, can equal irrational behaviour - even among the supposed experts.
In recent months, we have seen plenty of this with fears around Brexit and trade wars repeatedly pushing investors into decisions that could be potentially detrimental to their long-term wealth. Political volatility has contributed to this environment, with panic mode spreading across the supposed governing class in recent months.
In forming his government, Boris Johnson dismissed 11 senior ministers and accepted the resignations of six others. It was described by MP Nigel Evans as "not so much a reshuffle as a summer's day massacre". The mass dismissal was the most extensive Cabinet reorganisation without a change in ruling party in post-war Britain.
Meanwhile, in the 2017 to 2022 Parliament, more than 50 MPs have changed party affiliation at time of writing (with several switching more than once), either voluntarily or through expulsion. That compares to just six in New Labour's first term in office from 1997 to 2001 and 18 during its controversial second term, a period that included the second Gulf War and its aftermath.
Before looking at what this febrile environment means for investors, it is worth recognising this behaviour is littered through human history (with a tip of the hat here to US commentator Morgan Housel). Take a trip back to early 16th century London for example, where we can see this panic equation in full effect.
In the 1520s, the major astrologers of the day were predicting a huge flood would engulf London based on something known as the Grand Conjunction, a theory that said when all the planets aligned they would cause huge tides. They had an exact date for this - 1 February 1524 - and this led to a huge exodus from the city, largely those with the financial capacity to do so, with figures showing a drop in the population from 120,000 in 1523 to 80,000 the following year.
As we know, this flood never materialised, highlighting the panicked behaviour that can come from misinterpreting data. There have been significant floods in the capital in the subsequent centuries however, most recently in 1928 and 1953, leading to the introduction of the Thames Barrier in Woolwich in 1982. Since then, the barrier has been in frequent use, closing more than 50 times in 2013-14, for example, and we would see this as a strong example of risk management. Prepare for all conditions with a well-diversified portfolio rather than panicking and running for the hills at the first sign of troubling data.
Another example to add some gloss. Few of you, I suspect, will have heard of Archibald Hill, a pioneering physiologist who won a Nobel Prize for his work on the production of heat and mechanical work in muscles. Hill's work with professional athletes worked out exactly how fast each one could run based on their physiology but ultimately proved an ineffective predictor of success on the track as it fails to take the emotional side of competition into account.
A similar story can be read across to investment when attempting to work out future equity market returns. Calculating returns requires three basic elements and two of these are easily accessible in the shape of dividend yield and earnings growth. The problem comes with the third of the trio, change in valuation, as this is where sentiment and the proverbial animal spirits come into play.
What stories such as these show is the danger of misinterpreting data and we continue to warn against the increasingly short-termist mindset of many investors. One of our key roles as a multi-asset manager is sifting through the masses of data produced by the investment industry to find a core of managers we believe can add long-term value - and we continue to repeat the message that focusing too much on short-term performance numbers and persistency of returns can lead to major mistakes.
As I wrote in the last issue of Multi-Asset Review, data from Morningstar showed that, from 1926 to 2018, US stocks owed all their outperformance to just 51 months, or less than 5%. And if investors had owned those companies for all 1,063 months apart from those 51, they would have failed to beat cash.
Even for the very best funds - the top 10% of all those that beat their benchmarks over 15 years to the end of October 2018 - the outperformance was due to just 16 months of excess returns, one year and four months out of 15 years.
For us, this stresses the importance of our mantra that consistency of performance is impossible for fund managers but consistency of process is essential. Focusing on the wrong data or misinterpreting the growing amount of market noise can send investors running for the hills in fear of a flood, while others continue to ignore the noise as much as possible and stay invested.
John Husselbee is head of multi-asset at Liontrust
This article appeared in the December issue of Professional Adviser's sister title Multi-Asset Review. To make sure you receive your own copy of the next issue, please do register your interest here
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