Any marketing material for unit trusts (collective investment schemes) prominently declare that “past performance is not necessarily a guide to future performance”.
There are good reasons for this.
Let’s look at an investor, Bob
In November 2000 and aged 35, Bob went to a financial planner and asked for a recommendation on how he should invest his capital in order to generate strong inflation-beating returns over the next two decades. Bob only wanted to invest in passive index-tracking investments.
Bob was advised to allocate his capital equally to SA equities, via a JSE Top 40 tracker and US equities, via an S&P 500 tracker. So, he did this and left his portfolio alone for the next decade.
Graph 1: Source: Allan Gray
At the end of the first decade, Bob evaluated how his portfolio had performed.
As can be seen in the graph above, investing locally would have given Bob a return of over 240%, whilst if he had invested in the US over the same period, he would actually have suffered a small loss of nearly -2.6%.
Rear view investing can be dangerous
Bob decided that a change was necessary. Without consulting his financial planner, and seized with this one graph, Bob decided that he would switch his entire holding into the JSE Top40 Tracker for the next decade as he extrapolated recent performance to continue into the future.
What happened in the second decade?
Graph 2: Source: Allan Gray
As can be seen in Graph 2 above, the last decade has been all about the US stock market, where the S&P500 would have delivered a return of about 545%, whilst the local stock market delivered him less than a 6% return
What if Bob had not tried to extrapolate recent performance and stayed the course?
Graph 3; Source: Allan Gray
As we can all see, had Bob rather maintained his diversified holding over the long-term than tried to position his portfolio based on recent performance, he would undoubtedly have been better off. This can be a danger of rear-view investing. By extrapolating the recent past and chasing what had worked in the short-term, Bob had done himself a significant disservice.
Table 1: Source: Allan Gray
So, what should Bob do NOW?
Bob finds himself now needing to decide how best to position his portfolio going forward. Will he look at how well the US stock market did over the last decade and put all his eggs in that basket, will he say that – over the last two decades – despite a difficult ten years it would have been best overall to only have invested in the local market, or will he allocate his capital to both markets (in some proportion or another). Will he switch all his capital to cash, gold or bitcoin??
The dangers of trying to predict the unpredictable
Trying to make personal investment decisions based on market predictions can be fraught with danger and when predictions are wrong, they can have real-world consequences. We live in an inherently uncertain world where risk means that there can (and often is) more than one possible outcome.
Trying to position your personal portfolio based on what you regard as being the definite/probable/likely outcome (based often on an “expert” in the press or on the radio confirming your world) view is very dangerous. Especially when these experts are pushing the “fear button” hard.
In an uncertain world it is prudent to invest with a wide range of possible outcomes in mind
There are a number of “fear themes” which are being bandied around in the local media. Phrases like “failed state”, “debt trap” and “collapse of fiat currencies” are being bandied about as if they are a certainty. Some respected investment managers are trying to position their portfolios with little or no exposure to stocks which earn most of their revenue locally. On the other hand, there are other respected managers who are telling us that they are excited about the domestic opportunities that they are finding and have tilted their portfolios significantly in that direction. Global managers are either maintaining their exposures to Amazon, Tesla and the other growth stocks that have been flying, or they are switching their portfolios towards emerging markets.
Having experienced a number of investment cycles over the past decades, we are used to times when there is a clamouring by our clients for positioning portfolios with a particular outcome in mind or extrapolating certain drivers of performance into the forever. You only need to think back in recent history to the Y2K Tech Bubble at the end of the last century and the stampede to resources stocks in 2006/2007.
We maintain our finger on the pulse of what is interesting to a range of asset managers, both domestically and around the world. We take their views into account when advising our clients on new and existing investments and always recommend a prudent approach to investing with a wide range of possible outcomes in mind.
Sometimes the lights in the rear-view mirror can be blinding.