Slaying investment myths
with market reality
Six issues are under the spotlight
According to Warren Buffett's partner, Charlie Munger, some of the most valuable principles and lessons on business and investing come from a $10 history book.
Investors don’t have to invent or imagine some fanciful future – the past is available as a treasure of information and wisdom, CEO of Cannon Asset Managers, Dr Adrian Saville, recently said at a seminar on risk and investment myths hosted by life insurer FMI.
Saville argued that successful investing was not about predicting the future, but about learning from the past and understanding the present. To this end, he discussed six principles he believes can help investors avoid unfortunate outcomes in the long run.
Dr Adrian Saville
1. The most important decision is not which stock to buy, but asset allocation
Over the past five years, Facebook, Amazon, Netflix and Google have delivered spectacular returns. While the S&P 500 have returned roughly 80%, each of these stocks gave investors multiples of that – Netflix in particular.
In investing, however, it was really asset allocation that did the lifting, Saville said. “It is the single most important decision. Sure, it may matter whether Netflix is in or out of your portfolio. What will matter far more is whether you are in equities, bonds, property [or] cash.”
The chart below shows the inflation-adjusted returns from various asset classes over the long term. Equities – the best-performing asset class – returned almost 1 000 times an investor’s money after inflation while cash lost purchasing power over the period.
In time its asset allocation that does the lifting
Source: Credit Suisse Global Investment Returns Yearbook (2015) and Deutsche Bank Market Research Long-Term Asset
Return Study (2017)
“So that single decision – cash or equities – would give you a spectacularly different outcome,” Saville said.
In the South African context, Naspers has been the big investment story. Over the past five years, Naspers investors would have made five times their money. Over the past decade, they would have made 20 times their money. “I wish that it was in your portfolio, but I wish even more that what was in your portfolio was equities not cash.”
Between 1972 and 2017, local cash investors would have received an after-inflation return of 1.5% per year, while equity investors got 8.6% per annum. Against this background, it would have taken cash investors roughly 50 years to double their money. Equity investors would have doubled their money in about eight years.
“Very often the myth, the perception, is that it is cash that is safe. If you give an asset long enough, cash is a very, very dangerous place to be as a single asset.”
2. Building effective portfolios boils down to effective diversification
For almost all investors, a multi-asset portfolio was the most effective way to manage risk, Saville said.
The chart below shows the drawdowns of investments in bonds (red) and equities (blue) in the US on the left.
The power of diversification
Source: Elroy Dimson, Paul Marsh and Mike Staunton, Credit Suisse Global Investment Returns Sourcebook 2011
“If you owned a single asset class, this is the worst you would do from top to bottom,” Saville commented.
On the right, the drawdowns of a portfolio with a 50:50 split of equities and bonds are shown to illustrate the point.
“All you have to do is build a portfolio 50:50 of these two asset classes and you halve the bumpiness and what we know from compounding results is that if you can moderate the drawdown, the compounding on the upside becomes far more powerful.”
3. Don’t try to beat the market at all cost, match it
Saville said the investment industry tends to be populated by the argument that successful investing was about beating the market. While there was a place for active investing, for most of the assets of most people, the most sensible place to be was matching the market.
Every self-respecting active manager will tell investors that they have an investment process and philosophy that can beat the market, he said.
“Certainly, Cannon has one, and we’ve demonstrated that in our portfolios over long periods, but does that mean that all of your money should be in that active solution? I’m going to argue to you no, because the chances are that if all of your money is in an active solution for all time – there is a good chance that when you need it most it will be behind the pace.”
The chart below shows the percentage of active funds beating the market. Over 10-, 15- and 20-year periods, most active managers are behind the market.
Source: www.marketwatch.com; Ryan Vlastelica, Morningstar (2017)
This was not a South Africa-only phenomenon but a global story across asset classes and geographies, Saville said.
4. Costs matter
The graph below shows the success rate of funds with different mandates.
Source: www.morningstar.co.uk; Russel Kinnel, Morningstar (2016)
“Why do each of these Manhattans slope downwards? Because on the far left of each cluster of buildings, you have the asset managers with the lowest costs and on the right of each cluster of buildings are the asset managers with the highest costs.”
The analysis does not focus on investment styles, approaches or philosophies, but on the cost of managing an investor’s money every year.
“The guys on the left-hand side of each of these clusters of the building is the percentage of active managers beating the market. What is their proposition? Low costs and that it is identifiable, it is knowable, it is repeatable," Saville explained.
“If you want to tip the odds in your favour of achieving superior investment performance. One: Match the market. Two: Get costs out of your investment.”
5. There is a place for active management
He said there was a place for active management: “It is probably not where all money should be, but that is where some money should be.”
In this regard, Cannon believes investors should look for opportunities where others are not. In the South African equity world, this means scanning mid-cap, micro-cap and even nano-cap stocks for opportunities, which it does for its Hummingbird portfolio.
6. The most powerful ingredient in investing is time
The most powerful ingredient at an investor’s disposal was time, which allowed compound interest to work its magic.
“There is no better time [to get going] than right now and fortunately, all of these nudges are well within our reach. They don’t require grand steps or grand leaps in faith or action,” said Saville.
“The greatest risk we pose to ourselves is exactly that – ourselves – and that we will outlive our money.” ■
Time allows compound interest to work its magic