Invest better in an uncertain world
It is incredibly difficult to forecast the future because we don't know what is going to happen. Reality is infinitely complex
Five truths about how we invest
You may think investment managers are in the business of forecasting things like the rand and the economy and how these will affect the returns shares or bonds or other investments will earn for you.
But two seasoned investment professionals at investment conferences recently declined to call the rand-dollar exchange rate or the market for the year ahead - or even a turning point in the local economy.
Pieter Koekemoer, the head of retail investments at Coronation, told delegates at the Allan Gray Investment Summit that if you were to ask him these questions you would get bad answers.
Forecasting is not a good way to consistently make money, said Koekemoer, citing cases where journalists, economists and analysts had made wrong calls on markets, countries, regions, currencies, economic growth and individual securities.
It is incredibly difficult to forecast the future because we don't know what is going to happen. Reality is infinitely complex, he said.
RECM founder and fund manager Piet Viljoen told advisers at the Collaborative Exchange's Meet the Managers events that he could not tell them what is going to happen in investment markets in the year ahead or which companies' managers would turn out to be crooked, but he could predict with absolute certainty a few truths about how we invest.
Knowing these truths can help you set up your investment portfolio to overcome them, said Viljoen.
• Your recent past influences how you feel
We think we are long-term investors but we are all affected by our recent past, said Viljoen.
In behavioural economics this is called anchoring or investing through a rear-view mirror, and it doesn't work, he said, adding that it is not only us, but even the smartest people in the world, like US economists who forecast US Treasuries, that are led astray.
Reacting emotionally to what is happening today is not a good idea, but it happens to all of us, said Viljoen.
• Things happen that don't make any sense
In markets, things can happen that do not appear to make sense. Apple's share price is a good example, said Viljoen.
The share price almost halved from its high in September 2018. In early January Apple issued a profit warning that should have sent its share price plummeting further, but instead it rallied, almost recovering to its September high.
The market reflects what investors in it think, he said. In Apple's case, most people expected a worse outcome than what was announced in January. When results came out better than expected, the share price that had fallen hard, rallied instead.
Good judgement comes in investing really relates to a very fine balance
Forecasting what is going to happen is hard enough, but predicting correctly what other people will think is going to happen is even more difficult, he said.
An analysis of the shares in the US S&P 500 index from 1930 to 2017 shows that although there were 30 years in which com-
pany earnings were down for the year, in only seven of those years did share prices also go down - most of the time they went up.
Your portfolio needs to be built to withstand things happening that you and other people do not expect, he said.
• You will get something wrong
In RECM's portfolio some of its bigger holdings, such as MTN, MediClinic and Clientele Life, have gone down 20%, 34% and 17% respectively since the manager bought them, despite it finding these three shares to be good, sound businesses.
"With hindsight we bought them too early," said Viljoen.
Fortunately RECM's portfolio has 50 to 60 stocks. The "mistake" share picks were small enough individually - each only 2% or 3% of the portfolio - not to damage it, said Viljoen.
• Diversification will make you feel stupid
In its equity portfolio, RECM owned two shares whose returns since January 2016 were down between 50% to 100%. It owned another four that were down between 20% and 50% over this period, but 11 that were up more than 20%, including three that were up more than 100%, he said.
Fortunately for RECM its positions in the winners relative to the losers were correctly sized.
Over the three-and-a-half years to June 30 this year, returns on the equity portfolio which had no exposure to Naspers, one of the market darlings over this period, were up to 44.4%, while the all share index was only up 25%.
• Your emotions will get the better of you
Your skill set as an investor depends on your ability to value companies, to interpret financial statements, to apply macro- and micro-economics and to think creatively and independently, Viljoen said.
But all of this is multiplied by your rationality or lack thereof, he said.
A good example of how people let emotions dictate their investment decisions is the extreme negativity about SA since Nenegate in 2015.
This has made many South Africans very negative about the country and a number of investors have been taking money offshore.
But in the face of all this negativity, the rand has actually appreciated 44% against the dollar since December 2015, mainly driven by the dollar and because it was already massively undervalued, said Viljoen.
Against the dollar, pound and Australian dollar the rand is where it was five years ago, so anyone who took money out and now brings it back will be worse off, he said.
Out of 24‚240 created half of wealth earned by investors in the S&P500 over 90 years to 2016
Koekemoer said: "You need to deal with uncertainty by expressing good judgment - and in the investment world good judgment really relates to a very fine balance between consistency, patience and discipline on the one hand and the wisdom to accept the information, to be curious, to be self-critical, to acknowledge when you are wrong and to make changes on the other."
Because many investors are investing for retirement and cannot afford to lose their savings, managers have to mitigate the risks of being wrong - and they will undoubtedly be at times - by diversifying portfolios with independent or uncorrelated ideas that are not dependent on the same outcomes, said Koekemoer.
Viljoen concurred that the key is a well-diversified portfolio with a number of uncorrelated positions and an appropriate exposure to each based on the value of the share.
Like a bundle of twigs, a diversified portfolio is made up of sticks that all look different from one another, he said.
Koekemoer said while there are typically four or five drivers of companies' share prices over the long term, it is impossible to call the many variables at play - from politics to natural disasters - when it comes to economic, currency and country bets.
Skill v chance: how much of our lives do we actually control?
By ALISON BENZIMRA
• Life can often feel like a night in a casino - the outcome of a decision depends on a lucky throw of the dice.
We're unsure if the outcome was a result of our actions or reliant on the conditions in which the decision was made.
But poker is different to hedging your bets on the roulette table or taking a random bet on the pull of a slot lever. Successful poker players learn the skill of making decisions in an uncertain environment. It is for this reason that Maria Konnikova, the renowned psychologist, New York Times bestselling author, professional poker player and guest speaker at this week's Allan Gray Investment Summit, says she believes poker is a metaphor for life and investing.
A poker player understands that their success rests in the balance between skill and chance. They learn to disentangle incomplete information and incorporate probability into their decisions. Honing this skill means they are not reliant on their emotions, but rather they learn what calculating probability feels like, Konnikova says.
This is an invaluable tool when making decisions. We face uncertainty in our daily lives and in our investment choices.
We may not be able to control the outcome, but we can control our decision quality.
In controlling the quality of our decisions, we must be aware that we discount the evidence that we believe does not benefit us, and that our past experiences will colour how we interpret the data, Konnikova says.
This does not mean that you should ignore your emotions. Your emotions help you to care about the risk linked to the outcome of your decision, she says.
When there is a lot of data, our emotions help us focus and can assist us to determine whether we are risk-averse or a risk taker. When you consider the role of your emotions in making decisions, you must remember that you don't make decisions in a vacuum.
Emotions will colour not only your decisions, but other people's decisions too.
Having the ability to understand this probably explains why the best investors are also the best poker players, says Konnikova.
Poker models real life as it is a game of uncertainty. Konnikova says she believes that we need to realise that we cannot control everything, and we need to be OK with that. Control what you can - your emotions, your decisions and the quality of your decisions.
Throughout this process, focus on learning, she says. Like poker, life is unpredictable. Ultimately, we do not know if we are making the right decision, only that we are making the best decision with the information that we have at hand at the time.
We worry too much about losing money when we're investing
By CHARLENE STEENKAMP
• Certain investment wisdoms are myths and should be thrown out the window if you want to be a better investor, says client service director Scott Nisbet from the UK-based global manager Baillie Gifford, who addressed the 2019 Allan Gray Investment Summit this week.
Although many managers go to great lengths to make your investment journey smoother, Nisbet says when it comes to investing in equities, losing money over the short term shouldn't matter - it is the long term that counts.
What managers refer to as downside risk - the risk of a short-term loss - is the $5 (R70) you put in a company that you never see again, he explains.
The point is that it is not that big a risk. You can have quite a few $5 losses, but if one of your $5 was invested in shares such as Amazon, Netflix or Tencent, the returns will have wiped out all your losses.
He says trying to minimise volatility is a waste of money and investors that revert to the mean will disinvest from shares that are still going to perform.
"Humans are programmed to guard against the next thing that can kill you, and in investment terms this means they focus on the next thing that can make your shares fall."
Another issue that affects us as investors is that we tend to be addicted to the over-dramatised, short-term, negatively biased news that surrounds us.
To improve your chances of making money, Nisbet suggests you consider your investments over a completely different time horizon. An instructive study of 90 years of S&P 500 index returns by University of Arizona professor Hendrik Bessembinder found that the total net wealth created by all listed US common stocks between 1926 and 2016 amounted to $35-trillion. Significantly, just over half of that came from just 90 out of 24,240 companies that had existed at some point during those 90 years.
Beyond the best-performing 1,092 companies, an additional 9,579 firms (37.8% of the shares) created positive wealth over their lifetimes. The wealth creation of these stocks was just offset by the wealth destruction of the remaining 14,661 (or 57.9% of total) firms, so that the top 1,092 firms created the same wealth as the overall market.
What matters is holding and owning a few of the home runs, Nisbet says.
The principle is borne out by the experience of Baillie Gifford with its flagship equities fund, the Long-Term Global Growth Fund, launched 15 years ago. The fund's five best investments are Amazon, Tencent, Hermes International, Atlas Copco and Apple - whose returns have outstripped the losses of the five worst performers over 15 years.
If you believe in reversion to the mean, Nisbet says, you would have sold these companies several times over. If you worry about the downside, you would not have owned them in the first place.
Sticking to this long-term strategy is uncomfortable, but keeping your eye on the horizonwill leave you much better off.