Terrorist attacks in France, coup attempt in Turkey, war in the Middle East, refugee crisis in Europe, BREXIT, a looming devisive presidential election in the USA, political deadlock in Australia ... with issues like these dominating our daily news feeds it is very easy to get depressed about the outlook for Australia and the world.  However,  it is not all doom and gloom especially if we take the time to look at some of the progress the world has made over a longer frame of time.

Jim Parker from Dimensional Fund Advisor has recently penned the following article reminding us all of some more positive developments.  Well worth a read and some reflection!!

A common discussion I have with new clients or existing clients adding funds into an existing portfolio is the issue of market entry risk.  This is the risk that you purchase investments at a peak only to see values fall after entry.  A strategy to moderate this risk that I canvas with clients is to spread out this market entry risk through either investing an immediate amount and then dollar cost averaging the remaining funds over a year or two or simply dollar cost averaging over a set period of time.

Jim Parker in his latest article for Dimensional sets out some thinking around this issue including the dollar cost average method I often use.

December 17, 2015

Have you ever seen a child standing tentatively at the edge of a swimming pool? She's torn between her desire to join the gang in the water and her fear of diving in. In committing to the market, investors can be like that.

You can always find a reason for not investing. "Perhaps I should wait till after interest rates rise?" goes one line of the thinking. "Or maybe I should delay till there's more clarity on China? Or hold back until after earnings season?"

Emotions and assumptions usually underlay this indecision. The emotion can be anxiety about "making a mistake" or fear of committing at "the wrong time" and suffering regret. The assumption is that there is a perfect time to invest.

Obviously, the ideal solution would be to enter the market just as it bottoms and exit the market right at the top.

But the reality is that precisely timing your exit and entry is close to impossible. If it were easy, millions would be doing it and getting very rich in the process. Instead, the only ones who tend to consistently make money out of market timing are those who write books about it.

The financial media certainly love market timing stories. For one thing, there is always some event or variable they can peg it to—like a decision on interest rates or upcoming earnings or a chart indicator. For another, the idea of timing the market is a powerful one and tends to get readers' attention.

For example, one high-profile US forecaster in early 2012 predicted a 50-70% equity market decline over the following two-to-three years. It was to be a replay of the 2008-09 crisis, he said, but with an even deeper recession.(1)

That turned out to be a bad call. Global equity markets, as measured by the MSCI World Index, delivered a total positive return in Australian dollars of 93% from the end of 2011 to the end of 2014. (2) In USD, it was 53%.

Others advocate more elaborate timing strategies. For instance, one recent academic paper suggested the stock market delivers better returns relative to Treasury bills in the second, fourth and sixth week after each of the US Federal Reserve's policy-setting meetings in a given year. (3)

The idea here is that the Fed leaks information about its interest rate intentions in such a predictable way that, even without the information, savvy investors can make money by just buying stocks in certain periods.

While these theories can be fascinating, it is arguable how many of us have either the time or inclination to try them out. And even if we did, this does not take account of the costs of all the required trades or the possibility that as soon as we implemented the idea it would be arbitraged away.

So ahead of a central bank meeting, some would-be investors fret about whether they should hold off until they see how the market reacts. Others already invested worry whether they should take their money out.

The truth is that for long-term investors, these issues should be irrelevant. What matters is how their portfolios are structured and how they are tracking relative to their chosen goals. Markets will go up and down, security prices will change on news and it makes little sense to second guess them.

But while no one yet has come up with a consistently successful strategy for timing the market to perfection, there are some things that everyone can do to help ease the anxiety they feel about investing.

One is to realise that it does not have to be a choice between being 100% in the market and 100% outside. Ideally, an investor should stick to their strategic asset allocation—be it 70/30 or 60/40 or 50/50 equity/bonds.

Another is that this strategic allocation can be combined with periodic, disciplined rebalancing, in which the investor shifts assets from well performing asset classes to those less favoured. This is a good way of controlling risk without necessarily trying to time the market.

A third option is that there is nothing wrong with investors taking into account the returns they have already enjoyed and adjusting their asset allocations if they are on course to meet their goals. So, for example, for some investors it might make perfect sense to lock in returns after a good period and put the money into short-term fixed income if that meets their needs.

Yet another option is dollar-cost averaging. This is a method where an individual invests small amounts of an available pool of cash into the market over a period, rather than investing a lump sum in one go.

A useful contribution on this subject comes from Ken French, Professor of Finance at the Tuck School of Business at Dartmouth College. In his role as an academic, Professor French says the optimal decision is to invest it all at once. But while this might give an individual the best investment outcome, he says it might not be the best investment experience. (4)

This is because people tend to feel regret more strongly when it results from things they did do than from things they did not. So, for instance, it feels much more painful to buy stocks now and see the price go down than it is to neglect to buy stocks and the price goes up.

Professor French says that by dollar cost averaging, people can diversify their "acts of commission" (the stuff they did do) as opposed to their "acts of omission" (the stuff they didn't do).

"The nice thing is that even if I put my finance professor hat back on, it's really not that damaging to your long-term portfolio to just spread it out over three or four months," he says. "So if you as an investor find that's much more tolerable for you, you're not really doing much harm."

So, in summary, it's always difficult to choose exactly the right time to get into or out of the market. For instance, it would have been nice to get out in late 2007 and back in around early March 2009.

But most mortals are unable to finesse it to that degree. The good news is that there are other options than just staying out of the market altogether and plunging back in.

These include maintaining a long-term strategic asset allocation in the first place, periodically rebalancing, taking money off the table if retirement goals are on track and dollar-cost averaging if that provides comfort.

It has been a number of months since we updated the website with Scott Francis' articles published in the Eureka report.  We have now caught up and welcome you to take a look at these pieces - 17 in total.

No matter what your opinion is on where investment markets will go next, one area of agreement is that markets have been volatile in recent years.   Nobel Prize Winner – William Sharpe – has recently provided his thoughts on investing in a turbulent market for the Stanford Graduate School of Business where he is a professor emeritus of finance - William Sharpe: How to Invest In a Turbulent Market

We think highly of Sharpe’s work and it forms a major part of the investment philosophy we use to develop investment portfolios for clients.

So has Sharpe’s views changed since the GFC started in late 2007?  In a word, NO.

In the Stanford article Sharpe provides an overview of his four pillars of investing - Diversify, economize, personalize, and contextualize.

In a nutshell these pillars are:

Diversify – invest in a broad range of shares and bonds – preferably all of them.

Economize – keep costs low.

Personalize – make invest decisions that are most appropriate for your own situation.

Contextualize – the price of an investment reflects the average opinion of investors about its future.  You may think your opinion is superior, but it pays to be humble, investing in the market rather than trying to beat it.

Sharpe provides some really important concepts that in our opinion should be the basis for developing a successful investment philosophy.

Regards,
Scott

• The plunge off the so-called fiscal cliff was averted.
• The euro zone did not fall apart.
• China’s economy and stock market did not crash.
• The bond market did not implode.
• The re-election of President Barack Obama did not derail the US market.
• Doomsday did not arrive on December 21, as some interpreters of the Mayan calendar suggested it would.

Scott

Researchers led by financial historian Larry Neal of the University of Illinois have replicated all the holdings and trades in the Bank of England, the East India Co. and the United East India Co., the Royal African Co., the Hudson’s Bay Co., the Million Bank and the South Sea Co. –the dominant companies at the birth of British capital markets three centuries ago.

The share registries survive, so the scholars were able to match virtually every investment with the person who held it – encompassing 5,813 investors during the 1690s and 23,723 by the end of the period.

These people included everyone from dukes and other aristocrats to “stockjobbers,” or brokers, along with merchants, apothecaries, glassmakers, drapers and goldsmiths – and up to 27% of them were women.

The researches concluded that investors were:

• underdiversified, with 86% of them owning shares in only a single stock;
• chased performance, with rising prices leading to higher trading volume;
• underperformed the market as a whole, earning lower returns and incurring higher risk.

Women appeared to be more conservative than men.

The WSJ article then goes on to compare those investors with investors today suggesting there is very little difference as investors today:

• underdiversify, holding an average of only three stocks;
• chase performance, with rising prices leading to higher trading volume;
• underperform the market as a whole, earning lower returns and incurring higher risk.

A lot has changed in the world over 300 years but human nature has not.  Smart investors can learn from the errors of history to better structure investment portfolios today:

• be well diversified;
• don’t chase performance rather invest in asset classes that haven’t been doing so well lately;
• avoid an active management approach to investing.

I have just sat down to a cup of coffee at Starbucks and began reading through some reports I downloaded over recent months.

I found HSBC’s The Future of Retirement Why family matters report very interesting especially as it looked at surveys conducted with 17,000 people across 17 countries but not Australia.  As I read I pondered whether the findings were relevant to Australian families and quickly came to the conclusion that the vast majority of findings would probably be consistent with responses from Australians.

The key findings for me were:

-       65% of men said that they make all or most of the financial decisions in the house without any input from others, compared to just 53% of women who said that they were the sole decision-maker.  This gender gap is apparent across all age groups.

-       The only area where women are more likely to be the sole decision-maker is in household budgeting. Even here, the gender gap disappears among those in their thirties, with younger men taking a stronger interest in this aspect of financial planning than older men.

-       Significantly, women are far more likely to stop working full-time when they have children (47%), compared to just 1-in-6 (15%) men. The onset of parenthood not only reduces women’s role in the workplace, it also reduces their role in making financial decisions in the home. When looking at financial decision-making, the gender gap is greatest among men and women who have children.

-       A major gender gap exists in financial planning: only 44% of women stated that they had a financial plan in place for their own or their family’s future, compared to 54% of men.

-       Married people plan ahead in greater numbers and experience a smaller gender gap when looking at who exercises financial responsibility – 55% of married women and 62% of married men have made a financial plan.

-       In spite of the changing financial needs throughout people’s lives, 60% of respondents have never sought professional financial advice to help them, relying instead on their own knowledge or that of friends and family.

-       The majority of households have a predominantly risk-averse attitude, and are more likely to forego the benefits of long-term investing in favour of security in the short term. This view is particularly prominent among women especially in Western countries.

-       (Somewhat surprisingly) Only 13% of men and 18% of women thought that investing in stocks and shares was extremely risky.

From their findings, the writers suggest 4 key points of action households can implement to improve future financial well being :

1. Share decision-making. It is important that household financial planning is shared and takes into account the family unit and the potential financial needs of spouses, children and any other dependent relatives.

2. Review financial plans in light of major life events. Financial planning should not be static. Family events like births, deaths and marriages should act as triggers to start or review the family’s financial arrangements.

3. Sense-check decisions with a professional financial adviser. Even where plans are put in place, they will contain gaps. Seeking professional advice can help to identify and plug any gaps that might arise.

4. Take a balanced approach to managing investment risk. Households should balance the need to protect their investments in the short and medium term with the need to generate an adequate retirement income in the long term.

These are pretty common sense steps for households.  If you would like to discuss details further or engage an adviser to work with you on securing your future financial well being please do not hesitate to get in cotact. 

Regards,
Scott

Scott

The savvy executive’s guide to buying back shares

1. Understand emotions. Investors need to recognise that investment markets are not only driven by fundamentals, but also by the often-irrational and erratic behaviour of an unstable crowd of other investors. Also, not only are investment markets highly unstable, they can also be highly seductive. Be aware of past market booms and busts, so when they arise in the future you doe not overreact – piling into unstable bubbles near the top or selling everything during busts and locking in a loss at the bottom.
2. Consider how you react. Recognise your emotional capabilities. Be aware of how you are influenced by lapses in your own logic and crowd influences. An investor should ask: “Am I highly affected by recent developments (positive or negative)? Am I too confident in my own expectations? Can I bear a paper loss?”
3. The right strategy. Choose an investment strategy that can withstand inevitable crises while remaining consistent with your financial objectives and risk tolerance.
4. Discipline. Essentially stick to your broad strategy even when surging share prices tempt you to consider a more aggressive approach, or plunging values might suck you into a highly defensive approach.
5. A contrarian approach. Finally, if 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 market tops, and extremes of bearishness often signal market bottoms. But contrarian investing is not foolproof – just because the crowd looks irrationally bullish or bearish does not mean it can’t get more so.

Investors frequently seek external validation to ease the anxiety of putting their money at risk. Problem is there is no guarantee that a "five-star" rating on a chosen fund will lead to a "five-star" investment experience.

It is human nature for consumers to seek comfort in the idea that the products they are buying are proven in the marketplace. That need is met by ratings agencies that play a legitimate and vital role in providing independent assessments of various investment products.

Those assessments are made in professionally compiled and detailed reports that can be a useful yardstick for investors and their advisors in comparing funds so that they can make a fully informed decision.

But despite diligent cautions from the agencies about chasing returns, problems arise when consumers blindly extrapolate star rating systems for various funds into imagined future performance.

The risks of this approach were highlighted in a survey by US private wealth management business Burns Advisory Group, which went back to 1999 to study the subsequent 10-year performance of Morningstar's five-star funds.¹

Burns found that of the 248 funds rated five-star by Morningstar on December 31, 2009, only four were still receiving that rating a decade later. Of the original sample, 87 had ceased to exist. Of those still existing, all had been downgraded to an average of just under three stars. Even worse, in all categories except international stocks, the average performance for five-star funds over this 10-year period was worse than the average for all funds.

"These findings imply the star ranking methodology leaves long-term investors in the lurch," Burns concluded. "If nothing else, it demonstrates clearly why investors should not rely on one measure as their sole research tool."

But it is not just unsophisticated investors that are chasing performance. Another recent report suggests that even wealthy individuals and institutional investors can be blind-sided by past returns.

The study by researchers at the European School of Management and Technology, quoted in The Economist magazine, looked at how investors allocated money to hedge funds over 10 years from 1994.²

The researchers found that the funds that had performed well in the previous three quarters attracted significantly more money than their competitors. In other words, the supposedly "smart money" was chasing past returns.

Bear in mind, also, that indiscriminately chasing returns can be even more costly with hedge funds, which typically charge management fees of 2% or more, plus 20% of the returns they generate for clients.

Given the large body of academic evidence that it is extremely difficult to predict market returns with any confidence, it should be evident that past returns should not be the foundation for choosing one fund over another.

Leading academics Gene Fama and Ken French, in a recent study of mutual fund performance, showed how hard it is for investors to distinguish skill from pure chance in analysing the returns of individual funds.³

So what should an investor and his or her advisor weigh up in making a decision? The key here is to focus on items within their control, such as:

While many of these attributes can lead to good outcomes for investors, they are no guarantee of positive returns every year. Anyone who makes those sorts of promises risks disillusioning those who put their faith in them.

But the above characteristics can give investors comfort that their money is being invested in a consistent, transparent way and that ensures that when the targeted premiums kick in, they are positioned to receive them.

This is a grounded, completely defensible approach. The alternative is that by reaching for the stars, investors are left clutching at straws.

1. McGuigan, Tom and Courtenay, Tim, Star Gazing: Five Star Funds Revisited, Burns Advisory Group, April 2010

2. Buttonwood, Who's the Patsy?, The Economist, May 29, 2010

3. Fama, Eugene F., and Kenneth R. French. 2009. Luck Versus Skill in the Cross Section of Mutual Fund Returns, SSRN