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Coronavirus update


Coronavirus

“I’m worried about my investments because of Coronavirus”

With markets having fallen dramatically recently, investing can sometimes feel like a roller coaster ride that can make even the most experienced want to run for the exits. The legendary investor Ben Graham once wisely said “The investor's chief problem and even his worst enemy is likely to be himself”, we must therefore remind ourselves of a few things before we bail out of the aeroplane and pull the rip cord.

Investment Return Behavior Gap graph


The recent market falls have been triggered due to widespread concern over the impact of the Coronavirus (Covid-19) outbreak which is spreading outside of China at an accelerating rate to various countries throughout the world. There is a worry that, apart from the health of individuals, it will impact on global demand and supply and thus impact profitability and growth.

This is a classic financial crisis event and immersed in the moment, these falls feel like a big deal, but your financial plan is a long-term endeavour, and so it’s crucial to maintain composure and to evaluate events in the context of the long-term rather than the moment. Panic selling is, however, never the correct response to sharp market sell-offs.

Our portfolios are also specifically constructed to be diversified and thus robust to market events. We may, by definition, not know what specific evert will occur or when, but we do know that they tend to occur relatively frequently and so we focus on building portfolios that can take these sorts of event in their stride.

Emotions or Logic

Human beings are primarily emotional, not rational, so we engage in “confirmation bias”: We start off with what we want to be true, look for evidence that supports our hopes, and screen out that which does not.

We all, investors and investment advisors alike, have an opinion (forecast) about where the market is headed. And we listen to those “experts” who support our view of the future while ignoring those who disagree. Acting on that forecast usually ends up being destructive to our financial health. Recognizing this, (by looking at our past experiences), should be enough to convince us that emotions have no place in the investment decision process.

Greed/Buy Fear/Sell graph



“Our job is not to help clients beat the markets;

it's to stop the market beating them”


As an investor you need to take your emotions out of your investment strategy because the emotions of fear and greed are very powerful enemies of the successful investor. If you can remain rational when everyone around you is in a panic, you will see that the evidence supporting a disciplined investment strategy is overwhelming. But I fear that most investors (and too many advisors) still have a long way to go before they can invest in a rational manner.

Responsibility of the Financial Adviser

Financial advisers have an enormous responsibility here. Keeping their clients disciplined is always the biggest challenge they will ever face.

Successful wealth management companies base their business on a core investment philosophy, and we are no different. Although we offer many specific strategies to suit the specific needs of our clients an overarching theme runs through the service we provide to clients – focus on those things that matter and the things that are within your control.

Instead, too many people focus on how the crisis du jour might impact the markets or the economy. Advisers too often focus on manager performance ratings, or the performance of an individual security or strategy, overlooking the fundamental principles that we believe can give them the best chance of success.

For example, although the asset allocation decision is one of the cornerstones for achieving an objective, it only works if the allocation is adhered to over time and through varying market environments. Periodic rebalancing will be necessary to bring the portfolio back into line with the allocation designed for the objective

It’s understandable that during the losses and uncertainties of a “bear market”, many investors will find it counterintuitive to rebalance by selling their best-performing assets (typically bonds) and committing more capital to underperforming assets (such as equities). But history shows that the worst market declines have led to some of the best opportunities for buying equities. Investors who did not rebalance their portfolios by increasing their equity holdings at these difficult times may have missed out on subsequent equity returns and hampered their progress toward their long-term investment goals – the target for which their asset allocation was originally devised.

Because investing evokes emotion, even sophisticated investors should arm themselves with a long-term perspective and a disciplined approach. Abandoning a planned investment strategy can be costly. Research has shown that some of the most significant derailers are behavioural: the failure to rebalance, the allure of market-timing and the temptation to chase performance.

The Informed Invester

The purpose of this guide is to set out an alternative way of thinking about how Coronavirus might impact on portfolios in the future.

Naturally, we don’t have a crystal ball and we are not attempting to discuss if the markets might go lower from here or how markets might be impacted in the future.

But the good news is; we don’t need to do any of that.

Security Prices are "Fairly Priced"

Markets are extremely efficient at taking into account all the views and opinions of every single one of us, and digesting them into a single price for each publicly traded security. It might not be the “right” price since as new information comes to light, prices change up and down all the time, but at any given time, prices reflect the views and opinions of everyone with an opinion to such an extent that we can operate on the presumption that security prices are “fairly” priced.

That is to say, the price right now, at every single instant reflects everything we could possible worry about to such an extent that it is highly unlikely that we can make a better guess as to what the fair price might be.

The key takeaway for investors is this

If you say you are worried “now” because of “x” event, you can relax because “x” event – be it Coronavirus or anything else, is not news because it is already known and priced into the market to such an extent that the price of literally everything has already moved to adjust to the news.

That’s pretty much the definition of news.

News, noun “information not previously known to (someone)”

As more news comes out prices will adjust further, good news driving up some prices and bad news driving them down. But you can be pretty sure that everything we know about Coronavirus is already in the price.

 Security prices are therefore not too high or too low right now, they are fairly priced given everything we all know right now.

Diversification works – Year to date as at 10th March 2020

Vanguard Global Bond Index graph

Source FE

Although stocks (in green) have clearly gone down, Bonds (in red) have performed exactly as expected and gone up to offset the impact.

Obviously, since we espouse diversification, none of our clients are invested solely in just one market segment, e.g. the S&P500. Your portfolio is globally diversified, amongst regions, sectors, countries and currencies and most clients have far less than 100% equities in their portfolio. This means that your portfolio is far better protected, and has almost certainly fallen far less, than the scary percentage falls of undiversified equity indices being quoted in the press.

It is often said that “Diversification is the only free lunch in investing”.

Given nobody has perfect hindsight to simply pick the best asset class(es) each year and given the majority of risky asset classes produce a positive return over long periods of time (whilst being volatile over shorter periods), owning a portfolio containing a number of different asset classes should, over longer periods of time, produce a positive portfolio return and makes sense from a “not having all one’s eggs in one basket” point of view.

In addition, diversification of asset classes in a portfolio has an additional benefit when it comes to the overall risk of the portfolio.  Due to the behaviour of the asset classes relative to each other (correlation) it is possible to reduce the risk of the portfolio beyond even the average of all individual asset class risks by combing different asset classes together. Essentially this is because different asset classes behave in different ways to each other so that often when one falls in value another will rise in value which means that a combination of assets is likely to have “smoother” performance (and less risk) than a single asset or asset class.

Take heart: your portfolio is well diversified and will be able to weather this storm.

Rebalance

Any period of volatility creates opportunities to sell more expensive investments and reinvest in cheaper assets with more upside. Rebalancing is a way of systematically selling at higher prices and buying at lower ones it is challenging as it requires acting against emotion.

Where your account is subject to a discretionary mandate, the mere fact that you do not need to make these rebalancing decisions yourself will help avoid any emotionally charged decisions to radically alter your investment strategy. If you do need to adjust your portfolio, then talk to us and we can discuss it in the context of your financial plan.

Time IN the market is more important – One Year

Vanguard global index graph

Even just extending the time period for stocks and bonds to just one-year sees a positive return from Stocks albeit only 1% - to put that into context, remember with bank accounts typically paying a fraction of 1% currently this now represents several year’s bank interest!

Maintain a Long-Term Perspective

Stock market falls and crashes are, whilst very uncomfortable, normal. They are the rule, not the exception, and are part of the journey. Stock market history shows us time and again that this happens. Just like the weather changes throughout the seasons, markets go through cycles of good and bad periods. As an investor with a long-term time horizon you should expect to see this happen.

Let’s have a quick look at a couple of the more notable and momentous falls in living memory and how investors would have fared over the long-term had they remained composed.

The chart below, courtesy of Vanguard, shows the varying outcomes for people who either pulled their money out or remained invested after the market crashed in 2008/2009:

Investor discipline graph

Source: Vanguard

WARNING: Past performance is not a reliable guide to future performance.


The message here is that investors who stayed the course were rewarded, those who panicked and went to cash locked in their losses.

The next chart shows a euro investor with 100% of their money in global equities just before the market crash in Sept 2008 to the end of February 2020:

Euro Investor chart

 

Source: FE Analytics

WARNING: Past performance is not a reliable guide to future performance.


Again, the message here is that investors who stayed the course were rewarded.

If you invested the day before the Dot Com crash in 2000 (the NASDAQ peaked on March 10th 2000):

Graph that shows pricing spread

 

Source: FE Analytics

WARNING: Past performance is not a reliable guide to future performance.


And finally, if you had invested the day before Black Monday in October 1987:

Pricing Spread graph

 

Source: FE Analytics

WARNING: Past performance is not a reliable guide to future performance.


Just like snow in November, we should expect market corrections.

There has been something like 13 corrections (decline of 10% or more) and eight bear markets (decline of 20% of more) since 1980 (using the dollar performance of the MSCI World and All Country Index as proxies for the stock market).

Yet. equity markets give a positive expected return above less risky assets like cash deposits because of this volatility. It is the price we must pay as long-term investors in order to reap the rewards of positive expected growth over time.

If we step back from short-term thinking, and instead consider recent turbulence in the context of our long-term financial plan, the correct question shifts from ‘should we sell’, to, now that stocks are cheaper, ‘is now a good time to buy given that equity markets are cheaper now than they were?’

There is Nothing New Here

Disciplined investors look at long-term growth

During my lifetime there have been many significant concerns for investors.

The good news is, markets go up on average 70% of the time declines of around 20% happen on average every 4 years. Being afraid of a market decline is like being afraid of leap years or the Olympics. The risk of a decline is the price to play the reward game.

MSCI World Index

The reward for a European investor being an average annual return from investing in global capital markets of just under 7%pa every year for the best part of the last 50 years.[1]

   

Conclusion

Venn Diagram showing what you should focus on

It’s important to remember why you are investing in the first place and to try and tune out the “noise” in the markets.

Your portfolio is designed to capture the returns from the markets over the long-term.

Your thinking should therefore be “is now a good time to buy?”

Do you have additional questions about the market or how to best handle your stocks at this time? Please feel free to reach out! 

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[1] MSCI data 1970 to 2018 copyright MSCI 2018, all rights reserved