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A key theme in establishing credentials is that a manager needs to have a track record of making the right calls, both historically and recently. He also needs to be impartial and he needs to be up to date.
Do not be surprised if organisations who have a vested interest in equities are still recommending equity funds. If they do this because this is all they have or where their main strengths lie then you might find that they tend to recommend equities indiscriminately in all conditions. Such a recommendation ceases to have any meaning or significance - it is simply a mindless mantra, like a recorded message over and over again.
It is worth remembering that any assets that were bought prior to the credit crunch and the 2008 crash would have been bought looking at a very different global economy to that which we face now.
In 2008 alone, the following events occurred:
- Russia invaded Georgia (and then lost at beach volleyball in the Beijing Olympics to Georgia)
- Terrorists attacked Mumbai
- America elected its first black President
- Oil reached an all time high in July of $147.27/barrel but finished the year down by over 2/3 from the peak
- The financial system came close to collapse with the US rescue package exceeding $1 trillion as the year ended
- The UK banking system saw HBoS and Bradford & Bingley follow Northern Rock into oblivion with RBS and Lloyds falling into significant government ownership
- Thailand’s parliament and airport were occupied by anti-government protesters
- Bear Stearns, Lehman Brothers, Washington Mutual and AIG were among the big casualties in America
- The governments of the Low Countries had to rescue ABN and Fortis
- The Australian Dollar came within touching distance of parity with the US$ before falling back to around 60 cents at the year end
- The S&P 500 had its second worst year ever
- US government bonds were at one stage rated higher risk than those of McDonalds Corp
- Bernie Madoff’s giant Ponzi scheme using US equities was uncovered
The world is a very different place now compared to a year ago. Any asset allocation strategy should be based on how the world looks today - not how someone mistakenly thought it looked pre-crash. New opportunities exist now and totally different information is available.
Look forwards not back - portfolio allocation should be driven by prevailing economic conditions. We would never, ever believe in the concept of holding onto an asset because of its value today relative to its cost. That has nothing to with its relative attractiveness. Two investors may each hold the same share which may today be valued at $10 per share. One investor may have paid $5 to buy the share five years ago. The other may have paid $20 just a few months ago. The prospects are the same for each investor going forwards irrespective of the fact that one is showing a 100% gain and the other is showing a 50% loss. The future behaviour of the asset is completely irrelevant to the purchase price.
This is, again, where the psychological aspect comes in. However, any understandable reluctance to realize an asset at a loss is based on emotion not rationality. Emotion generally does not predicate good investment decisions. The emotions of investors who feel more able to live with a loss on an asset so long as they do not realize that loss by selling the asset are entirely understandable, very human but ultimately pure self-deception - the asset is currently selling for today’s price whether you choose to sell it or keep it. The only question of relevance is, “Looking at today’s investment conditions, how much, if any, of that asset should I hold?”
To answer that, we would always go back to the only measure that we understand for deciding whether to buy, sell or hold any asset - the relative attractiveness of the disposed value of that asset compared to cash. In life, doing nothing is rarely the right solution to any problem.
Understand history - one widely used argument is that history supports the idea of holding onto assets that have fallen in value. I suppose the idea here is that empirical evidence can be produced that shows that it is invariably better to hold than to sell; better to stick than to twist as it were.
However, such claims are generally based on very flawed hypotheses. Fidelity analysed stock market performance over the period 1993-2008. Being primarily an equity manager, their research supported the idea of remaining invested in equities throughout a cycle. They supported this with a table showing the effect of missing the best days in the global equity markets over the last fifteen years. For instance, an investor into the S&P 500 had made returns of 8.39% per annum during this time. Take out the best ten days over that period that return fell by over 3% per year. That sounds a lot.
However, it should be remembered that the ten best days were widely interspersed throughout the whole time span. To manage to be invested for 3,644 days but to pull out JUST for each of the ten widely scattered days and be re-invested for the next day would take far more monkeys equipped with Quotron machines and dealing desks than would ever be needed at typewriters to produce the complete works of Shakespeare, Proust and Tolstoy.
It is a totally implausible idea that someone would choose to not invest for just ten days out of fifteen years and would, somehow, randomly pick ten days dotted so variously throughout the fabric of the period.
To be continued…

The above data and research was compiled from sources believed to be reliable. However, neither MBMG International Ltd nor its officers can accept any liability for any errors or omissions in the above article nor bear any responsibility for any losses achieved as a result of any actions taken or not taken as a consequence of reading the above article. For more information please contact Paul Gambles on [email protected]

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