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Humans have a hard time being investors.  Normally, we like to purchase things when they are cheap and avoid them when they are expensive, but that is often not the case for equities.  We tend to get overly optimistic and enthusiastic when equity markets rise dramatically, as they have done since the Global Financial Crisis a decade ago.  Yet when markets fall materially, we feel bruised and cautious, seeking to hang onto our stable bonds and even selling equities to avoid further falls in portfolio value.  That’s rarely a good idea, especially if you do not need the bulk of your capital in the foreseeable future.

As a client you will know that we have always sought to rebalance your portfolio on a regular basis, by which we mean returning it to the original target allocation that we initially established with you.  Most often, over the past few years, rebalancing has meant selling growth assets (equity-like) and buying defensive assets (bonds) in a contrarian manner.  This has helped to avoid the portfolio becoming dominated, over time, by the riskier growth assets component of the portfolio and to keep you within your emotional tolerance for falls, your financial capacity to weather them and your need to take risk in the first place.

Logically, the reverse also applies; at times like these the proportion of equities in your portfolio will have fallen below their long-term target.  This matters because your portfolio now has too little risk and it will be harder for the growth assets remaining to recoup the falls in value when markets eventually recover.

We can work that idea through with a simple example.  Imagine you own a £10,000 portfolio split 50% (£5,000) into growth assets and 50% into defensive assets.  In the growth assets portion, you own 50 units of a global equity fund priced at £100 per unit.  Growth assets fall by 40%.  Let’s assume your defensive assets are unchanged in value.  You still own 50 global equity fund units, but they are now priced at £60.  Your growth-defensive split has moved from 50/50 to 37.5/62.5.  Time to rebalance.

Figure 1: Market falls leave you underweight growth assets

Source: Albion Strategic Consulting

Rebalancing i.e. buying equities to realign the portfolio with its allocation target, helps to ensure a quicker recovery back to where you started.  This is because the breakeven price of your equity holdings is now lower.

So, let’s now assume that you rebalance by taking £1,000 from your defensive assets and buying growth assets to get you back to a 50/50 split (left hand grid below).  You can buy 16.7 units at £60 with the £1,000 raised.  To get your portfolio back to its starting value of £10,000 your now 66.7 global equity units need to rise 50% to £90 per unit (middle grid).  However, an un-rebalanced portfolio (right hand grid) only rises to £9,500 with this 50% rise.  In fact, to get back to a portfolio value of £10,000 and un-rebalanced portfolio requires a rise of 67% in the global equity units to £100.

Figure 2: Rebalancing helps the portfolio to recover faster 

Source: Albion Strategic Consulting

Even if the markets fall again after rebalancing, the opportunity exists to rebalance again, likewise further reducing the rate of return required to get back to where you were compared to un-rebalanced portfolios.  That takes courage and discipline, when your emotions are telling you to do the opposite.

The issue of a potential rebalance on the back of large market falls is certainly being considered and don’t be surprised if we raise this with you.  You now know why.  Remember, if you are drawing an income from your portfolio, withdrawing from bonds can get you closer to your target.  Likewise, if you have incoming cashflows, this too can be used to buy growth assets.

As David Swensen, CIO of Yale University’s Endowment and one of the world’s most highly respected institutional investors states^[1]:

‘The fundamental purpose of rebalancing lies in controlling risk, not enhancing returns.  Rebalancing trades keep portfolios at long-term policy targets by reversing deviations resulting from asset class performance differentials.  Disciplined rebalancing activity requires a strong stomach and serious staying power.’

Do you really need to rebalance?  The answer for most investors is likely to be ‘yes’ when the time comes.  If we feel a rebalance is necessary, we will be in touch to discuss this with you.

As ever, please feel free to give us a call if you have any questions.

Risk Warnings

This article is distributed for educational purposes and should not be considered investment advice or an offer of any security for sale. This article contains the opinions of the author but not necessarily the Firm and does not represent a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable but is not guaranteed.

Past performance is not indicative of future results and no representation is made that the stated results will be replicated.

Errors and omissions excepted.

[1]    Swensen, D., (2000) Pioneering Portfolio Management.  New York: The Free Press

Context is an important tool when it comes to investing.  All investors around the world will be feeling the emotional pressures of the recent rapid equity market falls, either because they can remember previous falls and times of uncertainty, such as the Global Financial Crisis (2007-2009), or as younger investors, they have not yet experienced material market falls.  We obviously do not have a crystal ball to see into the future, but the global equity market falls we have seen since January – of under 20% or so at the time of writing – sit well within previous falls since 1970. In terms of expected ranges of outcomes, we generally estimate that 95% of the time annual equity market returns should sit within an approximate range of +45% to -35%.  Outliers do exist beyond these limits.

Figure 1: Today’s falls still sit well within both history and expectations (1/1/1979 to 18/03/20)

Data: Global equities – MSCI World Index (net div.) TR in GBP Morningstar Direct © All rights reserved.

The Table below provides numbers around both the depth and recovery times for each of the five largest falls since 1970 in the figure above.

Table 1: Declines and recoveries of global equity markets (1/1/1970 to 18/3/2020)

Data: Global equities – MSCI World Index (net div.) TR in GBP Morningstar Direct © All rights reserved.

How deep or long the current fall will be, no-one knows.  There will certainly be more rises and falls to come.  Yet we should take some comfort from the fact that things have been just as challenging at times in the past, albeit for very different reasons.  Recovery times sit well within the investment timeframes of most investors.  It is worth noting that an investor in global equites today has, in nominal terms, more money than they did at the end of April 2018, despite the market falls in late 2018 and those recently experienced.

These are tough times for all of us and for our Nation, but the words of wisdom that we always return to at these times are those of the legendary investor John Bogle:

‘This too shall pass’.

It will.

From an investment perspective the key message is to be brave and disciplined as a fall only becomes a loss if you sell. Remember, we are always available to take your call or answer your emails.  Please feel free to contact us if you have any specific questions or simply if you would like some reassurance.

Risk Warnings

This article is distributed for educational purposes and should not be considered investment advice or an offer of any security for sale. This article contains the opinions of the author but not necessarily the Firm and does not represent a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable but is not guaranteed.

Past performance is not indicative of future results and no representation is made that the stated results will be replicated.

Errors and omissions excepted.

We are delighted to announce that, as of October 2019, Pacem and Redrock Financial have combined our businesses to provide our clients with a coordinated range of financial planning, taxation and accountancy services. Daniel Glover, Managing Director of Pacem, explained “our shared values and commitment to a client-focussed service have made this partnership possible and we are delighted to be joining forces with Lyn, Alison and the rest of the team. It is an exciting time for our business and our clients.”

Pictured are Directors Tony Glover, Alison Bell, Lyn McMaster and Daniel Glover.

Could’ve, would’ve, should’ve!

It is human nature to look at an investment that has done particularly well and wish you had been invested in it. We all risk being dragged into ‘if only’ mind games: ‘If only I had put a £10,000 into Amazon in 2003, I’d be retired by now’[1].  ‘If only I had bought Bitcoin at £1…’. These thoughts are dangerous to investors, as this fear of missing out (FOMO) can tempt them into taking speculative risks, often based on a rear-view mirror perspective. Concentrated risks have concentrated outcomes, both good and bad.

We have a lot of respect for the fund manager Neil Woodford, but anyone reading the news lately will have seen that his concentrated, high conviction, long-term strategy takes a lot of living with, which few investors seem to have the stomach for.  His fund, which peaked at above £10 billion, has less than £4bn in it today and the doors are currently closed to new money and withdrawals. Concentration risks are real.

A powerful insight into the dangers of owning a concentrated portfolio can be found in a piece of research on the US market from 1927 to 2015[2]. Of the 26,000 companies that have been listed on the US exchanges, only 36 made it through the whole period. The total wealth of $32 trillion generated over the period was entirely accounted for by just 4% of companies.  The market as whole – the good and bad in aggregate – delivered an annualised return of nearly 7% after inflation p.a. i.e. investors doubled their money roughly every 11 years, over this period.  That’s a pretty good outcome and a direct consequence of being diversified.

The difficulties of trying to time markets or to pick companies, sectors or managers, in the face of little evidence that professional investors have persistent skill in these fields suggests that a rational investor should eschew such approaches and seek to place their investment eggs across a wide range of baskets.

Diversification is ‘always having to say you are sorry’

The challenge with owning a diversified portfolio is that sometimes investors fail to look at the big picture, diving into the detail of their portfolio valuation to pick out the fund that is not performing well, and possibly moaning about it.  Underperformance does not mean that it is a bad fund or a bad strategy or a bad manager, particularly when systematic, low cost funds are used in the portfolio to capture market returns.  It just means that some markets (or parts of markets) are zigging while others are zagging – the very essence of diversification!

A diversified portfolio is not always easy to live with, as there will always be something you don’t own that is doing better than the portfolio and always something in the portfolio that is doing poorly.  So, if your adviser has to say they are sorry sometimes about an underperforming fund always remember that a) they are not responsible for market returns and b) they are acting in your best interests by making you remain diversified and stick with the programme.

[1]  In 2003 Amazon’s stock price fell as low as $7 per share.  At the time of writing, the share price is over $1775

[2] Bessembinder, H., (2017) Do Stocks Outperform Treasury Bills? WP Carey School of Business, Arizona State University.

Other notes and risk warnings

Risk warnings

This article is distributed for educational purposes only and must not be considered to be investment advice or an offer of any security for sale. The reference to any products is made only to make educational points and must, in no circumstances, be deemed to be any form of product recommendation.

This article contains the opinions of the author but not necessarily Pacem Glover and does not represent a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable but is not guaranteed.

Past performance is not indicative of future results and no representation is made that the stated results will be replicated.

Errors and omissions excepted.

Systematic, evidence-based investing often results in very little activity in a portfolio.  It is wrong to think that this is the result of a ‘set-and-forget’ strategy.  Pacem Glover’s Investment Committee would be aggrieved at such a suggestion!  Considerable effort goes on behind the scenes to allow this state of calm consistency to exist.  The fortitude and discipline to deliver ‘not much needs to be done to your portfolio except for rebalancing’ advice, comes from a rigorous process of ongoing challenge to the status quo.

The broad terms of reference of the Investment Committee are set out below:

Manage risks over time

• The Investment Committee is responsible for the oversight of the risk in portfolios and the wider investment process. Meetings are regular and minutes are taken, which include all action points to be followed up on. Third-party inputs and guest members – such as Albion – provide independent insight and challenge.

Challenge the process

• The investment process at the Pacem Glover is driven by the latest empirical evidence and theory available. It is always open to challenge. If new evidence suggests that doing things differently would be in our clients’ best interests, then we will revise our approach. The investment process is evolutionary, but change is most likely to be slow and incremental.

Review the portfolio structure

• The underlying characteristics of Pacem Glover’s client portfolios are reviewed, including performance and risk level attributes. Risks (asset class exposures) and their allocations within a portfolio are evaluated. Any issues are raised and resolved. Existing asset classes are reviewed alongside asset classes and risk factors that currently sit outside the portfolios. Areas of interest are placed on a longer-term ‘watch’ list.

Review the incumbent ‘best-in-class’ investment products

• The incumbent products are ‘best-in-class’ choices seeking to deliver the returns due to investors for taking specific market risks. Each product has a role to play in a portfolio and its ability to deliver against this objective is regularly reviewed. Any product-related issues are raised and resolved.

Screen for new products and undertake appropriate due diligence

• Although the incumbent products were recommended as ‘best-in-class’, new products are regularly being launched. Tough screening criteria are in place against which new funds are judged. New, potential ‘best-in-class’ products face detailed due diligence and approval. They are included only when they make the grade.  Given the quality of the products already in portfolios, the threshold for replacement is high, but not insurmountable for newer products.

Reaffirm or revise the investment process

• The Investment Committee is accountable for reaffirming or revising the structure of client portfolios. Risk (asset) allocations and product changes are approved by the Investment Committee. Any actions arising from portfolio revisions will be undertaken, after discussion with and agreement by clients.

The next time you open you latest valuation report, remember that despite the lack of activity on the surface, the Investment Committee continues to paddle furiously behind the scenes to allow this be the case.  In the immortal words of the investment legend and author Charles Ellis:

‘In investing, activity is almost always in surplus.’

Perhaps we should amend this slightly to:

‘In investing, activity is – except for the Investment Committee – almost always in surplus.’

Other notes and risk warnings

Use of Morningstar Direct data

Morningstar Direct © 2019. All rights reserved. Use of this content requires expert knowledge. It is to be used by specialist institutions only. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied, adapted or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information, except where such damages or losses cannot be limited or excluded by law in your jurisdiction. Past financial performance is no guarantee of future results.’

Use of this document

This document may be provided to a client of Pacem Glover either in hard copy or as a PDF.  It may not be in any circumstances be placed on any website or any form of social media.

Risk warnings

This article is distributed for educational purposes only and must not be considered to be investment advice or an offer of any security for sale. The reference to any products is made only to make educational points and must, in no circumstances, be deemed to be any form of product recommendation.

This article contains the opinions of the author and does not represent a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable but is not guaranteed.

Past performance is not indicative of future results and no representation is made that the stated results will be replicated.

Errors and omissions excepted.