Maybe it is the natural optimist in us, but imagination often goes missing when investing, writes Simon Evan-Cook. Especially when many are stuck shovelling their money into yesterday’s winners …
Mass surveillance? States tampering with the media? Home-entertainment devices that transmit from the home as well as to it? Hard to know if I’m describing life today or in George Orwell’s 1984.
Published in the late 1940s, 1984 was a work of imagination that served as the ultimate risk warning and our fear of Orwell’s fictional dystopia has since helped to prevent it from happening. Seventy years later, our data-obsessed industry, which measures risk to two decimal places, could do with a little more of that imagination.
We are all in the risk-management business. We have to manage risks within our funds: you have to manage the financial risks in your clients’ lives. As such, you are – I am sure – no strangers to the concepts of life, illness or injury cover.
Not the most thrilling of products, but they do have imagination fitted as standard: “Yes, you’ve been okay so far” you say, “but imagine your world after a serious car accident.” Okay, so it is somewhat macabre, but it is imagination nonetheless.
Most of your clients will never call on that policy. But the few that do should be grateful. You imagined – on their behalf – a future that turned out to be very different from their recent past. And thank heavens you did.
Maybe it is the natural optimist in us, but sadly that imagination often goes missing when investing. More often than not, it is assumed – by advisers and fund managers alike – that the near future will look exactly like the recent past.
Change, in contrast, is rarely considered and quickly dismissed. The most commonly used investment risk measures, such as ‘Value at Risk’, rely exclusively on data from the recent past.
Remember the ‘Commodity Supercycle’ from the noughties? The widespread belief then was that resource prices would never stop rising as ‘proved’ by the preceding decade. Natural resources funds were top of the performance tables and, as a result, top of the sales tables. By 2010, the trend was no longer a trend, it was the status quo. Like breathing air.
I remember several multi-asset funds promising a permanent allocation to commodities – often as much as a third of the portfolio. We were baffled: commodities were ignored in the nineties, and even a cursory glance at history showed they could spend decades going backwards, particularly after a prolonged rally.
So, having just seen a prolonged rally, it was not hard to imagine them slumping again. So why would you want to invest anything in those assets? Let alone hardwire them into your fund’s design.
“Investors are thinking it is okay to own a bond with a negative real yield, or scrambling to pay record-high valuations for any safe-looking equity.”
Sure enough, as the noughties rolled over, so did commodities. Natural resources funds duly tanked, and many were closed. Investors who failed to imagine a world where resource prices fell, not rose, lost a lot of money. Our fund holders, meanwhile, enjoyed the view from the side-lines.
We find it is usually useful to ask: can we imagine a world that is meaningfully different to today? And, considering our current positioning, will our clients lose money if that world arrives?
So what could today’s ‘Commodity Supercycle’ be? There are several candidates. The first thing that springs to mind is beards. Recent graduates may be surprised to learn that just 10 years ago, unless you worked in the Open University, a real ale festival or on a North Sea trawler, beards were simply unacceptable.
But perhaps more relevant to clients’ portfolios is the widely-held belief that inflation is now permanently low.
There was a fringe theory ten years ago – that we might be turning Japanese. But now it has gone mainstream. Investors are thinking it is okay to own a bond with a negative real yield, or scrambling to pay record-high valuations for any safe-looking equity.
But now imagine a public that is weary of austerity and low economic growth (not hard), and politicians realising that hiking public spending will win them votes (even less hard). Then imagine what a spending splurge (say, for example, significant public sector pay rises) would do to inflation. What would that do to the values of bonds priced for the opposite?
Also picture what could happen to the prices of popular quality-growth equities if the narrow, winner-takes-all-environment of the last ten years was replaced by a world in which all boats were floated. We do not think it would be pretty in either case.
We are not, by the way, predicting that this is going to happen – just that it might. That is why we are keeping our portfolios balanced, not exclusively holding one type of asset. But it seems that many investors now assume that today’s world will never, ever change.
So, just as they did with commodity funds in the noughties, they are back to shovelling everything into the previous decade’s winners. The world will change though, eventually, just as it always has before. Imagine that …
Simon Evan-Cook is senior investment manager at Premier Multi-Asset Funds
This article appeared in the October issue of Multi-Asset Review, which has now gone to press.