Investment Markets: A rough start to the year and the importance of being patient

Global markets are once again providing investors with a rough ride at the moment . 2016 has started much where 2015 left off with basically the same worries driving another bout of share market falls. Geopolitical concerns have played a role but the main issues are uncertainty regarding the Chinese economy, wariness about the Fed raising interest rates and the impact of a rising US dollar and falling Chinese Renminbi.In times like these investors can have a tendency to spend much of their time thinking tactically instead of psychologically . they want to know how to handle the next week or month in the markets without ever planning for the next year or decade

Market volatility unnerves people. That’s natural in a world increasingly geared around the short-term. But while falling markets can be worrisome, maintaining a longer-term perspective makes the volatility easier to handle.

A typical response to unsettling markets is an emotional one. We quit risky assets when prices are down and wait for more “certainty”. These timing strategies can take a few forms. One is to use forecasting to get out when the market is judged as “over-bought” and then to buy back in when the signals tell you it is “over-sold”.

A second strategy might be to undertake a comprehensive macro-economic analysis of the Chinese economy, its monetary policy, global trade and investment linkages and how the various scenarios around these issues might play out in global markets.

In the first instance, there is very little evidence that these forecast-based timing decisions work with any consistency. And even if people manage to luck their way out of the market at the right time, they still have to decide when to get back in.

In the second instance, you can be the world’s best economist and make an accurate assessment of the growth trajectory of China, together with the policy response. But that still doesn’t mean the markets will react as you assume.

A third way is to reflect on how markets price risk. Over the long term, we know there is a return on capital. But those returns are rarely delivered in an even pattern. There are periods when markets fall precipitously and others where they rise inexorably. The only way of getting that “average” return is to go with the flow.

Second-guessing markets means second-guessing news. What has happened is already priced in. What happens next is what we don’t know, so we diversify and spread our risk to match our own appetite and expectations. Spreading risk can mean diversifying within equities across different stocks, sectors, industries and countries. It also means diversifying across asset classes. For instance, while shares have been performing poorly, bonds have been doing well.

Markets are constantly adjusting to news. A fall in prices means investors are collectively demanding an additional return for the risk of owning equities. But for the individual investor, the price decline only matters if they need the money today.

To put all this into a longer term perspective , a number of our clients ,based on our assessment of their investor profile , have portfolios managed by us with growth asset exposures of between 50% and 70% . The charts below show the growth in wealth of $1 over the past 12 mths , 3 years and 5 years ( ending Dec 2015 ) of a typical 50% growth and 70% growth portfolio constructed and managed by us .

Growth of wealth over the past 12 months

Source : DFA Returns Program

Growth of wealth over the past 3 years

Source : DFA Returns Program

Growth of wealth over the past 5 years

Source : DFA Returns Program

As you can see , whilst the past 12 months have been quite volatile , the medium to longer term returns from these portfolios have been quite acceptable and highlight the value of intelligent portfolio construction , proper risk management and sticking to strategy

To earn those returns, you had to remain fully invested, taking the unsettling down periods with the heartening up markets, but also rebalancing each year to return your desired asset allocation back to where you want it to be.

If your horizon is five, 10, 15 or 20 years, the current uncertainty will soon fade and the markets will go onto worrying about something else. Ultimately what drives your return is how you allocate your capital across different assets, how much you invest over time and the power of compounding.

As we have mentioned before , the greatest short term contribution you can make to your long-term wealth is exercising patience. For investors that have the proper asset allocation in place , market volatility , whilst unpleasant , is something that is manageable and must be tolerated . From Calibre’s experience in managing private client portfolios ( and more importantly their emotions ) through numerous market cycles over the past 15 years ,most people will reflect back 5 or 10 years from now on the current market situation and conclude that it was far less dire than it may seem right now.