Why You Should Ignore All Market Forecasts

forecasting is like roulette

In the week that RBS tells us to “sell everything” ahead of a “cataclysmic year” it’s worth thinking about whether acting on market forecasts is of any value. Here are three reasons why forecasting is a waste of everybody’s time.

 

1. Nobody Knows The Future

Yes I know I’m stating the obvious here but it needs to be said again and again. Nobody knows where gold or oil or the S+P500 (or anything else) will be a year from now. And yet we (helped of course by all those ‘news’ headlines) so often succumb to these so-called experts who are, more often than not, wrong.

2. Which Forecast Is Right?

We’ve also heard this week from SocGen’s Albert Edwards, who thinks that the S+P 500 could fall 75% from here (no, not a typo, no decimal place between the 7 and the 5). ‘Renowned investor’ Marc Faber is much more optimistic, expecting only a 40% plunge in U.S. markets in 2016. But what about Citigroup, who expect a 23% rise in European equites, or Piper Jaffray, who foresee U.S. equities 15%  higher? And what about the hundreds of other forecasts in between? The problem? We just do not know which one will be correct. The solution? Ignore them all. Not only do the ‘experts’ not know the future but most of them got the past wrong too (Edwards predicted further plunges in U.S. equities in 2012, just before the start of a massive 3 year rally).

3. Trader Danger

If you decide to, say, switch out of equities into cash for the next 6 months because you think that stock markets have further to fall, the problem is you are now a trader, not an investor, and that brings with it a world of danger. What happens if equities rally while you’re stuck in cash? How do you time future entry/exit points? Do you honestly think you can successfully trade your portfolio?

What to Do?

We have to remember why we invest in the first place. Put simply, it’s because equities outperform inflation and cash in the long run. At Money Smart we firmly believe that the only way to handle inevitable market ups and downs is to build a long term multi-asset portfolio with the riskiness (or equity content) of that portfolio driven by two key factors: how comfortable you are with short term volatility and when you need the money back. Or to put it another way, we believe that trying to reposition portfolios every week, month or quarter so as to benefit from short term market forecasts is a complete waste of time and money.

Money Smart can build you a diversified long term investment portfolio. Call 01 276 0006 or email info@moneysmart.ie.

Alternative Investing : Private Equity

Private Equity InvestingThis is the last of a short series of blogs on ‘alternatives’ – investments in anything other than stocks, bonds or cash. We have examined the four most common alternative asset classes in general order of risk/return profile; Absolute Return, Commodities, Property and Private Equity.

No.4 of 4 : Private Equity

What is it?

Private equity is the investment in the equity of a company which is not listed on a public stock exchange. Private equity firms such as Blackstone or KKR will generally start a new fund every three to five years. Most funds have a ten year life, typically investing in a portfolio of private companies in the first half of that decade and disinvesting over the course of the last five years. Private equity managers combine leverage with a focussed strategic or operational goal (aided by having a controlling stake in target companies) to create added value. This added value is crystallised into actual return on exit, which is normally achieved either by sale or by IPO. 

What are the Pros?

  • Most data suggest that private equity has consistently outperformed public equity through bull and bear markets, perhaps by as much as 5% over the long run.
  • Long locked-in investment periods deter poor manager and investor entry/exit decisions.
  • Diversification into alternative investment strategies and into an asset class that is (arguably) uncorrelated to public equities.
  • Benefit from the expertise and (legal) inside information of specialised managers in inefficient markets.

What are the Cons?

  • Illiquidity – your funds can be locked away for as long as 10 years.
  • Your commitment is generally called incrementally as the manager invests so you have to maintain a cash-like reserve that is quickly available for capital calls. If factored in to your investment this deflates total IRR considerably.
  • Costs are high (management and performance fees) and opaque.
  • Performance across various funds and managers is highly diverse.

How to invest?

A handful of Dublin private client brokers offer access (to qualifying investors) to the best known American and European private equity managers, either via single funds or funds of funds. This of course adds another layer of charges.

Do you need it?

Given the minimum investment is often €100k, I would advise that only investors with investment and pension portfolios of €1m+ need to consider adding private equity to their portfolios. And if you do invest, allocate no more than 20% of your total portfolio to this asset class and pick a fund of funds structure that offers both manager, strategy and geographic diversification.

 

Talk to Money Smart about how to build a portfolio with appropriate asset class exposure by calling 01 276 0006 or emailing info@moneysmart.ie.

Alternative Investing : Property

Buy-PropertyContinuing our short series of blogs on ‘alternatives’ – investments in anything other than stocks, bonds or cash – in which we take a look at the four most common asset classes in general order of risk/return profile; Absolute Return, Commodities, Property and Private Equity.

No.3 of 4 : Property

What is it?

From my experience as a financial advisor, in Ireland property is far from an investment alternative. In fact for many, everything except cash and property are alternatives! So I think you’ll understand if I skip the ‘what is property?’ bit. What I will say is that today I’m evaluating property as an investment for those who already own their own homes. Just for the record, I believe that owning your own home makes really good financial sense for lots of reasons – which I’ll cover in a future blog. But for now, let’s just talk about non-home property investments.

What are the Pros?

  • Expected long term returns of around 6% – higher than cash and bonds.
  • Portfolio diversification as performance is not correlated to equities.
  • Property is a ‘real asset’ that has an obvious ‘bricks and mortar’ capital value and pays (rental) income.

What are the Cons?

  • Single property risk and hidden fees can be higher than expected.
  • Can be subject to equity-like volatility and severe illiquidity.
  • Diversification benefits cannot be relied on in a financial crisis.

How to invest?

You (or your pension) can of course directly buy an investment property and take advantage of expense income tax relief – but the capital gains tax exemption has now been phased out. Or you can avoid the additional costs, worries, single property risk and leverage risk (if you’re borrowing to invest) of being a landlord by simply buying a property fund which exposes you to a large portfolio of property assets.

Do you need it?

Not necessarily, but for a more balanced portfolio, yes. At Money Smart we stopped recommending direct property investment once the capital gains tax exemption ended. But we do believe that your investment portfolio can benefit from a small exposure to a diversified property fund (or ETF or REIT) which may have both direct and indirect commercial (and perhaps residential) property holdings.

 

Talk to Money Smart about how to build a portfolio with appropriate asset class exposure by calling 01 276 0006 or emailing info@moneysmart.ie.

Alternative Investing : Commodities

CoffeeContinuing our short series of blogs on ‘alternatives’ – investments in anything other than stocks, bonds or cash – in which we take a look at the four most common asset classes in general order of risk/return profile; Absolute Return, Commodities, Property and Private Equity.

No.2 of 4 : Commodities

What are they?

Commodities are the raw materials used to create products, from ‘hard’ commodities such as gold and silver to ‘soft’ commodities such as coffee and sugar. Some investment professionals believe that commodities can lower portfolio risk while still providing an excellent return.

What are the Pros?

  • Higher expected long term returns than cash and bonds.
  • Portfolio diversification as performance is not correlated to equities.
  • Exposure to an asset class with a different performance cycle.

What are the Cons?

  • Commodities do not pay interest or dividends.
  • High volatility – can be more than twice as risky as bonds.
  • Diversification benefits much less evident since 2008.

How to invest?

You can now get cheap and efficient access to commodity funds on most investment platforms. If you are tempted to invest, stick with a whole market index ETF rather than expose yourself to single commodity risk.

Do you need them?

No. At Money Smart we believe that your investment portfolio can be perfectly balanced without the addition of commodities. Your absolute return and equity holdings (assuming you have them) should have sufficient direct and indirect exposure to commodity markets.

 

Talk to Money Smart about how to build a portfolio with appropriate asset class exposure by calling 01 276 0006 or emailing info@moneysmart.ie.

Alternative Investing : Absolute Return

Absolute Return

This is the first in a short series of blogs on ‘alternatives’ – investments in anything other than stocks, bonds or cash. We will take a look at the four most common alternative asset classes in general order of risk/return profile: Absolute Return, Commodities, Property and Private Equity.

No.1 of 4 : Absolute Return

What is it?

Targeted absolute return funds can be considered part of the hedge fund universe in that they manage investments with the goal of generating positive returns regardless of the direction of the general market. This flexible mandate may employ long and short positions, derivatives and leverage. The absolute return sub-set tends to have reasonably conservative performance goals, resulting in risk/return behaviour somewhere between bonds and equities.

What are the Pros?

  • Higher expected returns than cash and bonds.
  • Positive returns through all market cycles (hopefully!).
  • Better diversification and less volatility (risk) than equities.
  • Lag equities in bear markets.

What are the Cons?

  • Capital is not guaranteed – can produce negative returns in bear markets.
  • Complex strategies (using derivatives) and a lack of transparency.
  • Active management risk.
  • Lag equities in bull markets.

How to invest?

As (mostly) regulated onshore products, absolute return funds are the cheapest and easiest to access part of the hedge fund world. All of the major insurance companies have their ‘house’ version and investment platforms now offer a wide range of these funds. Because of the diverse range of funds, strategies, asset classes, geographies and performance, I would recommend you seek independent professional advice.

Do you need it?

At Money Smart we believe that multi-asset absolute return has a valuable part to play in a balanced portfolio. Although it does not have the negative correlation (to equity) benefits of bonds, absolute return can provide better returns than bonds in exchange for marginally more volatility – a key attraction in today’s low interest rate environment.

 

Talk to Money Smart about whether you need an absolute return fund in your portfolio (and which one) by calling 01 276 0006 or emailing info@moneysmart.ie.

 

Don’t Get Stuck In Default Mode

too many choicesDo you think you have free will? How often do you exercise it? You may need to think twice about your answers because every time we make a decision there are powerful behavioural forces hampering our ability to choose.

The dominant force I want to talk about is inertia, our deep psychological resistance to change. In many situations we seek to minimise the effort or cost of thinking. For example, as Nobel Prize winning author Daniel Kahneman points out in “Thinking Fast And Slow”, 12% of Germans are organ donors versus 99% of Austrians. The reason why? Inertia. Germans (like us Irish) have to opt-in but Austrians have to opt-out. It’s easier to do nothing than to do something. Default settings are therefore powerful tools in framing our choices.

Whether it be a pension plan, a privacy setting or a car rental agreement, any change to the default requires effort on our part. This may be a good thing if product providers are acting in our best interests but as Cass Sunstein notes, “Choosing Not To Choose”  is often not the right decision. For example, we end up with some unwanted and expensive holiday insurance when all we actually wanted was to book a budget flight online.

In my business I see a lot of people whose pension details are not just buried in a dusty shoebox, they are also stuck in an inappropriate asset class. Because pensions are boring/complicated/opaque, no great effort is made to match asset allocation to the clients’ circumstances. Some surveys show that up to 85% chose the default option – which in my experience is often too conservative for a lifetime investment strategy. Similarly, I know of many instances where fear and loss aversion has driven money into cash after the 2008 crash but inertia has resulted in many years since of low/no performance.

The solution? In the case of pensions, ensure your financial advisor has an ongoing hands-on approach to your pension investments. If you don’t have an advisor you will need to make a little bit of effort to rescue your pension from the doldrums.

More generally we have to hope that governments and corporations take more responsibility so that our pre-wired inertia bias is no longer used against us when it comes to product sales.

Talk to Money Smart about maintaining a pension portfolio appropriate to your needs by calling 01 276 0006 or emailing info@moneysmart.ie.

Smart Beta – What You Need To Know

SmartBeta1

You may have seen the term Smart Beta bandied about as the latest ‘must have’ for your investment portfolio. So what does it mean and what can it do for you?

Beta = Passive

Let’s just first talk briefly about Beta. Beta is passive investing – buying an index tracker that cheaply and efficiently delivers market return. Sounds like a rational investment strategy, doesn’t it? It most certainly is. But of course we’re not rational beings so we’re not happy with the average – we want to beat the average. And that’s where it all starts going wrong …

Alpha = Active

In our (and our fund managers’) quest to beat the market we often fail. How do we find star performers? Are they worth the extra fees? Active management, epitomised at an extreme by hedge funds, is a world of general failure in which outperformers are the exception. So how can we rationally and consistently do better than average?

Smart Beta = ?

Smart Beta blends aspects of both passive and active investment management. It’s active in that it attempts to beat market capitalisation weighted indices by capturing long standing market anomalies. And it’s passive in that portfolio construction is rules-based and transparent. For example, Dimensional, renowned Smart Beta managers, tilt their passive portfolios towards value stocks and small-caps in the knowledge that these two factors provide long term consistent outperformance of the index. While not as cheap as pure passive funds, Smart Beta (or factor) funds are significantly cheaper than active funds.

So, Where’s The Catch?

The ‘catch’ is that the outperformance factors identified by Smart Beta managers cannot be relied on to deliver outperformance year in, year out. For example, value stocks lagged in the bull market of the mid-2000s. But over the long term, patient investors have been rewarded for bearing the risks of being overweight value and smaller companies. A recent article in the Journal of Indexes looked at a subset of Smart Beta indexes and found that all of them outperformed their comparable index over the last 1, 3 and 5 years as well as since inception. And, smart beta factors have generally not been correlated with each other – that is, each factor tends to be rewarded at different times of the economic cycle.

What Do I Think?

I think every investor should have core holdings of beta/passive funds, augmented by Smart Beta. In fact, the new Money Smart risk targeted portfolios are exactly that – portfolios of world renowned passive or smart-passive funds designed to provide global diversification, cheaply, efficiently and smartly.

To hear more, please get in touch by calling 01 276 0006 or emailing info@moneysmart.ie.

Do You Know Your Alpha From Your Beta?

alpha and betaDo you invest or plan to invest in the stock market? If you do the first thing you need to know is the difference between alpha and beta. Let me explain the two concepts and why this should matter so much.

Beta is the market return, and this is easily and cheaply accessible via index funds. These funds form a core part of Money Smart investment portfolios because they consistently deliver the market return at a low cost and with good liquidity.

So, what’s not to like? Well, flawed human beings that we are, many of us have delusions of being the next Warren Buffett. We think we can beat the market. We think we can find stocks or funds that will perform better than the market average. We think we can find alpha.

Alpha is the return over and above the market return, the outperformance of your stock or fund versus its benchmark market. The problem of course is that the majority of fund managers underperform the market. Research has shown that ‘active’ managers generally return the market average – before fees. In other words, their average net return is 1 to 2% below the market return.

A recent JPMorgan report of the U.S. equity market since 1980 found that 40% of stocks have delivered negative returns over their entire lifetime, and two-thirds have underperformed the index. The same JPMorgan study showed that index investors happily achieved the market return helped by the 7% of “extreme winner” stocks that go on to provide huge returns. Still fancy yourself as a stock picker?

Alpha is elusive and expensive. It’s easy to find a star manager, or stock that has outperformed in the past but how do we know that it will outperform in the future? And how do we find a fund or manager that truly seeks the alpha for which you handsomely pay. Many of the balanced/managed/consensus funds popular in Ireland for far too long are in effect passive funds charging alpha fees. Their true alpha component (if there is one at all) is an almost imperceptible degree of under/over-weighting that cannot deliver the outperformance their fees should justify.

So, what should you do? Recognise that your investment decision has an alpha / beta implication. The decision to invest in a passive index fund is a decision to abandon any attempt to gain alpha. The decision to invest in a more expensive active fund is a decision to pay a premium for a blend of alpha and beta, knowing the alpha could well be negative.

And what do we at Money Smart do? We build portfolios largely made up of a large core holding of renowned global passive funds (including so-called Smart Beta) and only add active funds if we are very confident that the fund’s management and strategy can deliver real alpha or if the fund offers access to a market or asset class not covered by a suitable index fund.

If you want to hear more about our new and exclusive range of Money Smart funds built on this very philosophy please email info@moneysmart.ie

The A, B, C and D of Investing

My A B C D of InvestingForget about learning the A to Z of investing. You probably have more important things to be doing with your time. But if you just manage to be aware of my A, B, C and D of investing then you will be a better investor.

Once your objectives have been clarified by a financial plan, you need to think of an asset allocation that matches both your planned goals and your risk tolerance. It’s at this point that you should consider four critical components of successful investing.

A is for Alpha.

Alpha measures how much your fund outperforms its benchmark. If your investment is anything other than a passive index you need to be very aware of this over- or under- performance – because you are paying extra, often a lot extra, for this ‘market beating’ promise. The market is littered with products that charge high alpha fees but only deliver market (ie, average) performance. The age old problem is finding fund managers who consistently beat the index and thus deliver the much promised (and very well paid for) alpha.

B is for Beta.

Beta is the portion of your return that comes from the market or benchmark movement (whereas the extra fund or fund manager return over and above this is alpha). Passive funds, as recommended by Warren Buffett, offer investors cheap access to the market return (beta). This is why they, and so called “smart beta” funds, comprise a large portion of Money Smart portfolios.

C is for Correlation.

Correlation is simply the relationship between returns of different asset classes. Negative correlation, asset prices which generally move in opposite directions, is the key ingredient to our next concept, diversification.

D is for Diversification.

Diversification means allocating your capital across different asset classes, thereby reducing the risk of investing in a single asset type, like property, or a sub-asset type, like Irish bank shares. If those asset classes or sub-asset classes are positively correlated (tending to move up and down together) then, as investors in Irish property and bank shares found to their horror in 2008, this is the opposite of risk reducing diversification – it is, in effect, doubling-up.

Admittedly these are concepts for the experienced investor. If you can keep these four metrics in mind when you construct or amend your portfolio you will ultimately end up with a cheaper, more efficient and more robust portfolio. But if you don’t have the time or inclination to be this attentive, then please don’t ignore them. Instead just call me for a free initial consultation. At Money Smart we build tailored investment portfolios with these concepts front and centre of our thoughts, maintaining client portfolios that are smart and cost effective.

The Big Lesson To Learn From The Crash

In the wake of our exit from the Bailout, it’s a good time to look back and think about key lessons that Irish investors should never make again. The more I think about it, the more I realise that there is really only one key lesson to learn.

Lesson One of One: Do not put all your eggs in one basket

Diversification works. Has always worked. Will always work. Because we cannot predict which asset classes will produce the best return in the future, we can reduce the chances of large losses by having a risk targeted portfolio of varying proportions of cash, bonds, commodities, property, equities and so on.

 

So applying this single lesson further to the Irish experience, we should remember that (and excuse me for being obvious) …

  1. Property is not the only asset class.
  2. Your home counts as property exposure.
  3. Adding debt (loan) to your (property) investment multiplies risk.
  4. Never buy a single stock; invest in an index or mutual fund.
  5. Holding only Irish bank shares is not diversification.
  6. Holding only Irish stocks is not diversification.
  7. A portfolio of Irish bonds, property and equities is just more eggs in (pretty much) the same basket.
  8. Know your pension asset class exposure – it matters.
  9. Know about all various asset class investment alternatives and how to access them.

 

At Money Smart all our clients are guided towards a bespoke globally diversified risk targeted portfolio of various asset classes to be held for the long term. We know where our clients want to get to, we know their true risk tolerance, we don’t pick stocks, we don’t time markets, and we keep it simple with portfolios built for boom and bust.

This lesson sounds obvious but it is still not being learned because we will always hear from some expert or other about the next big thing to pile into. So we all need to keep reminding ourselves about this or else we will be going back to the roulette wheel again and again.