The legendary investor’s views, which argue that it has been “far safer” to invest in a diversified portfolio of stocks over less volatile securities such as government bonds, has been met with broad agreement from the UK fund management industry – with one manager saying there has been “a bear market in risk-taking” over recent years.
In his letter, Buffet (pictured) said: “For the great majority of investors … who can – and should – invest with a multi-decade horizon, quotational declines are unimportant. Their focus should remain fixed on attaining significant gains in purchasing power over their investing lifetime. For them, a diversified equity portfolio, bought over time, will prove far less risky than dollar-based securities.”
“If the investor, instead, fears price volatility, erroneously viewing it as a measure of risk, he may, ironically, end up doing some very risky things. Recall, if you will, the pundits who six years ago bemoaned falling stock prices and advised investing in ‘safe’ treasury bills or bank certificates of deposit.”
“People who heeded this sermon are now earning a pittance on sums they had previously expected would finance a pleasant retirement.”
“If not for their fear of meaningless price volatility, these investors could have assured themselves of a good income for life by simply buying a very low-cost index fund whose dividends would trend upward over the years and whose principal would grow as well (with many ups and downs, to be sure).”
In his letter, Buffett focused on the long-term differences in holding US stocks and securities such as treasuries, pointing out that the S&P 500 returned more than 11,000 per cent between 1964 and 2014, when re-invested dividends are taken into account.
When it comes to the dollar, however, what could be bought for 13 cents in 1964 now costs $1.
While Buffett focuses on the US, a similar picture is seen in the UK. The latest Barclays Equity Gilt study estimates that UK stocks have returned 5 per cent per annum over the past 115 years, while gilts have returned 1.3 per cent and cash just 0.8 per cent.
The research also argued there is a 91 per cent chance of stocks outperforming cash if held for 10 years, while there’s a 79 per cent likelihood of them outperforming gilts.
Performance of indices over 10yrs
Source: FE Analytics
Rob Burdett (pictured), co-head of F&C's multi-manager team, has been concerned for a while that investors are not taking enough risk in their long-term portfolios and leaving themselves with a lower chance of meeting their investment objectives.
“In general terms we have been saying for some time that the effects of a ‘lost decade’ – or more – for the FTSE have scarred and scared investors – and perhaps their advisors and the industry – to such an extent that the risk is investors don’t take enough risk to meet their personal long-term needs and goals and sit there in cash underperforming inflation,” Burdett said.
He added: “In effect there has been a bear market in risk-taking.”
“For the equity markets right now we feel this is in part an underpin as there is little chance of investors who shouldn’t be owning equities in the first place don’t. So there are less ‘wobbly apples’ to fall when the market has one of its inevitable worries.
“We think this effect explains in part the resilience of the market into the last 12 months’ extraordinary events in the Ukraine, terrorism, etc. Not many buyers then, but even fewer sellers left.”
Retail fund flow figures from the Investment Association highlight this point. While IA UK Equity Income was the best selling sector in 2014 – largely down to Neil Woodford launching his own fund – the next most popular are the preferred hunting grounds of the more cautious investor: the IA Property, Mixed Investment 40-85% Shares, Mixed Investment 20-60% Shares and Targeted Absolute Return peer groups.
Looking back over recent years also shows investors flocked to more defensive sectors: IA Mixed Investment 20-60% Shares was the best selling sector in 2013, 2011, 2010, 2008, 2007 and 2005; IA Sterling Strategic Bond led in 2012; and IA £ Corporate Bond in 2009.
James Budden, marketing director at Baillie Gifford, said: “Something strange is happening. Multi-asset, property and income is selling well, but regional and global equities – i.e. the longer-term funds – have been disappointing.”
“There’s a fear of volatility out there at the moment. More and more I’m seeing a sense of doom and gloom: the Grexit, a meltdown in China, the UK election, the falling oil price and so on. However when you look at the returns, these longer-term funds are doing very well.
Budden agrees that volatility should not be too closely equated with risk and points to James Anderson's £3.2bn Scottish Mortgage Investment Trust as an example which makes this point.
“A lot of people think volatility equals risk, but they’re wrong,” he said. “A patient long-term approach means there will be a lot of volatility at certain times, but look at the long-term result. One of the biggest risks out there is opportunity cost.”
FE Analytics shows Scottish Mortgage is one of the most volatile members of the IT Global sector, with annualised volatility of 23.71 per cent over 10 years ranking it 32 out of 33 trusts.
But investors who ruled it out because this would have missed out on its 355.07 per cent return over the same period – which is more than double the gain of the sector and the FTSE All World. What’s more, the trust’s Sharpe ratio of 0.55 means it is one of the best funds in the peer group on for risk-adjusted returns.
Performance of trust vs sector and index over 10yrs
Source: FE Analytics
Simon Evan-Cook (pictured), senior investment manager on Premier's multi-asset fund range, agrees with Buffett’s point that equities have been less risky over the long term. He points to the Barclays Equity Gilt study, which shows investors have never made a real loss from holding UK equities over any 23-year period but the same cannot be said for gilts or cash.
This suggest a young person saving for retirement could be taking more risk by holding the “supposedly safer assets” than they would be if they held equities. The manager says the current low gilt yield, which increase the likelihood of these bonds making a real loss in the coming years, makes this point “particularly relevant” at the moment.
Evan-Cook added: “It’s very hard to argue with anything Warren Buffett says. Perhaps that’s why I don’t. This time is no different. His comments on investors’ unhealthy focus on volatility are spot on.”
“We certainly don’t view volatility as risk, for the simple reason that they are clearly not the same thing. Take commercial property back in 2008. Prices were not volatile, but as the subsequent experience showed, this was not because the assets weren’t risky, it was because they were illiquid.”
“Conversely, volatility can sometimes signal a bad investment becoming a good one, purely by dint of its share price dipping as momentum investors fall out of love with it. Avoiding such investments solely because their price is fluctuating quickly is likely to mean opportunities missed.”