Long-term investors need to understand which short-term risks can be ignored as well as which need to be factored into portfolios, according to Skerritts head of investments Andy Merricks.
In his latest note to investors, Merricks argues that a common trend appears to be that “the long term is getting shorter”.
In recent years, for example, investors appear to have become more fixated on the daily fluctuations in the value of their portfolio and show an apparent willingness to switch out of investments after a period of underperformance as short as six months.
The biggest tail risks for global fund managers
Source: Bank of America Merrill Lynch Global Fund Manager Survey, December 2016
“Human nature is becoming more fickle,” he said.
“Just look at the world of football where a bad run of three games can see a manager lose their job. If you are running Birmingham City even a good run of results is enough to turn to someone else.
“What is the best way to manage an investment portfolio in a more volatile, short-term, uncertain global backdrop?”
Step one, according to Merricks, is to decide which short-term risks are worth worrying about and which will be too difficult to accurately protect portfolios from.
“There is so much to potentially keep an investment manager awake at night you have to decide what to worry about,” he said.
“Can you defend against natural disasters, terrorism or the irrational behaviour of influential individuals? Probably not. Should you be second guessing the outcome of an election, referendum, policy committee meeting or private telephone conversation? Probably not either. 
“Should you worry over the direction that the world is heading, stated central bank or governmental policies, rising tensions between sovereign states or regions, general social mood and sentiment and overall market valuations. Yes, these are worthy of a slice of one’s allocation to angst.”
In essence, investors need to weigh up a range of short-term and long-term factors that are parts of “the overall jigsaw” but they need to accept that a portfolio cannot be positioned to offer protection against all risks.
“Sometimes you have to accept that you take a short-term blow to the chin,” Merricks said.
Another element of getting the most opportune balance between short- and long-term positioning, he explains, is to recognise that simply holding onto an asset for a lengthy period of time might not be the best strategy. Indeed, he argues that in some instances holding onto an investment over the long term can mean missing out on other opportunities.
“For example, if someone had bought a FTSE 100 tracker that excluded dividends on Christmas Eve 1999, it would have taken until September 2009 to have recovered, and not gone back to, your original entry point. In effect, 10 years of nothing. Many alternative investment opportunities existed elsewhere during that timeframe,” Merricks explained.
“But that’s not to say that the FTSE 100 was a waste of time. If you had invested in that same dividend-less FTSE investment vehicle on 6 March 2003 and held it all the way through the financial crisis until 27 January 2017, you would be sitting on a return of 234 per cent.
“The same investment would have produced very different outcomes for different investors over the long term, so it is folly to dismiss any market or sector. It is the entry point that makes a huge difference to returns.”
That’s not to say that no investments should be made on a long-term basis. Skerritts has exposure to themes such as cybersecurity, robotics & automation, biotechnology and the ageing population in its portfolio as it believes that their progress is “going away, so we are prepared to buy and hold investments that reflect this view”.
Merricks says the question for portfolio manager is whether they should “chop and change” the shape of portfolios to reflect short-term shifts in sentiment or whether it is preferable to maintain positioning, ignore short-term discomfort and hold out for rewards in the long run.
“The chart highlights just how entrapped we are by regular cycles since the financial crisis. A continuous overshoot in either direction is followed by a corrective move in the opposite, but the main feature has been that every correction has preceded a period whereby the markets continue on an upward trajectory (a bull market),” he added.
Cycles since the financial crisis
Source: JP Morgan
“This has led to the buy and hold strategy of the run-of-the-mill tracker fund appearing to be the most sensible and cost effective way to invest. People have very short memories and most will not have experienced buying a tracker on Christmas Eve 1999 and holding it for 10 years with virtually no return, having experienced most of those years in negative territory.
“How long can this current bull market that we’ve experienced since early 2009 last? It would be great if it carried on for ever, but sadly it doesn’t work like that. Could we be nearer the point of needing to pay more attention to the short term than taking the wait and see approach of closing our eyes, putting our fingers in our ears and waiting 10 years to see where we’ve ended up?”
So in the short term, Skerritts is taking a cautious stance as it appears that the world is rejecting globalisation, the US is becoming more mercantilist, and a trade war between the US and China could be on the cards.
For long-term positioning, however, the wealth management firm is focusing on bets to specific themes, overweighting the developed world over emerging markets and paying more attention to smaller companies in the UK, Europe, the US and Japan.
“Who knows what will happen in the short term? We don’t,” Merricks concluded. “But we’ve got to be ready for it as it shapes what our clients’ accounts look like in the longer term.”