Skip to the content

Why you need to prepare for “the four most dangerous words in investment”

21 July 2017

Skerritts’ Andy Merricks examines the argument that "it's different this time” and explains how he is positioning portfolios for the ‘new normal’.

By Gary Jackson,

Editor, FE Trustnet

Sir John Templeton famously said that the “the four most dangerous words in investment are ‘it’s different this time’” but Skerritts Chartered Financial Planners’ Andy Merricks argues that this may very well be the case today.

As a result, the group is using a range of strategies – including exchange-traded funds (ETFs) focused on ageing populations and cybersecurity – and exposure to smaller companies outside of the UK to capitalise on the onset of a new environment in markets.

The suggestion that ‘it’s different this time’ should usually be taken with a pinch of salt as it is often used to justify excessively high valuations – such as when tech stocks got ahead of themselves in the dotcom bubble – or ignoring other times when past experience would suggest difficult conditions could be on the horizon.

However, Skerritts head of investments Merricks believes there is indeed reason for investors to expect the future will look very different to what has gone before.

“Leaving aside the question of whether the abbreviation of ‘it is’ constitutes one word or two, we wonder whether the saying needs to be updated in the aftermath of the financial crisis of 2008. Perhaps now, the most dangerous belief in investment is the failure to understand that, yes, it is different this time,” he said.

Performance of global equities and government bonds since 2008

 

Source: FE Analytics

“The world has been very slow to understand the new framework within which we live, due primarily to the fact that most economists, politicians, fund managers, policy makers and people who write investment commentaries such as this all learned their trade during the two and a half decades leading up to said crisis, studying the same theses and listening to the same tutors before marrying each other, living in the same districts and frequenting the same eateries and socialising at the same watering holes, having had their ‘normal’ shaped by the longest and biggest credit boom of all time.”

Merricks added that many have spent the years since 2008’s global financial crisis waiting for “their ‘normal’ to reappear”.

“Those who are so entrenched in their beliefs of what constitutes normal, and can not adjust, will have a long and increasingly uncomfortable wait,” he warned. “Some, and there will be a few ‘names’ among them, will not survive with their business models.”


A recent Bloomberg article titled Markets No Longer Make Sense to Macro Managers highlighted the challenges facing hedge fund managers, who are finding it difficult to operate in markets that seem to be shaped more by trading algorithms and low volatility than they are economic trends, currency moves, politics and monetary policy.

“I felt the intensity of following markets at a time of increasing political and economic confusion very hard. My entire career had centred on an understanding of monetary politics and I had trouble getting my head around it all. It was exhausting,” said one manager who has closed his hedge fund after nine years.

Annualised volatility of MSCI AC World index over 10yrs

 

Source: FE Analytics

Merricks thinks this shows how investors need to embrace a new way of thinking: “In a nutshell, he failed to understand that it’s different this time.

“As an aside, if you want a clue whether someone ‘gets it’ with the new environment in which we live, listen out for anyone using the word ‘normalise’ – as in ‘we expect rates to begin to normalise in the next few months’. These people are still entrenched in pre-2008 beliefs.”

Of course, there isn’t anything particularly new about the new normal – Merricks noted that it has been a factor for the past decade. However, investors are still coming to terms with what it means for them.

One consequence is abundantly clear though: low interest rates mean equities have benefitted from quick recoveries from market dips and corrections. Given the very low returns on cash and bonds at the moment, each fall in stock markets is quickly followed by them becoming good value again.

“As long as the equities that you were buying before a correction make sense as investments, they will make even more sense to own again once they become, say, 10 per cent cheaper than they were before the correction occurred,” Merricks said.

“Consequently, markets make what is termed as a ‘V-shaped’ recovery. Even the great crash of 2008 saw markets recover within a year. Since then, liquidity provided by the central banks has forced institutions to buy equities, propelling markets to ever-higher levels.”

Many investors have a natural fear around record highs in markets, as it appears that the only direction stocks are likely to go in the short term in down. However, Merricks noted that a key element of capitalism is for markets to experience constant growth: “It is time, not timing, that is the greatest ally to an investor.”


With this in mind, the head of investments suggested those who buy and own stocks that the world wants are “onto a winner”.

“Old school investors tended to allocate their portfolio geographically, but it makes sense to us to allocate along sectoral lines,” he added. “As a result, our portfolios are full of sectors such as cyber security, robotics and automation, healthcare and biotechnology, and areas associated with an ageing population.”

Skerritts Chartered Financial Planners hold products such as ETF Securities ISE Cyber Security GO UCITS ETF, ETF Securities ROBO Global Robotics and Automation GO UCITS ETF and iShares Ageing Population UCITS ETF USD to take passive exposure to these themes in its portfolios.

Performance of ETFs vs global equities over

 

Source: FE Analytics

Active exposure to some of the themes is taken through the likes of AXA Framlington Biotech and Worldwide Healthcare Trust.

“It doesn’t really matter to us where in the world these companies are listed,” Merricks added. “However, we see the return of the European consumer and so allocate to European smaller company funds, as well as Japanese smaller companies which, as with their European counterparts, tend to be more domestically focused.”

Funds offering exposure to these parts of the market include JPM Europe Smaller Companies and Legg Mason IF Japan Equity.

Allocations to the assets that can benefit from ‘the new normal’ has led to strong returns for Skerritts’ Tactical Alpha Plus portfolio, which has holdings in all of the funds mentioned above. A very similar strategy is being pursued in the 8AM Focused fund that Merricks co-manages with Tom McGrath.

FE Analytics shows that the Tactical Alpha Plus portfolio has made close to 100 per cent over the past five years, compared with a 71.07 per cent gain in the AFI Aggressive index.

Editor's Picks

Loading...

Videos from BNY Mellon Investment Management

Loading...

Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.