Investors need to turn around the way they look at risk in recognition of the fact that opportunities do not present themselves in a linear manner – despite what the asset management industry says.
This is according to Charlie Parker, managing director at Albemarle Street Partners.
Parker notes that a typical fund is set up according to the level of risk the underlying investor is willing to tolerate, whether that is a US growth strategy that is allowed to diverge from the benchmark by 4 per cent a year or a balanced managed product that aims to beat cash by a certain amount.
He said the problem with this approach is that it assumes the way to make money is by taking the same level of risk every year, regardless of the underlying conditions. However, he warned this is not how markets work.
“If you look outside of our industry and at the people who have all the world's money in their hands, like Warren Buffett, Apple and sovereign wealth funds, the people who are already very wealthy, they are in a position where they don't take risk in a linear way,” Parker explained.
“Rather, they recognise that there is a great deal of time where there's not a lot of point taking risk and then there are specific moments in time where there are huge opportunities.”
One example came in the 2008 financial crisis when Buffett loaned Goldman Sachs $5bn in the form of preference shares yielding 10 per cent. In 2011, Goldman Sachs redeemed the shares, earning Buffett a profit of $3.7bn.
Parker is not recommending investors attempt to time the market, pointing out that numerous studies suggest that it leads to worse outcomes. A study published by Fidelity last year showed that someone who waited until the FTSE All Share suffered a major crash before investing would have underperformed someone who drip-fed their money into the index over the long term. Even worse, Parker said that of the IFAs he works with, a handful reported they had clients who pulled money out of the market last year after March’s crash.
The perils of attempting to time the market
The first investor, ‘Steady Eddie’*, began investing regularly in the FTSE All Share 30 years ago (1 February 1990), making an annual contribution of £1,000 during that decade and increasing this to £2,000 a year between 2000-2009, and £3,000 between 2010-2019. In contrast, ‘Bad Timing Betty’** only invested in the FTSE All Share when the market hit a cyclical peak, before a downturn. Like Eddie, Betty set aside £1,000 a year, increasing this by £1,000 each decade between 1990 and 2020. Finally, ‘Good Timing Gary’*** chose to invest in the FTSE All Share when the market was at its lowest. He saved the same amounts each decade as his counterparts.
Instead, he said that investors need to do their own research rather than take the assertions of the asset management industry at face value.
“If you go back to the question ‘what market factor works?’, the first thing you’ve got to do is realise you can't do that intelligently if your input is coming from fund management companies. Fund management companies are unreliable witnesses to this phenomenon, they are talking up their books one way or another.”
Returning to Buffett’s Goldman Sachs deal, he said: “Buffett only had to bet Goldman Sachs would survive 10 years to know he would make a huge amount of money.
“In the short term, he was taking a lot of risk. But if you are a fund manager, you may think, ‘I can't buy Goldman Sachs in March 2009 because if I have another two bad quarters, then my investors will dump my fund and buy someone else’.”
Parker believes that a non-linear and binary investment opportunity could now be opening up in value stocks.
Referring to the Fama and French Three Factor Model, he pointed out it shows that value investing “knocks every other possible approach out of the park” over the long term. And on the subject of value’s underperformance over the past decade, he said the argument that this strategy no longer works is not unique to today.
Performance of indices over 20yrs
Source: FE Analytics
“Obviously, this time it has been linked to technology, with people saying it's because there is all this secret value in these technology companies and we aren’t measuring it properly. But actually, the historians say that that happens at the fag end of every economic cycle: people lose faith in value.”
Rather than being broken, Parker said the timeframe over which value now takes to work has grown longer than is tolerable by the majority of investors. And he added that if you were to take anything from the underperformance of value over the previous cycle, it is that buying something just because it is cheap is not a viable strategy.
“We could not have held on to value for the last five years because our business wouldn't have been here. Most value managers got sacked,” he continued.
“But I think it's absolutely reasonable to say that if you buy value in the early phase of the economic cycle – and it's quite clear that we have lurched from the end of an economic cycle, through an obvious bust and to the start of a new economic cycle – value will work.
“If you go back and look at the last 100 years of economic cycles, we can over-intellectualise and overanalyse this thing until we're blue in the face, but I suspect that it will just do what it's done in every other economic cycle. Value will work and it will work for a long time.”