Many of you will have watched Hideki Matsuyama win the US Masters Golf recently and, as with all the champions down the years, key to his success was playing the Augusta course rather than against his tournament partner Xander Schauffele and the other 86 competitors.
Our clients will know how much we enjoy applying any kind of sporting analogy to the world of finance and particularly our brand of patient multi-asset investing. The acceleration of the pandemic, and, more recently, the flood of day traders into stocks such as GameStop have reiterated the potential impact of volatility on clients’ wealth. None of us can control the markets, other participants or volatility itself but what we can manage is our own behaviour and play our own game, as it were. There are certain things we can do and, more importantly, avoid as we look to ‘win’ the investment game over the long term, and a vital part of this lies in not losing, much like a golfer should concentrate on avoiding unforced errors.
As Scottish-American golfer Tommy Armour said: ‘It is not solely the capacity to make great shots that makes champions, but the essential quality of making few bad shots.’
Investment has become massively more competitive in recent years, with 154,000 CFA Charterholders worldwide compared with just 10,000 in 1990. According to Greenwich Associates founder and investment consultant, Charles D Ellis, ‘the professional money manager isn’t competing any longer with amateurs who are out of touch with the market, now he competes with other experts’. A major factor behind that has been the democratisation of information driven by the internet, with the top three websites (Google, Youtube and Facebook) accounting for 152 billion visits each month.
Given this backdrop, Ellis’s book Winning the loser’s game makes the claim that the best strategy for winning in investment is to avoid mistakes and he suggests four ways to approach this: concentrate on your defences, keep it simple, play your own game and don’t take it personally; all of these are applicable to the key tenets of our investment process.
Taking concentrate on your defences first, a central part of winning by not losing is focusing on the potential downside of any investment decision before considering the upside. Some basic numbers make this point very clearly, with rapidly rising percentage gains required to make back higher losses. Losing 10% of an investment’s value only requires an 11% gain to make up the shortfall but this number climbs rapidly to a 67% return needed to make good a 40% decline and 100% to get back to par after a 50% drop. For us, this focus on downside protection is critical to meeting client outcomes and we tend to favour underlying managers with a similar mindset to us in this respect.
Moving on to keep it simple, this is about following an established investment process and understanding what ultimately drives performance: long-term data show 80% of portfolio returns come from asset allocation, which is why strategic asset allocation (SAA) underpins our funds, and just 20% from stock selection and market timing. To be clear, fund selection and tactical asset allocation (TAA), where we look to invest in our favoured areas at cheap levels, are also key parts of our process, but SAA remains the primary driver of returns.
Another part of keep it simple is avoiding those unforced errors that tend to come when investors try to time the market, which decades of data show even the most experienced professionals cannot do with consistency. Any book on behavioural finance will go into detail on what lies behind these common investing mistakes but, ultimately, they all manifest in certain ways, either trading too much or too little, or taking too much risk or not enough. Again, this comes back to our golfing analogy: it is ultimately not the few great shots that determine success but reducing the number of bad ones.
This leads on to the third of Ellis’s lessons, which is play your own game and, in an investment context, this is about focusing on client outcomes and ignoring short-term noise as far as possible. This encompasses several lessons which also centre on patient investing with an ultimate goal in mind. Key to this, we suggest, is remembering that equities tend to drive returns over the long term (as part of overall asset allocation), diversification is integral despite the temptation to zero weight underperforming assets, and while consistency of performance is impossible across all timeframes, consistency of process is vital.
The ongoing active versus passive debate is a good example of the kind of noise that ultimately does little to help long-term wealth generation. Our approach is that both should play a role in portfolios but selecting active managers is the way to produce higher returns over the long term. For patient investors, there is enough dispersion in returns to identify manager skill, as opposed to luck, and select those who can outperform long term. To find such active winners, we look for various characteristics and a core one is consistency of process; again, we tend to favour managers who mirror our own patient approach, showing clarity and consistency of process plus courage and conviction in executing it.
A final way to win at a loser’s game is don’t take it personally and, once again, this is about avoiding unforced errors and not giving way to the forces of fear and greed that influence so many investment decisions and lose people their hard-earned money. We have talked about the potentially damaging impact of FOMO (fear of missing out) investing in recent years and the market psychology cycle shows how quickly hope and euphoria can turn into denial and panic, or fear becomes greed and vice versa.
A few numbers show the potentially devasting impact of poorly timed decisions and reacting to short-term noise: missing the best 50 days in markets over the 11 years from March 2009 to February 2020 would reduce the return from £100,000 invested in an average Cautious Managed fund from £218,700 to just under £130,000 – which equates to 75% lower returns.
We pursue what we call noise-cancelling investment as far as possible: staying the course in a well-diversified portfolio and ignoring market fluctuations. Over rolling three-month periods in the last 25 years, the FTSE 100 has been down 30% of the time and up 70% of the time; if you extend that period to rolling 10-years, the ratio shifts to 98% of the time being positive periods. Making decisions based on short-term data rarely produce good results.
Winning by not losing may be less spectacular, whether in investment or golf, but it reduces the emotional rollercoaster experience and helps to avoid those unforced errors that can be so damaging in both pursuits. For us, successful long-term investing needs to focus on achieving risk-adjusted returns and meeting desired client outcomes rather than beating peers or markets; in this context, patience, discipline and consistency of process pay off, and we suspect Hideki Matsuyama might say something similar.
