Let ‘keep it simple’ be your motto
More on Philip Coggan
Eleven years ago, when I wrote my first article for Investment Adviser, the world looked completely different. The equity market had just finished a long bull run. Few anticipated the disappointments ahead. The UK economy was motoring. Gordon Brown boasted of “no more Tory boom and bust”. The tragedy of September 11 had yet to occur. UK troops had yet to enter Iraq or Afghanistan.
In terms of investment products, investors had barely heard of self-invested personal pensions or exchange-traded funds. Many companies were still offering final salary pensions to their workers, rather than hiving them off into defined contribution plans. And savers could still count on a reasonable real return on their deposit accounts.
So perhaps the key lesson of this, my last article for Investment Adviser, is that a lot can change in the course of a decade or so. Investors and advisers need to be aware of the staggering level of uncertainty, and prepare accordingly.
The first consequence of this is the great insight of Benjamin Graham, Warren Buffett’s guru, that investors should allow for a “margin of safety”. We do not know how the future will turn out. So we should be very wary of investments that can only offer a decent return if a highly specific – and historically unlikely – set of circumstances were to occur. Back in 2000, many technology stocks traded on a price-earnings ratio of over 100, requiring a long period of double-digit growth in profits to make them worthwhile. Very few companies in history have maintained such a pace of growth for long, and the task of the technology sector was all the more difficult since such companies would inevitably be competing with each other.
Right now, investing in government bonds at very low – and in Germany, negative – yields is a bet that there will be a long recession, combined with a euro break-up, and that central banks will not allow inflation to rise sharply. That might be the right call, but the potential losses if it is the wrong outcome will be very large.
Investing in government bonds at very low – and in Germany, negative – yields is a bet that there will be a long recession, combined with a euro break-up, and that central banks will not allow inflation to rise sharply.
The corollary to all this is that it is easy to get blindsided by news headlines, political intrigues and all the rest. Focus on the initial valuation of an asset and you won’t go far wrong in the long run. That final qualifying phrase is crucial. One reason why I have been so pessimistic for much of the last 11 years is that valuations have been so high.
A way of exploiting this effect is to look at the sectors that have performed best in the past 10 years – and avoid them. Back in 2001, the performance tables were dominated by technology funds. Now it is emerging markets and commodity funds. While both sectors still have their attractions, as a play on a rebound in global growth, the tech example shows the danger of having a very high exposure to either asset class.