Staying invested through turbulent times

By Nedgroup Investments

IT HAS BEEN A TOUGH FEW YEARS FOR SOUTH AFRICAN INVESTORS

The South African economy has been under severe pressure over the past few years. GDP growth has been weak, Government debt has grown to unsustainable levels, State-Owned Enterprises have been struggling and our unemployment rate has reached new highs. As a result, domestic growth assets (listed equity and property shares) have not performed well. On top of this, the recent outbreak of the global pandemic COVID-19, has led to an extreme downturn in global markets – including South Africa - in early March.


 

The chart above illustrates the performance of the domestic equity market – a key component of domestic multi-asset funds - since the start of 2014 to the end of April 2020. The lack of growth over the past few years, combined with the COVID-19 crisis, has made it very difficult for domestic multi-asset (MA) and equity funds to deliver performance in line with inflation, let alone their inflation-beating targets. The chart below reflects the average performance of the respective fund categories over a 3- and 5-year period as at 30 April 2020.

 
Markets continue to be extremely volatile. No one knows for sure how this crisis will work out, as it is largely dependent on how long populations have to be confined, and economies supressed. This uncertainty is becoming increasingly difficult for clients to manage. Even though growth assets are now in general cheap, and by many labelled as ‘on Black Friday sale’, investors are tempted to sell funds with exposure to growth assets in favour of cash and the protection it offers. As difficult as it may be - or as foolish as it may feel – it is important that investors remain invested and stick to their long-term investment plan. Here are three tips to help you manage the intuitive behaviour brought on by panic.

BE AWARE OF HOW THE HUMAN MIND RESPONDS TO COMPLEXITY

To understand how the human mind responds to complexity, answer the following three questions – without reaching for your calculator or using Google.
 What is 2 + 2?
 What is 62 + 48?
 What is 32 765 + 69 561?

The first two questions were easy to answer. ‘2 + 2 = 4’ is part of our memory and similarly, ‘60 + 40 = 100’ and ‘2 + 8 =10’ made it easy to get to 110. The third is more complex and needs to be calculated, as opposed to simply recalled from memory. Most people are initially overwhelmed by this complexity and tend to think it is impossible without a calculator. It is only after you take a deep breath and relax that your mind allows you to tackle this problem step-by-step, just like we learned in primary school.
Volatile markets and complex news flow often cause the human mind to go “blank” and can easily lead to irrational decisions. In these times, it is important to take a step back and separate the noise from the fundamentals.

MINIMISE BEHAVIOURAL PORTFOLIO MANAGEMENT MISTAKES

Behavioural biases are shortcuts the human mind takes to make decisions, using several filters manufactured by day-to-day life and unique experiences. These biases often lead to irrational decisions and for most investors it is impossible to be unbiased in investment decision-making. However, investors can mitigate biases by understanding and identifying them.

The availability bias is believed to be one of the most common in investment decision making. This mental shortcut assumes that if something can be recalled, it must be important. However, it is usually the most recent or the most traumatic results that we remember first and then base our decision on.

For example, an investor with an investment horizon of 5 years, invested in a multi-asset high equity fund, is likely to compare the recent short-term performance to that of multi-asset income funds. As per the ‘traumatic’ chart on the left below, multi-asset high equity funds have underperformed income funds over a rolling 1-year period 84% of the time over the last 5 years. The availability bias may result in this investor disinvesting from his suitable multi-asset high equity fund to invest in a multi-asset income fund instead. Multi-asset income funds offer less growth potential due to its limited allocation to growth assets, but a higher degree of capital protection. These funds are suitable for investors with a shorter investment horizon and/or specific income needs.

As per the chart on the right above, the likelihood of multi-asset high equity funds outperforming multi-asset income funds over a rolling 5-year period is far greater than what the recent short-term performance suggests. The extent to which multi-asset high equity funds can outperform income funds over a rolling 5-year period also far exceeds what the recent short-term performance suggests.

To minimise the availability bias, investors should review the performance of funds over its appropriate time horizon and consider its long-term track record over complete investment cycles.

AVOID KNEE-JERK REACTIONS TO SHORT-TERM DISCOMFORT

The past two months have certainly been a tail of two halves for the domestic equity market. The month ending 24th March was a turbulent one, down close to -30%. Conversely, the month ending 24th April markets showed positive returns in excess of +20%. As per the chart below, domestic multi-asset and equity funds experienced a similar level of extreme volatility.


 
To quantify the opportunity cost of knee-jerk reactions, let’s assume an investor disinvested from the equity market on the 24th of March, just after this year’s low point, and invested in cash instead. The performance over the above mentioned two months for this investor is illustrated below (grey area) and compared to that of the equity market (green line).


 

In just one month, this investor lost out on a recovery of R 15 000 for every R 100 000 invested at the start of the period. This is a 15% recovery that was missed.
The key take out of this is the critical importance of investors sticking to their long-term investment plan. Trying to time the market is impossible to get correct on a consistent basis and investors need to manage their emotions of anxiety during times of market stress.

We urge investors to stick to the basic principles of investing through these turbulent times, a few of which are listed below.
 Your investment time frame is the key driver of the level of risk you can afford;
 Your risk tolerance drives the asset allocation suitable for your objectives and needs;
 Asset allocation is an important driver of expected return;
 Diversification has benefits as it enables you to reduce risk without compromising return;
 Emotions can erode value, so avoid knee-jerk reactions to short-term discomfort;
 Reasonable returns compounded over long periods can produce great investment results.

Remain in close touch with your financial advisor, stick to the agreed investment plan and importantly, be patient.