A multi-asset approach and ignoring emotions

Speaking to TRUSTNET on the 3rd December 2011

We spotted this article on the Trustnet adviser website this week. It gives food for thought for new and existing long term investors alike. Here at Create Wealth Management, we too have been espousing the benefits of multi asset investing and allowing fund managers, who with their experience and research teams can make the important structural and timely changes needed to take full advantage of market rises and falls. We believe that Michael Azlen echoes our own beliefs and attitude to investing, avoiding trying to ‘call the markets’ when they enter rough waters, as they have been these last few years.

Michael of Frontier Investment Management says,”Taking a multi-asset approach and ignoring emotions is the most reliable method of generating consistent returns over the long-term.

The current environment should not be a cause for impromptu investment decisions when assessing an investment portfolio.

A large amount of research indicates that an investment decision made due to a market event or environment often proves to destroy rather than add value, for example by crystalising losses and missing subsequent rallies.

Sound empirical evidence demonstrates that capital market asset classes have an embedded return in excess of cash and inflation, known as a risk premium. In the case of UK equities, this has generated an average return of approximately 11 per cent per year over a 100-year timeframe.

There have been a number of 12-month periods during this time when returns were negative but very few 10-month periods when the asset class has underperformed cash. Therefore, if an investor commits to investing over a five- to 10-year term, periodic market downturns should signify little more than the regularity of a market cycle, which in turn should not affect long-term portfolio performance.

The importance of time can be exhibited through empirical evidence – in this case an equally weighted multi-asset class portfolio across a range of rolling time periods, relative to cash and inflation. The portfolio initially comprises of four asset classes – global equities, global bonds, real estate and commodities – increasing in 1991 to eight asset classes with the addition of emerging equities, emerging bonds, hedge funds and managed futures.

Between 1973 and 2010, this equally weighted portfolio produced positive returns in 90 per cent of rolling 12-month holding periods (468 in total) and 82 per cent of the periods were above the return of inflation.

Furthermore, rolling 10-year holding periods over the same timeframe (360 periods) resulted in positive returns 100 per cent of the time and exceeded inflation by a minimum of 3 per cent per year in every 10-year period (in our experience, the target return used by most financial planners for cash modeling rarely exceeds inflation plus 3 per cent).

In essence, the probability of return capture increases with the time horizon while the inherent risk premiums embedded in each asset class are compounded over time to provide a much enhanced return over inflation in the longer-term.

Taking the above into consideration, every investor should be encouraged to “weather the storm” and make no changes during an equity market downturn. Investors that trade on emotion – in particular fear and greed – tend to make irrational investment decisions that can result in wealth destruction rather than preservation and/or growth.

Staying the course is of great importance when enduring market cycles and the benefits of doing so can be illustrated as follows. During the period January 2000 to December 2009, the US stock market generated an annualised return of -1 per cent per year. Over the same period, the best-performing mutual fund was the CGM Focus Fund, which delivered an 18 per cent average annual return.

Unfortunately, the return earned by the average investor in this fund was actually -11 per cent per year. The reason behind this unexpected result is that the investors exhibited typical behavioral responses that led them to buy after periods of strong performance by the fund and to sell after periods of weaker fund performance.

Over the period, these actions negatively impacted average investor performance when compared with an investor that bought into the fund at the outset and held for the entire 10-year period.

Focusing on strategic asset allocation across a range of asset classes combined with a long-term investment horizon can help investors achieve good investment returns, year on year, with relatively low volatility. To see this theory in practice, investors should look no further than the US University Endowment Funds, such as Harvard and Yale, which have successfully used a multi-asset approach to investing to deliver consistent returns over the last two decades.”

Michael Azlen is executive chairman at Frontier Investment Management. The views expressed here are his own. You can view this article by right clicking your mouse here.

If you want to discuss this or any other article and how Stephen Ng & Peter Davies, the Directors at Create Wealth Management support Michael Azlen’s view, please get in touch.

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