11 September 2019
By John Husselbee, Co-Fund Manager HC Verbatim Portfolio Growth Funds
One of the clearest lessons from history is that trying to time moves in and out of markets to catch the peaks and troughs rarely works – and yet so many investors still try to beat the odds.
A common saying in investment circles goes that timing the market is a fool’s game, whereas time in the market (meaning keeping your money invested) will typically lead to solid results – and new research from Morningstar makes that point in the starkest possible terms.
In response to the question ‘Is there a good time to buy or sell actively managed funds’, the report concludes with a resounding no, based on the fact most equity performance over multiple decades has come down to just a few months. Being out of the market for these so-called critical months can have a massive impact on overall wealth generation.
To put some numbers on this, Morningstar revealed that from 1926 to 2018, US stocks owed all their outperformance to just 51 months, or less than 5% – and if investors had owned those companies for all 1,063 months apart from those 51, they would have failed to beat cash. The group performed the same test for global actively managed equity funds and found a similar phenomenon: just 5% of months are determining overall performance.
Even for the very best funds – the top 10% of all those that beat their benchmarks over 15 years to the end of October 2018 – the outperformance was due to just 16 months of excess returns, one year and four months out of 15 years.
Adding my own analysis to this picture, I looked at one of my UK equity holdings, a well-known quality growth fund, and found the portfolio has outperformed the FTSE All-Share by 105% over ten years to the end of June 2019. If you remove 23 of the 120 months however (so around 20% but bear in mind the shorter timeframe), this relative performance falls away to nothing. None of these critical months came in a near two-year spell across 2016 to 2018 and most came after falls in the broader market.
As we said at outset, what this shows very clearly is that timing the market is all but pointless when it comes to actively managed funds and, as the Morningstar report concludes, staying invested is the name of the game.
“Miss those months and you will have missed all the risk premium to be earned from holding a volatile asset such as stocks,” the group added. “There is solid evidence most actively managed funds' excess returns are not normally distributed but from our perspective the exact shape of that distribution does not matter; what matters is that trying to find the best time to buy or sell a fund is most likely futile.
“If you think you have identified a skilled manager, the best course of action is to buy in or dollar-cost average, regardless of the moment, and hold on to him or her over long periods of time.”
Morningstar adds that the obvious, and perhaps even more important, corollary of this is that considerable patience is required to adhere to such a program and selling on the “what have you done for me lately” rationale is typically a mistake. The report ends with the rather dramatic ‘No one knows the day or the hour when outperformance will strike’ but this broader thinking on staying invested could have come straight out of our investment process.
As we have said over the years, there will always be volatility when investing – this is not putting money in the bank after all – but evidence shows that, over the longer term, equities outperform bonds and cash. It is also vital to understand the difference between temporary drawdowns and permanent capital losses – investment always carries the risk of capital falling but a well-diversified portfolio should be designed to withstand such losses and ultimately meet investors’ desired outcomes.
With that in mind, we are strong believers that people should invest for the long-term based on their risk appetite and ignore the ebbs and flows of markets as far as possible.
One of our key mantras when selecting funds – and something underlying this Morningstar analysis – is that consistency of performance is impossible but consistency of process is a prerequisite and can ultimately lead to long-term excess returns.
For me, this data also chimes with a couple of other core messages behind our multi-asset approach.
The first is the importance of blending styles – as we wrote about recently – to get the full benefits of diversification. It stands to reason that growth and value managers for example would have different critical months and we have always argued against zero weighting an asset class such as bonds, even if bearish on its prospects. While it might be uncomfortable to hold a falling asset, something else is likely to be rising at the same time and it is the overall blend that helps produce a smoother performance ride over the long term.
Another importance takeaway is the importance of mixing active and passive funds in a portfolio, putting the reductive either/or argument between these to the sword.
As Morningstar says, staying invested in is the name of the game and we continue to believe using passives to enact short-term tactical asset allocation decisions rather than disturbing our chosen managers is the best route to take. After all, as the data shows, missing just a couple of months can be hugely detrimental to long-term returns.
The value of investments and any income from them can go down as well as up and is not guaranteed. Your clients could get back less than they originally invested. Past performance is not a guide to future performance. The portfolios' investments are subject to normal fluctuations and other risks inherent when investing in securities. Verbatim Asset Management has taken due care and attention in preparing this document, which is solely for the use of professional advisers. Verbatim cannot be held responsible for any inaccuracies arising out of information detailed within and will not accept liability for any loss arising out of or in connection with its use. This article is for information only and should not be deemed as advice.