It was my wedding anniversary on Wednesday, and what better way to spend it than investigating where I went wrong last time. Amongst other factors, a story in The Atlantic titled The Divorce-Proof Marriage proposes a positive correlation between marriage length and the number of wedding guests (see below).
Eloping American couples are 12.5 times more likely to end up divorced than couples that get married at a wedding with 200 or more people. For me, there were only seven last time around, including the photographer and celebrant, so it’s surprising the thing lasted the week. Second time around, The Architect and I had about 15 guests, but I wasn’t aware of this chart three years ago.
The theory is that the more people that witness your marriage, the greater the power of the commitment effect. Accepting that correlation is not causation of course, but much the same thing goes for an investment publication like this. It’s easy admitting a mistake to oneself compared to putting it down in print before tens of thousands of readers. But that’s what senior analyst James Greenhalgh did with iSentia this week.
It was only a month ago that James added the stock to our Buy List. The media monitoring service had issued a profit warning, the share price had collapsed and yet the company’s market position looked “impregnable”, or so he thought. But after further research – good analysts are always doing further research – James filed for divorce. It was an unprecedentedly rapid separation.
In this business, if you get six or seven picks out of 10 right, you’re ahead of the game. James’s stock picking record might be a little better than that because of an ability to not just pick cheap stocks but to change his mind and publicly admit mistakes. Maybe I should have married him.
To the list of psychological biases that undermine investment returns, you can also add myopic loss aversion (focusing too much on the short term at the expense of long-term gains), anchoring (fixing on an arbitrary things like a buy price and not adapting to changing circumstances) and herding (doing what everyone else does, like getting married).
There are so many biases they’re a herd unto themselves, each doing its bit to tug us away from rational, independent, profitable decision making. It’s a tricky business, which explains why the average investor sucks at investing.
Sources: BlackRock; Bloomberg; Informa Investment Solutions; Dalbar.
The latest data from 1996 to 2016 supports the claim. Whilst the average annualised return of the S&P500 was 8.19 per cent, the average mutual (“managed” in an Australian sense) fund investor returned just 2.11 per cent, again less than inflation. Doh.
So, how does the average investor get 75 per cent less than the index return? Well, they’re buying the same stocks as you and I, but instead of buying them low and selling them high they’re doing the opposite. It is their emotions that fail them, not their analysis. Another Blackrock chart spells it out with a shrink-like language we can all relate to.
The point of capitulation – the blood-in-the-streets-moment, as Buffett would say – is in aquamarine blue, when most investors are selling. That’s the point when the smart money is being put to work. The euphoric optimism at the top, when prices stretch far beyond value, is in green. This is when the smart money gains from the previous capitulation are locked in.
Of course, no one gets the timing exactly right but if price and value is your guide rather than fuzzy psychological concepts like herd euphoria and panic, by selling out to the patsies at the top and buying from them at the bottom you’ll do well enough.
So, where are we on the chart? No one knows, of course. It’s easy knowing what will happen two years hence when your starting point is five years in the past. But, as I rarely knock back a future opportunity to look foolish, let’s take a stab anyway.
In residential apartments I’d guess many investors have recently tipped over from euphoria to either nervous or worried. In bonds, since the sell-off late last year, the Trump-driven comeback suggests optimism about a return to normality in terms of interest rates, economic growth and inflation. The yield on US 10-year treasuries hit 2.39 per cent this week and the Bloomberg Barclays Global Aggregate Index, a measure of investment grade debt from 24 countries, yesterday enjoyed its third consecutive monthly gain. Hopeful then, maybe.
As for stocks, despite the S&P/ASX200 near a two-year high and a generally good reporting season, investors seem encouraged but hardly euphoric. We’re still finding the occasional opportunity, but are not spoilt for choice. All up, those emotional extremes that characterise the high and lows are hard to find, except perhaps at the occasional inner-city auction. Incidentally, S&P reported this week that more borrowers are falling behind on their mortgage repayments.
Nevertheless, these charts make a salient point. As famed investor Seth Klarman once said, “Investing is the intersection of economics and psychology”. Getting the economics right in my view is the easy bit. It’s the kind of decisions that James faced with iSentia this week where so many of us go wrong, professionals included.
Actively managed funds – those that try and beat their benchmark index – are having a terrible time of it. Active managers face all the problems average investors do, plus the additional headaches of short-term performance measurement and a big money problem, which restricts the range of stocks they can own. The typical result is index-like performance if you’re lucky, minus the fees.
According to S&P’s SPIVA 2016 mid-year report, over the most recent 10-year investment horizon, 85 per cent of large-cap managers, 91 per cent of mid-cap managers and 91 per cent of small-cap managers failed to outperform on a relative basis. Interestingly, while only 1-in-10 active managers beat their benchmark, the same figure for value managers was 1-in-3; better but still not great.
Australia lacks results over a similar timeframe but the shorter timeframes are equally damning. I’m unaware of any other industry than can do such an appalling job for its customers and still be so ludicrously overpaid for it, especially here, where fees tend to be higher than the US.
What is an average investor to do? If active funds generally don’t beat the index and managing your own money is too taxing or time consuming, the first option is to settle for index returns at a much lower fee and get on with life. Many investors appear to be doing just that, as this FT chart of US data, indicates.
A decade ago, passive US assets (index trackers and the like) accounted for about 20 per cent of total sharemarket assets. They’re now twice that, fuelled not just by the rise of passive funds but also the booming market in exchange traded funds (ETFs).
The second option, which, unlike most passive funds, acknowledges the over-exposure most Australian investors have to property, the big banks and our own economy, is to build a portfolio of low cost ETFs which correct for these factors. Or you can pay someone like us a modest fee to do it for you (see InvestSMART’s ETF-based portfolios).
Those wanting to beat the market over the long term have two further options. The first is to use a service with a good long-term track record of doing so, like Intelligent Investor (that sound in the background is me pushing a barrow) and use it to help you run your own portfolio.
The second is to use a few carefully chosen active fund managers (diversification is sensible in funds as it is in stocks), ensuring that the fees are reasonable, the track record is good and that the fund isn’t too large, which can handicap future returns. There are plenty of choices, including Intelligent Investor’s SMAs based on our model portfolios. But as I said, choose carefully.
The final point is down to you. No matter what choice you make, if you panic at the wrong time, selling out when stocks are cheap and buying in when they’re expensive (the fear of missing out), you’re effectively choosing to be one of those investors that fail to beat inflation. Like marriage, success in investing is a game played largely in the head.
Have a good weekend and, in the words of Clive Dunn in Dad’s Army’s, don’t panic (please check out the video, it’s oddly hilarious even now).