The Power of Not Having A View
There is a stigma attached to saying, “I don’t know”. Nobody wants to sit on the fence or stand in the middle of the road, but for investors this is the best place to be most of the time. We are operating in a highly complex, uncertain environment where most predictions are either difficult or impossible.
If you work in the investment industry, then you must always have a view about everything. When will interest rates peak? Is CSL expensive? If we don’t have an opinion then we either lack knowledge or conviction, perhaps both.
The majority of investors have all sorts of views. There are two reasons why investors are keen to predict everything. The first is simple overconfidence – we think we are better than we are. The second is because it is expected of us – our clients want us to have a view, so we must form one.
Why is there an expectation for investors to have views on everything? Because it gives a sense of control. Financial markets are messy, chaotic, and anxiety-inducing; when an investor makes predictions and trades on them it provides some level of comfort, even if misplaced.
On 10 November 2022, the U.S S&P 500 index recorded one of its biggest daily increases – up 5.5% in one day. On that day I typed ‘S&P 500’ into Google and look at the range of recent headlines I saw:
Within a matter of 48 hours, the news was proclaiming the spectrum of the S&P 500 ‘plunging’ and ‘faltering’ to ‘rocketing and surging’. Never a better example of the media’s use of ‘fear and greed’ to attract eyeballs.
Two weeks after these headlines, Alan Kohler wrote an article[i] noting Australia’s leading economists were predicting the Reserve Bank cash rate to end up between 3.1% and 4.5%. That is quite a range.
If I shared these two pieces of information with an investor, how on earth could they form a view on what to do?
Over short run horizons markets are noisy and unpredictable, and I would simply be guessing with little confidence in my outlook. The value of trades each day on global stockmarkets exceeds $1 trillion - that is a lot of money incorporating all available information to help set prices between willing buyers and sellers.
But ask me to predict whether global equities will generate positive returns over the next ten years, and I have a view. Over the longer term the performance of equities will likely be driven by the cash flows they generate. History also tells me the odds are in my favour in having a confident (though not certain) perspective.
We should only express forthright views and take positions where we have a long-time horizon and a robust evidence base that suggests the likelihood of our view coming to pass is strong. But a long-term horizon does not mean all investment managers in public markets will flourish.
Standard & Poor’s has been publishing their SPIVA research reports every 6 months for 20 years. SPIVA stands for ‘S&P Indices Versus Active’, and reports are prepared for every region of the world, including Australia. On this 20th anniversary, S&P have summarised the most important points from their research[ii]. Their key findings are:
Most active managers (meaning those who pick stocks and/or time markets) underperform most of the time, measured by either gross or net of fee performance.
After adjusting for risk, most active managers underperform most of the time.
The tendency for underperformance typically rises as the observation period lengthens. The two graphs below show what percentage of Australian funds survive after 15-year periods (i.e., do not close) and of the survivors, what percentage outperform their benchmark:
Over 15-year periods, the majority of funds do not survive, and of the survivors, a handful outperform their benchmark.
As S&P conclude:
the SPIVA data tells a consistent story. The first SPIVA Scorecard reported most active managers had underperformed a benchmark appropriate to their investment style over a full market cycle. Our most recent SPIVA update reports more or less the same thing… These conclusions are robust across geographies. When good performance does occur, it tends not to persist… Above-average past performance does not predict above-average future performance...SPIVA can serve to remind investors that if they choose to hire active managers, the odds are against them.
2022 has seen most asset prices adjust lower. That means that all else being equal, expected returns are higher than they were in late 2021. If the news going forward – on issues like inflation, economic growth and earnings – is better than what is currently reflected in prices, asset prices could adjust higher. In this context, remember that what moves markets the most is news it didn’t expect.
Even in tough economic environments innovation and wealth creation continue. Companies still bring together raw materials, technology, labour, intellectual and financial capital to develop new products and services that create wealth for shareholders. Governments and companies still need to raise funding in bond markets to deliver services and build long-term infrastructure. Investors who participate in bond and equity markets have an opportunity to share in the wealth created while financing those developments.
Uncertainty is a constant. But if there were no uncertainty, there would be no return. And while the good times don’t last forever, neither do the bad.
Author: Rick Walker
[i] https://thenewdaily.com.au/finance/2022/11/03/interest-rates-economists-disagree-kohler/
[ii] https://www.spglobal.com/spdji/en/education/article/talkingpoints-assessing-the-impact-of-20-years-of-spiva