Investment Update - October 2018
Investment portfolios had a rather subdued month in September, capping off a very strong quarter driven by solid returns during the months of July and August. In fact, the US share market produced its best local currency quarterly return since 2013, with the S&P 500 up 7.2% for the September quarter.
While volatility has increased in global share-markets so far in October, our assessment is that this has been driven by sentiment with markets digesting a range of issues such as: rising interest rates, trade concerns, and apprehension around company profit margins.
Looking through these, there are a range of underlying drivers that remain positive for global markets and provide important support against volatility, which is an inevitable part of a long-term investment approach. This is driven by three key pillars:
- Economic growth, with leading surveys and indicators pointing to further expansion. The International Monetary Fund (IMF) recently revised their 2018 and 2019 global growth forecasts to 3.7% per annum;
- Earnings growth; company forecasts remain positive with expectation of 15-20% growth over the next 12 months; and
- Valuations; the MSCI global share-market index is now valued at 14.7 times annual company earnings, 8% below the long run average of 16. This means that investors benefit from more company earnings than usual, per dollar invested in shares.
Market volatility can be unsettling and unpredictable in the short term, but it is not unusual. What is more predictable though, is the superior performance of markets over the long term. So, if you are a long-term investor, staying with markets through thick and thin has always been the best thing to do.
Diversification - Keeping your Baskets in Order
Diversification is a key principle to live life by. Most people tend to think of it in a financial context, but it can apply to various aspects of life. Having a good work-life balance, getting fulfilment from multiple facets of life and woman’s attitude to shoes is a great example.
It turns out that many women are experts in the field of diversification. A properly diversified ‘Shoe Portfolio’ demonstrates not having all your ‘shoes’ in one basket with some good and bad weather shoes, some casual and formal shoes and in a variety of colours to suit the occasion.
A Diversified ‘Shoe Portfolio’
The benefit of good financial diversification is no different and not to be scoffed at. Most importantly it manages risk and reduces the impact a bad event in any one asset has on your overall financial wellbeing. There can be several things which impede good diversification, such as becoming emotionally attached to a single investment or preferring certain investments for reasons that are not 100% objective.
We often come across stories of people who have ended up with a large holding in a single investment due to a number of reasons. One common example is getting attached to a stock that has done very well. Naturally people can often form an emotional attachment to these companies and find it difficult to part ways with the investment. It can leave them over exposed to that company and not fully appreciating the risk to their wealth that a single position has. This emotional attachment is also linked closely to a second example, a bias where people put more value on an asset they own, simply because they own it.
To illustrate the two biases together, imagine a company whose share price has risen 100% over the past year. Someone who bought into the company before the 100% rise is much more likely to continue to own shares in the company than someone who has watched the stock rise, even though the value of the company to both investors is exactly the same.
A useful approach
A useful approach is to build diversification into the natural framework of an investment portfolio, spreading investments across the major asset classes, (i.e. New Zealand, Australian and Global Equities) in different countries and companies operating in a wide range of industries. With this diversification in place, there is a solid foundation to add detailed investment analysis on the areas that offer the best prospects. The result is a portfolio that intelligently manages risk by not being over-exposed to any one investment, while at the same time making the most of attractive investment opportunities.
There are a few critical items that you must consider when investing. One is to make sure you know your investment time horizon. Once you know and are confident of your investment horizon, you can then find an appropriate investment that matches your time horizon. If there is a mis-match, you are setting yourself up for future pain and possible permanent wealth destruction. Then once you have ticked these items off, you must be properly diversified, (shoes too).
If you have investments external to Lifetime and would like some help or a second opinion on matching investments to your time horizon and / or on adequate diversification, please contact your adviser.