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Why Short Term Portfolio Fixes Can Add More Long Term Pain

Topic: Investor Insights 1 June 2022

Investors have experienced a tough year with Global markets hit by a perfect storm of factors that has led to a cycle of negative growth. Unsurprisingly this has caused a rise in anxiety among investors who in watching their portfolio values decline, feel pressured to make changes to their investments - changes that might ease their fears and settle their nerves in the short term but often lead to longer term problems that can have significantly greater costs. 

In this report, we explain why short term fixes can add more long term pain and why a strategy committed to long term growth by investing in quality funds and fund managers is the best way to endure volatile markets.


Lessons From The Past

It can be hard to appreciate in the midst of high volatility and market uncertainty, but bull markets follow bear markets and often erase the declines sooner than most anticipate.

In 2007, global equity markets peaked and one of history's worst market cycles began. At the time, there was little hint of the panic to come. Declines were gentle, and banks weren't yet taking huge (and unnecessary) balance sheet write-downs. But a year later, the fallout extended as banks drastically marked down illiquid securities and the US Fed and Treasury responded haphazardly. The economy felt the impact and panic was spreading. Autumn 2008 and the following winter were harrowing for most investors. From the peak to the 9 March 2009 trough, the S&P 500 Index fell 55.3%. In the darkest days, some felt like equities would never rise again. Many feared their investment goals were finished. Yet in the following years, equities markets not only recovered but they added significant extra growth. Whilst that doesn't make the memories of that period any less painful, it does highlight a key lesson: If you have a medium to long term investment time horizon, staying invested through negative market cycles is unlikely going to result in missing out on your longer-term goals.


Short Term Fixes Can Add More Long Term Pain 

The volatile and unpredictable events of the past several months have naturally led to doubt and anxiety for many investors, with some panicked investors selling off their funds at a sizeable loss and moving into other strategies that seem less susceptible to the current market stresses. Whilst this may seem better in the immediate short term it ignores the fact that falling markets don't last. They will recover as has been demonstrated throughout history, and acting during a highly volatile period - such as the one we are currently experiencing - can compromise your long term financial goals.

Losing sight of this can be dangerous. Changing strategies and selling off funds after participating in a deep decline locks in losses and raises the risk that equity prices snapback before you get back in, resulting in feeling the losses of the downturn and then missing the sharp, initial rebound. This is one of the key reasons why looking for short term comfort can cause more long term harm. 


Why Ignoring Short term Performance Can Help Avoid Long Term Problems

Market forecasts can influence how we invest but often these forecasts are nowhere near the reality when the forecasted period transpires. 

Forecasts about markets encourage the worst behaviours in investors such as short-termism and over-trading. Also, the belief in market forecasts among investors can diminish their perceived need for diversification, and ultimately lead to them assuming greater risk with their investments. 

In recent times global economies have been faced with several challenges from supply chain issues, soaring energy costs, the cost of living crisis, the fallout of the war in Ukraine, and fear of global food shortage. These are all factors that have wide ranging consequences. 

They all have had a role in negatively impacting investment markets, typically due to the fear of what impact they will have on economies and industries rather than their actual impact. They are based on current fears and emotions which dictate their opinions on what will transpire. But making judgements on the future based on the emotions of now is dangerous. 

Forecasts are driven by political and economic events and how these will impact the economy. But the economy and stock market are not the same things. In a nutshell, the stock market is driven by supply and demand and although economic and political factors both regionally and globally can influence supply and demand, for larger more established industries and innovative companies such as those who push the advances in technology, demand for their services will drive their values up irrespective of general economic conditions.  

As such, it is important to stick to an investment strategy that is diversified, utilises proven funds and fund managers and is structured to meet long term objectives rather than making decisions based on forecasts or short term trends. For example, many investors have dumped funds at a loss and bought into energy funds that have seen a spike in growth in recent months. Some of these energy funds have seen growth of 45% this past 6 months. Whilst there are energy focused funds that are well balanced and have a long term, sustainable balanced strategy that can add value, many do not.

To some, investing in a fund that has returned 45% in 6 months is an obvious and smart choice. But when looked at rationally this is rarely the case. For example, most who now invest in these funds have done so after the fund experienced the peak of their growth - which is unlikely to be replicated as much of their growth was due to the panic caused by rising oil and gas prices which surged when Russia invaded Ukraine, and by the subsequent sanctions. But as a consequence, European governments are actively working on plans to break away from the reliance on Russian energy - and oil and gas in general, which could limit the growth potential of these commodities and enhance the growth of the sustainable energy sector. 

Another factor is these commodities are very volatile and therefore high risk. As a consequence, investing in such funds can significantly increase a portfolio's overall level of risk and potential for losses. Also, with the exception of the past several months, many energy funds have in fact returned negative growth over the long term, which is a more reliable performance metric than near term performance. Ultimately, making decisions based on current trends or short term movements is rarely conducive to successful investing.


When To Consider Moving Your Investments

Selling your investments during periods of high volatility and negative market conditions is rarely a good idea. For investors with sufficient investment time frames it is something that should only be considered if their portfolio of funds has consistently underperformed long before a market decline kicks in. In such a scenario, switching to a portfolio with higher quality funds can aid recovery when markets rebound as well as improve long term outcomes. 

It is important to clarify that such a decision should be taken with the goal of improving the long term quality of a portfolio and not on moving into funds that have short term benefits such as those that are simply weathering a volatile market better. The fact is, many of the funds that fare better during negative market conditions often hold assets in companies that have less to lose because they have limited market share and lower long term growth potential. We believe that when markets stabilise and recover it will be the proven funds that have holdings in quality companies that will yield the best returns.


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No one wants to experience a sustained period of losses that comes with a falling market, but it is and will always be a part of investing. Also, investing during such conditions needn't be a permanent setback, provided you remain invested during the market recovery.


The Importance of Remaining Disciplined

Behavioural pitfalls such as trying to time the markets or chase performance are among the biggest derailers of investment plans. Most investors understand the importance of remaining disciplined at times of heightened uncertainty, but very few succeed in staying calm in turbulent markets. Indeed, many end up taking exactly the wrong course of action that could have significant long term implications for their investments.

The strength of any investment plan is in its composition. Best practice shows that a portfolio should be diversified and have a robust asset allocation model that is strategically weighted to fit each individual appetite for risk and contains only suitable top performing funds. Outside of this, everything else is noise.

There will always be contradicting market forecasts from industry experts who have different outlooks and reasons for their opinions. But opinions are really all market forecasts are, which is the reason why they should not interfere with your investment plan.


Invest With Quality Fund Managers

9 in 10 of the funds available to UK investors are poor quality, long term underperformers. They underperform over the long term as many invest heavily in stagnant industries and lack the foresight to adapt in time to changing consumer trends. 

For example, growth of the electric car market has grown exponentially in recent years as technology improves the quality of electric vehicles, and with greater emphasis on the climate crisis UK government legislation aims to ban sales of new combustion engine vehicles from 2030; and the European Commission has proposed a carbon emissions-cutting scheme that would effectively see the EU follow five years later. This obviously has significant implications for the motor industry and creates huge opportunities for investors beyond that of simply investing in electric car manufacturers such as Tesla.

Quality fund managers exploit industry channels to identify the core innovation routes and identify key markets such as the sub companies closest to these routes and the structure and dexterity of these companies. This is what sets them apart when it comes to putting in place proficient investment strategies to outperform their peers.  

For example, plans to accelerate the switchover to electric cars mean we’ll soon need many more charging points. You might think that entails a rush to retrofit petrol stations with banks of charging bays. But, research shows that the home and workplace are expected to become the key plug-in locations with development in this area expected to result in more advanced and convenient charging units. Public power points will still be required, for instance, to top up electric cars making long journeys. But many will be at places focused on other activities. It is the hardware and software companies at the forefront of this development, and in sub industries connected to the EV market which are viewed by many quality fund managers as the real opportunities that have exponential growth opportunities. 

The growth potential of such strategies is not always evident during volatile markets which is why short term performance should never be the main factor for making investment decisions. Instead, investors should trust in the long term opportunities that come with investing in quality funds and fund managers.


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Fear Is The Enemy

Despite Global markets suffering negative returns in recent months the actual earnings for companies in the S&P 500 (which is a stock market index tracking the performance of 500 large companies listed in the United States.) has been better than feared. Although volatility remains high with daily market swings this will eventually settle and markets will recover, which is why investors should look beyond the current volatile cycle and hold firm to a long term perspective, as this will pass. 

The investors who are jumping out of quality funds and into funds that have fared better over negative market conditions are making decisions based on fear. Seeking comfort in the short term rarely adds value. 

The fact is, some of the most diverse, high quality funds on the market with a history of exceptional performance will have performed worse during negative market conditions than some funds with a history of poor performance whose holdings are in companies who are structurally poor, have limited market share and low growth potential. Moving from the former into the latter might settle nerves in the short term but when conditions improve, and they will improve, it is the quality funds that are much more likely to deliver.

Ultimately, for anxious investors simply avoiding accessing their investment portal during volatile times can be the best strategy.

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