The importance of resisting the herd
As humans, we have centuries of experience in creating trends, tribes, and even trails for others to follow take comfort in mimicking social behaviours. The idea is that we would rather be wrong in the company of many than take the risk of walking with the few. However, when it comes to our finances, moving with the herd does not always produce the best results. Buying the market and following trends is comfortable, but the best investment ideas are often found where others fear to tread. Therefore, unless you are happy to invest in an index, it is vital to seek out an independent financial adviser who will help you stick to your objectives and appropriately position your assets with quality asset managers who protects against ‘herding’, when you are being tempted by the crowd.
Why do investors herd – is it appropriate to follow?
Markets can often be intimidating to investors during volatile times, and in effect often leads to irrational behaviour. This is often the case when market valuations seem a bit grim resulting in the- temptation to act because you think everyone knows something you don‘t and everyone can’t be wrong. But this can be counterproductive. Emotions get the better of all of us both on the upside and mainly the downside. When things are going well we tend to be overly optimistic, assuming that the future will continue on an upward trajectory leaving one with a sense of complacency.
The reverse also holds true causing investors to run for the exit when asset values fall. At this stage in the market cycle, the herd will tell you to (sell out of the market) and move your money to a money market account. Your experienced financial advisors would initially suggest an absurd idea of (buying into the market) at that time. This is always the preferred (rational) route to take. After asset prices would have taken a hit for no good reason, this would allow for asset values (stocks) to trade at significant discounts allowing the investor to buy more units for better value.
South African politics – a hard case for rationality
Considering the recent and troubling news of our credit rating downgrades, business confidence, was severely impacted, unsettling both local and especially offshore investors. Poor sentiment is a problem, but an even worse problem is the lack of growth. China and India are examples of economies that have grown exponentially over time. South Africa, however, has stagnated and shown little value from the opportunities given. Businesses have stagnated, economic activity is depressed and the country has entered a recession. The debt to GDP ratio is also worrying, which should call for the government to refrain from spending. Our current account deficit is sitting at 52% of GDP. This is not an alarming figure in itself, but the problem is that revenue is not growing. Of everyone rand of revenue, 13 cents goes towards servicing debt. It is the rate of the increase in debt and debt servicing costs that concerns the ratings agencies, and this is what could lead to a downgrade of even our local currency debt ratings.
A downgrade of our local currency government debt rating could mean that foreigners who are only mandated to invest in investment grade debt have to leave the country. Where some foreigners exit, it is more than likely others will follow in their wake – even those who are have stronger ties in South African assets. This kind of herding has the potential to derail our fragile economy.
How does this impact your investments?
Risks are elevated in the current environment. This means you should think about how much risk you are prepared to take on (risk capacity), how much risk you can afford, and your risk appetite, i.e. how much risk you are willing to accept in pursuit of greater returns. Your answers should inform your investment decisions. Companies like Allan Gray use their portfolio managers to determine the risk allocation of assets within unit trusts and manage the asset allocation on an ongoing basis. A good, independent financial adviser helps you to choose a unit trust with a risk profile that matches your financial objectives and goals. If you invest for the right reasons at the outset, and choose your investments carefully, it should be easier to resist the herd.
Steer clear of the herd
Do your research – Read regularly and keep up to date with relevant articles. Make sure you have a good understanding of the picture and try to make a rational, informed decision. Seek advice about your long-term objectives – Emotions often get the better of us when investing. Formulating a long-term plan with your independent financial advisor for advice on the investments that are best suited to your needs while keeping your long-term objectives in mind will help you remain rational and avoid herding.
Investing offshore – Core to your long-term plan
When looking at South Africa on a global scale we represent but a fraction of the investable opportunities out there. SA represents only 6% of emerging markets and less than 1% of world markets. There is also a growing concern for the volatile currency and uncertain political climate. In the last 18 months, the rand has strengthened by +/- 13% against the trading currencies, however, since 2010 the rand has devalued from +/- R7.00 to +/- R13.00 against the US Dollar. As the rand is expected to depreciate over the medium to long term by at least 8% p.a. it would be advised for investors not to make any adjustments to their current offshore investment holdings. This very well supports the need for diversification in all investment portfolios.
Bearing this in mind, it is important to consider offshore investments as core part of your long-term investment portfolio. It is also important to invest offshore consistently, rather than in reaction to dips in the rand or in response to mainstream media and news headlines. With access to our selected (fund manager) platforms investors have access to both local and foreign currency denominated unit trusts with the maximum allowed offshore exposure.
Managing downside risk
While we view risk as the permanent loss of capital, in economic environments such as this we certainly position our portfolios to limit this risk. While investors experience the current short-term underperformance, we believe focusing on managing this risk is the best way to preserve and grow our client’s wealth over the long term.
Long-term growth is something that is achieved and more evident though the mindset of taking the long-term perspective. Under current economic conditions underpaying for assets not only leads to superior returns in the long term, but also reduces the risk of permanent capital loss to client portfolios. Similarly, it is also important to avoid areas of the market which look particularly expensive, as is the case with the so-called “defensive” shares.
Bearing this in mind, we look at our selected reputable fund managers, with whom we place our client’s trust, that are specialised in managing our client’s “investment’’ funds through a down-cycle. At the same time, this coincides with our holistic financial planning services that encompass the four key financial planning areas managing lifestyle risk, Investment, Retirement and Tax planning optimising our client’s individual needs, financial objectives, and risk profiles.
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