How short-sightedness hurts your investments in the long term

Dr. Francois Stofberg: Senior Economist at Efficient Wealth and the Managing Director of Efficient Private Clients, with specialist input from Renier van Zyl.

Taking a hiatus from checking your investment portfolio for a month can be akin to stepping back from the canvas of daily market fluctuations. It is a deliberate act of patience, allowing the market’s ebb and flow to paint its own picture before returning to assess the masterpiece.

In the intricate tapestry of financial markets, September often paints a canvas of uncertainty and volatility. Historically, September has proven to be the worst month for equity market returns. In fact, it has been the worst-performing month, on average, going back nearly a century. It is a period when investors are reminded of the unpredictable nature of the financial landscape. Market participants refer to this phenomenon as the “September Effect”. It is a calendar-based market anomaly in the sense that it occurs without any real causal link or event, challenging the efficient markets hypothesis.

Challenging the established order is crucial, especially when the downturn is more pronounced than usual, as is the case this year. There are several reasons for this: The looming threat of a United States (US) government shutdown is causing market uncertainty. This potential shutdown is owing to a sharp ideological division between House Republicans that could lead to a halt in federal agency funding by 30 September. The shutdown will continue to loom unless Congress agrees on all 12 appropriation bills in time for the new fiscal year beginning on 01 October.

In August, Fitch Ratings downgraded the US owing to precarious debt ceiling disputes between the Democrats and the Republicans. This downgrade highlights the fragility of US fiscal policymaking compared with its AAA-rated counterparts. Another government shutdown would only exacerbate this vulnerability.

Additionally, the US is already walking a financial tightrope with the nation’s debt now exceeding $31.1 trillion. It is a complex interplay of economic necessity, political debates, and global repercussions, all influencing the US’ fiscal future. In the last week alone, the US managed to add a staggering $100 billion of additional debt (this is more than a quarter of South Africa’s annual gross domestic product (GDP)). Persistently high interest rates will lead to the US refinancing its debt at increasingly costly levels, potentially surpassing $1 trillion in annual borrowing costs before the end of 2023. Without a debt limit, there is little incentive for fiscal restraint. If the situation continues to deteriorate, it could result in another downgrade of the country’s debt rating.

Then there is the consumer: The US economy will stay utterly dependent on the consumer to steer it to a place of relative safety; investors are, therefore, constantly monitoring the health of the US consumer. Intriguingly, the latest downward revision of second-quarter GDP consumption figures paints a challenging picture. As a result of the revision, quarter-on-quarter GDP growth plummeted from an annualised rate of 1.7% to 0.8%, the lowest rate since the onset of the COVID-19 pandemic. Personal consumption, constituting more than 68% of nominal US GDP, faces mounting pressures owing to tightened lending conditions, student loan repayments, and dwindling savings. Even Bloomberg reports that most Americans, excluding the wealthiest 20%, now have less cash on hand than when the pandemic began. Expiring support programmes are also adding to the strain.

In this environment, patient, methodical financial planning becomes evermore important. Planning of this kind helps investors steer away from being short-sighted and running after deceptive returns. Usually, these short-sighted investment decisions are fuelled by emotions rather than by logic, and this does not play out well in the long term. Independent, holistic financial advice allows investors to step back from the canvas of short-term market fluctuations (read emotions) and make the most of long-term opportunities by buying the right companies at the right prices. In the current environment, the right company is resilient, with a strong balance sheet and products that are in high demand. With patient, methodical financial planning, uncertainty and volatility eventually fade away, and all that remains is peace of mind.

Bottom-up and top-down investment strategies

Dr. Francois Stofberg: Senior Economist at Efficient Wealth and the Managing Director of Efficient Private Clients, with specialist input from Christiaan van Wyk.

The investment industry, like most other professions, has evolved over time with various approaches and strategies coming to the fore, each with its own inherent characteristics. When investing in listed shares, two dominant approaches stand out: Fundamental bottom-up and top-down investment strategies. These approaches represent distinct methodologies for selecting and managing investment portfolios, each rooted in a unique perspective and analysis framework. Fundamental bottom-up investing is based on the scrutinisation of individual assets or securities, assessing their intrinsic value, and making investment decisions based on the merits of each specific opportunity. Conversely, top-down investment strategies take a broader macro-economic viewpoint, where investors first evaluate global or sectoral economic trends and then identify industries likely to benefit from those trends before honing in on specific investments. Understanding these two contrasting approaches is crucial for investors seeking to tailor their strategies to their investment goals and risk tolerances.

Fundamental bottom-up investing offers several benefits. One of the primary advantages is its ability to provide a deep understanding of individual securities. By focussing on the intrinsic value of each investment, investors can potentially identify undervalued opportunities and make well-informed decisions based on the specific strengths and weaknesses of each company. However, fundamental bottom-up investing also has its drawbacks: It can be time-consuming and resource-intensive, requiring extensive research and analysis for each individual investment. This approach may not suit investors who prefer a more hands-off or passive approach to managing their portfolios. Moreover, it can be challenging to anticipate macro-economic trends or market shifts that could impact the performance of individual assets, as the focus is primarily on micro-level analysis.

The top-down approach, in turn, is primarily centred around its macro-economic perspective, allowing investors to assess global economic trends, sectoral developments, and broader market conditions. This strategic outlook enables investors to allocate their capital effectively and to capitalise on emerging opportunities, potentially yielding higher returns. Furthermore, top-down investors can adapt their portfolios to changing economic climates, making it a flexible approach when navigating market volatility. However, top-down investing is not without drawbacks. One significant challenge is that it may lead to overgeneralisation and missed nuances, as it emphasises broader trends over individual asset analysis. Investors relying solely on top-down strategies might overlook potentially lucrative opportunities within specific sectors or companies. Additionally, accurately predicting macro-economic trends can be exceptionally challenging and even small miscalculations can have adverse effects on portfolio performance. This approach can also lead to a lack of diversification if investors become too concentrated in a particular sector, increasing portfolio risk in the event of unexpected market shifts.

We, at Efficient, believe that the best approach to managing equity portfolios is to balance the macro-economic perspective with careful stock selection, which increases the investor’s potential to achieve favourable long-term returns. An investor must understand the underlying drivers of profitability for each company that they invest in, as well as the price that they pay for their share in those profits, while also managing the overall portfolio risk by comparing the portfolio exposure with the expected economic climate and secular themes at play. As with most things in life, finding an appropriate balance often leads to optimal outcomes.

Information overload is limiting investment returns

Dr. Francois Stofberg

Managing Director: Efficient Private Clients, With Specialist Input From Christiaan Van Wyk

 

Since the arrival of the internet, talks about the “information age” and its many benefits have taken place continuously. Benefits such as cheap, or even free, access to large volumes of information. But the discussion rarely progresses to the potential negative impacts that might arise from too much information. We believe that the benefits of access to information are real, clear, and well-documented, however, as with anything in life, too much of a good thing is generally bad. Not only has the volume and accessibility of information increased but also its frequency, so much so that real-time data has almost become the norm. This creates a unique problem when the goal is to achieve a long-term target. People, in general, have grown accustomed to speed and efficiency, and get frustrated at the mere thought of having to wait, especially if the immediate environment seems uncertain. This picture is the polar opposite of investing.

 

Investing, especially in equity markets, requires a long-term mindset, with very little attention being given to the noise surrounding you in the short term. Warren Buffett said it perfectly: “If you don’t feel comfortable owning a stock for 10 years, you shouldn’t own it for 10 minutes”. This is generally the approach that most investment managers take when selecting assets to include in their portfolios, and it increases the probability of achieving optimal performance over the long term. Unfortunately, investors are not always as patient, and often impair their investment performance by making short-term decisions based on emotion, or as we will elaborate further, information overload. The average retail investor receives performance reports at least quarterly, with investment fact sheets piling into their inboxes monthly. Then we are not even talking about the myriad of competing investment managers force-feeding their marketing material via e-mails, social media, phone calls, and even airport terminals. No wonder the average investor feels overwhelmed by the investment question and second-guesses their decisions at every corner!

 

Investment managers are also being forced to adapt to the “information age”, not only in terms of the changing investment landscape but also from a client management perspective. Owing to the frequency with which investors can access investment information, and the vast amounts of alternatives being marketed to them, investment managers are being pressured to make shorter-term investment decisions, limiting their long-term return potential. An example of this problem is the performance differential between retail investments and alternative investments, such as private equity funds. One of the key differences is the investment period. A typical lockup period (the time in which investors cannot withdraw funds) for a private equity fund is at least five to seven years, with infrequent investment information throughout the period. This creates an environment wherein the investment manager can make long-term investment decisions without the pressure of clients withdrawing funds in the short term, which increases the probability of achieving favourable long-term investment performance.

 

As with most real-world problems, the solutions are, unfortunately, not simple. One approach that can address some of these issues is the bucket approach to financial planning. This approach involves creating different buckets or pockets of investments, each addressing a different investment need with its own investment horizon. This affords the client the much-needed comfort that their unique needs are being addressed, it simplifies how they look at their total investment portfolio, and it increases their chances of sticking to a long-term financial plan. For long-term financial success, we recommend trusting your investment manager, maintaining a long-term mindset, and avoiding getting distracted by short-term noise.

The active versus passive debate

Dr Francois Stofberg
Managing Director: Efficient Private Clients, With Specialist Input From Christiaan Van Wyk

The active versus passive investment strategies debate has been raging for many years, with both sides trying to make the case for their own strategy at the expense of the other. Without pre-empting our own beliefs on this matter, we will start with the words of John C Maxwell: “A great idea is simply the combination of many good ideas”.

Before one can start the conversation about active versus passive investment strategies, one must first look at the key characteristics of both. A passively-managed investment strategy is one where the investment manager pools large sums of investor money to buy assets in accordance with the constituents and weightings of a chosen index. The manager will, therefore, make no active decisions regarding which benchmark assets to include in or exclude from the portfolio, nor will the manager change the benchmark weighting assigned to the given asset. In contrast, an active investment manager will decide which benchmark assets to include in the portfolio and will, typically, deviate from the benchmark weightings. An active manager will further, typically, hold fewer assets than the benchmark, making the portfolio more concentrated than the comparable passive portfolio. In doing so, it affords the active manager the opportunity to outperform the benchmark.

Both active and passive investments have strengths and weaknesses. For example, passive strategies are usually cheaper than actively-managed portfolios but are limited to the benchmark they track, whereas active managers have the flexibility to invest in the specific assets that are expected to deliver index-beating returns. Tax is another topic of debate: Passive investors argue that the buy-and-hold strategy gives them the upper hand via pre-tax compounding returns, whereas active managers can manage taxes for the investor – offsetting taxes on gains in a year where the investor has realised other losses.

The decision of whether to use active or passive investment strategies usually comes down to investor preference. But could a “great” investment solution not simply be a combination of two “good” investment strategies? We believe that there is a place for both active and passive investments, and instead of choosing a single strategy, one can combine these two strategies to create a solution that will benefit the individual client. As an example, the investment manager can allocate a portion of a client’s portfolio to a passive investment, which will give the client beta/index returns, then use the remainder of the portfolio to make active decisions and only allocate capital to high-conviction ideas. The result is a cost-effective portfolio that can achieve alpha/excess returns over time; this strategy is commonly referred to as a “core-satellite approach” to portfolio construction.

The core-satellite example is but one of many ways that investment managers can utilise both active and passive investment strategies to build and to optimise investment solutions. In closing, we believe that it is, therefore, fruitless to debate which investment strategy is superior: In the end, it all comes down to the needs of the client and the skill of the investment manager to utilise all of the tools at their disposal.
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Masala money madness: Spicing up your portfolio in incredible India

Dr Francois Stofberg
Managing Director: Efficient Private Clients, With Specialist Input From Renier Van Zyl

Over the past two decades, we have arguably witnessed the greatest era in men’s tennis. We saw a constant tug-of-war between Roger Federer, Rafael Nadal, and Novak Djokovic. Federer, who originally held the most Grand Slam titles, was overtaken by Nadal, who was recently dethroned by Djokovic. It now seems likely that Djokovic will be crowned the Greatest of All Time. Well, at least until the next tennis star comes along.

Like tennis, we have seen countries battle for economic supremacy. One country after another has managed to dethrone the reigning world power either through war or sheer economic force. The trophy, however, is not a piece of Wimbledon silverware but rather the opportunity to call its currency the reserve currency of the world. As recently as the 1700s, it was the Dutch who reigned supreme with their superior shipbuilding capabilities. The British then overtook them in the 1800s with some masterful shipbuilding of their own. Finally, the United States (US) managed to come out on top during the 1900s. The US managed to go largely unscathed through two world wars while the Europeans saw their countries and economies plundered. Unfortunately, as with the Dutch and the British, there will come a time when the mighty US will also be dethroned by another rising power. In fact, we are already seeing signs of this happening. As to who the successor will be, it is anybody’s guess but we would put our money on India or China.

With regards to the US, it is slowly but surely losing its shine because of its ever-growing debt, internal conflicts, and external conflicts with other countries. Recent signs of this could be seen in the debt ceiling negotiations, the storming of Capitol Hill, and the geopolitical tensions between the US and China. China, on the other hand, is not a clear favourite to dethrone the US: Its population is shrinking and its impressive housing boom is over. There is also the Communist Party which reveres greatness over growth, and who exhibits self-reliance over interdependence that previously characterised its economic success. Foreign investors are more wary than ever, seeking to relocate or to diversify their supply chains and investment portfolios. India, conversely, offers investors and businesses transparency and assurance when doing business. It aligns itself with both the West and the East, and has a growing population as well as an up-and-coming middle class. Experts expect India’s economy to grow, on average, by 6.3% until 2030.

For investors who want to invest in India, there are several investment vehicles, ranging from US-listed exchange-traded funds (ETFs) to securities listed on the Bombay Stock Exchange. There is also the National Stock Exchange of India that investors can trade on. ETFs, however, represent the easiest way to access Indian markets. Furthermore, there are also US-listed companies, such as PepsiCo, Apple and Amazon, that offer investors exposure to India through their generated revenues.

At Efficient, we opt for the latter. We still view India as an emerging market with its accompanying risks. We believe that, at least for now, there are still better opportunities in other markets, such as the US and China, and we are happy to gain exposure to India through the likes of Alphabet, Microsoft, and Amazon, among others. We are, however, constantly on the lookout for our first Indian winner in our portfolio.

Do Life Assurance Products Provide Investment Returns?

Life assurance is often seen as a grudge purchase – much like disability cover, dreaded disease cover, and income protection cover. However, it is an important part of an overall financial portfolio as it assists loved ones and nominated beneficiaries if you pass on before the term of your cover has passed.

If you are looking to generate returns from your life assurance cover, you will need to choose carefully. It is an error to assume that assurance products provide exponential returns in the medium and long term: it is in the nature of these products to generate diminishing returns as time goes by.

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Investment Management vs. Wealth Management

While investment management is an important segment of financial planning and overall wealth management, wealth managers take a more holistic view of a client’s financial health. Our expert financial planners at Efficient Wealth are proven leaders in the financial industry in South Africa. We specialise in wealth and investment management. With this in mind, in this article, we will explain how the two professions differ and why you may need the professional services of both.

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Different types of financial planning can aid you in achieving discipline over your finances and a layout a concise direction of where you wish to be in your life. In this article, we’ll discuss the four types of the practice and how sacrificing funds to support them will benefit your life now and in the future.

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The long-term effects of the tightening cycle

Dr Francois Stofberg
Managing Director: Efficient Private Clients.

 

The global economic landscape has been experiencing a tightening cycle for roughly a year, and it is becoming apparent that its effects are both spreading and deepening as disequilibrium becomes more apparent. Recently, we have also experienced that the banking system is likely to be a contributor to the damage being done. The flow of liquidity from cash and credit to assets and spending is critical to the success of economies, and the combination of central banks raising interest rates and draining reserves, coupled with banks experiencing more constrained deposit and capital conditions and tightening credit standards, is likely to constrain the flow of money and credit to markets and economies. This, in turn, is likely to have a detrimental impact on spending and income.

Three major equilibriums and two major policy levers interact to drive markets and economies. The first equilibrium in the rich world is spending and output in line with capacity, which roughly translates into approximately 2% real growth with 2% inflation, a nominal spending growth rate of 4% to 5%, and an average unemployment rate. The second equilibrium is that debt growth must be in line with income growth, meaning credit growth that is not too high or too low, with interest rates that act as neither a major incentive nor disincentive to borrow. The third equilibrium is a normal level of risk premiums in assets relative to cash, meaning that bonds provide an expected return above cash, and equities an expected return above bonds, commensurate with these assets’ risks. The two policy levers are monetary policy and fiscal policy. The economic and market swings that we see reflect the never-ending struggles of the marketplace and of policymakers to achieve equilibrium. In the West, we are far from equilibrium, while in the East, we are closer to it. The closer an economy is to equilibrium, the easier it is to fix problems and the lower market volatility.

In developed economies, high nominal spending, when compared with the ability of an economy to produce more, remains the greatest disruption to equilibrium today. This leads to inflation that is significantly above target, leading to big policy shifts and high market volatility. Despite aggressive policy action, the United States (US), Europe, and the United Kingdom (UK) have not moved much closer to equilibrium. On the margin, the nature of the disequilibrium has shifted from too much inflation to not enough growth, with the risk premiums on assets decreasing relative to cash.

The path from disequilibrium to equilibrium allows for big market swings. When looking at why the economy is in bearish disequilibrium, we see that inflation is too high. Nominal spending, in turn, is too high to bring inflation down and unemployment is too low to bring wages down, and despite nominal growth being too high, the real growth rate is lower than desired. In the end, a weaker real growth rate, that is, an earnings recession of sorts, is required to resolve the other imbalances.

In conclusion, the effects of the recent tightening cycle are spreading and deepening, and the damage to the banking system is a manifestation of this tightening. Markets are in disequilibrium and the high level of nominal spending remains the greatest disruption to equilibrium today. Despite aggressive policy action, the US, Europe, and the UK have not moved much closer to equilibrium. The path from disequilibrium to equilibrium allows for big market swings, which is a frame of reference for longer-term positioning. It is thus crucial for policymakers and market participants to remain vigilant and proactive when managing these risks and when taking steps towards a more stable and sustainable economic environment.