Our Blog Jul 17, 2017
Where are the investment opportunities and risks in today’s market, and why might investors value a consistent approach to investing now more than ever?
Q: What is your outlook for financial markets?
There are two big concerns when it comes to the general outlook for financial markets. One is the high valuation of equities, and the other is the direction of interest rates. Following the U.S. presidential election, there was a rally in U.S. equities based on the assumption that the new administration’s policies would stimulate growth quickly. Now, it’s uncertain if those measures will get passed, and it’s even more doubtful that they will get passed quickly. In fixed income, there isn't a lot of controversy that rates will rise because historically, they’re at such extraordinarily low levels. The real issue is how fast they will rise. But aside from those what-ifs, we do have good growth trends in both the U.S. and around the globe.
Q: With this extended period of historically low interest rates, are investors taking unintended risk to generate income?
Yes. Chasing income has become one of the market’s major themes, and it’s certainly alarmed me for a few years. The premium that people are prepared to pay for a higher current yield, or current income, is concerning in regards to both equities and fixed income. The relationship between a higher level of risk and a higher return seems intuitive, yet that reasoning doesn’t seem to resonate as much when it comes to income. People don't always consider that if they’re getting a higher current income, it’s because they’re taking a higher level of risk.
The feedback that we get from advisors and investors is that consistency of income is really the big driver of long-term satisfaction, not the level of current income. Getting a nice high yield today that's going to be under threat tomorrow is not such a good thing. Being able to get a decent yield today that is sustainable through a number of changing circumstances and markets is far more important.
Q: What trends do you see in global investing?
When we talk about global investing, we think in terms of the U.S., Europe, Japan or emerging markets. But I believe those traditional, geographically defined ways of investing are going to become increasingly obsolete. We have to think more in terms of horizontal themes rather than vertical time zones. It’s important to develop more global, sustainable, longer term growth opportunities within a framework rather than one bound by the traditional geopolitical constraints.
A good example is infrastructure. It’s a global theme, but the vast majority of the infrastructure investment vehicles available to retail investors are structured around geographical constraints: a U.K., U.S. or Japanese equity fund, or a similar fixed-income equivalent. Investment products that are defined by a horizontal theme continue to be a very narrow field, but one that I think will start to grow quite rapidly.
Q: What makes infrastructure a sustainable longer term opportunity?
It's interesting how much is written about the U.S. or European economies, and there are debates as to whether they will grow at 2.4% or 2.5%. These are relatively small differences, yet we have a clear opportunity that infrastructure could grow at least 6% per annum for a decade or more. There’s really no country I can think of that doesn’t need to do some work on its infrastructure.
It’s also important to note that the nature of infrastructure is changing, offering more diverse opportunities for investors. Wireless and internet infrastructure links people together just as much as physical links like roads and bridges. On a recent trip to the Philippines, I saw that their approach to connecting people to the financial services system is not to build thousands of new bank branches, but to create virtual banks through wireless networks.
Q: Why do you think the consistency of income or returns drives long-term satisfaction?
The evidence is that investors chase the previous year's most spectacular returns, and yet our research proves this to be a very poor strategy. The financial industry often uses the disclaimer that past performance does not guarantee future results. It's actually very true, yet people don't seem to pay any attention to it.
Whether you're trying to save money to help your children go to college or build income for your own retirement, it is the consistency of the return that is most important. It’s far better to get 6% consistently than positive 10% one year, minus 2% the next year and then positive 4% after that. Using simple arithmetic, the compounding effect of a more consistent return is advantageous. But perhaps more importantly, there is also a behavioral advantage: People who chase higher returns are usually the first to sell when their investment goes through a bad patch.
Q: Is there a quantifiable benefit to achieving consistent investment outcomes?
There's a lot of controversy at the moment about fees on active vs. passive products. But our research suggests the difference between active or passive may cost investors somewhere in the range of 60 to 80 basis points per year, whereas the behavioral trait of selling low and buying high is actually costing people up to 200 basis points per year. If we can combat this behavioral tendency by offering strategies that have a more consistent return, investors will be less apt to panic during periods of volatility. This can have a big effect on their long-term results. Go for consistency, not for short-term spectacular returns.
Q: Does the high frequency of elections and geopolitical events make it more difficult to achieve consistency?
The asset management industry as a whole is too eager to blame external factors like Brexit, the U.S. election or some other major event or circumstance. Our knowledge of geopolitics is important because ultimately it helps provide a more consistent experience for investors. It might appear to be a separate skillset from investing, but there needs to be an understanding of what the range of outcomes might be.
For instance, what will happen in the next big election? You can speculate that the underdog will win, and you may generate a lot of excess return if you make that bet. But ultimately, you're putting a lot of capital on something that has a low probability, and it’s usually not a good tradeoff. What we're trying to do is provide the highest probability of a reasonable return over time. So when an investor is aiming toward a goal of retirement or saving for their children's education, they'll have the highest chance for success.