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Beat the confirmation bias blues

25 July 2017Paul Bosman, PSG Asset Management
Paul Bosman, Fund Manager at PSG Asset Management.

Paul Bosman, Fund Manager at PSG Asset Management.

Headlines in South African newspapers don’t make for peaceful bedtime reading, and investors are understandably concerned. Making investment decisions can be difficult when the future looks so uncertain.

Hastily selling your investments out of fear, however, can be devastating to your long-term financial wellbeing.

Various human biases can cause irrational selling. One of these is confirmation bias: once we reach a certain conclusion or develop a specific narrative in our minds, we search for or interpret information in a way that confirms our preconception. For example, once someone has decided South Africa is ‘going the route of Zimbabwe’, they can only take in information that confirms this theory. This person would be a hasty seller in the current environment.

One of Warren Buffet’s top investment tips is to be fearful when others are greedy and greedy when others are fearful. In other words, don’t just blindly follow the market. Taking his advice, then, the time to be ‘greedy’ is actually when fear is driving the prices of securities (shares and bonds) lower.

Currently, there are a couple of reasons why ‘greedy’ investors have better odds.

Firstly, plenty of bad news has already been discounted into the prices of securities. Current prices are therefore relatively low, as they already incorporate the bad news that’s in the media as well as fears for the future.

As a result, quality JSE-listed companies can be bought at price-earnings (P:E) ratios in the high single-digit to low double-digit range – that is to say, prices that are very attractive when compared to the earnings a company is generating. This is a standout opportunity.

Secondly, uncertainty and daunting prospects reduce competition, which is the most important driver of profits.

If in the year 1900 you knew which political developments would take place in South Africa over the next 117 years, would it be your investment destination of choice? Probably not. However, a recent study by Credit Suisse found that since 1900, South African stocks have generated higher US dollar returns than any other geography.

Similarly, consider the tremendous social and regulatory pressure the tobacco industry has faced over the last 20 years. Despite this, an index of listed US tobacco companies has returned an annualised total return of 15.4% over this period – significantly more than the S&P 500 Index, which has returned 7.1% when measured on the same basis.

Why these unlikely outcomes? We believe that lack of competition was a significant contributor in both cases. In South Africa, sanctions and generally daunting political conditions kept new entrants at bay. In the tobacco industry, banned advertising made it impossible to enter the market.

Current domestic uncertainty is warding off competition – both from outside investors and from many South African companies that are allocating capital offshore rather than competing locally. According to figures from the South African Reserve Bank, South African companies invested R300 billion outside our borders over the past five years.

We don’t know the future for a fact, but we do believe that odds are currently better for buyers of undervalued South African equities than for sellers. However, remember that when investing this way, you need to invest for the long term – even when it’s hard to do so.

Quick Polls

QUESTION

The FSB is thinking of scrapping Level II Regulatory Exam (which would have tested product knowledge) in favour of an approach that forces insurers to train staff and monitor their actions. Do you agree with this approach?

ANSWER

Yes. The Level II Regulatory Exams were a massive headache for those who had to write them
No. At least with the exams you knew who were the top achievers. A lot of trust now needs to be given to insurers.
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