A fresh take on equity investing
A great way refresh your equity investing knowledge is to travel beyond the “investment only” world. We took advantage of such an opportunity at the recent launch of iTransact, a new exchange traded fund (ETF) platform. The company had invited Mark Varder, co-author of It’s not about how SMART you can be – it’s about how WEALTHY you can be, to share his views on stock market investing. Varder’s not your typical financial guru, having only recently added investment smarts to his impressive advertising and marketing resume. His presentation was titled: How I learnt to stop worrying and love the beast!
The “beast” Varder referred to is the Johannesburg stock exchange. The reason so many South Africans shy away from direct involvement in the market is because they’re scared of it. “Most South Africans know the [stock market] exists – they know it’s about making money – but they don’t know enough about it to enter without some sort of assistance,” says Varder. Financial advisers are the default option when Mr Joe Average gets involved in equities. But it needn’t be this complicated! “It’s not about investing in the stock market; but investing through the stock market,” says Varder. Every rand you invest through the market finds its way to real companies participating in the domestic economy. And that’s pretty easy to understand.
A moment of clarity
Varder split his presentation into three parts: a moment of clarity, being smart is not so smart and building castles. His moment of clarity started with the question: “What does the long-term performance of the stock market look like?” Markets go up and down on a daily, weekly, monthly and even yearly basis; but over the long-term you wouldn’t want to be anywhere else.
Varder borrowed a graph from the JJ Segal book, Stocks for the long-run to illustrate the 200-year total return index of US-listed companies. What you get when the swings and roundabouts are smoothed out is a consistent upward-trending graph. The US markets posted constant real annual returns in the region of 6.6%. Every dollar invested in the market 200-years ago would be worth $355 000-plus today. Over the long-term stocks in Sweden delivered +7.9% per annum real return, +7.8% in Australia and a credible +7.5% per annum in South Africa. Of course, joked Varder, all we have to do now is work out how to live for 200 years.
Being smart is not so smart
The trouble with most private investors (and fund managers too) is they expend too much resource in their attempt to find the perfect share or time their entry and exit to the market. This strategy – known as active management – requires precision and an element of luck. To be successful you must be able to pick the five or six shares out of each hundred that will drive the market higher? Share picking is like playing roulette with a 16-shot revolver, with 15 rounds loaded – you’ll only get it right a faction of the time. And that’s the share picking side of the strategy “shot” to hell.
By the time we consider the “timing” side of the equation it’s hard to believe active fund managers attract the kind of money they do. In order to outperform a “buy and hold” strategy you have to buy at the right moment, sell at the right moment and make these decisions correctly 70% of the time. The ordinary investor has no chance! Further analysis of investor behaviour suggests the best thing any long-term investors can do is sit on his/her hands. In the US the average annual return from equities over 20-years stood at 8%. Funds returned 6% over the same timeframe – basically the market less 2% for fees. But the average investor walked away with a mere 1.9%. Varder concludes: “80% of all attempts to beat the market fail!”
In the real world analysts tend to lag the market. They’re getting the gossip about the next “hot” share when the company is already on the move. By the time they’re shouting at their clients to “buy” the share, it’s already on the way back down. US market performance through the sub-prime crisis of 2008 is a case in point. Before the year began the consensus among fund managers – those “in the know” investment professionals – was for US equities to post a nominal return of +28%. The markets delivered negative 40%!
Time to build a castle
“Costs are much more important than I ever imagined possible!” said Varder. And they remain the single biggest threat to long-term market performance. Consumers are used to dealing with big number, so when we see a fee of 1%, 2% or even 2.5% they tend to dismiss it as unimportant. But when you consider the 50-year real returns from equities (+7%), property (+4%) and bonds (+2%) the impact of costs suddenly hits home. That’s why Morningstar, a respected global investment ranking agency, recently said: “Low fees are the most dependable indicator of a funds’ future performance!”
US investment guru, John Bogle, built his Vanguard Fund on two basic investment principles. These include: Don’t try to beat the market (just get the market return) and cut your costs and fees to the bone. As a result of his passive investment strategy the Vanguard Fund is now the largest mutual fund in the world. Bogle’s philosophy is enshrined in a modern financial product known as the exchange traded fund (ETF). It’s a financial instrument designed to deliver index returns at low costs.
The US ETF industry has exploded from $40 billion a decade ago to more than $1 trillion today. Our fledgling industry is just getting started; but we’ve already got 25 funds to choose from. “ETFs are an incredibly good way to invest,” says Varder. And in iTransact, financial advisers finally have a platform to facilitate ETF investments for their clients.
Editor’s thoughts: Passive investments attract huge cash flows through recession. In the US a massive $500 billion flowed into passive or index space while $350 million flowed out of the active space as the economy faltered. We didn’t want to open the active versus passive debate, so we’ll ask instead: Do you think the average investor needs a financial adviser to assist with ETF investments? Add your comment below, or send it to [email protected]
