2015 winners become 2016 losers

Andriette Theron, Senior Investment Analyst at PPS Investments.

The last two years clearly demonstrated the old adage that one should never blindly judge the future performance of financial markets based on past performance. Global asset classes were the worst-performing asset classes of 2016, after having been the best-performing asset classes during 2015.

Exposure to offshore assets (property, bonds and equity) contributed significantly to portfolio returns for the South African investor during 2015, mainly driven by the rand depreciating by 35% against the US dollar and 25% against the pound over the period. For the 2016 calendar year the rand appreciated by 11.5% against the US dollar and 26% against the pound, placing significant pressure on the performance of offshore assets.

Also, domestically, the worst-performing asset class of 2015 (domestic bonds) turned out to be the best-performing domestic asset class of 2016, recovering from the impact of the decision to remove Nhlanhla Nene as Finance Minister towards the end of 2015.

This was not only the case for asset classes, but also for investment strategies implemented within asset classes. There has been a major shift within equity markets (globally and locally) as value-oriented investment strategies came back into favour during 2016.

Graph 1 clearly shows that the period from 2012 to 2015 was characterised by ‘growth’ investment strategies outperforming ‘value’ ones as economic growth was in scarce supply and record-low global interest rates placed a premium on companies that could grow their earnings.

With the strong rally in resource counters since the beginning of 2016 it is no surprise that portfolios with a value-orientated investment strategy were some of the top-performing funds during 2016 after being the worst performers during 2015.

Graph 1: Value vs Growth (Source: Morningstar)

The most basic principle of generating superior investment returns is to buy low and sell high. 2016 serves as a perfect example of how, by chasing recent strong performance, one would have ended up doing exactly the opposite. As asset class fortunes changed, buyers of these asset classes in late 2015 or early 2016 experienced none of the upside of the past performance and only the downside of the subsequent weakness.

Now this does not necessarily mean that investors will be better off by always allocating capital to the worst performers of the preceding 12-month period.

The asset class ranking table below clearly shows just how volatile and unpredictable the relative returns of asset classes are over the short term (each column represents the relative ranking of returns in each calendar year). It is impossible to predict how an asset class will perform over the next 12-month period purely based on its performance over the most recent 12-month period.

(Source: Morningstar)

There is no guarantee that an asset class will recover immediately after a year of poor performance. Global bonds’ poor performance in 2009 was followed by another weak performance in 2010 only to recover in 2011. Even a strong performance over multiple years does not mean that the good performance will continue indefinitely. Domestic equities, for example, delivered muted returns during 2015 and 2016 after strong performances for three consecutive years (2012, 2013 and 2014).

The relative ranking of asset classes over the short term is best described as variable.

This variability of returns over the short term is not just limited to asset classes. The returns of individual asset managers are as unpredictable and volatile over the short term given that their underlying investment strategies perform differently at different stages of the investment cycle.

Even with this mind there have been numerous studies that show that investors often react irrationally and make poor investment decisions when disappointed by their own short-term returns.

Dalbar, a leading market research firm based in Boston, US, publishes a study each year that measures the effects of investors’ decisions to buy or sell mutual funds, on their investment returns over various periods. This study shows that the average investor consistently earns less than what mutual fund performance reports would suggest. One of the key findings in their 2016 study was that investments into money market assets tend to increase substantially during periods of market downturn, but are only reinvested into the equity markets well into market recoveries.

Another example of how investors can be their own worst enemies when it comes to investing is illustrated by the study done by Fidelity Investments. The study was conducted on its Magellan Fund which was managed by the famous Peter Lynch from 1977 to 1990. Over this 13-year period the Fund delivered an average return of 29% per year. The study found that the average investor over this period actually lost money despite the phenomenal returns delivered by the Fund. They concluded that the main reason for poor returns achieved by the average investor in the Fund was the tendency to withdraw from the fund during periods of poor performance only to reallocate capital to the Fund after periods of success.

As multi-managers we are uniquely positioned to assist individual investors in achieving their long-term investment goals. Our investment process is designed to focus on the fundamentals of asset classes. This ensures that we maintain a long-term perspective when making investment decisions. We have a team of investment professionals focused on constructing portfolios that combine asset managers with investment strategies that are driven by underlying factors that should perform at different times during the investment cycle.

When we look at asset manager performance over the short term the emphasis is on whether the manager performed as expected given its investment strategy and the prevailing investment environment instead of placing emphasis on the absolute returns generated over the period.

Our portfolios are well-diversified across asset classes, manager strategies and underlying securities and aim to provide investors with exposure to various sources of returns, therefore providing the necessary protection over the short term while achieving the required growth over the long term.