Should investors shun equities after the whirlwind 2016?

Andriette Theron, Senior Investment Analyst at PPS Investments.

Despite volatility in equity markets, investors should still guard against trying to time the markets, or getting out of equities at the wrong time.

Domestic equity markets delivered cash-like returns over the past three-year period, and underperformed cash over the past year.

The Association of Savings and Investments South Africa (ASISA) recently reported that money market funds attracted strong inflows during 2016, amid the severe equity market volatility. This could be indicative of a widespread sense of caution many investors had tended towards in a year full of surprises.

However, moving in and out of equities haphazardly could be far more detrimental than riding out the tough times. This is because missing out on a strong calendar year or even a couple of strong market days could significantly reduce the returns from holding equities over time.

A recent study undertaken by PPS Investments indicated that missing out the best ten days in the market over a twenty year period would have halved investors’ returns from holding equities, while missing out on strong calendar years would likewise have been equally detrimental.

The same also applies to trying to time allocations to managers. The ASISA statistics referenced earlier indicate that investors frequently chase manager performance. Typically, funds flow from managers that have recently underperformed to managers that have recently performed well.

Again, such behaviour can be detrimental to generating returns. This is shown by findings of a well-known US study that was conducted on the Magellan Fund managed by the famous Peter Lynch from 1977 to 1990. While 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.

It is therefore critical for investors to maintain a suitable allocation to equities in order to meet their inflation targets over the long term, as well as backing managers through periods of short-term underperformance. We believe that a multi-manager process that is sensibly diversified across both asset classes and managers can help investors cope with periods of short-term volatility.

A reputable financial adviser can help you determine the appropriate level of equities you would require to meet your long-term financial goals, and to stick to a sensibly constructed and well-diversified investment portfolio – which includes an allocation to equities.