The most valuable investment lesson you will ever learn
The financial services environment is an extremely complex space. To master this universe you have to know about insurance (short and long-term), healthcare and investments. In each of these disciplines there are a myriad of complex products, sometimes not even understood by the actuaries who designed them. We reckon the opening scene from science fiction film Terminator could as easily have resulted from a war between mankind and an evolved insurance product as between man and machine.
Jokes aside – today’s newsletter focuses on the investment world (excluding long-term insurance) which usually comprises a mix of cash, bonds, property and equities. The process of splitting an individual’s wealth into these asset classes is known as asset allocation. And the possibility of understanding all the options available in each of these asset classes is referred to as a “pipe dream”.
Which product to invest in?
Even if we strip out property, cash and bonds and focus on equity rich investments we’re confronted by thousands of possibilities. The simplest method to complete an equity investment is to purchase shares in a public company. You can purchase listed companies through a stock broker on stock markets in almost any country or currency you can imagine. The local market is limited to around 400 companies while markets in the UK and US offer thousands. And that’s where the fun begins. Because, the experts say, investing in a single company exposes you to too much risk.
To get rid of this risk financial service providers have created a range of risk diversifying investment options You can purchase Exchange Traded Funds, Index Trackers, Unit Trusts etc to diversify across asset classes, lock in a ‘benchmark’ return or secure a chunk of precious metal. And to further complicate matters you can purchase any of these options in local or foreign currencies on markets at home or abroad. With each level of complexity you can be sure the entry fee and ongoing management fee will spiral higher. Instead of buying shares directly on the market you pool funds and buy a unit trust run by a fund manager. And before you know it you’re invested in a fund of funds with management on three or four levels. No wonder returns are hard to come by when markets fall.
Can we really expect a single investment adviser to successfully navigate an investment universe with so many options? It’s no wonder individuals in the industry end up working as ‘tied’ agents. Picking an appropriate product from a single provider is much simpler than searching for that option from the entire ‘investible’ universe. With your preferred product in mind the trick is to decide when to buy.
Getting the timing right – when to invest in equities
But timing the stock market is a mugs game. Any investment adviser worth his salt will probably tell you its “time in” and not “timing” the market that counts. Yet every investment presentation one attends, at every quarterly economic update or outlook, the top guns at the country’s big financial houses play the ‘timing’ game. They disguise it in terms like ‘cheap’ and ‘expensive’. The long and short of it is this: if you can call the cheap or expensive market then you can time it! So who’s fooling who?
Although we missed the latest Old Mutual Investment Group SA (Omigsa) quarterly update – your editor was blowing money on expensive coffee at the wrong hotel – we’ve had a chance to peruse the press release covering the event. Under the title SA equities not cheap despite bear market – big rally not likely head of Omigsa’s Investment Research team, Steve Minnaar concludes we haven’t yet seen truly cheap equity valuations on the JSE. “Even though the FTSE/JSE All Share Index fell by 23.3% in 2008 and another 4.2% in the first quarter of 2009, even at its worst levels in February and November, the market has not necessarily been too cheap,” he says.
And he offers a reason to support the house view. “Based on our valuation framework using cash flow returns on investment (CFROI), share prices were so unrealistically high in mid-2007 at the peak of the bull market – pricing in corporate returns far above the long-term average – that they have now only fallen to levels where returns on investment are closer to the long-term average.” Its great advice; but knowing that shares were unrealistically high mid-2007 isn’t helping anyone at the end of Q1 2009! And we couldn’t help wonder whether Omigsa ‘fair value’ conclusion for equity prices at mid-April 2009 would still hold when CFROI is unleashed at the end of Q1 2011.
How low does the bear go?
Predicting market trends is just as difficult as timing the turning points. We’ve heard hundreds of analysts, local and international, trying to get to grips with the current market downturn. Every time shares move more than 10% they start talking about trend reversals, dead cat bounces, bear market rallies and any number of other confusing market phenomena. A 20% recovery elicits claims of a turnaround from some while others point to the frequent 50% rallies during previous market collapses.
Omigsa isn’t keen on calling the current trend. “Although equity markets around the world have rallied in anticipation of a recovery, and we may have already seen the bottom of our market, it’s still too early to say for sure – the JSE could be experiencing a ‘bear rally’ (a rally within a bear market),” says Minnaar. Where equities are concerned the only perfect science is that of hindsight. So the only way an analyst can answer what will happen in 2009 with 100% accuracy is to wait until close of trade on 31 December. It comes as no surprise that experts differ about individual shares too. When we spoke to Alwyn van der Merwe (of Sanlam Private Investments) he told us Anglo American was worth accumulating; but only if it dropped to the R150 level. Omigsa, on the other hand reckons the share is dirt cheap. They say the current “bearish expectation is way off Anglo’s multi-decade track record.” You decide whether to buy or sell at the current price!
That concludes our tongue-in-cheek look at the world of equity investing. Though it may sound a trifle pessimistic we believe the best investment advice you’ll ever hear is this. “Nobody knows!”
Editor’s thoughts:
We hope you enjoyed today’s rant about excessive choice and opinion in the world of equity investing. Our intention is not to give fund managers a hard time; but to simply query the complexity of the environment the product providers have created over time. How do you go about choosing an appropriate unit trust for your client? Add your comments below, or send them to [email protected]
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