The ongoing European debt crisis has resulted in high levels of uncertainty amongst investors throughout 2011. With many retirement fund trustee boards and members reviewing their investment portfolios for 2012, it is critical that they avoid making rash decisions and structural changes to portfolios in the hope of preventing any financial losses.
According to Mark Saunders, institutional asset consultant at acsis, both trustees and members need to understand that exiting the market during volatile times is not an investment strategy, it’s merely a reaction. In fact, it is in direct contradiction with one of the most basic rules of successful investing, namely buy low and sell high.
Saunders says proof of this is PF 130, which focuses on good fund governance and stipulates that a retirement fund’s investment strategy (as adopted in terms of an Investment Policy Statement) should be communicated to all members and reviewed annually to ensure that it remains appropriate in terms of the member profile and needs of the fund. “The circular specifically does not say that the strategy should be reviewed when markets are volatile or when there is a market crash, as the risks associated with the fund’s investment strategy should have been factored into the strategy when it was adopted.”
He says that the most important thing for trustees to remember is not to be tempted to take action and make changes to the fund and member’s investment strategies. “Instead, trustees should continue to focus on the long-term investment objectives laid out and remember that the strategy was developed to meet these objectives. Generally, the only time to consider changing an investment strategy is after significant corporate activity, if there is a change in the structure of the fund’s membership or if the members’ needs have changed.”
Saunders says that diversification is key in protecting an investment portfolio against risk and volatility. “When developing an investment strategy, it is crucial to ensure that it is sufficiently diversified and is not overly exposed to any one risk factor. Trustees should also ensure that they clearly understand the risk involved in targeting the investment objectives. While this should be done at the outset when the investment strategy development of the investment strategy, it is valuable to review these risks during times of stress. These risks must be clearly communicated to members at the outset rather than at the first sign of danger.”
He says that funds which offer member choice should caution their members against switching to more conservative investments in order to protect themselves against losses. “The simple reason for this is that it is extremely difficult to successfully time the market, as they will have to exit at the correct time and then know exactly when to switch back to the original, long-term investment strategy. As the old adage goes, investing successfully requires time in the market and not timing the market.”
Saunders says that a useful analogy to understand the behavioural biases affecting investors during volatile times and the potential impact of these is to consider the following scenario. “An individual leaves the office after work with the objective of rushing home so that he can relax on the couch and watch the latest episode of his favourite TV show. As he drives out of the parking lot, he encounter horrendous traffic as a bus has broken down on the highway. He then has another idea to try a few other cunning routes, back roads that no-one else knows. To his dismay, he finds out that a hundred other drivers with the same herd mentality had the same great idea. After a few unsuccessful attempts, he decide to phone his wife, explains the situation and ask her to set the PVR to record the show. However, he still has one major decision to make - at what point does he rejoin the original route home and just sit it out?”
All the twisting and turning has merely cost the individual time and angst (and petrol or diesel) as he is likely to rejoin the normal route considerably further back than he would have been with a little bit of patience. “Once investors decide to get back on track with their strategies, they are likely to be considerably behind. In long-term investing there are always side roads and other routes seem to be the wiser choice when markets are stormy. In reality, these routes are likely to result in lost capital and leave investors even further away from their objectives,” concludes Saunders.