Simple strategies are the best
Investors were shocked in 2008 when they discovered diversifying a portfolio could not get rid of risk. Economists were less unsettled. They tend to look at a whole range of views, examining data and information domestically and globally in order to form an opinion about what might happen next.
“We’re interested in the future. But the only guide is the past and that is an imperfect guide, particularly as our understanding of the past changes as future unfolds,” noted John Redwood, chairman of Evercore Pan-Asset Capital Management.
Redwood, a Conservative MP since 1987, held senior investment roles at Robert Fleming and NM Rothschild in the 1970s and 1980s and since then has been a pension trustee, investment committee member for an Oxford college, chairman of an investment company and a non-executive director of a hedge fund and an investment trust.
Investors thought they were diversifying their portfolio into private equity, commodities, real estate, hedge funds and others. “They were for the most part,” says Redwood, “merely multiplying the same kind of risk.” All asset classes were geared to high borrowing and low interest rate risk and leverage. Once leverage was withdrawn, there were big losses. He concludes there was only one way to diversify successfully in 2008 and that was into bonds.
Investors had believed if they held their nerve, over a 10-year period, they would make money. This clearly was not the case for the last 10 years. That poor 10 years for conventional equity investment in the US, UK, Japan and the EU has shaken investor confidence. What, they are asking themselves, will the next 10 years bring and how should investors now behave?
Redwood believes the global economy is “nowhere near the end in this secular trend.” He points to the big shift in Japan between 1950 and 1990. In that period Japan always beat the US and UK. While many thought this was a risky place to put money at that time because of the phenomenal growth, the only really risky period was the enormous property bubble which brought the house crashing down in 1990.
China and India are still, says Redwood, in the Japan 1950–90 stage. “Growth will come through,” he says. If those countries learn from the past, the best shares over the next decade could be in these two countries.
Redwood also says finding a good active manager is now even more difficult. “Properly measured, the average actively managed dollar must underperform the average passively managed dollar, net of costs. Empirical analyses that appear to refute this principle are guilty of improper measurement,” quoting William Sharpe, the 1990 Nobel Prize winner in economics.
Finding good active managers is now a priority. He says finding an active manager – really good ones – takes “humility”. He notes there is a less than a one in 10 chance of finding anyone.
Looking at hedge funds Redwood said the 2008 results were “extremely disappointing”.
“When things go wrong, as they did in 2008, it causes strains between money managers and clients,” notes Redwood. However, he believes that when markets shift as rapidly and dramatically as they did in 2008, it was “like catching a knife”.
In future he beleives investment managers will need to explain to clients that “the future is a foreign country of which we know little with the infinite capacity of markets to humble even the best,” he says. It is best to find people who make sensible judgements in different strategies.
To keep it simple he recommends only making judgements where they cannot be avoided. He says he is content to index his main portfolio, to buy the index and keep costs down.
“If you follow an asset allocation strategy, you can’t avoid making decisions every time the market opens. It will be tested,” he says.
Sensible risk management will weigh probabilities and draw on experience and in this way it should be possible to avoid the worse errors.
Looking ahead he is pessimistic about the UK economy. “We were especially exposed to global financial problems. Two of the very largest banks are under public ownership. The balance of payment is not correcting despite a sizeable devaluation,” he says.
This year, he says, is as difficult as 2008. He is unsure of the final outcome. While China and India continue to produce positive results, he thinks it is a good place to put a lot of value.
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