Should I invest now?

PHIL: Will, let’s start with the most common question the team and I are getting at the moment – why should I get invested now when I see US stock markets at all-time highs again even as the economic data is telling us that we are in the sharpest economic downturn since records began?

Deploying hard-earned savings into capital markets is psychologically challenging at the best of times, but having just witnessed what we’ve seen in the first part of the year, that is obviously even more the case. There is no easy answer here, because the reality is that investing will always be a bit of a leap of faith. By investing in a diversified mix of assets you are making two implied statements. First, you believe that the centuries of innovation that lie behind us are not over – humankind will continue to invent new things and get better at using those new things. Second, the price to access all of that future innovation remains sufficiently attractive.

On the first point, obviously we can’t guarantee anything about the future. However, a careful study of the past points reasonably in that direction. On the second, there are certainly parts of the world’s capital markets that look expensive to our eyes – government bonds are certainly offering a lot less in the way of real prospective returns than they have done at any time in my career. Some of the share prices of the modern US corporate titans have been increasing based on cash flow assumptions that leave little margin for error. However, when put together with the other necessary parts of our diversified funds and portfolios, do these elements suggest overall returns will be below inflation over the next decade? No. With that being the case, now is still the best day to get invested.

That actually brings me on to another challenge I often get. I still look at the months ahead and I see US elections, Brexit, rising fears of a second major wave of the pandemic and so on. Many just don't see the point of getting invested ahead of all that, so why should they?

I totally understand and this is one of the most difficult concepts to get your head around in a way, even for seasoned market professionals – that is that prices are forward looking. Market prices incorporate in varying degrees all of our hopes and fears about the future, and all of the actual information that is available today. For the most part, they do this relatively efficiently. The recovery in share prices from the March lows is a good example of this. I don’t think many people felt like putting their money to work for the first time at the end of March – they were very brave if they did! At that stage, the economy still seemed to be in freefall, the first surge of infections was still very much in motion in most geographies and yet stock markets were about to embark on a dramatic rally. The point is that investors were already looking through to the other side of the crisis, aided by a robust response to the crisis from policymakers and very tentative evidence that lockdowns could be effective in flattening the infections curve. If you wait for the perfect moment to invest, it never comes.

I would note on this that the team did a great job of adding to equity and credit risk at the very moment you described at the end of March. However, I just want to get into what you said in a bit more detail as there are a couple of other questions in there as well – namely US elections. I take what you said about markets being forward looking, but is the team thinking of making asset allocation changes to reflect some of the risks around US elections?

There are several problems here in a way, Phil. Try looking at it backwards. So, in order to take an investment position on something or other, I would need to have a strong view about a particular policy that would be enacted within a certain time frame. If I work back another step, this would require me not only to have a strong view about the occupant of the White House post-November, but also the political hue of Congress. On top of all of that, I have the problem that there can be a gap between campaign trail rhetoric and actioned policy. If I put that together with the fact that elections are simply not very predictable, we are left realising that anyone who takes strong positions based on a US election view is massively exaggerating their ability to see the future.

You can take reassurance from the fact that most of the time the occupant of the White House is just one of many factors with the potential to move markets into the year end. However, who sits in the Oval Office for the next few years is irrelevant for the longer term trajectory of your portfolio or fund – that will be driven by that productivity story, as suggested above.

So you mention “other factors” there, are there any you would highlight in particular?

The problem here, I think, is that we tend to anchor to the stuff we think we can see. So, any beginning of the year list of risks will always skim through the calendar of political events and identify a few potential uglies. However, remember that risk is like an iceberg, most of it is submerged from view until we hit it, so to speak. Now that may sound alarming, but the second point to bear in mind here is that risks in the context I’m talking about here are not just about things that could go wrong out of the blue, but also that can go right. News on vaccines, treatments and so on could surprise positively or negatively for example and really could have a significant effect on the short-term outlook for the economy.

Yes, that makes sense. However, I know that a lot of clients are worried about protection – if you can’t provide much reassurance about the future, how can investors protect against the downside?

In the short term, the answer is with great difficulty unfortunately. I wish I had a more comforting message here, but the reality is that the upside to investing is very hard to sustainably access without risking shorter term market spasms of the like we’ve just seen. They are part and parcel of investing life. Some will point to the magical qualities of certain assets, sub-sectors or even types of companies, but I’m not convinced that many such investments can consistently provide the kind of robust protection they are often associated with.

However, if you are a longer term – say 10 years and beyond – investor, the question gets a little different. On this time frame, you are really trying to make sure that you are not just assuming a continuation of the recent past, but are incorporating the potential for myriad different future paths into your mix of assets. As you know, our asset allocation team have sophisticated ways of incorporating this into our products.

What about gold? It’s done well recently and, as usual, when something does well, you get a lot of people coming out of the woodwork telling you that more of the same is in the pipeline!

Yes, I think this is another example of the dangers of driving whilst only looking in the rear view mirror in truth. The big question for asset allocators at the moment is what to do with the portion of my allocation that is not equities? In a world where nominal government bond yields, the traditional safe haven asset for many years, are so low, they simply can’t be expected to play the same anchor role in portfolios as in the past. The suspicion with gold is that it dances a little bit to the same tune. So in fact, you would be increasing your exposure, indirectly, to government bonds or at least real interest rates, not decreasing it. To that end, we remain comfortable with the exposures we get with a diversified basket of commodities.

It’s not been a winning part of the portfolio for the last few years, but we are mindful of the idea mentioned above – we do not want our asset allocation to be inexorably sucked towards a basket of recent winners. We don't know enough about the future to allow that to happen. Regimes change, and they can do so quite suddenly and unpredictably. Maybe this crisis is the catalyst for that change in the socio-political, macro and/or regulatory backdrop. Or maybe not. However, I would not want to bet my savings, or anyone else’s, all on one answer or the other.

To be clear, we don’t just blindly continue to back parts of the portfolio based on the hope that they will come good at some point in the future. We have a regular process where we assess all the inputs into our portfolios taking into account both statistics and theory. There are no sacred cows. We are simply trying to find the best mix of assets at all times to give us the best chance of delivering optimal client outcomes. Diversified commodities continue to fit into framework in spite of the sector’s more lacklustre contribution to performance in recent times. 

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