Welcome to our 2019 Investment Report which introduces our revised approach to performance reporting. You’ll note below that we go into much more detail on themes, trends and events that have influenced markets over the past year. As ever, we will not attempt to forecast what markets will do this year.
We couldn’t agree more with Paul Samuelson that an investment portfolio should aim for steady growth rather than taking risks for the chance of making gains, however exciting or tempting that maybe. 2019 saw a continued trend for the UK retail market to adopt the same approach, with net outflows from active funds of £3.1bn and net inflows to passive funds of £21.5bn for the year to date at the end of October (Simfund 2020).
“I tell people investing should be dull. It shouldn’t be exciting. Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas” – Paul Samuelson, Economist and Nobel Prize Winner 1970
Over in the US, the size of passive assets has surpassed that of their active peers. The exodus of funds from active managers continued throughout the year and ended with an unwelcome early Christmas present for the active managers of the California Public Employees’ Retirement System (CalPERS). In an unprecedented move, four of its five equity managers were fired, and the scheme cut its allocation to active funds from $33.6 bn to $5bn. CalPERS cited continued underperformance and will redistribute the funds to passive strategies.
Both performance and pricing continue to drive this trend. Pricing competition in the UK remains strong, offering investors the opportunity to capture capital market gains at ever decreasing costs. Vanguard, the UK’s largest provider of passive funds, cut fees on 36 ETFs and index funds in October 2019. The average OCF (Ongoing Charges Figure – the cost figure that all fund managers are required to publish for each fund) for a Vanguard index fund is now 0.2%, a third lower than it was 10 years ago.
Research evidences the failure of the stock picking masters of the universe to outperform the market on any consistent basis while charging fees, far in excess of their passively managed counterparts. 2019 was no exception, the chart below shows that poor performance remains prevalent in both developed and emerging markets.
When stating these facts in the past, we have often been presented with the question “well yes, but what about Woodford?”. We would dare say that this question has answered itself in 2019, but we are not smug, and this is not something to gloat about. Significant sums of money, real people’s savings, have been lost as a result of the collapse of Woodford’s funds. This serves to remind us how important it is to have a deep understanding of the investments that we make and to ensure they are appropriate for our investment profile. “Watching paint dry” is likely to be all that we need to reach our financial goals. And without doubt, the loss of the UK’s “Poster Child” for active management will certainly do nothing to stop the flow of funds towards passive investment.
Lastly, no review of 2019 would be complete without acknowledging the passing of the grandfather of systematic investing, John C. Bogle, who created the first index fund in 1975. Bogle’s notion that trying to surpass the market is a fool’s errand, and that attempting to match the index is the most efficient way to deliver investment returns, was the acorn that in 2019 looks to have grown into an oak tree. As Warren Buffet noted on Bogle’s passing and his contribution to investors:
“If a statue is ever erected to honour the person who has done the most for investors, the hands-down choice should be Jack Bogle”.
Don’t Mention the “B” Word!
Brexit has been the UK’s proverbial pandora’s box, for year upon year, the world looked on in wonder and some would say amusement as UK leaders fell and governments changed but no headway was made on whether the UK would actually leave the European Union. Journalists relished in the turmoil, the strong feelings on both sides of the argument made excellent headline material and the continuing political pantomime was a bonus.
However, the real issue for investors, is not whether the UK was to remain, but the prolonged period of uncertainty. Markets detest ambiguity, any event that can be predicted with some certainty can be managed. Brexit caused businesses to postpone investing and delay recruitment which ultimately inhibited economic growth and UK capital market returns. Data suggests that the UK economy has been in a somewhat stagnant state since the 2016 vote, with average growth over the period 2016 Q1 to 2019 Q3 of 0.37% (Office of National Statistics 2020).
UK equities have returned 43.47% since the EU referendum in June 2016, while the rest of the world has returned 61.12% (Financial Express 2020. *UK: FTSE All Share, World: MSCI World.). Behavioural biases mean investors are often tempted to put more money in their home market, but this cannot be relied upon to serve them well. The Brexit commotion serves to highlight the importance of our investment philosophy, that of holding a global asset allocation within our portfolio. By taking a global perspective, the uncertainty of Brexit on overall investor returns has been minimised, diversifying portfolios avoids being overly exposed to the geopolitical risk of individual markets.
Asset Class Returns 2019
The year began with the fear mongering masters of the universe predicting all manner of strife for capital markets in 2019. Indeed, 2018 had been a challenging year for investors, after almost a decade of fruitful returns, many asset classes fell in value. Indeed, the last quarter of 2018 saw the worst quarterly performance for global equity in seven years (MSCI ACWI All Cap).
But again, the experts and their crystal balls have been proved wrong. Forecasts of major market corrections, multiple US interest rate rises and a no holds bar trade war between China and the USA failed to come to fruition. Instead, forecasters, again have eaten considerable amounts of humble pie. Instead, both equity and bond markets in developed and developing rallied, this can be seen in the chart below. Even with the difficult conditions in 2018, returns for all asset classes over the longer 3 and 5 year periods are very strong.
Despite the wearisome issue of Brexit, UK equity generated a 19% return, in part due to the weak pound which served to increase the value of repatriated international earnings. The announcement of yet another general election in October and the subsequent increase in value of both domestic stock and the pound, suggested the markets put more faith in the pollster’s predictions of a Conservative landslide than most political commentators. With subsequent election of a new government and the clarity that brought for markets, the year ended with a “Boris Bounce”.
Entering 2019, a slowdown in China stoked fears of an impending global recession. Alongside the prospect of an increasingly bitter trade war between the USA and China, this created expectations that the Federal Reserve would make up to four interest rate hikes over the year. This proved thoroughly mistaken and the Fed actually lowered rates three times.
The reduction in borrowing costs for households and businesses and the increasing competitiveness of US exports, as the value of the dollar fell, provided stimulus to the US economy. Despite the Trump tariffs, the US economy appeared to remain remarkably unscathed by the continuing trade war. US unemployment fell to 3.5%, its lowest level for 50 years, in part helped by the fact most Americans work in fields such as professional services, healthcare and hospitality – areas unaffected by the trade war. By year end, China and the USA were making serious headway in reaching a trade agreement to remove the drag on both countries’ economic performance. Despite the trade war, which is estimated to have reduced economic growth from 2.6% to 2% in 2019, US equity managed to return an impressive 26%.
Some may be tempted to reduce equity exposure following the bumper year for equities in 2019, in case 2020 results in a reversal of fortunes. Others may be subject to recency effect and expect the strength to continue. Either, or both, could prove wrong. The smart investor understands the key to investment success is to take a long-term perspective and remain diversified across the entire global market. The Asset Class Return Matrix at the end of this article shows why, illustrating the unpredictability of asset class returns over time. As Neil Bohr the Noble Prize winner in Physics once said:
“Prediction is very difficult, especially if it’s about the future!”.
Portfolio Performance
2019 did not deliver the widely anticipated market downturn. Many investors started the year concerned that the strong performance of capital markets seen since the recovery following the Financial Crisis, meant we could be due for a reversal, but this did not materialise. This only goes to emphasise the difficulty with calling short term market movements and reinforces the need for a long-term approach.
Our long-term, diversified investment strategy provided strong returns this year, capturing the performance of the capital markets. The following charts show the returns of our portfolio suites over the last 1, 3 and 5 years:
As we see, the profile of performance reflects the risk profile of the portfolio range, with the higher equity allocations providing the stronger returns and the lower risk, fixed income-based portfolios, doing their job. Performance over the last year for our 100% equity portfolio was strong, with a return of 20%.
The first of the two charts below, shows asset class returns over one, three and five years. It’s clear that this period has been very good for investors and so it’s especially important to remind ourselves that we must not be complacent by allowing recency bias and over confidence to influence our decision making.
The second chart, what we call the “patchwork quilt” demonstrates the randomness of returns and therefore the folly of attempting to predict in advance which asset class will provide the best returns in any given year.
As always, we are not in the business of predicting where markets will go in the short term, for this is irrelevant to the long-term investor. Diversification remains about the only free lunch in investing; the portfolios hold around 15,000 individual securities which, in our view, represents the optimum blend of assets to capture the market return for the risk taken.
We thank you for your continued support and look forward to working with you all in 2020. If you have any questions or wish to get in touch, please don’t hesitate to do so.
