Very few things in life are predictable; perhaps only death, taxes and the next three Russian presidential elections. The investment industry is based on prediction, which is a pity because it isn’t very good at it. Like a medieval alchemist attempting to transform base metal into gold (again), it is too often fixated with predicting the near term results of marginal companies while eschewing the more realistic pursuit of making a worthwhile stab at what is likely to happen (over longer periods of time) to enterprises of substance. As the economist John Maynard Keynes noted (and no slouch of an investor, himself) it was better to be vaguely right than precisely wrong. Or, to put it another way, I see little point in trying to predict exactly when my wife will tell me she needs another pair of shoes but in the same way that Wednesday follows Tuesday or Spring yields to Summer, I can rest easily, knowing with certainty it will indeed come to pass.
A substantial proportion of investment is undertaken on the basis that a portfolio must largely represent a major index; the FTSE 100 would be a good example. The manager then attempts to beat the relative performance of the index. It consequently follows that if the index is the benchmark, you are in essence, a forced buyer of its constituents. You may vary the weights of certain companies or sectors but if beating the index is the goal, it is the index that influences the construction of the portfolio. As I write, the aforementioned index is 10% below its value at the end of 1999. Even if your portfolio ‘outperformed’ by, say, only falling 5%, the absolute loss secured renders the exercise pointless. To lose less than most is an odd kind of success. So, rather than replicate an index, would it not make more sense to ask which companies (whether within an index or not) you might actively want to own?
There is another problem with indexing and that concerns changes in the constituents themselves. This happens on a fairly regular basis and results in new stocks entering, thus taking the place of those ejected. It is common to see the prices of the latter under pressure while the former benefit from index buyers having to purchase almost immediately. Consequently, forced buyers have likely had to pay through the nose to acquire stock they are only owning because of index inclusion. How attractive is such a proposition for the underlying client? If purchases and sales are the result of robotic behaviour, are the odds of long term investment success in your favour or against you? How many successful people do things randomly? Does Federer just whack the ball over the net? Did Whicker get on the first plane he saw at the airport? Does Ronaldo kick the ball in the general vicinity of the opponent’s goal?
This industry generally does a poor job for clients because it’s forgotten what it is supposed to be doing. George Bernard Shaw noted that all professions represented a conspiracy against the laity. He was originally talking about doctors but something tells us he’d likely met a few investment managers along the way.
The value of investments and any income from them can go down as well as up and you may not get back the amount originally invested.
This material should not be considered as advice or an investment recommendation. Investors should seek advice from an authorised financial adviser prior to making investment decisions.
John Newsome can be contacted on 01423 705123 or john.newsome@williams-im.com. Williams Investment Management LLP is authorised and regulated by the Financial Conduct Authority.
