Equities have a positive expected return, but we often forget that the payout does not come every year, and it does not follow a straight line. That’s why our investment strategy is based on discipline, broad diversification within and across asset classes, and long-term thinking.
In November 2011, researchers Andrew Ang and Knut Kjaer published a paper called Investing For the Long Run, which identified several advantages enjoyed by investors with a long horizon. First, they can ignore short-term fluctuations in returns, which are merely noise. Second, they can profit by buying assets when fear levels are high and prices are low. “Taking off risk is always easy,” they write. “It is the ability to put on risk in troubled times that makes the difference between professional and mediocre investors.”
Ang and Kjaer point out that even the “smart money” has a difficult time with this idea. The $225-billion California Public Employees’ Retirement System (CalPERS), for example, has a much longer time horizon than you or me. Yet CalPERS loaded up on real estate assets during the property boom of the mid-2000s, and they were a seller of equities during the turmoil of 2008 and early 2009. Rather than sticking to a strategic asset mix, the largest public pension fund in the US made the same mistake we are all prone to: they bought high and sold low.
Contrast this with the behaviour of the $500-billion Norwegian sovereign wealth fund, which follows a strict set of rules set by parliament. Following this long-term strategy, Norway was an active buyer of equities during 2008 and 2009. As a result, the fund enjoyed much higher returns in the following years.
Ang and Kjaer go on to explain that individuals should employ a similar set of rules that discourage acting out of fear. “It is precisely during these challenging times you most need the rules,” they write. This is exactly what we do when we rebalance our clients’ portfolios: we sell assets that have recently gone up in value and buy those that have declined in price. This rebalancing schedule is a key part of your Investment Policy Statement.
No one knows what lies ahead. But rest assured that our portfolios are designed to withstand whatever the markets throw at us. Understanding this idea should help you face the years ahead with faith rather than fear