Why Betting On Markets Can Make For A Bumpy Ride
The New Year has ushered in a boom for US equities, with the sharemarket there invigorated by a new President spruiking a pro-business agenda.
For investors watching for the likely 'winner' of the equities race 2017, the Dow Jones' recent record-breaking performance might make an overweight to the US seem tempting.
However, before you start making wholesale changes to your portfolio, it's worthwhile pausing and taking a look back at how global sharemarkets performed during 2016 to see why pinning your hopes to a winning asset class or ignoring a seemingly poor performer can actually weigh your portfolio down.
At the start of last year, investors were focused less on America and more on China, specifically how its slowing demand for raw materials might impact Australia's economy. That concern manifested in the local sharemarket underperforming global markets in January, clocking a -5.92 per cent return for the month.
Fast forward to the end of 2016, and the broad Australian market returned 11.79 per cent for the calendar year – an impressive double digit return, particularly given the current low-growth environment. However, you would have missed out if you'd pegged Aussie equities as a laggard early in the year.
As 2016 progressed, concern over the state of the Chinese economy gave way to shock as Britons voted to leave the European Union. This caused considerable consternation across global markets, no less the UK. The subsequent volatility was short-lived, however, and the UK bourse proved resilient with a 4.97 per cent return for June, taking only about a week to recover from its Brexit-induced gyrations.
Next came the US presidential saga, which caused market jitters as the long-run race drew closer to election day – the US index recorded -1.90 per cent for October. But since then, nerves have given way to exuberance as markets have endorsed President Trump's moves to boost the American economy.
Despite concerns for Australian, US and UK sharemarkets at various points throughout 2016, these three markets were among the best performers globally last year. Even if you had backed these markets at the start of the year, it would have required some amount of intestinal fortitude to stay the course during the periods of uncertainty and underperformance that these markets endured during the year.
The point here is that markets oscillate over the course of any given year, and their overall performance is nigh on impossible to predict. And, even if you do predict the best performer, you will invariably experience periods of poor, or even dire performance. That's why it's important keep two central tenets in mind when it comes to choosing investments to include in your portfolio.
Spread risk to account for uncertainty
Over the course of 12 months, or even across multiple years, the relative performance between equity markets in different countries can vary and investment uncertainty can be significant. By diversifying across countries, however, this uncertainty can be reduced.
For instance, if we rank the performance of the developed markets – Australia, US, UK, et cetera – against a global market index that combines them all, the global variant will typically sit more or less in the middle of the pile performance-wise, and this was the case in 2016.
That's because the index roughly represents the average performance of all countries. By definition, the global index will provide a smoother ride than that of its constituent countries. In fact, all of the component countries in the MSCI All World Index underperformed the aggregate index itself at some point during last year – even the year's top performers.
By moving the focus from individual performance of markets to global diversification, which is possible either by taking a broad approach to active security selection or by tracking broad-based indices, investors can benefit from exposure to a wide pool of countries, industries and companies of all sizes which can help insulate a portfolio against the inevitable ups-and-downs of the market.
The market changes, your goals shouldn't
Many investors, from individuals to institutional, read the Brexit vote in June as an ominous sign and fled UK equities. In hindsight, however, this proved to be a misstep as the UK market subsequently rallied.
Rather than focusing on current events and how they may impact the market, almost all investors would be better placed reminding themselves of their long-term investment goals and constraints. For example, 'what is my investment timeframe?', 'how much risk am I willing to take?' or 'what level of income do I want to achieve?'
It is unlikely that a referendum in the UK or a presidential election in the US will change your own personal investment constraints or objectives. Working out what you're going to do with your portfolio and when, and how much risk you're willing to expose your capital to should only change based on developments in your own personal circumstances.
Markets change all the time, which can induce anxiety and myopia causing investors to abandon their long-term objectives. The trick during periods of market exuberance or turmoil is not to try and profit from the uncertainty. This can lead an investor to lose sight of their long-term goal.
Looking ahead this year, if investors learn anything from 2016, it's that asset classes do not always behave as expected. Broad diversification across global markets can help tame the market's behaviour by reducing volatility and alleviating some of the uncertainty that comes with investing.
Those looking for a successful strategy in 2017 should base their portfolio on their long-term objectives, rather than their short-term outlook for the market. It's worthwhile remembering that the definition of success is based on an investor's own financial goals, not the prevailing mood in the market.
Robin Bowerman is Head of Market Strategy and Communication, Vanguard Australia.
As a renowned market commentator and editor Robin has spent more than two decades writing about all things investment.