In his latest insight note, Simon Evan-Cook, Senior Investment Manager for Premier’s multi-asset, multi-manager funds, looks at the risk of arriving late at an investment party, and asks if many investors are about to make the same costly mistake they made ten years ago.
Have a peep at these charts:
Similar, aren’t they?
What are they? Let’s start with Chart A:
The blue “Winners”1 portfolio consists of the ten best performing funds – across all IA sectors - over the 10-year period of the chart2 (to the 14th October 2010 for Chart A – seems like an arbitrary cut-off, but I’ll explain in a bit). The green “Losers” portfolio consists of the ten worst-performing funds for the same ten years. So that’s ten funds each, equally weighted at 10% of the portfolio.
“What on Earth is the point of doing that?” You may very sensibly ask. “You’d have to be extremely lucky to have picked the ten best funds, or extremely unlucky to have picked the ten worst. In either case it’s hardly going to be relevant to any decision we’re facing today.”
That would be right if humans didn’t run as herds. But we do. So when you look at what makes up the Winners and the Losers portfolio, it’s far from random (we’ve removed the fund names to spare any blushes):
Source: FE Analytics, data from 14.10.2000 to 14.10.2010.
Looking at the 2010 “winners” portfolio, it’s clear they were linked by a couple of themes. One was natural resources driven by the prevailing “Commodity Super-Cycle” theme (Latin American and Eastern European markets are dominated by large mining and energy companies). The second was the not-unrelated “BRIC” concept (Brazil, Russia, India and China), which shows how giving a theme a whizzy acronym can help to co-ordinate and prolong herd-like behaviour.
The relative performance of commodities peaked late in 2010 (hence the arbitrary-looking date of the chart). At that time, the theme had been with us so long that investors began to forget it was a theme and assumed instead it was a permanent state of affairs (very much like beards in that respect): commodities always go up, so buy lots of them.
This is what has happened to those two portfolios since that peak:
For those watching in black and white, that’s a complete reversal: If you had blindly backed the ten “worst” funds3 of 2010, you would have since outperformed anyone who picked the commodity-heavy “best” funds (and many did) by a cool 262%.
That brings us back to Chart B. This is what you get if you re-run the ‘Ten-Year Tell’ exercise using today’s winners and losers (as at the time of writing: 16th July 2019). Here’s the chart again:
Source: FE Analytics, data from 16.07.2009 to 16.07.2019.
You won’t need to be overly forensic to spot the common themes among 2019’s “winners”4:
So what will the next ten years hold? Will those investors sinking their fangs into US and/or tech-heavy funds see a second-consecutive decade of incredible returns (thank heavens there isn’t a whizzy acronym joining the winners together this time – that would be worrying!). Probably no need to state our own view explicitly here, but in the spirit of what’s known in legal circles as “leading the witness”, here are those charts again.
Note that late-coming investors are usually right. Just not in a way that makes them any money. Those who bought tech funds in 1999 were betting that technology would dominate our lives, and that tech companies would dominate future markets. Spot on! Yet they generally lost money over the next 10 years. Likewise, those chasing 2010’s winners expected China to keep growing, and to consume mountains of commodities as it did so. Tick! But again they lost money over the following decade.
Running the 2010 winners-losers chart from the start of the trend to date helps explain why:
If you’d caught the commodity trend at the start, you’d have made a 602% return over the last 19 years (by investing in the commodity-heavy “Winners” portfolio). That works out at just shy of 11% per year: a good return. Irritatingly, markets don’t usually give you a neat 11% every year tied up with a ribbon: they give you a little, then a lot, then nothing. That’s because a trend can take a while to get noticed, but as more people do notice and jump on5 they push prices up faster than the assets can generate the returns. In effect, future returns are being dragged forwards.
At some point, all those future returns have effectively been earnt. Anyone joining at this point is generously paying for the 'early birds' to cash in 19 years of returns after just 10 years of waiting. Put numerically, the early birds made 22% a year for the first ten years, while the 'Jonny-Come-Latelies' have lost 0.5% a year ever since. And because of the way markets work, there are many more 'Jonny-Come-Latelies' than there are early birds.
So ideally, you’d want to buy early into a genuine trend that hasn’t been noticed yet. Because if everyone has noticed it, there’s no-one else left to push up prices.
Do you think anyone’s noticed the US technology trend yet?
I appreciate this sounds cynical. So I’ll clarify: we are not cynical about the power of US companies, in particular US tech companies, to dominate our lives for years to come. We are simply worried that the trend is so well popularised, that plenty of their future returns have been dragged forward, thereby raising the risk of a sparse few years while future returns catch up with today’s prices.
Likewise, we’re not suggesting you should exclusively back a portfolio of today’s “Losers” (although we do think some of them are worth considering). There’s another 2,008 funds between the worst ten and the best ten, many of which offer a decent balance between risk and reward. And it’s there that we’re focusing most of our exposure: there’s simply no need for heroics at this point in a market cycle.
1Note I am using terms the "winners and losers" or "best and worst". I am not suggesting any of these funds are necessarily good or bad, just that they've been on the right / wrong end of a very powerful market trend.
2These are the top or bottom performers of those funds that have survived until 2019. Several funds that may have appeared in this list don’t because they’ve subsequently closed (almost always because of weak relative performance). I suspect that including “dead” funds would have made the trends shown in these charts even more extreme than they are here.
3Note that the 2010 “Losers” portfolio featured quite a few tech funds, which would themselves have been among the “Winners” if you’d done this exercise in 2000: they had an abysmal run in the noughties as investors lost interest after the bubble burst in 2000.
4Yes that is the same "Tech-heavy" Japanese equity fund that appeared in the "Losers" table in 2010. So in 10 years it has gone from 758th out of 760, to 2nd out of 2,028.
5It’s not just excitable investors joining in. If a trend lasts this long, and gets this big, it starts to get built into benchmarks and risk models. These then act as a psychological “anchor”, encouraging otherwise sober-minded investors to buy an amount that might have seemed crazy just a decade before (but would, of course, have made them loads of money if they had).
Chart source: FE Analytics, taken on a bid to bid, total return (income reinvested) UK sterling basis. Past performance is not a guide to future returns.
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