Returns

According to T Bailey, the Nottingham based fund of fund manager, investors are better off being in the wrong fund in the best performing sector than the right fund in a poorer performing sector.  Or, put another way, your asset allocation will have a much greater impact on your returns than choosing the ‘best’ manager.

This will come as no surprise to anyone who has even a passing acquaintance to investment theory.  Even if all you do is check out a list of the twenty best performing funds over the last year, you will be struck by the fact that they all come from the same sector, be it China or Fixed Interest.  The sector of choice will, of course, change over time but more often than not there will be a flavour of the month.

It is slightly odd for an active fund manager to publish research which rather undermines part of their role but it does generate publicity and perhaps it is true, even in the world of finance that there is no such thing as bad publicity.

For many investors, it is always useful to be reminded from where investment returns come.  Get an asset allocation suitable for your needs and you are ninety percent of the way to successful investing.

It seems that the woes of New Star, the high profile new boy on the fund management block, worsen by the day.  It seems like only yesterday, or last year, that New Star could do no wrong. Their right ups in the Press were glowing and public and advisers alike rushed into their well performing funds.  Now, its funds languish at the bottom of performance tables, managers are reshuffled between funds and its shares disappoint.

This is neither the time nor the place to analyse the exact reasons for New Star’s travails, which may be short lived, but there are lessons to be learnt from their fall from grace.

Out performance of the market can only come through either manager skill or manager luck.  As with Napoleon’s generals, it seems that it is better to be lucky in the fund manager world.  Manager skill is notoriously difficult to isolate and the marketing machine puts a lot of effort into persuading that positive results stem from skill rather than luck.  This, it seems, plays into the hands of much of the public and their advisers because there is comfort in believing that the person managing your money has a special skill.  In order to outperform the market, a manager must make bets by holding investments in a way which are different to their weighting in the market.  I do not think much of granny’s money would wing its way into a fund were the advertising emphasised that the manager had been very lucky with his bets of late.  No, what the public seek is skill, any sap can be lucky.  Skill is worth paying for, luck is not.

The problem with luck is that it turns.  It also cannot be engineered, it is all down to chance.  So, if stellar performance turns out merely to have been luck, as it usually is, there is nothing for it but to await its return.

None of which brings any comfort to those who bought into the skill story only to find it was down to luck.  Someday, perhaps, investment management groups will have to warn investors that any outperformance can only be attributed to luck.  Another reason to stick to tracker funds.

Many investors in shares are wondering how they should respond to the current volatility in most Stock Markets and the fear that 2008 will be as troublesome as last year, if not more so.  The answer to this really depends on why you are investing and for how long.  Many cash rich emerging nations, such as Kuwait, China and Singapore, and other wealthy investors are greedily gobbling up almost anything we are selling at a knockdown price.  They have very long time horizons and very deep pockets.  For them, the prospect of picking up stakes in some of the developed world’s finest financial institutions at five year lows is too good to miss.

I strongly suspect that many guardians of public wealth in the UK, for example, company pension funds, are eager sellers and may well have proved once again to have sold at exactly the wrong time whilst buying into, probably, bonds at the wrong time as well.  Like second rate defenders in football, they seem destined to rush time after time towards the player with the ball only to see it deftly passed to another who has space and time.  Oh, the humiliation of it all.  Meanwhile, much as the England Football team are often found to wanting custodians of the hopes of a nation, the trustees responsible for around £1 Trillion of the public’s money are wrong footed by foreign operators to whom they gave the game in the first place.

Where does this leave the rest of us?  Well, if you are investing in shares you really ought to know that they will not deliver stellar returns year after year and sometimes suffer losses from which they can take quite a while to recover.  It makes sense to diversify your investments away from shares alone, this is generally held to be a sensible strategy but you should ask yourself about how long you intend to be invested.  If, like Kuwait, you expect to be an investor indefinitely, then, perhaps, you should not worry about how poorly things are going now but wonder whether you are in a position to buy something on the cheap.  It is odd how discounts in shops turn us into buyers and discounts in stock markets turns us into sellers.

Now may be a good time to reflect on whether you have the stomach for stocks at all, there is no shame in admitting that they hold too much fear.  Fear and greed need to be kept in balance and shares can be more scary than, for example, fixed interest investments.  What is wrong with holding index linked bonds?  They may not offer the prospect of much real growth but you may be able to sleep at night.

Will our house prices go the way of those in the US, i.e., downward?  Well,  our American friends were until recently busy building houses at the rate of 2million a year, which is a pretty astonishing rate of activity compared to us in the UK, where we build about 200,000.  Given that their population is about five times ours, that means they are building twice as many new homes per head of population than we are.  It would seem, therefore, that their supply of property is better than ours.  Here, it is difficult for young professionals with good jobs to buy a home, let alone the much discussed sub-prime sector.  In the parts of the UK were people most want to live, the South East, mainly, there just are not the numbers of homes being built.  Other places, such as Liverpool and Manchester may find the market in a slightly weaker state over the coming couple of years but there seems to be no reason for too much gloom amongst those who have a home.

Here, there seems to have been much less of the sub-prime lending that is causing so many ructions in the markets at the moment, so, perhaps we shall avoid most of the dislocating problems associated with widespread repossessions.

Of course, if you do not have a home, a crash is exactly what you may need to be able to afford a place.  The trouble with property is that people do not flood the market with cheaper places when prices are under pressure, for the mos part, they stay put until they can sell it at a price with which they are happy.  Developers, also, may just sit tight and wait for better times, except for those who have over built.   

Things may get sluggish here but a crash in the places were some need it most seems highly unlikely.  Even in the early nineties, prices did not fall except were there was a distressed borrower and back then we had a recession and very much higher interest rates to spice things up.

Certainly, parts of the States are seeing some more 'realistic' pricing and some borrowers will struggle with affording their mortgage but interest rates have come down a fair bit over there and this may ward off the worst that could have happened.

Still, expect to see many more headlines of the scary sort in months to come even if there is no good news for would be first time buyers.

Is the stock market, as a whole, an inherently riskier place to invest money than the residential property market?  Now, I am not for one second suggesting that either is an appropriate place to put your money, although one or both may be, I am just opening up the discussion.  I am also considering the property market in investment terms rather than housing terms, no share portfolio will keep you dry through the winter or give you somewhere to show off your latest plasma TV.  These thoughts are probably, therefore most applicable to excess property investment, by which I mean a second property, a buy-to-let property or a house larger than your requirements, which you hope to sell to fund your retirement.

Firstly, what do we mean by risk?  It is, I suggest, unlikely that the stock market or the property market will drop in value to zero.  It is, of course, possible to make a bad choice of investment.  Some companies will go bust and some properties may become worthless, perhaps because of flooding or encroachment by the sea.  Now, you would be daft to buy a property without insuring it against these risks but most people will buy a share in a company without any corresponding insurance against loss (i may cover how another time).  This, then, starts to colour our view of the relative merits of the investments; we take more risk with our stocks, for some reason, than we do with our real estate.

The world of professional investors usually expresses risk in terms of the volatility of returns.  An investment which can deliver high returns with periodic big drops in values is considered to be riskier than an investment which is more steady in its delivery, even if they end up at the same spot.

So, how does volatility compare?  My main concern here is one of information delivery.  If you valued your share portfolio every year, it may not look particularly volatile and, indeed, in most years it would have gone up in value, probably even in 1987.  This is where the stock portfolio is at something of a disadvantage when compared against property.  You see, property is not valued by anyone, let alone the market (as distinctly opposed to an estate agent or even a surveyor) in anything like real time.  Depending on how often we move, a property may only be market valued, i.e. bought, once every seven years.  We may read in the press about the general sentiment but no one is able to rub our noses in its value in real time, minute by minute.  If you own a stock portfolio, you can watch it go up and down every minute of the working day, responding instantaneously to investor sentiment, and it can be frightening for some.

Also, I have referred to a stock portfolio as opposed to one stock, mostly, as it would not be rational to hold only a couple of different shares.  Diversification is easy with shares, not so with property as it is expensive and slow to sell, amongst other things.  

What of the returns?  Well, ignoring income form dividends or rent, which I gauge to be similar after costs, I think property and equities have probably delivered similar capital growth.  If you take into account transaction costs and the difficulties of diversifying across a number of properties, it may well be that a property portfolio has lost ground to a share portfolio.  What, though, will the next twenty bring?