BUSINESS NEWS - According to Warren Buffett’s partner, Charlie Munger, some of the most valuable principles and lessons on business and investing come from a $10 history book.
Investors don’t have to invent or imagine some fanciful future – the past is available as a treasure of information and wisdom, CEO of Cannon Asset Managers, Dr Adrian Saville, recently said at a seminar on risk and investment myths hosted by life insurer FMI.
Saville argued that successful investing was not about predicting the future, but about learning from the past and understanding the present.
To this end, he discussed six principles he believes can help investors avoid unfortunate outcomes in the long run.
The most important decision is not which stock to buy, but asset allocation
Over the past five years, Facebook, Amazon, Netflix and Google have delivered spectacular returns.
While the S&P 500 have returned roughly 80%, each of these stocks gave investors multiples of that – Netflix in particular.
In investing, however, it was really asset allocation that did the lifting, Saville said.
“It is the single most important decision. Sure, it may matter whether Netflix is in or out of your portfolio.
"What will matter far more is whether you are in equities, bonds, property [or] cash.”
The chart below shows the inflation-adjusted returns from various asset classes over the long term. Equities – the best-performing asset class – returned almost 1 000 times an investor’s money after inflation while cash lost purchasing power over the period.
“So that single decision – cash or equities – would give you a spectacularly different outcome,” Saville said.
In the South African context, Naspers has been the big investment story. Over the past five years, Naspers investors would have made five times their money. Over the past decade, they would have made 20 times their money.
“I wish that it was in your portfolio, but I wish even more that what was in your portfolio was equities not cash.”
Between 1972 and 2017, local cash investors would have received an after-inflation return of 1.5% per year, while equity investors got 8.6% per annum. Against this background, it would have taken cash investors roughly 50 years to double their money. Equity investors would have doubled their money in about eight years.
“Very often the myth, the perception, is that it is cash that is safe. If you give an asset long enough, cash is a very, very dangerous place to be as a single asset.”
Building effective portfolios boils down to effective diversification
For almost all investors, a multi-asset portfolio was the most effective way to manage risk, Saville said.
“If you owned a single asset class, this is the worst you would do from top to bottom,” Saville commented.
On the right, the drawdowns of a portfolio with a 50:50 split of equities and bonds are shown to illustrate the point.
“All you have to do is build a portfolio 50:50 of these two asset classes and you halve the bumpiness and what we know from compounding results is that if you can moderate the drawdown, the compounding on the upside becomes far more powerful.”
Don’t try to beat the market at all cost, match it
Saville said the investment industry tends to be populated by the argument that successful investing was about beating the market.
While there was a place for active investing, for most of the assets of most people, the most sensible place to be was matching the market.
Every self-respecting active manager will tell investors that they have an investment process and philosophy that can beat the market, he said.
“Certainly, Cannon has one, and we’ve demonstrated that in our portfolios over long periods, but does that mean that all of your money should be in that active solution?
"I’m going to argue to you no, because the chances are that if all of your money is in an active solution for all time – there is a good chance that when you need it most it will be behind the pace.”
The chart below shows the percentage of active funds beating the market. Over 10-, 15- and 20-year periods, most active managers are behind the market.
