Performance narratives can often blind investors to the development of emerging risks and a more realistic appraisal of future return expectations, says Ian Rees, Head of Multi Manager Funds, Premier Miton Investors.
It seems obvious to say that the investment approach employed can impact the return outcomes achieved for investors. However, all too often investors fail to critically appraise their behaviours when evaluating performance results, mostly crediting poor outcomes to market direction or bad management (not theirs!).
As an industry, we build trust and rapport with a client through seeking to understand their own personal investment aims and outcomes, and we formulate that into a long-term plan to follow. Rather disappointingly, too often the progress of that plan is reviewed not in relation to how the client goals are being met within the context of a long-term timeframe, but rather on the relative performance of its components over much shorter periods.
We have all heard of examples of clients being more emotional when their investments lose money than when they are making good returns. Yet time and again we see investors chasing investment performance without regard for the risks.
Aligning with what is popular generally means buying into areas that have demonstrated performance momentum that acts as an anchor to expected future potential. This helps to promote herding into investment themes, regions or individual managers that are the fashion of the time. Such a strategy can appear self-fulfilling, as ever-increasing numbers of investors propel the trend onward, generating ‘crowd momentum’ in the process.
However, performance narratives often blind investors to the development of emerging risks and a more realistic appraisal of future return expectations. Whether motivated by greed or a ‘fear of missing out’, this typically results in buying an otherwise good investment at the wrong time or wrong price.
Likewise, investors who experience subsequent performance disappointment can react emotionally to the loss, selling the investment to rid themselves of the psychological pain. This can happen largely irrespective of the performance outlook or recovery potential.
The stock market is volatile and even the best managers will see their performance ebb and flow too. So, investors would do well to remember the words attributed to former Liverpool manager Bill Shankly, who remarked ‘form is temporary, class is permanent’.
Not appraising the performance outlook from the point of purchase can mean investors buy into hype and performance peaks so overpay for their investment – all generating a bad outcome. Having a sense of valuation perspective can help alleviate some of these risks.
Similarly, investors should guard against being too fickle with their investments. Bad luck or events can happen to the best of investments.
The trick is to resist an emotional response, taking a more impassive approach to assessing the outlook with a sense of perspective, especially if the performance headwinds could be considered temporary in nature. Selling at the wrong point may crystallise losses that might not be recovered elsewhere, or worse, compounded by seeking comfort in areas that are overbought and overvalued elsewhere.
Such experience has helped formulate ‘Rees’s Rules’: Buying good managers when they are out of favour can help stack the odds of long-term outperformance in our favour. If we do mis-time the purchase of a good manager, we resist the urge to sell when they are enduring a period of weak performance – good managers will rise again when their headwinds abate, so we believe it’s important to be patient to benefit from their long-term outperformance.
Main image: oscar-keys-AmPRUnRb6N0-unsplash
