Timeless principles that can work for you
In his excellent recent book ‘Principles’ Ray Dalio, former CEO of the world’s largest hedge fund Bridgewater Associates defines principles as ‘ways of successfully dealing with reality to get what you want out of life’.
I can’t think of a better way of explaining the principles we adopt at Callisto in putting together our client’s portfolios.
We believe that there are two ways of investing.
• Active or judgemental investing – so called because active managers make judgement calls on whether or not to invest in certain companies, sectors or markets based on their research, in an attempt to beat the market rate of return available to all investors. There is a wealth of academic evidence which shows that it is difficult to do better than the market return with consistency over the long-term. It is also very challenging to identify future top-performing managers in advance of investment decisions.
• Passive or systematic investing – this investment method is centred on capturing the return of global markets in a fully diversified way, whilst managing risk, emotions and costs. This system does not require forecasting in an attempt to deliver a market-beating rate of return. There is also a wealth of academic evidence which shows that markets work pretty effectively at aggregating information into the current price, and spotting the mis-pricing of investments is likely to be rare, short-lived and even more difficult after costs are taken into account. We believe that judgemental investing is a loser’s game that our investors do not need to play.
Standard and Poors – a leading supplier of investment data do an annual study – S&P Indices Versus Active (SPIVA®) of the performance of fund managers against their benchmarks. The data over over all time periods is compelling, and as an example over ten years it shows that of UK managers 74.16% investing in the UK underperform, whilst 94.06 underperform in global funds and 75.18% underperform in European funds. This is an independent study and this shows that active management doesn’t pay in any market as the odds of the funds beating their benchmarks are against you.
There are numerous ways that advisers can invest their client’s money, some clearly better than others. We are not saying that ours is the only way, but we do invest in a rules-based, systematic method, which is backed by decades of scientific evidence. Successful investing is all about risk management and we adopt a common sense way of investing that seeks to mitigate and minimise risks where possible.
For an insight into how one of the world’s most respected fund managers used academic research and the same principles, please watch this video:
We follow ten fundamental principles that we believe will make our clients successful investors if they take them on board.
1. Let Markets Work for You – Markets work. Millions of participants buy and sell securities each day, and the real-time information they bring helps set prices. You are also competing against the brightest people and the huge resources of large investment companies. James Surowiecki in his book ‘The Wisdom of Crowds’ found that if you want to make a correct decision, large groups of people are smarter than a few ‘experts’. There is no point in playing the game of trying to outsmart the market with the amount of broadly diversified low cost funds available today. The market return is there for for the taking – accept it and pay low costs and you won’t go far wrong.
2. Investment is not speculation – the market’s pricing power works against fund managers who try to outsmart it. Few managers who do perform well repeat their performance in subsequent time periods. Active investors rely on speculation about short-term future market movements and ignore the lessons embedded in vast amounts of historical data. In his 1900 doctoral thesis, “The Theory of Speculation,” Louis Bachelier set forth his revolutionary conclusion that “there is no useful information contained in historical price movements of securities.” Therefore, the expected return of speculation is zero (minus costs).
3. Take a long-term approach – The financial markets have rewarded long-term investors. Historically, the equity and bond markets have provided wealth growth that has more than offset inflation. Having a long-term outlook also guides you to treat inevitable market volatility with the appropriate perspective and allows the amazing power of compounding to work for you.
4. Consider the drivers of returns – Academic research has identified equity and fixed income dimensions that point to differences in expected returns. They are pervasive across different markets and persistent across different time periods, and can be pursued in cost-effective portfolios. These factors help us to understand where investment returns come from and enable us to position our client’s portfolios to be able to take advantage of this peer-reviewed research.
5. Practice smart diversification – Diversification helps reduce your risk, but simply diversifying within the UK is not enough. Smart diversification means investing globally. It is now possible to invest in thousands of companies in many different countries, markets and sectors. As investors, we do not know with a high degree of certainty when one part of the world is going to outperform the other, so it is in our best interest to invest globally. Although some investors may feel uneasy investing in companies they are unfamiliar with, they can be confident in the fact that the vast mechanism that is the market is working for them. An additional important aspect of diversification is diversifying across time. When investors maintain a globally diversified portfolio for long periods of time, they are able to maximise their ability to capture the complete range of returns that are offered by the global markets.
6. Avoid market timing – You never know which markets will outperform from year to year, so by holding a globally diversified portfolio, you are well positioned to capture returns wherever and whenever they occur. Market timers claim the ability to predict the future movement of the stock market, moving into the market before it goes up and getting out before it goes down. However, numerous studies from industry and academic experts demonstrate market timers have no such ability to beat the market, and they should be avoided.
7. Manage your emotions – Markets go up and down. Reacting to current market conditions may lead to making poor investment decisions at the worst times. In his book Your Money and your Brain, Jason Zweig dissects the human brain to discuss how people are motivated to make decisions – mainly out of fear and greed. These emotions are valuable for survival, but can become a hindrance when dealing with money. Specifically, Zweig states, “for most purposes of our daily life, your brain is a superbly functioning machine, instantly steering you away from danger while reliably guiding you toward basic rewards like food, shelter, and love. But that same intuitively brilliant machine can lead you astray when you face the far more challenging choices that the financial markets throw at you every day.”
8. Look beyond the headlines – Daily market news can challenge your investment discipline. Some messages stir anxiety about the future while others tempt you with the promise of easy profits. The challenge for all advisers is to cut through the clutter that is the media and to get our clients to focus on the things that are both important and within their personal control. By the time you read financial news, it’s too late to act on it. If markets are indeed efficient at aggregating information into market prices, it means that by the time the information becomes available, larger, faster participants will have already analysed the implications of the news and acted on it. Calling your adviser the next morning to act on the “news” is like locking the stable door after the horse has bolted.
Please watch this video endorsing this principle:
9. Keep costs low – Over long time periods, high costs can be a drag on wealth accumulation. Strive to incur only those costs that are unavoidable and those that add value to your investments. John Bogle the founder of Vanguard advocates low-cost, long-term index investing. That way, he says, you benefit from “the magic of compounding returns” without having them “destroyed or severely eroded by the tyranny of compounding costs.” Enough said.
10. Focus on what you can control – We can create a plan tailored to your personal financial needs while helping you focus on actions that add value. This can lead to a better investment experience. We believe that there are only three things that you can really control in investing – your investment policy, how much risk you take and how much you pay in costs. Issues such as interest rates, inflation, wars, the stock market, government policy, taxes and terrorist events are clearly beyond your control, are cyclical and can be short-term in nature. It is easy and damaging to get caught up in these matters, but the disciplined and patient investor that uses a long-term, buy-hold and rebalance approach will view such issues with the appropriate perspective.