We have been warning our clients for some time now that the markets have delivered excellent returns and that we do not anticipate that these returns will be matched in future periods. These lower returns we believe will be necessary to bring equity valuations back to more sensible levels.
The lower returns could manifest in three forms.
- Consistent positive, yet lower, increases in share prices over an extended period or
- Very volatile share prices, with negative movements matched or exceeded by positive movements
- A market re-rating – whereby share prices fall over a short period to bring share valuations back to sensible levels.
Which one of these three potential market outcomes actually occurs is to some extent irrelevant for those investors with long time horizons. By choosing a portfolio of funds which targets an asset allocation that should deliver inflation beating returns these investors are positioned to forge through both positive and negative markets. By ensuring a sufficiently diverse exposure to assets and asset managers, investors can also limit the downside volatility risk of their portfolios.
Those market participants with short time horizons and who are very averse to volatility risk should however take note. Below is a graph of the South African All Share over the past 10 years.
What needs to be noted here is that we enjoyed two bull markets over the past 10 years with the 2008 credit crisis a clear negative event. We also have examples of all three possible outcomes listed above. Number 1 and 2 are evident in the period 2011 to 2012 with the market marginally positive with negative volatility events. Number 3 would be akin to the market drop we experienced in 2008.
Our Recommendation:
Our long term investors are positioned to achieve their growth targets over the long term and we will not recommend any changes to these portfolios. We do however need to manage expectations and we caution that lower returns and volatility could be on the horizon.
For those investors acutely averse to market volatility or who anticipate that they may require their capital within the next 2 years we would recommend a review of their exposure to more volatile assets such as equities.
While we believe that the above is prudent advice we are cautious of availability bias. This refers to investor behaviour which is based on the outcomes of past events when similar circumstances prevailed. For more information on this bias we invite you to read our May 2014 Newsletter which discusses this bias in greater detail.
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