Fran Troskie | Senior Manager Analyst | PPS Investments | mail me |
Staying calm amid market volatility is not easy, given the constant stream and access to news headlines and market updates. When investing, it’s important to keep in mind that stock markets will experience periods of sustained growth and decline, respectively.
History shows that periods of growth tend to outweigh periods of decline. However, the first instinct, when experiencing these periods of decline, may be to seek relatively safer options, which may have an adverse effect on reaching long-term financial goals.
Another phenomenon during times of uncertainty is that investors also look to time the market. They try to miss the worst days in the market to minimise losses and realise gains, but this can also lead to missing the upside of the best days, too. Trying to time the market is a tricky, and almost impossible task to achieve.
Different scenarios
We looked at the returns of the JSE All Share Index (in Rands) and the MSCI All Countries World Index (in US dollars), to see whether there was a significant difference in the returns for each index under different scenarios.
In other words, depending on your investment strategy, would your outcomes be different?
- Base case scenario: Stayed invested throughout the period. You didn’t panic, you didn’t fall prey to euphoria, and you didn’t try to time the market. You just stayed invested. What would your annualised return have been?
- “Unlucky” scenario: Missing the best “x” % of the days on which the market did well. How would this stack up relative to the base case?
- “Really lucky” scenario: Missed the worst “x” % of the days that the market hit the skids. How would you have fared relative to the base case?
The charts below illustrate the difference in outcomes using a range of percentages (1, 2, 5, and 10%).
Source: Refinitiv Datastream, 1 January to 30 November 2022. Daily returns for the FTSE/JSE ALSI in ZAR.
Source: Refinitiv Datastream, 1 January to 30 November 2022. Daily returns for the MSCI ACWI in USD.
We’ll use an illustrative example for the FTSE/JSE ALSI (ZAR) and note that the pattern is the same for the MSCI ACWI (USD).
Using 5%:
- staying invested in the local bourse gives you an annualised 20.3% return over the period.
- missing the best 5% of the days on which the market did well, means that your return is 0.5%. You “lose out” on roughly 15% vs had you stayed invested.
- missing the worst 5% of the days on which the market did poorly, means that your return is 45.2%. You “gain” 25% vs had you stayed invested.
The asymmetry in returns is quite pronounced, clearly bearing out Nassim Taleb’s theory:
“The downsides (i.e the days on which the market did poorly) have an outsized negative impact on your annualised returns, whereas the upsides (when the market did well) generates a relatively muted additional gain.”
Blending strategies – the age-old active versus passive debate
As an investor, you would need to be remarkably prescient, skilled, and nimble in getting into and out of positions (or have a magic eight ball to predict the outliers), to be able to consistently miss all of the worst days or be invested on all of the best days.
It is important to acknowledge that passive investing (just investing in and staying invested in an index tracker) may not be the answer. We are not negating that low-cost, passive strategies may have a place in investors’ portfolios, as they provide easily accessible exposure to market beta.
Equally undeniable, however, is the value that nimble, astute, active asset managers can add in terms of alpha. Ideally, we select active managers who can read market signals and who have agility in rotating into and out of positions.
Skilled active managers may not be able to miss all of the worst days, but they can liquidate positions relatively quickly, ensuring only partial exposure to downturns. Similarly, skilled active managers are unlikely to have the best timing and foresight to buy into shares just before they shoot the lights out.
Managers may also be able to research and interpret the trends and/or the underlying factors which will trigger a stock’s appreciation and are more likely to get at least some of the uptick in the market.
Stay invested in a diversified portfolio
Markets are fragile domains, particularly during periods of heightened uncertainty fueling volatility. Nassim Taleb’s observation about the asymmetry of returns during the best and worst days in the market is borne out.
Timing the market is a fool’s errand and kneejerk reactions to market movements seldom lead to optimal investment outcomes. Instead, we encourage selecting and blending an appropriate mix of complementary managers that are skilled and nimble in effecting decisions.
From a portfolio construction perspective, aim to blend low-cost passive strategies with active strategies (where suitable), which can generate solid, sustained investment returns, regardless of market cycles and outcomes.
