A little bit of tea-leaf reading from Michael – and i’m offering it for free, so you just know how valuable it’s gonna be. My prediction is that we are about to re-enter the world of investment managers and super funds bragging about investment returns.
i know… you’re all going to slap me with a fish across the face, while yelling “what’s there to brag about..!!!??” That may be true in a broad sense but i’m going to share with you some figures to show that this is the magical, mystical wonderland period that inevitably follows an extended slump in asset prices. Pretty much everyone’s returns have looked insipid for the last 5 years, and not many marketers have the gall to boast about achieving returns not much different from that of a cash account. Even when returns lift a little, many institutions will be hesitant to brag too much, as they would have a lot of investors with legacy accounts that still need a large lift just to get back to where they were a few years ago. BUT this will all change, as the one, three and 5 year returns start to move away from a measurement period that includes the horror of the 2008/09 global financial crisis plunge in markets. We are already seeing it a little bit in some property trusts but my prediction is that we will start to see a lot more of this boasting about returns. Hence my wanting to share with you a bit of reflection on the relative validity of such boasting…
Where the money was made – and lost
Let’s do nothing more than look at the broader market returns of the sharemarket in the past 12 months, as measured to the end of August 2012. Here’s another prediction… you probably did not think that these figures were anywhere in the market that has been reported on every night on the evening news, did you? Come on, be honest. It’s been pretty much doom and gloom, with the occasional piece of trench-humour thrown in to show that there is more to the world than money. We are going to look at the two major “groups” of shares measured on the Australian Stock Exchange.
Would you have thought that these were the figures for the past 12 months?
i am not providing these figures to bamboozle you with facts and figures. i want to make a specific point here. It is the difference between showing some level of skill versus having the luck to be in the right place at the right time. And it is a point that i can highlight one hundred times, yet still find that the underlying principles are ignored tomorrow.
Firstly, what has happened to market prices?
To state the obvious, Australia’s mining companies have taken a massive hit following a cascade in the price of their commodity products.
If we focus on iron ore, notice how the spot price has plummetted recently. Once it dropped through the $100 level it quickly fell to nearly $80. Remember how BHP and Rio Tinto argued with their buyers for a change from yearly negotiated contract prices to more of a spot market price? It ain’t lookin’ so good right now. You can see how the spot price can be seen as an indicator of the likely direction for average prices. Indeed, if the price keeps at these levels then that is exactly what you’d expect. Except of course, that a great deal of speculation goes into the spot price, and it is more open to manipulation, false data or misunderstandings than a yearly agreed price. For example, the spot price has already risen back to the ~$105 level. After 5 years of difficult investment markets, fund managers, analysts and investors have become an impatient lot. Within weeks (days?) of the price falling to the $100 level announcements started to be made about halting mine expansion plans, laying off staff and lowered expectations of business incomes. Yet no-one knows where the price will go next week, next month or next year, do they? Very strong arguments could be made for continued robust demand for bulk commodities. But that is an argument for another day (especially given that i am completely ambivalent on the issue, and touching on it superficially can make it appear that i am holding an opinion that i am not).
As i said, investors around the world are now terrified of large drops in prices. This tends to exacerbate the occurence of large drops in prices, as the herd makes for the exit at the merest hint of a possible drop in value. Hence you have massive volatility of prices in companies tied to these markets – something continuing today. Have a look at Fortescue Metal Group’s shareholders rollercoaster ride in the last 12 months…
And if we narrow in on the past 10 trading days… it just gets curious’er and curious’er.
Not very comfortable looking, is it?
Now i am just picking on Fortescue here because it is an obvious target. Fortescue’s prospects are purely a result of the expectations for the iron ore market, and it is therefore leveraged to any outcomes through its operational and company capital funding risks. It therefore makes a good proxy for the tenor or “mood” of expectations for iron ore. And you’d have to say that the mood is borderline concerned/manic/terrified.
Picking winners in a losing market
This is where my shaggy old head begins to shake and shudder, as i endure the boasts and trevails of those who are of equal capability but just in the wrong/right market at the right/wrong time.
Let’s get something very, very, very, very clear. You ain’t a clever character if you’ve managed to do well in a great market – any more than you are hugely deficient if you fail to do well in a losing market. In funds management industry jargon, there is “beta” – which is the return of the market and not something that you should be overly rewarded for achieving… and there is “alpha” – which is the return you achieve above (hopefully) the market. Alpha is a scarce thing over a rolling measurement sequence but is inordinately achievable in a shorter time period or in times when there is a high dispersion of returns away from the market average.
Please forgive the lapse into financial planner’y talk but this is one of the most fundamental points of investment, and one that is lost on the bulk of the population (and on a lot of industry insiders too, as they tend to get swayed by their own marketing stories, and sometimes get too close to the trees to see the forest).
If we return to the original table of figures, the overall Australian sharemarket return was 5.48% to the end of August 2012 (using the most common index measurement, the S&P/ASX 200 index PLUS dividends). So far, so good. It ain’t great but it ain’t bad either. Now look at the returns from an industrial portfolio of 19.11%. Now that IS a good return. Now go back and look at the resources return… MINUS 23.12%. That is an awful return.
When returns from broad market sectors vary from minus 23% to plus 19%, there is a lot of room for individual, practically accidental purchasing and selling decisions to influence the outcomes. And this is the point of this post. It will be very easy for the funds oriented towards industrial shares to show a great return. The return will actually look even better than it really is, as it can be comfortably contrasted with the outcome of a funds manager account that is focussed on resources or pretty much anything to do with the sector (for example, engineering, design, construction and maintenance firms in the mining industry).
And this is where one must be very careful to compare apples with apples, and bananas with bananas (or apples, you make the choice). If you are looking at the performance of your investment or super fund or broker or neighbour, please remember to ponder their boasts/laments only in comparison with the appropriate benchmark. Here’s another example to keep in mind… If someone boasts about having avoided the GFC by holding cash all the way then try to remember that this particular strategy has really only worked for a very limited number of time samples in the last 50 years – it just so happens that the last 5 years is one of those times.
This is also where super funds will start to tout their respective returns, as if there is some magically clever group of folk sitting in the backroom, implementing super-clever strategies that they (and only they) know of. The reality of long term investing is that the returns achievable within any asset class are pretty much limited to a very tight collar around the average asset class returns. Yet this is exactly the opposite impression of what any reasonable reader would come to after reading the marketing material of various investment and super funds.
Let’s see whether my predictions are any better than those of any other internet spruiker out there… You can be my eyes-on-the-ground. If you spot a piece of bragging, feel free to send it in with a comment or two.
As usual, please remember the Great Disclaimer – nothing in this post or on this site is to be taken as personal advice. It is broad coment and opinion of a general nature, and you must not act on my musings without undertaking appropriate research or seeking the advice of a suitably qualified professional in the respective field.