There is no one in the world who can truthfully profess to having the perfect investment strategy. Every day we tune into financial based media such as Bloomberg and see numerous industry “professionals” completely disagree about the same topics. However, there are some people who have it more right than others and Warren Buffet is near the top of that list.
Buffet recently described how USD 40 invested in Coca Cola in 1919 would now be worth USD 11,000,000. This is obviously an incredible statistic with the added benefit of nearly one hundred years of hindsight, but what Buffet is teaching us is that patience is the key to investing. No one could have predicted the global dominance that Coca Cola would build over last century. Fewer still would have weathered the Great Depression, another World War or even the market peaks where it looked like a good time to sell. The point Buffet is making is that it is dangerous to try and time the markets and worse still to let your emotions guide investment decisions. The example shows us that with a good company you can figure out what is going to happen, not when it is going to happen.
One hundred years is a long time to achieve a return, so let’s reduce this to the past fifteen years. Here are three well known companies of the 21st century:
- Monster Energy – manufacturer of energy soft drinks
- Deckers Outdoor Corp – owner of the Ugg boot brand
- Gilead Sciences – a pharmaceutical company that has produced revolutionary drugs for HIV and Hepatitis-C
If we had invested USD 1,000 in each of these companies on January 1, 2000, our portfolio would now be worth USD 648,781. That’s a total return of over 20,000 percent and an average annual return of 36.38 percent. What’s more, this includes the 2007/8 Global Financial Crisis, the worst fall in markets since The Great Depression. It sounds pretty good, but of course, there are some obvious problems with this example.
For a start it is easy to pick winners when we look backwards. In reality who could have predicted that the world would take to consuming huge quantities of caffeine laden sports drinks whilst wearing sheepskin boots. Even if we could predict the right industry, how would we then know which company in that industry to buy? There are many pharmaceutical companies that would have lost all of your investment over 15 years chasing the same dream as Gilead.
What this example really highlights is the risk that comes with picking individual stocks. Yes, the rewards can be significant, but so can the losses. In this regard it is no different to gambling your hard earned savings on the Roulette table. For this reason we do not pick individual stocks for ourselves or our clients. Instead, we use actively managed investment funds that are broadly diversified geographically and among asset classes. The key words hear are actively managed and they are often misunderstood by investors.
Our investment managers are selecting those companies they believe could be the next Coca Cola or Monster Energy. Do they always get it correct, of course not, but they are spreading that risk across hundreds of different companies. Furthermore, each of our clients portfolios will typically hold 5-10 different investment funds, this means they hold positions in hundreds and hundreds of companies. The overall effect is an enormous reduction in risk and a higher chance of consistent returns over the long-term. But, not all investment managers are created equal, as with anything there are good and bad ones.
We monitor tens of thousands of investment fund managers around the world and when judging them we use a very strict set of criteria. Two of the most important factors we consider are:
Longevity
The most important factor when judging a managers performance is to look at how long and how consistently they have delivered their returns. Looking at a track record over a short time frame tells us nothing. To demonstrate this point consider the Franklin UK Smaller Companies fund (ISIN: GB00B3VGKJ64). This fund has delivered average annual returns of 26.07 percent over the past three years putting it in the top 10 percent of all UK Small-Cap Equity funds. However, over ten years its performance is so poor it is in the bottom 10 percent of all UK Small-Cap Equity funds. Investing should never be about short-term gains so the second statistic is the important one.
Capital Preservation
Volatility erodes investment performance; an investment manager must be able to manage risk and preserve the capital that they manage. In our earlier example, Deckers Outdoor Corp provided an average annual return of 24.26 percent over ten years. But its deviation above and below this average is over 50 percent. We cannot tolerate this kind of fluctuation and we would not expect our investors to either.
There is a lot written about how investors should buy indexes instead of actively managed funds. This is an unwise investment strategy for a number of reasons. The first is that many indexes are very poorly diversified, for instance the Dow Jones contains only thirty companies. More important than their diversification, however, is their performance. To illustrate this look at the returns of two of the world’s major indexes:
- FTSE100 in the UK – 10 year average annual return 2.46%
- S&P500 in the USA – 10 year average annual return 5.65%
Now, it is important to understand, that there are many active investment managers that have performed the same, or worse, than these examples. But there is also a group of investment managers who have consistently delivered returns far above these indexes. This out performance has not occurred over the past few years, it has been consistently demonstrated for 10, 15, 20 years and often even longer.What most people miss is how important small differences in performance can be. They might say if I can get 5.65 percent in the S&P500, isn’t that enough? Again, let’s look at the numbers:
- USD 100,000 growing annually at 5.65% for 20 years would grow to USD 308,745
- USD 100,000 growing annually at 10% for 20 years would grow to USD 732,807
Average annual returns of 10 percent are attainable and they do not have to come with high risks. It is possible to achieve this return and double your gains with the right selection of investment managers. In many cases the correct selection of assets not only improves performance, it also reduces risk.
Investing should not be exciting or sexy, it should be consistent and reliable. When we plan our futures we need to be able to make reasonable assumptions about how our assets will perform. This cannot be achieved if we are constantly on the hunt for the next Ugg boot because who knows how much money we’ll lose trying to find it.
A well managed portfolio, spread across a range of high quality investment fund managers, will deliver the returns and capital preservation that you need to achieve any financial goal within a reasonable time frame.
Please note that beijingkids does not necessarily endorse the views presented in this article.
About William Frisby
William originally arrived in Beijing as a finance guy on a bicycle and will probably leave as a finance guy on a bicycle. He works for Premium Finance Group (PFG), a financial consultancy that has been established in China for over ten years. PFG offers clients no-nonsense, personalized advice and serves the whole of China from their Beijing and Shanghai offices. Services include international property, investment, insurance and financial planning. To contact William, email william.frisby@premiumfinance-group.com.
Photos: Tax Credits, Alan Cleaver (flickr)
