“The skill of the sports player is not the result of superior knowledge of the future, but of an ability to employ and execute good strategies for making decisions in a complex and changing world. The same qualities are characteristic of the successful executive. Managers who know the future are more often dangerous fools than great visionaries.”
John Kay, ‘Only fools claim to know the future’ .
Only fools and economists, that is (this is known as tautology). Of the money routinely misspent in the financial markets, that misspent on economists is surely the most egregious. Any strategist, investor or fiduciary knows that he may be wrong – but only the economist has the potential to be wrong at least twice. Once in the overconfident forecasting of future economic trends, and once again in extrapolating from those dubiously forecast economic trends to make deductions about the likely investment outcome. “I may be only a fish and chip shop lady,” said Pauline Hanson, “but some of these economists need to get their heads out of the textbooks and get a job in the real world. I would not even let one of them handle my grocery shopping.”
The dawning of a new year is invariably a time for forecasts. One of our new year’s resolutions for 2013 is not to join the crowd in issuing them. Another is not to waste any time in reading them. Having spent at least the last decade honing an investment approach designed to be proof against the very worst that an imperfect world, politicians, bankers and other investors can throw at it, it would be a capitulation at this stage to suddenly subcontract asset allocation or investment selection to somebody else’s subjective assessment of the world or any given asset class, worse still to any economist. And yet, we still devour investment commentary as if there were some unfound nugget of wisdom and insight that, once located, would finally reveal all the investment answers.
Personal finance journalist Ian Cowie last week confessed (in his article ‘Bond bubble fears and why I took the biggest bet of my life’) that he had sold all the bonds in his company pension to buy shares instead. His arguments are all rational:
- He expects bond prices to fall when interest rates rise, which is almost a mathematical certainty;
- Interest rates have sunk to derisory levels and can barely go lower;
- Gilts are by no means as riskless as conventional thinking dictates;
- Gilts are by any sensible analysis ridiculously overvalued.
He also makes a very shrewd observation about the psychology of investing: “…some of my best investment decisions felt uncomfortable at the time.” But we have some reservations about the binary decision to ditch bonds (one presumes specifically Gilts) and put the proceeds into the stock market. To our way of thinking, that is shifting an asset allocation from a commitment to capital protection (at least in theory) and certainty of income, towards capital risk and uncertain income. But many have come to the same conclusion even if, unlike Mr Cowie, they have yet conclusively to act on their misgivings.
The decision to ditch Gilts and buy stocks presumes that these are the only two asset choices in town. Not knowing Mr Cowie’s pension arrangements it would be unfair to speculate as to the flexibility of his pension fund platform in accommodating other forms of investment. But this apparently black-or-white judgment call away from Gilts into equities leaves us feeling a little nervous at a purely conceptual level, let alone in terms of hard cash. This may turn out to be a brilliant decision leading to a very comfortable retirement. We will now deploy two words that most economists will never use: nobody knows. The reason for our caution lies with a healthy respect for the volatility of the listed stock markets, especially at a time when the prices of all financial assets are being fundamentally distorted through the mechanism of money printing by the world’s major central banks. The future, of course, is not known to us, or to anybody else. But there is a possibility (a possibility too heavy for us to entirely ignore) that equity markets will disappoint, perhaps at a profound level, those investors for whom they have become a panacea out of desperation at any obvious alternative. To put it more plainly, ditching Gilts to buy stocks may be jumping from the frying pan into another frying pan. To put it more plainly still, stock markets are only cheap by reference to grotesquely expensive government bonds, and the risk of significant price falls is ever present, especially at what is surely the tail-end of a multi-decade expansion in credit. A falling tide might sink more than one type of boat.
We highlighted before Christmas Russell Napier’s suggested asset split: cash, equities, gold. As we wrote, this doesn’t seem at all bad. But if you buy our thesis that the investment world is more than usually fraught precisely because we’re at the tail-end of a multi-decade expansion in credit, then you may in turn buy our thesis that it makes sense to be more than usually diversified by discrete types of asset. Since we haven’t held Gilts for years, we don’t have any problem with Ian Cowie’s vote against them. But we still see some merit in owning objectively high quality bonds issued by the world’s creditor sovereigns and quasi-sovereigns, especially when we can earn a yield of roughly 5% from doing so. We also like exposure to non-western economy currencies. Admittedly, those options may not be open to Mr Cowie – but they are to us. And to further supplement Russell Napier’s cash, equity, gold allocation, we maintain judicious exposure to the one type of actively managed fund that doesn’t attempt to forecast the future, but merely operates by respecting the previous history of prices, namely systematic trend-followers.
Admittedly, an entirely justifiable question would be: given the circumstances, why own bonds at all, even of the best quality? Our response: because nobody knows. Western government bond markets may blow up this year – or they may yet see their yields creep even lower, courtesy of a sudden wave of risk aversion, fears of deflation, state coercion and financial repression, or some other strange cocktail of the surprising. If we are correct in our general thesis, a four-fold, multi- asset approach may serve our clients well in terms of capital preservation precisely because the future seems so much more unknowable today than at any time before. Kyle Bass, a fund manager for whom we have extreme respect, quotes Dick Mayo, founding partner of fund management group GMO, who recently said that it was the most difficult time to invest in his lifetime. We concur. As a result, the only true conviction we have is in diversification – to a greater extent, we suspect, than most of our peers. That markets remain weirdly ebullient doesn’t discredit our thesis, even if we’ve been focused on capital preservation for some five years now and counting. The reality, given that we’re shepherding the irreplaceable assets of our clients, is that if we weren’t pursuing a mandate of capital preservation in extremis, we would simply be pursuing the wrong mandate. Life is pretty tough as an asset manager in 2013, but it’s precisely at this point where a resigned capitulation in favour (perhaps exclusively) of the stock market might just be a terrifically dangerous conclusion to reach. We would rather place four bets than just one.
Tim Price is Director of Investment, PFP Wealth Mangement, London.