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Lessons Learnt in 2018

06 December 2018

Lessons Learnt in 2018

As the year (and an eventful one at that!) winds to a close, it’s a good time to reflect on the investment principles turbulent markets in 2018 have once again reminded us of.

When stocks trade at high multiples, there is little room for disappointment

The list of FTSE/JSE All Share Index stocks trading at more than 50% below their five-year highs runs into the 50s. Of these, seven are trading at more than 80% less. That is hard to come back from if you bought in at the top.

While not true for all of them, some of these shares traded at high multiples (well over 20 times – in some cases over 40 times!) before the decline. This implies that expectations for them were also high. Shares can trade at high price/earnings (P/E) ratios for a long time, but when these valuations unwind, they seldom do so in a measured fashion. Managing overall and individual exposures to the highly rated stocks in your portfolio by trimming along the way may make you feel like you are missing out in the short term, but in the long run it could save you some pain.

Inflation should matter, not market indices

If your starting point is to beat the index, you could regard holding large positions in the big index constituents as low risk, with little concern for over-valuation and absolute risk. If your starting point is beating inflation by a large enough margin over the appropriate period, your mind opens to debating the downside as well as the upside in individual stocks. You also become more willing to assess other asset classes, for example government bonds at yields of over 9.5% and longer-dated negotiable certificates of deposit at 9%. The right level of absolute return over the right period should matter most. Ideally, every decision should improve your chances of achieving that.

Markets react very quickly to news – and not always appropriately

If we believed the market, then the mere appointment of an interim leader was enough to undo all the structural damage to the South African economy over the prior decade. That was Ramaphoria earlier this year. It was a perfect illustration of short-term over-reaction that was in contrast with the longer-term reality. It takes a long time to turn a company or country around, and investing based on news is not always wise. It is far better to bear long-term valuations in mind, rather than short-term sentiment.

It’s impossible to time offshore investments

The rand started 2018 off with a 20% rally, only to depreciate by over 30% in the second half of the year. Most investors felt less inclined to take out money at R11.50 than at R15.50 (the two extremes we saw this year). The lesson here is that offshore investments should always be a part of a diversified strategy. You should be working towards allocating a percentage of your portfolio offshore over time, rather than trying to time when to make large adjustments. This will serve your long-term return better.

Proper diversification is always important

The role of diversification is to have parts of your portfolio behave differently over time while still contributing to long-term returns. The aim is not to improve the level of expected returns, but rather to consistently provide a more acceptable outcome – a better chance of achieving what is required – over time. This means getting the basics right in terms of asset allocation (region, asset class and sectors). It also means that, from time to time, you will have to live with parts of your portfolio (for example, JSE-listed equities over the past year) not performing as you’d like them to in the shorter term. During such times it is important to stick to your long-term plan.

What diversification is not, is taking an all-or-nothing view on offshore versus local, investing in a basket of high-P/E shares regardless of their sectors because everyone else owns them, or conversely investing in a basket of ‘cheap’ shares with poor balance sheets, taking comfort in the low P/E ratio of your overall portfolio. True diversification requires a considered approach, lots of debate and enquiry, and the insight to construct an all-weather portfolio. It is far from a box-ticking exercise.

Finally, mistakes are inevitable – stay humble and learn from them

The list of price decline casualties in portfolios this year seems long. But in reality, investing in shares is always accompanied by uncertainty, imperfect and incomplete information, a range of possible outcomes and inevitable mistakes along the way. What made this year feel worse, was that the JSE’s return was low. (In fact, returns only start edging away from inflation with some margin when looking beyond five years back.) A bull market compensates for individual mistakes, but a flat market highlights them. The important question to ask is what was learnt from these mistakes or, if they were avoided, why they were avoided – was it luck or the outcome of a considered investment process. If it was due to process, we need to spend time determining how to apply this even more thoroughly in future, to further minimise mistakes.

Data as at 4 December 2018.

Anet Ahern is the Chief Executive Officer of PSG Asset Management.

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Anet Ahern

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