Practice makes permanent – not perfect!

Steve Crouse: Chief Investment Officer and Senior Financial Advisor

Life has a funny way of teaching us lessons. If you cast your mind back to your school days, you will remember that we were taught in the following manner: you learnt a lesson and then took a test. The extent to which you absorbed the content of the lesson and could recall it largely determined your grade in the test.

But the way we learn lessons after school, in the so-called “University of Life”, turns the traditional model entirely on its head. Because in life we are given the test first, and then only learn the lessons needed to get through it, with the hope of responding more capably the next time we face that same challenge.

It’s the same as going to the gym or exercising; without resistance you won’t grow stronger, without pushing your boundaries you won’t improve. It takes a specific action to get specific results. And so it is with your investment portfolio.

I use this parable as the preamble to my thoughts on the recent pattern of global markets and the high levels of volatility experienced by investors across the globe. On 24 April 2015, global markets peaked at record highs – and then swiftly turned on a dime and retreated, taking back almost 14% of investors’ net worth along the way.

As we stand today looking ahead at the coming months and quarters, the uncertainty around the US Federal Reserve raising interest rates for the first time since 2006 dominates the headlines:

  • When will US rates rise?
  • What will happen to asset prices when they do?
  • By how much will interest rates be raised on this upward leg of the rate cycle?
  • Will the rand weaken to even weaker record levels?

What makes matters more difficult is that the answers to these questions are truly not known. So what should we all be doing with our investments? Should we be hiding them under the mattress and waiting for a break in the clouds and an environment of greater certainty? Should we be moving it all offshore to capitalise on currency depreciation? Or should we be investing in guaranteed return products like we hear advertised on radio and TV? These are all questions reflecting valid concerns and appealing options.

At Octagon, our investment committee and the professionals we’ve partnered with to manage your money take all of the above, and more, into account when making decisions on finding opportunity. And while hiding under the blankets until the monster (these levels of volatility) goes away does sound viable, the long-term impact on ‘missing out’ could hamper your returns over the long term.

So what are we doing for your investments in an effort to keep your performance on the path towards the goals you have set? I sum up our role as advisers and managers as hinging on three primary factors:

  1. Diversification
  2. Consistent performance
  3. Downside cushioning

Diversification

Simply put, diversifying is the act of not putting all your eggs into one basket. But it is also a little more complicated than that, because real diversification is only achieved when your different ‘baskets’ are ‘uncorrelated’ – i.e. they are not expected to move in tandem.

By constructing your portfolio with assets that bear little resemblance to one another and with each providing different results through the cycle, we can achieve both an overall higher return than the average of the assets, but also a lower volatility than the average.

Diversification is said to be ‘the only free lunch we get as investors’ – we aim to use it wisely!

Consistent performance

Consistency in performance is all about the smoothness of the ride. It is not just about total returns, but the manner in which those returns are achieved. Volatile markets produce both headwinds and tailwinds – and often the direction changes all too quickly. Blending together asset classes that will perform differently at different stages of the cycle is therefore essential. The big benefit to an investor is that this takes out the worst of the volatility and discourages the wealth-destroying behaviour of buying at the highs and selling at the lows.

Downside cushioning

In truth, there is nothing out there that is truly risk-free – everything carries some risk! But the extent to which this risk can be managed or mitigated is key to your long-term success. And hence this final point of protecting your portfolio from big drawdowns in the market – by being sensitive to what is going on in markets and taking risk off the table when the stakes get too high.

Most investors rejoice when they see their portfolios outperforming the market when times are good, yet the most important time to seek this outperformance is actually when markets go down.

Minimising losses can have a major long-term impact on your wealth creation journey. Consider that if your portfolio loses 50%, it then has to gain 100% just to get back to where it was. Whereas if it only lost 15% while the market lost a lot more, the growth required to recover would be just 18% – and you wouldn’t have to take as much risk on the way up!

Sticking to these three rules will give you a greater chance of achieving your long-term goals and not falling prey to the threats of volatility.

There’s a saying I often quote to my investors, particularly in times like these, and it guides our thinking every hour of every day: ‘When the tide goes out, it’s easy to see who’s been swimming without a costume!’