Why we rarely ever change our portfolios
“The stock market is a device for transferring money from the impatient to the patient” – Warren Buffet
Occasionally a client will ask me why we rarely change our portfolios. I think this is a fair and legitimate question at the best of times and with all that is presently going on in the world it might be something that you too are thinking…
Let’s start with a look back in time
In 1975, the first ‘Index’ tracking fund was established by Jack Bogle of Vanguard.
Most of you will know we are huge admirers of Vanguard and the good that they do for the world. Vanguard removes a huge amount of unnecessary cost for investors by offering super low-cost index tracking investments. They are a huge success and are now the 2nd largest fund management group in the world with over $4 trillion of assets under management. (1)
An index tracker looks to buy and hold a small part of each company in the index they are tracking (i.e. the S & P 500 or FTSE All Share Index). By doing so, an index tracker gives you instant diversification at a very low cost. Index funds don’t pick individual shares or bonds to beat the market, they track the performance of the entire market. Or as Jack Bogle put it, “Don’t look for the needle in the haystack. Just buy the haystack!”.
So how about that history lesson – in 1924 the very first investment fund became available and ‘active management’ was born. Fund managers were paid a fee to analyse companies and if they could obtain better information about a company than their competitors, they had an advantage. Shares could be identified as being ‘mis-priced’. Often the manager was right and sometimes they were wrong.
So, what’s changed?
With the advent of the internet, information became more readily available to all. This meant that fund managers lost any advantage over their competitors as access to information was instant and available to all fund managers at the same time.
As Charlie Ellis says – “Decades ago, most trading was done by amateurs, making it easy for skilled professionals who had access to proprietary data to beat the market. Now, 99 percent of trading is done by experts and computers who are so good that they can’t beat each other”.
Since then, there have been countless Nobel prize winning academic studies which tell us that active management—which means hiring a manager to pick stocks in an effort to beat the market — is rarely successful. (2)
What approach do we take?
An Index fund buys the whole market, to get exactly that – the market return minus a very small cost. Some ‘active’ fund managers will beat the index in any given year, and some may even consistently beat the market for a few years in a row. However, our analysis concludes that only a very small % of ‘active’ fund managers outperform the whole market consistently and it is impossible to tell if this is by skill or by luck and those that do very rarely repeat their outperformance. (3)
So, at Brett Investment, we don’t even attempt to pick ‘active’ fund managers, instead we use Index funds to buy the market (using Vanguard and for some clients Legal & General) and Factor-based funds (through Dimensional) to buy certain parts of the market which will give our portfolios a higher long term expected return than a simple ‘whole market’ one.
Evidence (Factor) Based Investing
Factor based investing is an investment approach that involves targeting quantifiable characteristics, or ‘factors’, that can explain differences in stock returns.
Our investment philosophy is built upon these factors through the research carried out by Nobel Prize winners Eugene Fama & Ken French. Their evidence concludes as follows:
- A low-cost portfolio will nearly always perform better than a high-cost portfolio
- Buying the haystack and owning lots of shares is the most reliable way of capturing stock market returns (as there are fewer ‘winning shares’ than you’d think)
- On average, certain types of shares (small, value and high-quality profitable companies) will perform better than others over time. These are called Factors (4)
- Exposure to these factors, and not fund management skill, determines performance.
So, each of our portfolios buy most of the market but aim to beat the overall market’s rate of return by investing more in the above factors and less in other types of shares where the expected return is lower.
So, I get that but surely it makes sense to change things up from time to time?
Intuitively you’d think that might make sense but until new academic evidence comes along (or someone can be more effective than Vanguard, L & G or Dimensional) we will stick to our buy and hold strategy. Evidence tells us time and time again that this type of approach nearly always, always does better than a ‘pick the winning fund’ strategy.
Indeed, trying to pick the winning fund just ramps up the risk of doing less well because:
- You end up taking substantially more risks, as by their very nature an actively managed fund is way less diversified than our typical portfolio… and if you get it wrong, which statistics tell us is very likely, then you lose out
- You pay significantly higher charges. ‘Active’ fund managers quite rightly ask for a fee for their work and they also incur transaction costs each time an underlying investment is bought or sold. Using ‘active’ fund managers is typically 3 to 4x the cost of a Brett Investment portfolio. This is a hurdle that few active managers overcome.
So, our patient, buy and hold approach offers you:
- A much higher probability of investment success than an actively managed portfolio
- Significant cost savings compared to an ‘active’ alternative
- ‘Factors’ that give you a higher long term expected return
- Mass-diversification as typically we hold around 13,000 global company shares and 5,000+ global bonds (think haystack!)
- Investments in local currencies around the world, to reduce the reliance on any single currency
- Funds spread around the world, investing in developed and emerging economies
- Short-term loans to large companies and governments around the world. This provides a defensive element to your portfolio.
Doing nothing is nearly always right
And the vast majority of our clients have been doing precisely that – nothing.
Remember that you, and every other Brett Investment planning client, has a comprehensive financial plan in which the projected outcomes are agreed, and stress tested using reasonable assumptions around future inflation and investment returns.
At times like these…
So, at times like these remember to breathe, stop checking the markets, and go and do something else. Having a wee peek, although tempting, makes no difference to the markets but can have a detrimental impact on your mental well-being!
Remember your portfolio has been back tested over decades of different actual outcomes and has proven to be resilient time and time again. It is based on logic and science and not some forecast or prediction on what might or might not happen next.
Successful investing is nothing to do with forecasting the future instead the actual returns we end up experiencing are nearly always a function of investor behaviour. My job is not chasing the latest fad or shifting from “winning” fund to “winning” fund (never a good approach) instead I’m here to help you to identify what you can and cannot control and focus all of our decisions around the controllables.
Enjoy your day. And only try to control the controllable.
1. Source Vanguard
2. Fama, E. & French, K. (1992) The Cross Section of Expected Stock Returns / O’Reilly, G. & Rizova, S. (2013) Expected Profitability: A New Dimension of Expected Returns
3. Latest SPIVA Scorecard results
4. Dimensional Fund Advisers