Diversification is key

From the first rumblings of the COVID-19 outbreak, things have escalated quickly and we now find ourselves in a full-blown pandemic. It’s hitting the economy, redefining ways of working and causing a lot of anxiety, about health and wealth alike.

In recent weeks the word ‘unprecedented’ hasn’t been far from the headlines. It’s become something of a sound bite in the briefings from Downing Street and to be fair, this situation is in many ways unprecedented. But that said, much of what we’re now seeing in the way markets are reacting, is not.

Looking for parallels

Nobody would underestimate the gravity of what’s happening right now – the coronavirus respects neither borders nor economies – but as ever, the history of the markets can teach us some important lessons.

Just about everyone remembers the 2008-2009 global financial crisis for example, even if they weren’t old enough to be in the workforce. That period also saw the spread of the H1N1 virus. More experienced investors will remember the tech boom and bust of the late 1990s and early 2000s and farther back, it was once hard to imagine anything tougher than the 1973-1974 bear market.

In 2020 we’re seeing the same kind of anxiety – times like these are never easy for investors, grappling with the feeling that “things just might be different this time.” Scrolling through the news while confined to our homes, it’s easier to see how the news can all seem negative.

But it’s important to remember that volatility is a normal part of investing and that allowing these emotions to get in the way of sound decisions is likely to be more detrimental for long-term investors than the downturn itself.

In this video, we hear from investment author Lars Kroijer on the importance of keeping a cool head.

 

Lessons from Wall Street

Imagine you’re reading this review of the financial markets in early January 2010:

“It’s been a rollercoaster over the past three years, living through the stress of the global financial crisis, then experiencing the recovery that began in March 2009. Investors who rode it out are beginning to be rewarded, but the rebound is 10 months old, and markets have a long way to go. Opinions are mixed about what might unfold in the coming year. A December 2009 article in the Wall Street Journal pointed out that although stocks have rallied and indices are on the rise, there are worries that the market is running out of steam. You may be wondering whether to stick with your investment plan or move into cash and wait for evidence that the markets have recovered.”

Now, let’s fast forward to today. Looking at total returns, global stocks more than doubled in value from 2010-2019, as the chart below shows. The MSCI All Country World Index, which represents global stock markets, had a 10-year annualised return of 8.91%.

In terms of growth-of-wealth, $10,000 invested in the stocks in the index at the beginning of 2010 would have grown to $23,473 by year end 2019.

 

Growth of Wealth
MSCI All Country World IMI Index, January 2010 – December 2019

Despite positive annual market returns for most of the decade, investors had to deal with uncertainty from a host of events. An unprecedented US credit rating downgrade, sovereign debt problems in Europe, negative interest rates and flattening yield curves – when there’s little difference between rates for short-term and long-terms bonds – a sign of investors losing faith in long-term markets and an early flag of an impending recession.

Add to that the Brexit vote, the US presidential election, recessions in Europe and Japan, trade wars, and geopolitical turmoil in the Middle East. The 2010s offered a very mixed bag of fortunes, but overall, the US and other global equity markets experienced moderate volatility. The next chart looks at returns and standard deviation – a higher standard deviation reflects wider market swings – as you can see the figure for 2010-2019 is among the lowest.

 

Volatility in Perspective
S&P 500 Index annualized returns grouped by decade (1930-2019)

Diversification is part of the long game

As you may be aware with our WRAPs portfolios we tilt toward small company and value shares and bonds. During the 2010s at some points they did underperform, but in the 2000s and over the longer term they have performed well.

Once more, we can say that predicting the markets, however tempting, isn’t possible, nor is it a sensible premise upon which to invest. The best strategy is to diversify across markets and asset groups to manage risks and pursue higher expected returns. But diversification isn’t a magic bullet – it’s an important part of investing for the long term. The markets will still rise and fall, surprise us and defy expectations, the value of diversification is in helping to shore up your portfolio and help it to roll with the punches.

Enduring principles

So back to now, here’s what we can learn from the past decade (and the ones that came before it). Despite all the change and uncertainty, the fundamentals of successful investing have endured.

Stay disciplined and keep a long-term perspective. Read the news but don’t be consumed by it, and avoid reactive investment decisions based on fear or anxiety. Don’t try to ‘beat’ or ‘time’ the markets. Instead, develop a sensible investment plan based on a strong philosophy – and stick with it. Investors who follow these principles can have a better financial journey in any decade.

This month’s fund focus

This month we’re looking at the performance of the Vanguard Global Bond Index fund. It’s a low-volatility fund made up of fixed-interest investments, with the lion’s share of its make-up in global fixed interest (89.20%).

Looking at cumulative performance, which shows year on year gains – the fund’s overall long-term performance since launch – we can see that while the last three months put growth at 1.01%, the long-term figure (in this case five years) is 12.87%.

Turning to discrete performance, the fund’s returns were up 6.63% between 31 December 2019 and the previous year. The fund has currently protected downside risk. Looking back from 27 March for one month, many equity funds had dropped 20% or more, this fund only 1.57%. How that figure looks at the end of 2020, bearing in mind the exceptional circumstances we’re experiencing, remains to be seen, but the overall trend for this fund in just over a decade of operation is a strong, steady upward curve.

View Fund Fact Sheet