Basic investment principles (when the markets turn for the worse)
This newsletter will find you in the midst of great volatility in the investment markets. Over the last five years we have often informed you of great principles to follow when markets take a turn for the worse. Although such times are never easy, it is precisely the time to stick to a proven investment strategy. We chose to appoint acsis as our portfolio advisors during 1999 because we embraced their investment philosophy and the principles they have applied to their portfolios since 1982. The choice to align with acsis has been vindicated, as we now have a track record in South Africa of almost 10 years.
It is during current times of volatility that we need to assess the basic principles of the acsis philosophy as described by the CEO of ipac Australia, Arun Abey, in his book How much is enough.
How do quality, value, diversity and time work?
QUALITY
First and most significantly, there is always a clearly identifiable reason why quality companies make profits and pay dividends and do so consistently. They are not slaves to market fashion. Typical attributes include sound longer-term earning potential, good returns on equity, capable management with a solid track record, a sound balance sheet and reliable core business franchises. They can be household names like Coca-Cola and IBM.
VALUE
The second principle of sensible investing, value, is a function of quality and price. There is a danger that shares in good, quality companies can be bid up to such high prices by optimistic investors that they cease to be good value.
Some of the most dangerous words in investment are, “You can’t go wrong buying…”. Some of the worst disasters have arisen from people paying too much for what are essentially quality assets.
Australian entrepreneur Alan Bond learned this the hard way. In the mid-1980s he bought Australia’s Nine TV Network from media mogul Kerry Packer for a huge sum. Within a few short years he sold it back to Packer for a fraction of the price. The Nine Network was a quality company both when Bond bought it and when he sold it. The difference was that Packer better understood its value.
The key to assessing value and quality is to know whether the asset can produce an attractive return, relative to its risk.
DIVERSITY
Diversification is such an obvious strategy that it is remarkable that so few investors follow it. It simply involves having investments across different asset classes, countries and funds. While many people start investing in a diversified portfolio, what typically happens is that they end up concentrating on those investments that have delivered the best returns. They gradually weed out investments that have suffered a bad 6–12 months. The portfolio is left with a few investments that have delivered high returns. Such behaviour was typical during the tech-bubble period. But when the crunch came, the result was devastating. For investors who retained small holdings in the affected companies and held a range of other investments, the impact was far less. Diversification is important because it provides access to a wide range of investment opportunities rather than focusing on one or two.
TIME
The ultimate test of a successful portfolio comes with time, and it is here that the numbers do tell the story. While the first three of the four principles were not fully rewarded in the late 1990s, they emerged once again with the collapse of the technology stock bubble. Investors who focused on the broader share market still suffered during one of the worst bear markets in history, but the pain was far less severe and the recovery far swifter. We also know that over the longer term, the stock market produced returns of inflation plus 7,5%. If we thus have a properly, scientifically diversified portfolio and our time horizon is more than 7 years we can expect to have the returns that will help us achieve our investment objective. We are proud to say that this is exactly what our strategic relationship with acsis has produced since inception in 1997.