Cape Town – It is in our nature to believe that the future will be like the past. We expect consistency.
One of the world’s great clichés is that history repeats itself. And it is a cliché because it is true.
The problem for us, however, is that our view of history is often very limited. What we take to be ‘the past’ is often only what we have experienced in our own lifetimes and is therefore only a tiny sample of a much greater whole.
This is particularly important when it comes to investing, because we tend to base our decisions on what we have seen and experienced ourselves. Walter Aylett, the founding fund manager at Aylett Fund Managers, believes that this tendency is prevalent amongst many investors today, and it is distorting our view of how markets really work.
South African investors who have only been active over the last decade and a half will have a very slanted picture of what to expect from equity returns.
“The emerging market space particularly has benefited hugely from what’s happened over the last ten years,” Aylett says. “This was backed up by the commodity super cycle.”
He points to Australia’s strong currency, as a very clear example. In South Africa we have benefited from low interest rates, a stronger currency and high consumer confidence.
This has also translated into exceptional equity returns. Over ten years to the end of September, the FTSE/JSE All Share Index delivered an annual total return of just shy of 19%.
This has been such a sustained bull run that many investors have come to think of this as normal. However, Aylett believes that if one takes a much longer historical view, this is not how markets work.
“When people look at the positioning of their funds, they tend to look at the last ten or fifteen years, but I think they should look much further back,” Aylett says. “I think they need to get used to a world where single digit growth in investments is the right number.”
He believes there are a number of themes that have to be considered when looking at what may happen in the markets over the next decade. High inflation in non-developed markets is one of them.
South Africa is in the same boat as countries like Turkey, India and even China where inflation may not be extreme but is nevertheless at levels way above those in developed markets. The risk is also far more to the upside.
This could have a telling impact on market returns.
Aylett also cautions that many governments around the world are looking at budget deficits and therefore need to grow their revenue. This inevitably means higher taxes, and whether that is higher tax on companies or more tax on the wealth of investors, ultimately it is negative for investment returns.
Another concern for Aylett is how hard equity markets have run in the US over the last 36 months. He says that, historically, periods of rapid market appreciation in the US have been followed by long periods of under-performance.
“You get swings were markets go up over 100% over a few years, but then fall back 50% or so over the next few years,” he says. “A big fall like that would change things quite a lot.”
And given how extreme levels of liquidity have driven the rapid rise in equity markets since the global financial crisis, investors need to be cautious.
“I know why the markets are up – it’s because reserve banks are printing money,” Aylett says. “And when they stop, I know how it ends.”
He warns that there’s not much more that central banks can do to shore things up from here.
“Federal bankers around the world have run out of many options,” Aylett says. “So when we look forward, we think people are going to make the mistake of thinking that the future will be like the past, but life is never like that.”
That being the case, investors have to be wary of the very high risks that exist.
“We have always been rescued, just like we were in 2008,” he says. “But what happens when we don’t get rescued? You only have to look at Greece and Japan to know the answer.”
Aylett’s advice is for investors with shorter time horizons is to pull back their expectations and instead of chasing high yielding, high risk assets they should rather be content with stable, dependable growth.
“Work closely with your financial adviser to identify fund managers that are in sync with you,” he advises. “Understand what you are getting into and understand that your time horizon should be ten years if you’re getting into equity markets.”
He believes that any time frame shorter than that is just too risky given current market levels.
“It’s when things get bad that you should up your equity exposure,” he says. “But when times are good, you need to think about taking something off the table, which is hard to do because the human psyche will not let you do that.
“Keeping your options open is very important,” he says. “That means holding lots of cash.”
This is not the sort of investment advice you hear very often, but Aylett says that cash is their preferred option at the moment, even though over the long term it is the poorest asset class. Market uncertainty is too high to take risks if you don’t have time on your side.
“Take the picture of the last 15 years and turn it upside-down,” he says. “What do you get then? Look at yields for instance. They have been coming down for 20 years. What happens if they go up for the next 20?”
He emphasises that when it comes to investments, risk is not about volatility or some other measure, but simply about your money losing its purchasing power.
“The trick in investments is not to make permanent losses,” he says. “I don’t think you should go around worrying that the sky is going to fall on your head, but you have to manage your risk profile depending on your time horizon. If you can’t sit it out then I think you should be in cash.”