Jonathan Davis: Forget Young Turk managers and stick with experience

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The Independent Online

When the core assumptions on which markets are based go pear-shaped, as appeared to happen last week, with the shocking terrorist attacks on America, what is the best thing for investors to do? The conventional wisdom is that they should do very little, and certainly not make hasty decisions. For once, the conventional wisdom is right: such statements are by their nature difficult to measure, but all the evidence points to over-hasty decisions proving costly in the long run.

When the core assumptions on which markets are based go pear-shaped, as appeared to happen last week, with the shocking terrorist attacks on America, what is the best thing for investors to do? The conventional wisdom is that they should do very little, and certainly not make hasty decisions. For once, the conventional wisdom is right: such statements are by their nature difficult to measure, but all the evidence points to over-hasty decisions proving costly in the long run.

At times of great drama, people find themselves keyed up to make transforming decisions, because this seems the most natural response to a crisis. They read more newsprint and watch more TV, in the search for information and meaning. They also start to worry more about the security of their investments. The airwaves are full of talking heads, debating possibilities and trying to provide predictions about things that are frequently unknowable.

To the sensible but mundane advice not to rush into hasty decisions, I would add that it is usually prudent to discount some of the more hyperbolic and portentous statements that bombard you at such times. Sentiments such as "the world has changed forever" and "the world is a riskier place today", while beloved of commentators, often turn out to be meaningless, and sometimes the exact reverse of the eventual truth.

What the second phrase, in particular, usually means is not that the world has become a riskier place, but that, because of heightened tension and uncertainty, people have become more aware of risk and more averse to taking it, which is not at all the same thing. Was the world a safer place before or after the Chernobyl reactor imploded? It was surely safer after the event, when the scale and nature of the risk from clapped-out Soviet nuclear power stations finally became known and remedial steps could be taken. Yet this did not stop people believing at the time, wrongly, that nuclear reactors all over the world had somehow suddenly become more risky.

There are parallels with the issues facing investors today. For five years, many investors have lulled themselves into believing that the world's equity markets had become immunised from risk. The unarguable fact that we have not seen a serious recession for 10 years somehow conflated itself into the absurd notion, solemnly debated one year ago at the Davos economic summit, that the new economy had somehow resulted in the business cycle being abolished.

The reality, of course, is that the risks in financial markets have never been abolished, but merely been rendered less visible by a sequence of events – eight continuous years of economic growth – that are exceptional but still well within the bounds of long-run probability. The underlying reality is that in most respects the investor's world remains roughly as risky as it was before: perceptions, and responses to those perceptions, change most rapidly, and largely drive short-term market movements. It is unfortunate that the terrible events in the United States last week should have taken place against a backcloth of what can now be seen more clearly as a fully blown (as opposed to incipient) bear market that had probably still not fully run its course even before the hijackers struck.

Historical precedents – what happened after Pearl Harbor, the Gulf War and so on – are interesting but not conclusive about what will happen over the next few months, since they did not take place against the same background of a fundamentally overvalued market. It is still too early to say with confidence how the future will pan out. The 10 per cent fall in European stock markets last week, combined with the initial 5 per cent drop on Wall Street on Monday, are readily explicable by a combination of the short-term visible impacts of last week's events (battered insurance companies, near-bankrupt airlines) and heightened risk-aversion by investors.

Brazenly and correctly, the Federal Reserve is standing by to pump liquidity into the system, with a reluctant European Central Bank finally being pulled along behind the Fed's proactive policy of cutting interest rates. Eventually, this medicine will have an impact on the economy, and will help sentiment in the financial markets as well. But there's nothing automatic about the scale or timing in any of these effects. (Just look at all those who said "never fight the Fed" earlier this year.)

In the short to medium term, the best advice is to stick with experience. In days like these, it is time to pension off that flirtation with the Young Turks who run many actively managed funds, and stick with those who have been down this kind of path before. Wise old fund managers such as Nils Taube, Anthony Bolton and Ian Rushbrook have all comfortably outperformed the markets this year. Monitoring their behaviour is as good a guide as I know to judging where we are headed next in these unsettling times.

Second, it probably pays to dust off your risk-assessment habits. The world may not be a riskier place than before, though many deem it so, but the odds are that many investors will not have reviewed their portfolios as carefully as they might. The key to risk minimisation is measured diversification, not frantic juggling from one asset class to another. (One of the remarkable features of the Equitable Life debacle, it turns out, is that so many policyholders seem to have had all their pension money with just one provider, which can never be right, however exalted its prior reputation). Finally, the best advice for those frightened by the events of the last week remains that expressed so eloquently by Jack Bogle, the founder of Vanguard. Juggle around with your portfolio at the margins if you must, adjusting here and there for risk-tolerance, age and circumstances, but above all, says Jack, "stay the course". That seems right to me: apart from anything else, there are good grounds for optimism even in the dark aftermath of the disasters in America.

Not only is the bear market making stocks cheaper by the day, which is unalloyed good news for anyone under the age of say 50, with a generation of investing still ahead of them, but it is far from clear to me that the net effect of last week's terrible events will turn out to be a negative one.

Financial wealth is most easily built in a climate of peace, freedom and democracy. If the US is now to lead a concerted international effort to purge the world of those who are prepared to wage war on those principles, that has to be a powerful reason for expecting that future generations will gain from any success this endeavour enjoys.

Faint hearts may worry about the consequences, or even the possibility of failure, but investors of all people can hardly complain about the justice and relevance of the cause.

davisbiz@aol.com

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