Investment: Winners avoid running with the herd

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THE END of the annual PEP season raises an interesting question: does the last-minute Gadarene rush, stronger this year than ever before, actually harm investors? By lumping so much of their buying into the last two to three months of the financial year, the last-minute PEP brigade are running an obvious risk: that they are buying their shares and bonds at what is a less than ideal time of the year.

It is not as if the market cannot see the punters coming. If a bookmaker on the rails knows Fred Punter always places his bets just before the race finishes, you can be certain that he will be offered tighter odds than if he placed them at modest, even intervals over the weeks before the race.

PEP buying has become such a significant factor in the overall flow of funds into the market at this time of year that the weight of money is becoming one of the factors helping to push up prices in the short term. On the face of it, there does seem some evidence that the market is adapting itself to the rhythms of the PEP-buying season. Since the great bond crisis of early 1994, the market has tended to be generally strong in the first quarter of the year. The last month of the current financial year is no exception: it has produced records for Wall Street and the Footsie index.

Anyone who has bought all his PEPs at the end of the past five financial years will almost certainly have paid a higher price than someone who spread his purchases evenly over each year (a strategy that has much to commend it on theoretical and practical grounds).

Anyone brave or smart enough to start investing in PEPs at the height of the great Russia/hedge fund crisis last summer would of course already be something like 20 per cent better off than this week's Johnny Come Lately - further proof, if proof were still needed, that you always do better by running against the herd rather than with it. Of course, if there is now a PEP factor in the market at the end of each financial year, it will not be the first calendar anomaly to excite the attention of investors. For years, academic theorists have struggled to explain how it is that, in a competitive and efficient market, January has proved to be such an exceptionally good month in which to buy shares, not just in the UK but everywhere in the world.

Historically, the evidence is clear-cut: research cited by Professor Jeremy Siegel in his book Stocks for the Long Run shows that of the 20 countries in the Morgan Stanley Capital Market Index, there is only one (Austria) where shares do not on average outperform in January. In fact, this month accounts for 30 per cent of the total return achieved worldwide by shares over long periods.

Nor does it stop there. The effect appears to be a seasonal rather than just a monthly phenomenon. The three months from December to February are by far the most productive quarter of the year. On average, and over time, no less than two-thirds of all returns achieved by stock markets worldwide in a year are concentrated into this period. The worst month of the year is September: its returns in many countries, though not the UK, have on average been negative.

(Useless fact for your next Christmas quiz: if you had invested $1 in the Dow Jones index every year since 1890, but only for the month of September, you would have had 22 cents left by the end of 1996. If you had invested $1 in the other 11 months only, you would have had $681.92.)

The interesting thing about the January effect is that it is most marked with small company shares, which consistently outperform large company shares in that month, again not just in one country but across many borders as well.

In fact, according to Professor Siegel again, the entire basis for saying small stocks outperform large stocks can be explained by the January effect. It all happens in that one month. But there is evidence that the January effect is now ceasing to work as powerfully as it once did.

There are plenty of reasons advanced to explain the January and first- quarter effects noted by researchers. Part of it obviously has to do with the fact that it follows the end of the calendar year, when investors tend to analyse the state of their investments. One interesting theory is that professional fund managers, who are closely judged on their annual performance figures, tend to buy riskier shares in the first quarter of the year and become steadily more cautious as the end of the year approaches.

There are all sorts of other explanations, from tax to psychology and even the weather.

The truth is there is no simple or single explanation that explains the January or small-company effect in all the countries where it has been noticed. Nor unfortunately is there any evidence to believe that you can be sure of making money out of playing the calendar anomalies.

To that extent, it remains an unexplained mystery. (Remember that simply by the laws of probability, you would expect one month to do significantly better than all the other 11.)

But there is still a message for PEP investors in all this. If you decide to keep going with an equity-based ISA this year, try not to leave it all to the last minute again. You will almost certainly do better by feeding your money in on a regular basis than you will by leaving it all to February or March.

As Warren Buffet has pointed out, investors are the only consumers in the world who seem to prefer to buy when things are expensive and sell them when they are cheap.