The Wise Words of Plato

This concept, which Plato observed some 2,500 years ago, holds true today, not only with respect to seasons, individuals, and governments but also to financial markets.

Some investors tend to extrapolate past performance infinitely into the future. What has transpired in the stock market of late becomes excessively over-weighted in the decision-making process. Behavioural finance academics call this the 'regency effect': the tendency for a perceiver to rely on recent cues or last impressions. Far too many investors keep on making this critical and costly blunder, much to the detriment of their future financial security.

Appreciating commodities

We are currently seeing this phenomenon today in the price of commodities. Analysts predict ever-increasing commodity prices, one bettering the other as to who can push it higher! Even some professional money managers fall into the trap of chasing these predictions. Much of the blame can also be laid with index-type investment funds that have lately become skewed because of these commodities that keep appreciating. As the commodities appreciate, the index funds have to buy them to keep up with the index (for example, energy stocks make up 30% of the S&P/TSX), and that keeps the bubble growing, until one day we get a sudden pop, when the index has to reduce its weighting, and all the other index funds will follow suit. This is called the 'lemming effect.'

Prudent investors realize that market prices are frequently inappropriate due to irrational behaviour by much of the investing public.

Don't give in to groupthink

We tend to follow investment strategies whose road-much-less-travelled requires incredible conviction and discipline. Successful long-term investors need the ability to tune out friends, family, Bay Street, and the media. These sources can all too often conspire to undermine rational investing. It is not intentional, but results in tremendous pressure on all of us to cave in to groupthink. And it is this succumbing to groupthink that has led to most of the past major market crashes and financial losses.

We can confidently guarantee to those of you who follow similar road-much-travelled strategies that you will assuredly, periodically, and inevitably be disappointed.

That's right - disappointed. Although Wall Street Marketing 101 dictates that you should never tell investors that they should expect to be disappointed on a regular basis, that's exactly what we are doing.

It's not easy

Are we crazy? Some folks would undoubtedly agree with that diagnosis, but we think it is the other way around. We certainly believe that it is foolhardy and downright wrong to give investors the impression that their chosen investment methodology is going to lead them into the financial promised land of perpetually satisfying performance year in and year out. It just isn't that easy. Famous investor Warren Buffett rightly points out when he states 'investing is simple but it not easy'.

Even the 'Oracle of Omaha' himself has suffered through some episodes where he admitted that his performance was sub-par. Of course, with his track record and marvellous communication skills he was able to keep most of his investors on board through trying times. During his time of disappointment, numerous newspaper articles stated that he was both too old and too stubborn in the late 1990s to realize we were in a glorious new era where bubbles endlessly inflated. Of course, those who were patient were vindicated by his wisdom and discipline.

Any against-the-grain type of investing strategy will tend to lag at times, especially late in an up-trend for a particular investment fad or an anomaly in the market.

Our strategy works

In order to minimize the downside, we recommend that our clients use a style-neutral approach, multi-managed, gradual re-weighting process, and recognize how prevalent it is for styles, sectors, asset classes - and the market itself - to over-shoot on the upside as well as on the downside. In addition, we try to systematically re-balance portfolios on a regular basis. We incorporate risk controls per cap and style categories to control the benchmark risk. Nevertheless, despite our best efforts to deal with reality, we strongly advise you to be fully prepared for periods of under-performance.

However, do not mistake this pragmatic acknowledgement of the vagaries of market movements for a lack of long-term confidence. We are convinced we will succeed in the investment marathon by sticking to our strategy unless either reversion to the mean or human behaviour changes in a material way.

If you would like to review your current portfolio in light of the recent market volatility, please call our office for an appointment.