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A good time for bad decisions

By Ian Millward, published 15 December 2020.

My 18-year-old daughter has just added a pair of flares to her Christmas wish list. By the time I was a teenager in the eighties, flares had become the ultimate fashion faux pas having long since been replaced by drainpipes and hair gel. It just shows that time heals, and history has a habit of repeating itself.

To be fair to flares, they have had the good grace to wait the best part of 50 years before attempting a comeback. As recently as the late 90’s the world went crazy over tech stocks. Investors piled in fuelled by ever spiralling valuations before the ‘dot-com’ bubble burst. In the immediate aftermath everyone swore (sometimes probably quite literally) important lessons had been learned.

The trouble with ‘bubbles’ is that, despite being obvious after the event, they are close to invisible at the time. Whilst it’s debateable whether we are in another tech bubble now, it feels as though the climate is ripe for investors (and poor advisers) to make bad decisions.

Why? Because most private investors tend to be heavily influenced by the recent past performance, and right now it is as disparate as I can remember.

The disparity in the performance between certain sectors (and by default funds and investment styles) arising (in part at least) from Covid is staggering. It is quite literally a case of the haves and the have nots. Technology shares have generally been booming whilst more traditional sectors like banking, insurance, travel and hospitality have been hammered.

Tesla is now the most valuable car company in the world. It recently knocked Toyota into second place despite Toyota outselling it 30 to 1 and having 10 times its revenue (and being profitable). Nobody questions that Tesla is a remarkable business, but is this a realistic valuation?

The big selling funds this year are Fundsmith (as usual) and just about anything run by Baillie Gifford. Scottish Mortgage Investment Trust (which they also run) has had a spectacular year but at one point held c13% in Tesla and 10% in Amazon. In all fairness to Fundsmith it is not a technology fund, but it has benefitted from a very favourable prevailing wind since launch, as the sectors in which its stocks reside (notably technology) have generally thrived.

In investing circles, companies like Tesla are referred to as ‘growth’ stocks. Their share price might look on the high side, but investors expect the company to continue delivering high growth to more than justify this (and push the share price higher still). On the other side of the fence, we have ‘value’ stocks, being companies whose share price looks on the low side versus their prospects – perhaps an unloved company/sector that investors believe could bounce back.

Over the last few years, these two styles have enjoyed differing fortunes. Growth companies have generally further increased in price whilst value has lagged or even fallen. Remember, this is not necessarily about the underlying performance of the businesses themselves; it is also about perception and how keen (or not) investors are to jump on board.

Of course, guessing which investment style will do better over time is a lottery. We use both in our portfolios. It is about balance and using them in an appropriate way. We build around a core of tracker funds, using a range of funds to give exposure to different sectors and styles. Income portfolios tend to have a natural bias towards value stocks, since growth stocks usually pay little or no dividends (they are either losing money, like Tesla, or reinvesting revenues to grow their business).

What we avoid is chasing past performance and, just as importantly, lose faith in funds during a lack lustre period (unless there is a compelling reason to sell). Unfortunately, very little in investing comes with a guarantee but, as a general rule, patience is often rewarded and sometimes the braver decision is not to act and make rash decisions.

I think this is harder for private investors and the dynamics of decision making are against them. In a sense it is totally logical and rational to move your money from your weaker performers to the top performers. But it is also a classic pitfall unless you really understand why you are doing things.

Anyone looking back over the last 4 or 5 years of information is likely to create a portfolio with a very high US growth and tech bias. More dangerously, they may place a large amount of their money in a single fund or approach. Of course, they could end up being lucky, but it is dangerous!

If private investors choose to knowingly take a risk that is entirely their prerogative. However, in many cases I suspect the key word here is ‘knowingly’. Most people value the return of their money way beyond the return on their money and, when it comes to retirement nest eggs, that is exactly as it should be. Not everyone needs or wants an adviser, but I do think people who make their own investment decisions need to be particularly careful at the moment.