Investment principles

Ryan_Futuristics

HarryD wrote: »

It is very difficult to pick a fund that will do better than the market in general. You might, but you might not. One solution is to buy an index tracker. If you buy, say, a UK All Share index tracker, you are buying shares in every company on the main London Stock Exchange. The other advantage of trackers is that they tend to have very low charges.

Actually if you'd just bought Hargreaves & Lansdown's recommended funds over the previous decade, you'd have outperformed the IMA sector for UK All Companies and Smaller Companies by 30-40%

http://www.hl.co.uk/news/articles/150-ways-to-make-more-of-your-money

Use resources like Citywire and Morningstar properly and you'd be unlucky to hit an underperforming fund ... There's a fair bit of literature out there that doesn't want you to think that (generally associated with people trying to sell you trackers)

masonic

Ryan_Futuristics wrote: »

Actually you'd have been out since 1993, but you'd have done just as well in bonds, only switching briefly when valuations were reasonable

(Green line)

As I have pointed out before, the blue line represents investing only in the US, which I consider to be a straw man, especially considering my previous post explicitly referred to "people slowly drip-feeding into a diversified portfolio". A drip-fed diversified portfolio seems a better proposition than either the blue line (just invest in US equities) or the green line (radically switch between US equities and bonds depending on an arbitrary CAPE value). A diversified portfolio is also likely to incorporate some bonds to reduce volatility and bring the portfolio in line with the holder's risk profile, but perhaps not as much as the green line, where holding 100% bonds for long periods has significantly dampened returns.

The purple line is about the best one could have done by formulating a strategy based on hindsight. It's a strategy described this year, which would have worked extremely well based on previous data. As I've mentioned before, I think there could be something in it and it's probably worth a punt as a small allocation of an otherwise diversified portfolio. However, it does require one to invest in volatile BRIC and PIGS-type markets, so there is a significant risk management element that needs to be considered before venturing into a strategy like this.

gadgetmind

HarryD wrote: »

If you buy, say, a UK All Share index tracker, you are buying shares in every company on the main London Stock Exchange.

Agreed, and it's a little better balanced than the FTSE 100, but not enough for me to regard it as being a sensible single equity holding. I tend to invest more globally but then apply a slight "home tilt" via All Share and Mid Cap trackers.

Ryan_Futuristics

masonic wrote: »

As I have pointed out before, the blue line represents investing only in the US, which I consider to be a straw man, especially considering my previous post explicitly referred to "people slowly drip-feeding into a diversified portfolio". A drip-fed diversified portfolio seems a better proposition than either the blue line (just invest in US equities) or the green line (radically switch between US equities and bonds depending on an arbitrary CAPE value). A diversified portfolio is also likely to incorporate some bonds to reduce volatility and bring the portfolio in line with the holder's risk profile, but perhaps not as much as the green line, where holding 100% bonds for long periods has significantly dampened returns.

The purple line is about the best one could have done by formulating a strategy based on hindsight. It's a strategy described this year, which would have worked extremely well based on previous data. As I've mentioned before, I think there could be something in it and it's probably worth a punt as a small allocation of an otherwise diversified portfolio. However, it does require one to invest in volatile BRIC and PIGS-type markets, so there is a significant risk management element that needs to be considered before venturing into a strategy like this.

Well the graph's just to answer a commonly posed question: what would have happened had you sat out of US equities when they were overvalued?

You've said you think the value strategy is based on hindsight ... There's a difference between identifying a region that's done well in the past and identifying a principle

Knowing to invest specifically in an overvalued US at the start of a bull market involves hindsight; identifying the principles that have steered you towards numerous bull markets is perhaps better described as insight

masonic

Ryan_Futuristics wrote: »

You've said you think the value strategy is based on hindsight ... There's a difference between identifying a region that's done well in the past and identifying a principle

I said the investing strategy indicated by the purple line on the graph (specifically, buying the cheapest third of global stock markets by CAPE and rebalancing each year) is based on hindsight. It was formulated using historical data and is only now being put to the test. It might work predictively going forward, or it might turn out to be an anomaly within the historical data set.

Knowing to invest specifically in an overvalued US at the start of a bull market involves hindsight; identifying the principles that have steered you towards numerous bull markets is perhaps better described as insight

I'm not quite sure what you mean by the first part of that sentence, but in terms of the value principles there are various different valuation metrics, which can be applied in a number of different ways. Some of these have proven successful at various times and others less so. It therefore pays to be cautious about a somewhat novel way of value investing that involves setting aside any other factors and comparing a valuation metric across an extremely diverse collection of global stockmarkets and picking the lowest numbers as those with the biggest growth potential. As I said before, I think it might prove to have been an insightful way of investing, but Russian, Brazillian and southern/eastern European markets are not cheap for no reason. Some of those issues could outlast my investment horizon.

darkvader

I'd like to give my view as a layman given I got a lot of help from this forum as I trawled through a lot of websites.

Im focussing my post on investing for the long term, not being an expert to know which country in some corner of the globe is doing well and using calculated risks.

So, firstly, there are a lot of good websites, magazines and information ranking funds, ITs, trackers etc. Take a look at which names keep coming up but also make a note of the duration thats used to rate investments. Its absolutely silly to rank based on 3 year performance and given the recent recession, every a 5 year view is not a true picture. Best to go further back, 10 years and more a very good measure of an investments worth

Secondly, most websites change their 'recommended' or star rated funds every year. Let's be honest. If you are, like me, investing a small amount every month, then you will end up with over 100 investments in your portfolio if you go by these yearly changes.

What I have decided on is keeping my investments geographically diverse. I decided how much I wanted to invest in which parts of the world first. For example, 20% each across North America, Europe and UK and 40% across Emerging Markets which is Asia, Australia, Africa & South Americas. You can chose what you feel best based on your research. Personally, as I am invested for the long term I wanted a slant to emerging economies

Once you have this split, you can drill down per area : equites, bonds, gilts, cash, property etc to build that geographical split. You may also have a preference for investments that focus more on banking or consumer goods or technology.

What was important to me was clarity on returns I wanted. There will be funds every year with 20% odd returns but can I realistically, with my monthly investment, chase these constantly? If I did, I'd end up over 50 funds and no clear focus. I'd be happy to get, on average, 9% to 12%, over the next 10 years and more with a slight chance of few years hitting 20%. At the same time, I dont want to crash and lose 20% in a recession. This view helped me decide which investments to go for : racier ones that fall a lot in a recession or slow and steady ones that protect your capital in rough times

So, I then chose funds, ITs to set up my monthly investment. There is no way I can constantly predict which part of the globe will have the best year so splitting my investments across the globe gives me some safety. In the long term, nothing beats equity investments, so few years of negative returns, backed by monthly investments will smooth out long term returns. This is split across the globe in decent percentages so if one some country/region has a fantastic year returning 40% I know I will get some of it

You do have to be vigilant, monthly drip feeding doesnt mean you can invest and forget. For example, if a particular region is suffers for 2 years on the trot, you may either stop investing there for a while or reduce monthly investments

Hope this helps and all the very best! It is fun once you get into it but remember, dont look at short term fluctuations, keep a long term view and stay invested for the long haul

DV

Ryan_Futuristics

masonic wrote: »

I said the investing strategy indicated by the purple line on the graph (specifically, buying the cheapest third of global stock markets by CAPE and rebalancing each year) is based on hindsight. It was formulated using historical data and is only now being put to the test. It might work predictively going forward, or it might turn out to be an anomaly within the historical data set.

Well not exactly ... The principle (using cyclically adjusted P/E to buy the cheapest regions, sectors or stocks) has been used successfully for somewhere in the region of 80 years by investors such as Benjamin Graham ... method is somewhat arbitrary

I'm not quite sure what you mean by the first part of that sentence, but in terms of the value principles there are various different valuation metrics, which can be applied in a number of different ways. Some of these have proven successful at various times and others less so. It therefore pays to be cautious about a somewhat novel way of value investing that involves setting aside any other factors and comparing a valuation metric across an extremely diverse collection of global stockmarkets and picking the lowest numbers as those with the biggest growth potential. As I said before, I think it might prove to have been an insightful way of investing, but Russian, Brazillian and southern/eastern European markets are not cheap for no reason. Some of those issues could outlast my investment horizon.

Well Faber notes it probably doesn't matter which metric you use or how it's applied ... they all tend to show the same thing as far as what you certainly want to be investing in or avoiding

Re: hindsight

You may just not follow me on this - but basically identifying a principle from a set of data gives you something potentially more universal to work with than simply identifying what happened

To put it another way: hindsight can tell you which lottery numbers you should've played; insight can tell you there's no point playing in the first place

gadgetmind

Ryan_Futuristics wrote: »

The principle (using cyclically adjusted P/E to buy the cheapest regions, sectors or stocks) has been used successfully for somewhere in the region of 80 years by investors such as Benjamin Graham ... method is somewhat arbitrary

Well quite.

I follow a few bloggers who put a lot of work into trying to track CAPE versus historical figures, work out how much (if at all) to tweak their weightings, etc.

The big question is what is (and isn't) "cheap" and how much do you trust this when deciding how much to tweak.

I will confess to doing this a little myself but GOK if it's worth the effort!

Rollinghome

Ryan_Futuristics wrote: »

Actually if you'd just bought Hargreaves & Lansdown's recommended funds over the previous decade, you'd have outperformed the IMA sector for UK All Companies and Smaller Companies by 30-40%

http://www.hl.co.uk/news/articles/150-ways-to-make-more-of-your-money

Use resources like Citywire and Morningstar properly and you'd be unlucky to hit an underperforming fund ... There's a fair bit of literature out there that doesn't want you to think that (generally associated with people trying to sell you trackers)

No one could fault HL's marketing abilities but I'd suggest that before you place too much faith in their fund selection abilities then you should use independent statistics, not those provided by their marketing department.

What do you mean by using Citywire and Morningstar "properly" and for that matter, what do you mean by an under-performing fund? All funds under-perform for periods of time and the concept is meaningless unless the period is specified.

It would be nice to believe that there really are "simple mathematical ways to assess how cheap or expensive a particular region or sector is at the moment" but if that were so then it would be surprising that even the revered John Chatfeild (sic) -Roberts, he of the Jupiter fund of funds, has found it so difficult, well under-performing both global indices and the IMA Global average (which also trails the indices).

I'd suggest that if it were really was as easy as consulting free listings on the internet such as Morningstar and Citywire then he'd have been more successful of late. And yes, his under-performing Jupiter Merlin Woldwide Portfolio is awarded a Gold rating by Morningstar. (You can find Chatfeild-Roberts' books "How to Pick a Good Fund Manager: A quick, comprehensive and independent guide for investors of all levels" and "Fundology" on Amazon too, though I wouldn't rush to recommend them.)

Once you've been investing for a year or two there's a good chance you'll discover it's a little trickier than you imagined.

masonic

Ryan_Futuristics wrote: »

Well not exactly ... The principle (using cyclically adjusted P/E to buy the cheapest regions, sectors or stocks) has been used successfully for somewhere in the region of 80 years by investors such as Benjamin Graham

For sectors and stocks, yes, I'm aware, but for countries/regions (and using a single metric in isolation in this case) I didn't think so - do you have any references? I'm not aware of anything pre-Faber that advocates simply using single country CAPE data to pick where to invest geographically and that's my main issue with this approach (if you haven't gathered already). It is often advised to compare stock valuations within market sectors to avoid industry-related noise - it seems to me that similar logic should apply to the diverse economies of different countries with their different economic, regulatory and political situations. Comparing Russia and the USA on the basis of CAPE alone is likely to lead to a misreading of the situation on some level.

... method is somewhat arbitrary

Well Faber notes it probably doesn't matter which metric you use or how it's applied ... they all tend to show the same thing as far as what you certainly want to be investing in or avoiding

I should think that method is very important. If it wasn't anyone could consistently pick a market beating portfolio of stocks using simple screening tools. You seem to be suggesting that valuation metrics are magical prognostic tools and that all other considerations can be dispensed with. I can't believe it is that easy. You might be aware of the review by Aswath Damodaran (downloadable here) in which a number of value investing approaches including that of Graham have been discussed at length. This includes a description of Graham's 10 step screening methodology, which is by no means simple and suggests (to me at least) method is not at all arbitrary. The paper also lists several things that can go wrong with simple earnings based valuations, such as the risk that earnings are set to fall rather than prices rising (or the potential for growth is limited), differences in the way earnings are reported, absence of diversification. Also pertinent is the tendency towards moving up the risk scale when investing in this manner. Several of these points are relevant to a country-based CAPE approach, especially considering such an approach is currently telling you to pile into Russia, Brazil and southern/eastern Europe. A stockpicking value investor might avoid companies where earnings are suspect, where the board of directors is not acting in the interests of investors, or where they might be adversely affected by specific difficulties. They would still have plenty of companies to choose from. There are a much more limited number of countries with an investable stockmarket and available valuation data and Faber's approach seems to ignore such potential concerns. This, along with the total reliance on quite a simple valuation metric, is where most of my doubts about the applicability of the value methodology to the selection of countries in which to invest lie.

Towards the end of the review I linked to above is a quote that sums it up quite nicely: "The bottom line is that beating the market is never easy and anyone who argues otherwise is fighting history and ignoring the evidence. Value investing starts with a solid base in behavioral finance and empirical evidence but to be successful with it, you have to bring something to the table, a competitive edge that cannot be easily found in the market, and be consistent about staying true to your core philosophy."

You may just not follow me on this - but basically identifying a principle from a set of data gives you something potentially more universal to work with than simply identifying what happened

To put it another way: hindsight can tell you which lottery numbers you should've played; insight can tell you there's no point playing in the first place

The key word there being 'potentially'. Extrapolation doesn't always work and is only insightful if it does.