Autumn 2018 investment commentary
Why Simple Beats Complex When Investing
Childhood fever was a major killer in 19th-century hospitals across Europe. Thankfully, Hungarian physician Ignaz Semmelweis discovered that the mortality rate of this disease could be cut drastically by using hand disinfectant in clinics.
The doctor’s ward at the Vienna General Hospital's First Obstetrical Clinic where he worked had three times the mortality rate of midwives' wards. So Semmelweis proposed that doctors, nurses and other medical professionals at the ward wash their hands with chlorinated lime solutions.
The same simple solution has since saved countless lives across the world. It made Semmelweis the early pioneer of antiseptic procedures and earned him the nickname ‘saviour of mothers.’
This historical story illustrates an important lesson: some of the most valuable solutions are in fact the simplest.
Sadly, there’s a pervasive human tendency to make things complicated and unsurprisingly the investment industry is no different. A great deal of time and effort is wasted creating complicated solutions to sometimes unsolvable problems.
A recent article in the Guardian (https://www.theguardian.com/money/2018/may/26/uk-biggest-fund-standard-life-gars-alan-miller) highlights one of the major failings of the investment management industry: the Standard Life GARS fund. The largest actively-managed fund in the UK manages over £20billion in assets, however its ‘ridiculously complex’ structure has undermined its value.
Over the past five years, not only has the actively managed fund underperformed its own benchmark, it has also underperformed the UK and global stock markets. Its complexity even proved too much for industry experts and so what possible chance would the average investor have of understanding it?
This particular example of faulty financial engineering was initially hailed for its sophisticated usage of alternative strategies, which in essence are bets against stock markets. The trouble with GARS was that it promised stock market-like returns (cash plus 5% a year) for taking a cash-like risk, in all market conditions! Needless to say, it failed miserably.
After the departure of its founding fund manager, the fund fell into decline, during which time successive managers failed to right the ship. The complexity of this financial vessel certainly wouldn’t have helped. And so the story of GARS presents another valuable lesson: Investors who place their faith and money in active managers’ hands also bear the risk of any career changes they might make. And unfortunately, the more complex the strategy, the harder it becomes to maintain consistent outcomes when the manager leaves.
The key takeaway here is that the investment industry loves complexity, driven by the twisted belief that complexity should earn a higher fee! The problem is, complexity breeds risk. It often yields worse results for clients. And sadly, it also sells better.
We’ve been careful to avoid these types of investments in our portfolios. Our approach is to keep our investment process as simple as possible. As a very wise fellow once observed, ‘any darn fool can make something complex; it takes a genius to make something simple.’
While we do extensive research on investment products, we doggedly avoid anything that we don’t fully understand and we certainly avoid anything that our clients have no hope of understanding. Our approach is designed to help our clients capture global capital market return over the longer term, while removing unnecessary cost from our portfolios and anxiety from our clients’ minds.
Asset Class Return
The chart below shows the total return of major asset classes and inflation over the past 1, 3 and 5 years.
Source: FE, data to 28/08/2018. For illustrative purposes only. Past performance is not a guarantee of future results. The indices used in the illustration above are not available for direct investment. Therefore, their performance does not reflect the expenses associated with the management of an actual fund.
The main takeaway from this is that the capital markets have been generous over the past decade or so. There are always concerns that future returns could be lower than they have been in recent times. But as long-term investors, we mostly ignore daily noise about what the market might do next, rest assured in the knowledge that the capital markets tend to reward patience over time.