You can’t predict the future, but you can manage risk

Over the long-term, investors should be rewarded for taking risk, but with markets generally on the expensive side and global economic and political prospects uncertain, the focus should be more focused on risk than reward, an analyst has argued.

Speaking about themes emanating from a due diligence trip where Investment Solutions met with more than 60 local and global asset managers, Mark Lindhiem, its chief investment officer, said the risk-reward dynamic shifts over time. During some periods, investors will be rewarded in abundance, and during other times, the reward, if any, will be subdued.

“We think right now where the markets are – economics, politics, just general developments – you need to be focused more on the risk side, because there is danger.”

Global uncertainty

While there is a lot of global uncertainty, there is a risk that investors may think the macro economic and political environment has never been this dire.

“That is probably not true, but I think it is true to say there is more noise around it now and therefore there is more risk that you can get caught up in it,” Lindhiem said.

It is the asset manager’s job to try and ensure that portfolios are constructed in a way that clients are as safe as possible.

Risk is typically low at the beginning of a bull market, which is often also the end of a bear market – the point in the cycle where investors are most fearful, he said.

Investors who took the leap in 2009 and invested in indices without paying active management fees, will now be sitting pretty, as markets have rewarded them handsomely for the risk they have taken.

Lindhiem argued that the situation has now almost reversed – at the moment investors should be taking a much more active stance and reflect on the fact that there is a lot of uncertainty.

In general, markets have moved up a lot since the bottom of the financial crisis and are mostly in expensive territory. However, since around 2014, the movement has largely been sideways.

There was a slight pullback in January and although markets have recovered since, “we are not at that trajectory where markets are still going up a lot”, he said.

Although markets could continue to go up, investors have to realise that sectors like consumer staples and healthcare particularly have run hard over the last couple of years.

Investors may still opt to buy a quality company, but if the price is expensive (as some global asset managers argue), future returns may be poor even though the company is still considered a quality business, he said.

Where does this leave investors?

Lindhiem said one option was to look at value stocks. However, over the last two to three years a number of value managers took a beating as they bought resources and mining companies that were considered less expensive but whose share prices continued to fall.

There has now been somewhat of a turnaround, and the returns this year suggest that the value style may be back in favour while momentum and growth may be out of favour.

“But we are not sure yet and ultimately we’ll only have conviction on that when it is almost too late.”

Lindhiem said it was very difficult to call these cycles and therefore it was important to focus on risk.

“You can’t forecast the future, yes, but you can risk manage and just try and protect yourself from these different outcomes,” he said.

While quality companies should provide more protection over time, if an investor bought the shares while they were trading in expensive territory the ultimate return might be disappointing.

Lindhiem said they find that both local and global asset managers identify quality companies in places where share prices have not risen as much.

One example is developed markets, which have outperformed emerging markets quite strongly over the last few years. Asset managers argue that this trend may now be switching.

Some South African resource companies may still do relatively well despite a drop in the oil price and may produce fairly decent cash flows.