2018 might be time to evaluate your risk-reward strategies, writes Ted Stephenson, executive director, CFA Society Emirates.
The asset classes held by most individual investors are generally limited to stocks, bonds and cash, while some would include real estate investments.
When short-term performance is emphasised, it’s clear that 2017 was another very good year for stocks. In 2017, the S&P500 benchmark returned 21.8 percent while the MSCI Emerging Market Index was even stronger at 37.8 percent.
For the S&P 500, this has been a continuation of a nine-year bull run. Emerging markets however, have been much more volatile and since 2009 there have been four years with negative calendar returns.
Since the beginning of 2009, by comparison, the S&P500 has had a cumulative return of 171 percent versus 35 percent for the MSCI Emerging Market Index in the same time period.
With stock markets continually closing at record highs, it might be time to seriously review the risk-reward equation. Active and tactical management is concerned with market timing and security selection.
However, there is a body of academic research that clearly demonstrates that most active approaches do not outperform a simple strategy of passive, index-replicating asset allocation.
In his 2014 annual letter, Warren Buffet wrote, “the goal of the non-professional should not be to pick winners but rather be owning a cross-section of businesses that in aggregate are bound to do well. A low-cost S&P500 index fund will achieve this goal. That’s the ‘what’ of investing for the nonprofessional.
The ‘when’ is also important. The main danger is that the timid or beginning investor will enter the market at a time of extreme exuberance and then become disillusioned when paper losses occur.”
For 2018, a new investor may want to wait for an inevitable correction. Existing portfolios may be rebalanced back to the long-term strategic asset allocation appropriate to the investor's objectives.
In terms of security selection, most individual investors are well served by investing in index replicating funds or ETFs. An ETF is an investment company whose shares are traded intraday on stock exchanges at market-determined prices.
The performance goal of an ETF is to track a benchmark compared to an active mutual fund where the goal is to outperform. The management of an ETF is passive and the costs are therefore lower.