Dare to be Different

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Investment managers are generally split into two categories: Active and passive. Active managers aim to outperform a certain benchmark index by being different from it. Passive investors seek to replicate an index. Both have their proponents and their detractors. Recently there has been a strong trend towards passive investment following a number of studies which show that the average passive fund has outperformed the average active fund after costs.

Active managers are not all the same though, and it’s a mistake to lump them all together. One of the most important differentiators of an active manager is active share. Active share is a measure of how different a portfolio is from a benchmark index. Active share is calculated by summing all the absolute differences between a portfolio’s position weightings and the benchmark’s position weightings, and dividing by two (because you’re double counting). A portfolio with an active share of 0% is replicating the index exactly – i.e. passive investing. A portfolio with an active share of 100% has absolutely nothing in common with the benchmark index. The higher the active share the more different a portfolio is from the benchmark – the more active it is.

Why is Active Share so Important?

Much of the active management industry purports to be active, charging active fees, but delivering portfolios with low active shares (i.e. <60%). These funds are closet indexers. They are a major reason why active management as a whole has lagged passive. If you hold a closet index fund, your gross return will be roughly the same as the index, but your costs will be higher than an index fund. This all but guarantees underperformance. There really isn’t any good reason to hold a closet index fund.

In contrast, truly active funds (those with active shares >80%) have outperformed their benchmarks in aggregate over long periods of time. This was demonstrated by Antti Petajisto in his paper Active Share and Mutual Fund Performance. There is a very real place for true active management – investment which demonstrates genuine conviction. Why is this so? Perhaps the most skillful investors are more likely to have conviction in their processes, so they tend to have higher active shares.

Unfortunately there isn’t much of this type of active management about. Between 1980 and 2009, the proportion of truly active US mutual fund assets dropped from 60% to less than 20%. According to a 2016 Morningstar paper, less than a quarter of actively managed European equity funds fell into this category. Only 2.4% had an active share of more than 90%. Why?

If high active share tends to outperform over time and closet indexing does the opposite, why has true active management shrunk over time? Because, in the short-term, high active share is a double-edged sword. Short-term returns are highly random. High active share guarantees periods of significant underperformance, even for the most skillful investor.

These periods are difficult for investors and investment managers to deal with. There are all kinds of emotional biases that mistakenly attribute randomness to skill or lack thereof. Despite the fact that closet indexing practically guarantees long-term underperformance, investors are far more likely to give up on an outlier in the short-term – i.e. a truly active manager.

Avoid the Middle

Far too much attention is given to outliers by advisors, investors and the media every quarter and every year, both on the downside and the upside.  There is simply no acknowledgement of the role that randomness plays in short-term outcomes, especially where active share is high. Distracted by the outliers, they ignore those hiding in the middle. Closet indexing is an easy way to survive as a fund manager once you’ve built up a sizeable fund. It ensures you’ll be consistently in the middle of the pack. Sadly, it is this group as a whole that adds no value to the end investors. This issue deserves far more attention, from advisors in particular. Charging active management fees for tracking an index is a great disservice to investors.

One indication of closet indexing (other than low active share) is a portfolio of household names that tends to track the market. There are 1 000s of relatively unknown, but still significant businesses listed around the world. One shouldn’t expect a sound active process to yield only familiar names.

For us there is simply no point in being a closet indexer. Passive investing delivers the same result before costs, but at lower cost. Closet indexing, while comfortable for some, is obsolete. What makes sense is to either be a true active investor, a passive investor, or to combine products at either end of the active share spectrum.

Analyzing our Active Share

Bellwood Capital’s active share is 95% relative to the MSCI World Index. We hold 49 different shares across all of our portfolios, vs roughly 1 600 in the benchmark. 20 of the shares we hold, comprising 43% of our portfolios, are not in the benchmark. The other 29 shares / 57% of our portfolios contribute just 6.5% to the MSCI World Index. Our portfolios are truly different from the index on an individual stock level. The returns they generate will also be different from the index. This is a good thing (though it might not always feel like it).

So why are we so different from the index? Are we being different just for the sake of it, or does being different add value? While Petajisto demonstrates that being different does add value on average over time, high active share isn’t a panacea that can stand in place of a sound investment process. High active share should be the result of a good process. It is important to get the cause and the effect the right way around.

Our approach is to build diversified portfolios of our best ideas from the available opportunity set. To achieve diversification doesn’t require much more than 30 – 50 stocks, provided they aren’t all exposed to the same industries and geographies (more on this lower down). Within this framework, we maximize exposure to our best ideas in terms of profitability, financial strength and valuation – the three causal drivers of return. The end result is likely to be very different from the benchmark. This is true active investment management, demonstrating a high level of conviction in our process.

Midcap vs Megacap

One theme seems to stand out when we examine the nature of the differences between our portfolios and the benchmark: Market capitalization. More than half of the index is invested in about 200 companies each with a market cap of more than $50 bn. Only a quarter of our portfolios is invested in a dozen of these 200 stocks. Further, we have a very significant weighting (about 40%) in midcap companies with a market cap of less than $10 bn. These are still very significant businesses. The index has less than 10% in these stocks. While we don’t generally prefer midcap companies, we do see more abundant opportunities among these stocks than the megacap stocks, as they are currently priced.

This comes as the trend towards passive has accelerated in the last few years. It is expected that assets invested in passive US equity funds will surpass their actively managed counterparts for the first time ever in 2019. In 1995, less than 5% of US equity assets were passively invested. The tidal wave of money flowing from active to passive in the last few years, and to the S&P 500 in particular, has meant that the megacap companies on which passive investing is generally focused have been bought indiscriminately at the expense of midcaps that don’t feature in the popular passive indices. This doesn’t make these businesses inferior investments, but it does mean that many are a lot cheaper than they’ve been in the past, especially relative to the megacap stocks.

Mind the Valuation Gap

Our portfolios are currently trading at their 5th percentile of historic valuations relative to the MSCI World Index. The valuation gap between the index and the stocks we currently hold is as wide as it’s ever been. This is a good reason to be different from the index, because valuation is a key causal driver of long-term returns.

By our estimates, the popular passive indices are not priced for good long-term returns, and no wonder given the massive indiscriminate flows in their direction the last few years. We’re quite happy to be different in this regard.

Applying Active Share to Diversification

While 49 stocks is undoubtedly diversified on an individual company basis, it doesn’t help if these are all in one or two industries or countries. There is another way to apply active share that helps to assess whether we are adequately diversified in this regard, or whether we are taking large industry or geographic bets*. We generally avoid these because they don’t have strong causal links to return.

The way to measure this is to calculate active share in terms of industry groupings and geographic groupings relative to a diversified index (like the MSCI World Index). Lower active shares on these measures indicate greater diversification. Ideally we would want our portfolios to exhibit high active share on the individual stock level, but low active shares at the industry and geographic levels. Our active shares are 33% and 29% respectively at the industry and geographic levels. This indicates high levels of diversification. Combined with an active share of 95% at the stock level, these measures put us right at the business end of well-diversified active investing.

* Side note: Whilst identifying the desirability of high active share at the stock level, Petajisto also demonstrated how these types of “factor bets” haven’t added value to investors over time, though he measured this using tracking error. Our tracking error is between 5% and 6% – on the lower end of the spectrum – which is consistent with our industry/geographic active share measures.

Dare to be Different

True active investing is about consistently applying a sound process to build a diversified best-ideas portfolio. It is not supposed to track the market, and if it does there’s something wrong. This type of investing adds real value over time, but it isn’t always easy. Bellwood Capital is a truly active global investor. Our active share demonstrates this. In an environment of generally high equity valuations, driven by indiscriminate passive flows towards the major index constituents, we’re far more comfortable being different from the market than following it.

Too Much Information

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The conventional wisdom in investing is that more information is better than less. In the past Peter and I have sometimes questioned whether we have an informational deficit, but over time we’ve realized that it is not quantity of information that counts, but knowing which information is important and analyzing it correctly. In fact, to the extent that too much information leads to overconfidence and emotional bias, more information can become a stumbling block.

Last year we wrote an article in which we compared insurance to investing. The focus was around diversification: How insurers are in the business of selling diversification for a profit. We feel there is a lot that investors can learn from the way insurers go about their business, which in many ways is very similar to the business of investing.

This time our focus is around information, and how that relates to the selection side of the process.

Focus on key variables and aggregate outcomes

Insurance is about aggregate outcomes. You isolate a few key variables – age, gender, smoking, family history and other health markers (for life insurance) – which largely explain variations in aggregate claims (or base rates). These variables are readily determined at low cost and can be applied broadly. This is called underwriting, the insurance equivalent of selection.

Further variations in individual claims are treated as random, either because they are random, or because the cost of collecting and assessing further information that might explain these variations outweighs any potential benefit of doing so.

Your life insurer probably won’t send someone out to interview you and find out about your life. The conclusions would likely be unreliable, especially to the extent that they differ from what the key variables are suggesting. Apart from the added expense, your insurer wouldn’t disregard the base rates in favour of a compelling story when setting your premium.

Your life insurer also won’t waste too much time second-guessing its underwriting process for every random deviation from the average, as long as the aggregates are in line. Claims are expected.

What is important about this approach to selection is that it is logical, business-like, and reasonably free from emotional bias. And it works.

The informational deficit mirage

In contrast, the investment world is obsessed with specific outcomes and individual stories. There are huge stakes attached to correctly predicting big winners and losers, which drives the investment community to generate and consume as much information as possible – as though this would somehow enable us to see the future.

The idea is that more information leads to more accurate predictions. This seems intuitive. The reality is that more information leads to greater confidence in forecasting, but not greater accuracy. This information-driven overconfidence causes investors to take big bets on specific outcomes without the required accuracy.

 Stories appeal to our emotions

The obsession with individual stories creates another problem: Investors are far more likely to allow emotional biases to bypass logical reasoning when stories are involved. In their paper On the Psychology of Prediction, Kahneman and Tversky demonstrate how compelling, but ultimately irrelevant information, can cause people to disregard prior base rates when making predictions, leading to systematic prediction error.

This sort of thing happens all the time in investing. Overconfident from all the information we have about a company, we fall in love with the story and often lose sight of the few key variables that determine aggregate outcomes.

It is staggering to see how different the approaches of the insurance and investment industries are, considering how similar their businesses are.

What are the key variables in investing?

Perhaps one reason why investors consume so much information is because there isn’t broad understanding of what the key variables in investing are. Understanding the causality of investment returns helps to isolate which variables are important. There are only three broad variables that really matter:

Higher profitability is associated with higher reward and lower risk. Higher leverage is associated with higher reward and higher risk. Higher prices are associated with lower reward and higher risk.

These are the three key variables that drive aggregate outcomes in the stock market. Every bit of information that you consume should be directed at trying to understand these three aspects of a business. Every bit of information that draws your attention away from these variables is probably impairing your judgement. The investment community generates far more of the latter.

Let’s do an example, then add a story to make it interesting…

You have the opportunity to invest in a persistently loss-making business that is operating in one of the most competitive and capital-intensive industries in the world. The company is highly geared, issues a lot of new shares every year, and burns through cash. The industry is cyclical. If the company was as profitable as its competitors, it would be trading at a PE of 30x – 40x.

Loss-making, leveraged, expensive… What do you think the base rates of return look like for a group of companies with these characteristics? Would you invest? Maybe this one is an exception.

What if I told you the company is a fast-growing, high-flying, tech company that is disrupting one of the most established industries in the world. The CEO is a billionaire genius who has successfully grown several startups into multibillion-dollar businesses.

How about now? The story tells you little about profitability, leverage or price, but it is representative of a mental model of success. Would you disregard the prior base rates in favour of the story? The market does this every day.

Investing like an insurer

We’ve always preferred a more actuarial approach to investing. The idea is to drill down to the key variables, and to ignore marginal information when it is no longer useful, or when it is introducing emotional bias that might cause us to lose sight of the key variables.

Though we often talk about individual companies, we always think in terms of base rates and try to build a portfolio of highly profitable businesses, with prudent leverage at attractive prices. It makes it difficult to keep portfolio updates interesting when the reasons we bought company X are always the same.

Finally, in investing as in insurance, there are always claims. Some periods are worse than others. High base rates combined with small samples can be dangerous. This is why diversification and time horizon remain critical to achieving investment success.

SA Foie Gras

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AfrAsia’s latest South Africa Wealth Report found that wealthy South Africans have 83% of their assets invested locally. According to the report, their asset class breakdown between South Africa and the rest of the world is:

Let’s exclude properties, businesses and alternatives, which tend to be illiquid and might correlate with where you live or work. Let’s focus on the 44% made up of local and foreign stocks and fixed income – the liquid, more readily investible assets where investors have greater flexibility. The splits within this category are consistent with traditional asset allocations in terms of both asset allocation and global allocation:

The split between stocks and fixed income might be justifiable. The split between local fixed income and foreign fixed income might also make sense to the extent that local cash is needed to meet short-term liquidity requirements.

Too much invested in local stocks

What doesn’t make any sense is investing twice as much in local stocks as in foreign stocks, when:

  • More than half of your wealth is already tied up in illiquid local assets;
  • You have enough local cash to meet your short-term liquidity needs;
  • The local stock market is <1% of the world.

The purpose of investing in the stock market is to grow wealth and match long-term liabilities like retirement or leaving an inheritance. Surely investors in this position should be aiming to diversify their risk, which is very concentrated in South Africa, and to take advantage of the widest opportunity set possible. This means investing as much of your stock portfolio as possible in the global markets.

This doesn’t necessarily mean excluding the local market (though you probably already have exposure through your retirement annuity/pension). It means that local stocks should have to justify their place in your overall portfolio on more than the fact that they are listed where you live. They should compete on merit with every other stock in the world.

 

So why do so many South African investors and their advisors still seem to favour local, despite the obvious risks associated with such concentration?

“No one-size-fits-all”

I think it’s time to retire this line. We know that every investor has unique circumstances, and of course everybody doesn’t have the average allocation in the AfrAsia report. But when the averages are so skewed towards local, we can’t keep pretending that this is the perfect end-product of every individual’s unique financial plan. We also can’t keep using this line to avoid debating this important issue.

Isn’t the JSE Internationally Diversified?

“More than half of the JSE’s revenues come from outside of South Africa.” – another line often used to justify local market bias. But those revenues come from a handful of stocks – Naspers alone is more than 20% of the local market, with the top 4 companies making up half the index.

You cannot build a diversified global portfolio with a handful of stocks. There’s simply no benefit to limiting your options like this.

Ask yourself the following question: If these stocks weren’t listed in South Africa, how much of your global portfolio would you invest in them?

Where are your liabilities?

Ideally you want your assets structured in such a way that they match your liabilities. If you’re living in South Africa, it stands to reason that most of your liabilities will be local.

As far as your short-term liabilities are concerned, it makes sense to have sufficient local fixed income exposure to meet these liabilities. The primary goal here is low volatility in Rand terms.

Once you start talking about building wealth and matching your long-term liabilities, you should be less concerned by volatility and you’re probably investing in the stock market.

You might think that adding currency volatility can interfere with your long-term asset-liability matching, or with your dividend flows, but different sources of volatility are often offsetting rather than additive. Stocks are already volatile. Dividends are also volatile in times of crisis. Adding currency volatility doesn’t make them more so, especially since the Rand tends to weaken during times of crisis.

In 2008 the JSE Top 40 index lost 26%. The MSCI World index lost 21% in ZAR. The following year JSE Top 40 dividends fell by 37%, while MSCI World dividends fell by 24% in ZAR terms. Currency volatility in the stock market is a bit of a red herring. If anything, it reduces overall portfolio and dividend stream volatility.

A globally diversified portfolio of your best investment ideas chosen from the widest possible opportunity set is far more likely to meet your long-term goals than a locally concentrated portfolio. The risks are also lower.

Strong Rand keeping you up at night?

Every debate about local vs offshore seems to devolve into a discussion about whether South Africa or offshore will do better. Apparently South Africans worry that South Africa might do well – that Rand strength might somehow make us poorer. They are worried about the possibility that 99% of the world might underperform 1% of the world, despite the fact that they already have 83% invested here. This is insane.

First, this argument ignores the fact that there are many more cheap assets outside of South Africa than inside. Simple Bayesian inference.

Second, it’s not about which will do better, it’s about risk management and where your exposure is. When you are 83% invested in one small country where you happen to live, return expectations become secondary to risk management.

If Turkey, an economy twice the size of South Africa’s, was your best investment idea in the world, would you invest two-thirds of your stock portfolio there, on top of your property and your business?

We need to stop mis-framing this issue as a return issue when it is in fact a risk issue. We can’t keep dangling far-from-certain return potential as a carrot to force-feed local investors something they already have too much of. As advisors and asset managers, is our job to sell SA, or to represent our clients’ best interests?

If you’re anything like the average SA investor, you are already hopelessly overinvested in South Africa. If South Africa recovers and the Rand strengthens, you’ll benefit more than 99% of the rest of the world. Your business, your properties, your local cash will all be worth more in real terms. This is a good thing. You will survive a strong Rand.

Be more concerned about what might happen if, heaven forbid, South Africa and the Rand don’t do so well.

Consistent Profitability

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Return = Yield + Growth + Revaluation = Sustainable Return + Revaluation

This understanding of return is central to our investment philosophy and process. We’ve written about this on numerous occasions. Those who have followed our writing will recall that revaluation, though dominant in the short-term, tends to cancel itself out over long periods of time.

The result is that over very long periods of time, Return ≈ Sustainable Return.

This makes sustainable return incredibly important as it is the underlying fundamental source of value creation to all investors in aggregate. Businesses with low or negative sustainable returns might deliver high returns at times when revaluation is strong, but because this isn’t a persistent source of return, these businesses ultimately fail to create value for their shareholders over time.

Revaluation acts as a transfer of wealth between investors, rather than wealth generated by the business itself. This doesn’t mean that revaluation isn’t worth pursuing, but because of its unpredictability it makes sense to own strong businesses that are likely to generate high sustainable returns, and to approach revaluation more opportunistically over and above this.

What causes high sustainable return?

So, what causes sustainable return to be better for some companies than others? The most important factor is profitability. If a business makes a profit it can reinvest it in the business to drive growth, or it can return it to shareholders as yield. Since Sustainable Return = Yield + Growth, it stands to reason that the base rates for sustainable return of consistently profitable businesses should be superior.

To demonstrate the fundamental relationship, we calculated the annualized sustainable returns of nearly 1 200 of the largest US-listed companies with at least 10 years of financial data history (as of June 2018), and categorized them by consistency of profits:

The base rates for those that were profitable 10 years out of 10 were significantly higher, whether measured in terms of earnings, sales or book value. Less consistent profitability was associated with lower annualized sustainable return, as we would expect from the causal relationship.

While this is quite a simplistic way of assessing profitability (because it doesn’t account for capital employed, cash flow, leverage or cyclicality), it nevertheless demonstrates just how powerful consistent profitability is in driving the base rates for long-term sustainable returns.

Don’t let the Rand dictate your portfolio

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For many South African investors, the Rand exchange rate is the single most important variable they consider when deciding whether to invest money offshore. It crowds out every other consideration. We think this is a mistake.
If you’re thinking about investing globally, but you’re worried about timing the Rand, ask yourself the following questions:

1) How much of your wealth is focused in South Africa?

This is probably the most important consideration: If you’re overexposed and something goes seriously wrong here, your wealth could be permanently impaired.

This is an emotive topic for many investors and advisors who have strong views about what will happen one way or the other, ranging from doomsayers and fearmongers to the fervent “we’ve always recovered in the past” crowd.

We fall into neither camp, preferring a more probabilistic approach to risk management. Risk events have two elements: 1) Probability of occurring, and 2) magnitude of loss. A failed state is generally a low probability event, but the magnitude of loss is very high. Low probability, high magnitude risks are risks worth managing. This is the reason young, healthy people buy life cover. We think about country risk the same way. Global diversification is a form of country insurance.

Depending on where the Rand is trading, country insurance may be free, cheap or expensive. Free insurance is a no-brainer. Whether or not you decide to pay for country insurance should depend on two factors: 1) Price, and 2) how much insurance do you already have?

So how much of your wealth is focused in South Africa?

If, like many South African investors, you have a local business, a house, a pension and/or retirement annuity, chances are high that most of your wealth is focused in South Africa. If most of your liquid, discretionary assets are also invested locally, paying a fair premium for some country insurance might not be such a bad idea.

If, on the other hand, you are a global investor with very limited exposure to South Africa, your mindset is totally different. You have become the insurer, and for you it may make sense to be moving in the other direction, collecting premiums in exchange for bearing country risk as part of your globally diversified portfolio. This is a good position to be in.

Discussions about how cheap South Africa and the Rand are should be framed within the context of your global asset allocation and the size of the currency premium, if any. The higher your country risk exposure, the more it makes sense to pay a reasonable premium to manage it. The lower your exposure, the more you can afford to be opportunistic.

2) Is the Rand cheap or expensive?

In December 2001, the USDZAR reached a high of 12.45, 80% above the “fair” value based on inflation differentials and long-term trends. The premium for country insurance at this point was extreme. The perceived risks did not play out, and within 3 years the exchange rate had halved. The short-term pain was compounded by the simultaneous popping of the tech bubble.

Long-term investors who bought the S&P 500 in December 2001, and held on until March 2019, would be up 321% in ZAR, or 8.7% p.a. – not great, but not as bad as one might expect for the worst timed investment of the last 20 years. Also bear in mind that things might have played out differently. We only see what did happen in hindsight making it seem like the only possibility, but the reality is that the future is uncertain.

More recently the 2016 USDZAR high of 16.87 was about 40% above our estimation of fair, still very high, but nowhere near the extremes of 2001. We estimate today’s premium at roughly 15%. For a long-term investor, this premium could easily be a lesser consideration when weighed against other factors.

The “always recovered” commentators often use 2001 as a warning against rushing for the exits when the Rand is cheap. But cheap and expensive aren’t black and white. The current exchange rate premium is much closer to fair than it is to 2001 levels.

Your context may be one of 100% exposure to South Africa, in which case you may be happy to pay the current premium to get some global exposure. A global investor’s context may be one of only 1% exposure to South Africa, in which case the premium may warrant further investment in the country.

Within the context of your exposure to South Africa, is this a reasonable premium or not?

3) Cheap relative to what?

So, the Rand is fairly cheap. But relative to what? The US Dollar? Ironically, we tease Americans about their perceived lack of awareness when it comes to the diversity of “Africa”, but many of us make the same mistake when investing “Offshore”. There is a whole world out there that isn’t pegged to the US Dollar. There’s also more to global equity markets than the S&P 500.

By our estimation Sterling, Yen, Euros, Canadian Dollars and the Swedish Krona are also cheap relative to the US Dollar. You aren’t paying much of a currency premium to invest in these places.

The relative valuations of other currencies should also be factored into your decision to invest globally.

4) Are Rand-based assets cheap or expensive? What about other countries?

One of the major benefits of a global portfolio is having access to a very broad opportunity set. This allows you to make better investments and achieve a greater degree of diversification. You might find very cheap assets in a country where the currency isn’t as cheap. Think of Hong Kong, where the currency is pegged to USD. One of our portfolio holdings is a Singaporean company, listed in Hong Kong, which does business globally. It reports and trades in HKD, but how relevant is HKD really in this equation? Should the strong HKD put us off investing here? No.

The same applies to many companies listed on major exchanges around the globe, as well as our own local exchange. Some advisors say that investors should invest locally because a) the Rand is cheap and Rand-based assets are cheap, and b) because some of our prominent local listings like BAT, Naspers and Richemont have nothing to do with the local economy. These two points are contradictory. The fact that these companies are priced in Rands on our local exchange means nothing if they earn almost nothing in Rands. These companies stand to benefit no more from a domestic recovery than Altria, Tencent and LVMH.

There are also companies listed in the US that are cheap despite the strength of the USD.

The valuation of an asset’s trading and/or reporting currency is less important than where the company does business. It is also less important than the overall valuation of the asset, where currency effects are but one factor.

In the global investment opportunity set where South Africa represents less than 1%, it is highly unlikely that our local assets are the only cheap assets in the world. Shunning the rest of the world’s investment opportunities because “the Rand is weak” makes no sense.

Investors should Ignore Annual Predictions

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After reaching new all-time highs in September, the S&P 500 lost nearly 13.5% in the fourth quarter of 2018, while MSCI World ex-USA declined by 11.4%. Equity markets have recovered somewhat from their December lows – the S&P 500 came within a hair’s breadth of official bear market territory (-20%) on 24 December, before rallying 5% in the following trading session, the largest one-day gain since March 2009.

2018 was one of the rare years in which none of the major asset classes generated returns for investors. This rarity has many investors asking “So where to from here? Have we bottomed?” The real answers to these questions are unknowable. Market movements like these are inevitable, but unpredictable.

Despite this inherent unpredictability, this time of year is always marked by an influx of predictions and forecasts for where the market is headed next, which sectors are likely to do best, which stock picks will do well in 2019, and so on. Ignore them. 85% of the major investment banks expected the S&P 500 to end 2018 higher, with the lowest price target still 5.7% higher than the final outcome.

Allowing short-term forecasts to influence your long-term financial planning is a sure way to destroy wealth. Short-term predictions – despite their popularity – don’t work. Ignore the noise and use the new year as an opportunity to reassess your financial plan and make sure you’re well positioned for the long-term.

To assist with your planning, ask yourself the following three questions:

1. Does your asset allocation adequately match your future liability profile?

  • Do you have enough liquidity to meet short-term/contingent liabilities?
  • Do you have enough equity/growth assets to counter the creeping effects of inflation and to build wealth sustainably over the long-term?

2. Is your overall investment portfolio being managed transparently and cost-effectively, or are there too many layers between you and your money?

3. Are you sufficiently diversified, particularly in terms of a global portfolio?

  • How much of your wealth is concentrated in South Africa? Are you comfortable with this?
  • Outside of South Africa, are you overexposed to any other country?

A globally diversified portfolio of consistently profitable businesses, with strong financial positions is likely to deliver good sustainable returns over time, through the inevitable highs and lows.

In our view, the best approach will always be to invest in a global portfolio of good businesses at good prices, ignore the noise and the unpredictable swings of the market, and allow the effect of compounding to do its work as the years roll on.