by Mark Dampier
I also know that many of tomorrow’s stock market stars are already out there somewhere in the AIM and smaller company sectors of the stock market. I am enough of a realist to know that, with my limited time and lack of relevant skills, the chances of my being able to spot them are very small. If you are tempted by investing in shares directly, my advice is to be realistic with yourself about what you can do and the time you can spend on it. Maybe you are an investment genius. Many ordinary investors thought they were just that during the internet bubble, until it all came tumbling down. If you enjoy researching individual shares and have the time and the inclination, by all means press on, but do please go in with your eyes wide open. It helps a lot if you have had relevant experience in business or financial analysis. My advice would be to limit your share dealing initially to no more than 10% of your overall portfolio, in order to find out whether you have the temperament and skills to do the job well. You certainly won’t know how good you are until you have lived through at least one serious market correction and found out how you feel when all your shares have fallen by 25% or more. Only if you survive that will you know for sure that you have got what it takes.
I always note with interest which shares the clients of Hargreaves Lansdown have been buying and selling in the largest quantities. 60% of clients hold at least one AIM stock, meaning they have been tempted by the riskier end of the stock market spectrum. The most popular AIM shares at the time of writing have been Quindell, Sirius Minerals, Monitise, IGas Energy and Falkland Oil and Gas. Dig down further into this list, and it becomes apparent that these types of stock are rarely held for the long term. That suggests that those who buy them are really speculating, or having a punt, rather than what I would call investing. To make things worse, even though the stock market as a whole is up, most of these stocks have lost money. All this buying and selling costs money. None of these stocks fit readily into my criteria of good long-term businesses that pay a good dividend and are likely to be around in many years’ time. It makes me wonder: are the buyers having a bit of fun, or do they seriously expect to make money from their share dealing? And that is why I prefer to stick with my funds – less exciting, certainly, but a safer and more suitable option for my way of thinking.
Points to remember
Passive funds are useful low-cost starting points for first-time investors.
Actively managed funds cost more, but will repay the effort if your fund choices are good.
Investment trusts are a reasonable practical alternative to unit trusts and OEICs – more complicated to understand and often more volatile, but with compensating advantages.
Venture capital trusts are a terrific potential source of tax-free dividends.
Think very carefully before opting to go into the buy-to-let market: it is a business as well as an investment.
Buying shares directly can pay off very nicely, but requires much more time and effort from investors.
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19 The reason is that it is much easier for an index fund manager to replicate the shares that make up an index of large, well-known companies which are traded in large volumes every day than it is to track indices in smaller, less liquid stock markets.
20 What they can do is issue more shares from time to time, either by buying them in and reissuing them, or making what is called a C share issue. It is still a more cumbersome process.
21 This was the case at the time of writing. The tax arrangements surrounding VCTs will be changing following intervention by the European Union, which may reduce their attractiveness and the way the trusts operate – it is important to take advice or keep up to date with these rule changes before investing.
22 Unless you are dividing a house into flats, you cannot easily manage your capital by selling out in tranches – for example, to manage your tax liabilities – as you can with financial investments.
23 In 2015 the chancellor announced plans to restrict the amount of interest that buy-to-let landlords can claim against tax. The rules on allowable costs are also being changed.
Chapter 9. Reflections on a Three-Decade Career
If you have been around the investment business as long as I have, it is impossible not to develop some strong opinions about the way that the industry has developed and is regarded in the wider world. In this chapter I offer some thoughts on the things that bug me, together with some further reflections on aspects of investing that I have only touched on earlier in the book. Feel free to disagree with me if you wish! As I have learnt over the course of the last 30 plus years, nobody can claim to be right about every aspect of investment. Experience is certainly the best instructor I have had.
On the perils of forecasting
There have been some dramatic stock market crashes in my time as a professional investor. The 1987 crash was a huge shock at the time. The internet bubble and subsequent bust was simply one of the craziest episodes in the whole of market history. The scale of the 2007–09 financial crisis, when stock markets fell by 50% for the second time in less than ten years, was also dramatic.
I would make an exception of the internet bubble, but it is fair to say that most stock market falls, including the biggest crashes, were not forecast by anybody. The 1987 crash was a seismic shock to the industry. Nobody had seen the markets fall so fast so quickly. You couldn’t deal in some unit trusts for three or four days. They simply wouldn’t answer the phone. That had never happened before and wouldn’t be allowed today.
In the aftermath of that crash, they wheeled out market historians such as J.K. Galbraith and all sorts of others who could remember the 1929 stock market crash on Wall Street, saying it was the end of the world. When you’re young and only a few years into your investment career, as I was, you think, “Well, these people ought to know what they’re talking about.” But of course I was wrong, as were all those doomsters who said that the 1987 crash would usher in a new global depression.
What you realise as you get older is that a lot of people who work professionally in the investment business don’t actually have a clue what they’re talking about – and the more expert they are, the worse they usually are. You can make a great career out of sounding good, even if your forecasts are almost totally useless. Most economists fall into that category. They get very well paid for being wrong almost all the time. There has never yet been an economic recession that has been predicted by the majority of economists. I find it incredible that they get away with it, but they do.
Mind you the fund industry can lose its marbles as well. In the 1980s and 1990s, many investment trusts borrowed money at absurdly high fixed interest rates. That cost their shareholders a huge amount of money. Equitable Life, the pensions and life assurance company, notoriously went out of business after promising its clients guaranteed annuity rates that it could not possibly afford to pay when interest rates began to fall dramatically.
If nothing else, these examples show that the idea that professional investors will always do better than private investors is complete rubbish. In my experience, the institutional and professional investor can be every bit as idiotic as any private investor, and sometimes even more stupid. I have seen too many examples in my time to think differently.
It also means that if you are in the business, it pays to be quite humble. You could always be wrong in the future. I am not clever enough to tell you where the stock market is going to go this year or next. It is easy to be a multi-billionaire with hindsight, but at the time things are never as obvious as they seem to be afterwards. The best you can do is take a long-term view and look out for prices or markets that have reached an extreme and bet that they won’t persist for long.
Something like that happened when interest rates reached 15% during the early 1990s. You just knew that could not be sustainable. Yet I remember having a hell of a lot of trouble trying to persuade a client to buy a guaran
teed income bond that paid out 13% a year and would also give his capital back at the end of the policy’s life – just think what that would be worth today. He just thought interest rates would go on rising indefinitely, which is what people tend to do – they just extrapolate from recent experience.
A good recent example is the Japanese stock market, which from a long-term historical perspective has looked undervalued compared to most other leading country equity markets. But there are still hundreds of investors who find it impossible to invest in the country’s stock market. Why? Because there have been so many false dawns before in Japan, and many investors still bear the scars of trying to get back in too early. London house prices are another example. People who say that prices will never come down again have short memories. We have had big setbacks in house prices at least three times in my career and at some point we will have another one, though don’t ask me to tell you when.
Dealing with market crises
Psychologically, as human beings we have a much greater aversion to losses than we have positive feelings about gains. That’s why I don’t gamble. Horse-racing is like investment in that the outcome is rarely very satisfying. If you bet and you win, you are disappointed because you should have put more money on the winner and if it loses you aren’t satisfied because you shouldn’t have put any money on it at all! Investing can sometimes be a bit like that too. When you get a winner, you think why didn’t I put more of my portfolio in that? And if it’s not doing well, you think why did I ever put any money in it in the first place?
Investments are basically driven by greed and fear. If you are going to be fearful all the time, I repeat what I said earlier. Investment is supposed to improve the quality of your life, but if you worry about it every second, then it’s not having that effect. It is certain that anyone investing will at some point have to deal with a crisis or a big market fall. There have been plenty of 5–10% corrections in the stock market over the last 20 years and quite a few scares which led to even worse outcomes.
Instant communications means market moves happen much more quickly, both up and down. I think it’s important for investors to appreciate that, whatever they invest in and however good the fund manager is, the likelihood is that at some stage your portfolio is going to take a hit. You’ve got to think, “How will I feel then? If I invest £100,000 and find it’s only worth £85,000 in a year’s time, how am I going to feel about that?”
There is a useful test you can take. Whenever you buy an investment, you should try and work out the worst-case scenario. When you get a mortgage I always ask clients, “What happens if interest rates go up and you have to pay 5% instead of 3%? Have you worked out how much money that is and can you pay it?” If you can’t, I question whether you should be having that size of mortgage, or even a house at all. It is surprising to me how many people don’t seem to think this way when it is really no more than common sense.
The same goes for investment. You need to have realistic expectations and be mentally prepared for the times when things are not going well. If your expectations are not fulfilled, you will naturally be disappointed. If that happens, don’t look at everybody else – think about yourself, about the investment itself and whether you are as genuinely long-term in your approach as you think. Rather than panic, I suggest you go fishing or take some time out rather than let your emotions get the better of you. It’s never fun to see your investments go down. Nobody enjoys it. But it is a fact of life and you have to know how to deal with it when it happens.
The speediest fall I have seen was October 1987. Then it was a huge shock because people had never seen a market fall so quickly. Wall Street on that Monday night fell 25%! London, on the Monday, had already fallen just over 10%, and the following day it fell 11.5%. Since 2000 we’ve had two falls of 50% in ten years, which is unusual, but it does underline the volatility of economic and financial cycles.
That tells you that you need to look longer term and you do have to make sure that you have sufficient cash around you to give you that buffer before you invest in the first place. Just because something goes down doesn’t mean that it’s a bad investment. An awful lot of the time, although people say, “You guys always say that,” we end up saying, “It’s a buying opportunity”. It might be trite, but 99% of the time it’s also bloody true!
This must be the only industry in the world, where, if prices go down, people don’t buy more, but less. If I said there was a 50% sale on at Harrods people would flock there. But in stock markets, people go the opposite way, become fearful and often don’t do anything at all! That’s the best time to be looking to buy, even if there is always a lot of luck involved. I get asked, especially when markets go down, “What should we do?” My answer is always the same. I just say, “Look, if you’ve already got a well-balanced portfolio, and if you’ve sorted out what you want to buy, then buy a chunk, say 10% or 20% on day one, leave it for a while, and if the market takes a fall, I’d definitely be putting some more money in.”
There’s psychological pressure for the DIY investor because, if your investment starts to go down, do you take a small loss or do you just ride it through? Back in 2008, funds like Old Mutual’s Small Cap fund and First State Asian Pacific all took a huge hit. They were down 40% or 50%. The DIY investor tends to say, “Well, if I had sold it at the top, that would have been great.” I say back at them, “Yes, but would you have bought the shares back at the bottom?” The news at the bottom is always worse than it is at the top. People too readily get into the doom and gloom and they don’t buy back what they have sold and so they lose it. If you’d held on to the Old Mutual fund in 2008, it has since risen by over 250%. The First State fund is up by a similar amount.
This all comes back to my point about decisions: the fewer you make, the better – the trouble is, if you are a seller one day and a buyer the next, both decisions have got to be right, and usually one at least is wrong. That’s enough to make you lose money. When markets are bad, I’m tempted to say the best thing is to turn off the news, don’t keep looking at your portfolio and focus instead on the long term.
Market squalls will come, and there could be two or three in a year, or there could be nothing for a year or so, but it is a racing certainty that over your lifetime you are going to experience some tough times. But as a general rule, markets and economies most of the time plough the middle course. It’s never as bad as you think, and it’s never as good as you think either.
If the market falls and a fund manager like Anthony Bolton, Neil Woodford or Nigel Thomas does poorly, it does not mean that they have become bad fund managers overnight. In fact, they’re the ones who thanks to experience will keep their nerve, which is what you need. What you don’t want is someone suddenly going off-base because something’s happened to the market and he’s doing something he wouldn’t normally do. That’s normally a recipe for disaster.
We always want a reason for something, but sometimes there’s just not a good reason. Back in the internet bubble, when the end came in early 2000, there was no single piece of news that suddenly said that this technology wasn’t going to work. In fact, everything that was said about technology in 2000 and what it was going to do we’re seeing happen now. We can see that clearly now, but tech stocks still fell like a stone back then. Like the railway and canal bubble they were wonderful for the economy in the long run because, although there was huge over-speculation and over-building, it’s exactly what the country needed. You would never have got all the railways being built if everyone had sat down and thought about it.
The final point I would put on the table is there are periods when markets do become overvalued or undervalued. There may be some indicators that tell you that your return over the long-term is likely to be higher or lower as a result. The famous buying point for the Hong Kong stock market is a PE of 8; when the market falls that low, it is almost invariably a good time to buy. It’s quite remarkable over the
last 30 years that the market has bounced off that level so often. It is a good example of how, rather than trying to make macro market or economic judgements, it is better to hold on to your historical perspective on where markets are and take a line from that. An objective signal is always better than relying on a personal or emotional approach.
That is why many fund managers prefer to concentrate on valuations in their chosen sectors and stick to that method. A fund manager such as Mark Slater at Slater Investments uses a lot of ratios when screening stocks, but he doesn’t do a lot of macro. Anthony Bolton never did a lot of macro, at least until later in his career. Giles Hargreave is the same. Of course, they may always have an opinion, but the question I like to ask fund managers is not what they think about the general economic climate but: “Are you still finding opportunities in the stock market today?”
If they can answer that question in the affirmative, that can be very helpful when trying to decide whether market valuations are too high or not. If they say no, it pays to be cautious yourself. You might think that their answer would always be “Yes”, but my experience is that the best fund managers – the ones who have been around for a while and are honest with themselves – are also pretty honest about sharing their current opinions.
The pensions revolution
I would be much happier if the government stopped tinkering with the pensions regime in this country. Pensions are the second most important financial asset that most people have, after their homes, and the endless messing with the rules about what you can and cannot do does few of us any good. However the recent pensions freedom changes first announced by George Osborne in 2014, and taken further in the 2015 Budget, are potential game-changers which – if they are left alone by future governments – will have a profound impact on millions of people’s future financial wellbeing. The chances are that if you are reading this book you may well be one of them; and even if you are not you will find a lot of people talking about the issue.