Late last year, I noticed that many high-net-worth (HNW) investors were pulling back on some equity sector allocations. Not exiting equities altogether, mind you, but certainly trimming back or rotating into different sectors or markets.
It’s a move we agreed with wholeheartedly and suggested in most circumstances. After an exceptionally strong year in 2013, we cautioned our clients that now was not the time to get greedy. Quite the opposite -- it was time to lock in gains and take money off the table (reduce risk), particularly with U.S. equities (perhaps less so with Canadian equities).
As it turns out, this was a very smart move. Take a look at this chart. It compares the 2013 performance of several different types of assets (as measured by common sector and index ETFs) to the year-to-date performance in 2014.
As you can see, almost everything that went up in 2013 has been down thus far this year; the only exception being high-yield bonds. Note also that many of the real high-fliers of last year (social media stocks; biotech; Bitcoin) have been among the hardest hit, while some of the assets that were gutted in 2013 (precious metals; gold miners; REITs) have thus far been the best performers.
Why the reversal in fortune? I strongly suspect that toward the end of last year, many investors started chasing performance. In professional circles, this is called “recency bias” – the tendency to remember recent events or performance best, and give them more “mental weight”. In an investment context, this often leads people to extrapolate recent performance far into the future, and assume that good times will last, and what has gone up will continue to go up. This is particularly a problem when performance is “parabolic,” as it was in some assets last year.
Needless to say, recency bias is an exceptionally dangerous phenomenon in investing. Chasing recent returns is almost always a recipe for disaster. And yet many investors (both professional and retail) can’t seem to resist it. The feeling that we’re “missing out on something” -- we’ve all had it, and it’s very strong. The same can be said of the desire to jump into a hot stock or asset class “before the train leaves the station”, as it were. It takes serious discipline to resist such emotional and gravitational pulls.
Taking a look at the chart, I think there’s a tremendously important takeaway here for all investors. Those who came late to the equity party last year have been stung so far this year. On the other hand, those who trimmed back on the best performers and instead shifted into less popular assets have been rewarded.
If you spend some time talking to HNW individuals, you’ll quickly find that most of them have done very well by being contrarians. They pay attention to where “hot money” goes, and then often end up doing the opposite or conversely, they tend to go “bargain-hunting” where monies are flowing out of.
HNW investors seem to inherently understand that what comes up usually comes down -- perhaps not right away, but certainly over time. They also understand that the opposite is true: what comes down usually comes back up. In other words, they understand that performance usually reverts to the mean. It’s just a matter of when.
Here’s another thing most HNW investors inherently understand: there’s almost always opportunity for solid gains somewhere in the market. But most of the time, those opportunities have been overlooked by the broader investment population and are considered “unpopular”. There comes a time when it’s prudent to take money out of winning positions and start searching for those overlooked opportunities. In actual fact, this constant process of reassessment and rebalancing – knowing when to exit positions and go searching somewhere else -- is an important part of their longer term success.
Now, I want to be very clear here: an asset class return chart isn’t a crystal ball. It’s not going to automatically predict which assets will be winners in the next year. Just because an asset class is down one year doesn’t automatically mean it will be up the next.
Nevertheless, they are a darn good place to start looking for where “hot money” is going, and perhaps most importantly, where it’s not going. And as many HNW individuals have discovered, that can lead to some very interesting investment ideas and opportunities ... think today of emerging markets equities, emerging market bonds, commodities, and other currently “unloved” asset classes you might not typically consider.
Thane Stenner is founder of Stenner Investment Partners within Richardson GMP Ltd., as well as Portfolio Manager and Director, Wealth Management. Thane is also Managing Director for TIGER 21 Canada. He is the bestselling author of ´True Wealth: an expert guide for high-net-worth individuals (and their advisors)’. (www.stennerinvestmentpartners.com) The opinions expressed in this article are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Richardson GMP Ltd. or its affiliates. Richardson GMP Limited, Member Canadian Investor Protection Fund.
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