A constant challenge (folly) investors face is that of predicting the following year’s returns. Too often, investors obsess with trying to predict next year’s winner – even as the evidence shows that making short-term predictions is impossible.
This graphic shows the calendar year returns of different asset classes. It highlights the challenge of trying to predict the asset class that will perform well in the coming 12 months.
Although interesting, a chart like this doesn’t help bring you a solution. That’s why the traditional advice for short-term investment goals is to invest in cash. While cash may not produce the highest return (it’s the only asset class never to rank 1st over this period), it does produce returns with the highest level of certainty.
We believe the best way to harness asset class returns and to ensure you hold next year’s winner is to diversify. To quote an interview with Charles Ellis, “Diversification says, I don’t know everything”. Given that we can’t know everything, we believe you should diversify your clients’ portfolios. But diversifying to reach client goals doesn’t mean naively combining asset classes. As we’re about to show, as unpredictable as near-term asset class returns are, they start to become more predictable in the long term. To illustrate this, we split all asset classes into two broad categories and repeated the above exercise over different time horizons:
Growth Assets (Local and Global Equity and Property) and
- Long-term capital growth and inflation protection
Defensive Assets (Local and Global Cash and Bonds)
- Short/medium-term capital protection and income generation.
Notice in the below charts that the unpredictable pattern over one year starts to become more predictable in the medium to long term, as the fundamentals of asset class characteristics come to the fore.
When we combine assets in our multi-asset funds, we do so strategically. We use the evidence of asset class returns and align with long term client goals, instead of tactically trying to exploit near term predictions. It is amazing to see how the noise and challenges of short-term predictions tends to fade when we focus on the client’s goals. By minimising the moving parts and focusing on client objectives, we can more reliably achieve them.
Chris Rule, Coreshares.