Sober investing tips: how to handle volatility

InvestNow members are generally glass half-full types.

Looking back at the last quarter of 2018, over 90 per cent of investors didn’t spill a drop as share markets served up another round of volatility; about a third of InvestNow members even took the opportunity to top up their portfolios as equities staggered downwards.

But if October left investors stirred, not shaken, the final two months of 2018 threatened to tip them off-balance. The last month of the year, in particular, saw some markets stumble to decades-long lows.

US equities, for example, recorded the worst December result (down about 9 per cent) since the Great Depression. As markets ducked and weaved during December, though, InvestNow members in aggregate held steady.

Mike Heath, InvestNow general manager, says an analysis of the platform’s December 2018 trading data shows members were net buyers of funds during the month.

“Despite US and other share markets – including New Zealand – experiencing their worst volatility since the global financial crisis (GFC) over December, InvestNow members collectively kept investing,” Heath says. “The data suggests InvestNow members are using the platform to create long-term portfolios rather than dabble in short-term trades.”

The December data, however, does reveal the strong market volatility produced some knock-on trading effects in InvestNow – with a few interesting behavioural differences emerging between active and passive fund investors.

Heath says InvestNow saw investor trading volumes for actively managed funds fluctuate higher than normal across both buying and selling through December.

“But buy orders for passive funds stayed largely on trend during December while sell orders for index funds moved around over the month in line with active funds – in fact, passive fund sales were higher than active for the latter part of the month,” he says. “The observation ties in with behavioural economic research that shows investors tend to be more loss-averse than risk-taking – especially when real market volatility hits.”

Nobel Prize-winning psychologist Daniel Kahneman, quantified loss-aversion in a famous 1979 research paper that found the prospective pain of losing is about double the joy of winning.

Kahneman’s results – and the InvestNow customer data – suggest even hard-core passive funds investors will struggle to beat those in-built human behavioural odds when markets plunge.

While the data indicates some differentiation between passive and active fund investors, in reality many of the 10,000 plus InvestNow members allocate to both styles depending on the asset class.

Heath said “back in late 2017 we asked our customers how they would respond to a period of material market volatility in the future. About 70 per cent of investors said they intended to stick with their long-term strategies regardless of market noise; of the remainder only 5 per cent planned to sell-down shares for less-risky funds if volatility persisted while the rest said they would review their approach over the next six months

If last year was a reminder that markets can go down as well as up (and rapidly), the period was also a lesson in the importance of diversification for those who prefer a smoother ride”, Heath says.

Performance data for the almost 100 funds currently listed on InvestNow clearly shows how asset class returns shift over time.

Although InvestNow has been in business for just two years, the performance figures for the majority of the funds on the platform go back at least five years.

Most funds on the InvestNow were in the red for the month of December while about half recorded positive returns in 2018. Just about all products listed on InvestNow, though, were up over multi-year timescales.

The winning asset class over the two-, three-, five- and 10-year periods ending December 31 last year proved to be Australasian equities.

During 2018, though, more defensive asset classes came to the fore as share markets fumbled. For example, listed property and NZ fixed interest funds feature heavily among the top 10 InvestNow performers for the 2018 calendar year; conversely, global and Australasian share funds cluster down the bottom of the table.

The defensive bent is further evident over the last quarter of 2018 where fixed income funds – local and global – fill all top 10 spots on the performance charts. In December the situation is more nuanced as a specialist Indian shares fund – offered by India Avenue – shares the winners circle with listed property and fixed income products.

“It’s clear that asset class performance has varied over different time periods,” Heath says. “It’s likely we will see further rotation between asset class performance as market volatility rolls on.

But trying to pick next month’s winner based on last month’s data is almost certainly a long-term losing investment strategy. Heath highlights that investors who stuck with global and Australasian shares have benefited by the rebound in these sectors during January and February, which are up by over
over 5% and 8% respectively.

“InvestNow members seem to understand that risk pretty well – our research shows most of them are creating diversified portfolios mixed with growth and defensive assets to personal taste.”

He says increasing volatility could tempt investors to chase returns or run to cash.

“Both those strategies if carried to the extreme usually leave investors with just one outcome; a quickly-emptied glass,” Heath says.