Simonelle is on leave and Mark LaMonica is filling in with the editor’s note this week.
He wears a mask and his face grows to fit it
There are few better lines in literature.
And while there are several ways to interpret Orwell’s poignant observation in his essay Shooting an Elephant, its meaning to me is clear. The constructs that guide the roles we play in life eventually become who we are.
I was thinking about this line when I was reading an interview with a portfolio manager for a dividend fund in the US. The second largest position in the dividend fund she manages is Amazon – a share that has never paid a dividend.
The rationale for this seeming deviation from common sense is illustrative of a type of thinking that bedevils professional and individual investors.
As the portfolio manager explained, her dividend fund is benchmarked against the Russell 1000 Value Index. The index currently has a 20% weighting to technology shares.
The technology allocation has doubled in the last year as more tech shares have joined the index – shares like Amazon.
In an investment world where performance against an index is paramount this means that even a dividend fund manager believes she needs to hold non-dividend paying shares to keep up with the benchmark.
Does it matter that nobody invests in a dividend fund to own non-dividend paying shares?
Apparently not.
Does the benchmark return align with the goals of any of the investors in the fund?
Unlikely.
The constructs that guide the thinking in the investment world can bear little resemblance to the whole point of investing in the first place.
The problem…is us
Before mocking the structurally influenced decision-making of professional investors it is worth examining why they behave this way.
French philosopher Joseph de Maistre wrote that every nation gets the government it deserves. And we are getting the professional investors we deserve.
Fund managers are fixated on keeping up with indexes because individual investors chase short-term performance and punish any shortfall.
The downside of underperforming in the short-term is much greater than the upside from outperforming over the long-term.
This perverse incentive structure is our fault.
We can’t seem to help ourselves. We don’t bother to define our goals but somehow think we will reach them. We quote Buffett while attempting to day trade our way to riches.
The personal investment decisions each of us make can do little to change the overall industry – but we can improve our own outcomes. A reminder of three ways investors often self-sabotage.
Defining success by someone else’s terms
Orwell was a minor colonial official in Burma. And what set Orwell apart from many of the other cogs in the imperialistic system was his self-awareness.
Orwell could see the downside to colonialism extended far beyond the people being colonised. He could see the ‘success’ of the system was backfiring against those imposing it.
As Orwell put it, when the white man turns tyrant, it is his own freedom he destroys.
Throughout life the way success is defined matters. And professionals aren’t the only investors fixated on indexes.
Just like the dividend fund the indexes many individuals use to measure success often have little relation to what we want out of life.
There are several ways comparing returns to an index can push investors in the wrong direction.
It could be comparing a diversified portfolio to a narrow index. The comparisons might be over short – and therefore meaningless - time periods. Survivorship or hindsight bias may distort the relevance of these so-called benchmarks.
Despite the constant feedback loop of prices and the numerous ways to judge performance, investing isn’t a competition. The purpose of investing is to help you get what you want out of life.
For some investors that may be the peace of mind that comes from holding more cash than advisable for a portfolio optimised for the highest possible returns.
For some it is generating steady and stable income by holding shares that pay dividends even if they fall behind in a bull market.
For others it is accepting the simple truth that the more money you have in relation to your needs the less risk you need to take.
None of this is easy. I’ve struggled to separate avarice from ambition and to stop viewing any departure from wealth maximisation as a character flaw.
Yet as I’ve grown older I’ve come to accept the only way to get satisfaction out of life is to define success in your own way. Don’t forget that investing is simply a means to an end.
Your portfolio and your life are linked
A crazed elephant showed up in the Burmese village Orwell oversaw.
Orwell was a sub-divisional police officer. It was his job to investigate but what seemed clear at the outset became muddled as he got closer.
A story always sounds clear enough at a distance, but the nearer you get to the scene of events the vaguer it becomes.
Most professional investors know little about the end investors. This asymmetrical relationship enables risk to be defined in peculiar ways. It enables a detached view of investing – afterall, it isn’t their money.
A dizzying array of metrics are bandied about – the Sharpe Ratio, standard deviation, beta, the Sortino Ratio. Portfolios are minutely adjusted to stay perched on the precipice of the mythical efficient frontier.
These risk measures have a role to play but they are often disconnected from how most individuals experience risk in their lives. The risk we face is measured in trips not taken, loved ones not helped, anxiety not relieved - our risk is missing out on our hopes and dreams for the future.
Trying to live up to a false narrative of sophistication
When it was clear the elephant was a danger Orwell knew he had to do what was expected of him by the villagers.
As he wrote, to be a sahib, you have to act like a sahib. Orwell didn’t want to shoot the elephant. But he knew the role he was playing in the farcical colonial system .
Many individual investors follow a false narrative of what it means to be a successful investor.
Investors are conditioned to believe each market environment can be exploited. There is a natural inclination to follow sophisticated sounding professionals.
Combine this with our natural action bias and you have a formula for overtrading and poor outcomes.
Some do this out of ignorance. But many people know that most professional investors underperform – yet still copy their approach.
There are no extra points for having the most complex portfolio. To sound sophisticated requires constantly having an opinion on the best course of action.
But building long-term wealth often means doing nothing.
I don’t rotate my portfolio. I don’t look for catalysts. I’m not making tactical asset allocation decisions. At best I rebalance when things get extreme while trying to keep my investment strategy as simple as possible.
Maybe I’m not the most sophisticated investor. I’ve made peace with that but I do have occasional moments of self-doubt and question my choices. Should I make more of a concerted effort to capitalise on every potential opportunity? Should I take on more risk?
These thoughts are generally fleeting and I go back and focus on the little things like growing my passive income, minimising taxes and fees, and saving money. That is what ultimately pays off.
Final thoughts
The constraints on individual investors are self-applied. The benchmarks are artificial. Many individual investors end up wearing a mask that isn’t meant for them.
Our biggest advantage is we don’t face the same challenges as professional investors.
We have no fickle investors to worry about.
We don’t have to explain each of our positions to our boss during an annual review.
We have no incentives to index hug, participate in group think or focus on the short-term.
Everyone internalises incentives and norms. Gradually they shape our behaviour and identity. For many professional investors the influence is structural and difficult to resist. Individuals have far greater freedom which we often surrender willingly.
Think clearly about what is important to you and the best way to get it.
Mark LaMonica
***
Weekend market update
From Shane Oliver, AMP
Share markets were mixed over the last week helped by some pull back in oil prices as the US held back from escalting further with Iran, a rebound in tech stocks and specifically chipmakers from oversold levels and the US Fed leaving rates on hold. However, it was a bit messy with only modest gains in US shares despite strong earnings results, a reasonable gain in Eurozone shares, but falls in Japanese and Chinese shares. The heavily AI exposed Korean share market rose strongly later in the week along with chipmakers helped by optimism that the unwinding of leveraged AI trades (including by a hedge fund called Situational Awareness) may be over or nearing an end. It’s the nature of bull markets to see relatively steady gains but then occasional sharp sell offs as investors who are predominantly long unwind their often leveraged positions. Of course the rebound in chip makers and Korean shares could just be a bear market rally so its best approached with some caution. Despite the global volatility Australian shares rose around 2.5% for the week helped by lower than expected inflation adding to expectations that the RBA will leave rates on hold at its August meeting. Gains were led by IT, health, telco, retail and property shares.
Bond yields mostly fell slightly but remain in a rising trend. Copper and gold prices rose slightly but iron ore prices fell slightly. Bitcoin was little changed although it remains shaky and yet to confirm that its latest crypto winter is over. It was helped by a slightly softer $US which also saw the $A rise slightly.
Oil prices intially fell sharply early in the past week following Trump’s latest TACO (with the US holding off on further escalation and Trump talking again about a “good chance” of a peace deal) and easing in hostilities but then reversed some of its falls as hostilities resumed, but it still fell over the week.
The combination of high and rising oil prices, ongoing pressure on central banks to raise rates, a rising trend in bond yields and worries about an AI bubble amidst stretched valuations leaves shares at high risk of another correction as we come into the seasonally weak months of August and September. Of course, just as Australian shares didn’t get much benefit on the way up in the AI boom they may not fall as much if and when it does really start to unwind. That said, we remain a bit sceptical that we are at the peak of the AI story just yet as related capex has a way to go and growth in demand for AI is real.
The latest de-escalation and re-escalation in the Iran War seen in the last week just highlights the mess Trump has got himself into with Iran. While he clearly wants to TACO – with key munitions running low, uncertainty about whether more strikes on Iran are achieving anything along with sensitivity about rising gasoline prices and bond yields - Iran is not so willing to play ball. And so the War continues with more attacks on energy infrastucture and Saudi Arabia joining strikes on Iran, the Strait of Hormuz remaining largely closed and uncertainty about the reliability of Saudi shipping through the Red Sea.
Another peace deal remains our base case with oil perhaps in a $US70-100 range with Iran preventing it going lower and the US moving to try and calm things down whenever it gets above $US100 as happened a week ago. On the latter Trump remains under immense pressure politically as Americans care most about inflation and affordability and not so much the Iran War which is just adding to inflation concerns. However, the risk remains that there will be no sustainable peace deal, the flow of oil out of the Middle East remains down 10-15% on normal levels and that we will have to face ever higher oil prices as reserves run down. This poses ongoing upside risks to inflation and downside risks to economic growth.
In Australia, lower than expected inflation for June provided relief with the RBA likely to hold in August - but it might just be a false dawn. June inflation fell to 3.8%yoy helped by a 10.9% fall in fuel prices and underlying or trimmed mean inflation remaining at 3.6%yoy. June quarter trimmed mean rose to 3.6%yoy too from 3.5%yoy in the March quarter but was materially lower than the RBA’s expectation for a 3.8% rise providing hope that inflation may have peaked.
The combination of lower-than-expected inflation along with weaker than expected jobs and housing markets provide scope for the RBA to remain in wait and see mode and so we now expect the RBA will leave rates on hold at its August meeting. We are not as confident as the money market though which sees a less than 1% chance of a hike – we would put it at 30%! However, the RBA is likely to retain a hawkish bias and we continue to expect one further hike by year end because: trimmed mean inflation at 3.6%yoy is still too high with no clear evidence of a downtrend in monthly data; second round impacts of the oil price rise are still in the pipeline with oil and petrol prices up again; housing related costs are still trending up; there are still more items with inflation greater than 3% than less than 2%; and the RBA needs to be more cautious than it was in the last rate cycle because after five years out of six with inflation above target there is now a greater risk of the inflation target losing credibility.
On the cost front – petrol prices in Australia look headed to around $2.10 a litre if the Government follows through with its plan to end fuel tax relief on 2nd August. They have already rebounded to $1.95 a litre from the 30 June low of around $1.53 a litre reflecting the 16 cents a litre from the halving of the 32 cents a litre fuel tax cut from 1 July and the flow through of the rebound in global oil prices. If fuel tax relief ends as scheduled, then petrol prices will rise around another 17 cents a litre (which is the remaining 16 cents a litre along with a 1 cent CPI adjustment). This will push up headline inflation again as well as the cost of the average households’ weekly fuel bill by around $20, although its still well below the levels reached in March.
Housing credit growth for June was little changed. It has slowed from its highs, but a further slowing is likely as past rate hikes hit and the Budget tax changes push many investors to the sideline, but its early days yet. Reports from NAB of a 15% fall in home loan applications points to a further slowing ahead as it will take a while to show up in actual housing credit data. Business credit growth remains solid picking up to 10.8%yoy with total credit growth rising to 8.5%yoy. No evidence of a collapse in the economy here - well not yet anyway!
Home price falls accelerated in July. Cotality’s monthly home price data for July won’t be released till Monday, but its daily indexes through to the end of July show a further acceleration in the pace of decline to 0.9%mom for the five big capital cities. This was led by Sydney (-1.4%mom) and Melbourne (-1.2%), Brisbane (-0.6%) and Adelaide (-0.2%) are now going negative with Perth (+0.1%) looking like it is too. The combination of higher mortgage rates, tax hikes on investors, poor confidence and poor affordability are the main drivers. The likely move by the RBA to leave rates on hold at its August meeting will come as a relief but it’s not likely to be enough to arrest the fall in prices just yet as the RBA is likely to retain a tightening bias and we think that it will hike again in November. Overall, we expect a top to bottom fall of 7% in national average home prices, of which they have currently fallen about 2%. Rate cuts next year should start to support property prices, but not till the June quarter next year.
One source of support preventing a deeper slump in property prices is the housing shortfall and this is unlikely to change anytime soon despite a rising trend in home building approvals. Approvals bounced 7%mom in June thanks to volatile unit approvals rising 18%mom. The good news is that the trend is up and is now running at 220,000 annualised which is getting closer to the Housing Accord target to build 240,000 homes a year which is necessary to eat into the shortfall. The trouble is that rate hikes, rising costs and project abandonments will likely see it rollover soon and completions continue to run at much lower levels such that the housing shortage will linger longer.
Also in this week's edition...
UniSuper CIO John Pearce shares his perspective on FY26 and what is ahead for investors.
Many investors are still suffering from the post budget blues. Joshua Derrington argues that the response from many wealthy people isn't the right one.
Value investing has fallen out of favour but Anton Tagliaferro and Simon Conn argue that the current market is ripe with opportunities.
Most of us are aware global diversification is needed given the concentration in our local market. Jarrad Stuart opines on the right way to do it
Saokai Fan outlines how macro forces are shaping the market for gold.
We could all use some positivity and Anthony Doyle outlines why you shouldn't count Australia out.
Curated by Simonelle Mody and Leisa Bell
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