Lest We Forget

By Mark Barnicutt on February 17, 2011

“We learn from history that we learn nothing from history.”  George Bernard Shaw

With equity markets, especially in Canada, getting close to previous bull market highs, investor behaviours appear to be changing.  Specifically, it appears that that some investors have completely forgotten about the Global Financial Crisis of 2008/2009 and the devastation that occured to their wealth due to aggressive allocations to “risky” asset classes and investment strategies.

It’s often been said that global capital markets operate in two modes: Fear & Greed.  If 2008/2009 were “Fear” periods, it appears that we’ve now entered the “Greed” period.  In other words, in 2008/2009 investors were focused on “risk” but now, in 2011, investors are now refocused on “returns”.

Because of this, I believe that a lot of short-sighted portfolio allocation decisions are being made that will come back to haunt investors in the coming years. Specifically, some investors are making huge allocation changes (also known as “bets”) by shifting completely away from lower risk assets (which act as stabilizers in portfolios) into higher risk assets and completely stepping beyond their tolerance for downside risk that had clearly been defined during 2008/2009.  Although the short-term emotional logic is understandable — ie: interest rates are rising and equity markets are “on a roll” — the following thoughts by Charles Ellis, author of ‘Investment Policy: How To Win The Loser’s Game’, are especially relevant at this time in the capital markets cycle:

 “The crucial question is not simply whether long-term returns on common stock would exceed returns on bonds or bills IF the investor held on through the many startling gyrations of the market.The crucial question is whether the investor will, in fact, hold on. The problem is not in the market, but in ourselves, our perceptions, and our reactions to our perceptions.This is why it is so important for each client to develop a realistic knowledge of his/her own tolerance for market fluctuations and his/her long-term investment objectives, and to develop a realistic understanding of investing and of capital markets.

The more you know about yourself as an investor and the more you understand investment mangement and the securities markets, the more you will know what asset mix is really right for your portfolios, and the more likely you will be able to sustain your commitment for the long-term.

In investment management, the real opportunity to achieve superior results is not in scrambling to outperform the market, but in establishing and adhering to appropriate investment policies over the long-term — policies that position the portfolio to benefit from riding with the main long-term forces in the market.”

Charles Ellis, Investment Policy: How To Win The Loser’s Game

This is not to say that we do not believe in portfolio allocations to risky assets — like most things in life, it’s a question of balance.  The challenge for all investors, and investment advisors, is to find the appropriate asset allocation mix between lower risk and higher risk assets that meets an investor’s investment objectives and true risk tolerance so that they remain committed, through the ups-and-downs of the global capital markets, to their investment plans.

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