Phase in, or take the plunge?

Ner­vous in­vestors may be con­sid­er­ing phas­ing in their in­vest­ments, but does this make rands and sense? Maya Fisher-French finds out

CityPress - - Business -

At the time of writ­ing this col­umn, the mar­ket is down about 15% from its high in April 2015, the rand is 35% weaker against the dol­lar com­pared with a year ago and con­tin­ues to slide, and the MSCI World In­dex is down more than 10% from its high in dol­lar terms. Fi­nan­cial ad­vis­ers and their clients are un­der­stand­ably feel­ing ner­vous about what the rest of the year will bring, and whether now is re­ally the time to in­vest a lump sum. Gen­er­ally, the ad­vice has been, for a while now, to rather phase in your money over a six- to 12-month pe­riod in­stead of in­vest­ing a lump sum.

This may sound like a sen­si­ble so­lu­tion, but re­search by Wade Witbooi, retail in­vest­ment an­a­lyst at San­lam In­vest­ments, found that phas­ing in was gen­er­ally not a good in­vest­ment strat­egy.

His re­search cov­ered the pe­riod from July 2000 to July 2015, where for each month he as­sumed an in­vestor made the de­ci­sion to phase in ei­ther over six or 12 months and then com­pared that with how the mar­ket had per­formed dur­ing that phase-in pe­riod.

For high-equity funds, where the fund in­vested pri­mar­ily in eq­ui­ties (shares), he found that 83% of the time, a lump sum in­vest­ment would have out­per­formed the phase-in ap­proach over six months and over 12 months.

Re­mem­ber, this pe­riod fell over the huge mar­ket crash of 2008/09, which ac­counted for the pe­ri­ods where the phase-in strat­egy was very ben­e­fi­cial. Ac­cord­ing to Witbooi, it is only in ex­treme mar­ket crashes that the phase-in ap­proach ac­tu­ally works.

The prob­lem is, we don’t know when we are fac­ing a rel­a­tively small cor­rec­tion or a his­toric crash.

While sta­tis­ti­cally you should just ig­nore phas­ing in as a strat­egy, An­drew Bradley, CEO of Old Mu­tual Wealth, ar­gues that when it comes to man­ag­ing in­vestor emo­tions, phas­ing in can be the bet­ter in­vest­ment strat­egy.

“For an ad­viser, the big­gest risk of a mar­ket cor­rec­tion is client man­age­ment and ex­pec­ta­tions, and the first an­nual re­view of a client’s in­vest­ment port­fo­lio is the most cru­cial,” says Bradley, who ex­plains that if af­ter a year or even six months a client sees that their in­vest­ment has fallen or that they would have been bet­ter off in a cash in­vest­ment, they will of­ten panic and de­cide to sell at the worst pos­si­ble time, com­pound­ing their losses. Even if an ad­viser has fully ex­plained mar­ket volatil­ity, the per­cep­tion of loss creates huge anx­i­ety for in­vestors.

As Witbooi ex­plains, hu­mans suf­fer more from the pain of loss than the rel­a­tive joy from a gain.

“Be­havioural econ­o­mist Daniel Kah­ne­man ob­served that hu­mans typ­i­cally ex­pe­ri­ence the pain of loss with dou­ble the in­ten­sity than they ex­pe­ri­ence the plea­sure from an equiv­a­lent gain. This fear of loss is in­nate to all hu­mans and could lead to ir­ra­tional in­vestor be­hav­iour,” ex­plains Witbooi.

For this rea­son, Bradley rec­om­mends that if an in­vestor is con­cerned about short-term mar­ket volatil­ity, a phase-in ap­proach is more sen­si­ble.

“A three- to six-month phase-in pe­riod would be an as­tute ap­proach. The more volatile the mar­kets, the longer the phase-in pe­riod, as noth­ing stops you from in­vest­ing the re­main­der of the funds once the mar­ket sta­bilises. I wouldn’t, how­ever, ad­vise a pe­riod longer than a year,” says Bradley.

How­ever, given the cur­rent mar­ket lev­els, Witbooi makes the valid point that from an in­vestor’s point of view, the fact that the mar­ket is al­ready down by 15% has re­duced the risk of in­vest­ing and the need to phase in. In fact, a phase-in strat­egy would have bet­ter suited the past six months more than the next month’s, so if you still want to fol­low a phase-in ap­proach, a shorter pe­riod may make more sense at this stage.

An al­ter­na­tive is to in­vest your lump sum in a mul­tias­set class fund that can in­vest across seven dif­fer­ent as­set classes, in­clud­ing bonds, cash, off­shore and de­riv­a­tives. This re­duces your ex­po­sure to a sin­gle as­set class. For ex­am­ple, all bal­anced funds and flex­i­ble funds fall into this cat­e­gory.

“An­other tool to de­crease an in­vestor’s ex­po­sure to fall­ing mar­kets is the use of de­riv­a­tives to hedge out at least some of the mar­ket risk. Funds that use this tech­nique are nor­mally a sub­set of the mul­tias­set fund cat­e­gory. In ad­di­tion to mak­ing as­set al­lo­ca­tion calls, they there­fore also buy ‘in­sur­ance’ [through de­riv­a­tives] against fall­ing mar­kets to pro­tect in­vestors’ money, while at the same time ex­pos­ing it to growth op­por­tu­ni­ties,” ex­plains Witbooi.

The thing one needs to keep in mind with mul­tias­set classes is whether or not they meet your per­sonal long-term in­vest­ment ob­jec­tives. Some­one with a 15- to 20-year in­vest­ment hori­zon may want to be fully ex­posed to eq­ui­ties, so a mul­tias­set fund may not meet those needs and a phasin­gin strat­egy (to calm the nerves) into a high-equity fund may be a bet­ter al­ter­na­tive.

If, how­ever, you are the sort of per­son who, even with a long-term in­vest­ment hori­zon, would be tempted to cash in with ev­ery mar­ket move­ment, per­haps a lower-risk, mul­tias­set fund could be the right so­lu­tion for you be­cause, al­though your long-term re­turns may be lower, try­ing to time the mar­ket is the fastest way to lose money.

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