Go for consistency of returns, not spectacular returns

Colin Moore (Global Chief Investment Officer – Columbia Threadneedle Investments) discusses where he sees investment opportunities and risks in today’s markets, and why he thinks investors value a consistent approach to investing now more than ever.

Q: What is your outlook for financial markets?
Colin Moore: There are two big concerns regarding the general outlook for financial markets. One is the high valuation of equities, and the other is the direction of interest rates.
Following the US presidential election, there was a rally in US equities based on the assumption that the new administration’s policies would stimulate growth quickly.
Now the markets are not quite sure that those measures will get passed and are probably even more doubtful that they will get passed quickly. In fixed income, the uncertainty stems from the possibility that interest rates won’t necessarily rise as quickly as expected if the administration’s proposed growth policies are not implemented. But underlying those questions, we do have good growth trends both in the US and around the globe.

Q: With interest rates set to rise, how should investors view fixed income?
Colin Moore: There isn’t really a lot of controversy that rates will rise because they’re at such extraordinarily low levels, historically. The real issue is how fast they will rise. If you believe that rates are going to rise quite quickly, it’s pretty hard to make a positive story about some of the traditional fixed income strategies because they’re so dependent on interest rates as the foundation of returns. So people then turn to more flexible fixed income strategies that have greater independence from interest rate movements.
For those that believe rates are going to rise more slowly, there are other ways to generate yield through what’s called credit spreads. The difference in what you pay for a corporate bond over what you pay for a US Treasury is known as the credit spread, and when that’s attractive, it can help offset the effect of slowly rising interest rates.

Q: With this extended period of historically low interest rates, are investors taking unintended risk to generate income?
Colin Moore: Yes. Chasing income has become one of the market’s great themes and has certainly alarmed me for a few years. The premium that people are prepared to pay for a higher current yield, or current income, is a little alarming in both equities and fixed income. The relationship between a higher level of risk and a higher return seems intuitive. Yet that reasoning doesn’t seem as intuitive when it comes to income; people don’t seem to consider that if they’re getting a higher current income, it’s because they’re taking a higher level of risk.
The feedback that we get from advisors and investors is that consistency of income is really the big driver of long-term satisfaction, not the level of current income. Getting a nice high yield today that’s going to be under threat tomorrow is not such a good thing. Being able to get a decent yield today that is sustainable through a number of changing circumstances and markets is far more important.

Q: What trends do you see in global investing?
Colin Moore: When we talk about global investing, we think in terms of the US, Europe, Japan or emerging markets, etc. But I believe those traditional geographically defined ways of investing are going to become increasingly obsolete. We have to think more in terms of horizontal themes rather than vertical time zones, and develop more global sustainable longer-term growth opportunities within that framework, rather than one bound by the traditional geopolitical constraints.
Infrastructure is a good example. It is a global theme, but if you look at most of the infrastructure investment vehicles available to retail investors, the vast majority are structured around geographical constraints; a UK equity fund, or a US equity fund, or a Japanese equity fund, or a similar fixed income equivalent. Investment products that are defined by a horizontal theme are still a very narrow field, but one which I think will start to grow quite rapidly.

Q: What makes infrastructure a sustainable longer-term opportunity?
Colin Moore: It’s interesting how much is written about the US or European economy and debating whether it’ll grow at 2.4% or 2.5%. These are relatively small differences, yet we have a clear opportunity for infrastructure standing to grow at least 6% per annum for a decade or more. There is really no country that I can think of that does not need to do some work on their infrastructure.
It’s also important to note that the nature of infrastructure is changing, offering more diverse opportunities for investors. Wireless and internet infrastructure links people together just as much as physical links like roads and bridges. Here’s one example: on a recent trip to the Philippines, I saw how their approach to getting people connected to the financial services system is not to build thousands of new bank branches, but to create virtual banks through wireless networks.

Q: Why do you think the consistency of income or returns drives long-term satisfaction?
Colin Moore: The evidence is that investors chase the previous year’s most spectacular returns, and yet our research proves that to be a very poor strategy. The financial industry often uses the disclaimer that past performance does not guarantee future results. It’s actually very true, yet people don’t seem to pay any attention to it.
Whether you’re trying to save money to help your children go to college or for your own retirement, it is the consistency of the return that is most important. It is far better to get 6% consistently than positive 10% one year, minus 2% the next year, and then positive 4% after that. Just arithmetically, the compounding effect of a more consistent return is advantageous.
But perhaps more importantly, there is also a behavioural advantage. People who chase higher returns are usually also the first to sell when that investment goes through a bad patch.

Q: Is there a quantifiable benefit to achieving consistent investment outcomes?
Colin Moore: There’s a lot of controversy at the moment about the fees paid on active versus passive strategies. Our research suggests the difference between active or passive may cost clients somewhere in the range of 60 to 80 basis points per year, whereas this behavioural trait of selling low and buying high is actually costing people up to 200 basis points per year. So if we can combat that behavioural tendency by offering strategies that have a more consistent return, investors will be less apt to panic during periods of volatility and this can have a big effect on their long-term results. Go for consistency, not for shortterm spectacular returns.

Q: Does the high frequency of elections and geopolitical events make it more difficult to achieve consistency?
Colin Moore: The asset management industry as a whole is too eager to blame external factors, whether it’s Brexit’s fault, or the US election’s fault, etc. Our knowledge of geopolitics is important because ultimately it helps inform our investment decisions as we pursue more consistent returns. It might appear to be a separate skill set from investing, but you need to understand what the range of outcomes may be.
So, for example, what will happen in the next big election? If you want to speculate that the underdog will win, you may generate a lot of excess return if you make that bet, but you’re putting a lot of capital on something that has a low probability and that’s usually not a good trade-off. What we’re trying to do is provide the highest probability of a reasonable return over time. So that when an investor is aiming toward that goal of retirement, or children’s education, or whatever, they’ll have the highest probability of success.