Surviving the pandemic: Investing lessons from the past
The Covid-19 pandemic and economic uncertainty, combined with geopolitical tensions, are battering investment markets. While investors are rightfully concerned, practising long-term investing discipline is paramount. Looking back in time can help provide perspective. Minimising the panic among members is a crucial role for retirement-fund trustee boards and management committees right now. A great way to do this is to look at funds that have been active for many years. Unlike theoretical benchmarks, actual funds present a much more accurate picture of investing reality. The South African collective investment scheme (unit trust) industry goes back to 1965, but much of that early history has been lost due to fund closures and mergers. If we turn to the United States, we get a much longer history, as some of the first mutual funds, as they are known there, are still active. The first mutual fund, the Massachusetts Investors Trust (MIT)*, was formed in 1924. It is an equity fund managed by MFS Investment Management. The first balanced fund, currently known as the Vanguard Wellington Fund*, was formed in 1929, just before the Great Depression, and is also still active. From an analysis of these two funds we can glean valuable investing lessons for today’s unsettled markets.
Lesson 1: Long-term wealth is typically created in stages
Long-term investment growth graphs tend to show upwardly sloping lines that highlight the historical upward movement of equity markets. While the general upward trend is valid, there is another message embedded in these graphs, particularly when shown on a log scale. Long-term wealth creation is not a continual, straight, upward line. This profile is well-portrayed by the MIT fund. The graphs show that the impressive long-term result has been interrupted by periods of sideways movement that show a stepwise growth profile. A buy-and-hold investor in this actively managed fund would have experienced three prolonged periods of little or no real growth. However, between these phases, there are periods of rapid appreciation. The real return for MIT Trust since inception is an impressive 6.1% per annum net of costs, proving that equity-related market wealth is not created in a constant upwardly moving line, but is rather a mix of strong growth periods interspersed with long periods of sideways movement.
Lesson 2: Portfolio diversification softens the impact of weak markets
If we rank the MIT annual calendar returns from highest to lowest, we see one of the biggest behavioural obstacles to equity wealth creation: the tail of negative returns, which can cause investors to abandon their long-term investment plans, often at the most inopportune times.
The smoother return pattern shown by diversified balanced funds can go a long way to keep long-term investors invested. We know that ‘time in the markets’ is generally better than ‘timing the markets’, but the former requires the ability to tolerate and survive the occasional negative returns. Such turbulent periods can unnerve even the most steadfast investor and cause mistakes such as performance chasing and market timing.
‘The valuable perspective provided by funds that have stood the test of time show that long-term investing programmes do not have to be derailed by a single market event.’
Diversifying balanced funds can smooth the long-term investment journey. If we overlay the annual returns of the diversified Vanguard Wellington Fund over the equity-based MIT fund, we see that the incidence of negative returns is lower, and the average negative return for the Vanguard Wellington Fund is a full 3.6% per annum better.
So one can see that the diversification benefit of the Vanguard Wellington Fund leads to a flatter line of returns. While it does not achieve the occasional sparkling returns of MIT, it posts fewer and less pronounced negative returns. The argument is that balanced funds, with their ability to dampen losses, can help to keep investors invested when times are tough. Partially protecting members from the occasional heavy negative returns while sacrificing some of the upside is the purpose of regulatory investment guidelines and limits, such as the enforced diversification contained in Regulation 28 of the Pension Funds Act.
Lesson 3: Stay the course
Over their histories, both funds highlight the long-term benefits of staying the course, and have posted very strong real returns. Staying invested today is arguably more difficult than at any stage in history. The rise of social media platforms has turned normal market news into a media frenzy that can challenge the resolve of even the most committed investor. This only amplifies a crisis like the Covid-19 pandemic. (Watch 6 tips for long-term investors.) The graph below shows that MIT – which is, as mentioned, an all-equity fund – has outperformed the diversified Vanguard Wellington Fund by almost 1% per annum. This results in massive terminal wealth differentials between the two funds. However, this differential will only be banked if an investor does not withdraw from the market and the fund in this period. Hence, the 5.2% real return for the diversified fund is a reasonable trade-off if it comes with less downside performance stress. The historical volatility of MIT’s annual returns works out at 17.8%, whereas the corresponding figure for Wellington is significantly lower at 13.3%. (This is not apparent from the graph due to the very long period.)
Most retirement fund members will have experienced a sharp decline in their retirement account values over the last few months. It is unnerving to experience such a sharp decline. (Read more on how Covid-19 has affected your pension fund.) However, the valuable long-term perspective provided by funds that have stood the test of time, such as MIT and Vanguard Wellington, show that long-term investing programmes do not have to be derailed by a single market event. The stepwise nature of wealth accumulation should be acknowledged, and investors can take consolation from the fact that the enforced diversification of Regulation 28 has helped soften the blow.
*Massachusetts Investors Trust and Vanguard Wellington Fund summaries
Massachusetts Investors Trust Inception date: 15 July 1924 Focuses on large-cap, high-quality companies with sustainable and durable business models, solid balance sheets and strong management teams. Aims for above-average and sustainable growth potential, trading at reasonable valuations. Top five holdings at 31 March 2020: Alphabet Inc. Microsoft Corp Johnson & Johnson Medtronic Plc Visa Inc. Manager: MFS Investment Management MFS Investment Management is an American-based global investment manager, formerly known as Massachusetts Financial Services. Founded in 1924, MFS is one of the oldest asset-management companies in the world and has been credited with pioneering the mutual fund. *Vanguard Wellington Fund Inception date: 1 July 1929 Vanguard Wellington Fund uses a conservative approach and emphasises broad diversification to moderate risk in pursuit of three objectives: long-term capital appreciation, reasonable current income, and capital conservation. The stock/bond mix has provided an all-weather portfolio with competitive returns in various market cycles. Equity component: fundamental research identifies high-quality large- and mid-capitalisation companies in out-of-favour industries. These stocks typically offer above-average dividend yields, low valuation multiples, and improving fundamentals. The fund invests 60% to 70% of its assets in dividend-paying, and, to a lesser extent, non-dividend-paying common stocks of established medium-size and large companies. In choosing these companies, the advisor seeks those that appear to be undervalued but to have prospects for improvement. These stocks are commonly referred to as value stocks. The remaining 30% to 40% of fund assets are invested mainly in investment-grade corporate bonds, with some exposure to U.S. Treasury and government agency bonds, as well as mortgage-backed securities. Manager: Wellington Management Company LLP Founded in 1928, Wellington Management Company LLP, Boston, Massachusetts, is among the nation’s oldest and most respected institutional investment managers. The firm has advised Vanguard Wellington Fund since 1929.