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The importance of persistence

2 weeks ago

There is a saying that goes “history doesn’t repeat but it does rhyme”, the origin of which is uncertain, and like most phrases of unknown source, it is usually attributed to Mark Twain. In times of stress, you often see and hear the phrase used when commentators compare the contemporaneous events to some historical analogue. It’s heard most commonly in politics, where leaders use historical analogies to perform information-processing tasks essential to political decision making. Essentially it is the inference that two or more events separated in time and space share one characteristic. Useful though this might be, it is very limited and only for creating rough heuristics. Its use in markets seems even less useful but, nevertheless, comparisons with the past abound.

Whenever one sees an analogy in markets then, it should be taken with a pinch of salt. In truth all periods are unique to the degree that any lessons that can be taken are only very broad and general. That is not to say that we can’t learn from the past when navigating market conditions, merely we should be very careful in not extrapolating too far. It is one thing to say that the present circumstance has similarities with another time, it is quite another to build an investment solution predicated on the subsequent market behaving in the same way. Lessons should be learnt, but if we’re being cynical, when it comes to economics, the only thing really learnt from history is to make a different mistake next time.

A thought experiment is to think about how often historical market conditions are compared with one another post hoc. That is to say, when was the last time someone compared two periods in market history to each other when both events are in the past? For example, in 2008, comparisons with 1929 were ubiquitous and you can see why at the time. Banks were failing, prices were falling (deflation) and asset prices, against which loans were made, were plummeting. But now, 14 years after the great financial crisis reached its nadir, no one compares 2008 with 1929. The reason is simply because any superficial similarities disappear under closer scrutiny and more importantly, the period beyond 1929 looks nothing at all like the period after 2008.

This brings us to the present. In recent months a number of factors have coalesced to bring about a pretty unpleasant experience for investors. In brief, supply chains have been a problem ever since the onset of COVID-19; this problem has been exacerbated by western sanctions on Russia following its invasion of Ukraine. In markets this has caused a nasty situation where stocks and bonds are falling in tandem. As the two pillars of investment portfolios, having both in decline simultaneously leaves few places to hide. When coupled with western inflation rates at levels not seen for more than a generation, investors, even in cautiously managed portfolios, are down substantial amounts in real terms.

Naturally then plenty are looking to the past as a guide to the future. Recently we have seen comparisons with 1972, 1979 and 1994. For 1972 it was because of the spikes in inflation seen in the aftermath of monetary largesse. In 1979, the comparison is the Iranian revolution, which effectively removed one of the largest oil producers from western markets. Whereas 1994 was the last time that bond markets and equity markets fell in tandem in a meaningful way. Which historical analogy one chooses rather depends on one’s knowledge. It doesn’t take a great deal of effort to discount each one as being the ‘right’ analogy; 1972 followed the closing of the gold window (not relevant now); 1979 ushered in the beginning of the Volcker era in the Federal Reserve (also not relevant); and 1994 was caused by the UK central bank tightening into a recession in order to match the Deutschmark, for which the government was battling an inflation spike following German reunification.

As with 2008 and 1929, the similarities are superficial and an important reason why events didn’t unfold as history would have suggested concerns reflexivity. Reflexivity is the idea that the relationship between cause and effect is circular. Anticipation of effect affects cause and cause affects effect. A big part of the reasons that the post-2008 looked nothing like the post-1929 period was because lessons from 1929 had been learned – instead of a prolonged depression we got quantitative easing. Anticipation of a depression meant that central banks were almost singularly focused on avoiding it in the 2008 redux. Once again, the only thing really learnt from history is to make a different mistake next time.

Rather than concerning ourselves with whether the current set-up is closer to 1972, 1979, 1994 or whenever else, much greater value is created in focusing on the long term. Our portfolios are constructed according to long-term assumptions that are created in our annual capital market assumptions process. These assumptions feed into our strategic asset allocation (SAA). The SAA is little altered year-to-year, ensuring a persistence in our portfolio dynamics. Finally, overlaying this is a tactical asset allocation framework (TAA). The purpose of a TAA is to mitigate risk in areas that may become heightened because of short-term factors. But it is subservient to the SAA; a TAA is simply used to tilt portfolios very slightly from the long-term allocation.

Our aim is to provide a series of low-cost investment solutions that are transparent and give investors access to long-term trends. By maintaining a persistently disciplined approach to asset allocation we aim to be able to navigate difficult periods and focus on our goal of generating risk-adjusted returns.

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Jamie Ward

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Head of Investment Solutions

Jamie graduated with a first class degree in Financial Mathematics from the University of Hull. He began his career as a Trainee Fund Manager at Brown Shipley in 2006, before moving to Williams de Broe in 2011. In 2013 he helped set up a hedge fund for Wolos Capital and took responsibility for a global equity book. In 2014 he became a Fund Manager at Oriel Asset Management where he ran their UK fund until 2021.

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