Some investing thoughts as the end of year approaches. Warning: this post is going to be controversial. By all means post your counter thoughts.
From a macro perspective, we are definitely living in “interesting times.” We’ve come from a 30 year period of declining interest rates, which has fueled tech innovation funded by cheap capital. We have just survived a worldwide pandemic which has disrupted supply chains, and there is an energy crunch caused by a war and a perhaps a too slow transition to alternative energy sources to address climate change. The geopolitical axis is shifting, and rising nationalism seeks to redraw political boundaries and trade balances. Social media has changed the way we view the world and our behaviour and beliefs. AI will not only change the dynamics of the workforce but also the dynamics of creativity. The climate is changing, and perhaps we are also changing as a species, mentally and physically.
What does all that mean in terms of #investing? First of all, some are predicting we are entering a potentially prolonged period of high volatility, interest rates and inflation. Many are saying the US will enter into a recession next year, and perhaps this will affect the rest of the world. We have become globalised and interconnected, and investment markets and asset classes around the world are increasingly correlated. Tech innovation and growth will slow down as the era of “free capital” disappears.
So here’s the controversial part of my post. The fundamental rules of investing are changing. I believe Modern Portfolio Theory (MPT) has failed us and may no longer apply in the future. The whole idea of MPT is that there is an efficient frontier from investing in a basket of diversified assets. That there is an “optimal” investment strategy depending on your risk tolerance.
However, globalisation has reduced correlation between assets and markets. For perhaps the first time, we are seeing a decline in all asset classes. Decreased growth prospects and increased volatility may mean it no longer makes sense to (over) diversify. Liquidity, stability and income may become the new yardsticks of investing.
In recent years, there has been a shift from active investing (timed stock selection) to passive investing (tracking a market index). Perhaps there is no long term positive alpha, and even factor investing and the notion of picking value may be questionable.
What remains? Minimising beta (volatility) is still worthwhile. There is some evidence that pursuing high income may lead to overall higher total return than pursuing growth, particularly as growth slows and sustainability becomes important. It may no longer makes sense to hold cash (rather than say a basket of liquid assets) and it may no longer makes sense to balance across asset classes just for the sake of balancing.
Holding a basket of underlying stocks may be better than tracking an index. I may talk more about this in followup post, if there is interest.