At 11pm on the night of 9 November, members of the Summer KiwiSaver Investment Committee discussed our asset allocation. I Chair this committee and Trump had just been elected – a whole new investment environment with new opportunities and new risks had been dropped on us. We decided meet formally the next day.
We thought that Trump would cut taxes and that interest rates would increase. We therefore decided to reduce our holding of bonds (fixed interest investments) and to map out a game-plan to increase our holding of international shares.
That turned out to be a pretty good call. Bonds have fallen in value and international shares have risen in value.
It is important to note that we took two steps – one a buy and the other a sell. The motivation of each of these actions was different: the sale of bonds was about risk reduction as bonds would probably fall in value. On the other hand, the purchase of the international shares was to enhance returns – buying into this asset class was about making money.
If I am managing your money and you want higher returns, I can get them for you very easily by simply taking on more risk. I get your higher returns from greater risk, but remember, it is your money,not mine that is in jeopardy.
Higher returns will make me look very good. The returns I get for you will be applauded, but the cheers won’t last. At some point, the high returns will come with volatility and during the downturns, investors are likely to get fairly grumpy.
Returns are clearly important, but they must always be judged by the amount of risk that is taken to get them. Following Trump’s election, we were certainly looking for opportunity but, equally, we cared about vulnerable investments.
Investors always need to think about risk adjusted returns. When someone is telling us about the great returns that they have, we need to ask how those returns were achieved. Sometimes they have indeed come from the application of skill – but sometimes they simply come from greater risk.
Warren Buffett said that there are two rules for investment. Rule number one to not lose money and, rule number two is to never forget rule number one! The greatest investor in the world cares as much (or more) about risk as he does about returns. Your first return should be the return of your money.
Buffett knows it is very difficult for an investor to come back from a significant loss. You have to get a lot of investment return to make up for an investment loss. Buffett manages risk by only investing in things that he knows well after doing a lot of homework.
Risk and return go together – they live in the same house. You can never completely avoid risk, but do not ignore it: every time you hear the word “returns”, think “risk”.
Martin Hawes is the Chair of the Summer KiwiSaver Investment Committee. He is an Authorised Financial Adviser and a disclosure statement is available on request and free of charge, or can be found at www.martinhawes.com.