How time in the market beats timing the market

Michael Goldberg | Collins St Value Fund

A man walked into his local florist and started ordering flowers. The order grew and grew until, unable to restrain her excitement the florist asked, “Is this a surprise for your wife?” “It sure will be,” replied the man. “She was expecting diamonds."

Our expectations drive our satisfaction, as much, if not more than actual outcomes.

Expectations in investing

The popular adage spoken and heard by many investors (often to themselves), usually uttered after a disappointing announcement or share price drop, sounds something like: “It’s fine, it’s a long-term investment.” Sometimes the internal rationalisation is enough and inner peace is found. Other times, investors can be forgiven for throwing the nearest object through the nearest window.

When investing in any risk asset (any asset that isn’t cash), investors need to have a reasonable expectation of how long their investment will take to bear fruit.

After all, if your investment horizon is 3 years, but it takes 10 years for the thesis to play out, your experience is unlikely to be enjoyable.

This is not a question of lowering expectations; investors should always retain high but realistic expectations.

Understanding different assets and timelines

PROPERTY Given holding costs, taxes, transaction costs and the time it takes to list and sell a property, it’s easy to understand that an investment in property will be a long term commitment. For most investors, time frames are measured in decades.

This view is not controversial, and it would be rare indeed for an investor to participate in property markets with a 6 month time frame.

Historically, property investments have generated outsized returns relative to cash. The cost of that outperformance is lower liquidity and higher volatility. It’s only with the benefit of time that the better returns can be confidently realised.

SHARES Shares are more volatile than cash and property but have generated better returns (over the long term) than either.

Even though both property and equities share the trait of being risk assets and are subject to volatility, it is only in shares where that volatility is visible with daily pricing.

For that reason, amongst others, investing in equities is viewed quite differently to other risk assets.

Even amongst equity investors, not all share their approach:

• institutional high frequency investors seek to fill a gap in inefficient market liquidity and measure their investment time frames in seconds,
• day traders seek to speculate on very near-term news flow and think in terms of minutes or hours,
• technical analysts seeking to exploit market momentum measure their returns in days or months.

Our preference is to assess the fundamental value of underlying businesses. This approach takes more time — both for us to consider, and for the investments to play out — until markets appreciate the value. Nevertheless, we happily trade that effort and time for the greater confidence we get in likely outcomes.

When investing in equities it’s of utmost importance to both understand the risks and understand the investment timelines.

Volatility is the cost of outperformance

to 30 September 2024

As a general rule, the perceived risk of volatility in certain companies leads to steeper discounting of those companies by investors. The steeper the discount, the more opportunity for fundamental analysis to uncover quality undervalued assets.

However, it’s important to understand that volatility does not always reflect risk. For instance, some investments will provide outsized returns in good times, but also provide outsized losses in down times. In those circumstances, movements are simply a magnification of market movements, both for profit and for loss. In these cases the volatility is a reflection of risk.

In other circumstances, investments might be generally volatile but add value to an investor’s portfolio in uncertain times.

This is the case with the Collins St Value Fund. Our fund has outperformed the ASX during weaker markets (suffering less than 60% of the down capture in negative months), and managed to capture much of the upside in positive markets. We would argue that the true risk (the risk of permanent loss of capital) may be lower than the market, even as our returns over the long term have been higher.

Understanding what we can control (and what we can’t)

The challenge for investors is to recognise what is in their control and what is out of their control.

For long term investors that means building in enough buffer so that even if an investment takes longer than anticipated, the rate of return is sufficient to pay for delays.

It also means that investors must understand the timelines and guidance of companies to ensure that they are happy to wait the required amount of time to achieve the ‘promised’ returns.

Time in the market

Our view is that most equity investments should be viewed as a five-year venture.

Taking a five-year view won’t necessarily completely remove the volatility risk associated with investing in equity markets, but it ought to give investors sufficient time to experience most of a cycle, for the underlying business to deliver on its promise, and for markets to cotton-on to the intrinsic value of the business.

Some years ago, my children and I were baking a cake. After mixing the ingredients, pouring the mixture into the pan — and most importantly licking the spoon — we put the cake in the oven to bake for 30 minutes.

After cleaning up, we all left the kitchen to wait for the cake to bake.

A few minutes later, I walked past the kitchen again only to find my youngest two children trying to open the oven to have a closer look at the progress of our efforts.

I explained to my kids that the process takes 30 minutes, and no amount of wishing, prodding or supervision would change the outcome – indeed, it would lead to a worse result.

Taking the message on board, the two of them stood guard to make sure that none of their siblings would disturb the progress.

Lessons learned from baking a cake:

• Don’t remove the cake from the oven after five minutes because you’re impatient.
• Once you’ve done your job, (combined the ingredients and set the cake to bake) leave it alone. Let the oven and time do their jobs.

That’s not to suggest that in the investment world outcomes cannot occur sooner. They certainly can and particularly so when investors are considering single stocks or highly concentrated portfolios. However, taking the longer view tends to be the wiser (if less exciting) approach.

The payoff for patience

Historically, equity markets have outperformed less volatile asset classes. Volatility is the price we happily pay for that outperformance.

As the following chart illustrates, any five to seven year time frame would have seen investors reduce downside risk and the total-return volatility, regardless of whether it included the worst years since 1900.

As the chart shows, the difference between a positive experience and a negative one can be as simple as extra time in the market.

For instance, a 3-year investment from 2007-2009 (including the GFC and one year of recovery) would have generated a -0.6% annualised return, yet a 7-year investment to the same end date would have generated almost 12% p.a.

When we invest, we attempt to match the company’s goals with our own expectations over a five-year time frame. As such, our recommendation to clients, keen to extract the best experience from our funds, has been that they too should match our expectations and adopt a five-year outlook. And, while there has been variance year to year in our returns over time, we have been very pleased with the almost 14% p.a. we’ve been able to achieve over the last 8½ years.

The potential cost of mistiming the cycle

Being in the market through the cycle is essential. Indeed, being in the market (especially) when things seem most uncertain is one of the keys to outperformance.

Historically, the periods after the deepest falls have been the ones that have generated the greatest returns. Missing even just a few of those most positive days in the market can dramatically affect your outcomes.

For instance, since 2009, the ASX200 has generated a return of approximately 7.8% p.a. However, if an investor were to have missed out on just the best 1% of days, their return would have been an underwhelming 1.5% p.a.

For this reason, investors must get comfortable being in the market, even during the times that are most uncomfortable. That’s not to suggest that investors ought to allocate capital haphazardly, but to recognise that once they have established that their investment process works, they ought to give that process the time it needs to fully exploit the opportunity.

Expected time frames and outcomes are frequently misaligned. It’s our job as investors to set reasonable expectations and position ourselves for success even when outcomes are delayed.

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All prices and analysis at 9 December 2024.  This document was originally published in Livewire on 9 December 2024. This information has been prepared by The Collins Street Value Fund (CSVF) which is managed by Collins St Asset Management Pty Ltd (CSAM) ABN 16 601 897 974 AFSL 468935. The content is distributed by WealthHub Securities Limited (WSL) (ABN 83 089 718 249)(AFSL No. 230704). WSL is a Market Participant under the ASIC Market Integrity Rules and a wholly owned subsidiary of National Australia Bank Limited (ABN 12 004 044 937)(AFSL No. 230686) (NAB). NAB doesn’t guarantee its subsidiaries’ obligations or performance, or the products or services its subsidiaries offer.  This material is intended to provide general advice only. It has been prepared without having regard to or taking into account any particular investor’s objectives, financial situation and/or needs. All investors should therefore consider the appropriateness of the advice, in light of their own objectives, financial situation and/or needs, before acting on the advice.  Past performance is not a reliable indicator of future performance.  Any comments, suggestions or views presented do not reflect the views of WSL and/or NAB.  Subject to any terms implied by law and which cannot be excluded, neither WSL nor NAB shall be liable for any errors, omissions, defects or misrepresentations in the information or general advice including any third party sourced data (including by reasons of negligence, negligent misstatement or otherwise) or for any loss or damage (whether direct or indirect) suffered by persons who use or rely on the general advice or information. If any law prohibits the exclusion of such liability, WSL and NAB limit its liability to the re-supply of the information, provided that such limitation is permitted by law and is fair and reasonable. For more information, please click here.