We are in a challenging investment environment. Broadly asset classes look unappealing; low interest rates reduce the appeal of bonds and elsewhere high property prices and a seemingly expensive sharemarket make it difficult to find cheap assets.
Investors often ask where they should put their money – shares or bonds, active or passive, value or growth, and small companies or large – but in an uncertain world this is amplified. People want to create a sense of order amongst uncertainty.
As humans we like certainty, probably due to our innate fear of the unknown and a desire to survive. Order is predictable and, at a basic level, tends to keep us alive; cavemen wanted to be sure that the noise coming from the bushes was the wind, not a deadly animal. One way we like to create a sense of order is to categorise.
Categorisation – essential to our lives
Organising things into categories, predicting how they will work and assessing these predictions is at the heart of science. But why is it so important to us to categorise?
Again, this is likely to have been born from survival instinct. Say a cavewoman discovered that a red berry was poisonous. Avoiding all red berries increased her chances of survival. But we know that not all red berries are poisonous.
Categorising brings predictability and helps us to simplify the complex. It also helps us to rationalise or justify matters and brings control. The trouble is that this desire for order and control can lead to decision making based on overly-broad categorisation. Which is a problem when investing, as we cannot control investment markets.
We tend to group shares together, focusing on factors such as company size, quality, or volatility, in the belief that all shares with these factors are likely to produce similar returns in the prevailing investing environment. The feeling that this provides control over investment outcomes is often illusory.
Creating categories of shares is risky. We believe it is better to be selective and treat each share on an individual basis. We need to differentiate and find the healthy red berries and with shares this should be based on fundamental business valuation.
We want to feel comfortable
Investing can take you outside of your comfort zone, no matter how much we want a sense of order.
Next time you find yourself wanting to invest in a category of shares we suggest asking yourself the following four questions to help with the decision making:
- Is investing in this category a shortcut to provide comfort in the face of uncertainty?
- If not, what is your thesis for investing in your chosen category and does it stand up to scrutiny?
- Is the performance of this category measurable against an existing benchmark? If so has previous performance been successful?
- How much of the out or under performance can be attributed the performance of the category rather than the performance of the individual shares?
Rather than tie ourselves to a single belief or style we can instead leave ourselves freedom of choice. At Allan Gray we are not exclusively value or growth investors for example, nor do we invest solely in large or small companies. We invest where we find opportunity, giving us the option of not holding a share if it is overvalued, regardless of the category it belongs to.
We believe it is better to focus on valuation versus price of a particular share, rather than on the merits of a broad category of shares.
Uncertainty is difficult to accept
Investing is often uncertain; fear of an unknown result takes you out of your comfort zone. Categorising shares can help alleviate this fear, but in the long term we believe it is better to devise a strategy that helps you analyse shares on individual merit. Sticking to this strategy when you invest gives you something to rely on and can make the uncertainty easier to accept. There are no shortcuts to investing, we have to be willing to test our investment theses and be prepared to change if they are unsuccessful.
Joy Yacoub holds a Bachelor of Economics and a Bachelor of Commerce (UNSW), specialising in Economics, Finance and Business law.
