The events of 2020 have upended every aspect of our lives. For many of us, our carefully laid financial plans appeared to be in jeopardy for a large part of this year, and, when we consider how hard we work and save, diligently contributing to our investments month after month, it’s hard to completely remove emotion from the investment decision-making process.
Taking this opportunity to pause and reflect on what has been an exceptionally challenging year in so many ways, we’d like to unpack some of the trends we have identified in investment behaviour. We’ll focus on some common mistakes that erode value and discuss the tools at our disposal to mitigate future risks.
How did investors react to the surge in market volatility?
Investors offloaded R5.2bn worth of South African equities in the first quarter of the year1 as Covid-19 evolved into a global pandemic and economic activity all but ground to a halt. While some analysts expected a protracted downturn, markets rebounded quickly, with South African equities returning 23% through the second quarter2. Those investors who pulled their money out of the market during – or just after – the crash missed out on the strong recovery and were left chasing the rally. The best days in the market often come directly after the worst, and investors who panic sell during a crash rarely reinvest in time to participate fully in the recovery rally.
This is the typical “panic” behaviour that we refer to when we talk about the “cycle of fear and greed”. Morningstar has done extensive research over about 25 years and has found that if investors missed just the best 25 days out of this entire period, their average annual return over the full 25 years almost halves, from around 13% per year to just 7.1% a year. This highlights the opportunity cost of knee-jerk reactions to spikes in volatility, and clearly demonstrates that remaining in the market can be crucial to achieving long-term investment goals.
How did South African investors react to the Rand’s weakness?
South Africans experienced a “double whammy” during the Covid-19 crash. Not only did our local equity market slide in tandem with global benchmarks in March, but our currency took a substantial hit as well, as risk sentiment soured. The Rand/Dollar exchange rate surged to above R19/$ in April, and CoreShares received a flurry of enquiries from investors seeking offshore investments. But the Rand has since recovered its losses and is back within the R15.00-15.50/$ range. It is a well-documented phenomenon in South Africa that when the Rand slumps, investors switch from local to offshore investments. Diversifying your investment portfolio to include offshore exposures is a sensible strategy in most cases, but offshore allocations should be consistent, methodical, and in line with your long-term financial goals – rather than knee-jerk reactions during periods of volatility. This is another example of how decisions based on gut instinct (panic) can be costly in the long run.
Some behaviour does, however, eventually change
So far, we’ve discussed investor behaviours that reappear each time we experience a severe market downturn. However, there were some other trends that gathered pace in 2020 and are worth discussing.
We continue to see reports, such as the SPIVA4 scorecard, which show that most active managers in South Africa and elsewhere struggle to outperform the market – particularly after taking fees into account. While active managers often argue that they are better able to protect capital during a downturn than passive strategies, this was not the case in 2020. The CoreShares Top 50 ETF outperformed 69% of active managers over the course of the Covid-19 crash5.
As such, we are seeing a broader adoption of passive investment strategies by all types of investors, including pension funds, multi-managers and self-directed retail investors, among others. Periods of poor performance and market stress are typically catalysts for meaningful change, and we see the events of 2020 driving the adoption of passive investing in South Africa at an accelerated pace.
“Time in the market is better than timing the market” – Warren Buffett
At CoreShares, we firmly believe that in order to get the best possible outcomes from your investments, all investment decisions should be based on evidence. Identify your long-term investment goals, choose the optimal mix of assets to achieve them, and then stay the course. Trying to time the market is usually futile. Academic research shows us that by sticking to your strategic asset allocations, you will have the best chance of meeting your long-term investment goals. Additionally, by incorporating passive instruments into your portfolio, you can keep costs low and therefore maximise your returns.
Keen to learn more about investor behaviour and evidence-based investing? We invite you to watch “Hard Questions. Better Answers” – a series of short videos featuring Gugulethu Mfuphi and some of South Africa’s best known finance experts: Maya Fisher-French, Warren Ingram, Victoria Reuvers, Grant Locke and Nerina Visser, available here.
- RMI Investment Managers Q1 CIS Analysis: Retail Industry Trends and Market Share (based on ASISA Q1 2020 Flows, SA General Equity)
- CoreShares Top 50 ETF performance from 1 April 2020 to 30 June 2020. Past performance is not indicative of future performance.
- Morningstar’s Victoria Reuvers discusses this investment research in Chapter 5 of the CoreShares documentary: Hard Questions. Better Answers
- SPIVA® South Africa Scorecard Mid-Year 2020: 95% of SA Equity active managers in South Africa underperformed the S&P SA Top 50 Index; and 90% of Global Equity active managers in South Africa underperformed the S&P Global 1200 over the past five years.
- “Can active managers protect your investments during a market crash?” – an article written by Chris Rule, 7 April 2020, available here.