The 17th-century English metaphysical poet John Donne declared famously: "No man is an island". With due deference to Nassim Nicholas Taleb and his black swan, this is surely true. I have never seen or even heard of a man who is also an island. For the sake of full disclosure, it might have been the case in the past that as I have paddled with my floaties in the waters off Singapore’s Sentosa Beach, the occasional passing plover might have fleetingly perceived me to be an isolated land mass. An exercise regime has since saved me from black-swan status.
Donne’s point was that we all share a common human destiny, and this is also true in the realm of investing. The ancient Greek myth of Sisyphus illustrates Donne’s wisdom well. The cheeky and impudent mortal king of Corinth trifled with and even mocked the gods. Among his many sins was that through a ruse he caught the son of Hermes stealing his sheep. This caused the boy’s dad no end of annoyance.
| The equity investor is like Sisyphus; he or she makes money from time to time only to lose it when the rock rolls back down the hill |
When near death, Sisyphus told his wife to throw his unburied body in the town square to test her love, and she did as he asked. When he awoke in the underworld, he talked Hades into letting him return to life to punish his wife for dishonouring him. Sisyphus then refused to go back to Hades’ realm as agreed. When he was eventually cornered by the Olympian Mafia they meted out an unusual punishment. He was condemned to roll a large stone up a mountain only to see it roll back down and to repeat the action for eternity. Sisyphus learnt that he, like us, cannot defy the gods. The equity investor is like Sisyphus; he or she makes money from time to time only to lose it when the rock rolls back down the hill. The gods have ordained it so. John Bogle, founder of Vanguard, demonstrated that between 1983 and 2003, the greatest bull market in history, the average equity mutual fund investor received only 24% of the return of the S&P500 index.
This was for three reasons. First, the average equity fund underperformed the indices. Secondly, Wall Street and the investment managers absorbed a good part of the return through fees and expenses. Thirdly, investors made poor timing decisions, such as jumping into TMT funds at the peak. Most hedge funds’ results are no better. The Credit Suisse/Tremont Hedge Fund Index had a cumulative return of minus 3% for the 10 years ending in June; rolling six-month US treasuries would have returned 37% over the same period. In the meantime, hedge fund managers netted tens of billions of dollars.
One should not assume that the recent period of poor returns is unusual. In The triumph of the optimists: 101 years of global investment returns, a book that every investor should study seriously, the authors at the London Business School point out that periods in which stocks underperform bonds are as long as 20 years in about 20% of the cases, and that periods of underperformance can last as long as 40 years, using US data. The equity rock goes up the hill only to crush the spirit of investors on the way back down. Bonds and bills do not roll back; they mature at par.
The logical strategy suggested by these facts is a counter-Sisyphean investment policy: syssy investing, if I may coin a neologism. Institutional investors should hedge their equity downside even though the cost of hedging will constrain the upside potential. This approach, however, is difficult for most individual investors.
They might wish to consider indexed annuities that guarantee a minimum return, perhaps 1% to 3%, in any 12-month period while giving the investor some, but not all, of the upside of the S&P500 or some other index, with the base value reset upward annually. This creates a ratchet that allows returns to move up but not to fall back, and these returns are guaranteed by an insurance company. Annuities only work for long holding periods, typically 10 years. If you cash out sooner, your return might well be negative.
Recently I attended a luncheon presentation of the Singapore Rotary Club North that illustrated returns for credit card issuers. The part that I found the most intriguing was the three-year interest-free financing that credit card issuers give for the purchase of white goods. On the surface, one wonders how they can make money by lending at 0% but that ignores the fact that a sufficient number of borrowers will become overdue on their payments, triggering large late fees to cover the cost of the programme plus the issuer’s profit.
Likewise, insurance companies issuing indexed annuities know with actuarial certainty that a large number of investors will cash out of the annuities before year 10, and their losses subsidize the returns of those who hang on, plus a nice profit for the insurer. The winning investment strategy is to stay in for the long haul. The human spirit is sometimes indomitable and investors, like Sisyphus, often think they can defy the odds and the gods. The data show, however, that investment success is more likely to be achieved by syssies.
Lincoln Rathnam, PhD, CFA, is an investment professional based in Singapore and Boston. In a career spanning almost 30 years he has managed equity, debt and venture capital portfolios and was a pioneer investor in emerging markets in the late 1980s