Introduction: Back to basics, again
The financial crisis of 2007-9 has had enormous consequences, but it has not led to major changes in the investment policies followed by institutional and private investors. One trend that has been accelerated by the crisis, and it’s aftermath of ultra-low interest rates, is the rapid move in various countries toward complete closure of company sponsored salary related pension schemes. Millions are now confronted with the challenge of building up their own pension pot to fund their retirement. Many of these, who, it is reasonable to suppose, have no particular interest in investment markets, need to be conscious of whether their savings are sufficient and "on track", and sensibly invested. This new edition is deliberately tilted toward such concerns of the private investor (see chapter 3).
Many of these concerns parallel those facing institutional funds. Since the crisis earlier investment trends have been extended, rather than new trends emerging. There has been a growing recognition by all types of investors of the importance of globally diversified equity portfolios (chapter 8), and although investment management fees have been squeezed by the rapid rise of inexpensive market-matching passive equity and bond funds, investment managers have been kept in the lifestyle to which they have been accustomed by continued growing allocations to high fee "alternative" investments, such as hedge funds (chapters 5 and 10). Twenty five years ago both authors would have been confident that investment manager fees would have been under relentless pressure in the decades ahead. Time has so far shown such a prediction to have been only half-right. However, even the most modest investor can now find easy access to reputable low fee strategies of equity and bond investments that might suit their needs and which are comparable to those discussed in the first part of the book. Norway's oil fund (formally known as the Government Pension Fund (Global)), which is reported to be the largest fund in the world, has essentially followed such a strategy, since 1997. Warren Buffet, who has a reputation as one of the most successful professional investors, suggested in 2017 that American investors who are saving for retirement should "consistently buy an S&P500 low-cost index fund….I think it’s the thing that makes the most sense practically all of the time."
As very low interest rates have persisted, stock markets have seemingly become more expensive. Bond markets automatically translate low interest rates, which are expected to persist, into much higher bond prices and it is widely believed that this helps to explain the buoyancy of prices for a wide range of collectibles from works of art to classic cars (see chapter 11). There is though no agreement on whether the same process has left stock markets dangerously overvalued, or simply as having adjusted to a new reality of prolonged low interest rates. Most investors have responded as if they are not sure how to read signs that markets may be expensive (see chapter 5).
The stock market will always be intrinsically volatile, but at the time of writing, stock market volatility was as low as it has been in recent decades. In chapter 9 the close relationship between the higher yield offered on corporate bonds compared to that on government bonds (the spread) is explored. In late 2017 this spread was as low as it has been since 2007. This seems to be explained in part by (what were at the time) tranquil stock markets. The message is to expect bond yields to adjust if and when stock market volatility increases.
The suggestion that markets might be expensive sounds like a good reason to delay investing. The difficult subject of market timing when markets seem expensive or cheap is discussed in chapters 5 and 6. When markets seem expensive, and also when they are volatile, the best strategy is normally to continue with a long term strategy of making regular contributions to a pension savings accounts or to maintain balance in whatever strategy is being followed. Chapter 6 (Are you in it for the long term?) emphasises that some declines in prices are good news for investors. If bond prices (or the stock market) do decline from their current levels, that is unambiguously good news for anyone saving for a pension, who can now buy more pension with each monthly contribution. For those enrolled in company sponsored DC pension plans, inertia is most likely (as in 2008) to keep regular contributions flowing unimpeded by all the noise and commentary from TV pundits. Those who already have a fund of investments, the best protection against ill-considered responses to news is a diversified investment strategy whose rationale has been thought through and agreed in advance with an advisor.
As with the previous editions of this book, the first part of the book describes the design of such “keep-it-simple” strategies of stocks, bonds and cash. Chapter 1 starts with the distinction between risk (which can reasonably be measured) and uncertainty (which cannot reasonably be measured and so is not captured by risk models but is still important). It emphasises the importance of thinking how vulnerable our investments and savings are to bad times (because they do happen every now and again, and most probably will arise at some stage during your retirement).
The book is divided into two sections, Part 1 provides a framework for thinking about the different aspects of risk and how savings and investments might be allocated to meet investors’ reasonable expectations. Keep it simple is a theme of this book, but it also provides in Part 2 more detail on equity and bond markets as well as an introduction to more complicated hedge fund and private equity investments, as well as much more widely held real estate (chapter 10) and collections (however modest) of art and other investments of passion (chapter 11).
The authors would welcome any feedback and can be contacted at the following email addresses:
Peter Stanyer: email@example.com
Stephen Satchell: firstname.lastname@example.org