Taking the long view of investment

By MARK FRYER

The turmoil of the past few years has changed everything for investors - right? Well, no, says a man who spends a lot of time thinking about issues such as investment strategy and the long-term performance of markets.

Don Ezra is director of strategic advice with Frank Russell Company, a firm which manages and advises on investments around the world, and says it helps clients to decide how to handle about $4 trillion.

In this country Russell's customers include some heavyweight institutional investors, among them the Government Superannuation Fund.

Visiting New Zealand from New York, Ezra has been spreading a "keep the faith" message, urging investors not to panic and not to take a short-term view of what has been happening lately.

In case you missed it, what has been happening has been one of the sharpest falls to hit overseas sharemarkets in the past century; international share prices have fallen for two years in a row and, short of a dramatic turnaround between now and December 31, are headed for three in a row.

In the US, says Ezra, it would be the first time in more than 60 years that share prices have fallen for three consecutive years.

All of which means that New Zealanders who listened to the message to invest in overseas shares, rather than keeping all their money at home, have been roundly punished for doing so.

"There's been a lot of screaming, a lot of pain, and the mind doesn't function when it's under torture of that kind," says Ezra.

"Part of our message to people is let us try to be a little more objective - step back and re-engage the mind and disengage the emotion."

He says he set out to test two key beliefs: first, that investing in shares produces higher returns than fixed interest and, second, that New Zealand investors benefit from having some of their share investments overseas.

While both propositions have looked distinctly shaky lately, Ezra says they still hold up if you look at the long-term figures.

If you take a series of periods, right back to the 1970s, the return on New Zealand shares has indeed beaten the return on local fixed-interest investments, by about three percentage points a year, although at the same time the shares have been considerably more volatile than fixed interest.

And, again taking the long-term view, New Zealand investors have benefited from buying overseas shares, he says. That's not because the overseas shares produced higher returns, but because a mix of local and international shares would have produced less volatile returns than a purely New Zealand portfolio.

All of which is fine and good in hindsight, but what should investors do right now? Possibly, not much, suggests Ezra.

"The toughest thing in emotional times is to ask yourself, 'Should I do anything', and the answer is usually no," he says.

"If you give vent to the emotion, the question you ask yourself is, 'What should I do', which presumes you should do something. If you change the question to, 'Should I do anything', the answer may well be no, just stick to your old philosophy."

If you're the sort of investor who set out with a plan - a certain percentage of your money in fixed interest, a certain percentage in shares, etc - the most logical step right now may be to "rebalance" to get the various investments back into the percentages you started with.

Which, in practical terms, means selling investments that have done well lately to buy others that have performed poorly. And yes, that can be a hard message to sell, he says.

Investors also need to have the stomach, and the time, to ride out the ups and downs.

One of the lessons of looking back, says Ezra, is that "long term" can be very long indeed - something between 10 and 20 years.

"Doing nothing and just rebalancing is possibly the most sensible thing to do, unless what you've discovered is that you've aged and you no longer have the same time horizon for risk - that's a different issue. Anyone else should just stay put."

For older investors who don't have a lot of long term left, the options are more limited. People in that category should have been steadily moving more of their money into less volatile investments as they got older.

"The time to adjust is while you're ageing; you shouldn't suddenly look at yourself and say, 'Oh, my God, I've aged, what a surprise, I no longer have a long term'."

If shares still have something to offer investors with time on their side, should it be local or overseas shares, or a mix? Lately there's been no question; overseas shares have been nothing but bad news.

Ezra compares two mythical investors - one who owns only NZ shares and the other whose share investments are split 50:50 between NZ and overseas. In the 24 months to the end of September, the stay-at-home portfolio would have beaten the international portfolio by 37 percentage points.

Longer term, though, he says there is a good argument for New Zealanders owning overseas shares and it is only when you concentrate on the past three years that owning international shares has hurt returns.

While many New Zealanders who bought overseas shares or managed funds in the heady 1990s did so because they hoped to make better returns than they could at home, Ezra says that's not the right reason for buying overseas.

"There is no reason why, in the long term, New Zealand should be below average in terms of market return. There's no reason why New Zealand should be above average, either. There's no reason why any one country should persistently over time keep beating other countries, as far as developed markets are concerned.

"On the return side, we don't expect any more when we invest internationally - we don't expect to win. But we also don't expect to lose by going international. Where we expect to win is not in return but in terms of lower volatility."

Long term, he says, an exclusively New Zealand share portfolio would have produced much the same return as a portfolio split 50:50 between local and overseas shares, but it would have seen more extreme ups and downs.



If the recent past hasn't changed the basic rules of the investment business, it has taught investors what the word "risk" really means.

Risk, says Ezra, "is an abstract concept until you experience it". And when investors do experience a real-life fall in the value of their investments, they suddenly discover their tolerance for risk is not as high as they thought it was.

What about recent claims that there has been some fundamental change in sharemarkets and that, even in the long term, shares will deliver lower returns than they have in the past?

Not so, argues Ezra. Shares will always be riskier than fixed interest, and the people who invest in shares will require a higher return to compensate them for that uncertainty.

Ultimately, it comes down to investors deciding whether they want to sleep well in the short term, by investing in fixed interest, or eat well in the long term, by buying shares. "There is no position that will enable you to do both at the same time. That's the choice.

"If you have a crystal ball, you might be able to time your ins and outs so you eat well when the market is going up and sleep well when it's going down, but in 30 years of searching for crystal balls we haven't found one yet."

* To contact Mark Fryer write to: Weekend Herald, PO Box 32, Auckland. Email: mark_fryer@nzherald.co.nz. Ph: (09) 373-6400, ext 8833; fax: (09) 373-6423.

Yes, things have been tough - if you had 30 Per cent of your money in NZ shares, 30 in oseas shares and 40 per cent in NZ fixed income then your return in the 12 months to the end of September - assuming you did as well as the market, no better, no worse - would have been minus 1.7%. In the time since 1970, such a portfolio would have prodced an average of 12.7 per cent a year. Last year close to what you might expece one ear in 10.

Don't excpect too much sympathy from aforeigner looking on - in the US, three year returns from that sort of portfolio around zero, whereas in NZ at least kept up with inflation.

Don't expect any sympathy from overseas; Ezra points out that those awful international equities to us are awful domestic equities to them.

Things can be different in the short term but over, say, 20 years, shares have indeed beaten bonds bu about 3.2 per cent a year, and been more volatile.

Over 20 years, Return on purely NZ portfolio about the same as on a 50/50 one, but the purely local shareholder has sufered more volatilitity.

Been talking to local institutional inverstors and financial advisers who deal with individual investors.

"The rest of the world says I'm sorry, we're screaming too hard ourselves to worry."

'The rest of the world says you know those rotten internation equities - they're owur doemstic equities and we have more of them."

"if you look at the long term, things work ok; over 10 year periods theu kind of move around a bit."

"It's the pain of the precent periods that blinds you tro the fact that things are really working pretty much the way that you'd expect them to."

"Theres a lot of pain - it's being shared around the world but that's no consolation."

If you're too young to have reaped long-term benefits, that hurtds,

The other story is the person who is aged and doesn't have much long-run left.

"That's what happened in the past, theress no guarantee it will happen in the future but is there any intrinsic reason to believe that future wilbe so dramatically different."

""quities are'eat well in the long term, don't sleep well in the short term - what you're experiencing is the don't sleep well - there's no realon to believe that you will not also have the esat well in the long term, you will have bnoth.

The lesson is in a sense an ubnfortunate one as human beings we do have a tendnecy to excess

Markets tend to extremes.

Sems unusualu because we've had such a long upturn, went to shigh, probably only in the past 10 years that ordinary peopke have really accepted investing in shares. "This is the first time that it's not just the rich who are suffering, its everybody.'

In the US 60 years since three down years in a roww, "his is really a very very bad time."

Institutional investors happy to accept the medssage, individuals have a tougher time