Transforming personal finance since 2011

#60 — The Turmoil and the Tortoise


March 10th, 2020

By Andrew Craig

Reading time: ~ 8 minutes

Yesterday, stock markets all over the world fell by more than 7% - the most since the 2008 financial crisis. Oil has fallen more than 30% since the end of last week and I haven't seen my trading terminal covered with this much red for more than ten years.

Long term readers of these articles will know full well by now that I advocate long-term investment. When it comes to your investments, you really should think in decades and categorically not in days. I have written repeatedly about how crucial it is to keep calm at times like this.

Given that we run an investment fund, however, I thought it important to make some sort of commentary on the maelstrom raging around our ears. I wanted to comment specifically on how it has affected our fund and, more generally, about the purpose and nature of the fund.

I think it is worth me saying right off the bat that I have the majority of my pension and ISA money in our fund. I would also note that the Plain English Finance team, our partners, Professors Andrew Clare and Steve Thomas and I went through something like four years of slog to do the work and raise the money needed to get it launched.

The reason that I was willing to do this and why my own money is held in the fund, is because I genuinely believe in the job it does with my money and also how relevant that job should be for many people.

Nearly 20 years of back-testing and real world experience suggests that the fund has a maximum peak to trough downside of 10%. That compares to more than 50% for stock markets (the S&P was -56% in 2007 to 2009 for example).

That same back-testing also shows that the fund can have greater than 20% returns every few years as well as a few solid 8, 10 or 12% years along the way. You can see full detail of this on page 18 of our Fund Overview document. Please have a look at 2003, 2005, 2009 and 2016 in particular (this table is also reproduced below, further down).

One of the most important functions our fund aims to perform is to protect against those times where markets fall 30, 40 or even 50%. Times like now perhaps.

Protecting the downside is utterly crucial to protecting wealth over time as I have explained many times before (and in the document I have linked to above).

The Break-even Fallacy again

If you own something that falls 50%, you will need that something to make 100% to get back to square one. It is a well-known fact that many people don't understand this. Too many people think that if you lose 50%, you need only make 50% to get back to square one. This common error is referred to as "the break-even fallacy".

The break-even fallacy is why Warren Buffett is on record as having said about investment:

Rule No.1: Never lose money.
Rule No.2: Never forget rule No.1...

To repeat: If you own something that falls 50%, you need to make 100% to get back to where you started. Making 100% is very hard.

As I write, our fund is down 4.04% since the beginning of the year. The FTSE 100 is down around 20% over the same time frame.

Having falling 4.04%, our fund will need to return 4.21% to get back to where it started at the beginning of the year. Anyone in the UK stock market, however, will need to achieve more like 25% to be able to say the same thing.

Below is a table that shows you how extreme this gets when you suffer big falls in the value of your financial assets:

Source - Plain English Finance

Our fund only needs to make 4.2% to recover. As the main financial markets crash in a big way, they could need to make more like ten times that return to do the same. Some of the crypto coins which were so fashionable in late 2017 will need to make nearly 2,000% to get back to square one (i.e. - they won't).

This is why Warren Buffett says what he says, why we believe it may be better to be an investment tortoise than an investment hare and why I have proudly described our product as the "Geoff Boycott" of investment funds in the past (you will need to know a little bit about cricket to understand what that means I grant you).

To see this graphically: The chart below is taken from page 17 of our Fund Overview document. It shows how this can impact your long run ability to build wealth. This break-even fallacy point is utterly crucial.

Source - Plain English Finance and Professors Andrew Clare, Steven Thomas & Dr. James Seaton. Please note: Simulated past performance is not necessarily indicative of future results.

Please have a look at how far above the red and orange line ('the markets') the blue lines (our strategy) are for most of the last twenty years and the difference in returns from the blue and the red as a result of this over time. This will be even more pronounced today that it was when we drew this graph at the end of 2019, given the red line is down another 20% or so since then.

What's the catch?

This all sounds great of course but there is a catch: The price you pay for this vital down-side protection and potential long-run performance, can be relatively long periods where the fund is flat or even down. i.e. the times when it is behaving like the proverbial tortoise.

Source - Plain English Finance and Professors Andrew Clare, Steven Thomas & Dr. James Seaton. Please note: Simulated past performance is not necessarily indicative of future results.

If you look at the strategy's performance above, have a look at 2011 - 2015. That was not the most exciting time to have been owing a fund like ours. And the same has been true since we launched it - which is never the best experience for a young investment fund.

But none of this in any way changes the long run function that the fund seeks to perform: Significant downside protection with the chance, every few years to make real upside - such that the overall annualised result over long periods of time is strong - particularly when you take account of volatility.

Our belief is that this is very rare in investment. This is why I am a huge believer in what we do and we have made the Herculean effort to pull it all together.

If you can have the patience to tolerate the periods of boredom and times when the fund is underwater - which can last quite long - you should get a really solid result in the long run. I would argue that times like these when markets are a sea of red show just how and why this should work. To evidence this statement, I would point out that that we are more than 15% ahead of the UK stock market so far this year as I write.

Peace of mind

I would also argue that you might very well be able to sleep far better at night than people who just own more conventional stock market investments, who could see their money down 50% every few years and deal with all the madness and panic and need to chase 100% returns just to get back to zero.

Financial markets are having the worst time in more than a decade, yet our fund is down just over 4%. Not 20%, 30% or even worse. In my opinion, our fund is a great product for those looking to build wealth by making regular, monthly investments over many years and as a wealth preservation and growth plan for those at or near retirement who have put a big lump sum in in one go.

The only option for anyone who wants "guaranteed" returns and to never be down at all is to keep your money in cash, in a cash ISA perhaps. Here you can "enjoy" returns of anywhere from 1.3% - 1.5% a year.

Our back-testing to January 2001 produced simulated returns of 7.52% (past performance being no guide to future returns of course). That is clearly a meaningful multiple of those cash interest rates, with all that this implies for your wealth over time. But to take advantage of those potential returns you do have to be willing to endure periods of negative and / or flat performance.

Our fund is built to limit that potential peak to trough down-side to no more than about 10% based on nearly twenty years of analysis and real world experience. This all means that it should capture nearly as much upside as ’the stock market’ over time but with materially less volatility. As I say - that is very rare.

Keep Calm and Carry on

At times like this, it serves to keep a cool head - to keep calm and carry on. I would argue that this may be easier to do this in a low volatility "tortoise" of an investment product like ours than in a high volatility "hare" where you might find yourself licking your wounds every few years in a big way.

If you're interested in seeing these arguments in more detail, please do consider spending 15 minutes or half an hour or whatever it might take you to read our Fund Overview document from cover to cover. If you do this, please do really take some time to look at all the charts and graphs. I would hope you would find doing so really instructive or interesting at the very least.

You will understand how it is that our fund sold out of most of our risk assets last week and is currently more than 70% in cash or cash equivalent "risk free assets" and hence why it has protected the downside so well this year.

Until next time.