We are all prone to FOMO (fear of missing out) when we see stellar stock performance, but Dr Benjamin Holdsworth shows why the best investors think long-term.
It can sometimes feel that the markets have gone a little mad. Almost everything you hear on the news or read about investing suggests that everything is going up.
At the time of writing, the US market is up by around 44% in the past year in dollar terms and Tesla’s share price has risen by 124% over the same period.
Furthermore, Lucid Motors, who have just started production on its electric car in Q3, for which it has a mere 13,000 orders, floated on the New York Stock Exchange and already has a market capitalisation greater than that of Ford, after its share price doubled in a month.
In the US, call options on individual company shares, which provide investors the right to buy a stock at given date in the future at a predetermined price in return for a premium payment, currently exceed the value of actual shares traded by value by almost a half.
Options are a way of leveraging exposure to a stock without having to come up with the face value of buying the stock directly. They are a sure sign of speculation, not least by retail investors.
There is no doubt that when markets become ‘frothy’, investors are prone to a fear of missing out (FOMO) that makes them wish that they were invested in something that has done well – mostly identified with hindsight.
This can tempt some to lose discipline and plunge in, hoping that the magic (luck) will continue. When things do not go as hoped, there is a temptation to cut losses and run.
The ARK Innovation ETF – Exchange Traded Fund, which is a type of security that tracks an index, sector or commodity – has hit the investment news headlines as one of the best performing funds in 2020, gaining over 150% in US$ terms.
It is a very concentrated portfolio of technology and healthcare innovators. It holds more than 10% in Tesla and the top ten of 45 or so stocks make up more than 50% of the portfolio.
The firm also owns more than 10% of the shares of a number of portfolio stocks, which raises liquidity risks – you may remember what happened to Woodford Investment Management.
In the case of ARK Innovation, it had a stellar run from April 2020, out of the bottom of the Covid-induced sell-off until December 2020, but has struggled since then, falling almost 35% at one point in the first few months of 2021.
It is worth noting that the fund had inflows of just US$25m in Q4 2019 but these peaked at almost US$7.8bn in Q4 2020.
You do not have to be a mathematician to work out that the investor money that went into the fund at the back end of 2020 will have not captured the bulk of the positive returns of 2020 and suffered the subsequent downswing.
Manager skill – or luck
A rough calculation using monthly performance and fund flow data suggests that, from the start of October 2019 to the end of October 2021, the fund delivered an annualised return of 66% a year. However, the average investor return was around 25% a year, which is over 40% per year difference.
ARK Innovation relies on manager skill – or luck – in picking a mere 45 or so companies out of the many thousands of companies around the world. The risks are very high.
The fund management world is littered with the corpses of such ‘stellar’ funds. In the UK for example, over the past 20 years or so, around half of all investment trusts launched have failed to survive in their original form.
It is hard not to suffer FOMO at times like these, but it is worth remembering that investing is a not a sprint but a marathon.
When markets rise substantially, as they have done recently, regular rebalancing results in the sale of assets that have performed well and banks the excess proceeds.
Seemingly irrational markets can persist for a long time and, as the old saying goes, no one rings the bell at the top of the market. Stay invested, remain diversified and be thankful that your financial well-being does not lie in the hands of any one fund manager owning just 45 stocks.
Remember that it is the tortoise who wins the race.
Dr Benjamin Holdsworth (right) is a director of Cavendish Medical, specialist financial planners helping consultants in private practice and the NHS
The content of this article is for information only and must not be considered as financial advice. Cavendish Medical always recommends that you seek independent financial advice before making any financial decisions.
Levels, bases of and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor. The value of investments and the income from them can fluctuate and investors may get back less than the amount invested.
Cavendish Medical Ltd is the go-to company for retirement planning for doctors. It has over 600 medical families as clients and £500,000,000 in client assets under administration. It operates a transparent investment policy and a fee-based approach allowing independent financial planning advice.