Paralysis by analysis: Why too much information can lead to stagnation
When the world is fast moving, buffeted by economic, political and corporate news, and markets react in apparently inconsistent ways, there is a danger that investors try to analyse too much. Can we determine the best possible outcome by burying ourselves in more and more detail? If I am much better informed will I make a much better decision? Instead, a good option is to stand back and concentrate on several key issues: what time scales am I investing for? And can I construct a portfolio which will benefit in several possible outcomes?
Time scales matter, particularly for investments such as real estate. Yes, we can use REITS, although their returns are equity like over time, but to gain the property risk premium we have to accept the illiquidity of this asset. Organic demand looks to be reasonable, against the backdrop of relatively buoyant economic growth; in addition, the lack of speculative new build and the relatively high spread over government bonds are helpful at this phase of the cycle. So, let’s go long property.
If one puts commercial property into an optimiser, it looks good – modestly positive returns and low volatility for most of the cycle, especially when seen as a bond like asset bought for carry. The danger is significantly negative returns and high volatility, when its equity like characteristics appear during the recession. Its innate risk inexorably grows as this business cycle matures – or if you are buying property when are you planning to sell?
That leads onto scenario analysis therefore, not just for real estate but any other asset. In the depths of February, financial markets were broadly pricing in stagnant growth but not yet recession. Into March a technical short covering rally appeared. Let’s extend our time horizons: we know there are cyclical and structural headwinds, such as the slide in commodity prices or the levels of indebtedness. We know that policy makers are responding – more expansionary fiscal policy in China – but we also have serious worries about the efficacy of policy changes, even unfortunate side effects – Japan’s shift into negative interest rates is a prime example. A range of scenarios can be produced, alongside different returns estimates and probability assumptions. These can help when creating a portfolio which will benefit in a world of slow but risky growth. Our House View continues to like real estate and good quality corporate bonds, moving further up the capital structure.
Andrew Milligan, Head of Global Strategy, Standard Life Investments
First published in Citywire Wealth Manager 17th March 2016.