Investors beware

There are three investment mistakes that most investors will almost certainly make over the coming years, all of which are eminently avoidable.

The next two to three decades should be one of the most rewarding periods for investors, as long as they know where they're going, are prepared, and keep their eyes open - in other words, equip themselves with a strategic understanding of long-term cycles, an awareness of the suitability of specific assets to their particular risk profile and a flexible mindset adapting to rapidly changing conditions.

Sadly the vast majority of investors and investment managers will fail to do so.

The extreme range of opinions about the health of the global economy highlights that while some investors may correctly guess the precise path from the current deflationary spiral back to a growth trajectory, this depends on unknown variables dictated by unpredictable politicians. That means trusting your financial future entirely to luck.

Prudent judgement involves applying a coherent macro-strategic overview, understanding risk and being ready every minute of the day to take corrective action if events unfold differently to your game plan. These essential disciplines are a prerequisite to realising the exceptional potential of the upcoming economic seasonal opportunity within the long-term cycle. This cycle typically tends to last between 50-80 years. With business and socio-economic cycles fundamentally rooted in human behaviour, we don't believe that this time will be any different.

As we won't be at this part of the cycle again for 50-80 years, decisions taken today will have a once-in-a-lifetime impact. The change from autumn cycle to winter cycle in 2000 was a significant shift - many global stock indices still remain below their highest levels of 12-13 years ago - but the shift to economic spring is equally dramatic. Many fortunes were made or lost during the last transition; the same will apply this time.

The three most common investment mistakes during this period are:

Lack of strategic direction

The winter cycle has been most successful for investors who followed our strategic advice to favour gold, cash and government bonds, but, when winter turns to spring, opportunities and risks will once again change diametrically:

Gold and bonds will become the ugly twin sisters of investment asset classes.

Cash will be far outpaced by the returns on risk assets such as equities or property.

Investors of all appetites, shapes and sizes need to realise that economic spring is almost a mirror image of economic winter.

While spring may not yet be upon us, now is the best time to start thinking ahead about suitable responses once springtime bursts out.

Inappropriate risk profiling

The global economy remains mired in the depths of winter and we don't know how soon spring will be upon us or how severe the rest of winter will be. Rather than speculating on these unknowns, each investor needs to understand the imminent risks and opportunities, to relate those to their own situation and to make risk-appropriate asset allocation decisions. We're aware that many investors who rely on their assets to produce income have stepped up the risk pyramid from cash to T-bills to longer bonds to emerging market debt to corporate bonds to high dividend stocks, little realising that each step progressively involves greater risk. In 2008 the high dividend stock index underwent a dramatic fall that saw investors lose over 50 per cent.

Irrespective of target investment returns or deeply held opinions about the state of the global economy, individual investment strategies must be grounded in sound risk principles and not result in a mix of assets that might cause losses greater than you can afford.

Aggressive investors can afford to focus on not missing the strong rebound that will occur as growth replaces deflation. They should already be looking out for valuation-driven opportunities, perhaps gently dipping toes into European equity markets where distressed valuations attaching to euro-zone-listed multinationals might be approaching the lows of the cycle.

For cautious investors however, the most suitable portfolio stance is best described as aggressively defensive, currently holding those assets which provide the greatest real protection to capital in the current environment - avoiding the bear traps that high-yield stock and corporate bond portfolios represent at this time. For investors unable to tolerate a permanent and significant loss of capital, the costs or downside risks of a wrong call are too expensive to contemplate and they should avoid betting the ranch on recovery, whatever their personal opinions of how benign the inter-seasonal shift may be.

Asset allocation passivity

The change from freezing deflation to sunny growth will necessarily be dramatic. Successful investors not only need to have a good strategic compass and an understanding of appropriate risk exposure, they also need to be responsive - adapting to the rapidly changing landscape. We often cite the example of William Henry Harrison, who enjoyed the shortest tenure of the office of President of the United States of America. Harrison was widely believed to have caught his death of pneumonia because of the lack of an overcoat and hat on the event of his inauguration during a very cold day in early March (when he gave the longest presidential inauguration speech on record). Prior to that day, the weather had been temperate for the time of year. Harrison tragically didn't adapt to the changed conditions.

Therefore, while investors need to understand long-term strategic issues and appropriate portfolios, they also need to monitor daily economic signals within a very disciplined and focused process. Aggressive investors must be poised to take corrective action and protect capital if economic temperatures fall further, frost permeates and the onset of springtime is delayed. If the overall picture remains so confused and unclear, it's vital not to get led astray by misreading the daily flow of news, data and information. One unseasonably warmer day or week in mid-December doesn't signal the end of winter - anyone throwing away their coat and hat will be as badly caught out by the weather as President Harrison was.

Short-term optimism should be tempered by the memory that in 1931 many commentators called an end to the Great Depression - about a decade and a half prematurely!

Even with a strategic compass and suitable risk-profiling, passive investors will be mere spectators in the highest octane economic event of the 21st century; active, adaptive investors of all risk profiles who read the runes well will be spectacular winners.

The three avoidable mistakes are:

A lack of a strategy to accommodate the change from deflationary winter to the green shoots of springtime growth.

Allocation to assets inappropriate to individual risk appetite.

Failure to adapt to the ever-changing economic landscape.

Just looking at equities, we expect that by the end of the spring cycle both the SET and the SP500 should be trading in a range of between 4,000-5,000. However, before we get there, it's entirely possible that both will be back below 700. This will create fantastic opportunities for investors who can avoid the three mistakes. Sadly, our expectation is that the vast majority of investors will, just like William Henry Harrison, pay a heavy price for being unprepared. The vast majority will make at least one of these mistakes and most investors will make all three. The frustrating thing is just how readily they can all be avoided.

Paul Gambles is managing partner and chief investment officer of MBMG Group

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