17 Nov Financial Advice: It Takes Conviction To Succeed
Investing beyond short-termism
Behavioural finance has uncovered a wealth of explanations for why individuals make poor investment decisions. One such theory is Framing: If the same facts were presented with a different approach the decision reached by the investor would likely be different.
We were introduced to short-termism by UBS’ Managing Director and Head of Australian Equities, Jakov Maleš. Short-termism is how many investors focus on short-term trends which lead to poor investment outcomes. Many people avoid investing in equity markets after having a bad financial experience such as negative returns or loss on an individual stock or a negative perception like the Global Financial Crisis (GFC).The individual bases their financial decisions on their most recent experience, rather than considering a more complete information set that incorporates the longer-term performance benefits from investing in equities or a diversified portfolio. This is a classic case of short-termism. GFC type events can dent returns and confidence but they are rare, temporary and can provide great buying opportunities. Hiring a financial planner can help remedy short-termism as we can help you make sound financial decisions that work with your income.
This blog goes through three different examples of short-termism to help you realise the potential financial benefits and pitfalls.
Origin Energy: Stock Specific Short-termism
A classic example of short-termism by investors is Origin Energy, an energy retailer. The market appears fixated on short-term headwinds, rather than long term value. Origin Energy’s current earnings have been subdued due to intensive retail competition and a series of negative one-offs such as elevated wholesale pricing due to outages, regulatory impacts and hedging losses. The market has extrapolated these temporary hits as permanent.
While we also value the near term declines in earnings, our analysis suggests such one-offs are likely to reverse and over the next three to five years, retail pricing will normalise and margins will improve.
Also, the company should benefit from its LNG projects going into production and there is a real possibility of energy deregulation in NSW and Queensland with notable impacts on future cash flows. By considering the impact of the short-term headwinds in the context of the complete picture (i.e. longer-term industry trends and company-specific projects), we can make superior investment decisions.
Insurance Sector: Sector Short-termism
It is not just individual companies who fall victim to short-termism. Entire sectors can too. Let’s consider the insurance sector. The share prices of general insurance companies typically sell-off on the back of catastrophes as the market extrapolates the impact of policy payments.
This was most certainly the case when Australia and New Zealand were beset by a series of natural disasters beginning with the Queensland floods in December 2010, followed months later by the horrific earthquake in Christchurch among other things.
Our long term investment thesis was that these events would help trigger significant premium rate rises over the medium term, in what was already a hardening market as capacity was withdrawn and prices raised to reflect greater risks.
We increased our overweight positions in Suncorp and Insurance Australia Group, the two companies with the greatest exposure to the Australian and New Zealand general insurance market and that looked to be trading at a discount to the market.
As expected, personal and home building rate premium increases occurred and Suncorp and Insurance Australia Group outperformed the market by around 40% and 80% respectively over the past two years.
Iron: Commodity outlook short-termism
Using a commodity as another example, iron ore is a key market with considerable debate regarding the short term versus longer-term outlook.
Iron ore supply is consolidated and dominated by Australians and a big Brazilian company. But it is a commodity and supply will increase by 20% in the near term. This is significant in any industry but a particular threat in commodity markets. What’s worse is that these volumes are being delivered by the lowest cost producers in the curve.
This is important because prices in commodity markets revert to levels related to the marginal cost of production. BHP Billiton, Rio Tinto and Fortescue Metals all have expansion plans that will reduce this level to below $90, well below current prices of over $130.
Just as prices overshoot on the upside, so they do on the downside and as China’s property market growth rate continues to fall, the outlook for iron ore is not good. Share prices continue to factor in more of the current iron price than the long term normal, contrarily we don’t own a single share in any pure iron ore play including Rio Tinto and Fortescue.
Financial Advice: Have a fundamental value-based philosophy
Share prices may indeed be impacted by short term trends, but these effects are often short-lived. The ability to form a longer-term view and the discipline to keep on track leads to a more predictable outcome.
UBS’s fundamental value-based philosophy is what differentiates us. We have conviction in our methodical, calm and rational approach to assessing the impact of short term trends and in our ability to recognise buying opportunities.
If you are considering investing, make sure to receive financial advice first. Our financial planners at Master Your Money Now have experience in helping individuals find the right market to invest in and the right financial solution for their needs. If this is a topic that you would like to discuss in more detail, please go to www.MasterYourMoneyNow.com.au/getstarted to book in your complimentary 30-minute strategy session.
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Disclaimer: This information is general information only. You should consider the appropriateness of this information with regards to your objectives, financial situation and needs. Past performance does not guarantee future returns.
Chris Carlin is an Authorised Representative (No. 1235031 for financial services and No. 514748 for credit) and Master Your Money Now Pty Ltd ABN 65 627 229 681 is a Corporate Authorised Representative (No. 1265677 for financial services and No. 514747 for credit) of Infocus Securities Australia Pty Ltd ABN 47 097 797 049 AFSL and Australian Credit Licence No. 236523