11 May 2016
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After March’s stellar returns, global share markets were more subdued in April, but still broadly positive overall. Australian shares were the month’s standout, rising by more than 3% thanks to a mining sector bounce driven by increased commodity prices.
The bounce in share markets will not be welcome news for those who switched to cash and other defensive assets early in the year. Markets have a habit of catching people by surprise, and that’s exactly why timing the market is a particularly hazardous exercise. But this doesn’t stop many from trying, including UniSuper members who regularly switch investment options to try and boost their savings. In this month’s update, we explore the merits—or otherwise—of frequent switching.
Performance of key markets
||3 Years p.a.
||5 years p.a.
|Australian shares (S&P/ASX 300)
|US shares (S&P 500) in US dollars
|US shares (S&P 500) in Australian dollars
|Asian shares (MSCI All Country Asia ex-Japan)
|Australian dollar (AUD/USD)
|Australian Fixed Interest (Bloomberg Composite)
|Cash (Bloomberg Bank Bill)
Returns are for periods to 30 April 2016. Past performance is not an indication of future performance.
*Returns relate to our Accumulation (not Pension) investment options and are published after fund taxes and investment expenses, other than account-based fees.
Did you know?
- In 2015 UniSuper members switched $2.8 billion between investment options.
- While the number of members who switch is less than 5% of our membership, those who do switch tend to do so frequently.
- Members who switch are disproportionately represented in the 50 – 70 year age bracket, when lifecycle decisions are made and balances are close to their peak.
- The record number of switches for a single member over a five-year period was 240, and this was at a time when only one switch was permitted per week!
- After only 6 moves in a game of chess, there are 9,132,484 possible combinations.
To switch or not to switch?
Investment switches are generally driven by one of two key things: (a) changes in life circumstances such as retirement or redundancy, or (b) in response to, or anticipation of, market movements.
Switching options in response to changed life circumstances is generally a legitimate exercise—particularly when the decision is based on sound financial advice.
However, some people switch more than once a year, presumably with the aim of “timing” the market. These are often members who switch to growth options in anticipation of a rally in shares or property, or switch to defensive options when they expect share market falls.
But timing the market is a particularly hazardous venture—even for the most seasoned investment professionals. We occasionally read about fabulous fortunes made by people trading markets for a living, but they generally make the news because they are an exception to the rule. As an example, let’s look at the performance of macro hedge funds as a group. This is a particular category of hedge fund that make their profits (or losses, as it were) by taking short-term bets on various markets. While they are often thought about as the “smartest guys in the room”, the statistics don’t quite support such a flattering label. Graph 1 shows the performance of the macro hedge fund index (blue line) against the performance of the US share market (green line) which is accessible to the common investor via a simple index fund.
Graph 1: Macro hedge fund performance
The underperformance by those attempting to time the markets shouldn’t come as a surprise given the body of academic research on the subject. Isaac Newton summed it up pretty well after his personal wealth took a hit from a mistimed foray into the stock market. The great scientist reportedly said “I can calculate the motion of heavenly bodies, but not the madness of people”.
Is switching within UniSuper adding or detracting value for members?
Graph 2: Switches into growth and defensive investment options
Graph 2 shows the aggregate switching behaviour of UniSuper members (blue bars), against the movement in the Australian stock market (green line). Blue bars below the horizontal line denote switching out of growth options (which are heavily weighted to higher risk assets such as shares) and into defensive options (which are heavily weighted to cash and bonds). It’s important to note that the graph does not distinguish between those who switch due to a change in circumstances and those attempting to time the market. Regardless, at face value it appears that those who do switch don’t get their timing quite right in aggregate. It seems that UniSuper members are just as likely to succumb to the foibles of human nature that make us prone to poor short-term trading decisions. One of these foibles is the tendency to be most fearful when the market is close to a bottom and greedy after the market has rallied.
For example, the graph shows:
- The steep rallies in the share market following the GFC in early 2009—and after the Euro-debt crisis from late 2012—were preceded by heavy switching activity out of growth and into defensive options.
- Heavy switching into growth options (late 2010 and 2012) occurred well after the stock market had started to rally.
Switching activity over the past six months has been in favour of defensive assets, and particularly so over January and February when global markets were taking fright from the collapse in oil prices. Based on historical experience, is this a harbinger of a near-term rally in share prices? Short-term trading would be such an easy game if history always repeated, but it doesn’t. The bottom line is: those who took fright during the GFC and European debt crisis by switching their funds to defensive options, and didn’t switch back, are now much worse off than those who simply remained in the Balanced option.
The decision to move to cash and stay in cash as the stock market “climbs a wall of worry” is quite common—even among professional asset managers—due to a behavioural foible known as confirmation bias. Moving to cash is usually predicated on the expectation of bad news being announced and, when it does, confirms the worst held fears, which in turn encourages even more hoarding of cash. In this environment any good news is dismissed as an anomaly, and the investor misses the ensuing rally.
Applying a bit more science to the topic
A member’s decision to switch between options can add or detract value. Value is added when the member’s balance increases, grows more quickly, or declines more slowly than it would have without switching. Conversely, value is detracted when the member’s balance decreases, grows more slowly, or declines more quickly than it otherwise would have without the decision to switch.
Using some sophisticated modelling techniques (beyond the scope of this article to discuss), we attempted to quantify the value added or detracted by member switching. The analysis was conducted over a five-year period, and it only included members who switched more than five times in five years to capture the “market timers”.
The results of the analysis are not very encouraging for those who want to back themselves, with 61 in 100 members detracting value as a result of their decisions to switch, causing a direct reduction to their life savings. The table below shows the estimated value detracted by switching:
|Proportion of “frequent switching” members
||Value detracted over five years
61 in 100
More than 0%
29 in 100
More than 5% (~1%p.a.)
12 in 100
More than 10% (~2%p.a.)
1 in 100
More than 20% (~3.5%p.a.)
Of course a more optimistic interpretation of the numbers is that 39 in 100 members actually added value by switching.
Yet another behavioural foible is optimism bias. Ask a large group of people if they think they are better than the average driver and the vast majority will probably say yes, even though statistically there will be an even spread between below- and above-average drivers. The same applies to short-term traders who think they are better than average.
The ability of any member to add value through switching is a blend of skill and luck. This is important to understand; a member with skill can be expected to continue to add value through their switching decisions into the future. In contrast, a member without skill is dependent on luck and is essentially gambling with their life savings.
We recommend seeking financial advice from a qualified adviser before making any changes to your investment strategy. You can learn more about our investment options at unisuper.com.au, where you can also access our Investment choice tool to model changes to your portfolio.
Exploring this further, we used a sophisticated technique to assess whether the 39 in 100 members who added value were lucky or skilful. The larger the margin over and above what could be expected from luck, the more the evidence was pointing to skill. The analysis indicated that two in 100 members who switch frequently showed moderate to strong evidence of skill. The bottom line is that if you are inclined to time the market on a frequent basis the fundamental question you need to address is “am I feeling lucky?” It may not be the most prudent way of managing your life savings.
Let’s finish by looking at how switching can be compared to a game of chess. Some of you may be wondering how chess is relevant to the topic of market timing. Let’s assume that each of the 32 pieces on a chess board represents a variable that can move the market in the short term (and in reality there are more variables). After only six moves there are 9,132,484 possible combinations. Still want to play?
This is not intended to be an endorsement of any of the listed securities named above for inclusion in personal portfolios. The above material reflects UniSuper’s view at a particular point in time having regard to factors specific to UniSuper and its overall investment objectives and strategies.
Past performance is not an indicator of future performance. This information is of a general nature only and may include general advice. It has been prepared without taking into account your individual objectives, financial situation or needs. UniSuper’s investment strategies will not necessarily be appropriate for other investors. Before making any decision in relation to your UniSuper membership, you should consider your personal circumstances, the relevant product disclosure statement for your membership category and whether to consult a qualified financial adviser. This information is current as at 10 May 2016.