PORTFOLIO INSIGHTS
Investment risk management insights
for professional financial advisers
January 2017
Our prediction for 2017: short-term return
forecasting remains a fool’s game
The new year is well underway and with
it has come the usual flurry of expert
predictions. So, in that great tradition, Innova
Asset Management unveils its 2017 forecast:
we truly don’t know what’s going to happen!
Manage risk, don’t chase returns
But that’s ok – nobody else does either. So why listen
to them?
Fortunately, building successful portfolios isn’t about
predicting the best performing asset class over the
short term. It’s about combining a range of assets
that will perform differently through various economic
environments to deliver sustainable long-term returns
which meet investors’ requirements..
Last year’s shock Brexit vote and Trump’s US election
victory were only surprises because ‘expert’ opinion
was so broadly accepted as fact. It’s not the first time
that experts’ powers of prediction have shown to be
false (the Soviet collapse, the Y2K bug, the GFC) and it
certainly won’t be the last.
Several studies have underlined the folly of forecasting
by pollsters, economists, investment analysts – and
even fund managers.
For example, consultant William A. Sherden analysed
the track records of experts across meteorology,
economics, investments, technology assessment,
demography, futurology, and organisational planning
in The Fortune Sellers: The Big Business of Buying and
Selling Predictions – and found that none consistently
made accurate forecasts.
Twenty years after his book was first published, little
has changed.
So what exactly can we know and what should investors
base their decisions on?
Investors want to know where they can make money.
So-called experts then meet this demand by attempting
to pick winners (we rarely see an assessment of past
predictions unless they’re right).
While nobody can predict investment returns, risk and
correlations with absolute certainty – or they’d be able
to run a perfect portfolio – risk is the most knowable
component. Risk is what can blow up a portfolio and
derail returns.
We define risk in multiple ways: the likelihood of losing
money, the average and maximum magnitude of those
losses, and volatility – all contributing to the risk of a
client not achieving their goals.
Investors will more likely win over the long term by
losing less. Those who have seen an investment
halve in value have already experienced this: they
know they then need to post a 100 per cent return
just to break even.
Risk presents itself in many forms and can crystallise
under different scenarios – and this is what investors
must focus on.
PORTFOLIO INSIGHTS
January 2017 – Our prediction for 2017: short-term return forecasting
remains a fool’s game
Innova Asset Management Pty Ltd
2
The risks we face today
A strong portfolio needs to be built to withstand risk
and allow returns to compound over time.
Investors have a right to be sceptical. They are facing
an array of potential new risks on the horizon and know
that experts have failed to predict previous crises –
and will fail again.
Forecasts are often wrong
IMF World Real GDP Forecasts (% change, year-over-year)
Percent change, year-over-year
5.5%
5.0%
Forecast Sept 2011
Actual Growth
Forecast Oct 2012
4.5%
Forecast Oct 2013
But while the actual trigger events behind each historical
crisis may differ, stretched valuations have been a
consistent warning signal of rising risk.
Forecast
Oct 2014
4.0%
Forecast
Oct 2015
3.5%
Forecast Oct 2016
US equity valuations have only been this extreme
at three other times in history 1 : prior to the Great
Depression, the tech-wreck, and the GFC. That’s not a
prediction – but it is a clear warning sign and strongly
suggests that future long term returns will be pretty poor
from here.
Markets have been acting under one dominant scenario
incorporating all of the potential upside of a Trump
presidency. However, it remains to be seen how much
of what he said during the election campaign he meant,
how much he will want to now implement, and how
much he will be able to implement.
A wiser approach is to view the full range of potential
risk scenarios and build a portfolio with a range of assets
driven by different risk factors.
For example, a portfolio dominated by equities and
bonds will perform poorly if inflation rises quickly
because they share this common risk factor. However,
rising inflation is likely to be positive for assets such as
inflation-linked bonds, gold or commodities (assuming
starting valuations are reasonable), and assets such as
floating-rate corporate bonds can provide protection
against a rising rate environment.
Investors can incorporate these assets into their
portfolios or into related strategies such as managed
futures or volatility trading strategies. Other baseline risk
scenarios could be falling economic growth, deflation or
God forbid a combination of both.
Unfortunately most ‘balanced’ funds still take a simplistic
approach to diversification and remain dominated by
equities (60-70 per cent). Equities tend to suffer under
3.0%
2.5%
2010
2012
2014
2016
2018
2020
Source: International Monetary Fund (IMF)
multiple scenarios: recessions or periods of high inflation
and deflation. This is the key reason balanced funds
posted significant double-digit losses during the GFC.
Strong portfolios require effective risk management
based on true diversification – not predictions which
have the accuracy of tossing a coin.
1
Based on the Cyclically Adjusted Price Earnings ratio, or CAPE
PORTFOLIO INSIGHTS
January 2017 – Our prediction for 2017: short-term return forecasting
remains a fool’s game
Innova Asset Management Pty Ltd
3
Important Information
This document has been prepared by Innova Asset
Management Pty Ltd, ABN 99 141 597 104, which is a
Corporate Authorised Representative of Fortnum Private
Wealth Pty Ltd, AFSL 357306.
Dan Miles is Managing
Director of Innova Asset
Management. Innova is a
boutique asset consultant
that advises on and
implements asset selection
and allocation, trade and
execution, and manager
selection for the Innova
Managed Accounts.
The performance reporting in this document is a
representation only. Innova Asset Management has
used a calculation methodology to simulate the
performance of the relevant investment program
as constructed by Innova Asset Management since
commencement, net of all fees and commissions at
the Fund/security level, and assumes monthly and
quarterly rebalancing.
Simulated performance does not reflect the performance
of any specific account; each account will have its own
unique performance history, potentially with varied
methods of implementation, fee and tax structures.
Therefore, an individual account and a particular trading
portfolio may have realised varied results from what the
simulated performance indicates.
This report is based on the specified model portfolio
without change. Other model portfolio results will vary.
This report does not apply to the results of any other
model portfolio.
Innova Asset Management Pty Ltd
ACN 141 597 104
3/36 Bydown Street
P.O. Box 1899
Neutral Bay NSW 2089
Phone: 02 9346 4656
Fax: 02 9953 5668
www.innovaam.com.au
This is not an offer of securities or financial products
nor is it financial product advice. This document has
been prepared without taking into account your
individual objectives, financial situation or needs. Neither
Innova Asset Management nor Fortnum Private Wealth
guarantees the performance of the Investment Program
or the repayment of capital invested. Investments
are subject to investment risk, including possible
delays in repayments and loss of income and principal
invested. Past performance is not a reliable indicator
of future results.
Although non-Fund specific information has been
prepared from sources believed to be reliable, we offer
no guarantees as to its accuracy or completeness.
Any performance numbers are not promises of future
performance and are not guaranteed. Opinions
expressed are valid at the date this document was
published and may change. All dollars are Australian
dollars unless otherwise specified.