Diversify, Diversify, Diversify
Put the odds in your favour by knowing what you don't know.
The U.S. presidential contest between Hillary Clinton and Donald Trump has certainly been a spectacle over the past months. Our clients have been asking us what all of it means for their investments. If Donald Trump becomes President what will happen to their portfolios? How much is a Clinton win already priced into markets? And what are we doing about it?
While these are all valid questions, the U.S. election illustrates a much broader and recurring issue for investors: how to position their portfolios for success when faced with uncertain macroeconomic events.
This is an important consideration because investors are often faced with uncertain events. Whether it’s oil price shocks, central banks making interest rate decisions, or elections and referendums, investors generally have incomplete information on key matters.
To understand how we approach events like the U.S. election, there are three principles to consider:
- Invest when you have an edge;
- Diversify otherwise;
- Realize that most of the time you don’t have an edge.
In investing, it is not enough to be “right”—you also want an edge. An edge occurs when you have an insight that is different from the collective view of the market. It happens when you have information that gives you confidence that the odds displayed in the market are wrong. In other words, you believe YOUR view of the odds to be more accurate.
With macroeconomic events, we do look for an edge, it’s just harder to find than at the micro, or individual company, level. The inherent complexity of macro events often make them and their consequences difficult, if not impossible, to predict in advance. And when we do find an edge, it often relates to the downside, i.e., we gain an advantage in figuring out what NOT to do.
Returning to the election, current polls suggest that Clinton is ahead of Trump. And yet who among us can say with conviction that Clinton will win? This is simply not something one can say with certainty. Anyone who “knows for sure” how the election will be decided might look at Brexit.
We certainly don’t believe we have any special information on the way the U.S. election will unfold or the impact it will have—at least not in a way that differs from the market. Therefore, we have no edge. This implies that making a one-way bet in this case would not be an advisable strategy. So instead, we opt to diversify.
With diversification you hold assets that should perform differently under different scenarios. With this strategy, you have not positioned yourself for one outcome only; it requires giving up some upside in order to protect most (but not all) of the downside. At Mawer, we realize that, regardless of who becomes President in 2016, negative repercussions are a possibility, but these are likely to be something that diversified portfolios built of solid, wealth-creating companies can withstand.