Introduction
There's a common phrase, "You wait for ages for a bus, and then two come along together", and the same could be true of today's client question. There hadn't been a response to a client question since our analysis of Michael Burry's trades in sunny August, and now this is the second of two blog articles today. Similar to the "Why should portfolios be rebalanced" client question (related to poor bond performance), this asks whether we should continue to hold some of the equity funds that have been doing less well in recent years.
The Portfolio
The client holds three equity funds (along with bond funds) in their portfolio. To give some background on the funds in question:
Fund A: Emerging markets (all nine cells in style box below)
Fund B: Developed markets containing smaller companies with more of a value tilt (bottom left cell)
Fund C: Developed markets, large and medium (top two rows)
(Note: the above style box was taken from Noel's book Planning for Retirement: Your Guide to Financial Freedom).
The client’s point was that over the last five years, Fund C had done very well vs Fund A and B, so what was the point of Funds A and B? Why not sell A and B and invest 100% of the portfolio's equity component in Fund C? To analyse and attempt to answer this question, we will use the following indices to (broadly) represent the funds in question:
Fund A: MSCI Emerging Markets Index (MEMI)
Fund B: MSCI World Small Value Index (MWSVI)
Fund C: MSCI World Index (MWI)
The last five years
If we look at performance over the last five years, it's completely understandable why the client asked the question, as MWI has far outperformed the MWSVI and MEMI, returning over 50% vs 23.7% for MWSVI and 14% for MEMI.
2000-2010 - The "lost decade"
However, we are fortunate to have a lot of historical data to analyse that goes back a lot further than the last five years. Let's investigate the period from 2000-2010.
We can see how the situations are reversed, with the MWI index posting negative returns over a whole decade, and that's before taking inflation into account! In contrast, MEMI returned almost 10% annually during the decade, with MWSVI not far behind. Some referred to this period as the "lost decade", where some parts of the market suffered in the aftermath of the .com bubble before being hit a few years later by the Global Financial Crisis.
2022 - inflation worries
It's also worth looking at 2022, where markets feared significant inflation on the horizon (and a potential rerun of the 1970s). We can see here that the MWSVI was relatively unimpacted.
1999-2023
We have around 24 years of data to analyse in this particular dataset. If we take the whole range, we can see how the indices have performed relative to each other.
(Of course, starting points matter, and it could be argued that the MWI peaked in 1999, just before the .com bubble burst.)
Real-world sustainability
Let's look at how these portfolio choices impact retirement income sustainability in the real world. We will use Timeline to analyse the following:
Portfolio 1: 100% MWI.
Portfolio 2:
60% MWI.
20% Developed markets, small-cap value (similar to MWSVI).
20% Emerging markets, with slight tilts to small cap value (similar to MEMI).
For portfolio 1, we can see that in the worst-case scenario (where we focus a lot of our attention when we plan clients' retirement - few are happy to face the prospect of running out of money), the portfolio is exhausted when the client is around 79 years old. This worst period had the client retiring in the late 1960s when our theoretical retiree had to endure the inflationary period of the 1970s early in their retirement.
The worst case for portfolio 2 shows the retiree having a few more years before his fund ran out.
It's worth noting that this analysis is deliberately simplified (for more in-depth analysis, we recommend reading our Is the 4% safe withdrawal rate still valid for UK retirees series), but hopefully emphasises the importance of diversification and not putting all your eggs in one basket.
Conclusion
The important takeaway here is to focus on the long term. Our clients will hopefully have a multi-decade retirement, and our retirement portfolios are built using around a century of historical market data. Five years may feel like a long time, especially if you are frequently analysing performances between asset classes/funds. However, in investing terms, we consider this to be short-term and not a sufficiently long enough period to make decisions around asset and fund allocation in a client's portfolio.
Next steps
If you want to build a robust retirement plan that copes with various market and investing cycles, please get in touch with us.
About us
The team at Pyrford Financial Planning are highly qualified Independent Financial Advisers based in Weybridge, Surrey. We specialise in retirement planning and provide pension, investment, and inheritance tax advice.
Our office telephone number is 01932 645150.
Our address is No 5 The Heights Weybridge KT13 0NY.
Please note: This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.
Although best efforts are made to ensure all information is accurate, you should not rely on this blog for your personal situation or planning.
The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.