What are you holding?

Key points

• As economic growth slows, inflation remains high, and interest rates head higher, navigating the implications of macro news and market sentiment can be difficult
• Understanding the individual stocks held in your portfolio can be important in not being swayed too much by short-term news flow
• Well-run companies tend to provide a superior long-term return, irrespective of the monthly changes in economic data
• Having a well-diversified investment portfolio that spans asset classes, sectors, and quality companies, could better protect from the effects of short-term volatility

Against a complex global macro environment, thinking about portfolios at the micro level may help investors to keep focused on the long term.

The global economy is at a delicate juncture, with the risk of a recession rising, inflationary pressures, and central banks with their foot on the rate-rise accelerator. Navigating this as an investor can be challenging.

Have we reached the bottom?

With financial markets and sentiment on edge with each major economic data release, all eyes are on how policymakers will best steer the ship.

If such attention is being given to macro news, individual investors may conclude that they too should be taking such data into account when making investment decisions. Questions such as, 'Have we reached the bottom?', 'Where will the market be in six months?', and 'How will the next inflation reading affect the market?' are valid ones to ask. That said, they can lead investors down the path of market timing, which can be a costly and futile endeavour.

The costs of being too informed

Given that over shorter horizons investments are often more volatile, focusing on the short term might make investing seem riskier, which can lead to actions and behaviours which are unhelpful in the long term.

These include the costs of inaction, as investors await certain signals, and attempts to time entry into or exit from markets. The emotional impact of this can also exacerbate behavioural biases, potentially impairing decision-making.

While the idea of paying less attention to the macro environment may feel counterintuitive, we pose a simple question which may help with the exercise – what are you holding in your investment portfolio?

What are you holding?

While much of the discussion is about the market, we remind investors that your portfolio is not ‘the market’. It can be helpful to think about which individual equities you hold. Instead of viewing it as stocks which are highly volatile and subject to swings in sentiment and the macro environment, it could be worth considering what exactly you hold at the micro level.

When your portfolio includes equities, you are holding shares in a selection of individual companies (in a professionally advised or managed portfolio, one would expect these to be better-run individual companies).

While the macro environment is important, as that is the one in which these companies operate, it’s worth remembering that a particularly unfavourable data release will not stop a strong and well-run company overnight from being well-managed (and likewise in the other direction).

The risk for investors during falling markets is a focus on the short term and a feeling of needing to gain exposure to whatever part of the market has the most momentum. This can result in investors selling structural winners only to buy structural losers.

The importance of diversification

There can be times when certain sectors fall in and out of favour due to a macro changes. For example, concerns over rising inflation and interest rates negatively affecting tech companies towards the end of 2021, or the war in Ukraine lifting energy company earnings in 2022.

Tactical positioning in response to such rotations in the short term can help to enhance returns, but attempting to catch this consistently is simply trying to time the market.

Over the long term, we would expect the best-run companies to deliver outsized returns across the business cycle. As such, when building a portfolio, we believe that investors would be best-placed in having core holdings that can be held throughout various market conditions. 

Having a well-diversified investment portfolio that spans asset classes, sectors, and quality companies can better protect from the effects of short-term volatility due to the correlations between asset classes. It may also insulate an investor from being caught up in the emotions sparked by portfolio volatility. Together, these can provide a solid foundation for protecting and growing your wealth.

Less information can lead to better decision-making

The idea of paying less, and not more, attention to news that could hit performance may seem counterintuitive to many investors.

The field of behavioural finance, however, shows that more information may not necessarily improve decision-making. News cycles are far shorter than the long-term investor’s investment horizon. Meanwhile, acting based on short-term signals can be unhelpful.

Short-term market volatility is a near permanent feature of investing in equities. However, despite each of these sell-offs feeling scary, the gradual and persistent improvement in company productivity, profitability, and growth has produced returns for patient investors over the passage of time.

When it comes to news flow, investors should be paying attention to the data and factors that will have a bearing on long-term investment performance. Much of the short-term flow is just noise.

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