The investment risks of unintended consequences

Bad things will inevitably happen — just don’t overreact to them

Simon Edelsten

Sport/Football, League Division One, The City Ground, England, 27th August 1977, Nottingham Forest v Derby County, Nottingham Forest Manager Brian Clough is pictured giving instructions from the dug-out (Photo by Popperfoto via Getty Images/Getty Images)
Brian Clough, manager of Nottingham Forest, in 1977, was known for his forthrightness © Getty


A nervous TV reporter once approached legendary Nottingham Forest football manager Brian Clough and hesitantly asked: “Can we have a couple of words for the programme, Brian?”

The normally belligerent Clough nodded with unusual acquiescence. The camera was readied, the microphone was switched on. Clough looked into the lens, smiled and delivered — as requested — a couple of words. The second was “off”.

He then strode off, roaring with laughter. The lesson: be careful what you wish for — you might just get it.

Over 35 years in the City, I cannot think of a time when we have been more at risk from the unintended consequences of the things we want to happen.

The obvious starting point is politics. The issue of our relationship with the EU has been so mishandled for so long that any outcome — remain, soft Brexit, no-deal Brexit — should now come with one of those bits of paper that are scrunched up in boxes of prescription tablets listing potential side-effects ranging from diarrhoea to death.

Many of us will welcome less restrained government spending, but we should also be wary of governments running up huge debts. It increases the likelihood of inflation, which is the easiest way to reduce those debts.

I have three thoughts to share with fellow investors who, understandably anxious as events develop, may be fretting about what to do to safeguard their savings.

The first is not to lose your trust in companies. The most recent data from the Investment Association shows that investors took out nearly £1.7bn from equity funds in the UK in July alone. Where is that money going? I fear a large proportion is being sunk into cash accounts. These are already yielding a negative return when you take inflation into account, and could become much worse if inflation suddenly shoots up.

The best companies have survived world wars. They have also withstood inflation at 15 per cent in the UK and much higher rates in some countries in which they trade. They have coped with interest rates at 15 per cent and governments of every hue.

This is because good companies adapt to the environment around them. They survive because they are providing goods and services that we need. You may lose money over the short term, but history suggests that over the long term, equities are best placed to grow your wealth.

Second, now is not the time to deviate from the basics of good investment — buy quality and diversify. Volatility can generate bargains, not all of them genuine. Do not be tempted by a company because it is trading on a quarter of the share price it was two years ago or because it has just endured a big sell-off on bad news and you are assuming the market is overreacting. You may be right, but examine the circumstances carefully and ask: “Could it get worse?” The answer is usually yes — and too often it does.

One of the reasons I run a global equity fund is that it offers more options to avoid risks. I can nearly always find a high-quality, resilient company somewhere that is on a fair valuation.

Think globally, be sensible in your ambitions and you open up a world of opportunities to protect and sustainably grow your wealth.

Diversification matters, too. There are some excellent active managers out there, but a good way to assess the risks they are taking is to check what proportion of their fund is taken by their top 10 companies. If it is edging towards 50 per cent, then they are taking some big bets (for the record, this figure is under 23 per cent in the Artemis funds I manage). Money is like manure, as the adage goes — so spread it.

One of the advantages of passive funds is that they can be an easy way to own a big range of companies, but be aware that they can also hold hidden pockets of concentration risk. Shell, HSBC and BP can make up 24 per cent of the FTSE 100. Passive funds also invest without discrimination at a time when I think it will pay to be more discerning.

Finally, I started by warning investors to be careful what they wished for. I end by cautioning you to be careful of what you fear most.

It is human instinct to be most worried about the things most likely to happen — like a 20 per cent stock market fall in the next two or three years. Yes, that will probably happen, but markets recover quickly and you can lose more money trying to time them than staying put.

Behavioural psychology has shown how bad humans are at taking into account low-probability events that come with very high costs.

The provision BP made for environmental damage was a tiny fraction of the $65bn the Deepwater Horizon disaster is estimated to have cost it.

In the North Sea, there are several hundred oil rigs that will need to be decommissioned in the next 30 years. What are the risks of a Deepwater Horizon in our own front yard? One of the advantages of sustainable investments is that you avoid the investment risks of such an event — one reason why I simply will not invest in oil. Similarly, I avoid tobacco stocks — killing your customers seems a rather unsustainable business strategy.

It is why I avoid certain countries, too. Russia is a good example. There is a small likelihood of assets being appropriated but a great risk you will lose everything if it happens.

You cannot avoid unintended consequences, you cannot avoid market turmoil and you cannot completely avoid unlikely things happening. But you can reduce their impact by not overreacting in the wake of negative events and by sticking to good principles beforehand — diversifying and investing with patience and prudence.



Simon Edelsten is the manager of the Artemis Global Select Fund and the Mid Wynd Investment Trust. The views expressed are personal.

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