Putting more into the stock market while the country is on the brink of national health crisis and the economy is on lockdown may, understandably, feel like the last thing you want to do. Governments and central banks are implementing ‘whatever it takes’ strategies to prevent an immediate recession turning into an outright depression and entire industries in the UK and parts of Europe and the US have been shut down. We don’t know how long it will take for western countries to get Covid-19 under control, or how long it will take for economies to recover.
But what we do know is that markets are significantly cheaper than they were last month. The Dow Jones Industrial Average, Euro Stoxx 50 and FTSE 100 have all shed over a third of their value since their 2020 peaks in February. The MSCI World All Cap index dropped 27 per cent between 20 February and 23 March. For long-term investors, this should present attractive growth opportunities. And with companies racing to produce a vaccine for coronavirus in record time and infection rates falling in worst-hit countries such as China and Italy, there are reasons to be optimistic.
“We’ve seen almighty pullbacks from the highs of late January and early February and there may be more to trim off the market but we will get through this,” says Andy Parsons, head of investments at the share centre. “Given the unbelievable measures the government has put in place there is reassurance that companies will be supported and prices will come back up.”
The benefits of dripping into markets
Timing markets is extremely difficult and no one knows when the current market downturn is going to bottom out. Indeed, if it was certain that the markets still had more to fall - they would already be at a lower price. While it may take many months for stock markets to pick up, if you have spare money to invest you might want to consider starting to phase money in now so you don’t lose out on gains when the markets turn.
By investing regularly, such as once a month, in volatile markets you should benefit from pound cost averaging. This means when markets fall you are buying more shares at a lower price. For example, let’s say you invest £1,000 per month in an investment trust. If the share price is £5 to start with you will get 200 shares. If the share price has dropped to £4 the following month, you will get 250 shares.
David Miller, executive director at wealth manager Quilter Cheviot, says it is “far better” to start investing as markets are falling and investors benefit from pound cost averaging because it “forces you to buy when markets are down.” He adds that regular investing is a “good discipline” and you should only invest if you are prepared for further short term losses. “You almost certainly have to buy on the way down if you are going to pick up the full recovery on the way through.”
Another technique for entering markets is value averaging, which is slightly more nuanced as you adjust how much you invest each month, putting in more when prices are lower. With this technique you set a target growth rate for your portfolio each month, then adjust next month’s contribution according to the relative gain or shortfall made on the original investment value. For example, suppose your account has the value of £10,000 and you want it to increase by £1,000 every month. If after the first month the account is worth £10,100, you would add £900 to push the value up to £11,000. You keep ensuring that the account rises by £1,000 per month, and as you will put more money in when markets fall you will buy more of your shares at a lower price.
A benefit to value averaging is that you are partly shielded from paying too much for stocks when the market is hot. Similar to pound cost averaging you buy more shares when markets fall, but the effect is more pronounced. A drawback is that you do not know how much you will have to put in every month, so it requires more attention than dripping in regular installments which can be set up to go straight out of your account, as if it were a direct debit. If markets continue to rise you may also miss out on gains as you will be holding money back.
Over the longer term holding capital back from your investment portfolio is “probably not a good idea,” says Dan Kemp, chief investment officer for Europe, the Middle East and Africa at Morningstar Investment Management. Mr Kemp says that while value averaging can be an intuitively attractive concept, it will “certainly not be of use to everyone and can add a layer of complexity without obvious benefits.”
What to invest in
Pound cost averaging and value averaging techniques work best in volatile asset classes with expected high return over the longer term, such as equities. For less volatile asset classes such as fixed income, there is less incentive to smooth price discrepancies and you may end up paying more in transaction fees - unless you are investing regularly as part of an ongoing savings plan.
David Liddell, chief executive of online investment service IpsoFacto Investor, says that as the global pandemic spreads picking which geographical area to invest in is “problematic” and suggests investing in a global equity fund to be as diversified as possible. For example, he suggests F&C Investment Trust (FCIT) for regular investors as it is large, well diversified and should have reasonably narrow spread. The trust is also conservatively managed and does not tend to have a lot of gearing (debt).
You might also want to look at funds that specify in sectors that you believe have strong long term growth prospects, and may be well positioned to recover fastest when markets pick up. Mr Parsons says the two key themes that he has been investing in - and will continue to invest in - are healthcare and technology. He says they are “without doubt two industries at the forefront of getting us through [the coronavirus pandemic].”
Mr Parsons suggests the Polar Capital Global Healthcare Trust (PCGH), whose managers also run open-ended healthcare funds. He says it has a very experienced management team with a robust and diligent investment process. In the tech space he likes the Smith and Williamson Artificial Intelligence fund, which launched in June 2017. Mr Parsons says the fund invests in companies that might revolutionise the way we operate and as artificial intelligence continues to be an increasingly important part of our lives.
Collective investments might be a better option than individual stocks. On Monday the UK Financial regulator asked all listed companies to delay the release of their full year results by at least a fortnight, which makes the job of discerning a company’s financial wellbeing even more difficult. Helal Miah, investment research analyst at The Share Centre, says “I believe buying funds, investment trusts or exchange traded funds will be the better way for now rather than trying to stock pick which could go disastrously.” Andrew Mackintosh-Walker, managing director at Close Brothers Asset Management says as the country is potentially heading into a deep recession “you should only invest in shares if you really know what you are doing and have done thorough due diligence on their balance sheet.”
Different approaches for different investors
People with a seven to ten year investment horizon may wish to put some spare money into an equity index tracker, says Mr Liddell. He says “for reasonably short-term investors I like the idea of investing in a global equity index tracker as you can capture any upside but you are not exposed to the risk that your fund manager could make bad investment decisions”. Those investing in index funds or exchange traded funds are also spared any widening of the discount on investment trusts which is always an investment risk.
Younger investors with a longer investment time horizon, however, are likely to have a higher risk tolerance and may look specifically at investment trusts as discounts are currently at historic highs, according to Morningstar's reading of the AIC's website data. The data shows the average investment trust discount was a stark 18.4 per cent on 23 March – up from an average discount of just 1.3 per cent in December 2019. Dzmitry Lipski, head of fund research at interactive investor, says: “Discounts may well have further to widen, and investors should never, ever, buy on the basis of discounts alone (or sell, for that matter). But it is equally true that investment trusts are now much cheaper than they have been in years."
Mr Kemp notes that in times of extreme market volatility there are price dislocations that shrewd active managers may be able to take advantage of. Similarly, areas of the market that have suffered heavy losses – for example hospitality companies – may have more scope for growth than other areas when markets recover. “Where active managers can really help is by reallocating to those beaten up areas which have become a much smaller part of the index,” he says. However adds that price dislocations in markets normally lead to differentiated returns – so while it is a good opportunity for some managers to outperform – others are likely to significantly underperform.
Mr Liddell suggests Scottish Mortgage Investment Trust (SMT) as a good closed-ended fund for a young investor with a healthy risk appetite. The portfolio is relatively concentrated and investments are chosen on their long term merits rather than with reference to geographical asset allocation or the composition of an index. The trust’s discount was 14.63 per cent on 23 March, compared with a 12-month average discount of 0.08 per cent.
You should only invest money that you can afford to lose. In terms of portfolio management, Mr Parsons says you should be dripping into the market with surplus cash you have available for investing, rather than selling equities you currently own that have performed badly to invest back into the market. “The worst thing you can do now is trying to sell into the market if you don’t need to,” he says. “Stay true to your principles as so far you have only suffered a paper loss. It is easy to say but don’t let emotions govern your investment decisions.”
Risks
If you drip into markets over a long period of time, you may miss out on valuable market returns. Adrian Lowcock, head of personal investing at Willis Owen says “pound cost averaging is great in theory but it often does not work in practice.” This is because markets rise more often than not so over time you lose out on potential returns by not being fully invested. However, he concedes that in current market conditions phasing in investments - in monthly or weekly installments - “makes a lot of sense”. Mr Miller warns that by investing too frequently you can “over-engineer the benefits” of dripping into markets and suggests that monthly installments should be sufficient.
For younger investors with a long time horizon, the benefits of pound cost averaging become less apparent, notes Mr Kemp, adding that generally over a long time horizon it is best to be fully invested for as long as possible. However, as many people invest alongside their salary, in practical terms it makes sense to continue to do so.
Investing is fraught with emotion and it can be difficult to stay disciplined. Even if it goes against your instinct, try to stick to your plan for entering the market, says Mr Liddell. “The most difficult time to invest is when everyone is panicking but of course generally that has been the best way to invest.”
However, Mr Parsons notes that investing in such turbulent markets can be very nerve wracking and the ability to sleep at night is “absolutely paramount”. If putting more money into equity markets is going to cause added stress in this difficult time, then you should question if the emotional burden is worth it.
