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Thu, 17 Jun 2010 - 17:20
Market Timing
Much gets written about the pros and cons of market timing, with the conclusion typically dependant on the view point of the author. There is also often much confusion between market timing and tactical asset allocation.
Market timing (our definition) is the process whereby an investor increases their position in risky assets (equities) at the expense of lower risk assets (cash and bonds) and vice versa. This allocation is typically done on news flow, some form of cognitive decision (typically influenced by some form of behavioural bias), or some updated forecast. While there are undoubtedly investors who are able to capitalise using this strategy, the large majority of investors will negatively impact their returns by engaging in market timing.
Humans aren't rational beings, and our actions are often incorrectly influenced by our inherent biases, which negatively affect investment performance. An example is switching into an asset class that has performed well over an extended time. Some research on market timing I found courtesy of global management company, VAM.
Market research company, DALBAR conducted the research based on flows in and out of mutual funds. This research shows how much value a market timing strategy can destroy. Investors, on a whole, destroy capital on a consistent basis as a result of their cash flows in and out of investments. Other studies also show how the average investor does worse than the performance of the fund that they invest into as a result of the timing of their cash flows.
James Montier of GMO used a quote of Ben Graham and Dodd to distinguish between market timing and (tactical) asset allocation adjustments:
The general dislike of market timing can be summed up by Graham and Dodd's statement, "It is our view that stock market timing cannot be done..." However, less well-known is the fact that he continues this sentence, "with general success, unless the time to buy is related to an attractive price level, as measured by analytical standards. Similarly, the investor must take his cue to sell primarily not from so-called technical market signals but from an advance in the price level beyond a point justified by objective standards of value."
Essentially what is being proposed here is tactical asset allocation where the investment decision is based on solid valuation considerations, and not other reasons. Fighting our natural biases is crucial in avoiding the associated capital destruction.
Take care,
Mike Browne info@seedinvestments.co.za www.seedinvestments.co.za 021 9144 966
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