Kate Rogers: There are ways to make surprises less damaging

How can charity investors allocate their capital in an increasingly unpredictable future, asks the head of policy at Cazenove Charities

Kate Rogers
Kate Rogers

Leicester City win the Premier League. A barrel of oil is cheaper than a bucket of fried chicken. Investors pay to lend money to governments. The world's largest taxi company, Uber, owns no taxis. And the world's largest accommodation provider, Airbnb, owns no property.

For most of us - perhaps with the exception of Leicester City fans - these statements would have seemed preposterous five years ago. But they are all true today, and lead me to question how charity investors can attempt to allocate their capital with such an unpredictable future. The answer, I believe, is threefold.

First, analysis. We can't predict the future, but we can carry out rigorous and detailed due diligence on companies and funds in which we are considering investing. For companies, analysis is very important. The appraisal of historical earnings trends and valuations, cash flow and balance-sheet analysis, along with non-financial factors such as environmental, social and governance risk, combine to create a picture of whether a company is one that should be supported or sold. For active funds, it is crucial to understand the investment process that drives returns, any style bias or key person risk. The better informed investor is the more profitable investor.

Second, humility. Despite rigorous analysis, how the future pans out can be totally different from what we expected. Exogenous factors such as geopolitics or regulation can make a significant difference to the anticipated profitability of a company. The unexpected 70 per cent fall in the oil price certainly dented the profit margins of resource companies, more recently helped by a significant rebound. Even fraud can surprise the most analytical investor, as the Volkswagen scandal proved. Successful fund managers recognise their mistakes early and, where appropriate, remove them from the portfolio, despite the loss. This flies in the face of our human behavioural tendencies of overconfidence, confirmation bias and loss-aversion. Humility can come with experience and the recognition that not everything will go right. Successful investors realise their fallibility and cut losses early.

Third, diversification. In an uncertain world, with many interlinked and unpredictable factors affecting investment returns, it pays to diversify. I am not talking about owning everything in order to even out your odds, but investing to recognise the risk inherent in your portfolio construction and owning enough different stuff to smooth out the inevitable ups and downs. Effective diversification can reduce risk without significantly impairing returns. In companies, it can spread the risk of an unpredictable event affecting a single stock or sector. In funds, it allows exposure to multiple managers and approaches, rather than a single style that is unlikely to be right all the time.

Living with the uncertainty of the future is the norm for investment managers. Charity trustees and executives might find some comfort in managers who express firm and definitive views, but they should embrace the reality that nothing is certain and the best we can all do is analyse, recognise our flaws and diversify our risk. By doing that we have the best chance of success, whatever the surprises.

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