Why Not Trying To Predict the Impact of Brexit Helps Your Portfolio

Recently, several clients coming to our office for meetings have asked what we think of the UK referendum vote to leave the European Union and how it will impact the stock market.  Obviously, this event had a significant short-term impact on the market–specifically, a one-day spike in U.S. markets prior to the vote, a two-day plunge after the vote, then a four-day recovery that essentially brought us back to where we started.  The long-term impact of the vote–on political, economic, and financial realms–is yet to be seen.  Therefore, our answer to clients is generally two-fold:  first, we believe in capital markets and the ability of businesses to adapt to changing environments, including the possible effects of a UK departure from the EU on the movement of goods, services, and people.  Second, and most importantly, neither we, nor anyone else, know exactly how this development will impact financial markets over the long term, and we won’t try to guess.

This refusal to make a prediction is not based on a disinclination to do the hard work of thoroughly researching the international economic implications of Brexit, nor is it based on any insecurity as to our collective intellect and expertise relative to other players in the market.  We think we’re a pretty clever and capable crew, and if we believed that mastering the minute details of the Brexit vote would help our clients, we would do it.  No, our refusal to guess the impact on the stock market of the Brexit vote (or the drop in oil prices before that, or the Fed starting to raise interest rates before that, or the volatility in Chinese markets before that, etc.) is based on academic research clearly demonstrating that investment managers trying to predict changes in the market generally lose money for their clients.

For example, in the case of actively-managed mutual funds, which try to move investors’ money in and out of particular stocks, particular asset classes, or the market entirely in response to or in anticipation of political and economic events, academic research plainly indicates that this strategy does not lead to positive results over the long-term–and rarely does in the short-term as well.  The chart below demonstrates that, leading up to the end of 2015, only 36% of these funds outperformed their relative benchmarks over a 3-year period, and only 17% of them outperformed over a 15-year period.  Interestingly, a majority of the funds did not even survive over the 15-year period.  (And considering current life expectancies, younger investors will go through several 15-year cycles in their investing lifetime, making it even less likely that selection of an actively-managed fund would be successful.)

A significant contributing factor to this underperformance is the level of fees that the funds charge investors.  The higher the fees, the less likely that actively-managed funds will outperform their benchmark (net of fees) over time.  It requires time, money, and effort to do the research and legwork necessary to try to outguess the market, so actively-managed funds have considerably higher fees than passively-managed mutual funds on average.  Unfortunately, in this case, you do not “get what you pay for.”

Thus, PFS is very committed to the strategy of not predicting the implications of the Brexit vote or any similar development in domestic or international affairs.  Of course, it will impact the market, but we will leave the guesswork of when and how to those expensive mutual fund managers, the vast majority of whom are underperforming relative to the market over time.