Investment Risk Guide - Part 4: Beta
Beta is very popular. Maybe that is because it is so easy to understand. We acquire assets at a price, and we hope that the value will increase. There can be many reasons why prices may go up: inflation, productivity, or general market growth. Consequently, there are also many different ways to get exposure to this type of investment risk. Buying shares in companies is one way, whether public or private, owning property or holding commodities are another means to participate in growth. As an investor, there are many different products that one can buy and there are many different formats, risks and structures that one can take. But let us be clear: prices can also go down. In other words, anything we buy and hold for growth is subject to absolute price risk.
So, what to buy in this almost infinite world of acquiring assets all over the world? As ever, buyer beware, and it is up to us to decide what we want to do. Buying a house can be expensive as far as commissions, duties and transaction costs are concerned. The risk is also very local and specific to that house, neighbourhood or city. Buying shares in private companies can take many months to negotiate contracts, whereas buying shares in Apple or in the FTSE 100, would be much cheaper and easier to transact. And lest we forget the risk of investing in commodity contracts, only to have several tons of pork bellies delivered to our house if we get the expiration date wrong. The point is, the opinions, circumstances and skillsets of the investor will vary widely and hence there are also so many different ways to structure a beta investment portfolio.
The important thing to remember, is that no matter what we buy, no matter how much money or energy we spend, there is no guarantee that we will get excess rewards. That’s the frustrating part of it all: you can be 100% right and still lose money, if your timing is wrong. If you invested in commodities in the seventies, property in the eighties, or value stocks in the nineties and noughties, you would have vastly underperformed other assets at the time. Sure, in the long run everything goes up: that’s growth, but there can be long periods of negative returns depending on when you buy anything.
Which is why we like to keep things simple and in the absence of having a crystal ball, diversification and keeping costs low are the key to any successful investment strategy. Picking stocks doesn’t work, and if the statistics don’t convince you (Financial Times: “99% of actively managed equity funds fail to beat their benchmarks.”), all you have to do is look at the long list of fallen geniuses (Neil Woodford anyone?). Property is wonderful, but it is complicated to achieve diversification and it takes effort (and money) to maintain the assets. Private equity is great, but you lock up your money for a very long time and the fees are very high. Commodities are awesome, but more so than any other form of beta, you are subject to timing risk, as the cost of storage is implied in the price. That leaves low cost, low maintenance, and hugely diversified equity index funds, in the form of easy to transact ETFs (Exchange Traded Funds). Happy days!
Check out our next post on Alpha > in this six-part series, as we look into all the core risk categories.