Investor lessons
This economic crisis has taught many lessons, but most are not new. Reflecting on the events of the past two financial years, investors can conclude the following:
- The role of governments is to set rules for the efficient and effective operation of financial markets, and to ensure appropriate regulatory standards are followed. When governments don't assume this responsibility; don't demand appropriate disclosure from participants; and don't properly manage market operations, there is a high likelihood that financial markets may fail.
- No boom lasts forever. Markets go up and down, and history says that booms will inevitably be replaced by periods of low or negative growth. Markets may fluctuate wildly over the short to medium term, but historically are remarkably consistent and closely connected to the underlying economic growth of nations over the long term. In future, underlying economic growth will largely depend on the planet's health - which means all investors must consider sustainability issues, in particular climate change (for more, see the VicSuper's approach section of this investment update).
- Investment risk and expected return are closely related. If higher returns are sought, the investor takes on more risk. In recent years, many institutional investors, including some Australian superannuation funds, wanted higher yield-based returns, which came with additional risk. As the crisis emerged and sharemarkets fell, these higher risk investments incurred significant losses.
- Complexity usually equals higher risk and higher fees. With the increase in financial innovation over the past 10 to 15 years, investment products such as hedge funds, which were offered to institutional investors including super funds, became highly complicated. Many promised a risk/return profile too good to be true, but due to the increased complexity surrounding the structure of the underlying assets, and a lack of disclosure and transparency from fund managers, estimating the actual risk was virtually impossible.
- Corporate failures such as Lehman Brothers in the US and ABC Learning in Australia helped to reduce investor confidence, affecting the entire market including well-managed companies. It's prudent to remember that not all companies are poor investments, even if their share price has fallen. And for superannuation, it is long-term performance that counts.