The fashionable view, now held by various experts, pundits and the chattersphere, is that the Covid-19 pandemic does not warrant the lock-down, notes Mica Townsend, business development manager at 10X Investments.
They say it does not justify the damage we have inflicted on our economy, and on our state’s already precarious finances.
Unsurprisingly, few people thought so mid-March when global Covid-19 fatalities were growing fast and furiously.
Then, we lauded the president on his decisive leadership. We lapped up the international applause for shutting down early, even before our first death, fully aware of the economic fallout that would inevitably follow.
South Africa appeared particularly vulnerable. As the HIV capital of the world, we expected a high fatality rate and our healthcare system lacked the capacity to deal with a large outbreak.
For reasons unknown, thankfully it hasn’t happened to date. But few concede that the lockdown itself played a large role, except with the caveat that it merely delayed the inevitable fatalities.
Today, our relatively benign outcome affects how we view the pandemic, to the extent that people today are more worried about the lockdown than the virus, even as confirmed cases and fatalities are escalating and stretching some regional hospital capacities.
Also, we now know more about the disease. Most infected people are asymptomatic. And we can see who is most at risk: ‘other people’. It’s the elderly, those with comorbidities, people who are overweight, people with low Vitamin D levels, frontline and essential workers.
There is now a risk mitigation factor for everyone, or reason to be extra cautious.
The current global case fatality (CFR) rate is now around 5%. Assuming that 90% of infections remain unconfirmed, the CFR would drop to 0.5%, which lines up with latest scientific estimates on the potential deadliness of the disease.
But if we exclude high-risk groups, then perhaps we can lower the CFR by another 80%, to 0.1% for everyone else. That is one death per 1,000 infected people.
These sound like decent odds, but no one would fly if that were the risk of dying in a plane crash.
It would mean 100 planes falling out of the sky every day, for a year. In the context of 100,000 commercial flights daily in normal times, the risk is still negligible.
Yet no one would accept those odds if these accidents were random.
We would also be a lot less cavalier about ending the lockdown. We would either refuse those odds, or reject that these outcomes are random.
That is our new approach to the virus. We see our personal odds as much lower than 1 in 1,000. We think we won’t get infected, and if we do, not only will we recover, we also won’t kill anyone around us.
It’s also how we approach investing. It’s why some prefer indexing and others active management, why some fear the odds, and the majority ignore them.
Financial markets are efficient at discounting available information, to the extent we cannot reliably predict future price moves. There is thus also no way to construct a portfolio that will reliably deliver superior performance, or to identify winning funds beforehand.
One way for investors to deal with this uncertainty is to consider their loss aversion. Behavioural finance studies suggest that investors feel the pain of a loss more severely than the pleasure of a profit, perhaps twice as much.
If the average market return (available risk-free from a passive index fund) is the neutral outcome, then earning less would be painful, earning more, pleasurable. In that case, investors would want the odds of beating the average to be at least even, and then only if the potential upside was much higher than the potential downside.
With active management, they can expect neither. Arithmetically it is not possible, and empirically it does not happen.
Studies repeatedly show that most active funds underperform corresponding index funds, with the pay-off profile skewed to the downside, inevitably so because of their higher fees.
For example, over the year to 31 May 2020, only a third of funds in the ASISA General Equity sector beat their respective index. Against the average sector return of -8.8%, the top five funds yielded 15,3% (percentage points) more, but the bottom five 19.6% less.
Even if the returns were evenly distributed, loss-averse investors should simply reject those odds, preferring the joyless but more importantly pain-free option of index funds. Collectively, they would feel much better.
The ASISA data indicates they don’t, though. 95% of unit trust money is held by active fund managers. And although index funds continue to gain market share, 84% of net inflows still went to actively managed funds.
By contrast, US investors have become far less masochistic.
According to Morningstar, half of the US stock market is now managed passively.
Locally, active managers still dominate, possibly because our investors don’t know the odds are against them. More likely, though, they don’t accept that investment outcomes are random. They still buy into the myth of the star fund manager.
They still attribute performance to skill and trust themselves to find it. They all expect to beat the odds, even if the majority don’t.
Denying randomness and massaging the odds is our way of confronting the pandemic. It may even be necessary to revive the economy and to keep our sanity. But it’s no way to approach investing.
Here, submitting to the market’s randomness, and choosing the pain-averting option of index funds should be the road more travelled by the investor universe. It may make for a duller savings journey, but also a more joyful outcome at the destination.
- By Mica Townsend, business development manager at 10X Investments