Mark Lamonica: Hi, and welcome to another episode of Investing Compass. Before we begin, a quick note that the information contained in this podcast is general in nature. It does not take into consideration your personal situation, circumstances or needs.

Shani Jayamanne: Now, a lot of regular listeners will know that we held our conference on the 13th of October, and we had a great lineup of speakers, speakers that we chose because they could contribute to an investor's understanding of the portfolio construction process, adding valuable insights into rates of return that investors can expect in the future, allocating assets, selecting investments, and how investors can navigate the current environment.

Lamonica: And the conference was, I thought, a great day, Shani. So, we got to meet a lot of Investing Compass listeners in person, which was really nice, and we finally got to meet Lisa. So, Lisa, of course is famous for her alpacas.

Jayamanne: She didn't bring her alpacas.

Lamonica: She did not bring her alpacas, but there's more animal news with Lisa. So, Lisa saved a goat's life, and then the owner of the goat named the goat Lisa. So, like, you can't make this stuff up.

Jayamanne: Yeah, incredible.

Lamonica: Yeah. And Lisa sent a picture of her with the goat.

Jayamanne: Yeah.

Lamonica: So, these are our listeners.

Jayamanne: Yeah. But I mean, it was probably my favorite part of the day apart from obviously the drinks at the end. But we also met a gentleman who traveled from Melbourne. He told us he listened to us while walking through the Dandenong, which I thought was very nice.

Lamonica: Yeah. No, that was really nice. And we met Rodney. So, Rodney started watching our webinars during COVID and has been listening to Investing Compass from the first episode. So, I don't know – it was pretty flattering to meet everybody. And we loved meeting all of you and looking forward to meeting even more of you. And nobody mentioned Warren Buffett. So, we couldn't have a drink during the conference, which was probably good since I was speaking at it.

Jayamanne: But we know that some people weren't able to attend. And for those that did, there was so much to absorb during the day, we just wanted to provide a summary of our favorite insights from the investment professionals on the date.

Lamonica: Yeah. So, we thought what we do is we run through the day and go through maybe one or two insights that each session provided.

Jayamanne: Okay. So, the logical place to start is at the beginning. And Mark, you opened the conference by speaking a little bit about where the market is and defining goals. And we obviously speak a lot about defining goals and goal setting on Investing Compass. So, I want to focus a little bit on the market and how it impacted investors. And one of your first slides was titled "Nowhere to Hide," and basically, what this showed was asset class returns for the 12 months up until the end of September this year. So, what were some of those returns, Mark?

Lamonica: All right. Well, as you can probably guess, they were all pretty negative, Shani, because the slide was titled "Nowhere to Hide." So, we had global and Aussie fixed interest down between 10% and 11%; global equities unhedged down 9.79%, hedged down 17.5%; U.S. equities hedged down 18%, unhedged down 5.47%; and then Aussie equities down 7.69%.

Jayamanne: Do you like how I've given you all the numbers this time?

Lamonica: Yes, I appreciate it. I've literally just done that four times, because I kept reading the wrong numbers. Will is about to kill me. If Will saw me shivering in a field, he would not do what Lisa did and rescue goat Lisa. He would just let me die in the ice storm.

Jayamanne: All right. So, I think it's important to acknowledge that, firstly, those are some pretty demoralizing returns. Secondly, we need to step back and look at what happened with investors in the market over the last two years. We've seen an influx of retail investors entering the market, and many of them investing for the first time.

Lamonica: And these investors were enjoying really strong returns, and as we've said before, could basically just throw a dart at the share market and whatever it hit would go up. And we've mentioned our Mind the Gap study before. But one of the findings of this study is that the highest outflow is out of funds and the biggest gap between investor returns and investment returns happens during times of market distress when markets are going down.

Jayamanne: And many of these investors who have enjoyed phenomenal returns just as they started investing have now been subjected to returns that would make even the most seasoned investors feel pangs of pain.

Lamonica: And this is happening at the same time as when interest rates, of course, are going up and getting a 3% or so return on a savings account might be starting to look pretty attractive.

Jayamanne: And it's very easy for investors once they've experienced a downturn and then locked in losses to decide that investing is just not for them, that they'll be happy with what they've got in the bank account and that they'll just leave it at that. No need to subject themselves to that pain again.

Lamonica: And it's at this point where we become the broken record again about having a plan and defining goals. So, understanding where you're trying to go, the investments you're in, why you hold them, and how they behave is not a complete antidote to that sinking feeling when you see markets dip, but it does lessen it and prevents you from locking in those losses.

Jayamanne: It's also realizing that we've seen this before. On average, markets experience a bear market every three years. If you're a long-term investor, it's going to happen. There's no part of the market that you can hide in that's risk free, but also rewards you over the long term. If you're a new investor or even a seasoned investor, this year has been really hard and that also means there's opportunities, which we will speak about when we explore our learnings from other sessions.

Lamonica: All right. So, obviously, when I left the stage, the conference started to get a lot better, Shani. That's at least what you told me. So, the next speaker was Matt Wacher. So, Matt is a CIO of Morningstar Investment Management, and he spoke about the next step in the portfolio construction process and that was calculating your required rate of return. But in his session, he was speaking a little more about what investors should expect in the future and what's an achievable rate of return. But one of the most interesting parts of his presentation was a simulation that he had run, and the simulation was really showing how investors could improve the odds of achieving their goals.

Jayamanne: And the simulation was looking at how valuation can impact your return outcomes and how investing in overpriced assets can set you back. And logically, we know this. We know that investing in overpriced assets means that there is more risk involved, but this study shows this empirically, and the opportunity cost of chasing returns and investing in overpriced assets. So, this simulation looked at the investable universe in 24 countries that Morningstar provides analysis and sorted it into three portfolio buckets based on valuation.

Lamonica: Yeah. So, the buckets were – the most attractive security based on price to fair value, so the cheapest; then a middle bucket; and then the least attractive or the most overvalued. And so, these buckets were re-sorted monthly between 1975 and 2016.

Jayamanne: So, the results looked at the growth of a dollar, and we'll start with the least attractive bucket. Over 40 years, you five times your money and ended up with $5.19, which is not all that impressive, but it is positive. Then there's a middle bucket, and that's at $14.77, which is still not amazing. And then, the most attractive bucket and that was $100.89. So, it was over 100 times your money.

Lamonica: Yeah. And I think this was the point of the conference I was sitting next to Shani, and she whispered to me – if you were in a bucket, you would be in the least attractive bucket. So, anyway, it's nice to bring back that little memory.

So, what Matt was really saying though was focusing on valuation from a return perspective can really help with reducing risk in your portfolio and of course, helping you achieve your goals.

Jayamanne: And I think at these conferences, some investors, not all, but some, do come to get some light bulb moment about a stock or a security, or some different way of investing that's going to help them double or triple their money.

Lamonica: Yeah. And I think the big thing is investing is hard because there's so many different distractions that cause investors to deviate from their plans. But this is one of those things that hopefully stuck in some people's heads – valuation matters – may not matter when you're trying to sell an idea to barbecue, but it matters.

Jayamanne: And it's hard when obviously FOMO and greed take over.

Lamonica: Yeah. No, exactly. And I think, realistically, we do need to understand that investing is boring, much like this podcast. It's not supposed to be this sexy idea or sexy stock.

Jayamanne: I think investing compass is quite sexy.

Lamonica: Okay.

Jayamanne: We talked about throuples.

Lamonica: We did, we did.

Jayamanne: I don't know if that episode is going to be released before this one. But look forward to that one.

Lamonica: Yeah. I think after that episode is released, we will shortly thereafter get fired.

Jayamanne: Yeah.

Lamonica: Yeah. Just go back and live in the unattractive bucket. So, anyway. And so, after that, Shani, Matt moved on. He started talking about drawdowns.

Jayamanne: And a drawdown is simply a fall in your portfolio. And when you look across the buckets at the least attractive securities from a valuation perspective, the drawdown percentage was significantly more than the most attractive bucket, which means that it was a lot more volatile.

Lamonica: Yeah. And with investing, remember, volatility is something that we take on so that we can get more of a return, and in this case, that actually didn't occur. So, overvalued assets are giving you more volatility in terms of drawdowns, but they're also giving you lower returns. So, once again, another vote for the cheaper assets.

Jayamanne: Okay. So, let's move on to asset allocation, and we split this into two sessions – pre-retiree and retiree. We know that generally there are different goals when you're in those two stages. So, let's start with pre-retiree. Something that really resonated with me was a point made by Annika Bradley, who was on the panel, and she is also our Director of Manager Research. So, she runs a team that writes all of our fund, ETF and liquid research here in Austria. And she was talking about mental accounting, and this is something that I do, and I know a lot of people do.

Lamonica: Yeah. So, she talked about buckets, which seemed to be a popular theme at the conference, but you talked about in this case buckets and how we tend to separate money into accounts based on their purpose. So, like in education account, a health savings account, et cetera. So, we have this human bias towards this mental accounting. And basically, what this resulted in is that people weren't looking at their risk capacity, and that's the risk they needed to take on in order to achieve their goals. But instead, they were just looking to segment off money into these different goals and let it accumulate without looking at time horizons or appropriate asset allocation.

Jayamanne: And she spoke about Richard Thaler, who is a Nobel Prize winning economist, and he said that the reason that we do this mental accounting is to aid our self-control, to make sure that there's not just some big pile of money sitting there unaccounted for. But what this also does is further another human bias, which is risk aversion. And it means that we, as Mark said, end up having more conservative portfolios that we need to achieve our goals.

Lamonica: And then, during the other session, so the retiree session, we had a question from the audience, and the question was, what is a big thing that 60 to 70-year-olds should be worrying about?

Jayamanne: Yeah, it's a great question, Mark. So, what did you use to worry about at 70?

Lamonica: You know, Shani, you made it pretty clear that I'll never reach 70, Shani. So, you told me that I would die at 45, which is rapidly approaching which Shani is very excited about. But we had three people on the panel during this retiree session trying to answer that question about what 60 to 70-year-olds should be worrying about. One of them was Al Clark, who is Head of Investments at MLC Asset management. And what he spoke about were opportunity sets and how they are limited and getting smaller and smaller and how much risk that a 60 or 70-year-old must take on now just to get an adequate return.

Jayamanne: And of course, risk translates to volatility, especially for retirees who are drawing down on their investments and are not structured in a way where they're drawing down from less volatile assets. And this can result in meaningfully less funds in retirement. Al remembered investing in cash when he was younger at 5% to 7% return, bonds were giving him 12%, and all of that has disappeared over 20 years. The two decades saw a decrease in rates and something called a financial repression where people were forced to take on more and more risks risk to generate an adequate return, and this is a quandary facing them, what do we do with this?

Lamonica: Yeah. And this is where he mentioned those opportunity sets – so, asset allocation and where opportunities aren't static. And he spoke about how real estate investment trusts were a place where they once saw an opportunity at MLC, and as the market has changed, the opportunity set has flipped where they can find cash and cash alternatives that are yielding more for less risk. So, he spoke about how retirees must fundamentally understand that risk and return can change for assets, and you do need to look under the hood, so to speak, of your portfolio to understand whether your investments are still working for you.

Then we had Brnic from Australian Retirement Trust jump in, and he added that these are problems that retirees have been dealing with for the last three decades. They've been investing their money in growing their capital. The biggest problem now is spending it. What's the point of saving for something if you're not going to spend it when you're there?

Jayamanne: And so, during this presentation, each of the speakers had their asset allocation listed on the board, and Brnic pointed to it and said, well, which one of these are you going to sell and take? You can keep on investing, but you're not spending anything. The biggest problem that's facing retirees is how do you convert capital to income.

Lamonica: And it's at this point the Graham Hand, the moderator and editor Firstlinks shared the statistic that 90% of retiring money is leftover after death. This money that they've worked hard to earn and grow that they've tried to convert to income without eating into the capital.

Jayamanne: And the truth of the matter is that retirees shouldn't be afraid to dig into capital as part of a measured plan. I know that with my retirement I will want to spend it as efficiently as possible. But the question and the hottest question that retirees face at the moment is how do I spend my money and make it last, but also enjoy it to the fullest.

Lamonica: Yeah. And of course, the answer to a question like that does not have any sort of easy answer that's universally applied because we don't know when we're going to die. But it's important that we realize a retirement is not this goal that we scrounge, save and sacrifice for while continuing to scrounge, save, and sacrifice during retirement. So, we should enjoy these years to the best of our ability in our own circumstances.

Jayamanne: Okay. So, following these panels there were two sessions. One was Gemma Dale from nabtrade talking about megatrends and thematics. And the part of Gemma's presentation that stuck out to me the most was when she called out that we have this perception of people that invest in thematics, and this perception is of young, inexperienced, the so-called dumb money that goes and invests in trends that have already reached their peak.

Lamonica: Yeah, and this simply isn't the case. So, we've all been guilty of seeing value in certain themes that we think will be successful because it logically makes sense. We use the example of lithium often. But one example that Gemma used that we haven't really touched on is milk. So, we saw huge trend in Aussies buying milk shares like Bellamy's and a2 because of the demand in China for high-quality milk products.

Jayamanne: And outside of this perceived notion of dumb money, this is where we see Gemma's presentation intersect with Matt Wacher's from the beginning about valuation. Of course, these themes make logical sense, but by the time most people jump on these trends, the wave is over. They're probably buying into overvalued shares where investors have already piled in.

Lamonica: And so, it's always a good idea to reflect on the thesis of a security and why you're buying it. If it's based on a thesis, there is an implication that you have an analytical edge. That's the ability to read, analyze and extrapolate data better than others. We won't go into this too much because we've spoken about this before in our episode on thematic ETFs. But it's important to realize that tech and healthcare and all those major thematics that we know aren't the only trends, and it isn't just dumb money that flows into the market, that the thesis might be right, but the price might be wrong.

Jayamanne: Okay. Let's move on to a couple of thoughts from our afternoon session. Two of our sessions had very different turns. We had Peter Warnes, who is our Head of Equity Research in Australia. He painted a pretty grim picture. In fact, someone at the conference spoke to Mark and said that they need to find something strong to put in their coffee.

Lamonica: Yeah. No, exactly. I think, Shani, we were probably at that same point as well, by the time we got to the afternoon sessions.

Jayamanne: Yeah, I think, it's likely before that. But yes, Peter was quite grim about the short to medium-term future for investors. But right after Peter came Dr. Shane Oliver, and he is the Chief Economist at AMP, and he saw a much rosier scenario and thought an end to interest rate hikes was approaching.

Lamonica: But one thing that we can take away from both presentations is that they both showed long-term charts of the share market, and they showed the timing of bull markets and the timing of bear markets. The vast majority of the time we've been in a bull market.

Jayamanne: And I think this is particularly pertinent given the environment that we've experienced and the one that we're currently navigating, and it's something worth remembering as the volatility continues.

Lamonica: Yeah. And we constantly hear references to individual investors as the "dumb money" on Wall Street. We even referred to dumb money when referencing other parts of the investing community. And whoever is making those references is not meeting the investors that we talked to at the conference. So, they aren't meeting the investors that correspond with us over email. People that we meet, people that email us are just trying to build a better future, and they're doing this while juggling their jobs and family responsibilities, and they're doing this while facing a barrage of products being marketed to them. And this isn't easy, and we need to acknowledge that. So, if you are feeling lost or overwhelmed, please know that this is natural. Just keep moving forward, because each day you stay invested, is one day closer to achieving your goal.

Jayamanne: And we've picked and chosen parts of the conference that resonated with us. We had great sessions that all received really good feedback and were insightful. Each of us are on a different path and there may be parts of these sessions that resonate with you more than what did we us, and they're all available to be watched on demand for those registered for the conference. And if you missed out, you can find a link in the bio of this episode.

Lamonica: And again, the best part of the conference was being back in person and finally getting to meet some of the people that we've shared this journey with over the last couple of years since we started doing this podcast and webinars. It's our favorite part of the job. So, we just love meeting all of you, and we're looking forward to continuing to meet you in the future.

So, thank you very much for listening today. We would love a comment or a rating in your podcast app. And once again, my email address is in the show notes. So, just send an email through.