The fall in the value of shares in the USA and other markets has hit news headlines this week suggesting it to be a dramatic turn of events. In fact, whilst the initial 6% fall in any day is large in isolation, the event is not extreme in the context of market fluctuations often seen along the path that generates long term returns.
As we noted in our quarterly commentary for the period ending 31 December, investors were favoured with unusually smooth and strongly positive returns during 2017. In this context the recent fall is well within the ‘normal’ range and the pullback has for the most part merely reversed the added gains of January 2018 returning values towards the closing prices of 2017.
Financial theory teaches us that risk and return are related, and that we get a premium for taking risk. Once we diversify out concentrated risks, that do not offer extra reward, we are left primarily with market risk expressed as volatility. That is, markets will have occasional set-backs on the upward path of value creation arising from corporate profits and economic growth. In this context the sporadic downturns are just as important as the uplifts, because without them there is no risk, and without risk there is no premium, and then we only achieve the cash rate of return, which for most of us is not enough.
It is natural to feel some emotion from the set-back that even a temporary fall in market value may provoke. However, I am reassured by the process we use to manage your money and the confidence I have in it, to deliver returns over time in keeping with your objectives. This process includes taking a measured amount of risk, with the knowledge that it comes with occasional blips in market value, that we ultimately need because it is linked to the premium we seek.