When it comes to the UK, there always seems to be a reason for investors to sit on their hands.
In recent years, a combination of political instability, stubbornly high inflation and consequently higher for longer interest rates has taken its toll on UK equity allocations.
Although July’s general election was decisive, attention has now shifted to 30 October when new chancellor Rachel Reeves will unveil her first Budget. It has been well flagged that we should expect some considerable pain, with this potentially being yet another reason for investors to ‘sit it out’ on the sidelines.
Of course, the question is, after several years of underperformance, how much of this is already priced in?
In our conversations with investors, we find that they 1) generally agree the UK is undervalued, under-allocated, and well-positioned for a rebound; but 2) are hesitant to invest now, preferring to pay a higher price later for the certainty that the market has turned, rather than going against the herd (and, perhaps more importantly, the benchmark). I like to remind them that in markets, nobody rings a bell at the bottom.
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Trying to time markets is a fool’s errand – as Bernard Baruch noted, the only people who consistently get their timing right are liars. So is there a strategy that can accommodate prudent allocation in a more measured way?
Instead of investing a lump sum into an asset class all at once, there is an argument for investing smaller amounts regularly over a pre-agreed timeframe. This is known as pound cost averaging which internally we call the ninth wonder of the world, the eighth being compound interest, which we equally espouse.
Consider a very simple example: An investor wishes to invest £3,000 into an asset but instead of investing all in one go, they deploy £1,000 a month over three months. Let’s say the asset’s value is 100p so 1,000 units are purchased in Month One. In Month Two, the price falls to 80p so 1,250 units are purchased.
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By month three, the price recovers to 120p, meaning that 833 units are bought. Although the average unit price over the three months is 100p, the investor in fact acquires 3,083 units for their £3,000 outlay, giving an average a buying price of 97.3p. This is a fascinating quirk of simple mathematics.
Pound cost averaging in practice
While pound cost averaging can be applied at a personal level to building a position in an asset class or fund, for example by monthly contributions to a SIPP or ISA, it can equally be applied to steadily building a holding within a fund. This is exactly the approach we took to build our position in Spirent Communications last year.
The specific reason was that, whilst we knew Spirent was a business we wanted to own and our qualitative and quantitative analysis came out positively, we also recognised that the market it operates in – mobile network infrastructure and testing – was beset with short term challenges; mainly due to a lack of capital expenditure by end customers in North America. In short, we wanted in, but we couldn’t be sure we’d seen the last of the profit warnings.
And so it proved – a few months into the exercise, Spirent duly warned on profits enabling us to pick up some of our holding at under 100p a share, in doing so accumulating a much higher quantity for the same fixed monthly outlay.
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Shortly after we completed our purchases, Spirent received two takeover approaches at material premiums to its share price and, at the time of writing, looks set to be sold to US-based Keysight Technologies for 201.5p in cash.
Whilst pound cost averaging in the funds is, for us, the exception rather than the rule, it is something that can work well on a case-by-case basis for specific reasons like Spirent. The same approach might be considered by investors looking to re-allocate to the UK but fearful of timing.
In the event of a market wobble, you benefit from acquiring more for the same amount of money. Psychologically, this helps alleviate the fear that comes with going against the herd and helps smooth out the entry point. You don’t get in at the bottom, but nor do you get in at the top.
Eric Burns is lead manager of the SDL Free Spirit fund
