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Shepherd or sheep?

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25 January 2019

David Prosser examines investor herd mentality, and explains how investment companies can offer some protection.

Stock market history is littered with warnings about the dangers of the herd mentality or the madness of the crowds. As is so often the case, Warren Buffet offers one of the most telling contributions. “[Investors] need a temperament that neither derives great pleasure from being with the crowd or against the crowd,” he told his shareholders a few years back. In other words, make the investment decisions that are right for you rather than worrying about what everyone else is up to.

Nevertheless, it’s human instinct to take an interest in other people, particularly if they’re making decisions that you’re also pondering. For anyone thinking about how to manage a portfolio of investments, whether new or existing, it’s perfectly natural to wonder what other people are doing with similar pots of money.

In this context, data on where investors are putting their cash always make interesting reading. And in the investment companies sector, the investment platform Interactive Investor publishes monthly statistics on which funds are attracting the most interest from investors – they’re effectively the industry’s charts.

Who’s top of the pops right now? Well, in December, Interactive Investor reveals that Scottish Mortgage was the most popular closed-ended fund with investors on its platform, the second successive month in which it finished number one. In second place came City of London Investment Trust, which moved up four places compared to November.

The top two tell us something interesting about how investors regard markets just now. On one hand, you have Scottish Mortgage, which has delivered outstanding performance over the past three years and is best known for its high exposure to US and Chinese technology stocks; you might call this fund a bet on the bull run for equities re-establishing itself. On the other, City of London has delivered much lower returns, but offers a far more defensive profile, focusing on dividend-paying UK companies where there is plenty of cash to underpin the income stream; this fund’s popularity feels like a wager that the volatility we saw in markets last year is set to continue in 2019.

This split is a pretty fair representation of the crossroads at which investors and their advisers find themselves today. There certainly are arguments to be made for improved stock market performance to come – under-valued stocks in the UK that will benefit from any better-than-expected Brexit outcome, for example, or receding fears that US interest rate policy is about to take a turn for the worse. Equally, it’s not difficult to be gloomy, if you focus on economic and political uncertainty, from the Brexit shambles to the tense relationship between the US and China.

That brings us back to where we started. In the long run, this is all noise: investors focused on their long-term objectives won’t worry too much about whether the Scottish Mortgage or City of London lens on stock markets is right for them over the months ahead. And if they’re sensible, they’ll take Warren Buffett’s advice and ignore the charts altogether.

Still, the rankings tell us that not everyone does operate in this way. People do, understandably, take comfort in investing in similar ways to their peers. Funds with very strong historic performance, or a particular profile, do attract more interest than other vehicles.

One final thought. It’s worth noting that investment companies do at least offer some protection from the herd mentality. As closed-ended funds, they don’t have to sell assets if the madness of the crowds moves against them and investors run for the exit doors. In such circumstances, the fund’s share price certainly will suffer, as the discount at which it trades relative to the value of its underlying assets widens, but the losses don’t have to be crystallised. That’s a valuable structural advantage in these uncertain times.

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