Time travel is every investor’s fantasy. Just imagine if you could go back 40 years and make investment decisions — knowing then what you know now. That’s precisely the opportunity I gave a group of investors one recent evening.

On the morning of that day, I had received a panicked call from a financial advisor I know quite well, who is located in my home market of Toronto. This advisor had just gotten off the phone with a high-profile economist who was scheduled to do a presentation to 200 of the advisor’s clients that evening. The economist had called to say that he had a family emergency and he wouldn’t be able to deliver this talk — and the advisor was inquiring to see if I might be able to fill in on such short notice.

When I asked this advisor what he wanted me to talk about, the answer was that he didn’t care — all he wanted was someone on the stage other than him.

That night, I stood up in front of the assembled audience, who politely hid their disappointment at the bait-and-switch tactic of having shown up to hear a celebrity economist and getting me instead. I asked them to imagine that it was Jan. 1, 1970 — 40 years ago — and that they had $100 to invest. They could put that $100 in one of six stock markets: the U.S., Europe, Japan, Hong Kong, Canada or Australia. Furthermore, they could divide it up in any way they wished: they could put it all into one market; divide it up evenly among the six; or devise any other allocation.

In essence, the people in the room had a chance to go 40 years back in time. I gave the audience a few minutes to decide on their allocation, and then we talked about where they’d placed their bets. Given the statistics on home-market bias and Canada’s recent performance, Canada was predictably the most popular choice. The proximity and size of the U.S. made it a favourite as well, with some investors putting money into Hong Kong and Australia. Almost no one put much of their $100 into Europe or Japan.

(The reason I chose 1970 as a starting point is because that’s when the company now known as MSCI Barra began gathering global market data. That company provides the industry standard for tracking investment returns. There is good data on U.S. markets going back to the early 1920s; but for most of the rest of the world, 40 years is as far back as reliable data exists.)

I then shared the outcome of that $100 investment in each market, all in U.S. dollars for the sake of consistency. Hong Kong had finished a distant first, with no other stock market in sight. Then came Europe, followed by commodities-driven Canada and Australia. Trailing the pack were Japan and — in last place — the U.S.

This exercise prompted lots of conversation. And I subsequently shared these six observations:

> The Perils Of Just Looking At The Numbers.

Looking at points in time often masks big market swings and substantial volatility along the way.

When the audience saw the numbers, many indicated they’d changed their minds and said they would increase their allocation to Hong Kong — until I showed them a chart of the incredible roller-coaster ride that investing in Hong Kong has been, with common moves of 50% both up and down. I asked the audience to think hard about whether they would have had the stomach for that ride.



> Be Aware Of The “Recent Effect.”

The “recent effect” is a phrase academics who study investor behaviour use to describe our tendency to place greater weight on more recent events.

Japan has done incredibly miserably over the past 20 years, so it received an almost zero allocation because members of the audience had forgotten the 1980s, when the Japanese stock market was the eighth wonder of the world — multiplying by 14 times over a 10-year period.



> Extrapolating Hot Markets.

Just because a stock market has done well in one period doesn’t mean it will outperform in the next.

The U.S. is an excellent example of this rule. In the 20 years from 1980 to 2000, the U.S. was the top-performing market, with an amazing annual return of 18%, increasing by 28 times and even ahead of Hong Kong. In contrast, Canada and Australia had average annual returns of 11%, multiplying by eight times in that 20 years.

@page_break@From this perspective, you see the impact of the commodities exposure in Canada and Australia; you also see the difficulty in extrapolating from one 10-year or even one 20-year period to the next.



> Understanding The Impact Of Currency.

If you have a short- or even a mid-term time frame, you need to be conscious of the effects of currency swings when investing globally.

One reason for the weak performance of the U.S. market in the past 10 years compared with the rest of the world was the weak greenback.

Even over longer periods, currency can have a big impact on both volatility and returns. In local currency, Europe’s index grew from 100 to 4,770 over the past 40 years. That’s well ahead of the U.S. index. But the gap is much narrower when we look at them in US$. This is simply because the US$ was significantly higher in 1970.

As an illustration of the currency impact, you need to see how the European stock market performance looks in both local currency and US$ terms. For example, let’s say the index began at 100, both in local currency and US$, on Jan. 1, 1970. In 1980, it was 163 vs 288, respectively; in 1990, it was 1,093 vs 1,241; in 2000, it was 4,768 vs 4,805; and in 2010, it was 4,770 vs 6,116.



> Pause A Moment Before Jumping To Conclusions About The “Lost Decade.”

There’s been lots of commentary about the fact that the 10-year period from 2000 to 2009 was a lost decade for investors — and, in fact, the worst decade on record.

That’s absolutely true if you’re just looking at the U.S. The fact is, however, that although returns may not have been sterling, inves-tors have at least seen gains in most markets outside the U.S. over the past 10 years. We need to remember that even though the U.S. market is still dominant — even after its miserable performance over the past 10 years — it represents only about half of the global market capitalization. In fact, there’s still the other 50% to take into account.



> Look Before You Leap.

Finally, check the facts before acting on stereotypes.

When you talk about investing in Europe, most North Americans instinctively think of militant unions, stodgy bureaucrats, ossified companies and interventionist, sclerotic governments. However, investors in Europe have done substantially better than those in the U.S. over the past 40 years.

Even more extraordinary, of the Big Three European countries — France, Germany and Britain — it’s France that has turned in the best stock market performance, and Germany the worst, over the past 40 years. That’s exactly the reverse of the order most Canadian investors and their advisors would have assumed.

So, what’s the most important conclusion here? It’s fine to have impressions and opinions. Just be sure to check the facts before acting on them. Unless you do that, even going back in time won’t improve your investment performance. IE

Dan Richards is CEO of Clientinsights
in Toronto. For other columns, visit
www.investmentexecutive.com.