By Euan MacLaren
Asset bubbles have been a feature of investment markets for hundreds of years. There are countless examples, from ‘tulip mania’ in 17th century Holland, to the 18th century South Sea bubble, to more recent examples such as the dotcom boom in the late 90s and the property market from 2004 onwards
Given the impact asset bubbles can have, it’s no surprise that they are a major concern for many investors, particularly since the financial crisis. Bubbles, however, are not as common as investors may think. They rarely occur when investors are actually worrying and talking about them; rather they emerge when there is no one left to invest in that asset; investors have all piled in having lost touch with the reality of the valuations underlying that asset.
Certain assets are more bubble-prone than others, such as those where valuations are based on intangible assets or over-optimistic future growth forecasts. Market hype is also a significant contributor, when investors become convinced that the next big thing has arrived and there is no way the asset can fall. This can lead them to overlook fundamentals that may point towards serious over-valuation.
The late 90s internet bubble was a classic example of this hype, when any company that added a ‘.com’ to its name would experience a jump in its share price. Investors became more focused on individual companies’ apparent technological advances than on fundamentals, and as prices shot up forgot to ask themselves if the experience was too good to be true. They soon found, to their cost, that it was.
It’s also very easy for investors to get swept along in the hype – even if they hold doubts or concerns about a particular asset. This is because they see their peers appearing to make money and feel pressure to join in. But more often than not, investors should trust their instinct; if an asset appears too good to be true then they should resist the urge to follow the crowd.
Taking a step back and having a look at the basis for the asset’s valuation is important. Investors should ask themselves whether the valuation is truly reflected in the fundamentals, or if it is based on overly hopeful predictions of future growth. Pension Schemes are long term investors looking for sustainable long term returns. If that return can be achieved in 6 months what is the associated risk?
Fund managers are by no means immune to asset bubbles either and investors worried about overvaluation in a particular sector should take a great deal of care when making manager selections. They should look for fund managers that have weathered the storms and bubbles of the past and have a strong track record of delivering returns to their clients across market cycles.
There will of course be periods of underperformance, to be expected as no manager can outperform all the time, but the consequent explanation should reflect the manager’s style and process. Investors concerned about asset bubbles should also quiz their managers on how they handled previous instances – did they follow the herd or stick to their strategy?
Most importantly, investment decisions should be made on the basis of whether or not they help meet an overall set of goals, specific to the individual investor. Following the latest fashion, without reference to the overall portfolio’s goals, is a sure-fire way for investors to find themselves trapped in a bubble.
Euan MacLaren is head of UK/Ireland institutional business, Natixis Global Asset Management
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