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					Managing Alphen Money Asset Sensibly Management

The Alphen Angle is an electronic publication of Alphen Asset Management

26 November 2008

That which we know, we know That which we don’t know, we don’t know We know what we don’t know, so there we should not go So let us all go, where we know we should go If we don’t, where we’ll go, we don’t know
Recently we have written extensively on issues relating to the perils of trying to time the entry to or exit from the market, and today we’ll take another look at this strategy. When planning a strategy, it is important to evaluate what it is that you know as a fact, and what it is that you don’t know. There is a lot which we don’t know, and consciously appreciating the knowledge that there are things that you don’t know is sometimes very important as it keeps one humble. In the field of investing, humility can prevent mistakes brought on by our ignorance. If we ignore the fact that we don’t know things, and mistakenly assume that we do, we are setting ourselves up for an unpleasant encounter with hubris when our mistaken assumptions inevitably cause unpleasant, and avoidable, outcomes. So much for Philosophy 101, but what does this have to do with market timing? One thing we do not know is what the future holds. Tomorrow, next week, next month, next year – the only thing we do know about these times is that we don’t know what will happen on those days, or over the course of those periods. (Anyone remember September 11, 2001, for example?) The perils of trying to employ an investment strategy which incorporates an attempt to time the market can be demonstrated by looking back at history. The table below looks at the total return of the ALSI between 18 July 1997 and 25 November 2008. The blue line is the total return of the ALSI – the return profile which an investor would have achieved had they been invested in the index over the full period. The red line is the total return an investor would have achieved had they missed the 10 best days of performance of the index over that period, and the green line, the total return an investor would have achieved had they missed the 10 worst days of the period.
900 800 700 600 500 400 300 200 100 0
Jan 98 Jan 99 Jan 00 Jan 01 Jan 02 Jan 04 Jan 06 Jan 07 Jan 03 Jan 05 Jan 08 Jul 97 Jul 98 Jul 99 Jul 00 Jul 01 Jul 02 Jul 03 Jul 04 Jul 05 Jul 06 Jul 07 Jul 08

Mark Cliff

10 No. best days missed 10 No. worst days avoided

Managing Money Sensibly

All Share Index

ALSI (missing the best days)

ALSI (avoiding the worst days)

10.0%
Source: I-Net Bridge and Alphen Asset Management

4.6%

17.5%

26 November 2008 What we can see, clearly and unsurprisingly, is that missing the worst days would have resulted in a significant outperformance of the index (an annualized 7.5% difference), and missing the best days a significant underperformance (an annualized 5.4% difference). Many of our readers may assess the returns results shown above and draw the conclusion that market timing can thus improve returns. Our response is that assumption would be 100% accurate – assuming perfect foresight. It is clearly evident from our analysis that market timing can result in extreme performances relative to the index. Unfortunately, however, all available statistics globally proves over and over that even professional investors destroy value when attempting this timing approach. They seldom time well enough to avoid bad periods and capture good periods. So why then should you try it, if even the most experienced and highly-paid managers have been shown to fail at this strategy? As followers of a value investment strategy, we would submit that the constant contribution strategy does not mean that investors should always and everywhere be fully invested. As has been noted by prominent proponents of value investing in the past, there is nothing wrong with holding cash for a while until a bottom-up bargain emerges. Sitting ever longer on the sidelines, waiting for bottom-up bargains to get cheaper is what we warn against. A better (more humble) approach would be consistent investing over extended time periods. This strategy would incorporate the best of times and the worst of times, but ultimately gains from the fact that realistically priced markets rise over time.

Alphen Asset Management
is an authorised Financial services provider

ADRIAN CLAYTON MARK SEYMOUR GREG FLASH

SHAUN LE ROUX PHILIPP WÖRZ

NEELS VAN SCHAIK MARK CLIFF

If you have any queries regarding the above commentary please contact Mark Cliff on 021 799 8069 or 083 700 3600 or

PLEASE NOTE: While every effort has been made to ensure that the information contained herein is correct, Alphen Asset Management cannot be held responsible for any errors that may occur. The views of the contributors may not necessarily reflect the house view of Alphen Asset Management. Views and opinions expressed herein may change with market conditions and should not be used in isolation.

Alphen Asset Management is a subsidiary of PSG Fund Management Holdings (Pty) Limited


				
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