Time in the market or timing the market?

Timing is everything, or so we’re often told. But does this apply to investing? And if it does, just how good does an investor’s timing have to be?

To find out, we’ve analysed the importance of market timing for the sterling investment grade credit market with the help of long-term excess return data. Our conclusions broadly support the idea that timing is important up to a point, but that perfect timing may matter more for gymnasts and comedians than it does for investors. Another well-worn phrase is ‘time in the market beats timing the market’, and we find this is also significant.

The table above shows excess returns (the return a credit investor gets over and above the returns explained by interest-rate moves, or the ‘true’ return for credit) for subsequent three-month, one-year and three-year periods for an investor in sterling investment grade credit in various market states. We have divided the data into percentile ranges, from 0% (the most expensive point the market has reached) to 90% (the market has only been observed at a lower price 10% of the time). Red colours show negative returns and green colours show positive returns.

Unsurprisingly, the more expensive ends of the range, from zero to 30%, show the most red and orange numbers, telling us that the higher price you pay for an asset the less likely it is to gain in price from that point. Conversely, buying at the lower percentile ranges rewards you with the most green numbers. So far, so obvious, but the interesting part of the table to us is what happens in the middle. When prices are neither good nor bad and offering no strong signal to either sell or buy, what is an investor to do? The data in figure one offers a clear signal.

Froth at the top, dregs at bottom, but the middle excellent  

Voltaire’s description of English beer in 1786 may still hold true, but it also aptly describes the historic return of credit in the middle of the above range. By looking at the above table, we can see that simply by avoiding the most expensive 30% of the time to buy, investors have enjoyed positive returns in all market scenarios in the following 12 months, with just one historical exception in the 80^th percentile, where the drawn-out nature of the 2011/12 sovereign crisis meant investors had to wait more than a year to see positive returns.

And merely by avoiding the most expensive ‘zero’ percentile, investors have enjoyed positive excess returns from credit in all subsequent three-year periods. In fact, over three years (our preferred investment horizon) investors investing at the 30^th percentile do almost as well as investors at the 60^th percentile, and it isn’t until we get to the 70^th percentile and beyond that excess returns materially improve.

Timing isn’t everything – but it helps

As a result, we believe that (almost) any time is a good time to invest in credit is welcome, but some periods are clearly better than others. For long-term active investors, this is an age-old problem with an equally venerable solution. A fully invested active credit manager will vary their position sizes to reflect current valuations. Put simply, we aim to take the most risk when prices are lowest and the least when prices are high.

We believe being able to redeploy our clients’ capital toward ‘safer’ bonds when prices are high and buy more of the riskiest and highest-returning bonds when prices fall provides our active clients with the opportunity to enjoy both the benefits of time in the market while still having the ability to ‘time the market’ too.