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Einstein’s theory of relativity and investing

Over a century ago, Einstein's general theory of relativity revolutionized our view of the universe. Just earlier this month, scientists uncovered the first direct evidence of gravitational waves, ripples in the fabric of space-time that Einstein predicted one hundred years ago.

Einstein’s theories tell us that time and space are not as constant as everyday life would suggest. Time can run faster or slower depending on how high you are and how fast you are travelling. Stand just one step higher on a staircase and you will age marginally faster, travel on a moving train and you will age more slowly than passengers on the platform. The outcome, according to Einstein, is relative.

But relativity can be unsatisfying when applied to finance. Investing in funds that measure success in relative terms can have drawbacks, for example, when indices turn negative. Relative performance, while important, doesn’t always deliver the desired outcome of a positive return.

Relativity can be unsatisfying when applied to finance.

So is there an alternative approach? Einstein’s theory gives us a clue. There is a measure that is the same no matter how high or how fast you are travelling and that is the speed of light. One could say that light-speed is real. Likewise, investors are increasingly demanding real rather than relative returns.

The trend towards real returns is partly fuelled by individuals gaining greater responsibility for their long-term savings. It makes sense that investors are looking for financial solutions that deliver outcomes relevant to their real-life goals rather than benchmarks.

As investors travel along their own unique financial journey, they are likely to be motivated by the need for one of three broad outcomes for their capital: preservation, growth or income. Rafts of products claim to deliver these outcomes but how best to separate the wheat from the chaff?

One of the best ways to maximize the risk/return trade-off and to smooth returns is to diversify, so choosing a fund that has diversification as a principle focus is important. Managers who allocate to a large number of asset classes, particularly in the alternatives space, are able to select assets that may have attractive return characteristics yet different return drivers. This means they should experience smaller drawdowns during times of stress and more consistent results.

Lastly, it is important to look for clear evidence that the investments are focused on the stated outcome and also make sure that the underlying investment process has the flexibility to uncover the specific opportunities that deliver the conservation, growth or income objectives. A proven capability in designing solutions and delivering outcome-oriented products that do what they are supposed to is therefore a prerequisite.

When it comes to investing, there is a true, not relative, north.

Important Information

Investments in non-traditional asset classes, may involve more risk than investments offered by other asset classes.

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