Now the bitcoin bubble’s burst, what’s the next big thing?

There goes bitcoin. The world’s most popular cryptocurrency has spent much of the past week in the grip of an old-fashioned crash.

Its value peaked just before Christmas at $19,434 per virtual coin. Last week, it plunged to more like $9,000. Down more than 50% in a month and many, many billions along the way.

Bitcoin isn’t the only one to have flipped. Other well-known cryptocurrencies, including  ripple, ethereum and litecoin, are having a torrid time too.

This will have come as absolutely no surprise to anyone with more than a decade of experience in any market. I have pointed out that the cryptocurrency boom has been about as obvious a speculative mania as markets have ever seen. I have noted over and over that a private crypto can’t ever be money for the simple reason that governments won’t allow it to be – this crash may have been triggered by talk of banning bitcoin trading in South Korea.

I have refused to accept the idea that cryptos are somehow like gold – money that isn’t government-sponsored, but is still universally accepted as a global store of value.

Gold has many thousands of years of history as money. It is approved by central banks (they all hold vast hoards of it). It has a genuinely limited supply (algorithms can be changed, a couple of billion years of geology cannot). And it has an intrinsic value (you can make stuff with it). Cryptocurrencies have none of these things.

But none of this means you shouldn’t be interested in the crypto boom, bubble and bust. Perhaps the world of money is changing and perhaps buying cryptos is a long-term way to build your wealth.

Maybe this seeming crash is a mere stumble on the road to total monetary domination. I doubt it. But those regular readers who keep lists of my mistakes might add this one in pencil just in case.

To outperform the market, you must own the best 4% of stocks

If you want to increase your long-term wealth faster than most other people, it is worth keeping a constant eye out for the next big thing.

An interesting reminder of this comes from a new paper from Hendrik Bessembinder of the WP Carey School of Business at Arizona State University. His conclusion is that most of the things we invest in aren’t worth the candle. By his calculations, 58% of stocks return less than one-month Treasury bills over their lifetimes and “the entire gain in the US stockmarket since 1926 is attributable to the best-performing 4% of listed stocks”. Outperforming the market as a whole is only possible if you hold those stocks.

For investors that can mean one of two things.

You can recognise that separating brilliant from overhyped is really hard – something bitcoin investors may be grasping this week as, until recently, making money in cryptos had looked pretty easy. In which case, you would probably go for the full diversification strategy of just buying a tracker fund. That way, you will get the overall performance without much stress or expense of fussing about finding the favoured 4%. It seems a good idea to do this with a good part of your cash.

The other possibility is to forget diversification completely and devote your life to finding the few investments that will be the world’s big winners – or hire someone else to be relentlessly investigative on your behalf. You will say that most fund managers purport to do exactly that, using their special stockpicking skills to seek out the best individual companies to hold for the very long term. But that isn’t really so.

Look at the average investment presentation (there are plenty in my office I can send you if you have none to hand). You will see a barrage of charts, yield curve discussions, sector comparisons and relative valuation metrics. You won’t find much in the way of original thinking, or discussion about what makes any particular company more innovative than others. Corporate longevity is also ignored (company lives are much shorter than they used to be – there is a lot of disruption out there).

Where to find the 4%

So where should you be looking for funds that might just have a chance of holding the modern equivalent of the 4%? There are some big funds that have a go, and we’ll come back to them another day. But bitcoin’s crash this week has coincided with the publication of the annual review of the Numis Smaller Companies Index. While jammed with the kind of charts and tables mentioned above, this reminds us yet again of the tendency of smaller companies to outperform.

Since 1955, the NSC index (which covers the bottom tenth of the UK stockmarket) has made a compound return of 15.2% a year – that is 3.4 percentage points a year more than the FTSE All-Share.

Put that in real money, and you can see the miracle of compounding in action. The total returns from one pound invested in 1955 would have been worth £7,209 by the end of 2017; one pound in the FTSE All Share would have been worth £1,095.

There are all sorts of reasons for this, and there is also room for caution in small-cap investing at the moment, as historical returns have been lower in times of rising interest rates. But it does hint that if you want to give your chosen stockpicker a good chance of success, letting him or her loose in the world of small-caps – with a brief that involves looking for a mix of innovation and longevity – has potential.

It is a tough call of course. But there are some funds that are worth looking at. The Independent Investment Trust (LSE: IIT) is mainly a small-cap fund and has some interesting-looking companies in it (albeit diluted by some housebuilders). Then there is Gervais Williams’ Miton Micro Cap Trust (LSE: MINI) (which I hold myself, and have written about before) and the Jupiter UK Smaller Companies Fund.

But a new entry for this column is the Amati Smaller Companies Fund. I suspect it would be a bit too diversified for Professor Bessembinder as it has 60 holdings. But it aims to invest in companies at the front end of innovation and technology and has a fine record of doing so (think top quartile performance over one, three, five and ten years). Additionally, it is small (£100m); reasonably priced (the management fee is 0.75%); and has no exposure to cryptocurrencies (yet).

• This article was first published in the Financial Times

  • AAJ

    Finding the goose that lays golden eggs. It’s a bit like the anti-pattern of modern investing. I.e. people should put money into a tracker, but of course then you only get market returns. The temptation of increased returns by betting on that new tech IPO, it’s just to damn alluring, I’m in.

    AAJ -clueless investor-

    • Bab Boon

      If you want a just past the IPO stage (but not tech) you might like to keep an eye on Keystone Law. It hit the AIM earlier this month and is yoyoing a fair bit but the trend seems to be up.

      (Epitaph for my punt on that stock probably).

  • Bab Boon

    Amati ain’t bad
    BUT
    Contrast the fund’s performance with:
    Blue Prism; Frontier Developments; IQE; Keywords Studios; Sophos ……
    (And for my money ‘coming soon’ ; Learning Technologies Group & Benchmark Holdingsx, maybe Wandisco & XLMedia too)

    I hadn’t heard of Bessembinder before – & thanks Merryn for highlighting that study – to my mind it makes sense.
    You ARE probably going to get the best return from a fairly concentrated, well considered narrow band of equities. The caveat being you’d be wise to keep a closer eye than most folk on the way things are developing.

    • AAJ

      “You ARE probably going to get the best return from a fairly concentrated, well considered narrow band of equities.”

      You are only likely to get a better return if the equities you pick do better than average. That is why your caveat may need a little attention. People need to know that this strategy will work, but the risk and volatility will be higher.

      As we head towards the top of the market, the possibility of making less over the medium term will grow. Personally, for my SIPP I am able to cope with say a 50% drop in equity prices for concentrated, small cap fund, compared to a possible 25% correction that may happen with a more diversified fund.

      The choice then becomes, are the possible returns worth the risk. Then you can pick your fund/trust.

      • Bab Boon

        At risk of digression AAJ – I’d use my ISA allowance fully before a SIPP.

        I realise you get tax relief at the outset on a SIPP, but as you then get normally taxed later – and absolutely HAMMERED for tax if you invest well and exceed the threshold (has that dropped to 1 or 1.1 million now, I forget) my thinking is bite the bullet now in return for tax free later.

        I’m not sure if there’s ‘one right answer’ that fits all comers.
        I suppose if you’re paying in modest amounts to a SIPP and unlikley to get much pension elsewhere to take you over the income tax threshold a SIPP could be best.
        But I suspect most folk in this forum aren’t in that position.

        Of course once you’ve already used your ISA allowance …..

  • John

    The author has very poor grammar skills, which makes this article hard to read. Author tried to use big words to sound intelligent, only to lose their audience attention span due to incorrect use and confusion. I gave up half way through article…

  • Carl Haynes

    I think it is a bit strong to say that the bitcoin bubble has burst……. It has certainly been significantly deflated, but, as you point out, this is absolutely no surprise to anyone with market experience. You will also know that not all governments are against it – as Japan has demonstrated.

  • Andrew Crow

    “In which case, you would probably go for the full diversification strategy of just buying a tracker fund.”

    It’s going to be interesting to see how well tracker funds track downwards. They are doing fine at present, but all the money going in, is going in to what we are frequently being told is overpriced stocks.

    Still hindsight will tell us at precisely which point we would have been better off cashing out. And that will be a great help in reaching the right decision next time. And knowledge is expensive to acquire, and takes a long time to repay as a generation of students will be able to testify.

    The markets will have to rise a long way further for today’s buying to still look good after a major correction.

    Meltup theory says that will happen. It’s not quite clear to me how a Meltup differs from a bubble. Except perhaps a Meltup is just bigger.

    Like the Hindenburg perhaps. With flames.

  • Apollocreed

    The last half of this article has just made the case for investing in Terry Smith’s Fundsmith. If you read his recent reports, he states that his strategy is all about owning the top companies in the world and worrying very little that their valuations are high.

    • AAJ

      It would be useful to know how the companies Terry’s fund holds did immediately following the last crash. His fund has done well over the past 5 years, maybe if it is also likely to do well following a correction then it may well be the best option for people worried about the next crash (but don’t know when that might be).