New Zealand is somewhat unique in that fortune telling, unless for the purpose of entertainment, is illegal. Section 16 of the Summary Offences Act 1981, “acting as medium with intent to deceive”, was likely not intended for the finance industry, but one can draw some interesting parallels.

The law states that “every person is liable to a fine not exceeding $1,000 who, acting for reward, with intent to deceive, purports to act as a spiritualistic medium or to exercise any powers of telepathy or clairvoyance or other similar powers”. One could argue that there are numerous people on business TV and social media that should be fined for their “clairvoyance”. They proclaim to be able to accurately forecast the returns of markets over the next few months, the next year or even the next week. While some at least indirectly admit how laughable this pretence is – we fondly remember the “vomiting camel” pattern for gold price forecasting – others continue to make short term predictions with a straight face.

For us here at Makao Investments forecasting future returns is less about predicting the exact future and more about being prepared for a variety of scenarios that investors might face. We have some concept, from academic studies, of what scenarios are likely, and how different asset class will react, but we would never pretend to know with certainty which one will eventually play out (in line with our value of humility).

What we do need to make sure is that portfolios are structured in a way that allow investors to withstand different adverse scenarios. As an example, we believe that investors can improve diversification with offshore investments, thereby protecting themselves from a localised adverse shock to the New Zealand economy, such as an industry crippling biosecurity breach.

Similarly, we need to make sure that we do not neglect scenarios that benefit New Zealand, while the rest of the world is struggling. We have created a scenario of global warming, for example, in which New Zealand is a safe haven for investors – given it likely is better equipped to deal with a severe global freshwater shortage than other countries.

Designing these scenarios and using different market environments in our forecasts also allow us to free our modelling from the shackles of single correlation numbers (see for example Getting Carried Away for how this impacts our views on currency).

To bring this all to life we use a series of financial data sources and tools. Most notably, we make the most of Financial Canvas to predict thousands of scenarios for different market environments. This software not only captures historical return patterns; we also use the tool to add in our own predictive stress scenarios. Given the tool’s high degree of flexibility we are also able to model other scenarios that investors might be particularly concerned about, without giving up a stable and systematic forecast process.

We believe it’s important to put the effort into an asset allocation framework that helps with building resilient portfolios. The benefit of our asset allocation framework is access to distributional outcomes and other information that is often lost in more simplistic models with one “optimal” answer. “It is better to be roughly right than precisely wrong”, as John Maynard Keynes once said.

An illustrative example of our interactive output from Financial Canvas is below (click the image to explore the demo dashboard):

Investing should not feel like a coin flip. We want to increase the odds of having a resilient portfolio during numerous potential outcomes. In our opinion this is a better way of thinking about the future than listening to someone who pretends to have a crystal ball.

For those who are interested, a more detailed illustration of our asset allocation process can be found on our website.