altAs the global financial crisis unfolds and financial planners question their assumptions about investment, the good news is that some things never change. Simon Hoyle reports.

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As 2009 grinds on, it feels as if the world  we knew has changed forever. We’re in  the teeth of an unprecedented economic malaise.  The only thing plunging faster than asset values  seems to be consumer confidence.  Retirees are wondering if their life savings are  going to last as long as they thought (and as long  as they need to), and those still saving for retirement are eyeing the future with a growing sense of  unease, adjusting their expectations of lifestyle in  retirement or knuckling down to work for a few  years longer.

The relationships between planners and clients  have been tested by the extent and the severity  of the global crisis and its impact on investment  markets. But amid the gloom and pessimism,  wrecked dreams and shattered plans, it’s the job of  the financial planner to guide clients out.  An analysis of this financial crisis shouldn’t be  limited to investment markets and clients, however.  The impact on the financial planning community  itself cannot be underestimated. Damian Crowley, head of adviser distribution at Pereptual, says many financial planners are  “severely rattled” by events.

“They are shell-shocked and fatigued,” Crowley  says. “Those are not too strong words to describe  this. Eighty-seven per cent of advisers back in May  ’07 felt that times were good, or very good, and  none felt that times were bad. By December 2008,  50 per cent believed that times were bad, which is  an amazing downturn.  “Unfortunately, advisers haven’t got a lot of  answers.”  And that’s not surprising – the events we’re  living through are unprecedented, and past experience is not necessarily of any comfort at the present  time. Crowley says that in adviser focus groups held  by the company, the shock is palpable.

Crowley says that one adviser told the focus  group: “I look at my qualification on the wall and  for me at the moment it’s the equivalent of someone  finishing a science degree, walking past a tree and  seeing an apple float off into space. Everything I  have been taught has gone out the window.”

However, the good news is that even though some things feel like they’ve changed forever, other  things simply haven’t changed at all. One of the  most valuable things a planner can do for clients in  the months and year ahead is refocus on two tried- and-tested investment principles: diversification,  and the related concepts of risk and reward.  The theme for investing in 2009 could be  described as back to the future.

Simon O’Grady, head of Tyndall’s global premia  division, says investors and their advisers largely  lost track of investment fundamentals during an  extended bull run. Most asset classes produced  positive returns, and there was no penalty for a lack  of diversification.  As a consequence, too many investors lost sight  of risk, and the absolutely critical importance of  making sure they were adequately rewarded for the  risks they were (sometimes unwittingly) exposed  to.

Far from being the case that diversification (at  an asset allocation level) is no longer an investor’s  ally, O’Grady says it’s critical that there be a sharp  refocusing on the benefits of both risk and diversification, and that planners employ both effectively.  In a recent investment update, O’Grady says  recent events in global investment markets have  “emphasised the importance of investors focusing  on risk premia as the basic building blocks of an  investment portfolio”.

“Asset classes are aggregates of several risk pre-  mia, and recent market turbulence has highlighted  that the mainstream asset classes of equities, credit  and property are all linked to the same risk factor:  corporate earnings. “This will come as a surprise to many investors  who erroneously viewed credit and property invest-  ments as diversifiers of equity risk.  “When an investor focuses on risk premia as  the portfolio building block it can deliver a number  of benefits.”  O’Grady says these include:

•            Making investors more risk aware, with a greater tendency to ask: “Where is this risk coming  from?”;

•            Making investors look far more  closely at risk premia, and to question whether the return  they are getting is appropriate for the risk they’re  taking;

•            Providing a framework  in which to evaluate the performance of all investments, and to  identify valuable risk premia that may be available  in non-traditional asset classes.

As a general rule, asset allocation is determined  by two things: an investor’s financial goals and their  current financial resources; and their ability to  tolerate financial risk.  It’s a financial planner’s job to use his or her nous to help the client achieve a financial goal using  the financial resources available to them.  That requires setting an appropriate long-term  asset allocation, using debt where appropriate,  using the correct investment structures, an element  of education to explain how everything is expected  to work, and last, but not least, a clear, unwavering  focus on the goal and the appropriate timeframe for  achieving it.

Asset allocation is partly driven by the goal,  therefore, and partly dictated by the investor’s toler-  ance for risk. Tolerance is defined in two parts: the  investor’s ability to physically withstand a financial  loss – that is, if the money disappeared tomorrow,  the impact it would actually have on their plans and  lifestyle; and their psychological ability to with-  stand a loss – if the value of a portfolio plummets,  whether it gives them sleepless nights or other  stress-related symptoms.

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