As 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.
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.