If setting an asset allocation to achieve a finan- cial goal (and putting in place the right structures to do it efficiently) is the science of financial planning, then accommodating the psychological needs of the client is the art. Planners need to continue to take these elements into account when defining and imple- menting investment strategies, but Tim Farrelly, principal of investment consulting firm farrelly’s, says the course of action also depends on what situ- ation clients are currently in.
“There’s a large group of planners who have clients who are reasonably fully invested,” Farrelly says. “They face a different set of issues than the ad- visers who have clients who are reasonably cashed up. They are obviously very different issues. “My sense is that there are quite a few advis- ers who have cashed-up clients. They are making a whole lot more noise than they have for a while. But there’s far more who have planned it for the long term, whose clients are pretty fully invested, and they are hurting right now.”
Farrelly says the main issue facing cashed-up clients and their advisers is how and when to de- ploy liquid funds back into investment markets. He says that while there’s a possibility that markets will get worse before they get better, when they do get better they may do so very quickly. The dual risks, then, are committing capital to markets ahead of a decline, and not committing it quickly enough to benefit from a recovery, if and when it happens. The issues facing clients who have had a long- term strategy in place, and who have stuck to it, are quite different.
“Clients have been beaten up,” Farrelly says. “But I think the real problems are going to start to emerge in three to six months’ time. “It seems like whenever there’s a major dip in the markets, everyone assumes it’s going to come back quite quickly. “The market falling to 5000 points or so didn’t really burn people too much. That was my sense. But it seems that the next leg, when the market fell by another 30 per cent, that really hurt. “People getting their [investment] reports through now would be quite shocked by that.”
But Farrelly says it’s future reporting periods that are going to become “really, really challenging for people”. “Even if the market rebounds to 5000, which is a pretty healthy rebound from where we are, a lot of clients are still down a fair bit. I think at that point the penny will drop that there’s been some permanent damage done. That’s going to be a real challenge for people: even if things get better be- tween now and [say,] September, they’re not going to get better enough to make people happy. “That creates a massive communication issue.
“On top of that, all evidence is that the economy is sinking like a stone at the moment. Economically, things are going to become more and more dire. The credit crunch doesn’t seem to want to go away. And that means more and more firms will go to the wall. Newspapers are going to be full of bad news.” So that’s the double whammy facing financial planners, Farrelly says: Just as economic condi- tions reach a nadir, investors will twig that markets haven’t improved enough to restore their pre-global financial crisis (GFC) positions.
“That’s the tricky bit,” Farrelly says. “What should planners be communicating? “If you take a forward-looking estimate of what returns are going to look like over the long term… the outlook is extraordinarily attractive. “Things do get back to normal.” (Or, as the head of Australian equities at Schro- ders, Martin Conlon, puts it: “I do not think this will be the first time that we don’t have a recovery.”) But a new view is emerging on the issue of asset allocation. Simon Doyle, head of fixed income and multi-asset at Schroders, says the traditional fixed strategic allocation that’s occasionally modified, occasionally with a modest tactical tilt, may not serve investors well in future.
Doyle says the approach needs to be more flex- ible, to allow investors to align their portfolios with the assets that are most likely to produce adequate reward. He says the traditional approach of having a fairly rigid 60/40 or 70/30 (or whatever) split between “growth” and “defensive” assets may be outmoded. An approach more akin to an “absolute return” fund might be better, so that investors have the flexibility to withdraw from overly risky asset classes (defined as those unlikely to produce suf- ficient reward).
For example, a Schroders fund managed along exactly these lines currently allows the manager to have an exposure to equities of just 25 per cent, reflecting the manager’s view that now might not be the time to pile back in, and gives the manager flex- ibility to place investors’ capital elsewhere until the risk/reward trade-off appears sufficiently palatable. Doyle says the task for financial planners and investors to focus on in the months and years ahead is relatively straightforward.
He says it is neatly summed up by John Hussman, founder and principal of the US funds management group Hussman Funds, in an article entitled The Stock Market is Not in ‘Uncharted Ter- ritory’. “Our activity as investors is not to try to iden- tify tops and bottoms, it is to constantly align our exposure to risk in proportion to the return that we can expect from risk, given prevailing evidence,” Hussman says.
