In other words, asset allocation should be dictated by where the best risk/reward trade-off is likely to be found, not by some ideological or marketing-driven adherence to a specific “growth asset/defensive asset” split. Hussman suggests that “investors can get a good understanding of market history by examin- ing a great deal of data, or by living through a lot of market cycles and learning something along the way”. “Only investors who have done neither believe that current conditions are ‘uncharted territory’, he says. “Veterans like Warren Buffett and Jeremy Grantham have a good handle on both historical data, and on the concept that stocks are a claim to a very long-term stream of future cash flows.
They recognise that even wiping out a year or two of earnings does no major damage to the intrinsic value of companies with good balance sheets and strong competitive positions. “Most importantly, these guys never changed their standards of value even when other investors were bubbling and gurgling about a new era of pro- ductivity where knowledge-based companies would make the business cycle obsolete, and where profit margins would never mean-revert. “They knew to ignore the reckless optimism then, because they understood that stocks were claims on a very long-term stream of cash flows.
They know to ignore the paralysing fear now, because they still understand that stocks are a claim on a very long-term stream of cash flows.” Doyle says it’s counter-productive to spend too much time “trying to forecast what is largely un- knowable”, and that it’s better to “redirect our focus to allocating our clients’ capital to those assets likely to reward them most over an appropriate invest- ment timeframe”. “First and foremost it suggests we should discard the notion of a fixed strategic asset allocationtypically dominated by equities – in favour of a much more dynamic approach that concen- trates investor risk capital in those assets offering prospective returns aligned with the goals of the investor,” Doyle says.
“Consistent with this, it means we need to be contrarian in our approach. The time to be worried about risk assets was when [historical measured] volatility and implied market risk premium were low, like 18 months ago.” Matthew Drennan, director of investments for Zurich, says diversification and a focus on risks and returns will stand investors in good stead in years ahead. But “the first thing is to do a comprehensive risk profiling exercise with the client”, Drennan says. “They have advanced a long way in recent years,” he says.
“You can get a lot from putting various scenario questions to clients – what their real risk profile is, and what their tolerance for loss is. “The second part, clearly, is that financial plan- ners need to place some reliance on research house reports on various products to give them at least a fundamental understanding of what the risks and rewards of various products are. “But I don’t think that’s enough. Once they have gone through the initial screening process, they need then to really understand the product in a detailed fashion.
And I think that’s where some financial planners let themselves down, and let their clients down in the recent bull cycle. “Some clients were being put too heavily into products that really were not adequate diversifiers in terms of their portfolios. I think it’s still very im- portant to get back to basics and say that Investing 101 demands diversification in clients’ investment portfolios.” Drennan says some fund managers were guilty, too: “You had situations where some fund manag- ers were masquerading leverage as alpha – they would put together a product that produced a small amount of alpha and then by leveraging it four or five times they gave the illusion of creating significant alpha.”
It’s a challenging time to be defining and imple- menting investment strategies. Perpetual’s Damien Crowley says investors’ trust in the financial plan- ning community’s abilities has been shaken. Inves- tors’ natural move to safe havens (such as cash) and a very strong “home bias” in equities are two of the forces that planners need to effectively combat to keep long-term plans on track. Now, more than at any time in the recent past, is when investors need really good advice, Crowley says. And a foundation stone of that advice is “regular, honest communication”, he says.
“Certainly, the main [business] response I have seen so far is an increase in client communication and contact,” Crowley says. “It’s been quite hard for newer advisers who’ve bought into the business in the past three or four years. They may have borrowed money as part of a succession planning model, and now their income is down, but they still have to service those income costs.” Crowley says the industry can be divided into two very broad groups.
First, there’s those planners whose entire value proposition was based on presenting themselves as some kind of investment guru, who possessed rare insights into markets and asset classes. Those planners are doing it toughest, because by and large clients no longer believe what the plan- ners have to say. They have failed comprehensively to deliver on an investment performance-focused value proposition. But the second group includes those whose value proposition encompasses much broader issues, including education, strategic planning, and much less of a focus on predicting or promising particular investment outcomes. “They are travelling quite well,” Crowley says.
“It’s the ones who were not as clear about their value proposition, or who have positioned them- selves more as investment gurus, who are suffering a bit more.” Tim Farrelly says a refocusing on proper diversification and sound strategic asset allocation remain key. Now is the time that planners should be listening to clients’ concerns, but seeking to mitigate against clients’ natural tendency to want to see a low-returning so-called safe haven. “This is the question that everyone should have focused on last year,” Farrelly says.
